The Financial Crisis of 2008: What Needs to Happen after TARP

10 Pages Posted: 29 Sep 2008 Last revised: 8 Oct 2008

See all articles by Campbell R. Harvey

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Date Written: October 5, 2008

Abstract

The Trouble Asset Relief Program (TARP) is an insufficient policy initiative to end the current credit crisis. The measures that I propose below call for a fundamentally different approach to dealing with troubled assets, the recapitalization of the FDIC and moves to reduce bank runs, mechanisms that the Federal Reserve and Treasury need to put in place to deal with the inevitable surge in bank failures, and a proposal for a Bank Capitalization Fund that would jump start our credit system. So far, policy makers have reacted to one crisis after another. My proposals are proactive and are guided by lessons learned in previous financial crises, in particular the Swedish banking crisis.

1. In implementing the TARP, Treasury avoid paying "hold to maturity" prices for troubled assets. The price should be set in between the firesale and hold to maturity. This insures a fair price for both the government and the financial institution. It reduces the cost of the program. In addition, the TARP should not purchase troubled assets at a premium price from any insolvent institution.

2. Establish a Bank Capitalization Fund (BCF) with the goal of purchasing amount equity of all viable financial institutions. This equity injection can be done quickly and will immediately impact the availability of loans.

3. Immediately fund the BCF investment fund with $200-$300 billion. Allow private investors to contribute capital.

4. BCF should expire in seven years.

5. Management of any government purchase of troubled assets should either not be outsourced or designed in a way so that the manager has minimum conflict of interest with their company's portfolio.

6. Recapitalize the FDIC both in anticipation of future bank failures and to instill confidence among depositors.

7. For a period of three years, guarantee all demand and savings deposits at FDIC insured institutions. Premiums that the banks pay the FDIC are frozen for three years. Afterwards, reset the FDIC maximum insured amount to $300,000. This will immediately boost confidence in the banking system.

8. Fed/Treasury needs to quickly put in place the staff to handle the potential of 750-1,000 bank failures.

9. Reestablish the Resolution Trust Corporation. This entity is mandated to dispose of assets of failed financial institutions.

10. Government incented principal resets of mortgages (cram downs). Resets determined by banks and both have the option to recover some of the reset if house price appreciates.

11. Two year moratorium on mortgage prepayment penalties.

12. Explicit quid pro quo for banks participating in TARP that credit should not be cut off from non-financial companies, particularly, small and medium sized companies that are the engine of growth and jobs in our economy.

Keywords: Financial Crisis, TARP, Bank runs, FDIC, BCF, RTC

JEL Classification: G20, G21

Suggested Citation

Harvey, Campbell R., The Financial Crisis of 2008: What Needs to Happen after TARP (October 5, 2008). Available at SSRN: https://ssrn.com/abstract=1274327 or http://dx.doi.org/10.2139/ssrn.1274327

Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

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