Why the failed PPIP should prevent TARP repayments

June 8, 2009

When the PPIP was introduced, everybody was scared about the amount of toxic assets on banks’ balance sheets. Don’t worry, said Tim Geithner: between the stress tests and the PPIP, we’re going to be able to put a price on all those toxic assets, work out what the banks’ losses are, and ensure that the banks have enough capital to absorb those losses.

The market loved this idea, and started going up rather than down, to the point at which people weren’t scared any more about the amount of toxic assets on banks’ balance sheets. And so it didn’t matter that the adverse scenario in the stress tests is looking positively sunny these days. And it didn’t matter that PPIP disappeared with a whimper, the toxic assets no more priced now than they were six months ago. So long as the stock markets are happy, what’s to worry about?

Ezra Klein, for one, is still worried; so am I, not least because of all those leveraged loans maturing over the next few years. In other words, this is no time for banks — which, by their nature, are fragile leveraged institutions — to start repaying TARP funds. As my colleague Matt Goldstein notes:

The recent surge in the stock market and a slight slowdown in the pace of job losses should not lull anyone into believing that the economy is on the fast road to repair. If all the talk about economic green shoots is just some mirage, the banks could be in for a lot more trouble if there’s a new spike in mortgage defaults or corporate bankruptcies. And given the current public mood, it will be impossible to provide any struggling bank with a new round of financial aid.

Optimism is good, and we all hope that the stock market’s present upward trajectory proves justified and sustainable. But hope is not a regulatory strategy. And TARP funds shouldn’t be repaid with the hope that the banks don’t need them any more; they should be repaid only when the banks have demonstrated — with clear prices for their toxic assets — that they’re definitively in the clear.


Comments are closed.