Authors: Adam Smith
This can be viewed as an instance of successful profit seeking by recipients converted to successful extraction by other far less visible parties. Suppliers, business partners, and large investors could all benefit indirectly from the continued solvency and liquidity provided to weak firms by TARP. Direct benefits to these Bootleggers in the form of transfers then became possible, because the TARP recipients were able to maintain payment schedules to their creditors and even generate new contracts with those Bootleggers indirectly favored by the much-celebrated political action.
As Verret demonstrates, the TARP mechanism created a complex arrangement with elements of pork generation, pork extraction, and indirect transfers all embedded within it. Consider, for example, the inclusion of special legislative language tailored to support the bank OneUnited, a constituent of the powerful Rep. Barney Frank (D-MA), then chair of the House Financial Services Committee.
Paletta and Enrich (2009) report:
Rep. Frank was intimately involved in crafting the legislation that created the $700 billion financial-system rescue plan. Mr. Frank says that in order to protect OneUnited bank, he inserted into the bill a provision to give special consideration to banks that had less than $1 billion of assets, had been well-capitalized as of June 30, served low- and moderate-income areas, and had taken a capital hit in the federal seizure of Fannie Mae and Freddie Mac. “I did feel that it was important to frankly try and save them since it was federal action that put them into the dumper,” Mr. Frank says.
By serving as handmaidens to local companies, lawmakers gained political advantage from an otherwise unpopular program.
Following this initial disbursement, applications for TARP funds grew at a rapid pace. Just two months after the initial disbursement, 206 additional banks had received subsidies under TARP’s Capital Purchase Program (Treasury Department 2009). In addition, the Treasury Department designed a new program for the sole purpose of accommodating the failing insurance giant AIG. This new program, called Systemically Significant Failing Institutions, allowed Treasury to consolidate previous obligations to AIG under the TARP initiative.
AIG, the world’s largest insurance company, invested heavily in mortgage-backed securities and was the leading writer of the credit default swaps that protected subprime mortgage investors from default losses. AIG’s operating losses rendered it technically bankrupt, but with financial linkages that reached across the entire financial community, AIG was viewed as too big to fail.
As a result, the federal government had become increasingly entangled with AIG even before TARP was established. The Federal Reserve Bank of New York had authorized a two-year loan of up to $85 billion for AIG to draw upon following the collapse of Lehman Brothers and the dramatic fall in the value of AIG shares on September 16, 2008 (Federal Reserve 2008a). An additional loan of $37.5 billion was extended on October 8 (Federal Reserve 2008b). On November 10, the Treasury Department assumed some of the financial burden by issuing a $40 billion subsidy through the TARP to purchase senior preferred stock. This allowed the Federal Reserve Bank of New York to reduce its previous allocation of $85 billion to $60 billion.
In exchange for this subsidy, the Treasury Department (2008b) stipulated the following:
Under the agreement AIG must be in compliance with the executive compensation and corporate governance requirements of Section 111 of the Emergency Economic Stabilization Act. AIG must comply with the most stringent limitations on executive compensation for its top five senior executive officers as required under the Emergency Economic Stabilization Act. Treasury is also requiring golden parachute limitations and a freeze on the size of the annual bonus pool for the top 70 company executives. Additionally, AIG must continue to maintain and enforce newly adopted restrictions put in place by the new management on corporate expenses and lobbying as well as corporate governance requirements, including formation of a risk management committee under the board of directors.
AIG thus had even more stipulations than other companies participating in TARP, given its special circumstances and previous financial assistance from the Federal Reserve Bank of New York.
Yet the public was split on whether AIG should be bailed out at all, with a Gallup poll showing 40 percent in favor of the rescue and 42 percent opposed (see Jacobe 2008). This lack of popular support further constrained the level of subsidy the Treasury Department could provide. Any bailout would need to come with hard constraints on what could be done with public dollars. In this sense, officials acted to tailor the TARP mechanism to individual cases when warranted, such as with AIG.
Using the disbursement of funds to AIG as a blueprint, three of the largest national insurance companies took steps to qualify themselves for TARP money. Lincoln National, Hartford Financial Services Group, and Genworth Financial each acquired federally regulated financial institutions to make themselves eligible for TARP. Whereas Genworth was unable to secure TARP funding, Lincoln and Hartford both announced their preliminary approval for the disbursal of TARP funds on May 14, 2009 (McGee and Frye 2009). Many other companies, such as CIT Group Inc., GMAC, and IB Finance Holding Company LLC, also repositioned themselves to qualify for TARP loans and take advantage of this new pork-generating mechanism.
Perhaps the most glaring example of the growing Bootlegger contingent came when General Motors, Chrysler, and Ford appealed to Congress for TARP funding. In testimony before Congress, the three CEOs of these firms argued that their companies were being driven to insolvency by the combination of a weak economy, constrained credit institutions, and the legacy costs of health care and retirement benefits promised to United Auto Workers union members. GM and Chrysler were on the ropes. They asked for $25 billion in TARP money (Vlasic and Herszenhorn 2008). Ford Motor Company, on the other hand, was in better financial condition and asked for a line of credit, rather than a direct injection of TARP money.
Though this initial request was rebuffed, President George W. Bush broadened the domain of the TARP through an executive order to include essentially any program he personally deemed necessary to avert the financial crisis. This stunning power grab was used to distribute funds to the ailing automotive industry: $9.4 billion to General Motors and $4 billion to Chrysler.
The United Auto Workers stood to gain a significant amount from the auto bailout as well. As law professor Todd Zywicki (2008) explains, the alternative of bankruptcy would have forced unions to “take further pay cuts, reduce their gold-plated health and retirement benefits, and overcome their cumbersome union work rules.” These ancillary benefits to blue-collar workers threatened with the loss of promised pensions might have introduced a much-needed Baptist element to the mix. If support for unions could increase popular support for TARP subsidies, then public officials and Bootleggers alike could rest a bit easier.
Yet in a Gallup poll taken in December 2008, respondents were critical not only of automotive executives but of labor unions as well, with 34 percent stating “labor unions that represent many U.S. auto workers” deserved a “great deal of blame” (Newport 2008b). Another poll taken just nine months after the bailout exposed waning sympathy for the plight of unions: more than 50 percent of respondents claimed that unions did more harm than good, particularly toward nonunion workers (Saad 2009b). Hence, not only did unions fail to generate increased demand for TARP disbursements, they may have also damaged their wider Baptist image as a consequence. The bottom line is that as Baptists, unions fared poorly.
In most cases, recipients of TARP funds had some link to financial markets and investment in subprime mortgages, no matter how indirect. In other cases, the primary goal was to counter rising unemployment and regional decline, whether or not related to subprime debt. Although these factors had little to do with the financial crisis, they did resonate more strongly with the electorate and paved the way for lawmakers to consider subsidizing them using the TARP mechanism, regardless of the break with TARP’s original objectives. Hearing the ring of the dinner bell, hungry Bootleggers began to arrive by the dozens.
TARP Runs Aground
Though recipients were initially pleased with their TARP funds, dark clouds of discontent soon loomed on the horizon. On January 15, 2009, just days before President Obama took office, Gallup reported that a majority of Americans (62 percent) believed Congress should block President Obama’s expected request to release the second half of the TARP monies ($350 billion) until more details were provided about how it would be spent. The rationally ignorant had become at least a bit more informed and were increasingly wary of bailing out Bootleggers. Only 20 percent of Americans felt that the money should be released without further conditions, and 12 percent said it should be blocked entirely (Newport 2009b).
On February 17, 2009, perhaps fearful of this increasingly irate electorate, President Obama signed into law a broad stimulus package, enacted under the American Recovery and Reinvestment Act of 2009. The legislation was nominally geared toward reducing unemployment rates and halting economic decline, but an additional provision in the act imposed greater restrictions on executive compensation for firms under TARP. The law further detailed how firms could exit TARP through buyback of preferred shares that had been sold to the Treasury Department, facilitating early departure for some firms, as we detail below. At least with respect to TARP, these restrictions were meant to further buttress the constraints on pork seeking, forcing companies to use taxpayer dollars in ways that would incur lower political costs.
Despite the greater attention to executive compensation practices generated by the Emergency Economic Stabilization Act, in mid-March 2009 AIG announced it would be handing out $165 million in bonuses to its top executives. A media firestorm ensued. Polls indicated strong disapproval of both AIG and the lawmakers involved in the bailout negotiations. A Gallup poll indicated that 55 percent of those polled described themselves as “outraged” by the bonuses, with 76 percent indicating they wanted the government to block them and recover those that had been issued (Morales 2009). A follow-up Gallup poll found that whereas participants were dissatisfied with Congress (65 percent); Treasury Secretary Timothy Geithner (54 percent), who had succeeded Paulson; and President Obama (39 percent), the greatest resentment was aimed at AIG itself, with 80 percent of those polled reporting dissatisfaction (see J. Jones 2009).
This result shows the danger for not only the political broker but also the Bootlegger when pork barreling draws public ire. AIG was contractually obligated to pay the bonuses, even before the financial crisis had hit its peak. Still, the use of taxpayer dollars to enrich those whose apparent blunders drove the financial turmoil was quite simply too much for voters and their political representatives.
This “populist outrage”—the reaction of an electorate now more rationally informed—spurred political actors to punish AIG along with other market enterprises connected to TARP, an acknowledgment that a greater supply of pork had been distributed than was politically palatable. As Phillips (2009) reports, Rep. Barney Frank admitted, “Clearly not enough was done in the beginning to put conditions on A.I.G.” The AIG controversy had shown that the original TARP mandate would not rest within the constraints that public officials so desperately hoped would confine it—constraints that had been forced upon lawmakers by the absence of credible Baptist support. Instead, the affected firms would use funds for politically unpalatable practices such as paying executive bonuses.
Accordingly, officials were forced to reduce the level of subsidies in response to voter outrage. These reductions manifested themselves in several ways, including a direct tax on bonuses, the establishment of a Special Master for Executive Compensation, and a proposed special tax to recoup TARP losses assessed to companies that had already paid back TARP monies. We briefly summarize each of these efforts.
Taxation on Bonuses, the Rise of the Pay Czar
Lawmakers immediately reacted to the news of AIG’s lavish bonuses by vilifying the company’s actions. In one of the more widely covered and representative responses, President Obama voiced strong opposition:
Under these circumstances, it’s hard to understand how derivative traders at A.I.G. warranted any bonuses, much less $165 million in extra pay. How do they justify this outrage to the taxpayers who are keeping the company afloat? In the last six months, A.I.G. has received substantial sums from the U.S. Treasury. I’ve asked Secretary Geithner to use that leverage and pursue every legal avenue to block these bonuses and make the American taxpayers whole. (
New York Times
2009)
On March 19, 2009, the House passed a bill specifically tailored to the AIG incident, which levied a 90 percent tax on all bonuses received by employees making more than $250,000 if they were currently employed by companies receiving more than $5 billion in TARP monies (Hulse and Herszenhorn 2009).
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The Senate version reduced this tax to 70 percent. By taxing the bulk of these bonuses, Congress was attempting to reel back in previously distributed pork.
For some, however, the damage had already been done. Sen. Chris Dodd (D-CT), the lawmaker held responsible for the inclusion of the exemption for bonuses in the executive payments clause of the TARP bill, came under heavy fire from the electorate. Despite his contention that he had tried to prevent the exemption language from entering the bill—only to be warded off by Secretary of the Treasury Geithner and White House officials—the controversy so damaged Dodd’s reputation that he opted not to seek reelection following the end of his term (Solomon and Maremont 2009). The more immediate result of the threatened tax was the voluntary return of bonuses by most executives—and a withdrawal of top talent from many of the TARP-subsidized firms.