News Item: Nearly 100 Banks Benefiting from TARP Are on the Brink of Collapse

According to the Wall Street Journal’s Michael Rapoport (“Bailed-Out Banks Slip toward Failure”, 12/27/2010, p. C1), 98 U.S. financial institutions, which collectively were granted $4.2 billion in handouts under Washington’s Troubled Asset Relief Program (TARP), are in danger of going belly-up.

The commercial banks imminently in peril, such as the Legacy Bank of Milwaukee and CommunityOne Bank of Asheboro, N.C., are in general “small”, i.e., less than $500 million in assets, “significantly undercapitalized” and saddled with nonperforming loans financing investments in commercial real estate. In the opinion of the General Accountability Office, the at-risk institutions are much “weaker than other [TARP] recipients and should have gotten more scrutiny before receiving taxpayer funded infusions”.

Why should we not be surprised?

In the rush to avert what was portrayed as the impending implosion of domestic financial markets, the Federal Reserve System and the U.S. Treasury asked for and received congressional approval of a program aimed at bailing out lenders that had made loans to homeowners and other investors in real estate that they could not plausibly be expected to repay. As my Independent Institute colleague Robert Higgs has so well documented, the government-inspired atmosphere of “crisis” supplied ideal conditions for expansionary governmental intervention at the expense of ordinary Americans.

A recent federal government assessment crows that TARP has been a good deal for taxpayers, estimating that it will cost us “only” $25 billion. But that figure includes repayments of TARP funds by recipients that didn’t want them in the first place. Perhaps taking lessons from his (inattentive) study of the Great Depression, Fed Chairman Ben Bernanke thought he could avoid the political firestorm that followed disclosure of the identities of the banks receiving loans from President Herbert Hoover’s Reconstruction Finance Corporation (RFC) by forcing all of today’s big players to accept them. (Taking advantage of RFC largesse was interpreted at the time as evidence that recipients were in dire financial straits and, hence, may have precipitated “runs” by depositors on them.)

Soon after the bursting of the housing bubble became evident in December 2007, he and Treasury Secretary Paulson therefore convened a meeting of the representatives of major Wall Street financial institutions at which all present, regardless of financial condition, were told in no uncertain terms that were would be participating in TARP.

Meanwhile, the Fed’s second program of “quantitative easing” (QE2) has, by raising bond prices and lowering their yields, shifted investment capital to the generally more risky stock market (Jon Hilsenrath, “For Tough Fed Call, Even Hindsight is Not 20-20”, Wall Street Journal, 12/27/2010, p. A2).

To be fair, the Fed’s dual mandate, under the Humphrey-Hawkins Act, demands that it foster price stability and full employment. Given its policy tools, it can accomplish one, but not both goals. Many respectable commentators have recommended that the Fed be abolished. Given that that objective is in all likelihood not yet politically feasible (although I support it in principle), repeal of the Humphrey-Hawkins Act would restore a modicum of sanity to current monetary and fiscal policy, the point of which should be to allow competitive market forces, not governmental policy, to sort winners from losers.

William F. Shughart II is a Distinguished Research Advisor and Senior Fellow at the Independent Institute, the J. Fish Smith Professor in Public Choice at Utah State University, past President of the Public Choice Society as well as the Southern Economic Association, and editor of the Independent book, Taxing Choice.
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