TARP oversight report: 'Implicit guarantee' of future bailouts hampering reform

Unwinding the Treasury Department's $700-billion rescue program will be difficult, so long as there is an "implicit guarantee" that the federal government will continue to save failing banks, according to a new report.

The 2008 Troubled Asset Relief Program (TARP) has ultimately prompted banks to adjust "to the notion... [they] will be safe, no matter what," explained Elizabeth Warren, chairwoman of the Congressional Oversight Panel that has been tracking those dollars.

"The whole market has adjusted to the notion that the big banks will be safe no matter what, and they can start planning their business approaches accordingly," Warren told CNBC on Thursday. "And thats dangerous."

"This business of regulatory reform that's going through Congress... is really where this is going to all come down," she added, as those reforms would allow the federal government to "credibly say to any large financial institution, 'If you screw this up badly enough, you really can be liquidated.'"

Without that legislation, "At the end of the day, when TARP is over, it's not really over," the chairwoman continued.

Warren's remarks on Thursday coincide with the Congressional Oversight Panel's latest look at the TARP's management and execution. The report, released this morning, stresses the legacy of the 2008 bailout program might be a lingering impression that the federal government will rescue failing firms that pose systemic risks to the nation's economy.

"This belief distorts prices, giving large financial institutions an advantage in raising capital that mid-sized and smaller banks – those not too big to fail – do not enjoy," Warren and her colleagues found. "These implicit guarantees also encourage major financial institutions to take unreasonable risks out of the belief that, no matter what happens, taxpayers will not allow their failure."

"So long as markets continue to believe that an implicit guarantee exists, moral hazard will continue to distort prices and endanger the nation’s economy, even after the last TARP program has been closed and the last TARP dollar has been repaid," the panel concluded.

Warren on Thursday stressed that lingering assumption, in particular, only strengthened the case for regulatory reform. New rules that would break apart sizable firms, or new tools to handle failing firms as they collapse, are two crucial ways to defeat the impression that the Treasury Department will save struggling banks, she said.

"Until that day comes, until we can credibly say that, then this economy remains at risk," Warren said, noting the House has already passed a reform bill. "And it remains an economy distorted by a guarantee than the financial institutions benefit from, but don't pay for."

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