Guest Post: Big Banks Pull off the Ultimate Bait & Switch

Submitted by Rolfe Winkler, CFA, publisher of OptionARMageddon

We’re not quite as healthy as we thought we were. Oops. (WSJ)

J.P. Morgan Chase Chief Executive James Dimon said…that March was a little tougher than the first two months of the year….Bank of America…CEO Kenneth Lewis also said that March had been a tougher month for his bank. [Convenient that they dumped this on Friday afternoon, and at the close of a very good week].

Readers may recall that a few weeks ago, Dimon and Lewis—along with Citi’s Vikram Pandit—said the first two months of the year had been very good:

Pandit, March 10th: “We are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007.”

Dimon, March 11th: “Jamie Dimon, the chief executive of JPMorgan Chase, said Wednesday that the bank was profitable in January and February…”

Lewis, March 12th: “We have been profitable for the first two months of the year,” Lewis told reporters after a speech in Boston today.

This was possibly the most nakedly self-serving bullshit the big bank CEOs have offered to date. (“bullshit” being a technical term of course, see Harry Frankfurt)

By February, it was understood that the big banks are all insolvent, certainly Citi and BofA. To deal with them, consensus among the cognoscenti was finally tending to a proper recapitalization: wiping out shareholders and forcing losses onto creditors via debt-for-equity swaps. Call it nationalization, call it preprivatization, call it FDIC receivership, it was clear that losses had to be recognized and by those to whom they properly belong: investors across the capital structure.

But no one really wanted to do this, not in Congress and certainly not in the Obama administration, where Timmy Geithner has made clear that his priority isn’t a cleansed banking sector, it’s a privately-owned one. For obvious reasons the banks don’t like this solution either. So they offered up their self-serving b.s. regarding January and February, buying just enough time for Congress/Bernanke to badger FASB into changing mark-to-market rules and for Geithner to roll out his private-public partnership plan.

Now whatever losses the banks can’t hide with revised accounting treatments, they can simply fob off on taxpayers via the partnerships. They got what they always wanted: A bad bank. An entity that will actually absorb losses from the asset side of the balance sheet. Shareholders and creditors don’t have to worry about further writedowns, not the ones that can’t be hidden anyway. Taxpayers will pick up the check!

Even better, the Geithner plan is so ridiculously complex—and public disclosure is likely to be so minimal—that toxic asset transfers are likely to happen largely out of view. Maybe Treasury will have to increase its borrowing substantially in order to fund the losses, but by that point everyone will be celebrating that banks have started lending again. Hooray!

By the way, are there ANY substantial protections to prevent banks from gaming this plan? What’s to stop them from acting as the equity investors in the partnerships, ponying up a sliver of equity to effect a transfer of toxic assets from their own balance sheets to the public’s? The FDIC’s FAQ for the legacy loans program doesn’t even address this particular Q. Is it not being frequently asked?

This is all of a piece. The longer CEO/policy-maker collusion can delay loss recognition, the more time they have to invent ridiculous leverage schemes (more money printing! more government borrowing to fund “stimulus”! more FDIC “guarantees”!) to inflate those losses away….and to continue looting the public’s wealth.

But losses aren’t going away. Trading smaller private liabilities for larger public liabilities in order to artificially inflate asset prices does nothing to repair the economy’s aggregate balance sheet. At the end of the day, we’re still just lending more and more against a dwindling pool of real equity. The unwind is coming. Adding more leverage to delay it will only increase the pain.

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  1. Nemo

    By the way, are there ANY protections to prevent banks from gaming this plan?

    Yes. The Legacy Loans Term Sheet says:

    Private Investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF.

  2. doc holiday

    Anyone else watching short term Treasuries crash?

    3-month now at .10% and falling like a pre-TARP dive to zero; it was 0.27% a month ago.

    I know this info below is a tad old, but, back in August it was right on the money and IMHO, will be right again:

    “Years ago, Larry Williams used to look for a situation he called the Jaws of Death —noting that when bond prices were weakening but stock prices were strengthening, the two differing trends opened a set of "jaws" that tended to snap shut, usually due to abrupt weakness in stocks.

    He points to expectations for lower volatility in the stock market (measured by the VIX index) at a time when credit markets are getting more worried. See the chart below:

    Those jaws could be setting markets up for a tough reckoning. Let's give Hussman the last word:

    In short, the markets are presently trading on a theme that largely overlooks the potential (and in my view, the reality) of a significant U.S. recession. At the point of recognition, we may very well observe abrupt weakness in both stock prices and the U.S. dollar."

    >> Nemo, what are you doing here?

  3. Rolfe Winkler, CFA

    Nemo. Thanks. That’s something at least. Though can’t banks just engage in mutual back-scratching? “I’ll vacuum up your legacy loans if you take care of mine…”

    And of course, private investors in bank credit might be willing to lose a little in one of the partnerships in order to protect their credit investments.

    Bill Gross has been arguing vociferously that we must “support asset prices.” As one of the world’s largest credit investors, he’s next in line to absorb losses after equity gets wiped out. So of course he’s in favor of this plan, and will use it to transfer risk from his own balance sheet to Uncle Sam’s.

  4. ruetheday

    Doc – I think you read my mind. I am very much in fear of a "Black Monday" type event. Over the course of 13 trading days, from 3/10 through yesterday, the DOW is up 21%, S&P is up 22%, and NASDAQ is up 25%. Yet what exactly has fundamentally changed over the past two and a half weeks? Nothing. Some BS announcements from bank CEOs and a dubious Treasury plan. We could see the markets erase those gains in a 2-3 day span and then continue much lower. Maybe not next Monday or the following Monday, but at some point over the next few weeks it is very likely to occur.

  5. doc holiday


    I’m kinda bored with trading data and keeping on top of all this crap lately, but it would be worth noting what Treasury yields have been doing during this short-term 21% spike. I really should care less of the market goes up 2000 points or down 2000, I just don’t have any faith in these retards and crooks. I keep thinking Obama is gaming the market and has taken over the PPT (Plunge Protection Team) switch, which Paulson and Team were so adept at flicking on and off …. I also would like to see where VIX is at and the dollar and things like that.

  6. Anonymous

    Geithner's plan is sheer genius. The bank executives have earned their bonuses again. Here is what I would be doing if I were Citi.

    Step 1: I would set up a new entity, say a Structured Investment Vehicel (SIV) and call it $chiti. I doubt the banking regulators will think there is anything strange with this name.

    Step 2: I would place 10 billion dollars of TARP funds into $chiti. This money, which the government gave Citi, comes in handy for setting up these off balance sheet companies.

    Step 3: I would instruct my lackey at $chiti to bid on $250 billion dollars of bad assets in Citi. These assets are not worth $250 billion, that is their face value. That means, that Citi paid $250 billion dollars to buy these assets. The problem is they are only worth between 7 and 10 billion dollars. $chiti would not bid $250 billion dollars for these gems. No, anyone could tell these mis-understood assets must be worth at least $300 billion dollars. So $chiti places a bid for $300 billion dollars.

    Now at this stage, one of two possibilities can occur. Some fool may bid more than $300 billion for the bad assets at Citi, or option 2, $chiti wins the bid and gets the assets.

    Let's go with option 2 first. $chiti wins the bid, and now needs to come up with $290 billion dollars (remember it only has $10 billion in it right now) to buy Citi's bad assets. This is where the government comes in. Tim's plan lends and "invests" the other $290 billion.

    So, now at Citi, I make $50 billion dollars of profit as I get $300 billion for assets that were originally worth $250 billion.

    $chiti does not fair quite so well, as the assets it bought are worth no more than $10 billion dollars. So over time the loan the government gave me through Mr. Geithner goes bad, and $chiti goes bankrupt. Unfortunately Citi loses its $10 billion investment in $chiti.

    So to recap. I get to shift $250 billion dollars of stuff that is probably worth only $10 billion dollars, to you the tax payer. Citi gets a $50 billion dollar profit from the sale, and $chiti gives Citi a $10 billion dollar loss. As a result I (Citi) make $40 billion dollars. Not bad, and definitely worth a $1 billion dollar bonus for engineering that plan.

    Now let's look at that first option. Someone else bids more than $300 billion for Citi's assets. I know it is unlikely, but you never know. Assume they bid $310 billion. Well then, Citi makes $60 billion in profit and it quietly shuts down $chiti and takes back the $10 billion in it. So overall I make $60 billion in money (the $10 billion coming back from $chiti does not count as profit it is really just moving an asset).

    So either way, Wall street can now engineer enormous profits for this year. Bonuses will be back with a vengeance. Everyone is happy. Until that tax bill comes due.

    In reality Citi won't be so blatant as to buy their own assets. They will collude with other banks, hedge funds, & private equity groups to set up a shell game of deals to launder the money from the public;s view. Each pig will get to feed at the taxpayer trough and ensure fat bonuses for everyone in the financial industry again this year.


  7. Nemo

    Rolfe —

    Yeah. There are still many ways the banks and other entities (especially bondholders) can game this plan. I think these folks are going to loot the taxpayer without so much a single vote in Congress.

    But as you say, at least it’s something.

  8. ruetheday

    I’m also more concerned with the rally in oil prices as a result of this misguided optimism. At the end of the day, the pinch at the pump affects more people (as well as the economy broadly) than blips in the stock market.

  9. FairEconomist

    Private Investors may not participate in any PPIF that purchases assets from sellers that are affiliates of such investors or that represent 10% or more of the aggregate private capital in the PPIF.

    Hmm. 10% each from BoA, Citi, GS, MS, WF, and Mellon. Throw in 4 hedge funds strung out on MBS and it’s a go! Face value bids, no problem!

  10. Anonymous

    Hmm. 10% each from BoA, Citi, GS, MS, WF, and Mellon. Throw in 4 hedge funds strung out on MBS and it’s a go! Face value bids, no problem!


    Yup, the new “club deal”. the old one was pe funds pooling resources to do an acquisition; the new one is banks/funds pooling resources to dilute their interests.

  11. Mannwich

    This is becoming a true tragic farce. They can say or do anything they want. There are no repercussions, so why not? Can’t blame ’em for trying in this little Banana Republic of ours.

  12. Lucifer

    What could go wrong?
    Bank of America May Raise Investment Banker Salaries (Update1)

    By Jacqueline Simmons and Josh Fineman

    March 27 (Bloomberg) — Bank of America Corp. plans to increase some investment bankers’ salaries by as much as 70 percent following the takeover earlier this year of Merrill Lynch & Co., people familiar with the proposal said.

    Bank of America, which has received $45 billion of taxpayers’ money, may raise the annual base pay for some managing directors to about $300,000 from $180,000, said the people, who declined to be identified because the final numbers are still under discussion. Salaries for less-senior directors would climb to about $250,000 from $150,000, and vice presidents would get $200,000, up from about $125,000, the people said.

  13. Rolfe Winkler, CFA

    Speaking of banks gaming the PPIP, according to WSJ:

    “Federal Deposit Insurance Corp. Chairman Sheila Bair said Thursday she would be open to letting banks see some of the profits if they dump problem loans that ultimately recover some value….

    Ms. Bair said banks might be able to take an equity stake in those funds as partial payment for their loans, which would give them a payoff if the loans ultimately rise in value and would provide bankers with more incentive to sell troubled assets.

    “We’d be open to comments on that,” Ms. Bair said.”

    I just don’t like the sound of that…

  14. Anonymous

    As I recall, when the first, rosy assessments of performance were made a while back, they followed news by a couple of weeks that bank executives personally had loaded up on the stock of these institutions, Citibank specifically. Then came Pandit’s announcement and up shot the price. What are we to look for this time, that they’ve liquidated recently?

    I’m entertained watching the recent reports of housing “turn-arounds”. I’m equally entertained by reports that the “surge” worked in Iraq when all that was achieved was to send 30,000 bursars there to put 100,000 Sunni insurgents on the payroll. I see reports this week that significant violence has returned to Iraq as complaints surface that the Iraqi government, who now is to handle these payments, isn’t making them. That’s the kind of housing “turn around” we’re about to experience.

  15. Alex

    Great guest post. I appreciate your views. I wonder though, how long this little papering over exercise will last? If it buys them enough time, it could actually lead to another crisis down the road. Or will it unravel in a few months, leaving us the job of really overhauling the financial system?

    I think the latter, just because the numbers bandied about do not look like enough to really make a big difference. I think by end of summer, maybe sooner, we will see things getting bad again.

    Frankly, I don’t know if I want to be wrong or right on this one.

  16. Anonymous

    But…. But…. DeLong says that we musn’t worry about financial pirates and their Cayman Island accounts! According to him, that would interfere with reforming the financial trades! And look at the man’s track record — praising Maestro Al, talking up his pal Timmy Geithner — DeLong is plainly a guy who knows the score!

    Wasn’t DeLong recently invited to squawk before some Congressional bloggers-invite tribunal, while the proprietor of **this** site was excluded? Talk about a travesty…

  17. Anonymous

    100% accurate.

    This is the same economy we had before the crisis. The problem of shrinking purchasing power had been hidden under a blanket of credit. Resuming credit allowance without fixing the problem of lost jobs and growing trade deficit will bring us full circle and the recession will creep up again, worst off this time since we’ll have no one to bail out the former bailed out nor the current debt holders (the US).

  18. Anonymous

    Rolfe Winkler, CFA said…

    Nemo. Thanks. That’s something at least. Though can’t banks just engage in mutual back-scratching? “I’ll vacuum up your legacy loans if you take care of mine…”

    Rolfe, you didn’t read all the Treasury white papers on PPIP before writing about it?

  19. Juan

    To note, Q4 corporate profits [not earnings] fell at the fastest rate in 55 years according to an FTAlphaville post.

    So, a few numbers from the BEA:

    – ‘Domestic profits of financial corporations decreased $178.7 billion in the fourth quarter,
    compared with a decrease of $75.5 billion in the third.

    – ‘Domestic profits of nonfinancial corporations decreased $89.1 billion in the fourth quarter, in contrast to an increase of $52.1 billion in the third.

    – ‘Profits before tax decreased $499.2 billion in the fourth quarter, compared with a decrease of $56.3 billion in the third.

    – ‘Domestic profits decreased 16.0 percent [for 2008], compared with a decrease of 7.4 percent [in 2007].

    – ‘The rest-of-the-world component of profits increased 12.2 percent, compared with an increase of 28.9 percent.

    No doubt an already weakening rate of profit, as profit relative to total capital [p/v+c], truly fell off a cliff. All the more cause to loot that wonderfully giving taxpayer.

  20. NHF

    It seems to me that Frankfurt doesn’t get the analysis of “x is an instance of bullshit” quite right. Some of the papers in _Bullshit and Philosophy_ are pretty good on this.

  21. Anonymous

    The political wildcard in the Geithner plan is the role of the FDIC. Correct me if you think I am wrong but when the public begins to get the word that the FDIC is being bankrupted, the plan will crumble or the FED will confront a real banking crisis.

  22. DownSouth

    Great post!

    I also very much enjoyed the tutorial video on your website explaining how the banks can game the system.

  23. Dave Raithel

    Anon of 1132pm (Friday): I have read through this link –

    and then those at the bottom of that page. I don’t see anything which answers Winkler’s question. The 10% solution would seem to prohibit the scheme suggested by Oliver and illustrated in the link submitted by Keene – but FairEconomist has the work around?

    So if you can cite the specific language that would prohibit the kind of gaming anticipated in the comments to Yves Smiths earlier post on Citi/BofA hoovering up bad MBSs, (which anticipated Winkler’s question) please share it. Not everyone who reads here is in this for a living, and so what’s clear to you for your familiarity with use of language may not be so to those of us following this as an avocation ….

  24. Anonymous

    On the FDIC FAQ:
    PPIF Public/Private can you spell *capture?*
    We’ve had similar experiences with our local government. We called it the FUQ…the Freq. Unanswered Question.
    word verify: *ionoxial*

  25. oliverks


    With a little “creativity” you can work around the Treasury requirement.

    I agree it would be hard to do in a completely above board way due to the limited number of trades that would take place.

    However these days no one seems to mind if competitors “talk” and as such it is fairly simple to envision a system where the rule can be circumnavigated.

    Even without collusion it would be possible to work around the problem, but it would be much harder.


  26. Anonymous

    Loss recognition will be delayed until they are fully transfer to the tax payer. Then they will be recognized. Of course by the the shares of all these banks will soar because they will have only good assets. I guess Obama is just a Bush of the same feather

  27. Anonymous

    “The same Aholes that destroyed CR’s website are migrating here…”

    I noticed that too. As recently as six months ago the CR comments were interesting and informative. It’s become a Yahoo! message board now.

  28. Eric L. Prentis

    All these bankers are crooks and support Timmy Geithner’s plan to have the taxpayers pay for their sins, and consequently, bailed out financiers will unfairly continue to live in luxury during the coming depression while the average person gets screwed to the wall, and adding insult to injury, these disgusting human beings disingenuously spout ideological hokum about individualism, responsibility and the sanctity of free markets. Our slimy, on-the-take politicians, including you President Obama, continue to bend over backwards to help these looters, instead, lets put a few in jail. Where is the justice.

  29. Anon1

    One thing that should pop the ridiculous (current) stock mini-bubble will be the coming failure of the G20 meeting to come to any real agreement on anything.

    I am hoping that Merkel sticks staunchly to her guns, that France stick to its guns, and that Gordon Brown stick to his so that nothing will come of the meeting, Gordon Brown will be toast in the coming elections, and, if there is any justice, Obama will blink and give into Germany/France’s demand of REGULATION FIRST AND FOREMOST over spending.

    Obama and his wrecking crew are absolutely wedded to getting the same old corrupt and defunct system going again, sans any real changes, while the French and Germans are demanding REAL change: no more freedom for thieving by the finance industry.

    Seriously, it is time to force finance to its proper place, BELOW that of the state, and by extension (in theory), below that of the People.

    We need a new paradigm that REQUIRES social responsibility in economics above all else. It must be taught and taught and taught that greed is NOT good, that it is always and everywhere a character flaw and, if one is religious, one of the seven deadly sins. ALL economic decisions must first and foremost be evaluated for what they will do socially. If the result of some financial plan or policy or regulation would harm many and enrich but a few, then it must be rejected out of hand.

    In any case, when the G20 comes to nothing, there will be a drop in the market.

  30. Anon1

    As for BoA planning to raise salaries to avoid punishment/taxation of bonuses…so lets increase the top marginal tax rate and include ALL income of ALL kinds as taxable in the top two tax brackets.

    Close any and all offshore tax loopholes to boot. Don’t allow the robber barons to get away with any untaxed (heavily) thin dimes.

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