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12 Feb, 2009 16:50

Bonus scandal and the bailout fraud

Bonus scandal and the bailout fraud

A banker told me he’s sick of people complaining about bonuses. And he’s sick of people blaming the banks for the financial crisis.

He says if governments just continue lending the banks cash, then the troubled assets, the toxic debt, will mature. Then the banks will just hand back the excess capital. Problem solved.

Well that just goes to show that financiers have no monopoly on understanding this financial crisis. What’s suspicious is that western politicians advance the same argument as that banker.

President Barak Obama has just announced $800 Billion to stimulate the US economy but much more, $2,500 Billion, in a new bailout for the banks. The new administration is pushing three times more cash at the banks than did President George Bush and his Treasury Secretary Hank Paulson.

At least that’s a better balance than Western Europe where stimulus plans are entirely about the banks, bar a few crumbs for car makers.

However it’s a bailout outrage, it threatens our future and it’s based on a lie. Western politicians are making populist attacks on bankers who pay themselves huge bonuses but are shovelling taxpayers’ cash into the very same banks. Yes, the bailout fraud rolls on.

The fact is, phoney bonus outrage is a convenient distraction. It saves bankers from having to own up to how much money they lost – and it saves politicians from asking if they’re fighting the wrong problem.

Bankers paid themselves hundreds of millions of dollars but they lost trillions. Most banks still do not know what their assets are worth or how much money they have lost or could lose. And western politicians aren’t asking.

In finance, a red herring is a document advertising a new security or product that hasn’t yet been approved by the authorities. In plain English it’s an argument intended to distract your attention. Funny, that.

We’re facing a crisis. Can western politicians address the facts? Here’s what I’ve learned talking to a lot of people in and around the industry.

What happened in a nutshell?

The massive expansion of credit, which facilitated the inflation of asset prices, has gone into reverse. That credit won’t come back, so asset prices in the business and consumer world are going to decline until they come into line with the credit available. This destruction of available credit is a separate and bigger issue than bank capital.

Oh that it were just a matter of bank capital. Put some more money in the bank vaults, cut official interest rates, and banks will start lending again. That has been the misguided policy of governments for the past six months.

Focusing on capital, governments miss the real story: credit. The banks hugely expanded the supply of credit (which inflated home prices and other assets). Effectively the banks, not governments, were creating money.

Like a dumb ox, the US government ploughs on. In February 2009, the US government returned to the original plan of former US Treasury Secretary Hank Paulson of October 2008, to buy up assets from the banks. The plan is to stop assets falling in value, put a floor under them and hope that will repair the banks’ balance sheets. Again, governments miss the point that it was the expansion of credit-money and it’s subsequent shrinkage that pulled asset prices down.

How was it that banks, not governments, created credit and easy money?

For 10 years, every second banker I met worked in some new area of credit: syndicated loans, structured debt or fancy-named mezzanine finance. The banks created new instruments, a secondary currency, which they lent and borrowed against, and which they, the banks, were able to expand ad infinitum, for a while (joke).

What do you mean the banks created credit or a second currency?

They could have been nuts (the currency, not the bankers). In earlier millennia they were seashells. In the new millennium, they were credits based on bundles of loans, yes, the new money was credits based on credits.

The banks expanded credit through collateralized debt obligations, which made risky investments look high grade, and structured investment vehicles, which bought high yield assets with short term debt.

Did bonuses make things worse?

Richard Deitz, president of VR Capital Group told me: "Mortgage backed securities are not bad securities, it's a useful market to have. What you had was people following very flawed methodologies and piling up leverage in very dangerous quantities and that is bad.

“So the creation of MBS – it's good, it creates efficiencies in the markets. Could you repackage them into Collateralised Debt Obligations and other products? I don't really see the need to do that but inherently even that's not bad. The problem is the ratings agencies drove this process with a methodology that was clearly bad.”

“I've worked on Wall St and I know the mentality there. Wall St has a bonus driven culture. People get paid for transactions. They do transactions and move things off their books.”

Deitz said it again, for good measure:

“Wall St has a bonus driven culture. Workers look to do deals, get paid bonuses and move on. They leave the risk with someone else. That's the problem. Had Wall St banks been required to keep part of this risk on their books they would never have originated those securities. The people involved in the business knew that they were junk. They knew that they were moving them to buyers who did not understand them.”

You don't read THAT in the Financial Times!

I thought governments created money. You’re saying it’s actually the banks?

Yes, read it.

How much did the banks lose?

On current estimates the US financial system will lose $3.6 trillion, half of that from banks and brokers. As the US bank's entire capital amounts to $1.4 trillion, they are already “effectively insolvent,” according to economist Nouriel Roubini.

As for the UK, we don't really know. The UK banks were hugely involved in overseas lending. The political obsession with bankers' bonuses has let the banks off the hook. They still have not “fessed up” to how many bad assets they have, how much money they lost and where it went (apart from on bonuses).

How was this crisis allowed to happen?

“I take full blame for all the American banks and all the things they did,” said Jamie Dimon, CEO of JP Morgan Chase, told the politicians, business leaders and journalists gathered at the World Economic Forum in Davos. Dimon took the blame because he was the only CEO of a major US financial institution with the guts to show his face at Davos this year.

“God knows, some really stupid things were done by American banks,” said Dimon. Yet, in a world of gross incompetence, Dimon’s record suggests he’s one of the cautious ones.

What to do next?

At Davos, US bank chief Dimon literally shouted at the political leaders to come up with a solution to the crisis. “This stuff is getting old! I just wish they would get on with it!”

Funny, a banker shouting at the politicians demanding THEY fix it. Are these big brash bankers just mummys’ boys at heart?

But the credit won’t “come back” despite millions of bankers clutching their hands, and shouting “just do something”.

Was it just the banks’ fault?

Any major catastrophe or accident has at least three drivers (my own theory) In the great credit collapse, we are just starting to work out what happened but it is clear that pillar one was the banking sector and its ability to create credit – a kind of parallel currency.

Pillars two and three include some of the following:

– government regulation
– central bank interest rate policy
– the role of ratings agencies
– the massaging of inflation data
– the stagnation of earnings for vast swathes of the US and UK populations
– the replacement of earnings by debt

So, though it offends some, the bankers are in the corner because, although we do not know all the causes of the coming collapse, we know that the banks and their role in creating credit as a kind of secondary currency was a key cause of the credit/asset boom and inherently its collapse.

Mark Gay, RT