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

by Nomi Prins

  Of course, other problems in the United States caused by AIG’s risky investments were just as bad. Local and state governments had invested $10 billion in AIG and 401(k) plans and in total had bought $40 billion worth of insurance from AIG. But these players ultimately mattered less.

  “In light of the prevailing market conditions and the size and composition of AIG’s obligations, a disorderly failure of AIG would have severely threatened global financial stability and, consequently, the performance of the U.S. economy,” Fed chairman Ben Bernanke said on September 23, 2008, in front of the Senate Committee on Banking, Housing, and Urban Affairs.77

  The first big piece of the AIG bailout was an $85 billion loan extended on September 16, 2008. The move diluted AIG shares, because the government took an 80 percent equity interest.78 AIG had to issue more shares for that to happen, significantly increasing the pool of AIG shares in the process.79 Cranky investors were left wondering why they weren’t allowed to vote on the loan.80 The Federal Reserve Bank of New York extended another round of money to AIG on October 8, 2008, by buying up $37.8 billion worth of AIG shares owned by third parties.81 A few weeks later, AIG announced that it was quickly taking advantage of taxpayers’ unwilling generosity, gobbling $90.3 billion of government credit by October 23, 2008.82

  Even more taxpayer money was on its way. On November 10, 2008, the Treasury used $40 billion of the TARP fund to buy AIG shares and reduce AIG’s original $85 billion loan cap to $60 billion.83 Meanwhile, the interest rate on the original loan was dropped to as low as 5 percent, and the payback time was upped from two to five years. If similar loan extensions were given to borrowers on their mortgages, their payments and struggles would be reduced. That restructuring of the AIG bailout included a Fed purchase of $52.5 billion worth of AIG’s toxic mortgage backed assets that replaced the $37.8 billion loan granted on October 6, 2008.84

  Finally, another $30 billion worth of credit was extended after AIG announced a $61.7 billion loss for the fourth quarter of 2008, bringing the AIG bailout to nearly $182 billion.85 That credit line was good for five years. AIG could draw on it “as needed and [it] will serve as a backdrop for our restructuring activities,” said Edward Liddy, AIG CEO and chairman, during a conference call on March 3, 2009.86 Liddy decided he was done doing the government a big favor by running AIG and, on May 21, 2009, he announced that he would step down from his post as soon as replacements were found for the CEO and chairman positions, which he recommended be made distinct.87

  After the Fed put itself in the hole for roughly $182 billion for AIG alone, Bernanke concluded on March 24, 2009, before a House Committee on Financial Services hearing that the government had failed in its role as market regulator.88 This epiphany did not stop him from positioning for more Federal Reserve authority under Treasury Secretary Tim Geithner’s plan for an “über regulator” or “systemic risk regulator” that would oversee all of the various types of financial firms in the system, not only the commercial banks—although the Fed’s bailouts transcended this group anyway.89

  “AIG built up its concentrated exposure to the subprime mortgage market largely out of the sight of its functional regulators. More effective supervision might have identified and blocked the extraordinarily reckless risk taking at AIG Financial Products Division,” Bernanke said during the March 24 hearing.90

  He didn’t mention that AIG had an admitted obligation to responsibly invest its shareholders’ and investors’ money. “We will create unmatched value for our customers, colleagues, business partners and shareholders as we contribute to the growth of sustainable, prosperous communities,” the code of conduct for AIG employees reads.91

  As far as AIG was concerned, its securities investment models designed by finance professor Gary Gorton were working, even though AIG was aware that those models did not take into account external market risk factors.92 AIG leaders had been downright giddy a year earlier. “It is hard for us with, and without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 in any of those transactions,” then chief financial officer Joseph Cassano said on a conference call on August 9, 2007.

  “No, I agree with you, I tend to think that this market is overreacting,” Tom Cholnoky, a Goldman Sachs analyst, replied.93 (Cassano would walk off with an eight-year accumulation of $315 million in his pocket in cash and bonuses after being fired in March 2008. He also kept pulling in $1 million each month as a consultant until the end of September 2008, even after taxpayers had bailed out AIG.)94

  Of course, AIG wasn’t the only one receiving bailouts about a year after Cassano’s ebullience; so were its big name backers, including Goldman, which were getting cash from all sides—from the government directly through TARP and indirectly by way of AIG. Transactions between AIG and third parties included a total of $12.9 billion that went to Goldman (the largest single recipient), $11.9 billion to Société Générale, $8.5 billion to Barclays, and $6.8 billion to Merrill Lynch.95

  It was all so shameless, yet the architects of this money transfer, namely, Geithner, Bernanke, and Paulson, remained silent about it, preferring to let the public and Congress focus on $165 million of bonuses that AIG paid out, ostensibly from bailout money.

  “The AIG bailout has been a way to hide an enormous second round of cash to the same group that had received TARP money already,” former New York governor Eliot Spitzer wrote on Slate.com on March 17, 2009. He added, “The appearance that this was all an inside job is overwhelming. AIG was nothing more than a conduit for huge capital flows to the same old suspects, with no reason or explanation.”96

  The question raised by Spitzer warrants further inspection. If all signs pointed to Goldman being financially solvent, why was it allowed to recoup its AIG losses via public funds? Furthermore, Goldman appeared to have known that AIG’s financials were on a downward trend in 2006 and 2007, when it demanded more collateral from AIG to cover risks to its investments.97 Did an AIG derivatives insider warn Goldman, or did Goldman figure out the situation itself? Either way, why didn’t anyone else seem to know about AIG’s declining position a year before the rest of the world did? And why did the Washington crowd allow itself to believe that without backing AIG, the world as we know it would cease to exist?

  More to the point of too big-to-fail-is-too-big-period—why not bust up AIG into an insurance component and a trading component, pull a Glass Steagall on this insurance company cloaked in a savings and loan wrap, and then after that’s done, why not do the very same thing to every other mega bank to create a more manageable financial system for the sake of our collective future economic stability?

  9

  Change, Really?

  The era that defined Wall Street is finally, officially over.

  —December 2008, Condé Nast, Portfolio magazine1

  We must not forget that we finance our own government.

  We are a nation of taxpayers, and nearly 80 percent of the tax revenue our government takes in each year comes directly from We the People.2 Our country is founded on the principle that in return for paying taxes, we get a say in how things are run. Taxation with representation. So here is what we must find out: How do we ensure that the banking system doesn’t collapse and, moreover, remains stable in the future? In other words, how do we ensure that we don’t keep getting screwed?

  Despite documented reports on the lack of transparency in the TARP process, there was no demand for comprehensive evaluations of junky assets. It turned out that promises for greater transparency from the Obama administration amounted to a Web site overhaul and a name change, which added more columns to a TARP activity report, none of which clearly answered the simple question “So, how are we doing?” In a stunning lack of departure from business as usual, President Obama (along with Tim Geithner) asked former Fannie Mae CEO Herbert Allison to replace Neel Kashkari as head of the TARP program. On June 19, 2009, Allison made his case to do just that, in front of the Senate Committee on Banking, Hou
sing, and Urban Affairs.3

  Allison had all of the checks necessary for the role. Bipartisan political ties? Check. President Bush’s treasury secretary Henry Paulson handpicked him to run Fannie Mae in September 2008, offering him the job while Allison was on a Caribbean vacation.4 And Allison served as finance adviser to John McCain’s 2000 presidential campaign. Ties to Geithner? Check. Allison served on an advisory committee to the Federal Reserve Bank of New York when Geithner was president there.5 Ties to Wall Street? Check. Allison rose through the ranks of Merrill Lynch to become its president and chief operating officer, before resigning over internal politics in 1999 after three decades at the firm.6 Ties to the investment community that buys and sells structured securities? Check. From Merrill Lynch, Allison became CEO of TIAA CREF, a ninety-year old pension and financial services firm with nearly $400 billion under management.7 Allison’s first major act at the firm was firing five hundred employees, a deed that became known as the “Herbicides.”8 That was the same year the firm launched its collateralized debt obligation business.

  Allison also managed to raise some eyebrows over his generous compensation during his years at TIAA CREF, even though salaries on the “buy side,” or asset-management side, of the financial world are generally not as good as those on the “sell side,” or investment-banking side. Still, Allison had enough money in 2006 to purchase the $25 million Westport, Connecticut, home of Phil Donahue and Marlo Thomas.9 None of this necessarily makes him a bad pick for running TARP, or a bad person. He certainly has good taste in real estate. But it does show that ties to Big Finance retain a solid place in the Obama administration and in running the biggest bailout in U.S. history.

  Until Washington gets a grip on that one, no meaningful solution to this crisis will result. Wall Street legal teams will continue to exploit loopholes in everything from how stocks are traded to how executives are compensated. The House’s swooning to pass a 90 percent tax on bailout-firm bonuses on March 19, 2009, was a knee jerk, theatrical reaction to public uproar over the news that AIG was going to pay $165 million worth of bonuses while existing by the grace of the public’s dime.10 Unfortunately, the act dealt with the symptoms, not with the source, of the structural problems in the foundation of the financial sector. The act stalled in the Senate. But true change requires more than campaign vows and dramatic congressional gestures; it requires courage the likes of which haven’t reigned on Capitol Hill since the 1930s and briefly in the mid 1950s. It requires not only a reregulation, but also a complete restructuring of the financial arena, of all banks, insurance companies, and hedge funds. Not just the illusion of transparency, but the real thing. Not merely promises of accountability, but true, legally binding responsibility.

  We have an astounding capacity to forget, to patch over the holes and paint the walls and pretend the house is sound. To keep on living our lives, making believe that everything is back to normal. Although it may be hard to imagine right now, there will come a time when everything will seem fine—or the news at least will focus on the rallying stock market, which will be accepted to mean that everything is fine. We won’t want to deal with the messy (and boring) difficulties of financial regulation. We will become enamored of, even as we resent, the glitz of Wall Street once again. We will start obsessing about how much our portfolios are up. When all of these things happen without any structural change, that’s when we’re in real trouble. Because when we forget, that’s when the pillage will begin again.

  Washington is masterful at conducting lengthy, painful debates over minutiae, which sap the country’s hope—not to mention the federal budget—and also distract us from undertaking more essential action on the profound structural problems. Expensive piecemeal remedies aimed at solving the financial system’s total failure have continued through the Bush and Obama administrations. We are suffering from a bipartisan disconnect.

  How many times have we heard statements like, “If we don’t fix the banks, the public will suffer,” from both Democrats and Republicans? And how many times have our elected officials decided that the solution is to “stock up” in failing behemoths such as Citigroup to help them over their capital hump? The government seems intent at plastering the (many) cracks in the walls of finance, rather than rebuilding its foundation. But we need an overhaul, not a tune up.

  Rather than take the opportunity to engineer drastic responses to the Second Great Bank Depression, the Obama administration and the current treasury secretary, Tim Geithner, opted to massage the hand me down plans of the Bush administration and former treasury secretary Hank Paulson. These plans, as we have seen, simply followed the “we must stay competitive” deregulation craze of the Clinton administration and Treasury Secretary Robert Rubin, which took its tone from the “government is not the solution” rhetoric of Ronald Reagan. Certainly bad government is not the solution, but we can hope for better than that.

  Instead of instituting actual sweeping reform, Obama and Co. merely call their ideas reform. As Obama took office on January 20, 2009, the first half of the TARP package—some $350 billion of taxpayer money—had already been dispersed.11 As of March 31, 2009, that investment had lost 45 percent of its value, and that wasn’t including the $78 billion overpayment to begin with!12 But did the incoming administration take the time to consider how it might use the second half of the TARP funds differently? No. Obama’s team was determined to continue the same pattern of disbursement that had already failed so miserably and had actually sparked a sort of childish petulance in the banking community, with a twist or two.

  America elected Obama because he presented himself as a thoughtful and visionary thinker—because he seemed to approach the country’s problems in exactly the opposite way that his fly-by-the-seat-of-his-pants predecessor had. So, what has happened to the enlightened perspective of our new president? Why has he not brought the same intellect to bear on the financial morass? He does not seem to be asking the essential questions: Why are we capitalizing banks when we don’t know what they hold on their books or how much borrowing they did using those assets as collateral? Why aren’t we questioning the Fed’s stealthy and expensive cash injections? Why are we backing the purchase of toxic assets by private investors with federal money? Why not just say, “No!” to the crazy federal bailout expenditures? Why meet with scripted, self interested bankers about ways to save the economy, instead of with independent minds such as Robert Kuttner, Naomi Klein, Dean Baker, Bob Johnson, Thomas Ferguson, Michael Hudson, Bill Greider, and others who have pointed out real problems and solutions? Come on!

  No, it’s not simple, but it’s doable. In the case of the banking world, it means pulling an FDR: shut it down, evaluate its loss, and dissect it into manageable, backable parts. As I’ve explained, we must separate the risky banks from the nonrisky ones, take away government backing from any firm that lobbied against government regulations, and dramatically roll back the amount of risk that the market is legally able to take on.

  None of these potential stability creating measures has been addressed, however. Instead, Geithner took a stab at making broad brush promises during his first week on the job, saying, “We will unveil a series of reforms to help stabilize the nation’s financial system and get credit flowing again to families and businesses. Included in those reforms will be a commitment to increase transparency and oversight.”13

  Geithner, like so many on the Hill, talks big about transparency but demonstrates no understanding about the connection between the creation of certain securities that were then used to build a cloud of pure profit for Wall Street and how this harmed everyone else on the planet. That’s why he had to ask them, the bankers, to tell him what they’ve been doing, as if that will lead to an objective evaluation. It would be more helpful if Geithner put rules in place to control what bankers can do to begin with. It would save on the question answer portion of this period.

  On February 10, 2009, in the official televised unveiling of his much anticipated “new plan,” Geit
hner actually commended the efforts of the prior administration and Congress in dealing with the crisis. And why not?—he played ball for that team, too.

  “Last fall, as the global crisis intensified,” he said, “Congress acted quickly and courageously to provide emergency authority to help contain the damage. The government used that authority to pull the financial system back from the edge of catastrophic failure.”14

  As Geithner spoke, however, the financial system was in a worse, less capitalized state than it had been in the fall of 2008. Nearly every major banking stock price was lower, meaning that its net worth, or market capitalization, was lower. The FDIC’s report of that quarter showed that reserves held against loan losses had increased substantially by the end of 2008 versus the end of 2007. Worse, these reserves still weren’t keeping pace with the losses. The problems were not in the entire banking sector; in fact, two thirds of the nation’s banks had posted profits. It was the “big banks” that were the troublemakers.15

  But Geithner didn’t go there; sometimes the truth is too painful to deal with. He did, however, open up the opportunity to outperform his predecessor (which won’t be difficult, because my five-year old nephew could pose more probing questions about the first round of bailouts than Paulson seems to have considered).