TARP: It Really Is All About Confidence

Give Henry Paulson some credit for an impressive slight of hand: On his watch, the government set up a massive bailout plan, and without spending a dime of those funds for their stated purpose managed to convince lending markets to calm down (at least for now. Track regular updates at Calculated Risk).

Treasury Secretary Paulson's announcement today that the government won't use its $700 billion Trouble Asset Relief Program to do the very thing its name implies (buy up troubled assets) should still prompt some minor disgust among those admittedly few investors who believed the government had a secure handle on the problem. Instead, the evolving nature of the plan is now just acquiescence to earlier proposals heavy on direct investment in troubled institutions. As Paulson put it, “I will never apologize for changing an approach or strategy when the facts change."

Some reactions:

Andrew Ross Sorkin:

Remember what John Maynard Keynes, the British economist, famously said when he was accused of flip-flopping on his views about government intervention in the markets during the Great Depression: “When the facts change, I change my mind. What do you do, sir?”

Most politicians would have gripped tightly to their original plan for fear that acknowledging failure would be even worse.

Sure, it is tempting to say “I told you so.” At the time of the original proposal, critics were already suggesting alternatives, including the one he is adopting now.

Given how quickly the initial plan was drafted and passed, it was always going to have holes in it. And it did. It is now clear that the plan isn’t working nearly as fast as advertised.

But I would argue the plan is working — it’s just that the government failed at managing expectations. The bailout was aimed at keeping the patient from dying; not rehabilitating it.

Greg Mankiw, who has the right to smirk a bit since he backed direct investments early on, says this: Good idea.

In the end, adjusting the TARP on the fly is probably fine, and will probably happen again. More varied direct investment will help shore up the financial system as well as the economy, and the risks -- moral hazard, rising deficits -- are still the same and depend on whether or not the government can turn off its largesse when the time comes. As for today, take a moment to marvel at the government's ability to convince the market that everything is under control, even when no one is really sure it actually is.