Stock

markets TARP and Financial

innovation
Introduction

Today I will introduce you to a topic on stock markets and more mainly on
rescue plan that the US have set up to save its banks following the financial
crisis, in a first part I would talk about market stocks and how these work And
in the second part I would talk about the troubled asset relief program and
make a parallel on the financial innovations.

I. How does stock market work?

The stock market is the market in which shares of publicly held companies are issued and
traded either through exchanges or over-the-counter markets

the stock market can be split into two main sections : the primary market and the secondary
market. The primary market is where new issues are first sold through initial public
offerings. Institutional investors typically purchase most of these shares from investment
banks. All subsequent trading goes on in the secondary market where participants include both
institutional and individual investors.

When companies are profitable, stock market investors make money through the dividends the
companies pay out and by selling appreciated stocks at a profit called a capital gain.
The downside is that investors can lose money if the companies whose stocks they hold lose
money, the stocks' prices goes down and the investor sells the stocks at a loss.

II. What is TARP?

A- Definition and goal

The Troubled Asset Relief Program (TARP) was established in October 2008 pursuant to
the Emergency Economic Stabilization Act of 2008 (EESA). It was one of the largest
government interventions to address the subprime mortgage crisis. Its primary purposes
were to improve financial stability by purchasing up to $700 billion of the banking
organizations troubled assets (thus allowing them to stabilize their balance sheets and
avoid further losses) and encourage banks to increase lending. Rather than purchasing
"troubled assets, the Capital Purchase Program (CPP) of TARP authorized the U.S.
Treasury to invest up to $250 billion (out of the $700 billion bailout package) in the
preferred equity of selected financial institutions to enhance their capital ratios.

B- Controversies

The primary purpose of TARP, according to the Federal Reserve, was to stabilize the
financial sector by purchasing illiquid assets from banks and other financial institutions.
However, the effects of the TARP have been widely debated in large part because the
purpose of the fund is not widely understood. A review of investor presentations and
conference calls by executives of some two dozen US-based banks by The New York Times
found that "few [banks] cited lending as a priority. Further, an overwhelming majority saw
the program as a no-strings-attached windfall that could be used to pay down debt, acquire
other businesses or invest for the future.

Moreover, while TARP funds have been provided to bank holding companies, those holding
companies have only used a fraction of such funds to recapitalize their bank subsidiaries.

Many analysts speculated TARP funds could be used by stronger banks to buy weaker ones.
On October 24, 2008, PNC Financial Services received $7.7 billion in TARP funds, then only
hours later agreed to buy National City Corp. for $5.58 billion, an amount that was
considered a bargain. Despite ongoing speculation that more TARP funds could be used by
large-but-weak banks to gobble up small banks, as of October 2009, no further such
takeover had occurred.
Government officials overseeing the bailout have acknowledged difficulties in tracking the
money and in measuring the bailout's effectiveness.

An other report, issued on the second anniversary of the crisis that drove Congress to
approve the $700 billion bailout effort, consulted several prominent economists to evaluate
TARP's performance. They concluded that TARP provided critical support at a time when
the financial system was in freefall, but created significant moral hazard in the financial
system and popular anger against taxpayer dollars going to the largest banks, especially
when the economy continues to struggle, remains high.

C- TARP LEGISLATION

Global credit markets came to a near standstill in September 2008, as several major
financial institutions, such as Fannie Mae, Freddie Mac and American International Group,
experienced severe financial problems, and as Lehman Brothers went bankrupt. Goldman
Sachs and Morgan Stanley changed their charters to become commercial banks, in an
attempt to stabilize their capital situations. TARP was intended to increase the liquidity of
the secondary mortgage markets by purchasing the illiquid MBS, and through that,
reducing the potential losses of the institutions that owned them.

The rules of TARP demanded that companies involved lose certain tax benefits and in many
cases placed limits on executive compensation and forbade fund recipients from awarding
bonuses to their top 25 highest-paid executives. From the programs inception until the
final date when funds could be extended on October 3, 2010, $245 billion went to stabilize
banks, $27 billion went to programs to increase credit availability, $80 billion went to the
U.S. auto industry (specifically, to GM and Chrysler), $68 billion went to stabilize AIG, and
$46 billion went to foreclosure prevention programs (such as Making Home Affordable). As
of December 2013, the Treasury was wrapping up TARP and said the governments
investments had earned more than $11 billion for taxpayers. The government says TARP
prevented the American auto industry from failing and saved more than 1 million jobs,
helped stabilize banks and restore credit availability for individuals and businesses, and
prevented foreclosures.

D- Financial Innovation

Advances over time in the financial instruments and payment systems used in the lending
and borrowing of funds. These changes, which include innovations in technology, risk
transfer and credit and equity generation, have increased available credit for borrowers
and given banks new and less costly ways to raise equity capital.
As seen with the global credit crunch sparked in 2008, which was triggered at least in part
by innovative financial products such as exotic ARMs, there will always be a need for
careful scrutiny of innovative financial products and their risks.

Conclusion :

Nowadays as long as huge banks can count on taxpayer-funded rescues, we should not be
surprised if banks take on enormous risks, knowing they can keep the profits if the banks
win and shift the losses onto the taxpayers if he banks lose.



Bibliographie :

http://www.investopedia.com/terms/s/stockmarket.asp
http://www.investopedia.com/ask/answers/12/tarp-economy.asp
https://www.stlouisfed.org/publications/central-banker/fall-2013/the-troubled-asset-
relief-programfive-years-later
http://www.newsmax.com/Finance/FinanceNews/Public-Anger-Bailouts-
Limit/2010/09/16/id/370548/
https://www.thebalance.com/tarp-bailout-program-3305895