Bailout Truth: Inflationary Crony Capitalism

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In proving motivation and intent, timelines often provide the best evidence of why someone acted as they did. A murderer who insures the life of his victim months before the crime provides the jury with compelling evidence of his motive. When looking for reasons for government action, it is often more difficult because government and its accomplices are powerful, omnipresent and criminally adept at hiding the real reasons for their actions. In looking for motivation, one should therefore always follow the money.

One of, if not the primary, undisclosed motivation for the bailout plan before Congress is to provide a financial windfall to the Rockefeller (Citibank) and Morgan (JP Morgan Chase) banking interests. In order to see this, one must look beyond the obfuscating din of Wall Street greed, executive pay, HOPE for homeowners, neighborhood revitalization and other such nonsense and look at the concerted actions of the Bush administration, Citicorp and JP Morgan Chase over the last few weeks. The timeline tells the tale.

On September 25, 2008, the FDIC foreclosed on Washington Mutual, one of the most troubled and most at-risk banks and one of the largest holders of subprime mortgages. The day before, the WaMu CEO had been in negotiations with several suitors, including JP Morgan, HSBC and Wells Fargo. Although the media reported that JP Morgan directly acquired WaMu, it did not. JP Morgan purchased WaMu's assets from the FDIC after the FDIC, through the Office of Thrift Supervision, executed what amounts to an overnight foreclosure and repossession. No bid, no auction and apparently no discussions with WaMu's other potential suitors. In short, this gun-to-their-head sale was about the furthest thing from an arms-length "commercially reasonable" transaction. Not even the WaMu board of directors, who were apparently on a plane at the time of the takeover, knew of the takeover or the preplanned and orchestrated asset sale to JP Morgan. Immediately after the takeover, JP Morgan paid the FDIC $1.9 billion for WaMu's over $307 billion in assets, including deposits and branches. Although JP Morgan also acquired $34 billion in non-performing loans, acquiring WaMu’s operations in other states was an unequivocal benefit to JP Morgan. Last year, James Dimon, JP Morgan's chairman and chief executive, presciently predicted that JP Morgan would find a means to develop a toe-hold in the coveted Florida banking market:

James Dimon, J.P. Morgan’s chairman and chief executive, has long coveted Florida – as have his customers. Although WaMu is dominated in Florida by Bank of America and Wachovia, J.P. Morgan is likely to boost WaMu’s 3% market share in the state by tapping into its base of New York customers who spend the winter months in Florida.

Last year, one of those New York customers expressed frustration at J.P. Morgan’s annual meeting, telling Mr. Dimon “it galls me” that the bank didn’t have a presence there.

“It p- me off too,” Mr. Dimon said, drawing laughter from the audience. “Believe me, we would love to be much bigger in Florida and we’ll find some way to do it. You will see us there.

The effect of the FDIC takeover and immediate fire sale to JP Morgan significantly impacted the WaMu equity holders, including an investment group that had invested $7 billion just six months ago. They were wiped out. As stated on the FDIC website:

At this time, the FDIC as Receiver for Washington Mutual Bank does not anticipate that equity and subordinated debt holders will receive any recovery on their claims.

On September 29, in what at least facially appears to be a somewhat less hostile and aggressive transaction, the FDIC "facilitated" the transfer of Wachovia's "retail bank, corporate and investment bank and wealth management businesses to Citigroup." Wachovia is a large holder of subprime mortgages. Although details of the deal are incomplete, Citi paid Wachovia $2.1 billion directly to acquire some liabilities and most of its assets, including a $312 billion pool of loans, $42 billion of which are non-performing. Although Wachovia reported assets of $812.4 billion as of June 30, 2008, it is unclear how much of these assets will end up in Citi's hands. Citi further agreed to tender $12 billion in preferred stock and warrants to the FDIC. Although the deal appears consensual as the Wachovia shell remains and the deal does not close until December 31, one can just imagine how it went down. Pointing to the WaMu takedown just five days earlier, the FDIC likely told Wachovia that if it did not submit to the sale to Citi, the FDIC had the power and will to force the transfer anyway.

Although the government's participation in these nakedly unjust transactions that have violated the property rights of the Washington Mutual and Wachovia equity holders is itself appalling, it is only part of the story. The real story lies in the fact that two of the biggest and most influential US Banks, with the help of the federal government, have just mugged two of their drunken friends and are now looking to fence part of their ill-gotten loot – a pile of worthless or nearly worthless non-performing real estate loans. This is what the bailout is all about and why it is so important to the powers that be that it get passed. Any politician that votes for the bailout violates his oath to protect and defend the Constitution, in particular the Fifth Amendment which prohibits government from taking property without just compensation.

All students of Austrian economics know that those who benefit the most from an inflationary infusion of currency in a central-bank fiat system are those that are first in line at the fiat money trough. From 2001 to date, this was the no-bid military contractors who were the first-in-line beneficiaries of an irresponsible fiscal policy that spent money the United States did not have. George W. Bush managed the war and the country according to the philosophy of Judge Reinhold's character in the Ruthless People: "If we can't afford it, we'll f***ing finance it!" From 2001 until 2007 this also included homeowners who responded to the Federal Reserve's soma of artificially low interest rates by refinancing and sapping the equity out of their homes.

The real reason that the bailout is "necessary," and "essential" is not that credit markets will freeze or that the world will end. By forcing the takeover of WaMu and Wachovia, the Bush Administration, Citi and JP Morgan have bet that together they can coerce and lobby Congress into passing a law that will allow Citi and JP Morgan to dump their newly acquired subprime loans on the gullible and unsuspecting taxpayer. If the bailout is successful, Citi and JP Morgan will have scored a two-fer. Not only will they have vastly increased their market share and asset base in the FDIC orchestrated takeovers, they will also be first in line at the fiat money creation trough as the Fed prints the money that will fund the Treasury's above-market purchase of their subprime booty. Nice work if you can get it.

Those that claim that the government will "make money" on the loans or that purchasing these unmarketable securities is a good public investment are either fools or liars. It is of course possible that Congress through the bailout and the Federal Reserve by printing money can effectively double the money supply and that this can, over a course of time lead to a scenario where a $100,000 non-performing loan is satisfied when the underlying property is sold for $200,000. This, however, is not "making money," it is devaluing the dollar. By the time the house sells for $200,000 gas will be $8.00 a gallon and gold will be $1800 an ounce. The Federal Reserve and the Bush Administration are complicit in the bailout because they do not want to face the sobering reality of a crash on the Bush Administration's watch and believe that they can inflate their way out of the problem. Men plan and God laughs.

Bailout advocates have offered two powerful fallacies in support of the bailout. The first is that credit markets are "frozen" and that only government action can loosen them up. Although banks generally are apparently now less willing to lend than they were just a year ago, banks are businesses and businesses are profit-seekers. Banks, like most businesses, are always willing to provide their service or produce their good if the price is right. Banks will not, however, lend at low rates when they believe that their own borrowing costs or market interest rates will rise in the near future. When the "market" price of money is consistent with their projections of future costs, banks will lend. It is important here to note that the Fed Funds rate and the prime rate are rates that are artificially influenced by the Federal Reserve through its purchase and sale of Treasury Securities on the open market. These rates are therefore only an imperfect reflection of market interest rates. Real market interest rates, like commercial paper and LIBOR, are beginning to rise. This is perhaps the best evidence that the banks are beginning to "loosen up." Banks will lend, but at a higher rate that accounts for the Federal Reserve's recent inflationary actions. Note that the only rate in the LIBOR chart linked above that has gone down in the last 30 days is the Fannie Mae 30-year mortgage rate. This is more evidence that government doesn't know the price of anything as it is creating an inflationary arbitrage opportunity for homeowners.

The second and somewhat compelling reason for supporting the bailout is that the new "mark to market" accounting rule, FASB 157, has artificially caused solvent entities to become insolvent and therefore the government must act to correct this artificial situation. This is wrong because it assumes that the rule is dictating the value of the non-performing loan. It is not. FASB 157 just makes formal what the market would ineluctably recognize – a non-performing mortgage loan is worth the value of the underlying asset less the costs of liquidating it. Although FASB 157 is causing some firms to become insolvent on paper and is giving banks and insurers fits in managing their government-mandated reserve ratios, FASB 157 simply compels that these institutions acknowledge reality – that is always a good thing. If interest rates are on the rise, very few Americans have sufficient savings to make the 20% down payment necessary for a mortgage and there are millions of properties encumbered with non-performing loans (large supply and no demand), then these non-performing loans in a high interest rate environment may be worth as little as 40 percent of their face value. Changing rules or pumping the economy with increasingly worthless paper will do nothing to solve this fundamental problem; indeed, it will just create more problems, more asset bubbles, and bigger and broader future problems.

October 2, 2008