Bank bailout under TARP in the US

This Blavatnik School of Government working paper examines the impact of the controversial Troubled Assets Relief Program (TARP), the largest government bailout in US history, launched in 2008 in response to the global financial crisis. It asks: did TARP help, hinder, or even worsen the financial crisis, and what would have happened to those banks that received bailout funds if they had not?

Authored by Mthuli Ncube, Professor of Public Policy at the Blavatnik School of Government, this is the first paper to examine the market response to TARP-related events, as reflected in stock returns and tail risk. It uses propensity score matching methods to permit a counterfactual interpretation of the data. This provides credible and robust empirical evidence that in the absence of bailouts there would have been greater tail risk and more negative abnormal returns than was the case with bailouts.

The evidence in this paper shows that, while TARP was highly unpopular with the public and was baggage for its supporters, the market response to its announcement was favourable, suggesting a restoration of investors’ confidence in the financial system. However, the market tended to react negatively to the receipt of TARP bailout funds, with banks that received larger bailouts experiencing greater stock price declines. This indicates that, instead of creating a certification effect, the receipt of bailout funds conveyed an adverse signal to the market.

The paper concludes that TARP had mixed results, but the empirical evidence suggests it did not in fact make any meaningful change in tail risk. The results can be used to give key lessons about the effects of government bailouts on the financial health of the banking sector.