TARP Postscript: FDIC’s Little Secret

There was an interesting story making the rounds last week which drew comparisons between US Banks with more than $1Billion in assets (a.k.a. those dastardly Wall Street Banks) and smaller regional and community banks.

It has been many months since the TARP program has been in the news on a daily basis but make no mistake, the program is alive and well, particularly at your friendly neighborhood bank.   You see, it turns out that while 23 of the 25 large banks have paid off their TARP loans in full, less than half of the 682 smaller banks that received TARP funds have paid them back.

At the time these loans were made, there was much talk in the media about bankers fearing that taking these loans would appear to be a sign of weakness and how, behind the scenes, the US Treasury was strong-arming these banks into taking the loans (“for their own good”).  The Feds’ theory was that if they provided these banks with more liquidity they would lend more.  Turns out that this theory was wishful thinking as all banks, both big and small, grew increasingly conservative about lending, more than offsetting any benefits that came from the fresh capital.

We all remember how many/most of the large banks couldn’t wait to get their TARP loans paid off.  The increased scrutiny and oversight that TARP brought along with it was more than enough incentive to find the exit as soon as possible.  You would think that such motivation would apply to all banks, both large and small.  That doesn’t seem to have been the case with the smaller banks and we are left to wonder why that is.

Could it be that these banks are generally in worse shape than the large banks?  Could it be that these smaller banks, as a group, were actually operating more risky business strategies than their big bank counterparts?  How could that happen?

A closer look at the residential and commercial mortgage businesses at many of these smaller banks, complete with cozy relationships with local developers and fast and loose mortgage brokers is probably a good place to start the analysis.

Throughout the recent credit crisis, the FDIC worked overtime to build up its reputation as the superior regulator, the one with the most experience overseeing and resolving problems at troubled banks in the US system.  Some of us found it more than a reach when the FDIC suggested that it was they who should be given supreme command over all bank regulatory enforcement.  Many of us felt that, while the FDIC might be able to make an argument for their experience with smaller institutions, it would be difficult for them to get their arms around the more complex large institutions (a.k.a. the dastardly Wall Street Banks).

With this new information about TARP paybacks, we believe that we now have some hard evidence to question whether the FDIC can even handle the small guys.  With decidedly simpler business models at your typical run-of-the-mill community bank, how is it that the FDIC which had been regulating these institutions for many, many years, missed some of the early (and some not so early) warning signs that lending and other banking practices were getting more and more risky?

The answer is that the FDIC was in over its head.  It turns out that the smaller community banks were actually in much worse shape (granted on a relative basis) than their Wall Street counterparts.  We can’t help thinking that if Sheila Bair was the head of the SEC, US Treasury or the Federal Reserve at this point in time, she would surely be utilizing these new facts to support her arguments for those organizations becoming the super regulator.  Probably good for all of us that she wasn’t in charge of those organizations because it seems clearer every day that the FDIC, perhaps more than any other regulator, missed the boat.

About markferraris
Managing Principal Orchard Street Partners LLC

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