When the governments $700 billion TARP bailout program was passed in late 2008 in response to the financial crisis, it was meant to “improve the strength of financial institutions”, according to the Federal Reserve. And to do that the Fed set guidelines for banks when they were preparing to exit the program. The point was to make sure that when banks repaid bailout money, they were on stable footing and able to withstand losses.
That meant that banks needed to raise capital before they exited the program. So the Fed decided that for every $2 in TARP money that weaker banks paid back, they needed to issue $1 in common stock to increase equity capital. But that didn’t happen.
The Treasury Department and bank regulators basically ignored the Fed’s requirements and instead bent to pressure from bank executives and made it easier for then to leave the program. Banks wanted out from under the government’s thumb. Because under TARP, the government set limits on executive compensation.
Bank of America, Wells Fargo and PNC were allowed to repay TARP money without meeting the Fed’s standards (on the upside, taxpayers were repaid).
Relaxing those standards was a mistake, according to the Office of the Special Inspector General for TARP. Letting the banks slide “was arguably a missed opportunity to further strengthen the quality of each institution’s capital base”.
So if banks are not strong enough to survive another crisis, would the government bail them out again? The answer is no, according to Moody’s. And that was the reasoning behind the agency’s recent downgrade of Bank of America, Wells Fargo and Citigroup.
In reality, banks are better capitalized today than they were in 2008 when Lehman Brothers collapsed. But having the ability to survive a financial crisis and being a good investment opportunity are two different things.
And we don’t need a ratings agency to issue a warning about banks. The markets downgraded banks a long time ago… financials are lagging other sectors with a loss of -19.8% over the past year. And looking at a proxy, Financials Select Sector SPDR (XLF), the fund has been a confirmed long-term sell since June.