On this same day a year ago, Rep. Barney Frank, the Democratic congressman from Massachusetts, jokingly proposed declaring Monday, September 15th, 2008 to be Free Market Day.
It was that Monday that the government let Lehman Bros. collapse into bankruptcy. Beginning on Sept. 16 and thereafter, the US government turned the US banking sector into essentially a state-protected industry.
"The national commitment to the free market lasted one day," Frank said at the time.
Whatever It Takes
"Whatever it takes" became the mind numbing mantra during the crisis from Federal Reserve chairman Ben Bernanke, as the US central banker and the US Treasury blew out all the stops with massive interventionist policies that many in Congress credit with steering the Great Panic away from turning into another Great Depression.
Government officials scrambled last fall to "put foam on the runway," as Treasury officials internally called it, according to David Wessel's must-read book "In Fed We Trust," to prepare for massive bankruptcies and to stop the meltdown in the banking sector, as a drunken fire brigade of Fannie Mae, Freddie Mac, Lehman Bros., American International Group, Washington Mutual and Wachovia were in free fall, with fears that Merrill Lynch and Morgan Stanley were on the brink, too.
But that has come to mean using your tax dollars as foam on the runway, as the government wrote a blank check for hundreds of billions of dollars in bailout money that flew out the government's front door with no strings attached.
It's 7p on Wall Street, but 1981 in Washington when it comes to regulatory oversight, to paraphrase Lawrence McDonald's also must-read book "A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers."
President Barack Obama spoke of the need to tighten regulatory oversight of Wall Street today, amidst cries of socialism. But amidst the din of bankers' complaints, what the president said made sense. The president is right.
Wafer-thin capital cushions must be beefed up, at minimum, and no debt securities should be loaded into those cushions--as Lehman Bros did before it blew up. Which is sort of like counting your credit card bills as your assets to get a loan. (and better cap cushions actually lower a bank's borrowing costs).
But it's funny how you don't hear Wall Street squawking about socialism when it's taking taxpayers' money to pay for the ticking time bonds that cratered their balance sheets but yes tossed of hundreds of billions of dollars in compensation and bonuses during the bubble years.
And now regulators are now struggling with the number of financial institutions that are still too big to fail, as even top bank regulators fear the bailouts have made this problem even worse.
"It is at the top of the list of things that need to be fixed," says Sheila C. Bair, chairman of the Federal Deposit Insurance Corp. "It fed the crisis, and it has gotten worse because of the crisis."
Too Big to Fail Problem Started Before Lehman
In the spring of 2008, then Treasury Secretary Henry Paulson told Congress emphatically: "For market discipline to constrain risk effectively, financial institutions must be allowed to fail."
The problem was, since the 1987 crash, the Federal Reserve under Alan Greenspan, and much later with Bernanke as Fed governor, had been enabling and habituating Wall Street to the notion it would rescue its every market belly flop with interest rate cuts and interventions.
The problem worsened when the Federal Reserve supervised the 1998 bailout of hedge fund Long Term Capital Management, run by John Meriwether and on whose board sat two Nobel-prize winning economists, Myron Scholes and Robert C. Merton.
A decade earlier, LTCM had previewed the collapse of Wall Street when it, too, levered up dramatically so as to deploy trading strategies such as fixed income and statistical arbitrage.
What Lehman Believed
Even up to the eleventh hour, Richard Fuld, then chief executive of Lehman Bros, believed the government would bail his firm out, even though Lehman had been rigging its profit numbers to inflate its financial results and was so damaged it didn't have suitable assets to post as collateral to secure a Fed loan. Its $70 bn in real estate assets were thought to be near worthless.
Even the British government was troubled about Barclay Capital's moves to buy the 158 year old Wall Street firm, with $613 bn in book liabilities (with more off the balance sheet). In a phone conversation, Alistair Darling, Britain's finance minister told Treasury Secretary Timothy Geithner, who tried to broker the deal: "We are not going to import your cancer."
Lehman's main operations were eventually sold to Barclays Capital for $1.75 bn"”with $1 bn being the value of Lehman's headquarters. So Barclays was essentially saying that Lehman's entire book of business was worth, gulp, just $750 mn.
Lehman tried everything, even using its own stock as collateral at the Fed's discount window, but the government wouldn't allow it.
But then the government started making the rules on the fly, an ad hoc approach that's being criticized to this day.
AIG was failing at the same time as Lehman. The Federal Reserve then accepted AIG's stock as collateral for the first time in order to let the country's biggest insurer borrow at its discount window (overall, AIG got a $185 bn bailout).
And General Electric didn't have to post any collateral when it used the Federal Reserve's new commercial paper funding facility, a backstop to the short term funding market that the central bank launched after Lehman collapsed and the Reserve Primary Fund, the oldest money fund, broke the buck after it wrote off the $785 mn in Lehman commercial paper the fund had invested in.
What the Fed is Now Accepting
And now the Federal Reserve is accepting as collateral to borrow from its Term Auction facility some dubious commercial-backed mortgage securities that are exposed to potentially illiquid properties owned by the likes of General Growth Properties, the bankrupt mall operator, and Peter Cooper Stuyvesant town, now on the verge of default.
Yes, the paper is ostensibly Triple-A rated, as per the Fed's rules for the program, but given the poor track record with the ratings agencies here, it's still anyone's guess how valuable those securities really are.
And the Federal Reserve has also taken on $74 bn in bad assets from AIG and Bear Stearns in their bailouts, which the central bank has housed in off balance sheet vehicles and upon which it booked a $9 bn paper loss by the end of last year.
And in the bailouts of Bear Stearns and AIG, the government settled counterparty trades with Bear and AIG at 100% on the dollar.
But does the government's moves to make 100% whole the trades counterparties made with AIG and Bear Stearns, meaning the likes of Goldman Sachs, Deutschebank and Credit Suisse, do those moves mean any such future trades could pose systemic risk, too?
Banks Still Too Big to Fail
Harvard University economic historian Niall Ferguson in a recent column cites data from Wall Street veteran Henry Kaufman, who says that between 1990 and 2008, the share of financial assets held by the 10 largest U.S. financial institutions increased from 10 % to 50 %, even as the number of banks fell from more than 15,000 to about 8,000.
And by the end of 2007, 15 institutions with combined shareholder equity of $857 bn had total assets of $13.6 tn and off-balance-sheet commitments of $5.8 tn"”a total leverage ratio of 23 to 1. They also had underwritten derivatives with a gross notional value of $216 tn, Kaufman says.
Today, JPMorgan Chase, Bank of America and Wells Fargo each hold 10% of the nation's deposits, and in some markets they own more than what the Justice Dept's antitrust guidelines allow. All three got tens of billions of dollars in bailout funds.
For example, in Santa Cruz, Calif., Wells Fargo, Bank of America and JPMorgan Chase hold three-quarters of the deposit market, reports indicate. And last October, when the Fed was arranging the merger between Wells Fargo and Wachovia, it identified six other metropolitan regions in which the combined company would potentially exceed the Justice Department's antitrust guidelines--in some cases it would hold more than a third of a region's deposits, reports note.
JPMorgan Chase, Bank of America and Wells Fargo also hold one out of every two mortgages and two out of every three credit cards.
Name (required)
Mail (will not be published) (required)
Website
XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>
Are more banks at risk?
New documentary looks at the legal battle
James Gorman comes from MS's brokerage unit
BofA claims attorney-client privilege
Obama to Address Congress
View all Blogs
Read Full Article »