Banks Who Received Bailout Funding Made Riskier Loans And Investments: Study
After receiving hundreds of billions of dollars in bailouts in the wake of the 2008 financial crisis, banks often did not come to the aid of credit-starved American businesses. Instead, it seems many banks went back to making the same high-risk bets that left them in need of government support in the first place.
Despite claims by government officials at the height of the financial crisis that bailouts would lead to more lending, banks that received bailout funding didn't increase total lending, according to a new study out of the University of Michigan.
But the banks did shift their investments toward risky loans and investments, including mortgage-backed securities. Under few guidelines, banks largely treated the bailouts as a windfall and, more importantly, a reassurance that the government would come to the rescue in the future, said the paper's co-authors, University of Michigan assistant finance professors Ran Duchin and Denis Sosyura.
The paper, released earlier this week, argued that the key factor predicting more risk-taking was not the bailout money itself, but the message that the government had the banks' back.
Banks that received bailout money were most inclined toward investing more money in speculative trading, corporate bonds, and mortgage-backed securities, Duchin said in an interview with The Huffington Post.
A higher level of risk-taking among major banks could make the financial system more prone to crisis, as banks face higher chances of seeing borrowers default and investments not pay off. Duchin said that risk-taking "definitely destabilizes the financial system."
With lagging economic growth, banks have had to compete more to find ways to reap profits. The overall demand for loans remains weak. As a result, many banks have lowered their standards while attempting to identify profit-making opportunities in a limp economy, said Gregory Daco, principal U.S. economist at IHS Global Insight.
Since the beginning of this year, banks have been easing their lending standards on most types of loans, especially those to corporations, according to the Federal Reserve. Banks have made 74 percent more floating-rate loans to junk-rated companies during the first eight months of this year compared to the same period last year, according to a study by the research firm Dealogic, the Wall Street Journal reported.
Another recent study found that financial institutions that actively lobbied the government in the years leading up to the financial crisis both were more likely to benefit from the government bailouts starting in 2008 and to have faster-growing portfolios of high-risk loans.
The Michigan study's co-authors said the government should have set clear guidelines for how banks spent bailout funds and should have tracked where that money went.
"Basically, they [the banks] just added it to total capital and did what they wanted," co-author Sosyura said.
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First Posted: 09/16/11 06:30 PM ET Updated: 11/16/11 05:12 AM ET