Should Banks Be Allowed to Pay Back Their TARP Money?

by: Tom Lindmark

The big news of the day is that the Treasury is going to allow 10 banks to repay their TARP money. For some reason that only a bureaucrat could probably appreciate, they didn’t publish a list of the banks that will be freed. The banks get to announce it individually but if you don’t want to wait this article from the NYT will clue you in.

There seem to be two discussion threads winding around out there as a result of the decision to allow repayment. One should the banks be allowed to repay the money and two how do we maintain the control that came with the TARP funds. Let me offer my thoughts on both.

The question as to whether the banks should be allowed to repay breaks down this way. Yes, they should because we may need the money to rescue some other banks or to put more into those that are still weak and it makes no sense to not take it back from banks that passed the stress test and have shown the ability to raise capital. No, we still don’t know the extent of the toxic assets on the banks’ books and probably won’t because the PPIP has been shelved. The banks should be made to keep the money just in case.

I’m not in the “just in case camp.” While I doubt the stress tests were perfect, I do think that they established a better base of knowledge about the relative strength of a group of banks which is sufficient to make reasonable decisions about their viability. Combined with the overall improvement in the interbank market (the panic has subsided) and the demonstrated receptivity for bank debt and equity in the private markets, it seems reasonably clear that some of the banks are beyond the need for continuing assistance. One might even argue that some were never in need of assistance in the first place.

It’s true that there are questions relating to the value of some of the banks’ assets and there may be further shocks to come, notably in the commercial real estate sector, but the specter of forced liquidations of these assets has vanished so that the banks should be able to spread any losses over a relatively long time horizon. It’s important to remember that taking losses is a part of the business of banking. The key is to ensure that the institutions have the reserves and earning power to accept those losses without impairing the business. I think that the case for that being the operative environment for most of the big banks is pretty well established.

The bottom line for me on this issue is that at some point you have to move on. There is never pure certainty about anything, least of all bank balance sheets. The “just in case” argument looks for absolutes that will never be attained. The risk involved with repayment at this time looks to be minimal.

The issue of control is the one that seems to stir more passion. The argument goes something like this. Regardless of whether these banks pay back their money it’s now eminently clear that they enjoy a government guarantee and as such are or should be subject to more oversight.

This is really a political argument as opposed to an economic one. The banks are clearly regulated — they were before this and they will be more so as a result of all of this. The argument for substantially more government involvement is couched in terms of reforming compensation as a means of reducing risk. In reality, it’s a backdoor into a command and control regime for the financial system.

When it comes to control we really need to consider two things. One is to bring the government’s regulatory systems up to standards that are capable of dealing with modern finance and two figure out a way to eliminate the too big to fail syndrome. Once too big to fail is no longer operative then the need for government interference other than safeguarding depositors and ensuring the orderly functioning of the system becomes a moot point.

So my preferences are to let them pay back the money, get the regulatory apparatus up to snuff and then get out of the business.