World War I. Food Administration electric signs, 7th Street and Pennsylvania Avenue NW, Washington DC
Ilargi: A lot of people write today about the new toxic assets plan Tim Geithner will presumably present on Monday (if he has time to read, he may reconsider), from Paul Krugman to James K. Galbraith to Yves Smith et al. Unfortunately, I think they all largely miss the point. When people conclude from what the New York Times writes today that the Treasury apparently thinks the $1 trillion+ in mortgage loans, securities and other paper that is about to be unleashed upon the American public, still has an X+1 value, they fail to see the main issue. I don't think the Treasury thinks anything of the kind.
Reading through what is available on the plan, I surmise that if the Treasury (or perhaps we should say the US government as a whole plus the Federal Reserve) was indeed of the opinion that the toxic paper had that X+1 value, it would never have defined the terms of the plan the way they stand (provided the NYT is correct), simply because there would not have been a need for such terms. Thet reason they are needed is that the 'mortgage-based papers' are not only not worth much of anything, they will plunge further along with real estate prices.
First of all, the Geithner and Summers team elects to completely bypass elected representatives. Instead of asking for Congressional funding, the boys plan to use FDIC and Federal Reserve funds. It’s not immediately clear how the $19 billion the FDIC has left will help, but then again, the agency is part of the Treasury. The FDIC will need a lot of additional money, that's for sure, wherver it comes from. Add to this the possibility that a major bank could go bust, and we're looking at high stakes wagers.
The 3-step plan:
Step 1: the FDIC "will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell."
Step 2: "the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money."
Step 3: "the Treasury plans to expand lending through the Term Asset-Backed Securities Loan Facility, a joint venture with the Federal Reserve. The goal of the plan is to leverage the dwindling resources of the Treasury Department’s bailout program with money from private investors to buy up as many of those toxic assets as possible and free the banks to resume more normal lending."
"the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets. The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent."
See, that's where my belief that the Treasury tries to find a "solution" starts to fly out the window. The private investors run no risk at all. Non-recourse loans provided by the FDIC/Treasury cover 85% of what the assets are bought for. Which means that if the assets are worth less than they are bought for, or lose -even more- value over time, the FDIC (re: you) will be stuck with the loss.
The line: "matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money..." is a tad unclear, but it may mean that the investors need to borrow only 42.5% on the purchase price. Since the loans are non-recourse, the difference may be trivial. However the details may pan out, the fact remains that the hedge funds and private equity tycoons run zero risk. At those odds, you would invest as well. But you don't get the invite. Your money, whether you like it or not, is injected at the part of the deal where 100% of the risk resides.
"The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that [..] Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent.
The main problem underlying basically the entire issue is that, as per the NYT, private investors won't pay more than 30 cents on the dollar for the "assets", while banks refuse to sell for less than 60 cents. First of all, I think that those numbers are very conservative. Even at 60 cents, many banks would run into huge problems, simply because the paper is at higher values on their sheets. And if you can show me substantial investors demand at 30 cents, I'd like to see that.
Another line from the NYT article clarifies reality a little:
”it is expected that the government will provide the overwhelming bulk of the money — possibly more than 95 percent — through loans or direct investments of taxpayer money”Look, the loans are non-recourse, which effectively means that 97% of the costs of buying up ticket slips from lost wagers at the racetrack are directly borne by the taxpayer. And it doesn't even stop there either. The idea behind the special vehicles to be set up by the FDIC is to securitize the bad assets just bought by the taxpayer, and sell them on to "the market". Which will insist it needs provisions and protections similar to what has just been provided in this very plan.
It could be more than $1 trillion. To make a dent in the banks’ troubles, it would have to be: their portfolio's of bad assets are far in excess of $1 trillion. Remember that they big three, JPMorgan, BofA and Citi have a combined derivatives book of some $170 trillion. Don't look, don't tell in its modern version.
Which leads to the next point: the plan won’t do anything to restore lending, if only because the toxic losses at the banks are way bigger than even this plan provides for. Other than that, there's of course the soaring unemployment and plummeting real estate prices, neither of which will be affected by the plan in any conceivable manner. All the money that flows into the financials' coffers will be used in either of two ways. First, to prop up balance sheets in order to shield the institution against future write-downs, Second, to engage in additional betting through derivatives trading, the best, nay, the only, way to make fast money, which is needed both for the firms at large and for the salaries and bonuses of their traders.
In short, it is no longer credible to maintain that Geithner and Summers are trying to find the solution that most benefits the American taxpayer. For a long time now, Washington politics have focused on a single goal: adding to the riches of the richest. There have been many different plans to achieve that goal in the past year, but none as daring and audacious as this one. As little as six months ago, it would have been inconceivable to present a plan that lets the taxpayer shoulder 97%-100% of the risk of a potentially multi-trillion dollar large scheme.
The Wall Street-Washington revolving door crowd is getting closer with each single step and each single plan to its ultimate goal: limitless access to the public coffers. The Geithner-Summers plan will be an 800-pound gorilla step forward for them, and a 150-ton blue whale step backward for everyone else.
I don't know what the president's role is in all this, whether he understands what's going on or not. There are no protests against Obama yet, people still 'believe'. Maybe that's why he was chosen to be elected, ahead of McCain or Hillary, because he was the only one whose popularity would provide enough time to finish the deal, to hammer in the final nail. If you read well, you see a virtually unlimited grip on the people's money, and out of the reach of Congress to boot. The plan doesn't just stink, it stinks on purpose.
Congressional Budget Office Projects 2009 Obama Deficit Will Reach $1.85 Trillion
President Barack Obama’s budget will generate bigger deficits than advertised every year for the next decade, including a $1.85 trillion shortfall this year, according to a new report. The nonpartisan Congressional Budget Office said today the deficit for the fiscal year ending Sept. 30 will be $100 billion larger than what the administration projected. CBO estimated next year’s deficit will reach $1.38 trillion, about $200 billion more than the White House projected. Between 2010 and 2019, CBO said, the government’s deficits will total $9.27 trillion, about $2.3 trillion more than the administration forecast.
As a share of the economy, CBO said, the deficit would total 13 percent this year, 10 percent next year and remain above 4 percent through 2019. The agency said government debt will eventually double to 82 percent of the nation’s gross domestic product by 2019 from 41 percent last year. The CBO figures will likely make it harder for Obama to gain approval of major items on his legislative agenda, including plans to expand health-care coverage and rein in greenhouse gas emissions. The CBO, Congress’s official scorekeeper, published today its assessment of how Obama’s budget request, released last month, would affect the government’s checkbook.
“This report should serve as the wake-up call this administration needs,” said House Minority Leader John Boehner, an Ohio Republican. “We simple cannot continue to mortgage our children and grandchildren’s future to pay for bigger and more costly government.” Senate Budget Committee Chairman Kent Conrad, a North Dakota Democrat, said “the reality is that we are going to have to make adjustments to the president’s budget if we want to keep the deficit on a downward trajectory.” He also said that “despite these new numbers, we will adopt a budget resolution that reflects the key priorities of the president and the nation.” White House Budget Director Peter Orszag emphasized that long-range budget projections are inherently uncertain because they rely on scores of assumptions about how the economy will perform over several years.
“There are huge numbers of technical assumptions that go into these overall calculations that for technical reasons can, and historically have, varied between different organizations,” Orszag said in a conference call with reporters. Orszag also said he expected lawmakers to make some changes to the administration’s budget. “It’s not the like the process would normally just have them take the budget, Xerox it and vote on it,” he said. White House Spokesman Robert Gibbs said “the president remains confident that we can pass the budget that he sent up, making the critical investments that we need.” The gloomier numbers are largely attributable to expectations by the CBO that the economy won’t grow as quickly as the White House predicts. Slower economic growth means less tax revenue pouring into the Treasury.
The agency said it expects the economy to contract this year by 3 percent before growing again in 2010 by 2.9 percent. Obama’s budget assumes the economy will shrink this year by 1.2 percent before growing next year by 3.2 percent. The CBO said the nation’s unemployment rate will increase to 9.4 percent by the end of this year before declining to 8.5 percent by the end of 2010. Last month, the unemployment rate jumped to 8.1 percent, the highest level in more than a quarter century. The estimate comes as lawmakers prepare their budget plans for the 2010 fiscal year, which begins Oct. 1. The House Budget Committee is slated to consider its tax-and-spending plan March 25, with floor action likely the following week. Lawmakers will use the CBO’s numbers for their budget blueprint.
Toxic Asset Plan Foresees Big Subsidies for Investors
The Treasury Department is expected to unveil early next week its long-delayed plan to buy as much as $1 trillion in troubled mortgages and related assets from financial institutions, according to people close to the talks. The plan is likely to offer generous subsidies, in the form of low-interest loans, to coax investors to form partnerships with the government to buy toxic assets from banks. To help protect taxpayers, who would pay for the bulk of the purchases, the plan calls for auctioning assets to the highest bidders. The uproar over the American International Group’s bonuses has not stopped the Obama administration from plowing ahead. The plan is not expected to impose restrictions on the executive pay of private investors or fund managers who participate.
The three-pronged approach is perhaps the most central component of President Obama’s plan to rescue the nation’s banking system from the money-losing assets weighing down bank balance sheets, crippling their ability to make new loans and deepening the recession. Industry analysts estimate that the nation’s banks are holding at least $2 trillion in troubled assets, mostly residential and commercial mortgages. The plan to be announced next week involves three separate approaches. In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell. In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.
In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Securities Loan Facility, a joint venture with the Federal Reserve. The goal of the plan is to leverage the dwindling resources of the Treasury Department’s bailout program with money from private investors to buy up as many of those toxic assets as possible and free the banks to resume more normal lending. But the details have been treacherously difficult, politically and financially, and some of the big decisions are the same as those that bedeviled the Treasury Department under President George W. Bush last year. Timothy F. Geithner, the Treasury secretary, provoked scathing criticism from investors in February by announcing the broad outlines of the plan without addressing the tough questions, like how the government planned to share the risk with investors or arrive at a fair price for the assets that would neither cheat taxpayers nor harm the banks.
Although the details of the F.D.I.C. part were still being completed on Friday, it is expected that the government will provide the overwhelming bulk of the money — possibly more than 95 percent — through loans or direct investments of taxpayer money. The hope is that such a generous taxpayer subsidy will attract private investors into the market and accelerate the recovery of the country’s banks. The key protection for taxpayers, according to people briefed on the plan, is that the private investors will bid in auctions against each other for the assets. As a result, administration officials contend, the government will be buying the troubled loans of the banks at a deep discount to their original face value.
Because the government can hold those mortgages as long as it wants, officials are betting the government will be repaid and that taxpayers may even earn a profit if the market value of the loans climbs in the years to come. To entice private investors like hedge funds and private equity firms to take part, the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets. The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent.
The government would receive interest payments on the money it lent to a partnership and it would share profits and losses on the equity portion of the investment with the private investors. Ever since last fall, industry analysts and policy makers in Washington have argued that the banking system’s biggest problem was the huge pile of troubled mortgages and other loans on bank balance sheets. Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60 cents on the dollar.
The result has been a paralyzing impasse. Banks, unwilling to sell their loans at fire-sale prices, have had less capital available to make new loans. Mortgage investors, unable to leverage their investments with borrowed money, have been unwilling to pay more than fire-sale prices. To break that impasse, the government’s crucial subsidy is meant to provide investors with the kind of low-cost financing that has been utterly unavailable in today’s credit markets. Administration officials refused to comment on the details of the plan, and refused to say what kind of interest rates the government would be charging investors. But government officials have long maintained that they could charge slightly more than the Treasury’s own cost of money and still offer rates far less than the private markets would demand.
To start the program, Treasury will ask banks, like Citigroup or JPMorgan Chase, to identify pools of residential and commercial real estate loans that they will be willing to sell through an auction. Private investors will bid against each other, setting a market price. No bank will be required to participate. Analysts worry whether the prices investors offer will be high enough to induce the banks to sell assets. The hope is that high valuations at the auctions will increase the price of assets that remain on the books of banks, bolstering confidence in the sector. Still, the Treasury Department’s biggest obstacle may be the current political environment in Washington, where Democratic lawmakers are furious about the pay packages and bonuses received by executives at companies being rescued by taxpayers.
Many investment executives said they were worried that participating in any bailout program would expose them to political wrath and potentially steep new restrictions on their own pay. Treasury and Fed officials have remained firmly against imposing any restrictions on pay for companies investing money in the rescue effort rather than receiving money from it. The plan comes as financial institutions continue to fail. Federal regulators Friday seized control of the two largest wholesale credit unions — U.S. Central Federal Credit Union and Western Corporate Federal Credit Union — which together had $57 billion in assets. They provide financing, check-clearing and other tasks for retail credit unions.
U.S. Sets Plan for Toxic Assets
The federal government will announce as soon as Monday a three-pronged plan to rid the financial system of toxic assets, betting that investors will be attracted to the combination of discount prices and government assistance. But the framework, designed to expand existing programs and create new ones, relies heavily on participation from private-sector investors. They've been the target of a virulent anti-Wall Street backlash from Washington in the wake of the American International Group Inc. bonus furor. As a result, many investors have expressed concern about doing business with the government in this climate -- potentially casting a cloud over the program's prospects. The administration plans to contribute between $75 billion and $100 billion in new capital to the effort, although that amount could expand down the road.
The plan, which has been eagerly awaited by jittery investors, includes creating an entity, backed by the Federal Deposit Insurance Corp., to purchase and hold loans. In addition, the Treasury Department intends to expand a Federal Reserve facility to include older, so-called "legacy" assets. Currently, the program, known as the Term Asset-Backed Securities Loan Facility, or TALF, was set up to buy newly issued securities backing all manner of consumer and small-business loans. But some of the most toxic assets are securities created in 2005 and 2006, which the TALF will now be able to absorb. Finally, the government is moving ahead with plans, sketched out by Treasury Secretary Timothy Geithner last month, to establish public-private investment funds to purchase mortgage-backed and other securities. These funds would be run by private investment managers but be financed with a combination of private money and capital from the government, which would share in any profit or loss.
All told, the three efforts are designed to unglue markets that have seized up as investors have stood on the sidelines. One big problem is that many of these assets no longer trade, which means it's very hard to put a price on them. Banks are unwilling to sell at too low a price, and investors are unwilling to take the risk. The Treasury's hope is that introducing private investors will help create market prices. Earlier attempts to have the government set the prices foundered because too high a price would have hurt taxpayers and too low a price would have hurt banks. Private investors, by contrast, could set a market price because they are unlikely to overpay and banks are unlikely to undersell.
To target troubled securities, such as mortgage-backed securities, the government will create several investment funds. Treasury will act as a co-investor, in most cases contributing $1 for every $1 contributed by the private sector and sharing in the first-loss position. To target troubled loans, the government will create a Disposition Finance Program with the FDIC. In that case, the government will be a co-investor, but could also agree in some cases to contribute 80% of the financing, with the government putting up $4 for every $1 in private financing. As part of that program, the FDIC would provide guarantees against losses on a pool of loans that a bank wants to sell. The program could guarantee as much as $500 billion in loan investments.
To beef up the amount of government funding, the Treasury is relying on the Fed and the FDIC to provide backing for these programs. For example, under the newly launched TALF, the Fed provides inexpensive and low-risk financing for investors to buy loans backed by consumer credit. Whether these programs will work as anticipated depends in part on how Wall Street investors react to the AIG furor this week. Congress is moving to clamp down on anyone receiving financial aid by severely taxing bonus payments. More broadly, investors have become leery about signing on to government programs for fear Congress will abruptly change the rules. Hedge funds, for example, which stand to make sizable profits from participating, worry they won't be able to keep their gains if the mood swing further against Wall Street.
Bankers are already expressing anger at Congress's moves. In a letter to employees Friday, Kenneth Lewis, Bank of America Corp. Chief Executive, said that Congress's proposals to clamp down on bonuses "have the potential to damage the ability of the government to engineer a financial recovery." Several of the government's plans, he wrote, "depend on the private sector being willing to contract with the government. If investors or companies in the private sector believe that the rules can change quickly and indiscriminately, they will be unwilling to participate." Those sentiments dominated some discussions among representatives of the Managed Funds Association, the biggest hedge-fund lobbying group, during meetings in Washington this week. The Treasury is still discussing whether it can get around restrictions on executive compensation that were included in the stimulus bill. That provision was designed to hit any recipient of bailout funds and some investors worry that their participation in the toxic-asset program would subject them to those restrictions. The Fed's TALF program already has such an exception.
For Mr. Geithner, getting this plan right is paramount to confidence in his abilities as steward of the economy. His reputation has taken a hit this week as lawmakers demanded to know why he didn't do more to derail the AIG bonus payments. Earlier, Mr. Geithner's nomination was clouded by questions about his failure to pay personal taxes. His February announcement of the toxic-asset plan, which was shy on details, was also widely panned. The plan might be the administration's best chance to make a big impact on the financial crisis. With bailout fatigue running high, the chances of Congress proffering more funds beyond the $700 billion authorized last fall are close to zero in the short term, lawmakers say. The Treasury instead will likely have to rely on the Fed, FDIC and private investors.
TALF raises red flags for U.S. toxic-asset plan
The lack of big investor interest in the debut of the Federal Reserve's consumer lending program is heightening fears private capital will also shun the government's toxic-asset plan amid public outrage over outsized executive bonuses. The Fed's new program to resuscitate consumer credit, the Term Asset-Backed Securities Loan Facility, or TALF, received only $4.7 billion in requests for loans out of $200 billion on offer. What's more, big money stayed away. Applications came from just 19 hedge funds and firms that manage between $3 billion and $5 billion, fewer and smaller than expected. The lack of investor appetite could also be a problem for the U.S. Treasury's public-private investment fund plan, which will aim to buy up to $1 trillion in assets by leveraging taxpayer and investor capital with government loans. More details of the plan are expected to be announced in coming days.
"If populist furor over bonuses and related issues fades in coming days, TALF may yet achieve its potential," said Dino Kos, who ran the New York Federal Reserve Bank's markets desk before William Dudley, now the New York Fed's president, and is now at research firm Portales Partners. Many big private investors are getting cold feet over the government funding plans in the wake of the public and political outrage surrounding American International Group, fearing that an irate U.S. Congress is more likely than ever to change the rules of engagement -- possibly retroactively. "If that furor continues to rise, TALF and for that matter, the nascent private-public investment program will prove to be white elephants," Kos said.
On Thursday, the House overwhelmingly approved a near total tax on bonuses paid this year to employees of AIG and other firms that have accepted large amounts of federal bailout funds. Following the vote, President Barack Obama said: "Now this legislation moves to the Senate, and I look forward to receiving a final product that will serve as a strong signal to the executives who run these firms that such compensation will not be tolerated." But it could send a discouraging signal to investors. One high-level private equity investor who asked not to be named said private capital was more cautious and wary about investing in the Treasury public-private investment fund because of what has unfolded with AIG. Another private equity official said the government hasn't consulted much with the private-equity industry. That official cited concern that details of private equity firms' proposals and future returns could be made public.
The Treasury's public-private fund is the cornerstone of the Obama administration's plan to clear toxic mortgage assets from banks' books, freeing them to lend again. It is expected to include about $5 in government capital for every $1 in private capital and leverage those funds with government loans, likely arranged through the Federal Deposit Insurance Corp. The aim is to set benchmark prices for illiquid assets and jump-start a market for them, and make banks more attractive for private investment. But the plan needs investment from hedge funds and private equity firms to work. Addressing the concern among investors that the government could slap potentially onerous restrictions on compensation and curb profits after a deal has been struck, a senior White House official concurred that it is an issue that needs to be ironed out.
"I think one of the things we do need to do is create some certainty," said Christina Romer, head of the Council of Economic Advisers told Reuters Financial Television on Friday. Concerns about the lack of investor interest in TALF rippled through the U.S. stock market, sending major indexes down about 2 percent on Friday. The Dow Jones industrial average .DJI slipped 122.42 points, or 1.65 percent, to 7,278.38, while the Standard & Poor's 500 Index .SPX shed 15.50 points, or 1.98 percent, to 768.54. "The climate is rather treacherous as investors do not necessarily trust that the government will not change the rules or create retroactive measures -- particularly as it relates to clawbacks," said Greg Peters, head of global credit strategy at Morgan Stanley in New York. Potential investors in the public-private investment fund "worry about getting involved with the government and then having congress try to dictate how to run your business," Peters said.
Geithner's Crappy Bank Plan Coming Monday
Tim Geithner will finally roll out his banking fix on Monday. The plan still appears to be a public-private hodge-podge that most likely either won't work or will result in a huge giveaway to banks and hedge funds (or both). A brief review: The plan is designed to help banks get rid of assets that are worth less than the banks say they are worth (e.g., "bad assets."). The banks can't sell the bad assets for market prices, because then they'd have to take more massive writedowns, and taxpayers would have to fork over tens or hundreds of billions more to keep the banks on life support. The banks can't keep the bad assets, meanwhile, because then they'd stay zombie banks and have to hoard their capital to offset future writedowns.
The Geithner plan consists of three parts:
- A "bad bank" that the government will dump bad assets into (at taxpayer expense)
- An expansion of the Fed's asset purchasing facility to include legacy crap assets
- A public-private partnership in which the government will lend money to hedge funds and other private investors to buy crap assets.
So what's wrong with the plan? The same thing that has been wrong with every plan the Geithner-Paulson-Bernanke regime has rolled out since last September: The price the government is going to pay for the bad assets. Banks like Citigroup still insist that assets are worth, say, 80 cents on the dollar when the market will only pay, say, 20 cents for them. To induce Citigroup to sell the assets, therefore, the government has to pay something close to Citigroup's fantasy value of 80 cents. And to induce hedge funds to buy the assets, the government has to deliver the assets at the hedge funds' desired firesale value of 20 cents. In short, the government has to bridge the gap between bid and ask, which is wide enough to fly a 747 through. How will it do that?
In the Geithner plan, by subsidizing hedge-funds' purchases of the bad assets with cheap loans (allowing the hedge funds to pay more and get the same return) and, thereby, secretly bailing out the banks by paying more for the assets than they are worth. If Geithner is actually able to accomplish get crap assets off the banks' books (not a given, now that anti-Wall Street rage has hit a new peak--see Thursday's Populist Rage Tax), this will be another big bailout of banks or hedge funds or both. Depending on how big the giveaway is, the plan might succeed in removing a significant percentage of the bad assets without bankrupting the banks in the process. And this, in turn, might help accelerate the return of normal bank lending and, thus, help fix the economy. But only at huge additional expense to the taxpayer.
What would be a better plan? Seize the insolvent banks, write down the assets to market levels, and make the banks' bondholders pay for most of the losses by converting a percentage of the bonds to equity. Then sell off and/or re-privatize the banks, which will now be well-capitalized. This latter plan would wipe out shareholders and hurt bondholders--which is what the Treasury is trying desperately to avoid. It would also hurt the same taxpayers who are getting hosed in the Geithner plan--because bank bondholders are generally insurance companies, pension funds, and other companies that taxpapers have a stake in. It's still a better solution, though. It will fix the problem once and for all, it will likely cost taxpayers less, and it's the morally fair thing to do. And the bank equity and credit markets should recover quickly, once they see that the newly recapitalized banks are actually worth owning and lending money to.
James K. Galbraith Reponds to Geithner’s Toxic Asset Plan
I've just been reading the NYT report. The central Treasury assumption, at least for public consumption, seems to be that the underlying mortgage loans will largely pay off, so that if the PPIP buys and holds, at an above-present-market price governed by auction, the government's loan to finance the purchase will not go bad. Recovery rates on sub-prime residential mortgage-backed securities (RMBS) so far appear to belie this assumption. IndyMac lost $10.8 bn on a $15bn portfolio (and if you count the wipeout of equity, the total loss is about $12bn). That's an 80 percent loss. It's possible that recovery rates at other banks will be better, but how can we know? No one is examining the loan tapes.
The NYT article points out that pools of RMBS can be sold for about 30 cents on the dollar now. But banks are unwilling to sell for less than 60 cents -- either because they really think the loans will experience only a 40 percent loss rate, or because they fear that acknowledging market value will put them into insolvency. Which it might very well. The way to find out who is right is to EXAMINE THE LOAN TAPES. An independent examination of the underlying loan tapes -- and comparison to the IndyMac portfolio -- would help determine whether these loans or derivatives based on them have any right to be marketed in an open securities market, and any serious prospect of being paid over time at rates approaching 60 cents on the dollar, rather than 30 cents or less.
Note that even a small loss of capital, relative to the purchase price, completely wipes out the interest earnings on the Treasury's loans, putting the government in a loss position and giving the banks a windfall. If I'm right and the mortgages are largely trash, then the Geithner plan is a Rube Goldberg device for shifting inevitable losses from the banks to the Treasury, preserving the big banks and their incumbent management in all their dysfunctional glory. The cost will be continued vast over-capacity in banking, and a consequent weakening of the remaining, smaller, better- managed banks who didn't participate in the garbage-loan frenzy. This will not achieve the stated goal, of bringing on new lending, for reasons already explained at length. It's all about not-measuring true asset quality at the big banks, permitting them to escape a clean audit, and therefore preserving them as institutions, while forcing the inevitable shrinkage of the financial sector to occur elsewhere. In short, the plan seems to me to be a very bad idea.
But the way to determine whether Geithner's and the banks' stated view of the toxic assets has any merit, is to demand an INDEPENDENT EXAMINATION OF THE LOAN TAPES, particularly looking to establish the prevalence of missing documents, misrepresentation, and fraud. This can be done by a sufficient sample. If the tapes look bad, it will be very difficult to justify the bank/Treasury view that the RMBS actually have value, which is somehow not realizable on the marketplace today because of "liquidity shortages" or "fire-sale conditions." Maybe there actually was a fire. In response to a question from Congressman Lloyd Doggett (D-TX) at Budget Committee on March 5, Geithner agreed to look into the possibility of EXAMINING THE LOAN TAPES. What response he gave the Congressman for the record is not yet known. Whether he has ordered any action is not yet known.
If I were a member of Congress, I would offer a resolution blocking Treasury from making the low-cost loans it expects to offer the PPIPs, until GAO or the FDIC has conducted an INDEPENDENT EXAMINATION OF THE LOAN TAPES underlying each class of securitized assets, and reported on the prevalence of missing documentation, misrepresentation, and signs of fraud. In the absence of a credible rating, this is the minimum due diligence that any private investor would require.
I hope what I'm driving at, here, is clear...
Despair over financial policy
by Paul Krugman
The Geithner plan has now been leaked in detail. It’s exactly the plan that was widely analyzed — and found wanting — a couple of weeks ago. The zombie ideas have won. The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.
To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad — I mean misunderstood — assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding. But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.
Or to put it another way, Treasury has decided that what we have is nothing but a confidence problem, which it proposes to cure by creating massive moral hazard. This plan will produce big gains for banks that didn’t actually need any help; it will, however, do little to reassure the public about banks that are seriously undercapitalized. And I fear that when the plan fails, as it almost surely will, the administration will have shot its bolt: it won’t be able to come back to Congress for a plan that might actually work. What an awful mess.
Calamitous day sees 3 banks, 2 credit unions seized
The pace of the ongoing credit crisis quickened significantly Friday when regulators seized three banks and placed two large corporate credit unions into conservatorship, citing a need to "stabilize the corporate credit union system." Banks in Colorado, Georgia and Kansas were closed by regulators, bringing the number of bank failures this year to 20, while the National Credit Union Administration Board seized corporate credit unions in California and Kansas that have a combined $57 billion in assets. Corporate credit unions are chartered to act as a sort of clearinghouse for the credit unions that serve consumers.
The Federal Deposit Insurance Corporation said that Stockbridge, Ga.-based FirstCity Bank was closed by regulators, adding that it will mail checks to FirstCity's insured depositors Monday morning. The failed bank's direct deposits from the federal government such as Social Security and veterans' payments will be transferred to SunTrust Banks Inc., the FDIC said. FirstCity had $297 million in assets and $278 million in deposits as of March 18, the FDIC reported. It also had roughly $778,000 in deposits that exceeded the federal deposit-insurance limit of $250,000.
FirstCity becomes the eighth Georgia-based bank to fail since the economy began sliding into crisis last August, according to FDIC data. The last Georgia bank to fail was Freedom Bank of Georgia on March 6, the regulator said. It estimated the cost of FirstCity's failure to the deposit insurance fund as roughly $100 million. The FDIC also said Colorado Springs-based Colorado National Bank was closed, and Texas-based Herring Bank will assume all of the failed bank's deposits. Colorado National had $123.5 million in assets as of Dec. 31, and $82.7 million in deposits, the FDIC said. It estimated the cost of Colorado National's failure to the deposit insurance fund as roughly $9 million.
Paola, Kan.-based Teambank also was closed by regulators, the FDIC said, while Missouri-based Great Southern Bank will assume its deposits. Teambank had $669.8 million in assets as of Dec. 31, and $492.8 million in deposits, the FDIC said. It estimated the cost of Teambank's failure to the deposit insurance fund as roughly $98 million. Meanwhile the National Credit Union Administration said Lenexa, Kan.-based U.S. Central Federal Credit Union and San Dimas, Calif.-based Western Corporate were placed into conservatorship "to protect retail credit union deposits and the interest of the National Credit Union Share Insurance Fund." U.S. Central has roughly $34 billion in assets and WesCorp has $23 billion in assets, the NCUA said. The NCUA said that service continues uninterrupted at both large corporate credit unions, and members are free to continue making deposits and accessing funds. "Credit unions that serve consumers remain very strong, with net worth exceeding 10 percent of assets, healthy growth in assets, membership, and loan portfolios despite the difficult economy," according to the regulator.
Save the Credit Unions!
The good news is that the two largest corporate credit unions -- cesspits of toxic waste which loaded up on mortgage-backed securities for no good reason and in violation of their raison d'etre -- have been "conserved" (taken over) by the NCUA, the credit-union equivalent of the FDIC, which has finally woken up to the fact that the current management at these shops is utterly incompetent and can't be trusted.
The bad news is that the NCUA is still committed to the disastrous decision it made back in January, to whack 56 basis points off the net worth of every federal credit union in the country, as well as reducing those credit unions' return on assets by 62 basis points, in an attempt to bail out these selfsame untrustworthy corporates.NCUA believes that the actions to conserve the two corporates, in tandem with established plans to enhance liquidity and generally stabilize the corporate network, represent the most cost effective and prudent alternative available to the credit union industry.
Today's decision is proof, if proof were needed (and frankly it wasn't) that the old plans -- which essentially involve member-owned and well-run retail credit unions being forced to bail out a bunch of sharks and gamblers -- were not only misguided but also woefully insufficient. I'm particularly mindful here of the small community development credit unions like the one I live next door to and sit on the board of, LES People's. We were always extremely assiduous in our loan underwriting, our asset quality is very high despite the fact that our membership has very low credit ratings, and our operating income has never been higher. Yet this proposal from the NCUA would force us to expend extremely precious and hard-fought-for capital in order to bail out the wastrels at the likes of WesCorp. At a stroke, it manages to redistribute capital from the people who really need it -- the poor members of local-community credit unions -- to faceless financial institutions which were lying to their regulator about their solvency all along.
Here are the facts about community development credit unions (CDCUs), and how they'll be affected by the proposed bailout:Last year, CDCUs nationally posted approximately $12.75 million in net income. Assuming all factors remain equal, a mandatory investment of 62 basis points translates into $28 million and would represent a net loss for CDCUs of $15.3 million in 2009, wiping out the modest gains made this year. The fallout from the economic downturn, coupled with the lack of capital, will result in a rapid reduction in community wealth, and for CDCUs, a crippling loss in earnings. We fear these challenges could permanently shutter dozens of CDCUs nationally.
Remember that all things are not going to remain equal: banks in general are suffering from rising delinquencies, and credit unions are no different. But after they've carefully built up capital cushions to protect themselves from exactly such an eventuality, it's unconscionable for their regulator to then turn around and remove that capital cushion just when they need it, saying that a bunch of speculators with more money than sense managed to gamble it away in the RMBS markets.
The big question in Washington these days is simple: "How can we get banks lending again?". Any sensible answer to that question must involve credit unions, which have proved themselves to be extremely responsible lenders. We should be bolstering their capital right now, rather than confiscating it. Now that the NCUA has woken up and realized that the corporate credit unions are beyond redemption, its board must rescind its extremely harmful decision to ask the real, consumer-facing credit unions to bail them out. At the very least, come up with some way of recapitalizing the small but vital credit unions which will be worst hit by this misguided policy. It's a nasty world out there, but they can be a hugely important force for good. If only you'll let them.
Treasury, Fed Reviewed AIG Bonus Info Months Ago
As Congress and the Obama Administration consider legislation to limit bonuses at American International Group , documents obtained by FOX Business show AIG bonuses and other compensation were reviewed and changed by officials at the Treasury Department and Federal Reserve in November, when the Treasury made its first investment of taxpayer funds -- $40 billion -- in the company. “Have your benefits team made any progress on the ‘soft’ issues, or heard anything from the fed [sic] on the bonus situation?” a Treasury official wrote in an e-mail on Nov. 1 about the transaction.
Despite their deliberations at the time, the Treasury and Fed officials, which were part of the Bush Administration, eventually decided to restrict compensation on just the top 75 company executives--and some of them may still have received hefty bonuses. The e-mails are included in thousands of Treasury documents obtained by FOX Business under a Freedom of Information Act lawsuit filed by the network for details of the department’s work on the $700 billion Troubled Asset Relief Program, or TARP. Many details from the documents were eliminated because Treasury argued they contained “privileged” information. Many of the Treasury e-mails sent in November discuss compensation at AIG, particularly for top executives, including compensation for CEO Edward Liddy, a former insurance-company executive who agreed to take the top job at the company in September.
“Do you/Treasury want to be involved in helping design/discuss Ed Liddy’s comp package?” one e-mail said on Nov 25. In November, AIG announced that Liddy would receive an annual base salary of $1 for 2008 and 2009. The rest of his compensation, the company said, would consist of “equity grants.” He also would not receive bonuses for 2008 and 2009, “although he may be eligible for a special bonus for extraordinary performance payable in 2010,” AIG said. It also said he would not be eligible for severance payments. In its negotiations with government officials in November, AIG submitted a “compensation proposal” to them, the e-mails indicate. The emails also indicate compensation provisions were changed several times. One e-mail, from a law firm that worked on the transaction, stated, “Please find attached our comments to the compensation-specific provisions…In a few instances, we have added comments to explain the thinking behind certain changes.”
In another e-mail, a person working on the transaction wrote, “We should get the term sheet to the company this morning. Because the comp section is still in real flux, we will take the content out of the draft to AIG.” The person added that the “cover e-mail” to the company “will contain the TARP…limitations plus additional restrictions we will get them in the very near term.” The person also wrote, “Comp people -- please keep that moving and send around a new draft of that section with an explanation for the recommendations.” Under terms of the revised bailout in November, the government applied “stringent” limitations on compensation on AIGs top five senior officers, as required under TARP legislation, according to a Treasury document. But Treasury took an additional step in compensation provisions, requiring limits on “golden parachute” severance packages and a freeze on the size of the annual bonus pool for the next top 70 company executives as well.
However, in the details of the term sheet on the assistance, officials specified that the annual bonus pools to the next 70 senior managers – called “senior partners” – for 2008 and 2009 “shall not exceed the average of the annual bonus pool paid to Senior Partners for 2006 and 2007. According to company financial documents filed with the Securities and Exchange Commission, as of November 12 last year, the balance in the senior partners plan was about $6 million. The term sheet also indicates senior partners were eligible for AIG’s “historical quarterly bonus program” as well. In their efforts to limit compensation at AIG, Treasury officials appeared concerned over accounting for it to a critical Congress. In one exchange of e-mails between David Nason, an assistant Treasury secretary, and Jennifer Zuccarelli, a public affairs officer, discussed televised testimony before Congress in December by Neel Kashkari, the Treasury official managing TARP:
Nason: How’s it going?
Zuccarelli: Bad. Serious questions, too, not “chump” type questions. They’re going to start to break Neel down soon, I’m getting worried he’s going to start snapping.
Nason: This AIG stuff is tough to watch.
Zuccarelli: They killed him on exec comp. He didn’t know answer.
Congress is considering legislation to limit bonuses at AIG after the company and Treasury disclosed it paid $165 million in 2008 bonuses last week to 400 employees at the AIG’s financial products unit, the division that nearly put the company into bankruptcy last year because it sold insurance coverage on risky securities held by other financial firms. The Treasury and Fed have committed more than $170 billion to AIG as it seeks to restructure and sell assets. The latest version of the bailout includes a Treasury commitment to invest another $30 billion in the company. AIG has not tapped the funds yet. Treasury officials say they are negotiating tougher limits on bonuses as a condition for dispensing it.
Obama says would not accept Geithner resignation
President Barack Obama said he would not accept Treasury Secretary Timothy Geithner's resignation if it was offered, according to excerpts from a television interview to be broadcast on Sunday. Obama said he would tell Geithner: "Sorry buddy you've still got the job." The Treasury secretary has been under fire from some lawmakers for his handling of the AIG bonus scandal. U.S. television network CBS, which secured the interview, said Obama told its "60 Minutes" program that neither he nor Geithner had mentioned his resignation from his Treasury post.
White House considers reforms for nonbank finance firms
Establishing a formal process for the U.S. government to unwind failing non-bank financial firms, like AIG, has moved to the top of the Obama administration's financial regulation reform agenda, sources familiar with discussions said late on Friday. While Treasury Secretary Timothy Geithner is expected to unveil the bare outlines of that agenda next week, sources told Reuters that President Barack Obama has put "unwind authority" on a fast track and wants urgent legislation from Congress. For now, that priority will sideline other initiatives, such as setting up a "systemic risk" regulator, taking steps to protect consumers and investors, and restructuring the U.S. financial oversight bureaucracy, the sources said.
The government's handling of the problems at Bear Stearns and the Lehman Brothers collapse in 2008, as well as the AIG affair, were severely complicated by the lack of a clear administrative procedure for dealing with such situations. The Federal Deposit Insurance Corp has a long-established process for bringing failing banks under government control, but there is no such procedure for non-bank institutions. FDIC Chairman Sheila Bair told a Senate committee on Thursday that her agency's process for dealing with troubled banks could also be applied to non-bank financial firms. At the same Senate committee hearing, U.S. Comptroller of the Currency John Dugan, also a bank regulator, said a national systemic risk regulator, whichever agency that may be, and the Treasury Department, not the FDIC, should be responsible for resolving the problems of failing non-bank firms.
In any case, an Obama administration official told Reuters this week that the president wants new tools to ensure that the government can deal with important non-bank institutions in danger of bankruptcy that pose risks to the financial system. The president will propose methods for putting such firms in conservatorship or receivership, as well as powers to control their operations and to sell or transfer parts of them to reduce risky positions, the official said. In addition, the government would be able to impose partial losses on various classes of creditors, the official said. New rules would allow for loans, asset purchases, equity investments or liability guarantees to help stabilize firms, although steps like these would be subject to close review.
The Treasury secretary would have the authority to act only after consultation with the president and upon recommendation of two-thirds of the Federal Reserve Board, the official said. The Treasury Department held private briefing sessions this week on the regulatory reform program. Lobbyists for consumer and investor advocacy groups attended on Thursday. On Friday, it was the turn of lobbyists for the financial industry. Participants in the sessions, who asked not to be named, said Treasury's presentations were vague. The participants each were given a few minutes to state their views while Treasury officials mostly listened, the participants said. Geithner is scheduled to testify to a House committee on Tuesday on AIG, along with Fed Chairman Ben Bernanke. On Thursday, Geithner is scheduled to testify on financial regulation reform before a House committee. He has been expected to unveil regulation reform proposals before then.
Washington Mutual sues FDIC for over $13 billion
Washington Mutual Inc, the failed U.S. savings and loan, has sued the Federal Deposit Insurance Corp for well over $13 billion in connection with the loss of its banking operations, which was acquired by JPMorgan Chase & Co. In a complaint filed with the U.S. District Court for the District of Columbia, the thrift's former parent accused the FDIC of having on January 23 made a "cryptic disallowance" of its claims, prompting the lawsuit.
It also accused the FDIC of agreeing to an unreasonably low price in arranging the a $1.9 billion sale of the banking business to JPMorgan on September 25, when regulators seized Washington Mutual and appointed the FDIC as receiver. JPMorgan did not buy the parent holding company, which filed for Chapter 11 bankruptcy protection the following day. In its complaint, Washington Mutual seeks to recover as much as $6.5 billion of capital contributions it said it made to its banking unit from December 2007 through the seizure.
Washington Mutual also seeks the return of $4 billion of trust preferred securities it said were wrongfully transferred to the banking unit, and said it may be entitled to as much as $3 billion of tax refunds. It also seeks damages of $177.1 million related to unpaid loans made to the banking unit. The company also made claims on several other matters that together could add to any recovery. Washington Mutual is seeking a jury trial.
In the January 23 letter, the FDIC said it disallowed Washington Mutual's claims because they lacked documentation or specificity, failed to state grounds to recover, appeared to be made against third parties, or had no legal basis. FDIC spokesman David Barr said the regulator does not comment on lawsuits. Seattle-based Washington Mutual failed after mortgage losses soared, and following a 10-day bank run when customers withdrew $16.7 billion of deposits. It had about $307 billion of assets, and remains by far the largest U.S. lender to fail. The parent is seeking to pay off creditors with amounts it recovers in the Chapter 11 proceedings.
Meet the New Quant
Over the years, the role of the federal reserve Board has steadily evolved. Once a cloistered tender of the money supply and manipulator of interest rates, its writ has quietly but inexorably expanded to that of de facto caretaker of the greater economy. As the agency's reach and influence have risen, so, too, has the status of its chairmen, most notably in Washington, and Wall Street. In his frequent obligatory close encounters with congress folk, a Fed chairman these days need only clear his throat in preparation for delivering anything from a financial forecast to an idle comment about the weather -- or, for that matter, to merely swallow some spittle -- to make lawmakers cock an eager ear. In Wall Street, of course, the faintest rumor of action, or lack of action, by the Fed can trigger a pyrotechnic reaction.
The legacy of a Fed chairman tends to be described, rightly or not, in a mot or two, encapsulating his approach to the job, some pivotal tactic during his tenure or a particularly telling phrase attributed to him. William McChesney Martin, for example, is invariably identified with for his vow to curb an eruption of animal spirits in the stock market by "taking away the punch bowl." Paul Volcker will always be known as the man who proved there was no such thing as a mission impossible by taming the horrendous outbreak of inflation of the 1970s and early '80s. Alan Greenspan has left several indelible imprints that are destined to commemorate his extended reign as head of the Fed: his unrivaled skill as bubble-enabler and what some inspired options aficionado dubbed "The Greenspan Put," in which Mr. G. implicitly pledged (or so the conventional Street wisdom interpreted it) to protect investors from the full consequences of their feckless follies.
Not to be outdone by his immediate predecessor, and perhaps with an eye not only on his legacy but possibly on keeping his job when his present term expires early next year, the current occupant of the high and mighty post, Ben Bernanke, last week went a long ways toward establishing his bona fides for entry into the Fed Chairman Hall of Fame, by promising some $1.1 trillion to get the credit markets -- and by extension, the economy -- breathing freely again. He thus became that rarity among Fed chiefs -- an admitted "quant," which stands for an adherent of quantitative easing -- and his conversion represents a quantum leap from the old-fogey notion favored by Fed chairmen of yore of rousing or restraining the economy by fiddling with fed-fund rates and kindred oblique monetary moves.
More specifically, this embrace of unorthodox policy which, if memory serves, Japan took a whirl at without much success as it sought to emerge from its near-perpetual recession, calls for Mr. Bernanke and his minions to gobble up long-term Treasury bonds ($300 billion worth for openers) and mortgage-backed securities, with the Fed's legendary printing press churning out the moola to pay for them. As the estimable John Gray, of the London School of Economics, wryly explains in the latest issue of the New York Review of Books, the point of quantitative easing is to furnish the means to "re-energize the economic activity so that society can in effect borrow itself out of debt." Why do we think there's something counterintuitive about the idea?
It beggars the imagination to suppose that a trillion bucks, atop trillions more that good old Uncle Sam has been shelling out, won't have an impact on the economy. Of course it will. But it's by no means clear that any fillip will be anything more than temporary, or prove a prelude to a broad economic recovery. And while the Fed's exertions may help lower interest rates still further (they're already rather minuscule), they're not, as covertly hoped, destined to spark another consumer-borrowing binge or reverse the gathering swing from spending to saving. As we've noted before, the "problem" is not so much the unavailability of credit, for all its tightness, but the reluctance of consumers to go deeper into hock for all sorts of reasons, most of them conspicuously sensible, from the worsening job drought to the foreclosure epidemic and plunging house prices -- which, all by themselves, to echo Bill Martin, have taken away the punch bowl.
Inevitably, Ben Bernanke's surprising and radical move -- however much it may have been designed to buck up the economy and reassure an antsy populace -- prompted suspicions that he and his cohorts were moved to such precipitous measures because they fear things are worse than they're letting on. Happily (and we sense the feeling is reciprocal), we're not intimate with anybody in the Fed's inner circle, so we can't say if that's true or not. We do think, however, that with the Treasury and the administration at the center of the big brouhaha over AIG's bonuses (what's the world coming to when a company can't reward its employees for their contribution to its failure?), Ben, who's nothing if not a team player, wasn't sorry to do what he could to divert attention from Messrs. Geithner and Obama. Bernanke & Co. also may have been anxious to launch their megabuck initiative before the rage of the masses reached a fever pitch that might endanger anything that smells even vaguely of a bailout.
Besides goosing Treasuries, the Fed managed to resurrect the specter of inflation, which had long been moldering in the grave. Or, as Euro-Pacific's Peter Schiff, in his captivatingly shrill manner, warned, "the Federal Reserve finally made clear what should have been obvious for some: The only weapon that the Fed is willing to use to fight the economic downturn is a continuing torrent of pure, undiluted inflation." And it won't knock your socks off to hear that Peter predicts all sorts of bad happenings as a result. The ferocity of Peter's tirade aside (and we should say, he has a commendable track record), Mr. Bernanke did achieve at least a minor miracle last week by temporarily diluting concerns about deflation and replacing them with worries about inflation. We can hardly wait for his next magic trick.
The immediate verdict of the stock market on the prospect of another trillion being added to the nearly $14 trillion or so that Washington has pledged in its so far unrewarded effort to turn the relentless recessionary tides was quite positive. But some second thoughts intruded, and by week's end equities had lost a lot of the steam that had powered them to an eye-popping performance in the early March going. That sparkling advance, starting on March 9 and ending seven sessions later, boosted the S&P 500 some 17%, which, according to Merrill Lynch, was the sharpest rise by that venerable index in a comparable stretch since 1939. For its part, the Dow's performance during that span wasn't exactly what you'd call shabby, either, climbing 14%. And the financials, reduced to a tribe of cowering skeletons, rose from the ignominious depths to which they'd fallen almost without letup, posting a 54% recovery, as dread fears of nationalization (whatever that is) abated.
The Fed's announcement, in other words, briefly added to what already had the makings of a stellar bear-market bounce. As you're probably tired of hearing (so put some cotton in your ears while we tell you this), bear-market rallies are pretty standard investment fare and can go on for a spell, tacking on as much as 20-25% in appreciation before petering out. How long will this one last? We'll hazard a couple of weeks, perhaps, but we confess we don't hold any strong conviction. Two things to keep in mind: The rush by shorts to cover that played a sizable part in fuelling the rally is pretty much history. And the market faces some punk news -- an- other truly ugly employment and a trickle that'll become a flow of depressing earnings releases -- as we head into April. On the other hand, it's spring and the sap in Wall Street as well as in human habitats tends to rise in spring. But most of that process may already have spent itself.
In many ways, the most noteworthy and certainly the most ominous impact the Fed announcement had last week was in the currency and commodities markets. The dollar turned tail and slid significantly lower, spooked by unease about that old devil inflation, and grumblings by our foreign creditors, China and Japan in particular, about the fresh threat of debasement of their stashes of dollar assets. That was accompanied by sharp gains in the price of oil and gold -- around 4% for both -- following disclosure of the Fed's move. Oil is valued in dollars and whenever the greenback turns even greener around the gills, it automatically causes a compensatory rise in petro prices. Any real rebound in oil stacks up as great for the producers, but bad news for just about everyone else. Even a whiff of inflation is elixir for gold, and the precious metal has been sniffing the odor of decaying paper money -- a distinct inflationary omen -- for months now. Political tension and economic misery are also great stimulants for gold and, sad to relate, there's no shortage of either just about anywhere on the globe.
E.U. Leaders: No More Spending on Stimulus for Now
European leaders brushed aside U.S. suggestions for more spending on economic stimulus plans Friday and said an urgent tightening of international financial rules was the best way to combat the worldwide economic crisis. "Colleges of supervisors" should be set up before the end of the year "for all major cross-border financial institutions," they declared, and rating agencies, hedge funds and other sophisticated investment vehicles should be brought under national and international scrutiny "regardless of the country of domicile." The anti-crisis platform, reached at a two-day European Union summit conference, suggested tough negotiations might lie ahead in the lead-up to a Group of 20 summit scheduled for April 2 in London. The gathering, President Obama's maiden outing in such a setting, has been billed as crucial in efforts to stem the financial crisis that broke out on Wall Street in September and since has undermined economies around the globe.
While embracing the calls for reform of the financial system, Obama has put the first priority on government spending to re-inject life into faltering economies in the United States and elsewhere. At home, he has pushed through an unprecedented $787 billion economic stimulus plan, and the Federal Reserve System announced Wednesday that it would put $1 trillion more into the U.S. credit system to get cash flowing to banks, businesses and consumers. But leaders of the 27 E.U. nations, in a communiqué, expressed confidence that they have done enough in Europe for now with stimulus packages totaling $510 billion, or 3.3 percent of the E.U.'s combined gross domestic product. Although deficit spending on stimulus packages was understandable given the severity of the crisis, they said, spending more would swell budget deficits to unacceptable levels under the group's Stability and Growth Pact and thus endanger the continent's long-term economic stability.
"Member states should return to their medium-term budgetary objectives as soon as possible, keeping pace with economic recovery and in conformity with the Stability and Growth Pact, thereby returning to positions consistent with sustainable public finances as soon as possible," the communiqué said. Avoiding excessive spending to combat the crisis has been a particular concern of Chancellor Angela Merkel of Germany, which fields Europe's largest economy. In comments Thursday before traveling to Brussels, she cautioned against letting the Group of 20 negotiations get bogged down in "artificial discussions" on the size of economic stimulus plans. "We should not be competing for the most unrealistic fiscal stimulus," she added in remarks to the German parliament. Merkel and French President Nicolas Sarkozy on Monday sent a joint letter to fellow European leaders laying out their goals for the G-20 summit and urging the Brussels gathering to put together a common E.U. platform to take to London. Their suggestions, it appeared, formed the basis for the program issued Friday.
"Europe's entire political leadership has chosen to seek ambitious results at the London summit," Sarkozy told reporters afterward, expressing pleasure at the outcome.
Since immediately after the crisis erupted, Sarkozy has been urging what he calls a "refounding" of the international financial system to make it more transparent and bring it under cross-national regulation. With his characteristic follow-me approach, he appears to have brought a majority of European leaders, including Merkel, over to his views. "The magnitude and the underlying causes of the ongoing global financial and economic crisis demonstrate the need to reshape macroeconomic global management and the regulatory framework for financial markets," they declared in the communiqué. "Prudential rules, crisis management arrangements and the supervisory framework must be strengthened at the national, European and global levels."
The European leaders said the International Monetary Fund, in collaboration with the Financial Stability Forum, should be strengthened to deal with such new responsibilities. They also said the major world economies should "very substantially" increase IMF resources to make more lending possible, particularly to poorer nations hit by the crisis, and offered a $100 billion in loan guarantees to get the movement started. Prime Minister Mirek Topolanek of the Czech Republic, which holds the E.U.'s revolving presidency, said European leaders urged strengthening IMF funding because, in their view, it should play a more active role in policing the world's financial exchanges. This should be high on the agenda of the G-20 meeting in London, he added. In addition to hedge funds, the main targets for more regulation, the European leaders said, should be credit rating agencies, derivative markets, offshore banking centers and remuneration schemes in financial institutions that encourage risk-taking.
These areas also were identified at a first G-20 summit in Washington last November as being in need of increased supervision. But the European leaders emphasized that the second summit in two weeks is the time to take concrete steps to bring them under scrutiny. This is necessary, French Prime Minister François Fillon said, not only to head off future crises but also to display an ability to get things done and restore confidence in the badly shaken financial system. Fillon has scheduled meetings in Washington on Monday with Vice President Biden and Lawrence Summers, head of Obama's National Economic Council, to argue the European case.
U.S. lawmakers ask Fed for muni lending facility
A group of Democratic lawmakers on Friday urged the U.S. Federal Reserve to create a temporary lending facility for the municipal bond market, saying it could help state and local governments access the capital markets. "This is a limited market with low underlying credit risk and it is likely the mere presence of a federal financing backstop alone would bring investors back and limit the need for the Federal Reserve to actually purchase bonds," the lawmakers said in a letter to Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner. House Financial Services Chairman Barney Frank and Representatives Paul Kanjorski, Michael Capuano and John Adler signed the letter, which said the Fed has the power to "provide immediate and dramatic assistance" through a federal financing backstop.
The lawmakers noted that issuance of municipal debt dropped toward the end of 2008 as interest rates soared. "While conditions have improved somewhat, it is still difficult for many state and local governments to access the market at attractive terms," the letter said, adding that borrowing for construction projects could spur creation of "desperately needed jobs." The municipal market for more than a year has been hit by the credit crunch, which stripped most bond insurers of their top ratings. That left a big chunk of munis to trade on their underlying ratings at a time when issuers' financial situations have deteriorated. This has led various state and local governments to plead for help from the federal government to ease their borrowing costs.
Citi, JPMorgan, BofA CEOs Push Back On Wall Street Bonus Tax
The chief executives of the nation's three largest banks on Friday pushed back against legislation that would heavily tax Wall Street bonuses.
Citigroup Inc. CEO Vikram Pandit and Bank of America Corp.'s Kenneth Lewis both issued memos to employees criticizing a tax that would make it hard to retain workers. And JPMorgan Chase & Co. CEO Jamie Dimon reassured his 200 top executives in a conference call that the bank is actively engaging Washington on the matter. The executives are responding to Washington's latest salvo against Wall Street bonuses. Outrage about massive payouts came to a head this week when it was learned that embattled insurer American International Group Inc. (AIG), which has received federal government funding to keep it operating, would pay $165 million in bonuses to employees of a unit that caused massive losses at the company.
The House passed legislation on Thursday to impose a 90% surtax on bonuses granted to employees with household income of more than $250,000 at companies that received at least $5 billion from the government's financial rescue program. The Senate is considering a similar plan that could be up for a vote as soon as next week. Eight banks - Citi, JPMorgan, BofA, Goldman Sachs Group Inc., Morgan Stanley, PNC Financial Services Group Inc. and U.S. Bancorp - have each received more than $5 billion from the government's Troubled Asset Relief Plan, known as TARP. Pandit said the proposals would affect "countless" people who would find it difficult to repay their bonuses. He noted that not all workers in the financial services field are to blame for the current economic morass, adding that the banking giant removed the people who are responsible for the company's distress and acted quickly to streamline its business.
"The work we have all done to try to stabilize the financial system and to get this economy moving again would be significantly set back if we lose our talented people because Congress imposes a special tax on financial services employees," Pandit wrote in a memo distributed to Citi's 300,000 employees. Dimon, whose bank is considered to be in the best shape out of the nation's biggest financial institutions, said retention remains important to JPMorgan and that the bank is actively engaging legislators in Washington. He encouraged them to call their local politicians to tell them how they feel, a spokesman for the company confirmed. At BofA, Lewis said his "first concern is about basic fairness to our associates." He said the Charlotte-based bank is "part of the solution for the financial crisis" through its acquisitions of distressed Countrywide Financial and Merrill Lynch.
"I also believe that these proposals have the potential to damage the ability of the government to engineer a financial recovery," he wrote. "Many of the government's plans depend on the private sector being willing to contract with the government. If investors or companies in the private sector believe that the rules can change quickly and indiscriminately, they will be unwilling to participate." Not everyone in Washington was in support of taxing bonuses. FDIC Chairman Sheila Bair, an outspoken critic of the nation's giant banks, on Friday raised concerns about moves to hamper bonus pay. In a speech in Phoenix, she said: " Some talent is better than others, and some people do need to be better compensated." In after-hours trading, Citigroup shares were unchanged from the Friday close of $2.62. BofA shares fell 2 cents to $6.17 and JPMorgan rose 10 cents to $ 23.25.
Actually, Banks Could Be Very Profitable In Q1
There's been deep skepticism over whether banks like Citigroup (C) and others should be believed when they say they're profitable again. An industry insider forwarded us the following back-of-the envelope analysis to explain that yes, in fact, the major banks may be quite profitable in Q1. The key lies in the government's effort to push down their cost of capital.
When Lloyd Blankfein says he will be profitable, few people are surprised. When Jamie Dimon casual mentions that JP Morgan is going to have a great year, the market barely reacts. But when Vikram Pandit and Ken Lewis make similar statements about profitability, the bears howled in disbelief and the bulls used the occasion as the foundation for a 10 day market rally.
Skeptical myself, I began to investigate how such a claim could be made, knowing full well that the price of making the claim without it ultimately being true would be a complete loss of any credibility still remaining at these institutions. What I found is astonishing and worth thinking about carefully for those still short the financials (or the markets in general). Financial Accounting Standards Board, the governing body on all things accounting, issued FAS 157 “Fair Value Measurements” to become effective for entities with fiscal years beginning after November 15, 2007. Banks must use the methodologies outlined in this statement to value their assets thereafter.
The statement separates assets into three groups, called Level I, II or III assets. Level I assets are stocks and other highly liquid assets for which valuation doesn’t warrant significant discussion. Level II assets are allowed some degree of freedom based on market inputs but the hard to value assets are pushed into the Level III bucket. With Level III assets, for which there is no market, the owner is allowed broad discretion in marking the assets to market. The favored methodology is a discounted cash flow analysis whereby the holder would estimate future cash flows from the asset and apply a discount rate to calculate the present value of the future payments. This discount rate is central in understanding why banks will indeed be profitable in 2009.
While the banks were operating using private capital, their cost of capital was likely in the 4% to 6% range. With the Federal Reserve driving rates down to near zero and providing, along with the Treasury, access to debt capital with very low interest rates, the cost of capital at this institution has come down considerably. Recall that most of these programs were started late in the banks Q4 reporting period and we have not had a full three months operating under the rates. Let us look at a simple example of what happens to the value of a 30 year interest only (IO) mortgage paying 6% when the holder’s discount rate changes from 6% to 3%.
Value at 6%: $100.00
Value at 3%: $158.80
So in our scenario, which doesn’t assume any impairment of the asset, the bank would realize a gain of $58.80 on the asset simply from a change in its cost of capital. While it would, eventually, realize this over time if the mortgage performed and its cost of funding remained the same over thirty years, the statement would allow a bank to recognize the gain immediately. This is, albeit, a simplistic example and the ultimate calculation would be more nuanced but you can see where this is headed.
With all the low cost funding provided by the Federal Reserve and Treasury, surely the banks will be profitable this year. It doesn’t take a lot to make even a distressed loan look profitable if you tweak a few assumptions. The problem comes when the mortgage holder stops making payments and the bank has foreclose and sell on the house. Now instead of a nice revenue stream to discount, the bank has a real asset that has a value that is less fungible and reality will set in.
Goldman Sachs Made BILLIONS Shorting AIG
In a nutshell - Goldman had bought billions in AIG CDS in the 2004 to 2006 timeframe. Whether this was predicated by their expectation that subprime would blow up, or their very early understanding just how bad things at AIG were, one will never know, especially not the SEC. However, one look at the CDS chart below shows what prevailing levels for AIG's CDS was in that time frame. As one can see, AIG 5 yr CDS traded in a range of 4 bps to 52.50 bps between October 1, 2004 (only goes back so far) and December 31, 2006. Indicatively 5 yr CDS closed yesterday at a comparable running spread equivalent of 1,942 bps.
Purchasing $10 billion in CDS (roughly in line with what Viniar claims happened) at a hypothetical average price of 25 bps (and realistically much less than that) and rolling that would imply that at today's AIG 5 yr CDS price of 1,942 bps, the company made roughly $4.7 billion in profit from shorting AIG alone! This would more than make up for the $2.5 billion collateral shortfall (out of $4.4 billion total) GS claims AIG had with Goldman Sachs... If AIG had filed for bankruptcy, and assuming Lehman is any indication, the P&L would have likely hit $6+ billion.
Implicitly, one could say GS was incentivized to see AIG fail. Does that maybe answer some of the questions of why GS allegedly pulled AIG's collateral and started the avalanche that lead to its bailout? However, a fine point - if AIG had really tanked none of the CDS would be collectible as the entire CDS market would have likely imploded... Thus demonstrating the need for a zombie bank system: not totally dead (systemic collapse) but barely alive to pocket a nice little CDS annuity from daily cash collateral posts as it leaks wider (and taxpayers foot the bill).
FBI Ramps Up Probes of Financial, Mortgage Fraud
The number of probes by the Federal Bureau of Investigation into corporate fraud and mortgage fraud is growing by the month. FBI Deputy Director John Pistole told a House panel Friday that the bureau has more than 2,000 open investigations into mortgage fraud as well as 566 corporate-fraud investigations. Mr. Pistole said 43 of those corporate-fraud investigations involve "matters directly related to the current financial crisis." Those numbers are all larger than those Mr. Pistole offered to a Senate committee last month.
Comparing Mr. Pistole's testimony Friday with the data he gave to the Senate Judiciary Committee in February, it appears the FBI has opened 36 new corporate-fraud investigations and 200 new mortgage-fraud investigations in recent weeks. Mr. Pistole said the FBI continues to experience "an exponential rise" in the number of fraud investigations it is conducting, "a trend we expect to continue." He said the FBI's investigations on corporate fraud and financial-institution failures are focused on accounting fraud, insider trading and financial-statement manipulation.
Mr. Pistole told the Senate Judiciary Committee last month that the FBI's investigations into the current financial crisis involve companies "that everybody knows about." Mr. Pistole said Friday that the growing number of fraud probes was straining the FBI's resources for investigating white-collar crime. President Barack Obama's 2010 budget proposal and various bills introduced in Congress call for additional financial resources for the Justice Department and the FBI to investigate fraud cases.
U.S. regulator probing "rampant Ponzimonium"
Hundreds of people in the United States are under investigation for financial scams, many involving Ponzi schemes, a U.S. regulator said on Friday, calling the phenomenon "rampant Ponzimonium." While none are as mammoth as disgraced financier Bernard Madoff's $65 billion fraud, multimillion-dollar "mini Madoffs" are proliferating from New York to Hawaii, the head of the Commodity Futures Trading Commission said. So far this year, the agency has uncovered 19 Ponzi schemes, which depend on an influx of new capital instead of investment profits to pay existing investors. That compares with just 13 for all of 2008.
"Because of the economy, people are seeking redemptions more than they ever have and that's making a lot of these scams go belly up," Bart Chilton, commissioner of the Washington-based Commodity Futures Trading Commission, said in a telephone interview. In the last month alone, his agency has pursued investment fraud in Pennsylvania, New York, North Carolina, Iowa, Idaho, Texas and Hawaii. Chilton called the problem "rampant Ponzimonium" and "Ponzipalooza" -- a play on the word "Lollapalooza," an American music festival featuring a long list of acts.
Many of the financial scams are small but grew fast to support lavish lifestyles, like the suspected $40 million, five-year Ponzi scheme that came to light last month when a North Carolina man, Bruce Kramer, committed suicide. Claiming he was an expert mathematician, Kramer is accused of persuading 79 people to invest in what he said was a foreign currency trading operation, Barki LLC. He promised monthly returns of at least 3 percent to 4 percent, the CFTC said. Instead, he funneled money into a Maserati sports car, a $1 million horse farm and artwork while holding "extravagant" parties, according to a CFTC complaint released on Wednesday.
As the economy soured, Kramer struggled to find new clients to keep the scheme going. In the days before his suicide, his investors demanded their money back and grew suspicious when they couldn't access their own funds, said Chilton. The Commodity Futures Trading Commission shares oversight of financial markets with the Securities and Exchange Commission, which also faces a swelling casebook of Ponzi schemes, including charges against Texas billionaire Allen Stanford, who is accused of bilking investors of $8.8 billion. The SEC has taken emergency action in 24 cases this year "to halt ongoing fraud," said SEC spokesman John Heine.
The FBI is also ramping up probes of financial wrongdoing. The agency has 43 corporate fraud cases under way directly related to the financial crisis, FBI Deputy Director John Pistole told a Congressional panel on Friday. The CFTC, which set up a task force last year to pursue foreign currency Ponzi schemes and fraud, discovered about $80 million invested in four Ponzi schemes this month. That followed 10 such schemes in February totaling about $1.46 billion, and about $450 million in such scams in January. Those accused of the scams used the money for cars, boats, clothing, jewelry, homes and ranches, said Chilton. One bought his own island in Belize in Central America, he added. "Some are easier to catch now because people are more vigilant than they have been," he said.
From Washington, an A.I.G. Flogging for the Masses
Can we all just calm down a little? Yes, the $165 million in bonuses handed out to executives in the financial products division of American International Group was infuriating. Truly, it was. As many others have noted, this is the same unit whose shenanigans came perilously close to bringing the world’s financial system to its knees. When the Federal Reserve chairman, Ben Bernanke, said recently that A.I.G.’s “irresponsible bets” had made him “more angry” than anything else about the financial crisis, he could have been speaking for most Americans. But death threats? “All the executives and their families should be executed with piano wire — my greatest hope,” wrote one person in an e-mail message to the company. Another suggested publishing a list of the “Yankee” bankers “so some good old southern boys can take care of them.”
Or how about those efforts to publicize names of individual executives who received bonuses — efforts championed by Attorney General Andrew Cuomo of New York and Barney Frank, chairman of the House Financial Services Committee. To what end? How does outing these executives fix skewed compensation incentives, which have created that unjustified sense of entitlement that pervades Wall Street? No, it’s mostly about using subpoena power to satisfy the public’s thirst for blood. (In light of the death threats, when Mr. Cuomo received the list of A.I.G. bonus recipients on Thursday, he promised to consider “individual security” and “privacy rights” in deciding whether to publicize the names.)
Then there was that awful Congressional hearing on Wednesday, in which A.I.G.’s newly installed chief executive, Edward Liddy, was forced to listen to one outraged member of Congress after another rail about bonuses — and obsess about when Treasury Secretary Timothy Geithner learned about them — while ignoring far more troubling problems surrounding the A.I.G. rescue. Oh, and let’s not forget the bill that was passed on Thursday by the House of Representatives. It would tax at a 90 percent rate bonus payments made to anyone who earned over $250,000 at any financial institution receiving significant bailout funds. Should it become law, it will affect tens of thousands of employees who had absolutely nothing to do with creating the crisis, and who are trying to help fix their companies.
Meanwhile, the real culprits — like Joseph J. Cassano, the former head of A.I.G.’s financial products division— are counting their money in “retirement.” Nobody on Capitol Hill seems much interested in getting that money back. (And the bill does nothing about bonuses that were paid before 2009, meaning that most of those egregious Merrill Lynch bonuses, paid at the end of last year, will not be touched.) By week’s end, I was more depressed about the financial crisis than I’ve been since last September. Back then, the issue was the disintegration of the financial system, as the Lehman bankruptcy set off a terrible chain reaction. Now I’m worried that the political response is making the crisis worse. The Obama administration appears to have lost its grip on Congress, while the Treasury Department always seems caught off guard by bad news.
And Congress, with its howls of rage, its chaotic, episodic reaction to the crisis, and its shameless playing to the crowds, is out of control. This week, the body politic ran off the rails. There are times when anger is cathartic. There are other times when anger makes a bad situation worse. “We need to stop committing economic arson,” Bert Ely, a banking consultant, said to me this week. That is what Congress committed: economic arson. How is the political reaction to the crisis making it worse? Let us count the ways.
IT IS DESTROYING VALUE
During his testimony on Wednesday, Mr. Liddy pointed out that much of the money the government turned over to A.I.G. was a loan, not a gift. The company’s goal, he kept saying, was to pay that money back. But how? Mr. Liddy’s plan is to sell off the healthy insurance units — or, failing that, give them to the government to sell when they can muster a good price. In other words, it is in the taxpayers’ best interest to position A.I.G. as a company with many profitable units, worth potentially billions, and one bad unit that needs to be unwound. Which, by the way, is the truth. But as Mr. Ely puts it, “the indiscriminate pounding that A.I.G. is taking is destroying the value of the company.” Potential buyers are wary. Customers are going elsewhere. Employees are looking to leave. Treating all of A.I.G. like Public Enemy No. 1 is a pretty dumb way for a majority shareholder to act when he hopes to sell the company for top dollar.
IT IS, UNFORTUNATELY, BESIDE THE POINT
Even on Wall Street this week, I didn’t hear anyone condoning the A.I.G. bonuses. They should never have been granted, and Mr. Liddy should have been tougher about renegotiating them. (A rich irony here is that any nonfinancial company in A.I.G.’s straits would be in bankruptcy, and contracts would have to be renegotiated. The fact that the government is afraid to force A.I.G. into bankruptcy, despite its crippled state, is the main reason Mr. Liddy felt he couldn’t try to redo the contracts.) But there is a much bigger issue that has barely been touched upon by Congress: the way tens of billions of dollars of taxpayers’ money has been funneled to A.I.G.’s counterparties — at 100 cents on the dollar. How can it possibly make sense that Goldman Sachs, Bank of America, Citigroup and every other company that bought credit-default swaps from A.I.G. should be made whole by the government? Why isn’t it forcing them to take a haircut?
What’s worse, some of those companies are foreign banks that used credit-default swaps to exploit a regulatory loophole. Should the United States taxpayer really be responsible for ensuring the safety of European banks that were taking advantage of European regulations? The person who has made this point most forcefully is Eliot Spitzer, of all people. In his column for Slate.com, he wrote: “Why did Goldman have to get back 100 cents on the dollar? Didn’t we already give Goldman a $25 billion cash infusion, and aren’t they sitting on more than $100 billion in cash?” Mr. Spitzer told me that while “there is a legitimate sense of outrage over the bonuses, the larger outrage should be the use of A.I.G. funding as a second bailout for the large investment houses.” Precisely.
IT IS DESTABILIZING
How can you run a company when the rules keep changing, when you have to worry about being second-guessed by Congress? Who can do business under those circumstances? Take, for instance, that new securitization program the government is trying to get off the ground, called the Term Asset-Backed Securities Loan Facility — or TALF. Although it is backed by large government loans, it requires people in the marketplace — Wall Street bankers! — to participate. This program could help revive the consumer credit market. But at this point, most Wall Street bankers would rather be attacked by wild dogs than take part. They fear that they’ll do something — make money perhaps? — that will arouse Congressional ire. Or that the rules will change. “The constant flip-flopping is terrible,” said Simon Johnson, a banking expert who teaches at the M.I.T. Sloan School of Business.
A.I.G. offers another good example. Not all the employees who face the possibility of having their bonuses taxed out from under them work for the evil financial products division. Many of them work in insurance divisions. Very few of them pull down million-dollar bonuses, and none of them brought A.I.G. to its knees. (And employees who bought the company’s stock are already hurting financially, having seen its value virtually wiped out.) They are the ones the company badly needs to keep if it hopes to sell those units at a healthy price. Taking away their bonuses — after they’ve already put the money in their bank accounts — hardly seems like the right way to motivate them. And demonizing them in Congressional hearings doesn’t help either. In previous columns, I have been an advocate of nationalizing big banks like Citigroup. But after watching Congress this week, I’m having second thoughts. If this is how Congress treats A.I.G., what would it do if it had a bank in its paws?
What the country really needs right now from Congress is facts instead of rhetoric. Instead of these “raise your hand if you took a private jet to get here” exercises of outraged populism, we need hearings that educate and illuminate. Hearings like the old Watergate hearings. Hearings in which knowledge is accumulated over time, and a record is established. Hearings that might actually help us get out of this crisis. It’s happened before. In 1932, Congress established the Pecora committee, named for its chief counsel, Ferdinand Pecora. It was an intense, two-year inquiry, and its findings — executives shorting their own company’s stock, for instance — shocked the country. It also led to the establishment of the Securities and Exchange Commission and other investor protections.
One person who has been calling for a new Pecora committee is Senator Richard Shelby of Alabama, a Republican and key member of the Senate Banking Committee. “As we restructure our regulatory system, we need to be thorough,” he told me. “We need to understand what caused it. We shouldn’t rush it.” Meanwhile, the House Financial Services Committee has scheduled a hearing on Tuesday featuring Mr. Bernanke and Mr. Geithner. The hearing has been called to find out only one thing: what did the two men know about the A.I.G. bonuses, and when did they know it? Is that Nero I hear fiddling?
The Dirty Dozen: 12 Firms Hit By 90% Bonus Tax
The new bonus tax passed by the House [Thursday] will apply a 90% rate to bonuses paid at firms that have taken over $5 billion from the TARP. While hundreds of banks and other companies have received capital injections from the TARP, only a dozen have taken enough to get hit by this restriction. If the bill becomes law, here are the 12 firms that would be hit.
• Citigroup (New York)
• JPMorgan Chase (New York)
• Wells Fargo & Co. (San Francisco)
• Bank of America Corp. (Charlotte, N.C.)
• Goldman Sachs Group Inc. (New York)
• Merrill Lynch & Co. (New York)
• Morgan Stanley (New York)
• PNC Financial Services Group Inc. (Pittsburgh)
• US Bancorp (Minneapolis)
• AIG (New York)
• General Motors (Detroit)
• GMAC Financial Service (New York)
In addition, Fannie Mae and Freddie Mac would be subject to the new tax.
Chrysler Asks Dealers to Lobby Government for Financing Help
Chrysler LLC, surviving with $4 billion in U.S. loans, has asked its dealers to send letters to government officials urging more aid for the automaker, said John Schenden, a member of Chrysler’s dealer advisory council. Chrysler faces a March 31 deadline to complete restructuring efforts in order to be granted $5 billion in additional loans. President Barack Obama’s automotive task force, led by Treasury Secretary Timothy Geithner and advised by Steven Rattner and Ronald Bloom, is weighing the Auburn Hills, Michigan-based automaker’s request for aid. “We’re sending notes to Geithner, Rattner and Bloom,” said Schenden, owner of Pro Chrysler Jeep in suburban Denver. “These are loans, it’s not a gift, and we are hoping that the government will do something to unfreeze some credit and get sales moving again.” Chrysler’s Rick Deneau confirmed the company is asking dealers to write letters of support to the government.
China backs discussion on dollar as reserve currency
China and other emerging nations back Russia's call for a discussion on how to replace the dollar as the world's primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday. Calls for a rethink of the dollar's status as world's sole benchmark currency come amid concerns about its long-term value as the U.S. Federal Reserve moved to pump more than a trillion dollars of new cash into the ailing economy late Wednesday.
Russia met representatives of China, India and Brazil ahead of the G20 finance ministers meeting last week, as the big emerging powers seek to up their influence on decisionmaking globally. Their first ever joint communique did not mention a new currency but the source said the issue was discussed. "They (China) did not formally put forward their position for the G20 summit but unofficially they had distributed their paper regarding the same ideas (the need for the new currency)," the source told Reuters, speaking on condition of anonymity. The source said the Chinese paper envisaged the International Monetary Fund's Special Drawing Rights (SDRs) being first assigned a role of a clearing currency on some transactions and then gradually becoming the main global reserve currency. "They said that the role of reserve currency should be given to SDR," the source said.
A U.N. panel of experts is also looking at using expanded SDRs, originally created by the International Monetary Fund in 1969, but now used mainly as an accounting unit within similar organisations as a new reserve currency instead of the dollar. Currency specialist Avinash Persaud, a member of the U.N. panel, told a Reuters Funds Summit on Wednesday that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket. The SDR and the old Ecu are essentially combinations of currencies, weighted to a constituent's economic clout, which can be valued against other currencies and against those inside the basket.
The Russian source said Moscow was aware that the emergence of the new global currency would not happen overnight and said its goal was to initiate a discussion about it at the G20 summit in London on April 2. The source said that India did not object to the discussion but was not prepared to take the lead. The source said South Korea and South Africa backed the idea, while developed nations were not "allergic" to it. "We are not waiting for everyone to say: 'How beautifully it has all been formulated, let's subscribe to it'," the source said. "The main idea is to start a discussion about it."
Russia holds about half of its reserves, the world's third-largest, in dollars, with the rest in euros and pounds. Prime Minister Vladimir Putin has called on reserve currency issuers to show more financial discipline. Finance Minister Alexei Kudrin told reporters on the sidelines of the G20 finance ministers meeting that it would take up to 30 years to create a new super-currency, suggesting there was no unity in Russia on the issue. President Dmitry Medvedev's top economic aide and G20 sherpa Arkady Dvorkovich is behind the Kremlin's G20 proposals, made public one day after Kudrin returned from England.
Nortel Wins Court Approval to Pay 8 Executives Bonuses During Bankruptcy
Nortel Networks Corp., once the largest telephone-equipment maker in North America, won U.S. and Canadian approvals to pay eight executives bonuses of as much as $7.3 million as the company tries to reorganize in bankruptcy. The potential bonuses are part of a larger plan to pay 92 managers more than $23 million, including the eight members of Nortel’s senior leadership team. Another 880 employees may be paid as much as $22 million under a plan to ensure key workers don’t leave.
Paying the managers more than the workers is necessary “because of the high level of expertise for these individuals,” company attorney James Bromley said. “We believe it is appropriate for the circumstances.” Toronto-based Nortel filed for bankruptcy in January in the U.S. and Canada after losing almost $7 billion since 2005. The company has said it will fire at least 5,000 workers this year as part of a plan to reorganize as a smaller business. U.S. Bankruptcy Judge Kevin Gross approved the plan today following a hearing in Wilmington, while Ontario Superior Court Judge Geoffrey Morawetz granted the same approval in Toronto over objections from about 67 Nortel workers who were fired and didn’t get severance pay.
“The board cannot properly function without the advice of its senior, experienced, leadership team,” Lyndon Barnes, a lawyer for the Nortel board, told the judge in Toronto. “This is an enormously complicated task.” Bromley said the $7.3 million is an estimate for how much the eight senior executives could make if the company achieves certain goals, including court approval for a plan of reorganization. About $5 million would be shared by five executives in the U.S. and the rest would go to three executives in Canada, Bromley said.
On March 6, the $22 million in retention payments for workers was approved, along with part of the proposal to pay managers a bonus. Full approval of the management plan was delayed in part because U.S. creditors sought financial projections for 2009 from the company before agreeing to the executive bonuses. Those projections have been delivered to the creditors, said Nortel’s Canadian lawyer Derrick Tay. In its Chapter 11 petition in Delaware, U.S. operating unit Nortel Networks Inc. said it had assets of $11.6 billion and debt of $11.8 billion as of Sept. 30.
Caisse de Depot Record Loss Will Cost Quebeckers $709 Million in Interest
Caisse de Depot et Placement du Quebec’s record loss in 2008 will cost the province of Quebec at least C$880 million ($709 million) in increased interest payments over the next two years, budget documents show. The government-owned pension manager’s loss will increase debt-servicing costs by C$285 million in fiscal 2009-2010 and C$595 million the following year, according to documents on the finance ministry’s Web site. The losses are the equivalent of about C$110 for each of Quebec’s 7.7 million residents.
Quebec Finance Minister Monique Jerome-Forget yesterday announced a deficit of C$7.7 billion over the next two years as the province battles a recession. Quebec’s gross debt will rise to C$160.3 billion by the end of fiscal 2010, from C$151.4 billion this year. “These negative returns hurt,” Yves St-Maurice, an economist with Desjardins Group, Quebec’s largest cooperative, said today in a telephone interview from Montreal. “If the Caisse’s returns don’t improve over the next few years, it’s going to cost Quebec even more.”
The province’s C$26.1 billion Retirement Plans Sinking Fund, which is used to pay civil-servant pensions, fell 25.6 percent last year. The fund is one of 25 depositors of the Caisse, which manages public pensions and various insurance funds for the provincial government. “The impact of the losses of 2008 on the RPSF’s income will be taken into account in the government’s balance sheet and results,” the documents say. The Caisse, which oversees C$120.1 billion as Canada’s largest pension fund manager, posted a record loss of C$39.8 billion, or 25 percent, last year on asset sales and writedowns tied to insolvent Canadian commercial paper. Former Chief Executive officer Henri-Paul Rousseau, who quit in May, said March 9 he wasn’t responsible for the fund manager’s poor showing.
The sinking fund, which needs to generate an annual return of 7 percent to be able to cover pension payouts, has 30 percent of its assets in bonds, 35.5 percent in stocks and the rest in other investments such as real estate. Nobody at the Quebec Finance Ministry was immediately available to comment about the budgetary impact of the Caisse’s losses when contacted by Bloomberg. Quebec hired former BCE Inc. head Michael Sabia as CEO of the Caisse on March 13. Sabia, 55, took over from Fernand Perreault, who had been interim chief executive since November.
RBS traders bought and hid toxic debt; collected bonuses
Billions of pounds of “toxic” sub-prime mortgages were bought by Royal Bank of Scotland traders in a spree that was not disclosed to the bank’s board.
Traders received multi-million pound bonuses after acquiring more than £30 billion of sub-prime assets during early 2007. Following these purchases the bank “didn’t stand a chance” of surviving unaided, one board director told this newspaper. The sub-prime assets are being blamed for causing the bank’s near collapse last year. Last month RBS posted a loss of £28 billion – the largest in British corporate history. Sir Fred Goodwin, the former chief executive of RBS, is this weekend under pressure to disclose what he knew of the sub-prime trading. He repeatedly put out statements to the City saying that RBS “don’t do sub-prime” even though traders were buying the sub-prime assets. RBS board directors suspect he may have acted negligently.
British taxpayers are being forced to underwrite the toxic loans bought undisclosed by executives working for RBS subsidiaries in America. In a series of interviews with RBS board directors and other senior insiders at the bank, The Daily Telegraph has discovered: Sir Fred did not tell the RBS board about the multi-billion pound decision to start buying sub-prime mortgages from other banks. RBS began buying up about £34 billion of sub-prime assets as US banks were offloading the mortgages. RBS was unable to sell the assets on as planned leading to the taxpayer bail-out. The system of annual cash bonuses encouraged bankers to buy up the assets with insufficient regard to the risks involved.
The Daily Telegraph has established that Sir Fred told the RBS directors’ board in 2006 that the bank would not be moving into sub-prime mortgage lending. However, two senior RBS directors have claimed that the information provided by Sir Fred did not reveal the whole picture. It is claimed that the former chief executive later disclosed that the bank had built up a multi-billion pound exposure to sub-prime mortgages during this period. Sir Fred is under pressure to disclose whether he sanctioned the hidden deals or whether he too was unaware of the strategy. Sub-prime assets carry high risk as they are based on loans to poorer people who often default on repayment. They have been widely blamed for starting the global credit crisis.
A former RBS board director claimed: “Sir Fred told the board that the bank was not exposed to sub-prime. Only a year later did he inform the other directors that the bank had, in fact, built up a multi-billion pound exposure.” Another board director claimed: “Citizens Bank [a subsidiary of RBS in America] went and bought up packages of sub-prime mortgages. They didn’t go to the board for approval. That was a mistake. “People at Citizens were severely reprimanded for their actions, the board did not know. As soon as we knew, it was disclosed but it’s pretty stupid in retrospect. I don’t know whether Fred knew about the sub-prime deals.” The disclosure raises serious questions over Sir Fred’s role in the decision-making process. The RBS board is legally responsible for scrutinising key decisions made by executives at the bank. If it is established that key information was not disclosed this could have legal consequences.
The Financial Services Authority is this weekend under pressure to launch a full investigation into the collapse of RBS. The SEC, the American regulator, has already launched an investigation into RBS’s involvement in the sub-prime market. Lawyers acting for the Government are also studying whether there are any grounds to recover Sir Fred’s controversial £17?million pension scheme on the basis of his role in the acquisition of sub-prime assets. Larry Fish, the chief executive of Citizens Bank, retired last April with a pension worth more than $2.2 million annually. Vince Cable, the Liberal Democrats’ Treasury spokesman, said last night: “It is very clear from the evidence that there was a major failure of corporate governance at RBS. “We need a proper investigation into whether negligence was involved in the decision to build up all these toxic assets. The lack of criminal investigation in this country compared to America is very striking.”
The Daily Telegraph has been told by several RBS executives that internal controls on the risks being taken by the bank were not adequate. The system of annual profit bonuses has been blamed for encouraging executives to behave recklessly. RBS was a medium-sized high street bank. However, over the past five years it embarked on a rapid expansion programme. Sir Fred, the group chief executive at the time, bought rival banks but also oversaw a major expansion in the activities of the investment banking division. During a board meeting in the summer of 2006, Sir Fred was asked by fellow directors whether the bank had any plans to move into the sub-prime market. He told the board that the bank would not move into sub-prime and that, as a result, “RBS is better placed than our competitors”. In the foreword to RBS’s 2006 annual report, published in April 2007, Sir Fred wrote: “Sound control of risk is fundamental to the Group’s business... Central to this is our long-standing aversion to sub-prime lending, wherever we do business.”
However, RBS insiders acknowledge that these statements may not have revealed the full picture. On April 13 2007, New Century Financial, one of America’s largest sub-prime lenders which was facing bankruptcy, disclosed in a Delaware court that it had agreed to sell 2,000 existing sub-prime mortgages to a unit of RBS – RBS Greenwich Capital Financial Products. Another major US sub-prime lender, Fremont General Corporation, had a $1?billion line of credit extended to it by RBS around this time. Citizens Bank, another RBS subsidiary, had also begun buying up existing sub-prime mortgages from other banks from late 2006 – allegedly without seeking approval from the RBS board. It is claimed that it was not until the summer of 2007, as Northern Rock was facing meltdown, that Sir Fred told the board that RBS had, in fact, built up a substantial sub-prime exposure. Its investment banking division had some £20?billion of sub-prime assets. Citizens Bank had about £14 billion worth of sub-prime exposure.
By the end of 2007, RBS was beginning to announce losses – or write-downs – on the value of sub-prime assets that had been secretly amassed. The majority of the bank is now owned by the Government. Last night, Sir Fred declined to comment as he is bound by a confidentiality agreement. A spokesman for RBS said: “The reality is that, like many others, RBS was heavily exposed to problems in sub prime markets via its own operations and those inherited from ABN AMRO. This is despite the fact that we did not engage directly in sub prime issuing. The Board was in possession of full information and the details provided to the market in all financial reporting reflected the Group’s honestly held opinion at the time.’’
The Big Takeover
The global economic crisis isn't about money - it's about power. How Wall Street insiders are using the bailout to stage a revolution
It's over — we're officially, royally fucked. no empire can survive being rendered a permanent laughingstock, which is what happened as of a few weeks ago, when the buffoons who have been running things in this country finally went one step too far. It happened when Treasury Secretary Timothy Geithner was forced to admit that he was once again going to have to stuff billions of taxpayer dollars into a dying insurance giant called AIG, itself a profound symbol of our national decline — a corporation that got rich insuring the concrete and steel of American industry in the country's heyday, only to destroy itself chasing phantom fortunes at the Wall Street card tables, like a dissolute nobleman gambling away the family estate in the waning days of the British Empire.
The latest bailout came as AIG admitted to having just posted the largest quarterly loss in American corporate history — some $61.7 billion. In the final three months of last year, the company lost more than $27 million every hour. That's $465,000 a minute, a yearly income for a median American household every six seconds, roughly $7,750 a second. And all this happened at the end of eight straight years that America devoted to frantically chasing the shadow of a terrorist threat to no avail, eight years spent stopping every citizen at every airport to search every purse, bag, crotch and briefcase for juice boxes and explosive tubes of toothpaste. Yet in the end, our government had no mechanism for searching the balance sheets of companies that held life-or-death power over our society and was unable to spot holes in the national economy the size of Libya (whose entire GDP last year was smaller than AIG's 2008 losses).
So it's time to admit it: We're fools, protagonists in a kind of gruesome comedy about the marriage of greed and stupidity. And the worst part about it is that we're still in denial — we still think this is some kind of unfortunate accident, not something that was created by the group of psychopaths on Wall Street whom we allowed to gang-rape the American Dream. When Geithner announced the new $30 billion bailout, the party line was that poor AIG was just a victim of a lot of shitty luck — bad year for business, you know, what with the financial crisis and all. Edward Liddy, the company's CEO, actually compared it to catching a cold: "The marketplace is a pretty crummy place to be right now," he said. "When the world catches pneumonia, we get it too." In a pathetic attempt at name-dropping, he even whined that AIG was being "consumed by the same issues that are driving house prices down and 401K statements down and Warren Buffet's investment portfolio down."
Liddy made AIG sound like an orphan begging in a soup line, hungry and sick from being left out in someone else's financial weather. He conveniently forgot to mention that AIG had spent more than a decade systematically scheming to evade U.S. and international regulators, or that one of the causes of its "pneumonia" was making colossal, world-sinking $500 billion bets with money it didn't have, in a toxic and completely unregulated derivatives market. Nor did anyone mention that when AIG finally got up from its seat at the Wall Street casino, broke and busted in the afterdawn light, it owed money all over town — and that a huge chunk of your taxpayer dollars in this particular bailout scam will be going to pay off the other high rollers at its table. Or that this was a casino unique among all casinos, one where middle-class taxpayers cover the bets of billionaires.
People are pissed off about this financial crisis, and about this bailout, but they're not pissed off enough. The reality is that the worldwide economic meltdown and the bailout that followed were together a kind of revolution, a coup d'état. They cemented and formalized a political trend that has been snowballing for decades: the gradual takeover of the government by a small class of connected insiders, who used money to control elections, buy influence and systematically weaken financial regulations. The crisis was the coup de grâce: Given virtually free rein over the economy, these same insiders first wrecked the financial world, then cunningly granted themselves nearly unlimited emergency powers to clean up their own mess. And so the gambling-addict leaders of companies like AIG end up not penniless and in jail, but with an Alien-style death grip on the Treasury and the Federal Reserve — "our partners in the government," as Liddy put it with a shockingly casual matter-of-factness after the most recent bailout.
The mistake most people make in looking at the financial crisis is thinking of it in terms of money, a habit that might lead you to look at the unfolding mess as a huge bonus-killing downer for the Wall Street class. But if you look at it in purely Machiavellian terms, what you see is a colossal power grab that threatens to turn the federal government into a kind of giant Enron — a huge, impenetrable black box filled with self-dealing insiders whose scheme is the securing of individual profits at the expense of an ocean of unwitting involuntary shareholders, previously known as taxpayers.
I. PATIENT ZERO
The best way to understand the financial crisis is to understand the meltdown at AIG. AIG is what happens when short, bald managers of otherwise boring financial bureaucracies start seeing Brad Pitt in the mirror. This is a company that built a giant fortune across more than a century by betting on safety-conscious policyholders — people who wear seat belts and build houses on high ground — and then blew it all in a year or two by turning their entire balance sheet over to a guy who acted like making huge bets with other people's money would make his dick bigger.
That guy — the Patient Zero of the global economic meltdown — was one Joseph Cassano, the head of a tiny, 400-person unit within the company called AIG Financial Products, or AIGFP. Cassano, a pudgy, balding Brooklyn College grad with beady eyes and way too much forehead, cut his teeth in the Eighties working for Mike Milken, the granddaddy of modern Wall Street debt alchemists. Milken, who pioneered the creative use of junk bonds, relied on messianic genius and a whole array of insider schemes to evade detection while wreaking financial disaster. Cassano, by contrast, was just a greedy little turd with a knack for selective accounting who ran his scam right out in the open, thanks to Washington's deregulation of the Wall Street casino. "It's all about the regulatory environment," says a government source involved with the AIG bailout. "These guys look for holes in the system, for ways they can do trades without government interference. Whatever is unregulated, all the action is going to pile into that."
The mess Cassano created had its roots in an investment boom fueled in part by a relatively new type of financial instrument called a collateralized-debt obligation. A CDO is like a box full of diced-up assets. They can be anything: mortgages, corporate loans, aircraft loans, credit-card loans, even other CDOs. So as X mortgage holder pays his bill, and Y corporate debtor pays his bill, and Z credit-card debtor pays his bill, money flows into the box. The key idea behind a CDO is that there will always be at least some money in the box, regardless of how dicey the individual assets inside it are. No matter how you look at a single unemployed ex-con trying to pay the note on a six-bedroom house, he looks like a bad investment. But dump his loan in a box with a smorgasbord of auto loans, credit-card debt, corporate bonds and other crap, and you can be reasonably sure that somebody is going to pay up. Say $100 is supposed to come into the box every month. Even in an apocalypse, when $90 in payments might default, you'll still get $10. What the inventors of the CDO did is divide up the box into groups of investors and put that $10 into its own level, or "tranche." They then convinced ratings agencies like Moody's and S&P to give that top tranche the highest AAA rating — meaning it has close to zero credit risk.
Suddenly, thanks to this financial seal of approval, banks had a way to turn their shittiest mortgages and other financial waste into investment-grade paper and sell them to institutional investors like pensions and insurance companies, which were forced by regulators to keep their portfolios as safe as possible. Because CDOs offered higher rates of return than truly safe products like Treasury bills, it was a win-win: Banks made a fortune selling CDOs, and big investors made much more holding them. The problem was, none of this was based on reality. "The banks knew they were selling crap," says a London-based trader from one of the bailed-out companies. To get AAA ratings, the CDOs relied not on their actual underlying assets but on crazy mathematical formulas that the banks cooked up to make the investments look safer than they really were. "They had some back room somewhere where a bunch of Indian guys who'd been doing nothing but math for God knows how many years would come up with some kind of model saying that this or that combination of debtors would only default once every 10,000 years," says one young trader who sold CDOs for a major investment bank. "It was nuts."
Now that even the crappiest mortgages could be sold to conservative investors, the CDOs spurred a massive explosion of irresponsible and predatory lending. In fact, there was such a crush to underwrite CDOs that it became hard to find enough subprime mortgages — read: enough unemployed meth dealers willing to buy million-dollar homes for no money down — to fill them all. As banks and investors of all kinds took on more and more in CDOs and similar instruments, they needed some way to hedge their massive bets — some kind of insurance policy, in case the housing bubble burst and all that debt went south at the same time. This was particularly true for investment banks, many of which got stuck holding or "warehousing" CDOs when they wrote more than they could sell. And that's were Joe Cassano came in.
Known for his boldness and arrogance, Cassano took over as chief of AIGFP in 2001. He was the favorite of Maurice "Hank" Greenberg, the head of AIG, who admired the younger man's hard-driving ways, even if neither he nor his successors fully understood exactly what it was that Cassano did. According to a source familiar with AIG's internal operations, Cassano basically told senior management, "You know insurance, I know investments, so you do what you do, and I'll do what I do — leave me alone." Given a free hand within the company, Cassano set out from his offices in London to sell a lucrative form of "insurance" to all those investors holding lots of CDOs. His tool of choice was another new financial instrument known as a credit-default swap, or CDS. The CDS was popularized by J.P. Morgan, in particular by a group of young, creative bankers who would later become known as the "Morgan Mafia," as many of them would go on to assume influential positions in the finance world. In 1994, in between booze and games of tennis at a resort in Boca Raton, Florida, the Morgan gang plotted a way to help boost the bank's returns. One of their goals was to find a way to lend more money, while working around regulations that required them to keep a set amount of cash in reserve to back those loans. What they came up with was an early version of the credit-default swap.
In its simplest form, a CDS is just a bet on an outcome. Say Bank A writes a million-dollar mortgage to the Pope for a town house in the West Village. Bank A wants to hedge its mortgage risk in case the Pope can't make his monthly payments, so it buys CDS protection from Bank B, wherein it agrees to pay Bank B a premium of $1,000 a month for five years. In return, Bank B agrees to pay Bank A the full million-dollar value of the Pope's mortgage if he defaults. In theory, Bank A is covered if the Pope goes on a meth binge and loses his job. When Morgan presented their plans for credit swaps to regulators in the late Nineties, they argued that if they bought CDS protection for enough of the investments in their portfolio, they had effectively moved the risk off their books. Therefore, they argued, they should be allowed to lend more, without keeping more cash in reserve. A whole host of regulators — from the Federal Reserve to the Office of the Comptroller of the Currency — accepted the argument, and Morgan was allowed to put more money on the street.
What Cassano did was to transform the credit swaps that Morgan popularized into the world's largest bet on the housing boom. In theory, at least, there's nothing wrong with buying a CDS to insure your investments. Investors paid a premium to AIGFP, and in return the company promised to pick up the tab if the mortgage-backed CDOs went bust. But as Cassano went on a selling spree, the deals he made differed from traditional insurance in several significant ways. First, the party selling CDS protection didn't have to post any money upfront. When a $100 corporate bond is sold, for example, someone has to show 100 actual dollars. But when you sell a $100 CDS guarantee, you don't have to show a dime. So Cassano could sell investment banks billions in guarantees without having any single asset to back it up.
Secondly, Cassano was selling so-called "naked" CDS deals. In a "naked" CDS, neither party actually holds the underlying loan. In other words, Bank B not only sells CDS protection to Bank A for its mortgage on the Pope — it turns around and sells protection to Bank C for the very same mortgage. This could go on ad nauseam: You could have Banks D through Z also betting on Bank A's mortgage.
Unlike traditional insurance, Cassano was offering investors an opportunity to bet that someone else's house would burn down, or take out a term life policy on the guy with AIDS down the street. It was no different from gambling, the Wall Street version of a bunch of frat brothers betting on Jay Feely to make a field goal. Cassano was taking book for every bank that bet short on the housing market, but he didn't have the cash to pay off if the kick went wide. In a span of only seven years, Cassano sold some $500 billion worth of CDS protection, with at least $64 billion of that tied to the subprime mortgage market. AIG didn't have even a fraction of that amount of cash on hand to cover its bets, but neither did it expect it would ever need any reserves. So long as defaults on the underlying securities remained a highly unlikely proposition, AIG was essentially collecting huge and steadily climbing premiums by selling insurance for the disaster it thought would never come. Initially, at least, the revenues were enormous: AIGFP's returns went from $737 million in 1999 to $3.2 billion in 2005. Over the past seven years, the subsidiary's 400 employees were paid a total of $3.5 billion; Cassano himself pocketed at least $280 million in compensation. Everyone made their money — and then it all went to shit.
II. THE REGULATORS
Cassano's outrageous gamble wouldn't have been possible had he not had the good fortune to take over AIGFP just as Sen. Phil Gramm — a grinning, laissez-faire ideologue from Texas — had finished engineering the most dramatic deregulation of the financial industry since Emperor Hien Tsung invented paper money in 806 A.D. For years, Washington had kept a watchful eye on the nation's banks. Ever since the Great Depression, commercial banks — those that kept money on deposit for individuals and businesses — had not been allowed to double as investment banks, which raise money by issuing and selling securities. The Glass-Steagall Act, passed during the Depression, also prevented banks of any kind from getting into the insurance business.
But in the late Nineties, a few years before Cassano took over AIGFP, all that changed. The Democrats, tired of getting slaughtered in the fundraising arena by Republicans, decided to throw off their old reliance on unions and interest groups and become more "business-friendly." Wall Street responded by flooding Washington with money, buying allies in both parties. In the 10-year period beginning in 1998, financial companies spent $1.7 billion on federal campaign contributions and another $3.4 billion on lobbyists. They quickly got what they paid for. In 1999, Gramm co-sponsored a bill that repealed key aspects of the Glass-Steagall Act, smoothing the way for the creation of financial megafirms like Citigroup. The move did away with the built-in protections afforded by smaller banks. In the old days, a local banker knew the people whose loans were on his balance sheet: He wasn't going to give a million-dollar mortgage to a homeless meth addict, since he would have to keep that loan on his books. But a giant merged bank might write that loan and then sell it off to some fool in China, and who cared?
The very next year, Gramm compounded the problem by writing a sweeping new law called the Commodity Futures Modernization Act that made it impossible to regulate credit swaps as either gambling or securities. Commercial banks — which, thanks to Gramm, were now competing directly with investment banks for customers — were driven to buy credit swaps to loosen capital in search of higher yields. "By ruling that credit-default swaps were not gaming and not a security, the way was cleared for the growth of the market," said Eric Dinallo, head of the New York State Insurance Department. The blanket exemption meant that Joe Cassano could now sell as many CDS contracts as he wanted, building up as huge a position as he wanted, without anyone in government saying a word. "You have to remember, investment banks aren't in the business of making huge directional bets," says the government source involved in the AIG bailout. When investment banks write CDS deals, they hedge them. But insurance companies don't have to hedge. And that's what AIG did. "They just bet massively long on the housing market," says the source. "Billions and billions."
In the biggest joke of all, Cassano's wheeling and dealing was regulated by the Office of Thrift Supervision, an agency that would prove to be defiantly uninterested in keeping watch over his operations. How a behemoth like AIG came to be regulated by the little-known and relatively small OTS is yet another triumph of the deregulatory instinct. Under another law passed in 1999, certain kinds of holding companies could choose the OTS as their regulator, provided they owned one or more thrifts (better known as savings-and-loans). Because the OTS was viewed as more compliant than the Fed or the Securities and Exchange Commission, companies rushed to reclassify themselves as thrifts. In 1999, AIG purchased a thrift in Delaware and managed to get approval for OTS regulation of its entire operation. Making matters even more hilarious, AIGFP — a London-based subsidiary of an American insurance company — ought to have been regulated by one of Europe's more stringent regulators, like Britain's Financial Services Authority. But the OTS managed to convince the Europeans that it had the muscle to regulate these giant companies. By 2007, the EU had conferred legitimacy to OTS supervision of three mammoth firms — GE, AIG and Ameriprise.
That same year, as the subprime crisis was exploding, the Government Accountability Office criticized the OTS, noting a "disparity between the size of the agency and the diverse firms it oversees." Among other things, the GAO report noted that the entire OTS had only one insurance specialist on staff — and this despite the fact that it was the primary regulator for the world's largest insurer! "There's this notion that the regulators couldn't do anything to stop AIG," says a government official who was present during the bailout. "That's bullshit. What you have to understand is that these regulators have ultimate power. They can send you a letter and say, 'You don't exist anymore,' and that's basically that. They don't even really need due process. The OTS could have said, 'We're going to pull your charter; we're going to pull your license; we're going to sue you.' And getting sued by your primary regulator is the kiss of death." When AIG finally blew up, the OTS regulator ostensibly in charge of overseeing the insurance giant — a guy named C.K. Lee — basically admitted that he had blown it. His mistake, Lee said, was that he believed all those credit swaps in Cassano's portfolio were "fairly benign products." Why? Because the company told him so. "The judgment the company was making was that there was no big credit risk," he explained. (Lee now works as Midwest region director of the OTS; the agency declined to make him available for an interview.)
In early March, after the latest bailout of AIG, Treasury Secretary Timothy Geithner took what seemed to be a thinly veiled shot at the OTS, calling AIG a "huge, complex global insurance company attached to a very complicated investment bank/hedge fund that was allowed to build up without any adult supervision." But even without that "adult supervision," AIG might have been OK had it not been for a complete lack of internal controls. For six months before its meltdown, according to insiders, the company had been searching for a full-time chief financial officer and a chief risk-assessment officer, but never got around to hiring either. That meant that the 18th-largest company in the world had no one checking to make sure its balance sheet was safe and no one keeping track of how much cash and assets the firm had on hand. The situation was so bad that when outside consultants were called in a few weeks before the bailout, senior executives were unable to answer even the most basic questions about their company — like, for instance, how much exposure the firm had to the residential-mortgage market.
III. THE CRASH
Ironically, when reality finally caught up to Cassano, it wasn't because the housing market crapped but because of AIG itself. Before 2005, the company's debt was rated triple-A, meaning he didn't need to post much cash to sell CDS protection: The solid creditworthiness of AIG's name was guarantee enough. But the company's crummy accounting practices eventually caused its credit rating to be downgraded, triggering clauses in the CDS contracts that forced Cassano to post substantially more collateral to back his deals.
By the fall of 2007, it was evident that AIGFP's portfolio had turned poisonous, but like every good Wall Street huckster, Cassano schemed to keep his insane, Earth-swallowing gamble hidden from public view. That August, balls bulging, he announced to investors on a conference call that "it is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 in any of those transactions." As he spoke, his CDS portfolio was racking up $352 million in losses. When the growing credit crunch prompted senior AIG executives to re-examine its liabilities, a company accountant named Joseph St. Denis became "gravely concerned" about the CDS deals and their potential for mass destruction. Cassano responded by personally forcing the poor sap out of the firm, telling him he was "deliberately excluded" from the financial review for fear that he might "pollute the process."
The following February, when AIG posted $11.5 billion in annual losses, it announced the resignation of Cassano as head of AIGFP, saying an auditor had found a "material weakness" in the CDS portfolio. But amazingly, the company not only allowed Cassano to keep $34 million in bonuses, it kept him on as a consultant for $1 million a month. In fact, Cassano remained on the payroll and kept collecting his monthly million through the end of September 2008, even after taxpayers had been forced to hand AIG $85 billion to patch up his fuck-ups. When asked in October why the company still retained Cassano at his $1 million-a-month rate despite his role in the probable downfall of Western civilization, CEO Martin Sullivan told Congress with a straight face that AIG wanted to "retain the 20-year knowledge that Mr. Cassano had." (Cassano, who is apparently hiding out in his lavish town house near Harrods in London, could not be reached for comment.)
What sank AIG in the end was another credit downgrade. Cassano had written so many CDS deals that when the company was facing another downgrade to its credit rating last September, from AA to A, it needed to post billions in collateral — not only more cash than it had on its balance sheet but more cash than it could raise even if it sold off every single one of its liquid assets. Even so, management dithered for days, not believing the company was in serious trouble. AIG was a dried-up prune, sapped of any real value, and its top executives didn't even know it. On the weekend of September 13th, AIG's senior leaders were summoned to the offices of the New York Federal Reserve. Regulators from Dinallo's insurance office were there, as was Geithner, then chief of the New York Fed. Treasury Secretary Hank Paulson, who spent most of the weekend preoccupied with the collapse of Lehman Brothers, came in and out. Also present, for reasons that would emerge later, was Lloyd Blankfein, CEO of Goldman Sachs. The only relevant government office that wasn't represented was the regulator that should have been there all along: the OTS. "We sat down with Paulson, Geithner and Dinallo," says a person present at the negotiations. "I didn't see the OTS even once."
On September 14th, according to another person present, Treasury officials presented Blankfein and other bankers in attendance with an absurd proposal: "They basically asked them to spend a day and check to see if they could raise the money privately." The laughably short time span to complete the mammoth task made the answer a foregone conclusion. At the end of the day, the bankers came back and told the government officials, gee, we checked, but we can't raise that much. And the bailout was on. A short time later, it came out that AIG was planning to pay some $90 million in deferred compensation to former executives, and to accelerate the payout of $277 million in bonuses to others — a move the company insisted was necessary to "retain key employees." When Congress balked, AIG canceled the $90 million in payments.
Then, in January 2009, the company did it again. After all those years letting Cassano run wild, and after already getting caught paying out insane bonuses while on the public till, AIG decided to pay out another $450 million in bonuses. And to whom? To the 400 or so employees in Cassano's old unit, AIGFP, which is due to go out of business shortly! Yes, that's right, an average of $1.1 million in taxpayer-backed money apiece, to the very people who spent the past decade or so punching a hole in the fabric of the universe!
"We, uh, needed to keep these highly expert people in their seats," AIG spokeswoman Christina Pretto says to me in early February. "But didn't these 'highly expert people' basically destroy your company?" I ask. Pretto protests, says this isn't fair. The employees at AIGFP have already taken pay cuts, she says. Not retaining them would dilute the value of the company even further, make it harder to wrap up the unit's operations in an orderly fashion. The bonuses are a nice comic touch highlighting one of the more outrageous tangents of the bailout age, namely the fact that, even with the planet in flames, some members of the Wall Street class can't even get used to the tragedy of having to fly coach. "These people need their trips to Baja, their spa treatments, their hand jobs," says an official involved in the AIG bailout, a serious look on his face, apparently not even half-kidding. "They don't function well without them."
IV. THE POWER GRAB
So that's the first step in wall street's power grab: making up things like credit-default swaps and collateralized-debt obligations, financial products so complex and inscrutable that ordinary American dumb people — to say nothing of federal regulators and even the CEOs of major corporations like AIG — are too intimidated to even try to understand them. That, combined with wise political investments, enabled the nation's top bankers to effectively scrap any meaningful oversight of the financial industry. In 1997 and 1998, the years leading up to the passage of Phil Gramm's fateful act that gutted Glass-Steagall, the banking, brokerage and insurance industries spent $350 million on political contributions and lobbying. Gramm alone — then the chairman of the Senate Banking Committee — collected $2.6 million in only five years. The law passed 90-8 in the Senate, with the support of 38 Democrats, including some names that might surprise you: Joe Biden, John Kerry, Tom Daschle, Dick Durbin, even John Edwards.
The act helped create the too-big-to-fail financial behemoths like Citigroup, AIG and Bank of America — and in turn helped those companies slowly crush their smaller competitors, leaving the major Wall Street firms with even more money and power to lobby for further deregulatory measures. "We're moving to an oligopolistic situation," Kenneth Guenther, a top executive with the Independent Community Bankers of America, lamented after the Gramm measure was passed. The situation worsened in 2004, in an extraordinary move toward deregulation that never even got to a vote. At the time, the European Union was threatening to more strictly regulate the foreign operations of America's big investment banks if the U.S. didn't strengthen its own oversight. So the top five investment banks got together on April 28th of that year and — with the helpful assistance of then-Goldman Sachs chief and future Treasury Secretary Hank Paulson — made a pitch to George Bush's SEC chief at the time, William Donaldson, himself a former investment banker. The banks generously volunteered to submit to new rules restricting them from engaging in excessively risky activity. In exchange, they asked to be released from any lending restrictions. The discussion about the new rules lasted just 55 minutes, and there was not a single representative of a major media outlet there to record the fateful decision.
Donaldson OK'd the proposal, and the new rules were enough to get the EU to drop its threat to regulate the five firms. The only catch was, neither Donaldson nor his successor, Christopher Cox, actually did any regulating of the banks. They named a commission of seven people to oversee the five companies, whose combined assets came to total more than $4 trillion. But in the last year and a half of Cox's tenure, the group had no director and did not complete a single inspection. Great deal for the banks, which originally complained about being regulated by both Europe and the SEC, and ended up being regulated by no one. Once the capital requirements were gone, those top five banks went hog-wild, jumping ass-first into the then-raging housing bubble. One of those was Bear Stearns, which used its freedom to drown itself in bad mortgage loans. In the short period between the 2004 change and Bear's collapse, the firm's debt-to-equity ratio soared from 12-1 to an insane 33-1. Another culprit was Goldman Sachs, which also had the good fortune, around then, to see its CEO, a bald-headed Frankensteinian goon named Hank Paulson (who received an estimated $200 million tax deferral by joining the government), ascend to Treasury secretary.
Freed from all capital restraints, sitting pretty with its man running the Treasury, Goldman jumped into the housing craze just like everyone else on Wall Street. Although it famously scored an $11 billion coup in 2007 when one of its trading units smartly shorted the housing market, the move didn't tell the whole story. In truth, Goldman still had a huge exposure come that fateful summer of 2008 — to none other than Joe Cassano. Goldman Sachs, it turns out, was Cassano's biggest customer, with $20 billion of exposure in Cassano's CDS book. Which might explain why Goldman chief Lloyd Blankfein was in the room with ex-Goldmanite Hank Paulson that weekend of September 13th, when the federal government was supposedly bailing out AIG.
When asked why Blankfein was there, one of the government officials who was in the meeting shrugs. "One might say that it's because Goldman had so much exposure to AIGFP's portfolio," he says. "You'll never prove that, but one might suppose." Market analyst Eric Salzman is more blunt. "If AIG went down," he says, "there was a good chance Goldman would not be able to collect." The AIG bailout, in effect, was Goldman bailing out Goldman. Eventually, Paulson went a step further, elevating another ex-Goldmanite named Edward Liddy to run AIG — a company whose bailout money would be coming, in part, from the newly created TARP program, administered by another Goldman banker named Neel Kashkari.
V. REPO MEN
There are plenty of people who have noticed, in recent years, that when they lost their homes to foreclosure or were forced into bankruptcy because of crippling credit-card debt, no one in the government was there to rescue them. But when Goldman Sachs — a company whose average employee still made more than $350,000 last year, even in the midst of a depression — was suddenly faced with the possibility of losing money on the unregulated insurance deals it bought for its insane housing bets, the government was there in an instant to patch the hole. That's the essence of the bailout: rich bankers bailing out rich bankers, using the taxpayers' credit card.
The people who have spent their lives cloistered in this Wall Street community aren't much for sharing information with the great unwashed. Because all of this shit is complicated, because most of us mortals don't know what the hell LIBOR is or how a REIT works or how to use the word "zero coupon bond" in a sentence without sounding stupid — well, then, the people who do speak this idiotic language cannot under any circumstances be bothered to explain it to us and instead spend a lot of time rolling their eyes and asking us to trust them.
That roll of the eyes is a key part of the psychology of Paulsonism. The state is now being asked not just to call off its regulators or give tax breaks or funnel a few contracts to connected companies; it is intervening directly in the economy, for the sole purpose of preserving the influence of the megafirms. In essence, Paulson used the bailout to transform the government into a giant bureaucracy of entitled assholedom, one that would socialize "toxic" risks but keep both the profits and the management of the bailed-out firms in private hands. Moreover, this whole process would be done in secret, away from the prying eyes of NASCAR dads, broke-ass liberals who read translations of French novels, subprime mortgage holders and other such financial losers.
Some aspects of the bailout were secretive to the point of absurdity. In fact, if you look closely at just a few lines in the Federal Reserve's weekly public disclosures, you can literally see the moment where a big chunk of your money disappeared for good. The H4 report (called "Factors Affecting Reserve Balances") summarizes the activities of the Fed each week. You can find it online, and it's pretty much the only thing the Fed ever tells the world about what it does. For the week ending February 18th, the number under the heading "Repurchase Agreements" on the table is zero. It's a significant number.
Why? In the pre-crisis days, the Fed used to manage the money supply by periodically buying and selling securities on the open market through so-called Repurchase Agreements, or Repos. The Fed would typically dump $25 billion or so in cash onto the market every week, buying up Treasury bills, U.S. securities and even mortgage-backed securities from institutions like Goldman Sachs and J.P. Morgan, who would then "repurchase" them in a short period of time, usually one to seven days. This was the Fed's primary mechanism for controlling interest rates: Buying up securities gives banks more money to lend, which makes interest rates go down. Selling the securities back to the banks reduces the money available for lending, which makes interest rates go up.
If you look at the weekly H4 reports going back to the summer of 2007, you start to notice something alarming. At the start of the credit crunch, around August of that year, you see the Fed buying a few more Repos than usual — $33 billion or so. By November, as private-bank reserves were dwindling to alarmingly low levels, the Fed started injecting even more cash than usual into the economy: $48 billion. By late December, the number was up to $58 billion; by the following March, around the time of the Bear Stearns rescue, the Repo number had jumped to $77 billion. In the week of May 1st, 2008, the number was $115 billion — "out of control now," according to one congressional aide. For the rest of 2008, the numbers remained similarly in the stratosphere, the Fed pumping as much as $125 billion of these short-term loans into the economy — until suddenly, at the start of this year, the number drops to nothing. Zero.
The reason the number has dropped to nothing is that the Fed had simply stopped using relatively transparent devices like repurchase agreements to pump its money into the hands of private companies. By early 2009, a whole series of new government operations had been invented to inject cash into the economy, most all of them completely secretive and with names you've never heard of. There is the Term Auction Facility, the Term Securities Lending Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility and a monster called the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (boasting the chat-room horror-show acronym ABCPMMMFLF). For good measure, there's also something called a Money Market Investor Funding Facility, plus three facilities called Maiden Lane I, II and III to aid bailout recipients like Bear Stearns and AIG.
While the rest of America, and most of Congress, have been bugging out about the $700 billion bailout program called TARP, all of these newly created organisms in the Federal Reserve zoo have quietly been pumping not billions but trillions of dollars into the hands of private companies (at least $3 trillion so far in loans, with as much as $5.7 trillion more in guarantees of private investments). Although this technically isn't taxpayer money, it still affects taxpayers directly, because the activities of the Fed impact the economy as a whole. And this new, secretive activity by the Fed completely eclipses the TARP program in terms of its influence on the economy.
No one knows who's getting that money or exactly how much of it is disappearing through these new holes in the hull of America's credit rating. Moreover, no one can really be sure if these new institutions are even temporary at all — or whether they are being set up as permanent, state-aided crutches to Wall Street, designed to systematically suck bad investments off the ledgers of irresponsible lenders. "They're supposed to be temporary," says Paul-Martin Foss, an aide to Rep. Ron Paul. "But we keep getting notices every six months or so that they're being renewed. They just sort of quietly announce it."
None other than disgraced senator Ted Stevens was the poor sap who made the unpleasant discovery that if Congress didn't like the Fed handing trillions of dollars to banks without any oversight, Congress could apparently go fuck itself — or so said the law. When Stevens asked the GAO about what authority Congress has to monitor the Fed, he got back a letter citing an obscure statute that nobody had ever heard of before: the Accounting and Auditing Act of 1950. The relevant section, 31 USC 714(b), dictated that congressional audits of the Federal Reserve may not include "deliberations, decisions and actions on monetary policy matters." The exemption, as Foss notes, "basically includes everything." According to the law, in other words, the Fed simply cannot be audited by Congress. Or by anyone else, for that matter.
VI. WINNERS AND LOSERS
Stevens isn't the only person in Congress to be given the finger by the Fed. In January, when Rep. Alan Grayson of Florida asked Federal Reserve vice chairman Donald Kohn where all the money went — only $1.2 trillion had vanished by then — Kohn gave Grayson a classic eye roll, saying he would be "very hesitant" to name names because it might discourage banks from taking the money. "Has that ever happened?" Grayson asked. "Have people ever said, 'We will not take your $100 billion because people will find out about it?'" "Well, we said we would not publish the names of the borrowers, so we have no test of that," Kohn answered, visibly annoyed with Grayson's meddling.
Grayson pressed on, demanding to know on what terms the Fed was lending the money. Presumably it was buying assets and making loans, but no one knew how it was pricing those assets — in other words, no one knew what kind of deal it was striking on behalf of taxpayers. So when Grayson asked if the purchased assets were "marked to market" — a methodology that assigns a concrete value to assets, based on the market rate on the day they are traded — Kohn answered, mysteriously, "The ones that have market values are marked to market." The implication was that the Fed was purchasing derivatives like credit swaps or other instruments that were basically impossible to value objectively — paying real money for God knows what.
"Well, how much of them don't have market values?" asked Grayson. "How much of them are worthless?"
"None are worthless," Kohn snapped.
"Then why don't you mark them to market?" Grayson demanded.
"Well," Kohn sighed, "we are marking the ones to market that have market values."
In essence, the Fed was telling Congress to lay off and let the experts handle things. "It's like buying a car in a used-car lot without opening the hood, and saying, 'I think it's fine,'" says Dan Fuss, an analyst with the investment firm Loomis Sayles. "The salesman says, 'Don't worry about it. Trust me.' It'll probably get us out of the lot, but how much farther? None of us knows." When one considers the comparatively extensive system of congressional checks and balances that goes into the spending of every dollar in the budget via the normal appropriations process, what's happening in the Fed amounts to something truly revolutionary — a kind of shadow government with a budget many times the size of the normal federal outlay, administered dictatorially by one man, Fed chairman Ben Bernanke. "We spend hours and hours and hours arguing over $10 million amendments on the floor of the Senate, but there has been no discussion about who has been receiving this $3 trillion," says Sen. Bernie Sanders. "It is beyond comprehension."
Count Sanders among those who don't buy the argument that Wall Street firms shouldn't have to face being outed as recipients of public funds, that making this information public might cause investors to panic and dump their holdings in these firms. "I guess if we made that public, they'd go on strike or something," he muses.
And the Fed isn't the only arm of the bailout that has closed ranks. The Treasury, too, has maintained incredible secrecy surrounding its implementation even of the TARP program, which was mandated by Congress. To this date, no one knows exactly what criteria the Treasury Department used to determine which banks received bailout funds and which didn't — particularly the first $350 billion given out under Bush appointee Hank Paulson.
The situation with the first TARP payments grew so absurd that when the Congressional Oversight Panel, charged with monitoring the bailout money, sent a query to Paulson asking how he decided whom to give money to, Treasury responded — and this isn't a joke — by directing the panel to a copy of the TARP application form on its website. Elizabeth Warren, the chair of the Congressional Oversight Panel, was struck nearly speechless by the response. "Do you believe that?" she says incredulously. "That's not what we had in mind." Another member of Congress, who asked not to be named, offers his own theory about the TARP process. "I think basically if you knew Hank Paulson, you got the money," he says.
This cozy arrangement created yet another opportunity for big banks to devour market share at the expense of smaller regional lenders. While all the bigwigs at Citi and Goldman and Bank of America who had Paulson on speed-dial got bailed out right away — remember that TARP was originally passed because money had to be lent right now, that day, that minute, to stave off emergency — many small banks are still waiting for help. Five months into the TARP program, some not only haven't received any funds, they haven't even gotten a call back about their applications. "There's definitely a feeling among community bankers that no one up there cares much if they make it or not," says Tanya Wheeless, president of the Arizona Bankers Association.
Which, of course, is exactly the opposite of what should be happening, since small, regional banks are far less guilty of the kinds of predatory lending that sank the economy. "They're not giving out subprime loans or easy credit," says Wheeless. "At the community level, it's much more bread-and-butter banking." Nonetheless, the lion's share of the bailout money has gone to the larger, so-called "systemically important" banks. "It's like Treasury is picking winners and losers," says one state banking official who asked not to be identified. This itself is a hugely important political development. In essence, the bailout accelerated the decline of regional community lenders by boosting the political power of their giant national competitors.
Which, when you think about it, is insane: What had brought us to the brink of collapse in the first place was this relentless instinct for building ever-larger megacompanies, passing deregulatory measures to gradually feed all the little fish in the sea to an ever-shrinking pool of Bigger Fish. To fix this problem, the government should have slowly liquidated these monster, too-big-to-fail firms and broken them down to smaller, more manageable companies. Instead, federal regulators closed ranks and used an almost completely secret bailout process to double down on the same faulty, merger-happy thinking that got us here in the first place, creating a constellation of megafirms under government control that are even bigger, more unwieldy and more crammed to the gills with systemic risk.
In essence, Paulson and his cronies turned the federal government into one gigantic, half-opaque holding company, one whose balance sheet includes the world's most appallingly large and risky hedge fund, a controlling stake in a dying insurance giant, huge investments in a group of teetering megabanks, and shares here and there in various auto-finance companies, student loans, and other failing businesses. Like AIG, this new federal holding company is a firm that has no mechanism for auditing itself and is run by leaders who have very little grasp of the daily operations of its disparate subsidiary operations. In other words, it's AIG's rip-roaringly shitty business model writ almost inconceivably massive — to echo Geithner, a huge, complex global company attached to a very complicated investment bank/hedge fund that's been allowed to build up without adult supervision. How much of what kinds of crap is actually on our balance sheet, and what did we pay for it? When exactly will the rent come due, when will the money run out? Does anyone know what the hell is going on? And on the linear spectrum of capitalism to socialism, where exactly are we now? Is there a dictionary word that even describes what we are now? It would be funny, if it weren't such a nightmare.
VII. YOU DON'T GET IT
The real question from here is whether the Obama administration is going to move to bring the financial system back to a place where sanity is restored and the general public can have a say in things or whether the new financial bureaucracy will remain obscure, secretive and hopelessly complex. It might not bode well that Geithner, Obama's Treasury secretary, is one of the architects of the Paulson bailouts; as chief of the New York Fed, he helped orchestrate the Goldman-friendly AIG bailout and the secretive Maiden Lane facilities used to funnel funds to the dying company. Neither did it look good when Geithner — himself a protégé of notorious Goldman alum John Thain, the Merrill Lynch chief who paid out billions in bonuses after the state spent billions bailing out his firm — picked a former Goldman lobbyist named Mark Patterson to be his top aide.
In fact, most of Geithner's early moves reek strongly of Paulsonism. He has continually talked about partnering with private investors to create a so-called "bad bank" that would systemically relieve private lenders of bad assets — the kind of massive, opaque, quasi-private bureaucratic nightmare that Paulson specialized in. Geithner even refloated a Paulson proposal to use TALF, one of the Fed's new facilities, to essentially lend cheap money to hedge funds to invest in troubled banks while practically guaranteeing them enormous profits. God knows exactly what this does for the taxpayer, but hedge-fund managers sure love the idea. "This is exactly what the financial system needs," said Andrew Feldstein, CEO of Blue Mountain Capital and one of the Morgan Mafia. Strangely, there aren't many people who don't run hedge funds who have expressed anything like that kind of enthusiasm for Geithner's ideas.
As complex as all the finances are, the politics aren't hard to follow. By creating an urgent crisis that can only be solved by those fluent in a language too complex for ordinary people to understand, the Wall Street crowd has turned the vast majority of Americans into non-participants in their own political future. There is a reason it used to be a crime in the Confederate states to teach a slave to read: Literacy is power. In the age of the CDS and CDO, most of us are financial illiterates. By making an already too-complex economy even more complex, Wall Street has used the crisis to effect a historic, revolutionary change in our political system — transforming a democracy into a two-tiered state, one with plugged-in financial bureaucrats above and clueless customers below.
The most galling thing about this financial crisis is that so many Wall Street types think they actually deserve not only their huge bonuses and lavish lifestyles but the awesome political power their own mistakes have left them in possession of. When challenged, they talk about how hard they work, the 90-hour weeks, the stress, the failed marriages, the hemorrhoids and gallstones they all get before they hit 40.
"But wait a minute," you say to them. "No one ever asked you to stay up all night eight days a week trying to get filthy rich shorting what's left of the American auto industry or selling $600 billion in toxic, irredeemable mortgages to ex-strippers on work release and Taco Bell clerks. Actually, come to think of it, why are we even giving taxpayer money to you people? Why are we not throwing your ass in jail instead?" But before you even finish saying that, they're rolling their eyes, because You Don't Get It. These people were never about anything except turning money into money, in order to get more money; valueswise they're on par with crack addicts, or obsessive sexual deviants who burgle homes to steal panties. Yet these are the people in whose hands our entire political future now rests.
Good luck with that, America. And enjoy tax season.