Using a program similar to the ones that regulators in the United States are using to help Citigroup and Bank of America, the government of the United Kingdom is looking to offer the same type of help to many of their big institutions with suffering loan portfolios. The program is aimed to “reinforce the stability of the financial system, to increase confidence and capacity to lend, and in turn to support the recovery of the economy,” claims the U.K. Treasury in a statement.
Loan guarantees to a wide range of banks and financial institutions is one of the options President Barack Obama is looking into as a way to restore economic growth in the United States. Unfortunately the plan has some key flaws in it according to skeptics, and these flaws are similar to ones found in the plans enacted by the Bush administration when they attempted to use the Troubled Asset Relief Program (TARP) to bailout the financial institutions. TARP promised banks and other financial institutions around $350 billion in help since October 2008.
The aforementioned problem is that a loan guaranteed plan will not force the banks to completely recognize the losses they suffered or the souring positions that they took on during the credit boom that ended during the summer of 2007. According to Joseph Mason, a finance professor at Louisiana State University, banks have to write off bad loans and work to raise new capital. If they don’t, any taxpayer funds that are used to support the weak economic system are only going to help existing institutions at a greater expense to the American people who are already suffering with their own stressed finances. “Until we start recognizing the losses, we’re just engaging in crony capitalism,” said Mason, who also works as a banking industry consultant. “Executives of banks that get federal support without being forced to take adequate writedowns,” he adds, “are using Congress as a piggybank.”
The first half of TARP was used to buy preferred shares in banks under the impression that banks’ capital shortfalls had to be filled before they could extend loans to boost the economy. Banks like Citigroup, JPMorganChase, and Goldman Sachs received funds that came with few strings attached that supposedly resulted in a more stable financial system and were adopted from a plan launched by regulators in the United Kingdom. However, the sharp economic decline at the end of 2008 and additional crisis that popped up forced the government to give $400 billion more in aid to CitiGroup and Bank of America, showing that TARP was inadequate to help. And, of course, the United States was not the only one to suffer.
Under the Obama administration banks may be expected to continue their outflow of money to help bolster the economy and credit growth. David Axelrod, Obama’s senior advisor, stated, “I think he is going to have a strong message for the bankers. We don’t want them to sit on any money that they get from taxpayers.”
Ed Gainor, a structured finance lawyer at McKee Nelson in Washington, feels that this type of dictation to the lenders could be counterproductive since lenders are conserving their capital due to the slumping economy and the raised odds that good borrowers could still default if they lose jobs. “Demanding that they make loans is somewhat silly on a grand scale,” says Gainor. “If the lenders can lend and make a profit, that’s what they will do.” Mason said the strong message the government needs to send is that existing losses must be recognized, and failing institutions allowed to fail.
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