Sorkin’s Questions Answered

Andrew Ross Sorkin has a great list of questions this morning for Congress to ask the big banks’ CEOs when they appear in Washington tomorrow. He’s too polite to provide the real answers, so let me try.

1. Try to sell American taxpayers on why they should invest in your firms and what kind of returns they should expect.

As standalone entities, absent a bailout, these banks are likely to collapse. With a bailout, they may not collapse. But if the government prevents collapse, then it should become the owner of the banks in so doing, and get all of any possible upside. As to the probability of any upside, the CEOs’ guesses are no better than anybody else’s. And they’re not in a position to bargain. They’ll take the bailout money on whatever terms it’s offered: they have no choice.

2. The government has lent your firms hundreds of billions each at an annual cost of 5 percent. There is speculation in the marketplace that you have turned around and used the money to buy corporate bonds with yields as high as 20 percent, like Alltel debt, for example. If that is the case, this new “carry trade” is allowing you to arbitrage the difference using taxpayer money. Is this so? And if it is, should it be?

Hey, you wanted us to get lending again; are you saying that Alltel’s not worthy of lending to? The point of the TARP was to unfreeze credit markets; providing a bid for high-yield bonds is a necessary part of that. But if the government would rather lend to Alltel directly, it should certainly feel free to do so.

3. This question is for Mr. Pandit of Citigroup… Why should taxpayers be willing to make a bet on a company that so far you seem unwilling to bet on yourself?

Again, this is really a question for Tim Geithner more than it is a question for Vikram Pandit. Pandit has no moral obligation to buy stock in an insolvent bank just because he’s its CEO. And the taxpayers aren’t speculators: they’re not buying Citi stock in the hope that it will go up. (If they were, they’d be the majority owner, and Geithner clearly doesn’t want that.) All the same, the government is calling the shots, and if it wants Pandit to leave, then Pandit will leave. If it doesn’t, then he might stick around a while yet.

4. Last month, several banks — Citigroup, Bank of America, Goldman Sachs and JPMorgan Chase, among them — lent $22.5 billion to Pfizer to help finance its acquisition of Wyeth. The two drug companies said that part of the motivation of the deal was to cut $4 billion in annual costs. Much of that is likely to come in the form of jobs… Given that Congress is considering a stimulus plan to help create and save jobs, is it consistent to allow TARP-funded banks to make loans to corporations that will inevitably hurt the economy, at least in the short run?

Job losses from M&A deals are the least of the economy’s worries right now: the government should be much more worried about companies which close down with the loss of all jobs, if no potential buyer is willing to step up. Admittedly, that was never a risk with Wyeth. And it’s probably true that the $22.5 billion going to Wyeth shareholders is unlikey to finance a lot of near-term job growth. But ultimately you wanted us to extend credit, and that’s what we’re doing, and you can’t know that absent the Wyeth deal, Pfizer and Wyeth might not have announced equally large job cuts on their own.

5. Since credit card defaults are correlated to employment, what happens if unemployment goes as high as 10 percent or more? What is the highest unemployment level that you’ve used in your forecasting models? And do you have adequate reserves for your worst-case situation? If your assumptions are wrong, what happens?

No bank has reserved enough money to cover credit-card losses in the event that unemployment reaches 10%. If it gets there, anybody with credit-card exposure is going to have to take further write-downs.

6. Do you think Glass-Steagall should have been repealed? Do you think there should be a limit on the amount of leverage, or borrowed money, that your banks can employ? (Not just capital ratios.) What’s appropriate?

As we’ve seen with WaMu and Wachovia, having a commercial bank without an investment-banking subsidiary hardly protects you. The key thing, as you imply, is not whether or not there’s an investment bank, but rather how much leverage you have. And yes, that should be regulated. If everybody else has their leverage strictly capped, we’ll all be competing on a level playing field. Otherwise, banks with prudent amounts of leverage will look like underperformers during good years.

(Update: Wachovia does actually have an investment bank, but it wasn’t responsible for the parent’s losses.)

7. Your compensation structure has been “heads I win, tails I win” for you and many of your employees, despite putting your firm and the nation’s fiscal health in jeopardy. What’s the right model? And how do you feel about forcing your employees to risk their own money, not just the firm’s, when they make a trade or participate in a transaction that puts shareholder capital at risk?

The right model, again, involves capping leverage — which by necessity means capping profits. Once you’ve done that, a lot of the excess paydays will be a thing of the past. As for employees risking their own money, would you lend me money at 4.5% over 30 years to buy a house?

8. Treasury has proposed a $500,000 cap on compensation for banks that take new TARP money. Many of you have privately complained that you will lose your top talent. Are these the same people that helped lose your banks billions? And can you quantify the impact on your earnings without such “talent?”

Yes. No. But the question’s largely moot, since the cap applies only to a handful of very top executives — no more than four or five at any firm. The rest of the company can still be paid millions.

9. Mr. Blankfein and Mr. Mack, both of you have been outspoken about your firm’s intention to repay the TARP money that you received as fast as possible. Mr. Blankfein, you have also hinted that you have little intention of changing your firm’s business model despite being granted bank holding company status and access to the Federal Reserve’s discount window. Please explain whether we should have provided you the money in the first place and whether your status as a bank holding company should be rescinded? If both took place, could you survive?

The bank holding company status allows Goldman to be regulated more assiduously, and its leverage to be capped. You really don’t want that? As for getting TARP funds in the first place, we had no choice in that matter: Hank Paulson gave us a take-it-or-take-it offer. Ask him.

10. Please explain how you feel about the newest TARP proposal from the Treasury secretary, Timothy F. Geithner. Would you be willing to sell toxic assets into a “bad bank” if you are forced to realize serious losses? At what price would you be willing to sell your toxic assets?

I’ll sell toxic assets at a loss so long as I can do so without violating my minimum capital requirements. You can buy those assets off me or you can simply recapitalize me directly: the net effect is similar, but in the latter case, of course, you risk ending up owning the bank, and you wouldn’t want that. Would you.