Corporate Fraud + Government Intervention = Bailout Nation

by Jim Quinn
by Jim Quinn

DIGG THIS

The U.S. financial system appears to be crumbling. Politicians and Washington bureaucrats are scrambling to make it appear like they are actually doing something. When politicians and Washington bureaucrats scramble, that means that taxpayers will be getting screwed again. They are throwing our money at mismanaged corporations and providing handouts to people who thought they were going to get rich buying and selling houses. The people who are getting screwed are the citizens who have lived within their means, those who did not take unreasonable risks and senior citizens who are now stuck with 1.5% interest rates on their savings while inflation exceeds 8%. One of the largest mortgage lenders in the country, IndyMac, has been taken over by the FDIC. Some 10,000 people will lose $500 million that is not covered by insurance. The FDIC estimates that this takeover will cost the American people between $4 billion and $8 billion. If that is their estimate, you can be sure the cost will exceed $20 billion.

Phil Gramm, one of John McCain’s chief economic advisors and a chief architect of deregulating the banking industry while a US Senator, has called us a nation of whiners. This is a man who is currently the vice chairman of UBS bank, making in excess of $500,000 per year in compensation. I wouldn’t be whining if I made more money than 99.9% of all Americans either. He has certainly earned that pay. His employer has written off $37 billion of mortgage debt so far. Stockholders are probably thrilled with his performance, as the stock has collapsed from $62 to $19 in the last year. Sounds like he is Treasury Secretary material in a McCain administration.

Of course, there are Democrats who are at least as financially illiterate as Mr. Gramm. Senator Chris Dodd from Connecticut showed his financial acumen when questioned about Fannie Mae and Freddie Mac. "They have more than adequate capital, in fact more than the law requires. They have access to capital markets. They're in good shape. To suggest somehow they're in major trouble is not accurate." Later that day, Hank (Mr. Bailout) Paulson committed our tax dollars to save these horribly run institutions. Fannie Mae has lost $7.7 billion in the last 9 months. Freddie Mac has lost $5.2 billion in the last 9 months. They are leveraged 60 to 1. As the current housing crisis continues to expand, these two companies will have to write off billions more in loans and are effectively insolvent. Mr. Dodd is lying to the American people because he doesn’t think we can handle the truth. The taxpayer will again be responsible for bailing out two of the worst run organizations on the planet. This bill will be a whopper. Jim Rogers, famed investor, said, "They’re ruining what has been one of the greatest economies in the world. Bernanke and Paulson are bailing out their friends on Wall Street but there are 300 million Americans that are going to have to pay for this."

Congress is about to pass a bill (attempt to bribe potential voters) that will throw billions of our tax dollars at banks, homebuilders, and reckless homeowners. President Bush has threatened a veto, but will surely buckle and sign the bill. This bill will shift greater responsibility to Fannie Mae and Freddie Mac. That is very comforting. Ron Paul in mid-May described the situation in his usual straightforward fashion:

"Lending standards were relaxed, or even abandoned altogether, creating an exaggerated pool of homebuyers that led to ballooning home prices that many, especially real estate investors, expected to continue forever. Now that the bubble has burst, the losses are staggering."

"However, many in Washington fail to realize it was government intervention that brought on the current economic malaise in the first place. The Federal Reserve’s artificially low interest rates created the loose, easy credit that ignited a voracious appetite in the banks for borrowers. People made these lending and buying decisions based on market conditions that were wildly manipulated by government. But part of sound financial management should be recognizing untenable or falsified economic conditions and adjusting risk accordingly. Many banks failed to do that and are now looking to taxpayers to pick up the pieces. This is wrong-headed and unfair, but Congress is attempting to do it anyway. These housing bills address the crisis in exactly the wrong way, by seeking to hide the problem with more disastrous government bail-outs and interventions."

Politicians and pundits have been trying to place blame for the current crisis. There is much to go around. Alan Greenspan enabled the bubble to start with 1% interest rates. The government agencies, SEC and Treasury vacated their regulatory responsibilities to the free market. Homeowners believed that home prices would go up forever. Rating agencies sold their souls by rating toxic waste as AAA credits. Poor people, who had nothing to lose, accepted the free money being handed out by banks. I think the majority of the blame should fall on the financial institutions and their leaders who should have known better. What they did constitutes fraud in my book. I think the following definition fits what these institutions have done – Intentional misrepresentation or concealment of information in order to deceive or mislead. The MBA, Masters of the Universe running the biggest financial institutions in the world created the playing field that deceived stockholders, rating agencies, and ultimately themselves. Now they beg for bailouts from the government.

I’ve selected five companies that represent everything that is wrong with our financial system. I could have picked another 25 companies, but these five will do. It is ironic that Bear Stearns was profitable right up to the day they were "saved" by JP Morgan. The collapse of some of their hedge funds early in 2007 was the canary in a coal mine for the coming financial meltdown. When you use tremendous amounts of leverage it can really juice profits on the way up. But, on the way down excessive leverage can put you out of business. Half of Bear Stearns’ 14,000 employees have lost their jobs in the last 6 months. Ben Bernanke was so worried by the potential collapse of Bear Stearns that he guaranteed $30 billion of their toxic waste mortgage debt. He did this with our tax dollars. The last Federal Reserve Chairman with any guts, Paul Volcker, had this to say about this intervention by Mr. Bernanke:

"The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices. What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: lend freely at high rates against good collateral; test it to the point of no return."

As you can see in the following charts, these companies generated phenomenal profits in 2005 and 2006. Of course, these profits were a fraud. By taking on tremendous leverage and developing exotic derivative instruments and selling them to people who didn’t understand the risks but relied on the ratings provided by Moody’s and S&P, these firms generated ungodly profits. The rating agencies made millions giving AAA ratings to instruments they didn’t understand. Everyone felt safe, because AMBAC and MBIA guaranteed many of these sub-slime mortgage pools. The managements of these companies raked in millions in salary, bonuses, and stock options. Stockholders were happy because their stocks were going through the roof. Since last summer, the billions in profits are being erased faster than they were "created."

The prestigious CEO’s of these companies made a few bucks on the way up. All of these CEO’s, excluding Bob Toll, have been "fired." When a CEO gets fired these days they receive the greatest payday of their privileged lives. Considering that the profits that their companies generated were fraudulent, these criminals should be forced to reimburse the stockholders. Instead they are at their private golf clubs working on their handicaps.

So, these corporate fat cats are set for life, but the stockholders have lost between 68% and 94% of their investment. The following quotes are examples of their lying and manipulation of the public:

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing."

~ Charles Prince in July 2007 shortly before writing off billions

"We finished the year positioned better than ever to capitalize on the array of opportunities still emerging around the world as a result of what we believe are fundamental and long-term changes in how the global economy and capital markets are developing."

~ Stanley O’Neal in January 2007 – Merrill reported an $8 billion loss in 2007

"But as I do reflect on it, and I do a lot, that nobody saw this coming. S&P and Moody's didn't see it coming, but they simply just downgrade bonds, they don't take hits. Bear Stearns certainly didn't see it coming. Merrill Lynch didn't see it coming. Nobody saw this coming."

~ Angelo Mozilo in July 2007 while he was selling $138 million of stock

"I’m confident our company is in the right businesses for the long term and that our strategy of being in high growth businesses and markets, our laser focus on customer service, our expense discipline, and our commitment to strong credit risk management, will create value for our shareholders in the future."

~ Ken Thompson in October 2007 – he was ousted 6 months later
as his $26 billion acquisition of Golden West Financial imploded

You can judge whether these CEO’s were criminal or incompetent regarding the actions they have taken in the last few years. At the end of the day, the actions of these men and many others on Wall Street have led our financial system to the brink of collapse. The people who have been hurt by their actions are the thousands of employees getting laid off, homeowners who followed the rules, and senior citizens trying to live off CDs.

Ron Paul, in his common sense rational way, explains the situation:

"The net effect of all this new funding has been to pump hundreds of billions of dollars into the financial system and bail out banks whose poor decision making should have caused them to go out of business. Instead of being forced to learn their lesson, these poor-performing banks are being rewarded for their financial mismanagement, and the ultimate cost of this bailout will fall on the American taxpayers. Already this new money flowing into the system is spurring talk of the next speculative bubble, possibly this time in commodities."

"Worst of all, the Treasury Department has recently proposed that the Federal Reserve, which was responsible for the housing bubble and subprime crisis in the first place, be rewarded for all its intervention by being turned into a super-regulator. The Treasury foresees the Fed as the guarantor of market stability, with oversight over any financial institution that could pose a threat to the financial system. Rewarding poor-performing financial institutions is bad enough, but rewarding the institution that enabled the current economic crisis is unconscionable."

Don’t worry. Your next rebate check will be in the mail shortly.

June 18, 2008

Jim Quinn [send him mail] is Senior Director of Strategic Planning, The Wharton School, University of Pennsylvania.

Copyright © 2008 LewRockwell.com