Bailout Nation (28 page)

One would be disappointed: The TARP plan, the various 2008 bailouts of Bear Stearns, Fannie Mae/Freddie Mac, Citibank, Merrill Lynch, Bank of America, American International Group (AIG), and others all took place during a purportedly conservative Republican administration.

Maybe it was less a matter of political ideology than it was governing style. For most of the Bush administration's two terms, the GOP adhered tightly—perhaps too tightly—to Karl Rove's discipline. The Rove approach helped President Bush govern, but it stifled debate on major issues. Too much party-line groupthink and too little independent thought is the likely reason why social conservatives became conservative socialists.

Just as there are no atheists in foxholes, there were no free market capitalists in the face of a financial system collapse.

W
hen Bear Stearns, the nation's fifth-largest investment bank, ran into trouble, the assumption among many Fed watchers was that it wasn't deemed “too big to fail.” It was almost an article of faith that the marketplace would be allowed to operate unimpeded. As the crisis at Bear heated up, though, both the Federal Reserve (headed by an academic expert on the Great Depression) and Treasury (headed by a former Goldman Sachs CEO) seemed increasingly uncomfortable with the prospect of so much creative destruction.

Maybe
panicked
is a better word than
discomfort
for how Ben Bernanke and Henry Paulson reacted.

In March 2008, Bear was “liquidated in an orderly fashion” (
rescued
is far too kind a word). With Treasury Secretary Paulson concerned with moral hazard, Bear was originally sold for $2 per share. Shareholders balked, and ultimately Bear went to JPMorgan Chase for $10 per share. The bondholders were made whole, with the Federal Reserve and the U.S. Treasury backstopping $29 billion in losses for the deal to get done.

The issue of whether “too big to fail” played a role in the Bear saga is still the operative question. Bear had extensive ties with JPMorgan Chase, including a rumored 40 percent exposure by JPM to Bear Stearns' $9 trillion derivatives book. A bankrupt Bear would have significantly damaged JPM, which by all accounts
was
considered too big to fail. The best explanation I've seen as to why Bear was rescued in the first place was to prevent its derivatives mess from dragging down JPMorgan Chase with it.

Thus began a 12-month period that would see bailout after bailout, all funded by the American taxpayer.

Then there were the government-sponsored enterprises (GSEs): It's hard to say why Fannie and Freddie were bailed out on September 7, 2008. Certainly the reason wasn't insolvency, for as former St. Louis Federal Reserve President William Poole had said in July 2008, they had been technically insolvent for years.
¹
And it wasn't cash flow, as the GSEs had enough operating capital to keep going for another 8 to 12 months. Politics during an election year? Saving the next president from making a tough decision? Influencing mortgage rates? These were some of the reasons given, and they are all questionable.

Then came Lehman Brothers. It wasn't deemed too big to fail, but its September 14, 2008, bankruptcy helped force the thundering herd of Merrill Lynch into the waiting arms of Bank of America. Curiously, we'll never find out if Merrill was too big to fail. More important, Lehman's demise impacted lots of the credit default swaps (CDSs) written in the shadow banking system, including hundreds of billion of dollars' worth insured by AIG. The same factors that caused Lehman's bankruptcy also triggered AIG's crash and contributed to the Reserve Primary Fund “breaking the buck.”

Soon Uncle Sam was scrambling for his checkbook again.

Size and interconnections were no longer the sole factors that mattered; side bets—such as the credit default swaps placed on Lehman's debt—became a key factor, also.

Bear wasn't allowed to fail for fear of damaging JPM; Lehman was allowed to fail, but no one considered letting AIG fend for itself. Rather than wait for Citigroup to fail, Treasury acted preemptively, rescuing the giant money center bank before it was on the verge of collapse.

Discern any pattern here? Me neither.

Bailing out banks one at time wasn't working, so on October 14, 2008, the U.S. Treasury injected $125 billion of capital into the nine largest banks and another $125 billion into other, smaller banks. Were the bailout architects using these other banks as cover—a smokescreen to conceal an attempt to shore up Citigroup? Perhaps Citi was closer to collapse than previously realized. Using the authority granted to him by Congress when it passed the controversial $700 billion TARP package (in another of Congress's finest moments, the original bill was defeated in the House but then approved after Wall Street freaked out and $150 billion in pork was added), Paulson literally made the banks an offer they couldn't refuse. Any fan of
The Godfather
or
The Sopranos
knows the term for someone who forces you to take money you don't want and might not need.

On top of the $25 billion Citigroup got in October, regulators decided the firm needed more money and protection from its own bad trades. Outrageous though it seems, the U.S. government gave Citi another $20 billion on November 24, 2008. And that wasn't all. Uncle Sam guaranteed $306 billion of troubled home loans, commercial mortgages, subprime bonds, and low-grade corporate loans the firm had made.

Why was there more than $300 billion for Citigroup, but General Motors and Chrysler had to beg and plead for $13.4 billion to stave off their imminent collapse in late 2008? Damned if I know why.

There is a pattern here, but it's one of randomness, not predictability. There seem to be no operative governing rules. Every event is a one-off; the response to each company was not part of any well-planned strategy or grand overview. James Montier of Société Générale called it an
adhocracy
. There has been no broad strategy and apparently no architects to the trillions in bailout dollars so far.

Battles are won with tactics, but in war victory is achieved via strategy.

T
he bailout decision-making process has been dominated by two very different minds and disparate personalities. At the Fed, there is Chairman Ben Bernanke. An academic, he has proven to be a quick study of the ways of Wall Street. His crosstown compatriot at the Treasury, Hank Paulson, was the former deal-making CEO of Goldman Sachs. They are intelligent men of very differing styles and approaches. The government's initial response to the crisis seems to be a hybrid of their two different approaches. We have yet to see if the dynamic will be any different with President Obama's Treasury secretary, Tim Geithner, who had a hand in many of the 2008 bailouts as president of the New York Federal Reserve Bank.

Saving the U.S. financial system bound Paulson and Bernanke together in common purpose. That neither man saw it coming further ties them together. There is a third factor they had in common: They each saw a leadership void as things progressed into crisis.

Indeed, about now you should be asking yourself why a cabinet department and a central bank were running the greatest government rescue operation in history. And you may be wondering, “Where is the man at the top of the organization chart?” It is a fair question. Why did George Bush go AWOL during this crisis period?

Indeed, during the second half of 2008, one got the sense that the Bush White House had no stomach for the entire affair. The bailouts were a repudiation of everything the president believed in; perhaps he simply couldn't bear to take the lead on something he found so philosophically distasteful. Bush's approval ratings were at record lows, his legacy and reputation in tatters. In the latter half of 2008, the sense was that the Bush White House was running out the clock. As Bush's last term was ending, the wheels came off the bus. Then the bus caught fire, rolled down a ravine, and ended up at the bottom of the sea. Running out the clock may have seemed easier than the alternative.

During the interregnum between the November 4th election day and the January 20th inauguration, the void became even more pronounced. Democratic Congressman Barney Frank criticized president-elect Barack Obama for not being more “assertive” during the crisis. “Part of the problem now is that this presidential transition has come at the very worst possible time,” Frank told
60 Minutes
. “You know, Senator Obama has said, ‘We only have one president at a time.' Well, that overstates the number of presidents we have at this time.”
²

Bernanke and Paulson soldiered on. To be fair to our D.C. twosome, this has been the crisis that keeps on changing. It started out as a real estate boom and bust, driven by ultralow interest rates and a bubble in credit and lending. That alone would have been difficult to resolve. It then slowly morphed into a full-blown credit crunch, where commercial lending ceased. Then it changed into a Wall Street crash as stocks crumbled globally and yields dramatically fell. Ultimately, it became a U.S., then global, economic recession, with deflation driving the prices of most commodities into the ground.

This has been an unprecedented period in American history.

All the while, the government's response has always been at least one step—and one crisis—behind the curve.

As the government dithered, flailed blindly, and generally meandered aimlessly, casting about for a suitable response to these many crises, the tally grew.

And grew.

Until the total commitment hit an astronomical figure: $15 trillion. That is how much Uncle Sam has spent, promised, lent, guaranteed, or assumed in liabilities thus far on its way to becoming Bailout Nation's government in residence. (See
Table 14.1
.)

The year 2008 has long since passed any other year—indeed, any other century—in terms of government expenditures directed toward rescuing damaged companies. As this book went to print, the total outlay of government monies and credit from the Treasury Department, the Federal Deposit Insurance Corporation (FDIC), and the Federal Reserve was nearing $9.5 trillion. Add in the $5.5 trillion in Fannie Mae/Freddie Mac mortgage portfolios that the U.S. taxpayer assumed responsibility for when the GSEs were placed into conservatorship, and you get an astonishing total.

Table 14.1
Bailout Tally