Student blogger Lucas Puente reveals good, the bad, and the ugly in the banking industry.

Here is a question that has been boggling my mind for a while: In protecting the financial system, should the Treasury Department be primarily looking out for the banks or the taxpayer?

Unfortunately, what the Treasury should do has not mattered much throughout this financial crisis or we would have seen real financial reform and less no-questions-asked money doled out to Wall Street. It seems clear to me that the Treasury’s main concern has been the banks, sometimes to the detriment of the taxpayer. Moving forward, it’s imperative that the Treasury acts boldly in negotiating with banks participating in the Troubled Assets Relief Program (TARP) in order to increase taxpayer return on investment and boost the public’s trust in the financial system and its overseers.

Yes, the Treasury’s TARP may have helped bring the financial system back from the brink of death, but it has been less successful in maximizing its return on investment (even one of Treasury’s best deals with Goldman Sachs looks second-rate when compared to Warren Buffet’s return on a similar deal).

Criticism of TARP has reached a fevered pitch recently. Earlier this month TARP overseer Neil Barofsky pointed out how the Treasury Department may have misled the public into believing the Big 9 banks that received TARP funds were healthy. In fact former Treasury Secretary Henry Paulson believed one of the banks (which has not been named) was actually failing. This was on top of the bonus-brouhaha over at American International Group, where executives received millions in bonuses even though the company posted losses and needed a government bailout.

Now is the time for the Treasury to make a bold move by putting taxpayers first. We saw the positive impact that such an approach can have in warrant redemptions (e.g. the 23% return from Goldman Sachs) and we have seen the negative impact of the Treasury’s early repurchase deals, which were seriously undervalued.  Of course this boldness must not come out only as Treasury exits these deals, but also as it continues to enter into even more transactions. While some believe TARP will be winding down soon, the reality is that capital injections are continuing to be made.

Last fall, the Treasury altered the parameters of TARP and began directly injecting capital into participating banks through a Capital Purchase Program (CPP). So far deals have been made with 682 banks, most of which traded preferred stock for taxpayer capital. In total, just over $200 billion in taxpayer capital has been injected into these banks.

Even as more banks have been accepting taxpayer funds, some have begun to repay their TARP investments. The first series of repayments came on March 31 of this year, when five banks paid off Treasury’s preferred shares. Over the next nine weeks, 17 more banks paid back their shares, putting $1.52 billion back into Treasury’s coffers. Then on June 17, a big portion of the government’s invested capital was returned when 10 of the country’s biggest banks, including JP Morgan Chase, Goldman Sachs, and Morgan Stanley, paid back a combined $68 billion in preferred stock.  Since then, however, only nine backs have repurchased Treasury’s preferred stock according to Treasury’s latest statistics, worth a total of $518 million. Manhattan Bancorp was the latest CPP program participant to have done so, having paid back its $1.7 million investment.

As financial institutions and markets begin to recover and attention turns elsewhere, it would be easy for Treasury to begin easing its approach to these deals. However, doing so would be a mistake, as there is still $134 billion- and counting- in taxpayer capital outstanding. Moreover, the improved investing climate is largely a direct consequence of Treasury’s earlier actions; thus it only makes sense that they demand a proper compensatory return, just as any rational investor would.

Lucas Puente is a senior at the University of Georgia where he is pursuing a double major in finance and international affairs. He is a member of the Roosevelt Institute's Campus Network.

Student blogger Lucas Puente sees benefits to a super-regulator...

Regulatory arbitrage is a dangerous  little Wall Street practice that, if left unchecked, threatens the stability of the economy. How it works: Under the current system, banks can shop around to find the most advantageous charter, which basically allows them to choose what kind of regulatory supervision they will have.  And with their future growth (or shrinkage) more or less tied to the number of banks they regulate, today's regulators have an unmistakable incentive to provide a permissive regulatory environment that favors the banks. Under this perverse system, it's simply not in their best interest to crack down on the banks they regulate. Actually, quite the opposite.

Why? Banks will simply switch their federal charter to a more lenient regulator. This was arguably most obvious in the regulatory "strategy" of the Office of Thrift Supervision (OTS), the home of 18 of the banks closed by the FDIC so far in 2008 and 2009.

The Treasury department has proposed measures to address this problem in its white paper. The first idea is to merge the OTS and Office of the Comptroller of the Currency (OCC) into a new National Bank Supervisor. Second, the Treasury called for the proposed National Bank Supervisor, Federal Reserve and the FDIC to enact uniform regulatory fees. Finally, it advocated lowered regulatory fees for community banks in order to encourage them to have a federal charter. Simply by removing 50% of the options banks have regarding federal charters, the first measure would be addressing this issue. The second and third proposal would eliminate arbitrage based off fees -- a key initiative as, in addition to choosing their charters off regulatory lenience, banks often chose the "cheapest" regulator, whether that is their state regulator or one of the federal bodies.

Treasury wants to blend two agencies into a bank supervisor, but Chris Dodd wants all four into one. Dodd, chairman of the Senate Banking Committee, proposes merging the four primary federal banking regulators (OTS, OCC, the Federal Reserve and the FDIC) into a super-supervisor, a la the U.K.'s Financial Services Authority. This restructuring would only apply to the regulatory duties of these entities, while the Fed would maintain its current role in conducting monetary policy and the FDIC would continue to operate its depository insurance fund. (Dodd is also behind the Consumer Financial Protection Agency).

Naturally, Dodd's plan faces stiff resistance from industry leaders, inertia-prone members of Congress, and, of course, current regulators concerned with protecting their home turf. Demonstrating this opposition, Edward L. Yingling, president of the American Bankers Association, remarked that Dodd's sweeping consolidation plan is based on a model that "hasn't worked in other countries that have tried it and it faces plenty of opposition in Congress." Although the U.K. has taken in plenty of hits in the current crisis, even the American Enterprise Institute acknowledges that the FSA has distinct advantages due to its streamlined regulatory structure.

Whether Dodd's bill is the right answer -- or the one that will pass -- is up for debate. The key is making sure that regulatory arbitrage doesn't get left out of whatever new system is put in place. The Beltway seems to be a place of astute amnesia, when it's politically prudent. Need we say "public option"?