Quelle Surprise! SIGTARP Report Finds Citi, Bank of America Allowed to Leave TARP Prematurely

We said at the time it was inexcusable for the Treasury to allow banks to repay the TARP as early as they did (US banks are still below the capital levels many experts consider to be desirable; Andrew Haldane of the Bank of England has made a well-substantiated case that higher capital levels cannot remedy the problem, since the social costs of a major bank blow up are so great, and you therefore need very tough restrictions on their activities).

And why were the bank so eager slip the TARP leash? To escape some pretty minor restrictions on executive compensation. This had NOTHING to do with the health of the enterprise and everything to do with executive greed. And not surprisingly, Treasury indulged it.

Due to the late (for me) hour, I’m relying on the report by Shahien Nasiripour of the Financial Times, who seems to be releasing the story before the actual SIGTARP report is out. My big reservation is why the line was drawn at Citi and Bank of America. Yes, they were clearly the weakest banks, but I don’t buy the implicit endorsement of the ability of all the rest of the TARP recipients to weather another financial crisis with no government support.

SIGTARP is upset that the Treasury went through the stress tests, which among other things, determined how much capital the banks would need to raise, then ignored its own findings. The SIGTARP discusses that Treasury effectively made up on the fly how much more capital the banks would need to scrounge up, with the required number being lower than the stress test number.

Let’s put aside the fact that this blog and quite a few financial services experts not in the pay of the banks or dependent on their good will (like equity analysts needing access) called the stress tests a sham. We’re surprised that SIGTARP finds this Treasury shell game (of allowing the banks to get away with raising less dough than the stress tests indicated) to be a surprise. We reported that this was Treasury’s plan back in May 2009:

This is the legacy of regulators who are so subject to what Willem Buiter’s “cognitive regulatory capture” that the believe the Wall Street party line, that they are the best and the brightest, and therefore are better judges of how to manage their affairs than any outsider. Despite ample evidence to the contrary, plus the danger of giving hungry organizations a taxpayer backstop, the Treasury has shown a predictable lack of resolve, completely in keeping with its industry-favoring posture.

The most disturbing revelation comes via the Financial Times:

US banks have been given government assurances they will be allowed to raise less than the $74.6bn in equity mandated by stress tests if earnings over the next six months outstrip regulators’ forecasts, bankers said.

The agreement, which was not mentioned when the government revealed the results on Thursday, means some banks may not have to raise as much equity through share issues and asset sales as the market is expecting. It could also increase the incentive for banks to book profits in the next two quarters.

So get this: the official releases on the stress test results and process weren’t honest and complete. We basically have the real deal, which is the unwritten understanding between the Treasury and the banks, versus the phony version presented to the public. And if we can’t even believe the headline number in the tests (the amount of money they are supposed to raise), is there any other aspect we can trust? How many other winks and nods were there between the Treasury and banks that weren’t leaked to the press?

Admittedly, there is normally some give and take with a regulator, but the public has been led to believe that this process would be transparent. It has wound up being somewhat so by virtue of leaks rather than by living up to its promise.

And in case you missed it, the phrase in the FT, “increase the incentive for banks to book profits in the next two quarters” is code for “fabricate earnings”. Per below, there were quite a few instances of permissive accounting this quarter. The powers that be are inviting more of the same. And this is all in the name of boosting confidence.

Key extracts from the Financial Times report today:

US regulators moved too quickly to allow Bank of America and Citigroup to repay their troubled asset relief programme bail-outs, according to a new government audit…

Policymakers at the Treasury department also sought to allow the banks a rapid exit, at one point approving a BofA proposal that ultimately was rejected because it allowed the company to leave the assistance programme by issuing $4.8bn less common equity capital than was required.

Shortly after so-called “stress tests” in 2009 revealed capital shortfalls in the largest US banks, regulators developed a benchmark designed to guide Tarp exit procedures. For every $2 in Tarp aid reimbursed, banks were to raise $1 in new common equity. The assessment was based in part on banks’ capital needs.

Just a few weeks later, that benchmark was tossed aside, resulting in an “ad hoc” and “inconsistent” process, Sigtarp said…

After submitting 11 proposals, BofA was finally allowed to repay taxpayers their $45bn by issuing $18.8bn in common equity, $1.7bn in stock to employees and shedding $4bn in assets.

At one point, the bank requested it be allowed to repay the part of its rescue package that would have ended restrictions on executive pay, an indication it was principally concerned with the issue, Ms Romero said. Regulators balked.

The Federal Deposit Insurance Corp, then led by Sheila Bair, insisted that the bank had to raise more common equity to meet benchmarks, as opposed to meeting capital levels through “gimmicks” such as employee stock issuances and asset sales. Treasury approved BofA’s seventh proposal, which called for reduced common equity and greater asset sales…

BofA exited Tarp on December 9 2009, when its share price closed at $15.39. It has since plunged about 60 per cent. It closed at $6.35 on Thursday.

Unfortunately, we are likely to see all too soon how well Treasury’s secret pact with the banks worked. And unfortunately, if they are proven to have gambled and lost, no one in the officialdom or at the banks will suffer all that much while the rest of us suffer considerable costs.

This post originally appeared on Naked Capitalism and is reproduced here with permission.