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Managing Risk in the Financial System

Managing Risk in the Financial System

Edited by John Raymond LaBrosse, Rodrigo Olivares-Caminal and Dalvinder Singh

Managing Risk in the Financial System makes important and timely contributions to our knowledge and understanding of banking law, financial institution restructuring and related considerations, through the production of an innovative, international and interdisciplinary set of contributions which link together the law and policy issues surrounding systemic risk and crisis management.

Chapter 4: The Troubled Asset Relief Program: Has Forbearance as Far as the Eye Can See Saved the US Economy?

Gillian G.H. Garcia

Subjects: economics and finance, financial economics and regulation, money and banking, law - academic, finance and banking law


1 Gillian G.H. Garcia 4.1. INTRODUCTION As work began on this chapter, the Republicans had just won the ‘Kennedy seat’ in Massachusetts – a most democratic of states. How could this have happened? Health care reform; ‘the economy, stupid!’ including unemployment, the deficit, and the housing markets; wars; the cold weather; bankers’ bonuses; Wall Street punishing Main Street; and disgust with politicians and regulators in Washington. Distrust of the Troubled Asset Relief Program (TARP) and its companion programs that were used to contain the financial crisis epitomize the reasons for ‘the winter of our discontent.’2 There are two contrasting approaches to dealing with a financial crisis. The first is to expand the financial safety net so that it allows the authorities to forbear from taking punitive action against failing institutions. Under forbearance the regulators relax, or do not enforce, the existing safety-and-soundness rules. In particular, they relax capital requirements to allow weakened banks to continue operating, probably with subsidies, until they earn their way out of trouble. Forbearance was used to nurse the US’s weakened major banks during the 1980s Latin American debt crisis. Congress enacted forbearance through phoney capital at the beginning of the 1980s S&L crisis, and the thrift regulators then, and more recently, practiced it to the extreme in their oversight of the banking system by not enforcing the existing laws and regulations.3 One problem with enlarging the safety net and conducting forbearance is that they do not discourage their recipients from taking excessive risks again...

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