Monday, April 13, 2009

Government Incentivizes Bigness

Actions taken under the TARP's Capital Purchase Program as of 4/2/09

This blog earlier reported criticism of Treasury’s slowness in launching its financial stability clearing house web shop. The site has been up and running for several weeks now. The site has offered little new information since launch and the data provided has been more limited than I would have expected. Yet the treasure trove that is here has barely been examined. The new site allows users to download all the purchases made under the Capital Purchase Program (CPP), one of the largest TARP measures.

A quick look at the data shows that CPP has been a program for big banks. The program gave out 54.5 percent of the $183.6 billion spent so far in its first week of operations. In that time, only seven firms received funds. The top names were not surprising: Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon, and State Street Corp. Following that massive first round injection, more than five hundred firms have been funded through the program. Above I’ve carted the value of money given and the number of firms receiving funds (right axis). The smaller banks all received much smaller injections.
Additionally, while almost all the injections have involved warrants, essentially options to convert to stock the government’s investment, smaller institutions are the ones who have seen those warrants exercised. No institution in the top 40 distributions has had warrants exercised against it.

Of course, TARP passed amid financial panic; concerns about providing incentives for excessive risk-taking were subordinated to preventing a system-wide meltdown. Yet the application of CPP should be a concern for moral hazard, excessive risk-taking by those who believe they can get government bailouts, going forward.

Yet with the threat of an immediate collapse receding, the Obama administration’s Financial Stability Plan (FSP) has provided little change regarding the focus on large institutions. The new plan to buy toxic assets, the Public Private Investment Partnership, draws heavily from Paulson’s original plans for TARP. The new plan requires that applicants to manage the government subsidized funds must have at least $10 billion under management. The size restriction is designed to attract the most talented managers to the funds, without pesky executive compensation provisions, and will allow the largest firms to extract the most gains. Treasury also seeks to create a “systemic regulator” to regulate specially designated institutions. This opens opportunities mostly to the large institutions that seem to have too much risk. Allowing smaller agents to manage funds could shift risk to institutions that currently have little and reduce the chance of one large firm defaulting.

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