Bailout Nation (34 page)

A
s Citi was teetering at the height of the crisis, a joke was pinging across Wall Street trading desks: “I went to a Citibank ATM this morning, and it said ‘insufficient funds.' I left wondering if it was them or me.”

That was no joke for Ben Bernanke and Hank Paulson. The thought of the nation's biggest and best-known bank taking a face-plant gave nightmares to the country's top finance officials. There was simply no telling what sort of ripple effect that would have—on the economy, on investor confidence, on the markets. Let Citigroup suffer the fate of its own misjudgment? Who wanted to be the guy who let America's biggest bank go down on his watch? That's hardly a legacy to be proud of. It was time for some preemptive action. Shore up Citi, send a message, get ahead of the curve—for a change.

One might assume the government would cut a hard bargain with the biggest, stupidest, most irresponsible bank in the country, especially considering how self-inflicted Citibank's wounds were. Instead, the Treasury essentially handed over the keys to the kingdom for a mere song. For reasons still unknown, the banking behemoth got a helluva good deal.

Credit new CEO Vikram Pandit for scoring such a sweet deal. First, he sold his hedge fund, Old Lane, at an absurd price to the suckers running Citigroup. Then as Citi CEO, he pulled a coup, getting the government to absorb a huge slug of the bank's liabilities. The net liabilities for a full decade of terrible decision making were transferred from Citi's bond/shareholders to the taxpayers—a terrible deal for Uncle Sam, but a fantastic score for Citi.

Citi took a $350 billion portfolio of assets—some junky, some not—and managed to get you and me to mark it at $306 billion. Never mind that other portfolios had taken 40 percent, 50 percent, even 65 percent haircuts. John Thain dumped some of Merrill Lynch's assets—financing 75 percent of the sale to Lone Star—for what amounted to 5.47 percent on the dollar.
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How did Citi manage to suffer only an 11 percent haircut? Were its holdings that much superior to everyone else's? Or was the mere idea of a colossus like Citi collapsing that much more threatening to Bernanke and Paulson? Imagine what would have happened to the rest of the banking idiots holding the same crappy paper as Citi if they had to dump all those assets at once. Perhaps it is the Federal Reserve's desire to maintain confidence that was behind this obscene taxpayer-funded boondoggle.

Even worse, the Citigroup rescue deal is open-ended. The government has given Citi what is effectively an unlimited line of credit to carry these assets: no fire sales and no panics about marking to market.

W
hile Citibank was slowly assembled over centuries, Bank of America, at least as we know it today, was a rather hastier creation. We'll skip its early but interesting history
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—its roots go back to surviving the San Francisco earthquake in 1906, and it eventually created Visa—and fast-forward to the 1990s. That's when the firm began a 20-year acquisition spree that worked out somewhat less than ideally.
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Recall the original “too big to fail” doctrine that came about when Continental Illinois was rescued by the FDIC. Continental Illinois went into FDIC receivership in 1984, came out of receivership in 1991, and was ironically purchased by Bank of America in 1994.
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Yes, Bank of America's track record of lousy acquisitions actually goes back decades.

It was in the 2000s when the management's acumen for killer acquisitions really shone:

On February 20, 2009, Bank of America's stock hit a low of $2.53. Before the Countrywide acquisition went bust, Bank of America's stock was at $52 (October 2007).

As bad as those acquisitions may be, some were even worse than they appear. When Jamie Dimon, CEO of JPMorgan Chase, agreed to take Bear Stearns off the hands of the Federal Reserve, he managed to convince Ben Bernanke to backstop the transaction to the tune of $29 billion. It was a shrewd move, as Bear's subprime and derivative losses have accumulated not to JPMorgan, but to the Fed. Similarly, Dimon waited for the FDIC to put Washington Mutual through the receivership process before acquiring the thrift in late September 2008.

Bank of America CEO Ken Lewis was not quite as savvy. He failed to obtain a government guarantee at the time the Countrywide deal was done, and he vastly overpaid for Merrill Lynch's thundering herd. Without the Fed's explicit guarantee, he got precisely what a thundering herd of cattle leaves in its trail. He could have waited 24 hours for the firm to fail and then picked up assets for pennies on the dollar, as Barclays did with Lehman's asset management unit.

Instead, Lewis bought the firm lock, stock, and barrel—and the barrel was stuffed with nonperforming assets. You didn't need the benefit of hindsight to see this was a disaster waiting to happen.

A
nd so September 2008 ended with the stock market in hasty retreat. The already weak stock market plummeted on September 29, 2008, when the House of Representatives rejected the $700 billion bank bailout. The Dow Jones Industrial Average suffered its largest-ever point decline in reaction, falling 777 points, or 7 percent. The S&P 500 took an 8.75 percent hit, its worst decline since the 1987 crash. The NASDAQ lost more than 9 percent, as Google fell below $400 for the first time in two years and Apple tumbled 18 percent. The following week (ending October 10) was the worst in the market's history. The Dow plummeted 20 percent to break under 8,000. One year earlier, the blue-chip index had been north of 14,000.

With markets in turmoil, it mattered little how the megabanks had been created—whether carefully assembled over two centuries or haphazardly over two decades. Their
past
was irrelevant, their
present
riddled with collapsing subprime derivatives, their
future
bleak. With too little capital and too much bad debt, management had no idea what to do.

Out of this maelstrom arose the Troubled Assets Relief Program (TARP): It was Treasury Secretary Hank Paulson's plan to save the big banks. Inject capital, buy the junk off their balance sheets, spend trillions in taxpayer monies to protect the banks from their own actions. Initial cost was $700 billion. By March 2009, the costs of this plan would rise to $2 trillion.

Why spend such an enormous amount of money rescuing such reckless, poorly run financial institutions? Perhaps the backgrounds of the men behind the bailouts are instructive.

The two Treasury secretaries of the bailout era each provide a cautionary tale for future presidents. Hank Paulson came to Treasury from Goldman Sachs. Over the course of three decades, he had risen through the ranks to become Goldie's CEO. His successor at Treasury is Timothy Geithner, the former president of the New York Federal Reserve Bank (or, as the credit trading desks call him, Turbo Tax Timmy). The New York Fed is a private Delaware corporation, owned in large part by its primary dealers—the 20 or so banks that purchase government Treasuries.
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(Geithner is also a protégé of another Treasury secretary, Robert Rubin.) Paulson and Geithner are both creatures of the banking world (and both are Dartmouth alums). They didn't seem to make a smooth transition from being employed by private banks to being employed by the president, working for the public.

Verily, the danger of the sacred cow is revealed. Rather than pulling out all the stops to save the
banking system
, the Treasury secretary was flailing desperately to save the
banks
. All of Paulson's energies were misplaced. That should come as no surprise, given his (and later, Geithner's) background. They are bankers, first and foremost. As such, they do what most professionals do when their industry is under assault: protect the institutions. And if it happens to take ungodly amounts of taxpayer money to accomplish, so be it.

The obvious solution—put the insolvent banks into FDIC receivership, fire management, liquidate holdings, sell the assets off, wipe out shareholders, and pay the bondholders whatever was left over—was simply unthinkable.

This is reflected in Paulson's original TARP proposal. It was shockingly short on details, calling for a tremendous expansion of the Treasury secretary's powers, with no oversight or liability:
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For $700 billion, the country
literally
got a one-pager: no details, few specifics, and an enormous price tag. Whether it was hubris or something else entirely, it was emblematic of Paulson's response to the banking disaster. There was no consistency to the decision making, no discernible thought pattern. Every choice seemed to be on the fly, off the cuff, and by the seat of his pants. Hank Paulson's Treasury department was little more than an “adhocracy.”

Is this anyway to run a Bailout Nation?