A fascinating, enlightening conversation and debate about the economy with Bill Ackman, major investor and hedge fund manager of Pershing Square Capital Management LP, Kate Kelly of The Wall Street Journal, Andrew Ross Sorkin of The New York Times and Joseph Stiglitz, economist and a member of Columbia University faculty.
Here is the complete transcript:
CHARLIE ROSE: The Obama administration today took the latest step in
its efforts to repair the nation’s banking system. The Federal Reserve
began releasing information about its stress test on major banks. The Fed
reported that while reserves had substantially reduced in some banks, most
had capital well in excess of government standards. The 19 banks examined
hold two-thirds of the assets and more than half the loans in the U.S.
banking system. The government privately told bank executives their test
results this afternoon. The Fed also released its methodology ahead of an
announcement of the results in two weeks.
We want to talk about the financial sector, the stress test, all of
this, with a very interesting group of people. Bill Ackman of Pershing
Square Capital management, a hedge fund here in New York. Joseph Stiglitz
of Columbia University, co-winner of the 2001 Nobel Prize in economics.
Andrew Ross Sorkin of “The New York Times,” a reporter and columnist. And
Kate Kelly of “The Wall Street Journal.” I am pleased to have all of them
here at this table.
I will begin with you. Tell me where we are in terms of -- what do we
know about the stress test? What do we know about the results? What are
they telling us and who cares?
KATE KELLY: Well, there are precious few details that have been
released so far. We’re going to know more I think on May 4th. But what
happened is, the banks underwent these stress tests. They had certain
parameters they were supposed to run their models against, run their
portfolios against -- assumptions about unemployment and how severe it
would get this year, for example; assumptions about losses on the value of
certain holdings that were approximately close to what you saw last year
with the Lehman Brothers failure. And the Fed met individually with the
bank management today. I think it was CEO, CFO, other senior people, risk
officers, to discuss where they stood, how strong they were -- I think they
had three buckets from strong to weak -- and whether they would need to
So what’s interesting is, there has been much back and forth about how
much to disclose, and I don’t think we fully know what they are going to
disclose yet. But what they do will have a major impact on public
perception. And even if they don’t give us all the details, based on who’s
raising capital, we’re going to be able to make some assumptions.
CHARLIE ROSE: Yes.
KATE KELLY: So the government is in a bit of a box.
CHARLIE ROSE: All right, Andrew, add to that.
ANDREW ROSS SORKIN: Well, so the issue this afternoon -- I talked to
a number of the executives who have been briefed on their status, if you
will -- and the question right now is what assumption the government used
for their revenue, right? They did all these other assumptions which they
used for everybody across the aboard, but what they didn’t do -- they
actually for each bank individually said what is their revenue going to be
for the next two years. And that’s the most fungible, if you will, of all
of these, because every bank thinks they’re going to have higher revenue
than the government seems to think. And so what we’re going to be seeing
over the next week is a debate privately, that hopefully will come out in
public at some level, over what those revenue judgments are, and -- and
that’s-- that’s what we’re going to find out. And that to me will tell us
in the end who’s strong and who’s not, and who we can actually believe.
CHARLIE ROSE: OK, but it will tell us that, and then what will
WILLIAM ACKMAN: It depends.
WILLIAM ACKMAN: The answer is, the banks that need more capital,
where does the money come from?
CHARLIE ROSE: Exactly.
WILLIAM ACKMAN: And the last six months, the money has come from the
taxpayer, and the question is if that is going to continue. And there are
some alternatives in the taxpayer.
And this past weekend, Larry Summers was on “Meet the Press,” and he
talked about asset liability swaps as alternative means to raise capital
for banks. I translate asset liability swap for debt-for-equity swap,
junior debt-for-equity swap, preferred stock for equity swap.
Basically, what’s interesting is that the banks in this country have
all the capital they need. The problem is too much of that capital is in
the form of debt, not enough is in the form of equity. The way we solve
that problem typically in America is through a reorganization process,
where a judge adjudicates a bankruptcy or some other form of
conservatorship or reorganization. They figure out the value of the firm.
They figure out how much equity needs to be raised, and they compromise
with the bond holders until the bond holders end up owning the firm.
And the benefit of this kind of approach is imagine a bank that needs
$100 billion of capital. You can put $100 billion in from the taxpayer --
in this case, Joe the plumber putting his money in. The money,
unfortunately, is going out the door to pay interest to call it Bill the
bond holder. And that doesn’t seem quite fair to me.
What you can do instead is Bill the bond holder has to convert $50
billion of his debt into equity, and that magically raises $100 billion of
capital, because for each dollar of debt that becomes equity, you’re
canceling a dollar of debt, you’re creating a dollar of equity. And the
system is really set up for this. This is a classic restructuring
CHARLIE ROSE: OK, why haven’t we tried this before? Is this -- do
you think this idea has merit? This idea of Ackman and Larry Summers
talking about it publicly?
JOSEPH STIGLITZ: It’s what I said they should have been doing all
CHARLIE ROSE: Oh, this was your idea?
JOSEPH STIGLITZ: No, what I’m saying is, it is what we have done. We
did it in Continental Illinois, we’ve done it in -- what they’ve confused
is the notion of too big to fail with the notion of too big to be
financially reorganized. And this is just a simple process of financial
reorganization. We do it all the time.
The bond holders don’t like it, because they would prefer the
taxpayers giving them money. It’s perfectly understandable. And the bond
holders have been -- their voice has been heard very clearly, but it’s not
in our national interest. The banks would be stronger after they do this
kind of financial reorganization. They don’t have to pay out every month
all the interest payments that they had to pay before. They now have all
the capital that -- you know, the leverage right now is huge. So small
change in the value of the assets means that the capital is all wiped out.
So now you have more capital, less debt. They’re in a better position to
go forward. It’s basically the notion that we call a fresh start.
CHARLIE ROSE: Right, so what does Mr. Geithner think of this?
JOSEPH STIGLITZ: Well, they’ve been resisting this.
CHARLIE ROSE: Because?
JOSEPH STIGLITZ: Well, the only reason I think is because the -- a
lot of influence from the bond holders, financial sector bond holders don’t
like it. You don’t have to be a genius to figure out why they don’t like
CHARLIE ROSE: Exactly right. Andrew.
ANDREW ROSS SORKIN: Well, no, I mean, it’s funny, you said Bill the
bond holder. I should say Bill Gross the bond holder from Pimco, and he is
someone who has had a lot of influence, as have other bond holders, who
have suggested that the moment that you effectively force these bond
holders to take a haircut or to swap out into equity, you are going to
undermine the entire bond market and we’re going to see some kind of
Now, I’m not sure that’s the case, and as you’ve seen in other
bankruptcies, we’ve gotten through that. So at the end of the day, yes,
this would instill more confidence, but there is other people on the other
side saying that it would kill confidence.
WILLIAM ACKMAN: There is also a lot of misunderstandings. I mean, I
think that if the taxpayer really understood that their capital was going
in -- if you think about a bank that took in $25 billion of TARP funds.
Let’s assume they have $400 billion of debt -- that’s a round number for a
systemically important bank -- $25 billion is enough to pay interest on
$400 billion of debt for a year. So banks won’t lend money because they
need that capital to pay interest on their debts.
I read a study by a guy by the name of Professor David Scharfstein of
Harvard Business School where he said of the $350 billion that was infused
into bank actually didn’t go into banks. Went into.
CHARLIE ROSE: This is the original TARP money?
WILLIAM ACKMAN: Right. It went into bank holding companies. Only
something like $17 billion went into the actual banks. And I know this is
a little technical perhaps for your audience, but I think it’s important.
The companies that trade on the stock exchange are called holding
companies, and they’re shells. They have debt. They have equity. And
they own the systemically important institutions. So the thing that we’re
worried about, that we want to protect, the deposit-taking institution, is
actually the subsidiary of the holding company. And that’s why these --
that’s why systemically important institutions are structured this way, so
that there’s the investor entity -- I call it the holding company -- can be
compromised. You know, the debt for equity then can be converted without
an impact at all on the subsidiaries. So the thing that guarantees
derivatives, the entity that lends money, you don’t want -- when Lehman
failed, what happened was construction stopped, derivative counterparties
tore up contracts. If they had been a deposit-taking institution, there
would have been a risk.
The beauty here is you can simply just walk your way through the
capital structure of the holding company and create enormous amounts of
capital. Let me just follow it through for what it can do. Imagine if we
did this across the 19 -- let’s not do it-- you don’t convert all the debt
into equity. What you do is you set a standard. You say, look, we need
these banks to be extremely well capitalized, which means they need to have
a certain amount of capital. We now have all the data we collected from
the stress tests. So each bank needs to have -- call it 10 percent common
equity to total assets, and we convert sufficient amount of debt -- you
know, if JP Morgan has a better balance sheet, you convert some. Less for
JP Morgan, then you pick another institution and (INAUDIBLE) balance sheet.
It’s a very fair process.
Once you do that, if the banks are now overcapitalized and you
restrict dividends and you restrict stock buybacks, the only way the bank
can earn an adequate return on its capital is by increasing assets. And
what does that mean? It means making loans.
Now you’ve got 19 banks competing to make loans, and it has a huge
impact on the economy, because the average businessman says, I can’t spend
money today because I have a debt maturity and I can’t refinance. But if
he has three bankers knocking on the door, or 19 saying, “I’m going to lend
you money,” they can start spending again, and the economy can recover.
CHARLIE ROSE: Go ahead.
JOSEPH STIGLITZ: Exactly right. I mean, and in a way, it’s so
interesting, because we’ve been spending our money dealing with what
they’re now euphemistically call legacy assets. They used to first call
them toxic waste, toxic assets, then they called them troubled assets, and
now the official term is legacy assets. But that’s backward-looking. And
CHARLIE ROSE: Why is that backward-looking?
JOSEPH STIGLITZ: Because it’s looking at the loans that were made in
CHARLIE ROSE: As long as those loans are there, those assets are
there, those toxic assets are there, these banks have a very bad balance
JOSEPH STIGLITZ: Yes, but there’s another way of dealing with that
CHARLIE ROSE: Which you can’t -- you don’t quite know how to
JOSEPH STIGLITZ: Which is to convert the debt -- convert the debt
into equity. No one knows how to value those risky assets. And what
they’re doing is very simple. They want to take all that trash and dump it
on the U.S. taxpayer. And it doesn’t make it disappear.
CHARLIE ROSE: The original idea, we buy all the toxic assets.
JOSEPH STIGLITZ: That’s right.
CHARLIE ROSE: Under the Paulson plan, the first Paulson plan.
JOSEPH STIGLITZ: Exactly. And then they went into buying it in bulk,
and then they -- the current program is to use the private sector as the
garbage collector and dump it on our backs, but it’s all basically the same
CHARLIE ROSE: From the beginning, the toxic assets have been a huge
problem. So what should we do about them now?
KATE KELLY: I just think there’s a fundamental debate going on here
about valuation, and I’m not sure what the answer is. But there is
certainly a countervailing view to what you were saying, that indeed these
toxic assets can be marked, and they should be marked lower than where the
banks think they should be, and that’s why the banks don’t want to sell
CHARLIE ROSE: But that raises the question, if they do that, what
will that mean to the balance sheets of the banks if they have to mark them
lower, and how many banks will we find are in fact at that evaluation
KATE KELLY: Probably quite a few, which is a scary prospect.
CHARLIE ROSE: And so what do you do then?
JOSEPH STIGLITZ: And that’s why you need to convert the debt into
equity. So that -- it’s the only way you can do it. If it turns out then
that the banks are right and the toxic assets are worth a lot more, then
the equity of the banks will go up automatically, and they get fully
compensated. So the issue here is who’s going to bear the risk of the
uncertain valuation? And is it the people who gave the money to the bank
or is it the U.S. taxpayer? And it’s really simple as that.
CHARLIE ROSE: Andrew.
ANDREW ROSS SORKIN: This all points, though, to the issue of
confidence and what the goal of the stress test was supposed to do, which
was supposed to be to instill confidence. We were supposed to have this
stress test. We were supposed to get the results and we were supposed to
say, ah, this is all going to work out.
CHARLIE ROSE: Meaning they had enough capital to do what they need
(ph) to do.
ANDREW ROSS SORKIN: They had enough capital or we knew which ones
were in trouble and which ones weren’t, and we were all supposed to feel
very good about it. Instead, what I worry about now is that we’re going to
look at the results of the stress test, and it’s almost a lose-lose.
Either you are going to be very realistic, perhaps even too realistic for
many people, and you’re going to suggest that some of these banks really
are either insolvent or in so much trouble that they are going to need
either additional tax dollars, beyond by the way taking preferred shares
and swapping them for common, or you’re going to decide.
WILLIAM ACKMAN: How about bonds…
ANDREW ROSS SORKIN: Or bonds.
WILLIAM ACKMAN: … into equity.
ANDREW ROSS SORKIN: Or you’re going to decide that the entire process
is a whitewash and you’re going to have no confidence in the test to begin
KATE KELLY: I think you’re right about that quandary, because
initially, I think people were excited about getting real results. Then
the word leaked out that nobody was going to fail the stress test.
Everybody was more or less in good shape.
KATE KELLY: Right. And then the public reaction was, well, are these
stress tests worth the paper they’re written on?
CHARLIE ROSE: And what is their methodology is another question about
KATE KELLY: How can that be? How can -- this is just going to hurt
JOSEPH STIGLITZ: And you look at the numbers when they come out, and
they certainly are not the worst numbers that one could imagine. I mean,
they’re sort of median. But stress is stress. It’s not where the average
is. It’s what happens if.
ANDREW ROSS SORKIN: I mean, they’re thinking worst case is
unemployment at 10.3 percent. Housing prices are down.
CHARLIE ROSE: You mean.
ANDREW ROSS SORKIN: The government.
CHARLIE ROSE: The assumption.
ANDREW ROSS SORKIN: The assumptions built into the stress test assume
three major things. One, that unemployment is at 10.3 percent.
KATE KELLY: In the worst-case scenario.
ANDREW ROSS SORKIN: In the worst-case scenario.
KATE KELLY: 8.8 is (INAUDIBLE).
ANDREW ROSS SORKIN: So this is median already in some cases.
Unemployment -- unemployment is at 10.3. We go to.
WILLIAM ACKMAN: House prices.
ANDREW ROSS SORKIN: . house prices at 22 percent. Thank you, I
apologize. And finally, the economy contracts by 3.3 percent. All of
those are right down the middle. Nobody would argue, I think, that that is
true stress, worst-case scenario.
CHARLIE ROSE: Right. What would true stress be?
ANDREW ROSS SORKIN: Probably 11 or 12 percent unemployment.
WILLIAM ACKMAN: I think an analogy that I think will help understand
this. Think of a bridge that a truck had driven over. The bridge
collapses, the truck falls down, kills a thousand people who happen to be
walking under the bridge. When something like that happens, when they go
to rebuild the bridge, that bridge had a 10,000-pound capacity; the truck
weighed 9,800 pounds, but stress and otherwise, the bridge collapsed.
Before people are going to feel comfortable crossing that bridge
again, what you do is you make the bridge have a 40,000-pound capacity,
knowing that trucks of 10,000 pounds are only going to travel over it.
Just to create an enormous margin of safety.
What doesn’t work is to do a stress test which is not the extreme
stress and say that a bunch of banks passed.
What you need to do is -- we don’t need well-capitalized banks under a
historic definition. What we need is extraordinarily well-capitalized
banks. And you have to ask yourself, what is the downside if the U.S.
banking system was the best capitalized banking system in the world? So
imagine a world -- and using this debt for equity -- the beauty of
converting debt for equity is it’s not a taking from taxpayer and it’s not
a taking from the bond holder. The bond holder is getting exactly what
they own. Right? A bond holder is an owner of a company in the same way
an equity investor. The equity investor.
ANDREW ROSS SORKIN: Except that most bond holders don’t want to do
ANDREW ROSS SORKIN: Most shareholders don’t want their stock to go