Whether to apply for or accept TARP Capital is a decision that each bank needs to make individually depending on its own markets and circumstances.  However, as explained below, we believe each bank needs to prepare a realistic, worst-case scenario for the next three years.  Unless your bank’s capital will remain strong, we think you should apply for TARP Capital.

In three years, your bank will likely be in position to redeem the TARP Capital.  If that’s true, then the TARP Capital will have served as an inexpensive insurance policy that went unused, and you won’t be subject to any further government restrictions.

On the other hand, it is possible that, in three years, the financial condition of your bank makes you unable to redeem the TARP Capital.  In that event, it is very clear that you needed the TARP Capital.

With only these two scenarios, we believe almost every bank is better off applying for TARP Capital.

Where is the Economy Headed?

As the residential real estate market declined, all the contractors and subcontractors associated with that market began to suffer.  These contractors and subcontractors include our drywall installers, plumbers, painters, flooring specialists, lighting specialists, landscapers, pavers, pool installers, and numerous others – a vast group of construction and service-industry workers.  With new residential starts drying up, and with in-progress projects shutting down, many of the employees in those contracting and subcontracting fields began to lose their jobs.

As those employed in the residential real estate market lost their jobs, our retailers began to feel the squeeze because their traditional consumers stopped spending.  Thus, the residential real estate crisis has begun spilling over into a retail crisis.  This downturn is starkly apparent in the October consumer spending numbers.

So today, as retailers continue to suffer through drastically reduced consumer spending, we have seen the commercial real estate market begin to suffer as well.  Without the income from consumers, our retailers cannot afford to keep up with their debt obligations.  This means that commercial real estate faces mounting trouble in the near future.  All elements of our economy are now facing a considerable negative impact from the current overall recessionary environment.

What began as a residential real estate crisis spilled over into most other sectors of our economy.  This deepening and expanding economic crisis mirrors a classic recessionary process.  Everyone should be prepared for that.

This should be a lesson to all banks, especially when considering whether to apply for TARP money.  Even those banks that were initially insulated from the financial meltdown because they had stayed away from the riskiest acquisition and development loans must now be wary.  As the crisis deepens and expands nearly everyone will be affected in one way or another.

Use of TARP Capital Money

We believe the government will want to recover its investment as soon as possible.  Similarly, we understand that our clients want to repay the government as soon as possible.  These mutual goals provide insight as to how we believe banks should use the TARP Capital infusion.  Specifically, we believe banks should not over lever the funds, but rather lever the capital just enough to break even or make a little money, but not so much that it makes it hard to repay.

After three years, the TARP Capital infusion will likely either have been a guarantee that the bank didn’t need to help get through the recession, or they will be funds that were important to weather the storm.  One of these scenarios is likely to be correct, and neither suggests that a TARP Capital infusion should be refused.

Our advice, even for those banks with few if any residential real estate products on their books, is to prepare realistic, worst-case scenarios for the next three years.  If your bank cannot realistically and relatively easily weather those worst-case scenarios for the next three years, you should strongly consider applying for TARP Capital.