If your bank gets government money under the Capital Purchase Program (CPP), what can you do with it? Can your bank deploy the new capital as it sees fit, or is it limited to using the CPP money to support lending? This question is taking on great urgency as the Treasury is investing up to $250 billion in an array of financial institutions in return for capital warrants.

New York State Attorney General Andrew Cuomo

Cuomo Enters the Fray

The latest figure to take a stand on the use of CPP money is New York State Attorney General Andrew Cuomo. The activist attorney general is investigating institutions’ executive compensation policies. Cuomo has written a letter to certain big institutions — Citigroup, Bank of America, Bank of New York, Mellon, Goldman Sachs, JPMorgan Chase, Merrill Lynch, Morgan Stanley, State Street, and Wells Fargo — demanding “a detailed accounting regarding your expected payments to top management in the upcoming bonus season.”

Cuomo referred to his ongoing investigation of troubled insurance giant A.I.G. “As my office has told A.I.G.,” he wrote, “now that the American taxpayer has provided substantial funds to your firm, the preservation of those funds is a vital obligation of your company. Taxpayers are, in many ways, now like shareholders of your company, and your firm has a responsibility to them.”

The letter to the targeted institutions cautioned, “Obviously, we will have grave concerns if your expected bonus pool has increased in any way as a result of your receipt or expected receipt of taxpayer funds from the Troubled Asset Relief Program.”

As the American Bankers Association reminded Treasury last week, it would be helpful if someone in the government would officially declare exactly what CPP’s purpose is and what uses of CPP money are permissible. Such guidance might also spare banks from criminal investigations mounted by a politically ambitious state attorney general.

Initially, government officials said each institution could decide how best to use the funds for the institution’s own purposes. For example, Interim Assistant Treasury Secretary for Financial Stability Neel Kashkari told the Senate Banking Committee that financing a merger would be an acceptable use of CPP funds. “If you have a small, failing institution being acquired by a much healthier institution … that is good use of taxpayer dollars because that community is well served by that combined, stronger institution,” Kashkari declared.

However, banks shouldn’t necessarily take Kashkari’s position as law. President Bush himself has said, “What we’re trying to do is get banks to do what they are supposed to do, which is support the system that we have in America. And banks exist to lend money; that’s how they make money. So we think that one of the things that we have to do is help recapitalize them so they have a capital base so that they are willing to lend money.”

Congress Weighs In

Likewise, some members of Congress have expressed a keen interest in making sure that banks will lend whatever CPP funds for which they might qualify. On October 31, House Financial Services Committee Chairman Barney Frank (D-Mass.) stated:

“I am deeply disappointed that a number of financial institutions are distorting the legislation that Congress passed at the President’s request to respond to the credit crisis by making funds available for increased lending. Any use of these funds for any purpose other than lending — for bonuses, for severance pay, for dividends, for acquisitions of other institutions, etc. — is a violation of the terms of the Act.

“I appreciate the fact that the Secretary of the Treasury has reemphasized that increased lending activity is the only legitimate purpose for taxpayer funding of these institutions. He must make it absolutely clear to any participating entity that the federal government will insist on compliance.”

Separately, House Judiciary Committee Chairman John Conyers, Jr. (D-Mich.) and Government Oversight Committee Chairman Dennis Kucinich (D-Ohio) issued statements opposing the use of CPP money for any purpose except lending.

“It is very troubling to learn that the $700 billion rescue package sold to the American consumer as necessary to ensure continued loans to small businesses and consumers is apparently being used instead to squeeze smaller banks out of the market,” Conyers said. “I’m concerned about the federal government using these funds to take sides in mergers and to promote [industry] consolidation … instead of reviving our economy.”

Kucinich added, “It seems evident that bailout funds are being used in unintended and objectionable ways. Nowhere is this more clear than in my district in Ohio, where National City was recently purchased by PNC; a bank that did not receive bailout money was purchased by a bank that did. Federal money should not be used to subsidize consolidation of the banking industry.”