Author: VD

Karl Denninger walks skeptics through the application of TARP and explains in detail why TARP did not represent Washington imposing its will on Wall Street, but rather elite Wall Street bankers rescuing the big banks by utilizing the federal government as a tool:

You realize that what you feared – a call to announce that the regulators were seizing all of your firms as they all had no mathematical way to survive isn’t what was going to happen at all! Instead, you were going to be given some $250 billion between you and the FDIC was going to take all credit risk on your new bond issues for the next year. In addition you were briefed on the TLGP which will guarantee your customers won’t run your bank as it provides their demand accounts with unlimited FDIC insurance protection. This is to be “free” for the first 30 days, and after that there’d be a fee, but compared to trying to keep your deposits and issue cheap debt it was for all intents and purposes zero cost. Finally, Ben was going to let you have basically unlimited Fed credit at near-zero interest rates for the next year, meaning there would be no issue as to whether you could fund routine operations or not.

Your firm was being saved and the taxpayer was going to cover the risk – whether he liked it or not.

You were going to be asked to do a few things, however. The public would never sit for being looted like this unless it looked like it was going to hurt a lot and there was simply “no alternative.” As it was Treasury and Bernanke were not sure that the public would buy it. Congress already had bought off on it, effectively; after all, Ben and Hank had corralled them into a room and threatened them with martial law if they didn’t pass TARP to begin with. But it was important to make it look stringent, so there’d be no big bonuses until you paid the TARP money back and dividends would have to be cut to effectively zero.

All in you were getting a screaming deal. Not only are you getting cheap capital, all things considered (the 5% preferred coupon with that FDIC backstop when your CDS spreads are being quoted in points up front literally saves your firm!) but the FDIC insurance on both senior debt issues and deposits – that is a pure windfall of unbelievable size.

You roll the numbers around in your head. There is roughly $850 billion in deposits throughout the system that would be covered by the FDIC “unlimited” deposit insurance, and the majority of it was in your bank and that of your TBTF friends. You figure that you and your buddies in the room could issue some $300 billion in “super insured” debt through the FDIC program and the surcharge from the FDIC is only 50 to 100 basis points; with the credit condition oncoming long rates will be headed southbound fast, so the odds are you’d see a 10 year in the 2.5% or so area soon. That makes the deal damned attractive; you figure between you in the room this will easily save you $15 billion a year in the first-year financing costs (about 500 basis points on that $300 billion) or more than the coupon on the preferred stock!

It doesn’t take long before the light comes on – this is a zero-cost option for you. The capital costs a coupon on the preferred but the savings on the bond issues more than make up for it and the FDIC deposit insurance makes sure nobody runs your bank.

For all intents and purposes you’re being paid to take the taxpayer’s money!

When you walked in the room you were sure you were going to be nationalized – or at least expropriated in some fashion, as you were dead flat broke. Now, well, let’s just say that it’s good to have friends in high places.

You wonder how the press is going to spin this one. This finance stuff is pretty tough for mainstream reporters; so long as nobody noodles on the numbers they probably won’t figure it out. Never mind that the bonds won’t all issue at once and most people will simply applaud the unlimited deposit insurance without thinking about the fact that it’s essentially a gift – the 10 basis point fee (0.1%) is a bad joke. $8 billion across the entirety of the system to provide unlimited coverage on $800 billion in deposits? This much is certain: Nobody’s going to be allowed to fail as that’s wildly lower than the actual risk premium on that transaction.

What’s not to like?

TARP was one of the most egregious breaches of capitalism in the history of the United States and no one who defends it, for any reason, can be considered even remotely pro-capitalist. Corporatism is not capitalism and Wall Street banksterism of the sort we have endured for the last three years has far more in common with royal mercantilism than it does with capitalism.

Do read the whole thing. The chances are very high that you will not only learn something, but you will be able to understand what actually happened in the fall of 2008.

Both the liberal orthodoxy, as represented by Paul Krugman, and the conservative orthodoxy still completely fail to understand the financial crisis. That is why they have not even begun to successfully address it:

In the real world, recent events were a devastating refutation of the free-market orthodoxy that has ruled American politics these past three decades. Above all, the long crusade against financial regulation, the successful effort to unravel the prudential rules established after the Great Depression on the grounds that they were unnecessary, ended up demonstrating — at immense cost to the nation — that those rules were necessary, after all.

But down the rabbit hole, none of that happened. We didn’t find ourselves in a crisis because of runaway private lenders like Countrywide Financial. We didn’t find ourselves in a crisis because Wall Street pretended that slicing, dicing and rearranging bad loans could somehow create AAA assets — and private rating agencies played along. We didn’t find ourselves in a crisis because “shadow banks” like Lehman Brothers exploited gaps in financial regulation to create bank-type threats to the financial system without being subject to bank-type limits on risk-taking.

No, in the universe of the Republican Party we found ourselves in a crisis because Representative Barney Frank forced helpless bankers to lend money to the undeserving poor.

O.K., I’m exaggerating a bit — but not much. Mr. Frank’s name did come up repeatedly as a villain in the crisis, and not just in the context of the Dodd-Frank financial reform bill, which Republicans want to repeal. You have to marvel at his alleged influence given the fact that he’s a Democrat and the vast bulk of the bad loans now afflicting our economy were made while George W. Bush was president and Republicans controlled the House with an iron grip. But he’s their preferred villain all the same.

The demonization of Mr. Frank aside, it’s now obviously orthodoxy on the Republican side that government caused the whole problem. So what you need to know is that this orthodoxy has hardened even as the supposed evidence for government as a major villain in the crisis has been discredited. The fact is that government rules didn’t force banks to make bad loans, and that government-sponsored lenders, while they behaved badly in many ways, accounted for few of the truly high-risk loans that fueled the housing bubble.

First, Krugman is totally and completely wrong about “the free-market orthodoxy that has ruled American politics these past three decades”. The last I noticed, the US financial system was still a government-mandated monopoly in the grand tradition of the East India and Hudson Bay companies. To claim that a nation which requires the reporting of all cash transactions over a certain amount to the government and where even cutting hair requires special permits is a “free market” is totally absurd.

But one cannot reasonably claim that the government is the primary villain in the financial crisis either. The government did put pressure on the banks to make bad loans, but the fact is that although they are certainly a serious probem, it is not the problematic banks loans are actually the major problem. Consider the following facts. The two total amount of money presently loaned out by all the commercial banks in the USA is $6.8 trillion dollars, down from a peak of $7.3 trillion in 2008. The total amount of debt presently owed by the financial sector is $13.8 trillion, down from $17.1 trillion in 2008.

This is the Wall Street Casino to which I have referred. It is sometimes referred to as the “investment” side of banks, which is nothing more than them borrowing money and gambling it in the form of derivatives on the different currency and equity markets. This is no more productive or capitalist than Grandma’s bingo night or Uncle Joe’s day at the horse track, it is simply gambling on a larger scale.

So, it should be readily apparent that anyone who is still attempting to frame the problem in terms of bank loans and not bank debts simply does not even begin to comprehend either the nature or the scope of the crisis.

There are serious economic problems, to be sure, but the core of the financial crisis would be better described as Bingo Night Finance than Rabbit Hole Economics.