By the third quarter of 2011, the top 19 banks that underwent the tests had added hundreds of billions in capital. A crucial measure of their capital is known as Tier 1, and it consists mostly of common stock, reserves and “retained earnings” — income that is not paid to shareholders but instead kept by the company to invest in the business. By the end of the third quarter, the top banks’ Tier 1 capital was up to about $740 billion. Using an average weighted to account for the different sizes of the banks, that’s 10.1 percent of their assets, compared with a low of 5.4 percent at the end of 2008.
As the banks built more capital, struggles erupted among various government bodies about when and how to let banks pay back TARP money. Most of the banks wanted to pay back the government as quickly as possible, mainly because the bailout money came with intensified oversight and potential restrictions on how much executives could pay themselves. And with the bailouts deeply unpopular with the public, the Treasury also pushed for the banks to pay back the money as quickly as possible so the government could claim the program was successful and hadn’t cost the taxpayers much.
But how should the banks replace the taxpayer money? Could they borrow to pull together the money, or should they be required to raise what’s known as common equity, the basic type of stock, whose holders absorb the first losses in the event of problems? Doing the latter would force banks to do the hard work of finding investors and amassing solid capital that could cushion them against economic blows.
The Fed led the process to answer this crucial question, with contributions from the FDIC, the Treasury and another major bank regulator, the Office of the Comptroller of the Currency (OCC).
In late 2009, regulators decided that the eight financial ins utions that hadn’t exited TARP immediately after the first stress test, including Bank of America, Wells Fargo and Citigroup, would be able to pay back every $2 of TARP money by issuing $1 in new common equity, according to a Sept. 29, 2011, report by the special inspector general of TARP.
The banks could raise the other dollars through other ways, such as borrowing.
Yet, almost as soon as they had decided on that standard, the Federal Reserve and OCC relaxed it for some of the most troubled big banks. The FDIC “was by far the most persistent in insisting that banks raise more common stock,” the report found.
The FDIC pushed repeatedly for the banks to adhere to the guidance known as the “2-for-1” provision.
Sheila Bair’s agency was particularly frustrated when the Fed and OCC eased their conditions for Bank of America, one of the most vulnerable banks.
Bair told the TARP special inspector general that “the argument [the Fed and OCC] used against us — which frustrated me to no end — is that [Bank of America] can’t use the 2-for-1 because they are not strong enough to raise 2-for-1.” She said: “If they are not strong enough, they shouldn’t have been exiting TARP.”
The Fed decided it could ignore the FDIC’s views.
On Nov. 19, 2009, an unnamed Federal Reserve governor stated that Bernanke’s position was that “we would go ahead without [FDIC] agreeing,” according to a previously unreported email from a draft version of the special inspector general’s report. And indeed, Bank of America fell more than $3 billion short of 2-for-1, raising $19.3 billion in equity to pay off the taxpayers’ $45 billion.
Since then, Bank of America has run into further troubles and been forced to sell assets and raise capital.
The Fed has taken pains to hide such tussles and compromises. The email describing Bernanke’s decision to override the FDIC, along with many others, was excised from the final draft of the special inspector general’s report. In a footnote in the final, published report, the special inspector general wrote that the Federal Reserve “strenuously objected to the inclusion of a significant amount of text” in earlier versions of the report, citing the need to keep communications with banks confidential.
Even though the special inspector general wrote that she “respectfully disagrees” with the Fed, she allowed the emails to be excised from the published report.
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