U.S. Will Let Some Banks Repay Aid
Move Doesn't Signal Economic Recovery, Officials Caution

By Binyamin Appelbaum and David Cho
Washington Post Staff Writers
Monday, June 8, 2009

The Obama administration plans to announce as soon as today that some of the nation's largest banks can repay billions in federal aid, but some officials caution that the show of progress is being underwritten by multiple layers of less visible government support.

Through cheap loans, debt guarantees and a promise that big banks will not be allowed to fail, these officials say the government has created an artificial environment in which profits and stock prices have rebounded, helping banks in recent weeks to raise about $50 billion from private investors.

The money allows the strongest banks to return federal aid provided at the peak of the fall financial crisis, but few banks have expressed eagerness for the government to end the other forms of support, creating concern that these programs will be habit-forming and more difficult to terminate.

As a result, independent experts warn that the government's relationship with the industry is entering a precarious new phase. As with mortgage giants Fannie Mae and Freddie Mac, the government will no longer share in the banks' profits, but it still stands ready to absorb losses.

"It's good from an individual investor point of view, it's great for the banks, but from a system point of view it's very dangerous," said Simon Johnson, a Massachusetts Institute of Technology professor and former chief economist at the International Monetary Fund.

The Treasury Department has invested about $200 billion in more than 600 banks under its financial rescue program, to patch problems, facilitate mergers and provide support for new lending.

In recent months, more banks have sought permission to return the money, to avoid restrictions such as limits on executive pay and to show renewed strength. The administration has allowed about 20 smaller banks to do so. It now plans to announce a list of large banks that can join them. J.P. Morgan Chase, Goldman Sachs and American Express are among the firms that expect to be on it.

Officials say they now are confident that the strongest banks no longer need the money, and they want to provide those banks with a public vote of confidence. The officials caution, however, that repayments should not be seen as evidence of economic recovery. Consumer demand remains weak. Unemployment continues to rise. It is still highly likely that the economy will contract during the second quarter.

Banks are recovering more quickly than the overall economy thanks to an array of targeted government rescue programs. The Federal Reserve has made more than $1 trillion in emergency loans. The Federal Deposit Insurance Corp. is helping banks borrow money by promising to repay investors if a bank defaults. And the administration has insisted that it will not allow large banks to fail, for fear of the collateral damage. Treasury officials say these efforts were critical to limit the number of bank failures and the scale of the financial crisis.

In allowing banks to return one form of government support, the direct investments, the administration has sought multiple assurances that the companies will not regret the decision. Regulators conducted stress tests on 19 of the largest banks to determine whether they had sufficient capital reserves to absorb likely losses. The nine banks that passed then were required to raise additional money from private investors.

Banks also were required to issue debt to private investors, without a government guarantee of repayment, to show that they can raise more money if necessary.

But allowing repayments is still a gamble, said Douglas Elliott, a finance specialist at the Brookings Institution.

"The fact that the regulators feel good enough to take the money back is clearly more confirmation that they're feeling good about things. But they could be wrong," Elliott said. "There's still a lot of potential for this to turn out to be a significantly worse problem than it appears to be at the moment."

The government also is foregoing billions of dollars in revenue. The investments were structured as five-year loans that paid an annual interest rate of 5 percent. J.P. Morgan, for example, which accepted $25 billion, would have paid the government up to $1.25 billion a year.

Still, almost no prominent voices have raised opposition to the repayments. Congress is eager to pull away from an unpopular program, and the administration is eager to show that its strategy has worked. Even critics such as Johnson say the government's focus now should turn to long-term changes, such as limitations on executive compensation for all banks.

The repayments are viewed by some administration officials as vindicating a decision made last year by then-Treasury Secretary Henry M. Paulson Jr.; Federal Reserve Chairman Ben S. Bernanke; and Treasury Secretary Timothy F. Geithner, who was then president of the Federal Reserve Bank of New York. After Congress allocated $700 billion to purchase banks' troubled assets, that group instead decided to invest the money directly in banks.

At the time, officials believed that stabilizing the banks was a critical first step, but it still might be necessary for the government to help banks sell devalued mortgage loans, mortgage-related securities and other toxic assets. In particular, officials warned that private investors would not return until banks scrubbed their balance sheets.

Officials acknowledge that the investments have succeeded in part because of the wide range of other federal programs bolstering the banks. But they increasingly believe that additional efforts may not be necessary.

The government has shelved a plan to finance the investor purchases of mortgage loans, and officials are working with less urgency on a plan to finance the purchase of securities. The administration's view of these programs has shifted, officials said. Rather than critical steps, they are now regarded as insurance in case banks fall back into trouble.

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