Bank of America is making a $7 billion dollar cash investment into China Construction Bank.

Bank of America received $15 billion directly from TARP and will get another $10 billion (when they close the Merrill Lynch acquisition at year end).

“Bank of America isn’t funding the purchase with proceeds from the government’s Troubled Asset Relief Program, or TARP,” spokesman Scott Silvestri told Bloomberg.

It’s the old “in one pocket and out the other” trick.

In the end, the U.S. taxpayer has just provided a capital injection into a Chinese bank.

Something is wrong here.

Let’s briefly review the chronology.

TARP was originally designed as a “troubled asset” program. Treasury Secretary Paulson officially abandoned that design yesterday.

TARP morphed into a program that would inject capital into the U.S. banking system.

Injecting capital is quick. The intention is that the capital is used to increase the number of loans – to jump start the credit system.

However, there are three flaws in the implementation.

First, some banks took the TARP money and just stashed it away to reduce their risk. They had to do this because they are sitting on so many troubled assets. The TARP money simply gives them breathing room. It does not help create credit.

Second, some banks use the TARP money for other purposes. Bank of America decided to increase its stake in China Construction Bank. This is not what the TARP was intended to do. It effectively injects capital into a foreign bank doing nothing for the credit problems we have at home.

Third, and you have heard this from me before, the TARP money should have been focused at the good banks. They are the ones that will take the money and loan it out. The motley list of recipients is a combination of good and troubled institutions. 30 large and medium-sized banks have received $250 billion of TARP.

Where are the other 8,470 financial institutions!?

I have no problem with Bank of America investing in China Construction Bank. CCB might be a very good investment.

I have a problem with Bank of America effectively using the TARP money to fund an investment in a foreign bank.

Indeed, it really should be the other way around. China is sitting on a huge pile of U.S. dollars. It would seem to be an ideal time for them to use these dollars to invest in some financial institutions or other real assets. It is obviously in their best interest to make sure the global economy recovers quickly. [Note my positive phrasing; I could have said ‘It is obviously in their best interest that we do not fall into the global financial abyss!’]

But no, it is the opposite. We are injecting capital into a Chinese bank.

Again, this might be a good investment under normal circumstances. But these are hardly normal circumstances.

If Bank of America want to use funds for this type of investment, that is fine with me. However, they should refund their TARP money.