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Tue March 6, 2012
Did The Fed Help Banks While Ignoring The Risks?
Originally published on Tue March 6, 2012 12:05 pm
Since the financial crisis of 2008, the Federal Reserve has shrugged off warnings and let the largest U.S. financial firms pay tens of billions of dollars in dividends to shareholders, instead of putting aside money as capital in case a new financial crisis hits.
Investigative reporter Jesse Eisinger details how the Fed made a critical oversight decision in the wake of the financial crisis — despite objections from the Federal Deposit Insurance Corp. His report was published jointly by ProPublica and The Atlantic online.
The head of the FDIC warned the Fed that banks were not able to "withstand stress in an uncertain economic environment," just as the Fed was looking at whether banks could pay dividends to their shareholders, Eisinger says.
Even though banks passed the Fed's "stress test," Eisinger tells Fresh Air's Terry Gross, many regulators and Fed employees believed that the banks were not as strong as the tests might indicate.
"This was a very generous decision for the banks," Eisinger says. "They were able to pay millions to shareholders amid huge uncertainties."
Those uncertainties include the financial crisis in Europe, as well as ongoing legal liabilities for banks involved in the housing crisis. A year ago, the banks admitted to using fake signatures or affidavits to sign foreclosure documents — a practice known as robo-signing. Five major banks and more than 40 state attorneys general recently agreed to settle with some of the homeowners affected. But there's still an ongoing investigation, and President Obama recently assigned the New York state attorney general to a task force investigating the matter.
"This is an ongoing legal problem that is metastasizing and shows that the financial crisis is still with us," Eisinger says.
It remains unclear, he says, if the ongoing problems with the banks were taken into account during the Fed's stress test.
"The FDIC, which is one of the major bank regulators, didn't think so," he says. "They had a lot of concerns that the Federal Reserve — which was conducting this stress test in late 2010 [and] early 2011 — had not really taken into account either the European financial crisis or, more acutely, the legal liabilities [facing the banks]. ... So there was a lot of concern that they were shunting aside these major issues on the horizon for the banks."
In November 2010, Sheila Bair, the head of the FDIC, wrote a letter to Fed Chairman Ben Bernanke warning that banks were not ready to pay dividends because they didn't have strong-enough earnings or solid-enough assets.
"Unfortunately, Sheila Bair and the FDIC didn't have an official say in the stress test and they were kind of shunted aside," Eisinger says. "And it was really up to the Fed and the Fed ignored those warnings."
The banks — which heavily lobbied the Fed — were given the go-ahead to pay billions in dividends, which went to both shareholders and executive compensation packages. Dividends are taxed at a much lower level than salaries.
"Why would they want to pay dividends? It's not just to shareholders. ... It's to executives, because executives at banks get paid in stock, largely, so they benefit personally when they get dividends or share buy-backs," Eisinger says.
The Fed has to make incredibly complex decisions while balancing a lot of different risks, he says.
"I'm not envious that they had to go through this," he says. "A lot of this is about confidence building and psychology. If investors are more confident, the stocks will go up, the banks can feel more confident about lending, they can sell stock at a higher price. All these things build on each other, and the Fed is constantly worrying about investor sentiment. But the danger there is that you get caught up in that and you do things for PR reasons rather than sound financial reasons because you think that confidence will take over — and then it becomes something that you've done for appearances rather than solid financial reasons."
On potential financial crises without a cushion
"Certainly, the European financial crisis is the most obvious one. Italy and Spain could have problems financing their debt. And if that happened, people would be very worried about the solvency of those banks, and they might have exposures to other countries and U.S. banks might have exposures to those banks — which would make investors very afraid. So what you want at the U.S. banks is big, big cushions to try to assuage those worries. If you really wanted to have a really safe banking system, you want to have much more capital than we have now, to absorb the losses before shareholders take a hit and the government has to come in and bail the banks out again."
On the banks before the bailout
"They probably were insolvent. Probably most of the big banks, if not all of them. And the federal government invested in the banks to save them. And then the central bank, the Federal Reserve, gave them literally trillions of dollars in low-interest loans. And those were incredibly profitable. The government got very little in return for that. We invested in stock where we didn't have voting power and we didn't have a lot of rights or a lot of upside if the banks got through this. So we ended up making money when we invested in the banks but not as much as we may have. And that was a very generous decision to those institutions, to the employees, to the executives, to the shareholders of those institution — the government paid a lot of money, took a lot of risk, and got very little in return for it."
On restrictions placed on the bailout money
"There was no restriction on bonuses and there was no requirement that they had to lend the money out, which means that people have had a much harder time than expected — even though interest rates have fallen — [doing things like] refinancing their mortgages, getting new loans to start new businesses, there's been a very severe tightening of credit. And the Federal Reserve's goal was to loosen credit but bank bonuses to executives have been pretty high — steadily — in the years after the financial crisis."
TERRY GROSS, HOST:
This is FRESH AIR. I'm Terry Gross. Ever since the banks came close to collapsing in 2008, the Federal Reserve has been working to restore the health of the financial system. The Fed has reduced interest rates for the banks to almost nothing and loaned the banks trillions of dollars. And last year, it allowed the banks to pay out tens of billions of dollars in dividends to their shareholders.
My guest, Jesse Eisinger, an investigative financial reporter for ProPublica, obtained a previously unreported memo, which reveals that the decision was opposed by Sheila Bair, who was then the head of the FDIC, the Federal Deposit and Insurance Corporation. She thought the banks should hold on to more capital as a cushion against possible future crises.
The Fed's decision raises questions about how it's managing the financial crisis and whether it's been too lenient with the banks. Eisinger's article is jointly published by ProPublica and The Atlantic Online.
Jesse Eisinger, welcome back for FRESH AIR. Now, the main focus of your article, which is jointly published by ProPublica and That Atlantic Online, is what you describe as one of the Federal Reserve's most critical oversight decisions in the wake of the financial crisis, and this was after the Fed had paid out bail money to the banks, bailout money. What was the decision?
JESSE EISINGER: Well, the Federal Reserve undertook a stress test of the nation's top banks. They wanted to see whether the banks could survive in certain kinds of dire economic scenarios: if the economy took a hit, if the stock market fell, if unemployment soared, things like that.
And they asked the banks to do a kind of self-test: Tell us how you will do under these scenarios. And if you pass, we'll allow you to pay out billions to shareholders in the form of dividends, or we'll buy back stock. And this is one of the ways that companies, including banks, pay shareholders for buying their stock. They take the money from earnings, and they pay it out in dividends and share buyback, and that's what you get as a shareholder.
It's one of the ways that you benefit economically from buying stocks. It's very important to investors to get that money from healthy companies, and banks especially, bank investors depend on that kind of dividend and buybacks especially.
GROSS: So the banks wanted to show hey, we're healthy again, you know, we can afford to pay dividends to our shareholders. And the question that the Federal Reserve had to answer is: Are they really healthy enough to do that?
EISINGER: Exactly, and so the Fed was going to put them through their paces, supposedly a very rigorous test, and then you'd come out of it, and there would be all sorts of benefits from it, supposedly. The banks would be able to say they were healthy, and shareholders would pile into the banks again.
That would mean that they would be more confident about lending, and of course it would make the Fed look better because the Fed would be able to say: See, we've brought all the banks through the financial crisis, and we've tested them rigorously, and they're safe. You can believe and trust in us, as well as the banks.
GROSS: Would it be fair to say that one of the bottom lines of your story is that even though the banks passed the stress tests, they might not be as healthy as the passing grade would lead us to believe?
EISINGER: Absolutely. This was a very generous decision for the banks. They were able to pay millions to shareholders amid huge uncertainties. Most people are aware that Europe is continuing to have a financial crisis. It's kind of in an ebbing period now, but it's still quite serious. And of course the housing market in the United States continues to fall, which continues to put a lot of pressure on banks.
And they have legal liabilities. So they are not out of the woods of the financial crisis yet.
GROSS: And when you say legal liabilities, what kinds of legal liabilities?
EISINGER: Two kinds of things, things that happened before the financial crisis and things that have happened since. Before the financial crisis, they sold a lot of securities that have turned out to be worthless or worth a lot less than they said they were going to be, and there were a lot of misrepresentations and problems with those securities, mostly having to do with residential housing.
And so they're suffering a lot of legal exposure because of that, and then the second thing is in dealing with the housing crisis and crash's fallout, they've had to deal with a lot of foreclosures and problems like that, and they've had a lot of legal problems.
The thing that we most know about is robo-signing, where they were - they had bank employees just signing forms, essentially false affidavits that they were reviewing materials and then therefore falsely foreclosing on people. And there are billions and billions of liabilities associated with that, as well.
GROSS: People are suing because of the robo-signing.
EISINGER: People are suing the states...
GROSS: Suing the banks.
EISINGER: Suing the banks. The state's attorney general just came out with a $25 billion settlement with the banks. And New York state Attorney General Eric Schneiderman has been assigned to a taskforce by President Obama to look into further problems with both mortgage securities and the foreclosure liabilities.
So this is an ongoing legal problem that is metastasizing and shows that the financial crisis is still with us.
GROSS: So the Federal Reserve decided, based on the stress test, that the banks were ready to pay out dividends, but the FDIC, the Federal Deposit Insurance Corporation, decided no, it's really, they're not ready. And Sheila Baer, then the head of the FDIC, you know, objected to the Fed's decision.
And of course the FDIC, this is the corporation that bails you out, as an individual investor, if your bank goes under. They're the ones that insure your bank account.
GROSS: So what was their difference about?
EISINGER: Well, the FDIC, and Sheila Baer in particular when she was the head of it, was a much stricter bank regulator, in part because they've got money on the line, as you say. So they really are interested in protecting that fund from bank failures and concerned about that. But they are also concerned about the larger financial picture, which didn't seem as good as the Fed seemed to think back about a year ago.
And so Sheila Baer wrote to Ben Bernanke, the chairman of the Federal Reserve, and said, don't let the banks pay dividends yet. They're not ready. They don't have strong enough earnings. They don't have solid enough assets. We don't think that they're ready.
Now unfortunately, Sheila Bair and the FDIC didn't have an official say in the stress test. They were kind of shunted aside, and it was really up to the Fed, and the Fed ignored those warnings.
GROSS: Did we not know about her objections until you found this - or I don't know how you got the memo, but you were the first to report a memo from her, objecting to letting the banks pay dividends.
EISINGER: Yes, we - ProPublica was the first to report that, in my story, about this objection, a pretty high-level, important dispute between two powerful bank regulators.
GROSS: So why is it so important that the FDIC disagreed with the Fed over whether the banks could pay dividends? Why is that important?
EISINGER: Well, it goes to the heart of whether the banks really are sound and safe now in the wake of the financial crisis and whether we should have a lot of confidence that the regulators have put these banks on safe and solid footing.
And the FDIC didn't think so, at least not last year, and things have arguably gotten worse. Europe has gotten worse. The housing market has declined. Other things, of course, have gotten better. The U.S. economy is looking a little bit better.
But the question really is, you know, if you've got two very high-level, powerful regulators in Washington, and they disagree, and then you've got banks heavily lobbying the Fed, and the Fed, with all this bank lobbying, overrules or shunts aside the FDIC with its cautious take and allows the banks to deliver billions to shareholders, it makes the banks less strong. It weakens the banks at this time of great financial peril.
And the question is, also, well, why would they want to pay dividends? It's not just to shareholders because - it's to executives because executives at banks get paid in stock, largely, so they benefit personally when they get dividends or share buybacks.
GROSS: And as a lot of us have learned, dividends are taxed at a much lower level than salary is, which is one of the reasons, I suppose, why it's good for executives to be paid in stock as opposed to salary.
EISINGER: That's exactly right.
GROSS: So how do banks lobby the Fed?
EISINGER: Well, they get meetings with the big governors who oversee these things. They write letters. They do the kinds of things that Washington is known for. In my story, I talked about how Jamie Dimon, the CEO of JP Morgan Chase, personally discussed this with Daniel Turullo, who is in charge, essentially, of the Federal Reserve's banking regulation (unintelligible). He's a governor who sits on the board of governors at the Fed.
And he said, he urged Turullo to let JP Morgan pay dividends, raise its dividend and buy bank billions in stock. He said that they were healthy enough to do it and that they should be treated differently than other banks, and the Fed eventually agreed - although there's no evidence that there was a direct quid pro quo, that it just - they were persuaded by that logic.
GROSS: If you're just joining us, my guest is Jesse Eisinger, and he's a senior reporter at ProPublica, which is an independent, nonprofit newsroom in New York City that produces investigative journalism. And his new article about the Fed and the bank stress test and the health of the banks is published jointly by ProPublica and The Atlantic Online. Let's take a short break here, and then we'll talk some more. This is FRESH AIR.
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GROSS: If you're just joining us, my guest is Jesse Eisinger. He's a senior reporter for ProPublica, the investigative news organization, and his article about the Federal Reserve, the bank bailout and disagreements between the Fed and the FDIC has been jointly published by The Atlantic Online and ProPublica.
So you say that the Fed's decision to let banks pay out dividends to shareholders when maybe the banks didn't have enough of a cushion to do that yet, that you have to see that decision in the context of other decisions the Fed made. What's another example of a decision that the Fed made after the financial crisis that you think was very favorable to the banks and maybe has a downside?
EISINGER: Well, in the lead-up to the financial crisis and at the peak of the financial crisis, banks probably were - had failed. They probably were insolvent, probably most of the big banks, if not all of them. And the federal government invested in the banks to save them.
And then the central bank, the Federal Reserve, gave them literally trillions of dollars in low-interest loans. And those were incredibly profitable. The government got very little in return for that. We invested in a kind of stock where we didn't have voting power, and we didn't have a lot of rights, and we didn't have a lot of upside if the banks got through this. So we ended up making money when we invested in the banks but not as much as we may have.
And that was a very generous decision to those institutions, to the employees of those institutions, the executives, the shareholders of those institutions. The government paid a lot of money, took a lot of risk and got very little return for it.
GROSS: There were also very few strings attached. I mean, for example, when the banks got all of this money in loans from the Federal Reserve, they didn't have to use the money to lend money. So the mortgage market remained really difficult, hard to get a loan, I think, for a lot of small businesses.
GROSS: But bank executives were allowed to take, what, larger profits?
EISINGER: Yeah, there was no restriction on bonuses, and there was no requirement that they had to lend the money out, which means that people have had a much harder time than expected, even though interest rates have fallen, refinancing their mortgages, getting new loans to start new businesses. There's been a very severe tightening of credit. And the Federal Reserve's goal was to loosen credit. But bank bonuses to executives have been pretty high, steadily, through the years after the financial crisis.
GROSS: Have bank bonuses eaten up all the money that would have been going toward credit? I mean, why aren't the banks doing more to loan money to people who need mortgages or loans for small businesses?
EISINGER: Well, they're afraid, they're afraid to lend into a very poor economy, and they don't want to make a bunch of bad loans. One of the things, the ironies, is that the Federal Reserve has given the banks very cheap money. They've lowered the interest rates, so that made the cost of money extremely inexpensive, very cheap, and banks take that money and lend it back to the federal government by buying treasuries, by buying government bonds.
When you buy a bond, you're really lending to the government. So they've borrowed from the government to lend back to the government, and in doing that, they're making enormous amount of profit because of that, because they borrow very, very cheaply, and then lend back at two or three percent. They're making that entire spread.
Then they can use that money to pay executive bonuses or pay out dividends and buy back stock.
GROSS: So is the government losing on both sides of that deal?
EISINGER: The government is - it's - I mean, it's not necessarily losing because the government might be able to make money in the long term, and the Federal Reserve is an enormously profitable entity for complicated reasons. But it's a question of whether this is a great use of the government's money, if they could do better - if the Federal Reserve could find some other way to channel money into the economy or more reasonably to force the banks to actually lend the money that they're getting.
GROSS: So were there any regulations that the Fed imposed on the banks that were bailed out about how much of that bailout money could be used to lobby the Fed on future decisions?
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EISINGER: None that I'm aware of. There were no restrictions on using the money to lobby, no.
GROSS: Did they use it? I mean, do we know that?
EISINGER: They - you know, money is fungible. So they had to use some of it to lobby. You know, Fannie Mae and Freddie Mac were bailed out, the two housing mortgage giants, and then they were prohibited from lobbying. But that's a great question, because the banks were not prohibited from lobbying, and they got lots and lots of taxpayer dollars, some of which they inevitably used to funnel back in to lobby for less regulation.
GROSS: So although a lot of critics of the way the federal bank bailout program was handled think that there weren't enough strings attached, that the banks weren't regulated enough after taking so much federal money, the banks were still anxious to get out of the TARP program as soon as possible so that they'd have no strings attached anymore.
But the government - you know, I always thought, well, the government would want the banks to pay back as soon as possible, and that would just be victory right there. But there was a lot of caution about making sure when the banks were ready to actually pay the money back and exit the program. Can you describe that process?
EISINGER: Yes, the banks wanted to pay back the money as soon as they could, because they were worried about the stigma, and they were worried that regulators might impose some strictures on them. And the government wanted the public relations victory, to say that look, the banks have paid all this money back.
And so everybody was - wanted to get them out as soon as they could, but some regulators were cautious. They said: Look, you have to replace this on a dollar-for-dollar basis so that you remain with this kind of cushion. And they ended up debating this, and the regulators decided no, it shouldn't be on a dollar-to-dollar basis, it's OK, it can be 50 cents on the dollar that they pay back the government, and they can borrow the rest of it.
And so they - people thought that wasn't enough, but they - the regulators ended up deciding, OK, 50 cents on the dollar is OK. And then, immediately after deciding on that kind of condition for the banks, they relaxed it for some of the weakest banks - like Bank of America and Sun Trust, a regional bank out of Atlanta, which were the weakest banks.
They said they're too weak to raise that kind of money, so we should let them out for even less. And that was pretty shocking to some of the regulators who had lost that debate.
GROSS: What are the implications of that?
EISINGER: The implications are that Bank of America now is struggling. It has had to sell assets. It has had to raise money from Warren Buffet. The question is whether it's a viable entity going forward. Sun Trust, also, is a very vulnerable bank, right now. Investors are deeply skeptical about the health of the bank. So these banks could potentially - and it's dangerous to discuss this, I'm not saying that they're going to - but they're more vulnerable to failure.
And the regulators have the obligation to try to prevent bank failures, to try to make banks solid enough to avoid failure not only because it hurts the customers of that particular bank but also because it can cause another financial crisis.
GROSS: So the Fed really has to balance a lot here because on the one hand, when the banks can be out of the TARP program, the money's reimbursed, or at least part of it is, the banks look healthier, it gives a positive sign about the banks' health and about the economy's health. On the other hand, if the bank really isn't all that healthy, it's very risky.
EISINGER: These are incredibly complex decisions that the Fed has, and I'm not envious that they had to go through this. They - a lot of this is about confidence-building and psychology. If investors are more confident, they'll - the stocks will go up. The banks can feel more confident about lending. They can sell stock at a higher price.
All these things build on each other, and panics also build on each other. So the Fed is constantly worrying about investor sentiment. The danger there is that you get caught up in that, and you do things for PR reasons rather than sound financial reasons because you think that confidence will take over, and then it becomes a kind of Potemkin confidence. It becomes something that you've done for appearances rather than solid financial reasons.
GROSS: Well, Jesse Eisinger, I want to thank you so much for talking with us.
EISINGER: Thank you so much for having me. I really enjoyed it.
GROSS: Jesse Eisinger covers Wall Street and finance for ProPublica, and he writes a column for the New York Times Deal Book section. His new article is jointly published by ProPublica and The Atlantic Online. You'll find a link to the article on our website, freshair.npr.org. I'm Terry Gross, and this is FRESH AIR. Transcript provided by NPR, Copyright NPR.