Posts tagged financial giants
ANALYSIS-Even with new rules, life goes on for Wall Street
Jun 27th
By Steve Eder
NEW YORK, June 25 (Reuters) – U.S. lawmakers have hammered out a law that is designed to fundamentally change Wall Street, but financial professionals largely yawned.
Legislators took steps that at first blush could change the industry, including limiting banks’ swaps-dealing operations and their investments in private equity and hedge funds.
But in the end, banks like Goldman Sachs Group Inc, JPMorgan Chase & Co and Morgan Stanley won concessions that watered down the proposals that could have been most damaging to their profits, staving off a watershed overhaul like the one that took place after the Great Depression.
One former executive at a major bank estimated that profits for the biggest dealers could fall by 3 to 5 percent because of the bill, which is far better than some had expected.
“It really could have been worse,” one banking lobbyist said on Friday morning, calling the process “grueling” and saying that just 24 hours earlier the proposals were more damaging for banks.
“People are going to have to make changes and it is going to cost money, but it’s not going to ultimately change their ability to do business.”
BRACING FOR THE WORST
Banks were bracing for — and lobbying against — a proposal by Sen. Blanche Lincoln, a Democrat, to force them to spin off their swaps-dealing operations. They were also worried about the “Volcker rule,” the ban on banks’ trading first proposed by White House economic adviser Paul Volcker.
But in the end, lawmakers took much of the sting out of both proposals.
In fact, after lawmakers’ 21-hour final push to seal a deal, bank stocks opened higher, underscoring how the sweeping rewrite may not be the new dawn that financial giants feared.
Some of the most dramatic proposals, such as one that would have broken up the big banks, dropped out of the bill. What was left means pinched profits and a few new watchdogs for Wall Street, but largely keeps its business model intact.
Lawmakers built exceptions into the Lincoln proposal that allowed banks to continue to engage in foreign-exchange and interest-rate swaps dealing, which account for the bulk of the $615 trillion industry. Banks would also be allowed to continue to participate in gold and silver swaps and derivatives designed to hedge their own risk.
They would need to spin off dealing operations that handle agricultural, equity, energy, metal and uncleared credit default swaps.
The final Volcker rule was also diluted with a key exception that allowed banks to invest up to 3 percent of their Tier 1 capital in hedge and private equity funds.
That provision could still be significant for Goldman Sachs, which had $15.5 billion invested in its own funds, including private equity and hedge funds at the end of the first quarter. A securities filing showed the firm had committed to provide another $12.1 billion to these types of investments. The Wall Street firm’s Tier 1 capital was $68.5 billion at the end of the first quarter.
Under the new rule, Goldman’s investments are above the threshold, leaving the company to invest only about $2.1 billion in these types of portfolios.
WATERING DOWN
Analysts and consultants say the bill leaves room for a bank to establish a derivatives business inside its holding company, but to place it overseas, escaping U.S. regulations.
“To me, it really doesn’t matter much,” said Cornelius Hurley, a professor and director of Boston University’s Morin Center for Banking and Financial Law.
U.S. regulators have a history of being lax about enforcing the walls between different parts of a holding company anyway, he added. “It might make it more costly in the sense that there will be a compliance cost.”
The rewrite of the Volcker rule could allow major banks with large amounts of capital to continue to invest billions of dollars in hedge funds.
“I don’t see things in that bill structurally that are going to cause banks to have weaker earnings,” said analyst Richard Bove of Rochdale Securities.
With U.S. financial regulation nearing the finish line, international capital standards still are expected this year, which could add further rules for banking industry.
But for now, some question whether Congress has come up with regulations that will prevent another financial crisis.
While the Volcker and Lincoln rules will have ramifications for Wall Street, they still do not carry the might of Great Depression-era Glass-Steagall reforms, which barred banks from affiliating with securities firms and insurers. Those laws were largely repealed in 1999 — which amounted to another game changer in the financial rule book.
“When you look at the underlying causes of the crisis, this bill barely scratches the surface on those and in some ways it exacerbates them,” Bert Ely, founder of financial institutions and monetary policy consulting firm Ely & Co.
See also: FACTBOX – New regulations limit banks’ investments in hedge funds
(Additional reporting by Elinor Comlay; Editing by Lisa Von Ahn, Matthew Lewis and Bernard Orr) ((steve.eder@reuters.com; + 1 646 223 6069))
GOP Filibusters Wall Street Reform For Second Straight Day; Obama: ‘That’s Not Right!’
Apr 28th
WASHINGTON — Senate Republicans, attacked for twice blocking legislation to rein in Wall Street, floated a partial alternative proposal Tuesday and said it could lead to election-year compromise on an issue that commands strong public support.
The outline surfaced shortly before Senate Republicans united for the second straight day to block action on White House-backed legislation designed to prevent any recurrence of the ills that led to the economic calamity of 2008. The 57-41 vote left the measure three shy of the 60 needed to advance.
The 20-page GOP alternative would prohibit the use of taxpayer funds to bail out failing financial giants of the future and impose federal regulation on many but not all trades of complex investments known as derivatives. It also calls for consumer protections that appear weaker than Democrats and the White House seek, and it would create new regulations on mortgage giants Fannie Mae and Freddie Mac.
A New York Times analysis found the GOP proposal “would give consumer regulators fewer powers, and give the government less authority to rein in the activities of large financial companies, than the Democratic bill proposes to do.” On consumer protections, the Times reported, “The Democratic bill would go further in enforcement, covering other mortgage companies (like mortgage servicers and brokers) as well as large nonbank financial companies – from payday lenders to pawn shops – that currently evade oversight.”
Senate Majority Leader Harry Reid, D-Nev., said he would hold additional votes later in the week, and, he, President Barack Obama and other Democrats have spent days accusing Republicans of doing the bidding of the big financial firms on Wall Street.
“It’s one thing to oppose reform but to oppose just even talking about reform in front of the American people and having a legitimate debate. That’s not right!” the president said in Ottumwa, Iowa. “The American people deserve an honest debate on this bill.”
Reid said, “More than two years after the financial collapse that sparked a worldwide recession, Senate Republicans are claiming we’re moving too fast. “Two-thirds of Americans support us cracking down on big bankers’ reckless risk-taking. And a majority supports us asking banks to pay for their own funerals – that’s the fund financed by the big financial firms to cover the cost of their liquidation.”
The events unfolded in the Capitol as Republicans and Democrats alike spent hours at a committee hearing criticizing current and former officials at Goldman Sachs for seeking profits from the collapse of the housing market two years ago.
But the Senate Republican leader, Mitch McConnell of Kentucky, said Democrats were going too far, coming up with a bill that “reaches into every nook and cranny of American business.” Moments before the vote, his second-in-command, Sen. Jon Kyl of Arizona, predicted that unlike the recent health care battle, this time bipartisan legislation eventually would pass.
The current stand-off follows months of fitful bipartisan negotiations that have failed to yield agreement.
The Republican summary, obtained by The Associated Press, differs from the Democratic measure on several key points.
While banning the use of taxpayer funds in liquidating large financial firms, it calls for the cost to be borne by creditors and shareholders. Democrats favor a fee on banks to cover those expenses.
Republicans suggested a council comprising bank regulators and independent appointees to ensure that large banks and other financial institutions do not take advantage of consumers, as opposed to a Democratic proposal for an independent agency with broader powers.
Derivatives, which are complex investments that contributed to the 2008 economic collapse, would be brought under federal supervision for the first time, but not to the extent Democrats seek.
Republicans also called for restrictions on government assistance to Fannie Mae and Freddie Mac and want the president to submit a reorganization plan. Both are essentially owned by the government, which took control when they lurched toward failure during the collapse of the housing market.
More on Financial Crisis
Roger Hickey: This Week: Obama’s Deficit Commission – or Pete Peterson’s?
Apr 25th
On Wednesday Wall Street multi-billionaire Peter G. Peterson, who has pledged to spend a billion dollars to panic Americans about deficits in order to get them to slash Social Security and Medicare, is conducting a “Fiscal Summit” in Washington featuring many of the very people who created the deficits Peterson decries.
This summit is designed to stampede President Obama’s new deficit commission (which meets the day before – on Tuesday – for the first time) into adopting their version of fiscal austerity.
At 3:30 on Tuesday, I will moderate a press conference, featuring Robert Kuttner, Heidi Hartmann and Dean Baker, designed to present a counter to Peterson’s simplistic explanations and dangerous proposals – and to warn the White House that having the two co-chairs of the Obama deficit commission participate in Peterson’s extravaganza will discredit the already dubious White House claim to be examining all the paths to fiscal sustainability.
But Americans looking for jobs and economic recovery are not likely to be persuaded by the bizarre collection of speakers Peterson has assembled.
The Bush tax cuts for the very wealthy were the first cause of soaring US deficits after Democrats cleaned up the red ink of the Reagan years. So who are Peterson’s headliners? Alan Greenspan, former Fed Chairman, who famously assured Congress that those deficit-creating tax cuts were OK – and who was recently forced to admit that his conservative blinders prevented him from seeing and acting to avoid the housing bubble and the deficit-creating economic crash that resulted. Other speakers, like Congressmen Judd Gregg and Paul Ryan, supported the Bush tax cuts. And Peterson himself, who benefitted hugely from the Bush tax changes, never seriously protested those irresponsible deficit-creating policies.
Also speaking: Robert Rubin, who as Clinton’s Treasury Secretary, presided over the deregulation of Wall Street financial giants, and then as CitiBank chairman, presided over the orgy of speculation and outright fraud (all enabled by his Treasury policies) that brought the financial system crashing down.
The chutzpa of this Peterson “fiscal summit” is just breathtaking.
Wall Street billionaires who helped Bush blow a whole in the federal budget – and who also actively enabled the financial deregulation and speculation that created today’s economic crisis and deficits – are gathering (at the Ronald Reagan building!) to lecture senior citizens and the rest of us about the need to tighten our belts and allow them to slash Social Security and Medicare.
This billionaires’ bash might seem comical – Saturday Night Live couldn’t do justice to it – except for the fact that the organizers have massive resources at their disposal and they are deadly serious.
For one thing, they are trying to sabotage all further efforts to stimulate a stronger economic recovery. And it is pretty clear that they have had an impact on the Obama administration, which seems to be giving up pushing for significant new aid to the states or job creation, like Rep. George Miller’s Local Jobs For America Act.
Under pressure from these conservatives, President Obama is on the verge of pivoting to the deficit, not jobs creation, as we go into the election season. That would be disastrous, both economically and politically – as Americans who watched the bank bailouts, continue to look for a jobs recovery.
Even more disastrous would be for Democrats to embrace Peterson’s deficit “solutions.” He wants the country (and Obama’s commission) to cut Social Security benefits, even though Social Security contributes nothing to the deficit. And he wants us to cut Medicare benefits (or turn Medicare into a voucher program, as White House commission member Representative Paul Ryan would do). This after President Obama has just successfully made the case that the target for deficit reduction should be overall health care costs, not Medicare.
President Obama, who has rightly blamed Bush economic policies and the current financial crisis for the growing deficit, should not follow Peterson advice on health care, on “entitlements,” or on jobs and economic stimulus. And he should make sure that his deficit commission co-chairs, Erskine Bowles and Alan Simpson (and three other members of the White House commission) who are speaking at the Peterson conservative extravaganza, are exposed to a more progressive point of view.
It really does look bad – just as the White House is warning more progressive members of the Obama Commission to hold off on publicly talking about the commission’s work – to allow the two co-chairs to attack senior organizations (as Simpson has, since being named) and to declare that Social Security and Medicare have to be cut (as Bowles recently did) and then to participate in this Peterson “summit” so obviously meant to push the White House in a conservative direction.
But wait, there’s more: the White House appears to be using a self-described “independent, non-partisan” group, called America Speaks to carry out what appears to be an “astro-turf” campaign to simulate public discussion of these issues. Heads up, folks. They announce on their website:
On June 26, 2010, thousands of Americans, in hundreds of locations across the United States and online, will weigh-in on strategies to ensure a strong economic recovery and a sustainable fiscal future.
Sounds like a cool, grassroots, online democracy kind of project – until you read further and find one of their big funders: the Peter G. Peterson Foundation. He is everywhere, manipulating the debate about our future!
Get ready for a fight, friends. The whole dynamic reminds me of the early 1998 period during which President Clinton issued his call for a nationwide series of town-hall forums to discuss the long-range future of the Social Security program. Those official White House forums gave half their program to people who wanted to privatize Social Security – and Vice President Al Gore’s bold declaration at one of these events that the White House was ready to “seize the third rail of American politics” greatly confused people, especially seniors, who wondered whether he and the President, and Democrats in general, might be willing to compromise with the enemies of Social Security.
Our efforts to turn around Clinton eventually grew into a powerful coalition that defeated George Bush’s privatization plan, but first we had to spend way too much time convincing Democrats that standing up for Social Security and Medicare was both good policy and good politics.
Get ready for another great debate – this time about the future of good jobs, secure retirement, and conservative austerity versus the raising of public revenues to finance investment in the next generation of sustainable economic growth. We know we will be up against the well-funded Peterson conservatives. Let’s work to make sure the Obama White House is on our side.
More on Alan Greenspan
Stacy Mitchell: Move Your Money and Save
Feb 22nd
The New Rules Project, in partnership with HuffPost’s Move Your Money campaign, is using its Community Banking Initiative to get out the word that banking locally can put the power back in the hands of individuals and communities, rather than Wall Street’s CEOs.
Bigger banks were suppose to lower costs for consumers. That was the promise made repeatedly in 1994 and again in 1999, when Congress dismantled laws that had long restricted the size and scope of banks, ushering in a wave of mergers that left the industry dominated by a few financial giants.
Testifying in support of the so-called Financial Services Modernization Act in 1999, Michael Patterson of J.P. Morgan used the word “consumer” no less than twenty-one times in his remarks. He told Congress that freeing up big banks to get even bigger would provide consumers with “greater convenience, more innovation, and lower costs.”
Many regulators and lawmakers echoed his assertions. Robert Rubin, then Secretary of the Treasury and later a director at Citigroup, said that the “reforms” would “lead to better service and lower costs.” Congress passed the bill by wide margins and President Bill Clinton enthusiastically signed it into law, promising that the changes would “save consumers billions of dollars a year through enhanced competition.”
Just seven years later, the fees consumers were paying on their checking and savings accounts had skyrocketed, rising from $21 billion in 1999 to $36 billion in 2006. (And these amounts do not include credit card and ATM fees, which also shot up.)
That bigger banks would mean higher prices was plainly evident in 1999 to anyone who bothered to consult the data. For the previous five years, the Federal Reserve had issued yearly reports to Congress that showed that bigger banks charged significantly higher fees on checking and savings accounts.
The Fed’s 1999 report, published five months before the Financial Services Modernization Act passed, found that overdraft fees were 41 percent higher at big banks compared to small. Big banks charged more for almost every fee imaginable, including 43 percent more for bounced checks, 57 percent more for stop-payment orders, and 18 percent more for ATM withdrawals.
But rather than allow the evidence in favor of smaller banks to guide policy, Congress decided to get rid of the evidence. At the urging of then Fed chairman Alan Greenspan, Congress ordered the Federal Reserve to stop publishing its annual report on bank fees. “The Fed fought to get rid of it,” said Ed Mierzwinski, consumer program director at the US Public Interest Research Group. “They said transparency was not a good use of their resources.”
For most of the last decade, information on the average cost difference between big banks and small local financial institutions has not been publicly available. But, as it turns out, the firm that the Fed once employed to gather this data, Moebs Services, has continued to survey fees at more than 2,000 financial institutions. Moebs agreed to share its 2009 data with the New Rules Project. As our charts show, the biggest banks still impose much higher costs on their customers than small financial institutions do.
Not only are fees lower, but several studies have found that smaller banks and credit unions pay higher interest on savings accounts. In a study published by the Federal Reserve Bank of Cleveland, researchers Kwangwoo Park and George Pennacchi examined data from 1998 to 2004 and found that rates on one-year CDs were an average of 14 percent higher at small banks (under $1 billion in assets) than at large ones (assets of $10 billion or more) and rates on interest-bearing savings accounts were 49 percent higher.
Why are small banks and credit unions a better deal? One reason is that they really want your deposits. Unlike big banks, which have access to wholesale funding, community banks rely much more on customer deposits to finance their lending and investments.
A second reason is that many small banks are more efficient than their big competitors. That may seem surprising at first. In many industries, more volume lowers costs, but in banking there’s an upper limit — a point at which a bank’s bloated bureaucracy makes the cost of doing everything more expensive, not less. Exactly where that threshold lies is a matter of debate, but some analysts suggest that the sweet-spot for efficiency starts as low as $500 million in assets and ends once a bank hits $4 or $5 billion. To put that in perspective, Bank of America and J.P. Morgan Chase are about 300 times that size.
But perhaps a more instructive question to ask is not why are small banks a better deal, but how do big banks get away with charging so much more? After all, people have a choice about where to bank and free markets are suppose to drive down prices.
Christopher Peterson, an expert on consumer finance at the University of Utah School of Law, says there are two main theories. Those who believe the market is working contend that “bigger banks have more comprehensive branch locations, so people will pay a premium for convenience.”
Another explanation is that banks are adept at obscuring their prices and make it hard to comparison shop. “I think our impulse in this country is to overestimate the ability of people to shop down fees that are not transparent,” said Peterson.
Indeed, the Government Accounting Office recently sent secret shoppers into 185 bank branches. They were unable to obtain detailed information on account terms at one-third of those branches and unable to obtain a comprehensive schedule of fees at one-fifth, despite the fact that such disclosures are required by federal law — a law that apparently is not enforced. More than half of the banks did not provide this information on their web sites, either.
Mierzwinski says big banks have the advantage of having recognizable names and branches everywhere. Many people simply go to the nearest big bank branch and don’t shop around. “They particularly don’t compare the bank’s penalty fees, which are so hard to find,” he said. “Everyone advertises free checking, but ‘free’ only defines monthly maintenance fees.”
If you bank at a big bank, all of this should prompt you to give some serious thought to ditching it. Even if you are good at avoiding penalty fees, why do business with a bank that charges exorbitant prices and attempts at every turn to hit its depositors with sneaky fees? Shop around instead for a institution that treats its customers fairly. Consumer advocacy groups say the best place to start is with local credit unions and community banks. The smallest have the lowest costs on average. But keep in mind that averages are just that; institutions vary and each should be evaluated individually according to how well it meets your needs and how responsive it is to your community.
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Stacy Mitchell is a senior researcher with the New Rules Project and its Community Banking Initiative. Her latest book, Big-Box Swindle, was named one of the top ten business books of 2007 by Booklist.
More on Bank Of America
Davos Talks Focus On Uneven Economic Recovery
Jan 27th
DAVOS, Switzerland â Upbeat bankers clashed with pessimistic economists on the opening day of the World Economic Forum, where the movers and shakers of global politics and business argued over whether to move forward with financial reforms â or to abandon what some claim would be a ruinous path toward over-regulation.
Just hours ahead of President Barack Obama’s first State of the Union address, bosses from Deutsche Bank, Lloyd’s and other financial giants warned Wednesday that a flood of new regulations risked choking off a global economy recovery. Others urged Obama, who has proposed restricting bank risk-taking, to push forward with stronger reforms.
The discussions in the rarefied air of this Swiss Alpine resort reflected the broader debate and anxiety over the global economy, and how to address an uneven recovery powered by a booming China and held back by high unemployment in the United States and other wealthy nations.
“Let’s get good regulation, better regulation, but not more regulation,” said Peter Levene, chairman of British bank Lloyd’s.
Peter Sands, the CEO of Britain’s Standard Chartered Bank, added that his industry already has been “fundamentally changed” by tighter regulations and supervision, while Deutsche Bank Chairman Josef Ackermann said “we will all be losers” if governments clamp down on markets too zealously.
“The pendulum might have swung too far,” Ackermann warned. “Consistent and global rules, and a level playing field is absolutely key to the global economy.”
Obama is expected to push Wednesday evening for greater regulation of Wall Street, and there are calls in the United States and Europe for tougher taxation on financial institutions to recoup the billions governments have doled out in rescue packages since 2008.
Coupled with the high unemployment much of the rich world is experiencing, there is strong public pressure for action against the sectors that were so deeply involved in leading the world into recession. Some economists said more needed to be done.
“Obama’s proposals on banking regulation are finally going in the right direction … but they are not enough,” said economist Nouriel Roubini, who gained prominence for predicting the financial and economic crisis. Roubini, dubbed “Dr. Doom” for his grim assessments, suggested separating commercial and investment banking, and other steps to avoid a return to “business as usual” for banks.
Bankers rejected that approach.
“Would it help the recovery for big banks to be broken up? The unambiguous answer is no,” said Sands, urging a cautious approach to reform. “The stakes are very high. If we get it wrong in one dimension, we will end up stifling growth. If we get it wrong in the other dimension we end up with another crisis.”
The five-day gathering was assessing a host of other issues facing the planet, from disaster aid in the aftermath of Haiti’s devastating earthquake to climate change.
But the most pressing concern was steadying a shaky world economy that is likely to face tough challenges in 2010 as rich world unemployment remains high and governments are forced to pull back from lavish bailouts and stimulus packages that have propped up banks and other industries.
“China alone cannot be the only engine of global economic growth,” Roubini warned. “In the first half, you are going to see the effects of the fiscal stimulus … in the second half of the year you will see a fall in the U.S., Europe and Japan.”
Some 2,500 participants are expected in Davos. French President Nicolas Sarkozy will formally open the event later Wednesday, with other headliners including Presidents Luiz Inacio Lula da Silva of Brazil and Jacob Zuma of South Africa. Former U.S. President Bill Clinton will encourage big business to support Haiti’s reconstruction, while “Avatar” director James Cameron and classical pianist Lang Lang are the event’s top cultural representatives.
The U.N. labor agency said 27 million people lost their jobs last year, with almost half of the losses in North America, Japan and Western Europe. The agency predicted an additional 3 million people in the rich world could lose their jobs or fail to find employment in 2010.
Dennis Nally, global chairman of PriceWaterhouseCoopers, said he was “cautiously optimistic” about growth this year, but he acknowledged: “It’s not a robust recovery from a job creation standpoint.”
For emerging economies, the mood was mostly positive. While there was concern about an over-reliance on these new engines of growth, Nally suggested that China and India no longer be included among their ranks.
“It’s a little bit unfair to call China an emerging market, India an emerging market and they’re in the same category as Chad or Mozambique,” Nally said. “In 2014, the GDP of the emerging markets will surpass the GDP of the developed markets. Some of these countries have emerged already. We should come up with a better term.”
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Associated Press writer Angela Charlton contributed to this report.
More on Davos
David Fiderer: How Paulson’s People Colluded With Goldman to Destoy AIG And Get A Backdoor Bailout
Jan 25th
Too Big To Fail is revelatory, though not in the way Andrew Ross Sorkin intended. The book offers startling evidence that Hank Paulson and his deputies colluded with Goldman to create a liquidity crisis at AIG, and to manipulate the government funding a backdoor bailout of AIG’s CDO counterparties, most notably Goldman. It’s not that Sorkin’s sources recounted the truth. Quite the opposite. Rather, they told him stories that were so transparently dishonest that the truth emerges by way of negative implication.
To understand what happened, you need to remember that the top guys at Goldman are really, really smart. They are like champion chess players who anticipate the possible moves of their opponent. The guys at Goldman can quickly grasp how pieces of a financial transaction work together, like the pieces on a chessboard, to game out different scenarios. This attribute is not unique to the guys at Goldman; it’s an essential quality of every good banker. But it does mean that the guys at Goldman cannot credibly profess to being oblivious.
The other thing that you must remember is that the dagger hanging over AIG and Goldman – the eventual payout to the CDO counterparties – was a zero-sum game between the two financial giants. On June 30, 2008, AIG’s net worth was $79 billion and its CDO obligations totaled $62 billion. On August 27, 2008 Goldman’s net worth was $42 billion and its share of the infamous CDO portfolio was $22 billion. The stakes were huge.
Also, none of the critical elements that led to AIG’s demise were obscure. In retrospect they seem quite obvious. Unfortunately, few in the financial media have attempted to understand those critical elements.
Before we get to the liquidity crisis at AIG, we need to go back to that special relationship between Goldman and AIG…
Goldman bought credit protection exclusively from AIG because:
Like its peers, Goldman underwrote billions of dollars of toxic securities known as subprime collateralized debt objections, or CDOs, and simultaneously bought credit protection on those CDOs in the form of credit default swaps. But Goldman was unique in that it only bought protection from AIG Financial Products, or AIGFP, and no one else. Under normal standards of risk management, this approach is imprudent; a bank should diversify its risk exposures whenever it can. Given that AIG was Goldman’s biggest client, and that the CDO exposure at AIG was a huge part of Goldman’s equity base, it’s inconceivable that Hank Paulson, Goldman’s CEO until June 2006, would not have been regularly briefed on this matter. The same goes for Goldman’s board of directors. It’s a very basic and essential part of any bank’s risk management and corporate governance.
It’s also a basic tenet of risk management to game out the different scenarios under which Goldman might seek recovery under its credit default swaps. Based on that analysis, the choice to deal exclusively AIG, in retrospect, seems very obvious, for four reasons set forth below.
1) AIG Financial Products was not regulated, whereas the monolines were;
This is one of those really basic things that few in the media seems to grasp. The other large companies offering credit protection on the CDOs were the monoline insurance companies, names like MBIA or AMBAC. AIGFP was not regulated, whereas the monolines were. A regulator can order an insurer to withhold any payout that might impair that company’s ability to service its other policyholders. That’s precisely what the New York State Insurance Department did last April, when it ordered Syncora, the monoline formerly known as XL Capital Assurance, to suspend payments. This state’s regulatory authority to interfere with the terms of a contract proved to be a powerful hammer. It incentivized the CDO banks to negotiate haircuts on their claims throughout 2008.
A lot of people compare the settlements with the monolines with those at AIGFP and wonder why the monolines negotiated better deals. But in fact, they are comparing apples and oranges. The only government entity legally authorized to interfere with AIGFP’s contracts was a bankruptcy court. But even that authority had been seriously curtailed.
2) AIGFP was willing to post cash collateral, which was outside the grasp of a bankruptcy judge;
Here’s another very basic thing. The credit protection sold by the monolines included financial guarantees as well as credit default swaps, whereas AIGFP extended only credit default swaps. A credit default swap is a financial derivative. One of the common, and insidious, attributes of financial derivatives is that a counterparty may need to post margin, or cash collateral, whenever the spot value of its contractual claim turns negative. Here’s an overly simple example: Suppose AIG promised to sell Goldman one barrel of oil on January 25, 2011 for $80, and then on June 25, 2010 spot price is $100 (i.e. an implicit $20 loss). AIG would post $20 in collateral with Goldman. If the spot price falls to $65 on July 25, then AIG would get its $20 collateral returned, and also receive $15 in collateral deposited by Goldman.
As a rule the monolines were unwilling to sign any contract that required them to post collateral. They accrue insurance reserves and, again, insurance regulation is predicated on the idea that one policyholder ‘s recovery should leapfrog ahead of all the others. But that’s precisely the idea behind posting collateral on a derivative. If AIGFP filed for bankruptcy, Goldman would be entitled to immediately liquidate the credit default swap and permanently keep its cash collateral; a bankruptcy judge could not touch it. The recently amended bankruptcy code clarified the special priority given to derivative counterparties over other creditors.
So, as you would expect, It wasn’t simply the support of the regulators that gave the monolines the upper hand in negotiating with the CDO counterparties; it was also the fact they they held the cash.
3) AIGFP would have been wiped out by a bankruptcy filing, because it was active in financial trading;
There’s another reason why the monolines had the upper hand, whereas AIGFP did not. Bankruptcy was always a viable option for the monolines, whereas it was not for AIGFP. Aside from its book of business providing credit support for CDOs, AIGFP was very active in all sorts of financial trading of all sorts of derivatives. The monolines were not really involved in that business.
The vast bulk of business done by financial traders is hedged, meaning there are always two back-to-back contracts. Another overly simple example: If AIG promised to sell Goldman one barrel of oil on January 25, 2011 for $80, AIG would simultaneously contract with Morgan Stanley to buy one barrel of oil on January 25, 2011 for $78, and lock in the $2 profit. Throughout the next 12 months, any profit from one contract would correspond to the loss on the other. But if AIG filed for bankruptcy on June 25, 2010, Goldman could choose to liquidate its contract and hold on to its collateral, whereas Morgan Stanley might still insist of selling the oil on the later delivery date. The hedge would then become unwound, and suddenly expose AIG to a huge trading loss.
The preferential treatment given to derivatives subverts the entire purpose of a bankruptcy filing, which is to buy time for an orderly restructuring. For AIGFP, the downside risk of a bankruptcy filing was vast and unknown, which was not the case for the monolines.
Because Goldman is very savvy about trading risk, it must have mapped out an endgame enabling it to declare “checkmate” once AIG were backed into a corner.
4) AIG did not understand what it was doing; it relied on the rating agencies.
But if Goldman was so smart, how could AIG be so dumb? There’s a short answer and a long answer. The short answer is three little letters: AAA. The long answer gets to the same result; it just takes a longer while to get there.
According to Michael Lewis’s reporting in Vanity Fair, the guys at AIGFP were clueless:
Toward the end of 2005, Cassano [the head of AIGFP] promoted Al Frost, then went looking for someone to replace him as the ambassador to Wall Street’s subprime-mortgage-bond desks. As a smart quant who understood abstruse securities, Gene Park was a likely candidate. That’s when Park decided to examine more closely the loans that A.I.G. F.P. had insured. He suspected Joe Cassano didn’t understand what he had done, but even so Park was shocked by the magnitude of the misunderstanding: these piles of consumer loans were now 95 percent U.S. subprime mortgages. Park then conducted a little survey, asking the people around A.I.G. F.P. most directly involved in insuring them how much subprime was in them. He asked Gary Gorton, a Yale professor who had helped build the model Cassano used to price the credit-default swaps. Gorton guessed that the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. He asked Al Frost, who had no clue, but then, his job was to sell, not to trade. “None of them knew,” says one trader. Which sounds, in retrospect, incredible. But an entire financial system was premised on their not knowing–and paying them for their talent! [Emphasis added.]
It seems less shocking if you understand how these CDOs were put together and sold. Take a few minutes and glance over the prospectus for Davis Square Funding VI, one of the dozens of CDOs structured by Goldman before the risk was laid off on AIG. You could spend all day studying the document, but you will never be able to answer the question, “What am I buying?” The document doesn’t tell you. That’s the point. It’s evident in every aspect of this document and the offering circulars for most of the other CDOs. The business purpose, the essence of the deal, can be summarized in one word: obfuscation.
Goldman argued that these CDOs were put together to meet market demand, but demand for what? These subprime CDOs were not financing anything (the underlying mortgages and mortgage securities had already been financed), nor were they promoting liquidity in the marketplace (they couldn’t be traded because nobody knew what was in them).
If you wanted to invest in a diversified pool of subprime mortgages, there was no reason to waste hours and hours studying the impenetrable documentation of a CDO. Instead, you could look into any subprime mortgage deal, like MASTR Asset Backed Securities Trust 2005-NC2. Skim the prospectus for five minutes, and you know that the deal is comprised of 3,380 subprime mortgages, all of which were originated by New Century Financial, 55% of which were in California, 100% of which are interest only, 60% of which closed with second liens, 58% of which relied on “stated documentation,” and 83% of which had prepayment penalties. If you don’t like MASTR 2005-NC2, you can easily compare it with hundreds of other stellar transactions.
Remember, AIGFP only assumed risk exposure on the “super senior” classes, or tranches, of these CDOs. They only assumed the risk on paper that was rated AAA. Therein lies the faulty assumption that AIG and almost everyone else made before they ever started slogging through the impenetrable documentation. It’s rated AAA so you don’t need to worry about the details. The offering circular for Davis Square Funding VI is just like the offering circular for Davis Square Funding VII and countless other CDOs. It tells you Moody’s Expected Loss Rate on a credit rated Aaa. After 20 years, the cumulative loss is 0.02 percent. It doesn’t tell you that the deal was structured to make a sham of the due diligence process.
People who bought these CDOs looked at the ratings and almost nothing else. They relied on Goldman and the rating agencies to make sure that everything was OK.
Which again brings us to the issue of posting collateral. As a matter of policy, financial institutions rated AAA or AA almost never agree to post collateral on their derivative trades. (That’s one reason why big banks find trading to be so profitable.) The only reason why the guys at AIGFP would have ever agreed to post collateral back in 2005 or 2006 is because they thought there was no way in hell that these CDO tranches rated AAA would never be valued at anything below par.
But Goldman’s credit default swaps would not trigger a bankruptcy, because there was no way to figure out their market value.
Goldman started harassing AIGFP to start posting cash collateral as early as August 2007, when the matter went to the “highest levels” at Goldman Sachs.
But Goldman met with limited success, for obvious reasons. The idea that these CDOs could be marked to market is a joke. There never was any real market of buyers and sellers of these things. AIG’s auditor, PricewaterhouseCoopers, and the Fed’s auditor, Delloite & Touche, determined under fair value accounting rules that there was no way that the CDO obligations could be valued according to any market benchmark.
AIG and Goldman had spirited talks over the amount of posted collateral for over a year, but those talks had remained at an impasse. No one could agree on the CDOs’ “market value.” So long as AIG was solvent, the inability to quickly ascertain the CDOs’ value worked in AIG’s favor. Later, when AIG faced a liquidity crisis, the inability to quickly ascertain the CDOs’ value worked against AIG.
Various side deals mask the true magnitude of Goldman’s participation in AIG’s CDO portfolio.
According to the AIG memo on CDO exposures, dated November 27, 2007, obtained by CBS News, Goldman’s CDOs represented about a third of the $67 billion total. But that may have been understating Goldman’s role in building up the portfolio. About 16 of Societe Generale’s trading positions were for CDOs that were arranged by Goldman. Apparently, one way that Goldman would offload CDOs would be to sell them, along with credit protection from AIG, as a package deal. In other words, some of the banks never seriously intended to hold the CDOs in the first place. But Goldman used them as a front for its own syndicating efforts.
Later, around the time Tim Geithner was brought in to settle the CDO matter, Goldman pulled another stunt to make it appear as if its CDO exposure to AIG was smaller than it actually was. The transaction is alluded to in a couple of obfuscatory paragraphs (pages 16 and 17) in Neil Barofsky’s SIGTARP report on the AIG bailouts. It appears as if Goldman suddenly sold $8 billion in CDOs to Deutsche Bank, so that it would appear as if Goldman’s share of the total would look smaller. But the only way that Deutsche Bank would have bought the stuff is if there were no risk involved.
On September 15, 2008, the rating agencies thought that AIG’s CDO portfolio looked just fine.
The Washington Post printed a 2,700-word article about AIG’s internal e-mails during 2007, when the guys at AIGFP kept insisting that the CDOs did not present any kind of troublesome risk. But the Post left out a critical element in the narrative. At that time, virtually all of the 148 CDO trades, listed in a November 27, 2007 memo obtained by CBS, were still rated AAA.
In fact, most of these CDOs were first downgraded in May 2008, the same month that AIG was downgraded from Aa2 to Aa3. At the time, the CDO downgrades were fairly insignificant. Of course we don’t know why the CDO downgrades occurred when they did, because we don’t really know what’s inside of them. But consider how bad the damage was by May 2008. Among the subprime bonds that comprised the ABX 2006-1 index, the average foreclosure rate was already 25%.
Was AIG really too big to fail? Maybe if you worked for Goldman.
The party line, expressed in Too Big To Fail and elsewhere, is that an AIG bankruptcy posed a greater systemic risk than a Lehman bankruptcy, because AIG was so much bigger. But that analysis is highly superficial and very misleading. AIG itself was a holding company, which guaranteed the debt of its unregulated financial subsidiary, AIGFP. The lion’s share of AIG’s revenues and profits, and about 80% of its consolidated assets, were concentrated among its different insurance company subsidiaries. Those insurance companies were solvent. They did not pose any systemic risk. In fact, it’s quite likely that they would have continued to operate outside of bankruptcy.
The only subsidiary with major problems was AIGFP, whose financial obligations were guaranteed by the parent. But AIGFP was only about one-third the size of Lehman. It’s almost impossible to see how AIGFP ever posed a systemic risk, unless everyone’s intention to provide a backdoor bailout to the banks. Put another way, it seems that the only reason that the government needed to step in for AIG was to provide a backdoor bailout to its banks.
Goldman’s scheme to create a liquidity crisis at AIG, in order to manipulate the government into paying CDO counterparties 100 cents on the dollar
Because of laws that emasculated regulatory oversight, Goldman’s trading positions in credit derivatives with AIG had escaped the scrutiny of the Fed until September 11 or 12, 2008, when AIG told the New York Fed that it would soon run out of cash. The CDOs did not trigger a liquidity crisis at AIG, at least, not directly. Rather, it was the imminent cash drain from anticipated downgrades, from AA- to A-, which would trigger $30 billion in new collateral postings on AIGFP’s trading positions. In addition, someone at the company had screwed up. They had invested billions in cash collateral, intended for someone else, in highly rated mortgage securities, for which there was suddenly no liquid market. So AIG needed to come up with the cash right away.
Simultaneously, of course, Lehman Brothers was imploring the government for support, and Paulson’s position, at least on September 12, 2008, was that the Federal government would provide no support of any kind to bail out a private company like Lehman or AIG. Private bankers must come up with a private solution on their own.
On September 15, 2008, the same morning that Lehman’s bankruptcy sent shockwaves, Geithner had convened a meeting with JPMorgan Chase and Goldman to work on an emergency bridge financing for AIG. Why include Goldman? Traditionally, the bank with the largest credit exposure to distressed borrower helps arrange the debt restructuring. Geithner opened the meeting, and left soon thereafter, leaving Paulson’s deputy, Dan Jester, in charge. Jester was a former Goldman banker whom Paulson had plucked in July 2008 to work on matters that concerned Paulson.
September 15, 2008: Paulson’s deputy sabotages efforts to negotiate a private bank deal.
Sorkin describes the opening of the Monday morning meeting:
“Look, we’d like to see if it’s possible to find a private-sector solution,” Geithner said addressing the group. “What do we need to do to make this happen?”
For the next ten minutes the meeting turned into a cacophony of competing voices as the banks tossed out their suggestions: Can we get the rating agencies to hold off on the downgrade? Can we get other state regulators of AIG’s insurance subsidiaries to allow the firm to use those assets as collateral?
Geithner soon got up to leave, saying, “I’ll leave you with Dan,” and pointed to Jester, who was Hank Paulson’s eyes and ears on the ground. “I want a status report as soon as you come up with a plan.”
A critical point here is that Pauslon’s deputy, not Geithner, sat at the table to lead government negotiations.
Job 1 was to persuade the rating agencies to forestall their anticipated downgrades, which would have burned up billions because of increased calls to post collateral. This task was assigned to the government’s representative, Dan Jester.
“He was as useless as tits on a bull.” [AIG CEO] Bill Willumstad, normally a calm man, was in an uncharacteristic rage as he railed about Dan Jester of Treasury, while telling Jamie Gamble[a lawyer at Simpson Thatcher] and Michael Wiseman [a lawyer at Sullivan & Cromwell] about his and Jester’s call to Moody’s to try to persuade them to hold off on downgrading AIG.
Willlumstad had hoped that Jester, using the authority of the government and his powers of persuasion as a former banker, would have been able to finesse the task easily.
Willumstad explained that the original plan “was that the Fed was going to try to intimidate these guys to buy us some time.” Instead, when Jester finally got on the phone, “he didn’t want to tell them.” Clearly uncomfortable with playing the heavy, Willumstad told them that Jester could only bring himself to say, “We’re all here, and, you know, we got a big team of people working and we need an extra day or two.”
If Jester spoke to Moody’s the way Willumstad said he did, then there is no doubt in my mind that Jester intended to sabotage the deal. No other explanation is plausible. The importance of the phone call was not unlike that of a death row lawyer seeking a last minute stay of execution. Jester had been the Deputy CFO at Goldman. It would have been his job to deal with the rating agencies regularly. There is no way that he would not have known what to say. All he would need to say is that since AIG’s last meeting with Moody’s, the situation is evolving in a way so Treasury and the Federal Reserve are feeling increasingly confident that the deal being hammered out will significantly ameliorate the company’s liquidity issues. Everyone knows that the rating agencies do not like to abruptly pull the trigger when a situation is still evolving. Everyone also knows that the rating agencies are acutely aware of their chicken/egg role they play in determining a firm’s liquidity situation. (A company has access to the capital markets because of its rating, but its rating reflects its access to the capital markets.) Also, as Janet Tavekoli once mentioned, investment banks train their analysts about how to place pressure on the rating agencies. Finally, it would not have been indelicate to allude to the agencies’ no-so-clean hands in building up the AAA pyramid scheme known as AIGP’s CDO portfolio.
An in case there were any doubt that Jester’s refusal to act as an advocate for AIG made the critical the difference, here’s how Jimmy Lee, of JPMorgan Chase, tallied the numbers on the morning following the downgrades. “They [AIG] have $50 billion in collateral and they need $80 to $90 billion. I don’t know how we can bridge the gap.” Because of the ratings downgrades, AIG posted an additional $32 billion by quarter’s end. In other words, they would have needed about $32 billion less if the downgrades had not taken place.
Minutes after Jimmy Lee briefed his boss, Jamie Dimon. Geithner, Jester Lee and the people from Goldman sat down to figure out what to do next.
September 16, 2008: Paulson installs a CEO at AIG who will favor Goldman.
And a few minutes after Goldman, JPMorgan Chase and the government tried to figure out what was next, at 9:40 a.m., September 16, Goldman CEO Lloyd Blankfein placed a call to Hank Paulson, which Paulson took, even though such communication was illegal. According to Sorkin’s sources, they discussed Lehman and not AIG. Just at the moment when the government was deciding whether to step in and save AIG, Blankfein never mentioned that an AIG collapse could have easily wiped out $15 billion in Goldman’s equity and caused everyone to scrutinize the dodgy CDOs underwritten during Paulson’s tenure. Do you think they just forgot?
As it happened, a few minutes after Paulson got done speaking with Blankfein, Geithner briefed Paulson about a tentative proposal for the government to extend AIG an $85 billion facility. The conversation with Geithner ended at 10:30 a.m.
Sorkin’s sources fabricated a tall tale about what took place afterward:
However resistant Hank Paulson had been to the idea of a bailout, after getting off the phone with Geithner, who had walked him through the latest plan, he could see where the markets were headed and that it scared him. Foreign governments had already been calling Treasury to express their anxiety about AIG’s failing.
Jim Wilkinson [Paulson's deputy, formerly of the White House Communications office] asked incredulously,” are you really going to rescue an insurance company?”
Paulson just stared at him as if to say only a madman would stand by and do nothing.
Ken Wilson, his special advisor, raised an issue they had yet to consider. “Hank, how the hell can we put $85 billion into this entity without new management?”– a euphemism for how the government could fund this amount of money without firing the current CEO and installing its own. Without a new CEO, it would seem as if the government was backing the same inept management that had created this mess.
“You’re right. You’ve got to find me a CEO. Drop every other thing you are doing,” Paulson told him. “Get me a CEO.”
Their choice: Ed Liddy, the former CEO of Allstate and Goldman board member.
The “same inept management that had created this mess”? It’s impossible to overstate the mendacity embedded in that brief passage from Sorkin’s book. If Paulson actually spoke what was on his mind at the time, the words would have been something like this:
“So if we don’t bail out AIG, then Goldman takes a $15 billion hit to its equity and faces shareholder lawsuits for actions taken under my watch. And Willumstad, the new AIG CEO who joined management after all these toxic CDOs were booked, will find it very convenient to also point the finger of blame at Goldman. [Willumstad joined AIG's board in April 2006, and became CEO in June 2008.] The AIG bankruptcy trustee might even sue Goldman for making fraudulent claims about the CDOs, the same way that HSH Nordbank sued UBS and M&T Bank sued Merrill.
“But if we bail out the company, there’s still no guarantee that Goldman can recover on the CDOs. And Willumstad can still point the finger at Goldman. So before we agree to anything we’ve got to get rid of Willumstad ASAP and replace him with someone who will make sure that Goldman’s interests are being looked after. Let’s use Ed Liddy. He’s a Goldman board member, so he will never disclose anything that makes Goldman look bad. If he wants to preserve the value of his Goldman stock, he’ll discreetly pay off the CDOs before anyone figures out what’s happening. So I decided Willumstad’s replacement will be Liddy, beginning tomorrow, and I don’t give a damn that my unilateral decision to change CEOs overnight is a complete travesty of corporate governance or government accountability. Our story will be that we are replacing the management that created this mess.”
How do I know that this was on Paulson’s mind and that these were his motivations? As noted at the beginning, the guys at Goldman are very smart, and they knew that the CDO settlement was a zero-sum game. Remember, AIG was Goldman’s biggest client and the issue of collateral postings had been in dispute for over a year. Up until June 2008, Ken Wilson was CEO of Goldman’s Financial Institutions Group. There is absolutely no way that Wilson did not know what was going on with AIG’s management, and that Goldman, not Willumstad was primarily culpable for building up the CDO portfolio.
Also, I’ve been a round the block a few times. Whenever faced with a crisis, senior people immediately think about how the situation will reflect on them. And they promptly think about damage control. And like many people who rise to the top, Paulson knows how to avoid leaving fingerprints. He probably learned his lesson decades earlier, working as John Erlichman’s assistant. Like those other famous CEOs, Bernie Madoff and Donald Rumsfeld, Paulson never used e-mail at work. The day after he fired Willumstad, Paulson spoke on the phone with Blankfein five times.
Whoever bore the blame for creating the mess at AIG, it’s extraordinarily reckless, during the middle of a crisis, to immediately install a CEO with no prior experience at the company, which is a huge sprawling conglomerate. That’s especially true when that new CEO has a conflict of interest the size of the Grand Canyon.
Sorkin also makes clear that it was Jester, not Geithner, who took control in structuring AIG;s bailout facility. Before Geithner gets on a conference call with Bernanke:
Jester and [Paulson's assistant Jeremiah] Norton were poring over all the terms. They had just learned that Ed Liddy had tentatively accepted the job of AIG’s CEO and was planning to fly to New York from Chicago that night. To draft a rescue deal on such short notice, the government needed help, preferably from someone who already understood AIG and its extraordinary circumstances. Jester knew just the man: Marshall Huebner, the co-head of insolvency and restructuring at David Polk & Wardell who was already working on AIG for JP Morgan and who happened to be just downstairs.
Months later, Paulson’s spokesman told The New York Times that, “Federal Reserve officials, not Mr. Paulson, played the lead role in shaping and financing the A.I.G. bailout.”
October 7, 2008: Paulson’s appointee unnecessarily pays out $18.7 billion to the CDO counterparties in exchange for nothing.
Actions speak louder than words, and AIG’s new CEO acted in a way that removed any doubt that he would make decisions in favor of Goldman. Remember, there was no need to hand over anything to the CDO counterparties, because there was no agreed-upon market value for the CDOs, which were all still highly rated. On October 7, 2008, AIG paid out $18.7 in cash in exchange for nothing. Before that October 7, only 26% of the CDOs’ face value had been paid out as cash collateral. Immediately afterward, counterparties hold cash for 56% of the CDOs’ face value of $62.1 billion. All of a sudden, the banks, not AIG, had the upper hand.
November 6, 2008: Only at the point when AIG is once again running out of cash and running out of time, and the CDO banks now hold the upper hand, Geithner is brought in to settle a matter when the government is backed into a corner. (Checkmate anyone?)
On November 5, 2008 only $24 billion remained available under the government’s revolving credit facility, though that cash could have been used up overnight if AIG were downgraded below A-. But, as S&P said, “if mortgage-related losses continue to worsen, then we could lower the ratings into the ‘BBB’ category.”
The CDOs, (which would all be downgraded into the CCC category in a few months), remained a dagger hanging over AIG’s liquidity situation. The only way to restore confidence in the company would be to remove that risk.
But the banks now had the upper hand, since they held most of the cash. Time was not on Geithner’s side, and protracted negotiations over the CDOs’ underlying value could have taken forever. Also, 29% of the remaining CDO exposure belonged to two French banks, whose regulator advised Geithner that it was illegal for them to settle at less than par. Challenging another country’s bank regulator would have opened up a whole can of worms at a point when the risk of global financial panic was very real.
Geithner’s attempts to drive a harder bargain would have created a crisis in confidence that could have likely triggered a further ratings downgrade. The $27 billion to remove the CDO albatross off of AIG’s books was only 15% of the entire $180 billion bailout package.
November 12, 2008: Following public disclosure of the backdoor bailout, Paulson announces his big bait-and-switch: his refusal to use TARP funds to stabilize the mortgage markets.
The collective amnesia of mainstream media notwithstanding, there was full contemporaneous public disclosure of the backdoor bailout of the banks at the time the deal was cut. The bailout package had a lot of moving parts, so it took The Wall Street Journal a day or so before it figured out precisely hat was going on. “New AIG Rescue Is Bank Blessing,” printed on page C1, explained that banks “will be compensated for the securities’ full, or par, value in exchange for allowing AIG to unwind the credit-default swaps.” And for anyone who was slow on the uptake, the Journal printed a picture:
Once the public learned that the CDOs no longer posed a risk to AIG, Paulson announced his his big bait-and-switch: his refusal to use TARP funds to stabilize the mortgage markets. This about face causes the value of all mortgage securities to plummet, imposing an additional loss on Maiden Lane III (and triggering the insolvency of Merrill Lynch).
But Paulson’s coup de grace was to use one of his appointees to fabricate a false history of the backdoor bailout. But that’s for another piece.
More on AIG
Buffett lets public down…again
Jan 23rd
Posted by PostMan in commentaries
7 comments
The public has always seen in Warren Buffett a different kind of capitalist, an honest observer providing sound financial advice regardless of his personal interests. But is he?
When it comes to his own holdings Buffett seems to use a carefully cultivated reputation for financial rectitude to feather his own nest.
On Wednesday he came out against Obama’s proposed bank tax, but his comments were inconsistent. On one hand he’s always maintained banks needed to be bailed out, yet he opposes ways to make them pay for it. At this point, financial giants in which Buffett has large stakes — Wells Fargo, Goldman Sachs and General Electric — all benefit from an implicit too-big-to-fail government insurance policy. How can Mr. Buffett, an insurance executive, argue that it’s inappropriate to charge them for it?
This is just the latest example of Buffett talking his book.
Buffett also lobbied for and profited greatly from the bailouts. He invested in Goldman, he said, with the expectation that Congress would “do the right thing” by passing the Troubled Asset Relief Program. In other words, it was a bet on a bailout.
Later he mocked the stress test, which forced over-leveraged banks to raise needed capital. This was bad for Buffett because it diluted his stakes in banks.
Less well-known is that Buffett was the first to propose a private-public partnership structure in order to rescue troubled banks. In a letter to Hank Paulson in the fall of ’08, cited in Andrew Ross Sorkin’s recent book, Buffett pitched his idea for a “public-private partnership fund” that would use public debt to finance private bets on toxic assets. When Tim Geithner rolled out a similar plan a few months later, it was widely panned as a giveaway to banks.
Buffett later complained about bailouts in his annual letter to Berkshire investors, saying that government subsidized funding put firms like Berkshire at a disadvantage. He failed to note that public subsidies — in particular FDIC’s Temporary Liquidity Guarantee Program — helped to keep afloat the eight banks in which Berkshire had a stake. From the end of ’08 through July of ’09, 75 percent of the debt sold by these eight banks came with the explicit government guarantee offered by TLGP. Without it, many might have failed, wiping out Berkshire’s equity stake.
It takes chutzpah to lobby for bailouts, make trades seeking to profit from them, and then complain that those doing so put you at a disadvantage.
Those who follow him closely are well aware that he talks his own book, but the wider public still believes him to be a trustworthy broker of unbiased financial advice and commentary. They shouldn’t.
Buffett didn’t respond to requests for comment.