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If you remove the 5 worst cases, the top 100 TARP recipients data shows several inference quite clearly,

(1) TARP funding was allocated in a practical manner. Companies with larger assets were given more TARP. The graphical analysis shows that on average 2.69 cents of TARP was distributed for every $1 of bank assets.

TARP(1)

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(2)  There is no descernable relationship between Equity/Asset ratio (risk recognition) and Asset size. That means the Equity/Asset ratio must have been driven by some internal measure of risk or at least the perception of this risk. The large spread in the Equity/Asset ratio (4% to 17%) reflects a large variation in the banks’ opinion of the quality of the assets they had. 

TARP(4)

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(3) The negative slope shows that less TARP was given to banks that were better capitalized (absolute capital ratio) than to banks that were not. Also a desirable policy. The effect of the allocation scheme was to get the average bank risk capital up to 12.10%. This a huge jump from 4% of Tier 1.

TARP(2)

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(4) The positive slope shows that the more TARP a bank received as a proportion of its equity, the more TARP it recieved as a proportion of its assets. Remember that this is normalized data. That is the less risk capital (greater TARP/Equity) a bank had the greater the bank’s actual asset risk (TARP/Assets) or the poorer the quality of the assets. Or the greater the risk the less likely a bank would recognize its own risk.

TARP(3)

Why should this be the case, when all banks were supposedly similarly affected by the mortage mess? Apparently not. Some banks had more risky assets than others. In otherwords some banks were undercapitalized for the risk they were taking, and were not facing up to these risk. Note, this is an industry-wide behavior, as these inferences are based on the top 100 TARP recipients.

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There are two lessons here:

(1) It is surprising to find that professional bankers are more likely to underestimate their asset risk, the more risky the assets become.

(2) Regulatory capital allocation cannot be linear. It needs to be a non-linear scheme. That is the first x% of risk requires $y of risk capital. The second x% of risk requires $2y of risk capital, and the third x% requires $4y, etc.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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