Did Crony Capitalism Lead to Wachovia's $54B Bailout?

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.

Comments

[Ishortyou:]

Stop whining about the tax payer money, do you think is it any better than Social Security? tax payer money that taxpayers will never see in the rest of their lifespan, or what about medicare? or wellfare? do you think that taxpayer money is soundly managed? or what about other government expenses and payrollls? well think again. Wachovia got rid off the prior toxic risky wasted bank subsidiaries and kept the good ones. Now it can start from scratch to build a new banking subsidiary with safe practice together with its remaining good outstanding subsidiaries. The current subsidiaries of Wachovia make it look like “Merrill Lynch without the toxic risky waste”, good job from management it separated the good bank from the bad bank overnight, plus its CEO Bob Steel is one of the top rated mutual fund managers. Wachovia will keep the valuable human resources and the talent that have expirience in the banking business saving them for the new banking subsidiary. Buying the municipal bonds or the auction rate securities will give the inflow of cash as long as its hold even to maturity. Some investors are taking money away from Hedge Funds going wild and putting that money into accounts manage by people that know what they are doing, Bob Steel is one of those people that know what they are doing, dont be surprise some of this money will go to Wachovia subsidiaries. Earnings will be adjusted accordingly, like simple arithmetics they will manage its expenses vs its earnings to come ahead in capital and start piling up cash (saving cash a hard job for most of us that live on debt), this new cash will give them the jump start of a new banking subsidiary without even thinking about to sell its remaining subsidiaries.Forgot to mention that Wachovia owns a hudge Insurance subsidiary which is making money and has sound book of business. Lehman debt is bonds most of them senior, as bankrupt as Lehman is those bonds get paid. ARS are Municipal Bonds as bonds they get paid, hold into maturity they get paid in principal, those ARS are cash flow. Preferred dividends will get paid accordingly because the holding company does not own the banking subsidiaries anymore so modification are going to be made. Getting rid off the toxic waste risky bank related subsidiaries is a good strategy and converting the remaining broker one to a new bank subsidiary with clean sheets is a good one too.

2008 Oct 03 06:32 AM

[knightmine:]

I agree 100%. And the same can be said for Merrill Lynch vs. Lehman Brothers. I own preferred stock in both and I have two very different outcomes.

2008 Oct 03 06:44 AM

[LittleRebel:]

It is OK Diane. It is now Wachovia & WellsFargo, which has always been rumored that the two banks would merge. It has finally happened and they will be very very competitive with BofA.

2008 Oct 03 08:30 AM

[chinooking:]

does citi still get the bonds now ,or does wells ?

2008 Oct 03 09:03 AM

[Big Al45:]

Its all good. The Citi/FDIC deal is dead.

WFC will mark down Wachovia's toxic crap and sell it to the taxpayers after the ballout is approved today. Saint Warren wouldn't have let WFC buy WB unless he knew that Congress would approve the deal.

As far as favoritism goes, that the way Wall Street has always worked (along with nepotism and family contacts.) Who knows - maybe Sheila Bair (or UMASS) was holding Wachovia bonds.

2008 Oct 03 09:13 AM

[chinooking:]

cool ,,,,,,,,long wfc

2008 Oct 03 09:15 AM

[User 274096:]

Is there an indication here that Citibank is not as strong as it is looking from outside ? Seems like Wells Fargo can offer a better deal with no Government support. Was Citi trying to extort money from Government ? Or is Citi genuinely cannot absorb the Wachovia ?

2008 Oct 03 09:20 AM

[connorport:]

These bondholders should be bearing some losses like the rest of us at this time. Whats next? Lets bail out all the people who have margin calls at this time so noone can lose. I say let these banks fail and all the people who have purchased beyond there means in the greed filled country we live in get a lesson in spending. This is the most rediculous crap i have ever heard of. Let the weak fall and the stronger rise from the ashes. Still noone is helping the little guy here!

2008 Oct 03 09:24 AM

[more inform...:]

I guess Diane's article could have had an impact today, had recent events not made the content absolutely worthless. Maybe "Withholding this kind of information" is necessary, because disclosing information that has yet to become applicable to reality, is common sense.

2008 Oct 03 09:52 AM

[swaps:]

Wachovia, WAMU were like large beached whales caught in the outgoing tide.

So bigger whales farther out in the deeper water are taking over their fallen brothers (or sisters, Diane).

But what is the point of creating ever bigger whales, any one of which has the expanded capacity to do even greater harm than the smaller ones they absorbed?

Let's change metaphors now and call these bigger whales in the deeper water ships. How long can these ships continue to take on water before they sink too?

As I have said before, one of the major trends causing the financial calamity - other than fraud and unbridaled greed- is that the investment-bank led destruction of jobs through foreign outsourcing, combined with deliberately open borders to bring in cheap foreign labor, has caused wage stagflation.

But the usury system requires ever inflating wages so that borrowers can keep up with usury payments. Otherwise, the lenders would eventually soak up all the money. That is the role of the "inflation fighting Fed": to continually inflate money supply. It has done so admirably, driving the value of a dollar down to a nickle since 1913. (Don't argue that government causes inflation because it could not do so unless the privately-owned Fed accomodates guvmint and prints the money that the government then borrows, agreeing to pay back interest. Ralistically, the government turned over the money printing operation to the central bank.).

The banking system needs inflation to keep the system running.
But the current wage stagflation has hit that need head on and it was the banks that are caving in, due to the resulting deflation.

The Fed can inflate all it wants and pump that into the lenders - but it does no good. The borrowers wallets have to be inflated and they aren't. so banking appears to be doomed ala 1929 - 1933.

Bank A is not loaning to Bank B because Bank A knows that when Bank B gives the money to Company C to build inventory, Company C's customers can't get money from Bank D to buy the product because of tighter lending standards, so Company C won't be able to pay back to Bank B who will not be able to pay back Bank A.

The situation is so simple to figure out. And impossible to solve without the entire economy shrinking its balance sheets, with all the accompanying pain.

2008 Oct 03 10:40 AM

[carey_jim:]

Some people call this gangster capitalism. Whatever you call it, it's been going on from the beginning.

It would be surprising if it was not percolating along as usual now also.

2008 Oct 03 12:29 PM

[Kinabalu:]

"Now, this is an amazingly bad deal for the US taxpayer. Especially since the US obviously could have gotten a much better one."

Very good! You got this one. Following on the WM deal you would think the people at FDIC could remember the deal they did a week before wiping out the bondholders.

Of course, I also think the Chairman of the FDIC has been so bad people would be able to get her name right. Its Sheila Bair, not Blair. Lets make sure we get rid of the right person.

2008 Oct 03 07:27 PM