MICHELE NORRIS, host:
From NPR News, this is ALL THINGS CONSIDERED. I'm Michele Norris.
ROBERT SIEGEL, host:
And I'm Robert Siegel. The government has issued the results of its stress tests. Ten of the nation's largest financial institutions are being told they must raise $75 billion in additional capital. Bank of America, Citigroup, Wells Fargo are among those coming up short. Treasury Secretary Tim Geithner, Fed Chairman Ben Bernanke and other federal regulators briefed reporters this afternoon about the stress test results. NPR's John Ydstie was there, and he joins me now. Hi, John.
JOHN YDSTIE: Hi, Robert.
SIEGEL: When all this started a couple of months ago, there were questions about whether some of these banks were healthy enough to survive, whether some might have to merge. What's the verdict now?
YDSTIE: Well, the headline message from the regulators is that these banks are basically sound. But the Treasury also painted a grim picture of losses that they've already absorbed - about $950 billion for these banks since mid-2007. Still, the tests show that they all have adequate cushions against future losses if the current forecasts for the economy hold up and things start getting better in the second half of this year. But if the economy gets worse than expected - no growth this year, another 20 percent loss in home values, unemployment rising above 10 percent - if that happens, the stress tests show that 10 of the 19 banks don't have a strong enough capital buffer to safely absorb what could be another $600 billion in losses.
SIEGEL: So they have to get the capital.
YDSTIE: Exactly.
SIEGEL: How are they supposed to do that?
YDSTIE: Well, they could increase capital by selling assets, subsidiaries, that sort of thing. Some banks, including Citigroup, are already doing that. And of course, they can raise money for capital by selling more shares to the public. Actually, this is what the government wants them to do because capital in the form of shareholder equity is the strongest kind of capital - the first line of defense against losses. If the banks can't sell more shares to the public because investors are still wary, the government has told them it will help out by allowing them to convert some of the TARP money it injected into the banks in the form of preferred shares, into common equity - if they need it.
SIEGEL: Now, that would mean that the taxpayers who now own - with the government acting on our behalf - preferred shares, in effect bonds or loans to these banks, we would swap those for equity stock in the banks. Riskier in that case, no?
YDSTIE: It is riskier. The preferred shares that the taxpayers own right now are a lot like loans. They pay interest, essentially in the form of dividends. If the banks fail, they could claim some of the assets of the banks before common equity owners. If the government converts the preferred shares to common equity, the government becomes an owner, and the risk of losses to the taxpayer increase. If the bank fails, taxpayers could be wiped out. The banks really don't like this idea, either, though, because the government would become a voting shareholder and have even more control of the banks.
So the government has come up with this solution; it's a two-step process. First, the government would swap the current preferred shares for convertible preferred shares with no voting rights. The banks would have the potential to convert them into common equity if they faced losses.
SIEGEL: So, as I understand what you're saying, the government would take a somewhat riskier position, but it would be a lot less expensive than going back to the Congress to get more TARP funds to come up with more money for the banks.
YDSTIE: Absolutely. And the government has already made this arrangement with Citicorp, and that's why the amount of capital that it needs is smaller than the amount that Bank of America needs by a large margin - even though it's not that much healthier. Now, Bank of America could do this same thing and swap these shares for equity, but it says it wants to raise its capital in the private market.
SIEGEL: John, I get why the government would do this. Private investors - would they do it, too, swap preferred stock for common stock?
YDSTIE: Well, in fact, in the case of Citicorp, some private investors have already agreed to do just that.
SIEGEL: NPR economics correspondent John Ydstie. Thank you, John.
YDSTIE: You're welcome. Transcript provided by NPR, Copyright NPR.
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