OUTRAGE

Every few months, I will devote a posting to items that outrage me. For this posting, I have four: the AIG-Goldman-Paulson connection, bank regulatory reform, TARP, and the Asness letter.

AIG-Goldman-Paulson

Since last September, the federal government has committed more than $170 billion to bail out AIG. Just after TARP had been passed by Congress, Paulson had a private meeting with AIG senior officials. As I reported in http://www.morssglobalfinance.com/reflections-on-tarp-aig-citi-and-compensation/, the only other person in that meeting was Lloyd Blankfein. Blankfein had just replaced Paulson as CEO of Goldman Sachs. Shortly thereafter, AIG divulged that it has used some of the government largess to pay Goldman Sachs $12.9 billion. This was after Goldman had already directly received $10 billion from TARP. Without the money from AIG, Goldman would have failed the recent stress tests (see p. 27 of http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf ). So today, instead of being required by the US Treasury to raise additional capital, Goldman is talking about paying back the $10 billion it received directly from TARP.

What outrages me most about this? The appearance of impropriety: the only outsider in the Treasury meeting with AIG was the person who replaced Paulson as the head of Goldman.

Bank Regulatory Reform

We have increasingly complex regulations to manage increasingly complex banks. Could we have a better testament to the fact that they do not work than the global credit freeze? And what is the government’s reaction? To add new, more complex regulations: Geithner has just announced draft regulations for derivatives. My suggestion goes in just the opposite direction: http://www.morssglobalfinance.com/regulatory-reform-of-the-financial-industry-a-proposal/. the banks are too complex to be effectively regulated, but they have to be safe. SIMPLIFY THE BANKS!

We trust banks because our deposits are insured by the Feds. That is all we care about: that are deposits are safe. My proposal is to limit Federal insurance to banks that:

• manage all of the loans they initiate, and
• do not engage in any form of trading activities.

In short, I am proposing we go back to the situation as it was in the ‘thirties: banking has to be safe; all peripheral activities such as investment banking must be spun off.

The Bank for International Settlements has worked for decades to develop standards for the capital adequacy of banks that try to allow for assets risk (Basel I & II). These efforts have spawned a risk management industry. Together, Basel I & II and its risk management industry have demonstrably not worked and will not work going forward.

Depositors ultimately pay for deposit insurance. Why should we pay for other bank activities when all we care about is the safety of our deposits? If banks were forced to spin off these other activities as they were in the ‘thirties and stick to managing their own loans, they would not need all their high-priced executives. Traditional banking is not rocket science.

I am outraged because my proposal, which I have mailed to the President, Geithner, Bernanke, and Barney Frank, will not get the time of day in Washington. Why? Because the people that run the big, complex banks want to keep their jobs, and their full time lobbyists in DC will make sure they do (Citigroup spent $8 million on DC lobbyists in 2008).

TARP

For reasons outlined in http://www.morssglobalfinance.com/the-global-credit-freeze-why-it-happened-and-what-is-next/, TARP was the wrong medicine for the disease. The most cost effective way to end the credit freeze would have been for the Federal Government to guarantee the loans of the major financial institutions. This approach avoids all the problems of purchasing stocks, bad loans, and sub-prime mortgages. It has no budgetary impact except for the small portion of loans guaranteed that fail.

But we got TARP instead. I urge all readers to visit the TARP website where payments to date are set forth – http://www.financialstability.gov/latest/reportsanddocs.html. Click on the most recent transactions report. There you will find documentation on:

• 8 pages on the $200 billion that has to date gone to more than 540 banks under the “Capital Purchase Program”;
• the $70 billion that has gone to what is called “Systematically Significant Failing Institutions”. The only recipient of funds under this program is AIG;
• the bailout funds for the auto industry – $31 billion to date;
• the $5 billion going to the auto suppliers;
• the additional $20 billion that Bank of America and Citicorp each received under the “Targeted Investment Program”;
• another $5 billion going to Citigroup under the “Asset Guarantee Program”
• $20 billion set aside for the “Consumer and Business Lending Initiative”, and finally,
• the 14 banks getting $15 billion under the “Home Affordable Modification Program”.

Put it all together: it totals $366 billion and there is more to come.

In a recent posting (http://www.frontlinethoughts.com/article.asp?id=mwo050109), John Mauldin made the point that the Administration is spending of $12 billion of TARP money to save Chrysler’s 54,000 jobs which works out to be $22,000 per job. He questions why Chrysler workers should get so much attention when 600,000 jobs are being lost monthly. How about Citigroup? It employs 300,000. So far, it has received $52 billion from TARP and an additional $270 billion in loan guarantees from the Feds. That works out to $1,073,333 per worker, a million dollars a worker!

The enormity of the bailout for those who created the mess in the first place is outrageous.

The Asness Letter

In my last posting, I copied a letter written by Cliff Asness, the managing partner of AQR Capital Management, complaining about the President’s criticism of the financial firms that did not go along with the Chrysler plan. I asked for my readers to comment. I received 17 comments. The vast majority questioned why I wasted their time with his letter. Fred’s comment was typical: “You know you have an intelligent audience. What is so special about this letter to quote the entire thing? I don’t see it. He has a very limited view. Just leave it.”

I included the letter because Asness is no fool (Ph.D. in finance working under Eugene Fama) and his view reflects many in the financial elite. It outraged me. Out of deference to my audience, I will not quote the letter again in entirety but only those points I want to comment on (below, Asness’ comments are italicized).

The President has just harshly castigated hedge fund managers for being unwilling to take his administration’s bid for their Chrysler bonds. He called them “speculators” who were “refusing to sacrifice like everyone else” and who wanted “to hold out for the prospect of an unjustified taxpayer-funded bailout.” I am still aghast at the President’s comments.

 Sure the President was angry: he was trying to save a large, failing company. He had a partner lined up, had gotten concessions from the unions, and most of the lenders. At the end, lenders representing only $295 million of the $6.9 billion distressed debt of Chrysler nixed the deal and forced it into bankruptcy court. The President almost had a deal, but now Chrysler and all the parties to the deal face the delays and uncertainty of bankruptcy court. One thing I like about Obama: you know when he is upset, and he was very upset that 4% of the debtors blocked the deal.

When hedge funds, pension funds, mutual funds, and individuals, including very sweet grandmothers, lend their money they expect to get it back. However, they know, or should know, they take the risk of not being paid back. But if such a bad event happens, it usually does not result in a complete loss. A firm in bankruptcy still has assets. It’s not always a pretty process. Bankruptcy court is about figuring out how to most fairly divvy up the remaining assets based on who is owed what and whose contracts come first.

The President and his team sought to avoid having Chrysler go through this process, proposing their own plan for re-organizing the company and partially paying off Chrysler’s creditors. Some bond holders thought this plan unfair. Specifically, they thought it unfairly favored the United Auto Workers, and unfairly paid bondholders less than they would get in bankruptcy court. The President’s attempted diktat takes money from bondholders and gives it to a labor union that delivers money and votes for him.

To get this deal done, 96% of the lenders had agreed on concessions. And by the way, the unions, like the lenders, had contracts with Chrysler; they also had agreed on substantial concessions. I know. Enough….