Pearlstein: Big banks and bailout money

Steven Pearlstein
Washington Post Columnist
Wednesday, December 16, 2009; 11:00 AM

Washington Post business columnist Steven Pearlstein was online Wednesday, December 16 at 11:00 a.m. ET to discuss why the big banks that received bailout money were able to pay it back so quickly.

Pearlstein won a Pulitzer Prize in 2008 and is co-moderator of the On Leadership discussion site.

A transcript follows.


Fort Worth, Tex.: Steven, more than once in these chats you've commented on the failures of the free market, and yet in your columns you've done an excellent job pointing out how little of the market is really free, given the strong ties from big business to government. It seems to me, and with your columns to back it, that we're really living in a pretty corporatist system, which manages to hold a veneer of free market. Your thoughts? To me it seems like blaming things on the free market is a bit of a strawman.

Steven Pearlstein: You've put that very well. We like to think we have a wild-west, totally free market system, but the reality is that there are lots of formal and informal ties that allow big business to take advantage of government money and power and give government a good influence on the behavior of the corporate sector. The ties are much much loser than they are almost anywhere else in the world, however. It is more than just a veneer.


Laurel, Md.: Could you help me with the factual background here? It's my recollection that when TARP was rolled out, Treasury required all the big banks to participate (whether an individual bank wanted to or not) because it didn't want to stigmatize the participants as needing a bailout when other banks did not.

Is the current crop of repayments mostly the unwilling participants (justifiably) getting out at first opportunity?

Steven Pearlstein: No, it is the rewinding of just what you started with. Once the very strong banks bought their way out, the others got more interested in repaying because, in part, they didn't want to be stigmatized as being unable to repay. In my opinion, this had much more to do with pride and ego and annoyance at having to hassle with another layer of oversight and public scrutiny than it did with actual operating performance -- extra cost or lost business. But there it is. Now there are still lots of smaller banks that have yet to repay, and for them it is largely a problem of not having the same access to new capital in the markets to replace the government capital.


Houston, Tex.: What did you think of the administration's extraordinary ruling on the Citigroup ability to carry forward operating losses after a change of control? By my reckoning, 34% of the value of the rulings benefits will accrue to the governments TARP shares and the other 66% is a giveaway to Citigroup shareholders. Is the government so desperate to show a "profit" on TARP that they are willing to spend 3 times as much in hidden giveaways to achieve it?

Steven Pearlstein: For everyone else, this refers to a Treasury ruling that the taking and then paying back of the government's TARP investments in Citi won't constitute a change of control for the purposes of the tax code. And this is because if you have a change of control, then unused tax losses that are on the books of Citi ($38 billion worth), would not be able to be applied to future year's profits, assuming Citi actually winds up making any. My feeling on that is that this was a reasonable ruling on the merits. The purpose of the IRS rule is to stop companies from buying other companies simply to take advantage of the accrued tax losses on their balance sheet. That really wasn't an issue here.


Memphis, Tenn.: Your column today is a good one but it misses an important point. After forcing the banks to raise external capital in May due to the stress tests, the TARP escapees are having to raise still MORE external capital to break free of taxpayer support. This is critical. Existing shareholders are being diluted and the taxpayer gets a more stable system than before because PRIVATE investors are stepping up. In a subtle but effective way, this is GREAT government policy.

Steven Pearlstein: Sure -- this is what you want to happen. But there is no reason it had to happen THIS WEEK. The Treasury and other regulators could have taken their sweet time about it, been very prudent and careful the way regulators can sometimes be, during which time they might have hinted strongly that they would be more disposed toward approving a repayment if they could see some progress on other fronts -- mortgage mitigation, small business lending, support of regulatory reform efforts. Would that be a bit of old-fashioned arm twisting by government of a private company. You betcha. And make no mistake -- if the situation was reversed, the banks would not have hesitated a minute to use a similar kind of leverage to get the government to do their bidding.


Washington, D.C.: What do you make of Joe Robert's company right now? Do you think they will survive?

JER Investors Trust Headed Toward Bankruptcy

Steven Pearlstein: It looks like it will be restructured.


Washington, D.C.: Are the bank paybacks in cash? I believe it was BoA that paid back the govt. in "preferred shares". Doesn't this just guarantee more Fed support in order to preserve/increase share prices?

Steven Pearlstein: No, they are raising cash by selling new shares and preferred shares, and using the proceeds to pay back the government. The government also demanded, and now owns, some preferred shares and common shares of various banks, which they will now sell on the open market, most likely at a profit, over the coming year.


Portland, Maine: Cheer me up, Steven. Is there any good news?

Steven Pearlstein: Sure, the economy is much stronger than any of us would have thought six months ago, and there is hope that job losses will turn into net job gains in the first quarter. I'm less optimistic about the second half of next year, however. I'm not ready to give up totally on the pessimistic outlook.


Silver Spring, Md.: Let me ask a general question. Am I wrong in thinking that the banks and the business community have learned nothing from the recession and have no plans to reform?

Steven Pearlstein: I think they have learned some lessons about risk taking nd risk management, but they fundamentally think their values, their structures, their cultures were great and the best in the world and don't need to be changed. Certainly on Wall Street, they are back to their old tricks, which is making ungodly sums of money doing lots of fancy transations that don't really add much real value to the economy.


Washington, D.C.: Glad to see the banks paying the bailout money back, even if they're no healthier than they were, and they may not be. At least they can't claim the President is socializing America while at same time taking public money. Happy holidays.

Steven Pearlstein: In their defense, I don't think it was the banks that were complaining about that, at least not the big ones. They know better.


Alexandria, Va.: Steve,

What makes you think the government will not bail out failing banks again? I'm afraid S&P's analysis of B of A is correct and we've created an enormous moral hazard problem with the big banks. There is nothing currently in place to prevent financial institutions from making outsize risky bets again. Why should executives care if they're replaced when their banks seize up? They'll have made huge amounts of money in the time leading up to the collapse and the old "I'll be gone, you'll be gone" adage will once again prove true. We should not allow the bailed out banks to return TARP funds so quickly. The only reason they are doing so is so the executives can begin feasting on huge salaries again.

Steven Pearlstein: There is no doubt the bailouts created moral hazard -- everyone understood that going in. But the way to mitigate that, as I suggested at the end of the column, is to make sure that the next time, we're talking about winding down the companies and making unsecured creditors and counterparties take haircuts. Only the insured depositors will be spared. That needs to be written into law, and until it is, frankly, I wouldn't have let any of them out from under the TARP. That would give them plenty of incentive to see that the financial reform bill got passed with all deliberate speed.


Las Vegas, Nev.: It used to be that banks had to loan money in order to make money. Now, with legal authority to dabble in markets and gather billions in 'fees', they may no longer have to loan money to make money. Is there some breakdown you could provide that shows the source of profits for these behemoths?

Steven Pearlstein: Well, the big banks are making most of their money by trading financial instruments and investing in them themselves, using the cheap money made available by central banks and their depositors. Loans, not so much.


Boston: Steve, you need to have experienced bonus season at an investment bank to understand the monumental push to get out of the TARP program right now. It's the season where typical Type A banker activity during the rest of the year goes into anxiety and angst filled hyperdrive--and that's just the spouses...

Steven Pearlstein: I have not had that experience (alas!), but I take your word for it.


Mount Rainier, Md.: Mr. Pearlstein, Time and again we get told that's what good for business (less health-care reform, tax breaks to pay back TARP) is good for main street. Time and again history shows us we're wrong. What, in your opinion, is the BEST response for an average citizen to this debacle? More to the point, how do we regain control over those who represent us, and fight off cynicism and malaise?

Steven Pearlstein: The best response is to be engaged, vocal, let your representatives know what you think, support candidates who share your views and only do business with banks and companies that put their customers first. BTW, you should read a very good piece in today's New York Times about the change in culture at Goldman Sachs, which has gone from a put-the-customoer-first culture built around its investment banking advisory business, to a culture that puts the firm's fees and profits first and is mostly a trading culture. It's pretty emblematic of the change that has taken place across Wall Street. And it is why the government needs to do more to try to nudge things back in the other direction in any way it can.


Philadelphia, Pa.: So, in my fantasy version of Obama's meeting with the bankers, he lets loose with his inner maybe not. What he does is lay on the table Plan A and Plan B for financial industry reform. Plan A is a tougher bill than the ones currently being considered. Plan B is tougher still, and is funded by directly extracting wealth from financial executives. He then gives them a week to personally contact every member of a relevant Congressional committee and to order their every paid lobbyist to do the same, with the demand to immediately enact Plan A. If they failed to do that, Obama would present Plan B in his State of the Union address as his preferred path to financial reform.

Steven Pearlstein: I like the way you think.


Nashville, Tenn.: Steve: Do you feel the TARP funds are being held by banks to help the FDIC foster more structured mergers of failed banks in the next 18 months?

Steven Pearlstein: No.


Mt. Lebanon, Pa.: Can we hope, it is the season of good tidings after all, that private equity firms will come in; buy up all the banks and "investment" firms; borrow all the free wealth remaining on earth from whoever's solvent: U.S. Treasury Open and sovereign wealth funds; saddle the new ventures with massive debt; pay themselves trillion dollar bonuses and management fees; then walk away when the whole planet splits in half under the debt load?

Maybe it'd make a funny Christmas-opening movie. I'm thinking Harvey Keitel as Santa, Chris Rock as Obama, Pee Wee as Geithner, and Rip Torn as the Fed Chief.

What do you think? Should I send a treatment to Quentin (Tarantino)?

Thanks much. HLB

Steven Pearlstein: Maybe you should send the treatment to Michael Moore.


Eye St.: Wouldn't a prudent banker, acting in his or her own self-interest, strive to privatize gain while socializing losses? Isn't this what economic theory predicts?

Steven Pearlstein: Yes, although I'm not sure economic theory has much to do with it so much as common sense and experience. But socializing losses is not easy and usually requires some complicity on the part of government. So there is nothing inevitable about it.


Silver Spring, Md.: Not to make you do my homework for me, but what banks are customer oriented these days? I'm pretty happy with my bank (a big bank, but one I have found to be fair). Or, is a small local bank the better way to go? Or even a credit union?

Steven Pearlstein: In general, the small local bank is probably the way to go as long as its fees are reasonable. They hold more of the loans they make. If you are a business or individual , they are more likely to stick with you during a rough patch. And its just nice to support the home team. Certainly Burke & Herbert bank in Alexandria is an example of that, and they've been increasing their lending in the last year, by the way, not reducing it. I like Cardinal Bank. And there are others, I'm sure, that I'm not aware of locally.


Dallas, Texas: What about limiting the investment options of bank deposits? Shouldn't they be limited from high risk derivative trading with our money? Im not saying don't let them do it, but make it transparent for depositors? Thanks.

Steven Pearlstein: They are limited with what they can do with depositor money. But the big banks also raise money, outside the insured bank but within the larger holder company, by issuing notes and bonds or borrowing from the Fed or other banks. And they can do with that money what they will, under certain rules and regulatory scrutiny.


usually requires some complicity on the part of government: Well, there's a novel idea. Or should I say: treatment?

I wish I could get treatment like that.

Not living in the Hamptons...Joe Citizen

Steven Pearlstein: Thanks Joe.


Boston, Mass.: Two questions (is that allowed?): What are the odds that McCain and Cantwell will revive Glass-Stegall and allow a Volcker triumph? Second: What could Obama do to show he is on the side of Main Street, not Wall Street?

Steven Pearlstein: Not much chance of Glass-Stegall. The genie is really out of the bottle on that one, the financial markets now do so much financial intermediation (as opposed to banks) that you really can't separate these like you could in the 1930s. That's not the problem. And in any case, it ain't gonna happen.


I'm sorry, I just don't get it: I don't understand the need for big bonuses. Outside the "elites," for lack of a better term, the rest of us go to work and hope to get paid. For most of my working life, had I even suggested that it would be nice to paid for the value I added to that workplace, I would have been laughed out the door. At this point, as a freelancer, I just hold my breath that I'll actually get paid at all.

Why does financial compensation have to be structured around bonuses? I mean, what these guys have proved in the last year is that they're not geniuses. Couldn't they add the same value to the economy if they just lived like the rest of us?

Steven Pearlstein: They get paid for what they kill, rather than based primarily on salary. There's nothing wrong with that. The question is why the commissions need to be so large? There is some justification for this: If I can manage a billion dollars for Citi and earn $100 million in a year, if Citi doesn't give me and my crew $50 million, I'll just go out on my own, raise a billion from the same investors, and do it outside of Citi. So that is a competitive threat that allows the value producer to capture much of the "value" he produces. That said, the real question is why those people who put up the $1 billion don't find someone willing to do the job for $25 billion. And the reason is that it would take time and entail risk, so the easier path is to find someone who made $100 million last year and just give the money to him.


Credit unions and local banks: Silver Spring asked you about local banks "or even a credit union". I have kept a checking account and a "life happens" fund (thanks, Michelle Singletary!) at a credit union for over 10 years now, and I have slept better at night than a lot of people I know. My credit union is owned by the depositors, and they stick to the plain daily banking functions that the big players have been pushing aside.

Steven Pearlstein: Yes, credit unions!


Severna Park, Md.: In answer to a question about the sources of profit, you said, "the big banks are making most of their money by trading financial instruments and investing in them themselves, using the cheap money made available by central banks and their depositors." Could you be more specific - exactly which financial instruments are they trading and how is it that such instruments provide revenue without adding much to the underlying economy?

Steven Pearlstein: Stocks, bonds, derivative contracts, commodities, futures, options, currencies, you name it.


Evanston, Ill.: Hey Steven, a big part of the financial crisis story that hasn't gotten much notice lately is the suspension by FASB of certain mark to market rules. Is there any way to know how much of an impact that has had? What would happen if these rules were reimplemented? I get the feeling that once we start unwinding all the guarantees and regulatory forbearance we will see a lot of credit problems surface from under the rug. This goes to your column today too. What happens if Citi pays back the TARP and needs to come back once we remove the various props?

Steven Pearlstein: Well, the forbearance was quite important to some banks, but I don't necessarily agree that it was a bad idea. It may be that it merely delays the day of reckoning for some bad loans and bad investment, but it won't delay it forever. As for Citi, that is a risk, but as I said today, the only thing that will happen to Citi is not that it will get bailed out again, but that it will be liquidated by the government in an orderly fashion. Citi has gone to the well one too many times. It has been bailed out three times in the last 20 years. And it won't happen again. People who invest in Citi, who lend it money, who use it as a counterparty, need to understand that.


Or even a credit union?: When some credit unions needed a bail-out, they got it from the credit-union system. For ordinary mortals, not Masters of the Universe, wouldn't they be a sensible choice, and overall safer for the financial system?

Steven Pearlstein: Same with banks. The FDIC fund is financed through premiums paid by banks.


Los Angeles, Calif.: Regarding bankers' and Wall Street bonuses, isn't a critical issue the fact that bonuses often are paid on "phantom profits" which appear in periods for which bonuses are due/paid but don't hold up later (e.g., Enron, the whole packaging/reselling of mortgages, etc.). Is there anything that can be done to prohibit bonus pay in stockholder or bailout companies unless profits hold up in subsequent periods? Shouldn't bonuses paid on phantom profits be considered company theft and treated as such with criminal sanctions and disgorgement?

Steven Pearlstein: Yes, that is a problem, but the regulators are about to take steps toward fixing that by requiring that bonuses be in stock or be held backk for several years to make sure the profits are real. Still, these bubbles can last a long time, and you can't hold the stuff back forever.


Abingdon, Md.: So, when all is said and done, how much do you think we will have made or lost on the TARP program?

Steven Pearlstein: On the banks we've made billions. But there will be losses at AIG and GM and Chrysler, so the net amount at the end is likely to be negative, but not monstrously so. The latest Treasury estimate, I think, is $75 billion.


Tampa, Fla.: The Treasury tax gifts to the banking industry come from Treasury, not the IRS. Under the current setup, Treasury tells the IRS what to do when it comes to guidance such as the Notice under 382.

Treasury has a long track record of protecting Wall Street. It's called "the Wall Street Rule." Much has been written about it in the tax press. It works like this: Treasury will order the IRS to bless any Wall Street deal, trade, or transaction if the Street gets enough of them closed before the IRS figures out what's going on. Treasury tells the IRS that it has no business "roiling the markets" by applying the law to those products, etc.

The only solution, to my mind, is to remove Treasury from the process of writing administrative rules and reserve that to the IRS. Treasury prides itself on being political, while the IRS prides itself on avoiding politics and applying the law as written. The IRS Chief Counsel is appointed to a 5-year term, as is the Commissioner of Internal Revenue. This greatly reduces the chance of a politicized IRS.

Note that this was proposed during the IRS Restructuring legislation during the Clinton Administration (remember those show hearings in the Senate Finance Committee under then-Chairman Roth?). One bill would have had the IRS Chief Counsel report to the Commissioner of Internal instead of Treasury. Then-Secretary of the Treasury Summers threatened to resign if this was done. Guess he didn't want to deprive us of his vast expertise in tax policy.

Also, a recent Chief of Staff of the Joint Committee on Taxation remarked after leaving how certain people in the White House consider themselves tax policy experts. Looks like their view of tax policy doesn't encompass legal niceties such as the Internal Revenue Code.

So I would urge de-politicizing the process of writing administrative (but not statutory) rules under the tax law. What do you think?

Steven Pearlstein: Interesting. You seem to know your stuff.


Steven Pearlstein: That's it for today folks. No chats the next two weeks. We'll pick it up in the New Year. Happy Holidays.


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