The Troubled Asset Relief Program, which was signed into law in 2008, was established to improve financial stability by purchasing up to $700 billion of banks’ “troubled assets” and to encourage banks to increase lending. The authors investigate whether this program unintentionally conferred competitive advantages on its recipients.
What’s Inside?
The Troubled Asset Relief Program (TARP) was established in October 2008 to address the US subprime mortgage crisis by improving the stability of the financial system and increasing the availability of credit. The program’s main component, the Capital Purchase Program (CPP), was a preferred stock and equity warrant purchase program that infused capital of $204.9 billion into 709 banking organizations.
The authors investigate whether the CPP—which, following popular usage, they refer to as “TARP”—gave its recipients competitive advantages. They also attempt to ascertain the channels through which these advantages were conferred.
How Is This Research Useful to Practitioners?
The authors find that TARP recipients got competitive advantages and significantly increased both their market share and market power relative to non-TARP recipients. Estimated correlation coefficients indicate economically significant market share and market power increases of 9.14% and 74.85%, respectively, when evaluated in light of observed sample means. They also find that the competitive advantages originated from TARP recipients that repaid “early” (defined as 2009–2010), suggesting that these banks significantly reduced their cost disadvantages and increased their revenues more than those that did not repay early.
During the hypothesis development stage, the authors present competitive advantage indicator patterns that correspond to eight competitive advantage channels. Their findings indicate that competitive advantages may be driven primarily by the safety channel (i.e., TARP banks may have been perceived as safer). This positive influence may be partially offset by the cost-disadvantage channel (i.e., TARP funds may have been relatively expensive).
For banks that did not repay early, the safety channel seems to primarily come in the form of lower interest rates for deposits and/or other types of financing, which more than offset the higher cost of TARP funds. In any case, the safety channel and the cost-disadvantage channel are the most important of the eight possible channels.
It should be of particular interest to policymakers that the authors’ findings, when viewed alongside other findings in the literature, suggest that TARP may have resulted in a possible distortion in competition, which may have misallocated resources. According to the authors, focusing bailouts on small banks instead of large ones should lead to fewer competitive advantages for recipients and increased lending and decreased risk.
How Did the Authors Conduct This Research?
The authors obtain TARP transaction data from October 2008 to December 2010 and a list of TARP recipients from the US Department of the Treasury’s website. They obtain bank data from quarterly Federal Financial Institutions Examination Council call reports from Q1 2005 to Q4 2012. Data for additional control variables and instruments are obtained from several other sources.
After exclusions and taking into account the need to use lagged values for some variables, the authors end up with a final regression sample of 178,604 firm-quarter observations for 7,323 unique banks.
The authors examine the effects of TARP on competition using a difference-in-differences regression analysis approach, which compares the differences between groups before and after a program or treatment. They also measure competitive advantage by focusing on two dependent variables: market share and market power. A bank’s market share is its local market (e.g., metropolitan statistical area asset share), whereas its market power is its Lerner index (Review of Economic Studies 1933) for gross total assets, calculated as its price–cost margin divided by price.
The main independent variables capture the effects of TARP from 2009 to 2012 (the period after TARP began) on differences between certain groups of banks: TARP recipients versus non-TARP recipients, TARP recipients that repaid early versus other banks, and TARP recipients that did not repay early versus other banks.
The authors control for proxies for capital adequacy, asset quality, management, earnings, liquidity, and sensitivity (or CAMELS, the declared set of financial criteria used by regulators for evaluating banks) as well as nine other bank characteristics.
Abstractor’s Viewpoint
I was impressed by the range of robustness tests that the authors used to validate their findings regarding TARP’s impact on recipients’ competitive advantage. The authors appear to be drawing from a set of tests that they and other researchers have refined over the years.
The authors seem to rely on a significant amount of inductive reasoning to arrive at conclusions regarding competitive advantage channels and TARP’s differential impact on the competitive advantages of small versus large banks. I think that the authors’ conclusions would be more convincing if they could find ways to study these phenomena more directly.