Taking Issue with the Way TARP Has Been Executed

I was stricken with malaise when the first round of TARP capital injections into the banks went out, so I didn't get a chance to comment when it was new/breaking story. However now that I'm feeling better and the Government is injecting cash into a smaller group of banks, I figure I'll take the time to share a few thoughts.

For what it's worth I do support the capital injections (in principle), I just have a couple of issues with the way the plan was executed:

Shotgun Approach: The plan appears to have been executed as if the goal was to shore up confidence into the banking system by injecting capital from the government, as opposed to resolving the root cause problem (falling markets, the credit crunch, et al.) of an undercapitalized banking system. In other words forcing X number of banks to accept cash injections doesn't necessarily solve anything, and it would've been smarter to assess each bank's capital needs and then give them a choice of either raising the money from investors or accepting cash from the government. The benefit to this approach is that it allows the strong banks to distinguish themselves (either by not needing capital or by being able to raise it), and it allows for a smarter use of taxpayer dollars by focusing resources on where they're most needed. 

In other words the mere presence of the Government isn't going to necessarily solve anything, and it's smarter to focus on the core issues and not take actions that (to an extent) penalize the companies that don't need government help in the first place. 

Capital Usage and Consolidation: At the moment there are some legitimate fears that larger banks will use their capital injections to buy smaller and/or weaker Rivals (fears that were probably heightened by PNC's purchase of National City Bank (NCC)), as opposed to using the capital to increase lending. On one hand you might say that some of these fears are overblown because an undercapitalized bank might just hang on to the cash and use it to shore up their balance sheet, on the other it's quite possible that banks could use Government cash to buy smaller rivals and strengthen their own balance sheets via absorbing the assets of a rival.

In truth this is a two-fold issue as you're talking about placing limits on bank consolidation (either for the duration of the crisis and/or on a go-forward basis), and placing parameters around how the banks can use taxpayer funds. 

Around the issue of bank consolidation I fully agree that some limits should be implemented, as we're already suffering from the systemic risk created when a small number of companies control too large a % of the nation's deposits, banking resources, etc. However I fully accept that there are plenty of situations where it's still in the best interests of the banking system for the Government to facilitate the absorption of Bank A by Bank B. I think that the Government needs to take the approach of spreading risk around as opposed to creating more of it, perhaps the next Wachovia should be split-up and spread around to various regional banks instead of being swallowed up by a single acquirer. 

I don't think it's in the public interest to create more banks who hold 10% (or more) of the nation's deposits, I'd rather have a banking system where 8 banks hold 40% of the country's deposits than to have one where 4 banks hold same. 

With respect to parameters around how the banks use the capital the story is simple, the Government injected cash into the banks hoping to stimulate a certain type of behavior without (instead) dictating how the banks could use the capital. Granted asking an undercapitalized bank to increase its lending activities just because it received capital is a bit spurious, however there needed to be more teeth (or at least carrots and sticks) in the capitalization agreements that would ensure the banks used the capital in a way that serves the public's interest as opposed to their own.

Lending: The undercapitalization problem isn't actually a new one as many banks were merely using regulatory arbitrage and/or derivatives to appear properly capitalized during the credit boom, what's happened over the past 18 months or so is that those spurious "capitalization strategies" were exposed after years of poor lending standards, poor risk management, etc. This creates a problem when you inject money into the banks in hopes that they'll lend again, because many banks need to reign in lending and raise capital in order to shore up their balance sheets/get properly capitalized.

E.g. proper expectations need to be set for go-forward lending, and the banks have to first recapitalize and then raise capital on top of that in order to truly loosen the lending reigns.

Overall the capital injections were the right way to go and I am playing (to some extent) Monday morning QB here, however considering everything that's at stake it's important to approach these problems in the right way so that effective solutions can be implemented. Moving forward the Treasury needs to think more in terms of solving the brass tax root cause problem s, as opposed to approaching things as if all it will take to fix things is a little dash of confidence. 

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Comments

[Hyrule:]

Why would anyone want to own any regional bank stock, given that folks like you advocate highway robbery. PNC shareholders are getting $29 per share windfall, while NCC holders get less than 30 cents on the dollar.

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2008 Oct 28 01:02 PM