Bank Share Collapse Points to the Failure of TARP
When Treasury Secretary Henry Paulson announced last month that he would use TARP funds to directly buy shares of banking firms, many on the left and right rejoiced. With an alleged run on the banks in progress, federal dollars borrowed from a private sector already short on risk capital would supposedly lead to a revivification of the banking system.
To its proponents, Paulson’s plan surely sounded nice amid frightened markets, but so far the results have shown yet again that government intervention in the private economy is always and everywhere a false God. Since mid-October the shares of Bank of America, Goldman Sachs and Citigroup are respectively down 45, 51 and 60 percent. Many would note that this past month has been a difficult one for stocks generally, but over that same timeframe, the S&P 500 has fallen a relatively pedestrian 11 percent. It’s also notable that the shares of San Antonio based Frost Bank, a banking concern that refused TARP funds, are down a scant 4 percent.
None of this should surprise us. By definition, federal money invested in private companies can only weaken them. Money supplied absent the sometimes rough hand of market discipline allows its unlucky recipients to delay the changes that brought them to the brink of collapse to begin with, all the while allowing the architects of those same mistakes to remain in place. It can’t be stressed enough that companies don’t so much fail due to lack of money as they collapse because investors lose faith in the executives in charge.
But even more problematic is that despite Paulson’s protests otherwise, there is no such thing as a government handout that doesn’t come with strings attached. Many, including Paulson, will note that the federal government’s shares are non-voting, but whether that’s true or not misses the point. Indeed, just six weeks in we’re already seeing the harm wrought by our federal minders.
First off, rule or no rule, the certain result of the federal lifeline offered to banks will be a curtailment of pay. That is so because a frightened political class eager to appease an angry electorate will make sure to demagogue any large pay packages that appear too big. The top executives at Goldman Sachs have already made public their plan to forego bonuses this year, and while this would have been a tough bonus year regardless of the political climate, it’s a near certainty that top performers elsewhere will be told that their pay must reflect market realities along with political realities.
To many the above might seem just, but a major part of Wall Street and banking’s appeal generally is the pay. To the extent that the young and ambitious shun the industry due to curbs on compensation, the average American will be burned twice. First because a weakened financial sector means that tomorrow’s Googles and Intels will have less skillful sources of finance to access for their world-changing innovations. Second, to the extent that all Americans pay taxes in this country, it will hardly help that the funds invested with their dollars will be overseen by the less qualified individuals willing to work in an industry that has lost some of its allure.
So to the extent that federal funds allegedly saved certain banks in the near-term, those same banks will surely pay over the long-term as the best and brightest exit the industry. There are no numbers supporting this yet, but it would be folly to assume that Goldman Sachs will recruit as effectively (Microsoft’s Bill Gates long noted that GS served as his greatest competitor when it came to attracting fecund minds) going forward considering that handsome compensation was one of the firm’s greatest calling cards. Goldman’s stock price surely to some degree reflects a future that is less bright.
But perhaps what will weaken Goldman the most over time was the requirement that it reclassify itself as a banking entity in order to partake in the Treasury’s giveaway program. It’s long been said that Goldman Sachs is a hedge fund wrapped inside an investment bank, and while it would be overkill to assume that its aggressive culture will be completely emasculated, it’s also true that as a heavily regulated bank, it will no longer be able to take the risks associated with big returns and impressive pay.
And when we consider bank lending generally, there was seemingly a broad consensus about how we got here. In particular, there existed the belief that the non-economic lending spawned by the Community Reinvestment Act and the empowerment of Fannie and Freddie was the major driver of a financial crisis that led banks to line up for federal help to begin with.
The above is interesting considering how many now countenance Paulson’s investments in the banking system. Speaking once again to the truth that there’s no federal money absent strings attached, Treasury has made it clear that banks must aggressively lend in order to lift the economy out of the ditch. That being the case, it’s very apparent that to the degree banks comply, more non-economic lending will materialize such that the seeds of the next financial crisis are being planted right now.
Worse, governmental demands that banks lend with no regard to prevailing market conditions are an impoverishing concept. How soon we forgot that a successful capitalist system is reliant on the efficient deployment of capital.
So what about the Frost Banks of the world that were careful, and in avoiding big mistakes, had no need to access federal funds? Is it fair that the prudent will have to compete with the imprudent now playing with funny money? Isn't capitalism a system of success and failure whereby the survivors gobble up those who don't succeed? If so, a bailout that so many said was essential to the health of our capitalist system will tear down capitalism's basic foundations in the process.
With bank shares continuing to fall, the best long-term scenario we can hope for is that thanks to the federal government’s shocking ineptitude as economic backstop, we’ll have historical precedent to bolster the non-intervention argument the next time time around; "next time" perhaps coming sooner than we think given a Treasury that has pushed money out to banks while shouting, "Lend!"
So while it’s surely nice to think that government money borrowed from the private sector can somehow smooth out periods of economic uncertainty, TARP’s impressive failure shows yet again that far from stimulating, government “help” is an oxymoron that bats 1.000 when it comes to scaring away investors.