It is also important to add that conclusions of the report do not preclude the idea that government will “make money”.

For example, if the government gave AIG $40 billion and gets 10% and also gets its $40 billion back, that is completely consistent with the report.

All they’re saying is that the government could have earned more for its $40 billion if it had thought about it like a private investor.

“The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy,” Paulson said in his statement. “This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative — a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.”

You’ll notice that he clearly indicates that this plan will cost money. He did not sell this as a plan for taxpayers to maximize their return on the investments.

If you look at the stories written during the debate about the TARP, the overwhelming majority of stories were questioning how much the government would ultimately lose with the program. A few mentioned that in theory the government could make money on the investments, but I don’t think many seriously beleived that.

Now, people want to evaluate the plan as if they should have acted like a private hedge fund? If they had done that, they would have let the banks fail and then bought their assets at steep discounts. The whole point of the TARP was to stabilize the financial system by preventing those failures. They thought spending money this way would yield an overall net positive for taxpayers by keeping the economy going, not by generating a positive return on the investments.

All this report does is say that private capital would have lent @ 25%, therefore the DCF of the government’s cash-inflows are around $20 billion…therefore the government paid $40 billion for $20 billion.

That’s the level of analysis these experts did.

You’re right that the government should not have provided the money in the first place. This is the mercantilism against which Adam Smith fought so hard. Nor should the government have nationalized the bad banks. The banks should simply have been allowed to be run by a liquidator, a system that had been fine-tuned by the law over decades.

A more legitimate gripe might be that under a given set of assumptions, we can see that that the government paid more than private investors did. However, that is exactly what should be happening. The government’s motives for investing– namely, propping up financial institutions to either help them survive when liquidity is not available, or keeping them on life support to provide for an orderly wind-down– are different than those of private investors (who just want to make a profit). Could the government drive a harder bargain to try and earn greater returns? Sure. But the more aggressive the government is, the more they fail to achieve their original intent– to keep the financial system functioning.

At the end of the day, there is only one reason the government is investing in private institutions– because the decision has been made that the social and economic pain associated with letting the private sector run its course is greater than it needs to be, and that targetted investment by the government can help the country sidestep the awful consequences of a full-blown, uncontrolled delevereaging (25% unemployment, anyone?). So the proper context for evaluating the government’s investments is not “how much did we pay for these preferred shares”, but instead it is “is the return on our total investment, in terms of a reduced recession and less unemployement relative to what it might have been, worth what we paid for it?”

The rest of these headlines are not just political spin and misleading, but very probably dangerous. They draw the public’s attention away from what is really going on here.

When the government gave AIG billions of dollars, how can we judge the private value of such a transaction when no private investor was willing to invest? We cannot.

Can we assume that a private investor would have invested on exactly the same terms as the government? Surely not.

In that case, what is this report telling us that we do not already know? I respectfully suggest that this is political spin, designed to give a message that bankers are stealing from tax-payers.
(You inspired me to write a more extensive blog post about this. Check it out)

Ted,
Notes that Bernie Madoff also used foreign accountants