Monday, 20 April 2009

Repaying TARP loans

Over at the Becker-Posner Blog Gary Becker writes on the repayment of the TARP bank Loans. He explains
Six months ago essentially all large American banks and many smaller ones received loans from the federal government to help shore up their capital base as they tried to weather the financial storm. Some banks would likely have failed during the severe strains in the capital market last September and October were it not for these loans. This past week, however, the two strongest large banks, Goldman Sachs and JPMorgan Chase, indicated that they wanted to, and were able to, repay their loans. Should they be allowed to do so?
Is this just signaling? Are these banks saying to the market, we are in good financial shape and to prove it we will repay our TARP loans. Becker goes on to say,
It appears that not all banks wanted to take government loans in October, but some large banks were apparently "forced" to as part of the TARP loan program devised by then Secretary of the Treasury Henry Paulson. According to some accounts, the government exercised this pressure in order to avoid disclosing which banks were the weakest and needed these loans to survive.
So the government was trying to cover up which banks were in bad shape. There is an obvious question as to whether this was a good idea. Wouldn't people want to know which banks are in a strong position and which are not? Participants in the financial markets surely need as much information as possible to make wiser decisions. Stopping them getting it seems counterproductive.

But my point is that even if this was the government's plan it seems to be unraveling, some banks appear to be trying to signal that they are strong by offering to repay the TARP loans. This would make sense for good banks, they hope to be able to separate themselves out from the bad banks and thus attract more business.

So should the government let the banks repay the loans? If they do they get a lot of money back-the taxpayers will be happy. But they would also provide a way for banks to show they are strong and thereby show which banks are weak. But this is the very separating equilibrium that the government was trying to avoid. Government plans never seem to workout just the way the government thinks they will.

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