Legal Commentary

By Gary Becker

Repayment of Tarp Bank Loans-Becker
Six months ago essentially all large American banks and many smaller ones received loans from the federal government to help shore up their capital base as they tried to weather the financial storm. Some banks would likely have failed during the severe strains in the capital market last September and October were it not for these loans. This past week, however, the two strongest large banks, Goldman Sachs and JPMorgan Chase, indicated that they wanted to, and were able to, repay their loans. Should they be allowed to do so?
It appears that not all banks wanted to take government loans in October, but some large banks were apparently "forced" to as part of the TARP loan program devised by then Secretary of the Treasury Henry Paulson. According to some accounts, the government exercised this pressure in order to avoid disclosing which banks were the weakest and needed these loans to survive.
This explanation of the government's behavior is strange since generally participants in financial markets do not have an excess of information about the financial viability of different banks, but rather they do not have enough information. It is wrongheaded for the government to try to mislead markets about which banks are weak. Indeed, the purpose of disclosure requirements mandated for banks and other companies is to raise the degree of public information available about different companies in order to assist participants to make wiser decisions. In any case, most firms and individuals active in financial markets already had a fair idea of which banks were stronger and which ones were weaker.
Many of the banks worse fears about the strings attached to these loans have been realized. The resulting government intervention in bank managerial decisions include the well-publicized restrictions on bonuses and other pay to executives, restrictions on banks' ability to hire foreigners, and frequent demands to appear before Congressional committees to justify what they are doing. Less onerous interventions include Congressional and the media's opposition to banks holding expensive golf and other outings, bank use of private planes, and meetings at luxurious resorts. Goldman, JPMorgan, and other banks want to repay their government loans primarily to eliminate these and potentially other government restrictions on managerial decisions. I see no compelling reason why they should be prevented from repaying their loans.
One argument made against allowing them to repay is the same one used to justify requiring the relatively strong banks to take the loans in the first place; namely, that the weaker banks would be exposed if the stronger banks repaid at this time. However, they are already exposed since the major participants in financial markets already know that banks such as Goldman and JPMorgan are much stronger than say Citi and Bank of America.
A more sophisticated version of this argument is that if the strong banks were allowed to repay now, the weak banks would also try to repay, and thereby become still weaken, since they do not want to appear weaker than their competitors. However, weak banks are unlikely to try to repay if that would so further weaken them that they would soon require even larger government bailouts before long. Moreover, repayment by strong banks would be a good motivator if it gave weaker banks stronger incentive to get into a financial position whereby they too could repay without damaging their viability.
Another argument advanced against allowing any repayment at this time is that this would weaken the capital position of repaying banks (even those that claim to have enough capital to repay). Yet especially the stronger banks would not want to repay the Tarp loans if that means that before long they have to ask the government for additional loans. Goldman has raised an additional $5 billion in equity to help finance their repayment, and the company has reduced its assets to 14 times its capital compared to 26 times at the end of 2007. JPMorgan claims to be able to repay their loan without having to raise any more capital.
In any case, the Treasury is soon releasing results of the stress tests they have given to all major banks. We will then have better information to determine if the banks that want to repay now can comfortably pass these tests. I am confident that these banks will rank quite high, which would help explain why they are eager to repay.
If Goldman and JPMorgan were simply allowed to repay their TARP loans, they would still have the sizable benefits of the Temporary Lending Government authority (TLGP) that provides FDIC guarantees on bonds issued by covered banks. These guarantees stem from Goldman 's conversion into a bank holding company last fall-JPMorgan was already such a company. Goldman has borrowed about $28 billion under TLGP. This would be the right time to start reducing these guarantees for Goldman and JPMorgan as a condition for these banks being allowed to reduce government controls over their decisions.

Full post as published by Becker-Posner Blog on April 19, 2009 (boomark / email).