Better Banking

Democratic critics need to give Treasury's rescue plan more time to work.

THE TREASURY Department's Troubled Assets Relief Program (TARP) is barely underway. But the second-guessing from Congress has already begun. Two Democrats, House Financial Services Committee Chairman Barney Frank (Mass.) and Senate Banking Committee member Charles E. Schumer (N.Y.), have taken shots at Treasury for allegedly not demanding enough in exchange for the $168 billion in fresh capital that it has so far pumped into banks. The gist of their complaints is that, instead of immediately increasing lending, banks are using taxpayers' money to pay dividends to their shareholders. This, Mr. Schumer says, "defeats the purpose of the program," and he has suggested setting targets for bank lending. He and Mr. Frank are also unhappy that some recipients of the bailout money are using it to acquire other banks.

We have some sympathy with these concerns. In our view, TARP would have been better if it had capped dividends at current levels or offered banks additional incentives to reduce them. But Treasury did cut a business deal with the banks that received public capital -- some of which did not want or even need to take it. The department's concerns -- that insisting on dividend cuts would have deterred participation -- might have been misplaced, but they were not far-fetched. As for bank acquisitions, it's not clear to us that this is inconsistent with TARP's objectives. If a well-capitalized bank swallows a poorly capitalized one and cleans up its balance sheet, well, that's one less failing bank the government has to worry about. Mr. Schumer and another Democratic colleague, Sen. Robert Menendez (N.J.) say that they object to acquisitions of "healthy" banks. But the market is probably the best judge of how healthy or unhealthy a merger target is. If government tries to pick winners and losers and guesses wrong, the Federal Deposit Insurance Corp. will get stuck with the bill.

Money is fungible. Perhaps not every dollar of public capital injected has yet been lent to customers. But lending might have constricted even further without the capital injections. By bolstering banks' financial health generally, TARP's equity injections enhance their capacity to lend more later; given the economy's present state, it's not clear how many firms and individuals are in a position to demand credit anyway.

TARP is an improvised approach to a financial panic. It is best conceived of as general, temporary support for the financial sector -- not the first phase of long-term, detailed government involvement in banking business decisions. The experience of many countries has shown that the more government gets into banking, the more politics controls the allocation of capital, upon which all economic activity depends. Efficiency suffers, corruption flourishes and the economy stagnates. As Congress exercises its legitimate and necessary oversight powers with respect to TARP, it must remain aware of those dangers.