Coyote Blog

Or maybe it is more correct to say that the taxpayer is being set up to keep BofA counter-parties whole. From Bloomberg, via Zero Hedge:

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation.

The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties, said the people, who asked to remain anonymous because they weren’t authorized to speak publicly. The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, while the FDIC, which would have to pay off depositors in the event of a bank failure, is objecting, said the people. The bank doesn’t believe regulatory approval is needed, said people with knowledge of its position.

Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with how to protect FDIC- insured bank accounts from risks generated by investment-banking operations. Bank of America, which got a $45 billion bailout during the financial crisis, had $1.04 trillion in deposits as of midyear, ranking it second among U.S. firms.

“The concern is that there is always an enormous temptation to dump the losers on the insured institution,” said William Black, professor of economics and law at the University of Missouri-Kansas City and a former bank regulator. “We should have fairly tight restrictions on that.”

Obviously I am not a huge fan of bank regulation, but if the taxpayer is going to insure deposits, then the government has got to set and enforce capital restrictions on how those deposits are invested.  How many times do we have to learn this lesson?  The S&L crisis and the Texas bank collapse of the 1980's was caused by the exact same BS, investing taxpayer insured deposits in increasingly risky investments.

Normally, in a free economy, we expect lenders to enforce rules and discipline on those to whom they lend, just as fire insurers in the 19th century developed the first building codes and inspections to protect their themselves.  But if depositors are insured, they are not going to get worked up too much about BofA -- I am a depositor but I know the Feds will make me whole if the bank crashes.  Deposit insurance provides comfort to depositors and pays some dividends in heading off bank panics, but at the same time it relieves the bank of any accountability for how the deposits are invested unless the US government takes on that role.  Of all the BS regulations financial firms have to put up with, this is the one that should actually exist, and the implication in this article is that despite thousands of pages of new regulation, these basic protections still don't exist.  Sure, they exist in law, but there seems to be nothing to stop an agency from issuing exemptions, and this Administration has shown itself to love giving exemptions.

This reminds me a ton of the AIG bailout.  For some reason, there are a group of Wall Street companies (cough Goldman cough) that seem to have immense political power to protect investments in which they are a counter-party.  To this point, people have been expecting that the BofA holding company might soon fail, but the underlying banks would be fine and just sold off in pretty good shape.  Most of the trash is apparently at the holding company level.

The losers in all this are the counter-parties to these various derivatives, who would rather have a better set of assets to grab if the ship starts sinking.  Of course, they don't have any right to this -- they didn't make these original deals with the depository banks, they made them with Merrill Lynch and other trash BofA has bought.  But never-the-less, the Fed seems fired up to give these guys a special deal.  It reminds me of the Solyndra deal where the Administration allowed certain private parties to move ahead of the US Government on the creditor list, though at least in Solyndra's case these parties actually put some money into the pot for the privilege.  This seems to be a straight giveaway, and it is no surprise that the FDIC is apoplectic.

I know the FDIC is often in a hurry to place assets from failed banks, but this deal appears absurd

The only way I can find that their math might be wrong is if in the loss payment calculation, the contract might add the value of the promissory note to the short sale proceeds, but that does not change the gravy train here.

I just got a note from Bank of America telling me that some of my accounts now have unlimited deposit insurance from the FDIC through 2012, above and beyond traditional limits.   We are worried about reckless banks so we are ...  further reducing and socializing the costs of risk-taking?  Notice I received below, I cannot yet find any info on FDIC site.  As usual click to enlarge.

So what does it take to overcome the opposition of Congressmen who said they opposed the bailout bill as too expensive, too big of a giveaway, and too much of a moral hazard?  Why, more moral hazard (in the form of higher FDIC insured balances), increased spending, and, incredibly, money for alternative energy.  Are these guys a joke or what?  (HT Hit and Run)

By the way, I had a conversation yesterday with a very anti-Bush, anti-Iraq-War Democrat -- the sort that can't get through a five minute conversation without making a Dick Cheney crack.  She was lamenting the failure of the bailout package in the House and excoriating Republicans for being so ignorant and narrow-minded.  My response was:

I find it surprising that you take this administration on faith in its declaration of emergency in the financial sector.   You've lamented for years about the "rush to war" and GWB's scare tactics that pushed, you felt, the nation into a war it should not be fighting, all over threats of WMD's that we could never find.  You lamented Democrats like Hillary Clinton "falling for this" in Congress

But now the mantra is the same - rush, rush, hurry, hurry, fear, fear, emergency, emergency. Another GWB declared crisis in which the country needs to give the administration unlimited power without accountability and, of course, stacks of taxpayer dollars to spend.  A decision that has to be made fast, without time for deliberation.  Another $700 billion commitment.     And here the Democrats go again.  Jeez, these guys may have the majority in Congress but it is sure easy for GWB to push their buttons when he wants to.  Heck, Pelosi is acting practically as the Republican Whip to get GWB's party in line.

This is Iraq without the body bags, and without the personal honor of brave soldiers in the trenches to give the crisis some kind of dignity.

This is taken from and expanded from the end of this post.

Everyone involved in the bailout plan says, at least publicly, that they are not trying to bail out a bunch of Wall Street folks who lived high off the risk premium of these investments but now want to avoid the costs when the actual risks become clear.  They claim to be bailing out Wall Street and various large banks because they fear that a financial meltdown and liquidity crisis will starve main street businesses of cash, and create a deep economic slowdown.

OK, if this is the real policy goal -- to maintain the ability of main street businesses to borrow -- then here is my alternative proposal:

1. Immediately increase the SBA loan gaurantee authority by $100 billion dollars.  That is enough for a million new small business loans of $100,000 each.
2. Authorize treasury to spend up to X hundred billion to buy rated new issues of bonds and commercial paper of US non-financial companies.  Some limits should be applied - such as the feds cannot buy any more than 30% of a single issue and/or more than 10% of the entire outstanding debt of one company.

That's the plan.  Here are the advantages:

• The government is addressing the actual policy goal of keeping liquidity in main street business directly
• The government is investing in success, in main street companies trying to grow, and not in failed banks and financial institutions
• Moral hazard issues are avoided with financial institutions. 
• The SBA loan guarantees cost nothing today.  In fact, they are cash positive in the short term due to loan guarantee payments by borrowers.  Of course, they risk future losses,  but such losses in the future are in part covered by the guarantee payments, and a future loss is cheaper than a loss today.
• Investments in corporate bond issues are much easier to value, and are far less risky, than investments in illiquid mortgage securities.  The taxpayer is far less likely to take a beating on these purchases.
• Banks may still fail, but the FDIC has an infrastructure and experience for handling this.  If necessary to calm people, the FDIC could make a public commitment to assisted mergers to maintain all depositors.
• If there is some big financial meltdown, which I still doubt, there might be a need to inject some mortgage liquidity, but since the Feds now own Fannie and Freddie, the vehicle for doing so is easily available.

Update:  I was not clear -- this is actually an alternative to by alternative.  My first, preferred alternative plan is "do nothing."

Those on the left and the right often try to laugh off libertarians, ascribing to "paranoia" our fear of the power of government. 

Well, I could argue that if this is paranoia, I share a similar phobia with men like Thomas Jefferson and James Madison, whose fear of government power permeate all their writings, as well as the Constitution they helped to produce.  They believed that even good men could be corrupted by the government, and they were proven correct in an incredibly short time by John Adams.  Adams is by all accounts a good man, dedicated to freedom and democracy, and one of the chief intellectual architects both of the Revolution and the Constitution.  But it was Adams that signed into law the Alien and Sedition Act, perhaps the worst piece of illiberal and unconstitutional legislation in the history of this country.

Or, if I didn't want to make the founding father's / original intent argument, I could just point to this (hat tip Marginal Revolution):

A federal judge in Texas, calling the Federal Deposit Insurance Corp. a "corrupt
agency with corrupt influences on it," awarded a Houston financier $72 million
to cover his legal fees in a decade-long suit involving a failed savings and
loan and the government's efforts to take control of a stand of endangered
California redwood trees in the 1990s.

The FDIC, a regulatory agency that insures deposits at banks and
savings and loans, filed suit against Charles E. Hurwitz in 1995, seeking to
collect more than $800 million because Hurwitz indirectly controlled a Texas
S&L that failed in 1988. The FDIC, after a series of legal setbacks, dropped
its suit against Hurwitz in 2002....

On Tuesday evening, Hughes issued a scathing, 131-page ruling. In it, he cited
evidence that the FDIC brought the case largely because of pressure from
environmental groups, members of Congress and the Clinton administration. The
reason: Hurwitz's Pacific Lumber Co. owned 3,500 acres of endangered redwoods in
Northern California. Hughes found that the FDIC, in close concert with
environmental groups, sued Hurwitz to pressure him into a "debt-for-nature"
swap, in effect giving the government his trees in exchange for his supposed
liability in the failure of the United Savings Association of Texas....

Hughes said FDIC officials and lawyers, in depositions, "ranged from
manipulative evasiveness to plain perjury." He cited records of two years of
communications, including extensive discussions of legal strategy and political
matters, between the FDIC and environmentalists over the proposal to use a
banking-practices lawsuit as pressure on Hurwitz to give up the
redwoods.

Hughes said FDIC officials "discarded the mantle of the American
Republic for the cloak of a secret society of extortionists. If the vice
president called, they responded. If a congressman called, they responded. If a
lobbyist called, they responded. They heeded every call but that of duty and
honor."

Wow.  I know many people are paranoid about the lack of accountability of major corporations, and felt vindicated by the Enron case, over which the press spilled acres of ink.  However, Enron is nothing compared to this.  While fraud is bad, Enron at least was never able to use the coercive regulatory and police power that the government has to seek its ends.