Government Bailout Hits $8.5 trillion

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Kathleen Pender

The San Francisco Chronicle

November 26, 2008

The federal government committed an additional $800 billion to two new loan programs on Tuesday, bringing its cumulative commitment to financial rescue initiatives to a staggering $8.5 trillion, according to Bloomberg News.

That sum represents almost 60 percent of the nation’s estimated gross domestic product.

Given the unprecedented size and complexity of these programs and the fact that many have never been tried before, it’s impossible to predict how much they will cost taxpayers. The final cost won’t be known for many years.

The money has been committed to a wide array of programs, including loans and loan guarantees, asset purchases, equity investments in financial companies, tax breaks for banks, help for struggling homeowners and a currency stabilization fund.

Most of the money, about $5.5 trillion, comes from the Federal Reserve, which as an independent entity does not need congressional approval to lend money to banks or, in “unusual and exigent circumstances,” to other financial institutions.

To stimulate lending, the Fed said on Tuesday it will purchase up to $600 billion in mortgage debt issued or backed by Fannie Mae, Freddie Mac and government housing agencies. It also will lend up to $200 billion to holders of securities backed by consumer and small-business loans. All but $20 billion of that $800 billion represents new commitments, a Fed spokeswoman said.

About $1.1 trillion of the $8.5 trillion is coming from the Treasury Department, including $700 billion approved by Congress in dramatic fashion under the Troubled Asset Relief Program.

The rest of the commitments are coming from the Federal Deposit Insurance Corp. and the Federal Housing Administration.

Only about $3.2 trillion of the $8.5 trillion has been tapped so far, according to Bloomberg. Some of it might never be.

Relatively little of the money represents direct outlays of cash with no strings attached, such as the $168 billion in stimulus checks mailed last spring.

Where it’s going

Most of the money is going into loans or loan guarantees, asset purchases or stock investments on which the government could see some return.

“If the economy were to miraculously recover, the taxpayer could make money. That’s not my best guess or even a likely scenario,” but it’s not inconceivable, says Anil Kashyap, a professor at the University of Chicago’s Booth School of Business.

The risk/reward ratio for taxpayers varies greatly from program to program.

For example, the first deal the government made when it bailed out insurance giant AIG had little risk and a lot of potential upside for taxpayers, Kashyap said. “Then it turned out the situation (at AIG) was worse than realized, and the terms were so brutal (to AIG) that we had to renegotiate. Now we have given them a lot more credit on more generous terms.”

Kashyap says the worst deal for taxpayers could be the Citigroup deal announced late Sunday. The government agreed to buy an additional $20 billion in preferred stock and absorb up to $249 billion in losses on troubled assets owned by Citi.

Given that Citigroup’s entire market value on Friday was $20.5 billion, “instead of taking that $20 billion in preferred shares we could have bought the company,” he says.

It’s hard to say how much the overall rescue attempt will add to the annual deficit or the national debt because the government accounts for each program differently.

If the Treasury borrows money to finance a program, that money adds to the federal debt and must eventually be paid off, with interest, says Diane Lim Rogers, chief economist with the Concord Coalition, a nonpartisan group that aims to eliminate federal deficits.

The federal debt held by the public has risen to $6.4 trillion from $5.5 trillion at the end of August. (Total debt, including that owed to Social Security and other government agencies, stands at more than $10 trillion.)

However, a $1 billion increase in the federal debt does not necessarily increase the annual budget deficit by $1 billion because it is expected to be repaid over time, Rogers said.

Annual deficit

A deficit arises when the government’s expenditures exceed its revenues in a particular year. Some estimate that the federal deficit will exceed $1 trillion this fiscal year as a result of the economic slowdown and efforts to revive it.

The Fed’s activities to shore up the financial system do not show up directly on the federal budget, although they can have an impact. The Fed lends money from its own balance sheet or by essentially creating new money. It has been doing both this year.

The problem is, “if you print money all the time, the money becomes worth less,” Rogers says. This usually leads to higher inflation and higher interest rates. The value of the dollar also falls because foreign investors become less willing to invest in the United States.

Today, interest rates are relatively low and the dollar has been mostly strengthening this year because U.S. Treasury securities “are still for the moment a very safe thing to be investing in because the financial market is so unstable,” Rogers said. “Once we stabilize the stock market, people will not be so enamored of clutching onto Treasurys.”

At that point, interest rates and inflation will rise. Increased borrowing by the Treasury will also put upward pressure on interest rates.

Deflation a big concern

Today, however, the Fed is more worried about deflation than inflation and is willing to flood the market with money if necessary to prevent an economic collapse.

Federal Reserve Chairman Ben Bernanke “has ordered the helicopters to get ready,” said Axel Merk, president of Merk Investments. “The helicopters are hovering and the first cash is making it through the seams. Soon, a door may be opened.”

Rogers says her biggest fear is not hyperinflation and the social unrest it could unleash. “I’m more worried about a lot of federal dollars being committed and not having much to show for it. My worst fear is we are leaving our children with a huge debt burden and not much left to pay it back.”

Economic rescue

Key dates in the federal government’s campaign to alleviate the economic crisis.

March 11: The Federal Reserve announces a rescue package to provide up to $200 billion in loans to banks and investment houses and let them put up risky mortgage-backed securities as collateral.

March 16: The Fed provides a $29 billion loan to JPMorgan Chase & Co. as part of its purchase of investment bank Bear Stearns.

July 30: President Bush signs a housing bill including $300 billion in new loan authority for the government to back cheaper mortgages for troubled homeowners.

Sept. 7: The Treasury takes over mortgage giants Fannie Mae and Freddie Mac, putting them into a conservatorship and pledging up to $200 billion to back their assets.

Sept. 16: The Fed injects $85 billion into the failing American International Group, one of the world’s largest insurance companies.

Sept. 16: The Fed pumps $70 billion more into the nation’s financial system to help ease credit stresses.

Sept. 19: The Treasury temporarily guarantees money market funds against losses up to $50 billion.

Oct. 3: President Bush signs the $700 billion economic bailout package. Treasury Secretary Henry Paulson says the money will be used to buy distressed mortgage-related securities from banks.

Oct. 6: The Fed increases a short-term loan program, saying it is boosting short-term lending to banks to $150 billion.

Oct. 7: The Fed says it will start buying unsecured short-term debt from companies, and says that up to $1.3 trillion of the debt may qualify for the program.

Oct. 8: The Fed agrees to lend AIG $37.8 billion more, bringing total to about $123 billion.

Oct. 14: The Treasury says it will use $250 billion of the $700 billion bailout to inject capital into the banks, with $125 billion provided to nine of the largest.

Oct. 14: The FDIC says it will temporarily guarantee up to a total of $1.4 trillion in loans between banks.

Oct. 21: The Fed says it will provide up to $540 billion in financing to provide liquidity for money market mutual funds.

Nov. 10: The Treasury and Fed replace the two loans provided to AIG with a $150 billion aid package that includes an infusion of $40 billion from the government’s bailout fund.

Nov. 12: Paulson says the government will not buy distressed mortgage-related assets, but instead will concentrate on injecting capital into banks.

Nov. 17: Treasury says it has provided $33.6 billion in capital to another 21 banks. So far, the government has invested $158.6 billion in 30 banks.

Sunday: The Treasury says it will invest $20 billion in Citigroup Inc., on top of $25 billion provided Oct. 14. The Treasury, Fed and FDIC also pledge to backstop large losses Citigroup might absorb on $306 billion in real estate-related assets.

Tuesday: The Fed says it will purchase up to $600 billion more in mortgage-related assets and will lend up to $200 billion to the holders of securities backed by various types of consumer loans.

Source: Associated Press

Net Worth runs Tuesdays, Thursdays and Sundays. E-mail Kathleen Pender at kpender@sfchronicle.com.


Jim Rogers Says Geithner Caused Crisis; Must Let Banks Fail

Banks Keeping Mum on TARP Bailout Funds; Only Morgan Stanley Coming Clean

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Morgan Stanley Is One Bank That Cites a Loan From TARP Money

Other Financial Banks Including Goldman Sachs and CitiGroup Keep Mum on How They Are Using TARP Cash

By CHARLES HERMAN, DAN ARNALL, LAUREN PEARLE and ZUNAIRA ZAKI

ABC NEWS

Dec. 17, 2008—

Banks that were rescued with billions of dollars in public funds have, in most cases, refused to provide specifics about how they have used or intend to use the money.

ABC News asked 16 of the banks that have received money from the Treasury Department’s $700 billion Trouble Asset Relief Program the same two questions: How has your financial institution used the money, and how much has your financial institution allocated to bonuses and incentives this year?

To read the banks’ responses, click here.

Goldman Sachs reported Tuesday that it paid $10.93 billion in compensation for the year, which includes salaries and bonuses, payroll taxes and benefits. That is down 46 percent from a year ago. Goldman Sachs received $10 billion from the Treasury.

“Bonuses across Goldman Sachs will be down significantly this year,” a bank representative told ABC News. The spokesman refused to disclose the size of the bonus pool or how much of the compensation fund of $10.93 billion was planned for bonuses.

“We do not break down the components of compensation; however, most of that number was not bonuses,” he said. Goldman Sachs added, “TARP money is not being paid to employee compensation. It’s been and will continue to be used to facilitate client activity in the capital markets.”

Goldman Sachs has pointed out that seven of its senior executives were forgoing bonuses this year. The company also reported Tuesday that it lost $2.1 billion in the last quarter.

“It looks like Goldman Sachs is treating this as business as usual,” said compensation expert James Reda. “They are taking our taxpayer money. They should be able to account for that money.

“What’s missing from this report is the exact amount of bonuses that were paid,” said Reda. He later added, “They’re hiding the ball.”

Fred Cannon, chief equity strategist with Keefe Bruyette and & Woods, an investment bank that specializes exclusively in financial services, said, “It is difficult to say what the TARP funds are directly used for. In terms of compensation, while TARP funds may not directly pay for compensation, the funds do provide additional overall cash to the companies.”

When pressed for what the TARP money was being used for, Goldman Sachs replied that it is spent to “facilitate client activity in the capital markets.”

Only One Bank Cited a Loan It Made

Of the 16 banks that were contacted by ABC News and asked how they were spending the hundreds of billions of taxpayer dollars, only one bank pointed to a specific loan that it made with the cash. That was a $17 billion loan that Morgan Stanley made to Verizon Wireless.

Morgan Stanley, which received $10 billion from TARP, released its quarterly finances today. The bank announced a dramatic and larger-than-predicted $2.37 billion quarterly loss but an overall year-end profit of $1.59 billion. That was down 49 percent from last year. The bank’s stock price dropped 72 percent this year.

In response to an ABC News email request, Morgan Stanley public information officer Mark Lake confirmed that bonuses are down “approximately 50 percent.”

Besides the Verizon loan cited by Morgan Stanley, the banks declined to detail how they were using the federal funds.

“Tarp money doesn’t go into bonuses,” Lake said, in an email to ABC News.

Wells Fargo said that of the $25 billion it received, it “cannot provide any foward-looking guidance on lending for this quarter [and] Intend[s] to use the Capital Purchase Program funds to make more loans to credit-worthy customers.”

More typical was the generic response by the Bank of New York Mellon, which said of the fortune it had banked in public moneys: “Using the $3 billion to provide liquidity to the credit markets.”

Congress and fiscal watchdogs have been frustrated and upset that the banks do not have to account for the way they are spending these publicly financed bonanzas.

The U.S. Treasury has spent or committed $335 billion of the $700 billion in the TARP fund in an attempt to get banks back in the lending business and to unfreeze the nation’s credit markets.

Last week Congress was angered to learn that giant insurance company American Insurance Group, which received $150 billion in TARP cash to stay afloat, was paying more than $100 million in “retention bonuses” to 168 employees.

That revelation prompted Rep. Elijah Cummings, D-Md., to complain, “It’s absolutely and incredibly wrong that we don’t have more transparency.”

All the Banks That Got TARP Cash Indicate They Are Paying Bonuses

While several banks said that its top executives would skip bonuses this year or its compensation pool was smaller this year than in past years, all indicated that some end-of-year compensation was in the works.

When asked how much the banks were paying out in bonuses and whether TARP funds would be used to finance them, most of the banks did not make such a declaration.

“Incentive compensation not yet allocated,” was as far as JP Morgan Chase, which received $25 billion from TARP, would go.

Bank of America, which got $15 billion from TARP, said only, “Have reduced the incentive targets by more than half. Final awards have not been determined.”

State Street Bank ruled out using TARP to reward its top officers.

“Will not use any of the proceeds from the TARP Capital Purchase Program to fund our bonus pool or executive compensation,” the bank insisted.

Cannon said the banks are being very conservative with their money.

After reviewing the statements the banks provided to ABC News he said, “The banks are expressing good intention in line with the good intention of the program. However, the answers from the bank belie the current challenge; the economy is deteriorating rapidly and making good loans, with strong underwriting into an economy that is falling apart is very difficult.”

ABC News’ MaryKate Burke contributed to this report.

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Paul Krugman: "On the Edge"

February 6, 2009
Op-Ed Columnist
On the Edge

A not-so-funny thing happened on the way to economic recovery. Over the last two weeks, what should have been a deadly serious debate about how to save an economy in desperate straits turned, instead, into hackneyed political theater, with Republicans spouting all the old clichés about wasteful government spending and the wonders of tax cuts.

It’s as if the dismal economic failure of the last eight years never happened — yet Democrats have, incredibly, been on the defensive. Even if a major stimulus bill does pass the Senate, there’s a real risk that important parts of the original plan, especially aid to state and local governments, will have been emasculated.

Somehow, Washington has lost any sense of what’s at stake — of the reality that we may well be falling into an economic abyss, and that if we do, it will be very hard to get out again.

It’s hard to exaggerate how much economic trouble we’re in. The crisis began with housing, but the implosion of the Bush-era housing bubble has set economic dominoes falling not just in the United States, but around the world.

Consumers, their wealth decimated and their optimism shattered by collapsing home prices and a sliding stock market, have cut back their spending and sharply increased their saving — a good thing in the long run, but a huge blow to the economy right now. Developers of commercial real estate, watching rents fall and financing costs soar, are slashing their investment plans. Businesses are canceling plans to expand capacity, since they aren’t selling enough to use the capacity they have. And exports, which were one of the U.S. economy’s few areas of strength over the past couple of years, are now plunging as the financial crisis hits our trading partners.

Meanwhile, our main line of defense against recessions — the Federal Reserve’s usual ability to support the economy by cutting interest rates — has already been overrun. The Fed has cut the rates it controls basically to zero, yet the economy is still in free fall.

It’s no wonder, then, that most economic forecasts warn that in the absence of government action we’re headed for a deep, prolonged slump. Some private analysts predict double-digit unemployment. The Congressional Budget Office is slightly more sanguine, but its director, nonetheless, recently warned that “absent a change in fiscal policy … the shortfall in the nation’s output relative to potential levels will be the largest — in duration and depth — since the Depression of the 1930s.”

Worst of all is the possibility that the economy will, as it did in the ’30s, end up stuck in a prolonged deflationary trap.

We’re already closer to outright deflation than at any point since the Great Depression. In particular, the private sector is experiencing widespread wage cuts for the first time since the 1930s, and there will be much more of that if the economy continues to weaken.

As the great American economist Irving Fisher pointed out almost 80 years ago, deflation, once started, tends to feed on itself. As dollar incomes fall in the face of a depressed economy, the burden of debt becomes harder to bear, while the expectation of further price declines discourages investment spending. These effects of deflation depress the economy further, which leads to more deflation, and so on.

And deflationary traps can go on for a long time. Japan experienced a “lost decade” of deflation and stagnation in the 1990s — and the only thing that let Japan escape from its trap was a global boom that boosted the nation’s exports. Who will rescue America from a similar trap now that the whole world is slumping at the same time?

Would the Obama economic plan, if enacted, ensure that America won’t have its own lost decade? Not necessarily: a number of economists, myself included, think the plan falls short and should be substantially bigger. But the Obama plan would certainly improve our odds. And that’s why the efforts of Republicans to make the plan smaller and less effective — to turn it into little more than another round of Bush-style tax cuts — are so destructive.

So what should Mr. Obama do? Count me among those who think that the president made a big mistake in his initial approach, that his attempts to transcend partisanship ended up empowering politicians who take their marching orders from Rush Limbaugh. What matters now, however, is what he does next.

It’s time for Mr. Obama to go on the offensive. Above all, he must not shy away from pointing out that those who stand in the way of his plan, in the name of a discredited economic philosophy, are putting the nation’s future at risk. The American economy is on the edge of catastrophe, and much of the Republican Party is trying to push it over that edge.

Numerous Myths and Falsehoods Advanced by the Media in Their Coverage of the American Recovery and Reinvestment Act

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Media Matters for America previously identified numerous myths and falsehoods advanced by the media in their coverage of the American Recovery and Reinvestment Act. As debate on the bill continues in Congress, other myths and falsehoods advanced by the media about the recovery package have risen to prominence. These myths and falsehoods include: the assertion that the bill will not stimulate the economy — including the false assertion that the Congressional Budget Office (CBO) said the bill will not stimulate the economy; that spending in the bill is not stimulus; that there is no reason for stimulus after an economic turnaround begins; that corporate tax rate cuts and capital gains tax rate cuts would provide substantial stimulus; and that undocumented immigrants without Social Security numbers could receive the “Making Work Pay” tax credit provided in the bill.

1. The bill will not stimulate the economy

In a February 1 article, The Associated Press reported an assertion by Senate Minority Leader Mitch McConnell (R-KY) that the recovery bill will not stimulate the economy without noting that the CBO disagrees. ABC World News anchor Charles Gibson echoed this assertion during his February 3 interview with President Obama, stating: “And as you know, there’s a lot of people in the public, a lot of members of Congress who think this is pork-stuffed and that it really doesn’t stimulate.” Additionally, on the January 28 edition of his show, nationally syndicated radio host Rush Limbaugh allowed Rep. Eric Cantor (R-VA) to falsely claim of the bill: “Even the Congressional Budget Office, controlled by the Democrats now, says it is not a stimulative bill.” Fox News host Sean Hannity repeated this claim on the February 2 broadcast of Fox News’ Hannity, asserting that the CBO “say[s] it’s not a stimulus bill.”

In fact, in analyzing the House version of the bill, H.R. 1, and the proposed Senate version, the CBO stated that it expects both measures to “have a noticeable impact on economic growth and employment in the next few years.” Additionally, in his January 27 written testimony before the House Budget Committee, CBO director Douglas Elmendorf said that H.R. 1 would “provide massive fiscal stimulus that includes a combination of government spending increases and revenue reductions.” Elmendorf further stated: “In CBO’s judgment, H.R. 1 would provide a substantial boost to economic activity over the next several years relative to what would occur without any legislation.”

2. Government spending in the bill is not stimulus

Several media figures, including CNN correspondent Carol Costello, CBS Evening News correspondent Sharyl Attkisson, and ABC World News anchor Charles Gibson, have all uncritically reported or aired the Republican claim that, in Gibson’s words, “it’s a spending bill and not a stimulus,” without noting that economists have said that government spending is stimulus. Indeed, in his January 27 testimony, Elmendorf explicitly refuted the suggestion that some of the spending provisions in the bill would not have a stimulative effect, stating: “[I]n our estimation — and I think the estimation of most economists — all of the increase in government spending and all of the reduction in tax revenue provides some stimulative effect. People are put to work, receive income, spend that on something else. That puts somebody else to work.” Additionally, Dean Baker, co-director of the Center for Economic and Policy Research, has said, “[S]pending is stimulus. Any spending will generate jobs. It is that simple.”

3. There is no reason for stimulus after a turnaround begins Continue reading Numerous Myths and Falsehoods Advanced by the Media in Their Coverage of the American Recovery and Reinvestment Act

Bank of America Throws Ten Million Dollar Super Bowl Party

T H I N K  P R O G R E S S

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Just weeks ago, the federal government extended $20 billion to Bank of America to keep it afloat, bringing its total in federal bailout dollars received to $45 billion. ABC News reports, however, that the bank managed to scrounge up millions of dollars to be an NFL sponsor and for “a five day carnival-like” Super Bowl party just outside the stadium:

The event — known as the NFL Experience — was 850,000 square feet of sports games and interactive entertainment attractions for football fans and was blanketed in Bank of America logos and marketing calls to sign up for football-themed banking products. […]

The bank refused to tell ABC News how much it is spending as an NFL corporate sponsor, but insiders have put the figure at close to $10 million. The NFL Experience was on top of that and was inked last summer, according to the bank.

The NFL said it was a “multi-million dollar” event and that it was also spending money to put on the event. A Super Bowl insider said the tents alone cost over $800,000.

The Huffington Post notes that this is the latest in a series of bailed-out banks that continue to spend lavishly on sports sponsorships.

Goldman Sachs Tax Rate Drops to 1%- From 6 Billion to 14 Million

By Christine Harper Dec. 16

(Bloomberg)

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Goldman Sachs Group Inc., which got $10 billion and debt guarantees from the U.S. government in October, expects to pay $14 million in taxes worldwide for 2008 compared with $6 billion in 2007. The company’s effective income tax rate dropped to 1 percent from 34.1 percent, New York-based Goldman Sachs said today in a statement. The firm reported a $2.3 billion profit for the year after paying $10.9 billion in employee compensation and benefits.

Goldman Sachs, which today reported its first quarterly loss since going public in 1999, lowered its rate with more tax credits as a percentage of earnings and because of “changes in geographic earnings mix,” the company said. The rate decline looks “a little extreme,” said Robert Willens, president and chief executive officer of tax and accounting advisory firm Robert Willens LLC. “I was definitely taken aback,” Willens said. “Clearly they have taken steps to ensure that a lot of their income is earned in lower-tax jurisdictions.” U.S. Representative Lloyd Doggett, a Texas Democrat who serves on the tax-writing House Ways and Means Committee, said steps by Goldman Sachs and other banks shifting income to countries with lower taxes is cause for concern. “This problem is larger than Goldman Sachs,” Doggett said. “With the right hand out begging for bailout money, the left is hiding it offshore.” In the first nine months of the fiscal year, Goldman had planned to pay taxes at a 25.1 percent rate, the company said today. A fourth-quarter tax credit of $1.48 billion was 41 percent of the company’s pretax loss in the period, higher than many analysts expected. David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, expected the fourth-quarter tax credit to be 28 percent. The tax-rate decline may raise some eyebrows because of the support the U.S. government has provided to Goldman Sachs and other companies this year, Willens said. “It’s not very good public relations,” he said.

Wall Street Bonuses Are Same As 2004

January 29, 2009

What Red Ink? Wall Street Paid Hefty Bonuses

Wall Street ArrestBy almost any measure, 2008 was a complete disaster for Wall Street — except, that is, when the bonuses arrived.

Despite crippling losses, multibillion-dollar bailouts and the passing of some of the most prominent names in the business, employees at financial companies in New York, the now-diminished world capital of capital, collected an estimated $18.4 billion in bonuses for the year.

That was the sixth-largest haul on record, according to a report released Wednesday by the New York State comptroller.

While the payouts paled next to the riches of recent years, Wall Street workers still took home about as much as they did in 2004, when the Dow Jones industrial average was flying above 10,000, on its way to a record high.

Some bankers took home millions last year even as their employers lost billions.

The comptroller’s estimate, a closely watched guidepost of the annual December-January bonus season, is based largely on personal income tax collections. It excludes stock option awards that could push the figures even higher.

The state comptroller, Thomas P. DiNapoli, said it was unclear if banks had used taxpayer money for the bonuses, a possibility that strikes corporate governance experts, and indeed many ordinary Americans, as outrageous. He urged the Obama administration to examine the issue closely.

“The issue of transparency is a significant one, and there needs to be an accounting about whether there was any taxpayer money used to pay bonuses or to pay for corporate jets or dividends or anything else,” Mr. DiNapoli said in an interview.

Granted, New York’s bankers and brokers are far poorer than they were in 2006, when record deals, and the record profits they generated, ushered in an era of Wall Street hyperwealth. All told, bonuses fell 44 percent last year, from $32.9 billion in 2007, the largest decline in dollar terms on record.

But the size of that downturn partly reflected the lofty heights to which bonuses had soared during the bull market. At many banks, those payouts were based on profits that turned out to be ephemeral. Throughout the financial industry, years of earnings have vanished in the flames of the credit crisis.

According to Mr. DiNapoli, the brokerage units of New York financial companies lost more than $35 billion in 2008, triple their losses in 2007. The pain is unlikely to end there, and Wall Street is betting that the Obama administration will move swiftly to buy some of banks’ troubled assets to encourage reluctant banks to make loans.

Many corporate governance experts, investors and lawmakers question why financial companies that have accepted taxpayer money paid any bonuses at all. Financial industry executives argue that they need to pay their best workers well in order to keep them, but with many banks cutting jobs, job options are dwindling, even for stars.

Lucian A. Bebchuk, a professor at Harvard Law School and expert on executive compensation, called the 2008 bonus figure “disconcerting.” Bonuses, he said, are meant to reward good performance and retain employees. But Wall Street disbursed billions despite staggering losses and a shrinking job market.

“This was neither the sixth-best year in terms of aggregate profits, nor was it the sixth-most-difficult year in terms of retaining employees,” Professor Bebchuk said.

Echoing Mr. DiNapoli, Professor Bebchuk said he was concerned that banks might be using taxpayer money to subsidize bonuses or dividends to stockholders. “What the government has been trying to do is shore up capital, and any diversion of capital out of banks, whether in the form of dividends or large payments to employees, really undermines what we are trying to do,” he said.

Jesse M. Brill, a lawyer and expert on executive compensation, said government bailout programs like the Troubled Asset Relief Program, or TARP, should be made more transparent.

“We are all flying in the dark,” Mr. Brill said. “Companies can simply say they are trying to do their best to comply with compensation limits without providing any of the details that the public is entitled to.”

Bonuses paid by one troubled Wall Street firm, Merrill Lynch, have come under particular scrutiny during the last week.

Andrew M. Cuomo, the New York attorney general, has issued subpoenas to John A. Thain, Merrill’s former chief executive, and to an executive at Bank of America, which recently acquired Merrill, asking for information about Merrill’s decision to pay $4 billion to $5 billion in bonuses despite new, gaping losses that forced Bank of America to seek a second financial lifeline from Washington.

A Treasury Department official said that in the coming weeks, the department would take action to further ensure taxpayer money is not used to pay bonuses.

Even though Wall Street spent billions on bonuses, New York firms squeezed rank-and-file executives harder than many companies in other fields. Outside the financial industry, many corporate executives received fatter bonuses in 2008, even as the economy lost 2.6 million jobs. According to data from Equilar, a compensation research firm, the average performance-based bonuses for top executives, other than the chief executive, at 132 companies with revenues of more than $1 billion increased by 14 percent, to $265,594, in the 2008 fiscal year.

For New York State and New York City, however, the leaner times on Wall Street will hurt, Mr. DiNapoli said.

Mr. DiNapoli said the average Wall Street bonus declined 36.7 percent, to $112,000. That is smaller than the overall 44 percent decline because the money was spread among a smaller pool following thousands of job losses.

The comptroller said the reduction in bonuses would cost New York State nearly $1 billion in income tax revenue and cost New York City $275 million.

On Wall Street, where money is the ultimate measure, some employees apparently feel slighted by their diminished bonuses. A poll of 900 financial industry employees released on Wednesday by eFinancialCareers.com, a job search Web site, found that while nearly eight out of 10 got bonuses, 46 percent thought they deserved more.

Paul J. Sullivan contributed reporting.

Small Banks Getting Short End of Tarp Bat

SEEKING ALPHA

William Patalon III

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Bank of American Corp. (BAC), which is getting $15 billion from the U.S. government as part of the Treasury Department’s $250 billion “recapitalization” effort, is doubling its stake in state-owned China Construction Bank Corp., and will hold a 20% stake worth $24 billion in China’s second-largest lender when that deal is finalized.

PNC Financial Services Group Inc. (PNC), which will get $7.7 billion from Treasury’s Troubled Assets Relief Program (TARP), is using that cash infusion to help finance its $5.2 billion buyout of embattled National City Corp. (NCC).

And U.S. Bancorp (USB), which received a $6.6 billion capital infusion from that same rescue package, has acquired two California lenders – Downey Savings & Loan Association, F.A., a subsidiary of Downey Financial Corp. (DSL), and PFF Bank & Trust, a subsidiary of PFF Bancorp Inc. (OTC: PFFB). U.S. Bank agreed to assume the first $1.6 billion in losses from the two, but says anything beyond that amount is subject to a loss-sharing deal it struck with the Federal Deposit Insurance Corp. (FDIC).

While the Treasury Department’s investment of more than $250 billion in U.S. financial institutions has been billed as a strategy that will bolster the health of the banking system and also jump-start lending, buyout deals such as these three show that the recapitalization plan has actually had a much different result – one that’s left whipsawed U.S. investors and lawmakers alike feeling burned, an ongoing Money Morning investigation continues to show.

Those billions have touched off a banking-sector version of “Let’s Make a Deal,” in which the biggest U.S. banks are using government money to get even bigger. While that’s admittedly removing the smaller, weaker banks from the market – a possible benefit to consumers and taxpayers alike – this trend is also having a detrimental effect: It’s reducing the competition that’s benefited consumers and kept the explosion in banking fees from being far worse than it already is.

This all happens without any of the economic benefits that an actual increase in lending would have had. And it does nothing to address the billions worth of illiquid securities that remain on (or off) banks’ balance sheets – as the recent Citigroup Inc. (C) imbroglio demonstrates.

In fact, Treasury’s TARP program has even managed to create a potentially illegal tax loophole that grants banks a tax-break windfall of as much as $140 billion. Lawmakers are furious – but possibly powerless, afraid that a full-scale assault on the tax change could cause already-done deals to unravel, in turn causing investor confidence to do the same.

One could even argue that since this first bailout (the $700 billion TARP initiative) has fueled takeovers – and not lending – the government had no choice but to roll out the more-recent $800 billion stimulus plan that was aimed at helping consumers and small businesses – a move that may spur lending and spending, but that still adds more debt to the already-sagging federal government balance sheet.

At the end of the day, these buyout deals are bad ones no matter how you evaluate them, says R. Shah Gilani, a retired hedge fund manager and expert on the U.S. credit crisis who is the editor of the Trigger Event Strategist, which identifies trading opportunities emanating from such financial-crisis “aftershocks” as this buyout binge.

“Why in the name of capitalism are taxpayers being fleeced by banks that are being given our money to grow their businesses with the further backstop of more of our money having to be thrown to the FDIC when they fail?” Gilani asked. “Consolidation does not mean that bad loans and illiquid securities are somehow merged out of existence. It means that they are being acquired under the premise that a larger, more consolidated depositor base will better be able to bear the weight of those bad assets. What in heaven’s name prevents depositors from exiting when the merged banks continue to experience massive losses and write-downs? The answer to that question would be … nothing.”

Lining Up for Deal Money

In launching TARP, U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. said the government’s goal was to restore public confidence in the U.S. financial services sector – especially banks – so private investors would be willing to advance money to banks and banks, in turn, would be willing to lend.

“Our purpose is to increase the confidence of our banks, so that they will deploy, not hoard, the capital,” Paulson said.

Whatever Treasury’s actual intent, the reality is that banks are already sniffing out buyout targets, while snuffing out lending – and the TARP money is the reason for both.

Fueled by this taxpayer-supplied capital, the wave of consolidation deals is “absolutely” going to accelerate, says Louis Basenese, a mergers-and-acquisitions expert who is also the editor of The Takeover Trader newsletter. “When it comes to M&A, there’s always a pronounced ‘domino effect.’ Consolidation breeds more consolidation as industry leaders conclude they have to keep acquiring in order to remain competitive.”

Indeed, banking executives have been quite open about their expansionist plans during media interviews, or during conference calls related to quarterly earnings.

Take BB&T Corp. (BBT). During a conference call that dealt with the bank’s third-quarter results, Chief Executive Officer John A. Allison IV said the Winston-Salem, N.C.-based bank “will probably participate” in the government program. Allison didn’t say whether the federal money would induce BB&T to boost its lending. But he did say the bank would likely accept the money in order to finance its expansion plans, The Wall Street Journal said.

“We think that there are going to be some acquisition opportunities – either now or in the near future – and this is a relatively inexpensive way to raise capital [to pay the buyout bill],” Allison said during the conference call.

And BB&T is hardly alone. Zions Bancorporation (ZION), a Salt Lake City-based bank that’s been squeezed by some bad real-estate loans, recently said it would be getting $1.4 billion in federal money. CEO Harris H. Simmons said the infusion would enable Zions to boost “prudent” lending and keep paying its dividend – albeit at a reduced rate.

Sounds good, right? Not so fast. During a conference call about earnings, Zions Chief Financial Officer Doyle L. Arnold said any lending increase wouldn’t be dramatic. Besides, Arnold said, Zions will also use the money “to take advantage of what we would expect will be some acquisition opportunities, including some very low risk FDIC-assisted transactions in the next several quarters.”

Buyouts Already Accelerating

With all the liquidity the world’s governments and central banks have injected into the global financial system, the pace of worldwide deal making is already accelerating. Global deal volume for the year has already passed the $3 trillion level – only the fifth time that’s happened, although it took about three months longer for that to happen this year than it did a year ago.

At a time when the global financial crisis – and the accompanying drop-off in available deal capital (either equity or credit) – has caused about $150 billion in already-announced deals to be yanked off the table since Sept. 1, liquidity from the U.S. and U.K. governments has ignited record levels of financial-sector deal making.

According to Dealogic, government investments in financial institutions has reached $76 billion this year – eight times as much as in all of 2007, which was the previous record year. And that total doesn’t include the $250 billion in TARP money, or other deals that Paulson & Co. are helping engineer – JPMorgan Chase & Co.’s (JPM) buyouts of The Bear Stearns Cos. and Washington Mutual Inc. (WAMUQ), for instance.

If You Can’t Beat ‘em… Buy ‘em?

When it comes to identifying possible buyout targets, M&A experts such as Basenese say there are some very clear frontrunners.

“I’d put regional banks with solid footprints in the Southeast high on the list, and for two reasons,” Basenese said. “First, demographics point to stronger growth [in this region] as retirees migrate to warmer climates – and bring their assets along for the trip. Plus, the Southeast is largely un-penetrated by large national banks. An acquisition of a regional bank like SunTrust Banks Inc. (STI) would provide a distinct competitive advantage.

There’s a very good reason that smaller players may be next: Big banks and small banks have the easiest times – relatively speaking, of course – of raising capital. It’s toughest for the regional players. Big banks can tap into the global financial markets for cash, while the very small – and typically, highly local – banks can raise money from local investors.

The afore-mentioned stealthy shift in the U.S. Tax Code actually gives big U.S. banks a potential windfall of as much as $140 billion, says Gilani, the credit crisis expert and Trigger Event Strategist editor. What does this tax-change do? By acquiring a failed bank whose only real value is the losses on its books, the successful suitor would basically then be able to use the acquired bank’s losses to offset its own gains and thus avoid paying taxes.

“While everyone was panicking, the Treasury Department slipped through a ruling that allows banks who acquire other banks to fully write-off all the acquired bank’s bad debts,” Gilani says. “For 22 years, the law was such that if you were to buy a company that had losses, say, of $1 billion, you couldn’t just take that loss against your own $1 billion profit and tell Uncle Sam, ‘Gee, now my loss offsets my profit, so I don’t have any profit, and I don’t owe you any tax.’ It was a recipe for tax evasion that demanded an appropriate law that only allows limited write-offs over an extended period of years.”

Given these incentives, who will be doing the buying? Clearly, the biggest U.S.-based banks will be the main hunters. But The Takeover Trader’s Basenese says that even foreign banks will be on the prowl for cheap U.S. banking assets.

Basenese also believes that Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) will be “big spenders.” Each will use TARP funds to help accelerate its transformation from an investment bank into a bank holding company. The changeover will require each company to build up a big base of deposits. And the best way to do that is to buy other banks, Basenese says.

“One thing [the wave of deals] does is to restore confidence in the sector,” Basenese said. “It will go a long way in convincing CEOs that it’s safe to use excess capital to fund acquisitions, and to grow, instead of using it to defend against a proverbial run on the bank.”

Not everyone agrees with that assessment. Investors who play the merger game correctly will do well. But the game itself won’t necessarily whip the industry into championship form, Gilani says.

“While consolidation, instead of outright collapses, in the banking industry may serve to relieve the FDIC of its burden to make good on failed banks, it in no way guarantees fewer failures,” he said. “In fact, it may only serve to guarantee, in some cases, even larger failures.”

Experts Are Bewitched, Bewildered and Befuddled By The Economy

Economy in Turmoil and Bailout Plans Adrift

THE SAN FRANCISCO CHRONICLE

Sunday, December 7, 2008

Washington

Detroit automakers are in line behind governors who are in line behind banks, seeking emergency aid from Washington. Nearly $8 trillion in federal commitments is already out the door, and half of the $700 billion October rescue package has been spent. The economic downturn is accelerating. And nobody is really in charge.

Among a lame-duck Bush administration, a lame-duck Congress, and a president-elect, Barack Obama, who has no legal authority to act and is reluctant to get entangled with the Bush team, Washington’s political vacuum has left policy adrift at the most critical economic period in a generation.

12lobby550Three of the most storied companies in U.S. economic history – General Motors, Chrysler and Ford – face possible bankruptcy. With GM threatening to topple by the end of this month, House Speaker Nancy Pelosi reached a compromise with the Bush administration on a temporary loan for less than half the $34 billion the automakers wanted. It is aimed at keeping GM and Chrysler alive until the Obama administration takes office. Ford said it could survive without loans so long as the other car makers avoid bankruptcies that would disrupt shared supply chains.

Horrendous job losses in November – 533,000, not including 422,000 who left the workforce – exceeded the gloomiest forecasts. Economists warn that failures in Detroit will intensify the contraction, but at the same time say $34 billion in emergency loans may not save the automakers anyway.

Nobody in Washington wants the automakers to fail, fearing the fallout on the rest of the economy, which is now in the kind of decline that no one under 30 has ever experienced.

“The economy is now locked in a vicious downward spiral,” wrote Nigel Gault, chief economist of economic forecaster IHS Global Insight. The problems have spread globally, greatly magnifying the danger of a long and painful downturn.

What to do?

A big part of the problem is that no one really knows what to do.

“The world is dealing with an unprecedented series of economic events,” said Joseph Grundfest, a professor of law and business at Stanford University and co-director of the Rock Center on Corporate Governance. “Anybody who stands up and says, ‘Look, this is what you should be doing,’ not only lacks humility, but also lacks a real appreciation of the intellectual difficulty of these circumstances. Because if the answer was so clearly obvious, everybody would have it.”

Pelosi backed off her insistence that the Bush administration bail out the automakers from the $700 billion bank rescue fund, agreeing to tap $25 billion already allocated to the automakers to build green cars. The first $350 billion of the bank fund is almost gone. Congress would have to vote to release the second half, and both parties are so furious with the way the administration has handled the bank rescue that they have warned Treasury Secretary Henry Paulson not to bother asking for more.

“I am through with giving this crowd money to play with,” Senate Banking Committee chairman Chris Dodd, D-Conn., said Thursday, a sentiment echoed by House Republican leader John Boehner.

President Bush, engaged mainly in a series of retrospective speeches and interviews on his legacy, nonetheless forced Pelosi to back off the bank fund Friday. After years of fighting Detroit on fuel-economy standards, Pelosi had resisted using money intended to retool the automakers. Bush said he was worried about giving tax dollars to “companies that may not survive.” Commerce Secretary Carlos Gutierrez warned that allowing Detroit to tap the bank rescue fund would only invite other industries to do the same.

As Congress plunged through two days of inconclusive hearings on Detroit, Obama remained noncommittal. His “one-president-at-a-time” line so irked House Financial Services chairman Barney Frank, D-Mass., that he let loose one of his signature retorts: “I’m afraid that overstates the number of presidents we have,” Frank said. Obama has “got to remedy that situation.”

Obama’s radio address

Obama responded with a presidential-style radio address Saturday, promising the biggest public investment in infrastructure since the federal interstate highways were built in the 1950s, along with all-out efforts to retrofit public buildings for energy efficiency, modernize school buildings, and expand broadband networks, including helping doctors and hospitals switch to electronic medical records. All are part of a huge fiscal stimulus program, with more to come, that he promised would create 2.5 million jobs and save money over the long haul.

“We won’t just throw money at the problem,” Obama said. “We’ll measure progress by the reforms we make and the results we achieve – by the jobs we create, by the energy we save, by whether America is more competitive in the world.”

The colossal bank bailouts, and the way Paulson has managed them, have rendered Paulson effectively powerless. Both parties, under his dire urgings and at great political peril, passed the unpopular $700 billion bank rescue a month before the election. Paulson told them he had a plan. Now they feel betrayed.

Paulson has run through $350 billion veering from one strategy to another. The money may indeed have prevented a banking collapse, but it has not unglued credit markets as much as expected. His rescue of banking giant Citigroup came under fire for its lack of transparency, generous terms and taxpayer assumption of close to $300 billion in debt.

“The value of these measures thus far has been to stave off a total meltdown, which we flirted with,” said Robert Shapiro, former undersecretary of commerce for economic affairs in the Clinton administration and now head of Democratic think tank and advocacy group NDN’s globalization initiative. Shapiro argued, however, as do many Democrats, that Paulson has failed to tackle the underlying problem of housing foreclosures that is causing banks to rein in lending.

Nor has the administration explained to the public the difference between bailing out banks and bailing out automakers, said Bruce Bartlett, a former Treasury official in the George H.W. Bush administration. That has led to confusion about why anyone is getting bailed out.

In addition, “the theory underlying the bailout has changed over time,” Bartlett said. “The $700 billion number appears to have been picked out of thin air. I never saw a rationale for it.”

Fed actions

The Fed has taken further radical steps to inject liquidity into the banking system and guarantee loans, $8 trillion worth by some estimates. Presumably not all the assets it has backed will sour.

The markets have judged some steps effective, Grundfest said. These include buying mortgage debt from Fannie Mae and Freddie Mac, which lowered mortgage interest rates; injecting capital into banks, which prevented them from imploding; and backstopping federal money market funds to stop a panic.

“But the reality is the effects are not large enough,” said Grundfest. “There is a massive global repricing of certain assets. It’s real estate values coming down not just in the United States but around the world, and a massive de-leveraging, not just in the United States but around the world.”

The consequences include widening recession, unemployment and foreclosures.

“Part of the unfortunate reality is that if real estate prices are going to re-equilibrate to a lower level that is significantly lower than the peak, it is mathematically impossible to have that happen without having homeowners and lenders lose a lot of wealth,” Grundfest said. “To the extent that people think government policy can prevent that from happening, the only way you can do that is by having the government say, ‘OK, you lenders and homeowners, you won’t lose the wealth, we the government will lose the wealth.’ And that means that all the rest of us will lose the wealth. But the wealth will be lost.”

Why banks are different from automakers

There is little disagreement that the failure of the Detroit automakers would pose a heavy burden on the economy as autoworkers lose their jobs and suppliers, auto dealerships and other businesses supported by the automakers fail. But these are different from the systemic effects of a widespread banking panic on the whole economy.

House of cards

Banks loan out far more money than they keep in deposits, roughly $9 in loans for every $1 in deposits. This is what some describe as an intentional house of cards. The system works fine in normal times to expand credit to consumers and businesses.

But if confidence in a bank collapses, and all the depositors demand their money at the same time, even a healthy bank will inevitably fail. This is known as a bank run, made famous in the Jimmy Stewart movie “It’s a Wonderful Life,” often shown at Christmas.

Panic mode

When there is a general collapse in confidence, and depositors rush to draw their money out of many banks at the same time, the entire financial system can fail. As depositors demand their money, banks call in their loans and sell their assets, and yet still cannot pay all their depositors.

Asset values are driven to fire-sale prices. Credit shrinks dramatically. The contraction is every bit as powerful as the expansion of credit that occurred when the bank initially leveraged its deposits into a much larger 9-to-1 portfolio of loans. This reverse process is known as “de-leveraging.”

When this happens to many banks at the same time, as happened in the Great Depression, the credit contraction can bring down the rest of the economy.

Tight credit

The U.S. financial system came quite close to a 1929 abyss in mid-September, which led Congress to pass a $700 billion rescue plan. Even so, bank credit remains sharply constricted and asset prices depressed.

After the Great Depression, the federal government put in place the Federal Deposit Insurance Corp. to protect depositors in a bank run and prevent panic from developing in the first place. (In the current crisis, the FDIC raised its protection level from $100,000 to $250,000 in deposits.)

– Carolyn Lochhead

E-mail Carolyn Lochhead at clochhead@sfchronicle.com.