Wednesday links roundup: The dance of the stress tests and the FDIC backdoor

When you try to paper over a problem in lieu of addressing it–which pretty much defines the government’s alphabet soup of funds transfer programs to keep blood in the veins of zombie financial institutions–it means, among other things, a lot of time and energy must be spent dancing frantically around the point. The looming question of stress test results for the U.S.’s 19 biggest banks illustrates the bind.

After floating the possibility that it might only release aggregate results, with no word about specific institutions, the White House is being forced to reconsider. As the Wall Street Journal reports this morning:

Since announcing the stress tests earlier this year, the government hasn’t made clear what, if anything, would be disclosed about the assessments. The Treasury originally suggested it would defer to individual banks to disclose results. But some regulators worried about banks selectively leaking information, causing a possible bias against rivals….

[S]ome within the administration believe a certain amount of information needs to be released in order to provide assurance about the validity and rigor of the assessments. In addition, these people also are concerned that the tests won’t be able to fulfill their basic function of shoring up confidence unless investors are able to see data for themselves.

Things get complicated when you’re committed to non-transparency. More on the politics of stress test disclosures from NYT.

But as Goldman Sachs prepares to buy its way out of the TARP program–and with other institutions making noise about following suit–the day’s real must-read is Louise Story’s NYT account of a backdoor aid program with no strings attached, courtesy of the FDIC. So far the big players have issued about $300 billion in new debt with AAA ratings thanks to FDIC guarantees; Bank of America leads the pack at $44 billion, followed by JP Morgan Chase, General Electric (!), Citigroup, Morgan Stanley, and Goldman, all of whom have issued $20-$40 billion apiece in new debt thanks to the little-noted program. Story writes:

The value of the assistance, economists say, is incalculable, because it helped keep participating banks alive despite the panic sown in financial markets after Lehman Brothers collapsed. “I don’t know how you measure that subsidy,” said Mark Zandi, the chief economist at Moody’s “That’s why they say it’s invaluable. It’s an infinite subsidy. It’s their franchise value.”

Also a must-read: Financial Times columnist Martin Wolf on the Simon Johnson essay in the Atlantic that I wrote about yesterday: “Is America the new Russia?”  The very patrician Wolf says no; he cannot countenance the idea that Washington is as awash in bought-and-paid-for agents of financial elites as the Moscow of yore. But his own argument suggests that for practical purposes, the answer is yes: “[T]he belief that Wall Street needs to be preserved largely as it is now is mainly a consequence of fear. The view that large and complex financial institutions are too big to fail may be wrong. But it is easy to understand why intelligent policymakers shrink from testing it. At the same time, politicians fear a public backlash against large infusions of public capital. So, like Japan, the US is caught between the elite’s fear of bankruptcy and the public’s loathing of bail-outs. This is a more complex phenomenon than the ‘quiet coup’ Prof Johnson describes.” Really?


Robert Reich: Why we’re not at the beginning of the end, and probaby not even at the end of the beginning; NYT: Wall Street’s brain drain; FT: Hackers escalate theft of financial data; Text of Barack Obama’s Tuesday speech on the economy at Georgetown University; Voice of San Diego: Real estate scams alive and well in the post-boom world (plus part two);

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Comments (2)

  1. Submitted by Ross Williams on 04/15/2009 - 11:36 am.

    Goldman Sachs provides a pretty good case study of how the financial system has worked to the benefit of all those ivy league bankers.

    Goldman was in the business of manufacturing AAA rated bonds from mortgages. They sold those securities, also known as CDO’s, to investors who wanted a better return than they could get on top rated corporate and government securities. The Fed’s low interest rates only made the CDO’s more enticing.

    The result was the tidal wave of money pouring into real estate investments that created the housing bubble. By investing in mortgages, rather than directly in real estate, much of the risk of those real estate investments was initially transferred to the home buyer with no concern for whether they were actually able to assume that risk.

    Unfortunately, many of those buyers were not really good for that risk. As long as their collateral, their homes, was worth more than they owed that was not a problem for the investors. But once housing prices started to fall, the risk that those home owners had taken on and couldn’t shoulder was passed back to the bond holders. Thus AAA securities became “toxic assets”.

    Of course most homeowners still own the risk. Bondholder are only responsible for the ones unable to meet payments or willing to turn their homes back to the lender. No one really knows how many of those there are. We also won’t know what their collateral is worth until the housing market settles out. This uncertainty just adds to the problem of finding buyers for these bonds at anything other than firesale prices.

    As one of the creators of this problem, Goldman Sach’s saw this coming. They held many of those bonds. But selling them would have been crating competition for their own bond creation business. So, instead, they bought “insurance”, aka CDS, transferring the risk that the bonds would fall to AIG. Unlike those homeowners who were defaulting on their risk, AIG had deep pockets.

    More importantly, AIG was ultimately backed by the federal government as “too big fail.” An argument both Goldman Sachs and its former CEO Treasury Secretary Paulson, made forcefully last fall. Thus AIG used over $8 billion in federal bailout money to make Goldman Sachs good on some of their “toxic assets.” And its not clear that is the end of AIG’s obligation. If the real estate market continues to hammer the CDO’s Goldman still owns, AIG, and the taxpayer, may well be responsible for most of those losses.

    The problem is not Goldman Sachs. This is the system working as designed. Most of the financial system is built on transferring risk. With the federal government as the final backstop, it is inevitable that the system will eventually deliver most of the risk to institutions that are “too big to fail” or where the risk will otherwise be assumed by taxpayers.

    And “everyone” in the financial community knows this. Fannie Mae and Freddie Mac have famously borrowed money at very low interest rates because, despite no legal obligation, it was assumed they were backed by the full faith and credit of the federal government.

    Apparently that same wink and nod support existed for Goldman Sachs, AIG and Bear Stearns, but not for Lehman Brothers and, now apparently, General Motors. There was a time when even the third of the big three, Chrysler, was too big to fail and had to be bailed out by government.

    Which brings us to the real question. Who is benefiting from all these financial gyrations and efforts to prop up investment banks? It certainly isn’t the people who were forced to pay way more for their homes than they were actually worth. Whether they can still afford the payments or not.

  2. Submitted by Susan Oehler Seltzer on 04/15/2009 - 09:45 pm.

    What are Minnesota’s legal community’s thoughts on:

    William K. Black’s views on the The Prompt Corrective Action Law: Section 1831o and the TARP/Bailout of banks and Goldman, that is now a depository intsitution, as a Federal Bank holding company?

    Professor Black’s comments in the Bill Moyers Journal interview about the “Prompt Corrective Action” (PCA) law (adopted in 1991) have sparked considerable comment in the blogsphere. Here is the portion of the interview transcript that discusses the PCA law.

    View this link for the PCA Transcript:

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