Tavakoli Structured Finance LLC

The Financial Report

By Janet Tavakoli

Why Obama Allowed Bailouts Without Indictments

In November 2008, President Obama was elected, and he was sworn in January 2009. The country was promised change and reform. Recently two democrats close to the top of President Obama’s administration made excuses to me for the lack of financial reform in the United States. Their separately related versions were remarkably similar, so similar they seemed scripted:

The administration made a bargain, and I’m not sure it was the right decision. The world was teetering on the edge of collapse. There was a crisis of confidence. There would have been unimaginable consequences. So bad even your imagination can’t handle the truth?

It was the lesser of two evils to let a lot of people get away scot-free than to risk a collapse in confidence.  There were only two choices according to this narrative.

It was better to let a lot of people get away scot free than to have the first African American president take on the establishment while the country was deeply divided and he needed agreement on big things like ending wars, health care, Supreme Court nominees (and LGBT rights). There were lots of battles without taking on the financial establishment.  It seems to me that reforming our financial system is a big thing. As for at least two of the narrative’s big issues: health care costs are zooming up, and it looks as if we’re rattling our swords for another military conflict.

The president was elected in part on his promise to effect change on the really tough issues, and there was no better time than when the crisis was fresh, and he had a groundswell of popular support.

All About Money

Another of President Obama’s broken campaign promises was that he would enact campaign finance reform. I believe that went right out the window, when he realized during his first campaign that corporations would throw money at him.

If the White House really didn’t like the Citizen’s United v. Federal Election Commission decision in 2010, it could have used moral suasion to work with Congress to amend our Constitution.

It now appears to many citizens as if the chief goal of most of Congress is to be reelected, and that means they’re more interested in campaign contributions than in representing the interests of their constituents and the country. As for upholding the Constitution, it is only a priority when it coincides with the special interests they seem to represent.

A Myth of the Crisis: There Wasn’t Time to Prepare

One of the myths of the financial crisis is that no one saw it coming. HSBC wrote off $6 billion related to subprime loans for the fourth quarter of 2006, and U.S. banks pretended they had no losses. The ABX-HE 06-2 BBB- subprime index dropped like a stone in the first quarter of 2007. I questioned why banks weren’t taking write-downs. The cover-ups of 2006 weren’t working anymore.

Mortgage lenders went bankrupt. Ownit’s bankruptcy at the end of 2006 was large and public. New Century, another huge lender, hit the skids. Although Countrywide didn’t go critical until August 2007, it was already in trouble. Dozens of other mortgage lenders went bankrupt in the first quarter of 2007.

U.S. banks continued fudging. In the first half of 2007, they issued more fraudulent collateralized debt obligations (CDOs) than for the full year 2006, as they desperately tried to shove losses on unwary investors.

Financial regulators publicly denied there was a problem, when they should have raised a ruckus. Congress did nothing. The sheepdogs that are supposed to protect the flock from the wolf pack are really wolves in sheepdogs’ clothing. They exit the regulatory revolving door in expensive bought and paid for wolf-skins.

Alternative to Treasury Bailouts: One That Does Not Violate the Spirit of Democracy

The Treasury’s plan was a variation of the Paulson Plan. It used billions of taxpayer dollars and forced risk and potential losses on taxpayers—instead of having those who enjoyed the gains take the consequences. I advocated a viable alternative.

In September 2008, there was no longer time to break up the banks all at once and no time for unwinding AIG. But a temporary backstop was possible, along with a restructuring in which either 1) creditors agree to discount debt in exchange for warrants (for potentially viable enterprises) or 2) creditors agree to transform (possibly discounted) debt into new equity—a new capital structure in which former shareholders are wiped out.

Instead of TARP, handing out money to cover banks’ losses, we could have forced creditors to accept a restructuring plan. This is what was done during the Great Depression. Creditors, i.e., debt holders including credit default swap counterparties, would have been compelled to accept a restructuring plan. That required partial forgiveness of debt in many cases and/or a debt for equity swap.

The government’s bailout plan destroyed capitalism. In a capitalist system, those who stood to gain–and already made off with large gains—would have to bear the risk. The bailouts represented a corruption of capitalism. Crony capitalism violates the spirit of democracy established by the Founding Fathers of the republic known as the United States. I expressed these sentiments in a letter to the Financial Times on September 29, 2008.

More Phony Accounting

During the crisis, no one trusted the value of the assets. Today, asset valuations are highly suspect, because we changed accounting rules to accommodate cash-strapped banks in April 2009.

The proposed Act released on September 28, 2008 extended the SEC’s authority to suspend mark-to-market accounting (FAS 157) when it is “in the public interest and protects investors.” The SEC’s proposed Act buried problems and prolonged price uncertainty to serve the interests of systemically dangerous banks. That particular bill did not pass, but in April 2009, the accounting rules were changed anyway.

It was a huge mistake. FASB board members supported mark-to-market accounting in September 2008, and supported mark-to-market in general, especially in illiquid markets. The SEC should have, too, but its September 2008 proposal exposed how captured it was.

Accounting changes promoted hold-to-maturity pricing for credit derivatives trading books and portfolios of residential mortgage backed securities and collateralized debt obligations, among other troubled assets. The danger was, and is, that Federal portfolio managers can claim they are making money on carry trades while the assets are declining in value due to defaults or permanent value destruction of collateral. This situation can continue for a long time to create the false appearance of profitability. In other words, U.S. taxpayers can be told they are making money, when in reality they are losing money. I would rather know the market price, even if the news is bad news.

Bloomberg Magazine later reported that the money we were told we made on AIG only appeared that way through some fiddling. Bloomberg didn’t even include the billions of taxpayer dollars paid to Goldman, Merrill, and other AIG counterparties whose CDOs should have been investigated instead forking over protection payments.

Even Warren Buffett Urged Mark-to-Market Accounting

Warren Buffett came out strongly in favor of mark-to-market accounting in an interview with Charlie Rose on October 1, 2008, and in another interview with CNNmoney on October 2, 2008. He proposed another viable alternative to the Bills floating in Congress.

Buffett proposed to allow private equity investors to put up 20%. The U.S. Treasury would put up 80% with the following terms: the Treasury gets paid back first, receives interest on its investment, and gets a share of the profits. This would ensure market pricing and allowing the banks to delever, while the Treasury—the only source of a large enough balance sheet—levered up with the protection of a 20% cushion and mark-to-market pricing. The government ignored Buffett’s proposal.

Treasury Secretary Henry Paulson Was a Section 8

All of this spells dark times for the future of the republic. On September 20, 2008, at the height of the crisis, Henry Paulson, former CEO of Goldman Sachs, and then the 74th U.S. Secretary of the Treasury, did not merely request immunity for actions he was about to take. In his original draft proposal of the Bailout Plan, he requested imperial powers:

“Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”

Paulson was not an elected official, yet he requested powers that surpassed those granted to any representative of the citizens of the United States.

Section 8 was formerly a type of discharge issued by the U.S. military that meant one was mentally unsuited for service. The spirit of Hank Paulson’s Section 8 continues to dominate the U.S. financial system.

TARP Special Inspector General: “Deplore Captured Politicians”

Neil M. Barofsky, the former special inspector general in charge of oversight of the Troubled Asset Relief Program (TARP), Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street. He asserts:

Americans should lose faith in their government. They should deplore the captured politicians and regulators who distributed tax dollars to the banks without insisting that they be accountable… Only with this appropriate and justified rage can we hope for the type of reform that will one day break our system free from the corrupting grasp of the megabanks.

Barofsky’s book appeared nearly four years after the Great Bailout. We continue to subsidize banks through low-cost funding and through meaningless slaps on the wrist for ongoing malfeasance.

Ongoing scandals make a mockery of existing laws, including the Sarbane’s Oxley legislation. In 2012 recent hearings, Congress gave Jamie Dimon a celebrity roast instead of holding him accountable for his utter lack of corporate governance of an out-of-control unit that reported directly to him and that cost JPMorgan at least $6.3 billion due to speculative proprietary trades in credit derivatives.

“Selling Democracy on the Cheap”

On September 23, 2008, Bloomberg Television‘s Betty Liu interviewed me about the bailout plans and what was then the House Finance Committee’s latest 42-page draft. I called the TARP Bill the most dangerous bill to come before Congress in my lifetime. “We are selling democracy on the cheap.” The following is the transcript of Bloomberg Television’s interview:

Betty Liu: Okay, let’s get to our next guest, Janet Tavakoli, president of Tavakoli Structured Finance in Chicago. She’s had some very strong opinions on this bailout plan from the Treasury. Janet, great to have you back on the program.

Janet Tavakoli: Hello Betty, how are you.

Liu: Good, good. So you’re pretty much incensed by this bailout package, tell us exactly why.

Tavakoli: Well Betty, I looked at this package, and it isn’t good for the American taxpayer, it isn’t helping the average American Citizen. It isn’t helping you, and it isn’t helping me. This is a massive bailout of Wall Street. I had a chance to review a 42 page draft that was going around, and if the House Finance Committee thinks this in any way protects the American taxpayer, they’re lying to us or they’re just not competent in drafting this Bill. I looked at P. 14 lines 9-12, and there it says that all the other oversights, all the other price controls go by the boards, when you need to buy pieces of a securitization for loan resolution.

Liu: What does that mean? What does that mean?

Tavakoli: Basically that means that every securitization done with mortgage loans or other loans, because [then Secretary of the Treasury Henry Paulson] has the assets…the authority to buy in those assets…all of them would be exempt from any kind of price review or oversight. And furthermore if you look at P. 34…

Liu: Uh, wait eh, uh, Janet, let me just interrupt you, and that means what, that means what exactly then?

Tavakoli: As I just said, it means the Secretary can decide the price where he buys in all those assets…contrary to what it tells you right before they’re saying, oh no, there would be some oversight, and we’d have to have some sort of reasonable pricing mechanism…but you can throw that all out for securitizations based on the language of that Bill.

Liu: So, so, so, are you, so are you concerned that…

Tavakoli: Let me get to the more important point, Betty. That the Secretary doesn’t really have any effective oversight built into this Bill. Basically, his word stands as the final authority on what’s going on with buying in these assets. Furthermore, it really doesn’t help in mitigating foreclosures in any specific way. Once you buy in the securitizations, finding the owner of the specific mortgage is extremely difficult to do.

Furthermore, my grandparents came to this country to get away from people who would draft Bills like this. The American taxpayer and the American citizen should realize this is the most dangerous Bill to ever come before Congress in our lifetime. We are selling Democracy on the cheap. For what? For getting our money market funds guaranteed? My grandparents were happy to endure economic hardship so they would get away from governments that would do something like this. We are basically subverting Democracy.

This is a terrible thing, and our Congress has not spoken out against it. My state senator, Senator Obama, has shown no courage at all in speaking out against this. McCain has said very little

Liu: But Janet, Janet, okay, Janet, Janet uh…then what is it, what is it that that you think needs to happen, because there are obviously a lot of people who have lost money in the market who want something done.

Tavakoli: Betty, I’ll tell you…I’ll tell you what should happen. This money could be much better employed in creating jobs for Americans. If you want to use taxpayer dollars to protect the economy, that’s a far better way to do it than this cobbled up plan that protects the interests of Wall Street and investment banks.

It provides no regulation at all for them, and it gives our Secretary of the Treasury [Henry “Hank” Paulson] basically the rights of a monarch. Queen Elizabeth should be having giggle fits right now, because we fought a War of Independence for nothing, and now we’re giving it away. We’re giving away our Democracy in a Bill like this.

This is the most dangerous Bill that I’ve ever seen come before Congress, and we’re using finance as the political boogey man so that this can get passed. That’s ridiculous.

Liu: Uh uh, okay. We don’t have a whole lot of time, Janet. In like 10 seconds, you know what, I can’t even ask that question, ’cause we’re not even gonna have enough time. Janet, thank you so much for joining us, and of course, you have your very strong opinions, and I’m playing devil’s advocate, and we’ll have you back on the program to talk more about this, and there’s going to be further developments, obviously when we have the Senate Banking hearing coming up in just about 45 minutes from now.

See also: “Repairing the Damage of Fraud as a Business Model,” Janet Tavakoli’s address to the Federal Housing Finance Agency’s Supervision Summit on December 8, 2010.

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