Easiest Way to Rob the U.S. Treasury? Own a Bank

William Black's book The Easiest Way to Rob a Bank is to Own One detailed how the deposit insurance fund was looted by unscrupulous bank managers and complicit regulators and politicians in the Savings and Loan crisis of the 1980s and 1990s. The Wall Street Journal on May 27, 2009, reported how banks are lobbying to rob the Treasury by way of the Public-Private Investment Partnership's (PPIP) Legacy Loans Program. In particular, the WSJ reports that many banks and banking trade groups would like the Federal Deposit Insurance Corporation (FDIC), which is guaranteeing the loans in that program, to allow them to buy assets off their own balance sheets.

Here is how a bank can make easy money at taxpayers' expense:

Suppose a bank has loans that are always worth $50. They can bid $140 for these loans. Under the terms of the legacy loans program (.pdf), the bank only has to put up $10 to buy them. The FDIC loan will be defaulted on with certainty. The U.S. Treasury will lose its investment of $10 and the bank will lose its investment of $10. Yet, the bank comes out a winner because it received $140 – $10 = $130 for a loan worth $50. On net, the bank makes a profit of $80. The FDIC loses $120 – $50 = $70, and the Treasury loses $10. That $80 profit for the bank came out of taxpayers’ pockets.

In general, it is a bad idea for any of the banks and investment banks that have over $100 billion of assets to be buyers of loans in the PPIP. This is even is true if these banks are buying other banks' assets. Holding toxic assets makes these banks more likely to make bad lending decisions and shift risks onto taxpayers and bondholders. This contention is supported by my solo and joint research with Wendy Yan Wu "Debt Overhang and Bank Bailouts" and "Common (Stock) Sense about Risk Shifting and Bank Bailouts". Zombie banks will be eager buyers and unwilling sellers of toxic assets at all but massively inflated prices according to my paper "The Put Problem with Buying Toxic Assets".

In the end, I think the banks will fail in this transparent attempt to extract pure subsidies by both buying and selling their own loans in the PPIP. The U.S. cannot afford such blatant welfare for bankers. When the co-chief investment officer of one of the largest bond funds, Bill Gross of PIMCO tells Bloomberg that the U.S. government will lose its AAA credit rating eventually, it is no time to give massive subsidies like this to the banking lobby.

Disclosure: I do not have any long or short positions in any banks' securities except long positions in broad-based index funds.

Comments

[johndumas:]

Government structures are a prerequisite to game the system. In private transactions these actions would constitute fraud. No one is going to put the government's bureaucrats (zombies "only following orders") in jail.

May 28 06:27 AM

[mtalaba:]

One of the most important things to do in effecting change is to make complex problems clear, and dangers readily understandable. Good show! Now, is there any way to get your commentary in front of President Obama? (I'm not sure we can trust Geithner, since he comes from the dark side.)

May 28 12:25 PM