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Diagnosing major banks’ health

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Kai Ryssdal: I think you could fairly say today that the banking rally has run its course. At least for the short term. Bank of America joined the financial earnings parade this morning. It reported better than $2 billion in profit last quarter. But as was the case with some of its peers last week, worries over B of A’s loan losses to come took a little life out of the announcement.

And not helping at all was a story in The New York Times today that the Treasury Department’s thinking about changing the terms of the investment it made in the big Wall Street banks as part of the bailout package. Our Washington Bureau Chief John Dimsdale is here to explain what might be happening. And why. Hey, John.


Ryssdal: So John, according to The Times, what the Treasury Department is going to do is change its preferred shares that it has now as a result of the bailout into common stock, right?

DIMSDALE: That’s right. You know, the government’s rescue fund is almost all committed and spoken for now. There’s only a little more than $100 billion left of the original $700 billion. And Congress is in no mood to approve more — anytime soon anyway. So by converting the government’s investments into common stock, that relieves the banks of having to pay 5 percent dividends to the government. And it beefs up a certain type of capital that banks can use as a shock absorber against future losses. So it’s a way for the government to give banks a bit more of a benefit for the same amount of money, but — and I’m sure you knew…

Ryssdal: And you knew there would be one. Yeah, go ahead.

DIMSDALE: Right, common shares are voting shares. The government can easily become the biggest shareholder of some banks and decide who is going to be on the board. It’ll influence other decisions, business decisions. Not to mention the potential conflicts of interest when the nation’s lawmakers become big shareholders of a company. Buying common shares is much closer to nationalizing the banks.

Ryssdal: Just to be clear, John, though, it’s not new money, right? They’re not getting fresh capital.

DIMSDALE: It’s exactly the same amount of money. It’s accounted for differently, it becomes tangible common equity, which some accountants use as a measure of the ability of a bank to weather a downturn.

Ryssdal: And, well, speaking of which. We’re about to get, in a couple of weeks, the results of the stress test that the Treasury Department has been doing. The tests of how well banks can weather a more prolonged downturn, right? What does this move, this potential move, say about the possible results of the tests when they come out in two weeks or so?

DIMSDALE: I put that question to Jeff Davis. He researches banks for the Howe Barnes Brokerage Firm. And he says that the fact that the government is considering doing this is not good news for the banks.

JEFF DAVIS: It implies the government believes that down the road — not this quarter or second quarter but later this year, into 2010 — loan losses are going to be significantly higher than what investors expect. Therefore, the banks are going to need more common equity to absorb losses than what they have today.

Ryssdal: OK, well, as one of those investors now, John, right, since I’m a taxpayer in this country. . . . What does this do for the risk that the taxpayer is taking with the bailout?

DIMSDALE: Well, there’s no guaranteed return with common stocks. And there are no dividends. Taxpayers are not at the head of the line to be paid back. There is more of an upside potential if banks turn around, and that would be good for government revenue and the taxpayers, but that dilutes the returns for private, common-share investors. Which is why the banks that have the ability will try to, as soon as possible, get out from under the government investments. Jeff Davis thinks that in the near future some of the stronger banks, perhaps Goldman Sachs, J.P. Morgan, BB&T Bank, will raise private capital, buy back the government investments, and that would be good for them, Davis says, but not for others.

Ryssdal: The government is going to be left with wards of the state, or quasi zombies. And the J.P. Morgans and the BB&Ts are saying, in effect, we don’t want to be part of that crowd.

Ryssdal: Yeah and of course the next big battle is whether or not the banks are even going to be allowed to repay back that TARP money, right?

DIMSDALE: Exactly. That’s a big question.

Ryssdal: John Dimsdale, our Washington bureau chief on the story for us. Thank you, John.

DIMSDALE: You’re welcome, Kai.

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