Bernanke Throws Stockholders and Taxpayers Under the Bus.

In my April 26th blog post, entitled “There is a crack in everything,” I wrote about Ken Lewis testifying under oath that Federal Reserve Chairman Ben Bernanke broke the law in a number of ways in December 08 and January 09, in regard to Bank of America’s acquisition of Merrill Lynch. Ways that I predicted would prove to be of huge consequence. That scenario played out this week as Bernanke testified under oath before Congress and denied Ken Lewis’ claims.

The fall ‘08 banking meltdown for sure featured many tense stand-offs in corporate boardrooms. None, perhaps more tense than interactions between Bernanke and Lewis. Bank of America (B of A), at the time, was not one of the banks about to go under because of toxic investments. They had problems, but still had “liquidity.”. That is why Bernanke chose B of A to absorb the floundering Merrill Lynch, who had spent an entire year losing an average of 59 million dollars a day, and had only days left to survive.

By this time Bernanke already had “bailout fatigue” and was in no mood for gamesmanship or negotiating. He was pretty much just telling everyone how it was going to be. The deal was struck during the three week period in early fall that featured collapses, bailouts, and forced marriages affecting every Wall Street investment house. The problem with the deal between B of A and Merrill Lynch was that Lynch CEO John Thain was not done losing money yet. He doubled down on his already toxic mortgage securities, having misjudged where the bottom was.

By December ‘08, when the two companies began preparing for a January ‘09 closing, Merrill revealed another $16 billion in losses on top of $118 billion in toxins. A stunned Ken Lewis notified Bernanke that he was thinking of backing out of the deal, invoking “MAC” (Materially Adverse Change), a clause that would have allowed him to walk away from the deal without consequence.

This is the moment Bernanke crossed the line. He went from powerful financial regulator to illegal megalomaniac manipulator, when he (according to Lewis’ testimony under oath), told Lewis that would he would remove Lewis and his entire Board if Lewis invoked MAC. Whether Bernanke in fact had the power to do so, or whether it was just pretending he was King of the World is not something that I have read anyone commenting on. More importantly though, Bernanke went on to instruct Lewis not to disclose the losses to the SEC (Securities and Exchange Commission) until the deal closed, a serious violation of the law.

Clearly, the onus for disclosure was on Lewis. And these are serious laws, meant to protect investors, who must trust the system to give them honest information to make informed investment decisions. This goes to the core of why the confidence is gone from Wall Street. If Bernanke used his position to threaten Lewis to break the law, he too, is guilty, and should (and perhaps will) be prosecuted to the full extent of the law.

If the SEC can spend months and years going after Martha Stewart for an insider trading charge that involved, I can’t remember, $50 thousand or something, then surely the illegal manipulation of information about a deal in the tens of billions is actionable, especially when the net result deprived stockholders of the right to dump B of A before the toxins hit.

So far, the congressional committee is not buying the inconsistencies in Lewis’ and Bernanke’s stories. The committee’s ranking member, Darrell Issa (R-Calif.): “I for one personally doubt all these can be explained away.” Bernanke denies that what he told Lewis constituted a threat. It was just a “suggestion.” Trouble is, someone in Bernanke’s position has to be aware of the power he wields. Jason Chaffetz (R-Utah): “with all due respect, I’m just not buying that…I think that’s a threat, and I think it’s reasonable for the CEO and the board to take it as a threat.” Richmond Regional Fed Bank President Jeffrey Lacker has already supplied e-mail evidence that very clearly has Bernanke bragging about threatening Lewis and his Board with their jobs if they pulled out of the deal.

This is about more than the Fed Chairman overstepping his boundaries. One, it falls into the same disturbing pattern we have repeatedly seen during this crisis, one of protecting the high and mighty and handing the bill to investors and taxpayers. Two, at a time when new (much-needed) regulatory powers are being debated as possibly being given largely to the Fed, it raises important questions about whether the Fed already has too much power, and whether the Fed often uses that power to its own ends. Remember, the Fed is not answerable to Congress or the President, or to anyone for that matter. It has never been audited. Its creation in secret on Jekyll Island in Georgia in 1917, and its role ever since, is shrouded in mystery.

Also, does the Fed deserve more power after its dismal performannce managing the economy? Senator Chris Dodd (D-Conn.) likens giving the Fed more regulatory power to "a parent giving his son a bigger faster car after he just crashed the family station wagon."

Bernanke keeps claiming his actions were to protect us against a broader systemic risk. But this is starting to feel more like decrees made by “divine” right. And always to the benefit of the Devine.

The words were taken from my mouth before I could utter them, when Chris Rupkey of the Bank of Tokyo/Mitsubishi UFJ said “It does have a kind of a Watergate feel to it.” Except that Watergate was after all, nothing more than a petty burglary. More about the implication of the action than actual consequence of that action. I’m not sure that the burglary itself ever netted anything. But it was enough to bring down a President. This is much different. This is all about a person of vast power, entrusted by us regular people to protect the financial system we depend on, using that power to break the law and manipulate vast sums of money for the benefit of the financial elite.

Committee Chairman Issa has charged that the Fed has covered up its involvement in the merger and “deliberately hid” important details from other regulators. In an atmosphere where so much white collar criminality is being swept under the rug, probably because no one has the stomach to upset the fragile recovery with high-profile prosecutions, it will be interesting to see if Congress and/or the SEC can find the willpower to go after Bernanke.

Doug Friesen
June 27, 2009

Alice in Bankland

In a world awash in acronyms, PPIP is just another side show in the rodeo. It stands for Public/Private Investment Partnership. Who cares? Except this innocuous sounding scheme, hatched by Obama’s financial czar Larry Summers and Treasury Secretary Tim Geithner had the potential of further bankrupting the American taxpayer in an effort to re-inflate the banking bubble. The plan involved doing quadruple by-pass surgery to balance sheets of superbanks, but with a twist. In this operation, the risk was not to the patient (the banks) nor to the surgeons (The Fed and the Treasury) but to the person who pays for the insurance (the public). But you don’t have to worry about it any more. The plan died on the table before the operation began.

Still it’s instructive to pull this apart as a stark reminder that the fantasy economy remains in la-la land. Here’s what happened. After the music stopped, the banks ended up with trillions in toxic assets. So many trillions, that many of Americas largest banks, even though they had huge assets, had even huger losses. They were close to insolvency or maybe even way over the line. We will never really know. But it all depends on how you tally the balance sheet. If you want to live to play another day, you do anything you can to pretend the losses really don’t exist. To do that, you must somehow hide the toxic assets from the balance sheets. Then you hope like hell something substantial will magically happen to erase them.

PPIP was that white night, created by the government just for that purpose. The government and the banks have a similar MO. For the banks, it’s more important to create a quarterly report that will maintain the illusion of prosperity than to peck away at the slow plodding work of long term viability. And the government has exactly the same agenda.

This is how it was supposed to work: The banks would remove the troubled assets from their balance sheets and put them up for auction. The auction price would be paid thusly: 7.5% from private investors, 7.5% from government (taxpayer) funds, and 85% from a loan from the FDIC. If the assets prove to be worth more, the private investor and taxpayer portion could pay out at 2:1, 3:1, even 4:1. They would then pay out the FDIC loan. If it turns out to be a bust, everyone walks away from the table with nothing and the FDIC owns the mess.

What’s wrong with this picture? The FDIC is ultimately backstopped by the taxpayer, so, in this highly leveraged investment, (weren’t we supposed to quit those?) the private investor has 7.5% of the risk and the taxpayer has 92.5% of the risk, but for the same potential payout.

A sucker’s deal all the way. In fact, with this set up, there is a very real risk of the private investor over bidding, since the risk is so small the potential reward so great. According to financial expert Peyton Young, “the more aggressively investors compete in bidding for these assets, the worse off the taxpayer will be”.

So the bank walks away with a good payout on their previously almost worthless toxic assets. Oh, sorry, we are calling them “legacy” assets now. Another nice perk for the banks is that they would get transaction fees as both the buyers' and sellers' agents. The banks liked the idea so much they lobbied to be able to bid on the assets themselves, essentially buying back their own assets at pennies on the dollar. According to Joe Wiesenthal of the Business Insider, “Having no shame, the only way the PPIP appeals to them is if they can use it for straight up money laundering.” Plenty of other highly regarded economists publicly expressed shock, including Nobel economist Paul Krugman, former World Bank chief Economist Joseph Stiglitz, and former IMF Chief Economist Simon Johnson.

But a funny thing happened on the way to the operating table: The patient got cold feet. A number of things substantially changed between idea and implementation. One problem was pegging an actual value for these hard to price assets. That would make it very difficult for the banks to pretend the assets were worth much more, and also would expose thier hand to other players. Also, the banks were able to raise billions in private capital, reducing the need to unload assets. Mostly because private investors were realizing the government would do anything, risk any amount of money, to make sure the superbanks came out smelling like a rose.

Instead of this meltdown punishing the big banks for engaging in foolishness, and rewarding the smaller banks who didn’t, it is exactly the other way around. Mostly the bailed out banks survive and smaller banks don’t because in this plan, winners and losers are chosen by the government. Competition in the banking sector is reduced, and the big banks remain “too big to fail”. You talk about your “moral hazard.” The incentive to step back from the brink of excessive risk is gone.

Another thing was the reversal of the “mark to market” rule. Under this rule, banks had to mark their assets as being worth what the current market would pay for them. That was great in good times, because it bloated the balance sheet in the banks favor. When times got bad, they lobbied heavily to reverse the rule. The worry was that the toxic assets' fall in value would reveal the Banks to be the hollow shells they really were. The rule was changed in March. Now, the banks could value the assets at whatever they felt they would fetch in some rosy future. With those pesky toxins not dragging down the books anymore, the banks were actually reporting profits.

PPIP is not officially dead. Instead it’s bobbing about in what one pundit called, “a Monty Python moment.” Critics of the plan say the banks can too easily game the system from both ends. Banks don’t like it anymore because they are afraid the bidding will reveal the real sorry truth about the “legacy” assets. Even investors worry that the rules would be changed mid-game if the public realized how crazy the whole thing was.

And in a world where no one really wants to face the painful reality that the delusional bubble we called prosperity isn’t likely to return any time soon, and certainly not by efforts like PPIP, this is what passes for reality.

Doug Friesen
6/16/09

Duxbury Clipper reviews "Age of Entitlement"

click this link for review by Duxbury Clipper owner David Cutler:

http://www.eduxbury.com/index.php?option=com_content&view=article&id=3579:tough-words-for-financial-leaders&catid=62:duxbury-aae&Itemid=100