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US Mortgage Crisis and the Troubled Asset Relief Program

Owning a home is part of the world-famous, American Dream. With home ownership comes pride, a sense of community, responsibility, and unfortunately, a mortgage. In the early 2000s conditions where just right for American's to buy a home with the amazingly low mortgage interest rates. Families who couldn't afford a mortgage were approved for mortgages; even people with bad credit were qualifying as subprime borrowers (Pritchard, 2013).

Unfortunately, the American Dream came to a screeching halt and the mortgage crisis began. Eventually, home prices stopped going up; adjustable mortgage rates increased causing monthly payments to increase and the people who purchased more home than they could afford were left with no choice but to miss their mortgage payments. In addition to over lending, banks were experiencing the impact of fraud on the part of homebuyers and mortgage brokers, together creating the great mortgage crisis of 2007 and 2008. According to the Troubled Asset Relief Program (TARP) website, there are five million American home owners delinquent or in foreclosures. In efforts to reduce the mortgage crisis and avoid complete financial meltdown, President George W. Bush signed into law the Troubled Asset Relief Program (TARP) on October 3, 2008.&Understanding the Subprime Mortgage Crisis& As stated in the introduction, families were taking on mortgage loans far exceeding their affordability as well as many families taking advantage of the equity and taking out second and third mortgages. In a study investigating the cause of the great mortgage crisis, Demyanyk, U. and Van Hemert, O. (2008) depict descriptive statistics for the first-lien subprime loans according the Loan Performance database. Their study showed (p. 1854) that, "the annual number of originated loans increased by a factor of four between 2001 and 2006 and the average loan size almost doubled." In 2001 the total dollar amount originated was $57 billion and in $2006 it was $375 billion. They continue and explain that "In 2007, the wake of the subprime mortgage crisis, the dollar amount originated fell sharply to $69 billion, and was primarily originated in the first half of 2007" (p. 1854). As the mortgage crisis developed, people began defaulting on their loans and banks and investors began losing money. Banks were hesitant to lend each other money, they became weak, and were eventually led to failure. According to Investopedia (2013), "Global credit markets came to a near standstill in September 2008, as several major financial institutions, such as Lehman Brothers, Fannie Mae, Freddie Mac and American International Group, went under."

Other leading institutions such as Goldman Sachs and Morgan Stanley changed their charter to become commercial banks, attempting to stabilize their capital situation. The impact of the American mortgage crisis turned global into the largest financial crisis since the Great Depression.

Credit Default Swaps

Another ingredient to the great mortgage crisis was the increasingly high use of Credit Default Swaps (CDS). A CDS is a financial swap agreement between two parties that agrees the seller of the CDS will compensate the buyer in the event of a loan default. The buyer of the CDS makes payments to the seller and, in exchange, receives a payoff if the loan defaults (Wikipedia, 2013). Credit default swaps began in the early 1990s and by the time the financial crisis hit near the end of 2007, the outstanding CDS amount was $62.2 trillion. Many of these CDSs were international, with other countries buying them from the American banks. It became a gambling game, betting on who would default and who would not. This was a high risk for the American and International banking system. Carbough describes a credit risk as a financial risk that "refers to the probability that part or all of the interest or principal of a loan will not be repaid" (p.526).

At the peak of the financial crisis, banks were not taking risk in to consideration. Low interest rates were being offered and approved even with low credit scores and a higher credit risk.

Troubled Asset Relief Program

One component to address the subprime mortgage crisis was the signing of the Troubled Asset Relief Program (TARP.) TARP was first presented on Friday September 19, 2008 by then Treasury Secretary Henry Paulson. "The troubled assets relief program was designed to take bad mortgages off the books of financial institutions in America, and onto the books of the federal government" (Troubled Asset Relief Program website, 2013). The program allows the United States government to purchase assets and equity from financial institutions to strengthen their financial sector. TARP authorized the secretary of the treasury to purchase up to $700 billion in troubled assets from ailing financial institutions. Troubled assets as defined in the Troubled Asset Relief Program: Report on Transactions Through December 31, 2008 is:
(A) Residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was origination or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and
(B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress (Congressional Budget Office, 2009).

The original intention to restore confidence and liquidity to credit markets, by relieving banks of troubled assets shifted within weeks; instead of absorbing troubled assets, "it began using the funds to purchase equity stakes in failing banks, in order to prevent them from going under" (Funk & Wagnalls New World Encyclopedia).

Windfall for U.S. Banks

During the chaos and timing around the implementation of TARP, the Treasury Department under George W. Bush, issued a five-sentence notice, without gaining too much public attention. "Corporate tax lawyers quickly realized the enormous implications of the document: Administration officials had just given American banks a windfall of as much as $140 billion" Paley writes in the Washington Post (2008). In a very questionable and sneaky act, the Treasury Department had changed a 22 year-old tax code policy to provide backdoor aid to banks.

The change to Section 382 of the code, which originally limited a kind of tax shelter in corporate mergers, now seemed as a gift to large corporations. According the Washington Post Article by Paley (2008), " Section 382 of the tax code was created by Congress in 1986 to end what it considered an abuse of the tax system: companies sheltering their profits from taxation by acquiring shell companies whose only real value was the losses on their books. The firms would then use the acquired company's losses to offset their gains and avoid paying taxes." This change robbed American tax payers of $140 billion in tax revenue.

Changes to TARP

TARP has experienced several changes during its lifespan. The original $700 billion originally authorized was reduced to $475 billion due to the Dodd-Frank Wall Street Reform and Consumer Protection Act. According to Wilson, L. (2012), as of June 30, 2012, $416 billion of the allotted money was spent. Some of the larger committed amounts of money went to:

purchasing bank equity shares through the Capital Purchase Program, purchasing of preferred shares of American International Group, stock purchases of Citigroup and Bank of America, loans and capital stimulus to automakers, homeowner foreclosure assistance, and other like initiatives (Wilson, L. 2012). Many of TARP recipient banks including: JPMorgan Chase & Co., Morgan Stanley, American Express Co., Goldman Sachs Group Inc., U.S. Bancorp, Capital One Financial Corp., Bank of New York Mellon Corp., State Street Corp., BB&T Corp, Wells Fargo & Co. and Bank of America have repaid TARP money.

TARP Alternatives and Successes

An opposition to TARP is the idea that the government shouldn't have used tax payer dollars to bail out irresponsibly and that the relief program wasn't addressing the real problem. If the banks were partaking in high risk business moves, the banks should be held responsible for their actions. Instead, the banks were given money from taxpayer's dollars to fix what they voluntarily created. The money the government used for TARP could have been spent aiding what was working well for the economy and not supporting irresponsible behavior of large banks and corporations. Despite controversies, TARP has been seemingly successful for both the Bush and Obama Administration.