What's ahead for the TARP?

Some news of late has given rise to what I would call nascent optimism about the end of the really bad part of the financial crisis. Some firms have even started to talk about returning TARP money.

Matt, over at TARP Results Blog is a bit optimistic about how close the end of the TARP program is. At the end of his post, though, he asks an important question:

Now that the top banks have been selected as "too big to fail", does this provide them with even more incentive for risky behavior?

The answer to this question is, in my opinion, absolutely critical in crafting the way forward. The most ingenious regulatory scheme will be absolutely worthless if, at the end of the day, it doesn't matter how bad it gets, these firms will always get bailed out. If that is the case, you may as well not even bother developing any rules. Just let these guys run amok and give them Geithner and Bernanke's home phone numbers. That way when all of their bets have gone bad and all the counterparties have deserted them, they can call these guys at home like a teenager calling his dad at 2am to tell him he wrecked the car.

No, we can't do that you say. We can't just give them a blank check. Don't make it blank then. Give them some limit that we are willing to pay. $500billion? $1 trillion? $2 trillion? Just tell them we will bail them out up to that number. After that, they are on their own. That's your regulatory scheme.

Not that I think we should go the, "whatever doesn't kill you only makes you stronger" route, but there is no way our business or, perhaps more importantly, our political leaders have been sufficiently chastened by these events to insure that this type of thing never happens again. No doubt this recession will not have a soft landing, but if we even get a U-shaped one it will look great compared to the dire predictions of not that long ago.

If a recovery of even modest proportions does take place soon, I don't believe for a second that we will get at, or anywhere near, the root of the recent crisis.

But don't take my word for it. Here is Martin Wolf of the Financial Times:

Bankruptcy – and so losses for unsecured creditors – must be a part of any durable solution. Without that change, the resolution of this crisis can only be the harbinger of the next.

So if the TARP avoids collapse of firms now, but prevents meaningful and necessary reforms from taking place and we end up in another crisis similar or worse to the current one, will the TARP be judged a success? Undoubtedly, no.