Fallout: The Financial Crisis

How B of A can raise the capital it needs

Marketplace Staff May 6, 2009
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Fallout: The Financial Crisis

How B of A can raise the capital it needs

Marketplace Staff May 6, 2009
HTML EMBED:
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TEXT OF INTERVIEW

Kai Ryssdal: Here’s the difference between big banks and you and me. If we need more money we go to the ATM, where we pick up some cash. When banks need money, first of all, it’s called capital, not cash. And second, the money machine they can run to is called the stock market, which presents its own slew of problems. So to explain how else Bank of America and the other stress-tested banks might bump up their capital we’ve called Karen Shaw Petrou at Federal Financial Analytics in Washington. Karen, good to have you here.

Karen Shaw Petrou: Thanks so much.

RYSSDAL: This was a very big number splashed in some very big headlines today. Break it down for me, though, and tell me in laymen’s terms what it means that B of A needs $34 billion.

Petrou: In laymen’s terms it means they need a really large amount of money. It means that to meet regulatory capital ratios, they need to adjust their capital by that amount.

RYSSDAL: All right, well how might they go about it? The simplest way I can think of is they print more stock, sell it, and make $34 billion that way.

Petrou: That would be the simplest and that would be the best because that would mean private capital believes in the bank and is willing to put $34 billion behind that bank. I think that’s the least likely of the ways.

RYSSDAL: All right, well what’s another way then?

Petrou: You basically move money from one capital pocket to another. Bank of America, and for that matter all of the big banks that are under the stress test, have a lot outstanding in preferred stock. Which, while it’s called stock, is in some ways closer to debt. And that’s why the regulators don’t feel good about counting that as real, hard capital. But you can convert preferred stock into common stock, that tangible, common equity.

RYSSDAL: Is that preferred stock, what the government already has?

Petrou: The government has preferred stock and private investors have lots of preferred stock in all of these banks. So either or both could convert into common stock and significantly recapitalize Bank of America and the other banks.

RYSSDAL: Just to make this clear, common stock is ownership stock. It’s owning the company?

Petrou: That’s correct.

RYSSDAL: Is that going to cost taxpayers any more money?

Petrou: No. It puts taxpayers at more risk. Preferred stock is called preferred for a reason. It comes ahead of the common stockholders, and it gets a dividend, which reimburses taxpayers. But it’s no more out-of-pocket money.

RYSSDAL: This is what’s already happened with Citigroup, right?

Petrou: That’s correct.

RYSSDAL: Now that we’ve got, effectively, the results of these stress tests before they’ve come out. I mean, we know probably half of them, right, before they get officially announced tomorrow. Are we going to know tomorrow the health of the banking system, and is that going to make anybody feel any better?

Petrou: We’re going to have, I think the first clear, tough look at the health of the banking system. The problem wasn’t just about what we call liquidity, about markets freezing up out of panic. Behind market fears were real solvency concerns because at the heart of it, people had taken out mortgages they couldn’t pay.

RYSSDAL: Are we not concerned anymore that the banks are insolvent? Or is what is happening today as a result of the stress tests designed to prevent that from happening?

Petrou: It’s designed to prevent that from happening. Insolvency, I do no think, will be demonstrated by any of these tests. Trouble, yes. I think almost all of them need to take radical action to improve their balance sheets. Actions a lot of them have resisted for far too long.

RYSSDAL: So, in a crazy way, it’s actually good news that Bank of America only needs $34 billion?

Petrou: In a crazy way it’s right. And it’s also good news that the market took that today and didn’t start jumping off of buildings and carrying on. That we’re now able to look at $34 billion and say, “Oh, OK,” is good news in of itself.

RYSSDAL: Karen Shaw Petrou is managing director at Federal Financial Analytics in Washington, D.C. Karen, thanks a lot.

Petrou: Thank you.

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