It Takes a Pillage: An Epic Tale of Power, Deceit, and Untold Trillions

by Nomi Prins

  For the most part, when a company acquires another company, it has to come up with the money and take on any risk that the merger might bring. No such thing with the Bear Stearns deal. The government spotted the money and took on the risk for JPM Chase.

  The fourth and final stage came on March 24, 2008, when JPM Chase announced that due to employee shareholder protests, the offer would be upped to $10 a share, bringing the price tag to $1.2 billion.21 In a sign of just how little that really was to pay for one of the nation’s most venerable brokerage firms, which had survived as an independent company for eighty five years through the Great Depression and twelve recessions, former Bear Stearns CEO James Cayne sold his Bear stock—just two days after the deal was completed—for $61 million. 22 Two years earlier, that stock had been worth $1 billion.23

  Don’t feel too bad, though. Most of that stock had been given to Cayne as part of his compensation package, meaning that he didn’t directly pay for the shares.24

  It didn’t take long for the government’s dealmakers to spin the Bear Stearns takeover as a tough but successful maneuver. “By reducing the probability of a systemic financial crisis, the actions taken by the Fed on and after March 14 have helped avert substantial damage to the economy, and they have brought a measure of tentative calm to global financial markets,” Geithner cooed a week and a half after the deal.25

  Everyone was happy, although the markets hadn’t even begun to enter crisis mode at that point. In an understated portent of things to come, Geithner added, “The Federal Reserve, working closely with other major central banks, will continue to provide liquidity to markets to help facilitate the process of financial repair.”26

  Geithner Wasn’t Kidding

  During the summer of 2008, despite the whole Bear Stearns maneuver, the home mortgage market was coming apart at its foundation. Foreclosure rates nationwide were up 55 percent in August 2008, compared to July 2007, and for the year there were more than 3 million foreclosure filings, an 81 percent increase from 2007.27 Existing single-family home sales fell to 4.3 million in 2008 from nearly 5 million in 2007, a 12 percent decrease.28 New one family home sales fell from 776,000 to 482,000 over the same period, or a decrease of 38 percent.29 Credit also stopped flowing, as mortgage lenders realized that their existing loans might not be paid and it would be a bad idea to take on more debtors.

  Still, thanks to Geithner’s soothing words there was an air of calm before the storm on Capitol Hill and in the media—or at least a sense that things were going to get better sooner rather than later. (That unfounded optimism would resurface in the middle of 2009, after much more financial wreckage had occurred, simply because the stock market bounced back for a spell.) The summer of 2008 was the summer of mixed messages. Some of the media balanced the more prevalent and accurate feeling among most Americans that things weren’t actually getting better, even as they reported that the government was trying to deflect a greater housing led crisis with a veneer of altruism.

  “If you’re a homeowner teetering on the edge of foreclosure, help is on the way. We’ll explain what the Senate did for you today in a rare Saturday session,” reported CNN anchor Kyra Phillips on July 26, 2008.30 She was referring to a $300 billion bill that would allow distressed homeowners to refinance their mortgages. The bill, the Housing and Economic Recovery Act of 2008, was signed with a flourish by President Bush four days after that broadcast.31

  The general message from Washington was that everything would be okay, we’re on top of this mess. “We look forward to putting in place new authorities to improve confidence and stability in markets and to provide better oversight for Fannie Mae and Freddie Mac,” White House spokesperson Tony Fratto said on the day the bill was signed.32

  Then there were the higher profile Washington insiders who traded premature optimism for downright delusion about the actual state of the economy, going so far as to blame the American people for the financial crisis. “You’ve heard of mental depression; this is a mental recession,”33 said Phil Gramm, the former head of the Senate Banking Committee who had led the charge for deregulation of the banking and derivatives industries, in a Washington Times interview on July 9, 2008.34

  With a complete lack of empathy, he concluded, “We have sort of become a nation of whiners. You just hear this constant whining, complaining about a loss of competitiveness, America in decline.”35

  Gramm made those clueless comments while he was cochair of John McCain’s presidential campaign. It was Gramm’s callous representation of an increasingly fearful American population that led to his ouster from the McCain campaign on July 18, 2008, but the damage had been done. McCain, who ultimately bore responsibility for Gramm’s viewpoint, appeared out of touch with the economic plight of the country.36 That apathetic tone may have been the biggest reason McCain did not get elected president.

  Despite the grim numbers, the powers that be in the Treasury were dogmatically confident (outwardly, anyway) that they had met and weathered a horrific storm after the Bear Stearns situation. Indeed, Treasury Secretary Henry Paulson was quite insistent that bailing out institutions would certainly not be a pattern.

  “For market discipline to constrain risk effectively, financial institutions must be allowed to fail. Under optimal financial regulatory and financial system infrastructures, such a failure would not threaten the overall system,” he stated in a July 2, 2008, speech at the Chatham House in London in front of international policymakers.37

  Paulson reiterated this point to the House Committee on Financial Services eight days later. “Market participants must not expect that lending from the Fed or any other government support is readily available.” 38 (Unless he deemed otherwise.)

  Paulson applied the same free market logic to individual homeowners during a July 8, 2008, hearing before the FDIC’s Forum on Mortgage Lending to Low and Moderate Income Households, essentially saying that hundreds of thousands of homeowners should likewise be allowed to fail on their mortgages, although he admitted that the fault for the bad loans really lay with the mortgage companies.

  “Due to the lax credit and underwriting standards of the past years, some people took out mortgages they can’t possibly afford and they will lose their homes,” Paulson said with an assassin’s calm on July 8. “There is little public policymakers can or should do to compensate for untenable financial decisions.” He further argued against government intervention in the mortgage market because an undefined “some” people might make a quick profit by flipping homes.

  “Now that their investments have not turned out as they had hoped, these people may walk away, even though they can afford their mortgage payment,” he said. “These borrowers can and should be living up to their mortgage commitment—government intervention here would be inappropriate.”39

  Bernanke, meanwhile, was far more constrained in his rhetoric. His remarks around that time focused on revamping regulatory agencies and leaving the door open for more bailouts—something he’d still be doing a year later. “The enormous losses and write downs taken at financial institutions around the world since August, as well as the run on Bear Stearns, show that in this episode, neither market discipline nor regulatory oversight succeeded in limiting leverage and risk taking sufficiently to preserve financial stability,” he told the same forum.40 But all his talk of regulation was just that: talk. The worst was yet to come.

  Giving Loans against “Non-Investment Grade Securities”

  By the fall of 2008, the notion that integral financial institutions should be allowed to fail outright without injections of government cash had evidently been thrown out the window. The Fed was opening more facilities and was lending money left and right using low grade assets as collateral. Its stated intent was to enhance market liquidity in the face of a dead credit market. In other words, because lenders were holding their money tight, the Fed had to change the rules and start new programs to help increase the free flow of capital, sort of acting like Drāno for a pipe clogged
with bushels of hair.41

  In September 2008 alone, the Fed injected $904 billion into the financial markets. From September 15 to 18, the Fed pumped $125 billion into the financial markets through open market regulation. On September 18, the Federal Open Market Committee expanded its currency swap lines by $180 billion to provide liquidity for the U.S. dollar. Eleven days later, the Fed tripled total short term lending, expanded its credit swap lines again, and noted they expected to hold two TAF auctions that would total $300 billion.42

  What had started as a housing problem was turning into a far greater credit problem. Despite all the extra cash flowing to banks and the Fed taking on risky assets that were unmarketable to the private sector, loans were still hard to come by. The TAF program was supposed to increase credit flow, but things weren’t happening fast enough, so the Fed upped its loan authorization to $900 billion on October 6, 2008.43 But by the last quarter of 2008, a Fed survey of banks showed that lending standards on commercial, industrial, and consumer loans were still tight and outstanding consumer credit remained nearly unchanged, at about $2.6 trillion.44 Furthermore, on the business credit side, an overall lack of commercial paper—an unnecessarily vague term for the short term loans companies use to meet regular operating expenses, such as payroll—caused the Fed to create the Commercial Paper Funding Facility LLC (CPFF). Under the CPFF, the Fed could finance approximately $1.8 trillion worth of commercial paper. For its part, the Treasury Department made a “special” deposit of $50 billion at the Federal Reserve Bank of New York to support this facility.45 This extra help, by the way—in true nontransparent form—was not mentioned in the press release that introduced the CPFF (nor on the Treasury Web site).46

  The Fed continued to create a plethora of new facilities identified by cute little acronyms, which were designed to hold riskier collateral than the Fed had ever taken on in the past. (If you want the real scoop on these facilities as they keep unfolding, you can follow them on my Web site, www.nomiprins.com. Details are in the appendix.) There didn’t appear to be any orderly rollout or overall plan for these facilities. They seemed to crop up sporadically to deal with that day’s or that week’s problems.

  On September 14, 2008, the Fed allowed noninvestment grade securities to be pledged as collateral at the PDCF, which had been established on March 16, 2008. In February 2009 the PDCF was extended until October 30, 2009.47

  On September 19, 2008, the Fed created the Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) “which extends loans to banking organizations to purchase asset backed commercial paper from money market mutual funds.”48

  Then, the following month, the Fed instituted the Money Market Investor Funding Facility (MMIFF), which along with the AMLF and the CPFF is “intended to improve liquidity in short term debt markets and thereby increase the availability of credit,” and pledged to lend the MMIFF up to $540 billion.49

  And so, the Fed, working fast and furious, continued its transformation into a hedge fund of last resort, relaxing its collateral posting rules and lending trillions of dollars to the Street. Where banks once had to pony up secure assets such as Treasury bonds to get loans from the Fed, they could now post far more risky assets in return for very favorable loan conditions, and the Fed would keep a lid on who they were, and how much they got.50

  Remember: That $700 Billion Is the Smallest Part of the Bailout

  Even with all the bailout money flowing by the end of September, the Fed and the Treasury were faltering. They couldn’t stop the oncoming financial crisis, as the credit and housing markets continued to decline and big banks continued to fail. But, as noted above, the Fed could and did throw trillions of dollars at the banking epicenter of the crisis, announcing “several initiatives to support financial stability and to maintain a stable flow of credit to the economy during this period of significant strain in global markets.”51

  Some argued that the Fed was doing its job to promote liquidity in the system, as explained in its mission statement: “If a threatening disturbance develops, the Federal Reserve can also cushion the impact on financial markets and the economy by aggressively and visibly providing liquidity through open market operations or discount window lending.”52

  But the scope with which it provided loans for lemons was unprecedented. And as we’ve seen, even before the Emergency Economic Stabilization Act of 2008, which included the Troubled Asset Relief Program, was passed on October 3, 2008, the Fed was doing its own bailing.53 Yet there was no Congressional furor about the trillions of dollars of Fed facility programs as the facilities were spawned, so deft was the body in its motions.

  Indeed, cloaking the cost of its part of the bailout in business as usual language became part of the Fed’s strategy. Press releases were designed to accentuate the positives of some new loan facility or drastic liquidity providing measure, without even admitting the risk it might incur. For instance, on September 29, 2008, the Fed announced a mammoth $780 billion shot into the markets, including $330 billion worth of currency swaps with foreign central banks, was cushioned with reassuring verbosity: “The Federal Reserve announced today several initiatives to support financial stability and to maintain a stable flow of credit to the economy during this period of significant strain in global markets.”54

  With all of Bernanke’s stress on the need for more powerful regulatory oversight of the financial arena, the question of just who was regulating the Fed was largely absent. Indeed, the Fed’s actions were far less transparent than the Treasury’s, which isn’t saying much. The Fed created facilities to dole out—or, in Fed-speak, to “lend”—cash to bleeding banks, in return for securities backed by sinking subprime, auto, and consumer loans.

  And Bernanke thought that was quite all right; it was just business as usual for the Fed. “Consistent with the central bank’s traditional role as the liquidity provider of last resort, the Federal Reserve has taken a number of extraordinary steps,” Ben Bernanke said on December 1, 2008, at the Greater Austin Chamber of Commerce in Austin, Texas. “We narrowed the spread of the primary credit rate . . . extended the term for which banks can borrow from the discount window to up to 90 days . . . and developed a program, called the Term Auction Facility, under which predetermined amounts of credit are auctioned to depository institutions for terms of up to 84 days.”55

  Only it wasn’t consistent with the Fed’s traditional role. In fact, it was new to the Fed’s range of powers, as Allan Meltzer, a professor of economics at Carnegie Mellon University and the author of A History of the Federal Reserve, told the New York Times. “If you go all the way back to 1921, when farms were failing and Congress was leaning on the Fed to bail them out, the Fed always said, ‘It’s not our business.’ It never regarded itself as an all purpose agency.”56

  To some extent, the New York Fed had dabbled in bailouts with the Long Term Capital Management (LTCM) crisis in 1998, mostly because the hedge fund was on the hook for lots of money to various investment banks, not because ordinary people would really be affected—sound familiar? The New York Fed stepped into the role of super negotiator and organized for a bunch of banks, including Goldman Sachs, Merrill Lynch, JPMorgan Chase, and UBS, to pony up $3.6 billion to buy LTCM and pay off its debts.57

  Former Fed chairman Alan Greenspan eased monetary policy in order to loosen up the credit markets that were freezing up, in fear of what a LTCM collapse could mean. The difference between the current situation and the LTCM bailout is that the government orchestrated a private buyout of LTCM and didn’t use public funds to save a risk taking fund. Plus, the size of the LTCM bailout was nothing compared to the Second Great Bank Depression bailout. It only amounted, in fact, to the size of Merrill Lynch execs’ 2008 bonuses.

  Still, the LTCM bailout showed that the Fed was willing to step in to find a way to pay banks back for choosing bad business partners. That precedent was exploited to the max in 2008 and 2009. The Fed’s facilities were created with an utter lack of accountability
and transparency. Multiple Freedom of Information Act (FOIA) requests to the Fed, seeking details of who used the lending facilities and to what extent, were rejected.

  The Silent Coconspirator

  Every successful heist requires a diversion from central command. Whatever the size of the loot, the idea is to keep the victims’ focus somewhere else. During the Second Great Bank Depression, while we were focused on a $700 billion Treasury bailout package, the Fed used a sleight of hand it had honed for decades to take on trillions of dollars in useless assets, giving cheap loans in return to the very banks that had created the bad assets.

  The chairman of the Federal Reserve is sort of like the CEO of money in America. Some chairmen pursue the influence of the position more than others. Alan Greenspan, chairman of the Board of Governors of the Federal Reserve System from 1987 to 2006, was far more involved in politics (and more famous as a result) than his predecessors were. He had been involved in the political sphere as an adviser for Richard Nixon’s presidential campaign in 1968 and had served as chairman for the Council of Economic Advisers during Gerald Ford’s presidency. He had a propensity for enacting a strong rate policy. He lowered rates in 1997 in response to the Asian currency crisis and hiked rates in 1999 as the U.S. economy and markets were booming. At the turn of the century, he also publicly warned about “unsustainable” growth rates and “overextended” stock prices.58