Confuse and Conquer: Bankers to the Barricades!


Apr 16, 2009, Ukiah, Mendocino County, North California

The trouble with the original Hank Paulson TARP plan last fall that handed $700 billion to the biggest banks in compensation for their bad judgment was that it was too transparent. By the time we got to the Christmas holidays, everyone had figured it out and was grumbling.

Paulson spooned out the bailouts over a four month period after warning Congress that the world would end if they didn’t give Hank the money by the weekend. Some in Congress finally began to look at what they had approved, once they noticed that the public was beginning to suspect a con job. Obama, a far wiser politician, has taken steps to avoid these errors in his approach to our economy’s continuing collapse.

First he bribed us with a $787 billion dollar economic stimulus program designed to ease our pain, protect the unemployed, and give the states huge sums to hand out more or less as they wished. Second, he directed his new Treasury Secretary, the bright and shiny penny, Timothy Geithner, to fashion a series of second phase bank bailout programs that would be far more opaque than Paulson’s, and which would be distributed quickly, in very large tranches (a phony French financial phrase meaning Gobs of Cash), and for the most part outside Congress’ purview. That should take care of those grumbling voters.

Now Geithner has encountered a sea of troubles with his PPIP, the Public-Private Partnership Program. The idea was to show that private sector funds could indeed form a partnership with us taxpayers to soak up the troubled assets resulting from the collapse of the housing market, the financial derivatives trading, the credit default swaps and the like. Geithner has been working feverishly on a new strategy since February, but has yet to announce his definitive attack plan. We will examine Geithner’s various proposals in a minute. But first, let’s try to understand one basic question:

“The dirty little secret”, writes economist F. William Engdahl in Global Research 3/30/09, “which Geithner is going to great degrees to obscure from the public is very simple: there are only at most five US banks which are the source of the toxic poison that is causing such dislocation in the world financial system. The heart of the present problem, and the reason ordinary loan losses as in prior bank crises are not the problem, is a variety of exotic financial derivatives most especially the so-called credit Default Swaps.” “Today five US banks hold 96% of all US bank derivatives positions” (data from Federal Office of the Comptroller of the Currency released March 30th, 2009). Most of America’s second and third tier banks never traded in these derivatives.

The five are, in declining order of their total derivatives holdings: JPMorgan Chase: $88 trillion in derivatives; Bank of America: $38 trillion; Citibank: $32 trillion; Goldman Sachs: $30 trillion; Wells Fargo-Wachovia: $5 trillion. “These banks consider themselves too big to fail and thus can dictate policy to the Federal Government. Some have called it a bankers’ coup d’etat, and it definitely isn’t healthy” Engdahl continues. “Should this become generally known, it would focus voter attention on real solutions”.

“The Federal Government has long had laws in place to deal with insolvent banks: The FDIC places such a bank in receivership and its assets and liabilities are sorted out by independent audit. Irresponsible management is purged, stockholders lose, and the purged bank is eventually split into smaller units and when again healthy, resold to the public” explains Engdahl. “This is what Wall Street and Geithner are frantically trying to prevent.” The longer the government delays and refuses to demand full and independent audit to determine the solvency or insolvency of these five banks, the more costly it will be for all of us.

When Hank Paulsen panicked the Congress into giving him $700 bn back in September 2008, supposedly to buy bad assets, he blew the money on the banks themselves: $125 bn to the 9 biggest banks and another $125 to smaller regional banks without any accountability. Then $80 bn went to the ailing AIG, several tens of thousands to Citigroup, and $20 bn to auto companies. Now there is less than $135 bn left and nothing much to show for it. None was used to buy bad assets because the banks wouldn’t sell them at anywhere near their market value since this would appear as a huge loss on the bank’s books. They continue to carry them on the books at inflated prices, and dare not reveal that, like the Emperor, they have no clothes. Paulson did use the funds to buy preferred non-voting stock in some banks, giving him little or no leverage over bank decisions, compensation packages or bonus policy. Paulson’s program temporarily shored up the hole in bank balance sheets without attacking the cause. Then our boy Hank was saved by that stirring ceremony on the steps of the Capital on January 20th. He has not made even a squeak since.

The $787 billion program does not address any of the problems in the financial sector. It is merely a stop gap measure to expand the food stamp program, increase unemployment insurance, provide some assistance with medical costs for the jobless, and hand out grants to states for their favorite public works programs. A total of 38% of the $787 bn are for various tax cuts. The job creation program, thought by many to be the key issue just now, received only $29 bn for 2009 and a total of only $200 billion over the entire life of the program. The jobs program is too slow and too small: it may create a few hundred thousand jobs in contrast to the 5 to 7 million who will lose their jobs in 2009. With this staggering level of unemployment and consequent decline in consumer spending, the Stimulus Package looks like a thin gruel indeed. A second stimulus bill will be necessary later this year.

“Geithner has become the Poster Boy for everything that’s wrong with the government’s scatterbrain financial rescue plan” complained Mike Whitney 3/23/09. “He played a central role in the $165 million AIG bonus scandal and helped ignite a huge public fury. Now he must finally announce the details of his long-awaited plan for removing up to $1 trillion of toxic assets from the balance sheets of the country’s biggest banks”. The delays have resulted in part from the fact that the hedge funds and other private sector investors, whom Geithner had expected to join with the government (read taxpayer) in picking up these banks’ toxic assets have been very reluctant to play along. Consequently he sweetened up the deal several times before announcing the heavily subsidized program described by Nobel Prize Economist Joseph Stiglitz below.

Geithner’s plan initially released at the end of March is described by Jack Rasmus in Z Magazine 4/01/09 as a combination of three proposals to stabilize the Financial System:

Part 1 is a $1 trillion effort called PPIP – Public Private Investment Fund which we discuss below.
Geithner also plans two additional programs but has provided little descriptive material so far:
Part 2 is TALF – Term Asset Backed Securities Lending Facility at a cost of another 1 trillion.
Part 3 is HASP – Homeowner Affordability and Stability Plan: a $275 billion to subsidize mortgage lenders, servicers and investors.

Joseph Stiglitz, NYTimes 4/30/09, describes Part 1 – the PPIP as follows: “ A win win lose proposition: banks win, investors win, taxpayers lose”. He reminds us of what caused this mess: “banks got themselves into trouble by over-leveraging – by using relatively little of their own capital and borrowing heavily – to buy extremely risky real estate assets using complex instruments called collateralized debt obligations”.

Stiglitz explains how the PPIP would work (We call this the Outside Bidder Alternative): “Take a toxic asset likely to be worth somewhere between zero and $200 in a year’s time. The ‘average’ value is $100 in a competitive market. Under the Geithner Plan, if a private investor is willing to pay $150, then he puts up $12 and the Treasury the remainder – $138 of which $12 is equity and the remaining $126 is a loan at zero interest. If in a year’s time the asset value declines to zero, the private investor loses $12, and the government loses $138. If the value after a year increases to $200, then the partners split the $74 of net gain after paying back the $126 loan. The private partner gains $25 on a $12 investment. The govt, who risked $138 gets back only $37. This is ersatz capitalism – privatizing the gains and socializing the losses!”

Fortunately, the private sector still shows almost no appetite for investing in these toxic assets, even when they only have to put up $12 for a $50 share and can lose no more than the $12. They know that the real value of these toxic assets is close to zero – so why put even a penny into them? Therefore Geithner continues to search for the magic formula that will protect the naked bankers and keep taxpayers confused. The naked bankers are indeed like the zombie who keeps coming back.

The Inside Bidder Gambit as recently devised by Geithner and Larry Summers is even worse than the Outside Bidder shuffle, in the view of Columbia University Economist Jeffry Sachs, Huffington Post 4/06/09: “Consider a toxic asset held by Citibank with a face value of $1 million and a market value of zero. An outside bidder such as the ‘private investor’ described by Stiglitz above, would pay nothing for such as asset. Suppose, however, that Citibank sets up a Citibank Public-Private Investment Fund (CPPIF) under the Inside Bidder Gambit. The CPPIF bids full face value of $1 million for the worthless asset because it can borrow $850k from the FDIC and get $75k from the Treasury to make the purchase! Citibank will only have to put in $75k of the total.

“Citibank thereby receives $1 million for the worthless asset while the CPPIF ends up with a perfectly worthless asset against $850k in debt to the FDIC. The CPPIF shortly thereafter quietly declares bankruptcy, while Citibank walks away with a cool $1 million”. The taxpayer (under the auspices of the FDIC) loses $925k and Citibank makes a net profit of $925k after deducting its original $75K investment in the CPPIF. “Cynics believe the Geithner-Summers Inside Bidder Plan is exactly what it seems: a naked power grab of taxpayer money by Wall Street interests”, Jeffrey Sachs concludes.

The Liberty Bond Gambit as introduced in the New York Times 4/09/09: Now that the Hedge Funds have opted out since they know there is no living breathing value left in these toxic assets, the Obama administration is encouraging several large investment companies to create the financial crisis equivalent of Liberty Bonds, right out of World War I. But now we will call them bail out bonds. “This is an opportunity to forge an alliance between Main Street, Wall Street and K Street” said an executive at Black Rock, the big money management firm. “Its giving the guy on Main street an equal seat at the table next to the big guys”. Geithner described it as a win-win-win program. The hope seems to be that the small Mom and Pop investor on Main street will not be equipped with a crap-detector equivalent to those in use by the hedge funds who have already turned down Geithner’s Outside Bidder scheme.

Why is Geithner kept on? In the Atlantic Monthly of May 2009, Simon Johnson, formerly Director of Research at the International Monetary Fund and MIT Professor, states that: “The crash laid bare many unpleasant truths about the United States. One of the most alarming is that the finance industry has effectively captured our government. If the US was an merging market economy under the control of the IMF, they would tell it what they tell all countries in that situation – recovery will fail unless you break the financial oligarchy that is blocking essential reform.”