Frederick J. Sheehan is the
author of Panderer
to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a
Legacy of Recession (McGraw-Hill, 2009), which was translated
and republished in Chinese (2014). He is researching a book about Ben Bernanke.
He writes a blog at www.AuContrarian.com.
RESERVE YOUR SEATS: On August 26, 2014, for what seems the fiftieth time,
the U.S. Court of Federal Claims rejected the U.S. government's attempt to extinguish
Starr International Co. v. United States. Judge Thomas Wheeler said the case
brought by Hank Greenberg's AIG (specifically, Starr International Co., which
owned 12.5% of the shares on September 15, 2008) will go to trial on September
29, 2014. Wheeler stated: "The complexity of the submissions and the
factual disagreements strongly point to the need for a trial." According
to Reuters, "a U.S. Department of Justice spokeswoman declined to
comment." On the other hand, David Boies, the Attorney of Record from
Boies, Schiller & Flexner, LLP, representing Starr International, did
comment: "The decision speaks for itself." Former AIG Chairman Hank
Greenberg has sued the U.S. government for $25 billion as compensation for the
shares owned by Starr International. According to Reuters, "The trial is
expected to last six weeks.")
: The news sounds
reassuring: "U.S. bank regulators plan to adopt
rules on [September 3, 2014] forcing big banks to hold more assets that they
could sell easily in a credit crunch, a requirement that is closely linked to
the experience of the 2007-2009 financial crisis." It is possible the rules
will work.
However,
no formula will capture rising or falling confidence in a financial company at
some future date. We are vectoring towards another 2008. Confidence, on the
part government and Federal Reserve officials, financial institutions, and the
public, are intertwined. When financial institutions are afraid to lend to each
other liquid assets will be held for dear life.
There
are two topics in store. First, changes to financial institution bankruptcy law
may prompt a bank run. Second, depositions in Starr International Company, Inc.
v. United States [the AIG lawsuit - see: "David
Boies vs. Citizen Ben S. Bernanke," and "The
Professor Who Did Not Save the World"] should awaken
investors to our "policy makers" disintegration when we needed a
leader. (It is significant when the bureaucratic meritocracy rose to positions
of leadership, it changed its role to that of "policymakers." That it
did not and does not want to lead is the reason it is spent.)
In the
discussion about financial institution bankruptcy (topic number one), it is
well to keep in mind consequences are magnified by topic number two. As a
footnote, it is inconceivable the government and Fed models, such as those used
to calculate the September 3, 2014, bank liquidity rules, include an
exponential factor that kicks in when the combined worries of a Dodd-Frank
"call" and a heavy-handed government rescue mission hit
simultaneously.
The
changes to financial firm bankruptcy are not new. They are part of the
Dodd-Frank legislation. After taking a poll (of three) it was agreed investors
and bank depositors are not conscious of the changes. ("Conscious of"
- banks may have sent notices, 10Ks and certainly security offerings served notice,
but memories fade.)
Since this is not new, a summary will be
brief. It is also a transcription of Paul Singer's description at the Grant's
Interest Rate Observer conference in April 2012. Singer is CEO of Elliot
Management Corporation and a lawyer. He explained: "Dodd-Frank radically
changed bankruptcy law to enable the FDIC to seize financial companies which
are thought to be in danger of default. Prior law for decades required, of
course, actual default or a voluntary filing by management. The seizure process
in Dodd-Frank takes two - count them - two days, and is essentially
unreviewable and unappealable. The FDIC is also ordered, pursuant to
Dodd-Frank, to toss out management and seek damages from people, including
third parties, who are 'responsible' for the financial condition of the
troubled company. It also enables the FDIC to transfer assets willy-nilly out
of the corporate entities where they reside, thus making the analysis of one's
counterparty impossible, and to discriminate among classes of creditors
similarly situated if the FDIC thinks it will fulfill some higher good.... Thus
creditors, counterparties, clearing customers and trading partners of financial
companies which become troubled, post Dodd-Frank, have only one rational response
to potential trouble or perceived trouble, given the opacity and leverage I
have mentioned before: instantly stop trading, sell claims, pull assets,
basically run for the hills."
Now, for
the bad news: The depositions in Starr International v. United States show a
government that did not wait for Dodd and Frank to muster 10,000 pages (and
counting) of bureaucratic snooping. In the pinch, Secretary of the Treasury
Hank Paulson, Fed Chairman Ben Bernanke and (then) New York Federal Reserve President
Tim Geithner acted willier and nillier than (we may hope) the FDIC will behave,
and without legal authority (as you will read below), during the 2008
financial crisis.
The public view was described last week by
Reuters: "The bailout saved AIG from [the possibility of] filing for
bankruptcy. The Federal government took 92% of AIG's shares in return for $152
billion that the Fed and Treasury eventually pumped into the insurer."
[Bracketed comment in Reuters dispatch added. - FJS]
Reading "The Plaintiff's Corrected
Proposed Finding of Fact," it looks as though the bailout forced
AIG into an unnecessary bankruptcy; hence the bracketed insertion in the
Reuters description above. This is the Plaintiff's case, of course, and
protests will be aired on the witness stand starting in late September.
Note #1: the wording from the Finding of
Fact is sometimes what a layman may call "telegraphic;" I have
left it as is. Note #2: Only a handful of the Findings of Facts are
discussed below. There are well over 100. The legal case may address
others.
Returning to the scene of the confusion,
then-New York Federal Reserve President Tim Geithner described the drama (in
deposition) on September 15, 2008: "Of the twenty-five largest financial
institutions at the start of 2008, thirteen had either failed (Lehman, WaMu),
received government help to avoid failure (Fannie, Freddie, AIG, Citi, BofA),
merged to avoid failure (Countrywide, Bear, Merrill, Wachovia), or transformed
their business structure to avoid failure (Morgan Stanley,
Goldman.)"
The United States (as stated in the lawsuit)
would not hear of outside parties that were willing to bridge or supply capital
needed by AIG. Quoting the Finding of Fact: "Sovereign wealth
funds, including the Government of Singapore Investment Corporation (GIC) and
the Chinese Investment Corporation (CIC) expressed interest in investing in
AIG."
Specifically, "The Chinese Investment
Corporation (CIC) expressed interest in investing in AIG. Defendant discouraged
the CIC and representatives of the Chinese Government from assisting AIG. At
12:25 p.m. on September 16, 2008, [it was relayed to Secretary of the Treasury
Hank Paulson].... CIC was 'prepared to make a big investment in AIG, but would
need Hank to call [Chinese Vice Premier] Wang Qishan.' The Chinese 'were
actually willing to put up a little bit more than the total amount of
money required for AIG.'" [Italics added. - FJS]
"On
September 16, 2008, [Under Secretary of International Affairs David] McCormick
spoke to Paulson about the Chinese interest in investing in AIG. McCormick then
told [Taiya] Smith [Paulson's deputy chief of staff and executive secretary]
that Treasury "did not want the Chinese coming in at this point in time on
AIG."
"Later that day, Smith met with Chinese
Government officials in California during Joint Commission on Commerce and
Trade in Yorba Linda, California. During that meeting, 'all [the Chinese
officials] wanted to talk about was AIG.' Smith spent one or two hours
explaining what was happening with AIG. She conveyed the message that Treasury
did not want the Chinese to invest in AIG." [Italics added - FJS]
Senator Hillary Clinton took time off from her
presidential campaign to save the floundering insurance company: ""On
September 17, 2008, United States Senator Hillary Clinton called Paulson
"on behalf of Mickey Kantor, who had served as Commerce secretary in the
Clinton administration and now represented a group of Middle Eastern investors.
These investors, Hillary said, wanted to buy AIG. 'Maybe the government doesn't
have to do anything,' she said.'" Paulson told Senator Clinton, 'this was
impossible unless the investors had a big balance sheet and the wherewithal to
guarantee all of AIG's liabilities.'"
Since the price of oil was descending from
its recent high of $150 a barrel, it was worth investigating whether they had
"a big balance sheet." As for "the wherewithal to guarantee all
of AIG's liabilities," Paulson had no idea what the liabilities were worth
- he could not explain to counsel why the government seized AIG: "Paulson:
The 'taking of equity in companies that receive government assistance' is 'a
punitive condition.'"
|
Treasury
Secretary Hank Paulson
|
Several outside parties were calculating
values, but from the evidence, no one within "The United States" did
so. None of the witnesses could tell David Boies where the "79.9% of AIG
shareholder's equity" - the original figure wrought - came from.
(Geithner: "I am not certain I understand the reason why it was not more
than that. I don't know why it was not less than that." Paulson: "I
didn't focus on how that number was determined, although I clearly focused on
the number and remember discussing it." FRBNY: "did not conduct an
independent analysis regarding the appropriate terms for Government assistance
to AIG." Bernanke: A. "I don't know." Bernanke left as he
entered - a space-cadet, paper-shuffler.)
There were, however, several parties that
calculated the value of "AIG," from different perspectives and for
different reason.
For instance: "According to BlackRock,
an independent advisor working on behalf of AIG, 'Collateral posted to
counterparties under the CDS in the portfolio is over $29 billion, far in
excess of the projected net cash flows in BlackRock's
stress case.' BlackRock estimated that AIG's projected net cash flows for the
life of the CDS contracts, discounted at LIBOR, ranged between negative $7.3
billion in a base case and negative $15.2 billion in a stress case."
Also, "New York State Superintendent of
Insurance Dinallo testified that even 'if
there had been a run on the securities lending program with no Federal
rescue, our detailed analysis indicates that the AIG life insurance companies
would not have been insolvent'" [Italics added. - FJS]
In addition: "KKR's [Kohlberg, Kravis -
FJS] Derrick Maughan provided sworn testimony that if 'AIG, the company, or the
Fed as lender of last resort, had wished they could have stabilized the company
through Government invention support [sic], and then introduced private
capital.'"
There were other avenues offered to prevent
AIG's nationalization: "BlackRock 'presented three options for FRBNY to consider.... [This
included] counterparties cancelling their credit default swaps and selling the
underlying CDOs to an FRBNY-financed SPV, for total consideration of par,
comprised of previously posted collateral, cash, and mezzanine note in the
SPV'; the obligation to perform under the credit default swaps 'transferred
from AIG to an SPV guaranteed by the FRBNY'; and creation of an 'SPV to
purchase the underlying CDOs from AIGFP's counterparties, in connection with a
termination of the related credit default swaps'"
Apparently, no option matched
nationalization. New York State was ready to save AIG. "Around noon on
September 15, 2008, New York Governor David Paterson announced that he had
'directed' the New York State Insurance Department to permit AIG to access
approximately $20 billion in liquid assets from certain AIG insurance
subsidiaries. He also urged the federal government to be involved in some type
of arrangement, whereby AIG would have the necessary resources and bridge loans
to tide AIG over until it could resolve its liquidity problems."
"On September 16, 2008, Dinallo reiterated Governor Paterson's offer to
allow AIG to upstream $20 billion from its insurance subsidiaries. Geithner
responded, "No, we're good." As a result, Dinallo was 'led to believe
definitively that we were no longer part of the fix.'" "Good" at
what?
If you ever watched Chairman Bernanke brush
aside Congressional inquiries about the Federal Reserve exceeding its authority
during testimony, he would invoke Section 13(3) of the Federal Reserve Act.
This always shut the congressman up, even though, on at least two occasions, he
leaned back for a Fed staff member to remind him the number of the section:
"13(3)."
In the Finding of Fact, Paulson and
Geithner are quoted far more than Bernanke except for some hysterical
recollections, including: "September and October of 2008 was the worst
financial crisis in global history, including the Great Depression." That
could be true, but is a wild assertion without support (which Bernanke has
never in his life supplied), a successful tactic that guided Time
magazine to name him Thing of the Year.
On the
other hand, Tim Geithner offered a more convincing assessment, that
"2008" was "the worst financial crisis since the Great
Depression." Chairman Bernanke accomplished a rare feat. He was a less
reliable witness than Tim Geithner.
Another example of Bernanke's fevered
understanding: "Of the 13 most important financial institutions in the
United States, 12 were at risk of failure within a period of a week or
two." He said this at least once before, when he testified during the FCIC
investigation. After the FCIC transcript was released, it was noted this was a
ridiculous comment. Yet, he persists. If the government approached every
financial institution's potential insolvency as it did AIG, the government
would have owned 6,000 banks in three days' time.
One finding shows AIG's
nationalization - the government acquiring equity ownership from shareholders -
was an ad lib operation by the trio. The finding states: "The
Federal Reserve had no authority to purchase or hold equity," the facts
include (there are many more):
Geithner: "Under section 13(3) of the Federal Reserve Act, the Fed is
prohibited from taking equity or unsecured debt positions in a firm".
Bernanke: "The Federal Reserve is authorized under the Federal Reserve
Act to extend credit in various forms, but is not authorized to purchase equity
securities of financial institutions."
Bernanke: "We had only one tool, and that tool was the ability of the
Federal Reserve under 13(3) authority to lend money against collateral. Not to
put capital into a company but only to lend against collateral."
Paulson, referring to the Federal Reserve: "They legally couldn't do
preferred. They legally could only make a loan."
"FRBNY General Counsel Thomas Baxter wrote to Federal Reserve
General Counsel Scott Alvarez confirming "we agree that there is no
power" for the Federal Reserve "to hold AIG shares."
"FRBNY's independent auditor Deloitte: "FRBNY cannot legally
control a commercial company, and therefore it is not appropriate for them to
consolidate an entity it cannot legally own."
Another Finding eliminates the only other legal
conduit for AIG's nationalization. "In September 2008, Treasury had no
authority to purchase or hold equity." Some of the many facts that confirm
Bernanke, Paulson, and Geithner broke the law. Nay, they trampled our
protection from tyranny with jackboots. Facts follow:
"The "Treasury Department as of September of 2008 had no
budgetary authority to invest in equities, securities of any financial
institution."
"FRBNY counsel to Federal Reserve Board officials on September 17,
2008, concerning 'Issues with regard to the NY Fed/Treasury's equity
participation in AIG,' Treasury 'consider[s] themselves legally unable to
assume ownership. This leaves the NYFed as Treasury's place to house the equity
position.'"
"September 17, 2008 report of Treasury's external counsel at Wachtell:
'Treasury legal is telling, as per doj, that they cannot hold voting
shares.'"
"TARP Chief Investment Officer Jim Lambright: In 'September when the
Fed extended the credit facility, the government didn't have an equity
tool.'"
"Board of Governors Legal Division: "'We understand that the
Treasury lacks the legal authority to hold directly voting stock of AIG.'"
"Paulson: 'Q. And prior to TARP's approval, Treasury did not have the
authority to purchase equity, either. Right?
A. Correct.'"
Given the cleavage from reason by our policy makers (one last, irresistible
Fact: no one from AIG was allowed in the room during its
nationalization), consider: (1) interests you may hold in financial
institutions and (2) Paul Singer's description of the now legal means to
redistribute those interests. Financial firms are more leveraged than is
generally understood. Sell their securities.