A piece by Denninger that is just
far too good to pass up -
Ok, I'll be nice.
Once.
See, I'm a kinda-charitable guy,
especially off-hours. Besides, there's a whole lot of "Tea Party" and
other "Right of Aisle" types that really need to hear this.
I may change minds here and I may not. I ask only one thing:
Read
this with an open mind, then verify anything that doesn't sound right.
Do not trust my figures, verify them yourself. Every source is cited.
It's
July 2008. You are a "TBTF" bank CEO. You've been running a 30 year
ponzi scheme using ever-increasing amounts of debt while GDP has
languished in roughly the same place for the last two decades in terms
of numerical growth. In the 3rd Quarter of 2007, when the S&P 500
hits 1576 and the DOW tops, the economy put about
six times
the amount of debt into the system as there was GDP growth, and at that
point GDP had started to roll over. It had an obvious geometric
progression look to it but only a few people in the blogosphere had been
hollering about it. You wondered how much longer it was going to be
before the people woke up.
Over the next three quarters from the 3Q 2007 GDP has actually gone negative. Debt demand has
cratered and is down by almost 50%. The handwriting is on the wall;
credit creation is going to go negative too.
You
have tens of trillions of dollars in credit instruments on and off your
balance sheet and things are looking pretty bad. You're getting
pestered by people who see the credit contraction and start asking if
you're good for those swaps, and the credit default swaps on
your bank are blowing out. They have a point too:
If
credit demand actually goes negative, you're dead. You're geared
at 30:1 which means you can only lose $3 out of every $100 of alleged
"value" of your assets before you're broke. The collateral calls alone on the more than $30 trillion in swaps are enough to kill your capital several times over should this occur.
See,
that's the nature of a pyramid. It all looks ok right up until demand
starts to reverse. Then it works in reverse, just like it did on the
way up. What made you $30 for every $1 of actual capital you had now
loses $30 for every dollar of capital. Attempting to fire-sale assets
to avoid the disaster simply tells everyone in the market you're busted
and they'll pile in short, destroying your stock price and further
widening the CDS. Too much of that and what you're trying to prevent
will happen anyway.
Your morning includes one less coffee as you
don't need any more jitters than you already have, and your evenings
have an extra scotch or two before going to bed.
Then the
phone rings. It's one of your Vice-Presidents; he is responsible for,
among other things, your repo desk. One of your traders just came into
his office and is as white as a ghost: Lehman has no collateral - they're bankrupt.
You
collapse into your chair, dropping your coffee mug on the marble floor,
which shatters into a hundred pieces. If your repo desk knows this so
does the NY Fed, headed by Tim Geithner. That means Bernanke knows. It
also means
every other firm on the street knows. You look at the CDS for Lehman on your Bloomberg and shudder.
The very nightmare that has woken you almost nightly for six months has begun.
Note this well: It's July 31st 2008, or quite some time before anyone
else
outside of "TBTF" banks will know Lehman is about to fail. Oh sure,
there have been rumors since Bear went down, but that's all they've
been. Lehman's stock is trading at $17, and has been reasonably stable
for a couple of weeks. It was as low as $12 two weeks previous and
looked like it was headed to zero, but then stabilized and recovered by
almost 50%. CNBC is chattering on a daily basis of rumors of all sorts
but the market has actually been improving for a bit in tone. The VIX,
which was just shy of 31 two weeks ago, is now trading at 23.
You thought maybe - just maybe - it was going to be ok.
Now you know
factually that it's not.
You
call your equity desk and ask them to start quietly shorting Lehman's
stock. Not in size - you don't want anyone to figure out what's going
on "outside" of those who already know. You figure that everyone else
in the TBTF club knows this too; there's no way they couldn't. But
you're cautious - while you know how much trouble you're in if credit
demand doesn't turn around fast
you also know that Fuld had dinner with Paulson in April - just three months ago and
that there were rumors flying around that Paulson "loved" their capital
raise. It didn't make sense that in just three months they had no
collateral for a routine overnight repo transaction!
The rest of
the world will not know, of course, for a while yet that Lehman has
effectively already detonated. In fact for the entire next month the
S&P 500 will actually trade up about ten points, from 1267 to 1277
in a choppy, directionless pattern.
During the next month credit demand doesn't move much.
Then "it" happens. Lehman files.
Suddenly
the collateral calls begin in earnest. Credit demand takes another leg
down and GDP prints negative. You're now in the hole and there's no
way out. The only good news is that everyone else in the TBTF club is
in there with you - hundreds of trillions of dollars of swaps, from
interest rate to CDS to god-knows-what-else that was bespoke by this
person or that, and they
all
want collateral as your credit condition is wildly deteriorating and
your own CDS quote looks like the peak of Mt. Everest on the upside.
Your stock price is falling like a stone and the bond desk is telling
you they're getting bid lists by the dozens from people trying to
liquidate to save themselves but there are no bids at any price.
In
the middle of all this you get called to Treasury for a meeting. TARP
has just passed and Hank and Ben want to talk with you and the rest of
the TBTF CEOs. You have your assistant call the hanger and get the jet
ready.
When you arrive you figure you're being nationalized.
You're done and you know it. There's nowhere for you to go; there's no
bid at any price for some of your assets and for those where you can get
a bid the loss will wipe you out. You have CDS on some of your
exposure but you're pretty sure the counterparties don't have the money
-- after all, you know
you can't cover everything
you
wrote if push comes to shove. The simple fact is that an exponential
contraction of credit demand into 30:1 leverage is not survivable. You
can protest all you want, but it doesn't matter; the math is going to
win as the collateral calls will eventually chew up all your cash while
the ratings agencies ratchet you down. With only $3 of capital behind
every $100 on your book there's just no way to make the math work, the
bond market is effectively shuttered with the door bricked over and
trying to raise equity capital into a crashing stock market is a fools
game. Even if you could get an offering off, which you can't, the
interest rate on bonds would be north of 10% and the dilution on a stock
offering would be hideous, never mind that you simply couldn't raise
enough money going that route. The bottom line is this: There's no way
to make money when you have to borrow at that price, and all banks
borrow in order to lend.
When you get to DC Hank and Ben are in
the room and they're smiling. You figure that the call to the board is
going to end with you sending your assistant in to start boxing up your
office, but when you all get there the mood is a bit different. Oh
sure, your TBTF buddies all think they're dead too, but once the door
closes the real intent is disclosed.
- The government's going to "give" you money.
It's not exactly a gift, but it's close. The mechanics of this will
look like a preferred stock purchase. The reality is somewhat
different. Among other things with your CDS spreads in the stratosphere
you can't issue bonds without paying 10% or higher interest rates,
which instantly collapses the company. But with an FDIC guarantee,
which is being put on the table as part of the package, you will get the
risk free rate of Treasuries, which are currently trading in the mid 3% area. That's a huge savings - 5-6% a year in interest expense! Suddenly the capital market door is open again!
- Then
Bernanke pipes up. Provided you do this there won't be questions about
your collateral, since you'll have the implicit backstop of the
government. This would go on to be worth over a trillion in direct loans; your "share" of it would wind up being nearly $100 billion, about 10% of your balance sheet, all at effectively zero interest.
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?
You
walk out of Treasury with one of your friends from the TBTF bank down
the street, yukking it up as you come down the stairs. Who would have
ever thought that such a heist would be possible? Even better, the
press reaction, especially from the right wing, can be counted on to get
this wrong and claim that the government had
stolen capitalism.
That will give you cover for the fact that your firm was so far
underwater when you walked into that room that you needed helium in your
dive tanks lest you be narced out of your mind.
You will go on to
pay record bonuses a year later, also paying back the TARP money.
Well, that which everyone saw anyway. The Auto industry is a different
matter of course, and there were plenty of games played with AIG, which
had written a lot of credit protection. Had they blown you were dead,
as they were the guarantor one way or another on far too much of your
derivative stack. But Geithner will claim at every opportunity that
"TARP made a profit" and the public is too obsessed with
American Idol to figure out that he's lying through his teeth.
But
the real problem from a budget perspective, when all is said and
done, was and is in Fannie and Freddie. Although not really "TARP"
funds their bailout was instrumental in preventing nearly all the 30:1
levered banks from blowing sky-high, not to mention pension funds and
insurance companies, as everyone had a material amount of MBS on their
balance sheets and had Fannie and Freddie defaulted it might have been
enough to sink the TBTF banks all on its own and spiral the big insurers
into the ground. The discounted cash flow cost of not letting them
blow up through 2009 was nearly $300 billion, of which $145 billion had
already gone in through direct cash infusions. This looked like
"protecting the public", but it really was protecting the banks and
insurers who were holding a crazy amount of MBS on their balance sheets
and were able to unload them to The Fed during QE1 at a very nice
profit, effectively screwing the taxpayer not only through the direct
subsidy but also through the price-supported buyout in the QE program.
The exact amount effectively stolen from the people in this regard is
hard to determine, but it is likely close to a half-trillion dollars in
total including the direct and indirect costs.
Of course it got better from there too for the banks.
We now know from the Bloomberg lawsuit that there was in fact over a trillion in revolving credit doled out
in the next few months to these firms, all at effectively zero interest
rates since the overnight rate was for all intents and purposes zilch.
This too was a benefit, as the market price of credit is never zero,
and that "benefit" continues to this day. Tim Geithner, who had to know
about the Lehman collateral problem in July of 08, would be rewarded
for his part in all of this by being appointed Secretary of the
Treasury. And Paulson? He got to keep his $500 million in Goldman
stock and options when he took the original Treasury job, tax free. He
has not a care in the world.
Capitalism didn't die in 2008.
That's a convenient story, but it isn't true. You can't expropriate a
broke man or a broke business; there's nothing to take, even if you want
to.
The truth is much simpler:
The taxpayer was just plain robbed by the government and banks acting together.
If
you think that $750 billion was a ridiculous subsidy to the TBTFs, or
that they really didn't join with the government to steal from the
public during 2008, the epilogue over the next three years went from
ridiculous to stupefying. From 2008 - 2010
we ran about $1,100 billion per year in additional deficits over the Bush years,
for a total of $3.3 trillion. This too was sold as "for the people"
but that was a lie. See, financial product credit (Z1 line
Z1/Z1/LA794104005.Q) contracted from $17.1 trillion to $13.8 trillion
today, or
almost exactly the same $3.3
trillion. Mortgages, during the same period, would contract by about
$600 billion while non-financial business credit remained pretty-much
flat and State and local borrowing expanded.
Put another way,
the entire deficit addition over the previous multi-year baseline was
literally given to the financial firms; the total amount of the taxpayer
heist is over $3 trillion from 2008-2010, and as of the 2nd Quarter of
2011 we're still literally stealing from the taxpayer and handing it to
the TBTF institutions via government deficit spending.
Ps:
The worst part is that we didn't fix anything, especially the
derivatives. In fact, with the consolidation and "swallowing" of failed
firms in 08 and 09 the risks now are higher
than they were three years ago, and we're further down the road with
the pyramid. We stopped it from falling over temporarily, but only by
shifting the debt accreation to the Federal Government and, to a lesser
degree, on the backs of students. If we do not voluntarily stop the
nonsense, as I pointed out in the other Ticker,
it will come crashing down anyway as we squandered our opportunity to
force these jackals to either cover or tear up those contracts that
cannot possibly be met in full.
