“Never Explained is Why Some Were Bailed Out and Some Were Not.”

The recent WSJ OpEd (below), by columnist Mr. Holman W. Jenkins, Jr., makes an important point in connecting “the rule of law” to greater certainty in economic decision-making and commercial transactions and this greater certainty to more robust markets. In this regard, Mr. Jenkins notes that the executive branch of our government is responsible for observing, and fairly and equally enforcing, “the rule of law”. In particular, he notes that the executive branch should not take legal but “arbitrary” actions or actions that are “expedient” but violate “the rule of law”, even in times of crisis. Because these actions, some well-intended, will cause individuals and enterprises in the private sector to lose confidence in government and the certainty “the rule of law” provides and this will lead to a reduced (below normal) level of risk-taking and investment; keys to a vibrant economy.

I concur with Mr. Jenkins viewpoint in this OpEd. I experienced first-hand our government’s arbitrary actions during and after the financial crisis, and read accounts of many others, and they continue to this day (in suing S&P but not Moody’s or Fitch and not holding to account the SEC who licensed and regulated these National Statistical Rating Agencies or the regulators who mandated these ratings use in bank and insurance investment policies and capital requirements). These arbitrary (or some potentially lacking a legal basis) government actions have created and continue to create great uncertainty for individuals and enterprises in the private sector and are hurting economic growth and job creation.

Key Excerpts from Mr. Jenkins’ OpEd:

“Never explained is why some were bailed out and some weren’t.”

“In the next emergency, government is likely to behave arbitrarily in dealing with private parties who come seeking rescues—or whom government feels compelled to rescue against their will. Our accumulation of precedents in this regard rests uneasily in a society built on law, and where trust in law is a precondition for the return of normal business and investment activity.”

“The regulator of Fannie Mae and Freddie Mac trumpeted them as solvent and well-capitalized amid the crisis, and then gave their boards immunity from shareholder lawsuit in the government takeover that followed a short time later, wiping out their shareholders.”

“But so much of today’s economic frustration arises because all sectors of the economy (except government) are sitting on cash, reluctant to commit to consumption or investment. Microsoft, when it found itself under assault during the 1990s by marauding trustbusters posturing as servants of “the law,” kept enough cash on hand to survive a full year without revenues—without a penny coming in. This was a remarkable statement of insecurity in its property and legal rights. Now every company is Microsoft.”

Relevant Excerpts from M. Perry’s Informal Mortgage Industry Talk on November 15, 2012 (see Statement 33):

“1. Fannie Mae and Freddie Mac, when placed in conservatorship, were not bailed out to the tune of $137 billion or whatever it is currently, it was the private and public investors in their unsecured and MBS bonds that were bailed out. This saved many banks, insurers, and bond funds around the world from failure, and government agencies in the U.S., and even some foreign sovereigns from tens of billions in losses. It also preserved the ability of the U.S. to issue Treasury debt to foreigners and protected the dollar as the world’s reserve currency.”

“What is ironic is that we held this multi-billion AAA private MBS portfolio, because it was our core business. We thought it was very safe, and because we believed the government when they said that they would not come to the rescue of Fannie Mae and Freddie Mac, so it was economically rational for us to hold AAA-private MBS. They had a somewhat higher yield but not so much that it would cause you concern. More a “liquidity/less-liquid market” premium and yet under regulatory capital rules had the same capital requirements as Fannie/Freddie backed MBS, and they had subordination/protection below the AAA (typically 6% or so on an Alt-a securitization). And yet, we got screwed both ways on this investment. The government did come in and rescue Fannie and Freddie, and if we had held riskier Alt-a whole loans (the same loans collateralizing our AAA-private MBS, but in whole loan form), while the economics over the long haul would have been somewhat worse (because of the 6% subordination), in the short run, we would not have been subject to abrupt and unprecedented ratings downgrades and mark to market accounting rules (when most of the comparable transactions were distressed transactions). Holding our Alt-a loans as AAA MBS rather than as riskier whole loans perversely led to IndyMac’s rapid demise in 2008. Before TARP, before $250,000 deposit insurance, before unlimited deposit insurance for near-zero-rate transaction accounts, before the SEC’s retroactive (to January 1, 2009) change in mark to market accounting rules, and before the FED-engineered low rate environment (because of the crisis and our business model and this private MBS portfolio), we were unfortunately early and yet Not Too Big To Fail.”

Was the AIG Rescue Legal?

Never explained is why some were bailed out and some weren’t.

By HOLMAN W. JENKINS, JR.

AIG is winding up an ad campaign to thank taxpayers for its bailout and note that the rescue returned a profit to the government. That’s nice, but we aren’t quite ready to wash our hands of the matter.

One reason for dwelling on the AIG bailout is that we may not be done with bailouts. In the next emergency, government is likely to behave arbitrarily in dealing with private parties who come seeking rescues—or whom government feels compelled to rescue against their will. Our accumulation of precedents in this regard rests uneasily in a society built on law, and where trust in law is a precondition for the return of normal business and investment activity.

One lawsuit brought by former AIG CEO Hank Greenberg (who left before the meltdown) was thrown out in November on a technicality, though not before the judge editorialized that government must be free to act in a national crisis. Fine. But that still leaves unanswered questions.

AIG offices in New York in September 2008

AIG offices in New York in September 2008

The government wiped out AIG shareholders while using AIG to bail out other companies whose shareholders were not wiped out. Why?

AIG’s owners perhaps deserved their fate due to AIG’s reckless reliance on rating agencies and bond insurers. But other companies (including many foreign banks) were excused from suffering for their own reckless reliance on AIG. Why?

All the more so because government’s profit on the bailout ($22.7 billion) so clearly accrued because taxpayers acquired AIG’s assets at fire-sale prices even while sparing other companies similar embarrassment.

GE wasn’t required to hand over chunks of shareholder equity in return for government guarantees of its commercial paper. The money-fund industry wasn’t required to turn over an 80% stake to Uncle Sam in return for a bailout of the money-fund industry. No exaction was required of Goldman Sachs and Morgan Stanley in return for access to the Federal Reserve’s lending window.

Maybe a courtroom isn’t the right place to explore these choices. Maybe AIG doesn’t make a sympathetic plaintiff. But explanations would be nice.

As the world was recently reminded, Mr. Greenberg has another lawsuit pending, which proposes that the AIG rescue was an illicit “taking” under the Constitution. This was the lawsuit AIG itself contemplated joining last month until it was buried in an avalanche of media opprobrium.

Mr. Greenberg’s claim seems a tad less fanciful now that the rescue has paid off so handsomely for taxpayers and for AIG counterparties, and so badly for AIG shareholders. AIG shareholders might have been better off had the company filed for bankruptcy rather than submitting to an ad hoc Washington “rescue.”

If the nuances here sound familiar, they should. In the Chrysler and General Motors bankruptcies, government played the role of “debtor-in-possession” financier, then behaved as no DIP financier would, using its leverage to do favors for an important Democratic constituency group, the United Auto Workers, at the expense of debt holders.

The regulator of Fannie Mae and Freddie Mac trumpeted them as solvent and well-capitalized amid the crisis, then gave their boards immunity from shareholder lawsuit in the government takeover that followed a short time later, wiping out their shareholders.

Not directly related to the financial crisis but coming in the same moment of untrammeled government discretion was the BP oil spill. The White House dictated a $20 billion compensation program, funded by BP shareholders, without benefit of any legal process at all.

One might look upon these criticisms the way history does Henry Stimson’s insistence that “gentlemen don’t read each other’s mail”—as the sort of excessive scruple that must be tossed aside in a crisis.

But so much of today’s economic frustration arises because all sectors of the economy (except government) are sitting on cash, reluctant to commit to consumption or investment. Microsoft, when it found itself under assault during the 1990s by marauding trustbusters posturing as servants of “the law,” kept enough cash on hand to survive a full year without revenues—without a penny coming in. This was a remarkable statement of insecurity in its property and legal rights. Now every company is Microsoft.

There is also a growing consensus that uncertainty about government actions played the biggest part in turning a housing correction into a general panic.

Do we have a solution? No, just a bad feeling. President Obama’s second inaugural address wrote a lot of checks—especially about the inviolability of Social Security, Medicare and Medicaid—that the Fed might be called upon to cash in coming years as the buyer of last resort for U.S. Treasury debt. If so, more disturbances lie ahead, and we may rue the precedent that the rule of law goes out the window just because financial markets are acting up.

Posted on February 7, 2013, in Postings. Bookmark the permalink. Leave a comment.

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