Saturday, April 13, 2013

An Audit Report That Critiques the Inevitable: SBLF and TARP

An Audit Report That Critiques the Inevitable: SBLF and TARP[1]

The Special Inspector General for the Troubled Asset Relief Program (SIGTARP) issued a report[2] that could have been written as Congress enacted the law that the report now critiques.  In September 2010, Congress created the Small Business Lending Fund (SBLF), a potential pool of $30 billion in capital that was to be invested in banks, so they could, in turn, increase small business lending.  In the end, the US Treasury only made $4 billion of investments and over half of the money was used by banks to pay off their TARP preferred, known as the Capital Purchase Program (CPP).  In other words, the banks swapped  SBLF for CPP, rather than lending to small businesses.  SIGTARP’s complaint is that the SBLF was not applied to its intended purpose.  Moreover, SIGTARP found that TARP recipient banks did less small business lending than non-TARP banks.
Dividing Internal Expanses (1999) 
As the SBLF program was being authorized, the US Treasury was already looking for ways to wind down the TARP program, and many in Congress were pressuring them to do so.  And, most of the TARP recipient banks wanted to get out from under the compensation and dividend restrictions built into TARP.  These institutions were predominantly small and didn’t have access to the public markets to raise the capital needed to pay off TARP.  You may vaguely recall, that the big banks, such as Goldman Sachs and JP Morgan, were able to issue new stock to the public and quickly pay-off TARP.   Most small banks were no so fortunate.

When SBLF came along, many small TARP recipients saw a way to get out of the CPP program.  In fact, 320 TARP banks applied for SBLF, and Treasury funded only 137 of them.  I don’t know why most of these institutions were turned down, but I’d guess that Treasury didn’t want to invest more capital in banks that were somewhat or deeply troubled.

SIGTARPs two main criticisms – that banks used SBLF to payoff TARP, and TARP banks made fewer small business loans than non-TARP banks – were inherent in the program from the start, and not decisions perpetrated by Treasury as SIGTARP claims.  Most of the 707 banks that originally received TARP investments were in areas with very slow growth rates, and the institutions were experiencing some level of distress or worse.  In other words, TARP banks weren’t a random sample of banks across the country.  So it should come as no surprise that TARP-recipient banks made fewer new loans.  Their markets just didn’t support big increases in lending activity, especially if the loans were to be made to decent credits.  Non-TARP banks tended to be in better shape and operate in better markets.  Thus, SIGTARPs conclusion comes as no surprise.

The payoff of TARP with SBLF funds is not a bad outcome.  Since the terms of the SBLF investments are somewhat better than those for CPP preferred, the banks that swapped SBLF for TARP were put into a more stable position.  This is not a bad outcome for institutions with limited access to the public capital markets.  We should want our community banks to be securer.  Moreover this result was entirely foreseeable because the US Treasury was looking for ways to wind up the TARP program even as SBLF passed Congress.  I am a big fan of SIGTARP and thought many of their previous reports and audits were well reasoned.  However in this instance, I think they’ve come up empty. 

As TARP winds down, it is time to look at what really went wrong.  We rescued the financial system by fostering a few mega-banks that are larger than before, and thus are now way too big to fail.  Moreover, we’ve done little to prevent these big banks from using insured deposits and cheap credit to engage in all kinds of risky behavior.  It’s time to move beyond picking at the details of TARP and address unfinished business.

[1] I was a consultant to Piedmont Investment Advisors, which had a contract with the US Treasury under the TARP program.

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