Banks Controlled Regulators During Bailout

Econintersect:  September 29, 2011 the latest report from SIGTARP (Special Inspector General for the Troubled Asset Relief Program) was issued.  It reveals a picture of banks directing the regulators instead of the reverse.  The report criticizes the Treasury for appearing to be more concerned with appearances of bank capital positions than with their adequacy.  The role played by Treasury Secretary Timothy Geithner is specified in some detail in the report summary.The situation being discussed in the latest report concerns the ten large banks that were determined weakest in the infamous stress tests of 2009. These were Bank of America, Citigroup, Fifth Third Bancorp, GMAC, KeyCorp, Morgan Stanley, PNC, Regions Financial, SunTrust, and Wells Fargo. Nine of them proceeded to raise additional and eventually close their TARP obligations.  GMAC was unable to do so and was refinanced Automotive Industry Financing Program, eventually reorganized into Ally Bank, 70% owned by the government.

The latest SIGTARP report contains the following:

…three aspects of the TARP exit process serve as important lessons learned.

First, Federal banking regulators relaxed the November 2009 repayment criteria only weeks after they were established, bowing at least in part to a desire to ramp back the Government’s stake in financial institutions and to pressure by institutions seeking a swift TARP exit to avoid executive compensation restrictions and the stigma associated with TARP participation. The large financial institutions seeking to exit TARP were notably persistent in their efforts to resist regulatory demands to issue common stock, seeking instead more creative, cheaper, and less sturdy alternatives that provide less short- or long-term loss protection than new common stock.  Bank of America, Wells Fargo, and PNC, for example, requested expedited repayment, but each institution balked at issuing the amount of common stock required by regulators.  When Bank of America, Citigroup, and Wells Fargo repaid Treasury in December 2009, only Citigroup met the 1-for-2 minimum established by the guidance, combining new common stock and other types of capital to meet a more stringent requirement.  Because the regulators failed to adhere to FRB’s clearly and recently established requirements, the process to review a TARP bank’s exit proposal was ad hoc and inconsistent.

Second, by not waiting until the banks were in a position to meet the 1-for-2 provision entirely with new common stock, there was arguably a missed opportunity to further strengthen the quality of each institution’s capital base to protect against future losses without selling sources of revenue. Although the 1-for-2 minimum was established as a capital buffer to allow each bank to absorb losses under adverse market conditions, the discussion quickly switched to analysis of how much common stock the market could absorb during a frenzied period in which each of these TARP banks wanted to exit at that time based in part on news that other large banks were exiting TARP. Concerned about executive compensation restrictions and a lack of market confidence that might result from being the last large TARP bank to exit, banks successfully convinced regulators that it was the right time to exit TARP, and that the market would not support a 1-for-2 common stock issuance. There was arguably a missed opportunity to wait until the market could absorb a 1-for-2 common stock issuance, which would have had long lasting consequences in further strengthening the quality of the banks’ capital base.

Third, SIGTARP also found that Treasury encouraged TARP banks to expedite repayment, opening Treasury to criticism that it put accelerating TARP repayment ahead of ensuring that institutions exiting TARP were sufficiently strong to do so safely.  Treasury Secretary Timothy F. Geithner told SIGTARP that putting pressure on firms to raise private capital was part of a “forceful strategy of raising capital early” and “We thought the American economy would be in a better position if [the firms] went out and raised capital.”  Treasury’s involvement was also more extensive than previously understood publicly.  While regulators negotiated the terms of repayment with individual institutions, Treasury hosted and participated in critical meetings about the repayment guidance, commented on individual TARP recipient’s repayment proposals, and in at least one instance urged the bank (Wells Fargo) to expedite its repayment plan. The result was a nearly simultaneous exit by Bank of America, Wells Fargo, and Citigroup, involving offerings of a combined total of $49.1 billion in new common stock in an already fragile market, despite warnings that large and contemporaneous equity offerings might be too much for the market to bear. While none of the offerings failed, Citigroup exercised only a portion of its overallotment option, and later complained that Wells Fargo’s simultaneous offering sapped demand for Citigroup’s stock.

A report in Seattlepi covers some of the other factors mentioned in the report:

The regulators also were motivated by a desire to cut the government’s stake in the banks it had bailed out in September 2008 when the financial crisis struck, the report says.

Meanwhile, the banks wanted to get out quickly from the so-called Troubled Asset Relief Program, or TARP, because they wanted to avoid its limits on executive compensation and the stigma associated with receiving rescue money, according to the report.

The same report from Seattlepi contains statement of disagreement with the SIGTARP report by The Office of the Controller of the Currency, as well as a statement from the Fed that, while it led the review of the bank’s repayment proposals, it consulted with all agencies.

Another quote from Seattlepi:

Robert Stickler, a spokesman for Charlotte, N.C.-based Bank of America, said the bank’s wanting to issue stock “all at once rather than in stages was because of market conditions.”

He rejected the idea that his bank might have pressured the regulators for a quicker exit. The bank’s primary motivation was to remove the stigma of being a TARP recipient, Stickler said, and there also was concern that the restraints on executive pay were making it hard for them to keep executives.

Editor’s note: Hard to retain executives?  Where would they have gone? To prison?

Sources:  SIGTARP.gov and Seattlepi

Hat tip to Brad Smith