Fed economists: Yes, TARP may have increased moral hazard

Two Federal Reserve researchers have confirmed what many have long suspected: big banks that were bailed out by the government took on greater risk without increasing lending to businesses. In other words, after they were stabilized by an injection of government funds, the specific loans made by “too big to fail” became riskier, perhaps in an effort to recoup losses, but the total volume of loans they made did not increase, which is part of why the recovery proceeded so slowly.
(Richard Drew - AP)

Lamont Black and Lieu Hazelwood, an economist and a financial analyst for the Fed’s Board of Governors, found that the level of business loans issued by big banks “declined dramatically” after they received bailout funds, relative to banks that didn’t. Instead, they write, large banks “originated higher risk, higher-interest loans without increasing loan volume.”

All this “is suggestive of moral hazard,” the Fed analysts conclude: big banks took on greater risks without assuming greater responsibility to lend more broadly to the taxpayers that bailed them out. In fact, overall lending still hasn’t completely recovered, as credit is still tight for small businesses, potential homebuyers, and others hoping to take out loans.

By contrast, smaller banks that received TARP funds were lending to businesses at a similar level as non-TARP banks, suggesting that they turned the injection of government capital into loans without moving to riskier borrowers, Black and Hazelwood explain.

It’s possible that big, bailed-out banks would have contracted lending even further without the bailout, and their collapse would have had far more dire consequences. But the Fed’s findings strengthen suspicions that big banks benefited from the bailout without being required to do their part to help ordinary businesses and consumers.