Category: Financial Crisis

The financial sector has contributed more than $300 million to federal candidates in this election cycle – split evenly between Democrats and Republicans – but it apparently was not enough. Today a motley coalition of free-market-loving right-wingers, fiscally conservative Blue Dog Democrats and anti-corporate left-wingers came together to deliver a stunning rebuke to the Wall Street bailout plan concocted by the Bush Administration and the leadership of both major parties.

The House’s defeat of the $700 billion plan represents (for now, at least) a breakdown in the tradition of acceding to the wishes of Big Business and Big Finance, especially at times when those monied interests need to be saved from their own excesses. It has taken a financial crisis of monumental proportions to expose as never before the rift between the needs of the corporate elite and those of the rest of us.

It has been fascinating to watch this play out across the political spectrum. Conservatives clinging to the ideology of market supremacy find themselves in a clash with corporate elites who have jettisoned their laissez-faire sentiments in favor of unprecedented government intervention. Joining the die-hard conservatives are progressives who oppose the Paulson plan but see the crisis as an opportunity to push for even more aggressive intervention, on behalf of working families.

In between are corporate-friendly Democrats and Republicans who were forced to lash themselves to the mast of the Bush Administration’s wildly unpopular plan. They were proud to have forced Paulson to abandon his original power-grabbing proposal in favor of a bill that included an abundance of oversight and disclosure as well as some safeguards for taxpayers. Yet by retaining same basic bailout concept, they were seen as doing little more than putting lipstick and various other cosmetics on a giant pig of a plan.

By taking Bush and Paulson at their word on the necessity of the bailout, mainstream Democrats, who made up most of the losing side in today’s House vote, have put themselves in a precarious position. This was captured in a vignette in today’s Washington Post account of the marathon weekend negotiations on the ill-fated bill. After the conclusion of a post-midnight press conference, Secretary Paulson, who had been showing signs of exhaustion during the talks, locked arms with Democratic Sen. Chuck Schumer of New York “and leaned heavily on the senator for support as they walked away.”

By trying to act “responsibly” in this tumultuous situation, the Democratic leadership may be literally and figuratively taking on the albatross of the Bush Administration and its Wall Street supplicants. Whether this is a trap that was deliberately set for them is hard to determine at this point, but the result is that Democrats find themselves out of step with the new anti-corporate zeitgeist.

The apparent sea change in attitudes toward Big Business may have repercussions far beyond the current credit crisis. It may also be felt, for example, at the state and local level. Here at the Corporate Research Project and Good Jobs First, we deal all the time with another sort of corporate giveaway – the often huge economic development subsidy packages given to companies ranging from Wal-Mart and Cabela’s to Dell and Toyota.

While we tend to critique those subsidies because they lack job quality standards and take funds away from public schools, there are libertarians who oppose them as an unwarranted intrusion in the market. Perhaps the right-left uprising against the bailout can help us form more effective strange-bedfellows alliances in our work as well. Look out, Corporate America, you may get outflanked from both sides.

This piece is being posted simultaneously on Good Jobs First’s Clawback blog.

If Congress approves the $700 billion bank bailout the Bush Administration is trying to force on the country through the threat of an economic mushroom cloud, the plan would not be carried out by career public servants. As in the war in Iraq, much of the grunt work would be contracted out to private companies. This raises the question: who will be the KBR or the Blackwater of the Big Bailout?

If William H. Gross has his way, the role will be played by his Pacific Investment Management Company, known as Pimco. Gross (photo) has been shamelessly promoting his firm as having the expertise and experience for the challenging job of using public money to buy up securities that in many cases may be nearly worthless.

When Pimco’s name first surfaced earlier this week, it appeared that the firm was trying to cash in on what would presumably be a bonanza of brokerage and asset management fees. Perhaps recognizing that this amounted to crisis profiteering, Gross gave an interview to the New York Times in which he offers Pimco’s services on a pro bono basis: “If the Treasury wanted to use our help, it would come, you know, free and clear.”

Is this one of the most selfless acts ever committed by a profit-making company, an egotistical play for personal glory, or a spectacularly audacious marketing ploy?

Gross can afford to be generous. His firm earns hefty fees each year managing portfolios (focusing on bonds) worth more than $800 billion for its clients, who are mainly “high net worth individuals” and institutional investors such as pension funds, university endowments and foundations. According to the Forbes 400, Gross has a personal net worth of some $2 billion.

The reason Gross’s offer may be taken seriously is that for the past year or more he was warning of the dangers of the subprime mortgage crisis while many in the financial world were trying to cover up the magnitude of the problem.

That’s all well and good. But it is also the case that Pimco is up to its neck in the crisis. Despite Gross’s concerns, the firm loaded some of its bond funds with mortgage-backed securities (MBS). Last May Pimco spent $2.6 billion to purchase the MBS portfolio of the Israel’s Bank Hapoalim. After Gross published a column last year in which he in effect called for the kind of rescue now being considered by Congress, blogger Mike Shedlock noted Pimco’s MBS exposure in a post titled “Bill Gross Wants PIMCO Bailout.”

This is the first of the problems with Pimco’s noble offer: it might not be so noble. PIMCO would in effect be helping to bail itself out. And perhaps also its parent, German financial conglomerate Allianz Group, which earlier this year wrote down the value of some $1.8 billion in asset-backed securities.

And that leads to the second problem: conflict of interest. Could Pimco, or any money manager for that matter, avoid the temptation to structure its purchases on behalf of the Treasury in a way that benefits its own private clients? The temptation might be even greater if the firm were not earning fees.

Even Gross’s friends are worried. Today’s New York Times piece quotes Luis Maizel of LM Capital Group as saying: “If you put this in Bill’s hands, Pimco is going to come out great, and I don’t know that the government will.”

Sounds like something you might say about the performance of Blackwater or KBR in Iraq.

A number of leading Democrats and Republicans expressed strong misgivings on Monday about the autocratic plan for bailing out Wall Street that Treasury Secretary Henry Paulson wants to ram through Congress. It remains to be seen whether this is mere posturing or serious opposition.

Critics are focusing on vital issues such as cost and oversight, but a lot less attention is being paid to the mechanics of Paulson’s proposal – specifically, the question of who would carry out the federal government’s purchase of $700 billion in “troubled” securities from banks. As I noted in my post on Sunday, the draft legislation circulated over the weekend includes a provision that seems to allow Treasury to contract out the process. Treasury then put out a fact sheet making it quite clear it intends to use private asset managers to manage and dispose of the assets it acquires, though the document does not specifically allude to the purchasing. Paulson himself referred to the use of “professional asset managers” during an appearance on one of the Sunday morning talk shows.

It amazes me that there is not more outrage over this aspect of the plan. Paulson seems to be leaving open the possibility that the same firms that are being bailed out could be hired to run the bailout. This would mean that institutions receiving a monumental giveaway of taxpayer money could turn around and earn yet more by acting as the government’s brokers. Aside from the unseemliness of this arrangement, this would be an egregious conflict of interest.

The alternative proposal floated by Senator Chris Dodd, which accepts Paulson’s language on contracting out, includes a section on conflict of interest. But rather than stating what the rules should be, the draft leaves it up to the Treasury Secretary to do so. There were reports on Monday night that Treasury would go along with the inclusion of a conflict-of-interest provision.

Paulson’s approach to the Big Bailout, particularly the insistence that there be no punitive measures for the banks, shows he is not the right party to oversee ethical issues. Paulson apparently can’t help himself. He still has the mindset of a man who spent more than 30 years working on Wall Street, at Goldman Sachs. He is a living example of the perils of the reverse revolving door: the appointment of a private-sector figure to a key policymaking position affecting his or her former industry.

The weak conflict-of-interest provisions Paulson is likely to impose would probably not address the inherent contradiction in having for-profit money managers running the bailout program. Even if Treasury chooses managers whose firms are not getting bailed out, there is still the danger that they will use their inside knowledge to benefit their non-governmental clients (and themselves) or will collude with buyers to the detriment of the public.

A Reuters story that ran on Monday reported that a leading contender for a federal money management role is Laurence Fink and his firm BlackRock, which was involved in managing the portfolio of Bear Stearns when that firm was sold to JPMorgan Chase as part of an earlier bailout. Last March, BlackRock, which is 49-percent owned by Merrill Lynch (now part of Bank of America), announced it was forming a venture to “acquire and restructure distressed residential mortgage loans.” Will Paulson see that as a conflict of interest – or more likely as a credential?

Letting financial firms that have profited from the mortgage crisis manage the bailout gives the impression that we are permanently in the grip of Big Money. To Paulson’s way of thinking, that’s not a problem, but it could make a bad plan much worse.

It appears that the Paulson-Bernanke juggernaut has prevailed, and Congress will quickly approve the most radical federal market intervention in U.S. history with few or no concessions from the financial institutions that created the mess. Meanwhile, President Bush is playing the shill in this $700 billion con game, telling the public yesterday “I believe, when it’s all said and done…that the taxpayer is going to get a lot of that money back.” Fat chance.

Lurking behind the Big Bailout are two other issues that now deserve close attention: how the plan going to be implemented and who stands to make a killing. The draft legislation floated yesterday by Paulson is remarkably simple: a two-and-a-half page document that authorizes Treasury to buy the securities while raising the federal debt limit. There is no provision for creating a new agency to handle the transactions. In fact, the proposal would allow Treasury to outsource the process.

This seems to create the possibility that the same Wall Street investment banks being bailed out could receive contracts from the federal government to handle the transactions through which toxic mortgage-backed securities are removed from their balance sheets. Presumably, the investment banks would expect to be paid for this brokerage service by receiving a percentage fee on each deal. The cost to the federal government would be in the billions, providing a bonanza for Wall Street on top on the enormous benefits from the bailout itself.

Apart from the matter of brokerage fees, there is the question of the terms of the transactions. The draft legislation is silent on what price the federal government should pay for the tainted securities: the price at which the institution purchased them, the value after the write-downs many institutions have implemented, or the current market value. Treasury has floated the idea of using reverse auctions to get the best price, but it is unclear why institutions would bid the price down if the feds are buying everything in sight. Besides, if investment banks are put in charge of purchasing securities from one another, they will have little incentive to get the best deal for Uncle Sam, thus escalating the cost of the bailout.

It would be nice to think that Paulson & Company will take steps to bar this sort of gross conflict of interest as well as a fee windfall, but don’t count on it. If there are any members of Congress still willing to stand on principle, they should insist that no financial institution getting bailed out be eligible to receive a contract to help implement the plan. If the bailout can’t be stopped, let’s at least prevent an additional bonanza for Wall Street.

Bailing out individual companies such as AIG is one thing. Today’s newspapers are filled with astounding reports that the federal government is devising a plan to bail out the entire financial sector—by taking over all the toxic assets that pollute the balance sheets of banks and other institutions. There is talk that this scheme is patterned on the savings and loan rescue of a generation ago. But unlike that rescue, the idea now is that the feds would, as the New York Times puts it, “take over only distressed assets, not entire institutions.”

“Bailout” hardly begins to capture the magnitude of what is being considered—apparently with bipartisan consent from Congress. This is absolution: the full faith and credit of the United State are being marshaled to absolve financial institutions of their sins. The consequences of years of greed, imprudence and short-sightedness would be wiped clean. With their financial souls thus renewed, we are supposed to believe banks will go forth to lend and invest with care and integrity.

One’s first instinct is to denounce this outrageous use of taxpayer money to rescue wealthy institutions that brought this problem on themselves, and will inevitability do it again. But perhaps that’s not the best response. The severity of the crisis has created openings for unprecedented government intervention. But why should banks get all the benefits? If Uncle Sam’s wallet is wide open, why shouldn’t the rest of us share in the largesse?

If banks are going to have their balance sheets cleansed, why can’t the same be done for the household accounts of America’s working families? Here’s the outline of a program for bailing out the rest of us:

• Wipe out unpaid medical debts of the uninsured and the underinsured;
• Wipe out credit card debt for all households with less than the median income;
• Wipe out subprime mortgages and give immediate title to the homeowners;
• Wipe out payday loans and all other predatory lending obligations;
• Wipe out unpaid student loan debt for those earning less than the median income; and
• Wipe out auto loans and other installment loans for those earning less than the median income.

Sounds unrealistic, ridiculously expensive? Probably so, but it would be no less outlandish than the proposals being made to benefit financial institutions that have brought the country to the brink of economic collapse. If now is a time for bold moves, let’s see some audacity on behalf of the many, not only the few.

The federal government’s takeover of American International Group marks the end of three decades during which we have been made to worship at the altar of “free” markets and deregulation. The religion of unbridled capitalism is dead, replaced by a new theology of ad hoc intervention and selective lemon socialism.

Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke are reshaping the financial landscape with the zeal of 1920s Soviet central planners. The difference is that they don’t seem to have a five-year plan. They are rushing from crisis to crisis, making up policies as they go along.

Bear Stearns is forced to merge into JPMorgan Chase, with the Fed backing up some of Bear’s riskier investments. Fannie Mae and Freddie Mac are placed into federal “conservatorship.” Merrill Lynch is thrust into a shotgun marriage with Bank of America. Lehman Brothers is forced to file for Chapter 11 bankruptcy, paving the way for Barclays to swoop in and buy its viable assets at a bargain-basement price. AIG is given a cash infusion of $85 billion, in exchange for which the federal government becomes an 80-percent owner of the insurance company.

The “invisible hand” of the market has been replaced by a ham-handed approach that puts expedience over coherence or prudence. The desperate way in which these emergencies are being handled is indicative of just how screwed up the financial system has become.

In many ways, the crisis at AIG is the most troubling of all. Unlike Bear, Merrill and Lehman, AIG was not supposed to be part of the casino-like world of investment banking. As an insurance company, it presumably had a responsibility to be somewhat more staid. In fact, it does have units—property & casualty coverage, aircraft leasing, etc.—that are doing well and will probably be sold off to raise cash.

What brought AIG down is its Financial Services segment and particularly its “credit products,” described opaquely in its 10-K filing as “credit protection written through credit default swaps on super senior risk tranches of diversified pools of loans and debt securities.” AIG, it seems, has been insuring the esoteric financial investments being made by others. It may be a good idea for investors — especially institutions like pension funds — to arrange for some protection when putting money in risky securities. But it turned out that the party doing the insuring, AIG, lost control of the process.

Last February, AIG disclosed that its auditors had found a “material weakness” in the company’s oversight of its credit default swap portfolio. That’s a polite way of saying it might have been cooking the books in terms of its exposure to swaps relating to mortgage-backed securities that were plunging in value.  It later came out that the Securities and Exchange Commission and the Justice Department were investigating whether AIG deliberately overstated the value of its swap position.

So let’s see if I got this straight. A company that was supposed to provide protection for speculators became a speculator itself and may have tried to hide how deep a financial hole it had fallen into.  And the same federal government that was investigating AIG now owns it. A fitting symbol of the end of market fundamentalism.

Addendum: Here’s some coverage of one of the previous instances in which AIG faced a government takeover—when the revolutionary government of Iran nationalized its subsidiary in that country in 1979. It remains to be seen whether the current takeover turns out any better. Click on the following link to see an excerpt from the New York Times of June 26, 1979.  The reference to AIG is in the last paragraph. Continue reading “AIG: Laissez-Faire R.I.P.”

This weekend’s announcement that the Treasury Department and the Federal Reserve will take steps to shore up Fannie Mae and Freddie Mac put a stop, for now, to the rapid decline of the shareholder-owned/government-sponsored entities (GSEs). Yet the nature of the federal intervention is raising questions about whether different groups of stakeholders are getting equal protection.

The greatest tension is between those who hold shares in Fannie and Freddie and those who hold bonds. In theory, the intervention would help both groups by allowing the GSEs to borrow more from the federal government, which would also, if necessary, purchase equity positions in the firms. Yet these capital infusions are being viewed more as a boon to existing bondholders by reducing the odds of a default while doing little to directly help shareholders whose stock has fallen in value by about 90 percent over the past year. The Wall Street Journal’s Deal Journal blog website argued today that the bailout of Fannie and Freddie, like that of Bear Stearns earlier this year, “leaves shareholders starving.” The Journal itself reported on Saturday that Treasury Secretary Henry Paulson (photo, taken earlier) was adamant about not bailing out shareholders.

Apparently, helping shareholders creates a “moral hazard” (de-sensitizing them to risk) while protecting bondholders is considered essential to protecting the financial system. There may be practical reasons why creditors have to be given preference over investors, but it’s instructive to see who comes out ahead or behind with that approach.

According to Fannie Mae’s most recent proxy statement, its largest shareholders are two money managers: Capital Research Global Investors (12% of shares) and Capital World Investors (11.3%). The two are both arms of Los Angeles-based Capital Research and Management, which oversees investments for the huge American Funds family of mutual funds.

According to the subscription service Vicker’s Stock Research, which assembles data reported by institutional investors, many of the other largest investors in Fannie and Freddie are mutual funds and their parent companies—including Fidelity, Vanguard and Lord Abbett. Vickers also shows that public pension funds, which provide retirement benefits to state and local government employees, are also big investors in Fannie and Freddie. For example, the New York State Common Retirement Fund had holdings worth a total of about $93 million in the two GSEs as of its most recent quarterly report.

Getting information on Fannie and Freddie’s bondholders is not quite so easy. But the Council on Foreign Relations has found that a massive amount of such debt is held by foreign central banks—especially those of China and Russia, with about $512 billion between them.

So this is what it has come to: the federal government will do whatever it takes to protect the “confidence” of foreign central banks while allowing the retirement savings of working Americans to be ravaged by the market.