Transcript

375:

Bad Bank
Transcript

Originally aired 02.27.2009

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Full audio: http://tal.fm/375

Prologue.

Ira Glass

The news has gotten kind of confusing. I don't know if I'm allowed to admit that as a person who talks here on the public radio. It's confusing to me, especially all this stuff about the trouble the banks are in. You know, you turn on The Today Show at random. And you can find yourself watching something like this.

Sheila Bair

As of this date, this is a static date, all these large banks exceed regulatory standards for being well capitalized. So, for right now, they're fine.

Ira Glass

That's the chairman of the Federal Deposit and Insurance Corporation, Sheila Bair. And this is mainstream network television, in the morning. God help you if you accidentally flip over to CNBC.

Male Speaker

So many of these banks, the stocks are telling you, the underlying equity value is zero or maybe a little bit above zero.

Female Speaker

Wouldn't mark to market accounting, a hiatus from mark to market, do that exact same thing?

Ira Glass

OK. I'm just going to stop the tape right there. I mean, come on. That's not even trying to help us understand. Even the Obama Administration, whose very jobs depend on us understanding what they're doing to try to fix the economy, who are actually trying to explain this stuff to us, even they have these moments.

Tim Geithner

Those institutions that need additional capital will be able to access a new funding mechanism that uses capital from the Treasury as a bridge to private capital.

Ira Glass

This is Treasury Secretary Tim Geithner, on Capitol Hill, explaining his plan to fix our banking system.

Tim Geithner

The capital will come with conditions to help ensure that every dollar of taxpayer assistance is being used to generate a level of lending greater than what would have been possible in the absence of government support. And this assistance will come with terms--

Ira Glass

Forget it. Here's what I understand, what I think most of us understand, the stock market's way down. It seems to be dropping. Banks aren't lending, even though the government has given them hundreds of billions of dollars of our money to help them start lending again. And my life, your life, the entire economic fate of our country and the world, for the next decade, depends on whether or not the United States can fix its banking system.

And maybe you're on the verge of just giving up, of figuring that this is just going to be one of those news stories that you're just going to kind of sit out. You know? I sat out Kosovo. I'm not proud about that fact, but I did.

Well, if that's your situation, I have good news for you. The team that put together our show explaining the mortgage crisis last year, that so many of you wrote to us to let us know that you found so helpful-- This is the team Adam Davidson, from NPR News, the NPR economics correspondent and This American Life producer Alex Blumberg. They are back. They are back today. And in the next hour, they are going to explain everything you need to know to understand the US banking system and how it might or might not be fixed.

And I've got to say, they've been working on this all week. I've heard the thing. It is awesome. It is awesome. And at the end of it, you will actually be able to have an opinion.

From WBEZ Chicago, it's This American Life, distributed by Public Radio International. Today's show is another collaboration between us and NPR News. The collapse of the US banking system explained in just 59 minutes. Stay with us.

And with that, I turn things over into the capable hands of Adam and Alex.

Act One. The Collapse Of The Us Banking System Explained In Just 39 Minutes.

Alex Blumberg

If you want to understand this crisis right now, this banking crisis, you need to understand this one thing. And it's one thing, Adam, that the mainstream media is afraid to touch.

Adam Davidson

They're afraid because they think it's really boring.

Alex Blumberg

Right. Right. Because what the central thing is, this thing that we need to discuss right now, is a bank balance sheet.

Adam Davidson

But please do not despair, because we think we've come up with a way to explain this to you. And we actually think it'll be pretty enjoyable. So to begin, let's imagine the simplest bank in the world. I would like to call it Adam's Bank.

Alex Blumberg

How come you're always the bank owner in these imaginary scenarios?

Adam Davidson

I mean, Alex, I just think of myself as more like a bank owner and you more like a bank customer.

Alex Blumberg

I see. OK, Mr. Fancy Pants, go ahead.

Adam Davidson

OK. So I have $10 of my own money that I'm going to start my bank with. So I take these $10, and I open for business. I start accepting deposits. And I go to my good friend and colleague Alex Blumberg. And I say hey, Alex, you want to open a savings deposit with my bank? I'll give you 3% interest a year.

Alex Blumberg

I say, that sounds great. I actually have $90, right here, that I'm saving for a rainy day. And so I will hand it over to you. Here you go. $80, $90. There you go.

Adam Davidson

All right. OK. So now I have $100 in my bank, $10 of which is mine, $90 I got from Alex. All right. And so right now this is a lousy business. I'm losing money because I'm paying Alex 3% interest. And I'm not getting anything coming in. I need to make some profit. And that requires one other person.

Caitlin Kenny

Hi guys.

Adam Davidson

Oh hey, Caitlin.

Alex Blumberg

Hey, Caitlin.

Adam Davidson

This is Caitlin Kenny, she's a Planet Money producer. Hey what's up? What's going on?

Caitlin Kenny

I need to borrow $100.

Adam Davidson

For what?

Caitlin Kenny

To buy a house.

Adam Davidson

You can get a house for $100?

Caitlin Kenny

It's a dollhouse.

Adam Davidson

Oh, actually, this is perfect. So I can give you, Caitlin, the $100 I have in my bank, but on one condition. You have to pay me back at a higher interest rate than what I'm paying Alex. So that way I can make some money. So let's say 6%.

Caitlin Kenny

Sounds good.

Adam Davidson

OK. Here you go. All right, that's $100.

Caitlin Kenny

Awesome. Later.

Adam Davidson

Wait. Remember, you've go to pay me 6% a year.

Caitlin Kenny

Huh?

Adam Davidson

The mortgage, you have to--

Caitlin Kenny

I've got to go. Yeah. Sure. Got it. No problem.

Alex Blumberg

All right.

Adam Davidson

Yeah. I'm in business. This is great. I'm getting 6% from Caitlin. I pay 3% to Alex. I get to keep the difference.

Alex Blumberg

OK. And at a fundamental level, banking is really this simple. You pay your depositors, in this case me, a low rate. And then, you lend out money at a higher rate. You keep the difference. In fact, there's even an old banking joke. Banking is a three, six, three business. You take in money at 3%. You lend it out at 6%. You're on the golf course by 3:00 in the afternoon. [FORCED LAUGHTER]

Adam Davidson

Oh, Bankers.

Alex Blumberg

Oh, bankers.

Adam Davidson

And this brings us to--

Alex Blumberg

--the subject of today's radio drama.

Adam Davidson

Correct. So what we have here, right now, is the world's simplest bank balance sheet. Picture a piece of paper with a line drawn down the middle. On the right side is my $10, the $10 I started the bank with, and the $90 I got from Alex. On the left side is the $100 I gave to Caitlin. If you notice, both sides are equal. $90 plus $10 on the right side equals $100 on the left side. And that's why they call it a balance sheet. Both sides have to balance.

Alex Blumberg

OK. Now, some jargon. Adam's $10, that's called the bank's capital. The people who own the bank, that is what they own. And when Adam makes his profit every year, you know, the difference between what he's getting from Caitlin and he's giving to me, that profit is added to the capital. So year over year, if the bank is well run, the capital gets bigger, Adam gets richer.

But now, the jargon gets completely confusing and backwards, because most of us aren't used to thinking like a bank. The $90 that I deposited in Adam's bank, that also has a name. And it's called Adam's liabilities. And to me, of course, it's not a liability. It's a deposit. It's my savings. But to Adam it's a liability because, if you think about it, he owes me that $90. He's liable to me for that money. I can withdraw it at any time. And he needs to pay me interest on it. To him, it's like a loan I gave him.

Adam Davidson

And I think we should introduce another piece of jargon.

Alex Blumberg

Sure.

Adam Davidson

That $100 that I gave to Caitlin, that's called my asset.

Caitlin Kenny

Huh?

Adam Davidson

Well, you have to pay me some money every month. So I think of Caitlin's dollhouse mortgage-- I think of it like an investment. I give you $100 up front. You pay me back 6% a year for 30 years or however long your dollhouse mortgage is. That is my asset, because you pay me that nice return every year. Right?

Caitlin Kenny

Huh?

Adam Davidson

You're going to pay me 6% a year, right?

Caitlin Kenny

Oh, I said that?

Adam Davidson

Yes. You have a mortgage.

Caitlin Kenny

Oh, OK.

Alex Blumberg

Excellent work guys. That was very nicely illustrated. OK. So the point is, every single balance sheet looks this way. You've got on the one side, on the left side, you have assets. And on the right side you have liabilities plus capital. And they always balance out. This is true from this very simple, hypothetical bank in a world with one depositor and one dollhouse to the largest and most complicated bank that has ever existed, Citibank, whose balance sheet I have right here.

Adam Davidson

And, Alex, you did not like secretly break into the corporate offices of Citibank, right? That's something that you can just print up off the Internet.

Alex Blumberg

Right. And it says here what they have. Instead of $100 in assets, of course, they have a little bit more, specifically $1.95 trillion in assets.

Adam Davidson

That's a lot of dollhouses.

Alex Blumberg

Yeah, it is. And I'm reading it right here. It says assets, total assets, $1.95 trillion. And then, on the other side, liabilities, $1.8 trillion. Capital, $150 billion. And that also equals $1.95 trillion. It all adds up. Assets equal liabilities plus capital. Both sides of the balance sheet balance.

So here's where things get interesting. And here's why we're explaining bank balance sheets on the radio and why you are, we hope, listening with rapt attention.

Adam Davidson

Alex, I really hope they're still with us.

Alex Blumberg

Me too. I hope you're out there. OK. It's getting interesting. It all has to do with Caitlin.

Caitlin Kenny

Hey, Adam.

Adam Davidson

Hey, Caitlin.

Caitlin Kenny

I can't pay my mortgage.

Adam Davidson

What the?

Caitlin Kenny

I lost my job. I mean, you didn't ask me about my job in the first place, but now I don't have one. So that money, it's not coming.

Adam Davidson

Oh, my God.

Alex Blumberg

Well, I mean, for a few years there, you bankers were giving out loans to all sorts of deadbeats like Caitlin--

Caitlin Kenny

Hey.

Alex Blumberg

Sorry, Caitlin. --without checking to see if they had jobs first.

Adam Davidson

All right. I'm going to kick you out and take the dollhouse.

Caitlin Kenny

But my baby, my baby. Where will my baby sleep?

Adam Davidson

Caitlin, it's a doll baby. Get out.

Caitlin Kenny

Fine.

Alex Blumberg

OK. So now, Adam's bank owns Caitlin's dollhouse. And he wants to sell it. But it's a down market in dollhouses. And all the dollhouses out there, just like Caitlin's are only selling for $95, which is a problem for your balance sheet, Adam. Because now it looks like this: liabilities, $90, that you owe me, $10 of your own dollars equals $100. But on the other side, assets, one dollhouse worth $95. Your balance sheet is out of balance.

Adam Davidson

So I'm a good banker. I know, obviously, the balance sheet has to balance. So that $90, that's Alex's money, Alex's deposit, that can't change, because if he wants to withdraw it at a moment's notice, I have to be ready to give him $90 at any time. The only thing that can change on that side of the balance sheet is my capital, the $10 of my own money I started out with.

So now my balance sheet looks like this: on the asset side, one dollhouse worth $95. On the liability side, $90 deposit from Alex, my liability. $5 dollars in capital, my money. So both sides equal $95. They're back in balance. But with the stroke of an accountant's pen, I've lost five of my own dollars. I've lost half of my money. This really sucks. And this situation I'm in with Caitlin, this is the situation a lot of our biggest banks are in right now.

Alex Blumberg

But much worse.

Adam Davidson

Right. Because instead of one Caitlin, there are millions of them. And they all bought dollhouses at the height of a dollhouse mania. And dollhouses have lost not 5% percent of their value, but 10%, 20%, sometimes 50%, depending on where they live. They've gone from being assets to toxic assets. That's probably another term you've heard.

Alex Blumberg

So if Caitlin's dollhouse is, in fact, a toxic asset, if her dollhouse has dropped in price-- let's say by 50%-- let's go back to our balance sheet. If the bank, you Adam, takes over Caitlin's dollhouse in this situation, and can sell it for only 50% of its value, then your balance sheet looks very bad. A $50 loss on the left side of the balance sheet, which has to be matched on the right side.

Adam Davidson

So my $10, my capital, that's totally gone.

Alex Blumberg

And $40 of my $90 is now gone as well.

Adam Davidson

So not only is my bank wiped out, but I can't even pay back my creditors, in this case my good friend and colleague Mr. Alex Blumberg.

Alex Blumberg

And this is, of course, a bad thing. I lose half my savings. Adam loses his bank. And it's all because of Caitlin and her stupid dollhouse.

Caitlin Kenny

Oops. [LAUGHTER]

Alex Blumberg

Is that all you have to say?

Caitlin Kenny

Sorry.

Alex Blumberg

All right. There might be a way out.

Adam Davidson

Yeah. I don't want this whole scenario to happen. And so I come up with a plan. I'm not going to sell Caitlyn's dollhouse.

Alex Blumberg

But what about my money? Isn't it only worth half of what she paid for it? You have to sell it. I need to get something back, right?

Adam Davidson

Hey, Alex, don't worry about that. Your money is totally safe in my bank, because, let me tell you something, the dollhouse market is coming back. And all I have to do is just keep Caitlin's dollhouse on my balance sheet for more or less its original value, somewhere around $100.

And I have a simple claim. The market for dollhouses is illiquid right now. In other words, I am not able to sell the dollhouse into this market. So there's no way to determine a market price. We're fine. We just have to assume the market is going to come back, and I can sell it for $100 down the road.

Alex Blumberg

But that's a crazy assumption. We're entering maybe the worst recession in decades. People are losing their jobs all over the place. Everyone says things are probably going to get worse in the short term, not better.

Adam Davidson

Shh, shh.

Alex Blumberg

[LAUGHS]

Adam Davidson

Alex, I've chosen to believe that this house will be worth more one day. Can you let me have my dream? If we just assume the dollhouse hasn't gone down in value, everything is OK.

Alex Blumberg

It's funny. I talked to a professor at Columbia Business School. He's an expert in bank crises and a former banker himself. David Beim's his name. He told me you'd say that.

David Beim

Most often, the bankers say, well, it's not as bad as that. For example, in the current crisis, many banks hold these so-called toxic assets, whose quoted prices are down around 20% or 30% of their face value. And the bankers say, look, I'm just sure it's worth more than that. I don't want a mark it to market.

Alex Blumberg

OK. That last phrase that he just said, let's listen again.

David Beim

I don't want to mark it to market.

Alex Blumberg

David Beim is saying you don't want to mark it to market. Mark to market, that's another phrase you might have heard. And it applies to exactly the situation Adam is in right now. He's got a dollhouse on his books for $100. But if he had to sell it now, he could only get $50. That's the market price, what he could get right now. Marking it to market means Adam would have to enter the market price, $50 or $20 or whatever it really is, into his books.

David Beim

And the bankers have all been saying, please, don't make me do that. Because if you do, I'll be declaring bankruptcy. If I show all those as a reduction from $100 all the way down to $20, you've just wiped out my entire capital and more. I'm going to have to go to the government and say, close me down. I'm broke. And bankers find that very hard to do. And furthermore, regulators don't really want that to happen to all the banks at once, certainly not all the big ones.

Alex Blumberg

Now obviously, in the real world, the assets that banks have on their books are more complicated than dollhouses. But if the banks had to sell them now, in today's market, they'd almost certainly take a huge loss, a loss big enough to wipe out their capital and shut them down.

Adam Davidson

And it's not just a few banks. Banking experts estimate that more than 1,000 banks are either facing this situation right now, or they will soon. And that includes-- and this is the crucial point-- many of America's largest banks. They owe more money than they have. And there's a word for this: insolvent.

You don't have to take our word for it. One of our colleagues on the Planet Money team, David Kestenbaum, talked to Jeremy Siegel, who is, it's true, called the Wizard of Wharton. Wharton, of course, being that famous business school.

David Kestenbaum

How many of the banks, right now, do you think would be insolvent if someone, as you said, hard headed went in and valued what they actually have?

Jeremy Siegel

Well, I don't know how many. But I think there might be, on a current market value-- and again, the market may be over discounting some of these. But probably, I wouldn't be surprised if Citi and Bank America, really, at current value of their assets, don't cover the depositors and the bondholders and would wipe out shareholders equity. And there could be others too.

Alex Blumberg

All right. Let's just pause there for one moment. When they talk about the banking crisis, this is what they mean. This is it. Siegel is saying two of the biggest banks in the United States, their assets are too small to cover their liabilities. The losses wipe out the capital. And there's still not enough left to pay for all the depositors and other people who lent the banks money. That is just huge.

Adam Davidson

Yeah. This quote really makes me nervous. Though, I do want to be clear about something. Normal people, depositors like Alex with a regular savings account, they would not lose any money under any scenario, because the government guarantees their deposits up to $250,000.

But big banks get a lot of their money from big investors who lend them millions or billions of dollars. And that money is not protected. If the banks go down, these investors could lose their money. And the consequences of that will ripple around the world.

Of course, Citibank and Bank of America dispute the claim that they're insolvent. They both say they have more than enough capital. And there's no need to worry. And we should say, the Treasury Department and federal regulators say that's true, that they have more than enough capital.

But it seems that the market does not believe this story. Consider this fact: Citibank claims on its balance sheet that it's worth, its own capital, is more than $150 billion. But if you add up all the stock out there, which is how you find out what the market thinks Citibank is worth-- Here I am just going to type C into Google. That's the code for Citibank'a stock. And wow. OK. As of Friday morning, when we're recording it, Citibank's total value, according to the stock market, the world's investors, is less than $10 billion.

Alex Blumberg

That's actually about the size of the Heineken beer company.

Adam Davidson

Less than the size of the Heineken beer company. And Citibank, historically, has been one of the largest companies in the world.

Alex Blumberg

So what you see here is two stories: what the banks are saying about their balance sheets, and what people outside the banks are saying. The government, by the way, is siding with the banks for now.

Adam Davidson

They believe that the dollhouse value will come back. They believe that if we just wait a little while, the banks will be fine.

Alex Blumberg

Right. Which is important to know because what you do about the banking crisis depends on which version of the truth you believe. And the Secretary of the Treasury and the Federal Government say, now anyway, that Citibank and all the other major banks are well capitalized, and they just need a little cushion for insurance.

Adam Davidson

All right. So this is the situation our country is in. If the Wizard of Wharton and the stock market are right, two of our largest banks are either insolvent or really, really close, and probably lots of others as well. Those two banks, Citibank and Bank of America alone, have over a quarter of all of the money in the US banking system. 90% of all the money anybody has on deposit in the US is just in the 20 largest banks. So if they start falling, the US economy, the world economy are basically done for a while.

Alex Blumberg

So what do we do? There are two options that have been discussed a lot. One option was the one that former Treasury Secretary Henry Paulson originally proposed: the first TARP. Which you'll remember, stood for Troubled Asset Relief Program. And now, that word might make a little bit more sense. The idea there is pretty simple. You take Caitlin's dollhouse as a typical troubled asset. It's selling right now for only $50. Under this plan, the government agrees with Adam that someday the market will pay a lot more for that dollhouse. And so it buys it from Adam for a higher price than he could get right now. Let's say $92.

Adam Davidson

OK. I'd still take a hit to my capital. I'd lose a lot of my money. I'd lose $8 of my $10. But I'd get to keep my bank. And I'd keep my depositors, like you Alex, whole.

Alex Blumberg

But we, the taxpayers, get stuck with a $50 dollhouse that we paid almost $100 for. And if dollhouse prices don't go up, the government turns out to be a pretty big sucker. And this plan bails out people like Adam, even though he's the guy who got us into this crisis by making unbelievably stupid loans to deadbeats like Caitlin.

Adam Davidson

Easy pal.

Caitlin Kenny

Easy, easy.

Alex Blumberg

Sorry guys. I got carried away. Anyway, the government can't pay less for the dollhouse, it can't get a better deal, because if it gets a good deal, if it only pays what the market would pay, that wouldn't save the banks. That would defeat the whole purpose.

Adam Davidson

Now, I just want to say that I, as a banker, I love this plan. I think it's brilliant, because sure, I'll lose some money. But I'm still in business. I'm solvent. And you know what? It's not just me. All my banker friends think this plan is brilliant.

I talked to Simon Johnson. He's an economist. He used to be with the International Monetary Fund. Now he's with the Peterson Institute. And he found a good example of another banker giving the hard sell for this plan.

Adam Davidson

So you brought us this piece of paper today. This is having you laugh. Can you tell me what this is?

Simon Johnson

Well, it's a note from Deutsche Bank. It's part of their US Daily Economic Notes series.

Adam Davidson

This is some staff economists there that send this out every day.

Simon Johnson

That's right. And they send these around to clients and to people that they want to have conversations with. And if course, it goes to government. These are very influential, these kinds of things. This research note-- Can I just plunge in to say what's in it?

Adam Davidson

Yeah.

Simon Johnson

The title is eye catching. It's called "Falling Short colon, The Government Needs to Buy Toxic Assets." So it's a very straight statement. It obviously speaks to the issues of the week. And the paragraph-- It's a one pager. And the paragraph that, the bolded text-- they bolded it-- that really struck me, and I think summarizes the tone of it is it says, "ultimately the taxpayer will pay, one way or another, either through greatly diminished job prospects and/or significantly higher taxes down the line. We think the government should do the following: Estimate the highest price it can pay for the various toxic assets residing on financial institution balance sheets which would still return the principal to taxpayers." Now, if I can cut through the-- If I can translate that, this is--

Adam Davidson

You have a phrase for this note.

Simon Johnson

This is a robbery note. It's saying, guys, either you'll have 20% unemployment or the national debt will go up to these dangerous levels, unless you buy toxic assets, not for what they're worth, not for what the market price is, as much as you can pay. Wow.

Adam Davidson

So it is saying-- I mean, the key line here is "the taxpayer will pay one way or another." I had a landlord. I don't think he was in the mafia, but he tried to cultivate the image. And he would, you know, he'd say things like, there's an easy way and there's a hard way. And I can just hear him saying that you're going to pay one way or another. And so basically, what this note is saying is look guys, you're going to hurt either way. Give us the money now. We'll try and make it easy for you.

Simon Johnson

My first reaction was, it's a spoof. My second reaction was, oh, my God.

[PHONE RINGING]

Adam Davidson

We figured Simon should argue it out with the Deutsche Bank guy, Joe LaVorgna.

Joe Lavorgna

Joe LaVorgna.

Adam Davidson

Hey, Joe. It's Adam Davidson from NPR.

Joe Lavorgna

Hi.

Adam Davidson

Hi. So I'm on the line with Simon Johnson. Your note today, did you write it? Or you wrote it with your staff?

Joe Lavorgna

Me.

Adam Davidson

You wrote it.

Joe Lavorgna

Right. Yep. I wrote it.

Adam Davidson

Simon was actually really nervous about calling Joe. He thought he'd get all mad at us for saying this was a robbery note. But Joe was cool.

Joe Lavorgna

I think the bottom line is simply, someone has to pay for the mess that's been created. And, there's no escaping, the taxpayer is on the hook.

Alex Blumberg

And let me just say, Joe LaVorgna is finally coming out and saying something that every other bank and lots of government people have avoided saying. They've been playing this game, saying there's some magical recipe where the government bails out the banks. The banks do better. The taxpayers end up making money. Everyone wins.

And this note is saying what we keep hearing from economists. That probably can't happen. Someone is going to lose. And Joe is saying he knows exactly who that's going to be. You and me and everybody who pays taxes.

Simon Johnson

I think Joe-- I found it refreshingly honest. But it also kind of took my breath away. And the reaction-- So I put it out there. And I asked people what they thought on my blog. I didn't use names. I just put out this key paragraph that you were just discussing and the key issue, the taxpayer will pay one way or another. So one guy said quote-- he's sort of paraphrasing how he read the note. He said, "that sure is a nice global economy you've got there. Be a shame if anything happened to it."

Adam Davidson

And Joe, I've got to say, what I love about your note, if we-- Do you mind if we call it a ransom note.

Joe Lavorgna

I wouldn't prefer to-- [LAUGHTER] If I was on my own, I would say fine. But I wouldn't say a ransom note. I would say a reality check. I mean, the thing is, I think Simon's exactly right. And this is the issue. We're delaying the pain. And you've got to just deal with the problem. And I guess the issue is just dealing with the problem. What we've done to this point has just simply not been aggressive enough. So whatever the approach is, let's just get there.

Adam Davidson

So let's talk about a second way the government could address this whole mess. The government could say to bankers like me, OK dude, get real. I would have to recognize my loss on Caitlin's dollhouse. So I'd just have to say, yes, I am $50 in the hole. So my capital is wiped out. And I owe my depositor, you know Alex, $40.

But then, under this second plan, the government comes in, on the other side of my balance sheet, and covers my losses. It gives $40 for Alex. And it replaces the $10 dollars in capital that got wiped out, that I lost. Now, the problem here is that if the government puts in that much capital, then the government now owns the bank, my bank.

And I want to say, as a bank owner, I do not like this plan, because I would lose my money. I'd lose my job. And you know, I'm a banker. I don't like this kind of government takeover of private industry. Its nationalization. I hate nationalization. This seems like socialism to me.

Alex Blumberg

Yeah. But at least this way I, as a taxpayer, have an ownership stake in a bank, not some crappy overvalued dollhouse. And the government won't just own it forever. It'll clean the bank up. Sell it to someone else down the road. And maybe we'll get some of our money back. And frankly, I like the fact that you lose your job. You got us into this mess.

Adam Davidson

Hey.

Alex Blumberg

Oh, now I hurt your feelings. I'm sorry. OK. I wish you could keep your job. But don't you understand what I'm saying? You know, I'm mad. We're all mad. And this is the traditional way governments usually fix banks.

For the last 20 years, Simon Johnson has worked on banking crises all over the world. He used to be the chief economist for the International Monetary Fund, an organization that's stepped in over and over around the globe to fix just the kind of crisis we're in right now. And the IMF, with the United States, pushed countries in similar situations to do what? To nationalize their banks temporarily.

Simon Johnson

Indonesia '97, Korea '97, '98, Russia, every couple of years, Argentina 2002. What would the US tell the IMF to do if this were any country other than the US? If you covered up the name of the country, and just show me the numbers, just show me the problems, just talk to me a little bit about the politics in a generic way, I know what we would do. I know what the advice would be. And that would be take over the banking system, clean it up, reprivatize it as soon as you can.

Adam Davidson

So then, the logical follow up question is, why? Why is the United States not taking it's own advice?

Simon Johnson

That is a great question, the huge question. My take is that it's too political. The politics are awkward. Remember, so cleaning up banking systems, in my view, technically, is not that difficult. But when you clean up a banking system, and you do it properly, some powerful people lose. They lose their bonuses. They lose their banks. They lose their access. So who's going to lose? Who's going to decide who's in and who's out? I don't think the people at the top are yet ready to have that conversation.

Alex Blumberg

One of the reasons they might not be ready to have that conversation has to do with the practical challenges of taking over the banks. Columbia Business School professor David Beim knows about this. He has experience himself taking over American banks, assisting the US government. This was back during our last banking crisis, the savings and loan crisis in the late 1980s. When that crisis hit, he started advising the FDIC on the problem, which was big.

David Beim

Every large bank in Texas and Oklahoma failed in that era, every one of them.

Adam Davidson

It was the biggest banking crisis America had faced since the Great Depression, and compared to now, it was nothing.

David Beim

What I faced in the '80s was a regional crisis. So that the FDIC was willing to shut every major bank in Texas and Oklahoma, cleanse them of their bad loans, relaunch them with new management and new shareholders. That was the best practice of the day. And they did it very well. And they got through the mess and got through it elegantly.

It's harder to do that for the nation. It's harder to say all the big banks in the country should now be closed. That is kind of awesome. I mean, you would not want to do that all at once.

This crisis has advanced so fast and so globally. It's not just the United States, of course. Banks are crashing all over Europe. The banks of Europe are actually in worse shape than those of the United States, even those that never touched a mortgage backed security. This is a global crisis. It's absolutely everywhere. And under those circumstances, it's harder to advocate closing down all the banks.

Alex Blumberg

But I'm trying to understand. What is the difficulty? Is it simply you need somebody to sell the assets to, and if you're taking over the largest banks in the country, like there's nobody to sell assets to? Is that what it is?

David Beim

Yeah. You can sell one bank. I'm sure you could put some buyers together. There's private equity funds and others who could, I'm sure, be found to buy one bank. But to buy the banking system of the globe is sort of a tall order.

Adam Davidson

There's another practical challenge to taking over all of our insolvent banks. The government might just not have enough people to do it. The one time the FDIC actually fully nationalized a US bank-- which was Continental Illinois in 1984-- it took more than 100 government regulators. Citibank alone is 20 times bigger. And the banking system is far more complicated now than it was then. One expert told me we might be talking about thousands of people needed for each bank we take over.

A second problem, nationalizations are kind of like potato chips. It's hard to have just one. You'd have to come out with a plan for all of them, or all the big banks. And you'd probably have to do the whole thing in one day, at one time. Because if you just take over one big bank, people with money at the other banks will start worrying that their bank will be nationalized next. And that will cause investors to panic. And they'll just pull all their money out of the bank.

Alex Blumberg

Now to be fair, there's debate about these logistical arguments. Simon Johnson, the economists who worked at the IMF, says he heard very practical arguments against nationalization in every country he went into. And there are ways to deal with all of it: the timing, the staffing. He said it might be possible, for example, for the government to hold on to the banks for just a few hours before turning it back over to private investors.

Adam Davidson

And so when bankers like me tell Simon that there's all these practical reasons we can't do this in America, he has an answer.

Simon Johnson

I'm sure they're all sensible, Adam. But let me speak as if I were the IMF, acting on the behalf and with the support of the US government back in the 1990s. Adam, stop with the whining. You know it's got to be done. Just do it.

The longer you wait, the more you prevaricate, the more it's going to cost you. This is the US Government we're talking about. These people, when they get organized, when they get focused, they get things done. This is the greatest country ever on the face of the Earth. We have plenty of talent. There's no shortage of brainpower. Just do it.

Adam Davidson

Now, you might have noticed that the government is not doing either of these options. Instead, they're doing sort of halfway versions of both. They have not committed to buying up all the dollhouses and other toxic assets at something closer to their full price. But they have created a new trial program that allows the government to help subsidize private investors who, they hope, will buy a lot of these assets.

And when it comes to option two, the government is not forcing the banks to sell their assets or value them at what they could get on the market right now. The government is not taking over the banks. They're not nationalizing them. In fact, the government has gone out of its way to give banks money without taking control. They've given banks over $240 billion, including $45 billion to Citibank alone. But the government structured the deal in a special way, specifically designed so it was not a nationalization.

And this week, when Citibank's troubles got worse, the government had to go through these amazing contortions to help the bank without becoming its owner. Because the government-- and all of them, from President Bush and Henry Paulson to President Obama and Tim Geithner and Ben Bernanke-- they all say the same thing. They don't want the government owning banks.

Now Alex, I always think that there is another option. The government could just let the banking system sort things out on its own. If banks made bad bets, then they go out of business. It's not our problem.

Alex Blumberg

Well, the Federal Reserve Chairman, Ben Bernanke, dismissed this option when he told Congress in a private briefing that it actually is our problem. He was quoted as saying, "If we let the banking system fail, no one will talk about the Great Depression anymore, because this will be so much worse." So we need banks, which Columbia Business School professor David Beim says is why governments always protect them.

David Beim

The year 37, in ancient Rome, there was a bank run. They had a very sophisticated banking system. And there was a run on those banks in AD 37. Some number of ships didn't come in with their cargo or something happened. And the emperor was out of Rome. And how did he deal with it? He did just what Ben Bernanke would do. He came galloping back into Rome with bags full of coin and distributed them to the banks. It's been happening as long as there have been banks. Governments must protect banks.

Adam Davidson

So if the government won't let these banks fail, and also won't take them over, it means that Citibank, Bank of America, throw in JP Morgan Chase, and three or four others, they have us over a barrel. We can't let them just fail. And it's going to cost us, one way or another, to keep them alive. And this sucks. I feel that. You feel that. Congress definitely feels that.

Alex Blumberg

Or at least, constituents are communicating those feelings to Congress. And this frustration leads to a lot of lashing out about almost exactly the wrong thing. Here's Massachusetts Congressman Mike Capuano yelling at the banks.

Mike Capuano

Start loaning the money that we gave you. Get it on the street.

Alex Blumberg

This might be a reasonable expectation for healthy banks. But for insolvent banks, it can be a disaster. And the reason all goes back to our balance sheet. When a bank is insolvent, it doesn't have the capital to cover its losses. In that situation, banks would actually be doing the right thing by keeping the bailout money that we're giving them. They need to hold on to their capital. And that's how they fix their balance sheets. If they loaned the money away, they'd be returning to the situation we are trying to rescue them from.

In other words, saving the banking system means that the banks that are worse off should loan less, not more. But beyond the balance sheet, David Beim has a much more profound reason why banks shouldn't lend. He shows me something on his computer.

David Beim

OK. So here is a picture. OK. This is a graphic.

Alex Blumberg

We're in his office. And we're looking at a graph, which is basically a measure of how much debt we, the citizens of America, are in, how much we all owe on our mortgages and credit cards and auto loans, compared to the economy as a whole, the GDP. And for most of history, the amount we, as Americans, owed was a lot smaller than the economy as a whole. This ratio, household debt to GDP, bounces along between 30% and 50% for most of the '30s, '40s, '50s, '60s, '70s. It breaks through 50% in the '80s. And then--

David Beim

From 2000 to 2008 it just goes-- it like almost a hockey stick. It goes dramatically upward.

Alex Blumberg

Like a rocket.

David Beim

It hits 100% of GDP. That is to say, currently, consumers owe $13 trillion when the GDP is $13 trillion. That's a 100% of GDP owed by individuals. That is a ton.

Alex Blumberg

And I'm going to ask you a leading question, because I'm looking at the graph right now. Tell me, professor, has there ever been a time in history when we've owed that much before?

David Beim

Why, I'm glad you asked me that. And guess what? The earlier peak, way off on the left part of the chart, is 100% of GDP in 1929. This is a map of twin peaks, one in 1929, one in 2007.

Alex Blumberg

Does that chart scare you?

David Beim

Yes. That chart is the most striking piece of evidence that I have that what is happening to us is something that goes way beyond toxic assets in banks. It's something that has little to do with the mechanics of mortgage securitization or ethics on Wall Street or anything else. It says the problem is us. The problem is not the banks, greedy though they may be, overpaid though they may be. The problem is us. We have over borrowed. We've been living very high on the hog. Our standard of living has been rising dramatically in the last 25 years. And we have been borrowing much of the money needed to make that prosperity happen.

Alex Blumberg

And so when you see Congress sort of saying, like, we need to make sure that there are strings attached to this money. We need to make sure that the banks are lending it out. That doesn't make any sense.

David Beim

It makes not only no sense, it makes reverse sense. It's nonsense, because what the banks have done is already lend too much. The name of this problem is too much debt. I really think that's the heart of what's wrong with us, is that we have over borrowed. And we've done that over many, many decades. And now, it's reached just an unbearable peak where people, on average, cannot repay the debts they've got. In the face of that, it is no solution to try and lend more.

Adam Davidson

All right. So, Alex, our little radio drama is over. We've laughed a little.

Alex Blumberg

Cried a little.

Adam Davidson

And we hope now that you will be able to understand the news.

Alex Blumberg

Now, let's just talk here, at the end, about what the government is actually doing this week.

Adam Davidson

It's been a pretty dramatic week. On Wednesday, the government revealed the details of its plan to save the banks. Now remember, we said that there are people out there who are saying the government has to act quickly to acknowledge the problems on bank balance sheets, declare insolvent banks insolvent, and step in aggressively to fix it all. One person who believes that, Simon Johnson, that former IMF official.

Simon Johnson

Yeah. I think there's a level of deceit here. Right? On the part of the banks. And I think the government is going along with it far too much. One of my colleagues nicely articulates what should be the principle now, which is no new lies. Right? The balance sheet at these banks is, as far as we know, a huge lie. Right? They don't want to show you and tell themselves what this stuff is really worth. And we're saying, deal with it now. Deal with it seriously. Confront the problems of the banking system openly. Or there will be hell to pay.

Adam Davidson

Simon Johnson says, every day we delay taking over insolvent banks, the economy gets weaker, and the solution gets more difficult. Well, according to the plan the Obama Administration revealed this week, they have a different view.

They think it's best to go about things a bit more deliberately. They announced on Wednesday, they are going to take two months to figure out how healthy the banks are-- that's the stress test you've heard a lot about-- and another six months to give some money to the banks that need it. And they've said to the media and to Congress that they're pretty sure they know what those stress tests are going to find: that America's biggest banks are healthy. The government will never need to take them over.

Alex Blumberg

In other words, given a choice between Simon's option, a scary and unprecedented, for this country at least, takeover of the nation's largest banks and much smaller measures where they keep the banks afloat, don't challenge them too much on the truthfulness of their balance sheets, and hope that, in time, things will sort themselves out, they're going with time.

But their public statements did leave them plenty of wiggle room. And of course, if they were planning to take over the banking system, they wouldn't announce it beforehand. They'd probably say exactly what they're saying right now, at least until they got everything set up, until they hired enough people, put all their plans in order. And then, one Friday evening, they'd make an announcement and nationalize the banks over the weekend.

Ira Glass

Alex Blumberg and Adam Davidson. In addition to their radio jobs, they do a blog and a podcast three times a week, where they explain the latest economic news in normal language that anybody can understand. This is the Planet Money podcast. It's at npr.org/money.

Coming up, after the break, we go on a field trip to visit a toxic asset in its natural environment, which in this case, turns out to be suburban New Jersey. That's in a minute, from Chicago Public Radio and Public Radio International, when our program continues.

It's This American Life. I'm Ira Glass. We've arrived at ACT 2 of our show.

Act Two. Clean Up Crew.

Lisa Chow

The first time I meet the guys who actually want more toxic assets in their lives is in a diner in New Jersey. Raj Bhatia is sitting at a corner booth with two other guys.

Raj Bhatia

My fellow Ivy League MBAs think I'm nuts because I'm going to get dirty. I'm going to have to get dirty now, you know?

Lisa Chow

Raj graduated from Columbia Business School in the mid '90s. And for years, he ran a hedge fund. And by getting dirty he means he's actually going to be getting out in the world, instead of sitting behind a desk. He's convinced he can make money buying home mortgages that aren't being paid back. Raj has teamed up with Albert Behin to buy pools of these mortgages.

Albert Behin

And we got together and basically said, you know, there's going to be some tremendous opportunities in buying some of this residential debt that I basically helped create over the past six, seven, eight years.

Lisa Chow

Albert started selling mortgages in 2000, just as housing prices began to skyrocket, and saw a lot of the abuses and terrible lending practices. He steered clear of most of that. And now, as those mortgages are starting to go bad, Albert and Raj are looking to buy them up at a discount. And they're meeting in diners like these with potential investors like this guy, Benek Oster, who's made millions in finance over the years.

Benek Oster

Hypothetically, I've got $5 million I'd like to put in. How many loans are you getting for $5 million in this--

Albert Behin

I'm going to make it-- No, I'm going to make it very easy for you. Average loan, figure $300,000 to $350,000. Figure one third of the price of that is one third--

Lisa Chow

I'm in a car with Raj, Albert, and This American Life producer Alex Blumberg. We're driving to a town in New Jersey called Wayne. The business pitch at the diner worked. Albert and Raj have a couple investors at this point. And they're getting ready to buy some mortgages.

Here's how it works. Banks have given lots and lots of mortgages to people who have stopped paying. To get them off their books, the banks have sold them at huge discounts. And they do it in massive numbers, thousands of mortgages at a time, to hedge funds and other large investment funds.

These funds are sometimes called vulture funds. They don't actually want to keep these mortgages. They just want to buy from the banks low, mark up the price a little, and sell to guys like Albert and Raj for a profit, which is why we're on this trip. Albert and Raj are thinking of buying the mortgages for 40 houses from one of these funds, all homes in New Jersey. And they want to go see what they're buying. They've made more than a dozen of these trips so far to look at different homes. And sometimes it feels a little weird, like they're spying or something.

Albert Behin

I'll tell you a story. One of the first times Raj came out to see houses-- I've seen a couple-- I went out a couple times already. And we're just snapping a picture of the subject property. And Raj is like, there's a cop. I'm like, we're not doing anything wrong. We're just snapping a picture of a house. [LAUGHTER]

Alex Blumberg

So this is totally new for you then, Raj. Like, you're not--

Albert Behin

It's new for everybody though.

Raj Bhatia

Well, that's another good point. Nobody has done this. Yes, big funds have bought a lot of product. But to actually go home to home and reprice the mortgages and talk to homeowners, this is all very, very, very new.

Lisa Chow

Raj and Albert know certain things about this group of loans. They know that 90% of the houses are in foreclosure. They know the balances on all the mortgages. They know when the borrowers stopped making payments. They know what the borrowers claimed in income on their original loan documents. Although, they also know enough not to believe those numbers too strongly.

But there's lots of things the mortgage documents can't tell you. For instance, Albert and Raj don't even know if someone's living in the house they're about to go look at. New Jersey's unusually slow to kick someone out of a house. Even on loans that are 15 months delinquent, people can still be there, waiting to be evicted. And they want to know other things. How does the neighborhood feel? And so far, this neighborhood feels good.

Raj Bhatia

Nice neighborhood. You can imagine what this looks like in the summertime with all the canopy of trees. It's an established area. I really am impressed with this. I mean, this is a nice home.

Albert Behin

This is-- I would grow up and raise a family in this neighborhood. This is great.

Lisa Chow

And Albert notices another good sign.

Albert Behin

The thing we look for is there's really no for sale signs around, which is great. So there's not that much product out there in this neighborhood. This is great. I've not seen a for sale sign. You'll see one or two coming up I'm sure, but not yet.

Lisa Chow

Which means the market's not glutted. If they take over the house, they can sell it. And that's another thing they're doing, looking at how houses similar to the ones in their pool have sold recently. We drive up to one house on a corner that recently got bought. Albert pulls out a digital camera and takes a photo.

Albert Behin

OK. Run, run, run, go. No, I'm kidding.

Lisa Chow

Then, we drive around the corner, to the house whose mortgage Albert and Raj are looking to own.

Raj Bhatia

This is it right here. All right. That's it on the right hand side.

Lisa Chow

Raj parks the car. The house is a red, old style colonial on a suburban street. Albert notices that there are little stickers in the window alerting firefighters that children live here. The lawn is well manicured. There's a fenced in backyard.

According to Albert's paperwork, the house's appraised value, back in the fall of 2007, was $635,000. Now, it's down to $440,000, which is pretty bad if you consider that what they owe on the house is $475,000. They're underwater. They owe more than their house is worth. And they haven't made a mortgage payment in 16 months, since October of 2007. But you'd never know by looking at it.

Albert Behin

You can see that there's kids there. There's obviously kids there. This is a neighborhood where you grow up a family. There's a backyard. This house is generally in good condition. You can definitely tell that there's someone still lives here. You know, some of the houses no one lives in at all.

Lisa Chow

The loan documents don't tell you any of that. Albert and Raj say they're not actually allowed, by law, to talk to the people living here. But once they close the deal and take possession of the mortgage, they can.

And in fact, the better deal Raj and Albert get, the better it might be for the homeowner. Raj explains it this way. Say the mortgage is worth $400,000. But they get it at $200,000. They can approach the homeowner and say, we can cut you a new deal, rewrite your mortgage. And then, for the homeowner--

Raj Bhatia

The numbers are very different. Their monthly payments can go down from $1,300 to $500 a month. And we are making an incredibly good return on our money.

Alex Blumberg

And you can do that because you've bought it at such a discount.

Raj Bhatia

Yeah. It's really not that we're using creative rocket science finance. We've bought the mortgage at a reduction. And somebody has taken a hit on that. And we have the ability to restructure that mortgage now.

Lisa Chow

But Albert says so far, in their experience, even with this kind of reduction, 3/4 of the homeowners can't afford to make the payments. So Raj says there's a second option.

Raj Bhatia

If they absolutely can't do something, then you proceed with the foreclosure. And right now, we're in discussions to rent back the homes to the homeowners. Where they've lived there. They stay there. But they're renting the home now. They don't own it. And lots of times, you would think that they would be resistant to that. They're not. It's really-- You know, it becomes almost a relief in a certain way. Let's pretend you--

Lisa Chow

To understand that relief, imagine the family in this house. They owe about $475,000 to the bank. Since the house is worth $440,000, even after they sold it, they'd still owe the bank $35,000. Albert and Raj would let them stay in the house, rent it at a reduced rent, and they'd wipe out all that debt.

For Albert and Raj, this is a business. They aren't doing this out of the kindness of their hearts. They want to make money. They're buying homes in the process of foreclosure. That process can draw out for months, which can be costly to Albert and Raj if the occupants aren't paying anything. So if Albert and Raj can't sell the house to the occupants for a lower price or get them to rent, they at least want them out. And in that situation, Raj has a simple pitch to the homeowners.

Raj Bhatia

Why don't we help you by writing you a check $5,000 to $7,000. Every home is different, depends on percentages. And we'll help you move. And you just give us the keys, and we'll take over the home.

Lisa Chow

Albert and Raj have already brokered a couple of pools of mortgages for other investors. Raj says the best case scenario is the home owners are willing to talk to them and renegotiate the loan.

Raj Bhatia

Worst case scenario really isn't worst case. It's that we're not getting any communication from the homeowner. We try to call. We try to send letters. We really haven't encountered, you know, a homeowner coming out with a shotgun saying get off my property.

Alex Blumberg

And see, but it strikes me, looking at what you guys are doing right now-- So if this works, you buy this pool. You get the house price to what it needs to be, basically. And you get the homeowner into either a mortgage that they can afford. Or they're able to sort of rent it. Or you pay them a little bit so they can move somewhere else. You know, it's not great. Nothing about this process is great. But it actually sounds like what we're talking about here is a free market solution to the problem. Right? Or not?

Raj Bhatia

That's exactly what it is.

Albert Behin

It is. But I don't think this alone either will-- I think that there's got to be some sort of government help along with this to--

Alex Blumberg

But why is that? I mean, you did this without government help. Or did you not?

Raj Bhatia

I'll tell you why. It's a simple answer. There's not enough of us out there to absorb what's out there. In other words, if we had unlimited funds, if Mortgage Strategies had unlimited funds--

Alex Blumberg

That's the name of your company.

Raj Bhatia

That's the name of the company. We could ramp up very quickly. And we could be putting away hundreds of millions of dollars of this type of product and working through it. I mean, we could do that. We would have a staff. And we'd be out there. And we'd do it. And that would, maybe, make a little bit of a dent here in the New York metro area. You've got to remember there's trillions of dollars of product out there right now.

Albert Behin

No, no there's even a bigger issue out here. What we're seeing is that a lot of banks don't want to get rid of this product, because I think they can't afford to get rid of it at the prices that the market is saying, this is market.

Alex Blumberg

Like in other words, if they sell you these pools of loans at the prices you need to be able to make money and actually do the work you're doing here, they'd go bankrupt.

Albert Behin

Yeah. They'd be insolvent. Yes. I think so. That's exactly what I'm saying.

Lisa Chow

Here's another problem. Albert and Raj, as hard as they're working and as complicated as it seems, are actually dealing with the simplest assets out there: simple home loans between a bank and a person. They're not dealing in the complex world of mortgage backed securities, where mortgages were bundled, sliced, and sold to thousands of investors, and where it's difficult to trace ownership and almost impossible to figure out what you're actually buying and who you're buying it from. They're not dealing in any of the exotic financial instruments like collateralized debt obligations. Essentially, Albert and Raj are buying the least toxic of the toxic assets on banks' balance sheets. Now, we just need someone to buy the rest.

Lisa Chow is a reporter for public radio station WNYC in New York.

Credits.

Simon Johnson

That sure is a nice global economy you've got there. Be a shame if anything happened to it.

Ira Glass

I'm Ira Glass. Back next week with more stories of This American Life.

Male Anouncer

PRI, Public Radio International.