November 2008 Archives

Adding New Floors to the Bailout House of Cards

Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke have added a few more floors to their ever-expanding bailout house of cards. Their two agencies kicked in another $800 billion in the latest frantic effort to ward off financial collapse. The Fed is putting up $600 billion to buy mortgage-backed securities and mortgages held by Fannie Mae and Freddie Mac. This seems, at least initially, to have brought down mortgage rates—assuming anyone is in a position these days to buy a house.

The plan for the other $200 billion is more dubious. Treasury and the Fed are going to use those funds to make loans to consumer finance companies, which in turn would be in a position to provide more auto loans, student loans and credit cards. Yet, as with the bailout of the banks, there seems to be no actual requirement that the finance companies use their new liquidity to open the spigots to consumers. We are apparently supposed to take it on faith that these lenders will in fact lend, even though it’s now clear that many of the banks used their federal assistance for other purposes.

Another questionable assumption in the plan is that consumers are aching to borrow more money. With unemployment soaring and the value of retirement savings dwindling, most people are opting for austerity, not seeking to add to their already heavy debt load. Creating more jobs and boosting household income are more urgent than allowing people to go further into hock.

And finally, it is worth recalling that many of the consumer finance companies have been as predatory in their lending as the unscrupulous subprime mortgage lenders. Nowhere is this truer than in the credit card business. These are the companies that, thanks to deregulation in their industry, have been gouging consumers with usurious interest rates and punishing fees.

The idea that bailing out these firms is the way to help consumers is yet another indication of the warped thinking of Paulson and Bernanke. It does not occur to them that the solution might be to lessen the hold that the card companies have on consumers—through measures such as interest rate reductions—rather than intensifying it. But what can you expect from what has become a government of the financial institutions, by the financial institutions and for the financial institutions.

Rescuing the Villain in the Citigroup Bailout

Treasury Secretary Henry Paulson has once again shown his willingness to take speedy action to rescue his friends in the financial world while allowing industrials such as the Big Three automakers to twist in the wind. The safety net for Citigroup that Treasury, the Federal Reserve and the FDIC announced last night represents the latest reversal in the ever-changing bailout “plan.”

Less than two weeks after announcing he had given up on the idea of purchasing toxic assets from banks in favor of capital infusions, Paulson is now saying that Treasury and the FDIC will “provide protection against the possibility of unusually large losses on an asset pool of approximately $306 billion” of mortgage-backed loans and securities. Given the way those securities have been falling in value, that possibility is far from remote. Citi graciously agreed to absorb the first $29 billion in losses, but taxpayers will probably be on the hook for much more.

In addition, Treasury is giving Citi another fix of $20 billion in capital. Paulson is driving a slightly harder bargain than in the past round of infusions, getting Citi to pay a dividend of 8 percent, up from 5 percent in the previous deals. Citi will also comply with “enhanced executive compensation restrictions and implement the FDIC’s mortgage modification program.” The latter is perhaps the most hopeful aspect of this new bailout, in that some homeowners may benefit.

Yet it is still amazing to see the federal government give essentially a blank check to Citi while the automakers are in limbo. The Big Three have a lot of mistakes to answer for, but they don’t compare to Citi’s checkered history. Throughout its history, the company has made reckless decisions that weakened the financial system and necessitated its own rescue. As early as the financial panic of 1837, what was then called City Bank had to be bailed out by tycoon John Jacob Astor. In the early 20^th Century, the firm, then the main bank of the Rockefellers and Standard Oil, was one of the first commercial banks to make a big move into securities. This paved the way for the excesses of the 1920s and the ensuing stock market crash.

During the 1970s, First National City Bank was a major instigator of lending to third-world countries, which later backfired on the big banks. That and other forms of forms of questionable lending weakened Citi’s financial condition, prompting it to solicit a big capital infusion from Saudi prince Al-Waleed bin Talal in 1991. Pursuing a replay of the 1920s, Citi merged in 1998 with insurance and securities giant Travelers Corp. and began acting more like an investment bank than a commercial one.

Over the past decade, Citi led the way in another boomerang situation: promoting subprime lending to low-income borrowers. In 2000 Citi spent $31 billion to purchase Associates First Capital, one of the more aggressive predatory lenders responsible for the wave of untenable mortgages that are now poisoning the financial system.

All this doesn’t include other scandals involving money laundering and collusion with the likes of Enron and WorldCom. In the latter two cases alone, Citi had to pay some $5 billion to settle investor lawsuits. Citi’s finances weakened to the point late last year that it had to get another Middle Eastern shot in the arm—a $7.5 billion investment by the government of Abu Dhabi.

And here we go again with another rescue—this time by a benefactor with the deepest pockets of all. Paulson would have us believe that Citi is a financial damsel in distress that must be saved for the good of the country. In fact, the company is more like a Snidely Whiplash villain who periodically lies down on the railroad track pretending to be a victim in order to get rescued by gullible Dudley Do-Rights. Who knows what mischief Citi will get into with its latest haul.

Clinging to a Defunct Ideology

Keynes famously wrote that “Practical men, who believe themselves to be exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.” The Bush Administration today is in the awkward position of continuing to espouse the laissez-faire rhetoric of Milton Friedman and Friedrich Hayek while spending hundreds of billions of dollars of public money to bail out the financial sector.

Last week, President Bush gave a speech to the rightwing Manhattan Institute in which he asserted with a straight face that “free market principles offer the surest path to lasting prosperity.” He went on to insist “I’m a market-oriented guy, but not when I’m faced with the prospect of a global meltdown.” The idea that the market itself brought on this state of affairs was conveniently not emphasized.

Today, Treasury Secretary Henry Paulson delivered a speech of his own at the Ronald Reagan Presidential Library, a monument to the man who, in his first inaugural address, declared: “In this present crisis, government is not the solution to our problem; government is the problem.” While the current economic mess prevented Paulson from saying anything quite so categorical, he did try to salvage a bit of Reaganism by warning against “implement[ing] more rather than better regulations.”

While Bush and Paulson are trying to preserve some semblance of their failed ideology, corporate executives are doing what they do best: lining their pockets. Back in 2002, in the wake of the scandals involving companies such as Enron, Tom Toles published a cartoon headlined: “The preceding 22 years. A Synopsis.” It showed Regan in the foreground making his statement about government being the problem, while in the background CEOs are seen looting a safe filled with cash.

That image is even more appropriate today. The latest indication of corporate cupidity comes in today’s Wall Street Journal, which reports that in the run-up to the current crisis, top executives in the housing and financial sectors cashed out more than $21 billion in stock and thus avoided the subsequent collapse in the value of those holdings.

At the same time, automakers, who for years resisted significant fuel-economy regulation, are clamoring for a place at the public trough alongside the bankers who managed to abolish many of the rules that governed their industry. For all of them, government is now seen as the solution—to their financial woes.

It remains to be seen how long the likes of Paulson will go on clinging to some vestige of market fundamentalism. For the rest of us, the question is whether a decent economy can somehow be built amid the ruins of deregulated capitalism.

Paulson Thinks He’s the Decider—and Doing a Heckuva Job

Treasury Secretary Henry Paulson’s handling of the financial crisis represents the last major manifestation of the Bush School of federal management: He asserts that he is The Decider, and he thinks he’s doing a heckuva job.

Paulson’s inflated view of his own effectiveness was evident in the op-ed he just published in the New York Times, in which he declares: “I am very proud of the decisive actions by the Treasury Department, the Federal Reserve and the F.D.I.C. to stabilize our financial system.” The Decider also bragged of “decisive action” in his testimony today before the House Financial Services Committee.

All this self-congratulation is no more effective than the efforts of former FEMA Director Michael Brown to rewrite the history of his performance in the aftermath of Hurricane Katrina. Paulson’s track record in the Big Bailout has been roundly criticized for inconsistency, ineffectiveness and lack of transparency. (A generally positive profile of Paulson in today’s Washington Post is an anomaly that is unlikely to change many minds.)

The problem is that Paulson, who has two months left in office, seems to think he is not only the Decider but the Dictator. Although Congress inserted oversight provisions in the bailout legislation, Treasury has dragged its feet in implementing them, and Paulson acts as if he had gotten approval for his original three-page proposal that would have given him total carte blanche.

Paulson’s hauteur was on display in today’s hearing. Despite a lot of hostile questioning, he continued to assert, in effect, that his judgment—including the decision to switch from asset purchases to capital infusions as well as his resistance to using any of the bailout money to help homeowners avoid foreclosure or to aid businesses outside the financial sector—is all that counts. Paulson seems to regard the need to testify as an annoyance, and he apparently sees his job as shooting down the ideas of members of Congress rather than taking their guidance.

The handling of the financial crisis and the bailout will go down in history as the last of a long string of Bush Administration fiascoes. Fortunately, Paulson will soon return to the private sector, where he can do as much deciding as he wants without putting the country at risk.

Note: I want to put in a plug for a newly published report I wrote in my other capacity as the research director of Good Jobs First. Called Skimming the Sales Tax, it documents the ways in which giant retailers such as Wal-Mart are allowed to divert more than $1 billion of revenue each year into their own coffers.

Consumers Beware: Henry Paulson is Coming to Your Rescue

Treasury Secretary Henry Paulson is once again trying to pull off a sleight of hand in his execution of the financial crisis, but he’s a lousy magician. His first trick—trying to depict the existing rescue plan as a success—fell flat. While Paulson tried to take credit yesterday for a “major accomplishment,” there is growing consensus that Treasury’s use of some $300 billion in federal funds to invest in a variety of banks has done little to achieve its intended purpose of stimulating home mortgage and business lending.

The ineffectiveness of the plan may be traced in part to a lack of oversight. As the Washington Post points out today, Treasury has so far taken no formal action to implement the safeguards that Congress included in the legislation authorizing the original bailout plan. Absent those provisions, Paulson found it easy to completely transform the plan that had been steamrolled through Congress—the federal purchase of toxic securities from banks. Yesterday, Paulson formally acknowledged what had become apparent in recent weeks: that he had abandoned the asset-purchase scheme in favor of a complete focus on capital infusions.

For his next trick, the Great Paulson is applying that same technique to the consumer finance sector. Using language similar to his scare talk in September about the housing and business finance sectors, Paulson yesterday warned that consumer finance “is currently in distress, costs of funding have skyrocketed and new issue activity has come to a halt. Today, the illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards.”

No doubt that is all true, but Paulson’s apparent plan to address the crisis is more of the same. Rather than helping consumers directly, he intends to provide capital infusions to the corporations that are supposed to provide those loans. In other words, he is applying the same dubious logic as with the bank investments: Prop up the balance sheets of the lenders and the loans will start flowing again.

Keep in mind that the consumer finance industry followed the same path as home lending in recent years. Shaky and often predatory loans were pushed on struggling borrowers and then repackaged as asset-backed securities that are now in precarious condition. Paulson’s infusions will go to the same companies that perpetuated that abusive system.

And even if we are willing to forgive the consumer finance companies for their transgressions, why should we expect that they will respond any differently to the Treasury investments than the commercial banks did? Given Paulson’s aversion to putting any significant strings on the federal investments, it’s likely that the consumer finance firms will follow banks in using the money to fund acquisitions and dividends rather than opening up the spigot for consumers.

What Paulson can’t seem to understand is that lenders of all kinds are spooked by the weakness of the economy. Credit is based on the faith that the borrower can repay the loan, and for now almost no one looks trustworthy. Until significant steps are taken to boost employment and household income, all the federal investments in the financial sector serve as nothing more than corporate handouts. Maybe that’s Paulson’s real sleight of hand.

Bush Administration, in Bed with Banks, Shuns Union with Automakers

George Bush has strong views on marriage. He is an ardent proponent of the marriage between the financial sector and the federal government, but he apparently finds intolerable a similar union involving the auto industry.

It’s difficult to pin down exactly why the very lame duck Bush is resisting calls for a bailout of Detroit. There were reports, subsequently denied, that he was using his opposition as a bargaining chip to get Congress to go along with his desire for a free trade agreement with Colombia, whose right-wing government is Bush’s only significant ally in Latin America.

Then there’s the theory that he does not want to assist an industry that is heavily unionized and that supposedly brought on its own troubles by giving in to the wage and benefit demands of those unions over the years. And there’s the notion that Bush is trying to reestablish his credentials as a free marketeer, but that’s hard to believe at a time when his administration is pouring seemingly endless taxpayer funds into the likes of AIG.

The explicit statements made by Administration representatives about the reasons for the resistance are perhaps the most preposterous. White House spokesperson Dana Perino suggested that the problem was that Congress had not provided explicit authority to assist industries other than banks. Since when does the Bush Administration worry about explicit Congressional authority in deciding what it can and cannot do? Take the bailout itself. Congress was steamrolled into approving a $700 billion plan under which the federal government would buy up “troubled” assets from banks. That plan was put on the back burner by Treasury Secretary Henry Paulson as he instead embarked on a program—never debated by Congress—to purchase holdings in the banks themselves. And isn’t it ridiculous to cite a lack of Congressional approval as a reason for not doing something being heavily advocated by leaders of Congress?

Until this mystery is solved, perhaps the best course of action for the automakers is to simply change their identity. Neel Kashkari, the interim assistant secretary at Treasury who is running the bailout, said in a speech on Monday: “We have allocated sufficient capital, $250 billion, so that all qualifying banks, potentially thousands, can participate. Therefore, it is important to note that Treasury will not implement this program on a first-come-first-served basis; there is enough capital allocated for all qualifying institutions.”

With the bailout window wide open for bank, why can’t the automakers follow the lead of investment houses Morgan Stanley and Goldman Sachs—as well as, more recently, American Express—and redefine themselves as bank holding companies (with cars as a sideline)? GMAC, the financing arm of General Motors that is co-owned by Cerberus Capital, is already moving in that direction. The rest of Detroit should follow suit. After all, the Big Three are not making any money trying to sell cars in the current economic situation; perhaps they will have more luck making loans. And, given the reluctance of real banks to lend, they should have an open field.

Kashkari Daydreams While Bailout Teeters

When Treasury Secretary Henry Paulson chose his protégé Neel Kashkari last month to run the Big Bailout, we were led to believe Kashkari was some kind of whiz kid who would use his background in both engineering and finance to stop the meltdown of the financial sector. A month later, Kashkari has succeeded—in his own mind.

Appearing at an event sponsored by the Securities Industry and Financial Markets Association, the Interim Assistant Secretary for Financial Stability gave a speech yesterday with a surprisingly upbeat tone. Kashkari spoke of having made “tremendous progress” and of having “accomplished a great deal in a short period of time.” He bragged that his team is “working around the clock” while “ensuring high quality execution.” The only problem is that, to the outside world, the bailout is looking more and more like a disaster.

As Kashkari was speaking, news was circulating that American International Group, one of the biggest recipients of federal bailout aid, had reported a $25 billion quarterly loss. At the same time, Treasury revealed it was upping its rescue package for AIG to $150 billion in capital infusions and purchases of the company’s toxic assets. Fannie Mae, another ward of the state, reported a $29 billion quarterly loss.

Also while Kashkari was speaking, readers of the Washington Post were learning that amid the initial phase of the bailout in September, the Treasury Department quietly announced a tax code change that gives a huge windfall (estimated by some tax lawyers at $140 billion) to banks that are buying up other financial institutions. The article reports that some tax experts believe the rule change was illegal.

And all this follows several weeks in which it has grown clear that many banks intend to use the capital infusions they are receiving from Treasury for making acquisitions and paying dividends rather than expanding their loan activity. Today the Post is reporting that the feds have concluded they need to draw up rules that will, in effect, coerce banks to use their rescue money to expand lending—something we were led to believe would happen spontaneously.

The only way all this translates into “tremendous progress” is if Kashkari is a financial Walter Mitty caught up in daydreams about financial greatness. Unfortunately for Kashkari—and fortunately for the country—his reveries will soon be brought to an abrupt end as the Paulson team is displaced by the new Administration.

This is not Corporate America’s Moment

The votes are still being counted in some places, but the battle for the soul of the new Administration and Congress has begun. Corporate America wasted no time in launching an effort to warn against any initiatives that would be seen as unfriendly to business. The Wall Street Journal is already predicting that Democrats will give in to the pressure and “go slow on controversial labor and regulatory issues.”

The National Association of Manufacturers (NAM) issued an open letter to Obama pledging to work with the new administration, but that pledge was followed by a dozen pages in which the group outlined its usual agenda of reduced corporate taxes, tort reform, easing of the regulatory “burden,” and so forth . The U.S. Chamber of Commerce was a bit more tactful. Its CEO Thomas Donahue put out a statement vowing to work with Obama and the new Congress “to help quickly restore economic growth,” avoiding for now the more contentious issues.

Not surprisingly, the sharpest battle lines are being drawn on labor law reform. Business has already been mobilizing to fight against proposed legislation—the Employee Free Choice Act (EFCA)—that would make it easier for workers to organize unions free of employer intimidation. Corporate interests targeted various members of Congress over the EFCA issue during the electoral campaign, to little effect, and undoubtedly intend to keep up the effort. Today NAM President John Engler told the Journal: “This is not the time and this is certainly not the issue with which to build a relationship.”

Someone needs to remind the business lobbies that elections have consequences. When George Bush won reelection four years ago, that same John Engler, speaking for the corporate class, declared: “This will be our moment.” Business Week added: “business groups are already busy claiming considerable credit for Bush’s win. Their wish lists are extensive.” Many of those wishes were granted by Bush and Cheney.

Despite the overblown McCain/Palin rhetoric, Obama did not run as a socialist, but he expressed clear disapproval of the deregulatory agenda. And he accepted extensive help from labor union members, many of whom were motivated by his criticism of corporate excesses and his support (albeit muted) for EFCA.

There may be reasons why the Obama Administration and Congressional Democrats have to proceed carefully on regulatory and labor issues, not the least of which is the apparent absence of a filibuster-proof majority in the Senate. Anti-union executives may not soon find themselves bodily removed from office, as Montgomery Ward President Sewell Avery was in 1944 (photo). Yet neither should business interests expect their wish list to be the current center of attention. This is not their moment.

Kashkari’s Gang of Five

The Bush Administration Treasury Department has been executing the big bailout with a limited amount of transparency, but today an article in the New York Times business section pulls back the curtain and gives a fuller picture of how Henry Paulson’s minions are functioning.

While the country has been preoccupied with the presidential election, a group of five young officials have been meeting to decide which banks will receive federal capital investment funds and which will not. While it originally appeared that Treasury would provide the infusions to any bank that wanted them, the Times describes a very different process. The five officials, led by Interim Assistant Secretary Neel Kashkari, Paulson’s 35-year-old protégé who used to work for him at Goldman Sachs, is unilaterally giving a thumbs up or thumbs down to each institution that applies. Their decisions are said to make use of rankings on a scale of 1-5 determined by each bank’s regulatory agency.

Given that eligibility for the infusions is now being treated by the market as key factor in a bank’s viability, Kashkari’s gang of five is making what the Times calls a “life-or-death decision” for each institution.

It’s amazing how far we have come from the bailout plan approved by Congress, which centered on the federal purchase of “troubled” assets. That scheme, which Paulson insisted be approved immediately to prevent financial doom, has been put on a back burner, while the capital infusion program, which was never debated by Congress, has taken center stage.

It now looks as if the Kashkari group will be remaking not only the banking sector but other portions of the financial world as well. The Wall Street Journal is reporting today that Treasury is considering using some of its investment funds to invest in bond insurers and specialty finance firms such as General Electric’s GE Capital unit and CIT Group.

With remarkably little oversight, Treasury is making wide-ranging decisions about the future of a major sector of the U.S. economy. Even before taking office, the new Administration should put an end to this undemocratic process and replace it with a coherent, transparent plan for economic recovery.

Peer Pressure to Join the Bailout Club

Once upon a time, there was a stigma attached to businesses that had to be bailed out by government. Only ones that desperately needed help—the likes of Lockheed, Chrysler and Continental Illinois—would resort to such a step.

In the upside down world of the current U.S. economic situation, the tainted firms may be those that are not being rescued. That seems to be the growing sentiment among the country’s banks, which are feeling increased pressure to participate in the partial nationalization plan being pursued by Treasury Secretary Henry Paulson. As the Wall Street Journal put it today: “Now institutions across the U.S. worry that if they don’t try for the money, the market will judge them as too unhealthy to qualify, or lacking the savvy to deploy cheap government capital on acquisitions and investments.”

It thus appears, according to the Journal, that thousands of banks will be applying for capital infusions from the federal government, whether they need them or not. For example, US Bancorp, known for its stability and conservative practices, announced today that it will be getting $6.6 billion from the feds. Depository institutions that for decades have proudly displayed their “Member FDIC” sign now feel obliged to advertise that they are also members of Paulson’s bailout club.

One banker already in that club told the Journal: “There’s a perception in the market that the government is actively picking winners and losers…we wanted it well-known in the market that we’re on the list of survivors.”

Those survivors are making sure their status as wards of the state does not cause them to lose much of their autonomy. High-powered banking lobbyists are working hard to thwart any new strings that might come with the federal investment, while financial industry trade groups such as the American Bankers Association are signaling that they would like to remove the modest restrictions on executive compensation that Treasury has already imposed.

Given the mood of the public, the pay rules are not about to be lifted, but neither is Paulson likely to go along with any additional rules. Banks may be largely responsible for the mess we are in today, and they want to use their federal money for acquisitions, bonuses and dividends rather than new loans, yet Paulson continues to treat them with kid gloves. His successor should be a lot less accommodating.