The housing bubble, its collapse, subprime mortgage crisis. Since about 1998, subprime mortgage loans have accounted for about 1/4 of US home sales. Such mortgages allowed people with low or bad credit ratings to purchase homes. Easy credit resulted in a housing boom/bubble between 2000 and 2005 and was touted as a major plank of Bush’s “ownership society”. The problem was people were sold too much house financed by loans that they could initially, if marginally, afford but which they could not after a few years as the terms on their loans changed and monthly payments greatly increased. The effects of this nonsensical lending and speculation were delayed for awhile as the housing market was on the way up and the value of homes (including those financed by subprime loans) steadily increased, but in late 2006 the bubble became unsustainable and burst. Ameriquest the largest subprime lender went belly up after a $325 million settlement with 30 state Attorney Generals for deceptive lending and marketing practices. (Its former CEO Robert Arnell was appointed Ambassador to the Netherlands by George Bush.) It was not alone. Other subprime lenders like Mortgage Lenders Network USA and Ownit followed suit. Market analysts try to downplay the significance of the subprime disaster but its effects continue to ripple through financial markets. For one thing most of the mortgage loans were not held by the original lenders but sold to investors and hedge funds. As a result two Bear Stearns funds failed and on August 9, 2007 the French bank BNP Paribas froze withdrawals from 3 of its funds due to subprime losses sparking a major sell off in stock markets and a liquidity crisis. In the following 3 business days, the Fed injected $64 billion into markets and the European Central Bank ~$213 billion in an effort to stabilize them. The fallout from this housing bubble collapse will be with us for years and is going to be very, very expensive.
On December 6, 2007, Treasury Secretary Henry Paulson presented the Administration’s much awaited plan to help homeowners with subprime mortgages. The program called for a voluntary 5 year freeze on rates due to reset between January 1, 2008 and July 31, 2010. It was available only to those who were not delinquent in their payments and delays but does not do away with interest rate resets at the end of this period. Finally, it would affect at most 20% of such loans and probably far fewer (~12%). All in all, the Paulson plan does little to help homeowners but then it was never meant to. The real reason for the plan was to support housing prices which could fall 20% to 30% due to the subprime bubble and so thereby minimize losses to investors.
On December 11, 2007, the Fed cut short term interest rates down to 4.25%. This is the rate that banks charge each other for overnight loans. It was the third rate cut since September 2007 bringing the total decrease to a full percentage point. While this could fuel inflation, it is unclear that it will have any effect on the underlying fundamentals of the liquidity crisis brought on by the subprime bubble.
On December 18, 2007, European central banks created a $500 billion fund to provide two week loans to commercial banks at 4.21% interest. The problem with most banks is not that they lack money on hand but that they are leery of lending it.
On February 13, 2008, Bush signed HR 5140 a $160 billion stimulus in the form of a tax rebate.
On March 16, 2008, JPMorgan agreed to buy Bear Stearns which had been heavily involved in the subprime crisis and suffered accordingly for $236 million or about $2 a share. Bear Stearns stock had traded as high as $172 in January 2006. The Fed assumed up to $30 billion in risk for the company’s shakier investments. Basically, JPMorgan got Bear Stearns’ assets and the Fed guaranteed its debts. The thing that really scared the financial community and led them to avert the company’s collapse was that it was into the derivatives market to the tune of $13.4 trillion. If it had fallen, it might have taken the whole international financial market with it. Even so Bear Stearns’ exposure to the derivatives market is not unusual for large investment banks. Still investors resisted, and on March 24, 2008, JPMorgan raised its offer to $10 a share.
On July 11, 2008, IndyMac, the largest savings and loan in Los Angeles, collapsed. It had experienced a run on its money after letters by Senator Charles Schumer (D-NY) expressing concerns about the bank’s viability were released on June 26, 2008. It is the largest bank failure related to the subprime fiasco. The episode is another demonstration of how the impacts from this debacle are still being felt and underlines the pervasive fear, protestations to the contrary aside, that the worst is not over.
The giants in the room are Fannie Mae and Freddie Mac, publicly owned government sponsored enterprises, who own or back some $5 trillion of the nation’s $12 trillion mortgage market. As of July 2008, they have lost nearly 80% of their stock value since the subprime meltdown in August 2007. They are quite literally too big to let fail although the Bush Administration is doing the minimum to shore them up. However the companies continued having problems raising money for their mortgage lending operations.
On September 5, 2008, the government informed the heads of Freddie and Fannie that the companies were going to be put into conservatorship. This would allow the government to restructure the companies while keeping them private. Government plans put together by Treasury Secretary Henry Paulson included replacing the current heads and boards of the companies, wiping out the holdings of small investors and backing those of large institutional ones: banks, foreign governments, mutual and pension funds. These guarantees will likely cost taxpayers hundreds of billions of dollars. It is a classic example of “privatizing gains and socializing losses.” As is so typical with the economic approach of this Administration, those who knew the most and can best sustain the losses will be secured while those who can afford it least and had the least involvement in creating this mess will be left to pay the bills for it.
On September 7, 2008, the government announced details of its takeover. Herbert Allison the former chair of teachers retirement fund TIAA-CREF was named to head Fannie. He was the national finance chairman for McCain’s Presidential campaign in 2000. David Moffett a senior adviser to the Carlyle Group was picked to run Freddie. A Carlyle hedge fund with large investments in Fannie and Freddie failed in March 2008. It is troubling that both come from groups that have the most to gain from a government bailout of the mortgage lending/holding companies. More disturbing still is that both have such glaring conflicts of interest.
Under the Paulson plan, each company would pay an at least 10% dividend on $1 billion of government preferred stock. But in return for this $200 million a year it would receive, the government has guaranteed to back their losses up to $200 billion ($100 billion each). Also at some time in the future if the companies ever became profitable the government could buy up 80% of them for $1 a share. The contrary case is more likely where the government would need to buy them because they continue to be unprofitable. A largely ignored part of the Paulson plan would be to reduce Fannie and Freddie participation in and share of the mortgage market beginning in 2010. This would have the effect of making mortgages less available and more expensive. But, at the risk of repeating myself, the whole government response to the housing bubble is and has always been about protecting large speculators in the name of market stability and at the expense of everyone else.
On September 14, 2008, the financial services company Merrill Lynch sold itself to Bank of America for $50 billion in what will likely turn out to be a bad deal for BoA. On September 15, 2008, the investment bank of Lehman Brothers, a prime player in the subprime market along with Bear Stearn, with its stock now virtually worthless, filed for Chapter 11 bankruptcy. Currently teetering are the bank Washington Mutual and the insurance giant AIG which was heavily into credit default swaps (these were essentially insurance policies for subprime loans and amounted to free money for AIG on the upside of the housing bubble but translated into enormous debt exposure when the bubble burst and AIG had to start paying up on them).
On September 16, 2008, the federal government bought a 79.9% stake in AIG in exchange for a two year $85 billion line of credit through the Fed at about an 11% interest rate. AIG has $1.1 trillion in assets and a customer base of 74 million. Its stock had traded as high as $70.13 in the last year but had since lost around 95% of its value. Amazingly, in just 10 days, the US government has become the world’s largest landlord and insurance provider.
Also amazing was that the only Wall Street executive at the meeting to decide AIG’s fate was Lloyd Blankfein Paulson’s successor as CEO of Goldman Sachs. Goldman was AIG’s largest trading partner and stood to lose $20 billion if AIG went under. So no conflicts of interest there, nope, no.
On September 19, 2008 , as the government’s intervention in financial markets continued, the Treasury Department said it would take the entire $50 billion worth of the Depression-era Exchange Stabilization Fund and use it to guarantee the $2 trillion money market financial sector. Money markets are big holder of short term and usually quite safe loans. Problems began, however, on September 16, 2008, when two of the largest Reserve Primary Fund and BNY Mellon Institutional Cash Reserves broke the buck, i.e. when the return on a dollar invested in them fell below one dollar, in response to losses from the Lehman bankruptcy. This began a run on the funds generally. $224 billion was pulled from them in the week ending September 19 with $89.2 billion on September 17 alone. There was also a report that Paulson intervened directly with institutional investors on September 18 to prevent another $500 billion from being withdrawn.
Also on September 19, 2008, the SEC announced a ban on short selling to last until October 2. This principally was to relieve pressure on the investment bank Morgan Stanley whose share price had fallen 40% in a week and caused a sharp rise on Wall Street as speculators were forced to cover their shorts. Most ominously Paulson and Bernanke stated their intentions of bailing out financial companies by buying their toxic mortgage backed securities. This is a horrendously bad decision for four reasons. First, it rewards those whose greed and stupidity are most responsible for this disaster. Second, it doesn’t help homeowners who have been completely forgotten in the rush to “stabilize” financial markets. Third, it leaves taxpayers holding the bag for what will end up costing them trillions. Fourth, it does nothing to change and re-regulate the financial system so this won’t happen again.
On September 20, 2008, the Bush Administration announced its plan to bailout financial institutions holding toxic mortgage backed securities. It would invest Henry Paulson with vast new powers. As CEO and Chairman of the investment bank Goldman Sachs, Paulson championed the deregulation and bad practices that led to the current financial meltdown. For the last two years, as Treasury Secretary, he did nothing to stave off the bursting of the housing bubble and until the last two weeks nothing to address its aftermath. The Administration’s proposal would give him $700 billion and absolute unrestricted discretion to buy toxic mortgage backed securities from whom he wants, at what price he wants, and do what he wants with them, without review by anyone, outside of a pro forma report to Congress.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
This is an impossibly bad idea for the 4 reasons I gave in the last paragraph but in addition puts one of the worst actors in charge of the “cleanup”.
On September 21, 2008, foreign banks decided they too wanted a piece of this $700 billion bonanza and Paulson obligingly modified his plan to include foreign financial institutions which had “significant operations” in the US whatever that means, and it could mean almost anything. The Fed also accepted the application of the last two investment banks Goldman Sachs and Morgan Stanley to join the Fed. They would convert themselves into bank holding companies, have to reduce their degree of leveraging to 10 to 1, and accept greater oversight but in exchange they would gain access to the Fed’s short term loan facilities. It was the drying up of credit that posed the greatest threat of failure to them. And in their new forms it is entirely conceivable that Paulson would ask them to help manage the bailout to the meltdown they did so much to create.
What is simply stupefying is that Paulson wants effective control of $700 billion based on a vague 2 page plan that White House spokesman Tony Fratto said the Administration needed months to work out. This raised the question of why Congress and the public were not brought in earlier and their input sought instead of presenting it as a fait accompli with only two weeks for the public to react and the Congress to act before its pre-election adjournment. The vagueness of the plan can not be overstated, unsurprising in such a short document. Indeed the only solid part of it is its $700 billion cost, and it turns out that was made up.
“It’s not based on any particular data point,” a Treasury spokeswoman told Forbes.com Tuesday. “We just wanted to choose a really large number.”
In this Administration, this is what passes for a serious plan and a considered approach to deal with a potential financial collapse. Such dimwittery got us into this mess. More will not get us out of it.
On September 24, 2008, the Fed announced it would extend the currency swaps (to supply dollars to foreign central banks) it introduced on September 18 for overnight loans to $10 billion each for the Reserve Bank of Australia and the Sveriges Riksbank and $5 billion each by the Danmarks Nationalbank and the Norges Bank. This brings the money committed to these to $277 billion.
On September 25, 2008, Washington Mutual, the nation’s largest savings and loan, with assets of $307 billion was seized by government regulators and, without informing either its board or CEO, sold to JP Morgan Chase for $1.9 billion. If WaMu had failed, it might have cost taxpayers $20-$30 billion. What is disturbing though is that JP Morgan picks up a very large bank for almost nothing and will be able to dump WaMu’s bad loans on to taxpayers as part of the Paulson bailout. In other words, JP Morgan makes out like a bandit. It keeps the good stuff and sells the crap to the
rubes taxpayers. This is the problem of bailing out Wall Street instead of reforming it.
Much was made of the fact that Paulson and Bernanke were not going to bailout Lehman Brothers, but that is not the whole story. On September 25, 2008, a commenter to a Yahoo message board noted that Citibank was Lehman’s largest unsecured creditor with claims of $138 billion. On September 15, 2008, the day Lehman filed for bankruptcy, JP Morgan transferred $87 billion to it, and $51 billion the next day for a total transfer of $138 billion. The Federal Reserve of New York made exactly similar transfers to JP Morgan on the same dates. So while Lehman was allowed to fail, the Fed used JP Morgan and Lehman to effect a secret bailout of Citibank. What the Fed got in return for its money is currently unknown. JP Morgan appears to have gotten WaMu. What is clear is that the Fed did a run around the bankruptcy laws in a way which could well be illegal and constitute fraud.
On September 26, 2008, the Fed added another $10 billion to its currency swap with the European Central Bank and $3 billion to the Swiss National Bank. Instead of overnight loans, these two banks and the Bank of England will make them for a week to ease end of the quarter cashflow problems. This brings the value of these swaps to $290 billion.
On September 23, 2008, Paulson and Bernanke pitched their plan to give them what they want or else to the Senate Financial Services Committee chaired by Chris Dodd (D-CT) and the next day before the House committee chaired by Barney Frank (D-MA). In the second hearing, Paulson modified his position slightly saying he was for some oversight and would accept caps on CEO remuneration. Both Dodd and Frank offered plans which were modifications of Paulson’s. On September 25, 2008, Bush was supposed to meet with Congressional leaders of both parties as well as the two Presidential candidates to finish the deal. The object was to give both sides cover for a plan that was strongly disliked by most of the public. John McCain in something of a political stunt “suspended” his campaign and canceled his appearance at the first Presidential debate scheduled for September 26 to hurry back to Washington to take charge. His efforts were appreciated by almost no one. He signed on to a flaky last minute plan put forward by House Republicans which would have involved more deregulation and cutting the capital gains tax. The deal blew up, and McCain decided that sufficient progress (and damage both to a deal and his campaign) had been made that he would, in fact, show up for the debate and restart his campaign which he had never really suspended. It is important to point out that none of these plans address the fundamental problems of refinancing mortgages and defusing derivatives, and so none of them will succeed. They may delay things by a few months at a tremendous price but we are still looking down the barrel of a very large and very ugly economic gun.
On Sunday September 28, 2008, Bush, the Presidential candidates, and Congressional leaders of both parties endorsed a “compromise” bailout plan (HR 3997). The bill was 110 pages long, so much longer than the original 2 page Paulson plan. But it was still the Paulson plan, just a lot of lipstick had been added. Paulson would still be able to buy, hold, and sell what he wanted (not just mortgage backed securities but any securities he wished) from whom he wanted (both American financial companies and any foreign one with “significant” US interests not owned by a foreign government). He would be the one to set up the market mechanisms (reverse auctions) to buy the finance industry’s crap assets. He would be the one to hire employees and contract companies to manage the auctions and assets, and he would be the one to write the conflict of interest rules which would govern these and ensure he could hire anyone he wanted. One of the few additions is an insurance program for bad assets which was unlikely to be widely used but was included to mollify rebellious House Republicans.
Of central importance was the retention of the $700 billion figure. The bill engaged in some kabuki on this to make it seem that there were conditions on the money but there really weren’t. Paulson would initially get $250 billion. When this was exhausted, he could make a determination to Congress and with the President’s OK alone get another $100 billion. The other $350 billion was also effectively at his disposal since it required a joint resolution of both Houses to disapprove it and in the face of a likely Presidential veto the Congressional resolution would require a veto override (a 2/3 vote in both Houses) to prevent its disbursement.
Most notably absent from the bill was any attempt to re-regulate markets now or to extend direct aid to distressed homeowners (except for continuing an income tax exclusion). On the other hand, it contained a veritable blizzard of oversight panels and calls for reports. A Financial Stability Oversight Board, the Comptroller General (GAO), SEC, Fed, OMB, CBO, a program Inspector General, various House and Senate committees, and an online list of the bailout’s business were all supposed to be part of the oversight process. Yet none of these had any enforcement authority. That power remained with Paulson. Among the reports (in addition to all the audits), one was supposed to give recommendations for market regulation to be completed by April 30, 2009, 7 months away and in another Administration. Another also on regulation by the Congressional Oversight Panel was due January 20, 2009, i.e. on Inauguration Day. A third was to examine the role of mark to market accounting (pricing assets according to their current sale value) in bank failures and a fourth was to cover the effects of leveraging and de-leveraging.
There were also interesting bits hidden away in the nooks and crannies of the bill. One particularly artful example involved a simple change of date to a prior bill but what it did in effect was to allow the Fed to pay interest on reserves held by banks and permit banks to carry zero reserves. Another suspended mark to market accounting allowing financial institutions to artificially inflate the value of their assets to improve their balance sheets.
Interestingly Paulson held no press conference on the bill’s contents for the public but he did make a private telephone conference call to 800 bankers and financial officers to discuss it. This call was subsequently leaked to the internet. His take home message was I’ll get the $700 billion, and I will take care of you guys. Paulson said that if Treasury was forced to make direct purchases from companies of their assets, then he would follow the same aggressive method he had used with Fannie, Freddie, and AIG where CEOs lost their jobs. However, if companies opted to participate voluntarily in the bailout program, he was willing to be generous. He would not buy their assets at fire sale prices but at what he called a “reasonable” value. Restrictions on golden parachutes applied prospectively, and only in cases of bankruptcy or firing. He would not seek stock warrants (essentially options to sell stock at some future time) on the first $100 million of assets purchased, and the warrants would be for non-voting stock. Finally, he sought to re-assure them over a provision of the bill that called for the government to recoup any losses to its $700 billion fund after 5 years from the financial industry generally. He said that this was essentially boilerplate that showed up in many Congressional bills, that 5 years was a long time away, and that new legislation would be required at that time for it. In other words, he thought it would be defeated and wouldn’t happen.
On September 29, 2008, in a 15 minute vote that was held open for 38 minutes, conservative Republicans and liberal Democrats defeated the bill 205-228 in the House. 140 Democrats voted for the Bush-backed “compromise”. 133 Republicans opposed it and their President. It is probably too much to hope for but it would be nice if at this point lawmakers discarded the Paulson plan and considered alternatives. The Swedish or Scandinavian response to their banking crisis in the early 1990s might be useful. Banks were forced to acknowledge their losses, and only when the extent of their losses was known were they recapitalized under stricter regulation. Such an approach encourages private participation because assets are set at their true market value.
In addition to this, however, there must be help for homeowners and restriction of the funny money instruments and accounting principles the financial industry used to produce this mess. For this, we don’t need further studies, all conveniently due in the next Administration. What we need is to recognize and clear out the debt in the present system, and this along with reform will create confidence in a new more regulated, transparent one.
In other events on September 29, 2008, the Fed increased its currency swaps pool with foreign central banks from $290 billion to $620 billion in a further move to inject liquidity into markets. The Dow Jones Industrial Average (DJIA) fell 777.68 points or nearly 7%. Another big bank bit the dust. Wachovia was bought out by Citigroup for $2.2 billion. Citigroup agreed to assume the first $42 billion of Wachovia’s mortgage related losses and to pay the FDIC $12 billion in preferred stock and warrants to assume the rest. The Citigroup buyout of Wachovia (which was for its banking operations) ran into problems when on October 2, 2008, Wells Fargo made a counter offer of $15 billion in stock for the whole company and planned on using Wachovia’s losses as tax write offs. Whichever way this goes, it represents a further and major concentration of banking in the United States and likely loss of competition.
Overseas the credit crunch was also taking its toll. On September 29, 2008, the UK seized Bradford & Bingley. The government kept control of its £50 billion mortgage portfolio and spun off its banking operations to Spain’s Santander. Meanwhile the Benelux countries forked out $16.2 billion to bailout and partially nationalize the bank giant Fortis which had problems with financing an earlier merger. On September 30, 2008, the governments of France, Belgium, and Luxembourg bailed out the bank Dexia, a lender to mainly local governments, with a cash injection of $9 billion. What this should tell you is that the shocks from the shaky American financial markets are being felt throughout the world economy.
On October 1, 2008, the Senate in a 74-25 passed its version of the bailout. Its bill ran 451 pages long. It contained the original “compromise” bill with few changes, such as an increase in the limit from $100,000 to $250,000 for FDIC insured accounts. The greater length was principally due to the attachment of an energy bill and a smorgasbord of tax provisions, including ones dealing with wooden arrows (Sec. 503, pp. 295-296) and wool products (Sec. 325, pp. 300-301). Only one Senator Bernie Sanders (I-VT) who gave a ringing speech condemning the bill was allowed to offer an amendment, one to raise tax rates for 5 years by 10% on those making over $500,000 a year ($1 million for couples) to help pay for the bailout. On a voice vote only Sanders’ voice was heard in favor of it.
An October 2, 2008 New York Times story related how after 55 minutes of discussion on April 28, 2004 the SEC, lobbied by the big 5 investment banks, removed limits on their ability to leverage. In exchange the companies agreed to open their books to the SEC but the SEC, especially under the leadership of its head Christopher Cox, made no real effort to keep tabs on what these companies were doing. Only seven people were assigned to an office to monitor them and their (before the fall) assets of $4 trillion, and the office has lacked a director since March 2007. The result was a casino mentality with no limits and no oversight.
There have been perhaps 4 major decisions that allowed the current meltdown to happen. This 2004 SEC decision was one of them. The other 3 are:
- the 2003 ban by the Office of the Comptroller of Currency on the pursuit of mortgage writers for predatory lending by state attorney generals.
- the 2000 Commodity Futures Modernization Act which included not only the “Enron loophole” but deregulation of derivatives markets.
- the 1999 Gramm-Leach-Bliley Act which repealed the Depression-era Glass-Steagall Act which placed a wall between regular banks and insurance companies on one side and investment banks on the other.
On October 3, 2008, the House voted on the Senate package which with the tax provisions now came in at over $800 billion and passed it 263-171 with a majority 172-63 of Democrats voting for and a majority of Republicans 91-108 voting against. There is no evidence that the liquidity the bill injects into the financial system will be used to free up credit. This is known as a liquidity trap. There have been several injections of liquidity into the system over the last year and the credit crunch has only worsened. The reason is that banks and financial institutions don’t know who is solvent and who is not. While the bill allows them to dump toxic assets on the government, $700 billion is unlikely to cover all their losses. It is only a down payment on them. So the problem remains the same. The banks and financial institutions don’t know who’s solvent. They are likely to hold the cash or restrict severely to whom they lend. Since the bill doesn’t help distressed homeowners beyond a little lip service to their plight, foreclosures, a housing glut, and downward pressure on housing prices will continue and feed back negatively into the financial system. The lack of re-regulation will not help re-instill confidence in the system either. What makes this all especially tragic is that there were at least 3 viable alternatives to the current crisis: 1) direct government buying up of problem mortgages; 2) direct government investment in banks; 3) direct government valuation of mortgage backed paper. These singly or in combination together with re-regulation would have provided a cheaper and more effective answer to the meltdown and subsequent credit freeze.
On October 6, 2008, the Fed announced that, per the passed Paulson plan, it would begin paying interest on required bank reserves. It also increased immediately to $300 billion the amount it would make available to banks in 1 and 3 month loans using crap paper as collateral. This is just the start. The loan program called the Term Auction Facility (TAF) could have after further auctions, according to the Fed, $900 billion in outstanding loans by the end of 2008, collateralized by, to repeat myself, crap.
World stock markets greeted passage of the bailout (and lack of concerted action in Europe) by falling precipitously. The Dow fell nearly 800 points during the course of the day (9525.32-10322.76) and closed, after a late rally, down 369.88 at 9,955.50, the first below 10,000 closing in 4 years.
Also on October 6, 2008, Henry Paulson named 35 year old Neel Kashkari as interim head to run the bailout. Kashkari was a senior adviser to Paulson at Goldman Sachs and followed him to Treasury in June 2008. Goldman Sachs will likely play an integral part in managing the bailout and profiting from it. In other words, what we are seeing is that those who caused the meltdown are being entrusted to deal with it. It is difficult to see how this could become more incestuous or how the conflicts of interest could be any deeper.
On October 7, 2008, the Fed, in response to the drying up of short term credit from money markets after some broke the buck after the Lehman failure, announced a new program the Commercial Paper Funding Facility which would make 3 month unsecured loans to eligible banks, companies, and local governments (to meet payrolls or pay suppliers, for example). The size of this market is large between $1.6-1.8 trillion and no dollar estimate was put on the Fed’s intervention. The Dow continued to react negatively to the government’s expensive but ineffective moves to shore up the financial system and fell 508.39 points to close at 9,447.11.
On October 8, 2008, while the small country of Iceland teetered on the edge of bankruptcy, the British partially nationalized 8 of its largest banks. In exchange for preferred stock, the British government agreed to provide capital and loan guarantees. This strategy invests their government in the total worth of the company, not just its bad asssets as with the Paulson plan, and gives it leverage to require that banks to free up their credit for normal business and consumer lending, again in contrast to the Paulson plan.
The Fed and several central banks minus Japan cut their lending rates half a percentage point. For the Fed, this meant a reduction in federal funds and discount rates to 1.5%. This will make money cheaper to borrow if you are a bank but it is unclear if it will make banks any more willing to lend to anyone else, like businesses and consumers. The Fed also announced that AIG which had already blown through $61 billion of the $85 billion advanced to it would receive another $37.8 billion injection of cash. In what is symptomatic of the lack of transparency in the financial system the Fed described its action in terms which were, in fact, opposite from what it was doing.
Under this program, the New York Fed will borrow up to $37.8 billion in investment-grade, fixed-income securities from AIG in return for cash collateral.
On October 8, 2008, the Dow dropped 189.01 points (2%). On October 9, 2008, the Dow dropped a further 678.91 points (7.33%) to close below 9,000 at 8,579.19. This is the lowest close since May 21, 2003. Exactly 1 year ago, the Dow closed at its all time high of 14,164.53. In that year, the Dow has declined 5585.34 points or 39.4%. Of particular note is that it has fallen 2251.88 points (20.8%) since October 1, 2008 when the Paulson plan was passed by the Senate and signed into law. This is a clear vote of no-confidence in both Paulson and Bernanke and their efforts to date. As a result, money is hemorrhaging out of stocks seeking safer havens, such as currency.
Also on October 9, 2008, Citigroup gave up on its bid to take over Wachovia. Interestingly, with all of its problems, Wachovia was able to loan $8 million to the National Republican Congressional Committee (NRCC). Although Wachovia is to be repaid at some point, what this amounts to is a very large campaign contribution to Republicans and goes to show that no matter how tottering the financial system is it is never too shaky for a little corruption.
An October 11, 2008 story in Bloomberg reported that Treasury Secretary Paulson had directed Fannie and Freddie in late September (in advance of the passage of the $700 billion bailout) to add to their portfolios of bad mortgage securities to the tune of $20 billion a month each from a $200 billion emergency fund that had been set up to help them deal with the problems that had sent them into conservatorship. This is yet another example of the double-dealing and lack of transparency which has come to characterize Paulson’s approach to the crisis. While he was telling Congress one thing, he was doing something else behind their backs. He used money meant to shore up Fannie and Freddie to increase their liabilities, and he did so in the pursuit of a strategy which the events of the last week have already discredited. To date, Paulson’s instincts on how to deal with the meltdown have been too little too late, and just plain wrong.
On October 12, 2008, the Fed okayed the takeover of Wachovia by Wells Fargo and Treasury said it would protect a proposed $9 billion Mitsubishi purchase of 21% of Morgan Stanley. On October 11-12, G7 finance ministers and central bank governors met and came up with no coordinated plan.
On October 13, 2008, the Mitsubishi-Morgan Stanley deal was finalized on terms so favorable to Mitsubishi that it was pretty much impossible for them to lose any money, and giving the Japanese company a reasonable chance of making a killing on it. This says a lot about the sorry shape the former investment bank giant is in. On this day, the Fed made another capital injection in financial markets when it took off all limits on currency swaps (which it had rapidly increased to $620 billion as recently as September 26, 2008) involving the Bank of England, the European Central Bank, and the Swiss National Bank.
European countries announced a series of initiatives to shore up their banking systems. In addition to the British move to partially nationalize 3 of its banks, the Germans announced $500 billion in guarantees for inter-bank loans and a further $108 billion to invest in banks. The French came up with $435 billion in guarantees and $52 billion to invest. The Spanish had a $130 billion plan and the Italians a $27 billion one. Meanwhile in the US, Paulson and his Mini-me Kashkari continued to dither. They announced they would be setting up a program to buy into banks. It would be voluntary, on what were described as attractive terms for banks, and would be as per the $700 billion bailout plan be for non-voting stock. Paulson’s policy of missing the point and doing too little too late continues.
In reaction to the European, as opposed to the American, actions, the Dow had a good day. It rose 936.42 points (11.08%) to 9,387.61. It is important to note that as currently structured this is a stopgap and has yet to address the fundamental problems: bank solvency, deregulation, credit default swaps, falling housing prices, and forgotten homeowners.
Later in the day, Treasury got around to announcing some of the details of its new plan. It would commit up to $250 billion of the $700 billion bailout package to buy stock in banks. At the same time the FDIC announced it would guarantee inter-bank loans for 3 years but would charge a premium to do so.
On October 14, 2008, Treasury announced further details of its new bank program. It would invest $125 billion in large banks and financial houses and make $125 billion available for smaller banks. Citigroup, Bank of America, JP Morgan, and Wells Fargo would each receive $25 billion. Paulson’s old firm Goldman Sachs and Morgan Stanley, both recently converted to bank holding companies (although I do not think that either currently owns a bank), would get $10 billion each. Bank of New York Mellon got $3 billion and State Street $2 billion. In exchange the government would get preferred non-voting stock paying a 5% dividend per year for the first 5 years and then 9% thereafter. Banks could, however, buy back this stock after 3 years. The government would also get warrants to buy common stock equal to 15% of the money invested. (These would only be worth something if the bank’s stock went up.) Excessive compensation and golden parachutes would be banned but this amounts to a restatement of the joke standards which occur in the original bailout bill. The FDIC also announced that it would extend protection to roughly the one-third of small business accounts that its new $250,000 limit did not currently cover.
On October 15, 2008, the Dow nosedived again dropping 733.08 points (7.87%) to close at 8,577.91. This volatility is an important indicator that the problems underlying the meltdown remain unaddressed and that the reality that the world economy is in recession is slowly sinking in.
An October 18, 2008 article in the Guardian reports that the 6 firms to receive a $125 billion injection of capital from the US government are slated to pay their employees $70 billion in compensation this year most of it in the form of bonuses. Obscene? Divorced from reality? Of course, that $70 billion is nearly half the size of the$160 billion stimulus package earlier this year for the entire country. But what did you expect? These are Henry Paulson’s people. He is one of them. The rest of the country may be headed toward Depression but those who sent it there must be kept in their Porsches and mistresses.
The industry argument is that bonuses are necessary to keep top talent at a company. There are two replies to this. First, this top talent is made up of those most responsible for the current meltdown. Are these the people they really want to keep, let alone reward? Second, seriously where are they going to go? The financial sector has been hemorrhaging jobs. The truth is that there are many others, at least as qualified, who would love to take their places.
An October 20, 2008 Wall Street Journal article reported that under pressure from Senators Dianne Feinstein (D-CA) and Mel Martinez (R-FL) insurance giant AIG recipient of a $122 billion bailout has agreed to cancel 160 events which would have cost $80 million. More importantly it has agreed to suspend its lobbying efforts which incredibly included a push to get states to loosen requirements on regulating mortgage lenders.
On October 21, 2008, the Fed announced yet another program the Money Market Investor Funding Facility (MMIFF). Its object was to help money markets in their redemptions (cash demands from their customers) by buying up to $600 billion of their short term (90 day or less) paper with the further goal of loosening up credit at more of a commercial and consumer level. In keeping with the lack of transparency and corporate cronyism that is typical of all these efforts, JP Morgan was chosen by a group of undisclosed money markets to administer the program and buy their securities and those of an also undisclosed list of other money markets. Nice bit of back scratching that.
On November 4, 2008, the Libor (short term interbank loan rates) fell to pre-Lehman levels. The 3 month rate fell to 2.71% and the overnight rate went to a historic low of .38%. This was a major goal of the trillions that Bernanke threw into the financial system. The theory was that getting the Libor lower would free up credit. This really didn’t happen however because the underlying solvency questions remained unresolved and unaddressed. The continuing credit crunch is seen in the spread between the Libor and Fed rates which remains elevated at 2.11%. Prior to September 15, the spread was 0.11%.
On November 6, 2008, the Bank of England cut its benchmark rate 1.5% to 3% and the European Central Bank cut its rate 0.5% to 3.25%. These are futher indications that the world economy is slipping into recession and that lenders continue not to lend.
On November 10, 2008, the Treasury Department announced that as part of a new comprehensive deal with AIG it would pour another $40 billion into the bottomless pit and sometime insurance company. It is getting really tricky even to know how much the government has spent on AIG. The government rather disingenuously argued that by investing $40 billion in AIG it was actually reducing its exposure from $152 billion to $112 billion. However most of the government’s $122.8 billion credit line to AIG or around $112 billion has already been spent. However most of the government’s $122.8 billion credit line to AIG (the $112 billion) has already been spent. Taking into account the $40 billion the government is now committing, it is likely that the $152 billion number is what has been sunk into the company to date.
There is, of course, more to the story. There always is. The government which now virtually owns AIG is setting up two shell companies to offload debt from AIG’s bottomline. The government as AIG will put up $5 billion and the government as itself will put up another $30 billion to set up a company to buy back $70 billion in credit default swaps (CDSs) for 50 cents on the dollar. Losses from this company will not show up on AIG’s balance sheet. Similarly, the government in its role as AIG will lay out $1 billion and as itself $22.5 billion to buy back collateralized debt obligations (CDOs which AIG had insured through its CDSs). So while the government is saying that it is reducing its interest in AIG it has actually increased its involvement from around $112 billion to $210.5 billion (the $40 billion plus the $35 billion and $23.5 billion entities). To add insult to injury, Treasury announced that it was freezing AIG’s bonus pool, not reducing or eliminating it, but just keeping it at current levels. The economy is in recession. It is hemorrhaging jobs. The deficit is exploding, and this is Henry Paulson’s idea of how to treat those most responsible for the debacle: that their bonuses only will not be increased. It would be laughable if it did not make you want to weep.
And one further point. Paulson is taking the $40 billion out of the $700 billion bailout (the TARP). No indication where the $52.5 billion for the two debt buying entities will come from. Taken together with the $250 billion bank bailout, this means that Treasury has already committed $290 billion of the intial $350 billion portion of the bailout and so far not one dime of it has been spent on its ostensible purpose of buying toxic assets. Given the speed with which Paulson is blowing through bailout funds, he is on track to spend most or all of them before President Obama takes office and to very little effect other than helping out his cronies.
A November 10, 2008 Bloomberg article reported that since the failure of Lehman on September 15, the Fed has dwarfed the Paulson bailout making $1.172 trillion in loans to banks and bringing its overall lending to more than $2 trillion.
A November 10, 2008 piece in the Washington Post reported that Paulson’s Treasury Department issued a 5 sentence revision on September 30, 2008 to a 1986 law governing Section 382 of the tax code. Known as the Wells Fargo Ruling, this change allowed banks to merge with other banks and use the losses of one to count against the profits of the other for tax purposes. Two days later on October 2, Wells Fargo used it to finance its takeover of Wachovia. It is estimated that the ruling was worth $25 billion to Wells Fargo in the deal. It has been used since in a rash of bank mergers and could result in a $140 billion windfall for banks over and above the $250 billion they are getting so far from the bailout. And oh yes, it isn’t legal. Neither Paulson nor Treasury had the power to change the law. It isn’t clear what a lameduck Congress will do about it though. This is just further evidence, if any were needed, that Paulson is a loose cannon who either is a bumbling idiot who doesn’t know what he is doing, or someone who will loot the government and break the law as long as he is allowed to do so to enrich his friends and cronies on Wall Street, or both.
The arrogant lawlessness of the current Administration, the greed of Wall Street, and the abject cowardice of the Congress guarantee that nothing will be done before the next Administration comes to office, and maybe not even then. The Great American Steal looks like it is going to be with us for a while.
On November 11, 2008, the Bush Administration announced another cosmetic plan to help homeowners. This one would work through Fannie and Freddie, be available to only a few hundred thousand homeowners not bankrupt, delinquent at least 90 days, and still owe at least 90%. Terms would be a rollback in interest for 5 years for a payment of 38% of monthly income or less, then an increase in rates with a mortgage extension of up to 40 years. The principle on the loan would not be reduced. This seems more like a plan to defer and spread out foreclosures for the benefit of Fannie and Freddie rather than avoiding foreclosures to help homeowners.
On November 12, 2008, in his never ending quest to show that he remains solidly behind the curve, Treasury Secretary Paulson announced that no bailout monies would be used to buy up toxic assets.
During the two weeks that Congress considered the legislation, market conditions worsened considerably. It was clear to me by the time the bill was signed on October 3rd that we needed to act quickly and forcefully, and that purchasing troubled assets – our initial focus – would take time to implement and would not be sufficient given the severity of the problem.
Over these past weeks we have continued to examine the relative benefits of purchasing illiquid mortgage-related assets. Our assessment at this time is that this is not the most effective way to use TARP funds
What you need to keep in mind is that buying up toxic assets was the raison d’être of the Paulson plan, the TARP (the Troubled Asset Relief Program) referred to above. It was what, he asserted, was needed to keep the financial system from collapsing. Even at the time he was warned by many that it was a supremely bad idea, and after kicking it around for nearly two months, he now agrees but makes it sound like he had questions about it from the beginning. He didn’t. This typifies the Paulson style: absolute confidence coupled with a refusal to address or even acknowledge core problems. He dithers, gets it wrong, and even when he stumbles or is pushed in the right direction he embraces a solution that is totally inadequate. In other words, Paulson is very much part of the problem, not part of the solution.
On November 14, 2008 , head of the FDIC Sheila Bair announced a mortgage assistance plan for distressed homeowners. It would involve modification of loans through a mix of loan extension, interest rate reduction, and forbearance on the principal. Bair estimates that half of some 4.4 million mortgage loans mortgages currently in default or expected to be in default by the end of 2009 and not held by Fannie and Freddie could be modified. Even if a third of these re-default, 1.5 million homeowners would be helped at a projected cost of $24.4 billion. Monthly payments would not exceed 31% of monthly income. For the first 8 years, the FDIC would assume half the loss of a redefault in conjunction with loan servicers. The major obstacle to the plan is that the $24.4 billion would come from the Paulson bailout and neither Paulson nor his younger clone Kashkari want to use even a thin red dime of it to help ordinary Americans.
On November 18-19, 2008, executives of the Big 3 auto companies came to Washington to testify before Congress and ask for $25 billion in loans. Republicans blocked any deal and Senate Majority leader Harry Reid (D-NV) told them to come back on December 4-5 with a detailed plan. Now there are several things that need to be said here. The American auto industry has been poorly managed for decades. They resisted successfully making their products cleaner and more fuel efficient and instead promoted the sale of trucks and SUVs on which they could make bigger profits. That said, the fault for the current downturn in the industry has less to do with Detroit than with Wall Street with regard to the credit crunch, the recession, and even the initial spike in oil prices (this item and 365). Unlike financial institutions, the auto industry is part of the real economy and represents millions of jobs which would be put in jeopardy if the Big 3 were allowed to go bankrupt. The loss of even a portion of these would send the economy into a deeper and longer recession. The amounts of money involved are actually rather small compared to the trillions that Paulson and Bernanke have been throwing (with little result) at banks and financial companies. There is also the mismatch between the no plans, no strings attached approach taken toward the financial community and the “detailed” plan demanded of automakers. And there is a continued absence of a concerted plan from the Congress on what it wants to see done by anyone.
Additionally, Republicans, especially Southern Republicans, would like to use the current crisis for ideological reasons to attack unions and effectively destroy the UAW and for purely selfish, extremely shortsighted, and even “unpatriotic” motives to use a bankruptcy of American automakers to favor foreign non-union auto plants in their states. What they don’t seem to understand is that if the economy tanks no one will be buying cars and autoworkers won’t be working whether they are living in Michigan or Alabama or in a union or a non-union shop.
Finally, no bailout of the auto industry or the financial community will work unless it is part of an overall coordinated plan to restart the economy.
On November 23, 2008, the Fed with participation by the Treasury and FDIC announced a rescue plan for what has been the nation’s largest banking concern Citigroup. The company has seen a drop in its share price in the last year from a high of $57.40 to a low of $2.91. Part of this reflects bad decisions it made. However, a lot of its recent fall was the work of short sellers which the SEC has done almost nothing to curb, despite the instability they produce. The Citigroup bailout consists of a government backed guarantee on $306 billion of the bank’s assets. The company will be responsible for the first $29 billion in losses. After that there will be a 90-10 split on losses between the government and Citigroup with the government responsible for the 90% share. Treasury will take the first $5 billion of these through the TARP. The FDIC is then in for the next $10 billion and the Fed is in for the rest to the $306 billion limit. In exchange for this guarantee, Citigroup will give the government $7 billion in stock with an 8% dividend ($4 billion to Treasury; $3 billion to the FDIC). It agrees to pay no more than 4 cents a year per share in dividends on its other stock and to submit a plan to limit executive compensation. In addition, Treasury will make a direct $20 billion investment in Citigroup. All the stock the government gets in the deal will be non-voting, or in other words more of the same: Citigroup gets the money and gets to keep its top management, and the taxpayer gets neither ownership nor control but does assume the risk.
A November 24, 2008 story in Bloomberg reports that the government has already made $7.76 trillion in commitments to the financial community as a result of the financial meltdown. The Fed whose role in this crisis has largely gone unreviewed has made $4.74 trillion or 61% of the pledges on behalf of the government. Financial institutions have already made use of $3.18 trillion or 41% of them. Meanwhile the government and Congress are going through contortions over a $25 billion bailout for the auto industry and the more than a million jobs it represents.
On November 25, 2008, the government upped its commitments to financial markets to $8.56 trillion. Paulson and Bernanke’s efforts to free up credit markets continue to founder due to the unstated insolvency of much of the banking sector. As a result in a further attempt to loosen consumer credit without addressing the fundamental issue of insolvency, the Fed announced yet another loan facility worth $200 billion with a $20 billion guarantee from the Treasury. The Fed would basically exchange money for the banks’ consumer credit paper. In an even bigger move, the Fed will buy up $600 billion of debt from Fannie and Freddie, $100 billion directly and $500 billion funneled through its asset managers.
On November 28, 2008, the National Bureau of Economic Research (NBER), the official caller of these things, announced that the US economy had been in recession since December 2007. Because the NBER analysis is retrospective, its announcement comes many months after the event. But it was obvious following the blowup of the housing bubble on August 9, 2007, the economy was in trouble. The $160 billion stimulus had only mild transient effects in the second quarter of 2008. That was about it. The country was distracted by the Presidential race, but the Bush Administration, Treasury’s Paulson, and the Fed’s Bernanke, for whom this wasn’t a concern, spent their time doing as little as possible to address the slowing economy.
On December 3, 2008, the Security and Exchange Commission (SEC) announced new rules for Wall Street’s three ratings agencies: Moody’s, Standard & Poor’s, and Fitch. The ratings agencies used old models to rate the new and much riskier financial instruments that led to the housing bubble and later the financial meltdown. They also had an inherent conflict of interest with those seeking their ratings because they were funded by them and made large profits by working with them. The new rules require greater transparency and verification in the ratings process, but, typical of the Bush Administration, leave the biggest conflict of interest, the funding mechanism, in place.
On December 9, 2008, the interest rate on T-bills hit zero on a Fed sale of $30 billion on 4 week notes. On the same day, the rate on 3 month notes actually turned negative. This is indicative of both a flight to safety but also deflation.
On December 10, 2008, the GAO issued a report on the Treasury bailout. It found that the TARP run by Neel Kashkari did not know, and had not put in place the means to know, how banks were spending the $155 billion so far injected into them under the Capital Purchase Program (CPP). As a result, the TARP had no way to tell if the banks were honoring their agreements with the government or if all those billions were having their intended effect. Instead Kashkari favored developing general metrics rather than specific monitoring by regulators to see if banks were doing what they were supposed to be. Likewise, he had no way to know if limits on executive pay, dividends, and stock repurchases were being respected.
Additionally, Kashkari has done nothing to smooth a transition to the next Administration. His office remains understaffed. As of November 21, it had 5 permanent hires and 48 employees assigned from other Treasury sections out of a projected need of 200. There was a lack of oversight of contractors hired by Kaskari’s office and a lack of internal controls to assure that the money Kashkari was spending was well spent. Nor were regulations governing conflict of interest in place. These are especially important because of the dominant role that former Goldman Sachs employees and contractors have had in the program. Of course, if this was done, this most crony capitalist of programs would have to fold up shop.
On December 4, 2008, the GAO issued a similar report on tracking banks’ aid to distressed homeowners.
Also on December 10, 2008, the Congressional Oversight Panel created by the bill that set up the TARP as an afterthought came out with a report that echoed many of the points made in the GAO report, underlined the perilous state of the US economy.
And in a December10, 2008 story in Bloomberg, it was reported that Ben Bernanke in a response to a letter from Senator Christopher Dodd (D-CT) announced that the Fed would not participate in any efforts to save American automakers. Now on the one hand, the Fed’s primary mission is to oversee the financial system but on the other given its massive and unprecedented intrusion into the economy and the failure of both the Fed and Treasury to foresee the devastating effects of the Lehman collapse, it seems a curious place to draw a line. But it is consistent with Paulson and Bernanke’s actions to shore up the paper “bubble” economy at literally any cost and their indifference and even hostility to the real economy and the plight of ordinary Americans.
On December 11, 2008, the Senate failed to invoke cloture 52-35 (60 votes needed) on a bill to bailout the auto industry effectively killing it. This made it more likely that the automakers and their supplies would be forced into bankruptcy. 3 million Americans could become unemployed at a time when the economy is already hemorrhaging jobs. The effort to destroy the industry, the union, and all those jobs was led by ideologically driven Southern Republicans, like Bob Corker (R-TN), Richard Shelby (D-AL), Jim DeMint (R-SC), and Senate Minority Leader Mitch McConnell (R-KY).
A few Republicans favored cloture: Bond (R-MO), Brownback (R-KS), Collins (R-ME), Dole (R-NC), Lugar (R-IN), Snowe (R-ME), Specter (R-PA), Voinovich (R-OH), and Warner (R-VA) but as it was clear the cloture vote would fail their votes were cosmetic and largely meant to placate constituents. Only Dole and Warner’s votes meant anything since both are leaving the Senate. Less explicable were the votes of Democrats who voted against cloture: Baucus (D-MT), Lincoln (D-AR), and Tester (D-MT). Reid (D-NV) also voted against but his was a standard parliamentary maneuver to allow for a later reconsideration. 12 Senators did not vote: Alexander (R-TN), Biden (D-DE), Cornyn (R-TX), Craig (R-ID), Graham (R-SC), Hagel (R-NE), Kennedy (D-MA), Kerry (D-MA), Smith (R-OR), Stevens (R-AK), Sununu (R-NH), and Wyden (D-OR). The reasons for the non-votes were various. I include this information because this was a vote of a critically important and criminally irresponsible nature. It was a vote to send the country into depression.
Also on December 11, 2008, Bernard Madoff, a former chairman of the NASDAQ was arrested for perpetrating a fraud which lost up to $50 billion in investors’ money. It has been called the largest Ponzi scheme committed by a single individual in US history. This appellation is perhaps intentionally misleading because it distracts from the fact that the whole financial system has been run collectively as an over-sized Ponzi operation. Madoff began his investment firm in 1960. He had consistent profits regardless of market conditions which no one else could reproduce. In 1992, a fund associated with Madoff was investigated but he seems to have escaped any real scrutiny. It appears he operated his scheme for decades. By 2000, his company had several hundred million in assets and it seems to have ballooned into the billions in the Bush years. He was able to get away with his fraud for so long because he held his accounts within his own firm instead of with an outside bank. He had status as a Chairman of NASDAQ. He had successfully dodged one investigation. And with SEC Chairmen like William Donaldson (2003-2005) and Christopher Cox (2005-present) who were rabidly anti-regulationist, he was essentially home free. It took the financial meltdown to do him in. His victims include many retirees, charities, foreign banks as well as many celebrities and wealthy. Some of these certainly knew that what Madoff was doing was too good to be true but as long as he was making money for them they were willing not to ask to many questions. As part of an eventual settlement those who made profits with Madoff will have to return some or all of them to make good in so far as that is possible those who lost their shirts. It is still an open question where the money went, how much was actually lost, and who all was involved in Madoff’s crimes. In any case, Madoff is a metaphor for the current financial system and its failures.
On December 16, 2008, the Fed announced it was lowering the federal funds rate (the rate at which banks lend to each other, usually overnight) to zero to .25 percent. It said it would continue to buy large amounts of agency debt (Fannie, Freddie, and Sally (student loans)) and mortgage backed securities (crap assets). Finally, it said it was considering buying longer Treasuries. Since it has taken short term rates to essentially zero, buying longer term T-bills would be a way of affecting and lowering longer term interest rates. To date Bernanke has pumped trillions into a liquidity trap, i.e. the money goes to the banks but doesn’t get lent back out, and has now lost an important tool in regulating monetary supply. Rather than change a failed policy which has done nothing to free up credit, he is continuing to double down, now contemplating a move into longer term interest rates.
On December 17, 2008, with the Bush Administration continuing to dither over extending a $14 billion bridge loan to the American auto industry, Chrysler announced it would close all of its 30 plants for one month beginning December 19, 2008. At the same time, Ford said it would increase its holiday shutdown to three weeks. There really is no other way to put it, as the economy skates on the edge of depression, the Republicans play games.
On December 19, 2008, as part in another of a long series of Friday news dumps, the White House finally announced a temporary bailout for the auto industry. $13.4 billion will be made available in short term loans from TARP funds with an additional $4 billion in February. In exchange the government would get warrants for non-voting stock. This is a deal that could have been worked out a month ago but wasn’t due to the ideological opposition of the Administration to doing anything that would help out the real economy and the ongoing desire of Republicans in both the Congress and the White House to destroy unions in general and the UAW in particular. The agreement contains the standard lines about limits on executive compensation and prohibits dividends during the course of their loans. The automakers are to show by March 31, 2009 that they are financially viable, a requirement which was never made of financial institutions which received the vast majority of TARP money. This is kabuki. The automakers will come up with re-structuring plans and, regardless of their feasibility, the Obama Administration will approve them (because the alternative is depression).
The package also has a set of noxious “targets” which represent a grab bag of conservative demands but being targets they don’t actually have to be met. Rather they are meant to supply conservative critics of the auto bailout future talking points:
- An exchange of equity for debt to reduce their debt by 2/3. This would essentially sell the companies to bondholders.
- Wages and work rules similar to those for foreign automakers by December 31, 2009. When legacy costs are factored in, these would likely make autoworkers for the Big 3 earn less than their non-union counterparts working for foreign brands.
- It would allow the companies to make half their payments into retirement funds in the form of fairly worthless stock
- And finally it would eliminate the jobs bank, something the union has already agreed to.
In addition, Secretary Paulson has asked that Congress free up the remaining $350 billion in TARP funds. Given how poorly Paulson has spent the first half $350 billion, it would be very unwise to let him anywhere near any further funds.
Also on December 19, 2008, the Fed announce that it would allow access to its $200 billion Term Asset-backed Securities Loan Facility (TALF) to all investors, including hedge funds, who hold consumer debt instruments. This means that they can dump these instruments on the Fed in exchange for cash. The theory, but unfortunately not the practice, is that these investors will use the money they get to invest in more consumer credit. There is no indication that they will. The inclusion of hedge funds is an especially worrisome sign because there are increasing questions concerning the solvency of these private opaque actors.
On December 29, 2008, Treasury announced it would lend $5 billion for non-voting stock with an 8% annual dividend to the finance company GMAC which is co-owned by GM and the Cerberus hedge fund (which also owns Chrysler). GMAC is in the process of converting itself into a bank holding company. In order for it to do this, bondholders must agree to swap 75% of GMAC’s $38 billion debt for stock. Treasury would also lend up to $1 billion to GM to buy a further stake in GMAC. Cerberus looks to be functionally insolvent and so can not sink any money into the deal but it is unclear, except for the crony capitalist way these deals get structured, why it shouldn’t lose its stakes in Chrysler and GMAC.
A December 31, 2008 story in TPMMuckraker notes another instance of crony capitalism perpetrated by those who are supposed to be seeing us out of this mess. Private managers of a Fed program announced November 25, 2008 (see above) to buy up $500 billion in mortgage backed securities from Fannie and Freddie (who themselves have been directed by Treasury’s Paulson to buy up some $400 billion in these toxic assets; see October 11, 2008 paragraph above) are Goldman Sachs (please try to restrain your surprise), Blackrock, Wellington Management, and PIMCO. PIMCO holds some $500 billion in these securities (61% of its assets) and lobbied for the creation of this program. Under a selection process that was not made public, it now comes out that it is one of those overseeing the buy back (a function it also lobbied for) of exactly the kind of securities it holds. All of this is one big conflict of interest and shows once again that the financial bailout is being run by and for precisely those who created the need for it.
On January 12, 2009, George Bush at President-elect Barack Obama’s request notified Congress to release the remaining $350 billion of the Paulson bailout. Doing it this way will allow Obama to use the money with the same lack of controls as under Bush.
On January 16, 2009, Treasury announced a further bailout of Bank of America. Bank of America expressed “surprise” that the investment bank Merrill Lynch which it took over in September lost $15.3 billion in the last quarter of 2008. In a deal structured similarly to the recent one with Citigroup, BoA will receive another $20 billion in TARP funds (in exchange for $4 billion in BoA stock) and it will receive a “backstop” for some $98.2 billion of its crap assets. BoA will cover the first $10 billion, the FDIC picks up the next $10 billion and the Fed and BoA split any other losses on the remaining $78.2 billion, 90% by the Fed, 10% by BoA. So just to recap, BoA is at most out $4 billion in stock plus $10 billion in initial losses plus 10% of $78.2 billion in subsequent losses or $21.8 billion. But it just received $20 billion from Paulson so for a net pay out of $1.8 billion, it has gotten a government guarantee on $98.2 billion of its crap assets.
This is just obscene. What is happening here is about recapitalization of the banking industry by the backdoor without the government or the taxpayer getting anything but debt in return. It is yet another case among so many of “Privatizing gains and socializing losses”. BoA is under no obligation after this either to help distressed homeowners or resume normal lending to ease the credit crunch. It is also an example of how taxpayers are paying for the consolidation now occurring in the financial industry. BoA takes over Merrill, keeps the good stuff, and dumps the crap on the government, and ultimately the American taxpayer. And it shows once again how the paper economy is favored over the real one. The BoA bailout is not just a sweetheart deal. It is a giveaway. It was agreed late at night with no one watching or asking questions and none of the very public and long drawn out groveling that was required of the auto industry and its executives for a deal that was much smaller and had much harder conditions.
As long as Paulson and his successors in the incoming Obama Administration continue to favor BoA and other institutions like it over the wider economy and the interests of ordinary Americans and as long as they refuse to address the fundamental problems underlying the meltdown, we are not going to get out of the current crisis but we will pay for it anyway. Their priorities and approach remain completely out of whack. BoA comes out of this stronger, but the economy and the country have been made weaker.
And if even after all this BoA still has problems, it can follow the model of Citigroup one step further. Citi is currently in the process of splitting itself in two. In one part will be its profitable operations and in the other will be its remaining crap and unprofitable divisions. One will go on conducting business as usual and the other will be allowed to fail, be bailed out again and again by the government, or be sold if anyone can be found crazy enough to buy it. There is no way that the government should let Citi do this, but there is not a chance that it won’t. But that is the thing, the people who perpetrated the meltdown on us are also the people who are running the response to it, and neither those in government or in the industry have changed how they do business, the business that got us in this mess, at all.
In a February 5, 2009 New York Times story, Elizbeth Warren, chairwoman of the Congressional Oversight Panel on the TARP, reported that, according to the panel’s calculations the Treasury in its bank bailout paid $254 billion for assets worth $176 billion for a loss of some $78 billion or a wastage rate of 30% of the funds it handled.