Former Senator And Chairman of the Congressional Oversight Panel Ted Kaufman: ‘TARP Was The Largest Welfare Program For Corporations And Their Investors Ever Created In The History Of Humankind’


Ted Kaufman


On Friday, free and efficient market champion Ted Kaufman, previously known for his stern crusade to rid the world of the HFT scourge, and all other market irregularities which unfortunately will stay with us until the next major market crash (and until the disbanding of the SEC following the terminal realization of its corrupt and utter worthlessness), held a hearing on the impact of the TARP on financial stability, no longer in his former position as a senator, but as Chairman of the Congressional TARP oversight panel. Witness included Simon Johnson, Joseph Stiglitz, Allan Meltzer, William Nelson (Deputy Director of Monetary Affairs, Federal Reserve), Damon Silvers (AFL-CIO Associate General Counsel), and others.

In typical Kaufman fashion, this no-nonsense hearing was one of the most informative and expository of all Wall Street evils to ever take place on the Hill. Which of course is why it received almost no coverage in the media. Below we present a full transcript of the entire hearing, together with select highlights.

The insights proffered by the panelists and the witnesses, while nothing new to those who have carefully followed the generational theft that has been occurring for two and a half years in plain view of everyone and shows no signs of stopping, are truly a MUST READ for virtually every citizen of America and the world: this transcript explains in great detail what absolute crime is, and why it will likely forever go unpunished.

Key highlights from the transcript:

In a recent paper, professors in Dallas and a co-author estimated that the CPP program, along with the FDIC’s Temporary Liquidity Guarantee Program, increased the value of banks participating in these two programs by approximately $130 billion, of which 40 billion represented a direct taxpayer subsidy to banks.

On the other hand, the political deals required to get TARP passed with an estimated 150 billion in largely unjustified and unjustifiable tax breaks, do not speak well for our democracy.


I estimated that the capital purchase program increased the value of banks debt by $120 billion at a cost of $32 billion for the taxpayers. Though in spite of the enormous value created by the government intervention, taxpayers ended up with a large loss.

TARP was the largest welfare program for corporations and their investors ever created in the history of humankind.

And some of the crumbs (ph) have been donated to the Auto Workers Unions doesn’t make it any better. It makes it worse. It shows that this redistribution was no accident. It was a premeditated pillage of defenseless taxpayers by powerful lobbyists. TARP is not just a triumph of Wall Street over Main Street, it is the triumph of K- Street over the rest of America.


There are exactly the issues you discussed with the previous panel in terms of additional losses coming through from major lawsuits and various kinds of put backs and so on. We don’t know how much capital they’re going to need to weather the next stage of the global cycle. And the Federal Reserve has not yet determined that, so why would you allow them to pay out any of this capital as dividends?

This is just reducing their equity and allowing them tohave more leverage in their business. The bankers, again,  want it, because they get paid on a return on equity basis. This is just letting them leverage up, and there’s a put option. We write the put option. We bear the cost of that.

You’re increasing the put option, which is not scored in anyone’s budget, by allowing them to pay these dividends. It’s unconscionable. It’s irresponsible. And the Federal Reserve should back off from allowing this increase in dividends, which is apparently where they are currently headed.


STIGLITZ: In these ultimate objectives, TARP has been a dismal failure. Four years after the bursting of the real estate bubble and three years after the onset of recession, unemployment remains unacceptably high, foreclosures continue almost unabated, and our economy is running far below its potential, a waste of resources (inaudible) trillions of dollars.

Lending, especially to small- and medium-size enterprises is still constrained. While the big banks were saved, large numbers of the smaller community and regional banks that are responsible for much of the lending to SMEs are in trouble. The mortgage market is still on life support.

So TARP has not just failed in its explicit objectives. I believe the way the program was managed has in fact contributed to the economy’s problems. The normal laws of capitalism where investors must bear responsibility for their decisions were abrogated. A system that socializes losses and privatizes gains is neither fair nor efficient.

TARP has led to a banking system that is even less competitive, where the problem of too-big-to-fail institutions is even worse.

There were six critical failings of TARP. First, it did not demand anything in return for the provision of funds. It neither restrained the unconscionable bonuses or payouts and dividends. It put no demands that they lend the money that they were given to them. Didn’t even restrain their predatory and speculative practices.

Secondly, in giving money to the banks, they should have demanded appropriate compensation for the risk borne. It is not good enough to say that we will repay, or we will be repaid, or we will be almost repaid. If we had demanded arms-length terms, terms such as those that Warren Buffet got when he provided funds to Goldman-Sachs, our national debt would be lower and our capacity to deal with the problems ahead would be stronger. The fairness of the terms is to be judged ex ante — not ex post — taking into account the risks at the time.

Thirdly, there was a lack of transparency. Fourthly, there was a lack of concern for what kind of financial sector should emerge after the financial crisis. There was no vision of what a financial sector should do, and not surprisingly, what has emerged has not been serving the economy well.

Fifthly, from the very beginning, TARP was based on a false premise: that the real estate markets were temporarily depressed. The reality was that there had been an enormous bubble, for which the financial sector was largely responsible. It was inevitable that the breaking of that bubble, especially given the kinds of mortgages that had been issued, would have enormous consequences that had to be dealt with. Many of the false starts, both in asset recovery and homeowner programs, have been the result of building on that false premise.

Particularly flawed was the PPIP, a joint public-private program designed to have the government bear a disproportionate share of the losses. The private sector, while putting up minimal money, would receive a disproportionate share of the gains. It was sold as helping the market reprice. But the prices that would emerge would be prices of options, not of underlying assets. The standard wisdom in such a situation is summarized in a single word:
“restructure.”

But TARP, combined with accounting rules changes, made things worse.

The sixth critical failure of TARP was that some of the money went to restructure securitization under the TALF program, without an understanding of the deeper reasons for the failure of mortgage securitization.

These attempts to revive the market have failed, and to me this is not a surprise.

Banks won’t focus on lending if they can continue to make more money by publicly underwritten (ph) specification and trading or by exploiting market power in the credit and debit card markets.

Moreover, too-big-to-fail institutions, whether they be mortgage companies, insurance houses or commercial investment banks, pose an ongoing risk to our economy and the solidness of government finances.

I want to conclude with two more general comments. First, we should not forget the process by which TARP and this oversight panel was created. That political process does not represent one of the country’s finest moments.

At first, a short three-page bill was presented, giving enormous discretion to the Secretary of the Treasury and without congressional oversight and judicial review.

Given the lack of transparency and potential abuses to which I have already referred, which occurred even with full knowledge that there was to be oversight, one could only imagine what might have occurred had the original bill been passed.

Fortunately, Congress decided that such a delegation of responsibility was incompatible with democratic processes.

On the other hand, the political deals required to get TARP passed with an estimated 150 billion in largely unjustified and unjustifiable tax breaks, do not speak well for our democracy.

When we think of the cost of TARP, surely the price tag associated with those tax breaks should be included in the tally.

Nor should we underestimate the damage that the correct perception that those who were responsible for creating the crisis were the recipients of the government’s munificence.

And the lack of transparency that permeated this and other government rescue efforts has only reinforced public perceptions that something untoward has occurred.

For these and the other failings of TARP, our economy and our society have paid and will continue to pay a very high price.


The unlimited bailout of Fannie Mae and Freddie Mac buy Treasury in the purchase of $1.25 trillion of GSE guaranteed mortgage-backed securities in the secondary market by the Federal Reserve under its quantitative — first quantitative easing program no doubt materially benefited the TARP recipients and other financial institutions. These institutions are not required, however, to share the costs incurred in the bailout of the GSEs.

In effect, the bailout of Fannie Mae and Freddie Mac permitted the TARP recipients to monetize their GSE guaranteed MBS at prices above what they would have received without the GSE guarantees and use the proceeds to repay their obligations outstanding under the TARP, thereby arguably shifting a greater portion of the TARP from the TARP recipients themselves to the taxpayers. Costs such as this should be thoughtfully considered when evaluating the TARP.

2010 report on the AIG bailout, and I quote, “The government’s actions in rescuing AIG continued to have a poisonous effect on the marketplace. By providing a complete rescue that called for no shared sacrifice among AIG’s creditors, the Federal Reserve and Treasury fundamentally changed the relationship between the government and the country’s most sophisticated financial players.

The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America’s largest financial institutions and to assure repayment to the creditors doing business with them. So long as this remains, the worst effects of AIG’s rescue on the marketplace will linger.

Treasury’s rescue suggested that any sufficiently large American corporation, even if not a bank, may be considered too big to fail, creating a risk that moral hazard will infect the economy far beyond the financial system.

Many senior officers of these institutions retained their lucrative employment and although they generally suffered many full dilution (ph), the shareholders and most TARP recipients were not wiped out

Main Street quickly realized that the TARP was heavily tilted in favor of Wall Street, while Main Street was stuck with dramatic rates of unemployment, neighborhoods decimated by foreclosure, banks that refused to lend and the general sense that the residents were left on their own.

Two, I believe and there is overwhelming evidence to support my position in our February 2009 report that at the time these initial TARP investments were made, the public did not receive anything like full value for our money.

Three, the Paulson Treasury Department was not truthful with the public when it said that the capital purchase program funds were only going to help the institutions and the Geithner Treasury Department has compounded this lack of candor be refusing to admit in testimony before this panel that Citigroup and Bank of America were on the verge of collapse when they received additional TARP funds in November 2008 and January 2009 respectively.

Four, the failure to replace bank management, to do a rigorous evaluation of the state of bank assets and to restructure bank balance sheets accordingly has left the United States with weak major banks and a damaged sense of trust between the American public and our nation’s elected
leaders.

Foreclosure prevention has been subordinated to the needs of the banks. The truth is that continued mass foreclosures of homeowners are a powerful source of systemic risk and downward pressure on our economy and on jobs. … the American people would judge TARP based not on the wealth of bankers, but on
the health of our communities.

likely consequence of failing to restructure the major banks.

encouraging firms to grow until they became too big to fail, thereby increasing the number and size of systemically risky firms in the economy. And in turn, increasing the amount of money needed to stem the financial crisis.

Unfortunately at least so far it does not appear that we have taken the necessary steps to end too big to fail.
Then the government needs to start charging marked-based fees to these firms for insurance provided to them through  substantially higher reserve requirements, which has been advocated by Professor Meltzer among others by requiring firms to hold additional alternative reserves against their systemically risky holdings, as has been proposed by professors in Dallas by charging firms for the bailout insurance along the lines proposed by the President of the Federal Reserve Bank of Minneapolis or through some alternative mechanism which forces these firms to pay the cost of the insurance that is currently being paid for by the American taxpayers.

Only by ending the taxpayer funded, survival guarantee for large firms, both domestic and foreign, will we return basic market discipline to Wall Street and ensure that large financial firms face the same competitive pressures faced by firms operating on Main Street?

There is a widespread perception — not a perception; I think it’s personally a reality — that Main Street did a lot worse than Wall Street on this one.

Are there some things that the TARP, that Treasury could have done at the beginning of this program to kind of more better balance between what was going to Main Street, the amount that would accrue to Main Street as opposed to Wall Street?

Professor Stiglitz’s testimony, he says, “Resolution authority has made little difference, because few believe that the government will ever use the authority at its disposal with these too big to fail banks.”

But once the markets had stabilized in the last quarter of 2008, begun to stabilize more in 2009, and certain institutions came back and said, “You know, by the way, we’re still insolvent. We’re still insolvent by the tune of many billions of dollars,” at that point there were rules on the books of the FDIC to take down these institutions, and they were not.

So it really makes me question that now you have new rules for new institutions. When it comes right down to it, will — will this happen or will simply more checks be written? And as more checks are written, more moral hazard will be created.

The Federal Reserve purchased a trillion-plus dollars of mortgage-backed securities, government backed mortgage-backed securities, which would not have been purchased at fair market value, if Fannie and Freddie had been permitted to fail.

So the bailout of Fannie and Freddie seems to me to have a direct correlation to the health of financial institutions and their ability to pay back the funds.

So I don’t know whether you saw there was a column in Wednesday’s New York Times alleging that banks supplied the measures that were used in the latest round of stress tests, ensuring that they would look good and rendering the tests rather meaningless. I think part of this comes from the — the fact that these latest rounds of stress tests, the results have been kept somewhat private and were not as public as the first time around.

What are the benefits and costs from making these results public and do you have any idea why Fed — the Fed has sent — tended to think that the benefits were less than the costs in making the results public?

But few mention that very little of the money has actually been spent. And that lack of spending frustrates those of us who believe that effective government investment into the housing market is essential for further financial stability and economic recovery. But with only $1 billion spent on the HAMP so far as estimated by the CBO and nearly 600,000 mortgages permanently modified, it’s difficult to conclude that HAMP has been a waste of money.

Even just a back of the envelope estimate, that’s around $2,000 per permanent mod and we know that there are certainly other more complicating factors, re-default rates and servicer incentives and the role that the GSE’s have played, but could you comment from a cost- benefit analysis?

KAUFMAN: Is there any concern that — widespread belief that there still are banks too big to fail. The market seems to indicate by the spreads that they give to the larger banks that they’re too big to fail. That people all over the world are trying to figure out — I know there’s a new study going to come out on resolution authority across borders, which has not been dealt with in Dodd-Frank and would be an incredible problem.

KAUFMAN: One of the frustrations I think that people — not just people, everyone has such as me, everyone and that is the fact that you know we went in, we helped out the banks, we helped out the corporations and then the jobs just didn’t come. The investment didn’t come. The banks held onto the money. They’re still not investing the money. The corporations didn’t invest the money.

Admittedly the big banks were given many enormous gifts, and he uses the term gifts, of which TARP was only one. The United States government provided money to the biggest of the banks in their times of need in generous amounts and on generous terms, but have been forcing ordinary Americans to fend for themselves.

“TARP was the largest welfare program for corporations of its — and their investors ever created in the history of humankind.

“That some of the crumbs (ph) have been donated to a lot of (ph) workers does not make it any better. It makes it worse. It shows that its redistribution was no accident.”It was premeditated pillage of defenseless taxpayers by powerful lobbyists.”

Do you have a sense of the — and whether the Federal Reserve’s ultimate purchase of 1.2 trillion in residential mortgage-backed securities was, in addition to the other effects, a way of removing those troubled assets from banks’ books and shifting them to the Fed’s books?

The FDIC’s TLGP was one of several extraordinary measures taken by the U.S. government in the fall of 2008 to address a crisis in the financial markets and bolster public confidence. The FDIC’s TLGP helped to unlock the credit markets, calm market fears, and encourage lending during these unprecedented disruptions.

At its peak the FDIC guaranteed almost 350 billion of debt outstanding. As of December 31st, 2010, the total amount of remaining FDIC guaranteed debt was 267 billion. Of that amount 100 billion, or 37 percent, will mature in 2011, and the remaining 167 billion will mature in 2012.

Given that 267 billion in TLGP remains outstanding, it is important that financial institutions continue to replace government guaranteed debt with private funds.

Currently, we are working with the Federal Reserve to review the dividend plans at the large banking organizations. We believe that a comprehensive review of dividend and capital replacement plans across large firms is critical, since these payments were a large drain on cash reserves prior to the crisis, leaving financial institutions more vulnerable to the disruptions that followed.

This is why the dividend plan review and TLGP repayment plans are intertwined. The regulators should not approve dividend and capital repurchases, which involve significant cash outlays by financial firms, until we are all fully confident that these firms will have the financial resources under both normal and stress conditions to repay debt guaranteed by the FDIC.

Mr. Cave, can you talk a little bit about the plans of the – that you mentioned in your testimony – about plans for large banking organizations to increase dividends and how you think that works and why you think that works and what has to be done before that should go forward?

Right now, and again, the Federal Reserve is – is the lead agency responsible for administering the – the stress tests and the review of the dividend plans.

LAWLER: Servicers have some conflicts in some parts of the process. For example, if they hold a second lien on a property where they’re also servicing the first lien, that’s a conflict and that’s certainly an issue.

MCWATTERS: Thank you. Following up on that, do these troubled assets, which are estimated at around $1 trillion as presently constituted, do they pose a systemic risk to the economy?

MCWATTERS: Okay. Am I putting words in your mouth in saying that it sounds like a no to me? I mean it sounds like a no answer. It’s not that these troubled assets, $1 trillion on the books, do not pose a systemic risk today? Is that a fair statement or …?

CAVE: I would, would need to get additional information to you on that.

MCWATTERS: Okay, okay. How about the robo-signing problems and the breach of representations that we read about a lot a couple of months ago. Do those create a systemic risk? In the opinion …

LAWLER (?): If the foreclosure process were to stop functioning entirely that would create some significant problems. Most of the – my understanding of those issues were that the processes were not followed correctly, but if they can be corrected so that they do work properly, then that’s not a systemic risk. If we simply were unable to foreclose on properties, then that could create more serious problems.

MCWATTERS: Well what about the systemic risk that could develop when financial institutions, the servicers, the originators, the securitizers are sued, particularly the financial institutions are sued in wearing any of those hats? Perhaps multiple hats being the securitizer and the originator. I mean there are claims now before the courts that investors were materially misled and they’re asking for a significant amount of damages.

I understand lawsuits, they happen all the time. But is a cumulative effect of these lawsuits, do they present a systemic risk to these financial institutions?

LAWLER (?): Again not to Fannie Mae and Freddie Mac because they’re not …

MCWATTERS: Okay.

LAWLER (?): … the ones being sued.

MCWATTERS: Mr. Cave, what do you think?

CAVE: I think that in our view, this is very much a question for the Financial Stability Oversight Committee. As you have noted, this situation involves various financial market participants as well as regulators and we believe that this is, this is something that is – that should be a question for the, for the FSOC.

MCWATTERS: Mr. Nelson, the fed, what’s the fed’s view of this?

NELSON: I’m sorry Sir, this is not an area of my expertise.

MCWATTERS: Okay, okay fair enough. So it sounds like no one is saying, with the exception of Mr. Lawler because his client is, has an unlimited check from Treasury, that the answer is simply uncertain. Let me ask one final question with the few seconds I have.

Mr. Cave, your testimony, which I found very interesting, expresses some concerns about dividends. And not surprisingly, the FDIC appears concerned that loans which the FDIC has guaranteed be paid first before any dividends get issued.

I am concerned further beyond that about the quality of earnings at the larger banks that are — that are proposing paying dividends. Do you — does the FDIC share my concern?

CAVE: Thank you. What I would say is, again, based on our recent quarterly banking performance report that, again, the state of the — the state of the industry earnings have improved.

We saw 2010 as a — as a turnaround year, stronger earnings, but that, you know, a portion of that was – was due to reductions in loan loss provisions, which, again, had a benefit on earnings. Revenues, we haven’t seen as much improvement.

That’s an area that — that we are looking at very closely to ensure that those reductions in provisions are appropriate, given the current risk of the assets. That’s — that’s an area where the work is — is needed, but we are — we are looking at that very closely.

SILVER: My time has expired, but I’m — if I can ask the chairman’s indulgence, I just want to clarify that for the non-bank regulators who might be listening.

What we’re talking about here — and you tell me if I’m wrong, right? — is that a fair amount of the earnings of the large banks does not reflect actual cash that has gone into those banks. It reflects changes in assumptions about future losses.

The dividends that would be paid would involve actual money, not — not assumptions or promises or other things, but actual money, so that on the one hand you have no money coming in for that part of those earnings, and on the other hand, dividends would involve real money coming out.

Is that — is that in a sort of simpleminded way, is that what you were just discussing?

CAVE: I think that would be a — a fair representation that, again, dividends would be cash coming out and that, again, there are various — various attributes of the – of the earnings streams that have various levels of quality.

SILVER: I am concerned about that. Thank you.

In a recent paper, professors in Dallas and a co-author estimated that the CPP program, along with the FDIC’s Temporary Liquidity Guarantee Program, increased the value of banks participating in these two programs by approximately $130 billion, of which 40 billion represented a direct taxpayer subsidy to banks.

It seems clear that many of the programs implemented by the Federal Reserve, including their purchase of mortgage-backed securities and a primary dealer credit facility, also provided significant financial assistance to banks.

Do you think the — the assistance from these other programs and other agencies enabled large banks to repay their TARP funds more quickly? I know that these efforts were coordinated between Treasury and the Fed and the FDIC. Was there some discussion about this?

And if so, do you think that these other programs allowed some of the shifts — some of the costs of TARP to be shifted to these other what I would call less scrutinized programs? Do you have any thoughts on that?

TROSKE: Mr. Cave, I guess I’d direct the same question to you. Do you think that the FDIC’s actions sort of benefited large banks and in some sense allow them – enabled them to be — more quickly pay back their — their TARP funds?

I mean, I’m not arguing that that was the main purpose, but was at one of the consequences of this action?

STIGLITZ: In these ultimate objectives, TARP has been a dismal failure. Four years after the bursting of the real estate bubble and three years after the onset of recession, unemployment remains unacceptably high, foreclosures continue almost unabated, and our economy is running far below its potential, a waste of resources (inaudible) trillions of dollars.

Lending, especially to small- and medium-size enterprises is still constrained. While the big banks were saved, large numbers of the smaller community and regional banks that are responsible for much of the lending to SMEs are in trouble. The mortgage market is still on life support.

So TARP has not just failed in its explicit objectives. I believe the way the program was managed has in fact contributed to the economy’s problems. The normal laws of capitalism where investors must bear responsibility for their decisions were abrogated. A system that socializes losses and privatizes gains is neither fair nor efficient.

TARP has led to a banking system that is even less competitive, where the problem of too-big-to-fail institutions is even worse.

There were six critical failings of TARP. First, it did not demand anything in return for the provision of funds. It neither restrained the unconscionable bonuses or payouts and dividends. It put no demands that they lend the money that they were given to them. Didn’t even restrain their predatory and speculative practices.

Secondly, in giving money to the banks, they should have demanded appropriate compensation for the risk borne. It is not good enough to say that we will repay, or we will be repaid, or we will be almost repaid. If we had demanded arms-length terms, terms such as those that Warren Buffet got when he provided funds to Goldman-Sachs, our national debt would be lower and our capacity to deal with the problems ahead would be stronger. The fairness of the terms is to be judged ex ante — not ex post — taking into account the risks at the time.

Thirdly, there was a lack of transparency. Fourthly, there was a lack of concern for what kind of financial sector should emerge after the financial crisis. There was no vision of what a financial sector should do, and not surprisingly, what has emerged has not been serving the economy well.

Fifthly, from the very beginning, TARP was based on a false premise: that the real estate markets were temporarily depressed. The reality was that there had been an enormous bubble, for which the financial sector was largely responsible. It was inevitable that the breaking of that bubble, especially given the kinds of mortgages that had been issued, would have enormous consequences that had to be dealt with. Many of the false starts, both in asset recovery and homeowner programs, have been the result of building on that false premise.

Particularly flawed was the PPIP, a joint public-private program designed to have the government bear a disproportionate share of the losses. The private sector, while putting up minimal money, would receive a disproportionate share of the gains. It was sold as helping the market reprice. But the prices that would emerge would be prices of options, not of underlying assets. The standard wisdom in such a situation is summarized in a single word: “restructure.”

But TARP, combined with accounting rules changes, made things worse.

The sixth critical failure of TARP was that some of the money went to restructure securitization under the TALF program, without an understanding of the deeper reasons for the failure of mortgage securitization.

These attempts to revive the market have failed, and to me this is not a surprise.

Banks won’t focus on lending if they can continue to make more money by publicly underwritten (ph) specification and trading or by exploiting market power in the credit and debit card markets.

Moreover, too-big-to-fail institutions, whether they be mortgage companies, insurance houses or commercial investment banks, pose an ongoing risk to our economy and the solidness of government finances.

I want to conclude with two more general comments. First, we should not forget the process by which TARP and this oversight panel was created. That political process does not represent one of the country’s finest moments.

At first, a short three-page bill was presented, giving enormous discretion to the Secretary of the Treasury and without congressional oversight and judicial review.

Given the lack of transparency and potential abuses to which I have already referred, which occurred even with full knowledge that there was to be oversight, one could only imagine what might have occurred had the original bill been passed.

Fortunately, Congress decided that such a delegation of responsibility was incompatible with democratic processes.

On the other hand, the political deals required to get TARP passed with an estimated 150 billion in largely unjustified and unjustifiable tax breaks, do not speak well for our democracy.

When we think of the cost of TARP, surely the price tag associated with those tax breaks should be included in the tally.

Nor should we underestimate the damage that the correct perception that those who were responsible for creating the crisis were the recipients of the government’s munificence.

And the lack of transparency that permeated this and other government rescue efforts has only reinforced public perceptions that something untoward has occurred.

For these and the other failings of TARP, our economy and our society have paid and will continue to pay a very high price.

MELTZER:   Why was it necessary to issue about a trillion dollars of public money to prevent financial collapse?

Further, Dodd-Frank put the Secretary of the Treasury at the head of the committee to decide on too-big-to-fail. That decision embeds two errors in the law.

Instead of subsidizing large banks we should make them pay for the costs that they impose. If a bank increases assets by 10 percent, capital must increase by more than 10 percent.

JOHNSON: And let me frame my agreement in the form of the following question: does anyone here think that Goldman Sachs could fail? If Goldman Sachs hits a rock, a hypothetical rock — I’m not saying they haven’t. I’m not saying they will.

But if it were to hit a rock, does anybody here believe that it will be allowed to collapse, fail, go bankrupt unencumbered by any kind of bailout, now or in the near future?

I’ve asked this question around the country and across the world in the past two years. I’ve yet to find anyone who realistically thinks it could fail. I’ve found some people who wish it could fail. But that’s a different question.  Goldman Sachs is too big. Goldman Sachs has a balance sheet around $900 billion. In the last data (ph), it was a $1.1 trillion bank when it came close to failing in September 2008.

And it was rescued by being allowed to convert into a bank holding company. It is too highly leveraged. Those debts are held in a complex manner around the world, including through its derivative positions.

And it is too inherently cross-border. We — I would remind you and I would ask you to reinforce with everyone you meet, we do not have a cross-border resolution authority.

Or it gets worse. You enter another phase of what the Bank of England now calls a doom loop where repeated boom/bust bailout cycles lead you not just to some unfortunate situation where there’s always a transfer from the public to the bankers, leads you to fiscal ruin.

We should also have implemented a cross border resolution framework, although as I said, that will always prove elusive

Lehman Brothers had 11.6 percent tier-I capital. We will end up between 10 and 11 percent. How can this, how can this make any sense? The Swiss National Bank is requiring 19 percent capital requirements, although I would suggest they go with pure equity for all 19 percent. The Bank of England is actively pursuing and trying to implement capital requirements closer to 20 percent. Raising capital requirements in this form is not socially costly.

I know that the bankers claim vehemently to the contrary, but they are wrong. And if you don’t believe me you should consult the research of Anad Admanti and her colleagues at Stanford and other leading universities. These are the top people in finance who are not captured by the financial industry and they say we need more capital, it’s not costly and we need a version I would suggest of exactly what Professor Meltzer just laid out for you most articulately.

ZINGALES: I estimate that the bank of (inaudible) largest bank would have wiped out 22 percent of their value for a total of $2.4 trillion, a number that doesn’t consider the cost imposed on the rest of the U.S. economy which could be a multiple of that.

Yet it is both false and misleading to say that there were no other alternatives. False because there were feasible and in fact superior alternatives. Misleading because it made TARP appear inevitable, forcing people not to question its cost.

I didn’t write a plan for AIG because I never understood what the real goal of bailing out AIG was. To save European banks, Goldman Sachs or the policyholder. We have to rely on Wall Street’s claims that the failure would have completely (inaudible) markets.

I estimated that the capital purchase program increased the value of banks debt by $120 billion at a cost of $32 billion for the taxpayers. Though in spite of the enormous value created by the government intervention, taxpayers ended up with a large loss.

TARP was the largest welfare program for corporations and their investors ever created in the history of humankind.

And some of the crumbs (ph) have been donated to the Auto Workers Unions doesn’t make it any better. It makes it worse. It shows that this redistribution was no accident. It was a premeditated pillage of defenseless taxpayers by powerful lobbyists. TARP is not just a triumph of Wall Street over Main Street, it is the triumph of K- Street over the rest of America.

Yet the worst long term effect of TARP is not the burden imposed on taxpayers, but the distortion it – to incentives it generated. First (inaudible) of the bailout ensured that the legitimate assistance i.g., recapitalizing smaller banks and (inaudible) became more difficult. Second the way subsidizes were distributed under TARP showed the enormous return to lobbying.

A member of the Bush Treasury admitted that in the summer of 2008 any phone call from the 212 area code had one message; have the government buy the toxic assets. Eventually this constant request became government policy. Third, the way the bailout was conducted destroyed the faith that the Americans have in the financial system and in the government.

In a survey conducted in December 2008, 80 percent of the American people stated that the government intervention made them less confident to invest in the financial market. Last but not least, it entrenched the view that large financial institutions cannot fail and their creditors cannot
lose.

This expectation leaves investors such as a CF4 (ph) I know, to invest their money in the banks most politically connected, not in the most financially sound. This is the end of the credit analysis and the beginning of political analysis.

JOHNSON: Gene Fama, the father of the efficient markets view of finance said on CNBC recently, too big to fail is not a market, it’s a government subsidy scheme. And it’s an abomination and it should, it should end. The new GSE’s, the Government Sponsored Enterprises of today – include most probably the largest six bank holding companies in the country; Bank of America, JP Morgan Chase, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.

These firms can borrow more cheaply because they are backed by the government. The estimates – responsible realistic estimates are they have a funding advantage of about 50 basis points, 0.5 of a percentage point. They can get bigger, they want to get bigger, they want to become more global.

Gene Fama suggests, and I actually agree with him, we should be looking at capital requirements closer to 40 or 50 percent. This is — this is just the percent of the assets financed with equity.

JOHNSON: There are exactly the issues you discussed with the previous panel in terms of additional losses coming through from major lawsuits and various kinds of put backs and so on. We don’t know how much capital they’re going to need to weather the next stage of the global cycle. And the Federal Reserve has not yet determined that, so why would you allow them to pay out any of this capital as dividends?

This is just reducing their equity and allowing them to have more leverage in their business. The bankers, again, want it, because they get paid on a return on equity basis. This is just letting them leverage up, and there’s a put option. We write the put option. We bear the cost of that.

You’re increasing the put option, which is not scored in anyone’s budget, by allowing them to pay these dividends. It’s unconscionable. It’s irresponsible. And the Federal Reserve should back off from allowing this increase in dividends, which is apparently where they are currently headed.

STIGLITZ: The real problem I had, and I tried to emphasize in my remarks, was the way they gave money to the banks was wrong. Now, interesting when TARP was passed, they said they were going to buy the troubled assets. Everybody pointed out that that was a flawed approach. And to their credit, Paulson changed the strategy after several weeks, and it would have been an even worse disaster had he not changed that strategy.

JOHNSON: And I completely agree that, given the options now on the table, capital is the answer.

We need a lot more capital. It needs to be pure capital, real capital, not funky capital, not hybrid capital, not contingent capital. It needs to be real equity capital in our financial system. This is not costly from a social point of  view.

The bankers don’t want it. They hate it. They fight against it. All the arguments they put forward against it are pure lobbying. They have no research on their side. They have no analysis on their side. It is complete public-relations exercise.

We need a lot more capital in the financial system here. And we need to persuade anybody who wants to do banking business or financial sector related business in the United States from another country needs to have whatever they do in the United States be just as well capitalize as our financial institutions.

And hopefully, that will be a lot more capital than we have today.

ZINGALES: You basically require a bank to do a debt for equity swap. There is enough long-term debt that can absorb those losses. And if you think that this requirement is coercive, you give the option to shareholders to buy back their shares through a scheme that is known in the literature as bad share scheme, which is very fair.

JOHNSON: (?) Okay very briefly, first I want to emphasize the two things that we’ve already said; one that you need more capital and that you need the mandate (ph) of more, increase in capital has to be commensurate with the size of the banks, the risk of too big to fail. That this distortion has to be eliminated.

So I think we do need additional regulations and more transparency that would circumscribe excessive risk taking by  either government insured institutions or large institutions because they’re implicitly government insured. Because I don’t think the capital is enough, is a full solution.

(UNKNOWN): At the risk of sounding as though Simon Johnson and I collaborated, I would say I’ll change the word capital to equity and picking up what he had said and what I would do, I would raise the requirement to say that for every – that after a minimum size to protect community banks, you start to phase in capital requirements which start at 10 percent and increase as the size of the bank increases so that it’s 11, 12, 13, going up toward 20, so that the largest banks will be paying what they were paying in the 1920’s.

(UNKNOWN): Don’t allow them to pay dividends today. Nobody knows – well we’re all agreeing you need more capital, nobody knows how much capital is necessary. Even the bankers will concede that the easiest way to increase equity in the business is to retain earnings. They have profits now. That money stays in the bank, it belongs to the shareholders.

Paying out equity under these circumstances makes no sense in economic terms. It’s irresponsible. It encourages risk taking of these banks, high leverage bets. And it’s completely contrary to the stated policy both in the broad of the administration; Mr. Geithner says we need capital, capital, that’s what he says all the time. But we’re not pushing for enough capital.

So why would you let them pay capital under these circumstances? It makes no sense and they shouldn’t do it.

STIGLITZ: So for instance, by the time we bailed out Citibank and Bank of America, we were very large shareholders.  We could have been ever larger shareholders if we got shares – if we’d gotten value for the money so to speak.

(UNKNOWN): Yes.

STIGLITZ: If we had gotten voice relative to the money we put in. If we had used that shareholder voice to say you can’t go make your profits out of speculation, you can’t go paying these bonuses – this goes back to the point paying out bonuses and dividends is recapitalizing the banks. And what was needed was recapitalization. And we allowed the decapitalization of the banks through the payouts of bonuses and dividends.

We didn’t put any pressure – any, constraints on the behavior of the banks. So there were – including the restructuring of the mortgages. So given the amount of money that, you know you’re putting in – if you’re putting in hundreds of billions of dollars, you should have some voice in what happens and the result of that is that we didn’t get what we wanted, which is a restarting of the economy. The long run are the more difficult – are the even more worse problems because we have a more concentrated banking  system, that means interest rates will be higher, spreads (ph) will be higher and the result of that is not only are there the long  risks that we’ve been talking about, but in the short run, because the market is less competitive, the flow of money in the long run will not be what it should be.

(UNKNOWN): Professor Johnson, Treasury seems convinced that the banks are healthy, or sound, or something like that. The – I wonder if you’d comment on two things. One is, is that right and two how can anyone know that’s right given the state – we’ve talked a lot about the capital size of the balance sheet, the liability side. Given the state of what we know or don’t know about the asset side of the balance sheet.

JOHNSON: And I fear that the stress tests they’re doing now, although they haven’t  disclosed anything really about them, I feel that those tests are even more gentle.

MELTZER: Yes. The bankers don’t want it and they come  down with lobbyists in hordes to tell the congressmen, you know, that’s just disaster, you’re facing disaster. There won’t be loans for the public. There won’t be capital to build industry. All that stuff.

(UNKNOWN): …that says that leverage doesn’t buy you anything except higher probabilities of default. And that – and so, that the argument that they’re making that it would interfere with the efficiency of the economy has no support in the economics  profession.

TROSKE:  But in the presence of too-big-to-fail, both shareholders and executives are willing to move towards more risky forms of investment and are going to compensated in that fashion.

(UNKNOWN):       And I would refer you to a paper by Sanjai Bhagat and Brian Bolton who went carefully through the compensation  received by the top 14 – by executives of the top 14 financial institutions in the United States between 2000 and 2008. They found that those executives took out in cash bonus and through stock sales $2.6 billion in cash. In fact, the top five executives took around $2 billion in cash.

And the shareholders at the same time – if you were a buy-and- hold shareholder over that period, you did pretty badly. So that suggests that as a practical matter, maybe it’s because of misrepresentation – I have a feeling that’s quite a plausible explanation – or maybe it’s for some other reason, the shareholders do not do well when the managers leverage, take a great deal of risk, and get paid on a more or less immediate return basis, which is linked to your return on equity basis not properly risk adjusted.

TROSKE: I’d like to ask you a little somewhat different question, more related to your recent paper, “Paulson’s Gift.” And I like your title. I wish I were that creative — or editors let me be that creative on my titles.

You estimate that TARP preferred equity infusions and the FDIC guarantee cost taxpayers between 21 and 44 bllion.

You talk about an alternative plan. The government could have changed more for both the equity infusion and the debt guarantee, as Warren Buffett did when he invested in Goldman Sachs three weeks before the Paulson plan.

ZINGALES:  First of all, the capital infusion that was done was done — known in market terms by any stretch of the imagination, was definitely worse than the one that Warren Buffett got in term of return.

And the same is true for the debt guarantee.

Now, what is interesting is we observed, when this debt guarantee was extended, that the overall cost of insuring these two institutions dropped.

So but even if we take the value of this cost after the announcement — so let’s think about — there is a systemic effect and there is an individual effect.

Even if we sort of take away the systemic effect, the cost of insuring this institution was too cheap, and was not really valuing according to the type of institutions.

So for JPMorgan, this was not very convenient. For Citigroup or Goldman, was tremendously convenient. So what the (inaudible) reported don’t give a good sort of picture, is sort of the cross- section.

There was an important redistribution also within banks. JPMorgan was heavily penalized by the plan, partly because the market expected them to buy on the cheap the assets the other people were selling.

And Citigroup was — Citigroup, Morgan Stanley and Goldman were tremendously helped by the plan. So there is sort of also this cross- sectional aspect, which I think is important because distorts the market incentives.

And by treating everybody the same, the good managers are not rewarded and the bad manager are not penalized.

STIGLITZ:      And you have concentrated beneficiaries. And the alternatives are this — are much more diffuse, very hard to get a fair battle when you have that — this much money at stake.

MELTZER: And there’s a lot of money that goes into campaigns coming from Wall Street.

(UNKNOWN):  There are other people, such as Treasury, and important elements within the New York Fed and within the Board of Governors of the Fed who are absolutely adamantly opposed to applying the logic that we’ve been discussing here today.

They say, well, I don’t know what — I don’t know what they say. They don’t come out and discuss it enough, and clearly enough. And I think, oh, you know, ultimately, a lot of the reasons they put forward make no sense at all.

And I think it was Mark Hanna, the legendary Republican senator, the turn of the beginning of the 20th century, the organizer of the Republican Party in the Senate around the country, who said, there are two things that matter in American politics.

The first is money. And I don’t remember what the secondone is.

(UNKNOWN):  Another example is when you have incentives where some of the things are — some of the CDSs are done in a transparent market and some are done over-the-counter. That is an incentive to move things into the dark areas and to engage in things where nobody — it’s difficult to regulate.

STIGLITZ: My own view — there are two separate issues. I think we have to deal very strongly with the too big to fail banks and financial institutions, whether they’re banks or non-banks, and with the too correlated.

MELTZER:   We ought to reverse that ruling and say that when your liabilities are only worth 95 cents, they’re worth 95 cents. That was a mistake.

JOHNSON: He said to me, “Simon, let’s face it. On — on the too big to fail debate, you lost. And now our question is, and what we’re working on in the hedge fund is, how do we become too big to fail?”

damon silver testimony march 4 2011

Submitted by Tyler Durden on 03/07/2011 22:10 -0500

Source: ZeroHedge

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