American Public to Wall Street Banks: Drop Dead

“Most illiquid bond assets are illiquid because they are not worth anything.” - Ron Paul

When this was forecast below was written a few weeks ago it was not with the idea that the 'offer' would be coming so quickly. But with McCain lagging badly in the polls, it looks like the money powers decided it was time to act just ahead of a congressional recess.

"When the banks make us an offer they think that we cannot refuse, we will be at the crossroads and will decide what we wish to be: slaves [to fear] or free men. Yes, it really is that simple."

Death of Capitalism: Financial Tsunami Incoming - 8 Sept 2008

How did we know this was coming? Because the setup really is that obvious. These guys are not clever, they are shameless.

What is most surprising has been the enormous response from the public to the Congress since Paulson's Treasury made their arrogant proposal to the country last week on behalf of Wall Street. Aides report that it is running solidly 99 to 1 against. The common sense of the people is a sleeping giant and has apparently been awakened by this outrage. Not completely, but stirring. We don't have any illusions. Its hard to stand up to the Big Lie. The Banks will get something.

The banks have mispriced assets on their books. They will never be worth what they thought they would be, where they marked them with the cooperation of the ratings agencies, if they hold them until kingdom come.

This is why they do not wish to hold them on their books. They want to sell them, but they do not wish to accept the price that an informed market will offer, now or in the near future.

Its hard to understand this unless you accept the inherently fraudulent nature of much of the paper that was packaged and put together for sale to others. This latest bubble fell apart prematurely when the market for this junk collapsed and the banks were left holding the bag.

Provide liquidity to the banks at a price. Put four hundred billion dollars into the FDIC to insure the savers' bank accounts and increase it to one million dollars per person. Put another three hundred billion in the Small Business Administration and Office of Thrift Supervision and the FHA if necessary to make loans to small businesses and consumers that cannot obtain market liquidity through the regional banks, which should be the key to the rebuilding of our financial system. Provide large amounts of liquidity to the healthy banks in the quantities required to support economic activity.

But do NOT buy this junk from the Wall Street banks, especially the investment banks. Allow the tide to continue to go out and let's see who is wearing what. If we provide a bailout to this crowd while they continue to pay out fat dividends and capital gains and outrageous salaries we deserve what we will most surely get in return.

"Last year Goldman paid its employees $20 billion, 44 percent of the firm's revenue. Chief Executive Officer Lloyd Blankfein took home $68.5 million, and many otherwise ordinary human beings took home $10 million or more.

This inspired young people everywhere, many of whom may have privately wondered whether it was still worth their time to become investment bankers. Torn between a future in, say, the law and the manufacture of mezzanine CDOs they sucked up their courage and plunged onto Wall Street. And thank God for that: we needed the best and the brightest to get us into this mess, and we'll need the best and the brightest to get us out of it."

America Must Rescue the Bonuses at Goldman Sachs - Michael Lewis

The Wall Street banks are an inefficient, manipulative, overly-expensive, oversized, and a hopelessly broken mechanism for the rational allocation of capital. A number of those banks need to be broken apart and liquidated, not replenished with increasingly scarce public capital. We need to cut out the parts that are hopelessly rotten, save what is good, and rebuild together from there.

What would we do if the oil companies said "Give us the Artic Wildlife refuge and 700 billion in public money to develop it or we won't give you any gas starting next month. We'll send it all to China and Europe."

What if the drug companies said, "Give us free malpractice insurance and accelerated drug approvals and scrap the FDA and 700 billion for research and development or you won't get any more medicine next week."

Or GM and Ford said "Give us 700 billion to retool to meet industry standards and pay off our healthcare and pensions or we stop fixing and shipping cars and crash the manufacturing industry."

Why is it when it comes to Wall street that people lose all perspective?

What would you do if your your teenager said they wanted a $7000 home entertainment system or they would throw themselves on the ground and make an embarrassing scene?

What are we going to do when the Big Banks come back in six months and say, "the 700 billion was not enough, we ran through it already. We need another 700 billion or the markets will crash and we will stop lending money."

Decisions made under the duress of dire threats and political blackmail never work out as intended, and never stop there, because appeasement does not work.

If we do not invade Iraq the first warning we will get about their WMDs will be a mushroom cloud. If you do not pass the Patriot Act immediately hidden sleeper cells will rise up and bomb the shopping malls.

We need to fix this problem, not just throw money at it and hope it goes away. Maybe there is a good case to be made for a capital infusion but we certainly have not heard it explained. So far all we have are demands and threats as this site predicted we would receive weeks ago.

ProPublica - History of US Government Bailouts

Nasdaq Composite Long Term Logarithmic Chart

This is a logarithmic long term chart of the Nasdaq Composite.

Quite a bit of these gains simply reflect the effects of dollar inflation which has a significant compounding effect over time.

But it does suggest that the potential downside is profound.

The indicators on the bottom of the chart are the volume-based money flows.

AIG Takes 85 Billion Fed Loan, Agrees to be Nationalized

AIG signs up for $85 billion Fed loan
By Alistair Barr,
MarketWatch
1:25 p.m. EDT Sept. 24, 2008

Insurer effectively 'nationalized' after failing to raise capital in private market

SAN FRANCISCO (MarketWatch) -- American International Group shares fell more than 10%on Wednesday after the giant insurer agreed to be effectively nationalized late Tuesday.

AIG narrowly avoided bankruptcy last week after the Federal Reserve stepped in with a massive bailout.

Some big AIG shareholders have reportedly been trying to raise capital in private markets to avoid the government seizing control of the company.

But late Tuesday AIG said it signed a definitive agreement with the Federal Reserve Bank of New York for a two-year, $85 billion revolving credit facility.

As part of the deal, AIG will issue a series of Convertible Participating Serial Preferred Stock to a trust that will hold the new securities for the benefit of the Treasury. The Preferred Stock will get almost 80% of any dividends paid on AIG's common stock and will give the government almost 80% of the voting power. The securities will then be converted to common stock at a special shareholder meeting, AIG said.

The agreement leaves "AIG essentially nationalized," Bijan Moazami, an analyst at Friedman, Billings, Ramsey, wrote in a note to investors on Wednesday. "Shareholder efforts to prevent the government from taking an equity stake in AIG will prove fruitless."

Indeed, AIG's new chief executive Edward Liddy said the company made an "exhaustive effort" to borrow money in the private market, but failed.

"This facility was the company's best alternative," Liddy added in a statement late Tuesday
.
AIG shares dropped 13% to $4.36 during afternoon trading on Wednesday.

Asset sales, dilution

Liddy said AIG is developing a plan to sell assets and use the proceeds to repay the government loan, hopefully emerging later as a smaller but profitable company.

FBR's Moazami expects AIG to borrow all the $85 billion immediately, partly because the company will have to pay hefty fees and interest on the money it doesn't use. The agreement with the Fed requires the insurer to pay an annual interest rate of 8.5% on the money it doesn't borrow from the loan facility.

AIG has to pay back the $85 billion from the proceeds of certain asset sales and the issuances of new debt and equity, the company said.

AIG has "little to no" capacity to borrow more money in private markets, so if it has to raise capital to repay the Fed the insurer will probably have to sell more common shares, diluting current investors even more, Moazami warned

The Failed Bankers Rescue of 1929 Redux

“This is scare tactics to try to do something that’s in the private but not the public interest,” said Allan Meltzer, a former economic adviser to President Reagan, and an expert on monetary policy at the Carnegie Mellon Tepper School of Business. “It’s terrible.”

Alan Meltzer of Carnegie Mellon just finished excoriating the Bernanke-Paulson plan on Bloomberg television and he is right. We need to allow the markets to work through this longer, to use the facilities we have in place, to allow the Fed if necessary to add liquidity to the markets if they feel the need and the situation calls for it.

But purchasing specific bad debt from specific banks with no strings attached is crony capitalism, with dividends to be paid, stock gains to be taken, management compensation to remain at lofty levels. It is a repugnant to the republic and free markets.

And it is increasingly difficult to believe that this proposal is being made in good faith with the intentions and objectives as stated.

...several leading Wall Street bankers met to find a solution. The group included Thomas W. Lamont, acting head of Morgan Bank; Albert Wiggin of the Chase National Bank; and Charles E. Mitchell, of National City Bank. They chose Richard Whitney, vice president of the Exchange, to act on their behalf.

With the bankers' financial resources behind him, Whitney placed a bid to purchase a large block of shares in U.S. Steel at a price well above the current market. As amazed traders watched, Whitney then placed similar bids on other blue-chip stocks.
Although a similar such tactic had ended the Panic of 1907, this action halted the slide that day and returned stability to the market only temporarily.

We may have finally figured out Ben's game and connected some of the dots that did not seem to make any sense in isolation. It was in his explanation of why the Treasury should pay well over market prices for the toxic bank debt held by Wall Street. (We're not willing yet to speculate on Hank's game yet.)

This morning in response to a question about why the Treasury should not penalize or demand anything in return from the banks for buying distressed assets in return for the risk, and pay closer to hold to maturity prices, Ben said that this would not be fair since all the banks stand to benefit from this action.'

The point of this exercise is not to help two or three banks or ten banks which are in trouble.

The point of this exercise is to try and support the debt markets by buying assets at prices well above the market, and to do it quickly and in size in the hope of forestalling a likely debt market and stock market crash. They are going to give the money to the banks for worthless assets because they want to gear up x10 using the fractional reserve money multiplier. Its a helicopter drop to the Wall Street banks. They will take a hefty cut for themselves for taking the package and doling it out like third world warlords handing out Red Cross aid.

This is eerily similar to the actions taken by the Morgan's Lamont and the NY banks in putting together a pool of money, and halting the Crash of 1929 by having Dick Whitney walk across the street, and loudly start buying stocks at above market prices to "restore confidence" in the markets. This did work, for a day.

It is also similar to a tactic Morgan himself and the bankers used in 1907 to halt the liquidity panic caused by some specific bank failures caused by overextension in bad assets.

Why are these policy failures? It presumes that the markets are wrong, and that they are pricing risk incorrectly. Further, it does nothing to change the dynamics and fundamentals underlying the markets assumptions except to hold out a federal subsidy at an above market price. The traders will come back and hit that subsidy over and over until it is exhausted, as the currency traders hit sterling when the Bank of England tried to support it above the market.

We think this will not work, is a policy error, because buying assets above market price will not stop this juggernaut of a collapsing bubble, and will merely throw 700 billion of capital we will sorely miss later down a hole, specifically benefiting a remarkably few individuals who will skim most of it before it is obliterated. It will inflate the currency and soon be exhausted. It will accomplish nothing and only make it worse for many who fail to take action to protect themselves, being deceived by this market manipulation.

In short, Bernanke's proposal fixes NOTHING. It provides some getting out of town money for some of the worst of the insiders of this financial fiasco.

That's why he needs this today or tomorrow. Because the US equity markets are in the process of crashing. And he is attempting the same type of banker's rescue that was attempted in 1929.

Sweeping actions will not work. We cannot fix this by reflating the bubble and pricing the assets back up to bubble levels. This would buy a little time at best.

We need to get in and tie off the bleeding parts, the truly insolvent banks, sort out which are good and which are foul, and cut them off in bankruptcy like Lehman. This cannot be done by banking insiders because of the obvious conflicts of interest which are profound, even in self-proclaimed purely objective Ben.

One last thing to think about. We are having these discussions about the fate of our biggest banks. Which ones to save and how? Which ones to take into conservatorship and manage their affairs as a major creditor. Which ones to fail and liquidate. How best to firewall the side effects.

What are our creditors overseas saying about us? About the US and the sovereign debt and our impending insolvency? And don't think they are not having these discussions, perhaps without our direct involvement.

There came a Wednesday, October 23rd, when the market was a little shaky, weak. And whether this caused some spread of pessimism, one doesn't know. It certainly led a lot of people to think they should get out. And so, Thursday, October the 24th -- the first Black Thursday -- the market, beginning in the morning, took a terrific tumble. The market opened in an absolutely free fall and some people couldn't even get any bids for their shares and it was wild panic. And an ugly crowd gathered outside the stock exchange and it was described as making weird and threatening noises. It was, indeed, one of the worst days that had ever been seen down there."

"There was a glimmer of hope on Black Thursday...About 12:30, there was an announcement that this group of bankers would make available a very substantial sum to ease the credit stringency and support the market. And right after that, Dick Whitney made his famous walk across the floor of the New York Stock Exchange.... At 1:30 in the afternoon, at the height of the panic, he strolled across the floor and in a loud, clear voice, ordered 10,000 shares of U.S. Steel at a price considerably higher than the last bid. He then went from post to post, shouting buy orders for key stocks."

"And sure enough, this seemed to be evidence that the bankers had moved in to end the panic. And they did end it for that day. The market then stabilized and even went up."

"But Monday was not good. Apparently, people had thought about things over the weekend, over Sunday, and decided maybe they might be safer to get out. And then came the real crash, which was on Tuesday, when the market went down and down and down, without seeming limit...Morgan's bankers could no longer stem the tide. It was like trying to stop Niagara Falls. Everyone wanted to sell."

"In brokers' offices across the country, the small investors -- the tailors, the grocers, the secretaries -- stared at the moving ticker in numb silence. Hope of an easy retirement, the new home, their children's education, everything was gone."