Ten US banks to repay TARP money

It's the latest sign of progress in fending off a global financial crisis: The US Treasury says that 10 big banks are healthy enough to start repaying capital that the government provided amid fears of a systemwide meltdown last fall.

That’s good news for US taxpayers, who have committed $700 billion to finance emergency rescues through the Troubled Asset Relief Program (TARP).

Despite the Treasury's Tuesday announcement regarding these 10 firms, nine other large banks will still have about $130 billion in TARP capital.

But the planned TARP paybacks reflect a significant shift in the financial climate. Fears that large banks will fail or be nationalized have receded. Another sign of the times is that all 19 of these large banks, as of Monday night, have a plan in place to ensure that they have adequate capital on hand in response to a recent regulatory "stress tests."

The two developments are related.

A cushion of capital

The stress tests, which regulatory agencies completed in May, focused on large banks whose failure might send shock waves through the economy. The results set a benchmark capital cushion for each bank, so that reserves are large enough to weather a possible tide of rising loan losses this year and next.

Once banks knew whether regulators required them to raise more capital (the answer was yes for some banks, no for others), they could also think about the next logical step: possible payback of TARP funds. Financial firms in general want to get out of the TARP if they can, in order to shed the "bailout" stigma and the extra regulatory oversight and congressional scrutiny that go with it.

Does this mean the financial crisis is over? This isn't an all-clear signal yet.

"These repayments are an encouraging sign of financial repair, but we still have work to do," Treasury Secretary Tim Geithner said in a statement accompanying the news.

For one thing, the economy still isn't in recovery mode. The bottom of the recession may be coming into view. But unemployment, an important cause of consumer loan defaults, is still rising.

Home prices continue to fall in much of the country, putting banks at risk of rising losses on foreclosed homes this year and beyond. Commercial real estate loans also represent a problem area – especially for small and mid-size banks that specialize in that area.

Some won't repay

Several of the largest banks, meanwhile, aren't yet deemed healthy enough to start paying TARP money back. Those include Citigroup, Bank of America, and Wells Fargo.

Some economists worry that by allowing banks to repay the government, the banking industry will be shrinking its capital base when the storm isn't over yet. If things get unexpectedly worse in the year ahead, that could potentially rekindle questions about the solvency of some firms. If banks have to focus on survival, they won't be able to make many new loans.

In this scenario, the US could replay the problems faced by Japan's economy during its "lost decade" of the 1990s.

Jan Hatzius, an economist at Goldman Sachs, sees a key difference between the US today and Japan then. US banks have a larger profit stream on the loans that are good, which should enable these firms to offset even a rising tide of losses through 2010, Mr. Hatzius says.

He's arguing that US banks can do what Japan's banks couldn't – earn their way gradually out of trouble.

The Treasury and the Federal Reserve, key bank regulators in the US, have apparently assessed the situation the same way. They have provided capital to help banks weather the storm. Despite the historic level of mortgage losses, the regulators have avoided taking over any of the largest banks as "failed" institutions.

– Guest blogger Mark Trumbull is a Monitor staff writer.