What Do TARP Repayments Show?

Irrespective of the fact that the stress tests were not “stressful” enough, one of their achievements was to separate the winners from the losers. Since uniform methodology was applied to all banks, the tests were probably precise on relative assessment, which is further reinforced by the TARP repayment approvals for the stronger banks, including JPMorgan Chase (JPM: 34.84 0.00 0.00%), Goldman Sachs Group (GS: 146.68 0.00 0.00%) and Morgan Stanley (MS: 29.26 0.00 0.00%).

The approvals also show that some other banks like Citigroup (C: 3.48 0.00 0.00%) and Bank of America (BAC: 11.98 0.00 0.00%) still need Government crutches. When the TARP was initially implemented, it was “forced” upon all the largest players so that the weakest ones did not have to suffer the bailout stigma. Since then, the markets have absorbed a lot of bad news about the weakest banks and as such the TARP repayment approvals did not cause any shock in the markets.

While the stronger ones might not have needed the TARP, there is no doubt that they benefited a lot from it and also several other Government programs, like the FDIC’s TLGP and the Fed’s emergency lending programs. TARP funds came at a time when confidence in the banking system was at its lowest.

Further, the stronger banks will continue to enjoy many of the concessions as also an “implicit” guarantee from the Government that they will not be allowed to fail. But now, they can go back to their old ways of executive compensation and bonuses, without the fear of having to face the congressional scrutiny and public outcry.

The worst of the credit crisis is now over, and these banks are now able to tap the debt markets without the FDIC’s support and also access the equity markets as the investor confidence returns in the stronger banks.

However, repayments should not be seen as any sign of the banking system being out of the woods. We still do not know the amount of toxic assets on the banks’ balance sheets, and many smaller banks continue to fail. Further, with deteriorating commercial real estate, rising credit card losses, and still declining housing prices, we can expect the credit losses to worsen.

TARP repayments by the stronger companies will enable the Treasury to bailout many smaller banks, which are in dire need of capital. And if Elizabeth Warren’s (the head of the Congressional Oversight Panel of the TARP program) recommendation for a new round of stress tests is implemented (please read Dirk Van Dijk’s blog for details), then it is almost certain that some of the current recipients will need some more bailout funds.

Further, the Administration has yet to provide details of any regulatory revamp, which is now long overdue, especially for those “too big to fail.” While we are not in favor of Government micromanagement of the banking system, it is absolutely necessary to ensure that the banks do not revert to the system of executive compensation that rewarded excessive risk taking — the major cause of the current crisis.