On the basis of "stress tests" it ran, the Federal Reserve has given permission to most of the largest U.S. banks to "return capital" to their shareholders. JPMorgan Chase announced that it would buy back as much as $15 billion of its stock and raise its quarterly dividend to 30 cents a share, up from 25 cents a share.
Allowing the payouts to equity is misguided. It exposes the economy to unnecessary risks without valid justification.
Money paid to shareholders (or managers) is no longer available to pay creditors. Share buybacks and dividend payments reduce the banks’ ability to absorb losses without becoming distressed. When a large “systemic” bank is distressed, the ripple effects are felt throughout the economy. We may all feel the consequences.
Most European banks passed stress tests in July 2011, only to find themselves near failure, including one major bank, Dexia, which was nationalized shortly thereafter. Even if U.S. stress tests are better, are American banks healthy and immune? Is it prudent to allow them to make payouts to shareholders? Before 2008, banks convinced regulators that they were safe on the basis of insurance they bought from AIG. Banks avoided billions in losses when AIG was bailed out. Assets considered “safe” by regulators routinely turn out to inflict losses. We often discover hidden risks when it is too late.
Among the most obvious mistakes made in 2007-2008 was allowing banks to deplete their ability to withstand losses. The largest 19 U.S. banks paid almost $80 billion to shareholders between the third quarter of 2007, when trouble in the housing market was looming, and through the worst of the financial crisis in 2008. About half of the money the government invested in banks during the crisis, when credit markets froze, was paid out to shareholders and not used for lending or to pay creditors.