Guest post: Repayments will make banks weaker and could lead to more failures

Submitted by Edward Harrison of the site Credit Writedowns.

Yesterday, I argued that allowing banks to repay TARP funds meant a continuation of overcapacity in financial services, which was a direct contributor to the credit crisis through its dampening impact on unlevered returns. Some of the banks now free of the TARP restrictions are arguably still undercapitalised, but have been made to look better through various mechanisms like the relaxing of mark-to-market rules.

It stands to reason that these firms will reach for yield i.e. take on more risk in order to generate enough profits to reduce lingering capital shortages. Remember, we still have a lot of writedowns in areas like commercial property and credit cards which have yet to be taken. Moreover residential property prices are still falling. Just because these loans and securities are not being marked to market does not mean the losses are not there.

Below is a good video from Bloomberg News in which Boston University Professor Mark Williams argues along similar lines. He goes as far as to say that allowing repayment now could sew the seeds of bank failures down the line. It is very understandable that these banks want to pay back the $68 billion, but it is the job of government to regulate so as to prevent systemic risk.

Certainly, it would be a black eye for regulators if any of these banks have to come back later and ask for more money. Irrespective, my fear is that some banks paying back or looking to pay back TARP money know they are undercapitalised and will be willing to take enough risk to ‘solve’ this problem. Think ‘savings & loan.’

Related article
The S&L Crisis: A Chrono-Bibliography, FDIC

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Brick

    There is a risk of banks chasing risk so they can escape tarp and the oversight of the government on pay structures. There is also the risk of them chasing risk to boost capital. The result would be predatory lending, and market manipulation. The ability to pay back the Tarp money should have been linked to the banks producing evidence of better risk management targeting loss reduction, and a policy of helping small businesses to produce sustainable business plans. That is not say they should curtail lending, just that it should be sustainable lending.

  2. Ricochet Smith

    Now that these banks have asked to reepay their TARP funds, acceptance needs to be contingent on no off-balance sheet MBS-type funds that haven't been sold or marked to REAL market.

  3. Edward Harrison

    Brick, that is exactly right. Take a look at the link to the FDIC chronology of the S&L crisis. It is comforting that such a forthright analysis of the causes of the S&L crisis is on a regulator's site for everyone to read.

    Why policy makers are not seeing parallels here is beyond me.

  4. Hugh

    Last night on one of the network news programs, a reporter said that the banks could pay the money back because they were in better shape and to bolster this point referred to the fact that they had all undergone stress testing by the government. I bring this up because it shows how narratives are created. The stress tests were shams from any number of perspectives but they moved from being stories in their own right to being terms or shorthand in the media discourse on the financial crisis. As such they become the building blocks upon which the next segment of the narrative can be constructed. Even in today's era of debased journalism, a reporter would find it difficult to announce that the banks can pay back the money they got from the government because they passed some sham tests. But once you separate the elements of the narrative from their contexts, it sounds perfectly reasonable to say that banks can pay back loans because they are in better shape as the stress tests they went through show.

  5. T.

    I'm not sure there's much worry about future failures of these banks. The Fed can and will bail them out when they get into any trouble.

    Still a bit of a mystery why Paulson and Helicopter Ben did not quietly use Fed funds instead of TARP. Some say it is to avoid the possibility of being sent to jail for doing something illegal. Now the entire USG including congress is complicit.

  6. Edward Harrison

    Hugh, you must be reading my mind because I had similar thoughts as well. One thing I would say is that the banks have used the stress tests which we see as a sham to give their position that they are well capitalised legitimacy. The result has been that the banks can now pay back the TARP funds and Geithnercannot complain even if he wanted to

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