Dirt Diggers Digest

What a difference eight months make. Last fall, Treasury Secretary Henry Paulson pushed through a bailout program that was seen as the salvation of the financial sector. The banks eagerly lined up to get their share of $700 billion in federal largesse with few strings attached.

These days, aid from the Treasury Department is about as welcome as the heaping spoonfuls of cod liver oil mothers used to force down the throats of their children. Large institutions such as JP Morgan Chase, Goldman Sachs and Morgan Stanley cannot wait to repay Uncle Sam. Several smaller ones have already done so. Allstate just became the second large insurer to announce that it is not interested in the insurance bailout fund reportedly being put together by the Treasury. “Given Allstate’s strong capital and liquidity positions…we will not participate in this program,” sniffed the company’s chief executive Thomas Wilson.

Bailouts are supposed to be situations in which companies come to Washington with a tin cup and plead with lawmakers to save them from obliteration. Lawmakers have to be persuaded to devote public money to rescue those suffering failure in the private market.

Somehow that has gotten completely turned on its head. We now face a situation in which the federal government is in effect pleading with large corporations to take its money, and those companies find it distasteful to do so. Getting bailed out is viewed as burden rather than deliverance. Financial policy has gone from being wrong-headed to being downright bizarre.

Treasury Secretary Timothy Geithner does not seem to be aware of the absurdity of his position. It is unclear why he continues to push his bailout medicine on financial institutions that claim they don’t need it—claims that on the surface have more validity following the completion of the stress tests that were dubious to begin with and lost all validity after it came to light that many banks successfully negotiated for more favorable findings.

To make things worse, Treasury is, according to the New York Times, allowing those banks buying back the feds’ holdings to do so on extremely favorable terms. “Treasury accepted a lowball offer,” one analyst told the Times.

The time has come for Geithner and his boss President Obama to admit that the bailout program has become a farce. There is little evidence that it ever accomplished the stated aim of freeing up lending. Whether or not the banks really needed the assistance in the first place is something that analysts will be debating for many years to come. The auto industry portion may have provided some breathing room for General Motors and Chrysler, but now it’s become clear that the real plan is to increase imports from low-wage countries such as China.

Let’s wrap up this botched flirtation with state capitalism and focus on rebuilding an effective system of financial regulation. Some investigations and prosecutions of those who caused the mess in the first place would also be welcome.

Treasury Secretary Timothy Geithner kicked off his big day with the publication of an op-ed in the New York Times asserting that the Obama Administration has brought a “forceful response” to the “damaged financial system” it faced upon taking office. “We chose a strategy to lift the fog of uncertainty over bank balance sheets,” he added, and “help ensure that the major banks, individually and collectively, had the capital to continue lending even in a worse than expected recession.”

Then why does the announcement of the results of the stress tests applied to 19 large financial institutions by federal banking regulators seem to create an even denser fog of confusion? You only had to look at the differences between the front-page headlines in the Washington Post and the Wall Street Journal to see the absence of a coherent story line from Geithner, Federal Reserve Chairman Ben Bernanke and other top officials.

BANKS NEED AT LEAST $65 BILLION IN CAPITAL blared the Journal in reporting the somewhat inaccurate information that had been leaked to it, while the Post presented its leaks with a more upbeat STRESS TEST FINDS STRENGTH IN BANKS. Following the release of the actual results late Thursday, the Post website was going with STRESS TESTS FIND BANKS NEED $75B IN EQUITY, while the Journal cranked up the alarm level with FED SEES UP TO $599 BILLION IN LOSSES.

The divergence in headlines reflects the contradictory messages that the Treasury and the Fed began feeding the public last fall and that have continued under the new administration. We’ve been whipsawed between the idea that there was a pressing banking crisis that required urgent aid from taxpayers and the notion that things were not so bad as to justify a federal takeover of the ailing institutions.

Bernanke continued the equivocation with his statement: “The results released today should provide considerable comfort to investors and the public. The examiners found that nearly all the banks that were evaluated have enough Tier 1 capital to absorb the higher losses envisioned under the hypothetical adverse scenario. Roughly half the firms, though, need to enhance their capital structure to put greater emphasis on common equity, which provides institutions the best protection during periods of stress.”

Given that the report tries hard to make the “adverse scenario” against which the banks were tested seem like a remote possibility, it is significant that nine of the institutions were deemed to have sufficient capital for such an eventuality. Ten did not. Bank of America is said to require an additional $33.9 billion in capital, Wells Fargo $13.7 billion, GMAC $11.5 billion, Citibank $5.5 billion and Morgan Stanley $1.8 billion. Five regional banks need to raise a total of $8.2 billion. These numbers suggest substantial relative weakness, yet Bernanke counsels us to feel comfortable, and many mainstream observers seem inclined to take that advice.

Geithner and Bernanke’s “don’t worry, be happy” approach seems designed to lull the financial markets while making the case for additional use of taxpayer funds to prop up some of the banks. It also serves to blunt any calls for nationalization.

If anything, the case for federal takeover of institutions such as Bank of America is stronger than ever in light of the stress test results. One way that BofA and others are expected to improve the quality of their balance sheets is to convert the preferred stock that the federal government received in exchange for its capital infusions into common stock, thus making the feds a more dominant shareholder.

Rather than seeing this as an opportunity to influence bank business practices, the feds will maintain a largely hands-off stance, according to the Financial Times. So we will continue to have a double standard between the activist approach adopted by the Obama Administration with regard to the auto industry and its unwillingness to challenge the banking elite, for whom the stress tests turned out to be a form of stress relief.

Treasury Secretary Timothy Geithner and federal bank regulators have been conducting what they call “stress tests” of the nation’s 19 largest banks. Yet the biggest test is the one confronting Geithner himself and ultimately President Obama: Are they willing to abandon the ruinous policy of propping up major institutions that should be dismantled while simultaneously spending large sums of taxpayer funds to buy stakes in healthier banks that don’t need or want that government involvement?

The sad truth is that Obama’s financial policy is as incoherent as that of the previous administration. It veers between tough talk and complete coddling of the banks. In the case of the stress tests, the results of which are expected to be released early next month, Geithner has put himself in an impossible bind. If all the banks are deemed to have passed the test, the exercise will be seen as meaningless. If any fail, there will be pressure on the Administration to take them over—something Geithner seems dead set against.

And how will Geithner’s desire to use yet more public money to shore up the banks—whether through subsidized purchases of their toxic assets or additional capital infusions—play against a backdrop of rebounding earnings in the financial sector? JPMorgan Chase just announced a healthy profit of $2.1 billion in the first quarter, which followed a $3 billion posting by Wells Fargo and $1.7 billion by Goldman Sachs. Even struggling Citigroup managed to net $1.6 billion for the three-month period.

Like his predecessor Henry Paulson, Geithner believes that in order to avoid stigmatizing truly needy large banks the federal government has to give assistance to all of them. Sticking to that position has made Treasury look foolish as institutions such as Goldman and JP Morgan loudly proclaim their intention to buy back the federal government’s stakes in their firms, as some smaller institutions have already done. Large banks are reported to be urging the Administration to curtail new aid linked to stress test results.

To make matters worse, evidence continues to emerge that the fundamental objective of the bank bailout—freeing up credit for households and businesses—is not being met. Loan volume by the big bailed out banks continues to decline, while large institutions such as Bank of America are boosting their credit card interest rates. It is also telling that within the financial results just announced by JPMorgan, the sector of its business with the most dramatic profit growth was investment banking. In other words, it is making a lot more money from deals and securities than from lending. The same held for Citigroup.

If the “teabag” protestors who rallied around the country this week had any sense, they would have focused on the bank bailout rather than mounting a pointless attack on the validity of the income tax. The question is whether liberals and progressives, who may support Obama on many other issues, will seriously challenge his wrong-headed approach toward the financial crisis.

Note: If you are looking for a handy guide to the bewildering list of federal handouts to the financial sector, check out Pro Publica’s new Eye on the Bailout website.

This blog has not exactly been kind to the big banks receiving billions in federal bailout funds, so when a letter arrived in my mailbox this week from Bank of America I couldn’t help but wonder if they were getting back at me. The letter said that BofA, which manages my Visa card, had decided to jack up the interest rate from a somewhat tolerable (by today’s standards) 9.99% to a more usurious 14.99%. “We are making this change,” it said, “due to a change in our business practices, and due to the pattern of payments and Annual Percentage Rates on the account.”

The fact that I always pay my bills on time and typically send in much more than the required minimum made me all the more suspicious. When I called to complain I got no clarification. Then I opened the Wall Street Journal and read that BofA had sent similar letters to several million cardholders who, like me, carry a balance from month to month. It used to be that credit card issuers encouraged people to follow that practice, since that is how the interest charges pile up. Now it seems that anyone who fails to immediately pay in full is a credit risk who must be punished with a higher rate—no matter how good their payment record.

BofA’s move is part of a pattern among credit card issuers to boost rates before restrictions on increases instituted by bank regulators last year take effect in July 2010. Similar moves have been made in recent months by the likes of Citigroup, JP Morgan Chase and American Express. AmEx went so far as to offer cardholders some several hundred dollars if they paid off their balance and closed the account.

I was angry at being treated as a potential deadbeat by a bank that contributed greatly to the near meltdown of the financial system and had to be propped up by $35 billion in federal capital infusions. Yet when I called customer service I was told that, not only could I terminate my old Visa and gradually pay off the balance at the existing rate, the bank was prepared to offer me a new card at that same interest rate—and transfer the unused credit line from the old card.

I don’t know how many of the millions of people affected by BofA’s new policy were also offered an identical replacement account. In my case, at least, all that BofA has accomplished is incurring additional costs from administering a second card. With a business model like this, taxpayers should probably kiss our $35 billion investment in BofA goodbye.

If the story had been dated April 1st rather than the 2nd, I would have assumed it was a prank. The Financial Times has just posted an article on its website headlined “Bailed-Out Banks Eye Toxic Asset Buys.” In it the London paper reports that major U.S. financial institutions that received bailout funds and capital infusions from the federal government are giving serious thought to buying up toxic assets from one another under the “Public Private Investment Partnership” scheme proposed by Treasury Secretary Timothy Geithner last week.

Yes, that’s right: the banks we’ve been told desperately need to rid themselves of those mortgage-backed securities are thinking about buying more of them. There are only two possible explanations for this. Either the banks have been bamboozling the federal government and U.S. taxpayers from the start about the supposed burden of these holdings. Or the Geithner plan is such a lavish giveaway to major investors that the banks believe they can potentially make a killing simply by reshuffling their portfolios.

The FT mentions that Goldman Sachs and Morgan Stanley are among the banks looking at toxic asset purchases. That’s not surprising, since Goldman, for example, is in good enough shape that it reportedly wants to buy out the $10 billion holding that the feds acquired in the firm last year. Yet also mentioned is Citigroup, an out-and-out basket case. If Citi thinks it can find a way to participate, you know this is the deal of the century.

This bizarre development further highlights the profound disparity between the way the Obama Administration is treating the banks and the troubled auto industry. If Detroit were getting the same kid-glove treatment as Wall Street, General Motors and Chrysler would be receiving big federal subsidies to buy each other’s unsold vehicles.

Instead, the head of GM was forced out by the feds, and the company is now being edged toward some form of bankruptcy, which would undoubtedly result in the decimation of what remains of contract protections for UAW members. Meanwhile, Vikram Pandit remains the chief executive of Citi and Kenneth Lewis continues to run Bank of America as Treasury goes through endless contortions to avoid the obvious conclusion that at least some of the large banks are insolvent and should be taken over and reorganized. One wonders how much longer the Obamans will cling to the dubious notion that only the bankers who caused the current mess can clean it up—and should be allowed to do so using what amounts to a blank check from the taxpayers.