Why Are Banks Paying Back Loans They Can't Afford?

The initial stress tests came at a time when the government kept pouring money into banks but had no way of testing whether this money was actually making a difference.

When the results of the first bank stress test were announced, the market did gain a small boost of confidence when they learned that banks would have to raise less capital than previously anticipated.

But, this confidence soon evaporated as the public learned that it would be near impossible to duplicate the test again. The banks themselves were calling the test unfair and confusing, and too many questions were left unanswered that the government was unwilling to answer or simply was unable to.

Now, as the Treasury announced that certain banks are going to be allowed to pay back $68 billion of TARP fund, the Congressional Oversight Panel is calling for more stress tests. They believe these stress tests should be conducted periodically because circumstances change and they can become strenuous on banks.

If this is the case, then why is the government allowing these banks to repay the loans when there is nothing more than circumstantial evidence that shows that they are in a “decent” shape?

Banks still hold large amounts of toxic debt in their books, and the fact that they’ve raised capital and are willing to repay their loans hasn’t changed this. The jobless rate in the U.S, at the current moment, is 9.4%.

This rate isn’t expected to go down anytime soon, if anything it’s expected to go up in the near future. President Obama’s promise to create 600,000 jobs over the next 100 days may just very well not become a reality in such a short span of time. With so many Americans out of jobs, it’s no surprise that credit problems are high and that credit card delinquencies have increased.

This spells trouble for the very same banks that are in a hurry to repay their TARP loans. Many of these banks issue cards, such as JP Morgan Chase & Co. (JPM), American Express Co. (AXP), Citigroup Inc. (C), and Bank of America Corp. (BAC), to name a few. Their profits are already expected to fall as recent credit card legislation bars credit card companies from charging certain excessive fees.

With so many problems against them, it’s a shock the government is actually permitting them to repay the loans at this moment. The banks actually believe that by repaying the funds the government will no longer meddle in their business, which is the real reason they’re in such a hurry to repay the loans.

They're wrong, so very wrong. Banks are going to be under government scrutiny for a very long time, so it doesn’t matter whether they pay the loans now or later. They may still have to undergo more bank stress tests and by returning money they can’t afford to give back, they are only putting themselves in a precarious situation.

So banks out there, it doesn’t matter if you return the money now or later, Uncle Sam is still watching you. Just keep the money and return it when you’re 110% confident that you actually can afford to. If not, you’re just going to dig yourself in a hole that the government just might not save you from again.

Comments

[User 428978:]

The Banks want to repay the Government so that they can start sinning again and once the government is gone, the executives can get their big bonuses. The government is an unwitting accomplice in this as they pumped money in temporarily, bank stocks jumped in price, followed by the issuance of more stock as investors gobbled up the new shares in hopes of further gains. But now there will be dilution, and the earnings will be spread among far more shares. So the transfer of wealth from the taxpayer and shareholders to the overpaid executives continues.

Jun 10 07:26 AM

[Peruser:]

The executives want their perks back.
If the financial institutions do not have T.A.R.P. funds on their books,it would be discriminatory to interfere with their bank's operations and leave other Non-T.A.R.P. recipients alone.
An analogy would be to loan money from a credit company,pay them back and have them tell you that you are loaning too much from other loan companies

Jun 10 07:29 AM

[jamesa40:]

The banks don't want Barney Frank calling them up, much like he did to Fritz Henderson to keep a distribution plant open in his state, and telling them who to make loans to, how much to make them for and why they shouldn't foreclose on them when they don't pay. Yak at bonuses and all that other crap all you want, but who the heck really wants the government to tell them what to do? Would you want them taking over your business?

Jun 10 08:39 AM

[Lngolf:]

Keeping the Government out of policy decisions is certainly a worthwhile benefit, but perhaps the biggest reason is an economic one - lower its cost of funds.

Jun 10 08:48 AM

[john s. gordon:]

banks with TARP $ chafe under restrictions as to executive compensation & bonuses, they are focused on eliminating these restrictions ASAP.
> jack

Jun 10 09:15 AM

[greedcanbgood:]

So what do you define as a “toxic” asset? I find this just the most recent in a sea of buzz words that people like to use to make a point. Is it defaults on commercial loans? Consumer loans? Credit default swaps? Something else? In addition, nobody ever makes a distinction between commercial banks and investment banks – they simply get factored in together.

Commercial banks have already significantly increased loan loss reserves and they don’t do so on a whim. Good commercial banks (and there are many more that are good than are not), large and small, employ rigorous analysis and modeling so that they can effectively weather any storm. They will be fine. This is the market at work and the market CAN learn. The best way for it to do so efficiently is to have the government keep it’s fingers out of it.

Jun 10 09:17 AM

[Old Trader:]

greedcanbegood,

How about "difficult, if not impossible to value/and or in danger of becoming non-performing" for a definition of a "toxic asset"?


On Jun 10 09:17 AM greedcanbgood wrote:

> So what do you define as a “toxic” asset? I find this just the most
> recent in a sea of buzz words that people like to use to make a point.
> Is it defaults on commercial loans? Consumer loans? Credit default
> swaps? Something else? In addition, nobody ever makes a distinction
> between commercial banks and investment banks – they simply get factored
> in together.
>
> Commercial banks have already significantly increased loan loss reserves
> and they don’t do so on a whim. Good commercial banks (and there
> are many more that are good than are not), large and small, employ
> rigorous analysis and modeling so that they can effectively weather
> any storm. They will be fine. This is the market at work and the
> market CAN learn. The best way for it to do so efficiently is to
> have the government keep it’s fingers out of it.

Jun 10 10:18 AM

[Mad Hedge F...:]

My question precisely. The world’s largest hedge fund is taking profits on one of its biggest positions. I’m talking about the US Treasury allowing ten banks to repay $83 billion in TARP money. I guess the banks really want to get the government green eye shades out of their board rooms, who have been surreptitiously swiping the soap out of the executive washroom. This means paying back 5% money when it costs 6% to fund in the markets, and 10% of you want to raise equity. I guess it’s worth it if this enables you to revive your celebrity golf tournaments in California for “clients,” throw Caribbean parties for your top producers, and get the Gulfstream out of storage after it couldn’t be sold. Could bonus compensation also be an issue? Gee, do you think? I have to begrudgingly give the government credit for making a ton of money on this trade. Not only did they borrow from us at zero and lend at 5% in huge size. They also got, at the point of a shotgun, fistfuls of equity warrants that have tripled. And they did stop the bank runs that took Morgan Stanley (MS) down to a near death experience of $6, boosting it back up to a positively virile $32. Alas, if only I could play by their rules. I have a question, Mr. Geithner. Does the government have to pay taxes on those profits? Will it report them?

Jun 10 10:39 AM

[greedcanbgood:]

Old Trader,

"How about "difficult, if not impossible to value/and or in danger of becoming non-performing" for a definition of a "toxic asset"?"

Again, you have to define these factors. In it's purest form, "value" could be defined as that which someone is willing to pay for a given asset at a given point in time. By this definition, an asset worth $1 today could be worth $1000 tomorrow. You might as well get into penny stocks. It doesn't work.

What about "danger of becoming non-performing"? How does one define this attribute? Admittedly, a simplified example could be a mortgage. Presume that a consumer has a $750k mortgage on a home that has now plumetted in value to $400k. They are underwater by $350k yet they have a job with good income, good credit and solid assets, even some that are liquid. What is their propensity to become "non-performing" on their mortgage? Most people would say that assuming all of those factors remain, the probability is quite low. That said, commercial banks are seeing these loans move immediately into default/voluntary reposession without warning. Why? Because the individual decides to go buy another home at $400k (start over at or near the bottom) and sacrifices the hit on their credit bureau for 7 years or so because they don't believe that their existing home will recover in value as much as their new home will appreciate. How can this be predicted?

My point here is that people need to be more responsible and define their interpretation of these latest "buzz words" (i.e. credit markets, toxic assets, etc.) if they choose to use them to make an argument.

Jun 10 10:45 AM

[TBill:]

It all makes perfect sense if you remember the purpose of these corporations is line the pockets of the CEO. All else, including the health of the company, is very secondary. When exec comp limitation suddenly appeared, there was a collective "Opps" and a rush to pay these things back.

Greenspan testified that his error was to think the bank CEO's would not put their company's at risk chasing a quick and easy profit, and therefore took their word that their complicated trading rooms were adequately hedged. All sorts of nasty stuff was hidden from us. That Greenspan and his regulators couldn't find it makes me feel better that I couldn't either... but not much.

Jun 10 01:13 PM

[greedcanbgood:]

You are WAY off-base TBill. Investment banks are different than commercial banks. Do you have a 401(k) plan with your employer? I bet you've got some bank stocks in that portfolio. At the end of the day, the corporation exists for the benefit of its shareholders.

Jun 10 02:13 PM

[Genesis:]

I don't have a comment on the article.

However, I think a certain magazine has already copyrighted the name, The Economist.

Jun 10 03:23 PM

[PainfullyAware:]

greedcanbegood

I find it interesting that you say that there is a "Difference" between Investment and Commercial banks, yet the Repeal Of Sarbanes/Oxley Muted The Distinction. Things Have Become Much More Blurred.


Your angling for a better definition of "Toxic Asset" shows that you have not done much research on the subject. I would suggest these for help with your education:

Shadow Banking, Off Accounting Book Assets, Derivatives (Collateralized Debt Obligations - CDO, Comercial Morgage Backed Securities - CMBS, Mortgage Backed Securities - MBS, Interest Rate Derivatives, Credit Default Swaps - CDS), Financial Engineering.

There are others search terms, but this list will give you a head start on your research. The creation and transfer method is what has created the "Unassailable Complexity" and as a result their inability to be "Valued".

There Is More To Know Than Can Ever Be Known.

Good Luck


On Jun 10 02:13 PM greedcanbgood wrote:

> You are WAY off-base TBill. Investment banks are different than
> commercial banks. Do you have a 401(k) plan with your employer?
> I bet you've got some bank stocks in that portfolio. At the end
> of the day, the corporation exists for the benefit of its shareholders.

Jun 10 04:23 PM

[The Lonely ...:]

Yes, I'm aware of The Economist. It's an amazing magazine and I completely respect their work.

However, I'm not declaring "The Economist" to be a named owned by name. It's just the user name that I've chosen. I don't pretend to own The Economist or any rights that it may own.

Thank you for the comment though.


On Jun 10 03:23 PM Genesis wrote:

> I don't have a comment on the article.
>
> However, I think a certain magazine has already copyrighted the name,
> The Economist.

Jun 10 09:33 PM

[greedcanbgood:]

Painfully aware - I concur that the difference between investment and commercial banks has become more blurred. That said, while most of the investment banks are now running under commercial charters it does not change (in the immediate term) their current business model and thus they remain starkly "different" from thier legacy commercial bank peers.

I'm quite familiar with off balance sheet instruments and yet not ALL credit default swap contracts or any of the other instruments you cited are, by defintion, "toxic." The problem here is that "toxic assets" is the latest and greatest buzz word that exists without definition. I do agree with you however in that the more these instruments are "pyramided" with one another the more difficult it is to asses their realitive value - and risk. Yet, that alone does not make them "toxic". If you are as familiar with these as you seem to be, you would know that they also exist as simple transactions.

Jun 11 10:51 AM

[PainfullyAware:]

Agreed - The issue lies in the "Actual Default" of the underling assets and the "Insane Complexity" that Evolved from "Unaligned Interests" of Originators and Securitizers.

In Theory - None Of The Structures I Mentioned, nor the ones I did not, Are "Toxic". However, the current rate of Default and Bankruptcy coupled with the Complexity Issue makes ALL OF THEM Suspect.

In the end (maturity), not all will be worthless. It Is Roulette At This Point.

Based upon my exposure to distressed real estate I conclude that there was a greater amount of "Fraudulent Valuation" than not; further adding to the fire.

Cyanide as a chemical is not toxic, until one is "exposed".


On Jun 11 10:51 AM greedcanbgood wrote:

> Painfully aware - I concur that the difference between investment
> and commercial banks has become more blurred. That said, while most
> of the investment banks are now running under commercial charters
> it does not change (in the immediate term) their current business
> model and thus they remain starkly "different" from thier legacy
> commercial bank peers.
>
> I'm quite familiar with off balance sheet instruments and yet not
> ALL credit default swap contracts or any of the other instruments
> you cited are, by defintion, "toxic." The problem here is that "toxic
> assets" is the latest and greatest buzz word that exists without
> definition. I do agree with you however in that the more these instruments
> are "pyramided" with one another the more difficult it is to asses
> their realitive value - and risk. Yet, that alone does not make
> them "toxic". If you are as familiar with these as you seem to be,
> you would know that they also exist as simple transactions.

Jun 16 03:38 PM

[picomanning:]

It's difficult enough to run any business. I would hate for the government to be looking over my business shoulder, particularly if I was working with their money. Americans really have to remember that it was our governement regulators who tempted banks to make those stupid loans in the first place. Frank & Dodd opened the door to subprime lending. Conservative banks who hated these reduced standards would suffer as customers simply went down the street to a less critical lender. Good banks wre losing business. This is what happens when government manipulates the market placve. What a set up! Meanwhile our government has not helped stabilize asset values. Banks are now being asked to make loans against weakening assets! Here we go again. Is this insanity? What sane bank would not want to get as far from government controls as possible in as short a period of time possible? Free markets are mentally healthy. Government involvement can only damage a laissez faire economy.

Jul 17 02:35 AM