Will banks exiting TARP take back their toxic waste now?

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Just last week, we saw a parade of banks exiting the dreaded TARP program set up last year by the U.S. government and used to temporarily recapitalize the U.S. banking system.  The banks were able to do so in no small measure because of the unrealistically rosy scenarios in the stress tests used to determine how adequate the banks’ capital levels were.  On the back of these tests, the banks raised shed loads of capital and promptly ditched the TARP program and the likely restrictions, scrutiny and reputational risk which comes with it.  Goldman Sachs and JPMorgan Chase even promised not to abuse government largesse by issuing FDIC-insured bonds.

So, then, when will these institutions give back the Treasury securities they borrowed from the Federal Reserve in exchange for the toxic waste they used as collateral?  Let me remind you of what I am talking about.  Do you remember when large financial institutions were forced to go hat in hand to the Federal Reserve when asset markets seized up post-Lehman?  Well, these companies had all sorts of Asset backed securities, CDOs and CDOs of CDOs – generally known as toxic waste and euphemistically called ‘hard-to-price assets.’  They off-loaded these assets onto the Fed ‘temporarily’ through mechanisms like the discount window, the Primary Dealer Credit Facility and the Term Securities Lending Facility.  The goal was to give the markets time to return to normal, to allow ‘liquidity’ to return to the markets so that these assets could start being traded again.

Why isn’t this happening now?

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This is a highly relevant question at this juncture for a number of reasons.

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  1. If this has been a liquidity crisis, then the crisis is pretty much over as most measures of risk like LIBOR, the TED spread or LIBOR-OIS are now back to pre-Lehman levels.  So, if liquidity has been normalized, those loans from the Fed aren’t necessary, are they?
  2. If the banks exiting TARP are truly well-capitalized, then they can afford to take the derivatives they schluffed off onto the Fed back onto their own balance sheets.
  3. If the banks exiting TARP are really no longer dependent on government largesse then there would be no better way to prove it than by taking back their junky derivative assets and helping the Fed restore its balance sheet.

But, I am sure you know this is not going to happen.  This has not been a liquidity crisis.  It is a solvency crisis. The banks are not well-capitalized because the stress tests were just a big charade and an effort to buy these firms time.  Moreover, it is painfully obvious that the banks are very much dependent on the government still – or they would be getting their dodgy assets back.

Meanwhile the Bloomberg lawsuit filed under the Freedom of Information Act to uncover what kinds of assets the Fed is now holding as collateral is still ongoing.

So, if you are wondering like me, when the Fed is going to start shaping up its balance sheet or when the Fed is going to come clean about what kinds of dodgy assets it now holds on that balance sheet, you’re likely to be waiting for answers for a very long time.

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