The Financial Times reports that banks and other financial institutions which received TARP funds may not be allowed to repay the loans. Yes, that is correct:

Strong banks will be allowed to repay bail-out funds they received from the US government but only if such a move passes a test to determine whether it is in the national economic interest, a senior administration official has told the Financial Times.

“Our general objective is going to be what is good for the system,” the senior official said. “We want the system to have enough capital.”

I understand that there are systemic issues as to liquidity, but I don’t recall any discussion when TARP passed that the government would not allow the loans to be repaid. The original purpose of TARP was to rescue failing financial institutions and stabilize the housing market by using federal funds to buy bad mortgages; and then TARP was changed to provide direct investment into financial institutions in order to stabilize balance sheets and provide liquidity.

According to the Financial Times article, the purpose has morphed yet again, this time into a recession management tool:

The official, meanwhile, said banks that had plenty of capital and had demonstrated an ability to raise fresh capital from the market should in principle be able to repay government funds. But the judgment would be made in the context of the wider economic interest. He said the government had three basic tests. It needed first to “make sure the system is stable”. Second, to not create “incentives for more deleveraging which would deepen the recession”. Third, to make sure the system had enough capital to “provide credit to support the recovery”.

Something is wrong here. This is taxpayer money, to the tune of $246.73 billion, handed out to banks to avoid a banking system collapse. That collapse, if it ever were a real threat, no longer is a threat. If this were a consumer loan, the banks which received the money could cry fraud:

JPMorgan Chase Chief Executive James Dimon said Thursday that his firm is eager to return the $25 billion they’ve received from the government, and will do so as soon as possible.

“We could pay it back tomorrow,” Dimon told reporters Thursday morning. “We’re waiting for guidance from the government.”

The justification for refusing to take the funds back is that the administration wants more lending. But maybe the problem is not a lack of liquidity, but a lack of credit-worthy borrowers. If we force banks to keep the money, the next step will be to require banks to lend the money by lowering credit standards, which is exactly the policy which got us into this problem in the first place. And to the extent the banks want to remove executive compensation restrictions to keep personnel, forcing the banks to keep the money and the restrictions may feel good, but it won’t get banks to lend.

There also is evidence that the government is contributing to the problems. Fannie Mae and Freddie Mac have added a 0.75% surcharge to all condominium loans regardless of the borrower’s credit rating, in addition to other surcharges on other types of properties.

It is one thing for the government to lend money to banks to help the banks survive. It is someting quite different to use the lending to maintain control of the private sector when the specific borrower-bank no longer needs the money. And the greatest irony is that many banks which didn’t want or need TARP money took it at the insistence of the feds, and now they can’t pay it back.

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