Topic: Finance, Banking & Monetary Policy

Don’t Be Fooled — GM Is Still Government Motors

General Motors chairman Ed Whitacre is appearing in ads on all the Sunday morning shows repeating the message of his Wall Street Journal op-ed, titled “The GM Bailout: Paid Back in Full,” and the company’s full-page newspaper ads:

We’re proud to announce: We’ve repaid our government loan. In full. With interest. Five years ahead of the original schedule.

But wait: In the Wall Street Journal, Whitacre says the company has made a $5.8 billion payment to the governments of the United States and Canada. But don’t I recall that the GM bailout was $50 billion? Shikha Dalmia of the Reason Foundation explains the whole story in Forbes: First, part of the bailout went into an “escrow fund,” and that government money is being used to pay back the small part of the bailout that was officially a loan. Second, GM is asking for another $10 billion loan to retool its plants to meet the stiffer Corporate Average Fuel Economy standards, and paying back one government loan – with other government money – will make it easier to get another government loan.

And finally, of course, most of the bailout money was transferred to GM in return for a 60 percent stake in the company. And the taxpayers will get that money back if and when GM becomes a publicly traded company again, provided that the company’s market capitalization is eventually higher than it’s ever been in history. Don’t hold your breath.

These are called GM ads, but they could just as well be called BS ads.

SEC Incompetence

There has been much speculation that the Securities and Exchange Commission (SEC) released its charges against Goldman Sachs on the eve of a Senate vote on new finance regulation in order to help Democrats win that vote.  Perhaps that theory is wrong: It now looks more likely that the SEC timed its Goldman case in order to divert attention away from two SEC inspector general (IG) reports criticizing the commission.

In one of the reports, the SEC IG found that several of the top staffers at the SEC were spending their days surfing the web for porn, rather than looking for securities fraud.  One senior manager spent almost 8 hours a day looking a porn, getting to the point where he even filled up his government issued hard-drive with porn.  His actions were not some isolated incident.  Over 30 employees were found to have regularly used SEC computers to download and view porn.  Some of the senior employees had salaries as high as $222,000 a year.  Sounds like nice work, if you can get it.

But the porn charges are the least of the SEC’s worries.  Also released was the IG’s report on the SEC’s failure to stop the Stanford Ponzi scheme.  The report shows a clear pattern of incompetence at the SEC.  Given the SEC’s failure to act on the Madoff scheme, and the repeated warnings about Stanford, one has to wonder how good SEC investogators are at discovering fraud if they don’t even pursue the clear-cut cases brought to them.

The IG report does help explain the SEC’s poor track record.  The SEC’s head of enforcement made it very clear that the staff was “to bring more Wall Street types of cases.”  Perhaps ones like the recent Goldman case?  The head of enforcement even goes so far as to ask the staff working on the Stanford case, “What are you bringing these cases for?”  Clearly the SEC only seems to care about fraud if its catches a big headline.  Since the SEC was first warned about Stanford, investors placed about $8 billion more into the Ponzi scheme, far more than the damages alleged in the Goldman case.

If anything should expose the current financial regulatory bill being debated in the Senate as a fraud, it should be the fact that it leaves the SEC still standing.  Even worse, it reduces Congressional oversight of the SEC by removing it from the appropriations process.

Angel Investors

The Wall Street Journal has an important editorial today on how the financial “reform” bill being considered by Congress could help kill the angel investment industry in the United States.

Burying angels under new regulations would be part of a one-two knock-out blow for this group of more than 300,000 higher-income Americans who invest directly into start-up companies. The Obama administration’s tax-increase policies would be the other blow, as I testified to the Senate earlier this year

Angels have played a crucial role in America’s dynamic job-creating economy over the decades. Policymakers would be absolutely crackers to screw up such a successful part of our innovation economy.

Wednesday Links

  • Clear and simple: It is unconstitutional for the federal government to force people to buy a private product.

SEC vs. Goldman Sachs: Legislation by Demonization

The Obama administration thinks it has discovered the perfect formula to cram legislation through in a hurry:  Demonize some prominent firm within an industry you plan to redesign, and then pass a law that has nothing to do with the accusation against the demonized firm.  They did this with health insurance and now they’re trying it with finance.

With health insurance, the demon was Anthem Blue Cross Blue Shield of California, which Obama accused of raising premiums by “anywhere from 35 to 39 percent.” Why didn’t some curious reporter interview a single person who actually paid 39% more, or quote from a letter announcing such an increase?  Because it didn’t happen.  Insurance premiums are regulated by the states, and California wouldn’t approve such a boost.  Yet the media’s uncritical outrage over that 39% rumor helped to enact an intrusive, redistributive health bill that has nothing to do with health insurance premiums (which remain regulated by the states).

Today, the new demon de jour is Goldman Sachs, a handy scapegoat to promote hasty financial rejiggering schemes  The SEC’s suspiciously-timed civil suit against Goldman looks as flimsy as the last month’s health insurance story.  It also looks unlikely to win in court.

As Washington Post columnist Sebastian Mallaby explains, “This is a non-scandal. The securities in question, so-called synthetic collateralized debt obligations, cannot exist unless somebody is betting that they will lose value.”  In such a zero-sum contest, big investors who went long knew perfectly well that other investors had to be taking the other side of the bet.  Goldman lost $90 million by betting this CDO would go up; John Paulson went short.

Columnists have moralized about the unfairness of the short investor (Paulson) negotiating the terms of this deal with a long investor, ACA Management, which had the last word. This too, notes Mallaby, “is another non-scandal.  An investor who wants to bet against a bundle of mortgages is entitled to suggest what should go into the bundle. The buyer is equally entitled to make counter-suggestions.  As the SEC’s complaint states clearly, the lead buyer in this deal, a boutique called ACA that specialized in mortgage securities, did precisely that.”

Like the earlier fuming about Anthem California, this new SEC publicity stunt is likewise irrelevant to the pending legislation.  Congress hopes to get standardized derivatives traded on an exchange. But synthetic collateralized debt obligations dealing with a customized bundle of securities could not possibly be traded on an exchange, and would therefore be untouched by reform.

Losses sustained by a few financial speculators on one exotic derivative had nothing to do with starting a global recession in December 2007 or the related financial crisis of September 2008. The core of the latter crisis was mortgage-backed securities per se, yet Goldman was only the 12th largest private MBS issuer in 2007.  Fannie Mae and Freddie Mac were and are the biggest risk; any reform that excludes them is a fraud.

The SEC’s dubious civil suit against Goldman is a wasteful diversion at best. It has nothing to do with the Obama administration’s suicidal impulse to impose more tough regulations and taxes on banks to encourage them to lend more.

[Cross-posted at NRO’s The Corner]

Obama’s Fannie and Freddie Amnesia

Peter Wallison calls attention to President Obama’s amnesia regarding events that precipitated Fannie Mae and Freddie Mac’s collapse. Writing in the Wall Street Journal, Wallison points out that in 2005 then-Senator Obama joined with his Democratic colleagues in stopping legislation that would have helped rein in the government-sponsored housing duo’s risky behavior:

The bill would have established a new regulator for Fannie and Freddie and given it authority to ensure that they maintained adequate capital, properly managed their interest rate risk, had adequate liquidity and reserves, and controlled their asset and investment portfolio growth.

These authorities were necessary to control the GSEs’ risk-taking, but opposition by Fannie and Freddie—then the most politically powerful firms in the country—had consistently prevented reform.

The date of the Senate Banking Committee’s action is important. It was in 2005 that the GSEs—which had been acquiring increasing numbers of subprime and Alt-A loans for many years in order to meet their HUD-imposed affordable housing requirements—accelerated the purchases that led to their 2008 insolvency. If legislation along the lines of the Senate committee’s bill had been enacted in that year, many if not all the losses that Fannie and Freddie have suffered, and will suffer in the future, might have been avoided.

The president’s complicity in the housing collapse hasn’t stopped him from pinning the blame on Republicans, “special interests,” and Wall Street “fat cats.” As he does with other problems, the president blames everyone except himself and his party.

As I recounted in a Cato Policy Analysis, Fannie and Freddie epitomized the tawdry relationship between businesses that receive special federal breaks and policymakers. Democrats, including Obama’s chief of staff Rahm Emanuel, played a key role in facilitating Fannie and Freddie’s destructive activities. Emanuel, a then recent senior adviser to President Clinton, was appointed by Clinton to Freddie Mac’s board of directors, where he earned $320,000 in compensation and sold company stock worth more than $100,000.

Then there’s the current Office of Management and Budget director, Peter Orszag. In 2002, Fannie Mae commissioned a paper authored by Nobel Laureate Joseph Stiglitz, Jonathan Orszag, and Peter Orszag, who was then at the Brookings Institution. The study concluded that “the probability of default by the GSEs is extremely small.” Oops.

Given the company Obama keeps, it’s not surprising that the administration still hasn’t come up for a plan on what to do with Fannie and Freddie.

The administration has intentionally not incorporated Fannie and Freddie into the federal budget in order to hide the cost to taxpayers. And on Christmas Eve the administration quietly announced that the government would cover all of Fannie and Freddie’s losses beyond the original $400 billion limit through 2012. The Congressional Budget Office estimates that the final cost to taxpayers for bailing out Fannie and Freddie will approach that figure, although Wallison calls that projection “optimistic.”

See this essay for more on the problems the federal government causes in the housing market.

Lehman’s Failure Taught Us Nothing

Several commentators have reacted to Senator McConnell’s floor statement regarding the Dodd bill as a defense of “doing nothing”.  And accordingly argue that such a position would be, in the words of Simon Johnson, both dangerous and irresponsible.  This familiar canard is based upon the oft repeated assertion that the failure of Lehman proved that we cannot simply let large financial companies enter bankruptcy.

The simple, but important, fact is that we have no idea what would have happened had we let AIG and Bear go into bankruptcy proceedings.  Nor do we know what would have happened if Lehman had been saved.  Macroeconomics does not have the luxury of running natural experiments to determine the impact of a corporate failure.   Scholars have an obligation to accurately reflect the uncertainties in the debate.  Those that assert Lehman proved anything, are being at best disingenuous, and at worst, dishonest.

Let us, however, put forth a few things we do know:

  1. We know none of Lehman’s counterparties failed as a result of Lehman’s failures.  Just as we know none of AIG”s counterparties would have failed if they did not get 100 cents on the dollar from their CDS positions.  So where exactly is the proof of contagion?
  2. We know we had a nasty housing bubble.  We were going to lose millions of jobs in construction and real estate regardless of what we did.  We knew financial institutions heavily invested in housing would suffer.  How exactly would saving Lehman have prevented any of that?

The debate over ending bailouts and too-big-to-fail will not progress, we will not learn a thing, if we let simple, empty assertion pass as fact.  Much of the public remains angry at Washington because those responsible, such as Bernanke and Geithner, have never laid out a believable or plausible narrative for the bailouts.  It always comes back to “panic.”  If we are ever to hope to return to being a country governed by the rule of law, rather than the whims of men, then we need a lot more of an explanation than “panic.”