For all the bailout money they've received, some of America's biggest banks are still unwilling to sell many of the toxic assets clogging their balance sheets. The prices being offered, they say, are simply too low, and neither massive government subsidies for buyers nor encouragement from President Obama has thus far been sufficient to change their minds.
At a meeting between Obama and the nation's top bankers on March 27, the President encouraged the CEOs to participate in programs designed to purge the toxic assets. But after politely voicing support for the programs in principle, the bankers said that in practice, the prices for the toxic assets were still going to be too low when the programs are launched in coming months, according to a source who was in the room, which was confirmed by another source who was briefed by participants. (See 25 people to blame for the financial crisis.)
This tension over pricing helps explain the leaked stories on Wednesday announcing that Treasury Secretary Timothy Geithner will make public the results of the banks' "stress tests" next month. The tests started out in March as a gauge of banks' ability to handle a worst-case economic downturn; now they've become a weapon for Obama and Geithner to force the banks to clean up their acts, officials say. "It gives [Obama and Geithner] leverage to make large institutions do things they otherwise wouldn't do," says a senior government official involved in the tests.
The banks' resistance may be the biggest hurdle Geithner faces in his plans to rebuild the financial sector. At the height of the crisis over the winter, there were neither buyers nor sellers for the toxic assets. Saddled with the assets on their balance sheets, the banks sharply curtailed lending, threatening to throw the economy into a tailspin. The Bush and Obama Administrations poured money into the banks to allow them to restart some lending, but the toxic assets remained on the banks' books. (See five lessons from the AIG-bonus blowup.)
At that point, pressure mounted from regulators, the Federal Reserve and Congress on the Financial Accounting Standards Board to loosen accounting rules so that the toxic assets' book value could be marked up to buttress the banks' balance sheets conveniently raising the assets' potential sales price at the same time. And in late March, days before the meeting with the bank CEOs, Geithner and Obama unveiled the government subsidies for buyers, drawing big names like Blackstone and Pimco into the market to purchase the assets from the banks and resell them.
But even with the accounting fix and the massive offer of government leverage to buyers, bankers are turning up their noses at the markdowns they will have to take on assets that once represented a large percentage of their equity. "You're not going to sell if you believe the assets are worth more," says Scott Talbott, the top lobbyist for banks in Washington. "The government dollars may not be enough to reduce the spread between the bid and the ask."
In a recent report from Goldman Sachs, the firm's research analysts calculated that the best of the banking industry's toxic assets are carried on banks' books at an average of $91 (on a bond with an original $100 price). But TIME's calculations suggest that the government-subsidized buyers would pay only $70, leaving the banks with a $21 loss on each bond sold.
In the end, though, the banks may have no choice. Since the 1930s, regulators have been able to force banks to shore up their balance sheets by selling assets, even at prices lower than the bankers would like. The stress tests give the supervisors the ammunition they need to do that. "With the results of the stress tests in hand, it just gives you more leverage," says the senior government official involved in the tests.
Obama and Geithner may not be completely out of the woods even if they do force banks to sell their toxic assets. Some banks may be so deeply in debt that even the proceeds from the sales won't be enough to fill their capital needs. In that case, the stress tests may prove useful in another way. Geithner has only about $35 billion of TARP money left to plug the remaining holes for the 19 largest banks. After that, he has to go back to Congress for more money at which point he'll need the stress tests to convince bailout-weary Representatives to shell out even more for the banks.
With additional reporting by Stephen Gandel