TARP Sees Sharp Turnaround

Are TARP Repayments a Sign of Financial Health — or a Way Around Pay Constraints?

In just four months, government loss estimates for the Troubled Asset Relief Program (TARP) fund have plummeted $200 billion, from about $342 billion to $141 billion. That still leaves taxpayers on the hook for huge liabilities, but it’s a big improvement. Most of the big banks have been paying back at least some of their TARP loans. Meanwhile, President Obama was expected to announce today that much of the savings vs. estimated losses will be now used for job-creation stimulus programs.

Although news that TARP appears to be less expensive than forecast earlier surprised some, it probably should not have, says Wharton finance professor Richard Marston. “Think about what it depends upon – the value of the assets on the balance sheets of the troubled banks as estimated at the time. If the assets have to be marked down a lot, losses are larger.”

But since March, “there has been what I call a sigh-of-relief rally in most risky markets worldwide,” Marston added. The sense of relief came as markets realized “the sky was not going to fall and the economy was going to survive this financial crisis.” So stocks of all types and bonds rallied. “It’s interesting the Treasury bonds have far underperformed corporate bonds and other riskier types of bonds.” And how does that affect TARP costs? “Well, if the prices of bonds rally, then any estimates of potential losses on the assets in the troubled banks have to be reduced as the prices of assets rise. So the cost of the rescue goes down.” Still, “all of this begs the question about whether the Obama administration is right to spend the extra money on new stimulus measures,” Marston says.

Franklin Allen, Wharton finance professor, also questions how successful any jobs program will be. He notes that the financial sector is recovering rapidly and that “it is good they won’t need the funds for financial institutions. The key issue is how they will spend the money for the jobs program. Unfortunately, the politics may mean the money is wasted.”

What’s more, it may be too early to pass final judgment on whether the TARP program is coming in below budget long term. “I would not be surprised to see Bank of America (BoA) back again,” says Richard J. Herring, a Wharton Finance professor, referring to $45 billion in Tarp funds recently repaid by Bank of America (BoA).

“I would interpret the unanticipated repayments as an unintended consequence of setting up a Pay Czar to oversee compensation for the top executives who participate in the TARP program,” Herring points out. “He has become, in effect, a very effective collection agent for TARP repayments. But this may not be in the best interests of stabilizing the banking system.”

Andrew Ross Sorkin, the author of the book Too Big to Fail, agrees. In his column in The New York Times today — under the headline “Bailout Refund Is All About Pay, Pay, Pay” — he considers why BoA was “in such a rush” to repay TARP loans. In addition to wanting to improve its public image, BoA is trying to find a “new chief executive to replace retiring Ken Lewis” and believed it “needed to repay the bailout money to offer a competitive compensation package…. Bank of America was so desperate, in fact, that it diluted its own shareholders by selling new shares worth $18.8 billion to replace some of the funds it is returning.”

Meantime, while most of the largest banks have been working to repay TARP funds, regional banks at the next level down in the banking industry’s pecking order have been noticeably absent. The reason: “Mounting defaults on commercial property may keep regional lenders from repaying bailout funds until at least 2011,” according to a Bloomberg report. Regional banks are almost four times more concentrated in commercial property loans than the nation’s biggest lenders.

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