A collection of government efforts to restore order and confidence in the banking system after the September credit freeze could be broadly successful.

The Treasury Department took the lead in proposing the $700 billion Troubled Asset Relief Program. After one failed vote, considerable debate in the Senate and the House, and the inclusion of additional oversight provisions, the program was ultimately approved by Congress, and its implementation is well under way.

But now Congress, acting as a protective steward for the American taxpayer, is about to commit a classic government error: grabbing the baton from free-market lenders and instructing them to lend, not hoard.

After more than 40 banks have received preferred stock investments from the government, new restrictions are being discussed for the receipt of Tarp funds. Congress is objecting to using the funds for acquisitions. It only wants new lending, but it does not recognize how damaging ill-timed credit expansion can be in a deteriorating economy.

Ironically, U.S. banks increased loans outstanding by $230 billion over the last few weeks — double the increase from the previous four weeks and after virtually no increase since last April. Nevertheless, barely a month into its effort to sell the solution to banks, the government is contemplating changing the rules.

The unintended consequences could well be less Tarp participation, more bad credits, and an even weaker financial system.

On their own, bankers have significantly tightened their lending standards. This tightening was overdue and was not an overreaction. According to the recent Federal Reserve Board survey on lending standards, banks are back to where they usually are when entering a recession. They are clearly willing to make repayable loans, but not unsafe ones. And banks are clearly willing to sustain lines to creditworthy customers. We should not forget that loosened underwriting standards were a major contributor to the financial meltdown.

Any recapitalization exercise should be designed primarily to strengthen our banks for future lending. Natural demand for substantial loan expansion is largely absent at the moment. Forcing credit into already overleveraged markets, whether consumer or corporate, is potentially destructive and cannot initiate economic recovery on its own. Expanding credit accompanies a recovery — it does not start one.

Unfortunately, the government is making three mistakes disappointingly consistent with its history.

First, it increasingly views its role as being a wise allocator. It is once again playing with levers and buttons in a cockpit it does not understand, while the frightened passengers unwittingly approve. Whether this is more a repeat of its role in the 1980s savings and loan catastrophe or something far worse, the unintended consequences are looming.

Second, the government specifically does not want to aid banking consolidation with Tarp money, since it thinks this would divert credit and enrich the wrong people. Actually, the reverse is true. No strong bank wants to acquire a weaker balance sheet without some economic offset for the risk. With some assistance, however, strong banks are clearly willing to take more risks off the FDIC's plate and probably reduce taxpayer risk for any overage.

Institutions produced by mergers usually become stronger than their components, and they can significantly enhance their lending capacity as the fundamental need for credit slowly returns.

Third, the government is destroying its credibility with banks and, more broadly, with the private sector. Jawboning against assisting acquisitions is foolish. Coming to the rescue with effectively involuntary capital infusions with unknown strings attached is wrong-headed. Changing the rules after the fact is disingenuous, and it violates the doctrines of good faith and transparency.

This is sadly reminiscent of the "supervisory goodwill" saga from the 1980s. This glaring parallel sadly lives on, still embattled two decades after Congress threw out regulatory agreements and bankrupted thrifts that had been unwittingly induced to rescue their weaker brethren. Many of the survivors, despite a Supreme Court ruling, remain uncompensated.

Government intervention in the S&L crisis cost more in the end than necessary and in many cases punished the cooperative. In this renewed time of crisis, the government should say what it means up front, and it should mean what it says.

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