TARP: Savior or Demise of the Economy? - Ethical Considerations
May 25, 2009
The Troubled Asset Relief Program is currently the cornerstone of President Obama's campaign to revive the troubled American economy. As most economists will agree, deflating housing prices not only preempted the current financial crisis, but continue to be an impediment out of it. The Troubled Asset Relief Program is designed to protect the values of homeowner's property. On the surface it has very noble intentions, but as with many complex business and social programs, it is not unanimous in benefiting all, and ethical concerns lay among many.
The underlying goal of the Troubled Asset Relief Program is to halt the decline in home values across the country. Many homeowners borrowed sufficient percentages of their home value, if not one hundred percent of it, in order to pay for them. Since values have declined in late 2006, many homeowners are now "upside down" on their homes, meaning that they owe more to the mortgagee of the property than the property is actually worth. The problem is that when banks issue loans on these homes they expect to be compensated for the amount of the money they loaned the borrower plus interest. To complicate matters further, many of these loans disbursed were adjustable rate, that is, their interest rate and payment were fixed for a certain number of years then adjusted upward. As these payments increased, many homeowners were not able to afford the new payments. They were counting on the idea promoted by many that home values would continue to increase and they would be able to refinance their mortgage into a fixed rate loan, or at worst case sell the house before the payment adjusted.
The problem arose, however, when values of these properties declined. Because the banks use the home as collateral for their loan, the majority of them were unwilling to refinance into a new loan on a property that did not provide adequate collateral value for the amount of the loan. Borrowers then resorted to attempting to sell the property, which they soon found they were unable to do at the same price they purchased the home for. Because the lender's interest is to at minimum recover the amount of the loan they distributed, homeowners were unable to sell their homes for less than they purchased them for, even if they wanted to.
This created a downward spiral in which more and more homes were being sold on foreclosure. Because foreclosure properties sell at a significant discount to identical properties not being foreclosed, buyers had little incentive to purchase homes listed for sale traditionally. This pressure of traditional homes to compete with foreclosures for buyers caused them to further lower their prices. This downward spiral has affected much more than the balance sheet of property owners. Because loans continued to be defaulted on, many lenders and their stockholders lost considerable amount of money. As many of these financial institutions went under from inadequate cash flow, employees lost their jobs, retail spending was curtailed, requiring less need for retail employees and resulting in their subsequent layoff. As one can see the issue soon spread throughout virtually all layers of the economy and has affected global markets worldwide.
Obama's initiative under the TARP program is to halt the decline in home values in an attempt to stabilize the economy. This effort has been championed under the Troubled Asset Relief Program. Under this program, troubled loans on the books of many banks were to be bought at their original value by the federal government, which would be paying above current market prices. Distressed homeowners would then be able to maintain their homes without having the variable rate adjustments previously designed to take effect. The other part of the program is that the government will insure banks to compensate for the lack of equity present on many homes. The homeowner would pay a premium for homeowners insurance, which is not a new concept, and if the loan were to default, the government would compensate the bank for the amount of loss inherent in foreclosing on a home that is undervalued in relation to the loan.
On the surface the program appears to be ethically sound in its attempt to solve the current market crisis. It is alleviating troubled homeowners and banks from distress to stabilize the market though. There are two primary parties, however, that do not benefit initially from the program. The first is the American taxpayer. Because government funds are being used to solve this crisis, the money is essentially coming from American taxpayer dollars. Many individuals feel that they should not be responsible for paying to help out homeowners who took on too much risk in purchasing their home. Is it ethical to be using funds collected from society as a whole to help out a certain group of individuals?
The other party that may be seen as losing out on this program are the many responsible homeowners who educated themselves to the risks of home ownership before purchasing a home and took responsibility in buying moderately sized homes. Many of these homeowners feel that it is unfair to help out families who were so reckless and extravagant in their home purchasing, and the responsible home owners are now stuck with moderate homes which they have had to pay responsibly before. Many see this as unethical to provide assistance to the families that did not demonstrate responsibility, while ignoring the families that did abide by the rules of responsibility and moderation.
To determine the validity of ethical decision making in passing this bill, one must first determine how they define their personal ethical system. If one is using the method of Communitarianism, I would see little argument that although we are helping out a select group of individuals, the long term effect to the community is a positive benefit. As demonstrated earlier, defeating the downward spiral of home prices will flow to many other sectors of the economy, providing a net gain in employment and services. In addition, although homeowners who were responsible in their property investment are not receiving direct benefit from this program, they are entitled to refinance their homes now should they choose to do so, which they may not have been able to before.
A deeper ethical concern, however, is determining exactly what kind of message this sends to the American and global economy and how it will influence behavior. The Savings & Loan Crisis of the 1980's was preempted by a very similar set of circumstances. The government's intention was to spur investment in areas previously underfunded because they were considered being of high risk. The federal government decided to insure financial institutions on their investments regardless of their risk. Because investments of higher risk warrant a higher return, financial institutions now purchased these securities in abundance knowing they would be compensated greater and were insured by the government if the securities defaulted. As a result, many of the risky investments did default and the government ran out of funds to supply all of the financial institutions. Because this reckless behavior was promoted through the insurance of the national government the corporations that did participate in reckless and irresponsible investment went bankrupt, and many jobs were lost, causing the United States to enter into a period of financial recession.
On the surface this would seem contradictive to the TARP program in that the S&L Crisis caused a financial recession, and the TARP program is seeking to alleviate one. However, the two programs are in fact sending the same message to consumers. It is saying that risky investment will be rewarded if determined to be serious enough to affect the economy. Sending such a message that it is ok to engage in risky behavior if the government will bail you out is inherently dangerous. Although business risk is more heavily encouraged in the US to stimulate growth, a tone of responsibility must also be demonstrated.
Therefore, although the overall financial benefit of the current system is likely to be positive for the economy as a whole, it is simultaneously sending a mixed unethical message that it is ok to engage in risky financial behavior.
The problem going forward then is how we solve the dilemma of putting ourselves into this situation where we will cave in and reward risky behavior because it is momentarily good for the economy as a whole. To start with, a message of responsibility must be added along with the measure. Those receiving bailouts from their risky behavior should only be receiving them along with certain stipulations. These stipulations would show the recipient that although they are receiving governmental relief, it still comes at a cost that could have been avoided had they acted responsibly.
The second key to implementing sound financial ethics for the country as a whole is to ensure greater regulation in investment activity. The prevailing belief held by economists for many years (including our formal chairman of the Federal Reserve Board Alan Greeenspan) has been that the government should not interfere in financial markets. There are many fundamental financial principles showing the government interference in financial markets restricts growth which we want to promote as a country. The problem with this ideology, however, is that it does not take human psychology in to factor.
Regulation in securities reform was brought about after the great depression to prevent subsequent stock market crashes. Regulation in annual percentage rate disclosures on financial documents in the 29th century more clearly communicated the costs of funds uneducated borrowers were paying that would likely not have known otherwise. Further regulation in the financial industry was taken to ensure banks and investment firms were not operating jointly in order to avoid another S&L type crisis. Therefore, regulation of the mortgage industry, although it may be counterintuitive to traditional financial principles, is a logical and reasonable measure to ensure responsible ethical behavior in the financial industry.
In conclusion, after taking the consideration of all stakeholders into account under a Communitarian ethical view, the society as a whole is likely to benefit from the Troubled Asset Relief Program. The debate of long term ethical merits in this decision is justified. However, the program must be accompanied with a solid message of ethical responsibility in financial responsibility to American consumers as well as regulation of financial markets to ensure we follow a long term ethical framework conducive to prosperity of our nation.
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