We’ve grumbled at points during the process of throwing various lifelines out to the financial sector, that media has tended to focus unduly on the TARP (no doubt encouraged by the powers that be who are eagerly pushing “the banks are fine” line) at the expense of the vast net of additional subsidies. The ones garnering least attention are the various backdoor measures, in which it is hard to tally what the real costs are.
The famed PPIP, which is largely stillborn, was an effort to disguise the level of support. No one would see how much above current market prices the trades under PPIP were (recall they HAD to be above market prices, otherwise there would be no reason for all the incentives to bidders; the banks could just unload the paper).
Another subsidy is the government (we count the Fed as the government these days; it’s acting as an arm of the Treasury) dealing with Wall Street on lousy terms. Wall Street’s gain is the taxpayers’ loss (Willem Buiter argue the Fed will ultimately need to be recapitalized rather than taking the inflationary step of printing to cover its losses). Remember all those quantitative easing purchases of MBS? Of course, we have to remember it’s not QE, the Fed likes to claims it’s something different, but let’s dispense with those niceties now. The Fed is apparently taking crappy prices on its big programs.
The question is whether the poor terms are by design (as in another subsidy) or ineptitude?
First from the Financial Times:
Wall Street banks are reaping outsized profits by trading with the Federal Reserve, raising questions about whether the central bank is driving hard enough bargains in its dealings with private sector counterparties, officials and industry executives say.
The Fed has emerged as one of Wall Street’s biggest customers during the financial crisis, buying massive amounts of securities to help stabilise the markets. In some cases, such as the market for mortgage-backed securities, the Fed buys more bonds than any other party.
However, the Fed is not a typical market player. In the interests of transparency, it often announces its intention to buy particular securities in advance. A former Fed official said this strategy enables banks to sell these securities to the Fed at an inflated price.
The resulting profits represent a relatively hidden form of support for banks, and Wall Street has geared up to take advantage. Barclays, for example, e-mails clients with news on the Fed’s balance sheet, detailing the share of the market in particular securities held by the Fed.
“You can make big money trading with the government,” said an executive at one leading investment management firm. “The government is a huge buyer and seller and Wall Street has all the pricing power.”
A former official of the US Treasury and the Fed said the situation had reached the point that “everyone games them. Their transparency hurts them. Everyone picks their pocket.”
The central bank’s approach to securities purchases was defended by William Dudley, president of the New York Fed, which is responsible for market operations. “We believe that opting for transparency is a greater good,” he said. “If we didn’t have transparency, we’d be criticised on other grounds.”
However, another official familiar with the matter said the central bank “has heard that dealers load up on securities to sell to the Fed. There is concern, but policy goals override other considerations.”
Barney Frank, chairman of the House financial services committee, said the potential profiteering may be part of the price for stabilising the financial system.
“You can’t rescue the credit system without benefiting some of the people in it.” Still, Mr Frank said Congress would be watching. “We don’t want the Fed to drive the hardest possible bargain, but we don’t want them to get ripped off.”….
Larry Fink, chief executive of money manager BlackRock, has described Wall Street’s trading profits as “luxurious”, reflecting the banks’ ability to take advantage of diminished competition.
“Bid-offer spreads have remained unusually wide, notwithstanding the normalisation of financial markets,” said Mohamed El-Erian, chief executive of fund manager Pimco in Newport Beach, California.
A separate but related sighting from Roger Ehrenberg, who makes a point that few commentators have stressed: the “paying the TARP back” meme, which is somehow treated as a sign of government success, is in fact an abject failure. The TARP support was badly underpriced. And he doesn’t mean the dickering over the warrants, either.
What we have is a return to business-as-usual. Except it’s worse than that. The US taxpayer has been systematically looted out of hundreds of billions of dollars, yet the press is focused on Andy Hall and his $100 million payday. Whether this is too much pay for Mr. Hall misses the big picture. Yes, the Wall Street pay model is messed up, and I recently provided an alternative approach. But how about the fact that Goldman Sachs is posting record earnings and will invariably be preparing to pay record bonuses, not nine months after the firm was in mortal danger? Whether anyone will admit it or not, without the AIG (read: Wall Street and European bank) bail-out and the FDIC issuance guarantees, neither Goldman nor any other bulge bracket firm lacking stable base of core deposits would be alive and breathing today.
Goldman is a great firm with a stellar culture, and in most circumstances it’s risk management and funding practices have been second to none. Except when the crisis hit. It stood with the rest of Wall Street as a firm with longer-dated, less liquid assets funded with extremely short-dated liabilities….In exchange for giving the firm life (TARP, FDIC guarantees, synthetic bail-out via AIG, etc.), the US Treasury (and the US taxpayer by extension) got some warrants on $10 billion of TARP capital injected into the firm. While JP Morgan Chase CEO Jamie Dimon prefers to poke a stick in the eye of the Treasury, seeking to negotiate down the payment to buy back the TARP warrants, Lloyd Blankfein smartly paid the full $1.1 billion requested. He looked like a hero for doing so, a true US patriot repaying the US Government in full for its lifeline, thanking the US taxpayer in the process. $1.1 billion… $1.1 billion…Hmm…something doesn’t seem right. You know why it doesn’t seem right? BECAUSE THE US TREASURY MIS-PRICED THE FREAKING OPTION.
There is not a Wall Street derivatives trader on the planet that would have done the US Government deal on an arms-length basis. Nothing remotely close. Goldman’s equity could have done a digital, dis-continuous move towards zero if it couldn’t finance its balance sheet overnight. Remember Bear Stearns? Lehman Brothers? These things happened. Goldman, though clearly a stronger institution, was facing a crisis of confidence that pervaded the market. Lenders weren’t discriminating back in November 2008. If you didn’t have term credit, you certainly weren’t getting any new lines or getting any rolls, either. So what is the cost of an option to insure a $1 trillion balance sheet and hundreds of billions in off-balance sheet liabilities teetering on the brink? Let’s just say that it is a tad north of $1.1 billion in premium. And the $10 billion TARP figure? It’s a joke. Take into account the AIG payments, the FDIC guarantees and the value of the markets knowing that the US Government won’t let you go down under any circumstances. $1.1 billion in option premium? How about 20x that, perhaps more. But no, this is not the way it went down….
Where we are left today, dear taxpayer, is a lot poorer. Unless you are a major shareholder and/or bonusable employee of Goldman Sachs. Brains, ingenuity and value creation should be rewarded in all fields, Wall Street included. But when value created is the direct result of the risks borne by others for your benefit, the sharing of benefits needs to be re-allocated. This has not and apparently will not be done, and we, dear taxpayer, are the worse for it. Further, such a crisis could have provided the opportunity and the impetus for a re-look at capital markets risks, getting CDS users to support a central credit derivatives exchange and revised capital rules to incentivize better gap management. The banks lobby like hell against these changes, because it cuts into their fees, notwithstanding the systemic benefits such changes could have on the global financial markets. Banks now lobbying with US taxpayer dollars against changes that could protect the US taxpayer from more harm in the future. Something is terribly wrong with this picture, yet all anyone wants to talk about are executives getting paid too much. It’s called missing the forest for the trees, and it is a fixture of both those trying to sell newspapers (get clicks) and run our Government, and it pisses me off.