It is bad enough that an insurance company, which should know a thing or two about risk, was so badly run that it needed to have the U.S. government nationalize it to the tune of an $85 billion purchase. But when the White House admits that taxpayers may not even see their money returned, you have to wonder if everyone has become a drunken spendthrift sailor. In answer to the concern that taxpayers may never see the money again, White House Press Secretary Dana Perino responded yesterday: “That’s true.”
Most people are smart enough to get a warranty when they buy a new washing machine. When it’s other people’s money that the Fed can just “print,” as many of its supporters remind those of us concerned about the now $900 billion that has been paid out or committed as a result of the subprime credit disaster, the standard of care appears to be less rigorously observed. And Republican administrations have always claimed to own the playbook on responsible fiscal management.
I suppose they may have caught the same disease as AIG, which, even though it was one of the world’s leading assessors and insurers of risk, still allowed risk to run out of control and drive the company into the ditch. It will be interesting to see whether this latest White House admission that the $85 billion may have just been thrown away will make its way onto the campaign trail and into Congressional hearings.
Only the hapless and accident-prone administration of George W. Bush could make the Chinese and the Russians looks like prudent stewards of the public purse.
Without a shot being fired or a ballot being cast, the United States government has been overtaken by an act of socialism on a scale that is as incomprehensible as it is shocking. Now, in addition to being the world’s largest mortgage backer as a result of its takeover of Fannie Mae and Freddie Mac, the U. S. government is the owner of the world’s largest insurance company following yesterday’s seizure of AIG Insurance. The implications of the $85 billion dollar bailout, which brings the tab (so far) for U.S. government rescues and Fed loan facilties related to the current crisis to be in excess of $900 billion, have not even begun to be considered. This much is clear: Financed by the Federal Reserve, whose head, Ben S. Bernanke, mused last year that the subprime credit crisis would not spread to the larger economy; led by Treasury Secretary Henry M. Paulson, Jr., who proclaimed months ago that “We are closer to the end of this problem than we are to the beginning;” and approved by George W. Bush, the most disconnected and unpopular President in modern U.S. history, the judgment of these players inspires little confidence.
American capitalism has abrupty changed course and headed into waters that may prove far more harrowing than the collapse of even a giant insurance company. Resourceful men and women can always find ways to manage disaster wrought by inattentive executives and directors such as those who drove AIG to the point of disaster. They can rarely survive or prevail when fundamental and guiding principles themselves become the object of disregard and abuse.
*Birthplace of Vladimir llyich Ulyanov (Lenin)
We have cast a skeptical eye in recent months on the Fed’s response to the subprime meltdown, and its handling of the Bear Stearns bailout. In The Wall Street Journal today, Greg Ip writes: (subscription required)
Since the credit crisis began last August, the Fed has expanded the volume and types of loans it is willing to make to banks and securities dealers — loans that are backed by a wide variety of collateral from subprime mortgages to student loans. It has so far not directly purchased such debt. It did, however, make an unprecedented loan of $29 billion to facilitate the sale of Bear Stearns Cos. to J.P. Morgan Chase & Co.
Actually, the Fed did not make a traditional $29 billion loan to JPMorgan Chase, as its official statements would have us believe. It was more of a wink-and-a-nudge deal to take on the poorer assets without going through the formality (and the barrage of questions that would follow) of actually purchasing them. How do we arrive at that conclusion?
When you take out a loan and provide collateral, the lender does not usually get to sell your collateral with the hope of making a profit. But that is precisely what Fed chairman Ben S. Bernanke plans to do, if you believe his testimony before the Senate Banking Committee last month.
If we sell these assets over time -and we have allowed ourselves up to 10 years- although we can sell these anytime we like and therefore avoid the need to sell into a distressed market- that we will recover the full amount and that, in addition, if we are fortunate, we may turn a profit…
He repeated versions of the same statement, reiterating the plan to dispose of these assets, throughout his testimony. We have previously noted the cozy relationship that many of Wall Street’s top players have with the Federal Reserve System.
This is part of what former Fed chairman Paul Volcker has described as pushing the legal limits of the central bank’s mandate. The Fed also refuses to disclose details about the Bear Stearns collateral it holds, prompting many to conclude that these assets are not entirely marketable in the first place and that only the Fed could afford to sell them off at fire sale prices over ten years. The whole process behind the bailout lacked even rudimentary transparency.
There are more details disclosed on the label of a jar of Jif peanut butter about the contents of that $2.90 product than the Fed has revealed about the contents of the Bear Stearns collateral it “bought” for $29 billion and the circumstances surrounding that transaction.
For a Fed that is likely to play a much larger role in the regulation of financial institutions, its standards of openness and candor require added scrutiny. If its own conduct in the Bear Stearns bailout is any clue to the approach it will take in the regulation of others, there is little that inspires confidence.
Fed’s dabbling with debt innovation in a time of over-leveraging is a decidedly subprime idea.
The Fed, which recently bailed out Wall Street over its subprime related credit blunders (see the testimony of Federal Reserve Board Chairman Ben S. Bernanke before the Senate Banking Committee on April 3, 2008), is now looking at ways of becoming even more creative in the economy. The Wall Street Journal reports options being considered include:
Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed; issuing debt under the Fed’s name rather than the Treasury’s; and asking Congress for immediate authority for the Fed to pay interest on commercial-bank reserves instead of waiting until a previously enacted law permits it in 2011.
One option we think should be on the Fed’s table is this: do less.
American governments, corporations and households are already mired in unparalleled levels of debt. The current credit fiasco is the result of an experiment in debt gone terribly wrong. It was made worse when Wall Street got into the picture and saw the unavoidable temptation of more subprime innovation. So far, in addition to record home foreclosures, mounting unemployment and staggering corporate losses, it has resulted in the collapse of Bear Stearns, which the Fed warned before the Senate last week nearly resulted in calamity for the world’s financial system. We will have further comments on the Fed’s Wall Street bailout in an upcoming post on these pages.
If we have learned anything from the efforts of these too-clever-by-half financial players to defy the laws of physics (i.e., risk) in the economy in recent months, it is that what is lauded as creative genius one day can quickly turn into a symbol of reckless folly the next. Americans don’t need a debt experimenting Fed in a time when excesses in risk and imagination have already created a masterpiece of chaos.
It can only be hoped that his recent experience with the limelight and the cheers of the Wall Street crowd has not turned the otherwise conservatively inclined, academically trained Ben Bernanke into the Angelo Mozilo of central bankers.
There has not been much critique of the latest Fed move, the ninth since August, to fix the ailing credit market. We would like to remedy that with the following observation.
The Fed cannot possibly continue to argue that it has given Americans and their policy makers a fair and accurate picture of the economy while making these frequent, unprecedented and horrifically costly interventions.
Americans are not passive and unaffected bystanders in what the Fed does or does not do. They are stakeholders who are entitled to assess its performance and whether it is ultimately acting in the public interest. That means more than what might be expedient for financial institutions, mortgage lenders and hedge funds that are struggling with the consequences of their risk misjudgments and still do not appear to understand the extent of their own folly.
Straight talk, not Fed speak, needs to be part of the intervention, too.
Update: The Fed’s move made a lot of money for some investors and company insiders. The stock of Countrywide Financial, for instance, a big player in the subprime mess, soared 17 percent for the day (Tuesday).
Some of these remarks were posted on The New York Times blog of Floyd Norris, one of our favorite commentators .
Trying to turn Jérôme Kerviel into the Lee Harvey Oswald of the banking world won’t fly. There is much more to be suspicious about when it comes to the role of his superiors at Société Générale and the governance failings of global financial institutions.
The disclosure that a lone trader’s unauthorized transactions had caused Société Générale to lose more than $7 billion prompted us to respond with a loud “Incroyable!” But when it was said that the bank’s efforts to minimize its losses may have led to the market meltdown that saw $1 trillion obliterated from stock markets worldwide, one could only think “C’est impossible.”
But of course, both situations were eminently plausible. (more…)
