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Out from under TARP, banks are now free to fail again

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By Steven Pearlstein
Wednesday, December 16, 2009

There's the president of the United States, sitting in the Cabinet room at the White House, cameras rolling, talking with the heads of the country's biggest banks, each one of which had benefited from an extraordinary government effort last year to prevent the financial system from collapsing. The purpose of the meeting is to pressure banks to make more credit available to small businesses, to restructure delinquent mortgages rather than pushing them into default and to call off their lobbyists, who have been trying to water down the administration's proposal to reform and strengthen bank regulation.

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At the same moment, officials next door at Treasury are putting the final touches on agreements that will dramatically reduce the legal and political leverage the administration holds over those very same banks by allowing them to repay the bailout money they received.

Hello? Is this what passes for political arm-twisting and bare-knuckle negotiation at the Obama White House? It's bad enough that the president's top priority of health reform was hijacked by a sanctimonious senator who can't seem to decide which side he's on. But in a capital where it is more important to be feared than loved, it's even worse for a president to tear into Wall Street "fat cats" one day and then let them off their leash the next.

As far as I can tell, top administration officials are fixated on voter rage over bank bailouts and the resulting hit to the president's poll ratings. So they're looking for any way to show that the economy is improving and that the government will not only get its bailout money back, but earn a profit besides.

By rushing to cash in their chips, however, the administration not only gave up political leverage and additional profit, but took the risk that one or more of the banks may find that it can't make it on its own. While the financial system has rebounded faster than anyone could have imagined, potential threats still loom -- a further collapse of commercial real estate, for example, or a string of sovereign debt defaults. And bank profits, while having rebounded, remain significantly dependent on the availability of cheap funding from the Federal Reserve and other central banks that cannot be expected to last indefinitely.

In other words, we're not out of the woods just yet. That's the reason cited by Treasury Secretary Tim Geithner when he notified Congress last week that he was extending the much-maligned Troubled Assets Relief Program for another year. But somehow that same caution was thrown to the wind when Bank of America, Citigroup and then Wells Fargo demanded to be freed of the stigma and extra supervision that came along with the bailout funds.

Certainly the banks' requests to repay the government, all in the space of two weeks, look suspiciously like they were driven not so much by financial fundamentals as by the same herd instincts that got them into trouble in the first place. There is no evidence that banks that remain under TARP are losing large numbers of customers or face significantly higher funding costs. And while banks are quick to identify executives they could not hire or traders who were lured away by hedge funds because of TARP's pay restrictions, it doesn't mean there aren't plenty of equally talented people who would be thrilled to do these jobs for less-than-Goldman wages. Certainly there is no harm in using TARP restrictions to slow Wall Street's destructive arms race.

The better argument for letting banks out of TARP is that investors once again are willing to provide the private capital necessary to repay the government and provide a sufficient cushion against future losses. It's certainly encouraging that banks have raised $160 billion this year on capital markets. But you'll pardon my skepticism if I note that it was the same markets that were throwing money at the same banks back during the bubble. If regulators should have learned any lesson from that debacle, it is that they need to make their own judgments about bank balance sheets rather than trusting in the infallibility of markets.

As to why investors may be so eager to put money into bank stocks, one need only consult Standard & Poor's evaluation of Bank of America's credit ranking on the eve of its recent stock offering. "We consider B of A to be highly systemically important and therefore continue to believe that B of A would receive extraordinary government support if necessary, though we do not believe such support will be needed," it said. In other words, they were bailed out once, they could be bailed out again.

Of course, S&P was wrong once before about Bank of America, and it could be wrong again. The political reality is that, no matter how large or interconnected, no bank -- and certainly not Citigroup or Bank of America -- will be bailed out again anytime soon. The next time the government is forced to step in, that bank's shareholders will be wiped out, its executives and directors sent packing and its operations wound down or sold off to competitors. Most significantly, creditors and counterparties who were bailed out in the past will get only what they would have gotten from an orderly liquidation.

The rules governing this wind-down process are still being hammered out as part of the regulatory reform bill now making its way through Congress. Until that legislation is signed into law, it would have been better to keep the banks right where they were, under the protective thumb of the government that rescued them.

Steven Pearlstein will host a Web discussion today at 11 a.m. at washingtonpost.com.


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