Bailout Accountability: Something's Rotten in the Treasury's Kingdom

In response to a request to reveal how bank bailouts funds have been utilized thus far, Assistant Treasury Secretary Neel Kashkari helpfully explains that when “you put in $1 into an institution, it’s impossible to follow where that $1 goes.” But nobody is really demanding a $1-for-$1 accounting from Mr. Kashkari. What taxpayers and investors want in hand is an unequivocal conceptual framework under which financial institutions have allocated the use of government aid. Without that, it is totally unreasonable to expect taxpayers to make any prudent assessments concerning the qualitative nature of the bailout exercise and investors to trade common shares of bailout recipients under any identifiable valuation umbrella.

As per an investment agreement signed with the Treasury Department on New Year’s Eve, Citigroup (C) will undertake “reasonable best efforts” to provide use-of-proceeds details on a quarterly basis. As Paul Kiel (ProPublica, January 9, 2009) pointed out, this was nearly the 200^th time the Treasury had executed such an agreement; but it was the first time that a recipient of taxpayer dollars was held accountable. Of course, certain critics of the Treasury’s actions since September are questioning why a “reasonable best efforts” clause was not replaced by a more affirmative statement for an agreement worth $20 billion. But what is more troubling is the fact that, without prodding from the Special Inspector General of the Troubled Assets Relief Programme, the Treasury may not have pushed for a disclosure clause in the Citigroup term sheet in the first place.

Little wonder then, that in the absence of any substantive information on the approximately $350 billion disbursed by the Treasury in supposedly controlling systemic risks, all kinds of troubling questions are propping up in the blogoshpere. Are the banks using taxpayer dollars to invest in the stock market? Are taxpayer dollars the cause of the last rally in equities? Since there is no evidence of a thaw in the credit markets, is the money being used to buy government debt or government-backed debt? Or, as one critic of the derivatives universe asked, has the bailout become a boon for the credit default swap and collateral debt obligations marketplace, with counterparties now willingly complying with settlement and delivery commitments?

The most important questions, by far, are for the Treasury. What were the valuation methodologies, if any, used to determine both yields on preferred stocks and strike prices for warrants? Why are the bailout stocks still trading when the fundamentals driving those stocks are not in the public domain? How can investors decide to buy or sell those stocks (AIG, AXP, BAC, C, GS, JPM, MS, WFC) if the impact bailout funds must have on earnings, solvency ratios and balance sheet risk profiles cannot be ascertained?

Last month, CNN’s efforts to get details on the use of the billions handed out by the Treasury were met with vague replies. A Bank of America spokesperson said that the funds were being used to “build our capital and make every good loan we can.” JPMorgan Chase has bought $1 billion of Illinois bonds, and plans to make loans to non-profit and healthcare companies. Wells Fargo refused to provide any details, and advised CNN to wait for the release of its next SEC filings.

But CNN’s frustration must have turned into shock this weekend: Morgan Stanley announced that it is likely to pay Citigroup as much as $3 billion for control of Smith Barney, Citi’s brokerage arm. A case of bailout candidates juggling bailout funds to create dubious value in an uncertain economic environment? Was not this money supposed to remedy the credit crunch in housing and business? Did Morgan Stanley, which recently reported a $2.3 billion loss for its fourth quarter, make sufficient loan- and asset-delinquency provisions in its own financial statements prior to offering $3 billion to Citigroup?

This writer’s short positions in the financial sector (XLF) incorporate the fact that lawmakers and regulators cannot let any of the bailout targets fail. They also incorporate another more compelling fact; numerous analysts who insist on issuing daily bullish calls on the beneficiaries of taxpayer dollars are unable to provide any factual basis for their price forecasts; as things stand, all the material facts required to credibly predict earnings are simply not available.

Disclosure: Author holds short positions in C, GS, JPM, XLF

Comments

[bosun.j:]

The time for accountability was before this TARP pornography was allowed to exist.

Jan 12 10:27 AM

[James Wilson:]

Citi can create a Smith Barney overnight with the number of good talented people unemployed right now.

What is so hot about Smith Barney ?

They did not prevent Citi from buying to many overvalued mortages !

They did not even do the simple acid test for value of the AAA Paper they were buying.

30% of the AAA Paper will have Fraud from Collusion with the Appraisers and the Lender to over value the properties so it lookked good on paper.

Jan 12 12:26 PM

[abeoman:]

Well put.....The TARP provision,or lack thereof, dessimates the benchmarks and standards sought by SEC on publicly traded companies. If "best efforts" clauses are what a public company today would guarantee their investors in multi billion dollar deals, in light of the current conditions, then good luck to us all!

Jan 12 12:27 PM

[Moon Kil Woong:]

There are 3 laws in the current banking business (include brokerages, insurance companies, and silly finance companies the government supports).

#1 Get as big as you can so no one will pull the plug on siphoning taxpayer money to you.

#2 Do whatever ridiculous things the Fed and Treasury ask of you so they won't give you a thumbs down on the next dole outs.

#3 Lastly, use taxpayer money to finance buying out other banks that have liquidity, especially ones wallowing in bailout cash even if they have a negative balance sheet because you know #1 and #2 apply.

Bailout banks are worse than a homeless person on the dole. For one they probably caused the homeless person. No homeless person needs a billion or more every 6 months. Seldom do homeless actually try to make their lot as bad as possible for survival's sake. And last, at least homeless people aren't actually walking dead like these companies.

Thanks for the article Saxena.

Jan 12 12:34 PM

[User 283977:]

The following is fiction presented for your amusement…

The stated purpose of the money was to allow banks to make loans again. No strings suggests the stated purpose provided to Congress was a spin and the funds were provided in an attempt to shore up the financial institutions to cover some kind of large common loss. Given the highly interrelated nature of the banking system, if several of the larger institutions went into insolvency, they would probably take the entire US financial system down with them. If the financial system went down, it would also take out a large number of other businesses as well.

The people that set up the program felt it was absolutely necessary to prevent the chain of dominos from falling. They also knew that trying to sell Congress on the wisdom of giving money to the financial institutions in order to forestall bankruptcy would be a very difficult sell. So they invented the spin that the funds would free up the flow of credit. Which story is an easer sell? Giving money to the financial institutions to forestall insolvency ala the automakers scenario, or telling people that the money would be used to increase individual and business access to needed credit? They reasoned that a "prevent insolvency approach" would take a lot of time, so they sold TARP with an access to credit rationale accompanied with wishful thinking that the funds would help free up access to credit.

Its an interesting possibility that explains the seemingly inexplicable stupidity of providing public funds with no guidelines with respect to their usage. Would something like this be illegal (lying to Congress), or was it a typical political ploy used to get needed financial relief to the financial institutions as quickly as possible while performing an end run around likely Congressional opposition from members of their own political party? What was the basis of that alluded to large common loss? Was it mortgage based derivatives, or was there something else, something that the Government and the large financial institutions were involved in? Something related to say …. oil speculation?

It might make an interesting movie plot… conspiracy, secret agendas, Harrison Ford figuring it out… Its kind of telling that in order to explain the complete incompetence of providing funds to financial institutions with no strings attached, I had to resort to fiction. It just does not seem realistic under real world conditions.

Oh well, I had some fun writing this up, I hope you had some fun reading it.

Jan 12 12:44 PM

[prudentinve...:]

The bailed-out banks should have been given the same oversight that the bailed-out auto companies are being subjected to. While I am personally against all bailouts, if we really have to do them, at least we should avoid double standards.

Jan 12 03:00 PM

[CautiousInv...:]

This was discussed today in a similar post on SeekingAlpha.

It's painfully clear that more time and thought should have been invested in TARP before its approval and funding.

Treasury's original TARP goal included avoiding widespread, systemic failure. Something about protecting taxpayers and forestalling further foreclosures was added subsequently. While implied, there was nothing specifically mentioned about extending credit or making more loans available.

These goals were to be realized through direct purchase of troubled assets........somethin... early critics said would be difficult because of the time it would take to price the assets under consideration. And after securing approval to purchase troubled assets, Paulson switched gears and started buying preferred stock, attaching few strings along the way.

Characteristically, we are now examining what has taken place and are asking whether the public good has been served and where the money went. Sadly, we got pretty much what we bargained for.

We did not demand much in the way of accountability in use of the funds..........and, as the author points out, we are not getting much. In a similar vein, we did not specify that the TARP funds should be used as reserves for expansion of credit. And sure enough, no new loans.

These are getting to be expensive lessons and I hope something is learned in the process.

Jan 12 03:56 PM

[MAMorris:]

You need to see Sunday's 60 Minutes show. Your fiction it turns out . . . is a documented reality. Check out their facts it will make you sick.



On Jan 12 12:44 PM Bob Lunn wrote:

> The following is fiction presented for your amusement…
>
> The stated purpose of the money was to allow banks to make loans
> again. No strings suggests the stated purpose provided to Congress
> was a spin and the funds were provided in an attempt to shore up
> the financial institutions to cover some kind of large common loss.
> Given the highly interrelated nature of the banking system, if several
> of the larger institutions went into insolvency, they would probably
> take the entire US financial system down with them. If the financial
> system went down, it would also take out a large number of other
> businesses as well.
>
> The people that set up the program felt it was absolutely necessary
> to prevent the chain of dominos from falling. They also knew that
> trying to sell Congress on the wisdom of giving money to the financial
> institutions in order to forestall bankruptcy would be a very difficult
> sell. So they invented the spin that the funds would free up the
> flow of credit. Which story is an easer sell? Giving money to the
> financial institutions to forestall insolvency ala the automakers
> scenario, or telling people that the money would be used to increase
> individual and business access to needed credit? They reasoned that
> a "prevent insolvency approach" would take a lot of time, so they
> sold TARP with an access to credit rationale accompanied with wishful
> thinking that the funds would help free up access to credit.
>
> Its an interesting possibility that explains the seemingly inexplicable
> stupidity of providing public funds with no guidelines with respect
> to their usage. Would something like this be illegal (lying to Congress),
> or was it a typical political ploy used to get needed financial relief
> to the financial institutions as quickly as possible while performing
> an end run around likely Congressional opposition from members of
> their own political party? What was the basis of that alluded to
> large common loss? Was it mortgage based derivatives, or was there
> something else, something that the Government and the large financial
> institutions were involved in? Something related to say …. oil speculation?
>
>
> It might make an interesting movie plot… conspiracy, secret agendas,
> Harrison Ford figuring it out… Its kind of telling that in order
> to explain the complete incompetence of providing funds to financial
> institutions with no strings attached, I had to resort to fiction.
> It just does not seem realistic under real world conditions.
>
> Oh well, I had some fun writing this up, I hope you had some fun
> reading it.

Jan 12 04:19 PM

[monday1929:]

I have stated for months that ANY Fiduciary investing others peoples money or doing business with thse Opaque banks will probably be found negligent by any jury hearing the case.

Jan 14 11:41 AM