Bailout Banks Made Riskier Loans: Study

ANN ARBOR, Mich. (TheStreet) -- The government bailout made banks appear safer but actually caused them to take on more credit risk, according to a University of Michigan study released Wednesday.

According to a working paper by finance professors Ran Duchin and Denis Sosyura of the university of Michigan's Ross School of Business entitled Safer Ratios, Riskier Portfolios: Banks' Response to Government Aid, banks participating in the government's Capital Purchase Program as part of the Troubled Assets Relief Program, or TARP, "significantly increased their investments in risky securities," by 10%, "displacing safer assets, such as Treasury bonds, short-term paper, and cash equivalents."

The study also found that although the banks receiving TARP money weren't any more likely to expand their lending, the group's lending activity shifted toward riskier mortgages "as measured by the borrower's loan-to-income ratio and the high-risk loan indicator based on the loan rate." According to the study, "the fraction of the riskiest mortgages in the originated credit increased for banks approved for [participating in TARP] but declined for banks denied [TARP money] by the regulators."

According to the study, the receipt of TARP money also led to "significant effect on the risk profile of corporate lending," similar to that seen for mortgage lending.

Duchin and Sosyura say that although TARP helped improve participating banks "capitalization ratios," the net effect was "the net effect is a significant increase in systemic risk and the probability of distress due to the higher risk of bank assets."

Among banks participating in TARP by selling preferred shares to the U.S. Treasury, the largest bailout recipients were Citigroup (C), which received $49 billion from the U.S. Treasury, and Bank of America (BAC), which received $45 billion in government money. Bank of America fully repaid TARP and Citigroup repaid $20 billion in TARP money, after converting $25 billion its TARP preferred shares to common shares, which were later sold by the government.