Bankers have become the new public whipping post as they bear the brunt of the public’s anger over the recession. While I agree that some greedy big-firm investment bankers and their corporate directors had a hand in causing our current economic mess, some of the blame belongs to others. Those others include the media and members of Congress, as well as members of former and current presidential administrations, who don’t understand the complexities of the issues or are primarily interested in blaming others in order to cover their butts.

Whatever the reasons, bankers are being given a bad name. There’s a misperception that they are not lending the capital made available through the Troubled Asset Relief Program (TARP) in late 2008. It seems that Congress and the Bush and Obama administrations thought that lending cheap money to banks would be a quick fix to what is, in reality, a very thorny conundrum that built up over years.

The truth is, many banks are lending and are using TARP capital to fund their loans, but only to credit-worthy customers. Banks are caught between a rock and a hard place. On one hand, they are being pressured to stimulate the economy by extending credit, while at the same time they are being aggressively regulated to not give credit to high-risk customers. (And who’s not at risk in a recession?)

It’s a convoluted issue, so rather than rely only on my own experiences in banking, I consulted my friends Mike Doyle, former chief credit officer at U.S. Bancorp and president of Credit Risk Advisors, LLC, and Greg Cleveland, president and CEO of BNCCORP, Inc., a bank holding company in Bismarck, North Dakota, where I am chairman of the board of directors. BNCCORP is a recipient of TARP funds. The following is our attempt to expose the common myths about TARP funds and bank lending today.

The 2008 Financial Crisis
Our conversation started with a brief summary of the 2008 financial crisis. We all agreed that the root cause was (and still is) the bursting of the bloated real estate market. What began as a laudable social goal to increase affordable housing during the Carter administration, and expanded in the Clinton administration, resulted in the high-risk sub-prime mortgage market. Further, in the 2000s, many other homeowners leveraged their home equity through second mortgages. This market grew from zero in 1993 to $625 billion by 2005.

To provide the capital needed to support the growth of new home ownership, mortgage originators started to securitize those risky mortgages by creating an investment bond that’s collateralized by a pool of loans. From 2000 to 2006, about 75 percent of all mortgage loans were securitized.

This phenomenon created many new players in the credit market, many of which were not regulated by the government. Plus, Wall Street investment banking firms and securities rating agencies like Moody’s and Standard & Poor’s made extraordinary amounts of money in the underwriting and rating fees of all these securitization transactions—much more than in traditional deposit and lending activities that are the bread and butter of the banking industry. “And these high-risk subprime mortgage products relied on models and assumptions based on theories untested by any historical experience,” Doyle says.

At the same time, the government was keeping interest rates low to encourage commercial real estate development and stimulate consumers to buy more stuff like cars and televisions, which also resulted in a lot of credit card debt. It was a recipe for disaster, and we all now know firsthand what that disaster looks, feels, tastes, and smells like.

What does this have to do with bank credit, you ask? Well, most of those non-bank originators of mortgages, auto loans, and credit cards have now disappeared. “Eighteen months ago, there were a lot of other third-party financial institutions extending credit, so the overall amount of credit availability was much larger,” Doyle says. As people lose their jobs and are unable to repay their loans—and demand for many business products has slowed—banks have imposed stricter terms on customers’ ability to repay, he says.

“Banks just aren’t going to do any marginal transactions right now,” Doyle says. “Banks can’t fill the credit void by themselves to get back to the way it was. It’s time to right-size and decrease the overall size of credit, and we still have not found equilibrium.”

So three factors have contributed to this so-called credit crunch: non-bank originators have disappeared, weak banks aren’t strong enough to lend, and healthy banks aren’t comfortable with lending in this environment.

Here Comes TARP
So that’s where the government stepped in with TARP and made about $700 billion available to financial institutions. In other words, the government is buying up troubled assets to avoid a complete collapse of the economy should Citigroup, Bank of America, AIG, and General Motors (to name a few) all go bankrupt or become seriously distressed.

Included in the overall TARP fund is the Capital Purchase Program, where $250 billion is being spent by the federal government to purchase bank preferred-equity shares. It’s not a bailout; it’s a preferred stock investment with annual dividends of 5 percent for the first five years and 9 percent thereafter. Banks getting TARP funds had to agree to certain conditions and compensation restrictions. The first $125 billion was spent on the largest banks that were considered too critical to fail. Many of those large banks needed the capital to shore up their balance sheets. But Cleveland and Doyle say that some banks were doing okay and were told they had to take the money anyway to avoid disrupting the entire credit system.

“It seems that the government is making the second pool of capital only available to banks that are financially sound,” Cleveland says of the other $125 billion now available. “Most people believe TARP funds are only for sick banks, but that’s not true. “That’s the first misconception about TARP capital,” he adds. “The next is that banks are not lending the capital back into the economy, but that’s not true either. It’s just that it is a complicated, borrower-by-borrower basis.”

Cleveland says that every bank in the United States has some toxic loans in its portfolio. To date, there hasn’t been a way for banks to divest themselves of these loans, so nobody knows how much excess capital they’ll need to weather the storm. “Do I want to get into bed with the government? No, but we didn’t have any other source of cheap capital right now,” he says.

For example, BNCCORP received $20 million in TARP capital at the end of January, and at the time of this writing in mid-February, it had made or committed to $20 to $25 million in new, ordinary commercial and industrial loans, and had about $45 million in mortgages in the pipeline. “The smaller community banks are the healthiest, and we’re lending only to the most credit worthy,” Cleveland says.

TARP Isn’t the Holy Grail
My banking friends and I also agreed that although TARP capital is a good source of cheap money for banks right now, banks will continue to extend credit only to very credit-worthy customers for quite some time. This recession is so deep and wide that it is going to take many forms of firefighting to squelch the blaze.

And the hottest fire remains declining real estate values, because things like houses, strip malls, and office buildings are the tangible assets that serve as collateral to extend credit. When will the bottom drop out of the real estate market? Unfortunately, it won’t be anytime soon. In the interim, businesses will have to figure out how to survive and prosper on their internally generated cash for operations and growth. Many won’t be able do that over the long haul and will fail, resulting in more job and tax revenue losses. Where it will stop? Nobody knows.