USD Law’s Frank Partnoy: Fed “revealed too little.”
Back in the Old West, watering of livestock was standard business practice. A cow would be bloated with water so it could be sold at a stiff price. Pretty soon, Wall Street learned how to water its own species of stock — and bonds too. These days, in San Diego and just about everyplace else, getting a loan based on a bloated property appraisal is as culturally deep-rooted as yarns about Jesse James.
Now it appears that during the recent financial crisis, our central bank, the Federal Reserve, was giving away money to banks, hedge funds, and all manner of financial institutions by knowingly accepting collateral that was thoroughly watered, or worth far less than claimed. The Fed knew it was getting bloated collateral but claimed it was using this process to bail out the financial system. “These bailouts have been an incredible giveaway to Wall Street,” says San Diego attorney Gary Aguirre, who has been assisting the staff of Senator Chuck Grassley of Iowa in interpreting bailout data that the Fed has released under duress. Freedom of Information Act requests by Bloomberg and Fox, along with provisions of the Dodd-Frank financial reform law, forced the Fed to open its books — a crack, anyway.
Attorney Gary Aguirre
During the crisis period that began in late 2007 and is still going on, the Fed was giving 90 cents on the dollar for toxic assets (such as complex financial derivatives) that it knew were worth only 60 or 70 cents, says Aguirre. Institutions such as banks and hedge funds “could put any value they wanted on the collateral,” and the Fed, which was trying to pump liquidity into the system, was happy to oblige.
How happy to oblige? There are various estimates. The most common guess is that the Fed provided around $3.3 trillion in liquidity, or actual transfers of cash, to financial institutions, and more than $9 trillion in guarantees and backup commitments. Aguirre says the sum is between $3 trillion and $4 trillion in cash transfers and $9 trillion to $11 trillion in commitments. Think of it this way: the gross domestic product, or America’s total annual output of goods and services, last year was $14.7 trillion. The Fed’s giveaways and promises to support supposedly ailing institutions may have equaled or even surpassed the nation’s total economic output last year.
On December 1 of last year, the Fed released data on 21,000 transactions between December 1, 2007, and July 21, 2010. “The Federal Reserve is committed to transparency,” boasted the central bank, despite the fact that it had fought information requests for several years, claiming that such revelations would embarrass the recipients of the largesse. On December 1, the press quickly figured out how huge Wall Street institutions had raked in the bread that the Fed was handing out: Citigroup, $1.8 trillion; Morgan Stanley, $2 trillion; Goldman Sachs, $800 billion, for example. A slew of foreign banks also got handouts.
The Fed was loaning money at around zero percent and taking in collateral of dubious worth. Quickly, the word got around that America’s central bank was giving money away. Matt Taibbi wrote a brilliant article on the greed orgy in the April 28 issue of Rolling Stone. Aguirre, who warned the Senate Judiciary Committee in 2006 that bank and hedge fund excesses could lead to a crash, is quoted in Taibbi’s story. Taibbi explained how the bankers managed to con the Fed for free money. “[It was] a masterful bluff by Wall Street executives. Once the money started flowing from the Federal Reserve, the executives began moaning to their buddies at the Fed, claiming that they were suddenly afraid of investing in anything — student loans, car notes, you name it — unless their profits were guaranteed by the state.”
Banks would get money for almost zero percent and quickly buy Treasury bonds at a higher percent. Taibbi quotes one congressional aide observing, “People talk about how these were loans that were paid back. But when the state is lending money at zero percent and the banks are turning around and lending that money back to the state at three percent, how is that different from just handing rich people money?”
It’s no different at all — and it’s reprehensible that the trillions given free to Wall Street have still not found their way to Main Street. Taibbi points out that hundreds of millions of dollars were given to hedge funds and others located in the offshore secrecy/tax haven of the Cayman Islands. It’s one thing for the government to look the other way when Wall Streeters evade taxes by registering their entities offshore. “But subsidizing tax evasion?” writes an indignant Taibbi.
Taibbi focuses on a caper called Waterfall TALF Opportunity. (The acronym stands for Term Asset-Backed Securities Loan Facility, a Federal Reserve program.) Christy Mack, wife of John Mack, then the head of Morgan Stanley, and Susan Karches, the widow of a former top executive of the same firm, got a giant welfare check from the Fed. “With an upfront investment of $15 million, they quickly received $220 million in cash from the Fed, most of which they used to purchase student loans and commercial mortgages,” writes Taibbi. “The loans were set up so that Christy and Susan would keep 100 percent of any gains on the deals, while the Fed and the Treasury (read: the taxpayer) would eat 90 percent of the losses.” It was a classic “heads-I-win, tails-you-lose investment,” coming right at the time the Macks were buying a multimillion dollar carriage house on the Upper East Side of New York.
The Fed’s transparency claim is a whopper, says Aguirre, who has been poring over the data on the Fed’s website. In the case of John Mack’s wife and her friend, “It looks like they are borrowing the money from the Fed, say, at 70 cents on the dollar and selling it back to the Fed for 90 cents. We can’t tell for certain because the Fed won’t tell us. The Fed publishes information but not enough for you to figure out what the hell happened.” Says Aguirre, “Suppose you own a San Diego car dealership and say it is worth $50 million — buildings, lots, and $40 million worth of cars. But I ask how many cars you have — how many Chevys, how many Cadillacs — but you won’t give me the numbers.” The Fed lists information on bonds involved in a transaction but won’t tell how many bonds. “The media should be screaming about this.”
Frank Partnoy, law professor at the University of San Diego, agrees that the Fed didn’t provide enough information. “The Fed’s new data have revealed too little,” Partnoy wrote in a Financial Times of London column on December 3. “The Fed charged low rates, often almost zero percent. It says these rates were justified because loans were ‘fully secured.’ However, unlike some Fed disclosures, the data include only the face amount of the collateral, and vague categorical labels. The Fed admits some collateral was inadequate. But without more details we can’t know whether the loans were fully secured, or whether the Fed, by lending at low rates without adequate collateral, was effectively gifting money to borrowers around the world.”
The Fed gave trillions of dollars to institutions and individuals, receiving smelly collateral in return. Then when legally forced to reveal what it had done, the Fed gave misleading information. People go to prison for that.