Why the financial industry isn't any more secure than before the meltdown.
On Monday, after two years of efforts to pierce the veil of secrecy surrounding the largest bank bailout in history, Bloomberg.com revealed the true scope of the phrase, "too big to fail." In short, the number is staggering: total loan guarantees and lending limits engineered by the Federal Reserve to rescue the financial system amounted to $7.77 trillion as of March 2009. Bloomberg got the information after the Supreme Court rejected an appeal last March by the Clearing House Association LLC, a group comprised of the nation’s largest commercial banks. They, along with Fed Chairman Ben Bernanke, tried to prevent the details from becoming public. The ultimate question: was both the scope of the effort--and the secrecy surrounding it--necessary? Unfortunately, the answer to that question is far from clear.
One thing is certain. In order to accept that any or all parts of the numerous transactions involved were necessary, one is required to accept as a given that the entire financial world was on the brink of systemic collapse. Was it? Perhaps a more accurate answer to that question is that the status quo was on the brink of collapse. It was a status quo where "too big to fail" had been institutionalized long before this particular crisis took hold. In 1984, faced with the failure of Continental Illinois, a large commercial bank, the government not only engineered a rescue, but extended FDIC insurance to both the bank depositors and all its other lenders, including those whose accounts exceeded FDIC limits, as well as global bondholders. In 1998, Long-Term Capital Management, a hedge fund whose financial excesses had many major Wall Street firms on the hook, was rescued by the Federal Reserve with funding from its member banks. Thus, long before the government-engineered housing crisis that led to the debacle of 2008 took hold, the pattern of "privatizing profits and socializing losses" had been established. This situation virtually invited financial institutions to take greater and greater risks.
As this latest revelation shows, those risks reached astronomical levels. In a single day, December 5, 2008, the banks were in such dire straits they needed a combined $1.2 trillion to remain solvent. Yet even as financial institutions were taking Fed funds, some of their leading officers were touting the strengths of the institutions involved. On Nov. 26, 2008, Bank of America Corp.'s former CEO, Kenneth D. Lewis, informed shareholders that B of A was “one of the strongest and most stable major banks in the world” despite owing the Federal Reserve $86 billion at the time. In a March 26 letter to shareholders, JP Morgan Chase & Co. CEO Jamie Dimon claimed his firm used the Fed’s Term Auction Facility (TAF) “at the request of the Federal Reserve to help motivate others to use the system,” even though the bank's total borrowings were nearly twice its cash holdings. He also failed to mention that the height of Chase's borrowing, which crested to $48 billion, occurred on Feb. 26, 2009--over a year after the TAF had been created. Spokesmen for both banks declined to comment.
Furthermore, borrowing by banks from the Fed substantially exceeded the $700 billion they borrowed from the Troubled Asset Relief Program (TARP), the rescue plan engineered by the government. The six largest U.S. banks--JP Morgan, Bank of America, Citigroup, Inc., Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley--received $160 billion of TARP funds, even as they took $460 billion from the Fed. Such borrowing amounted to 63 percent of the average daily debt owed to the Fed by all publicly traded U.S. banks, money managers and investment-service firms. That represented a 13 percent increase from the 50 percent the Big Six owed prior to the bailout.
And then there was the secrecy. Bush administration officials who managed the TARP program were unaware of what the Fed was doing. So were top aides to then-Treasury Secretary Hank Paulson. So was Congress, including Judd Gregg, former New Hampshire senator who was a lead Republican negotiator on TARP, and Rep. Barney Frank (D-MA), who chaired the House Financial Services Committee. Cryptically both men claim they were unaware of the "specifics," although Frank admitted both men "were aware emergency efforts [by the Fed] were going on." Even Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009, said he “wasn’t aware of the magnitude” of Federal Reserve lending taking place.
Fed Chairman Ben Bernanke justified the secrecy, claiming that borrowers would be "stigmatized" if the extent of their loans were revealed. He further contended that investors and counterparties would shun such firms, and that needy firms would be reluctant to borrow -- in the next crisis. Others contend revealing the extent of the crisis as it was happening would have exacerbated it, leading to a run on financial institutions, subsequently leading to even greater lending by the Fed as a result.
Whether either argument is reasonable is debatable. But what is now known is that the lack of knowledge was undoubtedly influential. The results of congressional legislation enacted--and not enacted--may have been radically different if those voting would have been privy to the extent of the Fed involvement. For example, the amount of money doled out via TARP legislation was based on information supplied by the Fed to the Treasury Department. Ostensibly, only banks that were still "healthy" enough to survive would merit funding, a point reinforced by Bernanke himself in a speech in April of 2009. Yet Fed internal memos described one of its biggest borrowers, Citigroup, as "marginal." At its peak in January of 2009, Citigroup owed the Fed $99.5 billion. One month later Bank of America owed the Fed $91.4 billion. Yet the top prize for a "healthy" borrower goes to Morgan Stanley. On the day of September 29, 2008 alone, they owed the Fed $107 billion.
Another piece of legislation undoubtedly influenced by the secrecy was the Safe Banking Act of 2010. Introduced by Senator Sherrod Brown (D-OH) and former Senator Ted Kaufman (D-DE), the bill was about placing hard caps on the leveraging abilities and size of financial institutions, aimed primarily at the aforementioned Big Six banking institutions. “The amount of pain that people, through no fault of their own, had to endure--and the prospect of putting them through it again--is appalling,” Kaufman said. “The public has no more appetite for bailouts. What would happen tomorrow if one of these big banks got in trouble? Can we survive that?” he asked.
Bank lobbyists weren't about to give up without a fight. From 2006 to 2010, spending to defeat the bill increased from $22.1 million to $29.4 million. The Financial Stability Board (FSF) sent a letter to Congress November 13, 2009, touting the "stability of large banks" and citing the "irreparable economic harm to the growth and job-creating capacity of the U.S. economy" if such a bill were to pass. Top Obama administration officials sided with the FSF, including Treasury Secretary Tim Geithner who, according to Kaufman, told the ex-senator that issue was "too complex for Congress and that people who know the markets should handle these decisions." The bill was defeated 60-31. Kaufman believes support for the bill would have been much greater if Congress knew the extent of the Fed's intervention.
The Dodd-Frank Wall Street Reform and Consumer Protection Act, billed as a fix for the financial industry, was also debated without knowing the scope of the Fed's involvement. Ironically, it creates a Financial Stability Oversight Council that has the power to shut down failing institutions in an "orderly way." The irony? The council is headed by Secretary Geithner.
Former Senator Bob Dorgan (D-ND) believes greater knowledge might have also led to the re-instatement of the Glass-Steagall Act. The Depression-era legislation separated deposit and investment banks. Its repeal during the Clinton administration--a move the former president now regrets--led to the creation of the mega-banks at the heart of the crisis. Newt Gingrich, who also supported the repeal, has recanted as well.
On the other hand, the mega-bailout has its defenders. "Ladies and Gentlemen, this is what a lender of last resort looks like," writes Reuters columnist Felix Salmon referring to the Bloomberg piece. "The Fed didn’t blink: it kept on lending, as much as it could, to any bank which needed the money, because, in a crisis, that’s its job," he adds. “Supporting financial-market stability in times of extreme market stress is a core function of central banks,” says William B. English, director of the Fed’s Division of Monetary Affairs. “Our lending programs served to prevent a collapse of the financial system and to keep credit flowing to American families and businesses.”
One suspects many Americans would dispute that assessment. While bigger banks have eased some of their credit restrictions, 80 percent of lenders have tighter credit since 2008. Furthermore, the "most prevalent tightening occurs in CRE (commercial real estate) loans, leasing, and small business loans. The most prevalent easing is in international, large corporate, asset-based lending, and leveraged loans." In other words, Main Street borrowers are still taking it on the chin while Wall Street is back to business as usual.
Maybe better than usual. Even though it's a relatively small number, banks earned an estimated $13 billion of income by taking advantage of the Fed’s below-market rates during the crisis. Total assets held by the Big Six have increased 39 percent, from $6.8 trillion on September 30, 2006 to $9.5 trillion as of September 30, 2011. The Big Six have also paid out $146.3 billion in compensation in 2010, which comes to $126,342 per worker. “The pay levels came back so fast at some of these firms that it appeared they really wanted to pretend they hadn’t been bailed out,” says Anil Kashyap, a former Fed economist who’s now a professor of economics at the University of Chicago Booth School of Business. “They shouldn’t be surprised that a lot of people find some of the stuff that happened totally outrageous.”
Much of the outrage is eminently justified. The overwhelming amount of it stems from the fact that while ordinary Americans were being hammered by a recession (and still are), the crony-capitalist nexus of big government and big finance was engineering a cushy landing for some of the most irresponsible people on the planet. People who not only remain unaccountable for their behavior, but have prospered from it.
Perhaps it was a necessary evil in the sense that a systemic failure might have hurt innocent Americans even worse than what has occurred. But it is truly disturbing that not one CEO or any other board member of the institutions who benefitted from the Fed bailout or TARP--which Bloomberg revealed was essentially collateral for the far bigger loans--was forced to resign as a condition for receiving the funds. And the "brain drain" rationale used to justify that fact is a howler. These are the same "brains" who brought the nation to its knees. No one but their equally-compromised colleagues would miss them.
Moreover, the revelations of the Fed bailout may have other repercussions. Already, Reuter's Felix Simon is contending that the European Central Bank (EBC) should emulate the Fed and bail out the European Union. On Monday the White House also pledged its support to the EU, in order to "reinvigorate economic growth, create jobs and ensure financial stability." And lest anyone forget, American taxpayers fund the International Money Fund (IMF) that has provided billions for the Greek bailout.
Furthermore, the Occupy Wall Street movement, despite its tenuous grasp of economics and its anti-capitalist underpinnings, is sure to get a boost. The boost will come from those Americans whose grasp of both concepts is equally suspect, and those who don't understand that the word "crony" in front of the word "capitalism" completely changes the parameters of the debate, as sure as the word "illegal" in front of immigrant does.
As for the idea that the financial industry has been saved and that something like this couldn't happen again, Exhibits A and B offer a different perspective. Exhibit A is the EU, which has the capacity to drag any number of American financial institutions back into trouble. Which ones? No one knows for sure, as "transparency," despite all contentions to the contrary, remains steadfastly elusive. Exhibit B is the move by Fitch ratings agency, affirming the AAA status of U.S. debt--but changing its outlook going forward from "stable" to "negative." Chances of another downgrade? Better than 50 percent over the next two years.
So was the Fed bailout a success? The "lender of last resort" claims almost all of the loans have been repaid, and that there have been no losses. But there is something equally big at stake here. Nobel Prize-winning economist Oliver E. Williamson explains. “The banks that were too big got even bigger, and the problems that we had to begin with are magnified in the process,” he notes. “The big banks have incentives to take risks they wouldn’t take if they didn’t have government support. It’s a serious burden on the rest of the economy.”
Burden? More moral hazard on steroids.
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