Audit: Bank of America and Citi Permitted to Leave TARP Prematurely to Avoid Compensation Restrictions

Recent troubles at Bank of America and Citi may be traced to a decision to permit the banks to exit the TARP program before they were financially stable in order to evade mandatory compensation restrictions.

The report, by the program's inspector general, reinforces concerns that the government was more focused on the financial sector's political support than on assuring the stability of the system that had led to the 2008 financial crisis.

There is a debate about whether the economy was so fragile that saving the financial system required unsavory choices which rewarded banks and bankers at the expense of longer term reforms. This latest report, however, suggests that even without the benefit of hindsight, it was apparent that the financial institutions in question were weakened. The argument that the only way to retain or attract talented executives was to offer competitive compensation has been challenged by many who point out that with massive layoffs in the financial sector at that time, there was a plethora of talent from which to choose.

The longer term problem is whether this further undermines public support for sometimes necessary government intervention and therefore weakens the economy even further. The latest layoffs at the big banks, a reported 30,000 at BofA alone, suggest that short-term thinking invariably comes back to haunt. This is particularly ironic as one of the reasons for this latest round is the absence of political support for further bail-outs based on public perceptions about the last one. JL

Shahien Nasiripour reports in the Financial Times:

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.

The financial institutions pressured regulators to quickly approve their exit schemes, largely due to restrictions at the time on executive pay, said the report released on Friday by the special inspector general for Tarp (Sigtarp).
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.

“They bowed to pressure,” said Christy Romero, Sigtarp’s acting chief. Ms Romero reckons that the Treasury was pressing regulators to approve repayment plans in part due to its desire to scale back government aid to large US banks.

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.

A senior Treasury official said the 2-for-1 capital proposal was a standard that was applied “practically”. He added that had banks such as BofA been forced to stay in Tarp for longer, they could have lost the confidence of investors.

The Treasury official said he had “no regrets” over allowing BofA to exit Tarp when it did. “I think you have to judge what regulators did at the time based on the information they had at the time,” he said.

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.

Ms Romero said the government missed an opportunity to force the banks to raise enough capital to mollify concerns over future taxpayer-financed bail-outs.