Wall Street bailout

SIGTARP (Special Inspector General for the Troubled Asset Relief Program) Reports

William D. Cohan’s House of Cards

Here are some excerpts from William D. Cohan’s House of Cards.

[page 95]
[On Sunday, 2008-03-16,]
Jamie Dimon called [Tim] Geithner downtown and told him the news.
Given the unknowable interconnectedness
of the various firms and their counterparties worldwide,
Geithner decided he could not—the world could not—
afford to risk the liquidation of Bear Stearns.

“For the first time in history,
the entire world was looking at
the failure of a major financial institution
that could lead to a run on the entire world financial system,”

a Fed official recalled.
“It was clear we couldn’t let that happen.”

[pages 98–100]

[O]n Sunday morning [2008-03-16],
when Paulson appeared on ABC’s This Week
[George] Stephanopoulos asked Paulson about
a comment by William Fleckenstein, president of Fleckenstein Capital,
that Gretchen Morgenson had featured in her column this morning—
“Why not set an example of Bear Stearns,
the guys who have this record of dog-eat-dog,
we’re brass knuckles,
we’re tough?
This is the perfect time to set an example,
but they are not interested in setting an example.
We are Bailout Nation”—
Paulson demurred and said that “every situation is different” and
“we have to respond to the circumstances we’re facing.”

There were certainly voices—
including Fleckenstein’s and even some within Bear Stearns itself—
that the free market should be the one to render judgment on
the firm’s years of strategic and tactical choices,
among them the decisions
to finance itself with short-term borrowings,
to pack its balance sheet with
hard-to-sell and hard-to-value mortgage-backed securities, and
not to diversify its revenue either geographically or by product.
“My personal view is that [Bear Stearns]
should have been made more of a victim,”
said one Bear senior managing director.
“I don’t think it should have been saved.
I don’t buy the argument
that the whole system would have unraveled and collapsed.

I really don’t.
I think it’s a terrible precedent.
I don’t think the Fed should be in the business of assuming this kind of risk.
I think it would have been a much better wakeup call for everybody
had things followed their course.”

However, this was not a risk that Paulson, Bernanke, or Geithner
was willing to take.
“On [Thursday] March 13, we learned from the SEC
that Bear Stearns was facing imminent bankruptcy,
and this presented us with some extraordinarily difficult policy judgments,”
Geithner explained.
“Bear Stearns occupies—occupied—a central position
in the very complex and intricate relationships
that characterize our financial system.
And, as important,
it reached the brink of insolvency
at an exceptionally fragile time in global financial markets.
In our judgments,
an abrupt and disorderly unwinding of Bear Stearns
would have posed systemic risks to the financial system
and magnified the downside risk to economic growth in the United States.
A failure to act would have added to the risk that Americans would face
lower income, lower home values,
higher buying costs for housing, education, other living expenses,
lower retirement savings and rising unemployment.
We acted to avert that risk
in the classic tradition of lenders of last resort
with the authority provided by the Congress.
We chose the best option available
in the unique circumstances that prevailed at that time.”

Bernanke said he, too, became concerned by
Bear Stearns deteriorating liquidity position during the week
and then especially by
the market’s counterintuitive reaction
to the back-to-back financing facility
that the Fed had made available on Friday morning.
“This news raised difficult questions of public policy,” he said.
“Normally, the market sorts out which companies survive and which fail,
and that is as it should be.
However, the issues raised here
extended well beyond the fate of one company.
Our financial system is extremely complex and interconnected,
and Bear Stearns participated extensively in a range of critical markets.
The sudden failure of Bear Stearns likely would have led to
a chaotic unwinding of positions in those markets
and could have severely shaken confidence.
The company’s failure could also have cast doubt on
the financial positions of some of Bear Stearns’s thousands of counterparties
and perhaps of companies with similar businesses.
Given the exception pressures on the global economy and financial system,
the damage caused by a default by Bear Stearns could have been severe
and extremely difficult to contain.
Moreover, and very importantly, the adverse impact of a default
would not have been confined to the financial system
but would have been felt broadly in the real economy
through its effects on asset values and credit availability.”

Miscellaneous Articles


Effectiveness of AIG's $143 Billion Rescue Questioned
By Carol D. Leonnig
Washington Post, 2008-11-03

[Emphasis is added.]

A number of financial experts now fear that
the federal government’s $143 billion attempt
to rescue troubled insurance giant American International Group
may not work,
and some argue that company shareholders and taxpayers
would have been better served by a bankruptcy filing.

The Treasury Department leapt to keep AIG from going bankrupt on Sept. 16,
and in the past seven weeks,
AIG has drawn down $90 billion in federal bailout loans.
But some key AIG players argue that
bankruptcy would have offered more structure and greater protections
during a time of intense market volatility.

AIG declined to comment on the matter.

Echoing some other experts, Ann Rutledge,
a credit derivatives expert and founding principal of R&R Consulting,
said she is not sure how badly the financial system would have been rocked
if the government had let AIG file for bankruptcy protection.
But she fears that the government is papering over the problem
with a quick fix that was not well planned.

[Yes, surely that is an accurate way to describe
how the early October $700G bailout bill was planned, pushed, and passed.
But who in the media was most prominent, shrillest, and insistent
in demanding quick passage?
For at least one answer, see this.]

“What we see now are a lot of games by the government
to keep these institutions going with a lot of cash,” she said.
“This is to fill holes in companies’ balance sheets,
and they’re trying to hold at bay
the charges that our financial system is insolvent.”

The deal that
the Treasury and the Federal Reserve Bank of New York pressed upon AIG
[Is that an accurate way to describe who was pushing the deal?]
was intended to stop any domino effect of
financial institutions falling because of their business ties to AIG.
The rescue allowed AIG to provide cash to huge banks and other players
who had invested in rapidly souring mortgages insured by the company.

Early this year,
investors had begun privately demanding that
AIG pay off its billion-dollar guarantees.
But in mid-September,
when the demands for cash reached a public crescendo,
AIG had to admit that
it didn’t have enough cash on hand to meet the obligations.

In the first weeks of its federal rescue,
AIG has used the loan money to post collateral demanded by these firms,
sources close to those deals say.

“No one else benefits,”
former AIG chief executive and major shareholder Maurice R. “Hank” Greenberg
wrote to AIG’s current chief executive on Thursday.
“Unless there is immediate change to the structure of the Federal loan,
the American taxpayer will likely suffer a significant financial loss.”

Another concern is that in this depressed market, AIG,
and the taxpayers that now own 80 percent of the company,
will lose coming and going.

The company may be forced to borrow
additional federal funds for rising payouts to counterparties.
[That doesn’t seem very consistent with
her assertion in para. 6 about who pressed whom.]

Neither the government nor AIG is releasing information about
the specific amounts paid to individual firms,
but numerous credit experts say that the value of those mortgage assets
is probably declining every week.
That means AIG has to pay a higher price as part of its guarantees.

The company also may be forced to sell many more assets at low, fire-sale prices.
As part of its loan deal, AIG was to sell some assets --
valued at $1 trillion before the crisis --
to raise cash to pay off the loan.

AIG’s Financial Products division is
the primary villain in the company’s free-fall.
It made
tens of billions of disastrously bad bets on mortgage investments
but may not have carefully hedged those bets
or properly estimated its risk.

The company’s rapid burn of $90 billion also suggests that
it grossly undervalued
its obligations to counterparties in a worst-case scenario.

In February, internal notes show, board members discussed
a growing dispute between AIG Financial Products and Goldman Sachs
about the value of those assets
when Goldman called for AIG to post collateral.
AIG’s chief financial officer warned of
“Goldman’s acknowledged desire to obtain as much cash as possible.”
But AIG’s external accountants warned that
it was they who alerted management to the dispute, not AIG Financial Products,
and that the division was not properly considering the market in its pricing.

Rutledge warns that because
there has been no public disclosure of AIG’s payments to counterparties,
it is impossible to know whether the pricing it is using now is proper.

The Federal Reserve and its advisers have acknowledged privately
that things are not going according to plan.

As AIG has rapidly eaten through the loan money,
the Fed has twice expanded its original $85 billion bailout --
which itself was
the largest government bailout of a private company in U.S. history.
Earlier last month,
the Fed reluctantly gave AIG $38 billion more in credit for securities lending
to try to keep the firm from drawing down its first Fed loan too quickly.

Then on Thursday,
the Fed agreed to let AIG borrow $20 billion
from a larger commercial paper bailout fund it had set up days earlier
for all institutions that lend money to each other.

If the company had filed for Chapter 11 bankruptcy protection,
AIG could have frozen the crippling collateral calls,
and shareholders would have had a chance at recovering some value
from the company’s 80 percent drop in stock price from earlier this year,
said Lee Wolosky, a lawyer for AIG’s largest shareholder, Starr International.

“AIG is nothing more than a pass-through being charged 14 percent interest,”
Wolosky said.
“Company assets are eroding on a daily basis;
asset sales have not begun
and can only be at fire-sale prices in the current market.”

But David Schiff of Schiff’s Insurance Observer said
he could not see how bankruptcy would have been a better solution.

“The point isn’t to save AIG;
it’s to save the U.S. financial system.
I think they were afraid
to find out who else goes under
if you let AIG fail,”

he said.
“But right now, no one knows if this is going to work.”

[Look, in the overall scheme of things I’m just a peon,
but why isn’t anyone important wondering
exactly who is really being bailed out here?
Obviously the money the government is giving AIG
is being used to pay off claims against insurance polices (aka “credit default swaps”)
that AIG wrote on other people’s bets on mortgages.

  1. Just who are those other people?

  2. Where is the money going?

  3. Doesn’t the government have the right to know the answers to those questions
    before it gives AIG the gigadollars?

  4. Doesn’t the public have a right to know where its tax dollars are going?

  5. Where are all the goo-goo groups
    that normally fight for transparency?
    Or are they all funded by
    the people who don’t want the answers to these questions known?
    (I vote yes to that last question.)

AIG Close to Getting New, Larger Bailout
By Carol D. Leonnig
Washington Post, 2008-11-10

Government Again Expands AIG Rescue Plan
By Carol D. Leonnig
Washington Post, 2008-11-11

Accountability Needed With Bailouts
New York Times, 2008-11-14

[Its entirety; emphasis is added.]

If you are going to hand out rescue packages,
it helps to understand how bad the problem is,
and to have some grasp of what is needed to fix it.

Now the automakers are in line for handouts,
and we can only hope the government
will have a better understanding of their problems —
and a willingness to force painful changes on the industry —
than it did of the financial industry,
where the first round of bailouts were made in a process
that is looking more and more absurd.

It is not just that the Treasury and the Federal Reserve
[but they weren’t the only ones pushing Congress]
pushed Congress to pass a bailout plan
that has now been abandoned.
Nor is it just that the early recipients
are already in line for more handouts.
It is that
the government seems to have written checks
with little knowledge of how deep the rot went.

There are lessons to be learned, but they can seem contradictory:

It doesn’t work to be a passive investor when you are handing out bailouts.

On the other hand, the idea that
government planners should determine where companies invest their money
does not sound so great either.

What is clear is that the Bush administration,
in this as in so many other things, will do as it pleases.
The bailout legislation contemplated the purchase of bad bank assets.
That idea is now abandoned for most institutions.
The legislation set up an elaborate oversight mechanism,
and required periodic reports.
None of that is happening.

Instead, the first round of bailees are back for second helpings.

Before it collapsed, the American International Group
was a haughty company that thought it was better than anyone else.
It still feels that way.

Instead of sounding chastened as its second bailout was announced this week,
the company was bragging about how wonderful its insurance operations are,
and denying this was really a bailout at all.

At a minimum, can’t the government announce and enforce a rule that
companies that receive more than $100 billion in bailout money
must at least admit their brilliance is open to question?

The automakers are next in line.
Before the checks are written,
the government should confront the question of
how this industry can be revived,
and force changes to do that.

But it is doubtful that a Democratic Congress
will have any appetite for huge layoffs and plant closings,
and certainly not for reductions in retiree health benefits.
[ Democrats = too-much-health-care ]
There will be talk of better fuel economy and hybrids,
but little in the way of pain
for anyone except future taxpayers
who will owe the money being thrown around now.

There may be some stringent financial provisions,
intended to force the firms to become commercially viable within a few years,
but don’t pay too much attention to them.
The early recipients didn’t.

It was less than two months ago that the government put up $85 billion for A.I.G.
The interest rate was high, and the term of the loan was just two years.
The company, under a new chief executive,
would have to shape up or close down within 24 months.

That new chief executive, Edward Liddy, now says he saw his first priority
as being to negotiate more lenient terms.
While he was at it, he asked for more money
and for a mechanism to get Uncle Sam
to take on the risk of some of his company’s worst assets
while letting A.I.G. share in the profits
if those assets should prove to be valuable.
He got it all.

Then he told the world that this was not really a bailout at all.
“The terms of the restructuring are commercial in nature,”
he said on a conference call.
“All of the facilities being provided by the U.S. government
are at market rates.”

Market rates?
The government is getting
the London interbank offered rate, plus 1 percentage point,
while it takes large risks that
the bad assets it is taking from A.I.G. will keep losing value.
If they do, A.I.G. is under no obligation to repay that loan.

A.I.G. would like us to believe that
it is a collection of wonderfully run insurance companies,
whose parent company made a mistake or two.
That is not exactly accurate.
Consider one part of the latest bailout.
A.I.G.’s insurance companies —
the ones that Mr. Liddy says “remain disciplined” —
lent out securities like corporate bonds to other investors,
as do most institutional investors.
Also, as is common,
the A.I.G. companies received cash temporarily
to assure that the securities were returned.

The normal procedure is for the company doing the lending
to put the money into supersafe overnight investments,
since the securities may be returned, and the cash paid back, at any time.
That produces a small but certain profit.

A.I.G. had a different idea.
Instead of putting the cash into safe investments,
it bought mortgage-backed securities,

which promised a much better yield.
Now those securities have lost a lot of value, and are difficult to sell.
A.I.G. needs to have the government provide the cash.

That practice was roughly akin to taking the rent money to the racetrack.
At least people who do that seem embarrassed when they ask for handouts.

Now the government will step in to buy those funny pieces of paper.
It will put up 96 percent of the cash,
but collect only 83 percent of the profits if the securities go up.
And the price the government pays
will be based on what A.I.G. says they are worth,
although the government is looking for a consultant to check those prices.

Another government bailout
that is running into problems only weeks after it was announced
is the one for Fannie Mae,
the government-sponsored mortgage finance company.

At Fannie, the government was not so shy about issuing orders.
It told Fannie to
borrow less,
buy more mortgages,
and cut the fees it charges to those who sell mortgages to it,
all at a time when losses from existing mortgages were growing.

This is akin to a family reacting to a financial crisis by saying
it will save more money
while increasing spending
as income declines.

It doesn’t work.

The problem is conflicting government desires.
It wants the costs of mortgages to fall,
and wants plenty of them to be available.
It also wants Fannie to stop growing.

This week Fannie said it may need a new bailout.
Are you surprised?

All this reflects the conflicting needs and responsibilities
of a government that deems companies to be too important to fail.
It wants to keep them going,
but also wants them to act in ways that seem good for society,
whether that consists of cutting mortgage rates or building fuel-efficient cars.
And it does not want to increase economic distress
at a time when millions are losing their jobs.

So the tough choices
that would normally have to be made by a company in trouble
can be postponed, thereby prolonging the pain.

In the meantime,
other firms have to compete with wards of the state,
on terms that can appear unfair.
Competitors say A.I.G. is holding on to customers
by cutting premium rates to unreasonable levels.
A.I.G. concedes premiums are down, but denies it is leading the cuts.
There is a risk that bailed-out carmakers will try to save jobs
by cutting car prices to levels
even lower than the ones that left them broke.

Bailing out companies turns out to be a lot like making loans.
Getting someone to take the money is easy;
getting them to pay it back is not.

Citigroup Saw No Red Flags Even as It Made Bolder Bets
New York Times, 2008-11-23

[This is a long, exhaustive account of what went wrong at Citigroup,
featuring lots of information from corporate insiders.
Robert Rubin is charged with bearing much of the responsibility for the disaster.]

Another Crisis, Another Guarantee
New York Times, 2008-11-25

[Its beginning; emphasis is added.]

Guarantees that could not be honored thrust the world financial system into its worst crisis since the Great Depression. Will a guarantee by the United States government finally restore confidence in the American financial system?

Only a week after Treasury Secretary Henry M. Paulson Jr. said that the government bailouts had stabilized the most important financial institutions, plunging stock prices forced the government to step in again, both to make another direct investment and to guarantee that losses would be contained from $306 billion in possibly toxic assets on Citigroup’s balance sheet.

The move sent stock prices soaring Monday, with financial stocks leading the way. But those gains did not come close to erasing last week’s losses, and left open the possibility that a renewed sense of concern about the safety of other banks could force still more bailouts in coming weeks.

One lesson may be that it is perilous for the government to even hint that it thinks it is through bailing. That can renew fear about banks, driving down share prices and forcing the government to do the opposite of what it had intended. Since the government has a printing press, it need never be short of dollars. That fact makes this guarantee much more credible than the ones, from bond insurers and other companies, that helped persuade banks and others to take what turned out to be huge risks. Many of those guarantors, it turned out, could not honor their obligations. The government feared financial chaos if there was a string of collapses. Even if Citigroup is the last bailout, the Bush administration, whose rhetoric was perhaps more supportive of free, unhindered markets than was that of any of its predecessors, will leave a trail of socialized risk.

But that trail may not be at an end.
The auto companies want billions in bailouts, and other industries are lining up.

as the nation’s obligations rise into the trillions,
at some point investors may begin to question whether
a government running huge deficits
can also credibly promise that
the dollar will not lose its value.

Such a worry conceivably could push up
the very low interest rates the Treasury now pays
to borrow from foreign investors to foot an ever-larger rescue bill.

Too Big Not To Fail
We need to stop using the bailouts to rebuild gigantic financial institutions.
By Eliot Spitzer
Slate.com, 2008-12-03

Last month,
as the financial crisis and the government rescue plan dominated headlines,
almost everyone overlooked a news item
that could have enormous long-term impact:
GE Capital announced the acquisition of five mid-size airplanes
with an option to buy 20 more—
produced by CACC, a new, Chinese-government-sponsored airline manufacturer.

Why is that so significant? Two reasons:

First, just as small steps signaled
the Asian entry into our now essentially bankrupt auto sector 50 years ago,
so the GE acquisition signals Asia’s entry into
one of our few remaining dominant manufacturing sectors.
Boeing is still the world’s leading commercial aviation company.
CACC’s emergence—and its particular advantage selling to Asian markets—
means that
Boeing now faces the rigors of an entirely new competitive playing field
and that
our commercial airplane sector
is likely to suffer enormously over the coming decades.

But the second implication is even bigger.
The CACC story highlights the risk that

current bailouts
—a remarkable $7.8 trillion [as of 2008-12-03]
in equity, loans, and guarantees—
may merely perpetuate
a fundamentally flawed status quo.

So far, at least,
we are simply rebuilding the same edifice that just collapsed.

None of the investments has even begun to address
the underlying structural problems
that are causing economic power to shift away from the United States,
sector by sector:

  1. Our trade deficit has ballooned from about $100 billion
    to more than $700 billion annually in the past decade, and
    our federal deficit now approaches $1 trillion.
    [Indeed, in early 2009 the CBO forecast a FY2009 deficit of $1.8 trillion.]
    These twin deficits leave us at the mercy of foreign-capital inflows
    that may diminish as Asian nations, in particular,
    invest increasingly at home.

  2. Our household savings rate has been close to zero—
    and even negative in some years—
    not permitting the long-term capital accumulation
    required for the investments we need;
    China’s savings rate, by comparison,
    is an astonishing 30 percent of household income.

  3. U.S. middle class income has stagnated over the past decade,
    while the middle class in China—granted, starting from a lower base—
    has seen its income growing at about 10 percent annually.

  4. Our intellectual advantage could soon turn into a new “third deficit,”
    as hundreds of thousands of engineers are being created annually in China.

  5. We are realizing that the service sector—
    all the lawyers, investment bankers,
    advertising agencies, and accountants—
    follows its clients and wealth creation.
    This, not over-regulation,
    is the reason investment-banking activity
    has begun to migrate overseas.

The great irony is that our new place in the global economy
is a direct consequence of
our grand victory over the past 60 years.
We have, indeed, converted virtually the entire world into
one integrated capitalist economy,
and we must now bear the brunt of serious and vigorous competition.
In the immediate aftermath of World War II,
the United States was essentially the only nation with
financial capital, intellectual capital, skilled labor,
a growing middle class generating consumer demand,
and a rule of law permitting safe investment.
Now we are one of many nations with these critical advantages.

This long-term change frames the question we should be asking ourselves:
What are we getting for the trillions of dollars in rescue funds?
If we are merely extending a fatally flawed status quo,
we should invest those dollars elsewhere.
Nobody disputes that radical action was needed to forestall total collapse.
But we are creating the significant systemic risk
not just of rewarding imprudent behavior by private actors
but of preventing, through bailouts and subsidies,
the process of creative destruction that capitalism depends on.

A more sensible approach would focus
not just on rescuing pre-existing financial institutions
but, instead, on creating a structure for more contained and competitive ones.
For years, we have accepted a theory of financial concentration—
not only across all lines of previously differentiated sectors
(insurance, commercial banking, investment banking, retail brokerage, etc.)
but in terms of sheer size.
The theory was that capital depth would permit the various entities,
dubbed financial supermarkets,
to compete and provide full service to customers
while cross-marketing various products.
[Citigroup epitomized this approach.]
That model has failed.
The failure shows in
gargantuan losses, bloated overhead, enormous inefficiencies,
dramatic and outsized risk taken
to generate returns large enough to justify the scale of the organizations,
ethical abuses in cross-marketing in violation of fiduciary obligations,
and now the need for major taxpayer-financed capital support
for virtually every major financial institution.

But even more important, from a structural perspective,
our dependence on entities of this size ensured that
we would fall prey to a “too big to fail” argument in favor of bailouts.

Two responses are possible:
One is to accept the need for gigantic financial institutions
and the impossibility of failure—
and hence the reality of explicit government guarantees,
such as Fannie and Freddie now have—
but then to regulate the entities so heavily that
they essentially become extensions of the government.
To do so could risk the nimbleness we want from economic actors.

The better policy is to return to an era of
vibrant competition among multiple, smaller entities—
none so essential to the entire structure that it is indispensable.

The concentration of power—political as well as economic—
that resided in these few institutions
has made it impossible so far for this crisis to be used as an evolutionary step
in confronting the true economic issues before us.
But imagine if instead of merging more and more banks together,
we had broken them apart and forced them to compete in a genuine manner.
Or, alternatively,
imagine if we had never placed ourselves in a position in which
so many institutions were too big to fail.
The bailouts might have been unnecessary.

In that case,
vast sums now being spent on rescue packages might have been available
to increase the intellectual capabilities of the next generation,
or to support basic research and development
that could give us true competitive advantage, or
to restructure our bloated health care sector,
or to build the type of physical infrastructure we need to be competitive.

It is time we permitted the market to work:
This means true competition with winners and losers;
companies that disappear;
shareholders and CEOs who can lose as well as win; and
government investment in the long-range competitiveness of our nation,
not in a failed business model of
financial concentration and failed risk management
that holds nobody accountable.

This point will be all too well driven home
when the remaining investment bankers in New York
board a CACC jet to fly to Washington
to negotiate the terms of a government bailout
of yet another U.S. financial institution that was deemed too big to fail.

Eliot Spitzer is the former governor of the state of New York.


Unfairly Rewarding Greedy Bankers, and Why It Works
By Steven Pearlstein
Washington Post, 2009-01-14

[I agree with many of Pearlstein's opinions in his columns.
In this one he makes some quite common claims about
why it was necessary to bail out the financial system.
Those are hightlighted in red.]

There’s been a lot of grousing lately
about the Treasury’s $700 billion bailout program,
which, according to its many critics,
has accomplished nothing other than line the pockets of undeserving bankers and their shareholders.

Maybe I’m missing something, but
I don’t see how it’s possible to rescue the banking system
without rescuing banks.
That’s not because anyone thought banks or bankers
were particularly deserving of public charity or even sympathy --
clearly they weren’t.
But by last summer,
with investors, lenders and depositors running for the exits,
there was a genuine fear that
the banking system could collapse and
bring the whole global economy down with it.
To prevent that outcome,
the Treasury asked for $700 billion
that it could use not only to mount rescues of individual institutions,
but also to try to get ahead of the crisis
by taking proactive steps to shore up the financial system.

Sure, you can question how the money was used -- many of us have --
but you can’t quarrel with the fact that
a financial meltdown has been avoided
as a direct result of the government’s extraordinary interventions.
Fannie Mae and Freddie Mac are providing much-needed support to
a mortgage market that would be shuttered without them.
The orderly wind-down of AIG‘s book of credit-default swaps
prevented the collapse of an enormous financial house of cards.
Citigroup was prevented from becoming the next Lehman Brothers,
while the balance sheets of the other big banks
have been fortified with additional capital
in expectation of further significant write-offs.

Who has benefited from all this? Every investor, every household and every business in the United States. You may not like the fact that, as a result of these actions, overpaid bankers were allowed to hang on to their jobs or preserve the value of their stock holdings. And you may be unhappy that the financial system remains in such fragile shape that it is still hard for some people and businesses to get loans they think they deserve. But let me assure you that things would have been a whole lot worse if these actions had not been taken.

One of the more specious criticisms is that the government “gave” $250 billion to big banks that are now just “sitting” on the money or using it to feather their own nests.

First off, we didn’t “give” money to anyone. We invested money in banks in exchange for preferred stock, which is now earning a 5 percent annual dividend. Unless the banks go under, taxpayers will eventually get that money back, along with a modest profit.

One big reason banks got into the trouble they’re in is because they were allowed to hold too little capital, or reserves, relative to the volume of loans they had made. To get themselves back into a more healthy balance, banks needed to either raise additional private capital, which under the circumstances was next to impossible, or reduce the size of their loan books. By increasing bank capital, the Treasury has made it possible for banks to “deleverage” without significantly shrinking their book of outstanding loans, or shrinking them less than they would otherwise have.

Moreover, if banks are finally increasing their capital ratios and tightening lending standards after a period of extravagantly loose credit, it’s fair to ask whether that’s bad for the economy or whether it’s a long-overdue correction.

Of course, because money is fungible, critics can always say that the Treasury money is now being used to pay excessive salaries or dividends, or finance unnecessary acquisitions -- or, for that matter, to clean the toilets or support local Little League teams.
But unless the government wants to get into the business of making every spending, lending and investment decision at every major bank, then we have to pretty much have faith that, in a free-market system,
banks will use the new capital
to run their operations and maximize their profits.
[Pearlstein omits “and minimize risk”.]
The way banks maximize profits is to lend out as much money as they can attract at a price higher than they pay for it.
“Sitting” on it is hardly a winning strategy.

The reason there is still a credit crunch isn’t primarily because bankers are too greedy or even that they are too cautious, although they may be both. The better explanation is that banks can no longer can sell their loans into the secondary market, where loans have long been packaged into bonds and sold to investors. This giant “shadow banking system” has been effectively shut down for the past year after investors lost confidence in the quality of the loans within the packages. The Federal Reserve is hoping to jump-start those secondary markets by buying those packages of consumer and small-business loans directly, as has already been done with some success for home mortgages and commercial paper. That effort, however, may well require additional funds from the Treasury, which is one reason the Obama team has asked Congress to release the second round of bailout money.

There is, however, an even bigger reason why the Obama team needs the next $350 billion. In the next few weeks, banks and other financial institutions will report their latest quarterly results, and they are likely to contain another round of multibillion-dollar losses. Without additional bailout funds at their disposal, the Treasury and the Federal Reserve may find themselves unable to rescue the next Citigroup or the next AIG.

There is plenty to dislike about the Treasury’s bailout program, and no doubt there are lots of ways it can be improved, but it is simply unfair to call it a failure. Given the size of the credit bubble and the excessive leverage that banks were allowed to take on, there was no way to rescue the financial system without injecting new capital, shrinking loan portfolios and shielding bankers from the full consequences of their misjudgments. The standard by which it should be judged is not whether it is fair, which it is not, or whether it has magically prevented foreclosures and restored the normal flow of capital, which it could not, but whether it has sufficiently stabilized the financial system to allow for an orderly restructuring.

By that standard, it has been a qualified success.

Expensive, Dangerous and Necessary
By Steven Pearlstein
Washington Post, 2009-01-16

Treasury Overpaid for Bank Assets in Bailout, Oversight Panel Says
By Amit R. Paley
Washington Post, 2009-02-06

Rules for A Bank Bailout
By Anders Aslund
Washington Post Op-Ed, 2009-02-06

Capitalist Punishment
By Harold Meyerson
Washington Post Op-Ed, 2009-02-06

A Rush-and-Shush Rescue
By David Ignatius
Washington Post Op-Ed, 2009-02-11

[Its conclusion; emphasis is added.]

Wall Street’s problems have stemmed partly from
the secrecy in which
its cockeyed financial schemes were hatched.
Treasury and the Fed have been enablers of this process,
with their fetish about
not “stigmatizing” institutions that receive bailouts.
That has to stop.
If Geithner wants our money for this new rescue package,
he has to give the public more details about how it’s being spent.
This is an area where sunlight really is the best disinfectant.

How We Can Restore Confidence
By Charles T. Munger
Washington Post Op-Ed, 2009-02-11

The writer, a Republican, is vice chairman of Berkshire Hathaway Inc.,
which owns 21 percent of The Washington Post Co.'s common stock.

Soup-Kitchen Accounting
New York Times Op-Ed, 2009-02-18

[An excerpt; emphasis is added.]

Executives of banks that have received TARP cash have said that
it is too hard to account separately
for how they spend their federal dollars.

Money is fungible, they argue, and therefore
they cannot readily distinguish between
outlays of their own resources and
those provided by the government.
But that’s the type of doublespeak
that would get the head of a town’s homeless shelter thrown in jail.
If bankers are unable to segregate cash by source
and specifically account for expenditures,
why are they in charge of banks in the first place?

Were a bank or other bailout beneficiary
required to maintain separate accounts for its federal receipts,
then independent auditors could track all direct outlays of those funds.
All they would have to do is
follow the checks drawn on the accounts used for government money.

The Bailout Is Robbing the Banks
New York Times Op-Ed, 2009-02-18

Propping Up a House of Cards
New York Times, 2009-02-28

[An excellent review of AIG’s bad practices.
A summary:]

More than even Citi or Merrill,
A.I.G. is ground zero for the practices that led the financial system to ruin.

AIG Said To Receive Access to More Cash
Insurer Expected to Report Record Loss
By Brady Dennis
Washington Post, 2009-03-02

[An excerpt; emphasis is added.]

The new deal, however,
will leave the federal government more deeply intertwined with AIG,
all but assuring that taxpayers will remain involved with the company for years.
It will expose taxpayers to increased risk over the long term,
as AIG’s assets fluctuate in value.

But sources close to the negotiations said
AIG still poses a very real risk to the global financial system,
and that
its demise would have proven far more costly to taxpayers
than will the sizable government investment.

In addition,
an AIG bankruptcy would almost certainly cause
massive disruptions throughout the insurance world,

upending the company’s 74 million policy holders
and causing more economic turmoil in the more than 100 countries where it operates.

“It’s like triage.
Band-Aids all over the place,”
said Bill Bergman, an analyst with Morningstar in Chicago.
“I think it’s a lost cause already.
Maybe we’re forestalling even bigger consequences by trying to keep it alive.”

I have yet to see anyone bound the liability
of all these financial instruments that AIG has written.

Let me give an example:
Suppose the weather changed such that
Florida became threatened by an endless stream of giant hurricanes.
That would affect
people and businesses located in Florida and
insurance companies with coverage there.
All would, no doubt,
request help from the federal government to meet this situation.
With regard to the insurance companies,
the first question the government would no doubt ask is:
“How much is your liability down there?
What and how much coverage have you written in those affected areas?”
The government would use that both in deciding what to do
and in determining how much of its money would be needed.
Further, the government would, I think,
let it be known publicly how much liability it was willing to transfer to itself,
and thus ask the general public to take on.

But that sort of information for AIG, if known by the government,
does not seem to be being made public.
Just how much is AIG on the hook for,
and how much of that is the government willing to take responsibility for?

On 2009-03-08, Patrick Lang raised the same issue.

U.S. Likely to Keep the Reins on Fannie and Freddie
New York Times, 2009-03-03

[Its beginning; emphasis is added.]

Despite assurances that
the takeover of Fannie Mae and Freddie Mac would be temporary,
the giant mortgage companies will most likely
never fully return to private hands,

lawmakers and company executives are beginning to quietly acknowledge.

The possibility that these companies —
which together touch over half of all mortgages in the United States —
could remain under tight government control
is shaping the broader debate over the future of the financial industry.
The worry is that if the government
cannot or will not extricate itself from Fannie and Freddie,
it will face similar problems should it eventually nationalize some large banks.

The lesson, many fear, is that
a takeover so hobbles a company’s finances and decision making
that independence may be nearly impossible.

In the last six weeks alone, the Obama administration
has essentially transformed Fannie Mae and Freddie Mac
into arms of the federal government.
Regulators have ordered the companies to
  • oversee a vast new mortgage modification program,

  • buy greater numbers of loans,

  • refinance millions of at-risk homeowners, and

  • loosen internal policies
    so they can work with more questionable borrowers.

Lawmakers have given the companies access to
as much as $400 billion in taxpayer dollars,
a sum more than twice as large as the pledges to
Citigroup, Bank of America, JPMorgan Chase,
General Motors, Wells Fargo, Goldman Sachs and Morgan Stanley

Regulators defend those actions as essential to battling the economic crisis.
Fannie and Freddie are basically the only lubricants in the housing market
at this point.


At A.I.G., Good Luck Following the Money
New York Times, 2009-03-15

[The government’s actions here seem outrageous.]

WE return this week to the subject of the American International Group, the giant insurer that has received $170 billion in taxpayer guarantees, because the clamor over its rescue continues to grow. Of concern to those on both Capitol Hill and Main Street is the secrecy surrounding the $50 billion funneled to A.I.G.’s counterparties since it nearly collapsed last fall.

Now that we live in bailout nation, why does the A.I.G. rescue rub so many the wrong way? Here is a hypothesis: Even as investors, employees, communities and taxpayers have been battered by the crippled financial system, A.I.G.’s counterparties were saved from losses on deals they struck with the insurer.

Add the fact that the government has resisted revealing these companies’ identities or how much federal money they received, and it’s easy to see why resentment boils. As a result of the A.I.G. rescue, taxpayers own almost 80 percent of the company. (Friday evening, as this column was going to press, rumors were swirling that A.I.G. might be releasing a list of all of its counterparties.)

Representative Carolyn B. Maloney, Democrat of New York, said she had twice asked for a full accounting from Ben S. Bernanke, the chairman of the Federal Reserve, which arranged the A.I.G. rescue. She has not received it.

“They have told others it is proprietary information,” Ms. Maloney said in an interview. “But we are the proprietors now. Taxpayers own the store, and we should be able to see the books.”

A.I.G., at one time the world’s largest insurer, sold contracts to these sophisticated counterparties that theoretically protected them from losing money if the debt they had purchased defaulted. Known as credit default swaps, the contracts offer the same kind of protection a homeowner receives from an insurance policy against fires and other unforeseen calamities.

The arrangements behind the deals produced fees for A.I.G. while the firms buying the contracts got peace of mind. No one thought A.I.G. might have to pay hundreds of billions of dollars in claims. Until, that is, A.I.G. came under financial pressure last year.

When the government stepped in to rescue A.I.G., its main and very reasonable concern was that a collapse of the insurer would drag down with it other big financial companies that were its customers. So the government shoveled taxpayers’ money into A.I.G., beginning with an $85 billion loan last September.

Then the rescuer went mum.

Officials at the Fed, who continue to oversee the A.I.G. rescue, have taken the position that the terms of the insurers’ contracts are confidential and that it would be wrong for the government to break those promises by naming recipients of taxpayer money. Another concern may have been that disclosures of A.I.G.’s counterparties might make investors and depositors uneasy about the well-being of the firms getting the money.

According to people briefed on the situation who were granted anonymity because they were not authorized to talk about it, the counterparties that taxpayers have bailed out include Goldman Sachs, Merrill Lynch and two French banks, Calyon and Société Générale. Along with other unidentified entities, the counterparties have received 30 percent of the $170 billion allocated to A.I.G. (Goldman has said that it had insulated itself from any financial damage that might have resulted from an A.I.G. collapse.)

Even A.I.G.’s own independent directors haven’t been told which of the counterparties were paid, according to a person with direct knowledge of the matter who requested anonymity because of confidentiality agreements.

SUCH secrecy raised hackles because the insurance claims were paid off in full, even though widespread defaults on the underlying debt have not occurred. Why, many people wonder, did the Fed make A.I.G.’s counterparties whole on losses that have not happened yet? Why didn’t it force these financial companies to close out the contracts at a discount, making them take what is known on Wall Street as a “haircut”?

Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Conn., and an expert in insurance, speculated that the United States was afraid that A.I.G.’s foreign bank counterparties would suffer large hits to their capital cushions, the amount they must set aside in case of losses.

“If somebody takes away the A.I.G. guarantee, all of a sudden the banks’ capital ratios look bad,” he said. “It might have stretched some of these banks.”

Still, Mr. Arvanitis said, it is not clear that the government had to pay out 100 percent of the contracts’ value to all the counterparties. Healthier institutions could have been persuaded to take a haircut, he said. “That is what tough negotiators do,” he added.

The government installed Edward M. Liddy as chief executive of A.I.G. when the company was bailed out. A former chief executive of Allstate, Mr. Liddy was also a director at Goldman Sachs before he joined A.I.G.

And in January, the Fed appointed three trustees to oversee the insurer. Their job is to maximize the company’s ability to repay amounts owed to the government and to ensure that A.I.G. is managed “in a manner that will not disrupt financial market conditions,” according to the Fed.

The trustees are Jill M. Considine, former chairman of the Depository Trust Company and a former director of the Federal Reserve Bank of New York; Chester B. Feldberg, a former New York Fed official who was chairman of Barclays Americas from 2000 to 2008; and Douglas L. Foshee, chief executive of the El Paso Corporation and chairman of the Houston branch of the Federal Reserve Bank of Dallas.

The trustees have already rankled a big A.I.G. shareholder. The American Federation of State, County and Municipal Employees pension plan, which owns 18,000 shares of A.I.G. common stock, had put forward a shareholder proposal on executive pay that it hoped would be put to a vote at the company’s annual meeting in May.

The proposal asked the company to adopt a policy requiring senior executives at A.I.G. to retain a significant percentage of the shares they received as compensation until two years after they left the company. Such a policy would help reward performance based on long-term value creation for shareholders, the pension plan said.

But Richard Ferlauto, the director of corporate governance and pension investment at Afscme, said A.I.G. trustees have indicated they oppose the proposal. But Kevin F. Barnard, a lawyer at Arnold & Porter who represents the trustees, said they were still considering the proposal. “To my knowledge, they are batting ideas back and forth but have not made fixed decisions,” he said.

Mr. Ferlauto said the compensation debate at A.I.G. would be yet another indication of how A.I.G. sees its relationship with those who continue to bail it out of trouble: taxpayers.

“If they do vote against a reasonable compensation reform,” he said, “then it would be an appalling breach of faith with the American taxpayer.”

Following the A.I.G. Money
New York Times Editorial, 2009-03-15

[Emphasis is added.]

The bailouts of American International Group
are also rescues of its trading partners — banks and other financial firms —
that would have lost out if the insurer had been allowed to fail.
But even after four bailouts between last September and this March,
no one knows with certainty who those partners are
or how much of the bailout money, now totaling $160 billion,
has gone to make them whole.

A.I.G. has not said who they are, and neither have government officials in charge of the A.I.G. bailouts — mainly Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke — despite repeated inquiries from Congress. (The Wall Street Journal, citing confidential documents, reported recently that about $50 billion in 2008 bailout money from A.I.G. went to at least two dozen firms, including Goldman Sachs, Merrill Lynch, Bank of America and European banks.) Late last week there was talk that more official information was forthcoming, but no one has seen it yet.

The secrecy is unacceptable.
Taxpayers have a right to know how their tax dollars are being spent.
Equally important, understanding how the financial crisis happened is crucial to ensuring that it does not happen again.
To that end, Congress and the public alike need to know
which firms are on the receiving end of the bailouts,
how they came to require a government lifeline,
and what responsibility they bear for the financial mess.

From what is known,
it certainly does not appear that A.I.G’s trading partners
were entirely innocent victims of extraordinary circumstances.
A.I.G. was a key player in a type of unregulated derivative
called a credit default swap.
Such swaps are often defined as a form of insurance because
the seller guarantees payment to investors in case their investments go bust.
They are not safe insurance in any familiar sense, however, because
A.I.G. was not required to set aside reserves in the event of a claim.
[And the government ignored this.
I thought the government regulated insurance companies.]

That is why, when the bubble burst and defaults rose,
A.I.G. was unable to make good,
provoking the bailouts.

Still, the trading partners knew, or should have known,
how dangerous the swaps were.
And that is not necessarily the whole story.
In the manic years of this decade,
credit default swaps took off as a way to bet on
the likelihood of default by a firm or an investment portfolio,
without having to own any financial interest in the firm or portfolio.
That is definitely not insurance, it is gambling.
The reason it is not illegal gambling is that, in 2000,
Congress specifically exempted credit default swaps from state gaming laws.

The result? Eric Dinallo, the insurance superintendent for New York State,
has said that
some 80 percent
of the estimated $62 trillion in credit default swaps outstanding in 2008
were speculative.

It is unknown
how much of the credit default swaps between A.I.G. and its partners
were for speculation.
That is a question that demands an answer.
Also unknown is how much had been wagered on the demise of A.I.G.
By intervening to prevent the insurer’s failure,
the government prevented those bets from having to be paid.
Who was let off the hook?

It is not enough to simply know more about A.I.G.,
its trading partners and their activities.
What is needed is transparency going forward.
Banks resist the idea of requiring that
all trading in credit default swaps be conducted on exchanges,
in the open and subject to full regulatory scrutiny.
It is an idea, however, that is long overdue.

A.I.G. Lists Banks It Paid With U.S. Bailout Funds
New York Times, 2009-03-16

Amid rising pressure from Congress and taxpayers, the American International Group on Sunday released the names of dozens of financial institutions that benefited from the Federal Reserve’s decision last fall to save the giant insurer from collapse with a huge rescue loan.

Financial companies that received multibillion-dollar payments owed by A.I.G. include Goldman Sachs ($12.9 billion), Merrill Lynch ($6.8 billion), Bank of America ($5.2 billion), Citigroup ($2.3 billion) and Wachovia ($1.5 billion).

Big foreign banks also received large sums from the rescue, including Société Générale of France and Deutsche Bank of Germany, which each received nearly $12 billion; Barclays of Britain ($8.5 billion); and UBS of Switzerland ($5 billion).

A.I.G. also named the 20 largest states, starting with California, that stood to lose billions last fall because A.I.G. was holding money they had raised with bond sales.

In total, A.I.G. named nearly 80 companies and municipalities that benefited most from the Fed rescue, though many more that received smaller payments were left out.


The Real AIG Scandal
It's not the bonuses.
It's that AIG's counterparties are getting paid back in full.

By Eliot Spitzer
Slate.com, 2009-03-17

Everybody is rushing to condemn AIG’s bonuses,
but this simple scandal is obscuring
the real disgrace at the insurance giant:
Why are AIG’s counterparties getting paid back in full,
to the tune of tens of billions of taxpayer dollars?

For the answer to this question,
we need to go back to the very first decision to bail out AIG,
made, we are told, by
then-Treasury Secretary Henry Paulson,
then-New York Fed official Timothy Geithner,
Goldman Sachs CEO Lloyd Blankfein, and
Fed Chairman Ben Bernanke
last fall.
Post-Lehman’s collapse,
they feared a systemic failure could be triggered
by AIG’s inability to pay the counterparties
to all the sophisticated instruments AIG had sold.
And who were AIG’s trading partners?
No shock here:
Goldman, Bank of America, Merrill Lynch, UBS,
JPMorgan Chase, Morgan Stanley, Deutsche Bank, Barclays,
and on it goes.
So now we know for sure what we already surmised:

The AIG bailout has been
a way to hide an enormous second round of cash
to the same group that had received TARP money already.

It all appears, once again, to be

the same insiders protecting themselves against
sharing the pain and risk of their own bad adventure.

The payments to AIG’s counterparties
are justified with an appeal to the sanctity of contract.
If AIG’s contracts turned out to be shaky, the theory goes,
then the whole edifice of the financial system would collapse.

But wait a moment, aren’t we in the midst of reopening contracts all over the place to share the burden of this crisis?
From raising taxes—income taxes to sales taxes—
to properly reopening labor contracts,
we are all being asked to pitch in and carry our share of the burden.
Workers around the country are being asked
to take pay cuts and accept shorter work weeks
so that colleagues won’t be laid off.
Why can’t Wall Street royalty shoulder some of the burden?
Why did Goldman have to get back 100 cents on the dollar?
Didn’t we already give Goldman a $25 billion capital infusion,
and aren’t they sitting on more than $100 billion in cash?
Haven’t we been told recently that
they are beginning to come back to fiscal stability?
If that is so, couldn’t they have accepted a discount,
and couldn’t they have agreed to certain conditions
before the AIG dollars—that is, our dollars—flowed?

The appearance that this was all an inside job is overwhelming.
AIG was nothing more than a conduit
for huge capital flows to the same old suspects,
with no reason or explanation.

So here are several questions that should be answered, in public, under oath,
to clear the air:
  1. What was the precise conversation
    among Bernanke, Geithner, Paulson, and Blankfein
    that preceded the initial $80 billion grant?

  2. Was it already known who the counterparties were
    and what the exposure was for each of the counterparties?

  3. What did Goldman, and all the other counterparties,
    know about AIG’s financial condition
    at the time they executed the swaps or other contracts?
    Had they done adequate due diligence
    to see whether they were buying real protection?
    And why shouldn’t they bear a percentage of the risk of failure
    of their own counterparty?

  4. What is the deeper relationship between Goldman and AIG?
    Didn’t they almost merge a few years ago but did not
    because Goldman couldn’t get its arms around the black box that is AIG?
    If that is true, why should Goldman get bailed out?
    After all, they should have known as well as anybody that
    a big part of AIG’s business model
    was not to pay on insurance it had issued.

  5. Why weren’t the counterparties immediately and fully disclosed?

Failure to answer these questions will feed the populist rage
that is metastasizing very quickly.
And it will raise basic questions about the competence of
those who are supposedly guiding this economic policy.

Eliot Spitzer is the former governor of the state of New York.

A.I.G. Bailout Priorities Are in Critics’ Cross Hairs
New York Times, 2009-03-18

[A helpful analysis of some of the problems with the bailout of AIG.
Emphasis is added.]

Every day,
insurance companies sell policies to homeowners
to cover the cost of damage in the case of fire.
Why would those companies agree to pay out in full to a policyholder
even if a fire had not occurred?

That is the type of question being asked about
the federal government’s bailout of American International Group
in which the insurance company funneled $49.5 billion in taxpayer funds
to financial institutions,
including Deutsche Bank, Goldman Sachs and Merrill Lynch.
The payments,
which amount to almost 30 percent of the $170 billion in taxpayer commitments provided to A.I.G. since its near collapse last September,
were disclosed by the company on Sunday.

The company had resisted identifying the recipients of the taxpayers’ money
for months, citing confidentiality agreements.

But instead of quieting the controversy,
the disclosure of the amounts paid to A.I.G.’s customers
has created still more questions and unease over the insurer’s rescue,
arranged by the Federal Reserve Bank of New York
and the United States Treasury.

Critics argue that
the government’s decision
to pay buyers of A.I.G. credit insurance in full and across the board
was an inappropriate use of taxpayer money.
In addition, these people say,
options not pursued by the government
could have allowed taxpayers to benefit from future gains
or at least have done a better job of limiting the potential for losses.

The criticism surrounds the action taken by the government
on credit insurance that A.I.G. had written and sold
to large and sophisticated investors, mostly financial institutions.
The banks that did business with A.I.G. bought credit insurance
to protect against possible defaults on debt securities
they held or had underwritten.

But when A.I.G.’s credit rating was cut last year,
the company was required to post collateral on these insurance contracts.
The need to quickly deliver cash that it did not have
created the downward spiral that brought it to the brink.

What upsets some people is that
the government paid the counterparties in full
even though
the underlying securities had not experienced widespread,
or perhaps even any, defaults.

“It is inappropriate to be giving money to A.I.G.
for them to give it out to their counterparties equally,
said Robert Arvanitis,
chief executive of Risk Finance Advisors in Westport, Conn.,
and an expert in insurance.

“If we decide that another bank will be in trouble because A.I.G. fails,
then we should decide explicitly that the bank should be supported.
We should not simply give everybody 100 cents on the dollar.”

When the government bought the underlying securities to cancel the insurance,
the taxpayer became the owner of these pools of debt issues.
Because the government chose to pay par or 100 percent of the face value,
the taxpayer has downside risk if the securities lose value
but virtually no upside.

Even if none of the debt securities in the pools experience a default,
the taxpayer is likely to receive no more than par — what the government paid —
when they mature.

Had the government negotiated for a lower price, say 75 cents on the dollar,
the taxpayer might have been able to reap gains down the road.

The top three recipients
of money from the government related to the credit insurance A.I.G. had written are
Société Générale, a French bank, at $11 billion;
Goldman Sachs, at $8.1 billion; and
Deustche Bank, at $5.4 billion.

A.I.G.’s disclosure of payments to its counterparties
did not provide any details of
how the government arrived at the prices it paid for the underlying securities.
If it overpaid, the taxpayer is at greater risk of loss
and the recipients may have received more than they were due.

Another troubling aspect to some is that
so many of the counterparties are foreign institutions.
Indeed, of the 22 institutions that have received
either collateral from the government
or cash payments to close out credit insurance deals,
16 are foreign.

“I find it impossible to understand why we as taxpayers
are bailing out foreign banks,”

said Thomas H. Patrick, a founder of new Vernon Capital
and a former top executive at Merrill Lynch.
“If the shoe was on the other foot
and major U.S. institutions were exposed to those banks,
would the U.K. or the E.U. tax their citizens to pay off JPMorgan?
There has to be some explanation of why we decided to do that.”

The decision to protect foreign institutions from losses in an A.I.G. collapse
may reflect how interrelated the global financial markets have become.
That is the view of Adam Glass, a partner at Linklaters in New York
and co-head of the firm’s structured finance and derivatives practice.

“It is an interconnected world,” Mr. Glass said.
“If UBS or these French banks collapsed, it is not just their problem.
It is our problem because world economic activity
would have been further impaired.”

Even though A.I.G. finally disclosed the names of the institutions
that received so much of the government money
that was thought to be going to A.I.G.,
the idea that it took six months still rankles some market participants.

“The system was undermined by asking the American people,
under the veil of secrecy,
to bail out one company
when in fact they wanted to bail out someone else,”
said Sylvain R. Raynes, an authority in structured finance
and a founder of R & R Consulting, a firm that helps investors gauge debt risks.

“The prospectus for the bailout was not delivered to the people.
And it was not delivered because
if it had been,
the deal would not have gone through

Key Argument for Incentives Questioned
Payouts Came After Worst Had Passed,
With Riskiest Bets Settled by December

By Binyamin Appelbaum and Brady Dennis
Washington Post, 2009-03-19

[An excerpt; emphasis is added.]

The unit at the heart of the troubles was Financial Products,
and none of its products were more problematic than
its sales of insurance-like contracts called credit-default swaps.

Companies bought the insurance from AIG on the performance of
investments called collateralized debt obligations,
which ultimately depend on borrowers to repay loans.
At the end of 2007,
the division had guarantees outstanding of about $78 billion.
[But the government has spent over $170 billion in bailing out AIG.]
If enough borrowers defaulted and the investors lost money,
AIG was on the hook.

Under the government’s rescue plan,
the Federal Reserve created a special entity to
buy the insured investments from AIG’s customers,
allowing the company to cancel the contracts.

The entity was called Maiden Lane III,
after the street that runs alongside
the headquarters of the Federal Reserve Bank of New York.

A collapse in the market for such assets has massively depressed prices, but
the companies were compensated at the full original value.
The Fed did not pay the full price.
AIG had already provided other assets to the companies
as collateral for its guarantees.
The companies were allowed to keep those assets,
and the Fed made up the difference between
the value of the original asset and the value of the collateral.

Through the end of December,
the government and AIG had paid about $62.1 billion
for assets valued in December at $29.6 billion,
rewarding the former holders of AIG insurance policies
with more than $30 billion in value they would not have received
if the assets had defaulted and AIG was unable to meet its obligations.

The Fed expects to get a return on the investment
by holding the assets until they recover their full value.
[Like the Fed has omniscience to know what that is.]

The greatest beneficiaries were the French bank Societe Generale,
which got more than $16 billion
for assets valued at about $8 billion in December,
and Wall Street giant Goldman Sachs,
which was paid almost $14 billion
for assets valued in December at about $6 billion.
Other large beneficiaries included Deutsche Bank and Merrill Lynch,
which was acquired by Bank of America.
Goldman Sachs and other banks have said that
they were separately protected against losses related to these AIG contracts
and therefore they would not have been damaged
if AIG had not bought the assets at full value.

[So why did the Fed buy those contracts?
Who would have been damaged?
Evidently, just those parties that were on the hook to indemnify Goldman Sachs
if GS took a loss on the assets described above.
Those parties, who are still unknown,
are the evident beneficiaries of the Fed’s actions as described above.]

Connecticut Senator Draws Voters’ Ire for His Bonus Role
New York Times, 2009-03-20

[An excerpt.]

On Thursday, the senator sought to defuse the furor over the latest revelation,
holding a conference call with reporters to explain
how legislation meant to limit executive compensation
was changed at the last minute.
That change exempted bonuses protected by contracts,
like those at American International Group,
a big campaign contributor to Mr. Dodd
that received billions in federal bailout money.

Mr. Dodd said that his staff revised the bill
at the urging of Treasury officials,
who he said were concerned that the compensation limits,
which he had written in the original legislation,
went too far and might invite lawsuits.


On Thursday,
Treasury Secretary Timothy F. Geithner came to Mr. Dodd’s defense,
saying in an interview with CNN that
his staff had raised concerns about
whether the legislation limiting executive compensation
“was vulnerable to legal challenge.”

Goldman Insists It Would Have Lost Little if A.I.G. Had Failed
New York Times, 2009-03-21

Hoping to reduce a swirl of speculation over
its role in the bailout of the American International Group,
Goldman Sachs reiterated Friday that
its direct losses would have been minimal
if A.I.G. had failed.


Under intense pressure from lawmakers,
A.I.G. recently released a list of counterparties, and
Goldman was among the largest,
accepting $12.9 billion of the insurer’s bailout money.
For some, this raised questions about the government’s motivations
for not letting the insurance company go into bankruptcy protection.


[So why did the U.S. give AIG $13G which AIG then promptly shipped to Goldman?
You know,
all this hysteria from the Fed, Treasury, and the media about
how these bailouts are necessary to prevent a “meltdown” of the financial system,
and the media’s favorite metaphor of “the house is on fire
are full of sound and fury,
but what the threat actually is or was
is left remarkably unprecise.
This is, I would suggest,
one of American political history's biggest snow jobs,
right up there with all those weapons of mass destruction
that various sources were absolutely sure were lurking in Iraq.]

The Real AIG Scandal, Continued!
The transfer of $12.9 billion from AIG to Goldman looks fishier and fishier.
By Eliot Spitzer
Slate.com, 2009-03-22

[Emphasis is added.]

The AIG scandal is getting ever-more disturbing.
Goldman Sachs’ public conference call
explaining its trading relationship and exposure with AIG
established, once again, that Goldman knows how to protect itself.
According to Goldman, even if AIG had failed,
Goldman’s losses would have been minimal.

How did Goldman protect itself?
Sensing AIG’s weakening capital position through 2006 and 2007,
Goldman demanded more collateral from AIG
and covered outstanding risk with instruments from other firms.

But this raises two critical questions.
The first is
why $12.9 billion of taxpayer money went from AIG to Goldman.
What risk—systemic or otherwise—was being covered?
If Goldman wasn’t going to suffer severe losses,
why are taxpayers paying them off at 100 cents on the dollar?
As I wrote earlier in the week,
the real AIG scandal
is that
the company’s trading partners are getting fully paid
rather than taking a haircut.

Goldman’s answer is that it was merely taking a commercial position—
trying to avoid any losses at all on its AIG positions.
I suppose we can hardly expect Goldman to reject
government assistance in the form of pure cash
that seems to have had no strings attached.

what were the government officials possibly thinking?
The only rationale for what we should call
the “hidden conduit bailout” to AIG’s trading partners
is that
the cascading effect of AIG’s inability to pay
would have been devastating.
But Goldman has now said very clearly
there would have been no cascade.
Not even a ripple.

Is the same true of AIG’s other counterparties,
including several foreign banks?

What examination of the impact of an AIG failure
did federal officials undertake
before deciding to spend countless billions
bailing out AIG and its trading partners?

[That’s a damned good question.
I don’t know if the answer is available somewhere, but if not, it should be.
And if it is, I wish I knew where.

In the circles I am familiar with, before a decision of that magnitude is made
a decision memorandum (or equivalent) must be prepared,
stating clearly and specifically
(none of this “the house is on fire” bullshit favored by the Post’s editorial page)
the consequences of continuing the current course of action,
the alternative courses of action,
the pros and cons of each,
finally making a recommendation as to the preferred resolution.
Do the Fed and Treasury work with a lesser standard of decision-making rigor?]

The government decision to bail out AIG was made
after the private parties, supposedly at risk,
had declined to structure a private series of investments
that might have avoided the need for use of public money.
Perhaps they knew the impact of an AIG default would be small,
or perhaps they knew that
the federal officials in the room would blink and ante up.
In a post-Lehman moment
when panic, not reason, was dominating the discussion,
perhaps they figured they could walk away with extra billions—
and, indeed, they did.

This issue cries out for immediate government inquiry.
Maybe one or two of the more than two dozen government entities
now beating their chests about bonuses
can redirect their energies to this much larger issue confronting us:
Who signed off on this $80 billion bailout—now approaching $200 billion—
and why?

[It is nice that Eliot Spitzer can raise these worthy questions.
Why is it the editorial board of, say, the Washington Post
seems so uninterested in raising these questions,
rather preferring to serve as cheerleaders, apologists and rationalizers for
whatever trillion-dollar bailouts, “stimuli,” and expansion of the money supply
the financial types ask for?]

The second question, of course, is
why Goldman was wise to AIG’s declining position two years ago
but nobody else appears to have known.

There is always the operating premise
that Goldman is better than the rest in the field,
but where were the federal agencies
that should have been taking a look at
AIG’s leverage situation and general financial health?

And were AIG’s public statements accurate in revealing a decline?
Or did Goldman, with its multiple trading relationships with AIG,
get an early warning?
This series of questions also demands immediate inquiry and resolution.

What continues to be fundamentally disappointing is that
the “too big to fail” institutions
continue to absorb enormous sums of taxpayer support
without either demonstrating the genuine need for such support
or altering their behavior after receiving it.

After getting $12.9 billion in what now seems to be a mere gift,
has Goldman begun to lend in a way that will restore the credit markets?
Were they asked to do so?

It is time the government realizes it has two simple options:
tightly regulate entities that are too big to fail
or break them up so they aren’t.

Eliot Spitzer is the former governor of the state of New York.

Inquiry Asks Why A.I.G. Paid Banks
New York Times, 2009-03-27

Members of Congress and the New York State attorney general
demanded detailed information Thursday on
how tens of billions of taxpayer dollars
flowed through the American International Group
during its crisis last fall
and ended up in
the coffers of several dozen big banks, shielding them from losses.


How to Conjure Up $500 Billion
New York Times Op-Ed, 2009-03-27

[An excerpt; emphasis is added.]

The F.D.I.C. was created to do what its name implies: insure deposits.
Deposits are loans of a kind:
when you make a deposit at the bank,
you’re lending the bank your money, normally at a very low rate of interest.
The F.D.I.C. exists to make sure that whatever happens to the bank,
you’ll always get your money back — up to a limit of $250,000.

Now, however, instead of insuring garden-variety bank deposits,
the F.D.I.C. is going to insure
extremely risky loans to
curious new entities called public-private investment funds.

And while banks can always borrow money somewhere,
these funds wouldn’t be able to borrow at all
were it not for that F.D.I.C. guarantee.

Imagine going to your local bank
and asking for $10 billion to gamble at the Toxic Asset Casino.
The bank would say no —
until you showed it a letter from your Uncle Sam saying he’d guarantee the loan.
Then, the bank would lend you as much as you’d like.
The F.D.I.C. has never taken on this kind of risk before.

It’s not the first time
that Treasury has magicked billions of dollars from some hidden back pocket,
just to avoid having to ask Congress for the money....

[The good news about the FDIC:
Their IT staff really knows how to have a fun golf tournament.
Would Sheila Bair .....?]

This Time, Geithner’s Plan for Banks Makes Sense
New York Times, 2009-03-28

Obama’s Ersatz Capitalism
New York Times Op-Ed, 2009-04-01

THE Obama administration’s $500 billion or more proposal
to deal with America’s ailing banks
has been described by some in the financial markets as
a win-win-win proposal.
Actually, it is a win-win-lose proposal:
the banks win, investors win — and taxpayers lose.

Treasury hopes to get us out of the mess
by replicating the flawed system
that the private sector used to bring the world crashing down,
with a proposal marked by
overleveraging in the public sector,
excessive complexity,
poor incentives and
a lack of transparency.

Let’s take a moment to remember what caused this mess in the first place.
Banks got themselves, and our economy, into trouble by overleveraging —
that is, using relatively little capital of their own,
they borrowed heavily to buy extremely risky real estate assets.
In the process, they used overly complex instruments
like collateralized debt obligations.

The prospect of high compensation
gave managers incentives to be shortsighted and undertake excessive risk,
rather than lend money prudently.
Banks made all these mistakes without anyone knowing,
partly because so much of what they were doing was “off balance sheet” financing.

In theory, the administration’s plan is based on
letting the market determine the prices of the banks’ “toxic assets” —
including outstanding house loans and securities based on those loans.
The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets.

The two have little to do with each other.
The government plan in effect involves insuring almost all losses.
Since the private investors are spared most losses,
then they primarily “value” their potential gains.
This is exactly the same as being given an option.

Consider an asset that has a 50-50 chance of being worth either zero or $200
in a year’s time.
The average “value” of the asset is $100.
Ignoring interest,
this is what the asset would sell for in a competitive market.
It is what the asset is “worth.”
Under the plan by Treasury Secretary Timothy Geithner,
the government would provide about 92 percent of the money to buy the asset
but would stand to receive only 50 percent of any gains,
and would absorb almost all of the losses.
Some partnership!

Assume that
one of the public-private partnerships the Treasury has promised to create
is willing to pay $150 for the asset.
That’s 50 percent more than its true value,
and the bank is more than happy to sell.
So the private partner puts up $12, and the government supplies the rest —
$12 in “equity” plus $126 in the form of a guaranteed loan.

If, in a year’s time, it turns out that the true value of the asset is zero,
the private partner loses the $12,
and the government loses $138.
If the true value is $200, the government and the private partner split the $74 that’s left over after paying back the $126 loan.
In that rosy scenario, the private partner more than triples his $12 investment.
But the taxpayer, having risked $138, gains a mere $37.

Even in an imperfect market, one shouldn’t confuse
the value of an asset with
the value of the upside option on that asset.

But Americans are likely to lose even more than these calculations suggest,
because of an effect called adverse selection.
The banks get to choose the loans and securities that they want to sell.
They will want to sell the worst assets,
and especially the assets that they think the market overestimates
(and thus is willing to pay too much for).

But the market is likely to recognize this,
which will drive down the price that it is willing to pay.
Only the government’s picking up enough of the losses
overcomes this “adverse selection” effect.
With the government absorbing the losses,
the market doesn’t care
if the banks are “cheating” them by selling their lousiest assets,
because the government bears the cost.

The main problem is not a lack of liquidity.
If it were, then a far simpler program would work:
just provide the funds without loan guarantees.
The real issue is that
the banks made bad loans in a bubble and were highly leveraged.
They have lost their capital, and this capital has to be replaced.

Paying fair market values for the assets will not work.
Only by overpaying for the assets will the banks be adequately recapitalized.
overpaying for the assets simply shifts the losses to the government.
In other words, the Geithner plan works only if and when
the taxpayer loses big time.

Some Americans are afraid that
the government might temporarily “nationalize” the banks,
but that option would be preferable to the Geithner plan.
After all, the F.D.I.C. has taken control of failing banks before,
and done it well.
It has even nationalized large institutions like Continental Illinois
taken over in 1984, back in private hands a few years later), and
Washington Mutual (seized last September, and immediately resold).

What the Obama administration is doing is far worse than nationalization:
it is ersatz capitalism,
the privatizing of gains and the socializing of losses.
It is a “partnership” in which
one partner robs the other.

And such partnerships — with the private sector in control —
have perverse incentives, worse even than the ones that got us into the mess.

So what is the appeal of a proposal like this?
Perhaps it’s the kind of Rube Goldberg device that Wall Street loves —
clever, complex and nontransparent,
allowing huge transfers of wealth to the financial markets.
It has allowed the administration to avoid going back to Congress
to ask for the money needed to fix our banks,
and it provided a way to avoid nationalization.

But we are already suffering from a crisis of confidence.
When the high costs of the administration’s plan become apparent,
confidence will be eroded further.
At that point
the task of recreating a vibrant financial sector,
and resuscitating the economy,
will be even harder.

Ex-Chairman of A.I.G. Says Bailout Has Failed
New York Times, 2009-04-03


Maurice R. Greenberg,
the former chairman of the American International Group,
said Thursday that
the government’s $170 billion bailout had failed and that
taxpayers would have been better off letting the company go bankrupt.

“It is clear that
the current approach has not worked and cannot work in today’s environment,”
Mr. Greenberg, who was ousted from A.I.G. in 2005,
told the House Oversight and Government Reform Committee.
“A.I.G., in my judgment, in the current plan, will not pay the taxpayers back.”

Refusing to accept any personal blame for his former company’s collapse,
Mr. Greenberg insisted that A.I.G.’s problems
stemmed from mismanagement after he left and that
the Treasury and Federal Reserve had made things worse
by trying to break the business up and sell it off in pieces.

He also disputed the statements
of both
the Treasury secretary, Timothy F. Geithner, and
the chairman of the Federal Reserve, Ben S. Bernanke,
letting the company go bankrupt
would wreak further havoc with the economy.

“There would have been a ripple,
but it wouldn’t have been catastrophic,”

Mr. Greenberg said.
“I don’t think it would have been disastrous.”


‘No-Risk’ Insurance at F.D.I.C.
New York Times, 2009-04-07

[Emphasis is added.]

The Federal Deposit Insurance Corporation was set up 76 years ago
with the important but simple job of insuring bank deposits.

Now, because of what could politely be called mission creep,
it’s elbowing its way into the middle of the financial mess as
an enabler of enormous leverage.

In the fine print of Treasury Secretary Timothy F. Geithner’s plan
to lend as much as $1 trillion to private investors
to help them buy toxic assets from our nation’s banks,
you’ll find some details of
how the F.D.I.C is trying to stabilize the system
by adding more risk, not less, to the system.

It’s going to be insuring 85 percent of the debt, provided by the Treasury,
that private investors will use
to subsidize their acquisitions of toxic assets.
The program, extraordinary in its size and scope,
is the equivalent of TARP 2.0.
Only this time, Congress didn’t get a chance to vote.

These loans, while controversial, were given a warm welcome by the market
when they were first announced.
And why not? The terms are hard to beat.
They are, for example, “nonrecourse,”
which means that if an investor loses money, he owes taxpayers nothing.
It’s the closest thing to risk-free investing — with leverage! — around.

But, as we’ve learned the hard way these last couple of years,
risk-free investing is an oxymoron.

So where did the risk go this time?

To the F.D.I.C., and ultimately, to us taxpayers.
A close reading of the F.D.I.C.’s statute
suggests the agency is using a unique —
some might call it plain wrong —
reading of its own rule book to accomplish this high-wire act.

Somehow, in the name of solving the financial crisis,
the F.D.I.C. has seemingly been given a blank check,
with virtually no oversight by Congress.

“Nobody is paying any attention to how they’re pulling this off,”
said a prominent securities lawyer who has done work for the government.
Not surprisingly, he, along with others I asked to review the program,
declined to be quoted by name.
“They may not be breaking the letter of the law,
but they’re sure disregarding its spirit.”

The F.D.I.C. is insuring the program,
called the Public-Private Investment Program,
by using a special provision in its charter
that allows it to take extraordinary steps
when an “emergency determination by secretary of the Treasury” is made
to mitigate “systemic risk.”

Simple enough, but that language seems to bump up against
another, perhaps more important provision.
That provision clearly limits
its ability to borrow, guarantee or take on
obligations of more than $30 billion.

The exact legalistic language says that
it “may not issue or incur any obligation” over that limit.
(You can read a highlighted version of the F.D.I.C.’s charter at nytimes.com/dealbook [here].)

So how is the F.D.I.C. planning to insure
more than $1 trillion in new obligations?
This is where things get complicated and questions are being raised.

The plan hinges on the unique, and somewhat perverse, way
the F.D.I.C. values the loans.
It considers their value not as the total obligation,
but as “contingent liabilities” —
meaning what it expects it could possibly lose.
As the F.D.I.C’s charter dictates:
“The corporation shall value any contingent liability
at its expected cost to the corporation.”

So how much does the F.D.I.C. think it might lose?

“We project no losses,”
Sheila Bair, the chairwoman, told me in an interview.
Zero? Really?
“Our accountants have signed off on no net losses,” she said.

(Well, that’s one way to stay under the borrowing cap.)

By this logic, though, the F.D.I.C. appears to have determined
it can lend an unlimited amount of money to anyone
so long as it believes, at least at the moment, that it won’t lose any money.

Here’s the F.D.I.C.’s explanation:
It says it plans to carefully vet every loan that gets made
and it will receive fees and collateral in exchange.
And then there’s the safety net:
If it loses money from insuring those investments,
it will assess the financial industry a fee to pay the agency back.

But think about this for a moment:
if the program doesn’t work — and let’s hope it succeeds —
the F.D.I.C. would be forced to “assess” banks it is hoping to save,
possibly bankrupting them in the process.
After all, if the F.D.I.C. starts losing money,
it will probably be
because the broader economic environment is deteriorating further.
So those fees will a new burden
at a time when key financial players can least afford them.

Ms. Bair said that she can not imagine the F.D.I.C. losing money on the scale I suggested in my doomsday scenario.
She said that before announcing the program,
the F.D.I.C.’s lawyers determined that
the statute allowed it to guarantee loans
by valuing them as contigent liabilities.
“That’s how we’ve interpreted it,” she said,
adding that the determination was made back in October
when the F.D.I.C. first introduced the Temporary Liquidity Guarantee Program,
which is also backed by the F.D.I.C.

She also defended her agency saying that
the F.D.I.C. has not experienced mission creep:
the various programs that it is participating in
are meant to insure the stability of the financial system,
which she says was always the goal of the agency.
She also pointed out that under the Temporary Liquidity Guarantee Program,
so far, the agency hasn’t lost a dollar —
and more important, she said,
the program has worked to stabilize the banking system.

All true, but that has come as the burden on the F.D.I.C. has increased
as it pays out more to cover losses of failed banks.

In a letter to the financial industry last month
seeking an assessment that could be as much as $27 billion,
Ms. Bair wrote,
“Without these assessments,
the deposit insurance fund could become insolvent this year.”
Ms. Bair seems to recognize that
the borrowing limit of $30 billion makes her job difficult.
And two officials with a lot of sway in this area
have sought to raise the F.D.I.C.’s borrowing limit
(by $100 billion, according to a bill introduced by Representative Barney Frank,
by $500 billion, in a bill introduced by Senator Christopher Dodd).

But then again, who needs a borrowing limit
when the potential liabilities from the new program seem to be zero?

If the P.P.I.P. program works — and again,
it’s in everybody’s interest to cheer it on —
it will be a boon for the economy and participating investors,
who will likely make off like bandits.

[Just how does this differ from “crony capitalism?”]

If the program fails, however, there will be heavy losses on us.
In other words,
taxpayers could be the ones stuck with
billions of dollars in “contingent liabilities.”

And these days, whenever anybody talks about risk-free investing,
it’s not hard to hear the famous line
uttered by Joseph J. Cassano of A.I.G. in 2007:
“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 one dollar in any of those transactions.”

[For a follow-up to this article, see
More on the F.D.I.C.’s ‘No-Loss’ Loan Guarantees” (2009-04-09).]

Big Profits, Big Questions
New York Times Op-Ed, 2009-04-15

AT its nadir last November, Goldman Sachs’s share price closed at $52, nearly 80 percent below its high of around $250. By then, many of its chief competitors — Bear Stearns, Lehman Brothers, Merrill Lynch and UBS — were dead or shadows of their former selves. Even Morgan Stanley, long considered Goldman’s archrival, had nearly died. But somehow, less than five months later, on the heels of a surprisingly profitable first quarter of fiscal 2009, Goldman Sachs is once again riding high, with its stock closing Tuesday at $115 a share.

The question many Wall Streeters are asking is just how Goldman once again snatched victory from the jaws of defeat. Many point to Goldman’s expert manipulation of the levers of power in Washington. Since Robert Rubin, its former chairman, joined the Clinton administration in 1993, first as the director of the National Economic Council and then as Treasury secretary, the firm has come to be known, as a headline in this newspaper last October put it, as “Government Sachs.”

How can one ignore, the conspiracy-minded say, the crucial role that Henry Paulson, who followed Mr. Rubin to the top at both Goldman and Treasury, played in the decisions to shutter Bear Stearns, to force Lehman Brothers to file for bankruptcy and to insist that Bank of America buy Merrill Lynch at an inflated price? David Viniar, Goldman’s chief financial officer, acknowledged in a conference call yesterday the important role the changed competitive landscape had on Goldman’s unexpected first-quarter profit of $1.8 billion: “Many of our traditional competitors have retreated from the marketplace, either due to financial distress, mergers or shift in strategic priorities.”

But he was largely mum on American International Group, which, Goldman’s critics insist, is the canvas upon which the bank and its alumni have painted their great masterpiece of self-interest. A few days after Mr. Paulson refused to save Lehman Brothers last September — at a cost of a mere $45 billion or so — he came to A.I.G.’s rescue, to the tune of $170 billion and rising. Then he decided to install Edward Liddy — a former Goldman Sachs board member — as A.I.G.’s chief executive. Goldman has since received some $13 billion in cash, collateral and other payouts from A.I.G. — that is, from taxpayers.

Why kill Lehman and save A.I.G.? The theory, we now know, was that the government felt it needed to save the firms, including Goldman Sachs, that had insured many of their risky ventures through the insurer. Indeed, had Mr. Paulson decided not to save A.I.G., its counterparties would have suffered serious losses. Lehman’s creditors will be lucky to get back pennies on the dollar.

In a conference call he held last month, Mr. Viniar made the shocking claim that Goldman “had no material exposure to A.I.G.” because the firm had “collateral and market hedges in order to protect ourselves.” If so, then why did Goldman need the government’s help in the first place? During yesterday’s conference call, Guy Moszkowski, an analyst from Merrill Lynch, asked Mr. Viniar what role the $13 billion Goldman has collected from A.I.G. had on its first-quarter showing. But Mr. Viniar would have none of it: Profits “related to A.I.G. in the first quarter rounded to zero.” Hmm, how then did Goldman make so much money if that multibillion-dollar gift from you and me had nothing to do with it?

Part of the answer lies in a little sleight of hand. One consequence of Goldman’s becoming a bank holding company last year was that it had to switch its fiscal year to the calendar year. Previously, Goldman’s fiscal year had ended on Nov. 30. Now it ends Dec. 31.

As a result, December 2008 was not included in Goldman’s rosy first-quarter 2009 numbers. In that month, Goldman lost a little more than $1 billion, after a $1 billion writedown related to “non-investment-grade credit origination activities” and a further $625 million related to commercial real estate loans and securities. All told, in the last seven months, Goldman has lost $1.5 billion. But that number didn’t come up on Monday. How convenient.

Which leaves us with the real reason Goldman has cleaned up this year: the huge misfortunes of its major competitors. Those other firms have disappeared or have become severely wounded, and as a result have more or less been sitting on their collective hands since the collapse of Lehman last September.

As part of its busy day on Monday, Goldman also announced it was raising $5 billion of equity capital and that it intended to pay back the $10 billion from the Treasury’s Troubled Asset Relief Program that Mr. Paulson forced on the bank last October. Being free of the TARP yoke will give Goldman yet another competitive advantage: the ability to pay its own top talent and new recruits whatever it wants without government scrutiny.

This is significant, since it is unlikely any of Goldman’s remaining competitors will be able to make a similar move anytime soon. There is a reason Bill Gates once said Microsoft’s biggest competitor was Goldman Sachs. “It’s all about I.Q.,” Mr. Gates said. “You win with I.Q. Our only competition for I.Q. is the top investment banks.” And then there was one.

William D. Cohan, a contributing editor at Fortune, is the author of
“House of Cards: A Tale of Hubris and Wretched Excess on Wall Street.”

Dimming the Aura of Goldman Sachs
New York Times, 2009-04-17

It used to be the most respected investment bank in the world.
Now it seems to be a part of more conspiracy theories
than the Central Intelligence Agency.

Goldman Sachs reported a $1.8 billion quarterly profit this week,
and sold $5 billion in new stock at a triple-digit share price.
It appears to have weathered the financial crisis
as well or better than any of its competitors.
It made money on mortgages when the making was good,
and somehow got out before the explosion devastated its competitors.

Unlike many of them, it appears to have had effective risk-management systems.
It says it spent $100 million buying protection against
something that seemed ridiculously unlikely at the time —
a default of the American International Group.

its denial that it profited from the government’s bailout of the insurance giant
is greeted with scorn.
People may not be sure about just what Goldman did that was improper,
but many seem to think there must have been something.


A.I.G. Chief Owns Significant Stake in Goldman
New York Times, 2009-04-17

Edward M. Liddy, the dollar-a-year chief executive
leading the American International Group since its bailout last fall,
still owns a significant stake in Goldman Sachs,
one of the insurer’s trading partners
that was made whole by the government bailout of A.I.G.

Mr. Liddy earned most of his holdings in Goldman,
worth more than $3 million total,
as compensation for serving on the bank’s board and its audit committee
until he stepped down in September to take the job at A.I.G.
He moved to A.I.G. at the request of Henry M. Paulson Jr.,
then the Treasury secretary and a former Goldman director.


Bank Aid Programs Are Seen as Open to Fraud
New York Times, 2009-04-21

Note also the DealBook article on this subject.


The Treasury Department’s most ambitious plans to rescue troubled banks —
partnerships between the government and private investors,
backed by the Federal Reserve —
are inherently vulnerable to fraud
and should not be started without stronger safeguards,
a top government investigator warned in a report to be released Tuesday.

The report also warned that
the Treasury’s $700 billion Troubled Asset Relief Program
has evolved into
a $3 trillion effort of “unprecedented scope, scale and complexity”
and comes with too little oversight
and too little information about
what companies are doing with the taxpayer money they are getting.

“The American people have a right to know how their tax dollars are being used,” wrote Neil M. Barofsky, the special inspector general assigned to monitor the bailout program, in his second report to Congress.

Mr. Barofsky was particularly critical of the Treasury Department’s refusal to demand detailed information from banks and other financial institutions about what they are doing with the money they receive.

Noting the widespread public outrage unleashed over the Treasury’s huge payments to the American International Group, the failing insurance conglomerate, Mr. Barofsky warned that Treasury officials were jeopardizing the credibility of their efforts by not requiring companies to disclose far more about their use of taxpayer money.

“Failure to impose this requirement with respect to the injection of yet another $30 billion into A.I.G. would not only be a failure of oversight, but could call into question the credibility of the government’s efforts,” he said. He was referring to bailout money that had been pledged, but not yet delivered, to the insurance giant.

The inspector general was particularly pointed in his criticism of the Obama administration’s plan to buy up questionable assets from banks. That plan calls for the Treasury to spend $100 billion to buy up troubled mortgages and mortgage-backed securities.

The plan also calls for multiplying the total volume of those asset purchases to almost $1 trillion by allowing private investors to borrow money at low interest rates from the Federal Reserve.

Mr. Barofsky said the plan posed “significant fraud risks,” especially when it came to buying up securities backed by exotic mortgages made during the peak of the housing bubble, when the excesses of poorly documented loans and no-money-down loans reached their zeniths.

The report said that the Federal Reserve intended its lending program, known as the Term Asset-Backed Securities Loan Facility, or TALF, to finance new lending rather than to buy up existing assets. It warned that the Fed was not currently planning to examine the securities that it would finance, and would be relying instead on the evaluation by credit rating agencies that originally failed to spot the dangers of subprime mortgages.

“Credit ratings, cited as one of the primary credit protections in TALF as currently configured, have been proven to be of questionable value,” the report said. “The wholesale failure of the credit rating agencies to rate adequately such securities is at the heart of the securitization market collapse, if not the primary cause of the current credit crisis.”

Mr. Barofsky also warned that the Treasury’s plan might allow investors to double up on government subsidies for buying up troubled assets. The Public-Private Investment Program would have the Treasury invest alongside private investors. But the partnerships would also be able to borrow money from the Fed through “nonrecourse” loans. If the investments flopped, the investors could walk away from the loans and leave taxpayers with most of the losses.

The Treasury and the Federal Reserve have not yet begun the asset purchase programs.

The two agencies started up a limited version of the TALF program last month, which is mainly focused on financing consumer and small-business loans.

In February, Treasury Secretary Timothy F. Geithner announced the broader Public-Private Investment Program, which is aimed at buying up both mortgages and mortgage-backed securities. Part of the plan calls for marrying the public-private program with the Fed’s lending program, but the program still appears to be at least a month or two away from starting.

Senator Charles E. Schumer, Democrat of New York and a member of the Senate Banking Committee, said some of the inspector general’s criticisms about buying up “legacy assets” — usually troubled mortgage-backed securities — made sense.

“There are a few problems with using the TALF program to buy up legacy assets,” he said. “First, it’s rewarding the worst behavior — buying no-doc loans.” Second, he said, the public-private program “is a very rich subsidy program to begin with. You have to ask whether it needs the extra enrichment of TALF, particularly when it involves the most egregious of mortgages.”

Treasury officials had no comment on Mr. Barofsky’s report. But Mr. Geithner is scheduled to discuss it on Tuesday at a hearing of a Congressional panel that oversees the financial bailout program.

Both the Treasury and the Fed have increased the amount of information they are making public about their various rescue plans. Treasury officials have pushed the banks to provide information about their lending volumes, and they are demanding more information about what banks are doing with their money.

But Treasury officials have argued that it is almost impossible to get meaningful information about how banks are using money under the troubled-asset program, in part because the money came with few conditions. Treasury officials have also noted that if the funds are allocated for one purpose, like mortgage lending, they free up other money that can be used for a very different purpose, like making acquisitions.

Quarterly Report to Congress (8MB PDF file)
Special Inspector General for the Troubled Asset Relief Program, 2009-04-21

Congress's Afterthought, Wall Street's Trillion Dollars
Fed's Bailout Authority Sat Unused Since 1991
By Binyamin Appelbaum and Neil Irwin
Washington Post, 2009-05-30

On the day before Thanksgiving in 1991,
the U.S. Senate voted to vastly expand
the emergency powers of the Federal Reserve.

Almost no one noticed.

The critical language was contained in a single, somewhat inscrutable sentence,
and the only public explanation was offered during a final debate
that began with a reminder that senators had airplanes to catch.
Yet, in removing
a long-standing prohibition
on loans that supported financial speculation
the provision effectively allowed the Fed for the first time
to lend money to Wall Street during a crisis.

That authority, which sat unused for more than 16 years,
now provides the legal basis
for the Fed’s unprecedented efforts to rescue the financial system.

Since March 2008,
the central bank’s board of governors has invoked its emergency powers
at least 19 times:
to contain the wreckage of Bear Stearns
and ease the fall of American International Group,
to preserve Goldman Sachs and Morgan Stanley,
to limit losses at Bank of America and Citigroup,
to lend more than $1 trillion.

The repeated use of the once-dusty law
has surprised and alarmed
a wide range of people, including economists and members of Congress.
It has even raised worries among presidents of the regional banks
that make up the Federal Reserve system.

Many critics are concerned that an institution not accountable to voters
is risking vast amounts of public money
and choosing which companies get help.
Others are concerned that
the Fed’s new role will interfere with
its basic responsibility for regulating economic growth.

There is also a question about the roots of the crisis:
Did investment banks take greater risks in the past two decades
because they knew the Fed could rescue them?

The 1991 legislation, authored by Sen. Christopher J. Dodd (D-Conn.),
was requested by Goldman Sachs and other Wall Street firms
in the wake of the 1987 market crisis,
and it would save some of them a generation later.

Fed Chairman Ben S. Bernanke and other leaders of the central bank
have argued that
the emergency authority has allowed it to rescue the financial system
and that without it, the economy would be in far worse shape.
And they argue that they are using the power as Congress intended.

“This provision was designed as a last resort
to make sure credit flows when times are tough and credit isn’t being extended,”
said Scott Alvarez, the Fed’s general counsel.
“That’s exactly what it’s being used for today.”

Rep. Barney Frank (D-Mass.),
chairman of the House Financial Services Committee,
said that the actions taken by the Fed have been necessary and important
but that those actions should have been taken
by an agency accountable to voters.
He said he was not aware of the Fed’s emergency power until September,
and he favored removing much of that authority from the Fed
once the crisis has passed.

“This is a democracy, and there is a problem with
too much power going to an entity that is not subject to democratic powers,”
Frank said.

“What the Fed has done is almost irreparable,”
said Allan H. Meltzer, a Carnegie Mellon University economist
who is a leading historian of the Fed.
“It’s going to be hard to get them to unlearn it.
Now Congress will look to the Fed
every time a constituent has a hard time getting a loan.”

The wind shifted in the late 1980s.
During the stock market crash of October 1987,
some commercial banks had refused to lend money to investment banks.
A few years later, the collapse of Drexel Burnham Lambert,
then the nation’s fifth-largest investment bank,
renewed concerns about the absence of a safety net beneath Wall Street.

Rodgin Cohen, a partner at Sullivan & Cromwell,
suggested to several of his clients
the idea of modifying the 1932 law
to allow lending to investment banks,

according to people involved in the discussions.
Cohen is a legendary figure on Wall Street,
building a career as perhaps the preeminent legal adviser on banking mergers,
in part through his command of the minutiae of federal regulations.

Dodd, at the time chairman of the securities subcommittee
of the Senate Banking, Housing and Urban Affairs Committee,
agreed to insert the language into a bill
whose primary purpose was to reform the Federal Deposit Insurance Corp.,
which guarantees commercial bank deposits.

Dodd declined to comment for this story, but at the time,
he said the legislation gave the Fed
“greater flexibility to respond in instances
in which the overall financial system threatens to collapse.”


The Fed has extensive regulatory authority over commercial banks,
to keep them from needing its safety net.
But after Dodd’s language passed into law,
the Fed did not seek new regulatory authority over investment banks,
nor did Congress move to provide new authority.

Instead, over the next two decades,
federal officials would emphasize that
investment banks had an incentive to be cautious
because they were operating without a safety net.


Too Big to Fail, or Too Big to Handle?
New York Times, 2009-06-21

“No one should assume that the government will step in to bail them out
if their firm fails.”

That’s Timothy F. Geithner, the Treasury secretary,
talking tough with lawmakers last week
as he promoted the government’s remake of the financial regulatory framework.

Talk is cheap, however.
And the notion that the plan shows a new aversion to bailouts
is not at all supported by its chapter and verse.
In fact, there’s precious little in the 88-page document
about how the government will eliminate systemic risks
posed by financial firms that aren’t allowed to fail
because they’re simply too big
or to interconnected to other important economic players here and abroad.

Rather than propose ways to shrink these companies and the risks they pose,
the Geithner plan argues instead for
enhanced regulatory oversight of the behemoths.
This suggests the taxpayer safety net
will be larger after our national financial train wreck, not smaller.

More than two years after the crisis began,
“too big to fail” remains
“too problematic to address”
with anything other than more souped-up regulation.
Given that earlier efforts at policing these entities failed so miserably,
why should anyone think that
a new-and-improved regulatory approach will fare better?


Big Estimate, Worth Little, on Bailout
New York Times, 2009-07-21

Just how much could the bailout of the financial system end up costing American taxpayers?

Neil M. Barofsky, the special inspector general for the Troubled Asset Relief Program set up by the Treasury Department, came up with the largest number yet in testimony prepared for delivery Tuesday to a House committee. “The total potential federal government support could reach up to $23.7 trillion,” he stated.

But in the report accompanying his testimony, Mr. Barofsky conceded the number was vastly overblown. It includes estimates of the maximum cost of programs that have already been canceled or that never got under way.

It also assumes that every home mortgage backed by Fannie Mae or Freddie Mac goes into default, and all the homes turn out to be worthless. It assumes that every bank in America fails, with not a single asset worth even a penny. And it assumes that all of the assets held by money market mutual funds, including Treasury bills, turn out to be worthless.

It would also require the Treasury itself to default on securities purchased by the Federal Reserve system.


Audit Faults New York Fed in A.I.G. Bailout
New York Times, 2009-11-27

The Federal Reserve Bank of New York
gave up much of its power in high-pressure negotiations
with the American International Group’s trading partners last year,
according to a government report made public on Monday.


The Big Squander
New York Times, 2009-11-20

Revisiting a Fed Waltz With A.I.G.
New York Times, 2009-11-23

A RAY of sunlight broke through the Washington fog last week
when Neil M. Barofsky,
special inspector general for the Troubled Asset Relief Program,
published his office’s report on
the government bailout last year of the American International Group.

It’s must reading for any taxpayer hoping to understand

why the $182 billion “rescue”
of what was once the world’s largest insurer
still ranks as
the most troubling episode of the financial disaster.


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