“Banks that received federal assistance during the financial crisis reduced lending more aggressively and gave bigger pay raises to employees than institutions that didn’t get aid.”

Using federal bank data, they compared 940 banks in the Troubled Asset Relief Program (TARP) and 7,400 banks outside it.  That’s a pretty thorough study.

Here are some of their published findings:

Lending fell
TARP banks: Outstanding loans to businesses and individuals fell 9.1% for the 12 months ending Sept. 30, 2009,
Non-TARP banks: Outstanding loans dropped 6.2% in the same timeframe.

Employee pay rose
TARP banks: Average pay rose 9.4% in the program’s first year.
Non-TARP banks: Salaries increased 1.8%.

Cost-cutting limited
Banks in TARP cut costs less than those outside the program.
TARP banks: Increased branches by 2.7%
Non-TARP banks: Decreased branches by 1.2%.

Essentially, what this says is that the banks that the federal government bailed out showed worse behavior than the banks that were not bailed out.  And by worse behavior, I mean worse according to the very metrics the government and policy makers care about and were trying to improve by bailing out those banks in the first place.

Check out the full article at:

http://www.usatoday.com/money/industries/banking/2010-04-21-tarp-banks_N.htm

The title refers to the creation of the US Federal Reserve Bank, which took place at a then-secret meeting in 1910 (later confirmed by the participants), at a resort on Jekyll Island, just off the coast of Georgia.

Most of us grew up thinking of the Federal Reserve as a quasi-government organization that helps stabilize our money supply. How it does that is often a bit of a mystery, although it involves interest rates, and possibly reserve requirements. And it isn’t always clear what the relationship is between the Federal Reserve and the US government.

Griffin argues that, in point of fact, the Federal Reserve is a private cartel created by the banks, with the sole purpose of maximizing bank profits. Inherent in its design are the seeds of periodic financial disaster (and inevitable, eventual collapse), which result in a massive transfer of wealth from depositors and taxpayers to bank executives. This is not an accident; it is the way the system is designed.

While this may seem an extreme view, Griffin’s evidence is undisputed, his logic is sound, and his arguments are highly convincing.  Much of the banking system which is ordinarily difficult to understand becomes extremely clear and transparent when viewed through this lens.

Moral hazard is a the observed phenomenon whereby, because something is insured, it becomes more likely to occur.  If a bad event (e.g. breakage or theft) will cost a certain amount, then if that event is insured, it will cost a bit less.  This makes the bad event less bad–which is the point of insurance.  Unfortunately, it also means that the insured person will not work quite as hard to prevent the bad event from happening, or, in extreme cases, may even cause the bad event to occur.

A silly illustration: if a grocery store could somehow insure every dozen eggs for $1000 against breakage, “Moral Hazard” is the insurance industry’s way of recognizing that there would somehow be a lot of broken eggs.

The industry tries to adjust for this in several ways.  One is by charging different premiums to different people depending upon their beliefs about the customer’s risk.  That’s why 16 year-old boys pay more for car insurance than 45 year-old married men.  Insurers also try to make sure there are other reasons the insured would not want the event to occur.

I had occasion to visit Lloyd’s in London a while back, and I learned that there are only two types of insurance that Lloyd’s will not place.  The first is life insurance, because the purchaser is betting someone will die–and in a world of moral hazard, Lloyd’s are uncomfortable with that idea.  The second is a pure financial guarantee.  In other words, they will not make someone financially whole simply because they lost money.  They must instead insure the events that might cause them to lose the money (fire, theft, etc.).  Over hundreds of years as the world’s foremost insurance marketplace, Lloyd’s has found the moral hazard associated with pure financial guarantees to be too great.  That’s because if all that is at stake is money, and the insurance will make one financially whole, then there is no alternative reason to prevent the loss event.

Which brings us to the FDIC.

The Federal Deposit Insurance Corporation insures depositors who put money in a US bank against loss, up to a certain limit.  Another way of saying this is that they insure the banks against loss, so that the banks will be able to repay their creditors (the depositors) in the event that the bank loses money.

This is a financial guarantee.  They are not insuring against an underlying event; they are making a pure financial guarantee–the type you could not buy at Lloyd’s in London.

But it gets worse.

The FDIC charges the same premium to all participating banks regardless of their perceived risks.  Of course, the “risks” involved are basically the risks associated with the bank’s loans.  So the bank is free to make any loans it likes, and it will not see a change in premiums.

The result is that all banks face the exact same downside potential, regardless of their business decisions.

Since banking is a somewhat competitive market, banks will try to get a higher return by charging more for the loans they make.  This force moves them toward making bigger and riskier loans, where they can charge higher fees and interest.

Under ordinary market forces, this would also increase their downside potential, which would be a force reducing the risks banks take in their loan decisions.  However, with FDIC insurance, we’ve eliminated this force, leaving only the force toward making riskier loans.

The result is that banks compete against each other by making riskier and riskier loans.  They may not realize they are doing this, but that is the market they are in.

The result is a steady increase in the risk levels of bank loan portfolios.  And that can only lead to one conclusion: a collapse in the loan portfolios of many banks.  Specifically, it leads to a collapse in the portfolios of the most competitive banks.  In order to be competitive they took on the risky loans.  And because they are successfully competitive, they are also the largest banks.

Does any of this sound familiar?

Customers who refused to send copies of their personal tax returns to American Express have had their accounts closed with prejudice.  They lose any reward points they may have accumulated, are required to immediately pay off the balance of any revolving credit, and have a negative report sent to the credit rating agencies, which results in a drop in their credit score.  If they fail to immediately pay off the revolving credit in full, they are sent to collections and face additional penalties.

“Do You Know Me?”

In many cases, these demands have been sent to cardmembers of more than 20 years, who have never missed a payment, or carried excessive balances.  These are not delinquent cardholders.  They are ordinary people with accounts in good standing who were simply customers of the wrong company.

For years Amex held out that it was not a bank, and so it was not subject to the same regulation as ordinary banks.  This allowed them to offer financial services (including credit cards and investment products) which would not ordinarily be possible at a bank, and without the unpleasant government oversight.  However, when the banks were being bailed out, Amex changed their tune and applied to become a bank, in order to get bailout money.

It’s pretty reasonable for Amex to want to reduce their risks.

But it is also reasonable for consumers to want to reduce their own risks.  And choosing a vendor who may suddenly make unreasonable demands under threat is a risk many people may not want to take.

You have a choice of what company to use for credit services.  Choose wisely.  Choose someone else.