Why Is The Treasury Pressuring Banks To Repay Bailout Cash?

Yesterday, I noted that Wall Street is likely to pay out a record amount of bonuses to its employees. As earnings reports come out, we're seeing some fantastic third quarters from banks like JP Morgan and Goldman Sachs. As a result, it might not seem surprising that the Treasury has begun urging banks to repay their bailout money, if they haven't already. Despite the recent success of some banks, I'm not convinced this is a wise move, and I worry its motivation is more political than practical.

The NY Times reports:

Concluding that some of the nation's biggest banks are in good enough shape to raise capital from private investors, senior Treasury officials would like more of them to repay billions of dollars in taxpayer money that bailed them out over the last year.

It's a little unclear which banks these Treasury official are referring to. I doubt one is Bank of America, as I understand it would like to begin repaying, but the Treasury isn't convinced it's stable enough to do so. I certainly hope Citigroup isn't on the list -- it's still a disaster.

In banking, a sort of line has been drawn in the sand at this point. There are banks that have paid back the bailout money and those that have not. The former group is considered far healthier, while the latter is generally considered still unable to easily raise the capital necessary. But the NY Times suggests another reason why banks haven't repaid the government:

But many of those banks would prefer to keep the money for several more years rather than raise new money and dilute their existing stockholders.

Perhaps, but I find that unlikely. No bank's management in its right mind should want to remain under Uncle Sam's thumb. Just ask Bank of America. What's a little shareholder dilution when you can free yourself from being a ward of the state?

The real reasons, I think, are cited by a few NY Times sources:

"The banking system remains fragile," Daniel K. Tarullo, a Federal Reserve governor, told the Senate Banking Committee on Wednesday. "Although capital ratios are considerably higher than they were at the start of the crisis for many banking organizations, poor loan quality, subpar earnings, and uncertainty about future conditions raise questions about capital adequacy for some institutions."

John C. Dugan, the comptroller of the currency, expressed similar caution. "We anticipate additional capital and reserves will be needed to absorb the potential losses in banks' portfolios," Mr. Dugan warned Senate lawmakers on Wednesday.

That's right. It's premature to think that banks are totally out of the woods. Many have a lot to prove and more losses to endure before they can raise capital at a reasonable price on their own.

So we return to the question: what's the Treasury thinking? I suspect it's worried about public perception. Anyone who reads a headline about Goldman's or JP Morgan's $3+ billion third quarters or billions in bonuses might think that it's back to business as usual in banking. Even if that isn't entirely true, the Treasury probably cares about what people think, valid or not. The public sees banks doing tremendously well, but lots of bailout money still in their hands. That isn't going to make the Treasury politically popular.

Of course, this problem could have been remedied easily enough: the Treasury could have created a more well-defined exit procedure for banks to follow. For example, it could have argued that, as soon as a bank shows three straight quarters of positive profits, it must repay its bailout money in full. That way, the Treasury could simply say that the banks who haven't given the cash back simply aren't healthy enough to do so -- and would have a mechanism to back that claim up.

Yet, such rules might have been misguided. After all, if the U.S. happens to experience a double-dip credit crisis, then those banks that chose not to rush to repay may have made a wise choice, and one the Treasury should allow. Indeed, it should not want banks to repay the capital before they are comfortable doing so. Yet, that's exactly what could result through pressure.