The Federal Reserve has this new paper out about TARP that does a bit of highly suggestive eyebrow raising about some banks that shall remain nameless. They start from the awkward fact that TARP wanted everything in one bag but didn't want the bag to be heavy, or as they put it:
The conflicted nature of the TARP objectives reflects the tension between different approaches to the financial crisis. While recapitalization was directed at returning banks to a position of financial stability, these banks were also expected to provide macro-stabilization by converting their new cash into risky loans. TARP was a use of public tax-payer funds and some public opinion argued that the funds should be used to make loans, so that the benefit of the funds would be passed through directly to consumers and businesses.
So you might reasonably ask: were TARP funds locked in the vault to return the recipient banks to financial health, or blown on loans to risky ventures, or other? Well, here is Figure 1 (aggregate commercial and industrial loans from commercial banks in the U.S.):
So ... not loaned then. But that's not important! The authors are actually looking not primarily at aggregate amounts of loans but at riskiness of loans and here's what they get:
Our results indicate that TARP had a surprising effect on bank risk-taking. In our event study and in our regression results, we find evidence that the average risk of loan originations at large TARP banks increased relative to non-TARP banks through 2009 whereas the average risk at small TARP banks decreased relative to non-TARP banks. Evidence also indicates that the interest spreads on loans from the large TARP banks increased substantially following the injections.
This may reflect the conflicting influences of government ownership on bank behavior. Although TARP money was given to increase bank stability and reduce incentives to take excessive risks, it was also given with the understanding that the funds would be used to expand lending during a period of increased risk. These two objectives have an opposing influence on bank risk-taking that may have led to a different effect of TARP on lending by large and small banks. Large banks may also have been more susceptible to the moral hazard associated with government bailout funds given to large “too-big-to-fail” institutions.
Hee hee. Also fun is that large banks reduced lending vs. non-TARP banks while increasing the riskiness of their loans. Lending:
(Don't worry about, like, units. Red line is TARP banks, dotted blue line is non-TARP banks, vertical line is time of TARP receipt, red line goes down faster than blue but recovers 18 months after TARP.) Aaaaand risk:
(Again, units will drive you mad if you let them; don't. Up is riskier.)
I pass this paper along to you in the spirit of copying and pasting charts into a Dealbreaker post so that you'll have charts to look at. It's interesting enough, I guess, but I don't really get worked up about its moral hazard story. If your goal was to measure, like, "did the biggest TARP recipient banks view TARP as a license to do whatever they wanted because they'd always get a government bailout?," one thing you probably wouldn't measure would be commercial loans because that is not ... like ... that is not the particular casino where I'd take my government money if I was feeling frisky, and I doubt I'm alone in that view. That seems to be the sort of business where you, y'know, invest $100 to get $100 back in five years and L+400 along the way. Everything's relative, but that doesn't strike me as a cesspit of moral hazard for people who have access to, like, CDO-squareds.
But the data is kind of fun and maybe you can tell a story from it. I liked this aside:
It is interesting to note that the average risk rating of loan originations at the TARP banks is significantly greater than the average risk rating of loan originations at the non-TARP banks both before and after the TARP injections.
Yes! Interesting! Riskier banks needed bailouts. (And then kept being riskier.)
Maybe one story you'd tell is - well, here is small bank lending activity:
You'll notice that small banks used their TARP money to lend more money to companies, which was the point, unless it wasn't. Also they tended to make less risky loans than non-TARP recipients.
We talked a while back about this cool paper basically demonstrating that bank capital regimes were driving banks to put more of their money into non-lending activities because those activities often get better capital treatment than lending. The author, Patrick Slovik, wrote:
[I]nnovative engineering of regulatory risks and the move to unconventional business practices by systemically important banks has been a consistent trend for almost two decades and was not limited to a few years preceding the financial crisis. The trend reached its lowest point at the onset of the financial crisis when the capital requirements of systemically important banks were determined based on the historically lowest amounts of risk-weighted assets (relative to total assets). Risk-weighted regulation leads to unintended consequences as it encourages innovation designed to bypass the regulatory regime rather than to serve non-financial enterprises and households.
So "systemically important banks" got up to most of their getting up to no good outside of commercial lending, which will probably come as no surprise to most of you, and they were driven to do so by capital requirements.
After TARP, or so my imaginary story goes, little banks, which were always basically in the commercial lending business and were now better capitalized than before TARP, could go make more loans while still looking financially stable, and so they did. On the other hand big banks - systemically important banks - now were better capitalized and so decided to make fewer, though riskier, loans. So where did their TARP money go? Well what if there was a way for them to put that money to work - in some sense, though not the sense involving lending it to companies - while also further improving their capital position, pleasing their TARPmasters and also maybe paying TARP back quicker? That seems like a good imaginary story.