Rolling up TARP: Will it be strong banks vs. weak?

[June 09, 2009]  NEW YORK (AP) -- The government is set to announce as early as Tuesday morning which of the country's biggest banks will be able to repay billions in federal bailout dollars in a decision that risks creating a two-tier banking system -- winners and losers.

Congress approved the $700 billion Troubled Asset Relief Program eight months ago as financial markets teetered on collapse. Almost ever since, banks have been eager to pay back bailout money and cut the federal strings that come with it. [Click on chart for larger image.]

Combined, the repayments could exceed $50 billion. Experts say that figure reflects a measure of stability that has returned to the banking system but caution that the crisis isn't over. Some worry the repayments could widen the gap between healthy and weak banks.

"We're going to find out who are the strongest kids on the block and who are not," said Bert Ely, a longtime banking analyst.

Banks started railing against the TARP almost immediately after they accepted the help. One CEO, Jamie Dimon of JPMorgan Chase & Co., called the money a "scarlet letter," referring to the public backlash and federal scrutiny that came with it.

Banks that are expected to get a green light to repay bailout funds include JPMorgan, Goldman Sachs Group Inc. and American Express Co. They would be free of federal rules ranging from caps on executive pay to restrictions on dividend payments.

But weaker banks such as Citigroup Inc. and Bank of America Corp. would remain tethered to the government and face a problem -- how to compete for business and top workers against rivals operating more freely.

"Banks had been at an equal disadvantage," said Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago. "Now you'll have some that are unfettered and others that are constrained. That will affect the ability to attract customers and talent."

Investors are also keeping score. Stock in Citigroup and Bank of America, which received a combined $90 billion in TARP money, has plunged. Investors will probably keep favoring firms that show they can stand without federal help, Ablin said.

"If you can decide between a weak player and a strong player, just about every advantage goes to the strong," he said.

The push to repay TARP money comes a month after "stress tests" of the nation's 19 largest financial firms found that 10 needed to raise $75 billion more to protect against future losses. All 10 had submitted plans by late Monday, the Federal Reserve said. The Fed said Monday that plans submitted by 10 banks to bolster their capital cushions are enough to help them survive a deeper recession.

The remaining nine institutions received a combined $56 billion in TARP money. They had to prove they could raise enough private capital without federal guarantees before they could return the money.

So far, 16 of the 19 banks have raised $75.2 billion, mostly by selling common stock. Meanwhile, about a dozen smaller banks have already repaid TARP money.

Regulators want to avoid letting a bank repay its TARP money only to have it return months later in worse shape, seeking another handout.

That's why regulators say they need to determine which banks are truly stable enough to repay their TARP money. Their decisions depend on how accurate the tests were in calculating the banks' capital needs.

"You could easily be off by $300 billion on how much capital these 19 banks needed," said Douglas Elliott, a fellow at the Brookings Institution and a former investment banker. "Maybe we'll get lucky and everything will be fine, but I wouldn't count on it. There are a lot of dangers still out there."

Industry insiders say a big worry is that banks stuck with limits on how much they can pay executives will watch star performers flee to other companies.

Federal rules imposed by Congress limit executive bonuses at banks that receive bailout money and cap total compensation of top executives at $400,000 a year. Administration officials are set to outline stricter rules later this week.

Much of the revenue at banks like Citigroup comes from a relatively small number of trading desks. So losing a few key traders could be a serious drag on the banks' bottom lines as they strive to right themselves.

Scott Talbott, top lobbyist with the Financial Services Roundtable, which represents the largest financial firms, said top salespeople and producers were already leaving banks for hedge funds and foreign firms. The growing gulf between TARP and non-TARP banks could speed that process, he said.

"It will impact sales people, and sales people are the life of the company," Talbott said. "If you can't make sales, you can't improve revenue. If you can't improve revenue, you can't improve your stock price. If you can't improve your stock price, you can't return the government's money. And that will just maintain the competitive disadvantage."

That's lost on the banks most heavily indebted to the bailout. Bank of America wants to repay the money "soon as possible, but the timing is up to the government," spokesman Scott Silvestri said.

A spokesman said Citigroup hasn't applied to repay TARP funds.

Simon Johnson, a former chief economist at the International Monetary Fund, said putting Citigroup and Bank of America at a disadvantage might be part of the government's plan.

"Both banks need to downsize, so this is going to cause them to lose talent if the constraints are effective," said Johnson, now at the Massachusetts Institute of Technology's Sloan School of Business. "That may be, given the political constraints, the most effective way to reduce systemic risk."

The Treasury declined to comment on whether it was concerned that bailout paybacks might increase strain on weaker banks.

One person who says he isn't worried: Rep. Barney Frank, chairman of the House Financial Services Committee.

"Do you think there are people who don't already know that there are strong banks and weak banks? We don't need TARP repayments to figure that out," Frank, D-Mass., said in an interview.

[Associated Press; By STEVENSON JACOBS and DANIEL WAGNER]

Wagner reported from Washington. AP Business Writers Madlen Read in New York and Jeannine Aversa in Washington contributed to this report.

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