Wednesday, October 29, 2008

Bailout: more bad policy on top of horrible policy

I've been against the bailout from the beginning, as have most right-thinking folks. Daily, more evidence piles up that the bailout was a bad idea, and the implementation is leaving a sour taste in everyone's mouth.

As a refresher: Sec. Paulson assaulted Congress and the American public and demanded $700 billion and unlimited power to do with it whatever he wanted, or else the economy would take a giant shit and we'd all get splattered. Nevermind that the giant shit was going to happen anyway, and we're all starting to get splattered. Predictably, the American public gave their collective middle fingers to that plan, and he was forced to say something about what he'd do with the money. His brilliant idea was to buy the worthless (err..... "troubled") "assets" from the crooks (err... bankers). OK, remember that plan (conveniently named "Troubled Asset Relief Plan- get it? It's a tarp, to cover up the giant shit). Presto-change-o the banks have adequate capital and crisis is averted. Oh, and he needed the money IMMEDIATELY, there was absolutely no time to look at alternatives. Congress decides to give Paulson the middle finger, the stock market drops 700 points, there was a bunch of secret late-night meetings held at the White House, they threaten to declare martial law, and then the bailout passes. With me so far?

Now, the secret reasons behind the bailout have started to come out, but you've got to put the pieces to the puzzle together. OK, remember the reason for the bailout? Banks couldn't lend because they've got all this worthless stuff that somehow magically ended up on their balance sheets, causing them to have to write all the worthless stuff down to it's value (0), which causes them to have to increase their reserves to compensate for the loss of these "assets". Banks weren't lending to each other, because they all knew that they all had this worthless stuff they were hiding and didn't know which one would be the next to go belly-up because of it. Paulson's theory was that the government would take all this worthless stuff off their hands, freeing the banks to start lending to each other again. But, as soon as the bailout passed, the plan morphed from buying "assets" from banks to straight liquidity injections, whether they wanted it or not. The idea this time was to cut out the middle step of buying the bad assets and just shore up the balance sheets immediately, thereby mitigating the need to raise more capital, even if the worthless (oops, I mean "troubled) assets come to light.

Now, it seems the plan has morphed again, albeit in a way that nobody's acknowledging. Now, the plan is to nudge the big banks to use that fresh liquidity to buyout smaller banks. Smaller banks didn't have the same exposure to these worthless derivatives, as a result of their need to actually serve their customers, so the smaller banks have excellent balance sheets compared to their larger brethren. Unfortunately for them, the big guys need that capital, so it's going to be merger time! Remember two weeks ago, when Citigroup was hoving over Wachovia, all set to go ahead with the buyout, when Wells Fargo swooped in? The Motley Fool breaks it down:

Why was Wells Fargo so eager to ante up a deal that was leaps and bounds sweeter than Citi was willing to pay? After all, Wells Fargo has a stellar reputation of keeping underwriting standards in check, so why would it want anything to do with a shoddy bank drowning in subprime mortgages?

Taxes. It was all about the taxes.

The day after Citigroup made its bid, the Treasury changed a tax rule that lets banks accelerate the losses and writedowns on banks they acquire against their own net income, offsetting the charges as tax write-offs.

Wells plans on writing off some $74 billion of Wachovia's $498 billion loan portfolio -- an insanely large amount that reflects just how poisoned Wachovia's books really were. With the new tax rules, it gets to use all of that $74 billion as a charge against its own net income, which means one thing: Wells Fargo's going to be a tax-write-off machine for years to come.

Just how much will it save? The Wall Street Journal, citing an independent tax analyst, estimates Wells Fargo could reap a tax savings of about $19.4 billion. To put that in perspective, the 0.1991 shares of its own stock Wells Fargo is offering Wachovia comes out to around $6.24 per share, or roughly $13.8 billion. Yes, Wells Fargo gets a $19.4 billion tax break for a company it'll pay just under $14 billion for (if the deal closed today).

In other words, Wells Fargo didn't pay anything for Wachovia: The IRS paid it more than $5 billion to take it. Who ever said you have to fear the taxman?

Nary a peep from Treasury on the deal, so the big guys figure it's a merger green-light. The Guardian reports:

A Californian lender, City National Bank of Beverly Hills, made it clear it would consider using its $395m capital infusion to make purchases. Its chief executive, Russell Goldsmith, told the Los Angeles Times the money "clearly enhances our financial capacity to make acquisitions and to lend to a larger degree".

The pace of deals in the banking industry has already picked up. On Friday, Cleveland-based National City Bank agreed to a $5.6bn buyout by a competitor, PNC, which is getting $7.7bn from the Treasury.

Keith Horowitz, a banking analyst at Citigroup, said National City did not need capital but had found itself vulnerable as a result of the bail-out.
"We believe [the bail-out] in a perverse way pushed/forced National City's management to sell the bank into a buyers' market," said Horowitz in a note to clients.

Not brazen enough for you? I agree- here's a more brazen example.

In point of fact, the dirty little secret of the banking industry is that it has no intention of using the money to make new loans. But this executive was the first insider who’s been indiscreet enough to say it within earshot of a journalist.

(He [JP Morgan executive] didn’t mean to, of course, but I obtained the call-in number and listened to a recording.)

“Twenty-five billion dollars is obviously going to help the folks who are struggling more than Chase,” he began. “What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop.”

I think former Secretary of Labor Robert Reich has good suggestions on his blog, too bad nobody in charge is listening. He argues that

the big bank beneficiaries of the bailout should be barred from (1) paying lobbyists who have anything whatever to do with administration or implementation of the bailout; (2) buying up other financial institutions; (3) paying dividends to shareholders; or (4) paying any bonuses or severance packages to any executives -- as long as the bailout continues. There's simply no excuse for using taxpayer dollars for any of these purposes.

This whole bailout has been a scam from day one, and I become more certain of that by the day. If they were committed to transparency and oversight as was promised, why would there be the secrecy and redacted documents?

The Freakonomics blog today asked a similar question to the one I posed yesterday. They just didn't take it as far... they were only wondering why there weren't any riots, I was wondering when the full-scale revolution is going to happen?

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