Robbing The Taxpayer

The United States government is colluding with the banks to rob the taxpayer. That, in a nutshell, is the newly shaped Tim Geithner bank rescue plan. That, in a nutshell, was the Hank Paulson bank rescue plan that has already stolen $350 billion of taxpayer funds, plus over $175 billion in funds directly to AIG, and paid off casino bets that the banks made with their depositor’s money.

We are now told that banks are holding at least $2 trillion in “toxic assets”. These are said to be mostly made up of residential and commercial mortgages that may have defaulted or are likely to default. Tim Geithner intends for the government to buy about $1 trillion of these “toxic assets” at higher than market values. Apparently the market wants to pay only 30% of the original value of these assets but the banks want to sell them at 60% of value. So, in steps the government offering to guarantee these assets if the buyers (with majority financing by the American taxpayer) will pay a higher price that the banks holding them will find palatable. This of course is voluntary on the part of the banks holding these “toxic assets”. Apparently, this same vaunted Free Market that got us into this mess will see the government giveaway and respond and get us out of this mess. And, voila!, everyone is happy. The government subsidizes the difference between the sell price and the ask price, guarantees against losses to the buying investors, and the American taxpayer ends up holding the bad assets which will miraculously rise in value and everyone will make money. The markets apparently just have a confidence problem, Geithner and team would have us believe. That, my friends, is not the kind of Hope we signed up for. Paul Krugman calls this kind of giveaway a “moral hazard”. But, coming on the heels of the $350 billion giveaway and the bankers cashing their big bonus checks for creating even bigger losses, this is nothing but theft of American taxpayer money.

I say, not a single dime more of American taxpayer money for these banks until we have some basic answers. The first answer must be an accounting of where every cent of the first $350 billion went. If the government cannot account for that, not a single dime more.

We learned last week that AIG had spent a large portion of the $175 billion it received from the tax payer to pay off credit default swaps it had sold to counterparties such as Goldman Sachs. Many of these counterparties also took a large chunk of the $350 billion from the American taxpayer and presumably used the money to pay off credit default swaps they had also sold to other counterparties. I say presumably because no one will tell us and the government’s man in charge of managing TARP, Neel Kashkari, tells us he doesn’t know. All this money was handed out to the banks without any thought of where it might go and how it may resolve the banking crisis. It was apparently presumed that if you throw money at the banks the banking crisis would go away.

Now, if we assume (and I think it is a pretty good assumption), that most, if not all (some obviously went to fat bonuses), of the money we gave to the banks went to pay off credit default swaps after the “insured” collateralized debt obligations (CDOs) went south, what does it all mean? First, it helps to understand what a credit default swap (CDS) really is. We are told it is an exotic financial instrument that shifts risks to a third-party. Because it does that, banks that hold CDOs love it because by buying a CDS they can shift the risk of default to the seller (the “insurer”). The CDS market is very complex and apparently that is why AIG has to pay “retention bonuses” to keep the smart kids employed so they can manage these complex transactions.

But the above explanation of CDS really misses the point. The most important thing to know about a CDS is that the party buying a CDS does not have to own the protected CDO. In plain English, a CDS is a side bet. The party buying a CDS is betting that a CDO (which the buyer may not own) will default. The party selling a CDS is betting that the CDO will not default. The buyer/better pays a premium at regular intervals for the life of the CDS (usually 5 years) to the seller/casino. If the CDO does not default, the seller/casino wins by collecting the premiums. If the CDO defaults, the buyer/better wins and the seller/casino has to pay the face value of the CDO.

The best part, from the Free Marketer point of view, is that the CDS market is unregulated. So, if you actually own a CDO, you can shift your risk of default to an unregulated market by buying these CDS. The seller of CDS is not regulated so he actually does not have to have enough capital reserve to cover all the CDSs he is selling in the event of default. And, if you don’t own any CDOs, you can place side bets to your heart’s content on CDOs other investors may own. Since CDSs also trade, you can sell the bets (CDSs) to other betters if you like. As long as the mortgage market kept going up, up, up everyone made money. The seller made money on the premiums and CDS traders made money by buying and selling these instruments. It is no wonder that the CDS market had grown to over over $62 trillion dollars last year. By comparison, the underlying mortgage market was $7.1 trillion and the stock market was at $22 trillion before its fall last year. Most of the CDS market were side bets on a much smaller pool of underlying debt obligations. There were more side bets than actual insurance on the underlying debts. There simply was not enough money to cover all the side bets in the event of a major collapse of the mortgage market. And that is exactly what happened.

So, when the government gave money to AIG to help it pay off the billions of dollars of CDSs that it had sold, was the government paying off side bets or was it paying off CDS that were sold to banks that owned the underlying CDOs? Given that until last week the government did not know who AIG’s counterparties were, it is probably very likely that the government has used taxpayer money to pay off side bets at the CDS casino. It is also very likely that the much of the $350 billion of the TARP funds that the government has given to the banks with no accountability has also been used to pay off side bets. The government, it appears, has given away our money to pay billions of dollars in side bets because those who sold those bets never intended to cover them. Moral hazard is an understatement.

So, the government owes us an accounting. Show us that Treasury Department has not been settling side bets with our tax dollars. Tell us that the initial pool of hundreds of billions of taxpayer dollars was not wasted on paying side bets of greedy bankers. If we settled side bets, how do we get our money back? Tell us how big the problem is. Who owns the CDS that protect actual “toxic assets”? We are not interested in paying off further side bets. Who are the counterparties that own actual “toxic assets”? How solvent are they?

Once that accounting has been done, the Treasury Department needs to explain to us why another giveaway to these banks is in our best interest. Specifically, it needs to explain to us why it is cheaper for the American taxpayer to throw more money at banks without having any control of these banks. Why should American taxpayers pay off these gamblers and casinos yet one more time? Why should we not consider this latest scheme another theft of taxpayer money?

We are going to need some answers before another dime is spent.