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Guest Post: The new bailouts are an end-run around Congress

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Submitted by Edward Harrison of the site Credit Writedowns

Edward Harrison here. What follows is a post I wrote for Credit Writedowns last night.  Before I present the post, I want to make a few editorial comments, however.

First, for full disclosure, I support Barack Obama. I voted for him, campaigned for him and contributed to his run for office. I am happy to see him as President.

Nevertheless, he is now making policy that affects us all. As a blogger, I am required to show some objectivity in analyzing his policy decisions. I am not altogether content with that policy and my articles do reflect this.

You should note that the post below is echoed in comments made by Felix Salmon in today’s New York Times (How to Conjure Up $500 Billion).

And now, my post:

The political realities of solving a financial crisis have often meant circumventing legislative approval to meet the exigencies of a particular situation. This was certainly the case in 1995 during the so-called Tequila Crisis in Mexico. And I believe it is the case again today in 2009. Before I go into how this applies to what is presently happening in the Obama Administration, I thought an example from 1995 would be illustrative.

This comes from a recent article in the New Republic called “Free Larry Summers.”

In December of 1994, the Mexican finance ministry alerted Summers’s assistant secretary, Jeff Shafer, that the country was nearing a currency crisis. During the early ’90s, Mexico had started down two paths that, together, proved unsustainable. First, the country ran large trade deficits. To pay for all the goods it was importing, Mexico needed dollars, which meant it had to sell government bonds. This led to the second problem: To appease all the foreign investors who worried the peso would lose value, Mexico issued certain short-term bonds–called “Tesobonos”–that were linked to the dollar.

This worked fine for a while. Foreign money flooded in as investors snatched up the Tesobonos. But, as the years passed, creditors began doubting that the government would pay off its bonds at the fixed exchange rate. Many began withdrawing their money, forcing the Mexicans to redeem the bonds for dollars. By the time Treasury tuned in, in late 1994, the dollars had almost run out and the government could no longer defend the peso-dollar exchange rate. The imminent decline of the peso would make Mexico’s foreign debt more expensive and raise the risk of a default.

Worse, Treasury itself was in limbo. Then-Secretary Lloyd Bentsen had announced his retirement, but Bob Rubin, his successor, had yet to replace him. It fell to Summers–whose team included Shafer and a young deputy assistant secretary named Tim Geithner–to figure out the consequences of a Mexican collapse. By January 10, 1995, the Summers group had a tentative answer: The fallout could be several hundred thousand U.S. jobs and a 30 percent spike in illegal immigration. If Mexico infected other emerging markets, it could wind up shaving a point off U.S. GDP growth.

That same day, Summers accompanied Rubin to his Oval Office swearing in. Once President Clinton administered the oath, Rubin recalls in his memoir, the new Treasury secretary turned to the president and urged a massive loan package. He then gave the floor to Summers, who briefed the president and concluded that something on the order of $25 billion would be necessary. Surely he meant twenty-five million, George Stephanopoulos interjected. No, Summers said, “billion with a ‘B.’” Clinton swallowed hard and, after weighing every angle, signed on.

The initial response from congressional leaders was also favorable. But the rank and file was hostile. Vermont’s then-congressman, the socialist Bernie Sanders, told Rubin to “go back to your Wall Street friends [and] tell them to take the risk and not ask the American taxpayers.” A freshman Republican named Steve Stockman accused Rubin of arranging a bailout to protect the investments he’d made while a partner at Goldman Sachs. Soon, even the once-supportive leaders were either quietly backtracking (Senate Majority Leader Bob Dole) or railing against the package outright (Banking Committee Chairman Alfonse D’Amato). It was what High Noon might have looked like if Gary Cooper had played a policy wonk.

As it became obvious that cooperation from Congress wouldn’t be forthcoming, Rubin and Summers began to consider plan B. Back in 1934, Congress had given Treasury a pool of money called the “Exchange Stabilization Fund” (or ESF) to help smooth out exchange rates. Sixty years later, the fund stood at about $35 billion, and Treasury lawyers believed they had the authority to draw on it. And so, on January 30, with no congressional help in sight, Summers, Rubin, and Clinton’s top White House aides decided to tap the ESF to the tune of $20 billion.

Still, even this amount was unlikely to restore confidence in Mexico. The only other source of money was the International Monetary Fund, and here’s where Summers’s occasional bullying actually served him (and the country) well. To help cajole what eventually became a $17.8 billion contribution out of managing director Michel Camdessus, Summers pushed and prodded relentlessly. “I remember late the night that this unfolded, in the early morning, Larry was in an adjoining office in rather strong terms telling the IMF they had to step up to the table here in a major way,” recalls one former colleague.

By early March, the first U.S. installment of the nearly $40 billion package was flowing. By mid-May, there were signs it was working. By early ’97, the Mexican government had completely paid off the loan–three years ahead of schedule.

What should be clear from the preceding article is the fact that Congress was in no mood to fund the bailout of Mexico in 1995. Nevertheless, the Clinton Administration was able to cobble together a bailout package of $40 billion that did not require any Congressional approval.

Fast forward to 2009 and you can see similar themes emerging. There is zero chance that the Obama Administration will get more funds for bailouts of the likes of AIG, Citigroup or Bank of America.

Enter the Federal Reserve and the FDIC.

The US authorities have no money to fulfil their ambition of stopping large US banks from failing without taking them into public ownership. The $300 bn left in the TARP kitty is all that is available for recapitalising banks, purchasing toxic assets and providing other financial support. Congress has thrown its toys out of the pram and is unwilling to appropriate more funds for the rescue of the banking sector.

As an aside: it is astonishing that Congress and much of the US populace are apoplectic about $165 mn (perhaps $182 mn) of bonuses paid to AIG executives and employees, when $170 billion or so of public money is at risk (and tens of billions probably already gone out of the window) in the rescue of this most undeserving of companies. Perhaps you can only get indignant about what you can comprehend… .

The US authorities are reduced to begging, stealing and borrowing the rest of the funds they believe they will need. The two main proximate sources of funds are the FDIC and the Fed. The ultimate sources of funds will be (1) the US tax payer and the beneficiaries of future US spending programs that will have to be cut, (2) the holders of nominally denominated liabilities of the US state, including the monetary liabilities of the Fed and US Treasury bills and bonds.

Owners of dollar-denominated debt instruments will see the real value of their claims on the government eroded by future inflation if, as I expect, the recent and prospective future increases in the US monetary base (driven by credit easing and, in the future also be quantitative easing) cannot be reversed in the future. The main obstacle to such a reversal will be the US fiscal authorities, who are unlikely to let the Fed dump large amounts of US Treasury debt, acquired by the Fed as part of its quantitative easing program, into the markets.

I believe that the raids by the US Treasury on the FDIC and on the Fed are illegitimate and, in the case of the FDIC, quite possibly illegal.

These are the words of Willem Buiter in a recent piece he has written on his site at the Financial Times. While the language he uses is more colourful than what I would say, I agree with him that what we are now seeing is an end-run around on the Congress. The Obama Administration know full well that they have to work with the money and institutions now available to them because Congress won’t stand for more bailouts and because populist sentiment in the American electorate is in a critical state.

But, more worrying for me are the changes to the TALF program now operated by the Federal Reserve. It was originally created to increase lending by increasing liquid in the marketplace for new asset-backed securities. Not any more, according to the press release by the Treasury for The Public-Private Investment Program for Legacy Assets, it will fund legacy assets.

“To address the challenge of legacy assets, Treasury – in conjunction with the Federal Deposit Insurance Corporation and the Federal Reserve – is announcing the Public-Private Investment Program as part of its efforts to repair balance sheets throughout our financial system and ensure that credit is available to the households and businesses, large and small, that will help drive us toward recovery.”

Willem Buiter has a word or two to say about this in a previous missive of his:

The legacy assets to be purchased by the two legs of the PPIP are legacy securities and legacy loans. The legacy securities are toxic assets. Toxic assets are assets whose value cannot be established with any reasonable degree of accuracy, because there are no liquid markets for them and because their complexity prevents too much faith being put in mark-to-model valuations.

The legacy loans, however, are just bad assets. They are plain vanilla household and commercial loans that have become impaired. Their value can be calculated quite readily by any reasonably competent banker. It is likely to be low relative to the notional or face value of the loan. That’s sad and too bad, but not a reason for getting the state involved through the PPIP.

By bundling toxic assets and bad assets, the Treasury muddles up price discovery issues and the recapitalisation of or subsidies to loss-making banks.

The long and short here?

  1. None of this requires Congressional approval. The executive branch and the Fed are working in concert in ways that exclude the legislative branch entirely.
  2. Changes in the TALF program demonstrate that the true purpose of TALF has now expanded from increasing liquidity to make new loans to helping banks get rid of so-called toxic assets.
  3. The assets in question do NOT all suffer from poor market liquidity. For example, loans are held to maturity on bank balance sheets and are NOT marked to market. They present no writedown risk until the loans actually sour. So, they have not been a writedown problem to date. Clearly, the PPIP is helping banks by taking these assets off their hands.

I find all of this quite troubling. But, as Felix Salmon argues, we are seeing policy made within the constraints of the present political environment, the economic consequences of which are decidedly sub-optimal.

Sources
More on robbing the US tax payer and debauching the FDIC and the Fed – Willem Buiter
The new toxic and bad legacy assets programs of the US Treasury: surreptitiously squeezing the tax payer and the Fed until the PPIPs squeak – Willem Buiter
Free Larry Summers – New Republic
How to Conjure Up $500 Billion – Felix Salmon, NY Times

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward

32 comments

  1. Anonymous

    Absolutely, Harrison.

    It looks a lot like Geithner is proposing that the Fed and FDIC act illegally, by giving gifts of underwater non-recourse loans (Fed &ultra vires doctrine) and guarantees of such loans (FDIC &constitution). The loans and guarantees look like they're intended to be underwater by allowing collusion.

    If you want to view the Federal Reserve member banks as private corporations, then it seems like a violation of the ultra vires case law that a corporation lacks power to do things it is not legally authorized to do and the Federal Reserve Act does not seem to authorize the Federal Reserve to make gifts. McCormick vs. Market National Bank, 165 U.S. 538 (Supreme Court on ultra vires acts being illegal and void). If you want to view the Federal Reserve member banks as government entities, it seems like a violation of the Constitution because only Congress is authorized to spend money. Article I, section 9, clause 1. United States v. MacCollom, 426 U.S. 317, 321 (1976).

    In particular note that the Federal Reserve Act authorizes member banks to “To exercise by its board of directors, or duly authorized officers or agents, all powers specifically granted by the provisions of this Act and such incidental powers as shall be necessary to carry on the business of banking within the limitations prescribed by this Act.” 12 USC 4.4.7. This seems to only give member banks the power to do things authorized by the Federal Reserve Act.

    And the reason the loans sound like they’ll be underwater is that Geithner hasn’t laid out rules strictly prohibiting entities holding bad assts from bidding on their own assets, colluding with each other to cross-purchase each other’s assets, or colluding with unrelated buyers in a kickback scheme to use those unrelated buyers as sham purchasers.

    People should write to their Senators and Congressmen asking Geithner to defend why the actions he proposes for the Fed and FDIC are legal. People should also ask the below public interest groups that believe in free markets to attack Geithner's plan. People should also ask Cuomo to investigate the lawyers involved with Geithner's plan to see if they violated the NY legal rules of ethics in adivising Geithner on the plan; all the lawyers are Simpson Thacher attorneys (Lee Meyerson, Barrie Covit, David Eisenberg, Brian Steinhardt, Marcy Geller, Catherine Kidd, Nentcho Nentchev, Parker Kelsey, Brian Korchin, and Jennifer Marsh). People should also write in to the Senate and House small business committees asking them to protest that Geithner's plan is limited to big players, and against smaller pensions, endowments, etc.

    These are the public interest groups that might be willing to fight Geithner's plan.

    American Legislative Exchange Council, 1129 20th Street, N.W., Suite 500, Washington DC 20036 http://www.alec.org

    American Enterprise Institute, Christopher DeMuth, President, 1150 17th Street, N.W., Washington, DC 20036 http://www.aei.org 202-862-5800; 202-862-7177

    American Institute for Economic Research, Charles Murray, President, P.O. Box 1000 Great Barrington, MA 01230 http://www.aier.org

    Atlantic Legal Foundation, William H. Slattery, President, 150 East 42nd Street, 2nd floor, New York, NY 10017 http://www.atlanticlegal.org

    Beacon Hill Institute, David G. Tuerck, Executive Director, 8 Ashburton Place, Boston, MA 02108-2770 http://www.beaconhill.org

    Capital Research Center, Terrence Scanlon, President, 1513 16th Street, N.W., Washington, DC 20036
    http://www.capitalresearch.org

    Cato Institute, Edward H. Crane, President, 1000 Massachusetts Ave. N.W., Washington, DC 20001, 202-842-0200
    http://www.cato.org

    Islamic Free Market Institute, Khalid Safuri, Chairman, 1920 L Street NW, Suite 200, Washington, DC 20036, http://www.islamicinstitute.org

    The James Madison Institute, J. Stanley Marshall, Founding Chairman, P.O. Box 37460, Tallahassee, FL 32315 http://www.jamesmadison.org

    Mountain States Legal Foundation, 2596 South Lewis Way, Lakewood, CO 80227 http://www.mountainstateslegal.org

    National Legal Center for the Public Interest, Ernest B. Hueter, President, 1600 K Street, N.W., Suite 800, Washington, DC 20006, http://www.nlcpi.org

    New England Legal Foundation (NELF), Andrew Grainger, President, 150 Lincoln Street, Boston, MA 02111 http://www.nelfonline.org

    Pacific Legal Foundation, Robert K. Best, President, 3900 Lennane Drive, Suite 200, Sacramento, CA 95834
    http://www.pacificlegal.org

    Pioneer Institute for Public Policy Research, Jim Stergios, Executive Director, 85 Devonshire Street, Eighth Floor, Boston, MA 02109, http://www.pioneerinstitute.org

    Southeastern Legal Foundation, 3340 Peachtree Road, N.E., Suite 2515, Atlanta, GA 30326 http://www.southeasternlegal.org

    The Justice Foundation, Allan Parker, Jr., President, 8122 Datapoint Drive, Suite 812, San Antonio, TX 78229 http://www.txjf.org

    Washington Legal Foundation, Daniel Popeo, Chairman and General Counsel, 2009 Massachusetts Avenue, N.W., Washington, DC 20036 http://www.wlf.org

  2. Dave of Maryland

    Congress might be a lot more understanding if there were criminal investigations underway. People in the dock. Trials held. Give us something tangible for all the money!

    I voted for Obama, but with my eyes open. He had no prior executive experience, nor any significant legislative accomplishments. As a senator, he was a newcomer to Washington who spent most of his time out of town campaigning for some other office. Which means he knew no one there.

    It was not hard to anticipate the result: The new President was easily captured by Washington insiders & quickly reduced to mindless pandering. I've seen a lot of that the last week. High-flown oratory is no substitute for effective executive management. They are, in fact, completely unrelated. So instead of actually governing, our new Emperor is instead out campaigning. Trying to persuade us he is wearing fine new clothes. Increasingly, we suspect otherwise.

    I hear the Europeans think he is "timid". God save us if they do. The Chinese never accepted American supremacy. The Russians have been looking for weakness since at least the days of Ivan the Terrible. Obama looks increasingly like the answer to Russo-Sino prayers.

    I, for one, enjoy the guest posts, and look forward to them.

  3. Iconoclast421

    Why do people feel the need to express the fact that they sucked up to the establishment by voting for Obama? He is a pawn, you got suckered, you lost your bet, so what? What did you expect to get from caving in to the mafia banksters and their sockpuppet Obama? Did you expect something different this time? Good grief it was the same with Clinton. He is no friend to liberty… nor is Obama.

    The Federal Reserve exists for the sole purpose of devaluing the money supply every time the bankers scam the bejezzes out of us. The Federal Reserve system is a Racket that allows the government to keep growing in size and power despite the fact that the taxpayer does not directly support such growth. We refuse to pay for bigger government? Fine, they just print more money, devaluing the money we have, and forcing a de facto tax upon the people to pay for the Big Government we never voted to accept. And you stupid idiots still havent realized the malicious intent behind this system? A criminal organization runs this country and they have the power to tax us without consent or representation of any kind. Dont you understand what that means? Do you have even a lick of common sense?

    After looting us dry, the banks position themselves to suck up all the newly created money once the Fed turns on the spigot. This has all been the talk of conspiracy theorists for decades. That’s how they own everything and the country gets poorer and poorer even as it denies that we’re under complete banskter/pigman/mafia rule. It’s time for you idiots to stop denying that, because you’ve got to get busy denying the next levels of fascism that are slowly oozing in… forced conscription, mass nationalization… go right on down the list… wake up and smell it the stench of decades of ignorance! Ahhh!

  4. RedSt8r

    “These are the words of Willem Buiter in a recent piece he has written on his site at the Financial Times. While the language he uses is more colourful than what I would say, I agree with him that what we are now seeing is an end-run around on the Congress. The Obama Administration know full well that they have to work with the money and institutions now available to them because Congress won’t stand for more bailouts and because populist sentiment in the American electorate is in a critical state.”

    Democrats have a full-on working majority in both houses of Congress. It can only be assumed that the Democrat leadership (such as it is) is in full agreement with the Obama administration on its bailout plans. They want the administration to use the FDIC and the FED in this illegal activity. But only if Congress is insulated from the blame. Congress, the house and 1/3 of the Senate run for office in less than two years and they don’t want the blame.

    This is far less an end-run around Congress and far more a political bed sharing with winks all around.

  5. Ryan

    What will happen to bank account holders (checking and savings) if the FDIC funds are used to pay for failures in this PPIP and then more banks also go insolvent? Is it not a REALLY bad idea to weaken the insurer of commercial banks, thereby increasing the likelihood that a large number of account holders will be left with less than their insured amount when their bank declares it’s insolvency, thereby possibly contributing to a bank run, which would make the crisis much longer and more difficult to recover from?

  6. ruetheday

    Can someone tell me what legal authority the FDIC had to insure bank bonds last fall?

    I keep reading through the law and I can’t find anything that allows the FDIC to insure anything other than bank deposits.

    Once that question is answered, then we can proceed to discuss the legal basis for the FDIC to loan money or guarantee loans to non-banks for the purpose of purchasing assets from banks (I can’t seem to find this authority in the statute either).

    At least the Federal Reserve Act has the “in unusual and exigent circumstances” clause that gives them some legal cover. I can find no corollary in any of the law surrounding the FDIC.

  7. Gregory

    ruetheday,

    It would seem that the FDIC is experiencing the sort of feature creep that Mish describes for The Fed in his “Fed Uncertainty Principle” post from a year ago. The similarities are notable: Like the FED, it’s more expedient for the FDIC to apologize later than to ask prior permission; any missteps are not used to critique the FDIC, they can be used as excuses to ask for more power.

  8. Anonymous

    The new President was easily captured by Washington insiders & quickly reduced to mindless pandering. I've seen a lot of that the last week.

    He was captured by insiders long before he became president. How do you think he raised more money than any other candidate? It wasn’t his charm, it was his willingness to whore himself. But democracies always elect the biggest whore. Always. Shame on those smart enough to know it but far too willing to ignore it for their own ego’s sake.

  9. ruetheday

    Gregory – There are some key differences between the FDIC and the Fed. The FDIC is a US Government Corporation. It is backed by the full faith and credit of the USG. It’s charter is to insure bank deposits and handle insolvent depositories (NB: ONLY the depositories, not the holding companies or other affiliated entities). Unlike the Fed, the FDIC’s charter does not grant broad powers in the case of “unusual and exigent circumstances”.

    The TLGP was conjured into existence by Bair publishing an RFC in the Federal Register and issuing a press release. Perhaps that was adequate for the Transaction Account Guarantee Program portion, but it certainly was not adequate for the Debt Guarantee Program. Bair may as well issue a rule change tomorrow mandating that all iPods sold in the US must be purple; her legal authority for doing so is about the same.

  10. setitnforgetit7

    Anon @ 12:43PM – completely agree. Anyone who mentions she supported Obama completely discredits herself as a mature, level-headed, rational grown-up. I never make it past the first paragraph of any post on this blog, particularly the guest posts – any one ever hear, ‘brevity is the soul of wit’?

    Anyhoo, I just read on Bloomberg (sellouts) that Obama invited the heads of the banking cartel (i.e. Blankfein (#1), Dimon, Pandit, etc.) to Washington in order to assuage their fears about the most recent bailout they’re getting (that is, having the taxpayer grossly overpay for assets that are, in reality, worth 20-30% of their nominal value in a rose-colored glasses case). This is truly bizarro world and is akin to asking bank robbers if they require a police escort from the bank following the robbery. Ridiculous. Where is the outrage?

    Stick to your knitting (watching Dancing with the Stars) Obama supporters and leave economic matters to the Austrian School, who has and always will be right. Keynesians will always be dead wrong and anyone who suggests otherwise is utterly delusional.

  11. Anonymous

    What will happen to bank account holders (checking and savings) if the FDIC funds are used to pay for failures in this PPIP and then more banks also go insolvent?

    Simple. Trillions of new dollars will be created. All depositors will be made whole – but the purchasing power of their deposits will be reduced by 50%.

    But the problem with doing that is depositors get their money first so they get the initial benefit of the inflated dollars. By doing it the Obama way (and let’s be honest here, the Obama way is they same way it’s been done since 1933 regardless of party in power) the banks get the money first so the banks get the benefit of the new dollars. You won’t have to worry about your bank being insolvent so you won’t have to worry about your deposits vanishing. But the purchasing power of those deposits will shrink (vanish?) by 60%.

    Those first in line will get the benefits, and may even enjoy a little deflation, those at the end of the line get reduced purchasing power.

    It worked that way in “sound money” systems, too: the king or emperor ALWAYS devalued the coinage by shrinking the size, adding more useless metal to the alloys, etc. You might want to test the gold bars you purchase.

  12. Anonymous

    Did Goldman Goose Oil?

    What’s the evidence of this? Much is circumstantial. Proving oil-trading manipulation is difficult. But numerous people familiar with the events insist that Citibank, Merrill Lynch and especially Goldman Sachs had knowledge about Semgroup’s trading positions from their vetting of an ill-fated $1.5 billion private placement deal last spring. “Nothing’s been proven, but if somebody has your book and knows every trade, it would not be difficult to bet against that book and put the company into a tremendous liquidity squeeze,” says John Tucker, who is representing Kivisto.
    http://www.forbes.com/forbes/2009/0413/096-sachs-semgroup-goldman-goose-oil.html

    Uh-Huh

  13. Anonymous

    Dave of Maryland said…

    “Congress might be a lot more understanding if there were criminal investigations underway. People in the dock. Trials held.”

    Indeed, if the Executive continues this end-run around the legitimate authority of Congress to constrain them, then the members of the Executive should be among those on trial.

    After impeachment and removal from office if necessary, of course.

  14. Anonymous

    It’s not so bad that someone voted for Obama. After all, the alternative was McCain.

    Neither was any good. Obama will kill our troops in Afghanistan. McCain wanted to stay put and do it in Iraq. Peas in a pod.

    I didn’t vote. But I’m no hero either, I just could not be bothered.

  15. Anonymous

    It’s almost comical how political partisans are quick to blame the other guy, but are strangely silent when their guy is in power doing the same thing.

    As a firm supporter of the Austrian school, it’s clear both parties are disasters. The Democrats misguided “bleeding heart” philosophy is predictably damaging. But the Republican actions seem more like a betrayal of their philosophy and the country.

    Power corrupts, and hence limits to power are our only hope.

  16. Eric L. Prentis

    Is there something in the White House tap water that magically transforms Republican presidents into troglodytes and Democratic presidents into Republicans. It would be nice to believe anything politicians say, what a sham.

  17. Anonymous

    Anyone here admitting that they supported Bush/Cheney? You think John McCain, Mr. S&L, was going to do better? Be less captured?

    The money influence will migrate as capital moves to more profitable industries. It will not go away, ever.

  18. Steve Koch

    Both parties are disasters. Is there anything that we can do to weaken the party system? Political parties lead to s much corruption. Term limits would help.

    The safest course is to vote such that control of the congress and the presidency are not in the same party (if you have a Republican congress, vote for a Democrat for president. If you have a Democrat congress, vote for a Republican for president).

  19. cap vandal

    In any asset valuation, there are two key variables — the default risk and the interest rate. Default risk went way up and the market interest rates to hold risky assets also spiked.

    The Treasury plan is an attempt to raise the effective price of bank owned financial assets by lowering the market interest rate.

    Leveraging 6×1 and an FDIC guarantee means that a vulture investor can make significant returns with assets purchased at roughly the rates they were initially capitalized at.

    2 year FDIC backed bonds are yielding 2% and change. Blend in 6 parts subsidized funding and 1 part vulture capital @ 20% and you get less than 5%.

    THIS, IN AND OF ITSELF IS A HUGE SUBSIDY.

    It means that assets can be purchased at much higher then current market prices and produce a profit.

    These are the same assets that were dumped when the shadow banking system collapsed.

    Perhaps everyone is so corrupt, etc. that they will engage in additional offensive behavior or lose money.

    However, THEY GOT THE SUBSIDY UP FRONT AND RIGHT IN THE OPEN.

    It’s on the term sheets.

    You don’t need to be an MBA to figure out that cash flows of several years valued @ 5% are worth MUCH MORE then identical cash flows valued at 10%, 15%, 20%.

    This is just another way of lowering effective interest rates. That is pretty much what the Fed and Treasury do, no?

    It is the only weapon in their arsenal and they are using every possible variant to jump start the economy.

    The way we got into this was screwing around with interest rates in the Greenspan era and the only way out without a full asset deflationary spiral is to keep interest rates as low as possible to allow as orderly a workout as possible.

    Lest people get too worked up over public vs private, don’t forget that the government gets 20% off the top of the GNP in tax revenue.

    Any analogy to hedge funds is purely coincidental.

  20. gordon

    Ah, Mexico, so far from God and so close to the USA (as some former Mexican President once remarked).

    As I said (with links) a little while ago here: “The Mexican bank Banamex (sometimes also called Banco Nacional de Mexico) accounted for roughly half of Citi’s profit in 2007. Banamex was bought by Citi in 2001, after the US Govt. had prosecuted Banamex for money laundering a few years earlier and after allegations that its previous owner (Roberto Hernandez Ramirez, one of the world’s richest men) was personally involved in the drug trade”.

  21. Alex

    Excellent post. It provides some good perspective to such internal measures, and it does look like another play from Sommer’s playbook.

    But alas, I cannot attribute this clandestine behavior to a difficult congress. I think its because key members of the current presidential administration are corrupt, and have only constituency; the bankers.

    Anything for Geithner’s little banker friends. That is all I see. They know that any measure structured to save the bondholders and their brilliant banker buddies would be torn to shreds. That would be all well and good.

    So instead they are drawing off valuable FDIC resources for this pathetic gift. It is disgusting and the height of corruption. Nothing else to me.

  22. Anonymous

    “First, for full disclosure, I support Barack Obama. I voted for him, campaigned for him and contributed to his run for office. I am happy to see him as President.”

    Telling people that you voted and participated in the scam electoral process is a sure fire way to demean your discernment and analytical skills and express to the world how gullible you are.

    Deception is the strongest political force on the planet.

    i on the ball patriot

  23. alex black

    Just curious, Edward. Do you support Obama because he is:

    A) Engineering the biggest theft of taxpayer money for the benefit of Wall Street, or

    B) Being an impotent patsy, letting it happen and doing nothing to stop it?

  24. Juan

    Ah Mexico is right.

    My recollection of that period, the Summers led bailout did little to nothing to help what had very quickly become a chaotic economy and one which also gave the drug cartels a decent boost. Tens of thousands of small businesses went bust, unemployment jumped considerably more than official figures would indicate, growth collapsed, the immediately prior el señor president Carlos Salinas [promoter of neoliberalism] had to, in effect, go into exile in the U.S., his brother Raul was found to have been involved in the murder of the pre-selected new president. [lets include allegations of being close to the drug trade and money laundering].

    So, in early ’95, I remember a conference call during which then Secretary of Finance Ortiz tried to assure foreign [U.S.] investors of the fundamentally sound quality of Mexico’s economy. Some probably believed him.

  25. CTMM

    Well now, congress could always revoke the FED’s charter to issue currency.

    Not that they’d dare, but they could. Things would have to get unbelievably desperate for that to happen.

  26. DanyBoy

    Excellent article:

    Rather than be impassioned, irate or outraged I will simply state:

    Obama needed the banksters, the banksters needed a president who could overcome Congressional reluctance to gow the financial sector.

  27. tz

    I would also note the Mexican overvaluation occured just as NAFTA passed, since it appeared to make Mexico appear as a more equal partner, closer to Canada than the 3rd world backwater it turned out to be. If NAFTA was sold as $0.10/day labor instead of $10/day, it would not have passed, at least not as easily.

    But I suppose the ultimate justice, irony, divine revenge is that our currency and system is now going the way of the peso.

    Don’t blame me I voted for Ron Paul (then Chuck Baldwin). Paul has a bill to audit the Federal Reserve. Perhaps a central bank should be independent, but only when it plays the detached part similar to the judiciary. If it is merely an non-disclosure protected unaccountable executive branch to corporation conduit, there is no reason for any independence.

  28. Doug

    The “Free Larry Summers” article was worth checking out… Well, it was mostly a puff piece, but the bit near the end was interesting about Summers deferring to Geithner on the PPIP bailout plan:

    “Thanks to his vast intellectual range and the urgency of the moment, Summers has thus far taken a leading role in the housing plan, the auto industry rescue, health care, and energy, in addition to the stimulus. But, when it comes to the bank bailout, the consensus is that Summers has scrupulously respected Geithner’s turf. It’s not that Summers doesn’t have opinions of his own, or that he doesn’t share them with Geithner. But, to the extent the two disagree, it’s Geithner who gets his way. This is perhaps one reason why the bank bailout seems, in terms of its aggressiveness and boldness, the least Summers-like of all the administration’s economic plans.”

    …implying that it really is Geithner’s plan and that Summers might have done something closer to nationalization/receivership.

    Wishful thinking, perhaps. But if/when Geithner’s plan fails and/or is recognized as essentially a looting operation, Geithner can go and Summers can come in and do the real cleanup via nationization/receivership.

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