Should banks repay TARP funds?

Last fall, Hank Paulson forced big banks to take funds from the Troubled Asset Relief Program (TARP) -- which has yet to provide an iota of Troubled Asset Relief -- and so far about $576 billion has gone out in the form of preferred stock. Paulson forced banks to take the money so that the ones that really needed it would not be stigmatized by investors and customers. Of course, any trader with a grain of a brain could see through that little scam -- and did drive down the stock prices of the real financial disasters (e.g., Citigroup (C)) to nearly zero.

Now some of those banks that probably never needed the money in the first place -- such as Goldman Sachs (GS), JPMorgan Chase (JPM) and Morgan Stanley (MS) -- want to pay back their $45 billion worth of TARP funds. Of course, they're not in the driver's seat -- the White House is. But if Tim Geithner is to be believed -- they won't get their wish since he just announced that only $25 billion will be repaid in the next year. Regardless, I think the White House should decide whether to let them pay back the money based on the answers to three questions:

  • How will paying back the money affect the strength of the global financial system?
  • If the banks that repay TARP funds need government capital in the future, will they be able to get it?
  • If the banks repay TARP funds, will taxpayers get a return on their investment?

How will paying back the money affect the strength of the global financial system?Repaying TARP would materially weaken the global financial system. How so? The banks that repay the TARP will be in a position to pay higher compensation than the ones that don't.

This means that the banks that are most at risk will lose talent. The talent will take its customers to their new employers. The result will be a potentially sudden failure of some very large banks. And unless the U.S. is prepared to handle the failure of some enormous banks, letting some banks repay the TARP would be bad news for the financial system.

If the banks that repay the TARP need government capital in the future, will they be able to get it?It depends on how much money they need. If these banks repay the TARP now and the money is still left a few quarters from now, then the government could give it back to these banks. But if that happened, there would likely be some pretty turbulent conditions which could rattle Congress enough to get it to loosen up even more taxpayer money if needed.

If the banks repay the TARP, will the taxpayers get a return on their investment? It depends on how much the U.S. decides to require the banks to repay to settle the terms of the warrants -- which gave the U.S. the option to buy the bank's stock at a low price -- it got along with its preferred investment. Taxpayer profit will not come from repaying the preferred but from the price the U.S. extracts as a condition of freeing banks from the TARP pay restrictions.

In addition, the taxpayer will still be at risk through the FDIC and other government entities which are providing guarantees for bank debt issuance. Until those banks can issue debt without taxpayer help, they should be under those pay restrictions -- which as I posted should include requiring all financial institutions to put banker and trader pay in escrow.

My conclusion is that given the risk of systemic failure, it would be a bad idea to let the banks repay the TARP on June 8 -- the date being floated. Waiting longer until this risk subsides or the U.S. can handle big bank failures will strengthen the financial system and potentially increase taxpayer returns.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book isYou Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He owns Citi shares and has no financial interest in the other securities mentioned.

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