I’ve gone through only the first day of testimony from the AIG bailout trial, and we are already up to our third bombshell.
The first witness called by the plaintiff, Starr International (an investment vehicle controlled by Hank Greenberg), was Scott Alvarez, general counsel for the Federal Reserve Board of Governors. Part of the testimony covered a discussion that took place late in the evening of September 15, the day Lehman declared bankruptcy in the wee hours of the morning. The topic was AIG. The participants included Alvarez, Timothy Geithner, Fed governors Don Kohn and Kevin Warsh, Ken Wilson, a senior investment banker advising the Treasury, Dan Jester, a recent ex-Goldmanite advising Treasury, and others.
One of the remedies they discussed was legislative solutions, which Alvarez states became the TARP and resolution authority in Dodd Frank.
However, notice the disconnect between what the Fed and Treasury officials were seeking to accomplish and what they told Congress and the public about the TARP.
Alvarez’s testimony makes clear that the plan was always to inject equity into the banks. But that was not what they said to Congress. The plan was called “Troubled Assets Relief Program” and was sold as a way to rescue the banks by getting toxic paper off their balance sheets.
As we said from the very time the scheme was first mooted, on September 19, it couldn’t possibly work as advertised:
Why do we need the government to create a massive and costly effort to buy paper at market prices? Institutions can sell paper at market prices now. This is clearly ether a massive game of smoke and mirrors (f we are lucky) or a plan to buy bad assets at above market prices but somehow pretend that they are indeed correct.
The latter takes us straight down the Japan path. The government is left holding lousy paper it will have to dispose of at a loss, the banking system gets subsidized not based on triage, on who might it make most sense to rescue, but who gets enough of the crappy assets sold at a high enough price. It’s a terrible, inefficient way to recapitalize the banking system. Why should taxpayers underwrite banks without getting some upside and a measure of control?
That Sunday, TARP was announced officially: a three page napkin doodle that put the Treasury secretary above the law and gave him a $700 billion blank check. Congress was still being reassured privately that the program would be used to buy bad mortgage paper, but Treasury was sorta coming clean about the subsidies. From our post, quoting a source:
I worked at [Wall Street firm you’ve heard of], but now I handle financial services for [a Congressman], and I was on the conference call that Paulson, Bernanke and the House Democratic Leadership held for all the members yesterday afternoon. It’s supposed to be members only, but there’s no way to enforce that if it’s a conference call, and you may have already heard from other staff who were listening in.
Anyway, I wanted to let you know that, behind closed doors, Paulson describes the plan differently. He explicitly says that it will buy assets at above market prices (although he still claims that they are undervalued) because the holders won’t sell at market prices.
It turns out this talk of buying toxic assets was all theater for the rubes from the get-go. The Alvarez call notes (embedded at the end of this post) and the related testimony make clear that the Fed and Treasury saw TARP as a way to inject equity into the banks. Yet the Fed and Treasury went to considerable lengths to make their toxic assets charade look plausible, including holding a conference call with analysts to discuss how the asset buying and other features would work.
They abandoned the diversionary asset purchase plan shortly after the sweepingly broad legislation was passed. The focus on toxic mortgage paper, rather than the real intent, equity injections, was presumably to distract Congresscritters and the public from asking: “Whoa, if we are providing equity, what control and upside do we get?” This was a way to avoid inconvenient questions like “Why don’t we cap pay? Fire the top executives? Replace the board?” and other things that are normally done with failing or failed institutions.
Here is the critical part of the testimony (you can read it in context starting on p. 158 of the PDF at the end). Q is David Boies, attorney for Starr, and A. is Alvarez:
Q. Now, there was another call concerning AIG that you participated in on September 15th, correct?
A. I believe so.
Q. And that took place around 10:15 that evening. Is that correct?
A. I think that’s right.
Q. And who participated in that call?
A. So, I believe Don Kohn and others. I don’t recall the entire list.
Q. Let me ask you to turn to Plaintiffs’ Trial Exhibit 65, which I would offer in evidence….And these are your handwritten notes of this conference call on September 15th, 2008, at 10:15 p.m.,correct?
A. That’s right…
Q. On the second page at the top, there’s a line that says, “Powers we would want.” Do you see that?
A. I see that.
Q. What does that refer to?
A. So, this was in — a part of the discussion this evening was about seeking legislative changes. So, these would be in that context.
Q. And the first legislative change listed here is “Treasury and Federal Reserve determine” — what’s that next word?
Q. — “for systematic reason.”
A. “Systemic reason.”
Q. “Systemic reason.” What does that mean?
A. That if there was a systemic need, there was some threat to the financial system, then the Fed and the Treasury could take certain emergency actions. This would be one of the potential legislative fixes we would seek.
Q. And if Treasury and the Federal Reserve determined that there were systemic reasons to do so, then the two legislative fixes that you identify here are, one, buy any stock, preferred or common, and any debt; and the second is resolution authority by conservatorship or receivership. Is that right?
A. That’s right.
Q. And was any request for these powers, for these legislative powers, actually made in September of 2008?
Q. When did that happen?
A. So, in September, the — Secretary Paulson led an effort to request both of these powers, and one of them actually became the TARP legislation that allowed the Treasury Department to inject capital into institutions in any form that the Treasury Department deemed appropriate if it was necessary to protect the financial system. The resolution authority was actually enacted as part of the Dodd-Frank Act later on, and that empowers the Treasury, the Federal Reserve, the FDIC to place financial institutions into resolution, and that is separate from bankruptcy.
Q. So that the resolution authority fix that you wanted was enacted in Dodd-Frank. Is that what you’re saying?
Q. And the buy any stock fix that you wanted was enacted in TARP? Is that correct?
A. That’s right.
So you can see Alvarez stating, under oath, that TARP was designed from the very outset as a way to buy bank equity. Even the reference in testimony to buying debt, in context, clearly means buying debt issued by the bank, as in having Treasury lend money in some form, say by buying newly-issued bonds of the financial institution, as an alternative to an equity infusion.
You’ll notice that the concept revolved entirely around the liability side of the balance sheet. There is nary a mention of buying bank assets, even though that was the misleading label put on the bill. The bait and switch was so egregious that Paulson was offering up explanations in October, barely after the bill had finally passed. From a 2008 post, quoting a New York Times article:
Mr. Paulson and Mr. Bernanke have been criticized for squandering precious time and political capital with their original $700 billion bailout plan, which they presented to Congressional leaders days after the Lehman bankruptcy. The two men sold the plan as a vehicle for purchasing toxic mortgage-backed securities from banks and others…
In the interview, Mr. Paulson said that even before the House acted, he had directed his staff to start drawing up a plan for using some of the $700 billion to recapitalize the banking system — something that Congress was never told and that he had publicly opposed.
Why? Because in the week before the plan passed Congress, conditions deteriorated significantly, Mr. Paulson said.
“Redirected” is now revealed to be a flat-out lie, along with pretty much everything told to the public when the TARP was being pushed through Congress.
This is yet another very big ticket example of the lesson too many people have learned the hard way in dealing with financial services industry salesmen: never, never, never believe what they are telling you. You can at most expect them to deliver on their contractual commitments. And if you read carefully, you will find that they will have described their obligations in the most vague and forgiving terms possible. You can also be assured they will take advantage of every inch of legal rope you give them, and then some.
Congress and the public took Paulson and Bernanke at their word as far as their plans for how to use the $700 billion was concerned. But you could see their real intent from the terms of the TARP itself. They refused to brook anything other than token restrictions on how they used a taxpayer-funded lifeline to reward banks and their executives* for incompetence and looting.
* Never forget that Wall Street showed its gratitude to American taxpayers by paying itself record bonuses in 2009 and 2010.