Everything Finance

Jonathan Parker

TARP and the Federal Reserve’s actions during the finance crisis and recession have been extensive.  Keeping track of all the policies that have been implemented has been mind boggling.  But now there is a Pew Foundation project and webpage devoted to keeping track of what businesses or investors have gotten subsidies and how big they were/are, often in terms of current or recent subsidy rates.

The subsidy rate (or cash subsidy) is based on the difference between what the government pays (and/or the market value of what it commits to pay) and the market value of what it receives in return. For example, if TARP gives money and lines of credit to AIG in exchange for an 80% ownership stake in AIG, the subsidy rate is based on the cost of the program – the money given and the market price the government would have had to pay to buy that conditional line of credit from the market – and the market value of 80% of AIG at its post-bailout value (a subsidy rate of 1 is pure gift, a negative subsidy would make money for the government). Having been involved in valuation of TARP holdings, I know first-hand how difficult it is to evaluate the direct subsidy involved in a bailout many months later.  The current AIG subsidy rate is around 60%. But what is really important for evaluating whether the cost of different programs were worth their costs are the initial subsidy rates of the programs at the time they were undertaken. 

The initial subsidy rate measures the benefits/subsidy of the program at the time of implementation and the cost to the taxpayers. (Although one can debate whether market prices are “right,” this measure is at least objective and the correct answer to a well-defined question which is not the case once one decides that prices are “wrong” so that values are not values). In contrast, the latest subsidy rates are useful for keeping track of government budgets, but incorporate whether things have turned out poorly or well, and so are not so useful for evaluating the costs vs. benefits of a given program.

As an example, if the Fed bought a $1 lottery ticket, the subsidy cost at implementation would be the expected value of the ticket, say 50 cents. A week later the subsidy rate would be a large negative number if the ticket won, and 1 if it lost.  The former represents the cost to the taxpayers at implementation, and the latter the ex post budgetary implications. Both are useful.

Of course subsidy rates all abstract from the benefits side of the programs.  None of these programs were undertaken because the government was trying to invest and make money. They were undertaken to stabilize the economy, an effect which is much harder to measure.