Richard Vague: Recapitalize the Banks. . .NOW

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dollars pic.jpgThis is a guest post by regular TWN contributor Richard Vague. Vague is the Founding Chairman and former CEO of First USA Bank. He is also the former CEO of Barclays US/Juniper Financial Services. He publishes the eclectic blog, DelanceyPlace.com.
Delaying the bank recapitalization is delaying the recovery
Are bondholders standing in the way?
Completion. On a date certain. Soon.
As regards the recapitalization of banks, that’s what is needed before a recovery can ever start to gain traction, and before the stock market can truly stabilize.
There are three primary things that need to occur to turn the U.S. economy around: 1) appropriate easing of the money supply; 2) recapitalization of the banks; and 3) productive stimulus–and we further need to coordinate these activities internationally and resist the temptation to impede business activity with either rhetoric or items reminiscent of the Depression-era Smoot-Hawley Act.
The first of these three is being done–a widely under-reported fact and a lesson learned indelibly from the Great Depression when the nascent Fed disastrously contracted the money supply by 25%. And a stimulus package has been enacted, albeit a messy and clumsy one. But the Treasury continues to dither on the subject of recapitalization, with no clear and comprehensive plan, and no date certain for its completion. And this is the biggest sin committed in these early days of the new administration, its consequence stares at us from the financial pages every day, and we have too many so-called ‘zombie banks’ instead of banks with the muscle to aide in our nation’s economic recovery.
The reason recapitalization is so pivotal is that banks scrambling to regain capital adequacy are not able to provide proper credit support to thousands upon thousands of their business customers, forcing many of these businesses–including the creditworthy among them–to contract or fail. Bank recapitalization, therefore, can be seen as the greatest job preservation and creation tool we have.
And as the nine thousand bank failures of the Great Depression demonstrated, an anemic banking system exacerbates the depth and duration of an economic crisis.
There are a several plans out there that would work well enough and can achieve recapitalization without nationalization, including the ones articulated by George Soros in the forthcoming The Crash of 2008 and What it Means, or Max Holmes in his New York Times Op-Ed “Good Bank, Bad Bank; Good Plan, Better Plan,” to name just two of many.
While they have differences, these plans have in common that they effectively take all bad loans off the banks’ primary balance sheet, force the stockholders to take the losses in line ahead of the government, include the bank’s bondholders in the equation, enable banks to take in new private capital, and result in banks that are private, “investable,” and ready to help their customers.
These plans do not require that existing management or the boards remain wholly intact. These plans keep the ‘moral hazard’ safeguard intact.
Instead of pursuing any plan of this type, the Treasury has been doing a little of this and a little of that, with its primary tactic being to put a few tens of billions of dollars into banks that have hundreds of billions of dollars of problems, a strategy has no hope of delivering a healed banking system anytime soon.
And thus the recovery is delayed. Banks where the problem is not fully addressed cannot meaningfully expand their customer lending support–even if Congress tries to require it of them.
Why has the Treasury avoided this type of plan when so many are calling for it? Some have speculated that it is the magnitude of the problem that has prevented Geithner, et. al., from this type of solution–that a full recapitalization would require trillions of dollars beyond what has already been spent, would frighten both the markets and the politicians, and would be politically unachievable.
(As an aside–we question all the extra time being spent on so-called bank “stress tests.” Ensuring bank capital adequacy under stress is the raison d’etre of our bank regulators. If there are not models already in place to quickly assess a bank’s capital adequacy under a variety of stress scenarios–especially after last September–what have our regulators been doing?)
Yet others have pointed out that if losses go against not just existing shareholders, but bondholders as well, the remaining problem will be manageable even with greater-than-expected stress, and the recapitalization could proceed quickly.
These observers speculate that it is the community of bondholders that have undue influence with Geithner and Summers, and are the reason a Soros-type solution is not being pursued. And the government’s existing preferred stock investments complicate this further still.
If so, it’s a tragedy–and an impediment to the economic turnaround we so desperately need.
In the type of plan we would prefer, a date is set, a valuation process (however imperfect) is established, banks have until that date to put their bad loans into a bad bank (or ‘side pocket’ in Soros’s case) guaranteed by the government, and new private capital is raised coincident with that activity (or as soon as feasible thereafter with the government either bridging the interim in some manner). The banks are then ready to be part of the solution rather than part of the problem.
— Richard Vague

Comments

35 comments on “Richard Vague: Recapitalize the Banks. . .NOW

  1. Erich Kuerschner says:

    Efforts are indeed ongoing to pursue fraud convictions. One such effort:
    NYT 3-11-09 “Financial Fraud Is Focus of Attack by Prosecutors” by David Segal
    http://tinyurl.com/c5hmo2
    A good article on AIG fraudulent practices
    “Moral hazard and AIG” is at econbrowser , linked under erichww above (Blog seems to block more than one http link, sorry)

    Reply

  2. Erich Kuerschner says:

    Efforts are indeed ongoing to pursue fraud convictions. One such effort:
    NYT 3-11-09 “Financial Fraud Is Focus of Attack by Prosecutors” by David Segal
    http://tinyurl.com/c5hmo2
    A good article on AIG fraudulent practices
    “Moral hazard and AIG” is at econbrowser here”
    http://tinyurl.com/cdlnev

    Reply

  3. Mr.Murder says:

    Print out debt vouchers with graded currency interest. Thus one can buy into debt with the money holding a portion of that. Think of it as an advance on money yet to be printed.
    This new currency, in the form of net debt, needs to be issued by the Treasury. It needs a face upon it. GWB’s smirk is perfect for the task.
    We need to mitigate or cusion the impact of this crash by diluting it in some form. Print out these as a form of short sell.
    The only option past that is nationalizing assets….
    Some monetary measures can also be implemented. Changing the amount of actual precious metals in currency(see also World War Two, when copper took on new importance) could also be done. It doesn’t seem like much, but somethnig done is better than nothing, and it makes for some collector items, start coining limited runs on sub valued coinage.
    Put real teeth back into the SEC. Level the playing field.
    We started doing our own currency buybacks w/Cheney to mask some of the debt problems going into election cycles when they were running things? Weigh out this result when you gain a budget savings on any other item, place a portion of budget savings into buybacks when it can benefit currency value.
    By the way, line bosses for steel subproducers are working together on ONE SHIFT at machine stations.
    Hope to see people take it to the streets soon.
    By the way, MLK Jr. would be marching on DC right now to tell us we need to leave Afghanistan and Iraq AND to say we need Jobs with equity, Health Care, and Education improvements.
    See how much things have changed?

    Reply

  4. Cee says:

    After reading about the recent antics of AIG I think of a global organized crime bust-out.

    Reply

  5. robert M says:

    Craig Hickman asked last week what grade you would give President Obama. The grade I would give him for economics is Incomplete. I originally gave him an “F”. I came to the conclusion that this grade would be detrimental to the argument I am going to make.
    President Obama receives an I because the economic problems he is facing require that he change his institutional thinking in examining this problem. Institutional thinking is the same problem Colin Powell had when dealing w/ the decision to invade Iraq. Colin Powell is first and foremost a military officer in the united States military. He achieved the highest rank in our system; Chairman of the Joint Chiefs of Staff. Powell’s institutional thinking was constrained by the fact as a military officer at that level he gives the President his absolute best position and plan(s). when the Presdient gives the order he says yes sir and carries out the order regardless of what he personally thinks. As Sec of State he had the opportunity to say no to the decision to invade Iraq and resign if he didn’t support it. Cyrus Vance set the precedence when he opposed the decision to mount a military operation to rescue the hostages in Iran and resigned. This action is the action of a civilian. colin Powell never acknowledged that was his real position.
    President Obama’s institutional thinking comes from being a lawyer. A lawyer’s thinking starts w/ the concept of contract. Contracts are based on rights and responsibilities. President Obama is not just any lawyer his specialty is the Constitution. The constitution is revered as the best contract ever written for the governance of man. Read the Preamble:
    We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.
    We the People of the United States….establish this Constitution for the United States of America. We establish this Contract. This contract is considered so sacrosanct it can only be amended by large votes in both Houses and ratification by voters in the States. This contract is to be protected against the passions and prejudices of men.
    In the our current world this desire to move w/ such institutional thinking and its measured approach is anathema to the situation we face in regards to our economy. The situation we face is the death spiral of our financial institutions. The death of these means the death of the country. This death spiral is being brought on buying the ownership of financial contracts that have become known as toxic assets. Toxic assets consists of two types. The first is mortgage backed bonds(CDO’s) and the second is credit default swaps(CDS). The latter, JPMorganChase’s monster are the assets that must die.
    CDS’s are a type on insurance for bonds. A bondholder buys one to insure the payment of interest and/or principal in case of default by the bond issuer. The seller prices them on a percentage of the face/nominal value of the bond and the bond issuers perceived risk of default and receives the premium. This premium is in basis points(.01 of 1%). So a premium on $10,000,000 bond might be 20 basis points or $20,000 against an interest payment of 4% or $400,000. Collateral/margin held by the seller is negotiable and it may or may not rise as the value of the bond changes.
    Slowly , the world and its opinion makers are coming to realize that the toxic assets known as Credit Default Swaps are a monster that most be killed. The monster is bigger than the aggregate GDP of the US. This monster grows everyday because no one will end the practice of issuing. I am advocating for a force majeure declaration that all CDS’s are null and void w/ the premiums repaid over 3 to 4 years. Precedence has been set by former Treasury Sec. Paulson under TARP legislation when he gave banks permission to extend the time their write offs of losses could be carried forward. If we really have to reach make it a matter of national security((paying of interest for one year a 5% interest rate on 10% of nominal dollar amount of bonds is $760,000,000,000. about 5%of GDP of 14.58 trillion) is a threat to ourselves and the world. It doesn’t even have to be done in a coordinated way w/ other countries just tell them we are doing it. They will follow suit or watch their financial institutions go to hell and their countries with it.
    to do the math:
    GDP of US 14.58 trillion
    Size of US mortgage debt 2007 10.7 trillion
    Nominal size of CDS’ outstanding 2nd Q 2008 $152 trillion
    Nominal size of CDS’s held by US institutions 2nd q 2008 15.2 trillion
    size of international corporate bond market $45 trillion
    size of US corporate bond market $25.2 trillion
    @ 5% interest payment on entire nominal amount
    $1.52 trillion(1%) x 5 = $7.6 trillion dollars
    assume margin of 2% on nominal value
    $1.52 trillion x 2 = $3.04 trillion
    President Obama’s budget deficit for 2010 assuming assumptions are accurate
    $1.75 trillion
    So if you null and void them $3 trillion dollars of margin equity(margin on stocks is 50%) or more immediately moves to financial institutions(FI) balance sheets. Currently much of this equity is coming from taxpayer as loans or guarantees. This means deficit spending goes up to provide further capital to the system. Why are we, the taxpayers supporting a contract that can grow greater than the abiity of the taxpayer to pay for it. The only losers are bondholders whose bonds go bad, speculators- do not lose as they get their premiums back and any other institution that has capitalized the projected winnings from cashing a CDS onto their balance sheet.
    We must kill the monster or let it eat us alive. This monster is a contract. President Obama in order to order Treasury Sec Geithner to declare force majeure must give up his institutional thinking that contracts are sacrosanct, that amending them must come slowly. This contract because of its unparalleled abilty to grow greater than the size of our total economy must be killed. It is our survival that is sacrosanct not the monster’s.
    There are readers of this blog (JJPolitics) that have to be going huh, how did you get to this conclusion? I came to it because I advocated for the original idea of the TARP in Oct of 2008. It was feasible that these assets could be priced and bought by the government to solve the implosion of the credit markets. The problem I did not foresee is that if the FI sold them at prices the buyers would pay they would be insolvent. Insolvency at the time would create bigger problems.
    Treasury Sec Paulson recognizing the problem gave the FI’s the money out right. Along w/ a massive expansion of the FED’s balance sheet which gave guarantees and loans to FI the immediate crisis was stemmed.(http://www.ritholtz.com/blog/2009/02/credit-crisis-watch-some-positive-developments/) The problem for the taxpayer wasn’t. In fact from the taxpayer point of view we were prepared to give more money if it would keep us in our homes. So how to solve the problem for the taxpayer became the next step..
    I then read this Do we need to cancel all CDS contracts; http://www.ritholtz.com/blog/2008/11/do-we-need-to-cancel-all-cds-contracts/. Then this; http://www.nytimes.com/2009/01/25/business/25gret.html?_r=2&ref=business. With the idea of killing them already in my mind the problem of AIG popped up again (good one here); http://www.ritholtz.com/blog/2009/03/ibanks-grabbed-50-billion-in-aig-bailout-cash/.
    With my thinking now changing I began asking why aren’t I seeing this idea being pushed on the financial channels. The conclusion was it was not in the interest of those people holding them. In fact AIG claims the world will come to an end if they aren’t supported;
    http://www.ritholtz.com/blog/2009/03/aig-is-the-risk-systemic/
    So now all that is left is appeal to President Obama by challenging his thinking to stop the death of our economy.
    Sources:
    Force majeure: http://en.wikipedia.org/wiki/Force_majeure_clause
    Credit default swaps : http://en.wikipedia.org/wiki/Credit_default_swap
    corporate bond market size:http://en.wikipedia.org/wiki/Credit_market
    size of GDP:http://en.wikipedia.org/wiki/Credit_market
    size of mortgage debt:http://mwhodges.home.att.net/nat-debt/debt-nat-a.htm#component

    Reply

  6. JohnH says:

    OK, we should implement the phony foreign policy that Bush campaigned on in 2000. Granted that everything Bush ever said was BS. But a humble foreign policy was perhaps the only good idea the man ever had, even though he never meant it.

    Reply

  7. pauline says:

    That “humble foreign policy that Bush campaigned on. . .” was, as my old poli sci prof said, “98% symbolic, 2% substance”, and that’s giving GW more credit than his ME foreign policies were worth.
    When Obama was asked very recently if the US was winning in Afghanistan, he quickly did not avoid answering the press question — he offered a distinct, “no”. Last night Rachel Maddow showed a similar question to GW a few years ago and he castigated the lady when she tried to ask a follow-up question.
    As I watched him, “hauty, rude, evasive, dictator-like” came to mind.
    GW was carrying out a ME foreign policy that was a million miles from “humble”. imo it was pre-planned long before daddy snuck him into the WH.

    Reply

  8. Robert M says:

    Slowly , the world and its opinion makers are coming to realize that the toxic assets known as Credit default swaps are a monster that most be killed. The monster is bigger than the aggregate GDP of the US. This monster grows everyday because no one will end the practice. I have advocated for a force majeure declaration that all CDS’s are null and void w/ the premiums repaid over 3 to 4 years. Precedence has been set by former Treasury Sec. Paulson under TARP legislation when he gave banks permission to extend the time their write offs of losses could be carried forward. If we really have to reach make it a matter of national security((paying of interest for one year a 5% interest rate on 10% of nominal dollar amount of bonds is $760,000,000,000. about 5%of GDP of 14.58 trillion) It doesn’t even have to be done in a coordinated way w/ other countries just tell them we are doing it. They will follow suit or watch their financial institutions go to hell and their countries with it.
    to do the math:
    GDP of US 14.58 trillion
    Size of US mortgage debt 2007 10.7 trillion
    Nominal size of CDS’ outstanding 2nd Q 2008 $152 trillion
    Nominal size of CDS’s held by US institutions 2nd q 2008 15.2 trillion
    size of international corporate bond market $45 trillion
    size of US corporate bond market $25.2 trillion
    @ 5% interest payment on entire nominal amount
    $1.52 trillion(1%) x 5 = $7.6 trillion dollars
    assume margin of 2% on nominal value
    $1.52 trillion x 2 = $3.04 trillion
    President Obama’s budget deficit for 2010 assuming(hahaha) assumptions are accurate
    $1.75 trillion
    So if you null and void them $3 trillion dollars of margin equity immediately moves to financial institutions balance sheets. Currently much of this equity is coming from taxpayer loans,or guarantees which means deficit spending goes down providing further capital to the system. Losers are bondholders whose bonds go bad, speculators- no lose they get their premiums back and any other institution that has capitalized the projected winnings from cashing a CDS onto their balance sheet.
    We must kill the monster or let it eat us alive.
    sources:
    CDS: http://en.wikipedia.org/wiki/Credit_default_swap
    corporate bond market size:http://en.wikipedia.org/wiki/Credit_market
    size of GDP:http://en.wikipedia.org/wiki/Credit_market
    size of mortgage debt:http://mwhodges.home.att.net/nat-debt/debt-nat-a.htm#component

    Reply

  9. JohnH says:

    Not just aid to Israel. The whole imperial project has to be up for reconsideration. You can only borrow so much from China for international adventures, particularly ones that have no clearly defined missions (Iraq, Afghanistan, Iran, etc. etc.)
    It’s time for that humble foreign policy that Bush campaigned on in 2000.

    Reply

  10. samuel burke says:

    during this financial crisis the united states will have to reconsider all the billions of dollars that we give to israel….these dollars only allow israel to flex its bellicose arm in the middle east causing great harm to our national interest in the middle east.
    our unconditional support of israel also causes discomfort to the russians who see in the middle east the same much needed resourses that the u.s is foolishly trying to appropriate using colonial methods of the past.
    israel is too costly to america both financially and diplomatically in this brave new economic reality which confronts most of the world.

    Reply

  11. questions says:

    As a quick afterword, Josh Marshall addresses some of my concerns in a current post at TPM. But I’m uncertain about what happens if the worst happens, and he leaves that unsaid it seems to me.

    Reply

  12. questions says:

    erichwwk,
    No, I’m not confusing personal wealth and the banking system. What I’m unsure of is what happens if the banks fail. Certainly a lot of shareholders are wiped out. Any equity funds that are tangent to banking might be wiped out (if private equity travels in the same circles). That’s the millionaire side of things.
    Of course, as WigWag has pointed out, a lot of retirees and near-retirees are dependent on the stock market, as are universities, public pension funds and the like. So shareholder wipeout becomes pretty widespread devastation.
    Another concern is what happens to massive farm purchases of seeds and equipment if the banking system fails. What happens to half-finished buildings if their lines of credit run dry. What happens to many of the really big things we do if Citibank goes under. How tied together is the economy?
    When you write, “If we are so stupid as stop doing what we must merely for a “lack of money”, one could argue that our society is not worth saving,” I am not sure how to respond. We avoid all sorts of duties because of a lack of money. We don’t feed hungry people, we don’t house poor people, we don’t grant much more than emergency medical care and we certainly don’t feed the whole world. A “lack of money” is a huge social problem. Should we then fail? Should merely those who lack money fail?
    I read vast quantities of material about the economy and I have to map it to what I know, and given that my coursework was not in econ, I will freely admit that I don’t “get” everything. So please tell me, are Geithner et al merely protecting the wealth of friends/the predator class, or is there a legitimate concern with social collapse if the financial system or the banking system or part of the banking system goes down? Does Citibank suddenly cancel every credit card and thus make it impossible for people to buy food? Will farmers be able to buy seed and fertilizer? Where are the concerns for collapse? Why does Roubini think nationalization is crucial while Blinder wants something else? I understand what they say, but not in a context that explains why banks matter. I’d love a link or a response. Thanks in advance. And sorry in advance if I’m being either sophomoric or obtuse.

    Reply

  13. kathleeng says:

    Hamas official hails British MP George Galloway as ‘hero’ in Gaza
    By The Associated Press
    Tags: Gaza, Hamas, Israel News
    A Hamas official on Monday hailed controversial British MP George Galloway as a “hero” upon the lawmaker’s arrival in the Gaza Strip.
    Galloway entered Gaza from Egypt with an aid caravan. About 50 British and Scottish volunteers and 100 vehicles carrying food, clothing and medicine passed through Egypt’s Rafah border crossing with him, a Hamas border official said.
    Receiving the activists, Ahmed Kurd, Hamas’ minister of social affairs, thanked Galloway for the “noble goodwill gesture” and called the lawmaker a “hero.”
    Advertisement
    Galloway, who was expelled from Britain’s ruling Labour Party in 2003 over statements he made in opposition to the Iraq war, said a total of 300 British citizens and 200 Libyans would be entering Gaza.
    After entering Gaza, Galloway called the aid a drop in the ocean, but said the trip was to send a message that the lifeline from Britain to Gaza is in.
    Other aid, including electrical generators and a fire engine, would enter Israel, where the British delegation hoped to get it into Gaza through coordination with the International Committee of the Red Cross, the official said.
    Israel allows daily convoys of aid into Gaza and denies that there are shortages of food, fuel or medicine there.
    On Sunday, activists belonging to Galloway’s “Viva Palestina” convoy clashed with Egyptian security forces in the north Sinai town of el-Arish, close to the border with Gaza.

    Reply

  14. erichwwk says:

    Spot on, John H.

    Reply

  15. erichwwk says:

    First, kudos to Richard Vague for his stance on terrorism, and for including bondholder assets, after stocks, but before taxpayer assets in recapitalizing banks.
    However, I find his statement:
    “These plans do not require that existing management or the boards remain wholly intact. These plans keep the ‘moral hazard’ safeguard intact.”
    disingenuous. I find these plans to address ‘moral hazard’ purely fluff, and meaningless, and seem to me to merely an attempt to distract from the fact that nothing of note has been done.
    Stating that Treasury “may” replace a few management personnel does not REQUIRE that even ONE person is replaced. Writing meaningful management incentive changes is not easy, even when one makes a good faith effort and it APPEARS that one has written tight rules.
    EG, it turns that out that a previous attempt to cap executive compensation, disallowing corporations to deduct compensation in excess of what “appeared as a tight $1M cap”, was in practice meaningless, and had no effect, according to a study by the National Board of Economic Research. Evading this rule is a piece of cake from those that made a living by essentially finding loopholes in financial contracts and money creation.
    http://www.nber.org/digest/dec00/w7842.html
    I also note that Richard Vague does not mention Treasury refusal to force banks to account for their assets by marking-to-market. Restoring integrity in financial reporting and accounting is another “must do” prerequisite to restoring markets for future contracts.
    And to avoid the issue of recapitalization of taxpayer accounts (after all it was THEIR balance sheets that were most affected by the manipulation of asset values to make it appear that a credit splurge was the optimal consumer behavior) is likewise disingenuous. What business demand for credit is there when consumers are reluctant to engage in future contracts because they have been tricked into false expectations and wish to restore (recapitalize) THEIR balance sheets?
    “Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone.”
    “The political problem of mankind is to combine three things: economic efficiency, social justice and individual liberty.
    – John Maynard Keynes

    Reply

  16. JohnH says:

    Nassim Nicholas Taleb, who was involved in trading for 21 years and is now a distinguished professor at New York University, puts it extremely well:
    http://www.ft.com/cms/s/0/fa89be08-02aa-11de-b58b-000077b07658.html
    “The [banking] incentive scheme commonly in place does the exact opposite of what an “incentive” system should be about: it encourages a certain class of risk-hiding and deferred blow-up. It is the reason banks have never made money in the history of banking, losing the equivalent of all their past profits periodically – while bankers strike it rich.” Bluntly put, there are no disincentives to bankers going bad.
    Bankers’ incentive plans promote the privatization of profits and the socialization of wealth, transferring wealth from taxpayers to bank executives’ pockets.
    If Vague and Soros are really serious about solving the problem, the incentive schemes must be changed BEFORE banks get recapitalized. Otherwise, they will just take these additional monies and direct them into their own pockets, AKA business as usual.
    As I said earlier, a few prominent prosecutions for fraud would do a lot to change the Wall Street mindset by creating urgently needed disincentives.
    If George Bush could let his good buddy, Enron’s “Kenney Boy” get convicted, Obama can surely summon the courage to lock up a few bankers and Wall Street types and throw away the key. It’s truly shocking that there have been ZERO prosecutions to date of any prominent bankers.

    Reply

  17. Robert M says:

    JPMorganChase’s Monster must die
    Slowly , the world and its opinion makers are coming to realize that the toxic assets known as Credit default swaps are a monster that most be killed. The monster is bigger than the aggregate GDP of the US. This monster grows everyday because no one will end the practice. I have advocated for a force majeure declaration that all CDS’s are null and void w/ the premiums repaid over 3 to 4 years. Precedence has been set by former Treasury Sec. Paulson under TARP legislation when he gave banks permission to extend the time their write offs of losses could be carried forward. If we really have to reach make it a matter of national security((paying of interest for one year a 5% interest rate on 10% of nominal dollar amount of bonds is $760,000,000,000. about 5%of GDP of 14.58 trillion) It doesn’t even have to be done in a coordinated way w/ other countries just tell them we are doing it. They will follow suit or watch their financial institutions go to hell and their countries with it.
    to do the math:
    GDP of US 14.58 trillion
    Size of US mortgage debt 2007 10.7 trillion
    Nominal size of CDS’ outstanding 2nd Q 2008 $152 trillion
    Nominal size of CDS’s held by US institutions 2nd q 2008 15.2 trillion
    size of international corporate bond market $45 trillion
    size of US corporate bond market $25.2 trillion
    @ 5% interest payment on entire nominal amount
    $1.52 trillion(1%) x 5 = $7.6 trillion dollars
    assume margin of 2% on nominal value
    $1.52 trillion x 2 = $3.04 trillion
    President Obama’s budget deficit for 2010 assuming(hahaha) assumptions are accurate
    $1.75 trillion
    So if you null and void them $3 trillion dollars of margin equity immediately moves to financial institutions balance sheets. Currently much of this equity is coming from taxpayer loans,or guarantees which means deficit spending goes down providing further capital to the system. Losers are bondholders whose bonds go bad, speculators- no lose they get their premiums back and any other institution that has capitalized the projected winnings from cashing a CDS onto their balance sheet.
    We must kill the monster or let it eat us alive.
    sources:
    CDS: http://en.wikipedia.org/wiki/Credit_default_swap
    corporate bond market size:http://en.wikipedia.org/wiki/Credit_market
    size of GDP:http://en.wikipedia.org/wiki/Credit_market
    size of mortgage debt:http://mwhodges.home.att.net/nat-debt/debt-nat-a.htm#component

    Reply

  18. erichwwk says:

    Questions, you do seem to me to confuse a collapse of the banking system with a collapse of bankers personal wealth. Keynes main point was when we muck up banks so bad that they cannot support normal living transactions, we must find an alternative means of communicating, of coordinating those activities. If we are so stupid as stop doing what we must merely for a “lack of money”, one could argue that our society is not worth saving.
    I AM grateful that so many TWN readers do get it.
    There are too many versions of “what happened” to list them all, so I’ll just list the two versions circulating among informed experts. Both are covered in an article at FORBES by Eric K. Clemons,a professor in the Information Strategy and Economics Group at the Wharton School of the University of Pennsylvania in responding to a group of visiting Chinese scholars query “How to get Rich?”
    http://tinyurl.com/agyupx
    The first view is the one espoused by those that profited from the fiasco, as represented by folks like Richard Vague, George Soros, Leo Tilman, and Rahm Emmanuel. While attempting to lessen the costs to the taxpayer in restoring balance sheets, it considers the funds withdrawn from financial institutions as personal compensation off limits. It is represented by this story quote, and describes CEO behavior as “perhaps unintentional”:
    “A colleague in the accounting department gave them a careful, scholarly, even-handed explanation of how firms’ decisions on the repricing of assets in their portfolio could perhaps have been used, perhaps unintentionally, to create false expectations in the marketplace, and could have been done in a way undetectable to auditors, leading to over-investment in toxic subprime assets.”
    The second view, by those that do NOT have skin in the game (ie those who earned an honest income) is represented by the second part of this story, and uses the word deliberately:
    “With much less tact, I explained that, indeed, mispricing of assets at an inflated price could have been deliberately used to create the illusion of value, and this could then have been used to create the very real rewards of wealth for the financial engineering wizards responsible for the scheme.”
    To those that study the incentive structure, and understand a previous comment (that “free markets” are NOT identical with “unregulated markets” (the view of Adam Smith and Friedrich Hayek, btw) recognize that transacting over FUTURE behavior requires that the contract expectations be realized. This is in spite of the terms becoming due not only far in the future, but also far away geographically, in a different culture, with a different language.(From a property rights perspective one does NOT trade “things” such as goods, but rather agrees to change one’s behavior re a thing, on the condition that the other party changes their behavior towards another thing).
    We see the dollar being supported because trust in the US Government (so far) exceeds trust in individual US corporations, where CEO’s create illusionary justifications to skim money to be moved to safe havens beyond the reach of courts.
    While I commend both George Soros and Richard Vague for solutions that are more realistic than what Treasury and the Fed is implementing, until both George and Richard acknowledge that a great deal of their “income” was earned fraudulently, and open up their PERSONAL funds to bank recapitalization, the public will rightfully continue to oppose bank bailouts. If the investment community wishes to include the small investor as a source of funds, it MUST ensure that corporation earnings cannot be manipulated as a basis of withdrawing funds, and diluting outside investor returns. PERIOD.

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  19. questions says:

    Merck-Schering Plough deal for 41 Billion??? Are we getting too big to fail in yet another sector? Could there be a ridiculous boom-and-bust in prescription drugs? Speculation on my part, but then who’da thunk that housing demand could become as elastic as it has?
    If there’s health care reform, maybe we aren’t going to pay for this merger?

    Reply

  20. Pacos_gal says:

    What we are not seeing out of Washington is leadership in the banking fiasco. Clear cut, this is what needs to be done and so we will do it kind of leadership. Obama speaks nicely, Congress plays politics with earmarks and partisanship while the economy continues to tank. Everyone wants to solidify their political position and in the end, nothing is done, no consolidated message comes out and wall street wants to try and hang on to doing business as usual. Until those things stop and the ones who can solve this problem decide to actually do so, nothing is going to get better. I think that everyone is waiting, hoping that there will be a turn around without actually having to take any action and put their “political” futures on the line. How long will it take, how many more jobs will have to be lost, how many more companies will need to fail before the fear is set aside and a real leader steps up. Whomever steps up to the plate is who will have the gratitude of the citizenship. People want leadership, Obama talked a good talk, but talk will not secure the economy, action will and action requires the White House and the Congress to come together and do whatever it is that needs to be done. I don’t see that happening now and I don’t see that happening any time in the near future.
    Will it ever?

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  21. pauline says:

    questions, please see the previous article I posted yestereday, “Who got AIG’s bailout billions?”

    Reply

  22. questions says:

    Pauline,
    There might be another issue that Lindorff doesn’t deal with, and that is, if we let the banks and AIG go, what kind of disruption do we end up with for some pretty basic things like food, water, electricity, transportation? Is the collapse of the banking system merely the collapse of the retirement funds of a few millionaires, or does it initiate not ripples but a tsunami? And if that tsunami means food riots or people freezing in the north and burning in the south, not educating their kids, and all the other hallmarks of a collapsing economy and society, we should be wary. I don’t know enough to answer this question, but until there’s a clear answer, I don’t think we can just say, gee ObamaGeithner, bring ’em on.

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  23. pauline says:

    Kiss the Banks Goodbye
    By DAVE LINDORFF
    The futility and stupidity of the Fed’s and the Obama administration’s policy of pumping ever more money into failing banks and insurance companies in a vain effort to get them lending again was demonstrated—if anyone was paying attention—by the collapse in auto sales this past month, with all the leading companies, Ford, GM and Toyota, reporting sales down by about 40%.
    This fall off in car buying was despite record discounting by the auto industry, and offers of 0% financing.
    Clearly, obtaining financing is not the reason people are not buying cars.
    People are not buying cars because they are worried about having a job to enable them to pay back the loan.
    It’s the same reason people aren’t buying houses. It’s not that you cannot get a mortgage. There are plenty of smaller banks that would be happy to lend money to buy a house these days. But who’s going to go out and buy a house in this economy? First of all, to buy a house, unless you are a first-time buyer, you have to sell your current house, but that would mean taking a huge loss. Indeed, one in five homes in America today is technically “underwater”—that is, it is worth less than the outstanding mortgage on the property. Probably another one in five are worth little more than the outstanding mortgage. No one would sell a house under either such circumstance.
    The point here is that if people aren’t willing to spend money, then what good is it to give more money to banks and their shareholders, in hopes that they will start lending it? The lending business has two sides—those offering to make a loan, and those wanting to borrow. If there’s no borrower, no amount of money available for lending is going to change the fact that there will be no loans written.
    Commercial lending is not that different in this regard. Companies generally borrow money to expand. You don’t need to borrow money when your business is shrinking, unless it is to try and stave off collapse. What a company does when its markets contract and its sales and earnings fall is it cuts back on production and lays off workers. It doesn’t need to borrow money to do this. Of course, if sales collapse too fast, the company could be caught owing back wages to workers. That’s true. And in that case, a company might want to borrow in order to meet its obligations, but that’s hardly the kind of loan a bank would want to make—to a dying enterprise unable to meet payroll.
    Business borrows when it is expanding, because that’s a great investment. If you know that you can earn a 15% return on your investment in a period of economic growth, and you can borrow money for expanded production at 4%, that’s a great deal. It’s also a great deal for the bank, since lending to a company that is expanding is a pretty low-risk proposition. The central government wouldn’t have to press banks to lend to such companies. The banks would do it on their own.
    So, with the economy still in free fall, with companies laying off American workers at a rate of over 20,000 per day, with real unemployment soaring past 18 percent—one in six American workers are now either out of work and looking for a job, out of work and giving up looking, or involuntarily working part-time—and with family wealth more than 50% eroded away, there is simply no way that Americans are going to turn around and start borrowing and spending again. And given that the American economy is 72% composed of consumer spending, there is no way that the economy is bouncing back anytime soon.
    That means that the hundreds of billions of dollars that are being poured into the likes of Citibank and AIG are being completely wasted. It is simply a pointless and scandalous transfer or wealth from the American public to the shareholders of these companies—the very companies and people who caused this catastrophe in the first place.
    If you wanted evidence of this futility, just check out the current market capitalization (the current value of all shares of a company) of Citigroup and AIG. Citigroup, despite having received $75 billion in taxpayer bailout money, is now worth $5.4 billion–which is less than Autozone, a chain of car parts stores, and less than H&R Block, the franchise chain of tax preparers. As for AIG, which has received an astonishing $180 billion in taxpayer bailout funds, its total market value today is less than $1 billion! All that bailout money has been lost into thin air, and the government today could buy both companies outright for about what it’s blowing every month in Iraq.
    It’s time to put a stop to this farce. Restoring the American economy is not going to be a matter of simply jump-starting consumer spending, or even business investment. It’s going to take a long, hard, focused effort to move away from a parasitic consumer economy in which profits are largely made through speculation, and towards a real economy that actually makes things that people both here and around the world need.
    The sooner this truth is recognized, the more resources the government will still have left to put into the kind of investments that can help make that happen—things like job creation, income supports, home refinancings and medical system reform that could help Americans get back on their feet. Of course, it would also be necessary to end the wars overseas and to dramatically slash military spending.
    When former companies like Citicorp and AIG are history, and when former Lehman Brothers, Citibank and AIG managers, as well as most of the Pentagon Brass, are out working at civilian conservation corps camps helping to restore watersheds or replant forests, we will know that the government has finally “gotten” it.
    Dave Lindorff is a Philadelphia-based journalist and columnist. His latest book is “The Case for Impeachment” (St. Martin’s Press, 2006 and now available in paperback). He can be reached at dlindorff@mindspring.com

    Reply

  24. alan says:

    Regretfully the banks and those who ran them into the ground have lost our trust. If you want taxpayers to save you here are a couple of things you need to do: try and jail, if found guilty, those crooks in the banking community who sold toxic products. Yes, they need to see the inside of a cooler. Then line up those gasbags on CNBC and get them to go to a typical Chines session to confess their sins a la communist style for being cheerleaders for Wall Street.
    In Britain they have a banker who ran his bank into the ground and that a**hole is fighting to keep his pension of 693,000 pounds a year. And you want us to trust this kind of an attitude? Lloyds, once a venerable institution is now effectively nationalised with the British Govt holding 75% of its worthless shares.
    We need to clean up root and branch, let the bondholders take their lumps and start afresh. My 401K is way down. Whose going to bail me?

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  25. jhm says:

    Warning: half-informed opinion follows:
    Missing from this discussion is the fact that CDS claims come
    before shareholders’ and bondholders’ claims. Bush/Gramm
    “reforms” make CDS claims come even before any bankruptcy can
    begin, and it isn’t clear that their would be anything left after.

    Reply

  26. kotzabasis says:

    I was remiss in the above post not to mention also the great failure that will issue from Obama’s opening the door of diplomacy to the Tehran mullahs and their sundry terrorist proxies who once they enter the discourse of diplomacy they will transform themselves into a huge constrictor—which is their true nature—smothering all reason and taking the last breath out of Obama’s dotty and foolish hope that it’s through an olive branch of diplomacy that one can resolve conflicts and issues with irreconcilable enemies.

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  27. kotzabasis says:

    On this great crisis of the economy the political credentials and “wisdom” of the Obama administration may implode, and the romantic urge of many Americans that attached them to the slogan ‘we are all Obamas now’ might yet finish with an ironic requiem ‘we are all dead Obamas now.’

    Reply

  28. pauline says:

    Who got AIG’s bailout billions?
    Sun Mar 8, 2009 8:30am EDT
    By Toni Reinhold, Reuters
    NEW YORK (Reuters) – Where, oh where, did AIG’s bailout billions go? That question may reverberate even louder through the halls of government in the week ahead now that a partial list of beneficiaries has been published.
    The Wall Street Journal reported on Friday that about $50 billion of more than $173 billion that the U.S. government has poured into American International Group Inc since last fall has been paid to at least two dozen U.S. and foreign financial institutions.
    The newspaper reported that some of the banks paid by AIG since the insurer started getting taxpayer funds were: Goldman Sachs Group Inc, Deutsche Bank AG, Merrill Lynch, Societe Generale, Calyon, Barclays Plc, Rabobank, Danske, HSBC, Royal Bank of Scotland, Banco Santander, Morgan Stanley, Wachovia, Bank of America, and Lloyds Banking Group.
    Morgan Stanley and Goldman Sachs declined to comment when contacted by Reuters. Bank of America, Calyon, and Wells Fargo, which has absorbed Wachovia, could not be reached for comment.
    The U.S. Federal Reserve has refused to publicize a list of AIG’s derivative counterparties and what they have been paid since the bailout, riling the U.S. Senate Banking Committee.
    Federal Reserve Vice Chairman Donald Kohn testified before that committee on Thursday that revealing names risked jeopardizing AIG’s continuing business. Kohn said there were millions of counterparties around the globe, including pension funds and U.S. households.
    He said the intention was not to protect AIG or its counterparties, but to prevent the spread of AIG’s infection.
    The Wall Street Journal, citing a confidential document and people familiar with the matter, reported that Goldman Sachs and Deutsche Bank each got about $6 billion in payments between the middle of September and December last year.
    Once the world’s largest insurer, AIG has been described by the United States as being too extensively intertwined with the global financial system to be allowed to fail.
    The Federal Reserve first rode to AIG’s rescue in September with an $85 billion credit line after losses from toxic investments, many of which were mortgage related, and collateral demands from banks, left AIG staring down bankruptcy.
    Late last year, the rescue packaged was increased to $150 billion. The bailout was overhauled again a week ago to offer the insurer an additional $30 billion in equity.
    AIG was first bailed out shortly after investment bank Lehman Brothers was allowed to fail and brokerage Merrill Lynch sold itself to Bank of America Corp.
    Bankruptcy for AIG would have led to complications and losses for financial institutions around the world doing business with the company and policy holders that AIG insured against losses.
    Representative Paul Kanjorski told Reuters on Thursday that he had been informed that a large number of AIG’s counterparties were European.
    “That’s why we could not allow AIG to fail as we allowed Lehman to fail, because that would have precipitated the failure of the European banking system,” said Kanjorski, a Democrat from Pennsylvania who chairs the House Insurance Subcommittee.
    TOXIC ASSETS/TOXIC WASTE
    As part of its business, AIG insured counterparties on mortgage-backed securities and other assets. The collapse of the U.S. subprime mortgage market, which triggered a global financial crisis, left the insurer and some of its policy holders facing possible ruin as the value of assets declined.
    U.S. regulators failed to recognize how much risk AIG was piling on in credit-default swaps, and by the time they understood, they had no choice but to pour in billions of public dollars, Kohn and other officials told the Senate panel.
    Senators were outraged by the lack of details about where the bailout money has gone.
    “That we find ourselves in this situation at all is … quite frankly, sickening,” said Senator Christopher Dodd, the Democrat who chairs the committee. “The lack of transparency and accountability in this process has been rather stunning.”
    Eric Dinallo, superintendent of New York State’s Insurance Department, railed on Friday against AIG’s failed business model, likening its insuring credit-default swaps as gambling with somebody else’s money.
    “It’s like taking insurance on your neighbor’s house and even maybe contributing to blowing it up,” he said at a panel sponsored by New York University’s Stern School of Business.
    U.S. lawmakers have said they are running out of patience with regulators’ refusal to identify AIG’s counterparties.
    On Thursday, Richard Shelby, the top Republican on the banking committee, said: “The Fed and Treasury can be secretive for a while but not forever.”
    (Writing Toni Reinhold; Additional reporting by Juan Lagorio in New York; Editing by Clive McKeef)

    Reply

  29. JamesL says:

    I double on what Sam and Tony said.
    If the banks must be recapitalized, they should line up downstream of individual citizens being recapitalized. This appears not to have occurred to anyone in Washington, not a good sign to those who still think citizens matter in America.
    If the banks are recapitalized (so they can do this all over again), it should only take place after all those in banking power who helped create this mess have been permanently evicted from positions of monetary responsibility, and the most prominent features of their reproductive organs have been confiscated and placed in jars on permanent display in the rotunda. That old link between sex and money just has to stop.

    Reply

  30. samuelburke says:

    http://www.lewrockwell.com/woods/woods105.html
    Even those who claim to support the free market see nothing amiss in a monopoly central bank with the monopoly power to create money out of thin air. They spend their time talking about what our Soviet commissar in charge of money and interest rates should do, instead of asking whether we need central planning of money and interest rates in the first place.
    The housing bubble could not have arisen without the Federal Reserve. Had people started buying houses at unusually high rates, banks’ loanable funds would have begun to deplete, interest rates would have shot up, and that would have been the end of it. That would have discouraged any additional speculation in real estate. But Alan Greenspan and the Fed could create money out of thin air, thus giving the banks more to lend and driving interest rates down, thereby perpetuating the destructive bubble in housing.
    In our country we have one group that believes you can print wealth into existence, another that tries to spend it into existence, and a third (and by far the largest) group that believes in both. This is a philosophy fit only for children and ignoramuses, and the editorial page of the New York Times – or perhaps I repeat myself.
    Then there’s the fourth group: the grownups, who understand that wealth is created through saving, investment, and entrepreneurial skill; that wealth has to be produced before it can be consumed; and that lending is impossible in the absence of prior saving. Simple things, really, but if it weren’t for the constant denial of these elementary ideas, our talking heads would have nothing to do.
    Today, we grownups have to explain these basic principles to the deranged children – as they run around with their fingers in their ears, and screaming “I can’t hear you!” – who run our government, write our opinion columns, and fill American airwaves with stupid and destructive economic advice.

    Reply

  31. TonyForesta says:

    Obama made a grave mistake appointing fundamentalist economics practitioners like Geithner, Summers, along with every single economic advisor in the administration all of who are all predator class Wall Street insiders. There is no liberal, progressive, or labor voice anywhere in Obama’s economic team.
    Fixing the banks or the financial sector, or housing markets will NEVER stabilize the global economic crisis.
    The key to restoring stability to the system and the global economy is jobs! If there are no decent jobs, – there will be no recovery.
    Obama’s socalled economic advisors will never work in the peoples best interests. There is no focus on job creation and a total tunnel vision toward bailing out cronies and oligarchs in the predator class who caused the crisis.
    Geithner, Summers and all the predator class Wall Street insiders (who are the only people Obama appears to be listening to) are bent on bailing out predator class cronies and the FAILED management of FAILED institutions, pimping FAILED models, and heaping all the costs, debts, pain, suffering, burdens, and deficits on the American taxpayer and our children.
    The entire banking system, and most of the major banks are insolvent. The PONZI scheme house of cards and paper valuations have collapsed and will not return. True values and wealth based on real assets will be realized only when the irredeemable debt products and PONZI schemes are unwound from the system.
    There is no way to avoid wiping out the shareholders, and bondholders of these FAILED institutions. That is the price they pay for bruting and profiting wantonly from PONZI schemes, collusions, fraud, bribery and other acts of financial malfeasance, perfidy, and skullduggery.
    The predator class alone benefited from the irredeemable debt PONZI schemes and bubble-r-us voodoo economic policies of the last decade. The American poor and middle class lost ground in the last decade in and by every significant metric and measurement.
    The predator class must pay their fair share of the costs of stabilizing and repairing this system. That payment will require giving back a portion of the illgotten booty funnelled into various offshore accounts. Certain individuals are responsible for grievous crimes and must be prosecuted and held accountable.
    The entire banking system is polluted, corrupt, unbalanced overty favoring the predator class alone, and wildly under monitored and under regulated.
    The system must undergo an orderly deconstruction, which only the government can do.
    FAILED institutions, FAILED management, and FAILED models must permanently eradicated from the system.
    A new more equitable, more economically sound (accounting for risk and worse case scenarios for example), more legal (PONZI schemes no matter how sophisticated are crimes), more heavily regulated, monitored, and policed, and strict enforcement and harsh punishments must be applied to discourage the kind of crimes and abuses we witnessed in the financial sector and among the predator class over the last decade.
    Staying the course, and hoping to prop up the FAILED banks, and shield the FAILED management of those FAILED banks by pouring thousands of billions of taxpayer dollars into the offshore accounts of the FAILED management and their predator class cronies and perpetuating the exact same FAILED irredeemable debt product and PONZI scheme models is a recipe for disaster!
    There will never be a recovery until the system accounts for FAILURE!!!!

    Reply

  32. chopper says:

    Geithner has been described as not a leader, much less visionary, but instead highly effective at pushing through an agenda. Skilled and knowledgable as a bureaucrat. And a true-believer in deregulation fundamentalism.
    Basically, if accurate, that is exactly the wrong person to have running the show. Someone with the very same ideological blinders that created this mess in the first place. Geithner is more concerned with protecting the bankers from an actual meritocracy (that is, they failed and they and their banks/shareholders pay the price), and propping up the failed and discredited belief that governmental oversight of markets is a problem.
    Government is the only solution right now. And if government had been being run properly, and providing the oversight and regulatory protections that are absolutly necessary for a long-term stable, prosperous market, this meltdown would not have happened. Instead, it failed in providing that oversight and here we are. And Geithner was at the very center of having the powers of oversight, and not using them.
    That is a failure of those who were running the government and their ideology, not government itself.
    Obama is not providing the visionary and bold leadership that is absolutly neccessary right now. If he doesn’t step up and look beyond the deregulatory/no-oversight true-believers he has baffingly placed in power (Summers and Geithner), he is going to extend and worsen the situation drastically.
    And in four years, if the situation is still a muddle, along with 100’s upon 100’s of billions, perhaps multiple trillions of taxpayer dollars poored into bankers’ pockets with little result, I will be happy to watch him get booted from office. I was an enthusiastic Obama supporter from early in the primaries. But if he blindingly adheres to the discredited notion that government needs to not be involved in markets, except for giving up taxpayer dollars without insisting upon control in return, he will get what he deserves in 2012.
    Obama will take the fall in 2012, for protecting failed bankers and those with anti-oversight blinders, in 2009.

    Reply

  33. silver slipper says:

    Finally! Someone is talking about the banking problem! I wish President Obama and Geithner would show serious concern about this issue and figure something out. I’m glad the author of this article didn’t say nationalism would be required. I hope President Obama agrees with that too. Geithner doesn’t seem like a very serious person to me. He always looks like he just woke up. I hope his attention to these details is more alert than his affect shows!

    Reply

  34. ... says:

    some have been convinced of the idea that “free markets” means the same as “unregulated markets”… clearly unregulated markets are a problem and they are just the means for the banking system to gun the same system… where have the federal reserve been in all of this? have they seen what was going on and turned a blind eye to it all? my answer to this last question is yes and they need to be held accountable for their role as the so called ‘central’ bank in all of this.. until the federal reserve is completely done away with, it will be on to the next bailout of even bigger portions…

    Reply

  35. JohnH says:

    The real problem here is trust. And to restore trust some prominent Wall Street heads must roll AND BE PROSECUTED for selling fraudulent financial instruments.
    It’s pretty obvious that the financiers and bankers failed to exercise basic fiduciary responsibility and knowingly created financial instruments not backed by minimal credit standards for borrowers (Alt-A loans). They then defrauded investors by selling these instruments in securitized packages, parts of which were known or should have been known to be absolute garbage. They then defrauded insurers who guaranteed the loans. Now the US government is giving tens of billions of dollars to AIG to pay for these fraudulent loans.
    It was a pretty slick scam. The government is now providing cover to the fraudsters by SECRETLY paying off investors via AIG. This will prevent lawsuits that would otherwise be brought by those defrauded investors.
    Now the government must step up and bring some high profile prosecutions and recover some of the vast sums of money that taxpayers are have been defrauded of.
    Barak Obama and Eric Holder: wake up!

    Reply

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