There is a crack in everything

There is a crack in everything
Sunday April 26, 2009

The occurrence last week of a financial event so profound as to be the equivalent of a crack in the fabric of space/time went largely unnoticed and underreported. I speak of the under oath testimony of Bank of America Chief Ken Lewis to NY Attorney General Andrew Cuomo, wherein Lewis claims that in December 08 Paulson and Bernanke more or less blackmailed him into completing B of A merger with Merrill Lynch even after he learned huge additional losses by Merrill Lynch just before the deal was ready to close.

Here’s the back story: Earlier last year, when the banking crisis first started to unfold, then treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke stepped in to “save” Bear Stearns, by forcing a shotgun marriage to JP Morgan Chase. By the end of summer, Fannie Mae and Freddie Mac, the two giant quasi government mortgage houses also required bailout, to the tune of $200 billion, the largest US bailout ever. When venerable trading house Lehman Brothers appeared to be on the brink of collapse, Paulson and Bernanke demurred. They had bailout fatigue, and played “tough love” with Lehman. A worldwide financial panic ensued, and Paulson and Bernanke were widely vilified for failure to take the reigns.

In September, as almost every major bank and investment house on Wall Street started to come apart at the seams, the two were desperate to somehow save the rest of the financial system and prevent a worldwide collapse. Merrill Lynch, which had lost billions in toxic mortgage securities was paired up with Bank of America. At the time, Ken Lewis was enthusiastic about the deal, as they were picking up a Wall Street giant for pennies on the dollar, and one which nicely filled holes in their financial profile.

These deals are not easily done, and Merrill Lynch was operating independently in the fall of 2008 pending shareholder approval and transfer of assets. Meanwhile, Merrill Lynch CEO John Thain was a busy man. Not only did he take time for a $1.5 million re-do of his office, he kept aggressively trading mortgage securities. Not chastened by billions in losses over the past year, he apparently believed the market for them had bottomed, and there was money to be made. He was buying. The same dense brained hubris that lost Merrill Lynch and average of 59 million a day for the last year caused Thain to think he could still master the situation. By the time he was done, in December 08, Merrill had lost an additional 15.8 billion, a staggering amount of money.

Even then, on his way out the door, Thain wrote himself a $40 million bonus and handed out almost $4 billion in bonuses to his crew. This was the start of the Wall Street Bonus scandal, and was what caused New York Attorney General Andrew Cuomo to investigate. Thain offered to reduce his bonus to $10 million. Cuomo felt zero was more what he had in mind, and also aimed to shine a spotlight in some of the dark corners of this messy deal.

December 5, Bank of America shareholders approved the merger. That’s what Merrill was waiting for, and the following week, they quietly and quickly recorded their additional losses. According to sworn testimony, On December 14 Bank of America CEO Ken Lewis was informed by his CFO of the additional losses, described as “a staggering amount of deterioration.” Lewis had expected additional losses and some of these losses were known to B of A officials but nothing of this magnitude. December 17, Lewis informed Paulson that he was thinking of invoking a “MAC” clause. MAC, stands for “material adverse change,” and allows a partially completed merger to be legally rescinded without penalty if adverse conditions arise during the merger.

Paulson and Bernanke were also busy men during this time, charged with saving the free world from financial Armageddon. They were in no mood for gamesmanship, and bluntly told Lewis that if he did invoke MAC, he and his entire board would be removed. Most importantly, they told Lewis to keep quiet about the losses until after the deal closed January 1. Lewis replied “that makes it simple, let’s deescalate.” Paulson also told Lewis that the government would at some point make TARP funds available to restore the lost equity. When Lewis asked for that in writing, Paulson said no. The deal closed Jan 1 right on schedule, and the shareholders were not informed of the losses until the second week in January. As expected B of A’s stock cratered, investors lost billions, and taxpayers were stuck with another bailout.

As Dianne Francis writes in the Financial Post “the gang that couldn’t shoot straight shot investors in the head.” Sure, Paulson and Bernanke felt they were justified in their actions because they felt the failure of the Merrill/B of A merger posed a systemic risk. But does that mean they can throw shareholders under the bus in such a selective manner?

Here’s the thing: Paulson and Bernanke’s actions violate Securities laws, which require material facts to be disclosed in a timely manner. Thing two is that the onus for this disclosure rests entirely on the shoulders of the CEO, and in an eventual suit between shareholders and Lewis, which now seems more likely than not, the defense “the government made me do it” will not stand up in court. Lewis was free to say: “No deal, I’m disclosing”.

Does the government have the right to play high stakes poker with the pension funds of Retirees? Especially when the resulting damage is almost entirely to shareholders, while the CEOs and traders still get their bonuses? Once again the Titans of finance come out intact and the public is collateral damage.

Thing three is that it is inconceivable that Timothy Geithner, (now Treasury Secretary) as the chairman of the New York Fed at the time, was not kept in the loop on this.

Thing four is the burning question: What other lies and deceit by those in power have been perpetrated during this collapse to keep themselves in power. The only constituency not being bailed out or protected in any way is the public.

Thing five is that such a violation of the rule of law will inevitably shake the confidence of the very markets we are trying to fix. As I say in my recently published book The Age of Entitlement (www.amazon.com, www.AgeOfEntitlement.com): From the most powerful hedge fund trader to the simplest homeowner, … the lack of market discipline removes the foundation of every investors decision to part with his cash.

This story could have huge implications. Not only does it blatantly expose the lengths that those in charge of the economy will go to in order to keep existing power structures intact, it highlights a casual disregard for protecting the rights of shareholders and taxpayers, the very people these regulators are entrusted to protect.

First Review of the book!!

"This interesting and easy-to-read book is packed with information for the average hard-working American. Doug's research into what has happened to our economy is outstanding. I think it is a very important book on two levels: First, it is a simple "kitchen table" tutorial on economics for those of us who have trusted others to be the experts. Second, it reminds me of those pre-Revolution pamphleteers (although this book is much more than a pamphlet) who spread their ideas far and wide resulting in vast change. I like to think that Doug's book will spur others to become active in grass-roots reform. I applaud Doug for caring enough to wade into the economic morass. It's all too easy to gripe about what is happening, but Doug has laid out the situation in a largely non-political, reasoned manner. For that he deserves credit for using his frustrations constructively and for being a good citizen. We need many, many more to read this and then speak out."

—Joan Collins, Business Coach 04/22/09

Intro to The Age of Entitlement book

Doug Friesen isn’t an economist. He’s a builder and home designer who, upon watching the business he painstakingly built over 30 years suffer and fall apart amid the economic meltdown, got angry enough to do something about it.

The result is The Age of Entitlement, a book that promises to help average Americans understand just how the worst economic crisis since the Great Depression happened.

The story, Friesen says, is one of corporate greed exacerbated by a society that has developed a profound sense of entitlement and an expectation of instant gratification.

With chapter titles like, “Chronology of a Crash,” “Self Esteem Run Amok” and “The Housing Bubble – or Hell in a Handbasket,” The Age of Entitlement concludes by addressing the question that many people are asking: “Where do we go from here?”

The Politics of Paralysis

The Politics of Paralysis

In today’s extreme political polarization, both Democrats and Republicans have reached a point of paralysis, where neither side can focus on the real issues as long as their brains are pre-occupied with demonizing the other. During a talk I gave last week about my recently published book, “Age of Entitlement – How greed and arrogance got us here” (Available from http://www.ageofentitlement.com/), the questions were narrowly focused on partisan attacks, instead of the real meat of the matter, which was taxpayers bailing out negligent banks even while our own 401Ks are halved because of Wall Street’s greed.

The fact that the bailout under President Obama is unfolding seamlessly from the bailout first engineered by President Bush should be sign enough that the top bankers have a stranglehold on both parties and all branches of government. I’m not suggesting a secret conspiracy with black helicopters and all. What I am suggesting is, what other outcome would you expect? After all, the key financial players in both administrations, Alan Greenspan, Ben Bernanke, Hank Paulson, Tim Geithner, Larry Summers, are all alums of the Federal Reserve or Wall St. banks, and as such will protect their own. Not necessarily because they are bad people, but just because it’s the only world they know.

Nowhere in the bailout debate is the common sense, time-tested solution: Failing companies that have made huge mistakes must be allowed to fail. The excuse “too big to fail” is worse than just an excuse, it’s legalized extortion. The stock market has functioned many years through ups, downs, and severe depressions. It has done so by refreshing the free enterprise system with the blood of failed business models. Smaller banks that didn’t make stupid risks would gladly fill the void created by the fall of Citibank and others.

Propping up zombie banks with taxpayer cash only serves to confuse investors as to where real value is. Ask Japan, who did the same with their banks in the 90’s and are now languishing with a stock market at a 25 year low.

Confidence cannot return to the markets with fake valuations and accounting tricks that falsely claim operating profits when in fact these banks still have huge losses and are in fact, insolvent. The bailout becomes nothing more than the people who caused the meltdown reimbursing themselves for their lost equity.

It’s all about personal responsibility. Not one single official in charge during the economic meltdown has come forward to say “Sorry, we really screwed up.” Not that it would make us feel better, but acknowledgement of past mistakes is the only solid foundation on which a recovery can be built.

No one, not politician nor voter, is taking responsibility for the crippling $11 trillion and mounting national debt on which we paid $451 billion in interest payments last year. It didn’t even come up during the last election cycle. Politicians didn’t talk about it because we didn’t talk about it, and we’re still not taking it seriously now. Why? Because people of all political persuasions are too busy trying to lay the blame on whoever isn’t in their clique.

Democrats would have to admit that they have to stop spending the next generations’ money on government programs, whether or not they have merit. Republicans would have to admit that 8 years of tax cuts without cuts to government spending have brought us to the brink of bankruptcy. There is absolutely no difference between increasing government spending, and cutting taxes without cutting government. Either way, we are spending money we don’t have and have no hope of paying back in our generation.