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March 11th, 2009

Government and TARP Banks in Tug-of-War



The laundry list of concerns over giving banks TARP money is growing by the day, and it’s growing from banks and industry experts alike. If you’re a consistent reader of this blog you’re well aware of the regulatory baggage that accompanies TARP money as well as the financial dangers of supporting weak institutions with round after round of taxpayer funding:

“I honestly believe the people in power pushing this policy see it as a win-win – as something that is good for the banking industry and good for homeowners and others,” said Douglas Elliott, a former investment banker who is now an economics fellow at the Brookings Institution. “But there is a slippery slope and there are potentially significant negative consequences.”

Financial institutions must maintain a certain level of capital that allows them to operate at a “healthy” level. During times of economic strain, banks need to retract their operations in order to preserve capital. Yet as credit lines and lending have diminished across the board, the government has demanded institutions (especially those receiving TARP money) jump-start lending, thus stretching their capital dangerously thin. Elliott says the tug-of-war between Washington’s policies and the banks’ weak financial positions is foreshadowing a crisis similar to one that developed under Fannie Mae and Freddie Mac in the 1990s:

In service of both shareholders and what they asserted was the public good, Fannie and Freddie borrowed extensively in order to buy and hold mortgages in their own investment portfolios. They purchased billions of dollars in risky subprime mortgages. As a consequence of having a public mandate, they also had a credit line with the U.S. Treasury and their risky business strategies were viewed by the markets as being guaranteed by the government.

To satisfy both mandates, the companies also faced fewer restrictions and were allowed to take on more debt than other financial companies. But when buyers began defaulting and home prices plunged, the companies nearly collapsed and last fall were placed under government conservatorship. Elliott said that some banks participating in the bailout program were now in the same conflicting position that Fannie Mae and Freddie Mac were.

Understanding these mounting circumstances many banks have begun returning, or at least considering returning, TARP funds.

The government has invested so much taxpayer money in these weak institutions to keep them afloat. Some are regarded as “too big to fail”; this is a concept which Fed Chief Ben Bernanke claims has taken an enormous toll on financial markets. Yet, their fragile financial status has made it difficult to perform for consumers as Washington wishes they will. As of now the tug-of-war continues.

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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