How the Government Has Made the Banks Into Gamblers
The New Republic's Noam Scheiber offers two reasons the prospect of banks straining to repay their Troubled Assets Relief Program money worries him. They worry me too, and for the same reasons.
The only thing I'd add is that this is a risk-free proposition for the banks. Imagine a card player at a casino. He's made some bad bets. Bad, big bets. He's run down the family's savings. He doesn't have enough to pay the mortgage. He's down to his final thousands. And he can't face his wife having lost this much money. So he has two choices: The first is to make big bets in the hope of winning everything back. The second is to go home, face the consequences, and slowly make his money back.
Now imagine the casino owner won't let him fail. Can't let him fail. Maybe he knows the guy's father. Maybe he owes him a favor. Whatever. If the gambler goes bust, he just gets more chips. The incentive, suddenly, is to make big bets. To try and pull out a miracle.
This is why the government needs to develop a credible process for allowing and managing a bank's failure. Right now, the banks are like that gambler. They've lost just about everything. But since the government won't let them actually lose everything, they have an incentive to make big bets. To repay the TARP too early and try and trick the market into thinking them healthy. The only thing they have left to fear is failure. But we've taken failure off the table. So what do they have left to fear?
The banks know we won't let them fail. We can't let them fail. Tim Geithner doesn't even have the authority to unwind them if they fail. Repaying their TARP money early is thus a low-risk proposition. High upside in that they look healthier to investors. Low downside in that they're still protected by the federal government.
Related: Simon Johnson has some further thoughts on the problem of insolvency in banks that can't fail.
(Photo credit: AP Photo/Nell Redmond)
May 21, 2009; 9:03 AM ET
Categories: Financial Crisis
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