If TARP Was So Smart, Why Are So Many Banks Failing?

So we taxpayers actually made money on the Troubled Asset Relief Program-at least so far. Goldman Sachs (GS), JP Morgan (JPM) and others have repaid the loans from the government, with interest, and the equity stakes that we hold in Citigroup (C) and Bank of America (BAC) have appreciated since Hank Paulson and Tim Geithner got us in. The Wall Street Journal this morning estimates that Uncles Sam made $30 billion on the deal.

But things aren't going so well outside the pale of banks too big to fail. The FDIC faces losses of $21 billion from the 84 banks that have gone under so far this year--more than in all of last year--and another 400+ banks are on its watchlist, the most in 15 years. If TARP was such a brilliant success, why do so many banks keep failing?

The answer is all pretty much contained in this report from the Congressional Oversight Panel, the senate panel assembled under Elizabeth Warren to keep an eye on TARP's progress. The one sentence version is that that Troubled Asset Relief Program has not, to date, offered any relief to troubled assets. It has done a nice job of building up capital for banks that the Feds deemed too big to fail. But the troubled loans that were the program's original targets haven't gone anywhere. We have just kicked that can down the road.

At the time the TARP was proposed, remember, the idea was to buy the spoiled mortgage loans and derivatives that were crippling the banking industry and in doing so, arrest the deterioration of the banks assets. But the loans proved too hard to value, the purchases too tricky to make, and the crisis was moving too fast. So the Treasury and the Fed decided instead to use TARP money to shore up the banks' capital. That helped stem the panic, but it left hundreds of small and medium sized banks in a precarious position,for a few reasons:

The toxic loans are still there and still toxic. An accounting rule change allows banks to carry illiquid securities at higher values than the market would put on them. But assets that default still have to be written down, and the only thing that would fix the continued deterioration of loans is a slowdown in home foreclosures, a drop in unemployment and a rebound in real estate values. We're not there yet.
Smaller banks are hit hardest. Among other problems, they have a harder time raising capital in the securities markets, and hold a lot of commercial mortgages, which are about to be clobbered.
That's bad for small businesses, which rely on regional banks for their borrowing needs.

Yes, it's nice for taxpayers to get some return on our investment in Goldman Sachs and JP Morgan and others whose outside profits and bonuses we've helped to fund. But let's not spend our payback just yet. Meredith Whitney, the celebrity bank analyst with Whitney Advisory Group, told the Federal Reserve presidents at their Jackson Hole retreat last month that 300 small and mid-sized banks would probably fail. We won't be seeing any ROI from them.

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