Ten of America’s largest financial institutions today were cleared to return $68 billion in bailout funds received from the federal Troubled Asset Relief Program (TARP), after successfully completing a government-administered stress test and raising capital from private sources if it was deemed more was necessary (more on that later). These funds were ostensibly intended to give banks needed funds to resume lending in an attempt to unlock frozen lending markets that were seen as both a cause and result of the worsening economic downturn.
Unfortunately, at the same time as these funds were being disbursed, regulators were tightening reserve capital requirements on banks, worried that they would need more money on hand to protect against future losses as another wave of home foreclosures hit the lenders’ books. So for the most part banks sat on this extra money as a way to shore up their books, and not much more lending got done.
Eight months ago the current issues like rising unsecured credit card defaults and impending doom on the commercial real estate front (see recent stories on the owners of the W Hotel downtown walking out on their mortgage tab) were barely a blip on the radar. Now, with these issues bubbling to the surface and an entirely new category of foreclosure victim gaining prevalence – the recently laid-off or underemployed worker who’d saved prudently and not borrowed beyond their means – why would the banks be wanting to give any extra money away when it would seem more hoarding was in order?
One answer could be that the government was making money off its investment. Over eight months, banks paid $1.8 billion to the government via dividends on preferred stock taxpayers received when the loans were made. Divide that into $68 billion in loans, and we the people were getting an average 3.97% annual return on our investment, better than triple the 1.3% yield on a 2 year Treasury bond available today and probably six time what banks are paying on your basic or even ‘enhanced interest’ savings account.
Another? Banks operating under government assistance were subject to stricter oversight, most notably including a $500,000/yr. cap on executive pay for those leaders that had guided their respective firms to their current state. Not surprisingly, the bankers themselves were some of the harshest critics of the TARP program, and reluctant from the get-go to take money their balance sheets told the world might come in handy.
But PSD, you say, at the beginning of this diatribe you told me the banks had all passed government-administered stress tests for financial soundness, and that those that needed more money were able to raise it themselves through private sources. Why shouldn’t they be able to operate independently and pay their noble executives whatever rate the market will bear, as our triumphant capitalistic society dictates they should? Well, given where on the internet you’re reading this I doubt that precise thought came to mind…
Tangent complete, back to the stress tests. What do we know about them? Not much. The regulators who conducted them kept many of the details in the dark, fearful that if consumers were properly informed about the strength (or, more likely, lack thereof) of their banks, depositors would stage runs on the weaker banks and money would flee from the institutions with insecure futures. Luckily, the test administrators were able to skew the results enough so that all 19 banks subjected to them could pass. There’s currently a debate in financial analyst circles about whether the tests were too soft, but without the exact testing criteria available we don’t know for sure who to trust.
For example, one main component asked the banks themselves how much money they stood to lose if the economy were to continue to falter for another two years. I’ve heard foxes make excellent henhouse sentries, this practice will actually let us test that theory. Whether the downturn will last precisely two years or will extend beyond 2010 is another matter of debate – if markets are still down in 2011 (will someone check their crystal ball and let the rest of us know?) the whole test results fly out the window. Another component of the tests consider that unemployment will rise to 8.9% in 2009 and peak around 10.3% in 2010. Unemployment as of last month nationwide was 9.4% and climbing, considerably higher in the nation’s most productive states like California.
There are more issues we could explore, but my feeling is that those mentioned above give enough reason for pause when it comes to taking the test results at face value, and I’ve expressed the opinion that the early exit from TARP is, more than anything, a move to stop paying dividends to the government and return to the bad old days of multi-million dollar rewards for failure in corporate management…