Morality in the Bailout: Citi Takes the High Road

DIGG THIS 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 Cantillon 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 announcement" 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 acquisition. 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 hand" 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 establishment 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 administration.

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 companies 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 economists 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.

Finally, 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.

October 11, 2008