Outside the Beltway

Thanks, But Here’s Your Money Back

Steve Verdon · Friday, March 13, 2009 · 5 comments

Banks that took bailout money are now finding out that the money came with strings attached. Color me shocked.

The list of demands keeps getting longer. Financial institutions that are getting government bailout funds have been told to put off evictions and modify mortgages for distressed homeowners. They must let shareholders vote on executive pay packages. They must slash dividends, cancel employee training and morale-building exercises, and withdraw job offers to foreign citizens.

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One of the biggest concerns of the banks is that the program lets Congress and the administration pile on new conditions at any time.

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The demands to modify mortgages or forestall evictions are especially onerous, some bank executives and experts say, because they could prompt some institutions to take steps that could lead to greater losses.

“We are taking an approach that wants the banks to help the economy and whether it is ultimately good for a particular bank is secondary,” said L. William Seidman, the former senior regulator during the savings and loan bailout. “Weak banks are being asked to do things that will erode their position.”

In other words, financial institutions are now being told to engage in politically motivated policies instead of policies that are designed specifically to return the financial institutions to a sound financial footing.

The article also points out that many of these institutions could find themselves in a Fannie Mae/Freddie Mac type of situation. Where these banks have duel objectives of trying to generate a profit for their shareholders, but at the same follow public policy dictates. It is even conceivable that these institutions have fewer restrictions than they otherwise would so that they can pursue the public policies. It could make the situation worse.

He and other experts also worry that, by relying on weak banks to carry out the administration’s or Congress’s policies, officials are not biting the bullet and shutting down weak banks that may be insolvent.

Worry? I think the possibility of this happening is quite significant. After all, when Fannie and Freddie were on the verge of collapsing the government stepped in and has propped them up. And a bank that is insolvent and totally dependent on the government for its continued existence is going to be quite malleable to the government’s dictates.

The article notes that during the savings and loan crisis in the late 1980’s and the early 1990’s the policy was to shut down weak institutions rather quickly. The thinking was that the weak banks damaged healthy ones since it is harder for a healthy bank to compete with a bank that is being backed by Uncle Sam.

The response that these banks are “too big to let fail” might be part of the problem though. After all, by propping up a bank that just about everybody suspects of being insolvent it creates uncertainty in the market. Further, the government’s past inconsistency in terms of bailouts doesn’t help either. Sure the Feds are propping up Citibank for now, but could they let them go the way of Lehmen? So everybody is sitting around waiting for the other shoe to drop. Thus the situation is prolonged raising the cost of the bailout. And that adds to the view that since the costs are growing they need even more control over how the money is spent.

C. R. Cloutier, the president of MidSouth Bank of Lafayette, La., and a survivor of the savings and loan debacle, said that his institution received $20 million from the rescue fund because he and his board believed it was patriotic and would help them offer loans during a recession.

But faced with what he says is an unwarranted stigma of participating in the program, as well as the new restrictions on banks taking the money, he is now considering whether to return the money, as other institutions have sought to do.

“Two things you learn in the banking business,” Mr. Cloutier said. “The first is, concentration is bad. We now have 64 percent of deposits in eight institutions. The second rule is, your first loss is your best loss. Get it over with. Don’t pump water in a dead fish.”

Japan went through something similar. They propped up bad banks for years, and the economy was sluggish during those years. Things only turned around when they realized the bad banks couldn’t be propped up indefinitely and faced the pain of restructuring their banking industry. Looks like we are going to do the same thing.