On Monday, while the whole world was watching to see if Congress would approve the $700 billion 'Bank Bailout Bill,' the Bush Administration went ahead with another bailout of their very own.
Wachovia (WB) bond holders got very very lucky. If I was cynical I would be looking around to see who got paid off. They certainly got a sweetheart deal - the FDIC bailed them out to the tune of $54 bIllion.
They apparently didn't need to run it by Congress either. George Bush and Hank Paulson, and uh "the FED," made the decision in consultation with Sheila Blair, the head of the FDIC.
Unlike the bonds of Washington Mutual (WM), whose value plunged to zero when the FDIC forced it into bankruptcy, the FDIC arranged for the Wachovia bonds to be taken over by Citibank (C) at par value, taking no loss of any kind.
This is rather troubling, because although the Wachovia bondholders didn't take any hit in the takeover, the US taxpayer sure did. The FDIC had to guarantee to backstop over $270 billion of Wachovia's worst assets to get Citibank to sign on the dotted line.
Citi is granting the FDIC $12 billion of preferred stock and warrants to compensate the FDIC for bearing this risk. A little quick arithmetic tells me that if those assets go to zero, the US taxpayer is going to get a return of about 4 cents on the dollar.
Now, this is an amazingly bad deal for the US taxpayer. Especially since the US obviously could have gotten a much better one. If the FDIC had done its job according to standard operating procedure, those $54 billion of Wachovia bonds would have gone to zero before the FDIC would have been on the hook for one thin dime.
If that had taken place, the FDIC would only have had to backstop $216 billion worth of Wachovia's bad assets instead of $270 billion. (And what a sad, sad sign of the times it is, that I can actually say "only" $216 billion dollars).
Maybe we are getting too blase about big numbers, but it seems to me that $54 billion is enough money to get excited about. It might not buy an aircraft carrier, but it sure would repair a lot of crumbling bridges. Yet for some reason I'm not seeing any calls in the press for an inquiry into why the Wachovia bondholders were given this sweetheart deal.
It surely is the primary fiduciary responsibility of the FDIC to avoid taking an unnecessary loss. What reason did they have to let Wachovia's bond holders off the hook and step in and assume the risk of default themselves? As far as I know, the FDIC hasn't put forward an explanation for the widely diverging outcomes. It seems extremely destabilizing to have such widely varying outcomes in two such similar situations.
First, by treating the Wachovia bond holders in such a preferential fashion, George Bush and Hank Paulson leave themselves wide open to charges of corruption and crony capitalism. Presumably they actually did nothing wrong, but the mere appearance of such favoritism is extremely destructive to basic social trust. What can the WaMu bondholders be thinking but "whose palm did I forget to grease," or "which friend of Hank or George has a big slug of Wachovia bonds in their portfolio?".
The basic problem of course, barring any actual impropriety, is that the Bush Administration shouldn't be making these decisions in an off-the-cuff, spur-of-the-moment fashion.
With all the stresses on our banking industry right now, the FDIC needs to make it crystal clear to other nervous bond holders of other troubled banks, exactly what criteria the FDIC is going to use to decide if their bond holdings are going to pay off at par, or become worthless, if the bank is seized by the FDIC.
With other big insurance companies hovering close to the edge, Hank Paulson needs to make crystal clear the exact reasons he seized AIG, and the exact criteria he used to decide to intervene in the marketplace.
It's a little after the fact, but it certainly would have calmed the market, and allowed everyone involved to behave a great deal more rationally, if he had been totally clear as to the exact conditions under which he would have let an investment bank fail, and the exact conditions under which he would not.
Withholding this kind of information leaves the market more destabilized than if he had done nothing at all. And it leaves him wide open to suspicions that his decisions are being made to benefit himself and his friends rather than the United States of America.
Disclosure: No stocks or bonds in Washington Mutual, Wachovia, or AIG, or any other financial institution for that matter. I am however, a somewhat disenchanted taxpayer.