Morality in the Bailout: Citi Takes the High Road

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was the first to comprehensively analyze the motivations behind
the bailout and to identify those who were its primary intended
beneficiaries: JP Morgan and Citibank. That October 2 piece showed
how JP Morgan and Citibank were poised to be first in line to receive
as much as $850 billion in newly printed dollars, a significant
increase in the U.S. money supply.

As Irish-French
(but truly Austrian)
economist Richard
first observed, in a fiat money system those who benefit
the most when the money supply is increased are those who are first
in line to receive it. This is because when new money is created
asset prices in the market do not immediately reflect the increase
in the supply of money. Because sellers of fruit and just about
everything else generally do not check their daily prices against
the adjusted
monetary base as published by the St. Louis Federal Reserve
they are for the most part initially unaware that the currency has
been debased. They realize the loss in purchasing power only long
after the initial debasement has occurred. Because most sellers
are generally unaware of the debasement, the holders of the new
dollars can purchase assets from them at relatively deflated prices.
Once the initial infusion runs through the system, the market (sellers)
recognizes that that the supply of dollars has increased and that
they can and must charge more for their product to keep up. Contrary
to the popular view, inflation is therefore really nothing more
than an increase in the money supply. The consequent increase in
wages and prices (the popular view of inflation) is just a delayed
effect of the earlier increase in the money supply. It must be noted
that inflation is not limited to fiat, paper currencies. If gold
were the exclusive currency and a mine that doubled the world's
supply of gold was discovered, the supply of money would be doubled
and one would expect, all other things being equal, that asset prices
would double. The problem in any centralized, government-controlled
money system is of course who holds the keys to the mine or, in
our case, the printing press.

The most pertinent
issues in the fog of the bailout debate were not a crashing stock
market, Wall Street salaries, the New Deal origins of Fannie Mae
and Freddie Mac, the unconstitutional Neighborhood Revitalization
Act or other red herrings. The most pertinent facts were that, one
week prior to the $850 billion bailout, the FDIC coerced over $600
billion in asset transfers from the two biggest subprime lenders
to the biggest, most politically-connected banks in the country:
foreclosing Washington Mutual and handing its assets to JP Morgan
and putting a gun to Wachovia's head and forcing it to agree to
sell to Citi by the end o the year. Finally, the October 2 piece
showed that those who claimed that the government would "make
money" or "profit" by purchasing unmarketable securities
were either dishonest or deluded. The politicians who coyly claim
that the government will "profit" "over time"
very likely cynically understand the inflationary effects of the
bailout and know that, if the government buys a non-performing $100,000
mortgage in 2008 and three years later sells the underlying property
for $200,000, this does not necessarily mean the government has
profited. If the money supply has doubled in that same time and
a bottle of Coca Cola has gone from $1.00 to $2.00, bread from $3.00
to $6.00, milk from $4.00 to $8.00 and gas from $3.00 to $6.00,
then there is no "profit' in the sale. The government's sale
of the property for $200,000 in 2011 is no different than if it
had sold it for $50,000 today. Devaluing the dollar by half and
then selling some thing for twice the present price is not profit.

On the day
after the October 2 piece, in a "surprise
Wells Fargo and Wachovia disclosed a deal
in which Wells would pay Wachovia $13 billion more for its assets
than Citi had agreed to pay with the coercive help of the FDIC.
On October
9, explained this deal for what it clearly was:
pigs fighting to be first in line at the trough.
Wells management,
in perhaps a cynical Austrian epiphany, suddenly saw value in acquiring
the right to sell perhaps as much as $300 billion in subprime securities
to the US taxpayer. In the days between October 3 and October 9,
Wells, Citi and Wachovia battled over which pig would get to be
first in line with JP Morgan, who had already secured its subprime
booty with the help of the FDIC. The October 9 piece, however, warned
Wells and Citi to be careful of what they wished for, because the
market price of JP Morgan since the bailout had gone precipitously
down, notwithstanding its unequivocal spot as first in line at the
trough and the infusion of $10 billion in cash. As indicated in
the October 9 article, absent market manipulation the omniscient
and invisible hand of the market could be warning Wells and Citi
that JP Morgan's right to receive $850 billion in newly printed
inflationary dollars could be as "toxic" as the securities
sold in exchange.

On the evening
of October 9, 2008, Citi announced that it would bow
out of the fight and allow Wells to go forward with the Wachovia
. Although reports indicate that Wells "won,"
it is very unlikely that Citi sees it that way. Citi will hang on
to its very good and very powerful breach of contract and tortious
interference claims against both Wachovia and Wells, but it will
not partake in the morally odious practice of acquiring unmarketable
securities through coercion and selling them to the US taxpayers.
As with all things in life, Citi's correct moral decision is also
market-wise. Even though Rockefeller Republican Barack Obama is
poised to become the next president of the United States, Citi has
wisely decided that it will not be a party to fleecing the US taxpayer.
It recognizes that the "right" to receive $850 billion
in a government-controlled transaction could end up being a very
messy, very inefficient and very unprofitable "obligation."
If, in the unlikely event that Wells achieves enormous profits from
the bailout, Citi's lawsuit will put it in a position to recover
any and all profits that Wells obtains. No risk, high reward. Smart.

Citi's decision
reflects what all serious students of capitalism and economics know:
freely flowing, private commerce without government interference
is the lifeblood of humanity. Further, the market is eminently moral
in its judgments and truly does reflect the "invisible
of collective wisdom. As any lawyer who has tried
a case to a jury can attest, there is a certain magic in the decision-making
of groups of people that are given complete access to all relevant
facts. This so-called Wisdom
of Crowds
is evidenced every day by a stock market
that is free from government interference and manipulation. A free
stock market is the world's best and most well-informed jury and
the truest sign of a free society. If the market does not look kindly
on JP Morgan or Wells over the next few years, I would argue that
its invisible hand is recognizing that these companies have, through
aggression, deceit, and coercion, sought to acquire a portfolio
of unmarketable assets and sell them to a taxpayer at inflated prices.
In short, they are accomplices to theft.

For someone
who sincerely likes and admires Wells, this is troubling issue.
In the author's experience, through its merger with Norwest Bank
Wells acquired some of the best, most capable and qualified people
in the country. Norwest alums Chairman of the Board Dick Kovacevich
and former general counsel Stanley Stroup are great men and great
leaders. Wells opportunistic participation in the bailout signals
a negative turn. For JP Morgan, this could be a particularly hard
time as it seeks to sell its portfolio of subprime securities to
a new government sponsored entity that will likely be under the
control of Rockefeller
man Barack Obama who menacingly warns of more government "oversight"
and "regulation" to come. In the century-long feud and
battle between these two big banks it cannot be a good thing for
Morgan to be the holder the world's largest portfolio of subprime
securities and the only willing and able buyer is a Rockefeller

So what should
JP Morgan and Wells do? First, they must recognize that no great
company became or stayed great through government assistance or
by making government its primary customer. As trite as it might
sound, great
are great because they first seek to do what they do best and thereby
serve humanity. Great companies and great people first seek to do
good and only then do they know that they will do well. Profit,
competition and seizing opportunities are what makes capitalism
fun, but knowing that one has truly provided a valuable good or
service and perhaps altered the course of someone else's life for
the better is what capitalism is really about. Companies like Nordstrom,
Wal-Mart, 3M, Apple, Microsoft, Sony, Hewlett Packard, Toyota and
Proctor and Gamble recognize this. Making money is not the end,
it is only an imperfect measurement of how well one is doing at
providing a valuable good or service to society. In this context,
money is nothing more than receipts for services rendered to society.
Good banks provide needed capital to businesses; they do not enter
into no-bid contracts with the government to unload a pile of unmarketable
debt and get first in line at the fiat trough.

Second, if
JP Morgan and Wells truly want their share price to increase and
people to invest in their companies, they should first seek to do
the right and moral thing. On Monday, October 13th they
should jointly announce that they want no part of the federal bailout
and that they have formed a privately funded clearing-house corporation
to which they will transfer all of their newly acquired subprime
mortgages at 5–10 percent of their face value. Realistic "mark
to market" FASB 157
would appear to support placing this
value on what is clearly illiquid and unmarketable. Because the
new corporation must do the dirty work of actually selling the properties,
must understand and accurately apply the foreclosure laws of all
50 states and must hold the properties for often lengthy redemption
periods, this significant transactional cost should further deflate
the value of the subprime portfolios. New
tax regulations
would also appear to allow these banks to take
an accelerated loss on the sale. The purpose of this new corporation
will be to efficiently foreclose and liquidate all of the non-performing
loans on their books. They will invite other lenders to participate
in the corporation pro rata so that the entire mess can get cleaned
up efficiently and effectively. There are still plenty of people
with lots of dollars sitting on the sidelines waiting for a bottom
of the real estate market. This new entity will find that bottom
quickly and will stimulate billions of dollars in transactions as
investors and individuals acquire these properties. Having acquired
the non-performing loans at 5–10 percent of face value, the new
entity, unlike the GSE created in the bailout, will also very likely
turn an actual, non-inflationary, profit. If the Obama-controlled
IRS challenges the sale, JP Morgan and Wells can point to the impending
inflation caused by the Fed and Congress and find plenty of Austrian
who will truthfully and credibly testify that, as a result of recent
fiscal and monetary inflation, the non-performing loans could very
well be worthless if the banks took no private action. These economists
will likely testify that the subprime mortgage became valuable only
because these brave banks rejected government interference and took
private action.

should JP Morgan and Wells take this action, the wisdom of the market
(the same market consisting of millions of people who told their
Congressmen to vote against the bailout in a 10:1 ratio) will respond
with hosannas of populist support by purchasing their stock. The
wisdom of the crowd will recognize that these brave companies have
saved them $850 billion and may have saved the dollar itself. A
further benefit will be that the public will recognize that the
market, not the government, is the answer. They will witness the
free capitalist market, not callow and dishonest politicians, solve
the unsolvable.

JP Morgan and
Wells are positioned to prevent the next great depression but they
must reject the interference of government in their business. If
they refuse to deal with the devil, the market will reward them.

11, 2008

Butler [send him
] is a Minneapolis attorney and the owner of Butler
Liberty Law

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