November 17, 2009

Regulation: Fed Up

As Congress debates an alleged attempt* at renewed regulation of the finance sector, one of the main issues is the proper scope of Fed authority.
[*Let’s never forget, short of breaking up the Too Big To Fails it’s all kabuki. All the debate over resolution authority is moonshine at best, disaster capitalism at worst, since none of the on-the-table proposals contemplate anything more than “resolving” TBTF entities when they again start to collapse. None seek to break them all up preemptively.
For that proposal we have to go to Bernie Sanders.]
It’s quite a fracas, with the Fed wanting to preserve and expand its powers; the administration and Frank dithering on distributing power between the Fed, the FDIC, some new “council”, and a newly merged OCC and OTS, but always wanting to maintain broad Fed power; and Dodd actually wanting to strip some Fed power and repose it in the OCC/OTS entity.
But in assessing all this we should always remain crystal clear that the Fed is not a regulator and does not see itself as one. It seeks regulatory authority only to put that range of authority on ice and open up a free fire zone for the banks, with whom it culturally identifies, and with whose personnel its personnel personally identify.
It’s a quasi-public entity only for legal and constitutional arbitrage purposes. Thus it argues its “public” status when convenient to shield it from various kinds of lawsuits and other accountability. But in its own mind it’s a private bank and the orchestrator of anti-public bank feudalism.
For a case study in all this, we have the new SIGTARP report (linked here) on the AIG swap contract resolutions.
This is the notorious incident where the Bush administration, having already bailed out the banks in numerous ways, laundered yet another bailout through AIG via the mechanism of paying off AIG-written CDSs at par.
The gamblers not only had their losses covered but here their losing bets were actually paid off as winners.
We’ve always known this was a corrupt act of theft from the people, organized by Tim Geithner at Goldman Sach’s behest, but thanks to the excellent Neil Barofsky and his investigation we have new details and analysis.
Geithner was supposed to conduct a negotiation with the AIG swapholders on behalf of the taxpayers whose money had bailed out AIG as well as many of those same counterparties. Barofsky found that the Swiss UBS volunteered to accept 98 cents on the dollar. But when Goldman and the French dug in and demanded a full payout, Geithner caved in. GS, acting as ringleader, was confident after the first AIG bailout that the government (it’s taxpayer money so I’m using “Fed” and “government” as synonyms) would bail everybody out across the board, and this was the line they followed.
Barofsky found that the Fed “refused to use its considerable leverage”. (He also correctly gets to the heart of the fact that actions are everything, conscious motive nothing: Geithner and the Fed cadres may deny it, but “irrespective of their  stated intent…tens of billions of government money was funneled inexorably and directly to AIG’s counterparties”. That’s a capital crime by its existential fact, and nothing can mitigate it.)
The report lays out the Fed’s attitudes as being these:
1. It saw itself not as a regulator, but as an AIG creditor. (And a creditor which didn’t care about its “own”, i.e. the taxpayers’, interests.) So it never talked in terms of “we bailed you out, now you need to make concession”, but rather of “AIG owes us all money, and I’m voluntarily not caring about what it owes me, so let’s see if anyone else is willing to make a voluntary concession”.
So even when UBS was willing to concede, when GS refused, the game was over from Geithner’s point of view. All he could do was ask them, and they said No.
2. The Fed decided it couldn’t treat foreign banks differently from domestic ones, so it coordinated with French regulator Commission Bancaire in handling the disposition of two French banks involved in the deal.
The French simply joined Goldman in putting up a solid front vs. anything short of a complete laundry delivery. Altogether 7 of the 8 banks involved refused concessions.
If Geithner had been negotiating on behalf of the people, he would’ve seized the opportunity for divide and conquer. Once UBS went first, they should’ve become the belle of the ball, implicitly first in line, which would’ve put pressure on the others to concede as well. (Needless to say, 98 on the dollar was absurdly high as well and should’ve been just the start of one heckuva massive haircut for these hippies.)
But this wasn’t possible, since:
3. Geithner believed on ideological grounds that his responsibility was to the “sanctity of contracts”. Never mind that (1) CDS as written by AIG were basically a scam, and the government has no responsibility to make whole the rich victims of scams, (2) in this case the “victims” were really co-conspirators, since CDS was a key part of the big bubble they were all blowing as hard as they could, (3) Geithner and the Fed’s first responsibility, their first contract overriding all others, was with the American people.
But as George Washington puts it:

Apparently, while Geithner was concerned with the sanctity of the CDS contracts (which – I would argue – were all based on fraudulent representations concerning how safe an investment they were), he didn’t care very much about the sanctity of the agreement of a government to do what is best for its people.

But actually, the New York Fed isn’t a government agency. The Fed itself maintains that:

While the Fed’s Washington-based Board of Governors is a federal agency subject to the Freedom of Information Act and other government rules, the New York Fed and other regional banks maintain they are separate institutions, owned by their member banks, and not subject to federal restrictions.
So really Geithner – as head of the private bank-owned and managed New York Fed – was simply serving his constituency: the giant New York money center banks. Geithner’s constituency never was the American public.

The giant banks were the creditors of the giant banks. Like two sock puppets putting on a big show of good cop / bad cop show, the New York Fed pretended that it was negotiating hard, but ended up making sure that the boys got their full cut.

After having been bailed out once already, Goldman turned around and said it would be illegal for the government to expect them not to demand a full bailout on their CDS position. It would be illegal for the Fed to say in effect “You should make concessions outside of bankruptcy court, because otherwise we’re not going to do anything, you’ll have to go into court with a bankrupt AIG and end up with little or nothing”.
(Of course, we never should’ve bailed out AIG in the first place. I would’ve let them collapse and blamed any reverberations on Goldman. Legally and politically.)
The Goldman argument was the argument Geithner wanted to hear anyway. As GS correctly assessed, Geithner and the Fed were absolutely committed to the bailout, every cent they could loot.
They really come off like the Keystone Kops:

The report also shed new light on the effect the rating agencies had on the way the Fed handled the A.I.G. emergency. The company’s run-on-the-bank disaster began with a major credit downgrade in September; the Fed quickly responded with an $85 billion loan.

But because the Fed moved so quickly, it recycled a set of lending terms that had previously been devised for A.I.G. by lenders in the private sector. The interest rate was too high, given A.I.G.’s distress, and so the loan that was supposed to rescue the insurer ended up putting it at risk of a second credit downgrade. That, in turn, could have set off a second run-on-the-bank episode.

The Fed got caught in a no-win situation, the report said. While it might have been able to win concessions by threatening to withdraw support from A.I.G., it also ran the risk that the credit agencies would take the threat too seriously and impose another catastrophic downgrade.

So the lesson of this sorry mess of a tale is something we should apply to our current situation. Barosky draws the right conclusion:

Mr. Barofsky said the facts also undermined the Fed’s arguments that banking secrecy was an essential part of bank stability.

“The default position, whenever government funds are deployed in a crisis to support markets or institutions, should be that the public is entitled to know what is being done with government funds,” he said.

The Fed is not a regulator and it never can be. By its very nature it wants to maximize finance sector private profit, and sees America simply as a cash cow. As Barofsky says, the Fed hates democracy, hates transparency, hates accountability. It is simply a rogue organization.
So whenever we assess any reform proposal, in addition to the minimum criterion that it breaks up the Too Big To Fails, we should also measure it according to the measure:
*Does it consider the Fed to be a viable regulator?
*Does it maintain existing Fed “authority”?
*Does it seek to add to that authority?
If the answers to these are Yes (and only Dodd’s proposal even gingerly suggests maybe the answer should be No), then it’s not real reform, but just another lie in the same tired good cop bad cop routine George referred to above.   


  1. It has been suggested that the AIG ‘exposure’ was nullified by side letters. AIG was never expected to pay off but was a bought co-conspirator in a regulatory scam. This makes as much sense as anything else.

    Comment by jake chase — November 17, 2009 @ 3:16 pm

  2. Sure sounds likely. One of the main selling points of CDS to begin with was regulatory evasion.

    When we consider that, and everything else which has come to light about these actors, I pretty much believe implicitly that any possible fraud probably was committed.

    Given the circumstances, it would’ve been out of character and indeed not “rational” for them to refrain.

    Comment by Russ — November 18, 2009 @ 3:44 am

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