JEFFREY BROWN: The plan to buy billions in banking stocks comes after a similar coordinated move was announced by European governments yesterday.
Less than a month ago in a congressional hearing, Treasury Secretary Henry Paulson seemed to dismiss the notion of a government equity purchase program.
HENRY PAULSON, U.S. Treasury Secretary: There are some that said we should just go and stick capital in the banks, with preferred stocks, stick capital in the banks. And that’s what you do when you have failures.
The right way to do this is not going around and using guarantees or injecting capital, and there’s been various proposals to do that, but to use market mechanisms.
JEFFREY BROWN: But that was then. By this morning, circumstances had changed, and Paulson and other top economic officials detailed a bank stock purchase plan.
HENRY PAULSON: Government owning a stake in any private U.S. company is objectionable to most Americans, me included. Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable.
When financing isn’t available, consumers and businesses shrink their spending, which leads to businesses cutting jobs and even closing up shop.
JEFFREY BROWN: Though the plan is voluntary, Paulson reportedly made it clear in meetings yesterday with the heads of large banking institutions that their participation was virtually required.
Today’s government actions include the $250 billion plan to purchase stock in U.S. banks. The money comes out of the $700 billion rescue package passed 11 days ago by Congress.
$125 billion goes to nine banks. Citigroup, Bank of America, Wells Fargo, and JPMorgan Chase will each receive $25 billion in return for preferred stock. Five other institutions will split $25 billion. Another $100 billion will be available for smaller regional banks.
The government would also guarantee new debt issued by banks for the next three years. In exchange, participating institutions promise to limit executive compensation and ban so-called golden parachutes for executives as long as the government holds the stock.
The FDIC will also now provide unlimited insurance to all non-interest-bearing bank accounts in the U.S. until the end of next year, a move intended to help small business.
The chair of the Federal Reserve, Ben Bernanke, an expert on past financial calamities, said the extraordinary moves were suited to the time.
BEN BERNANKE, Federal Reserve Chairman: We will not stand down until we have achieved our goals of repairing and reforming our financial system and thereby restoring prosperity to our economy.
The actions today are aimed with restoring confidence in our institutions and markets and repairing their capacity to meet the credit needs of American households and businesses.
The voluntary equity purchase program, described by the secretary, will strengthen financial institutions’ capacity and willingness to lend.
JEFFREY BROWN: Sheila Bair is chair of the FDIC.
SHEILA BAIR, Chairman, Federal Deposit Insurance Corporation: Our efforts also parallel those of the international community. Their guarantees for bank debt and increases in deposit insurance would put U.S. banks on an uneven playing field unless we acted, as we are today.
JEFFREY BROWN: After the plan was announced this morning, markets surged, before falling into negative territory by day’s end.
Evaluating Paulson's move
JEFFREY BROWN: And joining us to discuss today's moves are: Robert Glauber of Harvard's Kennedy School of Government. He's former CEO of the National Association of Securities Dealers and served in the Treasury Department under the first President Bush.
Dean Baker, co-director of the Center for Economic and Policy Research, a Washington think-tank.
And Richard Sylla, an economic historian at New York University's Stern School of Business.
Robert Glauber, a good move, a necessary move? How would you describe it?
ROBERT GLAUBER, Harvard University: I'd say it's a necessary move. I think the Treasury obviously was hesitant to do this, but became convinced for a number of reasons that it was time to take really quite dramatic steps, not unprecedented steps, but really quite dramatic.
JEFFREY BROWN: What pushed them? I mean, we saw what Paulson was saying not that long ago. What changed his mind?
ROBERT GLAUBER: I think two things. One is I think they looked at numbers that convinced them that the banking system is undercapitalized and needs an injection of capital.
And the other is what Sheila Bair said in your introduction, that Europe has done this now and there's a competitive problem. If European banks are better protected than American banks, money could flow there and come out of here.
JEFFREY BROWN: Dean Baker, how do you see today's move?
DEAN BAKER, Center for Economic and Policy Research: Well, I think it was the right thing to do. I think it was unfortunate that it took Secretary Paulson so long to go down this path. I mean, originally he was proposing to buy up the troubled assets of the banks.
And I think, you know, Barney Frank made the comment that we don't really know how to do that. It's a difficult process. It's unclear what you do. That's a very indirect way of injecting capital into the banking system.
The immediate need was to shore up their capital, and this does that. And, again, the guarantees, I think, are very important for deposits, non-interest-bearing deposits, and for new debt from the banks.
So I think it's definitely on the right track. I mean, there's some quibbles I would make with the program, but...
JEFFREY BROWN: Like what?
DEAN BAKER: Well, I would have -- well, one, just, you know, the interest rate we got, I note that when Warren Buffet gave -- invested in Goldman Sachs, he got 10 percent. We're getting 5 percent. I don't think there was a need for us to take a substantially below-market interest rate.
And, two, again, getting back to the issue of executive compensation, I don't really think that this will be very binding on the banks.
The U.S. as a 'passive investor'
JEFFREY BROWN: All right, let me come back to those. First, I want to bring in Richard Sylla, because I want to try to help people understand this. It's been referred to as a partial nationalization. Now, what exactly does that mean?
RICHARD SYLLA, New York University: Well, in the countries where they totally nationalize banks, the government just comes in and takes them over, pays off all the stockholders, and then operates them almost like government agencies for a while.
In this case, most of our banks will continue to have most of their capital from private sources, but they will receive an injection of capital at a time when extra capital is needed to help them get back in lending to people.
So I think, you know, maybe the government is taking a minority stakeholder position in these companies, nothing like a majority position.
JEFFREY BROWN: And are there precedents that you look to that help us guide our way?
RICHARD SYLLA: Well, we did the same thing back in the 1930s. And from 1933 to 1935, President Roosevelt authorized the Reconstruction Finance Corporation to inject capital in the form of preferred stock into banks.
And something like 6,000 banks received injections of capital at that time in the form of preferred stock. And along with deposit insurance, this injection of capital, which I think was not too far different, you know, in that economy from what this current program is, along -- so the injections of capital and deposit insurance stabilized the banking system. And, you know, it helped us get out of the Great Depression.
JEFFREY BROWN: So, Robert Glauber, if the U.S. is a kind of passive investor here, let's talk about some of the questions that Dean Baker just raised. For example, does the government get a good return on its investment? What kinds of questions are raised for you?
ROBERT GLAUBER: Well, I think a number of questions are raised, and they're difficult ones.
First of all, the government is going to have to decide which banks it injects capital into. That means it's going to pick winners and losers. And whenever it does that, that's a very hard decision for government to make.
JEFFREY BROWN: You're talking -- excuse me, you're talking about all the other banks out there, because so far we're just talking about the biggest, right?
ROBERT GLAUBER: That's right. They've chosen the nine biggest. That, I think, is the easy decision, but how about the other 7,000 banks?
My bet is a number of them are going to queue up. And the government is going to have to decide how much money to put in each one of them. And that basically puts them in the position of choosing winners and losers. That's a tough decision for government to make.
There are other difficult problems, as well. It's said that this is passive, but one of the things the government has already done is say what it wants to have happen about compensation contracts. And it has outlawed certain compensation contracts.
Beyond that, the government is going to have to decide eventually what it does with the warrants it gets. It gets some participation in the common stock. It's going to have warrants that are valuable and eventually going to have to sell those. So this isn't the end of the difficult decisions.
The taxpayer's role
JEFFREY BROWN: So, Dean Baker, I mean, we're talking about the government here, but we mean taxpayers in a sense. Are you suggesting that we don't have enough protections here or guarantees on return?
DEAN BAKER: Well, I think so. I mean, as I say, I would like to have seen us get -- you know, I don't know if we get the same deal that Warren Buffett got, but if he can get 10 percent, why shouldn't we...
JEFFREY BROWN: This is when Warren Buffett invested in Goldman Sachs.
DEAN BAKER: Invested in Goldman Sachs, yes. You know, why shouldn't we get something at least comparable to that?
And, again, I say that for two reasons. One is, you know, taxpayers should try to get as much by way of protection as they can, but the other point is, you know, when Secretary Paulson first announced his idea, he said, "This should not be punitive." And my view is absolutely it should be punitive.
I mean, you're talking about taking money from people who, you know, work as school teachers and firefighters. You're taking their tax dollars and using it to reward banks that got themselves into enormous trouble.
And these are the absolute richest people in the country. So I can certainly understand. I think there's a need to tell people that, no, it's not going to be fun. This isn't a party. We're not handing out money to the banks. We're extracting tough conditions from them.
JEFFREY BROWN: And the limits on executive pay and compensation, are they not enough?
DEAN BAKER: I think they're very lax. I mean, the undersecretary, Kashkari, met with Wall Street bankers earlier this week, or I think it was last week, actually.
There was a report on this in the Wall Street Journal. And he said you shouldn't worry about that. You know, it really won't be very tough. My guess is that virtually all the banks will find ways around it. I'll be very surprised if we here of pay cuts for any executives at the banks as a result of this.
JEFFREY BROWN: Richard Sylla, do you want to weigh in on all these kinds of questions, given what you've seen from the past and the role of government in the private sector?
RICHARD SYLLA: Well, I would disagree some with Dean Baker, in the sense that Warren Buffett is, you know, the chairman of a company, Berkshire Hathaway. And he's using that company's money to invest in Goldman Sachs and General Electric, and so he has to look after the interest of his stockholders.
The government isn't in this to make a profit. The government, it may well make a profit, but the government is in this to stabilize the financial system.
So I don't think it should demand the most draconian of terms from the banks. We have a systemic problem that we're trying to solve.
And so I think that, you know, you don't want to sort of treat the taxpayer as an investor in this one. We want to get the financial system functioning again.
JEFFREY BROWN: Do you want to respond?
DEAN BAKER: Well, I think the first priority has to be to get the financial system functioning, but, again, I think it is important that we do have harsh conditions, because, again, these banks are in trouble.
You know, in many cases, they would be out of business. These people would be out of jobs without the government's support.
So I don't see any problem with imposing harsh conditions, saying, you know, if you take our money, then you're going to have to really give up something.
In England, they're required that they stop paying dividends to shareholders. I think that would have been a reasonable condition here.
Beginning the end to the crisis
JEFFREY BROWN: Robert Glauber, I want to ask you about another piece of this announced today, which was the government guarantee of new debt taken on by banks. Explain why that part is important. What does it do?
ROBERT GLAUBER: Well, what it does is it makes it easy for banks to borrow from each other, because they're now borrowing using the government's balance sheet as a backstop.
The danger with it is that it allows weak banks to borrow as easily as strong banks, because they all have the government backstop. And when that happens, weak banks could decide or try to borrow a large amount of money, make risky investments to try and make some money to get whole.
That's what happened back with the S&Ls. And the only way to prevent that is to have strong regulation. That's going to be the job of the FDIC, to make sure that weak banks don't try and grow themselves out of their hole.
JEFFREY BROWN: Well, staying with you, Mr. Glauber, it goes to a question I keep wondering is, how much do we know, even at this point, about the depth of the problem for so many banks?
ROBERT GLAUBER: Well, we don't. What we do know is that banks were frightened to lend to each other, and so they perceived problems with each other, but we don't know the details.
The regulators presumably do. And that's going to be the job of the front-line regulators, the controller of the currency, the FDIC, to make certain that these banks, which are newly empowered by having borrowing ability, because the government is behind them, don't misuse that borrowing ability and take risks that could get them into more trouble.
JEFFREY BROWN: Dean Baker, how do we know when anything is working? I mean, what do we watch for at this point?
DEAN BAKER: Well, we watch for the interest rates -- you know, for interbank lending rates, you know, a number of other short-term rates that tell us about the immediate credit conditions in the market. And those have come down a little it. So, you know, at least the early signs are positive.
But, you know, we're still very, very far from having the credit markets working as they would ordinarily, so we have a long way yet to go. As I say, the first signs are positive, but, you know, it's very -- it's far too early to say we're out of the woods just yet.
JEFFREY BROWN: Richard Sylla, what do you think we watch for next, in terms of the relative strength or weaknesses of many of these institutions?
RICHARD SYLLA: Well, I think that -- I agree with Dean that the interest rate actions today seemed to show that we might be moving toward a solution here.
And I think many of these things we've been hearing about on TV, all these programs, we've talked about them, and they've been announced, but they haven't really taken effect yet.
I think, in the next two or three weeks, these programs are going to spring into action. And if we continue to see the markets improve, interest rates come down, then I think we might well say this is the beginning of the end of the crisis and it may be over by the end of the year or early next year.
And then, of course, we'll have to worry about the economic fallout. It looks like we're moving into a recession that will be a little more serious than previous recessions.
JEFFREY BROWN: And I want to ask you before we go, you know, every night here we talk a little bit about the philosophical shifts underway, the relationship of government and markets, and sort of unprecedented or new moves every day.
How do you see today? Clearly, a new philosophical shift, in terms of the government's role in banks, I guess.
RICHARD SYLLA: I think so. In the middle of a financial crisis, ideology is sort of pushed to the side. You know, the government could do no wrong or the government can do no right.
We forget about that, and we say we have an immediate problem, and we have to solve it.
And so I think that we're going to move maybe toward the center. It's not going to be deregulate, let the market work, and it's not going to be let the government take over the economy.
We're Americans. We're pragmatic. We're in the middle. And we're going to work our way out of this problem.
JEFFREY BROWN: All right, that's a hopeful way to end tonight. Richard Sylla, Robert Glauber and Dean Baker, thanks very much.