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Altering Bailout Rules, US Moves Closer to Nationalizing Troubled Banks

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The Obama administration has revamped the terms of its emergency aid to troubled financial firms that could lead to the government nationalizing some of the country’s largest banks. With nationalized banks on the horizon, we speak to Robert Johnson, former chief economist of the Senate Banking Committee, and former investment banker turned journalist, Nomi Prins. [includes rush transcript]

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This is a rush transcript. Copy may not be in its final form.

AMY GOODMAN: The Obama administration has revamped the terms of its emergency aid to troubled financial firms that could lead to the government nationalizing some of the country’s largest banks. In a joint statement, the Treasury Department, the Federal Reserve and federal bank regulatory agencies announced yesterday the government might demand a direct ownership stake in major banks that do not have enough capital to withstand an extreme recession. The government will begin a series of so-called “stress tests” this week on twenty of the country’s largest banks with $100 billion in assets. The Obama administration has confirmed it’s already in talks with Citigroup, that could raise its stake in the company, one of the world’s largest financial institutions, to as much as 40 percent.

The news was welcomed by some investors. Even as the Dow Jones Industrial Average plunged on Monday to its lowest close in twelve years, shares of Citigroup climbed ten percent. And shares of another troubled bank, Bank of America, rose about three percent.

But administration officials emphasized nationalizing any of the major banks was their least favorite solution to the banking crisis. Treasury Secretary Timothy Geithner has said he wants to avoid an explicit takeover that would put the government in charge of running the banks, but as a last resort the government would consider taking temporary control.

Meanwhile, President Obama takes center stage this evening to announce his broader agenda for jolting the country out of deep recession and confronting long-term economic challenges. President Obama will deliver a State of the Union-style address at 9:00 p.m. Eastern time in his first appearance before a joint session of Congress since taking office.

For more, we go to two guests. Nomi Prins is a former investment banker turned journalist. She used to run the European analytics group at Bear Stearns and is now a senior fellow at Demos. She’s the author of two books: Other People’s Money: The Corporate Mugging of America and Jacked: How Conservatives Are Picking Your Pocket. Her upcoming book is called It Takes a Pillage.

And we’re joined by Robert Johnson. He’s the former chief economist of the Senate Banking Committee and a former managing director at Soros Fund Management. His latest article is called “Nationalize Failing Banks? Think Twice.” It’s online at

We welcome you both to Democracy Now! Rob Johnson, let’s begin with you. You know the Newsweek cover: “We Are All Socialists Now”?

ROBERT JOHNSON: Well, this seems to be another example of the kind of spin that Stuart Ewen writes about in the Social History of Spin. They’re trying to frighten us from the notion that the people who pay the money somehow are dangerous, meaning the taxpayers can’t operate banks. In fact, the same people operate the banks. The only thing that would change is the taxpayers would become the citizens who are providing the bailout, rather than the existing stockholders who made the mess.

AMY GOODMAN: What exactly do you think has to happen?

ROBERT JOHNSON: I think — what surprises me is that they’re talking about stress tests. And I’m saying, where were they two years ago? Bank examiners should be conducting ongoing investigation and stress tests. So let’s start by presuming they haven’t done that. They have to do that. They have to find out where the losses are, the scope, the scale and the breadth of the losses.

They then have to separate banks into a handful of categories. Those that are fine, leave them alone. Those that have to be shut down, shut them down immediately. Those in the middle, some who need assistance but could be shut down, something like Washington Mutual was. Or something that’s a behemoth like Citibank probably needs massive assistance, the stockholders wiped out, large portions of the management fired, or at least fired and rehired, and then continue to operate the bank and eventually sell it off.

AMY GOODMAN: Explain how the new plan works, as you understand it.

ROBERT JOHNSON: Well, I think there are so many dimensions to it, it’s hard for me to understand what the new plan is, and that’s part of why I think the markets are so jittery. My sense is they’re trying to take the old money that was in preferred stock and, at a price that’s a very, very violent concession to the bankers and harms the taxpayers, convert that preferred stock into common stock. Then they’re going to do what I call insurance guarantees of assets. And the question is, at what price do they provide the guarantees, and at what level do the guarantees kick in? These assets have been known for over a year to have been quite impaired, and the taxpayer providing those guarantees are, in essence, providing what they call open bank assistance and subsidizing the stockholders of the existing firms.

AMY GOODMAN: Nomi Prins, you’ve been writing about, among other things, the President, Obama, tapping into a source of public fury, decrying shameful excesses of Wall Street and proposing capping cash components of executive compensation at half-a-million dollars. Talk more about this.

NOMI PRINS: Well, I think, obviously, we all distrust Wall Street, and rightly so. It’s made a complete mess of the economy. I spoke here a year ago about how it had overleveraged itself or borrowed itself beyond its risk. And in the process of doing that, it paid a lot of people a lot of money, not just in cash. The cash component of most Wall Street executives is actually very, very small. Hank Paulson, the Treasury Secretary who was involved in creating the beginnings of this bailout, only made only $600,000 in cash before he leapt into the Treasury Secretary slot from Goldman, but he made $33 million worth of options and shares and other types of compensation. So the idea of the cap is helping a sort of public outcry, but it’s not necessarily changing the risk nature of the people on Wall Street who have made all the money and created all of this mess.

AMY GOODMAN: So, what do you think has to happen?

NOMI PRINS: Well, I think, first of all, we have to understand how the mess was created. And to go a little bit off of what Robert was saying, currently the administration still has no idea, if they are stress testing now, what was created to create this crisis. And it was a lot of assets and a lot of packaging and a lot of borrowing and a lot of fees that made a lot of people have record profit years in 2006 and 2007, and record bonus years at that time, for securities that then completely collapsed. So you shouldn’t have a bonus structure that creates the ability to take out short-term cash and leave a long-term mess. And so, if you’re going to have any kind of compensation cap, that has to be a part of it, and that will create a better need to understand how the mess was created, how these assets actually took down an entire global economy.

AMY GOODMAN: Rob Johnson, is there a right way to nationalize banks and a wrong way?

ROBERT JOHNSON: I would say the wrong way is to set up a bad bank, transfer assets at mystery prices behind the veil of secrecy, and milk the taxpayers.

I think the right way is to zero out the current equity; examine the bank thoroughly, see what it needs to continue to operate; inject capital; as Nomi suggests, change the incentives of executives ongoing; recapitalize the bank; and then potentially someday sell it and form a bad bank after the bank has been nationalized, not before. Bad bank is then conducting auctions to sell off the bad assets. That has to be done under very bright floodlights, so that people can understand who’s buying what and at what price from the taxpayer.

AMY GOODMAN: You’re talking about financial HMOs, Single Payer 2.0.

ROBERT JOHNSON: Yes. We were, how would they say — Tom uses the metaphor single-payer to refer to the benefits that are given, not to people regarding their physical health, but to existing bank owners and executives to ensure their future financial health. It’s a bit ironic.

AMY GOODMAN: Tom Ferguson is your co-author on “Nationalize Failing Banks? Think Twice.” That’s at

Nomi Prins, some British banks have been nationalized.

NOMI PRINS: Yeah, but there’s also more of a control of the government in terms of the nature of those banks. The main problem in nationalization is that we’re currently talking about it in terms of an investment strategy, with some more oversight than has been given the banking industry. What we need to do beyond that is separate the banking industry, take what Robert said and add to that the fact that we have banks that, in Citigroup’s case and in Bank of America, now Bank of America-Merrill Lynch’s case, have taken depositor money, leveraged it, used it to speculate and bet and borrow beyond their capability to handle the risk.

We need to dissect those banks. We need a 1933 solution, which, if we’re going to nationalize, if we’re going to do a little bit of what Britain has done, if we’re going to actually create a stable foundation for going forward and fix the mess, I wouldn’t want to take on Citigroup as the government. I would want to take the parts of Citigroup that directly relate to depositors and to loans, not borrowed loans, but actual single deposit to loan. I’ll insure that, I’ll buy that, I’ll run that until it’s right, but I don’t want to take the whole mess on. I want the banks dissected into what they should have always been dissected into, which is the risky parts, which the government doesn’t back, which the taxpayers don’t bail, and the non-risky parts, in which the taxpayers have a direct interest because our deposits are there, and we want that to be safe.

AMY GOODMAN: Your forthcoming book is called It Takes a Pillage. Explain.

NOMI PRINS: Well, in ’04, when I wrote Other People’s Money, the idea was that these banks were taking deposits to leverage into all these arcane securities that the regulators either ignored or didn’t understand and, to this day — Robert and I were talking about a little bit before we came on — don’t understand the actual securities that they’re talking about taking on. That was the problem then.

I don’t know what it takes to get the awareness through Washington and through the regulations that we have, to change them to be able to understand that we are continuing to take trillions and trillions and trillions of fabricated dollars that become real pain to real people out of the system. We’re creating securities and continuing to not changing the rules that allow them to operate. We’re taking on Goldman Sachs and Morgan Stanley, which are leading the speculation and changing those regulations to allow themselves to operate in a very murky way, and we’re allowing them to become bank holding companies and bailing them. What does it take to sit there and look through the rules that have created this mess and drastically change them to allow a stable economy and a stable financial structure going forward? And that’s really the question that I’m grappling with in the It Takes a Pillage book.

AMY GOODMAN: Rob Johnson, hasn’t the FDIC been nationalizing banks at like, what, the rate of two a week recently —-


AMY GOODMAN: —- as they take over banks, restructure them and then sell them back to private industry?

ROBERT JOHNSON: They do. And auto companies and airlines and venture capital firms are restructured all the time. The FDIC does this as a matter of course. What is incumbent upon the FDIC is to exercise a clause in a 1991 law called Prompt Corrective Action. What that means is when the bank is starting to fail and passes through zero, you’re supposed to stop them quickly before they lose lots of money.

When a bank has negative net worth, the incentives that Nomi spoke of become very perverse. Because they know they’re in negative territory —-any losses aren’t theirs anymore -— they throw the long ball in the end zone like it’s the fourth down to try to score a touchdown and recover. So they start taking more risk as they get more insolvent, and the FDIC has to shut them promptly. They have done a very good job of that over the most recent fifteen years or so. And in the last two years, I think Sheila Bair has done a pretty good job, as well.

AMY GOODMAN: Nomi Prins, do you agree?

NOMI PRINS: No, I agree. She’s done a great job. My concern with what happens after the FDIC leaves is taking these things private. IndyMac, which was one of the bigger FDIC takeovers, they did a great job of working out the loans, helped homeowners work through a lot of mortgages, etc., and now they’re selling it to a bunch of private equity guys who will be running it, too, who are from Goldman and run a company called Dune, that are effectively consorting with people that are going to run this bank forward. And that’s the problem, to not create a bigger mess to deal with later. The FDIC came in and fixed a lot of things. There needs to be oversight and not a complete privatization of that bank, in its pure equity sense, to private bankers who are going to extract a lot of money from it in the next phase of the ongoing financial situation.

AMY GOODMAN: And the issue of stopping foreclosures? We had Marcy Kaptur on, the longest-serving Democratic woman member of Congress. The Ohio Congress member had a very simple solution: she encouraged, from the floor of the House, people to simply squat, stay in the house that’s about to be foreclosed. She said the mortgages were made, then bundled into securities, then sold and resold repeatedly by the very Wall Street banks that are now benefiting from TARP, the Troubled Asset Relief Program. The banks foreclosing on families very often can’t locate the actual loan note that binds the homeowner to the bad loan. “Produce the note,” Kaptur said. She recommends those facing foreclosure demands on the banks say, “Produce the note.” What do you think of that, Rob Johnson?

ROBET JOHNSON: I think that’s an innovative strategy. I like that.

AMY GOODMAN: But what about mortgage foreclosures? What about people getting relief on the bottom, as we keep talking about relief on the top?

ROBERT JOHNSON: Well, what we need, I believe, is the change in money to politics in Washington, because these sensible ideas, which are analogous to bankruptcy, 9/11, a new start — avoiding foreclosure by renegotiating mortgages has been opposed by community banks. Well, it’s been opposed by the entire banking industry, because they like to maintain their leverage. On the other hand, the devastation of neighborhoods, the destruction of property, all these things make the costs not a zero-sum game, and it’s quite surprising to me that we haven’t done more, when even conservative economists like Martin Feldstein are advocating widespread foreclosure. Now, he wants to subsidize the banks to do it, but everybody sees the need for it. And Marcy Kaptur is very creative. I like that idea.

AMY GOODMAN: Final question. You’re former head of the — chief economist at the Senate Banking Committee. The whole issue of partisanship that’s being raised now, how was it when you were there?

ROBERT JOHNSON: It was less violent than it is. It was less polarized than it is now. But at some level, I kind of subscribe to the David Sirota school, which is the hostile takeover means that both parties are somewhat aligned against the people in favor of campaign contributions. If you want to do all of this stuff well — Nomi talked about how to get rid of problems with the disposition of assets, how to monitor the FDIC — we need a vision of proper regulatory reform that we’re going to sell these institutions or their pieces into. And in order to get that, we need to take money out of politics, so the bankers and investment bankers don’t make the rules of their own game.

AMY GOODMAN: And that’s done how?

ROBERT JOHNSON: And how is that done? That’s a difficult question. But I think it’s probably, as Bill Greider says, the magic bullet is outrage, public outrage, and demanding change.

AMY GOODMAN: We’ll leave it there. I want to thank you for being with us, Rob Johnson, former chief economist of the Senate Banking Committee, and Nomi Prins, a former banker turned journalist, has now written her third book, is coming out soon, It Takes a Pillage.

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