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Where the Hell is Bailout Headed Now?

The intellectual and political bankruptcy of the Bushadministration just keeps getting worse; for the next two months, that may be the most dangerous bankruptcy crisis of all. Secretary Paulson announced on Wednesday, November 11th thatthe $700 billion that Congress authorized … Read More

By / November 17, 2008

The intellectual and political bankruptcy of the Bushadministration just keeps getting worse; for the next two months, that may be the most dangerous bankruptcy crisis of all.

Secretary Paulson announced on Wednesday, November 11th thatthe $700 billion that Congress authorized under the Troubled Asset Reclamation Program for the purchase of asset-based securities will not be used to purchaseany asset-based securities. Instead, the Treasury will continue to pump money into banks.  This follows on the announcement of arenegotiation of the loan to AIG on terms much more favorable to the company — and much less favorable to the taxpayer — than had been negotiatedearlier.  That announcement followson the gift of $125 billion to nine large banks and another $125 to publicly traded regional banks.  At this point it seems salient to ask, what the hell is going on? 

The Bush administration is sticking to its story even as thestory itself changes literally by the day.  The TARP program was sold to Congress as an absolute andimmediate necessity to avert total and immediate calamity:  at the meeting of 20 nations to discuss global finance on Saturday President Bush declared that but for hisadministrations "decisive measures" there was a danger of a depression worse than the Great Depression.  Thiswas the hard sell that Paulson brought to Congress.  We had to immediately purchase toxic assets or a Depressionwould ensue, there would be riots in the streets, cephalopods would fall from the sky.  "Really, seriously," said Paulson at the time, "this is absolutely the only thing we can do and there’sno time for discussion."  Now he issaying "actually, we have a better idea."  In response to this urgency, we remember (it was all so long ago) Congress provide $350 billion,with a fast track procedure by which Paulson can ask for $350 billionmore.  Now Paulson has told us thatthe entire plan to buy distressed assets is scrapped. 

Then there’s the the AIG loan, a single company bailout that is a third the size of the entire TARP funding to date.  Originally, AIG received an $85 billion 2-year bridge loan, of which $61 billion has been drawn.  The rate on the loan was Libor + 8.5%– currently around 10.6% — plus fees. In addition, AIG has drawn approximately $20 billion from a securitieslending facility created by the Fed of New York called the Commercial Paper Funding Facility.  Timothy Geithner, the president and CEO of the New York Federal Reserve, is on Obama’s short list for a potential Treasury Secretary (I support him rather than his one-time mentor Lawrence Summers.) The new plan, in addition to a new infusion of $40 billion, involves renegotiating the loan to a 5 year term at lower interest.  Good for AIG, not so good for the taxpayers.

The revised AIG loan also involves creating two new facilities by the New York Fed. One is designed to purchase asset-based securities, using $1 billion supplied by AIG and $22.5 billion supplied by the New York Fed.  With that program in place, as AIG executives put it in a conference call, "AIG’s remaining exposure to losses from its U.S. securities lending program will be limited to declines in market value prior to the closing of this entity and our $1 billion of funding."  In other words: no worries, the taxpayers will eat the losses.  The second new facility will provide $30 billion to purchase up to $70 billion in credit default swaps at discounted prices, to accompany $5 billion in subordinated funding to come from AIG.  (I have discussed thebackground issues involved in earlier posts.)  The way these programs are written, they can extend beyond AIG in the future, or at least provide a model.

Critics of the revised AIG plan were outraged, and with good reason.  But what we learned fromWednesday’s announcements was that the renegotiation of AIG’s loan was part of a larger reconsideration of economic strategery. Paulson said that the administration will not, after all, use any of the $700 billion that was provided under the TARP program to purchase asset-based securities:  instead, the Treasury will continue to use $250 billion of the program to purchase stock in banks and is looking tomake $50 billion of the TARP funds to help lenders who issue credit cards,student loans and car loans. Paulson said that the consumer credit market urgently needs support.  "This market, which is vital for lending and growth, has for all practical purposesground to a halt." Of the $2.6 trillion in consumer credit outstanding in September, finance companies were the third largest holders with $600 billionafter banks ($845bn) and ABS ($678b). Paulson explained that the administration has decided that using billions of dollars to buy troubled assets is not, after all, "not the most effective way" to use the $700 billion bailout package.

The manner in which this extraordinary announcement was made was striking.  I have to assume that members of Congress are going to be absolutely enraged when they come back for their lame duck session.  Andthe bait-and-switch aspects of the deal are not restricted to the original hardsell.  Among the objections to the TARP plan from the outset was the argument that it was funneling money to thevery entities that had created the problems.  That objection is only made stronger by the declaration that buying assets is not, after all, as important as funneling money to banks.  In the face of a certain political firestorm, did Paulson first present this to congressional leaders and secure their support, or attempt to secure support from the incoming Obama team?  Don’t be ridiculous.  No more than he was initially willing to identify the nine banks receiving $125 billion in public money, and no morethan Neel Kashkari – the "bailout czar" and yet another Goldman, Sachs alumnus- was willing to entertain questions after a speech on Monday.  The absolute arrogance of the Bush Executive has not diminished a whit, nor has its fondness for secrecy nor itscomplete contempt for Congress.

Wait, there’s more of the more of the same:  the Bush administration is vying to go beyond the "worst administration in history" to become "the worst administration of which the human imagination can conceive.."  Paulson also praised a new set of guidelines issued Wednesday by the Federal Reserve and other bank regulators.  These guidelines "urgeinstitutions to continue lending to credit worthy borrowers and to work with mortgage borrowers to avoid defaults," and "encourage the banks to set dividend payments for shareholders and compensation for executives with the current crisis in mind.  The Fed, FDIC, and Office of Thrift Supervision all announced that all financial institutions are expected to follow the new guidelines, even those not receiving federal assistance.  Note the verbs here.  "Urge," "encourage,""expected"; it’s the same old completely discredited game of voluntary compliance.  We are still not learning from the British example that the way to get banks to lend money is to provide them with funds on the condition that they lend them.  We — our President and his administration — are still parroting the tired old "magic of the markets" line even after Alan Greenspan’s mea culpa (he was shocked, shocked, to learn that people will not voluntarily forego profit in order to preserve the integrity of the system.)

Keep in mind that the TARP program is not by any means the only game in town.  All told, the government has allocated more than $2 trillion so far, including more than $1.4 trillion in loans to banks in the form of purchases of collateral, most of itsubsequent to September 14th rules changes that lowered collateral requirements for lending; the monthly limit on these loans was increased to $300 billion in October.  $29 billion went into aspecial lending facility to save Bear Stearns so that JP Morgan could take themover.  $11.4 billion has been drawndown so far from the FDIC’s deposit insurance fund after 19 bank failures in 2008.  $3.9 billion went to states and municipalities in assistance to buy up and rehabilitate foreclosed properties, and there have already been $9 billion so far in government purchases of student loans from private lenders. A whole series of programs directed at money market funds, more than $1.1 trillion just since September14th when the rules governing collateral for such loans were relaxed. These loans have been made under 11 different programs, 8 of which have been createdin the past 15 months. 

In other words, it is rapidly becoming an alphabet soupout there, an environment that invites entrepreneurial lobbying and gaming the system. Some of the particular programs are almost laughable.  Consider the $300 billion thatwas allocated in July for the Federal Housing Finance Agency, which is authorized to buy back and renegotiate an estimated 400,000 mortgages.  That program started October 1st; unfortunately, lenders are not interested because they are required to absorb losses up front and participation in the program — you guessed it — is entirely voluntary; effectively, it’s up to the homeowner to persuade her lender to participate.   In the first two weeks of its operation the Hope for Homeowners program got a total of 42 applications. 

There are some hopeful counterexamples.  This past week the FDIC — in apparent defiance of the administration — has announced a plan to set aside $24 billion to help 1.5 million households avoid foreclosure, and a number of major lenders are engaged in renegotiating large numbers of mortgages on their own initiatives.  Then there is the Commercial Paper Funding Facility that was mentioned earlier in connection with AIG.  Under that program, which went into operation at the end of October, the Federal Reserve Bank of New York agree to buy outstanding unsecured and asset-backed 3-month loans.  The model involves government seed money used to attract private investment in bonds.  The proceeds go to a newly created purchasing entity, which will hold the commercial paper until maturity and will use the proceeds from maturing commercial paper and other assets to repay its loan from the New York Fed.  What is extraordinary about the CPFF is that it actually seems to make sense.

The effects of all this for the credit markets have thus far been modest.  At the meeting with foreign leaders on November 15th Bush declared that there were signs of progress,that credit is no longer "frozen" and that it will take time to get money to the banks, which in the administration’s view is the really important thing.  Has credit become more liquid?  The Libor/Treasury spread, which was up to 480 in October, is now "down" to a little over 200; prior to Sept. the all-time record was 250 and the 10-year average was 22.  The total amount of "Asset Backed Credit Products"  – i.e. total pool of all credit for car loans, student loans, floorplan loans, fleet loans, mortgages- is down 51% ($748b) since June 2007. An awful lot of banks that have received money are just sitting on it,or using it to pursue mergers and acquisitions; at the end of the day one ofthe consequences of Paulson’s plan may simply be that the biggest banks get even bigger and small ones disappear. So much for small business.

And now it’s the automakers’ turn.  Democrats in Congress are talking about making an additional $25 billion available to the Big Three on top of  $25 billion the auto industry hasalready received this year to help speed the development of fuel-efficien tvehicles.  At the moment the plan seems to lack the necessary votes, but some version is likely to be forthcoming.  (All of this, incidentally, follows an earlier discussion of using government money to fund a GM-Chrysler merger that was said to be essential to GM’s survival but has since been called off.  They changed their minds, too.)  

But even that may not be enough.  GM announced last week that it will "approach the minimum amount necessary to operate its business" by the endof this year, and are asking for $50 billion from Congress GM says they need $25 billion to pay for retirements, and an additional $25 billion to pursuefuel efficiency.  Readers may be forgiven for lacking faith in GM’s commitment to this laudable goal, particularly if they happened to catch the following exchange in a recent Frontline episode entitled "Heat." The interviewee was Beth Lowery, General Motors’ vice president for environment, energy and safety policy, was particularly interesting.  In response to the question "Why did Toyota beat you to the Prius?" here was Lowery’s answer: 

"Actually, Toyota and General Motorsworked together on a number of technologies over time. Toyota looked at the hybrids and the Prius from an overall standpoint, knew there would be the lossof money for some time on the cost of that, but looked at it from an overall marketing and image standpoint, and General Motors really looked at it from abusiness [perspective]: Can this vehicle make money?" 

Lowery goes on to extol GM’s success in — I am not making this up — selling a million vehicles in China; the best-selling line is Buick.  She also explains that CAFÉ standards are not effective mechanisms for reducing dependency on oil imports.  The executives of the American auto manufacturer have doubled down on trucks and SUVs over and overagain, effectively ceding the market in well-made, efficient passenger cars to Asian and European manufacturers. Ford’s new models are said to be a vast improvement, but at this point American companies have spent 20 years building a reputation for shoddy workmanship, poor design, and terrible service; it will take a long time before American consumers will trust them. GM’s response?  Build cars for the Chinese.  To really add insult to injury, just this weak GM’s board issued a statement that it has no reason to lack confidence in the company’s management team.

In other words, any bailout of the auto industry looks like a temporary measure to delay the inevitable consequences of mind boggling stupidity, greed, crony capitalism, and willful ignorance on the part of American auto executives. In fact, it is difficult to think of any group less deserving of huge transfers of public money, or less likely to use that money in the ways that will do the most good for the public weal . . . except for the financial industry.

I described the Bush administration as exhibiting intellectual and political bankruptcy. After banktruptcy, in the best case scenario, comes reorganization.  That would be the Obama administration.  So we are allwaiting for this long national descent into policy nightmare to be over.  But by the time Obama takes office, the Bush administration will have transferred a staggering amount of money, measured in trillions of dollars, to private banks.  That money will no longer be available for the kind of employment-based stimulus package that we desperately need, nor for targeted and potential more effective mechanisms to increase liquidity in the credit markets such as an expanded version of the CPFF, nor to secure access to education.  And still, after all this time, the Bush administration is seeking to jam this enormous program down the throats of Congress and the American people without consultation ,oversight, or transparency.  Will Congress just stand there and watch this happen?  Again?

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