Do Post-Bailout Banks Need New Rules?

Douglas J. Elliott
Douglas J. Elliott Former Brookings Expert, Partner - Oliver Wyman

June 9, 2009

The administration plans to introduce new compensation guidelines that would apply to financial companies, including those that returned taxpayer money. What new federal restrictions, if any, should be imposed on the banks leaving TARP? More broadly, does this move by the Treasury Department show that its financial recovery programs are working? Douglas Elliott and other experts discuss these and other questions in a New York Times running commentary.

It’s further good news that the government is allowing 10 banks to repay $68 billion of TARP funds. This is a logical extension of the positive results of the bank stress tests, which found only $75 billion of additional capital would be needed to keep the big banks healthy through a recession somewhat tougher than we expect. Economic and financial news has been good since the test results were announced, so it’s not surprising that many of the banks are allowed to repay.

However, it is very important not to read too much into the stress tests and the repayments. There remains a great deal of uncertainty about how well the banks will fare through the remainder of this recession. If the stress tests were off by even 3 percent in their valuation of the banks’ assets, we would have found a need for $375 billion, rather than $75 billion. If we knew that now, the markets would tank. It’s sensible to be optimistic that things are leveling out for the banks, but it should be very cautious optimism. We’ve been surprised many times in this crisis; there’s no guarantee that our crystal balls are perfect now.

As for the repayments, it is important that taxpayers get reasonable value for the warrants they still hold in these banks. The banks have done well from all of the federal support, both direct and indirect. It is reasonable to be paid fair market value for those warrants; future political support if we need to provide the banks with more assistance could depend on that.

Along the same lines, I’d be inclined to raise the cost of guaranteeing newly issued bank debt through the F.D.I.C. We are no longer at serious risk of a wider financial meltdown, so we don’t need to make the guarantees so generous in order to reassure everyone.