Bailing out big banks that messed up their balance sheets by making bad loans appears to have encouraged big banks to make even riskier loans. That’s what a new Fed study of the Troubled Asset Relief Program finds, anyway. Here’s the nut, as quoted by James Pethokoukis (The Enterprise Blog, March 7):
The results from the event study illustrate that the average risk rating at large TARP recipients increased more than at large non-TARP recipients following the capital infusions. Conversely, the risk of loan originations by small TARP recipients appears to have decreased relative to non-TARP recipients.
In our regression results, we find consistent evidence that the TARP capital injection significantly increased the risk of loan originations by the large banks receiving the funds and significantly decreased the risk of loan originations by the small banks receiving the funds.
Supporting evidence from interest spreads also indicates that the spreads on loans from large TARP recipients widened substantially following the TARP capital infusions.
Overall, we find that the degree of risk in commercial loans made by TARP recipients appears to have increased for large banks but decreased for small banks.
As Pethokoukis notes, estimates of the the taxpayer cost of TARP (which Treasury now pegs at $68 billion) certainly understate the real costs. If today’s bailouts make banks less averse to making unwise loans, then there will be more bailouts in the future.