TheTradingReport

Let’s say that your corner store runs into a bit of a bad patch. A good friend bails you out with a generous loan at extremely low cost and tells you to repay the cash when you can. When do you do so?

There are at least a couple of possible answers to this question. One is to repay the cash years down the road when you’re back in perfect financial health and don’t need the money anymore. That’s the good scenario.

The not-so-good scenario is to repay the cash as soon as you can, especially if you suspect that even bigger trouble is looming ahead. This may seem silly—why pay back cheap money?—but think about the implications. By ending the loan, you send the signal that you’re a good risk. Your enhanced reputation allows you to sign up lots of partners before calamity strikes.

You should keep these conflicting scenarios in mind when assessing the new eagerness of U.S. banks to repay the funds they received through the Troubled Asset Relief Program (TARP). There are multiple explanations of what is motivating the banks to give Washington back its cash, and it’s not clear which one is most accurate.

The most flattering explanation (at least from the banks’ viewpoint) is to say that they’re back on their feet, don’t need the money and don’t want the stigma of having government cash on their books.

The problem with this viewpoint is that some of the banks (notably Bank of America Corp.) are having to raise money through equity offerings to pay back the government loans. Those equity offerings constitute more expensive capital than the government cash, so the repayment hurts existing shareholders. Why would management want to do that? Why not continue to reap the benefits of low-cost government cash?

A second explanation for the rush to repay the TARP funds is that bank executives want to get out from under Washington’s thumb, especially when it comes to pay restrictions. This makes sense. It just seems brazen.

A third explanation is that banks see more turbulence ahead, especially from commercial real estate loans, and want to raise equity capital before trouble hits to give them a buffer against potential losses. Enticing equity investors is difficult if you still have billions of TARP money on the balance sheet, so you have to first repay the TARP money.

All three explanations have some merit, but Bill McBride of Calculated Risk believes the most likely explanation is the last one. He believes the year ahead will be marked by even more losses on U.S. real estate. Alarmist? Perhaps. But McBride has been one of the most accurate diagnosticians of the continuing real estate turmoil in the United States, so his opinion counts. And his theory has the additional benefit of explaining why U.S. banks are so reluctant to lend right now.

Freelance business journalist Ian McGugan blogs for the Financial Post.

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TARP repayments may signal troubles ahead