Where’s My Bailout? The Feeding Trough May Not Be Bottomless, After All

Many years ago, when I was in business school, one of the courses was taught by George Cabot Lodge. He said he could remember distinctly the day in 1968 that it occurred to him that the US could not simultaneously end poverty, send a man to the moon, and fight a ground war in Asia, that there were limits to what the US could do.

Similar doubts are allegedly crossing the minds of the bailout overlords, or perhaps this is an excuse to draw the line with non-financial supplicants (but having allowed American Express, clearly NOT a systemically important player, to form two bank holding companies so as to get access to cheap funding, I don’t see how Detroit can be told “no”). We have said before that the Fed cannot shore up the entire financial system, or keep it from deleveraging. The Fed and Treasury have consistently endeavored to save the current institutional architecture, when that is clearly rotten, rather than try to salvage (in some fashion) the critical activities that those firms perform. Note that many of the same firms would still recapitalized, but the posture towards them would be very different. The authorities would have a clearer vision of who and what they were saving and why.

One problem appears to be that by being unduly generous with the TARP. The terms on offer were far better than those from investors like Warren Buffet, when the time-honored Bagehot principle is to lend generously, but at a penalty rate. Suddenly a host of the needy has shown up wanting similar terms, and the authorities oddly feel compelled to be fair (the whole point of having power is that you get to be capricious).

The Wall Street Journal says today that the government plans to start saying no, allegedly out of necessity (but the necessity of scarce resources should have been apparent from the outset and led to more measured responses):

The U.S. government’s financial-system rescue plans are coming under pressure as a growing array of distressed companies signal the need for assistance.

On Monday, mortgage giant Fannie Mae said it is losing money so rapidly it may need a cash infusion from the Treasury Department by year’s end. The funds would come from a special $100 billion pool Treasury set aside back in September to aid the company. Fannie Mae had a loss of $29 billion for the third quarter…

General Motors Corp., which has been lobbying heavily for government aid, said Monday it might violate the terms of some of its debt by the end of the year…

The Treasury has committed all but $60 billion of the first $350 billion in funds granted by Congress under the TARP plan.That sum remains after accounting for Treasury’s planned investments in the banking sector and Monday’s additional $40 billion investment in troubled insurer American International Group Inc.

Yves here, This is no surprise. The whole point was to spend the dough before regime change, and with the possibility of an Obama victory, that meant dispensing as much as possible before the election.

The rescue efforts are “evolving in ways that I don’t think anyone anticipated,” said Camden Fine, president and CEO of the Independent Community Bankers of America, a trade group. “Things are just hitting them from every single direction, every day, and I don’t think they know whether to spit or go blind.”

Yves here. This is disingenuous. Recall that some of the nine banks that received equity infusions did not want it, others did not need it, but they were all force fed allegedly so as not to taint the ones who really needed it. Similarly, American Express, as we indicated in an earlier post, is simply not an essential financial player (and they are not at risk of going under, either)

Back to the Journal:

The additional life jacket for AIG — plus the thrashing from Detroit — makes it increasingly likely that Treasury Secretary Henry Paulson will turn to Congress for the second half of its promised $700 billion….

The Treasury secretary is likely to face a hostile reception from lawmakers angry over Treasury’s reluctance to aid the auto industry as well as its decision not to force banks receiving government assistance to lend out those funds to consumers and small businesses…

All the woes could undermine prospects for one possible Obama cabinet appointment: Federal Reserve Bank of New York President Timothy Geithner. Mr. Geithner, a former Clinton administration official widely viewed by top Democrats as a pick for Treasury secretary, has been a main player in the government’s financial bailouts this year…

Sen. Charles Schumer of New York said lawmakers want Treasury to put in place new requirements to encourage lending and to focus the program on struggling, not healthy, institutions. Mr. Schumer also wants Treasury to widen the scope of the program to include a greater variety of financial firms.

“My concern is that in its desire to be inclusive that Treasury didn’t set up enough criteria and made it too easy for healthy financial institutions to come to the window, get capital, and hoard it or use it for mergers,” Mr. Schumer said.

The Senate Banking Committee wants to see Treasury provide more help to struggling homeowners. It also wants to induce banks receiving federal funds to lend money to consumers and business, and it seeks new restrictions on bonuses for financial firms that receive the capital injections, according to a congressional aide.

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  1. Anonymous

    Thank you for this posting. The ongoing looting of the curency is criminal. To think that it will not be prosecuted as such is depressing.

    Can I stop paying taxes now?

  2. eh

    Well, it is bottomless:

    To which I say, pshaw! If the U.S. were ever to arrive at such a situation, here’s what I’d recommend. First, have the Federal Reserve buy up the entire outstanding debt of the U.S. Treasury, which it can do easily enough by just creating new dollars to pay for the Treasury securities.

    This is how I understand it: the Fed can create as much money as it wants out of nothing more than the legal authority to do so, which they have. And Bernanke has clearly shown he’s a lot more interested in rescuing banks and the economy — as he sees it — than in protecting the soundness of the dollar. Which consists of what? Of the willingness to accept it as ‘legal tender for all debts public and private’. And what is the ‘full faith and credit’ of the US based on? The ability of the US government to coerce taxes. I don’t really see either of these pillars of support for the dollar — crude as the latter is — being at risk. This is why when the Treasury goes to sell debt it finds plenty of willing buyers, even today. Will that change? No idea. If it looks like the administration and the Fed think they can do and get away with anything, then this is because so far they’ve been right — they can. With the help and support of Congress.

  3. rahuldeodhar

    The funny thing is how people expect that all these bailouts are free! There is a cost to these bailouts and I am not sure how it is going to accrue. higher inflation? – may be Jim Rogers has a point – the money is going to get somewhere.

    Or is it going into saving accounts. People fatten up their accounts is good sign – but if they are doing it now then bailouts are going to be useless.

    The Keynesian way seems to be only way out – the way China wants to do it. Create infrastructure! I just hope they open their markets and not close them else there will be another problem.

  4. Richard Kline

    The whole point of the WSJ piece is to shape the space of debate so that workers and public works projects can be redlined after financial system acme predators eat up all the money. This was always the Paulson way; I mean, he’ll be out of a job in 70 odd (very odd) days. Spend down all of the marginally appropriate borrowing authority of the state giving money gifts to the financial industry, then when a new Congress comes in looking to bailout GMs workers and their pensions, pass a health care systemic reform, and spend into infrastructure build out to say, “We regret to inform you that the state is borrowed out. ‘Tis a pity the peasants are outside the castle’s redline, what with zombies running amok. Better move along.”

  5. Jojo

    @rahuldeodhar said “The funny thing is how people expect that all these bailouts are free! There is a cost to these bailouts and I am not sure how it is going to accrue…”

    I don’t think people understand money these days, how it is created, etc. We believe we can borrow forever. But as you say, someone is going to pay for allof this and that is the young people and children going forward for generations ahead.

    Take Calif for instance (where I live). Even though we have at least a $14 billion budget shortfall, the Governator is asking for new taxes (which isn’t going to happen this year), the people of Calif. still went out this past election and approved new bond issuance for a high-speed rail plan, children’s hospitals and veteran’s housing loans (possibly others also).

    The majority of voters do not give a thought to the fact that any government bond issue typically costs 2x the face value of the bonds and they only get 1/2 the value.

    I think the MSM and all bloggers should start replacing the word “government” with “taxpayer”. Then people might start getting the idea that government spending comes out of the pockets of the taxpayer!

  6. River

    If the bailouts were to cease and the economy allowed to cleanse itself, as prescribed by Mellon in the great depression, going forward we would have sound companies with sound biz models.

    The bailouts are extending the lives of companies that were ‘dead men walking’ in the good times, much less now.

    The bailouts are also extending the lives of big financial institutions that became big with securitazation models that will probably never return.

    What will the US economy look like after the train wreck is over? Do we want a few big companies and financial institutions with poor management and poor biz models, dominating the economy? Or, would we be better served by letting these institutions go the way of the dinasaurs?

    I think we are bailing out the wrong institutions, if any need be bailed out at all.

  7. Anonymous

    the whole point of having power is that you get to be capricious

    Okay, I’m going to go tear down my “Yves for President 2012” signs right now. :)

  8. Stephen


    So what was the day he realized it? Was it a specific incident or day that triggered it?

    Sadly, GWB reminds me of LBJ. Has GWB said no to any spending program, or wasnt it a consistent, tell me what you need and then the taps were opened?

  9. Anonymous

    i was talking with George Cabot Lodge many years ago and he told me to get my feet off the coffee table…..

  10. Dave

    “I don’t think people understand money these days, how it is created, etc. We believe we can borrow forever.”

    Absolutely correct Jojo.

    Most have no understanding. Most probably do not understand the “borrow into existence” credit expansion mechanism and certainly cannot fathom the truly adverse consequences of B52 Ben cranking up the printing presses. Welcome to Weimar.

  11. William Mitchell

    Given the rate of expansion, we seemingly poison the well of Treasury bond demand before the end of 2009.

    A historian like Bernanke may think high inflation solves the mortgage problem by shrinking the value of principal relative to everything else. This erroneously presumes workers have wage bargaining power, as they did in 1935 or 1975.

    Today, thanks to global labor competition, there is no reason to believe wages would rise under conditions of high inflation. Everyone would just get poorer.

  12. Carlosjii

    re: Richard Kline @ 5:33 I recall Clinton staffers saying the Bush 1 people had removed the light bulbs from the WH offices as they left

  13. doc holiday

    Does The Fed still have cash for Harley — we need to help Hell’s Angeles and support them too ASAP!! The clock is ticking and the hogs are hungry!!

    The Rating Outlook is Negative. Fitch’s actions affect $3.2 billion of debt at HDFS and $175 million of debt at HOG. Due to the existence of a support agreement and demonstrated support by the parent, HDFS’ ratings are linked to those of HOG.

    The rating action is driven by HDFS’ declining operating performance, reduced financial flexibility, and deteriorating asset quality combined with declining sales and weaker margins at HOG.

  14. S

    rahuldeodhar said…

    Kenyesianism = borrowing. See River/Jojo comment.

    Liquidate it all. Mellon was right. we are going to have the pain anyway, only now the rotting corpses get to stick around. Looks a lot like the Obama administration and the Bush adminsitration and the entire DC complex. Failure begets promotion. Made in the USA

  15. whistlingpastthegraveyard

    I have been amused by many of the analyses of Obama’s policy ideas, which sanctimoniously warn that he must find the money to pay for these $5 billion and $10 billion programs–while nobody bats an eye about paying for all these enormous bailout efforts.

    eh: If I were a foreign creditor, I would not want to rely on the US government’s ability or willingness to coerce taxes. Taxes are politically toxic. Another going-away present from the conservative movement.

  16. Simon

    eh's comment is spot on about the powers of the printing press. In order to see how this will play out, you have to consider that the members of the Fed are bureaucrats whose major fear is of doing something unconventional. Better to fail conventionally than succeed unconventionally, as Keynes put it. The conventional wisdom is that the government must take vigorous action to avoid deflation. Money from helicopters. That is, the Fed is more than willing to monetize any amount of fiscal deficit so as to keep interest rates down–this is powerful stuff. Will the Congress be willing to run a big deficit? Is the pope catholic? Does the sun rise in the east? All politicians love to spend money and cut taxes at the same time. You betcha Congress will do just that. The Republicans will make noises about irresponsible Democrats imposing an intolerate burden on future generations, etc, etc. But I doubt those Republicans are going to filibuster universal health care. More than likely, they'll just insert enough provisions to protect insurance companies that the final result is far more expensive than it should be. So we'll get a bigger deficit. The massive fiscal stimulus, together with Fed accomodation in monetizing it all, should ensure that there will be no lost decade like in Japan.

    Once the economy rights itself, there will be massive inflationary pressure. Here again, we need to consider the conventional wisdom, which is that low inflation and inflation fighting credibility is important. Bernanke is very outspoken about this. So either the Fed will have to raise rates sky high, or the Congress will have to close the fiscal deficit by either raising taxes or cutting spending. Which is more likely? My bet is on sky-high interest rates, as in 5% real. This will crush stocks, real-estate, commodities, long bonds and all other assets other than cash. Prices on stocks, for example, will have to fall about another 50% from where they are now (S&P500 about 880) for the risk-adjusted return to match a risk-free 5% real rate on t-bills.

    Bottom line for investors. Cash is going to be king for many more years.

  17. Anonymous

    Yves, AmEx “…are not at risk of going under”

    What you said about AmEX is not correct, AmEX is and was in very big trouble the spread was 825/775 on Oct 29. Spreads over 700 are likely default.


    AmEx’s business model is broken.

    Whether they are systemically important, is debatable.

    If AmEx went chapter 11, the market would not react well.

    The ties the hold the system together aren’t readily apparent. Who has exposure to whom is up for grabs. If AmEx paper fails the money markets, hedge funds, banks, pension funds, would take large hits. AmEx has 75 billion in long term paper, so if you add in a few more billion in CDS exposures, the bill could be quite large.

    An AmEx Failure would be felt.

  18. Yves Smith

    Anon of 3:23 PM,

    Upfront payment on CDS is a sign that the CDS market thinks default is likely. I have seen no indication anywhere that Amex CDS are trading on an upfront basis. CDS are usually faster to register worries about distress than cash bonds and are seen as the more reliable proxy, which are far less liquid.

  19. Anonymous

    The unmitigated gall of the US financial ruling class is stupefying, i.e., the incompetent financial bunglers are made whole to the tune of $2.25 trillion taxpayer dollars while the politicians only grouse about mere details. The sense of entitlement by the bankers with full support by Bernanke and Paulson makes bank robbers look wholesome. The Federal Reserve should be renamed for what it truly is: The Bankers Fund.

  20. HMDMSR

    There is no scarcity of resources. As with all crises of capitism, this is one was born from the chaos inherent in the market system. Organize. Seek an alternative.

  21. Jim

    I support a bailout with strings attached. Sell all but one of their corporate jets. 90% cut in wages for the top 5% of their employees- no severance packages for CEOs or board members whom are responsible for this mess. 10 % cut in every other employee to show that they are contributing to helping the company stay afloat. Keep it this way for 5-10 years depending upon sales.

    They must actually start using the money Governments have offered them on research and development. They must also commit to building all the new eco-friendly and fuel efficient vehicles in Canada, U.S.A. or whomever is giving them the most bailout money.
    We must also establish a minimum amount of jobs they will ensure for a set time period for "X" amount of government "welfare". I wrote an opinion piece in the spring in the Peterborough(Ontario) Examiner warning of this disaster. I put the blame where it belonged- C.E.O.s of the big 3 & wasteful lowering of corporate tax levels without getting something back!

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