Banks Exiting TARP Is Bad News

Wall Street giants such as Goldman Sachs and JP Morgan seem to be anxious to throw off the government shackles of the TARP program. On the face of it, this seems to be good news. After all, isn't it better that the banks face the discipline of the marketplace rather than corporatist government aid?

However, the short-run effect of such a move could prolong the current recession. The US banking system is still woefully undercapitalized for the size of its balance sheets. The battered capital ratios must be boosted so that lending to the wider economy begins growing again. If banks instead shrink their capital base in order to exit TARP, this will delay the credit expansion that any recovery is reliant upon.

The TARP legislation provides that banks can only leave the prgram with the government's permission. It is not enough to just pay the money owed back to the government. The US government should take advantage of what is written in the legislation.

The US Treasury should not let banks out of the TARP program until they have enough capital for the desired level of lending that the government wants. This is probably the best way to "force" the banks to use their money to start lending again and not use the money for lavish bonuses.