CONGRESSMAN HENRY B. GONZÁLEZ once asked me if I could name the largest transfer of wealth in our country’s history. I stumbled through a couple of New Deal acronyms and had moved on to the defense budget when González stopped me. “Mortgage lending,” he said. González was a liberal Democrat from San Antonio who chaired the House Banking Committee from 1989 to 1995. In 1988 he reminded me that at the time a thirty-year fixed-rate mortgage required the average family to pay for its house twice—once in principal and once in interest. He described mortgage lending as a vast transfer of wealth from the working class to the stocks-and-bonds class.
The Public-Private Investment Program—a.k.a. PPIP, or the “Geithner Plan”—doubles down on the perennial transfer of wealth that González described. A brief recapitulation of the plan as described in the April 15 issue of the Spectator:
The U.S. Treasury lends 85 percent of the purchase price of toxic bank assets (now more genteelly described as “legacy securities”) to hedge fund managers, who buy assets from banks that need to clean up their balance sheets. Treasury also does a dollar-for-dollar match on the 15 percent cash outlay. For that 92.5 percent, Treasury (the taxpayer) gets 50 percent of any profit that might be made if the toxic asset recovers its value. As does the investor, who has 7.5 percent in the deal.
The incentive for the private investor is not only the small amount of skin in the game, but the freedom to walk away from the Treasury Department loan if things don’t work out. The private investors participating in the program belong to the same plundering class that made obscene fortunes selling the collateralized debt obligations and other exotic bank derivatives that lost value and created the current economic crisis. So the soufflé will rise a second time for many of the Wall Street swells who already got rich once by making the mess that Treasury is trying to clean up.
“I’m outraged by it,” said Damon Silvers.
Silvers is a member of the Congressional Oversight Panel for Economic Stabilization, set up by Congress to oversee the bank bailout. His opinion of PPIP is his own, not the opinion of the panel, nor that of the AFL-CIO, where he serves as general counsel.
“No matter what happens, the taxpayer is exploited,” Silvers said. “You’ve got a leveraged structure where 90 to 95 percent of the capital comes from or is guaranteed by the public. If the assets recover…the hedge funds we hired at exorbitant fees make a lot of money. Somehow we [taxpayers] make a lot of money. And half the money goes to the people who put up 5 percent of the capital.”
Silvers said the market had to be buttressed by public funding because “no sane person paying with his own money” would buy toxic assets at the value the banks place on them.
OTHER PEOPLE’S MONEY—Silvers is right. One of the rules of high-risk investment is that it’s OPM—other people’s money—that is put at risk. Buyers of toxic assets will be motivated by government loans that follow them as they bid asset prices higher. The PPIP attempts to “bridge a gap,” economist Simon Johnson told Fresh Air’s Terri Gross. Banks hold assets that were worth a full dollar when issued, but have since been marked down to eighty-five cents on the dollar. Buyers value those assets at forty cents. The taxpayer subsidy is intended to encourage buyers and bankers to meet halfway—at, say, sixty cents.
Fund managers understand that: Investors win. Bankers win. Taxpayers lose. “Essentially it is to let private investors buy these assets cheaply and to simultaneously let the banks sell them at high prices at the expense of the taxpayer,” hedge fund manager Ray Dalio wrote in a letter to investors. “So it gets around the transfer pricing problem because the public doesn’t understand the value of the leverage/non-recourse loan.” The public should understand that “non-recourse” means “no collateral” other than the asset purchased. If the asset goes south, the buyer defaults and loses only the 7.5 percent he put up. (Try offering a deal like that to the bank that holds your home mortgage or car note.)
Buyers are the big guys like Dalio, who manages an $80 billion investment portfolio for Bridgewater Associates, one of the largest hedge funds in the country. Only investment funds such as Bridgewater, BlackRock, Pimco, Goldman Sachs, and Legg Mason meet the Treasury Department’s requirements to purchase legacy securities, according to Rep. Darrell Issa (R-CA). On April 7 Issa wrote to Treasury Secretary Timothy Geithner, demanding all Treasury Department communications with the big investment firms and complaining that only an “elite group of industry titans” is allowed to participate. Geithner’s scheme is so perverse that it allows Issa, a multi-millionaire Republican from San Diego, to appropriate the populist mantle of Henry B. Gonzalez. And Bridgewater, as it turns out, won’t be buying assets through the PPIP after all.
A MAN, A PLAN—”Americans should be outraged at the latest sweetheart deal in Washington. Congress will put us taxpayers on the hook for potentially hundreds of billions of dollars…. If a dime of taxpayer dollars ends up being directly invested, the management and the board should immediately be replaced, multimillion-dollar salaries should be cut, and bonuses and other compensation should be eliminated. They should cease all lobbying activities and stop payment to outside lobbyists. And taxpayers should be first in line for any repayment.”
There’s a quote from July 2008 that will make you miss presidential candidate John McCain, even if the prospect of a volatile, reactive John McCain in a White House in crisis makes you want to scream like Edvard Munch’s gaunt figure on the bridge. McCain was talking about Freddie Mac and Fannie Mae, the two government-sponsored entities that are always fair game for Republicans, because they represent government encroachment into the private sector. (Imagine that.) Yet the standard that McCain defined should be applied to all the insolvent institutions that accepted government funding.
“Why isn’t Barack Obama saying that?” asked Walker Todd. Todd is a veteran bank regulator and author of a study of the Reconstruction Finance Corporation—the Depression-era agency that recapitalized or shut down insolvent banks during the Franklin Delano Roosevelt administration. Todd was one of a group of policy experts gathered in Washington for the six-month anniversary of the Emergency Equalization Stabilization Act, which created the Troubled Assets Relief Program (TARP). (Some people know how to have fun.) The event was sponsored by Demos, a New York-based non-partisan public policy group. Todd believes the Federal Deposit Insurance Corporation should take control of insolvent banks, wipe out shareholders and management, and require the banks, when solvent, to pay back what it cost to make them whole again.
The panel that Congress established to monitor the Treasury Department’s TARP implementation seems to agree. The committee is chaired by Harvard professor Elizabeth Warren, who in a few months has established a reputation as Congress’s cop on the bank bailout beat. The report the Congressional Oversight Panel for Economic Stabilization released on April 7 included a bank recapitalization primer based on the program Jesse Jones created to rescue the nation’s banks during the Depression.
Jones was a conservative banker and investor from Houston whom Roosevelt made chairman of the Reconstruction Finance Corporation. Jones concluded that providing failing banks with loans wasn’t enough. To save them, according to the TARP panel report, the RFC had to: “(1) write down a bank’s bad assets to realistic economic values; (2) judge the character and capacity of bank management and make any needed and appropriate changes; (3) inject equity in the form of preferred stock (but, critically, not until the write-downs have taken place); (4) receive the dividends and eventually recover the par value of the stock as the bank return[ed] to profitability and full private ownership.”
Transparent, efficient, and heartless when it came to euthanizing institutions at death’s threshold, Jones’ RFC invested $1.7 billion in 6,104 banks. The process he put in place has served as a template for rescuing failing financial institutions since 1934. It even provided a model for resolving bank failures in Sweden and Japan.
OBAMA’S BANKERS—Geithner’s PPIP is more than a sweetheart deal for Wall Street. It is complex. It is opaque. And it is devious. It creates, for example, structured investment vehicles (like Enron’s infamous Chewco) that operate on little capital, lots of leverage, and keep liabilities off balance sheets. It creates two types of auctions, one for asset-backed securities that banks are holding and another for actual mortgage loans that banks have on their books. It implies that buyers can return for a second round of borrowing after they purchase the toxic assets, although the details are so vague that one financial analyst told me she is advising clients that second loans “might be possible.” It protects management and boards of failed institutions, and dilutes, but does not wipe out, shareholder equity.
A creation of Wall Street investment bankers who delivered it to the Treasury Department, PPIP is nothing Jesse Jones would have recognized and totally unlike anything ever used to recapitalize banks in any country.The plan puts President Obama in a difficult situation, creating an ethical Achilles’ heel that could put his presidency at risk.
The president has been a favorite of Wall Street since he was elected to the Senate in 2004. Goldman Sachs principals, employees, families, and political action committees provided Obama $1,035,095 in political contributions between 2003 and 2008, according to the Center for Responsive Politics. In 2008 the hedge fund community gave the Obama campaign $1,316,436. By comparison, Hillary Clinton came in second with $760,400, and John McCain, fourth with an anemic $605,000.
Penny Pritzker was the national finance chair for Obama’s presidential campaign. Pritzker, a Chicago billionaire, was chair of Superior Bank of Chicago when it was seized by the FDIC after losses related to subprime home mortgages left it insolvent. Pritzker was a passive bank officer who had stepped in to represent her family’s interest in the bank after the death of her uncle. Superior was largely run by its other half owner, but Pritzker’s reputation was sufficiently damaged that she removed herself from consideration for any appointment in the Obama administration.
Bill Clinton’s first Treasury Secretary, Robert Rubin, began advising Obama after he won the nomination. Rubin’s deregulation work at Treasury created the climate that made the current crisis possible and Rubin became something of a toxic asset himself when it was evident that Citigroup, Rubin’s employer after he left Treasury, was collapsing under the weight of dicey subprime loans. (The Obama campaign quickly moved Rubin offstage.)
Rubin protégé Lawrence Summers, who completed the bank and investment deregulation scheme started by Rubin and Republican Senator Phil Gramm, is now the director of Obama’s National Economic Council. In early April, the Wall Street Journal reported that Summers earned about $5.2 million over two years, working one day a week for the D.E. Shaw hedge fund.
Rubin’s son Jamie, who works for a private equity group, has been another Wall Street adviser to the Obama administration.
This is not to suggest that Obama is in the tank for Wall Street. But the influence of financial institutions on the president is the 800-pound gorilla that progressive Democrats seem determined to ignore. And the decisions the president is making in an attempt to right an economy recovering from eight years of George W. Bush are fraught with peril for the Obama presidency. And for the country.
NO BANKER LEFT BEHIND—New York University economics professor Nouriel Roubini has been ahead of the curve since he predicted in specific detail the nature and severity of the current economic crisis two years before it began to unfold. Here’s the encapsulated Roubinomic evaluation of the stress test that Treasury Secretary Geithner required the country’s nineteen biggest banks to undergo. The test creates a hypothetical optimistic (baseline) variable and a hypothetical pessimistic (adverse) variable for gross domestic product, unemployment, and home prices. It then runs the banks’ numbers through computer models programmed to predict how each institution will perform in the event the numbers on GDP, unemployment, or home prices fall to the hypothetical levels used in the test. Roubini’s critique: real world numbers are already worse than the hypothetical numbers in a test designed to predict how banks will perform if the economy gets worse. In other words, the economy is already worse.
The “optimistic” baseline scenario on GDP projects a 2.1 percent decline in the nation’s gross domestic product in 2009, while the adverse scenario has the GDP contracting 3.3 percent. Roubini cites Goldman Sachs, Merrill Lynch, and Morgan Stanley analysts who have the GDP contracting 3.5 percent this year. Roubini’s own online publication, RGE Monitor, predicts a 3.7 percent decline.
The employment metrics in the stress test assume a 7.7 percent baseline and a 7.8 percent adverse unemployment rate. The problem with those numbers is that unemployment hit 8.5 percent in March, with no signs of improvement. A mainstream Morgan Stanley analyst cited by Roubini predicts double-digit unemployment by June of this year.
Stress-test numbers on home prices predict a baseline decline in value of 14 percent and an adverse decline of 22 percent. Home prices fell 1.8 percent in January 2009, which compounds to an annual decline of 25 percent.
All nineteen big banks are passing the test, according to the New York Times, even if several banks will require more federal aid to maintain their capital reserves. Yet every metric in the stress test is more optimistic than the facts-on-the-ground economic numbers.
Cardiologists test heart function by putting patients on a treadmills and increasing the speed from a slow walk to a demanding and sustained near-run. There is little reassurance in banks passing a test that amounts to a slower than average walk on the treadmill. Roubini might sound like the Chicken Little of the dismal science, but in this case the smart guys at Treasury, the Fed, and the FDIC seem blind to the fact that the sky has already fallen.
F-22 DOWN—The F-22 that crashed during a test in March went down near Edwards Air Force Base in Southern California; not, as we reported, in our April 15 issue, near Andrews Air Force Base in in Southern California. Apologies, as well, to Maryland. Thanks to the diligent reader who pointed out the error.