Get Ready for More Failures of Bailed-Out Banks

Ever since the banking industry began to heal after the financial crisis, the bank bailout appeared to be working. By now, most very big banks have paid back what they owed the government. Even AIG -- one of the most troubled bailout recipients of them all -- is on track to leave taxpayers with little or no loss. But most of these news stories focus on the large institutions that most Americans have heard of, like Citigroup, JP Morgan, and Bank of America. Many smaller banks that took government aid aren't faring as well.

In fact, Michael Rapoport of the Wall Street Journal reports that nearly 100 U.S. banks that took bailout (aka "TARP") cash are in danger of failing:

Seven TARP recipients have already failed, resulting in more than $2.7 billion in lost TARP funds. Most of the troubled TARP recipients are small, plagued by wayward lending programs from which they might not recover. The median size of the 98 banks was $439 million in assets as of Sept. 30. The median TARP infusion for each was $10 million, federal filings show.

So the losses we're talking about here are in the millions of dollars for most of these banks, not in the billions, since smaller banks took less bailout money. The article says that these institutions took a total of $4.2 billion. That's a significant amount of money, but considering that we're talking about 100 banks here, it could be worse. Indeed, this is just a fraction of the loss that might have resulted if just one large institution had failed. This also assumes that the government doesn't manage to get anything back during liquidation from these smaller banks.

You might think that the government would be working hard to make sure that bailed-out banks don't fail. After all, wasn't that the spirit of the bailout in the first place, and wouldn't the Treasury want to save taxpayers as much money as possible? There's a strange tension that may arise here, however.

First, there's the Obama administration's point-of-view. Its job is to ensure that taxpayers' loss is minimized. As a result, it's beginning to get aggressive with banks that are having trouble making dividend payments on the money they owe the government, according to an article by Zachary A. Goldfarb in the Washington Post today. He writes:

The Obama administration has begun monitoring the high-level board meetings of nearly 20 banks that received emergency taxpayer assistance but repeatedly failed to pay the required dividends, according to Treasury Department officials and documents. And it may soon install new directors on some of their boards.

Really, pushing for new management is all the Treasury has the power to do at this time: it can't loan banks any more money, since TARP has expired. If management can't turn around these banks -- and in some cases, their loan losses might be so great that even the best management couldn't prevent their failure -- then there's nothing the Treasury can do.

In the meantime, the Federal Deposit Insurance Corporation can't really be swayed by any attempts by the Treasury to keep these institutions afloat. If they need to be resolved, then it's the regulator's job to wind them down or sell them to another institution. And the WSJ article mentioned earlier implies that we may begin to see more of that in the days to come.

Despite the good news constantly reported about the success of the bank bailout, relatively few firms have paid back the government in full. According to ProPublica, of the 935 recipients, just 85 have returned all their bailout money. That leaves 850 that still owe the government.

Even though the Treasury certainly wants to see these institutions succeed, and taxpayers to take the smallest loss possible, at some point it will have to be practical. The bank bailout did, indeed, serve its intended purpose. It helped to stabilize the financial system when it was on the brink. The very large "too big to fail" banks have mostly recovered. Those still struggling should probably have failed, not because of mere panic, but because their loan portfolios produced losses too catastrophic to recover from. Over the next year or two, we can expect to see the FDIC take over more bailout banks falling into this category.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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