GWEN IFILL: So the banks are passing stress tests and repaying the government. Does that mean they’re out of the woods and the government rescue plan worked?
Here to take an initial pass at those questions are William Cohan, author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street.” He’s a former Wall Street banker.
And Peter Wallison, a former general counsel of the Treasury Department in the Reagan administration, he’s now a fellow at the American Enterprise Institute.
Welcome to you both.
William Cohan, today Timothy Geithner said that repayments are, as he put it, an encouraging sign of financial repair. Do you agree with him?
WILLIAM COHAN, author, “House of Cards”: Well, it’s hard to complain, Gwen, about returning back to the taxpayers, you know, whatever it is, the $30 billion, $40 billion, $50 billion, $60 billion that they’re returning and that they owe to us, and that’s a good thing. It’s very hard to complain about that.
On the other hand, you have to ask yourself, why in the world, when we knew that the system was so badly broken six months ago, why are we in a mad rush to restore exactly the same system as quickly as possible?
GWEN IFILL: Peter Wallison, is that what is happening here as we see these loans repaid, the same old system still in place?
PETER WALLISON, American Enterprise Institute: Well, yes. The same system is in place, but there has been one major change, and that is the stress tests, which turned out to show that the banks were probably not in as bad financial condition as most of the reports had said.
And since banking is very much a question of confidence, it now looks as though the banking system is going to be able to return to something closer to normal. And under those circumstances, it’s a good thing for the government to get out.
Results of stress tests
GWEN IFILL: So you're saying -- let me get this right, Mr. Wallison -- that basically the stress tests proved that this was an over-inflated problem?
PETER WALLISON: I don't say it proved anything, but what it did suggest is that the problem of toxic assets in these banks was much smaller than many people had believed.
If you believe the stress tests and if you believe the fact that the stress was a little bit tougher than the current situation in our economy, then it's possible to believe that the banks actually will be returning to normal. And if they are, they would be good investments.
GWEN IFILL: What do you think about that, William Cohan, not only the point about returning to normal, but also whether you believe that the stress tests are as they were advertised?
WILLIAM COHAN: You know, I don't really believe the stress tests tell us a whole lot. I think the stress tests were designed to make sure that the banks, who are undergoing the stress tests, pass them. And nobody wanted anything remotely like a shock in confidence if a certain bank was told they couldn't pass the stress test and had to go out of business or they had to raise so much capital that they possibly couldn't raise.
I mean, let's not forget what happened at the end of the Bush administration. Say, for example, at Citigroup, where $301 billion of assets were ring-fenced with Citigroup taking the first $29 billion in losses and we, the people, taking a cascading percentage of the losses after that.
These assets are said to be worth probably around only $150 billion. And, in fact, they were valued at $301 billion. That guarantees losses, it seems to me.
At Bank of America, the Bush administration right before it expired agreed to take $118 billion of assets away from Bank of America and ring-fence losses against those assets, as well.
So you have to, I think, wonder why we are going back and re-establishing the status quo as quickly as possible, because I think that's the reason why the TARP money is being paid back and why they want to pay the TARP money back so quickly, as was pointed out in the earlier report.
They want to be able to pay people exactly what they want. They don't want the government in their business. I can't say as I blame them.
But I think we do need to restructure the entire architecture of the financial system while we have the opportunity. And letting these banks get out of the TARP and slither away from the grasp of the government at just the moment when we need to restructure the banking system is not wise.
Government as an investor
GWEN IFILL: Peter Wallison, that's an evocative term, that the banks are slithering away from the grasp of the government. Is that what you see as happening with the repaying of this TARP money?
PETER WALLISON: No, no, of course not. The government actually turns out to be a terrible investor, because most investors want to make money, but the government actually wants to just score political points.
And as a result of that, they are forcing the banks to make decisions on compensation, for example, which will weaken them terribly over time. We shouldn't want to weaken our banks. In fact, it makes no sense at all to weaken our banks.
Also, I'd like to mention that I'm probably the last person who might be supporting what the Treasury Department is doing right now, but in the case of the stress tests, I don't think this was a game.
I do think the supervisors adopted a series of tests that were -- at the time they were adopted, they looked pretty tough. And the fact that the banks could get through those tests and still have some capital left so that they were not deemed to be insolvent or grossly undercapitalized suggested, I think, to the market that things were just not as bad as they had been led to believe.
GWEN IFILL: William Cohan, let's go back to some basics here, that the title of -- what TARP stands for is "toxic assets recovery program." Were the toxic assets, the bad loans that Paul Solman was talking about, were they recovered in this process?
WILLIAM COHAN: Well, as was pointed out in the earlier part of the report, no, of course not. That subject seems to have once again faded into the background.
Those toxic assets still exist on the books of these banks. There's been no trading of those assets. The subject seems to have gone away in part because of a little-known move by the FASB at the end of the first quarter of...
Flexibility in accounting
GWEN IFILL: The FASB being?
WILLIAM COHAN: The Financial Accounting Standards Board, which, at the end of the first quarter of 2009, gave banks much more flexibility in mark-to-market accounting. They, therefore, marked some of those assets up, which is how in part a lot of these firms reported profits in the first quarter, so they loosened the tight reins they had on the mark-to-market.
Now investors, who might be willing to purchase those assets, what they thought might be an attractive price, now are scratching their heads saying, "Hmm, now they've marked them up again and our potential profit margin is gone," so they're not that interested anymore.
The truth is, these assets are still on the books of the banks. They're doing funny things with the accounting. And they're not, you know, being realistic about their worth, their value, and taking their markdowns.
And I don't think the government wants them to do that, because that would, in fact, go to the whole issue of confidence again, which they are so busy trying to restore.
GWEN IFILL: Peter Wallison, of course I got that acronym wrong. It's the Troubled Asset Relief Program.
PETER WALLISON: Troubled assets.
GWEN IFILL: So do you agree with what he just said about what actually happened to those assets, whether they have -- whether the drag that they're putting on these banks' bottom lines has been relieved and now things are better?
PETER WALLISON: No, no, I don't agree at all, as a matter of fact. The supervisors reported that there were about $200 billion in these so-called toxic assets. These are these collaterally backed assets of various kinds, like mortgage-backed securities, on the banks' balance sheets.
And that was 19 banks, so that doesn't reflect very large numbers of such assets to begin with, which I think was an interesting point here.
In addition, they were not marked up as Mr. Cohan is suggesting. What happened is that the supervisors in valuing those assets used a discounted cash flow method to value the assets instead of looking at market prices.
Many of us have been saying all along that they should be using discounted cash flow in the banks to value these assets rather than market prices. And when the supervisors did this, they found that, of those assets, only about $35 billion -- this is for 19 banks -- only about $35 billion had to be marked down, which they did at that point. But that suggests a much lower level of toxic assets than people had been talking about before.
The upside for taxpayers?
GWEN IFILL: I have a final, brief question for you both, which is what -- now that we see this money being repaid, what is the upside for taxpayers -- William Cohan, starting with you -- in this program, in this repayment, in this whole rescue program?
WILLIAM COHAN: Well, for starters, we get some of our money back, Gwen, which is very, very important and very welcomed. We also, I believe, have still continued to own warrants in some of these banks. And as the stock prices of these banks increase, we'll be able to cash those warrants in, assuming they do increase. And that will have some value to taxpayers.
But I think we're giving up something very, very valuable in the short term, which is our hooks into these banks that are repaying the TARP funds and to get them to be more accountable for their compensation systems and for the activities that they are undertaking at the banks.
And this is a very crucial moment, and we're about to lose it.
GWEN IFILL: Peter Wallison?
PETER WALLISON: Well, of course that isn't the way that we ought to be dealing with the banks. We ought to make a law. We ought to have some regulations if we think it's important, not just to take a few banks that have taken the TARP funds, distinguish them from the ones that haven't taken the TARP funds, and try to adjust the way they do business.
The way banks do business should be left to the banks, not to the government deciding on a political basis with inadequate review of the issue how banks should be doing these things.
GWEN IFILL: And we'll leave it right there. Peter Wallison and William Cohan, thank you both very much.
WILLIAM COHAN: Thank you, Gwen.
PETER WALLISON: Thank you.