Reuters details the newest $30 billion small bank bailout program, which emerged in the administration’s latest budget proposal. Fifty-five mostly small community banks in the Troubled Asset Relief Program (TARP) failed to pay dividends on the taxpayers’ 5 percent preferred stock at last count, according to my research. Issuing preferred stock with dividends as low as one percent with and no warrants is an unnecessary subsidy to the banking industry. If these banks have not raised private capital yet, they probably are too sick to pour any more taxpayer funds into. It is much less costly to society to restructure banks that pose no systemic risk than to inject heavily subsidized capital into them.
Many of the banks with below $10 billion in assets would be lucky to issue preferred stock with 9 percent dividends at par. Suppose that a bank qualifies for the minimum 1 percent dividend that rises to 9 percent in year five. If these recipient banks’ cost of preferred stock is 9 percent, a one percent dividend means that taxpayers should expect less than 70 cents on the dollar for their investments. Thus, taxpayers should expect to lose at least 30 percent of their “investment” in these small banks. This program is not as bad as TARP. It is much worse.
Further, any attempt to inject capital into banks is going to have little affect if banks are already well capitalized. While my solo and joint research does show that common stock (not preferred stock) injections can improve lending incentives for troubled banks, so can shutting down poorly capitalized banks. The resolution of these small banks poses no systemic risk, and is much more socially efficient in the long and short run.
There is substantial evidence that weak business demand for credit, due to a poor economic outlook, is driving tepid lending. See question four on page 23. There are many much more effective methods to stimulate aggregate demand than injecting cheap capital into banks that cannot operate without taxpayer subsidies. The administration should focus on other more traditional stimulus measures or paying down the deficit rather than creating a new bank bailout program.
Disclosure: I only have long positions in broad based index funds.