How TARP Doomed the Democrats

They helped save the economy, yet the bank bailouts were politically ruinous.

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Save the economy, and get voted out of office. How does that happen?

Here's how: In the midst of a severe financial crisis, orchestrate a rescue plan that's too complex for ordinary people to understand. Explain it poorly. Overpromise results. Ignore the politics of it. Make fairy-tale assumptions about prolonged bipartisanship. Most importantly, forget to toss some swag to the little guy.

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As the Troubled Asset Relief Program officially expires, it's looking more and more like an economic success. For starters, it accomplished exactly what it was supposed to, stabilizing the financial system and preventing a depression. Banks are getting healthy again, big companies can borrow normally, and lending to consumers and small businesses is gradually improving.

TARP is also looking like a prudent use of taxpayer dollars, believe it or not. The original $700 billion price tag produced gasps when Congress passed the legislation in 2008, but most of the banks that got TARP money have paid it back, with interest. The latest estimates show that the program may only cost $50 billion or so, when it's all tallied. That's less than the cost of a lot of other recession-related measures—such as a series of extensions for unemployment insurance—that have generally been uncontroversial. If AIG, General Motors, and Chrysler are ever able to pay back their loans in full, TARP may even turn a profit for the government.

All of that has helped minimize the pain of a deep recession and keep unemployment lower than it would have been otherwise. Yet TARP has become such a reviled government program that politicians who voted for it dare not speak its name. TARP was truly bipartisan—begun during the Bush administration, and continued under President Obama. Yet it's now a wedge between the parties, with Republicans using TARP as one of the primary exhibits in their case against the Obama administration's economic policies. It may work: By most projections, Republicans seem poised for major gains in the November midterms, and the primary reason is dissatisfaction over the government's handling of the economy.

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Unfortunately for Democrats, it's virtually impossible to make a populist case for TARP's success. The first problem is that TARP's architects failed to anticipate the terrible optics of extravagant bonuses at bailed-out banks. In its early days, TARP morphed from one thing to another, but credit (or blame) for the final plan goes to President Bush's Treasury Secretary, Henry Paulson, who finally settled on the idea of injecting huge amounts of government capital into the banks as a sign that Washington would do whatever necessary to calm the financial markets. It was a bold and effective move. But while making those early deals with dozens of banks, Treasury didn't think about regulating pay at firms that were suddenly receiving taxpayer funds. Paulson and his team knew that most of the banks would pay back the money in short order, once things calmed down. And in the scheme of things, even multimillion-dollar bonuses were not relevant in a huge economy spiraling toward a depression.

But politically, those bonuses were explosive, and the Bush administration, by failing to rein in pay as a condition of the TARP bailouts, left a time bomb that exploded in the Democrats' lap in early 2009. That's when news broke about huge bonuses at Merrill Lynch, AIG, and other firms that would have gone bust without government intervention. Since there were no "clawback" provisions in the bailout term sheets, there was little the now-in-charge Democrats could do except hold hearings and fulminate.

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Ironies abound. Deeper involvement by politicians who usually gum up the process might have prevented these abuses. Paulson famously sought the autonomy to invest vast sums of money provided by Congress as the Treasury Department saw fit, with minimal oversight. That was meant to prevent politicians from steering money toward favored constituents. But members of Congress like Barney Frank and Chris Dodd may very well have had better political antennae than Paulson & Co., and been able to foresee the bonus problem.

Right on the heels of the appalling bonuses came the "backdoor bailouts" for Goldman Sachs, Merrill Lynch, and 14 other big banks via the AIG rescue. Technically, AIG got government aid partly through TARP and partly through separate actions by the Federal Reserve. But to voters it was all starting to sound the same—preferential treatment for the rich bankers who caused the whole problem in the first place. Subsequent investigations revealed that the Fed and the Treasury faced no good choices with AIG, mainly because there was no set procedure for dealing with such a catastrophe. They made it up as they went along, and generally defaulted toward pumping money into the system instead of forcing more losses on the already shaky banks. But the government clearly could have insisted on tougher terms for Goldman and the other AIG creditors, delaying the payback until the worst danger had passed. Again, the financial maneuvers made sense, but politically, the rescuers were tone-deaf.

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The TARP bailouts were also supposed to help the little guy. Really. As the banks got healthier, in theory, they'd resume normal lending so people could continue to buy cars, homes, and all the other things that make them feel good. At the same time, however, regulators clamped down on the banks so they'd stop making the kinds of irresponsible loans that got them into trouble in the first place. A prolonged spike in foreclosures was inevitable, as the housing bust and recession intensified. A variety of government aid programs was supposed to help, but Washington still hasn't figured out an effective foreclosures-mitigation program. Once more, nobody foresaw the political blowback coming as the same banks that got rescued by the government booted millions of Americans out of their homes.

Had the Democrats devised something they could characterize as bailouts for voters, it might have counteracted growing skepticism about TARP and related rescue programs. In fact, they tried. The big stimulus bill that passed in February 2009 contained modest middle-class tax cuts, and there have been half a dozen extensions of unemployment insurance that put money into the hands of the most needy. Obama even sent Social Security recipients a $250 check to make up for a missing cost-of-living adjustment, since inflation was so low. But the Democrats cast their lot with the huge macro stimulus bill, and did a poor job advertising their more blatant giveaways.

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The Democrats' flubs over the stimulus bill are well known by now. When it passed, most forecasters failed to foresee how deep the recession would be and how many jobs would be lost. Obama's economic team made rosy projections about how the stimulus would save the economy that haven't come close to reality. The stimulus helped avert a steeper downturn, but "It Could Have Been Worse" isn't much of a campaign slogan. So the Democrats have a lot of explaining to do, and not one of them has yet come up with a convincing campaign-style sound bite that exalts Obama's policies.

Had they prevented the bonuses, exacted tougher terms on the richest banks, paid more attention to jobs, and been more realistic about the stimulus, Democrats might now be able to point to TARP as a shining success. Instead they're running from it, and they probably can't run fast enough. TARP might have saved the economy, but it can't save the Democrats.