Tuesday, March 30, 2010

"But It Was Cheaper Than You Thought It Would Be"

I am already tired of the new defense of the financial industry bailouts - that one portion of the bailout or another "could turn a profit" or that it "cost less than critics feared". In reading this article about Timothy Geithner, I was struck by the self-approbation:
“My basic view is that we did a pretty successful job of putting out a severe financial crisis and avoiding a Great Depression or Great Deflation type of thing,” he said. “We saved the economy, but we kind of lost the public doing it.”
As if there was only one path to "saving the economy" - the approach of smothering out any sign of flame with a truckload of money - and that as it "worked" there is no need to reflect on why the same end could not have been accomplished by different means, at a lesser cost, at greater return for the taxpayer, or some combination thereof. The one consistent element that has prevailed throughout Geithner's "decision-making" is that the welfare of the financial oligarchs, bondholders and shareholders should whenever possible take precedence over any other interest, and certainly should predominate over making the taxpayer whole. To the extent that one corner or another of the bailout threatens to "show a profit", it is by accident - it is certainly not by design.

I'm not arguing that Geithner's approach was all wrong - far from it. I am arguing that some of the proposed alternatives may have been better for taxpayers and for main street, and that some alternative approaches would have done a great deal more to deter the return to "business as usual" on Wall Street. At the same time, the import Geither appears to have placed on restoring Wall Street to "business as usual," at the expense of any other goals or interests, is a very fair topic for criticism. When you keep writing blank checks, sooner or later you'll have poured enough money into an industry to be able to claim to have "rescued" it - not only is there no particular genius in that approach to a problem, it insulates the industry from the consequences of its bad decision making, and potentially sets things up for yet another failure to be again bailed out at exceptional cost to the taxpayer.

Geither's defense of his blank check approach to Wall Street?
He suggested that his critics draw up a balance sheet comparing the Administration’s expenditures on programs that benefitted Wall Street with those that benefitted Main Street. “By any measure, the Main Street stuff dwarfs the Wall Street stuff. Compare money for housing versus money for banks. Measure tax cuts for working families versus money for banks.”
So stimulus measures aimed at industries responsible for about 92% of the nation's GDP, "by any measure", are larger than the bailout directed at the industry responsible for 8% of the nation's GDP? With due respect to the fact that the fire that was burning down the economy was fueled by the financial industry collapse, why does Geithner believe that to be a defense of his "blank check" approach to bailing out the financial sector, perpetuating - really subsidizing - its extraordinary levels of compensation, and insulating its participants, individually and collectively, from meaningful consequence for their own failures?

Take a look at the Citigroup bailout. Every step of the way, the bailout focused on giving the taxpayers the least possible amount for their money.
On November 23, 2008, the government bought $20 billion in preferred shares in Citigroup. It also received another $7 billion in preferred shares in exchange for guarantees on $300 billion in bad assets. At the time, the combined value of the investment in preferred shares and the guarantee on bad assets exceeded the full market value of Citigroup stock on November 21st, the last trading day prior to the deal. In other words, for the same financial commitment that the government made on that day, it could have owned Citigroup outright.

The government subsequently held onto to its preferred shares until Citigroup's stock had nearly tripled in value. In September of last year it traded its preferred shares for common shares that were priced at a level that only give the government a 27 percent stake in Citigroup. These shares have have now risen enough to give the government an $8 billion profit on its investment. While the Post tells readers that:
"The windfall expected from the stock sale would amount to a validation of the rescue plan adopted by government officials during the height of the financial panic, when the banking system neared the brink of collapse. A year ago, Citigroup's stock hovered around a dollar a share, and the bank's future seemed in doubt. On Friday, the stock closed at $4.31."
The logic of the Post's assertion that the profit on Citigroup stock validated the bailout is not clear. By making capital available to Citigroup at below market rates, the government effectively subsidized the income of Citigroup's shareholders. It also allowed its top executives to make millions of dollars because they were smart enough to be able to get taxpayers to subsidize the bank. The current market value of Citigroup is $123 billion, with only $33 billion belonging to the government. This means that the government has effectively given $90 billion (@ 25 million kid-years of health care provided through the State Children's Health Insurance Program or SCHIP) to Citigroup's shareholders and billions more to its executives by not demanding a market price for its support.

It is also worth noting that the government has supported Citigroup through other mechanisms. The Fed created various special lending facilities that allowed Citigroup to borrow money from the government at extremely low interest rates. Since one of the main uses of this money was buying government bonds, Citigroup was essentially getting free money from the government. If it borrowed $200 billion at near zero interest and lent it back to the government by buying 10-year Treasury bonds at 3.7 percent interest, then the government was effectively handing Citigroup $7.4 billion a year for nothing. This money is not deducted from the Post's estimate of the government's "profit" on its dealings with Citigroup. (The Fed refuses to tell the public how much money it lent to Citigroup and other banks at below market rates.)
Part of the backdoor bailout involved the government buying up mortgage-backed securities:
If the Fed's program of buying mortgage-backed securities lowered the interest rate on 30-year mortgages from 5.5 percent to 5.0 percent, then this would raise the value of Citigroup's outstanding 30-year mortgages by more than 7 percent. If Citi had $500 billion invested in mortgages or related assets, then the action by the Fed would have effectively given Citi $35 billion.

If the Fed subsequently resells the $1.25 trillion in mortgage-backed securities it purchased in order to push down mortgage interest rates in an environment in which interest rates have risen, then it will lose money on these purchases. If it sells the mortgage-backed securities when interest rates are 6 percent, then it will lose close to 15 percent, or more than $180 billion on its purchases of these mortgages.
Yeah, some deal for the taxpayer.

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