Whew. How big a bullet did Wachovia dodge?
When news was breaking last night that Citibank was the next in line for an Uncle Sam bailout special, it was not really news. Not to anyone that had been paying attention. Citi’s bid for Wachovia — undertaken with a massive assist from the feds — was as much about saving Citi as it was saving Wachovia. When Wells stepped in with a better deal for Wachovia and the taxpayers, the Citi rescue process merely continued along a different path, ending with the $306 billion bailout announced last night. The federal government now directly owns $45b. worth of Citibank. Hooray.
The precipitating event — as ever — was pressure on Citi’s capital ratios. By rights the pressure should have been allowed to continue as investors signaled their lack of faith in Citi and the FDIC assumed control, liquidating the bank in the process. But no. This was Citi. Too big to fail.
Meanwhile, New York Fed Bank chief Tim Geithner as Barack Obama’s Treasury Secretary. Hey, big change there Mr. Hope and Change. Geithner and current Treasury strongman Hank Paulson are the same guy.
There have been two guys in every meeting of federal regulators since the financial sector meltdown started, Geithner and Paulson. They’ve been joined at the hip. They have moved in lockstep to pump what is now trillions of public dollars toward failed bankers. The audacity of something for sure.
Here’s how Institutional Risk Analytics, one of the few sources of clear-thinking left in the financial world, describes what the dynamic duo has done:
If you look at how the Fed and Treasury have handled the bailouts of Bear Stearns and AIG, a reasonable conclusion might be that the Paulson/Geithner model of political economy is rule by plutocrat. Facilitate a Fed bailout of the speculative elements of the financial world and their sponsors among the larger derivatives dealer banks, but leave the real economy to deal with the crisis via bankruptcy and liquidation. Thus Lehman, WaMu, Wachovia and Downey shareholders and creditors get the axe, but the bondholders and institutional counterparties of Bear and AIG do not.
Few observers outside Wall Street understand that the hundreds of billions of dollars pumped into AIG by the Fed of NY and Treasury, funds used to keep the creditors from a default, has been used to fund the payout at face value of credit default swap contracts or “CDS,” insurance written by AIG against senior traunches of collateralized debt obligations or “CDOs.” The Paulson/Geithner model for dealing with troubled financial institutions such as AIG with net unfunded obligations to pay CDS contracts seems to be to simply provide the needed liquidity and hope for the best. Fed and AIG officials have even been attempting to purchase the CDOs insured by AIG in an attempt to tear up the CDS contracts. But these efforts only focus on a small part of AIG’s CDS book.
The upshot is that the Fed and the Treasury simply cannot afford to try to make good, to “guarantee” whatever that means and at face value for some inexplicable reason, the trillions and trillions of dollars of highly speculative, highly leveraged instruments still out there in the wild. The Paulson/Geithner model assumes that sooner or later — but at no fixed point — someone other than the federal government will want to own these things. When, no one knows, why — no one knows.
This belief allows officials and pols to ignore the other more painful b-word — bankruptcy. AIG should be in bankruptcy, its assets such as they might be, liqudated in as orderly a fashion as possible. Like we said, Citi should be in the hands of the FDIC, depositors made whole according the enhanced guarantees on deposits, and moves made to break it up and seed the parts among other banks.
The fact that this is not happening reveals a massive disconnect between reality and the popular confusion that Obama — by continuing and accelerating the bailout mania of the Bush administration — would be implementing a New New Deal. No. This is wrong.
Just this AM I heard Al and Stacy on WBT compare Obama’s moves to that of FDR. Not to pick on them, but this is mistaken on very fundamental level. FDR’s actions in the financial sector, indeed across the entire economy, were very direct and final. Regulators simply shut down and stopped activity they deemed not to be in the public interest. Bailouts were not offered, bankruptcy and direct government control were.
In a way, the FDR view had a deeper distrust of corporate entities and more faith in markets to work, at least to accumulate wealth. Maybe this was the hangover from the trust-busting days of the Progressives, but whatever the source when an entity floundered it was liquidated not strung along at public expense. And it was not the case that some entities survived and others were wiped out depending on who knew whom in the corporate boardroom. What we have today is form of crony capitalism with a big government safety net for the connected. Balance sheets and markets do not matter as much as personal relationships. In fact, it is scarcely capitalism at all.
When the stock market jumps 800 points based on rumors that one of the connected will stay wired to the federal Treasury you can tell something is not right.
Update: Why is Bloomberg the only outlet able to bottom-line what is going on in this fashion? I know why, its reporters actually grasp what is going on:
The U.S. government is prepared to lend more than $7.4 trillion on behalf of American taxpayers, or half the value of everything produced in the nation last year, to rescue the financial system since the credit markets seized up 15 months ago.
That is half of GDP people! And there is at least twice that much still waiting to blow up in credit default swap contracts. There is literally not enough money in the world to pay for all this.
