Ken Houghton's Loyal Reader directed my attention to this WSJ blog entry, commenting on, and attempting to provide cover for, the management and actions of The Old Firm.

I'm sympathetic to the general argument—Ace Greenberg's naming of Jimmy Cayne to succeed him was incredibly bad judgment that had real consequences, but not malice aforethought—but the WSJ's attempt to defend upper management rather goes off the rails.*

Let's look at some of the analytical parts of the article:

Investment banks were certainly imprudent in leveraging themselves 33 to 1; but they also announced it publicly in their quarterly statements.

"Certainly imprudent" is having unprotected sex with someone who clearly has open genital and/or oral herpes sores. 33x is larger even than the Cox-allowed 30x leverage (which was imprudent in the first place). "Thirty times leverage; it's not just imprudent, it's the law."

UPDATE: My Loyal Reader e-mails:

Cohan writes that only at the end of a quarter was Bear around 40:1 and most of the rest of the time it was at 50 or 55:1....JPMorgan Chase at the time of the takeover calculated that out of $300 billion Bear Stearns counted as assets, $220 billion could be considered "toxic".

So even Moore's 33:1 is known to be optimistic. And having more than 73% of your "assets" rated as "toxic" isn't prudent management: it's doubling-down while hitting on 17.

We all know that the Prudent Investor definition has been redefined beyond reality, but it's difficult to believe anyone would consider BSC's practices to compile with reasonable Standards and Practices.

Shareholders, in turn, never complained as long as the banks were making money in 2006 and 2007. It was only when the music stopped and the economy turned bad that shareholders started to blame the banks for shifty dealings.

And it was only when Madoff admitted there were no more assets that "shareholders" complained. Are we supposed to take some affirmative defense from this, or is Heidi Moore just clueless? (You can chose "and" if you want.)

Meanwhile, regulators are said to still be curious about what caused the “bear raids” that took down Bear Stearns and Lehman and threatened Morgan Stanley and Goldman Sachs.

They're welcome to be curious, but the minute Alan Schwartz went on CNBC and said, "We think we're solvent" is the minute anyone with any brains and capital went massively short Bear. And they were late to the party, since anyone in the market with any brains and knowledge of MBS ramifications—think the guy at Solly who called Michael Lewis and said "Buy potatoes" as Chernobyl was happening—knew exactly who was going to be Most Likely to Pay Off if you bought (again, common knowledge) some proverbially-undervalued far OOTM put options.



In fairness, Cohan appears to believe this is a smoking gun. But we've heard those rumours since before the bankruptcy, and Bear Stearns is not Iceland. If Cohan's correct in his assertion on Stewart's show that the people who bought all those OOTM put options were hedge funds that had previously used BSC for their Clearing Agent, then they voted with their feet in the face of reality.

And the rest of the market isn't dumb. They could see who was buying, and what their previous relationship with Bear had been. And they would see Alan Schwartz and realise this is not the man who is going to make it between the Scylla and Charybdis. And they would take that—along with things such as Goldman's immediate affirmation when the rumours starting about Lehmann and Bear that Lehmann would continue to be a respected competitor and trading partner—and be able to add.

As the Beatles said, "One and one and one is three/Got to go short Bear cause he's so hard to see."

But the WSJ wants you to think that going even beyond Christopher "I never saw a regulation I planned to enforce" Cox's SEC-permitted leverage ratios is not a violation of the law, and that hedge funds who see incompetence and near-bankruptcy do not act on that information.

The coolest thing about the Stewart/Cohan interview was when Cohan said "creative destruction" and Stewart immediately came back with Schumpeter by name. Maybe this is why Heidi Moore's piece opens by calling Stewart "our nation’s foremost financial commentator." (Take that, Paul Krugman!) But the attempts to argue that The Old Firm was substantively different from a Ponzi scheme are going to need a better case made than she does.

Capitalism deserves a better defense.


*They specifically miss connecting the dots on where there was clear fraud committed by management—and I suspect Cohan did as well, since no one who talks about the book seems to mention it. UPDATE: I'm now told he did deal with it, but sloughed it off. So expect Yves or Barry or Felix (blogroll update candidate, btw) or Paul (maybe even Mish, who has the mindset for the job)—someone who pays a lot more day-to-day attention to the market than I can right now—to jump on this one in the near future.

I've spent most of the past two weeks alternating between dizziness and sleep. Maybe the dizziness explains why I find myself in agreement with a WSJ editorial:

In a better world, Citi would have long ago been put into bankruptcy. The FDIC could have taken over and disposed of the bank's assets, while protecting insured deposits as it always does. The profitable parts of Citigroup could then have been sold off to people who could better manage them.

Let's do some elementary math in support of the WSJ position:

Taxpayers have already put more than $50 billion in capital into the bank, while guaranteeing $301 billion of its bad assets, and the bank still can't stop its slide.

All right, I'll work with the low number, which is the most optimistic estimate anyone has published recently: $50 Billion. The Big C's market capitalisation (the Present Value of the Expected Unencumbered Future Cash Flows as expressed as the stock price times the number of shares) as of last night is $8.18 Billion.

Can we stop talking about the evils of "wiping out the existing shareholders"? They were wiped out more than $40 Billion ago.

The WSJ does make one mistake:

But in this vale of taxpayer tears, Citi is "too big to fail" and thus must be propped up lest it (allegedly) spread contagion through the financial system. While that may have been true last fall amid the worst of the financial panic, we don't think the contagion would be the same now that the federal government has guaranteed anything in the financial system that moves.

Well, not exactly. By my count from the FDIC Failed Banks list, 28 banks have been closed since October of 2008, including two yesterday. And there's no sign that that trend is ending. But this is spot on:

That isn't the view at Treasury, which yesterday agreed to a stock swap that will buy Citi more time to, well, who knows? The feds will trade the preferred taxpayer shares for Citigroup common, which means giving up their 5% dividend and taking on more future risk in return for a 36% ownership stake.

Let's review below the fold:

1. The Fed has put at least $50 billion into The Big C.*
   
2. The Big C is worth, according to its best-informed shareholders, slightly over $8 billion.**
   
3. The Fed's $50 billion will get it a 36% share in The Big C.
   
4. Basic Math Interlude: $50B=0.36x => x = $50B/0.36 = $138.89B implied value
   
5. Pause to repeat: The market thinks The Big C is worth just over $8 Billion. The current "book value" of the institution—a mythical number only an accountant could love, and her only because she is paid to love it—is just over $80 Billion. The Best Case Scenario for the Fed commitment is that The Big C is worth nearly $140 Billion.
   
6. Interlude: [search Internet for a picture of The Nile to insert here. Settle for trying to get the Sadly, No! guys to photoshop Tim Geithner's head onto Pam Tillis's body.]
   
7. Remind the blogsphere of Simon Johnson's answer to Question 8:
   

   8. How many of the largest 5 banks will likely end up with government as majority owner?
   
   - Any honest market-based valuation of bank assets will show a majority of large banks are presently insolvent but can be righted with substantial new capital.
   
   - If the answer isn’t “at least two,” then either the Treasury does not plan to properly value assets, or someone is not yet prepared to tell the full truth.

   
   
8. Point out that, if you believe the market, there are two banks that are currently Serious Outliers in Book-to-Market Value, The Big C and BofA.
   

   
   
   

   
   

9. Decide not to discuss stress testing, which indicates that Wells Fargo is also seriously endangered, in this post, in large part because of its acquisition of WalkAllOverYa, which had previously acquired World Savings Bank. Leave for later; tell audience not to hold breath.

Now, let's pretend that past is prologue and that Timmeh! is just making the best deal he can. (Pause for laughter to subside.) Let's just Focus on the Future.

The Obama Administration is commonly described as planning to ask for $750 Billion in additional "bailout funds." They are claiming that this should be shown on the budget as $250 Billion, since they expect to get about 2/3s of the funds back over time. [link added, h/t Frank Rich in the NYT]

Given the above details re: The Big C, and the abundant reports with multinational historic examples that shows nowhere near that size of return, why should we be expected to believe them?

With regard to The Big C, I'll give the penultimate word, once again, to the WSJ editorialists:

Meanwhile, Treasury is forcing the bank to get some new, and presumably more competent, directors. Many of the current directors were going to leave later this spring anyway, but at least this imposes some discipline in return for the federal largesse. Citi's management will stay in place, at least for now.

Again in a better world, the new board and Treasury would find better managers. But yesterday's announcement included no roadmap for how the bank plans to restructure, if it even plans to do so. The hope is that it can earn itself back to profitability. More realistically, a bank that has failed as often as Citigroup needs to shrink until it is no longer too big succeed.

As followers of the Iraq War know, Hope is not a Plan. When the WSJ endorses nationalisation, it's clearly an idea whose time has come.

*We can pretend the asset guarantees—a Really Stupid Idea from people Robert assures me are smart—are independent of the firm; that is, if Goldman or BofA owned them, they would have gotten the same deal.

**I maintain that the current stock price is approximately the price of a two- or three-year call option at a price marginally above the current level—say, $3 or $5—and as such we should rightly view the current stock value as $0.00. But that's for another post.

All (somewhat***) via Mark Thoma:

Thomas Frank in the WSJ tells me why I always disagree with Robert (and the Other Economists) on the role of rating agencies:

And who makes sure that Moody's and its competitors downgrade what deserves to be downgraded? In 1999 the obvious answer would have been: the market, with its fantastic self-regulating powers.

If you look at the spreads of various debt products, you can see that the market was doing that type of job even in 2007. For instance, the debt market priced ["rated"] Bear Stearns's five-year bond issue in August 2007 at 245 over: rather closer to "junk" status than its rating would have implied. If you compare the debt and stock markets, it's easy to see which is closer to "rating." Unfortunately, the area where information is more valuable* is not the one discussed and understood in the press, where BSC kept trading up for several more months.

If a market "regulates" but no one notices, does it make the WSJ?

Brad Setser finishes the destruction of Tyler Cowen's LTCM "argument" begun by Buce, while revealing its underbelly:

The big banks called to the New York Fed were the creditors of LTCM and they were in some sense “bailed-in.” To avoid taking losses on the credit that they had extended to LTCM, they had to pony up and recapitalize LTCM. [footnoted exception for BSC]

It just so happened that the market recovered and it was possible for LTCM to exit many of its positions without taking large losses, or in some cases any losses. The banks that took control of LTCM when LTCM was on the ropes were able to unwind LTCM’s portfolio in a way that didn’t result in additional losses. But the result Cowen desired — large losses for the banks and broker-dealers who provided credit to LTCM – was quite possible if LTCM’s assets weren’t sufficient to cover all its liabilities. No creditor of LTCM was able to get rid of its exposure as a result of the Fed’s actions. [emphases mine]

It used to be a standard rule that if you wanted to bury something in a newspaper, you published it on a Friday, or the day before a holiday. This seems to be what the NYT is doing with Casey Mulligan (previously discussed here here), who dropped the other shoe yesterday and was, amazingly, worse than expected. PGL at Econospeak does the read and calls out the deed:

Mulligan is essentially saying that those poor saps who have lost their jobs actually quit so they can game the mortgage system. In other words, there is no such thing as involuntary unemployment or being forced to either lose one’s home versus enter into one of these mortgage modification programs.

As noted in the WaPo two weeks ago (via Stan Collender at Capital Gains and Games),** qualifying for the "mortgage modification" program (i.e., reducing the principal on your loan to not more than 90% of the current market value) is an onerous task:

He was hoping he could qualify for the federal government's Hope for Homeowners program, which allows the Federal Housing Administration to insure a new mortgage if the lender voluntarily writes down the mortgage principal to 90 percent of the new value of the home. But when he asked his bank about that, he was told he would have to be on the brink of foreclosure or have an adjustable-rate mortgage.

So Mulligan is basically blaming (1) those whose ability to keep their home depended on keeping their job and (2) those who took Alan Greenspan's venal advice to go into ARMs just at the point at which he started raising rates. Class act.

And, finally, lest you think I'm always bashing Tyler Cowen, he notes a phenomenon in chess and suggests a reasonable conclusion:

I also see a general principle operating: the more exact a "science" the game becomes, the smaller is the value of accumulated experience relative to sheer skill.

The sheer is dicey, but the identification of the shift in proportionality may be accurate, and probably has applications in economics as well.

*The debt market is less liquid and therefore considers information more valuable. This is effectively the corollary of the DeLong, Shliefer, Summers and Waldmann papers: if you can't depend on momentum trading, you take more care not to be the "greater fool."

**Yes, I saw the Collender-bashing in my previous post. I've said before that CG&G became significantly less readable after the election, and am foolishly optimistic enough to believe that they may be returning to rationality. Besides, he happened to be correct: any given from increased military spending is definitionally no better (and likely worse) than spending the same amount on public infrastructure.

***I read PGL's piece before seeing it in the links, but they're all there.

Greg Mankiw presents Yet Another Reason to regret skipping the AEA this year, though somehow the word "intentional" was left out of the description.

Stan Collender, of all people, does the job I wished someone would do on Martin Feldstein's WSJ op-ed. I may have beaten him by a day in calling it out, but there's nothing so perfect as Collender's conclusion:

Finally, something that's not in the Feldstein piece: dollar for dollar, military spending doesn't provide as much an economic return as domestic spending. Building an extra tank or missle that then sits idle because it's not needed provides a one-time boost to the economy. But building a road, bridge, tunnel, sewer, or information superhighway that is needed continues to provide benefits as people, goods, and information travel faster, less expensively, and far more productively than would have otherwise been the case.

That means that starting with the headline, Feldstein was seriously mistaken.

Differences between now and 1992, positive version: In 1992, Dave Barry made a legendary appearance at the National Press Club. At some point during the Q&A, he declared that he was going to end all of his answers with the phrase "failed Clinton Administration." (There may have been cheering.)

UPDATE: I was trying to think of a nice way to be rude about Tyler Cowen's NYT piece on how "the seeds of the crisis" were planted by the resolution of the LTCM crisis.* () But Buce at Underbelly saves the day with a two-point takedown (not the three-pointer of Collender, but still aces) called Long-Term Confusion:

Tyler Cowan has an amazingly confused piece in this morning's NYT arguing tht we owe our current plight in large part to the "bailout" (I use the term advisedly) ten years ago of Long-Term Capital Mangement (link). But the point of LTCM, as Tyler's own piece acknowledges (but Tyler ignores) is precisely that LTCM was not a bailout, except perhaps in the sense that the Feds provided lunch.** Okay, and a little bit of arm-twisting. But I should think that would be on the approved list for even the most hairy-chested libertarian. The message was: look, we love ya, and we will work with ya, but we will not put skin in the game. [italics mine, but they could have been his]

In 2008, the NPC appearance of note is by Paul Krugman (h/t EconLib, again of all places), whose six part presentation and q&a session is available on YouTube and therefore easier to watch for the Internet-impaired than his Nobel Lecture.***

McMegan Wuz Robbed! Then again, that's nothing compared to the abomination of this voting, where something that's already remainder and long-forgotten appears to be winning.

And, finally, proof that it's really TOUGH to live in Hoboken.

Happy New Year!



*If Robert Samuelson had published the same piece, Brad DeLong would not have been nice. As it is, we can just assume DeLong hasn't read it yet amidst his globetrotting.

**Meaning in this case literally the food for the sixteen conversants, fifteen of whom anted up.

***Yes, I assume anyone who accesses YouTube from a non-networked machine has a downloading program. Also, am I the only one who just realised that YouTube is maintained on a Linux-based server?

davenoon at LG&M and Kikuchiyo Jones subbing for the good Roger Ailes both clobbered the WSJ's most egregious fluffing this year.

Martin Feldstein continues to try to destroy the previously-brilliant David Warsh's reputation by openly declaring that the major Bush administration policy initiative was a complete failure, and that a dollar spent with a multiplier of at best 1.0 should be preferred to investments with spillover effects into private industry (and therefore multipliers definitionally greater than 1.0).

Warsh may never live down this piece, though economic historians may well find the seeds of the destruction of the discipline outlined therein.

UPDATE: PGL at Econospeak was there first, but is nicer than I am.

Meanwhile, it was left to the WaPo to explain Moral Equivalence in the Beltway:

Bill Clinton was sharply criticized for issuing dozens of pardons in his final days that included fugitive financier Marc Rich, while Bush's father came under fire for forgiving Caspar Weinberger and others involved in the Iran-contra affair.

Yep, a man whose prosecution was viewed by the publisher of the New York Sun as "an error and a tragedy" is at least as evil as actively violating U.S. and international laws while working to support terrorists and destabilize democratic governments. Glad we got that one straight, guys.

Among their editorial suggestions for replacing Tim Geither as head of the New York FRB:

Better choices would include ...David Malpass, an economist who worked at the Reagan Treasury and long predicted the credit bubble....

Yes, you saw that correctly.

David Malpass.

Strangely, they don't describe him as "David Malpass, former Chief Economist for Bear Stearns, who long advocated taking monies out of your house because appreciation in housing prices changed "the structure of the household portfolio."

And that "long predicted the credit bubble"? This is a family blog, so I can't call that horseshit. So let's look at what Malpass said in August of 2007—the point at which his firm was issuing bonds at what were essentially junk levels—about the bubble, in the very pages of the WSJ:

Another aspect of the market disruption is a dramatic stand-off between bond buyers and sellers: Buyers in both housing and debt markets are using the market discontinuity to claw prices and terms back to Earth. The slowdown talk weighing on equities also reflects the Wall Street view that debt, mortgage and takeover businesses have replaced General Motors as the economy's bellwether. According to the bears: As goes the credit market, so goes the economy.

Fortunately, Main Street is not that fickle. Housing and debt markets are not that big a part of the U.S. economy, or of job creation. It's more likely the economy is sturdy and will grow solidly in coming months, and perhaps years.

Unlike the 1998 seizure in credit markets to which many are now drawing comparisons, reservoirs of global liquidity are full to overflowing, not empty as they were that year. The deep 1997-1998 Asian crisis has been replaced with an all-cylinder boom. Unemployment rates are falling all around the world, while China's equities have continued hitting new highs. [emphases mine]

The other nominees are little better, including the Gary Stern, current head of the Minneapolis Fed of "Credit Crisis? What crisis?" fame. (At least Stern admits he doesn't care about finance as much as some other things.) But Malpass—and the lies told in support of him—should be beyond the pale even by WSJ standards.

Among their editorial suggestions for replacing Tim Geither as head of the New York FRB:

Better choices would include ...David Malpass, an economist who worked at the Reagan Treasury and long predicted the credit bubble....

Yes, you saw that correctly.

David Malpass.

Strangely, they don't describe him as "David Malpass, former Chief Economist for Bear Stearns, who long advocated taking monies out of your house because appreciation in housing prices changed "the structure of the household portfolio."

And that "long predicted the credit bubble"? This is a family blog, so I can't call that horseshit. So let's look at what Malpass said in August of 2007—the point at which his firm was issuing bonds at what were essentially junk levels—about the bubble, in the very pages of the WSJ:

Another aspect of the market disruption is a dramatic stand-off between bond buyers and sellers: Buyers in both housing and debt markets are using the market discontinuity to claw prices and terms back to Earth. The slowdown talk weighing on equities also reflects the Wall Street view that debt, mortgage and takeover businesses have replaced General Motors as the economy's bellwether. According to the bears: As goes the credit market, so goes the economy.

Fortunately, Main Street is not that fickle. Housing and debt markets are not that big a part of the U.S. economy, or of job creation. It's more likely the economy is sturdy and will grow solidly in coming months, and perhaps years.

Unlike the 1998 seizure in credit markets to which many are now drawing comparisons, reservoirs of global liquidity are full to overflowing, not empty as they were that year. The deep 1997-1998 Asian crisis has been replaced with an all-cylinder boom. Unemployment rates are falling all around the world, while China's equities have continued hitting new highs. [emphases mine]

The other nominees are little better, including the Gary Stern, current head of the Minneapolis Fed of "Credit Crisis? What crisis?" fame. (At least Stern admits he doesn't care about finance as much as some other things.) But Malpass—and the lies told in support of him—should be beyond the pale even by WSJ standards.

Thursday morning editorial:

The voters may be full of hope about the looming Obama Presidency, but so far investors aren't. No President-elect in the postwar era has been greeted with a more audible hiss from Wall Street. The Dow has lost 1,342 points, or about 14%, since the election, with the S&P 500 and Nasdaq hitting similar skids. The Dow fell another 4.7% yesterday.

Much of this is due to hedge fund deleveraging,* as well as dreadful corporate earnings reports and pessimism that the recession will be deeper than many had hoped.** We also don't want to read too much into short-term market moves.*** But there's little doubt that uncertainty, and some fear, over Barack Obama's economic agenda is also contributing to the downdraft.****

What WSJ readers did on seeing that (via Google Finance):

And, lest you think I'm cherry-picking to avoid the broader markets, from the same source:

*This is from the paper that argued continually until October that the hedge funds were running perfectly.

**There might be a link there.

***Really?? So how do they explain the next sentence?

****This is on a par with deleveraging, lack of investment, lack of profits, lack of markets that clear, fading real estate values for the mall-stores, and the multiple recent retail bankruptcies (Circuit City, Ponderosa, Applebee's, etc.)? Looking at the six-month graphic, it appears that the market hit a bottom on October 27th [Oct27 close: 8,175.77, more than 100 points below the level when the editorial was written], bought into the Obama rumor, and has been selling some gains on the Obama fact and the Fed easing and Hank Paulson's admitting he has never known what he was doing.

Thursday morning editorial:

The voters may be full of hope about the looming Obama Presidency, but so far investors aren't. No President-elect in the postwar era has been greeted with a more audible hiss from Wall Street. The Dow has lost 1,342 points, or about 14%, since the election, with the S&P 500 and Nasdaq hitting similar skids. The Dow fell another 4.7% yesterday.

Much of this is due to hedge fund deleveraging,* as well as dreadful corporate earnings reports and pessimism that the recession will be deeper than many had hoped.** We also don't want to read too much into short-term market moves.*** But there's little doubt that uncertainty, and some fear, over Barack Obama's economic agenda is also contributing to the downdraft.****

What WSJ readers did on seeing that (via Google Finance):

And, lest you think I'm cherry-picking to avoid the broader markets, from the same source:

*This is from the paper that argued continually until October that the hedge funds were running perfectly.

**There might be a link there.

***Really?? So how do they explain the next sentence?

****This is on a par with deleveraging, lack of investment, lack of profits, lack of markets that clear, fading real estate values for the mall-stores, and the multiple recent retail bankruptcies (Circuit City, Ponderosa, Applebee's, etc.)? Looking at the six-month graphic, it appears that the market hit a bottom on October 27th [Oct27 close: 8,175.77, more than 100 points below the level when the editorial was written], bought into the Obama rumor, and has been selling some gains on the Obama fact and the Fed easing and Hank Paulson's admitting he has never known what he was doing.

Stormy noted that Wells Fargo's bill is based in part on "exploiting a presumed tax loophole."

I forgot to ask the question one should always ask when confronted with a Chess Ending problem, "What was the move before?"

In this case, we know (from A C Shareholder's comment) that Wells had been discussions to purchase "WalkAllOverYa" last weekend. But they didn't commit then, while, suddenly, Friday, they did, in what the Wall Street Journal editorial page would like us to believe is an example of free-market capitalism coming to the rescue:

A better canary in the cyclone is Thursday night's news that Wells Fargo has agreed to buy Wachovia for $15.4 billion and without any government involvement. Only Sunday night, Wells Fargo had backed out of a similar deal for a higher price.

Without any government involvement? Marcy Gordon of BusinessWeek (h/t Mark Thoma) sets the record straight:

On Tuesday, the Internal Revenue Service issued guidance boosting banks' ability to offset the losses from loans and other bad debts held by other banks they acquire. The guidance allows banks to take larger tax write-offs against future profits....

Before the IRS ruling this week, there were limits on the amount of certain losses that an acquiring bank could write off against post-combination profits. Now those limits have been suspended, said Jeff Harte, an analyst at Sandler O'Neill.

With banks suffering billions in losses from soured mortgage-related assets, the IRS move "potentially increases buyers' ability to realize tax benefits from bank acquisitions," Harte wrote in a note issued Friday. The change "could spur significant bank industry consolidation," he said.

"We suspect that the new IRS guidance allowed Wells Fargo to place a higher bid for Wachovia today than it might have been willing to a few days ago," Harte said.

And who was responsible for the IRS announcement? Mark Sunshine, guest-blogging at the NYT Economix blog, suggests it was Secretary of the Treasury Paulson:

But Mr. Paulson’s fiscal-stimulus work didn’t end with the bailout bill.

With hardly anyone noticing, on Wednesday he pushed through very technical and obscure changes to tax regulations that provide a "tax subsidy" for acquirers of troubled banks. Just as automakers stimulate car sales through rebate checks, the Treasury is providing a form of tax rebate to acquirers of troubled banks. Everyone can thank Hank Paulson and his stealth tax-driven fiscal stimulus for the astonishing news that Wachovia was being acquired by Wells Fargo and not Citigroup. It was Mr. Paulson’s tax subsidy to Wells Fargo that provided the fiscal grease to make this deal happen. Pundits who point to the deal and proclaim that the "free markets work without government help" don’t understand the motivating effect of several billion dollars of tax benefits to Wells Fargo.

Couldn't have said that last better myself.

Stormy noted that Wells Fargo's bill is based in part on "exploiting a presumed tax loophole."

I forgot to ask the question one should always ask when confronted with a Chess Ending problem, "What was the move before?"

In this case, we know (from A C Shareholder's comment) that Wells had been discussions to purchase "WalkAllOverYa" last weekend. But they didn't commit then, while, suddenly, Friday, they did, in what the Wall Street Journal editorial page would like us to believe is an example of free-market capitalism coming to the rescue:

A better canary in the cyclone is Thursday night's news that Wells Fargo has agreed to buy Wachovia for $15.4 billion and without any government involvement. Only Sunday night, Wells Fargo had backed out of a similar deal for a higher price.

Without any government involvement? Marcy Gordon of BusinessWeek (h/t Mark Thoma) sets the record straight:

On Tuesday, the Internal Revenue Service issued guidance boosting banks' ability to offset the losses from loans and other bad debts held by other banks they acquire. The guidance allows banks to take larger tax write-offs against future profits....

Before the IRS ruling this week, there were limits on the amount of certain losses that an acquiring bank could write off against post-combination profits. Now those limits have been suspended, said Jeff Harte, an analyst at Sandler O'Neill.

With banks suffering billions in losses from soured mortgage-related assets, the IRS move "potentially increases buyers' ability to realize tax benefits from bank acquisitions," Harte wrote in a note issued Friday. The change "could spur significant bank industry consolidation," he said.

"We suspect that the new IRS guidance allowed Wells Fargo to place a higher bid for Wachovia today than it might have been willing to a few days ago," Harte said.

And who was responsible for the IRS announcement? Mark Sunshine, guest-blogging at the NYT Economix blog, suggests it was Secretary of the Treasury Paulson:

But Mr. Paulson’s fiscal-stimulus work didn’t end with the bailout bill.

With hardly anyone noticing, on Wednesday he pushed through very technical and obscure changes to tax regulations that provide a "tax subsidy" for acquirers of troubled banks. Just as automakers stimulate car sales through rebate checks, the Treasury is providing a form of tax rebate to acquirers of troubled banks. Everyone can thank Hank Paulson and his stealth tax-driven fiscal stimulus for the astonishing news that Wachovia was being acquired by Wells Fargo and not Citigroup. It was Mr. Paulson’s tax subsidy to Wells Fargo that provided the fiscal grease to make this deal happen. Pundits who point to the deal and proclaim that the "free markets work without government help" don’t understand the motivating effect of several billion dollars of tax benefits to Wells Fargo.

Couldn't have said that last better myself.

The editors of the WSJ agree with Brad DeLong that the Fannie/Freddie problem is that their short-term cash flows may be(come) impaired:

The most immediate danger is that investors will shrink from rolling over the debt of the two companies, leading to a run a la Bear Stearns....With so much on the line, we've been suggesting that Treasury and Congress step up now with a public capital injection to help [Fannie Mae and Freddie Mac] ride out their losses.

So let me see. The solution to avoiding spending taxpayer monies is...spending taxpayer monies? Let's see how quickly they backtrack:

Yes, this would mean putting some taxpayer cash up front, but in the cause of avoiding the far greater risk of a collapse or Bear-like run. If the capital injection was made in the form of a subordinated debt or preferred stock offer, taxpayers would get a stake in the companies and some return on their investment once the crisis passes.

Isn't this usually what gets done in the "free market"? In fact, iirc, The Big C has done this a few times recently.* Why should FNMA and FHLMC be different?

We haven't suddenly become socialists. What taxpayers need to understand is that Fannie and Freddie already practice socialism, albeit of the dishonest kind. Their profit is privatized but their risk is socialized. We're proposing a more honest form of socialism, with the prospect of long-term reform. [emphasis mine]

The above paragraph is something I could have written. And probably have. And it only gets better:

In return for putting up the cash, the taxpayers would also need some reassurance that this Fan and Fred debacle couldn't happen again. Thus their regulator would need the power to shrink their portfolios of mortgage-backed securities that have made them such high-risk monsters, and ultimately to wind the companies down. Apart from outright failure, the worst scenario would be a capital injection that left the companies free to commit the same mayhem all over again two or 10 years from now.

You got it, folks. The WSJ has just come out in favor of (1) a government bailout and (2) more regulation of, effectively, an industry.**


But wait. Did you catch the shift? Let's try it again:

Thus their regulator would need the power to shrink their portfolios of mortgage-backed securities that have made them such high-risk monsters, and ultimately to wind the companies down.

Whoop, there it is! Same old WSJ. Save the mortgage market just to destroy it. Which must be why, since (see the DeLong link above) Fannie and Freddie are solvent in the long-term, they go on to object to one option:

On Friday, Senate Banking Chairman Christopher Dodd (D., Conn.) declared that Fannie and Freddie are "fundamentally strong," that fears about their capital are overwrought, and that "this is not a time to be panicking about this. These are viable, strong institutions." Yet he also said that one option under discussion is to let the two companies borrow from the Federal Reserve's discount window.

Let's see. We have a short-term cash flow issue that may arise. Two possible solutions are: (1) ensure that the firms have a borrowing line available that is both higher than the FedFunds rate*** and perfectly in keeping with the implicit guarantee of their loans or (2) add some cash now, but with the goal of eliminating the firms, probably just about the time the U.S. housing market starts to recover.

If that second is the case, will their auditors be allowed to say, "Since you don't intend this to be an ongoing concern, we aren't going to bother to dig too deeply?"

The WSJ piece ends with a classic "disregard what we've said for the past several years, especially the David Malpass and Larry Kudlow editorials":

If there's any other good news in all this, it is that the scandal of Fannie and Freddie is at last coming into public focus. The Washington political class has nurtured and subsidized these financial beasts for decades in return for their campaign cash and lobbying support. Wall Street and the homebuilders also cashed in on the subsidized business, and also paid back Congress in cash and carry.

The losers have been the taxpayers, who will now have to pay the price for this collusion. Maybe the press corps will even start reporting how this vast confidence game could happen.

Dear Press Corps: please start by examining the WSJ's continual "everything is good because house values keep appreciating" pieces.


*Yes, I know they have. Just don't have time to find links now.
**Since Fannie and Freddie-backed mortgages make up a large majority of the industry; op. cit. here.
***I'll stop making fun of the "Discount" Rate when it goes back to being a Discount Rate. Possibly, the next President will be sane.

The editors of the WSJ agree with Brad DeLong that the Fannie/Freddie problem is that their short-term cash flows may be(come) impaired:

The most immediate danger is that investors will shrink from rolling over the debt of the two companies, leading to a run a la Bear Stearns....With so much on the line, we've been suggesting that Treasury and Congress step up now with a public capital injection to help [Fannie Mae and Freddie Mac] ride out their losses.

So let me see. The solution to avoiding spending taxpayer monies is...spending taxpayer monies? Let's see how quickly they backtrack:

Yes, this would mean putting some taxpayer cash up front, but in the cause of avoiding the far greater risk of a collapse or Bear-like run. If the capital injection was made in the form of a subordinated debt or preferred stock offer, taxpayers would get a stake in the companies and some return on their investment once the crisis passes.

Isn't this usually what gets done in the "free market"? In fact, iirc, The Big C has done this a few times recently.* Why should FNMA and FHLMC be different?

We haven't suddenly become socialists. What taxpayers need to understand is that Fannie and Freddie already practice socialism, albeit of the dishonest kind. Their profit is privatized but their risk is socialized. We're proposing a more honest form of socialism, with the prospect of long-term reform. [emphasis mine]

The above paragraph is something I could have written. And probably have. And it only gets better:

In return for putting up the cash, the taxpayers would also need some reassurance that this Fan and Fred debacle couldn't happen again. Thus their regulator would need the power to shrink their portfolios of mortgage-backed securities that have made them such high-risk monsters, and ultimately to wind the companies down. Apart from outright failure, the worst scenario would be a capital injection that left the companies free to commit the same mayhem all over again two or 10 years from now.

You got it, folks. The WSJ has just come out in favor of (1) a government bailout and (2) more regulation of, effectively, an industry.**


But wait. Did you catch the shift? Let's try it again:

Thus their regulator would need the power to shrink their portfolios of mortgage-backed securities that have made them such high-risk monsters, and ultimately to wind the companies down.

Whoop, there it is! Same old WSJ. Save the mortgage market just to destroy it. Which must be why, since (see the DeLong link above) Fannie and Freddie are solvent in the long-term, they go on to object to one option:

On Friday, Senate Banking Chairman Christopher Dodd (D., Conn.) declared that Fannie and Freddie are "fundamentally strong," that fears about their capital are overwrought, and that "this is not a time to be panicking about this. These are viable, strong institutions." Yet he also said that one option under discussion is to let the two companies borrow from the Federal Reserve's discount window.

Let's see. We have a short-term cash flow issue that may arise. Two possible solutions are: (1) ensure that the firms have a borrowing line available that is both higher than the FedFunds rate*** and perfectly in keeping with the implicit guarantee of their loans or (2) add some cash now, but with the goal of eliminating the firms, probably just about the time the U.S. housing market starts to recover.

If that second is the case, will their auditors be allowed to say, "Since you don't intend this to be an ongoing concern, we aren't going to bother to dig too deeply?"

The WSJ piece ends with a classic "disregard what we've said for the past several years, especially the David Malpass and Larry Kudlow editorials":

If there's any other good news in all this, it is that the scandal of Fannie and Freddie is at last coming into public focus. The Washington political class has nurtured and subsidized these financial beasts for decades in return for their campaign cash and lobbying support. Wall Street and the homebuilders also cashed in on the subsidized business, and also paid back Congress in cash and carry.

The losers have been the taxpayers, who will now have to pay the price for this collusion. Maybe the press corps will even start reporting how this vast confidence game could happen.

Dear Press Corps: please start by examining the WSJ's continual "everything is good because house values keep appreciating" pieces.


*Yes, I know they have. Just don't have time to find links now.
**Since Fannie and Freddie-backed mortgages make up a large majority of the industry; op. cit. here.
***I'll stop making fun of the "Discount" Rate when it goes back to being a Discount Rate. Possibly, the next President will be sane.