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    Do Not Repay This Loan

    Do Not Repay This Loan

    The Financial Times reports that banks and other financial institutions which received TARP funds may not be allowed to repay the loans. Yes, that is correct:

    Strong banks will be allowed to repay bail-out funds they received from the US government but only if such a move passes a test to determine whether it is in the national economic interest, a senior administration official has told the Financial Times.

    “Our general objective is going to be what is good for the system,” the senior official said. “We want the system to have enough capital.”

    I understand that there are systemic issues as to liquidity, but I don’t recall any discussion when TARP passed that the government would not allow the loans to be repaid. The original purpose of TARP was to rescue failing financial institutions and stabilize the housing market by using federal funds to buy bad mortgages; and then TARP was changed to provide direct investment into financial institutions in order to stabilize balance sheets and provide liquidity.

    According to the Financial Times article, the purpose has morphed yet again, this time into a recession management tool:

    The official, meanwhile, said banks that had plenty of capital and had demonstrated an ability to raise fresh capital from the market should in principle be able to repay government funds. But the judgment would be made in the context of the wider economic interest. He said the government had three basic tests. It needed first to “make sure the system is stable”. Second, to not create “incentives for more deleveraging which would deepen the recession”. Third, to make sure the system had enough capital to “provide credit to support the recovery”.

    Something is wrong here. This is taxpayer money, to the tune of $246.73 billion, handed out to banks to avoid a banking system collapse. That collapse, if it ever were a real threat, no longer is a threat. If this were a consumer loan, the banks which received the money could cry fraud:

    JPMorgan Chase Chief Executive James Dimon said Thursday that his firm is eager to return the $25 billion they’ve received from the government, and will do so as soon as possible.

    “We could pay it back tomorrow,” Dimon told reporters Thursday morning. “We’re waiting for guidance from the government.”

    The justification for refusing to take the funds back is that the administration wants more lending. But maybe the problem is not a lack of liquidity, but a lack of credit-worthy borrowers. If we force banks to keep the money, the next step will be to require banks to lend the money by lowering credit standards, which is exactly the policy which got us into this problem in the first place. And to the extent the banks want to remove executive compensation restrictions to keep personnel, forcing the banks to keep the money and the restrictions may feel good, but it won’t get banks to lend.

    There also is evidence that the government is contributing to the problems. Fannie Mae and Freddie Mac have added a 0.75% surcharge to all condominium loans regardless of the borrower’s credit rating, in addition to other surcharges on other types of properties.

    It is one thing for the government to lend money to banks to help the banks survive. It is someting quite different to use the lending to maintain control of the private sector when the specific borrower-bank no longer needs the money. And the greatest irony is that many banks which didn’t want or need TARP money took it at the insistence of the feds, and now they can’t pay it back.

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    Matt, I think you *do* need to recognize that there were banks that claimed up front, before any disbursements were made, that they didn’t need it.

    I agree that post-facto, it’s easy for a bank to claim that it didn’t need it.

    I do have to ask, why it would be ‘trusting, borderline suicidal’ for a bank to be free of government control (and therefore heedful of its shareholders’ interests)?

    Equally, what if one of the controls that the government imposes on TARP recipients is PRECISELY to continue to take the same excessively risky choices thatdamaged them in the first place?

    To establish my biases – I would have preferred the government had not bailed out anyone, and let banks fail.

    I know that some of the banks claimed they didn’t need the money before they took it; Lehman claimed it was well capitalized a week before it failed. I do not place any weight on what any of the troubled banks say.

    I believe it would be suicidal because the banks have demonstrated that the current regulatory structure and reward system does not sufficiently discourage them from taking excessive risk, The current system rewarded investment bankers very heavily for taking extreme risks; One of the major disincentives to doing so was the possibility of bank failure. The actions of the government since Lehman failed has convinced most observers that the TARP banks will not be allowed to fail. Until something is changed that brings back the belief that major will banks will be allowed to fail, they must not be allowed to take the risks they current structure rewards.

    The government requiring them to take the same excessive risks is a real possibility, and is exactly what Congress did by trying to prop up the housing market with Fanny and Freddy last year and FHA this year. I would be against that, as well. If your argument is that the current government is more likely to do that than the banks would on their own, I’d agree if the banks were under new leadership.

    We’re in heated agreement on the issue that the current regulatory structure and reward system does not discourage the banks from taking excessive risk, AND, as you note, the perception is that TARP banks will not be allowed to fail.

    The problem, from my perspective, is that there’s no evidence whatsoever that government control of these banking institutions will result in a better product.

    Indeed, if you really believe that banks should be exposed to risk of failure, you should be cheering banks on who are prepared to put their foot down and retain control of their balance sheets. Primarily here, I’m talking about mid-market banks. The big boys like Citi are a different matter, the only upside will be the object lesson of what happens when you let the state run a bank.

    Your last paragraph is interesting – I really don’t buy the claim that the old leadership were any more venal or incompetent than a new leadership would be. The regulatory structure outright encouraged, (nay, demanded, in the case of the CRA) that they should take risk. Now, has the regulatory structure changed? The same people who were encouraging the old bankers to take that risk are still there.

    I agree on mid-size banks in the sense that I don’t think they really matter; it is the large ones (Goldman, Wells, JP Morgan, BOA, Morgan Stanley in particular) that I think matter. I don’t include Citi because I don’t think the idea of them paying back TARP passes the laugh-out-loud test.

    I agree that there is no evidence that government control will result in a better product; I argue that there is the chance that it will, and there is evidence that private control under the current system, with the added evidence that failure is not a risk, is unacceptably bad.

    I believe that new leadership might shift the weight toward private control and away from governmental control because new leaders will have the incentive to quickly mark their balance sheets to reality, and blame the mistakes on the previous leaders. My fear is that most of the large banks would fail under realistic valuations of their balance sheets.

    I believe that what is going on is a desperate attempt by the current and previous administrations to shift the losses on the banking system balance sheet from those who would currently bear them (insurance companies, pension funds, hedge funds, central banks) to the taxpayer.


    Bingo. In that we can COMPLETELY agree 🙂

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