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The Federal
and the big banks fought for more than two years to keep
details of the largest bailout in U.S. history a secret. Now, the rest of the
world can see what it was missing.

The Fed didn’t tell anyone which banks were in
trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their
single neediest day. Bankers didn’t mention that they took tens of billions of
dollars in emergency loans at the same time they were assuring
investors their firms were healthy. And no one calculated until now that banks
reaped an estimated $13 billion of income by taking advantage of the Fed’s
below-market rates, Bloomberg Markets magazine reports in its January issue.

Saved by the bailout, bankers lobbied against
government regulations, a job made easier by the Fed, which never disclosed the
details of the rescue to lawmakers even as Congress doled out more money and
debated new rules aimed at preventing the next collapse.

A fresh narrative of the financial crisis of 2007 to
2009 emerges from 29,000 pages of Fed documents obtained under the Freedom of
Information Act and central bank records of more than 21,000 transactions.
While Fed officials say that almost all of the loans were repaid and there have
been no losses, details suggest taxpayers paid a price beyond dollars as the
secret funding helped preserve a broken status quo and enabled the biggest
banks to grow even bigger.

‘Change Their Votes’

“When you see the dollars the banks got, it’s hard to
make the case these were successful institutions,” says Sherrod
, a Democratic Senator from Ohio who in 2010 introduced an
unsuccessful bill to limit bank size. “This is an issue that can unite the Tea
Party and Occupy Wall Street. There are lawmakers in both parties
who would change their votes now.”

The size of the bailout came to light after Bloomberg
LP, the parent of Bloomberg News, won a court case against the Fed and a group
of the biggest U.S. banks called Clearing House Association LLC to force
lending details into the open.

The Fed, headed by Chairman Ben S. Bernanke, argued
that revealing borrower details would create a stigma — investors and
counterparties would shun firms that used the central bank as lender of last
resort — and that needy institutions would be reluctant to borrow in the next
crisis. Clearing House Association fought Bloomberg’s lawsuit up to the U.S.
Supreme Court, which declined to hear the banks’ appeal in March 2011.

$7.77 Trillion

The amount of money the central bank parceled out was
surprising even to Gary H. Stern, president of the Federal Reserve Bank of
Minneapolis from 1985 to 2009, who says he “wasn’t aware of the magnitude.” It
dwarfed the Treasury Department’s better-known $700 billion Troubled Asset
Relief Program, or TARP. Add up guarantees and lending limits, and the Fed had
committed $7.77 trillion as of March 2009 to rescuing the financial system,
more than half the value of everything produced in the U.S. that year.

“TARP at least had some strings attached,” says Brad
Miller, a North Carolina Democrat on the House Financial Services Committee,
referring to the program’s executive-pay ceiling. “With the Fed programs, there
was nothing.”

Bankers didn’t disclose the extent of their
borrowing. On Nov. 26, 2008, then-Bank of America (BAC) Corp. Chief Executive
Officer Kenneth D. Lewis wrote to shareholders that he headed “one of the
strongest and most stable major banks in the world.” He didn’t say that his
Charlotte, North Carolina-based firm owed the central bank $86 billion that

‘Motivate Others’

JPMorgan Chase & Co. CEO Jamie Dimon told shareholders
in a March 26, 2010, letter that his bank
used the Fed’s Term Auction Facility “at the request of the Federal Reserve to
help motivate others to use the system.” He didn’t say that the New York-based
bank’s total TAF borrowings were almost twice its cash holdings or that its
peak borrowing of $48 billion on Feb. 26, 2009, came more than a year after the
program’s creation.

Howard Opinsky, a spokesman for JPMorgan (JPM), declined to comment about Dimon’s
statement or the company’s Fed borrowings. Jerry
, a spokesman for Bank of America, also declined to

The Fed has been lending money to banks through its
so- called discount window since just after its founding in 1913. Starting in
August 2007, when confidence in banks began to wane, it created a variety of
ways to bolster the financial
system with cash or easily traded securities. By the end of 2008, the central
bank had established or expanded 11 lending facilities catering to banks,
securities firms and corporations that couldn’t get short-term loans from their
usual sources.

‘Core Function’

“Supporting financial-market stability in times of
extreme market stress is a core function of central banks,” says William B.
English, director of the Fed’s Division of Monetary Affairs. “Our lending
programs served to prevent a collapse of the financial system and to keep
credit flowing to American families and businesses.”

The Fed has said that all loans were backed by
appropriate collateral. That the central bank didn’t lose money should “lead to
praise of the Fed, that they took this extraordinary step and they got it
right,” says Phillip Swagel, a former assistant Treasury
secretary under Henry M. Paulson and now a professor of international economic
policy at the University of Maryland.

The Fed initially released lending data in aggregate
form only. Information on which banks borrowed, when, how much and at what
interest rate was kept from public view.

The secrecy extended even to members of President
George W. Bush’s administration who managed TARP. Top aides to Paulson weren’t
privy to Fed lending details during the creation of the program that provided
crisis funding to more than 700 banks, say two former senior Treasury officials
who requested anonymity because they weren’t authorized to speak.

Big Six

The Treasury Department relied on the recommendations
of the Fed to decide which banks were healthy enough to get TARP money and how
much, the former officials say. The six biggest U.S. banks, which received $160
billion of TARP funds, borrowed as much as $460 billion from the Fed, measured
by peak daily debt calculated by Bloomberg using data obtained from the central
bank. Paulson didn’t respond to a request for comment.

The six — JPMorgan, Bank of America, Citigroup Inc. (C), Wells Fargo & Co. (WFC), Goldman Sachs Group Inc. (GS) and Morgan Stanley
— accounted for 63 percent of the average daily debt to the Fed by all
publicly traded U.S. banks, money managers and investment- services firms, the
data show. By comparison, they had about half of the industry’s assets before
the bailout, which lasted from August 2007 through April 2010. The daily debt
figure excludes cash that banks passed along to money-market funds.

Bank Supervision

While the emergency response prevented financial
collapse, the Fed shouldn’t have allowed conditions to get to that point, says Joshua
, a banking analyst with Graham Fisher & Co. in New York

who predicted problems from lax mortgage underwriting as far back as 2001. The
Fed, the primary supervisor for large financial companies, should have been
more vigilant as the housing bubble formed, and the scale of its
lending shows the “supervision of the banks prior to the crisis was far worse
than we had imagined,” Rosner says.

Bernanke in an April 2009 speech said that the
Fed provided emergency loans only to “sound institutions,” even though its
internal assessments described at least one of the biggest borrowers,
Citigroup, as “marginal.”

On Jan. 14, 2009, six days before the company’s
central bank loans peaked, the New York Fed gave CEO Vikram Pandit a report
declaring Citigroup’s financial strength to be “superficial,” bolstered largely
by its $45 billion of Treasury funds. The document was released in early 2011
by the Financial Crisis Inquiry Commission, a panel
empowered by Congress to probe the causes of the crisis.

‘Need Transparency’

Andrea Priest, a spokeswoman for the New York Fed,
declined to comment, as did Jon Diat, a spokesman for Citigroup.

“I believe that the Fed should have independence in
conducting highly technical monetary policy, but when they are putting taxpayer
resources at risk, we need transparency and accountability,” says Alabama
Senator Richard Shelby, the top Republican on the Senate Banking Committee.

Judd Gregg, a former New Hampshire senator who was a
lead Republican negotiator on TARP, and Barney Frank, a Massachusetts Democrat
who chaired the House Financial Services Committee, both say they were kept in
the dark.

“We didn’t know the specifics,” says Gregg, who’s now
an adviser to Goldman Sachs.

“We were aware emergency efforts were going on,”
Frank says. “We didn’t know the specifics.”

Disclose Lending

Frank co-sponsored the Dodd-Frank Wall Street Reform
and Consumer Protection Act
, billed as a fix for financial-industry
excesses. Congress debated that legislation in 2010 without a full
understanding of how deeply the banks had depended on the Fed for survival.

It would have been “totally appropriate” to disclose
the lending data by mid-2009, says David Jones, a former economist at the Federal Reserve Bank of New York who has written
four books about the central bank.

“The Fed is the second-most-important appointed body
in the U.S., next to the Supreme Court, and we’re dealing with a democracy,”
Jones says. “Our representatives in Congress deserve to have this kind of
information so they can oversee the Fed.”

The Dodd-Frank law required the Fed to release
details of some emergency-lending programs in December 2010. It also mandated
disclosure of discount-window borrowers after a two- year lag.

Protecting TARP

TARP and the Fed lending programs went “hand in
hand,” says Sherrill Shaffer, a banking professor at the University of Wyoming
in Laramie and a former chief economist at the New York Fed. While the TARP
money helped insulate the central bank from losses, the Fed’s willingness to
supply seemingly unlimited financing to the banks assured they wouldn’t
collapse, protecting the Treasury’s TARP investments, he says.

“Even though the Treasury was in the headlines, the
Fed was really behind the scenes engineering it,” Shaffer says.

Congress, at the urging of Bernanke and Paulson, created
TARP in October 2008 after the bankruptcy of Lehman Brothers Holdings Inc. made
it difficult for financial institutions to get loans. Bank of America and New
York-based Citigroup each received $45 billion from TARP. At the time, both
were tapping the Fed. Citigroup hit its peak borrowing of $99.5 billion in
January 2009, while Bank of America topped out in February 2009 at $91.4

No Clue

Lawmakers knew none of this.

They had no clue that one bank, New York-based Morgan Stanley (MS), took $107 billion in Fed
loans in September 2008, enough to pay off one-tenth of the country’s
delinquent mortgages. The firm’s peak borrowing occurred the same day Congress
rejected the proposed TARP bill, triggering the biggest point drop ever in the Dow Jones Industrial Average. (INDU) The bill
later passed, and Morgan Stanley got $10 billion of TARP funds, though Paulson
said only “healthy institutions” were eligible.

Mark Lake, a spokesman for Morgan Stanley, declined
to comment, as did spokesmen for Citigroup and Goldman Sachs.

Had lawmakers known, it “could have changed the whole
approach to reform legislation,” says Ted Kaufman, a former Democratic Senator
from Delaware who, with Brown, introduced the bill to limit bank size.

Moral Hazard

Kaufman says some banks are so big that their failure
could trigger a chain reaction in the financial system. The cost of borrowing
for so-called too-big-to-fail banks is lower than that of smaller firms because
lenders believe the government won’t let them go under. The perceived safety
net creates what economists call moral hazard — the belief that bankers will
take greater risks because they’ll enjoy any profits while shifting losses to

If Congress had been aware of the extent of the Fed
rescue, Kaufman says, he would have been able to line up more support for
breaking up the biggest banks.

Byron L. Dorgan, a former Democratic senator from
North Dakota, says the knowledge might have helped pass legislation to
reinstate the Glass-Steagall Act, which for most of the last century separated
customer deposits from the riskier practices of investment banking.

“Had people known about the hundreds of billions in
loans to the biggest financial institutions, they would have demanded Congress
take much more courageous actions to stop the practices that caused this near
financial collapse,” says Dorgan, who retired in January.

Getting Bigger

Instead, the Fed and its secret financing helped
America’s biggest financial firms get bigger and go on to pay employees as much
as they did at the height of the housing bubble.

Total assets held by the
six biggest U.S. banks increased 39 percent to $9.5 trillion on Sept. 30, 2011,
from $6.8 trillion on the same day in 2006, according to Fed data.

For so few banks to hold so many assets is
“un-American,” says Richard W. Fisher, president of the Federal Reserve Bank of
Dallas. “All of these gargantuan institutions are too big to regulate. I’m in
favor of breaking them up and slimming them down.”

Employees at the six biggest banks made twice the
average for all U.S. workers in 2010, based on Bureau of Labor Statistics
hourly compensation cost data. The banks spent $146.3 billion on compensation
in 2010, or an average of $126,342 per worker, according to data compiled by
Bloomberg. That’s up almost 20 percent from five years earlier compared with
less than 15 percent for the average worker. Average pay at the banks in 2010
was about the same as in 2007, before the bailouts.

‘Wanted to Pretend’

“The pay levels came back so fast at some of these
firms that it appeared they really wanted to pretend they hadn’t been bailed
out,” says Anil Kashyap, a former Fed economist who’s now a professor of
economics at the University of Chicago Booth School of Business. “They
shouldn’t be surprised that a lot of people find some of the stuff that
happened totally outrageous.”

Bank of America took over Merrill Lynch & Co. at
the urging of then-Treasury Secretary Paulson after buying the biggest U.S.
home lender, Countrywide Financial Corp. When the Merrill Lynch purchase was
announced on Sept. 15, 2008, Bank of America had $14.4 billion in emergency Fed
loans and Merrill Lynch had $8.1 billion. By the end of the month, Bank of
America’s loans had reached $25 billion and Merrill Lynch’s had exceeded $60
billion, helping both firms keep the deal on track.

Prevent Collapse

Wells Fargo bought Wachovia Corp., the fourth-largest
by deposits before the 2008 acquisition. Because depositors
were pulling their money from Wachovia, the Fed channeled $50 billion in secret
loans to the Charlotte, North Carolina-based bank through two
emergency-financing programs to prevent collapse before Wells Fargo could complete
the purchase.

“These programs proved to be very successful at
providing financial markets the additional liquidity and confidence they needed
at a time of unprecedented uncertainty,” says Ancel Martinez, a spokesman for
Wells Fargo.

JPMorgan absorbed the country’s largest savings and
loan, Seattle-based Washington Mutual Inc., and investment bank Bear
Stearns Cos. The New York Fed, then headed by Timothy F. Geithner, who’s now
Treasury secretary, helped JPMorgan complete the Bear Stearns deal by providing
$29 billion of financing, which was disclosed at the time. The Fed also
supplied Bear Stearns with $30 billion of secret loans to keep the company from
failing before the acquisition closed, central bank data show. The loans were
made through a program set up to provide emergency funding to brokerage firms.

‘Regulatory Discretion’

“Some might claim that the Fed was picking winners
and losers, but what the Fed was doing was exercising its professional
regulatory discretion,” says John Dearie, a former speechwriter at the New York
Fed who’s now executive vice president for policy at the Financial Services
Forum, a Washington-based group consisting of the CEOs of 20 of the world’s
biggest financial firms. “The Fed clearly felt it had what it needed within the
requirements of the law to continue to lend to Bear and Wachovia.”

The bill introduced by Brown and Kaufman in April
2010 would have mandated shrinking the six largest firms.

“When a few banks have advantages, the little guys
get squeezed,” Brown says. “That, to me, is not what capitalism should be.”

Kaufman says he’s passionate about curbing
too-big-to-fail banks because he fears another crisis.

‘Can We Survive?’

“The amount of pain that people, through no fault of
their own, had to endure — and the prospect of putting them through it again
— is appalling,” Kaufman says. “The public has no more appetite for bailouts.
What would happen tomorrow if one of these big banks got in trouble? Can we
survive that?”

Lobbying expenditures by the six banks that would
have been affected by the legislation rose to $29.4 million in 2010 compared
with $22.1 million in 2006, the last full year before credit markets seized up
— a gain of 33 percent, according to, a
research group that tracks money in U.S. politics. Lobbying by the American
Bankers Association, a trade organization, increased at about the same rate, reported.

Lobbyists argued the virtues of bigger banks. They’re
more stable, better able to serve large companies and more competitive
internationally, and breaking them up would cost jobs and cause “long-term
damage to the U.S. economy,” according to a Nov. 13, 2009, letter to members of
Congress from the FSF.

The group’s website cites Nobel
Prize-winning economist Oliver E. Williamson, a professor emeritus at the
University of California, Berkeley, for demonstrating the
greater efficiency of large companies.

‘Serious Burden’

In an interview, Williamson says that the
organization took his research out of context and that efficiency is only one
factor in deciding whether to preserve too-big-to-fail banks.

“The banks that were too big got even bigger, and the
problems that we had to begin with are magnified in the process,” Williamson says. “The big banks have incentives
to take risks they wouldn’t take if they didn’t have government support. It’s a
serious burden on the rest of the economy.”

Dearie says his group didn’t mean to imply that Williamson
endorsed big banks.

Top officials in President Barack Obama’s
administration sided with the FSF in arguing against legislative curbs on the
size of banks.

Geithner, Kaufman

On May 4, 2010, Geithner visited Kaufman in his
Capitol Hill office. As president of the New York Fed in 2007 and 2008,
Geithner helped design and run the central bank’s lending programs. The New
York Fed supervised four of the six biggest U.S. banks and, during the credit
crunch, put together a daily confidential report on Wall Street’s financial
condition. Geithner was copied on these reports, based on a sampling of e-
mails released by the Financial Crisis Inquiry Commission.

At the meeting with Kaufman, Geithner argued that the
issue of limiting bank size was too complex for Congress and that people who
know the markets should handle these decisions, Kaufman says. According to
Kaufman, Geithner said he preferred that bank supervisors from around the
world, meeting in Basel, Switzerland, make rules increasing the amount of money
banks need to hold in reserve. Passing laws in the U.S. would undercut his
efforts in Basel, Geithner said, according to Kaufman.

Anthony Coley, a spokesman for Geithner, declined to

‘Punishing Success’

Lobbyists for the big banks made the winning case
that forcing them to break up was “punishing success,” Brown says. Now that
they can see how much the banks were borrowing from the Fed, senators might
think differently, he says.

The Fed supported curbing too-big-to-fail banks,
including giving regulators the power to close large financial firms and
implementing tougher supervision for big banks, says Fed General Counsel Scott
G. Alvarez. The Fed didn’t take a position on whether large banks should be
dismantled before they get into trouble.

Dodd-Frank does provide a mechanism for regulators to
break up the biggest banks. It established the Financial Stability Oversight
Council that could order teetering banks to shut down in an orderly way. The
council is headed by Geithner.

“Dodd-Frank does not solve the problem of too big to
fail,” says Shelby, the Alabama Republican. “Moral hazard and taxpayer exposure
still very much exist.”

Below Market

Dean Baker, co-director of the Center for Economic
and Policy Research in Washington, says banks “were either in bad shape or
taking advantage of the Fed giving them a good deal. The former contradicts
their public statements. The latter — getting loans at below-market rates
during a financial crisis — is quite a gift.”

The Fed says it typically makes emergency loans more
expensive than those available in the marketplace to discourage banks from
abusing the privilege. During the crisis, Fed loans were among the cheapest
around, with funding available for as low as 0.01 percent in December 2008,
according to data from the central bank and money-market rates tracked by

The Fed funds also benefited firms by allowing them
to avoid selling assets to pay investors and depositors who pulled their money.
So the assets stayed on the banks’ books, earning interest.

Banks report the difference between what they earn on
loans and investments and their borrowing expenses. The figure, known as net
interest margin, provides a clue to how much profit the firms turned on their
Fed loans, the costs of which were included in those expenses. To calculate how
much banks stood to make, Bloomberg multiplied their tax-adjusted net interest
margins by their average Fed debt during reporting periods in which they took
emergency loans.

Added Income

The 190 firms for which data were available would
have produced income of $13 billion, assuming all of the bailout funds were
invested at the margins reported, the data show.

The six biggest U.S. banks’ share of the estimated
subsidy was $4.8 billion, or 23 percent of their combined net income during the
time they were borrowing from the Fed. Citigroup would have taken in the most,
with $1.8 billion.

“The net interest margin is an effective way of
getting at the benefits that these large banks received from the Fed,” says
Gerald A. Hanweck, a former Fed economist who’s now a finance professor at
George Mason University in Fairfax, Virginia.

While the method isn’t perfect, it’s impossible to
state the banks’ exact profits or savings from their Fed loans because the
numbers aren’t disclosed and there isn’t enough publicly available data to
figure it out.

Opinsky, the JPMorgan spokesman, says he doesn’t
think the calculation is fair because “in all likelihood, such funds were
likely invested in very short-term investments,” which typically bring lower

Standing Access

Even without tapping the Fed, the banks get a subsidy
by having standing access to the central bank’s money, says Viral Acharya, a
New York University economics professor who has worked as an academic adviser
to the New York Fed.

“Banks don’t give lines of credit to corporations for
free,” he says. “Why should all these government guarantees and liquidity
facilities be for free?”

In the September 2008 meeting at which Paulson and
Bernanke briefed lawmakers on the need for TARP, Bernanke said that if nothing
was done, “unemployment would rise — to 8 or 9 percent from the prevailing 6.1
percent,” Paulson wrote in “On the Brink” (Business Plus, 2010).

Occupy Wall Street

The U.S. jobless rate hasn’t dipped below 8.8 percent
since March 2009, 3.6 million homes have been foreclosed since August 2007,
according to data provider RealtyTrac Inc., and police have clashed with Occupy
Wall Street protesters, who say government policies favor the wealthiest
citizens, in New York, Boston, Seattle and Oakland, California.

The Tea Party, which supports a more limited role for
government, has its roots in anger over the Wall Street bailouts, says Neil M.
Barofsky, former TARP special inspector general and a Bloomberg Television
contributing editor.

“The lack of transparency is not just frustrating; it
really blocked accountability,” Barofsky says. “When people don’t know the
details, they fill in the blanks. They believe in conspiracies.”

In the end, Geithner had his way. The Brown-Kaufman proposal
to limit the size of banks was defeated, 60 to 31. Bank supervisors meeting in
Switzerland did mandate minimum
reserves that institutions will have to hold, with higher levels for the
world’s largest banks, including the six biggest in the U.S. Those rules can be
changed by individual countries.

They take full effect in 2019.

Meanwhile, Kaufman says, “we’re absolutely, totally,
100 percent not prepared for another financial crisis.”

source: Bloomberg News

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