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

Your Party Affiliation Won’t Get You into Heaven Anymore

Gun control, homeland security, stem cell research, abortion. There are many heated debates among liberals and conservatives that are in no danger of being reconciled or solved. That’s good. It means the electorate is not asleep at the switch. As the power of the left and the right ebb and flow from one administration to the next, these issues usually find some sort of equilibrium, even if it’s usually an unhappy one for both sides.

The interesting part is to observe how carefully politicians tread these minefields, their utterances coming only after whetting a finger and holding it up to test the wind direction of the masses. That is why it is so stunning to watch the public stand mutely by while politicians of both parties have engineered the gutting of the public purse by the kings of Wall Street.

Setting aside hysterical partisan blaming, little healthy reasoned debate is heard, let alone a hue and cry that should be directed at outlaw bankers whose greed fest destroyed the economy. This is not a partisan issue, this economic meltdown is an equal opportunity destroyer. Shrinkage is affecting every sector, and Job losses go right from the factory floor to the management suites of executive America. Perhaps our outrage is held in reserve for fear of rocking the economic boat. For sure, the governments’ idea is to return to prosperity as quickly and easily as possible, even if it means a return to the same fantasy bubble economy that just imploded. That’s likely what we have in mind too.

Contrary to what many believe though, the so called prosperity of the last few decades has not been broadly based. It’s been concentrated almost entirely to the top 1% of earners, and even more so on the top 1/10th of 1%, who have seen their income rise by over 500%. For the rest of us? The average middle class income taken by itself and adjusted for inflation has stayed more or less flat for over 30 years.

Sure, we feel wealthier than we were in the seventies, but that’s primarily for two reasons: Firstly, almost all households with income over $75,000 have two wage earners now instead of just one. That alone is responsible for rising household incomes since the seventies. Secondly, much of our “stuff” was bought on credit. The 12% personal savings rate from the eighties has been reduced to almost zero, while consumers have taken on a staggering 11 trillion in debt, doubling in just the last decade. The 50% gain in worker productivity during the same time period hasn’t helped either. That benefit by-passed the middle class entirely.

The trickle down effect of tax cuts for the wealthy was supposed to be a rising tide that lifted all boats. But the last time middle class wages consistently rose was in the post war period, up to the mid seventies, the longest sustained broadly based prosperity ever. Middle class incomes, adjusted for inflation rose consistently for almost 30 years. And that was when tax rates for corporations and the wealthy were twice what they are now, and had been for almost 40 years, ever since FDR’s “New Deal” created the middle class after the great depression. Since the eighties, tax cuts for the wealthy have succeeded only in a huge concentration of wealth at the highest income levels while all other income levels stagnated.

That subtle redistribution of wealth happened while the middle class was comfortably numb in a credit induced stupor. The dirty little secret of the GOP: if you are a Republican and you are middle class, you voted yourself a pay freeze. And who is middle class? Almost all of us. Individually, only 2% make over $250,000, and only 7% make over $100,000. And most of these tax cuts happened at levels far above that.

Does that make Democrats the friend of the middle class? Not while the entire Obama economic team is comprised of Wall Street bankers. The two main players Geithner and Summers, are hugely guilty of creating the conditions for the crash. Tim Geithner, as chairman of the New York Fed was responsible for policing Wall Street. Summers, as Clintons Treasury Secretary, was among a handful who are responsible for refusing to regulate trading in derivatives, a major cause of the meltdown. The entire top level of Obama’s financial team are Wall Street alums who at the very least, aided and abetted Wall Street’s criminal behavior. Why would they be of any help now except to drive the getaway car?

If banks are too big to fail, that must make us too small to succeed. Both the outgoing Bush administration and the present Obama team sold an angry public the same ugly bill of goods: Salvation lies in propping up the existing flawed financial structure regardless of cost, or society will face financial Armageddon. But wait: isn’t this the same house of cards that sowed the seeds of its own (and our own) destruction? Has there been any assurance the business models have been recalculated or even updated? Has there been introspection or contrition? The geniuses who had no idea the havoc they were wreaking will now apparently lead us to a stable future. But first they need us to recapitalize their banks. It sounds almost as preposterous as that e-mail scam where a Nigerian prince wants you to help him transfer several million dollars of which he will give you 20%. But first you need to send him $10,000.

Have we learned anything? Mortgage lenders are already gaming the $8,000 first time home buyer credit, and have reportedly begun signing up another round of sub-prime borrowers, as if there were even any left. Banks are gaming the bailout, and many banks that should have been seized and the parts sold to the highest bidder, will come out stronger than ever in a few years. Instead of the business being spread out to smaller smarter banks, the bigger dumber ones will dragged to prosperity on our nickel. Competition in the banking sector will be reduced instead of enhanced, and the behemoth banks will still be “too big to fail.” But wait that’s not all: The taxpayers will be handed the tab for trillions of dollars. If “free enterprise” means the freedom to plunder the public at will, maybe next time we’ll try the “Armageddon” option.

What can we do? It is not correct to say politicians don’t listen to people. Witness the rise of “green”, even though it’s still more talk than action. No politician of either party can afford not to talk about green. That’s not because they want to talk about it. Not because there is a green lobby paying them to talk about it. It’s because we demanded the issue be addressed. Is it too much to demand a proper accounting of why our economy is so whacked out, and what we are going to do to really fix it? And sorry, re-inflating the bubble by throwing billions at idiot bankers does not constitute fixing it.

FDR’s New Deal ended the last banking reign of terror and helped to set the stage for the great middle class prosperity we all grew up in. That didn’t happen by accident. It was governments’ response to popular outrage. FDR created a middle class that never existed before the depression, by taxing the outrageous income of the robber barons of the day, creating conditions that allowed the middle class to flourish. Big business was outraged too, but at the New Deal policies, to which FDR quipped: “Why are you so mad at me? I’m saving you from yourselves.” He was right. Business ended up doing as well as the middle class in the great post war boom.

That’s the lesson for our situation now. There will be no broadly based return to prosperity with a shrinking middle class, for that is the engine of the economy. And this attempt to fix the economy from the top down by reimbursing wealthy investors for their lost equity is not going to do it.

At your next cocktail party debate, don’t bother blaming the “other” party for this meltdown. You are wasting your outrage on fellow victims while the bankers get away with murder. Your party affiliation won’t get you into heaven anymore.

Doug Friesen
5/25/09

Bank Stress Tests: The crazy Grandmother is still in the attic

It was abundantly clear long before the results of the so called “stress tests” report card, the object was not to see which banks where too weak to survive. The object was always to see how much money it will take to make them survive. Treasury has made clear that they will not allow any of the big banks to fail. It doesn’t matter how much money it takes. This is the new economy, where the government picks the winners and losers by decree.

The test contains two economic scenarios for the next several years, a baseline scenario and an adverse scenario. As Andrew Leonard points out in his May 7 Salon.com article, The biggest economists of the day, at least the biggest ones not being paid by someone to issue “happy talk” forecasts, Paul Krugman, Joseph Stiglitz, Simon Johnson, are all convinced that the biggest US banks are insolvent. According to them, the “adverse” scenario has already become the baseline, and it could get much worse.

That view is backed up by Elizabeth Warren, head of the Congressional Oversight Committee: “It looks disturbingly close to where we are now.”

The results indicate the banks in need of a further 75 billion immediately and perhaps 600 billion over the next several years. Nothing that investors don’t already know. But now they know the government will backstop the losses no matter how large they get. Whether that will instill confidence in the markets is an open question. Bank stocks have rallied in the last six weeks, so now investors will get to grade the report card itself. It will be interesting when that grade is handed down, which will be indicated by what happens to the banks’ share prices in the next few weeks.

Risk, more than any single factor, is what caused the meltdown, as in, inability to judge how much risk is prudent. So it seems like a good idea to introduce some risk controls, at least to protect capitalism from itself. Here’s the problem: Backstopping the risk by government fiat may backfire. Look at Fannie and Freddie, the two quasi government mortgage companies whose risk was backstopped by the government. That went well, didn’t it? They required the largest single bailout ever, because it was never their own butts on the line. Sebastian Mallaby of the Washington Post suggests the government’s unending bailout will transform all of Wall Street into Fannie and Freddie, and they will charge ahead, oblivious to risk.

I realize that Obama’s message here is that it can all be fixed, some banks are not weak and the ones that are weak can be strengthened. In this perfect world, at some point, when the banks are strong enough, the fantasy economy would be replaced by the real economy. I wish I believed that could work. But the economy can’t be tinkered with as if it’s a Swiss watch. It’s more ethereal than that. It’s all about uncontrollable things like trust, risk, belief and confidence, stuff that slips through your fingers.

Jaidev Iyer, a former chief of risk management at Citigroup, says taxpayers will ultimately be on the hook. “If there is no appetite to let losers fail, then the real losers are the market at large, the government, and the taxpayers.”

I continue to be perplexed by the lack of accountability for the meltdown. Consider the airline industry. When they have a crash, It is picked apart in excruciating detail, sometimes for years, then a report is issued. The airline industry has an incredible safety record. The economy, well that’s a whole different matter. In our dysfunctional economic model, the crash is the crazy grandmother in the attic; it will not be spoken of. Somehow we are going to build a new economy without really ever doing any detailed thinking about what went wrong with the old one.

Doug Friesen
5/08/09

This just in!!

Article about "The Age Of Entitlement" in May 1st edition of Duxbury reporter:

http://www.wickedlocal.com/duxbury/news/x845557666/Duxbury-businessman-Doug-Friesen-writes-book-on-financial-crisis

The Banksters ride again

The Banksters ride again.

During the heyday of the market run-up that led to the Great Depression, the last time tycoons hollowed out the economy, a new term was born: Banksters. The veiled reference to the mob aptly described the manner in which the barons of the day used deceit and fraud to accomplish what Capone did with a machine gun. William K. Black conjures up the reference to describe todays "banksters" fleecing the public. Black knows fraud, perhaps better than anyone. He wrote a book with the title “The Best Way to Rob a Bank is to Own One.” Black is the former director of the Institute for Fraud Prevention, and has caught some pretty big fish, including the “Keating five” which touched off the Savings and Loan scandal.

According to Black, the essence of fraud is creating a foundation of trust, then betraying that trust to get something of value. In an interview with Bill Moyers, Black makes it clear that most corporate failures result from calculated dishonesty by those the highest levels. The current meltdown is no different. CEO’s deliberately jacked up bad deals to create record profits and huge bonuses. In fact the bonus system is the mechanism by which companies’ internal checks and balances are defeated. Money buys out the morality.

Black goes on to talk about how the entire system, stripped of regulation, drifted to the dark side. There was no one looking in from outside, and from inside, well, it all just felt so good. Corporate culture being what it is, who is going to kill the golden goose? Case in point - one of the truly slimy aspects of the mortgage crisis: so called “liar” loans. No income verification, no job verification and no asset verification. The more you lie, the better deal you get. One bank, Indy Mac, specialized in these loans, and in 2006 resold 80 billion dollars worth of them into the securities markets. This company eventually recorded loses greater than the entire S&L debacle.

As Ronald Reagan said, trust, but verify. It was the lack of verification that allowed the fraudulent loan securities to be cleansed and passed along to innocent pension plans and the 401K’s of widows. That part of the laundering was done by the rating agencies, who have yet to adequately answer for consistently giving these toxic securities triple A ratings, when these investments went on to lose 60-80% of their value. Of course, by the time that scenario played out, the fraudsters have cashed their bonuses and are driving the getaway car over the proverbial state line. It was a classic Ponzi scheme in all respects but one: everyone knows who did it; no one is being prosecuted. In fact William K Black calls Bernie Madoff a “piker, he doesn’t even get into the front ranks of Ponzi schemes.”

The FBI warned the Bush administration way back in 2004 that there was an epidemic of mortgage fraud going on that would result in a debacle at least as large as the S&L. At the time Bush had re-allocated most of the white collar crime unit to counter-terrorism, and they were never replaced. Now, with a fraud a hundred times worse that the S&L, there are one fifth the number of available white collar crime specialists that worked the S&L.

After the S&L, congress passed a law called the Prompt Corrective Action Law. This law requires the government to put failed banks into receivership immediately, not to keep them alive on corporate welfare. What was called “Receivership” then, is now being called “nationalization” by the hotheads hoping to hang the socialist mantle around Obama’s neck. That mantle rightfully is shared by both parties, who both have ignored and are still ignoring what this law mandates them to do. That would be to make these banks rightfully eat their own losses, not hang them on the broke, beleaguered, and unemployed taxpayers for the purposes of recapitalizing millionaires.

Politicians of both parties have acted in consort with the Treasury and Fed to hide the true extent of the losses and to prop up the existing power structures. All done, I’m sure they would claim, to protect the system from panic and total collapse. But the net result is to protect criminals with taxpayer money.

There is another reason no one being prosecuted, or even being asked to account for their mistakes. It is because this Ponzi scheme is systemic. It’s not where do you start prosecuting, it’s where do you stop? When half of Wall Street is behind bars? That’s the dilemma. A proper accounting of what went wrong would require stomping on the patient (the economy) right when we are desperately trying to revive him. We won’t swallow that medicine either, because we all got mighty used to the prosperity and we want it back as soon as possible. In that way, we too, are playing our part in the world’s largest Ponzi scheme.

Doug Friesen
5/04/09