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In the scenario I’m about to paint for you, the dialog is fictional, but all the facts and figures are real.
The time: 1 AM, November 23, 2011, exactly two years from now.
The place: the White House, suddenly and unexpectedly under siege as a new financial crisis erupts.
The economic booms of 2010 have morphed into superbooms … the superbooms into bubbles … and the bubbles into busts.
Large banks are again on the brink. Financial markets are again in turmoil.
Wall Street giants like Goldman Sachs, JPMorgan Chase, and Morgan Stanley — the outstanding survivors of an off-again-on-again debt crisis — are now its primary victims.
Investments like long-term U.S. Treasury bonds — long sought as safe harbors — are now collapsing in price, turning into torpedoes that can sink even the sturdiest of portfolios.
But most important, the government’s too-big-to-fail bailouts, shotgun mergers, and mad money printing — previously hailed as cures that killed the contagion of 2008 — are now widely viewed as far worse than any disease.
President Obama and Treasury Secretary Geithner have huddled in the Oval Office for hours, struggling to find new solutions to old problems: Wall Street meltdowns, renewed threats of a great depression, millions more thrown out of work.
After a long and heated debate, the president slumps back into his armchair, signaling it’s time to talk more frankly — to reminisce about past policies and rethink what might have gone wrong.
“With 20-20 hindsight,” he remarks after an introspective pause, “it’s clear we were overly focused on the intended consequences of our efforts — the economic recovery, the bounceback in markets, the jobs saved. Meanwhile, we were blindsided by the unintended consequences, many of which have proven to be bigger, more durable and, ultimately, more impactful than the benefits we did achieve.”
The Treasury Secretary, weary from marathon meetings on precisely the same subject, nods in silent agreement.
“So, perhaps one of our tasks,” continues the president, “should be to document two basic issues: What precisely are the unintended consequences? And what exactly did we do to cause them?”
“We don’t have to,” says Geithner sheepishly.
“Why not?”
“Because it’s already been done. Those issues have already been thoroughly documented.”
“Since when?”
“Since the fall of 2009. That’s when SIGTARP — the Special Inspector General for the Troubled Asset Relief Program — revealed the mistakes we made with the giant AIG bailout. And that’s also around the time the public began to react to the enormous contradiction between massive unemployment on Main Street and the monster we helped to create on Wall Street.”
Monster Bonuses
“Monster?” queries Obama. “You mean the giant bonuses?”
“Exactly. We already knew Wall Street execs had been giving themselves megabonuses for most of the decade —
— $29 billion for Citigroup’s Weill in 2003 … $27 billion for Blankfein at Goldman Sachs in 2006 … another $106 billion for Jon Winkelried and Gary Cohn, also at Goldman Sachs, in 2006-2007 … and many more. We already knew how the money from these obscenely large bonuses alone could have been enough to save millions of jobs.”
“Yes.”
“But what we did not know is how soon after the bailouts Wall Street would be at it again — first, dishing out megabonuses to heavy hitters in their trading rooms … then to sluggers in their sales departments … and later, as soon as the public tired of protesting, to themselves.”
“Exactly how soon?”
Geithner answers with questions of his own. “When was Wall Street on the verge of a total meltdown? In September of 2008! When were the record bonuses paid out? In December of 2009! So that’s 14 months. It was just 14 months later that the employee bonuses at the three big Wall Street survivors — Goldman Sachs, JPMorgan Chase, and Morgan Stanley — exceeded all prior records.”
“Even the record bonuses they paid out before the crisis?” the president asks with a mix of disbelief and disdain.
“Yes, even bigger than their record bonuses paid out before the crisis.”
“But why do we blame ourselves for all this?” the president wonders out loud.
The Bungled AIG Bailout
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“In public, we don’t … and hopefully never will,” responds Geithner furtively. “But in private, we must admit that we screwed up — particularly with the AIG bailout.”
“Why?”
“For the simple reason that we — the Treasury and FRBNY, the Federal Reserve Bank of New York — didn’t just bail out AIG. Indirectly, we also bailed out all of AIG’s major counterparties, the biggest of which were Société Générale and Goldman Sachs.”
“Said who?”
“Said SIGTARP, the Special Inspector General for the Troubled Asset Relief Program, in its special report of November 2009. I have a copy of the report right here.”
“What precisely did SIGTARP find?” asks the president.
“In essence, they found that AIG’s counterparties — 16 major global banks — should have lost money in their trades with AIG, just like most investors lost money when other companies failed. But instead, AIG’s counterparties did not lose money. We made those creditors whole, practically to the penny.”
“How much did we pay ’em?”
Before responding, the Treasury secretary flips to page 20 of the SIGTARP report and glances down at Table 2 — Total Payments to AIG Default Swap Counterparties (reproduced below).
Source: SIGTARP, November 17, 2009. “Factors Affecting Efforts to Limit
Payments to AIG Counterparties,” page 20 (pdf page 24).
“Société Générale,” he says, “got $9.6 billion in collateral payments from the money we had loaned earlier to AIG. Plus, we paid Société Générale another $6.9 billion through a special purpose vehicle we created, called Maiden Lane III. In total, the French bank walked off with $16.5 billion.
“Goldman Sachs,” continues Geithner, “got $8.4 billion in collateral payments, plus another $5.6 billion from Maiden Lane, adding up to $14 billion. “Deutsche Bank got a total of $8.5 billion … Merrill Lynch — $6.2 billion … UBS — $3.8 billion … plus …”
“Please cut to the chase,” says the president impatiently. “How much overall?”
“They got $62.1 billion, plus another $2.5 billion we agreed to pay to compensate them for shortfalls in their collateral. Grand total — $64.6 billion.”
“Wait a minute!” interjects the president. “A lot of these big banks, notably Goldman Sachs, have forever insisted that they never wanted a bailout, never needed one, and never got one.”
Geithner picks up the report and waves it for emphasis. “And SIGTARP has forever disagreed.”
“What’s their conclusion?”
“In effect, SIGTARP concluded that, via this back door, the 16 banks not only got big bailouts … they never had to pay back a dime of the money.”
The Sad Saga of How Taxpayers Were Sold Out
“What do you think really happened?” asks the president.
“I don’t think; I know. Remember, I was not only there, I was mostly in charge. So I can tell you flatly: We had our backs to the wall. Sure, we asked 12 of the biggest AIG counterparties to take haircuts, to accept some losses. But 11 out of the 12 refused. So we had no choice but to give them everything they wanted.”
“Why didn’t you press harder?”
“We had no negotiating leverage. Later, with GM and Chrysler, we forced creditors to make concessions by threatening to let the automakers fail. But with AIG, we had already declared, in effect, that we’d never let it fail.”
“When?”
“Several weeks earlier — when we loaned $86 billion to AIG, the biggest bailout in history. The end result was that, when it came time to negotiate with AIG’s creditors, we could no longer function as unbiased regulators. We were already in deep — as the company’s biggest stakeholder. The creditors knew they had us over a barrel. There was no way we could twist their arms.
“If that wasn’t bad enough,” Geithner continues, “I then compounded the problem by adhering too strictly to one of FRBNY’s core values — the concept of treating all counterparties equally. That doomed the negotiations because it gave each party effective veto power over any possible concession from any other party. The way I set things up, either all the banks had to agree to concessions … or none of the banks would agree to concessions. So, needless to say, none agreed to concessions. They got everything.”
Profound Impacts
My fictional scenario ends here. But the impacts of those fateful decisions of late 2008 and early 2009 do not.
The AIG rescue was the biggest taxpayer rip-off of all time. Worse, it was the master seed that sprouted a whole series of similar taxpayer rip-offs on Wall Street.
Just connect a few of the dots, and you’ll see what I mean:
- The U.S. Treasury rushes to bail out AIG. That alone helps protect AIG’s counterparties from the direct losses they’d otherwise suffer in an AIG failure.
- The Federal Reserve Bank of New York creates a special entity to pay off AIG’s creditors in full. While ordinary U.S. investors lose fortunes even in companies that are financially viable, 16 major banks don’t lose a penny even in a company that would otherwise be bankrupt — all thanks to the Fed’s largesse.
- Prominent among these government-blessed banks is Goldman Sachs, Wall Street’s most extravagant giver of executive bonuses in 2006 and 2007 … and also Wall Street’s most lavish payer of employee bonuses in 2009.
The money flow is clear:
- From taxpayers to AIG …
- From AIG and the Fed to big Wall Street investment banks like Goldman Sachs, and then …
- From Goldman Sachs to its employees in the form of lavish bonuses.
It is, by far, the greatest taxpayer rip-off off all time!
Don’t get sucked up into this madness!
Check your email later this morning for specific instructions on how to avoid it, even profit from it!
Good luck and God bless!
Martin
About Money and Markets
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