06 October 2011

Gillian Tett: America’s six key lessons for a ‘euro TARP’

But before investors get too excited, it is worth taking a hard look at what America did back in 2008 and 2009 that made TARP “work”. For, to my mind, there are at least six key points – five bad, and one good – which Europe needs to consider.

• Firstly, size matters. When Hank Paulson, then Treasury secretary, unveiled Tarp back in 2008, he told colleagues he was looking for a “bazooka” to stun the markets and turn sentiment around. At the time, $700 billion seemed big enough to work, since this number – crucially – outpaced market expectations. And while those expectations subsequently got inflated – and analysts started calling for, say, $1,000 billion – these doubts did not set in until later; and, crucially, after sentiment had turned.
• Secondly, co-ordination is crucial. One reason why Mr Paulson’s bazooka “stunned” the markets was that it was wielded by a single team – policy was being set by a close-knit group of Treasury and Fed officials. This mattered because in late 2008, investors had no stomach for delay or conflicting policy signals.
• Thirdly, excessive democracy does not always help. In the first stage of Tarp, politicians were involved. But later a tight team of bureaucrats took control and were able to fire the Tarp bazooka with speed, in a straight(ish) line.
• Fourth, plans need to be flexible. When Mr Paulson initially created Tarp, his team thought that the $700 billion would be used to buy bad assets from banks. However, they later decided to recapitalise the banks instead.
• Fifth, stress tests only work if they address the visible points of stress that the public and markets care about.

There is nobody obvious in Europe like Mr Paulson who can demand a bazooka and fire it with speed; except possibly Jean-Claude Trichet (and he is on his way out).

But if Europe can overcome that handicap, there is a sixth key point to remember. Back in 2008, it was widely assumed... that most of the $700 billion used in Tarp was permanently “spent”. But these days, Treasury officials reckon that less than $50 billion has really been lost. For once Tarp was deployed, and sentiment stabilised, then asset values rose, along with bank earnings, enabling much of that money to be repaid.

The good news, then, is that if a euro Tarp does emerge, that money might not be “lost” in the long term; or not if the earlier lessons about speed, coordination and flexibility are learnt. The bad news is that this remains a big “if”. No wonder the markets are worried.

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