The Great American Bank Robbery, Part II
How did the bankers make off with all of our money? Nobel Prize-winning economist Joseph Stiglitz explains.
"The U.S. government should have played by the rules and "restructured" the banks that needed rescuing, rather than providing them with unwarranted handouts. This is so, whether or not in the end some of the banks manage to pay back the money that was given to them. But both the Bush and the Obama administrations decided otherwise.
As the crisis broke out in late 2007 and early 2008, the Bush administration and the Fed first veered from bailout to bailout with no discernible plan or principles. This added political uncertainty to the economic uncertainty. In some of the bailouts (Bear Stearns), shareholders got something, and bondholders were fully protected. In others (Fannie Mae), shareholders lost everything, and bondholders were fully protected. In still others (Washington Mutual), shareholders and bondholders lost nearly everything. In the case of Fannie Mae, political considerations (worrying about earning the disfavor of China--as a significant owner of Fannie Mae bonds) seemed to predominate; no other good economic rationale was ever presented. Though there was often some reference to "systemic risk" in explaining why some institutions got bailed out and others didn't, it was clear that the Fed and the Treasury had insufficient appreciation of what systemic risk meant before the crisis, and their understanding remained limited even as the crisis evolved.
Some of the early bailouts were done through the Federal Reserve, leading that body to take actions that were totally unimaginable just a few months before. The Fed's responsibility is mainly to commercial banks. It regulates them, and the government provides deposit insurance. Before the crisis, it was argued that investment banks didn't need either access to funds from the Fed or the same kind of tight regulation, since they didn't pose any systemic risk. They handled rich people's money, and they could protect themselves.
But all of a sudden, in the most munificent act in the history of corporate welfare, the government's safety net was extended to investment banks. Then, it was extended even farther, to AIG, an insurance firm. Eventually, by late September 2008, it became clear that more than these "hidden" bailouts through the Fed would be required, and President Bush had to go to Congress. Treasury Secretary Paulson's original idea for getting money into the banks was referred to by its critics as
"cash for trash." The government would buy the toxic assets, under the Troubled Asset Relief Program (TARP), injecting liquidity and cleaning up the banks' balance sheets at the same time. Of course, the bankers didn't really believe that the government had a comparative advantage in garbage disposal. The reason they wanted to dump the toxic assets on the government was that they hoped the government would overpay--a hidden recapitalization of the banks. The real tip-off that something was awry came when
Paulson went to Congress and presented a three-page TARP bill giving him a blank check for $700 billion, with no congressional oversight or judicial review. As chief economist of the World Bank, I had seen gambits of this kind. If this had happened in a Third World banana republic, we would know what was about to happen--a massive redistribution from the taxpayers to the banks and their friends. The World Bank would have threatened cutting off all assistance. We could not condone public money being used in this way, without the normal checks and balances. Indeed, many conservative commentators argued that what Paulson was proposing was unconstitutional. Congress, they believed, could not walk away so easily from its responsibilities in allocating these funds.snip
The advocates of the proposal for equity injections (including myself) had wrongly assumed that it would be done right--taxpayers would receive fair value for the equity, and appropriate controls would be placed on the banks. Cash was poured in to protect them, and when they needed more money, more cash was poured in. In return taxpayers got preferred shares and a few warrants (rights to purchase the shares), but they were cheated in the deal. If we contrast the terms that the American taxpayers got with what Warren Buffett got, at almost the same time, in a deal with Goldman Sachs, or if we compare it with the terms that the British government got when it provided funds to its banks, it was clear that U.S. taxpayers got shortchanged. If those negotiating supposedly on behalf of Americans had been working on a similar deal on Wall Street, they would have demanded far better terms.
snip
Worse still, even as taxpayers became the principal "owner" of some banks, the Bush (and later Obama) Treasuries refused to exercise any control. The U.S. taxpayer put out hundreds of billions of dollars and didn't even get the right to know what the money was being spent on, let alone have any say in what the banks did with it. This too was markedly different from the contemporaneous U.K. bank bailouts, where there was at least a semblance of accountability: old management was thrown out, restrictions on dividends and compensation were imposed, and systems designed to encourage lending were put into place.
snip
In effect, the Obama team had finally settled on a slight variation of the original cash-for-trash idea. It was as if it had decided to use a private garbage-hauling service, which would buy the garbage in bulk, sort through it, pick out anything of value, and dump the remaining junk on the taxpayer. And the program was designed to give the garbage collectors hefty profits--only certain members of the Wall Street club would be allowed to "compete," after having been carefully selected by the Treasury. One could be sure that these financiers who had been so successful in squeezing money out of the economy would not be performing these duties out of civic-mindedness, gratis.
The administration tried to claim that the PPIP was necessary to provide liquidity to the market. Lack of liquidity, it argued, was depressing prices and artificially hurting banks' balance sheets. The main problem, however, was not a lack of liquidity. If it were, then a far simpler program would work: just provide the funds without loan guarantees. The real issue is that the banks made bad loans in a bubble and were highly leveraged. They had lost their capital, and this capital had to be replaced.
The administration tried to pretend that its plan was based on letting the market determine the prices of the banks' "toxic assets"--including outstanding house loans and securities based on those loans--as the "Partnership" bought up the assets. The magic of the market was being used to accomplish "price discovery." The reality, though, was that the market was not pricing the toxic assets themselves, but options on those assets, basically a one-sided bet. The two have little to do with each other. The private partnerships gained a great deal on the "good" mortgages, but essentially handed the losses on the bad mortgages over to the government.
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http://www.alternet.org/news/145795/the_great_american_bank_robbery%2C_part_ii
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