Junk By Any Other Name Would Smell

The Treasury this week disclosed details of their plan to pump $1 trillion into the financial system by removing “Legacy Assets” from the balance sheets of banks. Wading through the multitude of documents and documents, I’m reminded of a remark by Michael Milken in a conversation with Charlie Rose on October 27, 2008 “Complexity is not innovation.”

Since its inception, the plan has been sold to Congress and the media as one with potential positive payoffs for the public coffers. To support this idea, proponents point to the experience of the Resolution Trust Company (RTC) in resolving the Savings and Loan (S&L) Crisis. Back then, RTC took over failing S&Ls – some of which were bankrupted by bad real estate loans made worse when they were forced to sell off below-investment grade bond assets – the by-now-well-known Junk Bonds.

Selling off today’s junk bonds will, I agree, clean up the balance sheets of the banks and make them more attractive to investors and depositors. But the investment in junk bonds now is not going to turn out like the investment in junk bonds then. For starters, the value of the junk bonds then declined as a result of the forced sell-off – Congress prohibited S&Ls from holding junk bonds on their balance sheets. When this supply was dumped on the market, the prices naturally dropped. Selling assets at depressed prices damaged a lot of S&Ls. RTC stepped in near the bottom of those prices to take control of the assets. When credit markets returned to normal, the prices of the junk bonds rose and the investments had positive returns.

Then, junk bonds paid extraordinary rates of return – 10 percentage points above Treasuries at the peak. At that time, a 30-year U.S. Treasury bond could be paying more than 18% interest.

Now, we are talking about junk bonds that we all know are junk – no matter fancy labels like “Legacy.” What rate of return could there be on a mortgage bond – no matter how you “slice-and-dice” it – created when mortgage interest rates were 5-6%? Add to that >our knowledge of the problems underlying these assets and it is increasingly unlikely that there will be any positive payoff for taxpayers in this plan.

On March 25, 2009, Mirek Topolanek, President of the European Union, called the U.S. economic plan “the way to hell.” His concern is that we’ll have to finance these trillion dollar bailouts with borrowing and that will ultimately further undermine global financial markets. He’s right, of course. The public-private partnerships will finance the purchase of the “Legacy Assets” by issuing debt. That debt will be guaranteed by the Federal Deposit Insurance Corporation (FDIC), the same agency that guarantees our savings accounts at the local bank. Our guarantee is backed by the payment of insurance premiums to FDIC. The guarantee on the debt used to purchase Legacy Assets will be secured by the Legacy Assets – which will be rated by the same credit rating agencies that gave us triple-A rated subprime mortgage bonds in the first place. How can this possibly turn out well? I’m sure Treasury, Federal Reserve and FDIC have good intentions, but as EU President Topolanek says, they may all end up as pavement on “the way to hell.” As NYTimes columnist Paul Krugman said of the new plan, “What an awful mess.”

Geithner is Wall Street's Lapdog

Treasury Secretary Tim Geithner is on the cover of the April 2009 issue of Bloomberg Markets magazine. In the lead article, “Man in the Middle,” the authors refer to his time at the New York Federal Reserve Bank (FRB) as “experience as a consensus builder.” This overlooks the fact that it was easy for him to get everyone to agree, to build group solidarity, when he simply gave the banks and broker-dealers everything they wanted.

The Primary Dealers, those broker-dealers and banks who have a special arrangement with the FRB for trading in treasury securities, agreed when Geithner let them fail to deliver $2.5 trillion of treasury securities for seven weeks in the fall; they agreed when he let them fail to deliver more than $1 trillion two years earlier; they agreed when he let them fail to deliver treasury securities even after Geithner’s own economists told him it was dangerous. By the way, last year the New York FRB’s public information department prevented those economists from speaking on the record about that research with a Bloomberg reporter.

Now, at a hearing on March 24, 2009 before the House Financial Services Committee, Secretary Geithner and Federal Reserve Chairman Ben Bernanke lectured us on the awesome responsibilities of Treasury and Federal Reserve in the current crisis – without admitting that they had those same responsibilities while the crisis was being created.

In a joint statement from the Department of the Treasury and the Federal Reserve they offer no explanation for their failure to fulfill their “central role … in preventing and managing financial crises.” Rather, they use the fact of that role to require that we accept whatever plan they put before us today as the best and wisest course. To convince us that their plan is the right one, they can all point to the fact that the stock markets rallied (gaining nearly 7% across the board) led by the shares of financial institutions (Goldman Sachs’ shares went from $97.48 on Friday night to $111.93 on Monday – a gain of about 15%).

I criticized the “Public Private Partnership” when it was announced in February 2009. Calling Wall Street’s bad investments “Legacy Assets” doesn’t change the fact that they are “junk.” They could call it “the hair of the dog” because they now want to invest taxpayer money into the same junk investments that started the financial snow ball rolling in the first place.

Just because the stock market rallied doesn’t make this “consensus building” – I call it being Wall Street’s lapdog.

City of Los Angeles Hits the Bottle

While San Francisco Mayor Gavin Newsom was recently chided for his water bottle usage, the city of Los Angeles hasn’t been much better.

It was recently reported that the city of LA spent $184,736 on bottled water in 2008, “despite a mayoral directive that it should not be provided at the city’s expense.”

City officials are encouraged to use coolers or pitchers of tap water for special events, and those that wish to drink bottled water “can do so at their own expense,” said City Controller Laura Chick.

Despite a 2005 memo for Mayor Antonio Villaraigosa stating that city funds were not to be used on bottled water, certain city departments continued to spend funds on the plastic bottles.

The biggest spenders were found to be Public Works ($69,696), Los Angeles World Airports ($31,429), Los Angeles Police Department ($19,708), General Services ($19,508), Transportation ($14,595), and Harbor ($11,993).

The Department of Water and Power cut their spending down from $31,160 in 2004/05 to $3,419 in 2008, while the departments of Community Development, Commission on Children Youth and Families, Fire, Housing, Library, Neighborhood Empowerment, and Personnel ceased purchases altogether.

Although spending has been reduced, public employees continue to expect the city to foot the bill for their bottled water. Such blatant non-compliance is hard to swallow.

Guessing Which Congressional Seats Change Hands at Census Time

The next official Census isn’t till 2010, but Election Data Services is already predicting considerable impacts on Congressional representation.

Things will be getting bigger in Texas, with four added seats, as well as Arizona, with two. Six states—Florida, Georgia, Nevada, Oregon, South Carolina, and Utah—will increase their federal delegations by one district each.

On the opposite end, Illinois, Iowa, Louisiana, Massachusetts, Michigan, Minnesota, Missouri, New Jersey, New York, and Pennsylvania will all relinquish one seat, with Ohio appearing to lose two.

While the redistricting process is in the distant future, it should prove interesting to see how the 2010 Census will change the seating arrangement in Washington.

Layout for the Bailout: $3.8 Trillion and Counting reporters Mark Pittman and Bob Ivry are reporting a running total of the money the U.S. government has pledged and spent for bailouts and economic stimulus payments. The total disbursed through February 24, 2009 stands at $3.8 trillion; the total commitment is $11.6 trillion. The Federal Reserve is providing the largest share at $7.6 billion, followed by the U.S. Treasury $2.2 trillion and FDIC $1.6 trillion. The Department of Housing and Urban Development (HUD) and support for Fannie Mae and Freddie Mac, combined with purchases of student loans – bailout money that comes closest to directly bailing out Main Street – total only $760 billion – less than 7 percent of the total.

The national debt currently stands at $10.8 trillion — versus an authorized limit of $12.1 trillion.

Last week, U.S. Treasury Secretary Timothy Geithner got into a tiff with the rest of the world (denied by President Obama) by telling them that they should spend at least 2 percent of their GDP on their own stimulus packages.

The U.S. commitment of $11.6 trillion equals 81 percent of U.S. 2008 gross domestic product (GDP). The $787 billion fiscal stimulus is 5.4 percent of GDP. Just the two-thirds of the stimulus that represents new spending (one-third is tax cuts) is 3.6 percent of GDP. Here’s what financial institutions in various countries got from U.S. taxpayers by way of the AIG bailout:


Bailout Benefit


 $   31.1


 $   19.1


 $   16.7


 $   12.8


 $     5.4


 $     2.3


 $     1.1


 $     0.3


 $     0.2


 $     0.2


 $     0.2

Nuts for ACORN

In about a year, the next U.S. Census will be upon us. However, one group participating in the survey is already driving some lawmakers nuts.

In February, The Association of Community Organizations for Reform Now (ACORN) signed a partnership with the Census Bureau to “assist with the recruitment of the 1.4 million temporary workers needed to go door-to-door to count every person in the United States.”

While the bureau currently has partnerships with more than 250 national organizations from the NAACP to TARGET, ACORN’s past allegations of fraud have raised the most concern.

The organization – a non-partisan group of low-and moderate-income people – came under fire in 2007, when several paid employees were alleged to have created more than 1,700 fraudulent voter registrations. In 2008, another worker in Pennsylvania was sentenced for creating 29 phony registration forms.

The census is used to “determine distribution of taxpayer money through grants and appropriations and the appointment of the 435 seats in the House of Representatives” and lawmakers do not want any fraudulent computing.

Spokespeople for both ACORN and the Census Bureau have refuted any suggestion that “any group will fraudulently and unduly influence the results of the census.”

Though doubts still remain, the bureau is now focusing on the more than 1 million applicants for 140,000 census taker positions, which is where assistance from organizations such as ACORN becomes needed.

Government accountability is under attack – as it was during the Bush administration, so shall it be under Obama. Given ACORN’s past reputation, confidence in the census itself could come up for question.


The Continuing Debate on AIG

The House of Representatives is debating a 90 percent tax on executive bonus payments made to companies receiving bailout funds. Anything they pass will still have to get through the Senate and past the President’s desk. They are “upset about something they already did,” according to Dan Lungren (R-CA). Congress ignored the opportunity to deal with this back when you and me and 100,000 other voters were telling them not to pass the bailout legislation.

Executive compensation schemes at American International Group (AIG) have been under investigation by the New York State Attorney General, Andrew Cuomo since last fall. He is ramping up the investigation now, given the news over the weekend of new bonus disbursements, to determine if the bonus contracts are unenforceable for fraud under New York law. AIG agreed with Cuomo last October not to use their own “deferred compensation pool” to pay bonuses – and then bargained with executives to make the payments anyway! AIG execs got contracts in early 2008 that guaranteed their bonuses – information that former Treasury Secretary Paulson and current Treasury Secretary Geithner (former President of the New York Federal Reserve Bank) had when they initiated the original bailout.

It’s pretty amazing 1) that taxpayers are bailing out a company that’s under criminal investigation; 2) that Treasury didn’t negotiate compensation schemes before they wrote the first check (like they do with auto workers?); and 3) that the bonuses are a bigger story than the fact that more than one-third of the bailout money was shipped overseas.


Economic Resilience in Rural America?

This week Reuters is hosting a Food and Agriculture Summit in Chicago. On Tuesday presenters, including leading agribusiness executives and business economists, reported that despite the challenging global economic climate, the U.S. rural economy has weathered the recession better than most sectors due to steady demand for agricultural products, stable land prices and healthy credit lines for farmers".

Jim Borel, a VP at DuPont Co stated that "fundamentally, food demand is there," as "people need to eat," which "helps to stabilize things." According to Reuters such claims were echoed by other participants, including Mark Palmquist, CEO of CHS Inc, who noted that the world keeps "adding mouths to feed," and that "food demand... tends to be pretty insensitive to what the global economy is doing."

While there appears to be some anticipation of stability at large agribusiness corporations, such optimism may be tempered among farmers, who have seen commodity prices drop by 50% or more over the past year. Such drops will create a more difficult business environment for producers. However, there is some hope that the strong prices received by farmers over the past couple of years will make them better able to, as one agricultural official in Wisconsin stated recently, "ride it out for somewhat longer than otherwise would have been the case".

Digging into AIG bonuses and other aid recipients

On Sunday March 15, 2009, American International Group, Inc. revealed the identities of some of the beneficiaries of about half of the nearly $180 billion the US government has committed ($173 billion actually paid out so far) to support the ailing international financial giant. As we now know, AIG sold credit default swaps (CDS) that paid off if the market value of some bonds fell. (I use the term “bond” here generally to refer to the alphabet soup of CDO, CLO, MBS, etc. – all of which are debt that is sold to the public.) Most CDS only pay off if the borrower fails to make payments – something that hasn’t happened in the case where AIG is making payments. The geniuses at AIG – and we know they are geniuses because they earned $165 million in bonuses for the effort – took on completely unknown risks for, apparently, insufficient premiums, resulting in the need for an emergency $85 billion loan last September from the Federal Reserve Bank of New York (courtesy of my buddy Tim Geithner) to “avoid severe financial disruptions”… as if that worked!

Whatever. So, now AIG is letting us know who got our money: $22.4 billion for payouts on the CDS and $27.1 billion to buy the bonds underlying the CDS (so some of the CDS could be cancelled). That’s about $50 billion so far for derivatives – no one knows how much more they’ll need. Here’s a summary by the country where the recipients are based:























Numbers in billions. $4.1 billion paid to “other” not included here. Numbers won’t total to $49.5 billion due to rounding.

There was also $12.1 billion paid to US municipalities (states, cities, school districts, etc.) – where states invested, for example, bond proceeds prior to expenditure. In those cases, the municipalities invested in assets with guaranteed rates of return (another genius idea at AIG!). The bigger numbers belong to the states that had recent large bond issues – for example, $1.02 billion to California which has yet to distribute a dime of the bond money raised for stem cell research (due to on-going litigation).

AIG took $2.5 billion for their own business needs – like the bonuses? The $165 million bonuses were just for the London-office that specialized in selling those very special CDS. Total bonuses paid were $450 million for all the geniuses at AIG – the AIG who made $6.2 billion in 2007 and lost $37.6 billion in the first 9 months of 2008!

The most interesting bit, perhaps, are payments of $43.7 billion to securities lenders – those stock and bond holders who lend out their shares to enable short sellers. This means that AIG borrowed stocks so they could short sell them – make an investment that paid off only if the prices fell. (If you don’t know what short selling is, here’s a five minute video that explains it in a light-hearted way.) Bottom line – it gave AIG incentives to push down market prices. And their announcements and actions at the end of 2008 certainly achieved that goal. Way to go, geniuses!

Buffett Update: Downgrade from Oracle to Seer?

A day or so after he was on CNBC, Warren Buffett went on Bloomberg Television and told them that he’ll continue to sell derivatives contracts. He’s getting deeper into investments that he has called “financial weapons of mass destruction.” Apparently he’s betting that there will not be a crash (which would require a payout) in corporate junk bonds, muni bonds or stock markets in the UK, Europe and Japan. Here’s the punch line: his stock is up 17.2% since he started talking!

Berkshire Hathaway shares peaked last year at $147,000 each when Buffett was buying energy companies. The price is so very high because they have a policy of never paying dividends. Therefore, all the company’s earnings are put back into investments. If you tried to use a standard finance model to determine the appropriate price for these shares, the answer would be “infinity” because you can’t divide by $0 dividends. Anyway, two months after the peak, the shares were in the tank – relatively speaking – at $77,500 per share. By the end of the week before his TV appearances, the shares were even lower, at $72,400. The day of the CNBC interview: Berkshire Hathaway shares closed at $84,844 – a cool 17.2% gain. Remember, this is the man who said he is fearful when people are greedy and greedy when people are fearful.

On March 12, Berkshire Hathaway lost its triple-A credit rating from Fitch Ratings because of potential losses from those derivatives. Not that we should believe everything Fitch says – Fitch is among the credit rating agencies that gave triple-A ratings to subprime mortgage bonds, and look what happened to those investments! For what it’s worth, Fitch gives Berkshire a “negative” outlook, meaning another cut is possible within a couple of years. The two other big ratings agencies, Moody's Investors Service and Standard & Poor's, still rate Berkshire triple-A.