Another bad policy decision may be in the offing. According to the FT, an Obama official says the administration will only let banks pay back TARP if their doing so is good for the overall system:
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.”
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”.
Translation: We’ll only let Goldman pay back TARP if we don’t think this will make Bank of America look like a basket case.
The administration’s concern here is presumably that allowing some banks to pay back TARP will trigger a run on the banks that can’t. The administration has also said, however, that it will bail out any bank that needs money (also a bad policy decision), so this shouldn’t be a serious concern.
More importantly, if Goldman pays back its TARP and the market punishes Bank Of America for not being able to do so, that’s fine. That’s what the market is supposed to do: Differentiate between “A” students and “D” (or worse) students. The moment you decree that, for the sake of the system, everyone has to be a “C-minus” student is the day you really have veered into socialism.
The “system” still has problems, but it will repair itself far more quickly if we allow the fittest to survive and the rest to fail. Despite the shoveling of hundreds of billions of dollars of bailout money into our banks, they’re still lending far less than they were last fall. Importantly, this is not just because they need to hoard their capital to protect against future writeoffs. It’s because there’s less demand for loans–and fewer creditworthy borrowers to lend to.
In other words, the system needs less lending capacity than it did two years ago. If a few basket-case banks go bust, therefore, the strong ones will can pick up the slack. And the “system” as a whole will be much stronger than if we force all banks to be mediocre and then help them all limp along.