Treasury Thugs
by Donald Devine
Issue 132 - May 20, 2009

The nation’s nine top bankers were called personally by the finance minister on a Sunday afternoon and told to attend a meeting at the ministry’s gilded conference room the next day at 3 P.M. The news story following noted that “the executives did not have an inkling” of what was to be discussed. By his own admission, the Minister “presented his case in blunt terms.” At the meeting – also attended by the central bank president and its largest subsidiary - the bankers were presented with a one-page document that said they “agreed” to sell ownership shares in their firms to the government and were told that they “must sign it before they left.”

Was this Reich Economics Minister Walther Funk of Nazi Germany in 1933 as reported in the Volkischer Beobachter? No it was U.S. Secretary of the Treasury Henry Paulson, Fed Chairman Ben Bernanke and New York Fed president (later to succeed Paulson) Timothy Geithner as reported in The New York Times on October 15, 2008. Paulson closed by saying “we regret having to take these actions” which were “objectionable” but unavoidable. The bankers were sweated for three and a half hours “peppered with questions” by three bankers, with quiet resistance from two (including Bank of America’s Kenneth Lewis) and outright opposition by Wells Fargo chairman Richard Kovacevich. But, as one observer said “it was a take it or leave it deal” and all signed before they left.

In early 21 st Century United States of America, its government forced the nine most powerful and wealthy private sector financiers to accede to its demands with merely a whimper from the “powerful” and with total unconcern from the public. The only strong popular reaction was against the bank executives following a later payment of bonuses without the merest consideration that this was contractually required, that many banks did not want the bailout in the first place, and that the government refused to let them pay it back. When this was told to a top conservative public relations executive, he responded: “Are you kidding, trying to get sympathy for bankers? They are pariah! No one likes them” - recalling similar thinking about another minority by the German people in the nineteen thirties.

Being somewhat less advanced along the road to serfdom, the polls showed that the American people did oppose both the first bailout under President George W. Bush in 2008 and the even larger one under President Barack Obama in 2009. Even so most of the messy details took place outside public scrutiny and did not leak until many months later. The most shocking was when the Wall Street Journal revealed that Bank of America’s Lewis had told Sec. Paulson that he was reconsidering Paulson’s request that Lewis buy ailing investment firm Merrill Lynch because its losses would pose a greater threat to his stockholders. Mr. Lewis testified under oath to the New York Attorney General that he only went forward with the deal when Messrs Paulson and Bernanke told him it was necessary to save the economy and that he and his board would be replaced if he did not.

Even more incredibly, while Mr. Lewis testified that he was not ordered to keep the negative information from his stockholders (and other investors) he insisted that was the clear intent of his regulators’ instructions. “It wasn’t up to me” but to them, he said, violating a CEO’s first responsibility to his stockholders, not his regulators. While his regulators did not punish him, his stockholders took the very rare step of overruling him, downgrading Mr. Lewis and limiting his authority. His regulators, Messrs Paulson and Bernanke, sitting on the Financial Stability Oversight Board set up by the Troubled Assets Relief Program (TARP) bailout, also did not inform their oversight authority of the Bank of America nor Merrill situations until it was a fait accompli.

In an even more alarming example last fall, a Credit Suisse employee said he received a phone call from a Federal Reserve official congratulating the firm for having avoided investments in the subprime mortgage market that had led to the U.S. financial meltdown. The representative then asked the Swiss firm to purchase American bank “toxic assets” through the U.S. TARP program. When the employee asked why they should participate when they had avoided these as too risky in the first place, he was told “Because someday you will need us.” It was perhaps not so subtle but extortion rarely is.

One of the conditions for the Treasury to make the bailout “investments” was a “stress test” examination of the financial health of the banking industry. Since Treasury had earlier told reporters that it did not want banks to repay the bailout loans to end government supervision so they “would not imperil the economy in the future,” it was not surprising that when the results were announced earlier this month even the healthy banks were required to build larger reserves of common stock, making it harder to pay the Feds back. Most of the 19 studied banks met the 6 percent legal requirement for reserves but the study required that they raise more in common equity rather than preferred stock (which the government had issued for the bailouts, artificially inflating their relative importance) or borrow from the government in new convertible (to common) preferred stocks. A few truly weak banks like Citigroup were required to raise funds but most, including Bank of America ($3.4 billion) and Wells Fargo ($1.5 billion) were required to buy common equity.

Why? The Washington Post called the addition of this requirement “a concession to investors,” that is, to the investment industry (which incidentally was the single largest source of funds for Candidate Obama). It is interesting that the well-financed Wells Fargo was required to meet a fully unexpected requirement that can best be understood as a government “payback” to Mr. Kovacevich (who happens to be a free market conservative) for his initial opposition to the bailout and his desire to repay the government funds and escape its nitpicking. Didn’t a Pole resist the last time too? As the Post reported:

Richard Bove, an analyst with Rochdale Securities, said Wells Fargo got an especially rough deal, considering that it stepped in to take a struggling Wachovia off the government's hands last year. Wells Fargo raised more than $11 billion so that it could buy Wachovia. "They did the government a massive favor," Bove said. "And the government returned it by saying: 'Screw you. Go out and raise more capital.'"

Wells Fargo chief executive John Stumpf prudently labeled the government's finding that the firm needed to raise $13.7 billion "excessively conservative" and said the company does "not want to be in a position" of seeking to convert the government's preferred shares to common shares, which would give the government a hefty ownership stake.” As for the $25 billion from the Troubled Assets Relief Program that Wells Fargo received last year, he said, "We will pay back TARP as soon as it's practical for us to do so."

To expand the reach of TARP, Treasury convinced Congress to pass a Term Asset-Backed Securities Loan Facility (TALF) program (to say nothing about the Public-Private Investment Program [PPIP] or the 12 bailout programs in all with $3 trillion in taxpayer funds) to woo private investment into the bailout game. But Treasury met resistance. First of all, the private sector demanded tough contracts to protect it from this new risk. Second, Congress added restrictions on those who invested, such as new limits on hiring immigrants. Most important, private firms feared the government would later changes the rules as they did on bonuses. “The government is viewed as being unpredictable,” said a partner in a law firm that represented potential TALF participants. So few firms signed up and the program apparently will fail to attract private capital voluntarily, forcing Treasury to get tougher.

Not satisfied with running the banking industry, Sec. Geithner is also managing the auto industry through his task force managed by long time Democratic operator Steven Rattner. His plan for General Motors was to give Treasury 50 percent stock control, the United Auto Workers 40 percent, and the public who have invested in the firm (mutual funds, pensions, hedge funds and normal investors) would get a mere 10 percent. According to the Journal, this would give the government an 87 cent return on its dollar investment, the union trust 76 cents, and the “powerful” big money investors an enormous 5 cents – not a bad return for the unions who were so instrumental in the Obama victory, with TARP and the dozen other programs always available for the investors.

The unions did even better at Chrysler, the UAW being offered a 55 percent share, Fiat (which was not an investor at all) 35 percent, Treasury 10 percent and none at all to the secured creditors (and the pensions and retirees that invested in them) who were legally in line first. The creditors at Chrysler first refused to accept the deal, forcing the auto firm into bankruptcy. But they only were this brave so long as no one knew who they were. When the bankruptcy judge forced investors to identify themselves, the number of complainants dropped from 20 to 5. Undoubtedly influenced by the specter of Kovacevich and Lewis, while the initial investor claims were $6.9 billion, the 20 were smaller firms with only an exposure of $1 billion, and the 5 who were willing to expose themselves to public scrutiny had only $300 million in claims. Fear had reduced the private claims by over 90 percent. The very next day, the 5 capitulated too: “In the end, they just concluded that the political cost to their institutions was too high to bear," explained their lawyer.

What “political costs” were the bankers and investors afraid to bear? The president of the United States himself upbraided them. At a news conference after Chrysler was forced into bankruptcy against Treasury’s wishes, President Obama lashed out (the Washington Post headlined, “President Slams Holdouts”): “I don’t stand with those who held out when everyone else is making sacrifices.” He castigated the secured stockholders as “a small group of speculators.” Of course, the Treasury and the UAW were small groups too, and they hardly made sacrifices. But who could stand in the face of displeasure from the most eloquent and praised president in recent years? Even the opposition Republicans in Congress dared not speak up for fear of being seen as supporting speculators. As a Journal investigative team concluded:

The banker's about-face was a vivid example of the government's tightening grip on a humbled financial industry. Pulling a trick from the hedge-fund playbook, the government used its leverage as the sole willing lender to Chrysler, either in bankruptcy court or out, to extract deep concessions from some of the country's biggest banks….upend[ing] a longstanding tradition concerning rights in a bankruptcy: Senior secured lenders usually get paid in full before lower-priority creditors get anything. Not this time.

Still, it has long been a mystery how the Treasury has been able to be so assertive in controlling and intimidating so many businesses. How could a 47 year old banking bureaucrat with a very small political team run such a power operation against the largest banks, investment, hedge and manufacturing firms? Using its internal sources within Treasury, a Post investigatory team discovered that White House Chief of Staff Rahm Emanuel decided “at the president’s urging” to become directly involved in Treasury operations after initial Geithner missteps. Sec. Geithner himself implicitly confirmed this by telling reporters “I had to make a judgment…that to do this right we had to have a fully integrated approach” with the White House. Emanuel, of course, is one of the most savvy political operators ever to play in Washington, most famous for his "You never want a serious crisis to go to waste" advice regarding how to use a calamity to maximize political gain.

Emanuel is not the first to flex Treasury’s muscle, just following the lead of the previous two administrations. The U.S. stock market has lost more than ten percent of its value over the past 11 years by forcing business into poor-risk loans and bailing out the losers under both political parties. Forget for a moment about the unprecedented amount of monetary liquidity injected by the Fed into the economy and its portents for a deadly inflation and the oncoming gargantuan entitlement crash. Who will voluntarily invest their own capital – and remember that retirement and charitable funds are the largest investors - or even their management skills into firms if even preferred investors cannot receive protection and the nation’s top executives are cowed before threats? CEOs forced to choose between regulators and stockholders cannot act. No one will be willing to invest freely when the government can change the rules retroactively.

So the Government must keep pushing harder to force ever more investment. It can get very personal. The Treasury special inspector general for bailouts told Congress he has 20 criminal investigations into potential “fraud” (mainly paying bonuses) pending. Who will take a risk even of jail? The best course will be to keep quiet and be prudent with investments, frustrating the whole idea of the bailouts - to “unstick” public investing. As with the TALF and PPIP programs, investors will demand guarantees or will simply hide even under thuggish threats. In fact, investment will come to a standstill. This is exactly why most of the world is poor. Their governments are free to debase people’s investments and to send the successful to jail so everyone hoards or invests abroad, guaranteeing stagnation.

It is easy to blame the private executives for cowardice but the Government has many weapons in a society that controls not only finance and manufacturing but every aspect of life from what kind of air one can breathe to what kind of care one can receive at the end of life, with more regulation promised at every turn to presumably greater and greater public support – although, again, the polls do show some unease about government control. Yet, few are willing speak up and the few who do are considered cranks. Unfortunately, there were not many heroes in Germany either - the Kovacevichs of the world are as rare as the Oskar Schindlers. Maybe there should be a “List” movie on Kovacevich too before we all have to raise our arms in salute before we can leave the Government’s room.

Donald Devine, the editor of Conservative Battleline Online, was the director of the U.S. Office of Personnel Management from 1981 to 1985 and is the director of the Federalist Leadership Center at Bellevue University.