Congress Made the Bank Bailouts Work for Taxpayers

Includes: BAC, BK, C, GS, MS, STT, WFC
by: Linus Wilson

Daniel Gross, the eloquent former leader of the bond giant PIMCO, tells Newsweek why taxpayers got most of their money back from the banks. Congress hit bankers where it hurt. It went after their bonuses, and with the pay czar looming, all the seven remaining original recipients of TARP have begun to pay back the taxpayers’ investments.

Sure, Neil Kashkari, who dreamed up and led the Troubled Asset Relief Program (TARP) in its early months and now works for Dan Gross at PIMCO, and his boss the then U.S. Treasury Secretary Hank Paulson, gave bankers a sweetheart deal. The two Goldman Sachs (NYSE:GS) alums passed out preferred stock with a 5 percent dividend, which was clearly a subsidy, according to the Congressional Oversight Panel and Congressional Budget Office.

Yet, if the folks at Treasury wanted to make friends with the bankers, Congress was ready to go to war. As my paper “The Goldman Sachs Warrants” recalls, Treasury was forced by Congress to obtain warrants in the banks. Congress changed the rules of the game with the stimulus bill, tightening executive pay restrictions in TARP and allowing banks to pay back the TARP monies immediately. (Treasury’s original agreements only allowed the banks to pay back before 2011 if they issued a ton of equity.) Even if Treasury was captive to the bankers, Congressional representatives have to go to town hall meetings every weekend to keep their jobs. The folks in Kansas and West Virginia see things differently than the bankers in midtown Manhattan and 85 Broad.

My solo and joint research shows that it is the bailout subsidy that encourages banks to behave recklessly. If bankers don’t want to accept the subsidy because Congress will otherwise make their lives miserable, then there is little incentive to act recklessly in the first place.

Congress messed up by not stopping the Bush and Obama administrations from giving the auto companies money. There were no good reason to give money to insolvent automakers badly in need of a Chapter 11 filing. Thus, the populist instincts of politicians don’t always work to taxpayers’ advantage. Nevertheless, with the banks, the politicians were right to make TARP tough.

Disclosure: I only have long posititions in broad-based index funds.