In 2008 it appeared that Wall Street and associated financial institutions, huge Too Big To Fail (TFTF) banks were endanger of collapsing. A clarion call was made by Hank Paulson, U.S. Treasury Secretary and former Wall Street bank at Goldman Sachs for $800 billion rescue. To some this was absolutely required to stem the panic in Wall Street. Others like myself wonder if other solutions couldn’t have been considered besides a giant giveaway to the Wall Street Banksters. I would rather characterize it as knee jerk Crony Capitalism.
Let me provide some details about this huge corporate welfare scheme. In 2008 the highly leveraged Wall Street investment banks started to “Go South” after betting on the mortgage market. Highly leveraged means their capital was a mere fraction of their investments. Maybe 2 or 2.5% of their investments. This money making game sounds like fun until somebody gets hurt, of course. And they looked to the U.S. government to provide corporate welfare to bail them out.
To put it in perspective, it’d be similar to the average Joe or Jill who went out and bought a million dollar home on the a downpayment of say $10,000. Of course in large part that’s what the average person was doing during the housing boom. Borrowing to the hilt in anticipation that housing prices would continue to rise, and then quickly sell for a profit far greater than that little down payment, of say $10,000, [or no downpayment at all in some cases], when they “flipped” the house.
The Investment bankers were betting on the same thing in this highly leveraged way, 40 to 1 or more. These sketchy mortgage loans that Joe and Jill Q. Public were making were packaged into “investments” and sold to Wall Street and to their clients. Wall Street began to trade with its own money after a time, in addition to representing their clients.
The most famous of those banks is Goldman Sachs; it’s a beehive of money making activity working just about 365 days a year. Recruited from the best business schools, those hires that survive the 30 interviews will see themselves working 110 hours a week, 7 days a week. They are all about the money. Nothing wrong with that I suppose. Just don’t ask me to finance your lifestyle through my tax dollars.
Anyway Goldman Sachs was the first to determine that the housing boom was coming to an end and they started to bet against it. In fact they were selling these mortgage backed securities to clients AND betting against them at the same time. They were fined $500 million in spring of 2011 by the SEC (Security Exchange Commission) for this very arrangement. The SEC are the guys who are supposed to watch over Wall Street but fall asleep a lot. (Does Madoff come to mind?) (See Money and Power, by William D. Cohan about Goldman Sachs).
The $800 billion TARP in 2008 that was rammed through Congress, with dire prognostications about the economy, if it failed to pass, was just the start. This money was used to prop up banks and purportedly save “Main Street” in the process. Of course 3 years later there are some six millions fewer people unemployed than in 2008 but Wall Street has been made safe for Democracy. But as I said this bail out was just the start.
Now comes another recipient to Federal government largess. The huge insurance company AIG insured these mortgage backed securities with something called Credit Default Swaps; it’s just insurance on failure of a bond. AIG figured this was easy money: money for nothing. They just collect the premiums and would never have to pay. Something like hurricane insurance for Michigan, right? Remember these are the smartest guys in the room. But OOOOPS! When the bottom fell out of the market, they didn’t have the funding to back them up.
Outrageously, Wall Street chose collectively not to aid itself, we find out. The Federal Reserve in late 2008 asked the Wall Street banks to ante up to save AIG; these are the guys that would be most affected by this failure of AIG. Wall Street refused. Now mind you, AIG held the insurance that was backing Wall Streets mortgage related investments. They would only be helping themselves if a consortium of banks contributed to their own rescue. And thus …
JPMorgan and Goldman offered no public explanation for rejecting [U.S. Treasury official] Geithner’s proposal. The public wasn’t even told the banks were asked to do their part. Nor did Federal Reserve officials argue with the decision or try to apply persuasive pressures. [Unattributed internet quote]
With Wall Streets refusal to help themselves, the cost to U.S. taxpayer was $182 billion to prop AIG up. I figure that’s about enough to support about a half a million welfare queens for about a 20 years to my calculation. (I just saw a story of couple swindling welfare $1,200 monthly for the last 10 years living in a $1 million dollar house….lets see how many years would they have to live to have taken as much as AIG….counting fingers, toes, I still counting … ok, just 12.5 million years) Instead we’re supporting a few millionaires, who will eventually buy a few Governorships or Senate seats like Jon Corzine or a sports team or two [only if the stadiums are supplied by the public of course]. These banks had the gall or audacity to refuse to ante-up when we were told that “we” were all in the same boat together, Main Street and Wall Street, one big happy family. The fact is when it came to saving themselves they wouldn’t even pony up and left the taxpayers with the bill.
So without further adieu Ben Bernanke, Chairman of the Federal Reserve, makes taxpayer billions available to AIG. This was backdoor bailout to the Wall Street banks including Goldman Sachs, Merrill Lynch and foreign banks like Deutsche Bank. Of course it wasn’t until a year and half that the Federal Reserve disclosed the deal that made these banks good.
Just for your information, the financial wizard said to be the most responsible for AIG’s collapse was Joseph Cassano who made $280 million in the eight years he was employed there plus he was allowed to keep the $34 million of bonus, when he walked away in 2008. It seems kind of unjust that the person most responsible for tanking AIG to the cost of $182 billion to taxpayers was made rich as Croesus in the process. I guess that’s why I got to believe in Hell; some people might think it sufficient to suffer someone like that to read my blogs for eternity….sounds fitting. (FYI: Mr. Cassano’s eventual disposition in the afterlife is only known to our Creator. I make no judgment as to his true character.)
I’m told we should feel better that AIG paid back most the bail out and they only owe $ 50 billion now. Like I say, just give me $182 billion today and I’ll gladly give it back to you tomorrow. The interest overnight would allow me to retire and all of my family, as well, for life. Meaning of course that capital is scarce and absolutely key to success of any enterprise, borrowing a few hundred billion here and there and giving it back sometime later is a fantastic gift and to a massive failure like AIG boils down to the dreaded “unjust enrichment”.
We’re not done yet with the chicanery. Big Ben (not the dope, Ben Roethlisberger, that plays quarterback for the Pittsburg Steelers and likes to mash young women and eat for free but Ben Bernanke, Fed Chairman) decides to allow Goldman Sachs to declare itself a member of the Federal Reserve banking system like a consumer bank. Voila! They have access to the Federal Reserves funding. Christmas came early and often for Goldman Sachs.
What Goldman Sachs could take advantage here was what is called the Primary Dealer Credit Facility, something only a very few financial institutions have privilege to, which is access to short term lending in the billions, at an interest rate that remains at a very low .5% interest. Goldman Sachs made use of $782 billion in loans from this “facility”.
In the same year Goldman Sachs made $13.4 billion in profit (2009) and their employees averaged a cool $500,000 a year. I suppose that “Main Street” should be breathing easy that “Wall Street” returned to profitability so quickly. But in fact the consumer sector, 70% of the economy, has been taught a very hard lesson with the Great Recession by the bail out of Wall Street. The financial elites made out but in doing so “Main Street” was largely left behind. More importantly consumer psychology had been radically changed into something like a bunker mentality with continued long term affects on economic growth.
What’s the solution? Not necessarily more Big Government. It’s Big Government that contributed to this mess in the first place. The guarantee of the banks’ “deposits” (actually payables) to begin with in 1933 put the U.S. taxpayer on the hook for bank stupidity (or rather speculative risk) since the depositor was much less concerned how the bank “invested” (lent out the deposits) and the bank had less fear to lend at dangerous risk.
And oddly many people place the blame solely on the Republican Party, the party of Business. But a Democratic administration under Clinton and a Democratic congress removed barriers to interstate banking under Riegel-Neal Act in 1994. This essentially allowed the creation of the mega-banks, TBTF’s (Too Big to Fails) , that we see today. In addition Robert Rubin, another former Chairman of Goldman Sachs, and Treasury Secretary for the Clinton administration, was instrumental in undoing the wall that Glass-Steagall of 1933 erected between commercial/consumer banking and investment banking (stocks and bonds). This added to the risk these large TBTFs could take by betting on the stock market using deposits guaranteed by the Federal Government.
Add to that Rubin, as Treasury Secretary under Clinton, deflected any oversight of the huge derivative mark in 1998. Brooksley Born, the director of the Commodity Futures Trading Commission (CFTC) at the time advocated oversight of this multi-trillion dollar market. Rubin, Alan Greenspan, Federal Reserve Chairman and Larry Summers, the next Treasury Secretary under Clinton all opposed any oversight. See below as to the import and meaning of derivatives:
Derivatives are highly volatile financial instruments that are occasionally used to hedge risk, but mostly used for speculation. They are bets upon the value of stocks, bonds, mortgages, other loans, currencies, commodities, volatility of financial indexes, and even weather changes. Many big banks, including Bank of America, issue derivatives because, if they are not triggered, they are highly profitable to the issuer, and result in big bonus payments to the executives who administer them. [Avery Goodman, 2011]
Credit default swaps would fall under this category. AIG sold them and Wall Street bankers bought them, thinking they would insulate them from risk, much to their peril. The reliance on these gave a false sense of security to Wall Street.
Continuing on this vein of how much influence Wall Street exerts in Democratic administrations read below:
Goldman [Sachs] employees and their relatives contributed almost a million dollars to Barack Obama's presidential campaign — making it "the company from which Obama raised the most money in 2008" — and Blankfein [Chairman]has visited the White House ten times as of February 2011. (wikipedia)
Have you had a chat with the President lately? Chairman of Goldman Sach’s has had numerous talks with the President, something akin to full access. It’s amazing what $ 1 million will buy you.
Instead of substantive reform, the Democrat solution in 2009 Frank/Dodd bill relied soley on more regulation. It does little to prevent another massive bailout since it doesn’t reinstate Glass-Steagall with its separation of investment and retail banking nor does it reasonably reduce the size of the TBTFs. It leaves it up to governmental agencies to scrutinize them. One of its provisions carries the risk of increasing the chance of a bailout; FDIC is allowed to borrow from U.S. Treasury thus providing for another avenue for a bailout.
As evidence as to the efficacy of Frank/Dodd regulation we have the recent MF Global failure, run by no less than Jon Corzine, former Governor and Senator of NJ and Co-Chair of Goldman Sachs. It appears that despite the oversight of governmental agencies envisioned by Frank/Dodd, MF Global crashed and burned and ended up losing $1.2 billion dollars of their customer’s funds in what might turn out to be massive fraud. In the last few months before they declared bankruptcy their clients funds may have been used to fund the “proprietary” accounts, that is the ones that the MF Global themselves bet with. As the company was losing money this would be a ready source of cash.
Once again there’s a tale of collusion between Wall Street and government despite the enhanced regulation meant to have been provided by Frank/Dodd. CFTC, the regulatory agency designated to oversee MF Global was led by Gary Gensler, a former colleague of guess who? Jon Corzine, at Goldman Sachs. Congress will be asking Mr. Genlser how he was asleep at the wheel, while MF Global burned, while using what appears to be customer money which is supposed to be completely separate from the firms trading accounts.
And wait it gets better. Another former Goldman Sachs associate, President of the New York Federal Reserve bank grants MF Global access to that Prime Dealer Credit Facility I spoke about above, that is to be a primary lender in February, 2011. This is after MF Global had several losing quarters. Granting primary dealer status generally takes several years, I understand. As a result they can borrow from the Federal Reserve at near zero rates of interest. It might appear that Mr. Corzine’s connection may have some to do with the approval. Nonetheless it was good money after bad.
I almost forgot former President Clinton was on their payroll at $50,000 a month. What were they buying there I wonder?
I think this throws the ability of Frank/Dodd to regulate the financial markets into question. The bottom line is that regulation is ever liable to influence peddling. Somethings like MF Global or Madoff somehow just get missed.
I won’t run through all the sensible solutions; admittedly regulation of markets is all important to assure transparency. Using the Federal Government as a big piggy bank is NOT.
One solution that I rarely hear about is the need for adequate capital requirements. That is how much “downpayment” is required to be kept on hand. Currently, if you go try to borrow for a house the bank is going to ask you for a 20% downpayment. I was in banking for 15 years. The old bank, run by the McPherson family, since 1865, leant out only about 50% of its assets. The remainder was in U.S. Treasury bonds. That bank survived several panics and the Great Depression. It was bought out to a “hot shot” lumber guy from Bay City, Michigan. They started the New Century Bank and began to liberalize their lending requirements where the vast majority of you assets were leant out, say 90% or some such. Of course much more money can be made lending than simply buying low yield but very secure U.S. Treasury Bonds. That New Century bank didn’t make it past a couple of years and managed to lose about $ 30 million in a year or so and was bought out by another regional bank shortly after.
Lesson is that today’s banks are far too leveraged, I realize there would be screaming world wide from the financial community but capital accounts requirements of 20%, not the 5% or so that’s now typical, should be mandatory. Each time these financial institutions are trouble, the cry is that they can bring down the whole economy, if so, they should have very high capital requirements and better yet they should be rationally downsized. Former Federal Reserve President, Alan Greenspan, was the only other person I’ve heard call for increases in capital requirements. The retails banks along with the investment banks are too highly leveraged and need a much larger cushion to protect the taxpayer and the economy.
Just a heads up, October 21, 2011 Bank of America shifted $55 trillion dollars of derivatives from its Merrill Lynch division to its retail consumer bank, Bank of America insured by the FDIC. FDIC, Federal Deposit Insurance Corporation has opposed this shifting of risk from Merrill Lynch investors to U.S. taxpayers. Another bailout?