A strange new twist for TARP rules

(breakingviews.com) -- Has the Federal Reserve been reading too many fairy tales?

Judging by the latest tweaks the U.S. regulator has made to the criteria banks must meet before they can repay capital injected by the Troubled Asset Relief Program, the Fed seems fixated on the Princess and the Pea: no matter how much cushioning it heaps onto bank balance sheets, it still feels the discomfort of potential losses.

Of course, there's much to be said for having a proactive regulator keeping its eye on all the downside risks. But policy contradictions appear to be piling up at the Fed.

Demanding that healthy banks like JPMorgan (JPM, Fortune 500) prove they can sell equity before allowing them to offload their TARP funds looks odd enough: the New York-based bank easily passed the Fed's stress tests, and the $5 billion that regulators told it to raise does little to bolster its already very solid capital ratios.

Now Morgan Stanley (MS, Fortune 500) has been told to raise an additional $2.2 billion. Granted, the Wall Street firm didn't fare as well in the stress test. But it took its medicine immediately, raising $4.6 billion the day after stress test results were made public. That not only proved the bank could tap public equity markets -- it was more than double what it needed.

That makes it appear there is little justification for forcing Morgan Stanley to go back to the trough. Unless the Fed is somehow tacitly admitting the stress tests weren't up to snuff, this extra bout of stock-selling only serves to dilute Morgan Stanley's shareholders unnecessarily.

Even more puzzling, the Fed doesn't appear to be compelling Goldman Sachs (GS, Fortune 500) to raise more capital. Sure, Goldman shouldn't need to -- it passed the stress tests and raised $5 billion of new equity in April. But giving one solid firm a pass while conscripting others seems illogical. At least the princess in the fairy tale was consistent.