Banks forced to take bailout money they don't want or need

Posted on November 25, 2008

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There are thousands of banks in the United States, most of which are local and have less than a billion dollars in assets. Some of them are even making a profit this year because they were careful and didn’t expose themselves to the mortgage and credit crises. Some of them were (gasp!) risk averse and (double gasp!) run wisely. So why are these strong banks being forced to accept federal bailout funds that they don’t want or need?

I’ve been digging based on a tip I got from someone in banking, and I’ve found that most if not all strong banks are signing up for the Treasury’s “Capital Purchase Program,” the program by which the Treasury is taking an equity portion of the bank in exchange for an influx of cash that is intended to be used in the bank’s lending. According to a story in the Houston Chronicle, banks throughout Texas are taking the federal money even though they don’t need it for a number of reasons. And some of the banks were worried about refusing the money because, as the President of Prosperity Bank Dan Rollins said:

The regulators are pushing us so dad-gum hard, we’re scratching our head saying, ‘If we don’t take it, does that put us on their bad list?’

I was told that the regulators supposedly asked the bank to participate, but the bank wasn’t given a choice to participate or not – the funds (equal to approximately 3% of the bank’s total assets) just “showed up” one day. According to the American Banking Association (via the Wall Street Journal Deal Journal blog), my source’s bank was hardly the only one. According to the WSJ, ABA president Edward Yingling wrote to Treasury Secretary Henry Paulson

[M]any banks have been contacted by regulators, and urged, sometimes forcefully, to participate in the [Capital Purchase Program] (emphasis original).

And the International Herald Tribune ran an article on healthy banks who were being pressured to take bailout money that they didn’t want for fear of being stigmatized.

If we assume for just a moment that the $250 billion used for the Capital Purchase Program is going to all of the banks in the U.S., than a huge amount of money is being forced on businesses who don’t want it. According to the ABA letter mentioned above, 95% of all banks were sufficiently capitalized and didn’t need the extra cash. If we even assume that only 50% would have said “no” had they not been pressured, that’s almost 120 billion that didn’t need to be spent.

So why was it?

I’ve been thinking about this some and I’ve come up with several possible reasons, although there may well be more.

First, the Treasury may be hoping that the strong banks will use the money to buy up their weaker brethren, although why a bank would voluntarily take on a likely unquantifiable amount of risk in this economy is beyond me.

Second, the Treasury may be hoping that the stronger banks will lend more of that money to people in need of loans. But if the banks are strong, then that means they were making smart lending choices, and so they’ll be much less likely to make loans to the very people who need the money the most – the high risk creditor. This isn’t likely to happen almost by definition.

Third, the Treasury may simply disbelieve that the books at the strong banks are accurate. A good accountant can make nearly anything seem possible, irrespective of legality, and with all the problematic securities floating around, I can buy that the economists at Treasury are skeptical about any bank’s books these days. It’s not fair to the banks that are really strong and that have been managed well and soundly, but I can at least buy this one.

And lastly, the Treasury may be spreading around their risk. Just like a mutual fund spreads around its investments in order to mitigate its exposure to a single stock tanking, Treasury could be figuring that by forcing banks to take a cash loan – and to pay it all back at 5% interest in the first 5 years with a jump to 9% interest afterward – they reduce the chances that they’ll lose money over the long run. After all, if only 5% of all banks are having problems as the ADA President suggests, then even if the Treasury loses every penny on that 5%, they’ll make a killing on the 95% of other banks who survive, likely more than offsetting the losses.

And while I understand that the Treasury is required by law to attempt to make the government money, they probably would have got enough real volunteers to participate in the Capital Purchase Program to still make money on their investment.

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