JP Morgan, Goldman Sachs, Morgan Stanley in race to repay TARP funds

Last week, following the stress test results, I suggested that banks would now be in a race to pay back their TARP funds to get the government off their backs. This week, Goldman Sachs (GS), JP Morgan Chase (JPM) and Morgan Stanley (MS) ran to the starting line to see who can get there first. Bloomberg reports today that all three have applied to refund their TARP funds, for a total of $45 billion.

The three banks can't just write a check to the government, however. They must first get the approval of the Federal Reserve. The banks must prove that they have enough capital to keep lending. Regulators will also consider the question of whether the financial system as a whole can supply the credit needed to ensure an economic recovery.

If the banks' reimbursements are approved, this will be the largest payback of TARP funds.

Why are they rushing? They want more flexibility in compensation and hiring than they is possible under TARP restrictions. By having greater flexibility than other banks still strangled by TARP regulations they will be able to lure the best and brightest employees from banks who can't offer the same level of compensation.

But Geithner might not let them get off so easy. Some expect Geithner to delay approval until the government issues industrywide compensation guidelines. Geithner said Monday that he wants to establish "some broad constraints" on compensation incentives in the financial industry instead of setting limits on pay.

These three banks would not be the first to repay TARP, but their repayment would be the largest. As of May 15, 14 smaller banks that received capital under TARP have repaid it, according to Bloomberg. The 19 largest banks couldn't even apply until after the stress tests.

Goldman Sachs and JP Morgan Chase were told they didn't need to raise any more funds after the stress tests. Morgan Stanley raised $4.57 billion by selling stock this month, which exceeded the $1.8 billion regulators said the bank needed. Morgan Stanley also sold $4 billion in debt not guaranteed by the government as a prerequisite for its repayment of funds.

In addition to paying back the TARP funds, the banks must also decide whether or not to buy back the warrants that the government holds as part of the TARP agreements. These warrants can be converted to stock if not repurchased.

What happens if the banks repay the funds and then need to borrow from TARP in the future? James Wareham, a partner in the litigation department of Paul Hastings Janofsky & Walker LLP, told Bloomberg they could face lawsuits in the future.

Will the banks be given the green light to repay the funds? Do you think they should?

Lita Epstein has written 25 books, including Reading Financial Reports for Dummies and Trading for Dummies.

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