Banks using government money for deals

[November 01, 2008]  NEW YORK (AP) -- Critics are outraged that the nation's banks are using billions of dollars of federal bailout money to buy other banks instead of boosting their lending. But is that really such a bad thing?

The official line from the White House is that the banks should use the $250 billion to make loans. If lending unfreezes, they say, that would help to stabilize the financial system.

But what isn't being articulated as clearly are the benefits of healthy banks buying weaker ones and how that ultimately could save taxpayers even larger hits down the road by preventing bailouts.

The Oct. 24 news that PNC Financial Services Group Inc. of Pittsburgh is acquiring struggling National City Corp. illustrates this point. The purchase price of $5.58 billion looks like a bargain when you consider that Cleveland-based National City's market cap was more than $11 billion just a month ago.

But after National City reported a larger-than-expected third-quarter loss of $5.15 billion, analysts raised questions about the bank's future if it couldn't get money from the government or find a merger partner.

If National City had gone under, it would have placed an additional burden on the Federal Deposit Insurance Corp., which is already dealing with 16 bank failures this year. The FDIC's deposit insurance fund now totals $45.2 billion - more than $5 billion below the minimum target set by Congress and the lowest level since 2003.

When IndyMac, a California-based savings bank, failed last July, the government took it over and it cost the FDIC fund $8.9 billion. In contrast, when Washington Mutual failed in September, JPMorgan Chase took it over, and the fund didn't have to spend a dime.

PNC's bet on National City would create the nation's fifth largest bank by deposits and will give it the fourth most branches. But what really paved the way for it to take the risk was the $7.7 billion in federal bailout funds it received. That shores up its capital and gives it time to work through National City's bad loans.

"The government really has to have two agendas with its bailout - one is to get lending started again, but the other is keep banks from falling into the arms of the FDIC," said Roy Smith, a professor of finance and entrepreneurship at New York University's Leonard N. Stern School of Business. "The problem is they are trying to send two messages that seem contradictory."

Smith thinks the PNC's action is just the beginning of the "government-blessed" takeover wave, and already some banks are saying dealmaking is in their plan.

In recent days, Los Angeles-based City National Corp., which will get $395 million from the taxpayer till, said the infusion will enhance its "strong, conservative balance sheet," but it will also be used to make "selected acquisitions," according to a news release.

BT&T Corp.'s announcement of a $3.1 billion government injection also said that the Winston-Salem, N.C.-based bank planned to use the additional capital to "not only extend and strengthen our lending capacity, but provide other strategic options as well."

In total, the administration plans to dole out $250 million through stock purchases to banks in return for partial ownership. Nowhere in the bailout law does it require banks to lend out the money, but that hasn't stopped federal officials from preaching that directive - most likely because that's what the public wants to hear since taxpayer money is on the line.

"What we're trying to do is get banks to do what they are supposed to do, which is support the system that we have in America. And banks exist to lend money," White House press secretary Dana Perino said Tuesday.

On Thursday, Ed Lazear, chairman of the Council of Economic Advisers, said that the banks have "huge incentives to lend" because they have to pay 5 percent annual dividends on the money they take from the government. Lending is "the way they make money; that's the only way they make money," he said.

Some Washington lawmakers are calling on Treasury Secretary Henry Paulson and others for an explanation of why such dealmaking could be allowed to be done with taxpayer money.

Among them is House Republican Leader John Boehner of Ohio. He sent Paulson a letter on Wednesday raising "concerns about how some of the funds allocated to financial institutions under the plan are being utilized."

Policymakers may be underestimating taxpayers' willingness to look beyond lending as the only solution to this crisis. Instead, they should be willing to acknowledge why acquisitions could also be of help.

Additionally, Paul Kedrosky notes in a recent post on his blog Infectious Greed that no one should want the banks to go back to "business as usual" lending - meaning doling out loans recklessly - just because they got this money.

"Was this bailout sold properly, with people told that banks shouldn't and wouldn't begin lending straight away? No, it wasn't," Kedrosky said. "Nevertheless, reasonable people should have been able to figure out on their own that giving banks capital just so they lend it out again into a deleveraging economy is absurd."

That's why dealmaking shouldn't be cast as a negative. It's far from it.

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Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org

[Associated Press; By RACHEL BECK]

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