Why TARP Doesn’t Work

Beginning in mid 2007 financial companies in the US started taking write-downs of assets. When this happens money is lost from the economy and all money still in existence gains in value. When money gains in value certain things happen. Those things are:

1) Consumers slow their spending. People will always spend less when money gains in value.

2) Asset prices will decline. As money gains in value assets must decline in value.

3) Prices must fall. As money gains in value prices must fall to reflect that gain.

4) Unemployment will rise. As people slow spending businesses must cut back as sales slow.

5) Borrowing will decline. Borrowing money that has gained in value is never a good idea.

6) Overall economic growth will decline to reflect all of the above.

The TARP program has never really addressed these issues and I will explain why in a minute. The TARP program was passed by Congress and authorized the Treasury Department to borrow up to $750 billion dollars to purchase troubled assets and for other purposes. And in that sentence is the reason why the TARP program does not address the fundamental issue facing the US Economy.

Borrow the money. The Treasury Department cannot simply create this $750 billion dollars it has to borrow the money. That means when the Treasury does its auctions to raise the money someone is always on the other end of that transaction loaning the Treasury Department the money. No new money is being created by these transactions. Hence the TARP program does not replace the amount of money lost to the economy from all the write-downs. All the TARP does is really move money around the economy as the Treasury Department decides to use it. TARP creates no new money to replace the lost money.

In order for the TARP program to work it would have to have created new money to replace the lost money. If the lost money is replaced then all money in existence stops gaining in value and consumers will go back to spending money at normal levels, prices will stop falling, asset prices will stop declining, unemployment will stop rising, demand for borrowed money will return and economic growth will once again turn positive.

The TARP program is a bold plan but it’s a misguided plan because it does not address the real problem facing the US economy which is the loss of money from all the write-downs which caused money to gain in value and that has drastically altered what people in America do with their money.