The Recession

What Happens When Banks Fail and We Own Them?

| by Robert Reich

The outcome of the "stress tests" will be that the banks needing extra capital
will get it from the Treasury. But where will the money come from, now that the
TARP fund is almost exhausted and Congress is dead set against providing more
bank bailout money? The Treasury will simply swap debt for equity – turning what
the banks owe the government into shares of stock in the banks. Presto. Ailing
banks will get more capital, and Tim Geithner won’t have to go back to Congress
to ask for it.

But by this sleight-of-hand, the public takes on more
risk. Much of the money we originally gave Wall Street took the form of senior
debt. We were preferred creditors, meaning that in the event of bankruptcy (or
some form of it) we’d get repaid first. But as shareholders, we’d get nothing.
As we’ve seen time and again during this economic crisis, shareholders lose

It’s possible, of course, that this is the perfect time to get
shares in major Wall Street banks, because the economy is poised for recovery.
But it’s just as possible this is the worst time – especially in banks judged by
the Treasury to be inadequately capitalized – because nonperforming loans keep
mounting. They won’t be repaid because so many people continue to lose their
jobs, even though the pace of job losses may be slowing. And because they’re
losing their jobs, they can’t pay their mortgages or credit card balances, or
even shop at stores that are closing on Main Street, thereby threatening
commercial real estate as well.

There’s a second problem with the
debt-for-equity swaps. We the public become controlling shareholders in several
large Wall Street banks. Should we be active shareholders – using our clout to
get management to do things management might not otherwise do? Or passive
shareholders, relying on the remaining private shareholders to police
management? I’d say we should be active. But that only raises a whole host of
questions. First, who represents us?

More importantly, if we’re active
shareholders, is our main objective to make sure the banks become profitable and
our we get repaid? Or should we push management to take actions that are in the
public interest but not necessarily geared toward higher shareholder returns in
the foreseeable future – such as limiting executive compensation, limiting the
payout of dividends, and pushing the banks to make more loans to Main Street?
I’d say we should do the latter. Otherwise, why bother bailing out the banks to
begin with?