Banks Are Repaying Bailout Money. Hooray?

Four TARP recipients returned their taxpayer loans in full this week. Signature Bank, Old National Bancorp, Iberiabank, and Bank of Marin Bancorp returned a total of $338 million to the Treasury. Small potatoes, but hey, it's a step in the right direction.

Or is it? Some say banks are eager to return TARP money because they're drowning in a circus of public outrage and impromptu rule changes after the AIG (NYSE: AIG  ) mess. This is true, of course.

The danger, they claim, is that vilifying every bank with bailout money could undermine TARP's goals of righting the economy. Mainly:   

  • Banks that can afford to repay TARP funds still should hold the money. 
  • Why? Because the whole point is to "get banks lending again."
  • Hence, banks aren't lending enough in the first place.
  • Returning TARP money could also destabilize the financial industry.  

Nonsense
All four points, I believe, are misguided. Let's break 'em apart.

1. If you can pay it back, please, pay it back!
However farfetched, TARP has two goals: Stabilize the financial industry while protecting taxpayers. If a bank feels it has enough firepower to pay back its TARP funds while stable enough to operate independently, heck, mission accomplished.

Wells Fargo (NYSE: WFC  ) insists that it never needed the money in the first place. Goldman Sachs (NYSE: GS  ) , JPMorgan Chase (NYSE: JPM  ) , and Bank of America (NYSE: BAC  ) have announced eagerness to return the money as early as this month. While that might prove embarrassingly optimistic, the four banks hold a collective $105 billion of TARP funds. If they're willing and able to pay it back, are we really going to complain?

2. Some say yes
Banks shouldn't be eager to repay TARP money, critics say, because we desperately need the money lent out. That was the whole point of TARP, they claim -- "to get banks lending again."

But was it really? When TARP was hastily formed last September, I remember it having just one goal: to halt a run on the banks.

Credit markets were screaming bloody murder after Lehman Brothers' failure and AIG's collapse. Perhaps more importantly, Lehman's bankruptcy caused the Reserve Primary money market fund to "break the buck," leading investors to extract $550 billion from credit markets "in a matter of an hour or two," according to Congressman Paul Kanjorski.

Panic-induced bank runs equal bank failures. Bank failures equal Great Depressions.

TARP's goal was never to get banks lending again -- it was to make sure we had banks the next day.

3. Besides, who says banks aren't lending enough?
In February, Wells Fargo issued a press release stating:

Since credit began contracting 18 months ago, Wells Fargo has made almost half a trillion dollars in new loan commitments and mortgage originations. Last quarter alone, we made $22 billion in loan commitments and $50 billion in mortgage originations. 

Look, everyone knows credit is extremely tight, but it's not because banks aren't lending enough. In fact, the most recent Federal Reserve data shows that banks have lent more to businesses this year than they did last year. (Here's a chart.)

The main reason credit is tight is because the shadow banking system -- nonbank lenders like Bear Stearns, Lehman Brothers, hedge funds, and SIVs -- has disintegrated.

Before the financial system imploded, shadow banks provided as much as 40% of all consumer lending by securitizing various forms of credit, from auto loans to credit card receivables. Most of that market is now kaput. That's also why some nonbanks like American Express (NYSE: AXP  ) scrambled to become bank holding companies when things when south last year.

4. If they return the money, we'll be back to square one
If banks return their TARP money, the financial system will become destabilized again, critics say.

While this seems logical, it might not be that straightforward. Why?

TARP was distributed in preferred shares that -- while restoring enough confidence to halt bank runs -- did nothing to strengthen banks' common equity capital, which is what's needed to repair their books. While considered "equity" to an accountant, preferred capital is essentially just more debt.

Case in point: Citigroup (NYSE: C  ) .

Its first bailout in October provided $25 billion through preferred shares. One month later, it was back for more -- $20 billion this time. Three months later -- shocker! -- it successfully begged the government to convert a large chunk of that preferred to common.

What happened? The first two bailouts didn't strengthen Citigroup's tangible common equity ratio, which was so thin that the bank was teetering on insolvency.

By and large, banks that are stable today will be stable without preferred TARP capital. For banks that truly do need help, converting preferred shares into common equity is what's needed.

Better yet, why not just shoot the zombie banks already?

Be happy
I understand the outrage. Bailouts aren't supposed to be fun. But let's not turn outrage over giving banks money into outrage over them giving it back.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. American Express is a Motley Fool Inside Value recommendation. The Fool owns shares of American Express. The Motley Fool is investors writing for investors.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 02, 2009, at 12:53 PM, BMFPitt wrote:

    Good. Taking public money should be made to be something painful, to be avoided at all costs (if we can't prevent Congress from giving it out in the first place.)

  • Report this Comment On April 02, 2009, at 2:27 PM, Bookmaker63 wrote:

    I don't understand how the Tarp was supposed to get banks to lend more money in the first place. When they lost insurance through credit swaps they had to come up with billions in cash to offset the unmitigated risk. The Tarp didn't even cover that, much less give them extra money to lend. To top it off the Government added stipulations that left all the risk with the banks so they still had to hoard cash to manage their risk. If the Government had come up with a method other than cash for the banks to mitigate the risk of lending money it would have gone much further at a lower cost. They could even have had the banks cover the cost of the insurance themselves and add extra oversight like they did when they implemented FDIC insurance. No regulated bank should ever have been allowed to use unregulated mechanisms to offset risk in the first place and that fault for that portion of the mess lies squarely with Government regulators.

  • Report this Comment On April 09, 2009, at 9:41 PM, Dana41 wrote:

    I think it's absolutely ridiculous, That some of these Companies are even asking for Bail out Money, They have Big Profits, From shipping jobs overseas and Mexico, Their CEO'S make more in Bonuses, Then Most People make in a Year.

    Everybody is Asking for bail out Money. How about Calling in Debts, Other Countries Owe Us in the Money we Lent , Them , Also Those Big Greedy ass, Big Wigs Sit there and, Snicker behind our Backs , About how they Stuck it to Us, Damn it. Enough is Enough, Charity Begins at Home. Help America Get back on it's Feet. Stop Shipping jobs Overseas and Mexico, Get those Greedy Ass CEO's to Give back their Bonuses, Let Them Go Without for a While, Let them loose their Homes, Cars and Luxuries, We can Only Dream About. Having. Let them Decide Weather to Pay the Lights, Gas, Water, Ect Instead Of Eating Or Getting necessary medications That Most People Need Every Day, Help Us Here at Home, First, Then worry about all the Extras, they take for Granted, Later. Do I sound Pissed Off? Hell Yes. I am Sick and Tired, We are Supposed to Pick ourselves Up, Dust Ourselves off and Get Back to Doing, What we Do Best,

    Running America, If we had a Woman Doing the Budget, You know Damn Well it Would Balance out, No Hiding Funds In Bogas Ghost Company's Or Tax Shelters for the Rich and Greedy. Get it Started , Get America Back to Where We Belong,

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