Going Viral: Why TARP, Like Herpes, is a "Gift" That Keeps on Giving

It's interesting how thoroughly Wall Street, abetted by our political class and the media, has eviscerated the idea of making big financial firms -- gasp! -- smaller.

Just look at the various hosannas to the Troubled Asset Relief Program following the program's official termination on Sunday. Stripped to their undies, arguments defending TARP come down to this:

It saved the global financial system from annihilation
Taxpayers might make money
Government works

Implicit in this calculus is that TARP's success increases the likelihood of future bailouts. Here's Daniel Indiviglio at TheAlantic.com:

Much to the dismay of free market-loving Americans, TARP actually worked incredibly well. Sure, it will still end up costing Americans something.

I agree TARP prevented total catastrophe. On the other hand, if the bailout worked so "incredibly well," why should it end up costing Americans anything? He goes on:

In fact, TARP worked so incredibly well that we probably haven't seen the last of it. Despite the best efforts by the summer's giant financial regulation bill to end bailouts, doing so is impossible. If the U.S. financial system manages to get itself into another mess in 10, 50, or even 100 years, then the government won't simply allow the industry to crumble and Americans to return to a state of nature. It will step in; it will have to.

Which is exactly the reason to conclude that TARP didn't work incredibly well. If it had, then future bailouts would be less, not more, likely, because financial regulators would've found a way to save the day without exacerbating moral hazard. Like a hereditary disease, TARP is passing down its causes -- and effects -- to future generations of taxpayers. This is financial genetics as destiny.

Will TARP eventually turn a profit? Be nice if it did. In some ways, though, who cares? We shouldn't be in the business of "investing" in massive government bailouts of any industry, no matter how lucrative the payout. Besides, as economist Ken Rogoff told the Congressional Oversight Panel, just because one bailout makes money is no guarantee that future ones will:

Ex-post accounting (how much did the government actually earn or lose after the fact) can yield an extremely misguided measure of the true cost of the bailout, especially as a guide to future policy responses. For example, had a major geopolitical crisis broken out while the banking system remained so fragile, the government guarantees might well have been called in on a large scale.

Indiviglio is on safer ground in saying we can expect more of the same. But the major reason to think the feds will rescue big financial firms in years to come isn't because bailouts are successful, but because this has been the pattern for well over a century, as the financial "panics" of 1869, 1893 and 1907 aptly demonstrate.

Here's the usual drill: After riding a surge of growth to fame and fortune, the Street's recurrent pathologies and loose government oversight eventually cause a crash. Economic mayhem, and the attendant political bloodletting, ensue. Rinse, lather and repeat.

But history isn't inevitability -- if it were, I would've stopped rooting for the Chicago Cubs years ago. After all, until FDR rewired the financial industry in 1934, it would've been a fair bet to assume that things would never change. But they did. And for roughly 60 years the U.S. banking system worked pretty well.

One reason why it eventually ran off the rails is the growing concentration of financial assets in this country. In 2000, the top five U.S. banks held 11 percent of all deposits; by 2008 that figure had grown to 37 percent, with financial services accounting for a dangerously large share of U.S. GDP. That growth capped three decades of deregulation, spawning vastly larger banks to lumber around breaking things.

It doesn't have to be that way. Forget globalization -- as numerous economists (not to mention Paul Volcker) have noted, over $100-$200 billion in assets banks contribute little to the general welfare. Nor does a trillion dollars or two ensure global competitiveness -- Citigroup (C), anyone? And as returns diminish for the economy at large, they multiply for bankers, which increases their political influence and opportunity to make mischief. On that score, regrettably, it's steady as she goes. Early on in the fight over financial reform, President Obama and lawmakers rejected proposals to break up big banks.

As for the notion that TARP proves that government can work, well, OK. But that was never really in doubt, even if several generations of Republicans -- and the odd Democratic president -- sought to tarnish the very idea of government. To celebrate TARP's success as a validation of government is to lend credence to, not rebut, a idea that is demonstrably absurd.

It goes without saying that downscaling the financial industry is no panacea (hey, what is?). But it just might put "too big to fail" firms on the endangered species list. At the very least, smaller banks mean smaller -- and perhaps even more incredibly successful -- bailouts.

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Alain Sherter

Alain Sherter covers business and economic affairs for CBSNews.com.

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