What's Wrong with TARP

On Monday, the Wall Street Journal published an article containing the chart below showing that some of the major recipients of TARP funds have been shrinking their lending in recent months. What the chart failed to show is why this is the case. The answer is straightforward, but not pretty. Most of the TARP money has been pumped into desperately troubled financial institutions. It should come as no surprise to anyone (other than perhaps politicians) that institutions fighting for survival are unlikely to be focused on taking on new risky investments.

click to enlarge

If you look at the same institutions in a little more depth, it becomes quite obvious that there is a close correlation between the profitability of these institutions and their willingness to lend.

Company Name	Return on Assets	Return on Equity	Q4 2008 Lending Change
Bank of America Corporation (NYSE:BAC)	0.23	2.48	-1.25
BB & T Corp. (NYSE:BBT)	1.21	12.83	2.1
Capital One Financial Corp. (NYSE:COF)	0.05	0.33	-0.3
Citigroup, Inc. (NYSE:C)	(1.12)	(17.49)	-3.1
Comerica Incorporated (NYSE:CMA)	0.33	3.46	-2
Fifth Third Bancorp (NasdaqGS:FITB)	(1.83)	(19.90)	-1
Huntington Bancshares Inc. (NasdaqGS:HBAN)	(0.21)	(1.73)	-0.2
JPMorgan Chase & Co. (NYSE:JPM)	0.20	2.55	-2.2
KeyCorp (NYSE:KEY)	(1.44)	(16.11)	-0.3
Marshall & Ilsley Corporation (NYSE:MI)	(0.90)	(7.52)	-0.9
Regions Financial Corp. (NYSE:RF)	(3.89)	(30.49)	-1.3
SunTrust Banks, Inc. (NYSE:STI)	0.43	3.94	0.2
US Bancorp (NYSE:USB)	1.17	12.44	3.91

What’s the profile of a loan officer at a troubled bank? He or she:

1. Has been moved into the workout department,
2. If still in the loan department, is looking furtively to his/her left and right to figure out who’s going to be next to go, or
3. Has been recently laid off.

Nothing in this scenario would encourage us as prospective borrowers to believe that we’re going to get a loan, nor should it encourage us as taxpayers to expect additional TARP funding to generate new loans from such a bank.

What’s wrong with TARP is that we are putting money behind the losers rather than the winners. We’re filling financial holes created by disastrously bad management decisions in hopes that those who made the bad decisions will make better decisions the next time. The worse the mistakes, the more money the bank gets.

Now is the time for a fresh start - before we spend the next $350 Billion and find that we are just that much deeper in the hole without anything being fixed. It’s time for a simple plan:

1. Declare one or more of the already semi-nationalized banks as our official bad bank(s). Several banks on the list above would seem to be good candidates.
2. Sell off the remaining good assets from the bad bank(s) to better managed competitors before further damage can be done.
3. Fund the bad bank(s) only to the extent needed to keep the bills paid as the unsalable assets are liquidated over time.
4. Provide new TARP funds to well managed banks that are committed to continuing to build a sound lending base. These would include those national and regional big banks that have shown themselves capable of either avoiding the problems (such as US Bank and BB&T clearly appear to have done) or aggressively addressing the mistakes of the past (First Horizon appears to be a good candidate here). Equally important, rather than merging the community banks out of existence, we should provide support for the many well managed smaller institutions that still have strong capital bases, are close to their customers and know how to make sound loans. Properly structured this support can be used to leverage new equity investment in these sound institutions to take some of the burden off the Treasury.
5. Finally a new regulatory structure is needed to encourage formation of well capitalized de novo banks backed by the private equity community, which remains relatively flush with cash, but finds it impossible to fund deals that fit the old leveraged acquisition mode of past years.

Source, Wall Street Journal, Capital IQ

Disclosure: I have no positions in any of these securities.

Comments

[MSmailbox:]

I like your plan... At least all the "junk" would be gathered together into one place, isolated from the nation's primary banking system. Good banks should be nurtured, just as bad ones need to disseminate over time. Your strategy contains the key elements of the restructuring and would appear gradual enough to avoid any shock to the primary system. It would appear that "Jubilee" has come for the banks (occcurs once every 50 years)!

I am heavily invested in MI, right now... I would say that it's going to be a long wait, but with the volatility we've seen, anything is possible (just so long as the presses keep printing). Honestly, I can imagine situations where MI could go either way, but I am heavily biased towards the positive, in this case.

It looks as if our economy is going through DETOX... Recovery and new life (business activity) await. It may take a while and it may hurt, but the outcome will be something that we can be proud of in fifty years from now.

Jan 31 12:56 PM

[John Slater:]

Let's hope 50 years is too conservative. Last down cycle ended around 1939 and the excessive leverage was completely cleaned up by 1954. it then took about 30 years for the current leverage cycle to begin.


On Jan 31 12:56 PM MSmailbox wrote:

> I like your plan... At least all the "junk" would be gathered together
> into one place, isolated from the nation's primary banking system.
> Good banks should be nurtured, just as bad ones need to disseminate
> over time. Your strategy contains the key elements of the restructuring
> and would appear gradual enough to avoid any shock to the primary
> system. It would appear that "Jubilee" has come for the banks (occcurs
> once every 50 years)!
>
> I am heavily invested in MI, right now... I would say that it's
> going to be a long wait, but with the volatility we've seen, anything
> is possible (just so long as the presses keep printing). Honestly,
> I can imagine situations where MI could go either way, but I am heavily
> biased towards the positive, in this case.
>
> It looks as if our economy is going through DETOX... Recovery and
> new life (business activity) await. It may take a while and it may
> hurt, but the outcome will be something that we can be proud of in
> fifty years from now.

Jan 31 03:16 PM