Why the banks should be hoarding their TARP money

7 Comments and Trackbacks to “Why the banks should be hoarding their TARP money”

1. pneogy Says:
   Tuesday, January 13, 2009 at 11:07 am

   "The justification for the capital infusions is that it [sic] will increase capital, not loans."
   --
   And to that end, I'm sure, banks are eliminating all bonuses and dividends.

2. Justin Fox Says:
   Tuesday, January 13, 2009 at 11:47 am

   @pneogy: Well, employees are human capital, which I guess can (tenuously) explain some bonuses. But I'm with you on the dividends.

3. bryanfromhouston Says:
   Tuesday, January 13, 2009 at 12:18 pm

   Justin,
   -
   And thus, we are stuck with what has been termed a Morton's Fork.
   -
   You see, the original proposal for TARP was to buy up all or at least a good enough quantity of bad assets to remove them from the bank's books. The downside to that was that if the assets were truly bad (nobody really knows the value of the seldom traded [thus illiquid] Mortgage Backed Securities (MBSs)) and underperforming then the government was giving money away and overpaying for something of dubious value.
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   So, why not just recapitilize directly? Good question and Krugman answered loudly. Glad you asked. Direct recapitalization would put money into the banks and the government could take out warrants (or in layman's terms preferred shares with a dividend payout). The theory being that if the government was going to loan money to the banks then it should have a share in the upside if they were willing to risk capital on the downside and the taxpayer could possibly make some money.
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   But a problem arose! What about when banks come to the government and beg for the money and investors start to realize that those are the banks that are in trouble? Won't they all want their money back from the bad banks thus meaning the banks that are marginally less healthy relative to their peers would be stuck in a liquidity trap or capital trap? The more money the government loans a bank...the more likely investors are to want to take their money and run. Isn't that what happened to some hedge funds and isn't it why they had to pull up the drawbridge and limit or stop redemptions? So, the government gave loans backed by shares, but to avoid signaling distress, everyone had to take a bit of the pie.
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   Well, this gets up to the bonuses and dividends. What do investors do when companies start eliminating bonuses and dividends? Isn't this the equivalent of signaling to the markets that we are in trouble and taking on water? Or, in the alternative, isn't this a signal that we are ready for the rough seas and will be here when the storm passes.
   -
   As an aside, somebody (Ali Velshi, Barbara (she's awesome at this) or maybe you, Justin) need to put something in dead tree on this topic. Far too many Americans don't understand the cause and effect of buying troubled assets versus recapitalization versus permitting a Lehman. In the land of the devil, there are no angels.

4. plukasiak Says:
   Tuesday, January 13, 2009 at 4:45 pm

   I guess what we're talking about here is the old "bait and switch" problem. The bailouts were sold as "liquidity" bailouts, i.e. that the financial sector could completely collapse and the economy could collapse because of a lack of cash to "move around" in the forms of loans (not just mortgages, but interbank loans, short term loans to businesses, etc.).

   Now we're being told that the capital is supposed to just sit there.

   Its bad enough that we were bamboozled into the bailout in the first place, but these shifting rationales are really getting annoying

5. bryanfromhouston Says:
   Tuesday, January 13, 2009 at 6:39 pm

   plukasiak,
   -
   Now, your last post is just flat out disingenious and/or dissapointing. It lacks intellectual rigor.
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   The simple reality is that they could either buy poor or non-performing securities, recapitalize banks and seek warrants, or they could let banks fail..ala Lehman.
   -
   In fact, all three have been tried with limited success. The Fed has taken some bad securities off the books after the Treasury has done some recapitalizing and they even let a semi-bank (Lehman) collapse.
   -
   Now, certainly they have not done a good job explaining why they had to be recapitalzing, but there is no plausible argument that this is a "bait and switch"! Any person with a basic understanding of banks understands the requirement for on-hand capital requirements ("It's a Wonderful Life" comes to mind). I'm sorry but if Citi and Bank of America need a trillion dollar loan to keep going...Congress will give it to them. The Saudi's and the Chinese have too much of their economic wealth tied up in those bread baskets. If allowed to fail, you will be sending the Saudis and Chinese your mortgage checks directly. Further, you can dependably believe that no US bank will be doing any further lending as the countries that are our creditors will be too scared to continue to do business with us. The rationales have not shifted, but the operation of which tools would be employed has changed.
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   And in fact, the government has stumbled into fixing the problem. It is just that the needs are now greater because they did too little to begin with. It was not enough to merely recapitalize alone but the assets are having to be bought off the books to keep from having to continuously recapitalize the banks. Why? I'm glad you asked.
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   The securitized assets (mortgages, credit cards, commercial real estate, car loans, etc.) have begun to underperform reducing their value on the books. As anyone is aware financial and insurance companies are required to have a certain amount of cash on hand to meet short-term operational requirements. That amount can be substantially raised if the regulating entity essentially performs a margin call (http://vimeo.com/2181485). Well, where do you get that cash in bad economic conditions? If you are a bank, maybe additional deposits or debt instruments...an insurer...additional premiums...but how likely is that in an economic downturn. Or! You could sell assets. But you are selling assets when they are least valuable and you put more of the assets on the market, it reduces the value of your assets forcing you to raise cash...it's called a liquidity trap. Check out the vimeo (http://vimeo.com/1933993).
   -
   In any event, the government has been pretty lucky that they have done thinsg in the order they have so far. Does anybody know why?

6. plukasiak Says:
   Wednesday, January 14, 2009 at 7:28 am

   Bryan...
   nothing disingenous about it. I was talking about how the bailout was sold, and what it would supposedly accomplish.

   The biggest threat to the banks was that they would be declared insolvent -- not because they were actually insolvent, but rather because the market for mortgage based securities (and their derivatives) had collapsed because no one knew what the real underlying value of these securities were. The "mark to market" requirement meant that banks had to show huge paper loses on these securities, even though the eventual return on them would be much greater.

   One of the things that could have been done would have been to temporarily relax the "mark to market" rules; rather than have financial statements reflect the price of these securities in the marketplace, the rules could have been changed to allow them to reflect the value of the performing (non-foreclosed) portion of the underlying assets. Its because the "mark to market" rules have not been relaxed that re-capitalization is/was necessary (there would still have been liquidity problems because the market for these securities would still not exist, but in that case the bailout money could have provided liquidity, rather than capital needed to shore up the bottom line of the banks.)

7. Barbara Kiviat Says:
   Wednesday, January 14, 2009 at 10:22 am

   Thanks, B from H. Joseph Mason was kinda eloquent on this topic in mid-December: http://www.rgemonitor.com/financemarkets-monitor/254737/should_banks_lend_loan_supply_vs_loan_demand

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