They’re BAAAAACK: The CIT Takeover of OneWest Bank

john thainWow. I mean. Just, wow.

You gotta love these guys.

Two phrases came to mind when I read the headline today about CIT Group taking over OneWest Bank.

First: “History does not repeat itself, but it certainly does rhyme.”


Second: “Madness consists of doing the same thing over and over again and expecting a different result.”

The casual reader of financial headlines will neither recognize nor care about this acquisition by a middle-market business lender (CIT Group) of a California retail branch banking institution (OneWest).

But it’s not the relatively anonymous companies that matter, but rather the people behind the takeover, and the historical provenance of the companies, that matters. This acquisition involves some of the key chess pieces of the 2008 Crisis and the worst excesses of that time. Let me go through some of the key names and highlights.


OneWest Bank – This is really IndyMac bank with a new name.

“A rose, by any other name, would smell as sweet.”

You haven’t heard of IndyMac?

IndyMAC was kind of a ground zero mortgage lender in the 2007/2008 time period. Before failing, it was the seventh largest mortgage originator in the United States, and when it was taken over by the FDIC in July 2008 it was the fourth largest bank failure in history.

Of course it was originally founded by the later notorious Countrywide founder Angelo Mozilo, who spun off IndyMac as an independent company in 1997.

IndyMac did the usual thing as everyone else, borrowing with short-term debt, and lending out in the form of illiquid dicey mortgages.

IndyMac in particular was a leader in the intermediate “Alt-A” mortgage lending segment – mortgages too risky to be considered ‘Prime,’ but not entirely as shaky as Sub-prime either.

OneWest Bank became a newly formed bank in March 2009 when it took over the remains of IndyMac, via an FDIC auction of the failed mortgage lender.

Leading up to this transaction, the CEO of OneWest is Steve Mnuchin, a former Goldman Sachs partner and member of the management committee.

Prior to taking over OneWest, Mnuchin led Dune Capital with other Goldman partners who had made their reputations and fortunes investing in the distressed assets of the Resolution Trust Corporation, the government’s response to the Savings and Loan Crisis of the 1980s.

CIT Group – In February 2008, this lending company rang the New York Stock Exchange opening bell to celebrate its 100 years of existence. By April 2008 the company was reeling from losses, ceased its student loan lending, and subsequently its home-loan lending by the summer 2008. With billions in shareholder value destroyed, the company declared bankruptcy in 2009. In January 2010. CIT hired John Thain as Chairman and Chief Executive.

John Thain – Once heir-apparent to the CEO position at Goldman Sachs under Hank Paulson, Thain left Goldman in 2004 to run the New York Stock Exchange when current Goldman CEO Lloyd Blankfein got the clear nod to succeed Paulson. Thain took over the leadership of Merrill Lynch in late 2007, after Stanley O’Neal did his best to drive the old bull straight into a financial ditch through self-inflicted subprime CDO wounds, leading to a $8.4 Billion write-down.

Thain – to his credit – quickly raised $6 billion capital from the Singapore sovereign national fund, only to have to oversee close to another $10 Billion in write-downs in his first half year on the job.

By the Summer of 2008, Thain was forced to market Merrill’s toxic CDOs, offering them to – among others – Steve Mnuchin at Dune Capital, before selling them to Lone Star Capital at a severe discount.

With Merrill reeling by the end of 2008 – and with by then a total of close to $50 Billion in sub-prime mortgage CDO-related write-downs, Thain managed to sell Merrill to the only CEO who actually performed worse than O’Neal throughout the crisis, Ken Lewis from Bank of America.

Criticism of Thain 

Thain subsequently was criticized for:

a) Spending 1.2 million to decorate his executive suite, including his famous $1,000+ gold-plated wastebasket

b) Requesting a $10 million personal bonus from the Merrill Lynch board for saving all of their collective bacon, and

c) Paying out $4 Billion in bonuses to Merrill Lynch executives, just prior to the Bank of America takeover in January 2009, after the firm received $25 Billion in a direct US Treasury infusion of taxpayer money in October 2008.

All of which are fair grounds for accusing him of a touch of, shall we say, hubris. But from Merrill Lynch’s narrow perspective, John Thain was a motherflipping genius.

Thain is a genius, of a sort

Thain’s simultaneous saving of the venerable Merrill Lynch, and fleecing of Lewis and Bank of America’s shareholders in the midst of a financial meltdown is the single greatest sales job ever performed in financial circles.

Seriously. Ever.

But here’s the key point that links this financial history to Thain’s pursuit by CIT of OneWest Bank:

This greatest-sales-job-ever all would have been impossible if Thain’s former boss Treasury Secretary Hank Paulson had not guaranteed a $20 Billion sweetener for Ken Lewis to consummate the deal in January 2009.

Lewis apparently woke up from whatever drunken stupor had led him to acquire first Countrywide, and then Merrill Lynch, and Lewis tried to back out of the deal between December 2008 and January 2009.

Secretary Paulson ponied up $20 Billion in taxpayer first-loss money and jammed the deal through. Paulson could not afford, in the midst of the crisis (as well as Presidential transition) to have Merrill Lynch dropped by Bank of America, and very likely, bankrupted.

 Some other relevant facts

Also, coincidentally, his direct protégé from his Goldman CEO days ran Merrill Lynch at the time. Anyway. Not completely off-point, Thain reportedly earned $83.1 million from Merrill Lynch during his service from December 2007 to January 2009. Anyway.

Thain was a hero for Merrill in December 2008, but crucially could not have pulled off his magic trick had Merrill not been Too Big To Fail. And THAT, my friends, is what this CIT takeover is about.

And Thain has said that as plainly as possible.

CIT, under Thain, wants desperately to be Too Big To Fail

In recent months Thain has talked about whether CIT would pursue a bank acquisition. The additional safe deposits would be nice for CIT, Thain has said, but the key to CIT’s next purchase would be to get well above the threshold of $50 Billion in assets. Why does that matter? Because $50 Billion is currently the cutoff for becoming a “systemically important financial institution, or SIFI.

As the Wall Street Journal reports

On a conference call, Mr. Thain said he believes CIT is ‘well-positioned to satisfy all of the criterion or being a SIFI institution.

And as the Wall Street Journal further reports,

The takeover of IMB Holdco LLC, which is OneWest’s parent company, will bump CIT’s assets up to $67 billion, making the bank large enough to be considered ‘systemically important’ by regulators. CIT, a lender to small and medium-size businesses, had $44.15 billion in assets as of June 30.


SIFI, by the way, is what we now call Too Big To Fail institutions.

Ironically, becoming a SIFI should be considered a disadvantage, because it involves additional layers of regulatory scrutiny. In a normal, pro-business, capitalist financial system, we would expect that becoming a “SIFI” would be a “NoNo” for any bank.

Since 2009, regulators from the FDIC, SEC, Federal Reserve, CFTC (and any number of other acronymic bureaucracies) have been struggling with how to deal with Too-Big-To-Fail financial institutions.

Their answer: More regulations, more ‘living will’ requirements, more stress tests, more disclosures, more restrictions on proprietary trading, more capital requirements.

You’d think that any growing financial institution would run for its life, away from this type of bureaucratic morass.

Not CIT. Not Thain.

He knows first-hand how awesomely, personally, profitable it can be to run a massive private financial institution that has socialized any future losses because it’s a SIFI. Thain’s no dummy.

Steve Mnuchin, no slouch himself, will join the company as vice chairman and will join the board as well.

Please see some of the related posts:


In Praise of SIGTARP Part II – We blew it on the repayment of TARP

SIGTARP Part V – The AIG Debacle


Book Review of Bailout by Neil Barofsky

Book Review of Diary of a Very Bad Year by Anonymous Hedge Fund Manager

Book Review of Too Big To Fail by Andrew Ross Sorkin


Life After Debt: Putting the Band Back Together

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GS research on TBTF and Bond Yields

Too Big To Fail

I frequently complain in this space about the Too Big To Fail (TBTF) banks in the wake of the 2008 Crisis.  For me, TBTF is short-hand for the idea that large, private, for-profit enterprises – and by extension their employees and investors – enjoy an implicit government guaranty in the event of financial calamity.  While small or medium sized financial institutions (or non-financial institutions) may and do regularly fail, certain companies cannot, by dint of their size and systemic importance.

As a result of the real and implied government guaranty, we widely acknowledge the risk of ‘moral hazard,’ in which executives, employees, and investors take greater risks than would otherwise be prudent, knowing there’s an invisible safety net below their high-wire activities.

The largest banks perhaps always had this implied government guaranty, although it had not really been tested until the 2008 crisis, so it was an idea talked about, in terms of moral hazard, but not necessarily believed in.

With the emergency investment of Troubled Asset Relief Program (TARP) funds in October 2008 into 12 systemically important financial institutions – combined with the concurrent receivership of mortgage insurers Fannie Mae & Freddie Mac, nearly unlimited liquidity provisions to AIG, and non-recourse liquidity by the US Treasury and the Federal Reserve to JP Morgan Chase and Bank of America to acquire the ailing Bear Stearns and Merrill Lynch respectively – we suddenly found out just who was TBTF and to what extent all taxpayers would have to backstop private firms, in order to ensure the financial system’s survival.

Given all of this, I have been naturally curious to read Goldman Sachs’ May 2013 research paper “Measuring The TBTF Effect on Bond Pricing.” **  I finally got around to it this week.

I enjoyed the piece and it has its strengths, which I’ll describe below.  Unfortunately, the paper is also a great example of how asking the wrong set of questions allows you to completely miss the relevant point.

The TBTF GS research paper

Goldman concludes that the advantage of being TBTF is limited, mixed, and inconclusive.

In short, large banks as a group enjoyed some small advantage before the crisis, a marked clear advantage in the years 2011 and 2012, and some apparent disadvantage in 2013.

Their analysis focuses on the differential in funding costs – technically ‘yield spread’ but to keep this simple let’s say funding costs – that the biggest banks enjoy, when compared to smaller banks.

If you can fund your business more cheaply, it stands to reason that you can make more money.  What their research says is that the largest banks as a group had a slight money-making advantage pre-crisis, a definite advantage during the crisis, and some measurable disadvantage now.

Unlike many who instinctively mistrust Wall Street – and in particular Goldman, the firm that weathered the financial storm the best – I expected Goldman’s research to not be derisible as entirely self-serving.  And I was right.  This is serious, albeit dry, analysis.

The most useful part – pointing out where others went wrong

The most useful part of their analysis is their criticism of earlier, academic, studies which found great financial advantages accrued to the TBTF banks.

The problem with some earlier studies, the GS research points out, is that they included non-bank financial institutions (REITs for example, or asset managers) which naturally have higher funding costs than large banks, thus making the large banks’ cheap funding appear more advantageous than it really was, or is.

Other studies, they point out, included a wide range of global financial institutions such as Albanian or Uzbekistani banks – which is admirable from a diversity standpoint – but probably irrelevant for analyzing the specific US problem of TBTF banks.

Finally, the GS research highlights the key point that large companies in any industry often enjoy lower funding costs, from a combination of efficiency, perceived stability, and the relative attractiveness of larger, more tradable, securities.

All of this makes sense to me and has given me a more skeptical view of studies which purport to show the ‘unfair’ funding advantages of TBTF banks.

But they asked the wrong question

On the other hand, however, it’s a terribly incomplete view of TBTF, as the authors limit their study to the pure financial effect of an implied government guaranty.

They ask the narrow question: Is there extra money to be made by TBTF banks by virtue of their TBTF status?  The answer to the narrow question is not terribly interesting: Yes there was a little extra money before, and a lot of extra money during the crisis, but none now.

I appreciate the question in pure financial terms, and I can agree, but I’m afraid it misses the bigger point.

The bigger point about TBTF is that if the largest financial firms have a government backstop – which still hasn’t been removed 5 years after the crisis – then how can these firms be considered private enterprises?

What I mean by that is that if taxpayers remain on the hook, ultimately and in nearly unlimited size, for future catastrophic losses, then how do we allow the private enjoyment of profits by employees and investors?

I really do believe in private enterprise, and nothing makes me happier than the idea of successful investors, entrepreneurs, and companies enjoying profits for delivering services in the private market.[1]

But TBTF banks aren’t real private companies.  It’s not about some narrowly defined ‘funding advantage’ as measure by bond yield spread.  It’s about only surviving because the government saved your bacon, and you still pay yourself as if the private profits are truly earned and deserved.

TBTF represents the worst kind of hybrid between government & taxpayer subsidy – socialized debts – and privately enjoyed profits.[2]  And I’m sick of it.


** Sorry, I had previously uploaded the paper and linked to SCRIBD, but SCRIBD removed it because I did not have copyright permission.


[1] Ok, a few things make me happier.  But we’re not talking about Rihanna here.

[2] I’m on a bit of an obsessive kick right now about these problems of government and commercial hybrids, especially after reviewing Jane Jacobs’ book on the topic.

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The Meaning of Jon Corzine

monopoly-go-to-jailWith the announcement that MF Global Trustee (and former FBI chief) Louis J. Freeh will charge Jon Corzine for failing in his duty to oversee the company, the meaning of Jon Corzine shifts once again.

Prior to this announcement, I understood the meaning of Corzine primarily through the following investment aphorism:[1]

“One of the worst things that can happen to you or a client is an early investment that wins big. You will become overconfident of your abilities and proceed to lose much more in the future through imprudent decisions than you initially made on the winner.”

Corzine’s career is the epitome of this wisdom, although he combined it with an uncanny ability to “fail upwards.”  A few salient points in his timeline illustrate his pattern.

The 1994 failure in Goldman’s Fixed Income department

1. He made partner as a government bond trader in the ‘80s, and later managing Goldman’s entire bond trading operation, but Corzine ramped up fixed income risk just when the wrong moment hit.

Interest rates rose sharply in 1994, prompting a bloody massacre of fixed income departments on Wall Street, including an existential threat to Goldman’s survival, due to losses.[2]  Instead of firing Corzine for his astonishing imprudence, the partnership felt it had no choice but to elevate Corzine to Chief Executive, all the better to unwind the level of risk in the fixed income department.  His elevation illustrated another finance aphorism:[3]

“If you owe the bank $1,000., they own you.  If you owe the bank $100 million, you own them.”

Corzine, as described in William Cohan’s Money and Power, How Goldman Sachs Came to Rule the World, in a sense ‘owned the bank,’ as the partnership could not afford to lose him due to its exposure to rising interest rates.  He was a massive risk taker in the lead-up to 1994, making extraordinary money in 1992 and 1993.  But when it all turned bad, instead of being fired, Corzine was rewarded with the top job at Goldman, paired with Hank Paulson to temper Corzine’s risk appetite.[4]

Summer of 1998, Long Term Capital Management, and Corzine’s attempted rogue portfolio trade

2. With the August 1998 Russian ruble-bond default and Solomon Brothers’ swap desk liquidation, most of Wall Street faced major exposure to the insolvent Long Term Capital Management, the first Too-Big-To-Fail hedge fund.  The New York Federal Reserve attempted a private sector “bail-in,” requiring cooperation and an infusion of capital from each of the Wall Street firms, via a Godfather-style meeting of the families, hosted by the New York Fed.

Corzine, however, nearly managed to personally blow up the whole bail-in, achieving the rare trick of pissing off not only the rest of Wall Street but the entire Goldman partnership as well.

While the Fed urged cooperation between banks, Corzine attempted a sideswipe of the portfolio out from under the rest of the Street.  He secretly negotiated a purchase of Long Term Capital’s entire portfolio using Goldman’s capital[5], presumably believing the firm could make a profit by taking on the risk of the illiquid trades.

This attempt, ultimately unsuccessful, came at a delicate time for financial markets, suffering unexpectedly large losses on Russia and exposure to LTCM.

Goldman, in particular, had been planning an IPO that Fall, which Corzine’s actions undermined.  The IPO was delayed by market conditions, but also by the frightening style of rogue trading risk which Corzine engendered with his move.  The firm leadership of Paulson, along with deputy heads John Thain and John Thornton, engineered a coup against Corzine’s leadership as a result.

Corzine seemingly never saw a risk he didn’t try to take, which ultimately proved too much for the partnership.  They allowed him to stay nominally in charge through Goldman’s IPO in June 1999, with the understanding that Corzine would be professionally sidelined after that.  His political career began shortly after.

MF Global and lack of risk controls

3. After unremarkable stints as Senator and Governor of New Jersey[6], Corzine landed the top job at MF Global, a medium-sized brokerage.

We now know Corzine continued his pattern of 1994 and 1998, in which he doubled-down and tripled-down on risks, in the face of extraordinary losses.  Although his trading led to huge losses, somehow his ability to fail upwards did not derail his own personal career.

Up until MF Global became the eighth largest bankruptcy of all time, the meaning of Corzine seemed to be about his almost Forrest Gump-like success, in the face of amazing failure.  His Midwestern affable, bearded, demeanor masked an unlimited appetite for investment risk.  Sometimes it worked, sometimes it didn’t, but either way Corzine kept on moving upward.

We know in retrospect that Corzine’s pattern of unrelenting risk-taking continued at MF Global, and that ultimately some wrong-way bets on European sovereign bonds pushed the firm into chapter 11 bankruptcy.

We also know some $1.6 Billion in customer funds were misplaced in the final days of MF Global, for which I’ve argued Corzine should be in jail.

A new meaning of Jon Corzine

Following the debacle of MF Global, and in the light of the 2008 credit crisis, however, Corzine’s career came to represent something darker and more insidious.

Unlike failed chief executives Dick Fuld of Lehman Brothers, or Jimmy Cayne of Bear Stearns, Corzine actually oversaw the misplacement of customer funds, not just the destruction of shareholder value.

We forgive – mostly – the leaders who drove their firms into the ground through errors in judgment, or risk management, like Fuld and Cayne.  Shareholders lost, but shareholders took equity risk and our system rightly allows for losses like that.

Fuld and Cayne lost personal fortunes invested in their own firms, as they should have, and suffered for the loss in their reputation.[7]

But we should not forgive those who commit the fiduciary sin of misplacing customer funds, like Corzine.

I make a distinction between these so that we do not lose sight of the different types of losses, and the consequences.  It bothered me, up until now, that Corzine was not pursued more aggressively for the loss of customer funds.

Too Big To Fail executives

For me, Corzine additionally offered the ultimate lie to the public about executive compensation.  Namely, if you’re so essential to your business that you deserve, say, $12.1 million per year in good times,[8] how can you not retain the liability and responsibility when things go horribly wrong?

In what way did you earn the upside profitability, but not deserve the downside liability?

If you’re so good at what you do, then you need to be held personally liable when $1.6 Billion in customer funds go missing.

All of which is to say that I’m extremely pleased to see MF Global Trustee suing Corzine for his responsibility in the failure of his firm.

MF Global, the firm, was not Too-Big-To-Fail when it went under in September 2011.

Jon Corzine, the executive, until now represented a type of CEO who could earn profits and bonuses in the good years, without suffering personal consequences when things went wrong.

With the latest news, however, I’m encouraged that at least one Too-Big-To-Fail executive will suffer the consequences.


Please also see Arrest Jon Corzine Now

And Update on Jon Corzine by the MF Global Trustee

And One more rant on Jon Corzine

Corzine pariah

[1] All credit for this aphorism to financial planner David Hultstrom, whose ‘Ruminations on Being a Financial Professional’ is the best collection of pithy and wise investment advice I’ve ever seen collected in one place.  See especially pages 9-12.

[2] Incidentally, I’m not in the prognostication business, but when you look at this simple chart of fixed income over the past 50 years, you see we’re at the very bottom of the rate cycle with very little to go from here.  No risk manager alive has ever dealt with a massive move upward in rates, only short spurts in a secular move to lower rates.  When the trend reverses, it will by U-G-L-Y.

[3] Attributed in different variations to John Paul Getty as well as John Maynard Keynes.

[4] I didn’t work in Goldman’s fixed income department until 1997, at which point Corzine ran the firm as senior partner, along with Hank Paulson from investment banking.  Corzine was the bearded, affable, sweater-vest guy who would occasionally come down to the bond trading floor.

[5] Matched with capital from Warren Buffett’s Berkshire Hathaway.

[6] An associate of mine who dealt with Governor Corzine frequently complained about Corzine’s leadership in New Jersey.  Although in agreement with his political persuasion, he found Corzine unwise politically and inconsistent to deal with.

[7] I actually wish we had more Japanese-style “begging of forgiveness” for corporate failure by chief executives.  The promise of public shaming might help temper risk appetite.

[8] Corzine’s scheduled final executive package, before he wisely offered it back, in the wake of the Ch. 11 filing of MF Global.

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Four Reactions to the Election

Four quick thoughts now that the elections are over, from a recovering banker.

1. The equity indexes fell immediately at the open today, and remain down over 2% on the day.  Do not let any talking head from the financial-industrial-infotainment industry try to suggest that this is in response to Obama’s election.  Every trader on the planet knew that Obama had a 60% chance of winning as of last month, a 75% chance of winning as of last week, and a 90% chance of winning as of the final 48 hours.[1]  Nobody who manages capital for a living was caught off-guard by the Obama victory, so nobody suddenly had to reposition their portfolio as a result this morning.  Markets and the people with real capital who participate in them are forward-looking and probabilistic; equity markets  already reflected widespread expectations of an Obama victory.

2. The next Treasury Secretary matters tremendously for the biggest financial-regulatory issue of the day – the unaddressed problem of Too Big To Fail banks.  Secretary Geithner pre-announced that he would not serve in a second Obama administration[2] so the hunt for a new Treasury Secretary is now underway.  Geithner’s utterly failed to address the TBTF problem and pushed the Obama administration into a business-as-usual, same-guys-in-charge approach to Wall Street reform.  Secretary Paulson’s background as the former Goldman chief who grew up professionally with the rest of Wall Street’s heads played an inordinate role in selecting the winners and losers of the Credit Crunch of 2008, along with in providing the ultimate government backstop for the country’s biggest financial firms.  Had Paulson come from any other industry – instead of finance – he would have seen what the rest of us saw: It’s unconscionable to allow firms to pay executive bonuses[3] in the same year that the firms were bailed out by taxpayers.  Geithner continued Paulson’s protective approach to Wall Street banks, rather than seizing the opportunity to extract real concessions or reform when the industry needed the government to survive.

I’m not suggesting we put someone like Elizabeth Warren[4] in charge, but we need someone who can independently evaluate what parts of Wall Street need supporting and which parts need curbing.  Somebody, in other words, who didn’t spend his or her entire life working on the Street.

3. The “Fiscal Cliff” and fiscal responsibility.

Obviously the FC now becomes the next hot topic for overheated punditry, at least until we pass the January deadline.

I’m not optimistic about the tone of the discussion nor about the possible results of fiscal compromise, but I do have my wishes.

I wish that, with elections for Congress now two years away, can we have less complete bullshit when it comes to fiscal policy positions?  Would that be too much to ask?

One party’s leader says the solution lies in tax cuts.  The other party’s leader says the solution lies in more generous social spending.  One party’s leader says military spending is untouchable.  The other party’s leader says transfer payments and social safety net spending is untouchable.  All those proposals leave us in a worse fiscal position as a nation.

Hey guys?  Can you treat us like grown-ups?  We can handle a bit more truth than you’re giving us credit for.  We know budget deficits have a terrible trajectory and only a combination of tax hikes and spending cuts will correct the course.

Say what you will about the 2016 Republican nominee, Gov. Chris Christie, he’s proved that refreshingly blunt and seemingly unpopular – but honest talk – can appeal to both sides of the political aisle.  Let’s have some more of that as we drive, full throttle, toward the Fiscal Cliff.

4. Tax policy

I’ll have more to write about this shortly, but one of interesting lessons of Mitt Romney’s candidacy is how little the US electorate understands, or cares to understand, about our income tax policies.

By releasing only his 2010 and 2011 income tax returns, Romney effectively obfuscated his financial background.  He signaled (albeit quietly) that his tax-planning strategies were so aggressive that their release would explode his electoral chances.  And yet, I don’t think this cost him anything real in the end in terms of votes.  He calculated – correctly! – that the electorate’s ignorance of current tax policies, and popular tax-planning strategies of the wealthy would protect him.

Despite heightened resentment toward the wealthy, I observe the “99%,” for the most part, has no idea what they don’t know.  They can’t even conceive of the many ways someone like Romney avoids paying his proportionate share of taxes.  Romney knew that, and he was not about to wake that ignorant, sleeping giant by revealing his methods in the unreleased tax returns.

[1] Because professional traders pay attention to data and evidence, not pundits trying to hype a competitive race.  Which is why Nate Silver is a the mutherflipping P.I.M.P. of the moment.

[3] Bonuses are for success.  Bonuses are optional.  Bonuses should reflect private profit and should never be paid by borrowing from taxpayers.  Only a deeply embedded executive like Paulson could have missed the implications of this.

[4] I know I may sound strident when it comes to Wall Street reform, but I actually admire the industry very much and I want it to thrive.  Warren, by contrast, strikes me as overly ideological when it comes to Wall Street, incapable of seeing the positive.

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SIGTARP, Part IV – What Small Banks Are Going Under Next?

Ok, so it’s no secret I’m pretty sweet on SIGTARP, the Norse God of Financial Accountability.

There’s the pleasure of calling a fellow US Treasury colleague a liar.

There’s the feistiness of a government official pointing out that through our failure to rein in TBTF banks, we’ve laid the groundwork for the next crisis

There’s the carefully balanced review of the Citigroup Bailout.

Frankly there’s the plain old fun of SIGTARP himself, Neil Barofsky, responding during his book tour[1] to my tweet about Geithner, unconcerned that Geithner would jump to Goldman, Sachs, because at least at GS he’d do less harm than as Treasury Secretary!

Barofsky’s response to my question about Geithner going to Goldman. “He could do less harm there.”

But I digress.  There’s a good deal of valuable information in SIGTARP reports, and in this installment I thought I’d highlight a few things we can learn about small and medium size banks.  I’m sad to say that four years after the Credit Crunch, many small and medium size banks are doing terribly.

US government regulators NEVER tell you which banks are in distress.[2]  But SIGTARP consistently goes where other regulators dare not tread.[3]  Read the full report to find out which small banks will go under next, probably by 2013, or simply go to the list of banks which have missed dividend payments.

On missing Dividend payments owed to Treasury for TARP money

The stated reason for TARP was to ensure that TBTF banks did not bring the entire financial system to a grinding halt when taken over by the FDIC or placed in receivership.  For less clear-cut reasons[4] however, Treasury also offered small and medium size banks a chance to take advantage of the fast-track route to recapitalization via government investment.

As it turns out, and despite explicitly forbidding this[5], the TARP money extended a lifeline to small and medium size banks that have failed to thrive following the Great Credit Crunch.  A few hundred of these banks have either succumbed to failure or have missed so many dividend payments to the Treasury that survival seems doubtful.

SIGTARP reports list not only those banks which have outright failed or those where the government has lost money, but also those banks that have missed dividend payments to the Treasury and the number of those payments as well.  The missed dividend signals the banks that are probably too far gone to survive.

Wondering if your local TARP-bailout bank is in good shape?  You can check for it in the SIGTARP report HERE.

To save you some time scrolling through the SIGTARP report, you can look on the following pages for:

Pp 98-102: 162 Banks that have missed one dividend or many dividends.

Pp 102-103: 41 Banks where the US Treasury has realized a loss through its TARP investment.

Pp 110-117: 99 Banks that have failed, gone bankrupt, or had their US Treasury investment forcibly restructured.


On troubled Community Banks that still owe TARP money

One measure of recovery from the Great Credit Crunch would be the strength and stability of banks in the United States.  And, unfortunately, a great number of small community banks, we learn from SIGTARP, are really still sucking wind.

While 90% of the original TARP money[6] from late 2008 has been repaid from all of the TBTF banks (except Regions Bank), small and medium size banks have been much slower to repay.

As of the latest Congressional report, approximately 400 small and medium size banks have yet to pay back TARP funds.  Even that group of 400 TARP banks overstates smaller banks’ ability to repay, since an additional 137 banks swapped TARP funds for a program custom-designed to let them off the TARP hook, through a financing called SBLF.

What are the implications for the future of small banks unable to repay TARP?

400 banks account for approximately 5% of banking institutions in the country, not a huge portion of the total.  In a strictly macroeconomic sense, it is systemically irrelevant whether these banks live or die in the years to come.  A case can even be made that fewer banks in the United States would be just fine.

From a taxpayer perspective the $20 Billion value in small bank preferred shares and warrants represents less than the US Treasury risked with individual banks such as Citigroup and Bank of America in the early days of the crisis.

On the other hand, comparing small bank failure to household financial failure shows the locally devastating effect if they implode financially.  That is to say, it matters to those banks and their communities if they fail.  Not only that, we can assume, not unreasonably, that failing banks will be concentrated in depressed regions of the country, exacerbating access to credit for small businesses and real estate developers in precisely those areas which can least sustain losses.[7]

The SIGTARP report provides evidence, if you read between the lines, that a great number of these smaller 400 TARP recipients are on life-support, and many will not make it out of the intensive care unit.

Congress passed the Small Business Lending Fund (SBLF)[8] nominally to provide more credit for small business, but in reality to allow medium and small banks to exit TARP and roll into a less restrictive government program.[9]  One hundred thirty-seven banks qualified for Treasury funding under SBLF by proving their likelihood of increasing their loan portfolio to small businesses – and exited TARP shortly thereafter.  Those who could exit TARP at that time, did – the rest could not.

Furthermore, executive compensation restrictions make it unlikely that any bank still owing TARP money has a profitable and sustainable banking franchise.  If they could have paid it back, they would have by now.

The 162 Banks Most Likely to Fail

As of the July 2012 report, one hundred sixty two, or almost half of the remaining 400 TARP banks, have missed dividends (currently with a 5% coupon rate) on the preferred shares owed to Treasury.  By law, the dividend rates jump to 9% on these bank preferred securities beginning in 2013.  Payments of 9% on their capital is an exorbitant rate for banks to pay when the costs of funds in the money markets for healthy banks remain below 2%.

In sum, the picture is grim for remaining small and medium TARP banks, but the financial system and ordinary taxpayers will not suffer extraordinary losses.  To badly hit communities, however, more pain awaits, probably in the second half of 2013 when 9% dividends deal the fatal blow to weak banks.



Also see:

In Praise of SIGTARP Part I, “Truth in Government”

In Praise of SIGTARP Part II, “We blew it on the repayment of TARP by the largest financial institutions”

SIGTARP Part III – “The Citigroup Bailout”

and SIGTARP V – The AIG Bailout

[2] There’s a good public policy reason for this.  Exposing a weak bank publically may create a self-fulfilling prophesy of weakness, as depositors and customers leave the zombie bank for its stronger competitors.

[3] Which is why it’s kind of an illicit thrill to see struggling banks publicly outed this way.  I know, I’m weird.

[4] One strongly implied reason at the beginning of TARP was the ‘safety in numbers’ idea.  That is, if many banks took TARP funds at the same time it would remove the stink of government intervention from the actual targets, the TBTF banks on the financial precipice.  Another reason is probably the sway of small and medium banks with their Congressional representatives.  One reason that makes less sense is the systemic value of small and medium banks.

[5] TARP funds were supposed to be only available to Qualifying Financial Institutions (QFIs.)  But the definition of a QFI included the mandate that they be “healthy, viable institutions.”  We know with hindsight that at least both Citigroup and Bank of America would have failed to qualify for this designation had “healthy, viable” been a truly disqualifying condition.  But we now also know hundreds of small banks failed that test as well.

[6] In this posting, by “TARP funds” I really mean to refer to the Capital Purchase Program (CPP) by which Treasury bought preferred shares and warrants in 707 banks, including the largest 17 TBTF banks.  Technically “TARP funds” could include a wide variety of other investment programs authorized under TARP, but I’d rather use the acronym TARP than CPP, since it is better known.

[7] See this interesting site with stats and maps of bank failures.

[8] In September 2010

[9] The initial dividend rate of 5% matches the TARP dividend rate of 5%, but crucially SBLF funding does not carry restrictions on executive compensation.  Much better, Smithers.

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The Citigroup Bailout – SIGTARP Part III

We love to criticize the wastefulness of bureaucracy, the agency ass-covering, and the naiveté of government officials.  But it’s a surprising pleasure to read[1] The SIGTARP [2]  review of the government’s response to Citigroup’s near-death experience and its bailout in the Fall of 2008.

Here we have a US Treasury position created for the purpose of reviewing the government’s own actions in the heat of the crisis, and we might be excused for bringing low expectations to the table.  I have to admit, however, that my jaundiced eye opens wide with the quality of the analysis and indeed the downright feistiness of the SIGTARP report.

The report reviews the timeline of the crisis, the systemic need to bail out Citigroup, and the particulars of negotiating – actually, Treasury mandated – a $20 Billion preferred-equity capital infusion and a loss-absorbing backstop for a $300 Billion ring-fence around Citigroup’s riskier assets.

We do not know what would have happened without government intervention on behalf of Citigroup, but the SIGTARP nicely summarizes the case for Citigroup’s status as a Too Big To Fail (TBTF) Bank for those of us with short memories.  Citigroup was at the time the largest currency exchange bank, the largest consumer finance lender, the world’s largest credit card lender, the 2nd largest banking organization, the third largest mortgage servicer, and the fourth largest student lender, with over $175 Billion in uninsured domestic deposits.

SIGTARP shares numerous interesting details from the negotiations in October and November 2008.

First, the government needed to lie to itself and the public in the Fall of 2008 when it declared Citigroup a ‘healthy and viable’ banking institution[3], as a necessary condition for providing an initial $25 Billion capital infusion through the Capital Purchase Program (CPP) in October 2008.[4]  Treasury Secretary Paulson and New York Federal Reserve Board (FRB) President Geithner clearly felt at the time that they could only get Congressional support for the CPP if it came with a large dose of self-deception about ‘healthy and viable’ banking institutions.  Why would a ‘healthy and viable’ banking institution need an emergency $25 Billion capital infusion from the government anyway?  It’s a Potemkin Village type absurdity, and SIGTARP lets us enjoy the irony.

Next, Treasury, FDIC, and the FRB cut a pretty good deal for taxpayers in negotiating with Citigroup.  Most importantly, they announced to the public (and Wall Street) the ‘ring-fencing’ of over $300 Billion in Citigroup assets – government insurance against losses.  By ring-fencing, they separated presumably toxic assets on Citigroup’s balance sheet, and declared these assets would be treated in a special way to limit Citigroup’s total losses.

Here’s the clever part about the ring-fence; Citigroup remaining on the hook for the first $39 Billion in losses, with a combination of Treasury and FDIC absorbing the majority of the next $15 Billion in losses, and the Federal Reserve Board absorbing the rest of the loss risk via non-recourse financing.  While the announcement emphasized the government insurance for Citigroup’s riskiest CDOs, RMBS, CMBS, and auto loan ABS, loss-scenarios suggested only Citigroup would bear the losses on the portfolio.[5]

If you can’t figure, as neither Citigroup nor the market could out at the time, what the bank’s biggest loss could be on its portfolio, then the market would assume the worst and treat Citigroup as a soon-to-fail entity going the way of Bear Stearns, Lehman, and AIG.  But if you can precisely define, as the ring-fence did, the upper limit of the bank’s losses, then the market understands the known limit and the self-fulfilling prophesy of expected losses leading to financial wipeout can stop.   So, that’s clever.

Following this announcement, as intended, markets credibly believed Citigroup to be TBTF, with a perceived government guarantee on a huge portion of its riskiest assets.  The stock-shorting activity reversed, CDS spreads tightened, and we saw no world-wide run on Citigroup’s bank deposits.

SIGTARP’s feistiness surfaces most particularly in reviewing not only the actions of government leaders, but their disagreements with each other and with its review.  Numerous times throughout the report, we learn of requests by FDIC’s Sheila Bair to change or redact statements in the report.  We also learn that Citigroup successfully withheld a listing of its ring-fenced assets from publication by SIGTARP, citing propriety information[6], but SIGTARP is not afraid to respectfully disagree.

SIGTARP’s summary of the story emphasizes the ad hoc, but ultimately correct, decision of government leaders to massively intervene on behalf of Citigroup.  SIGTARP calls out our own government for what they failed to make Citigroup do; this distinguishes the report and makes for good reading.

SIGTARP gets to the heart of unsolved problems with the government interventions of 2008.  Citigroup, along with more than a dozen financial institutions, today remains TBTF.  Which means we could repeat the same crisis we all just survived. 

Not only that, but SIGTARP rightly states that the last bailout may increase the likelihood and severity of the next crisis, because the moral hazard problem also remains with us today.  High-risk takers, namely Citigroup creditors and counterparts, were not punished in the bailout, so they may reasonably expect to under-price similar credit and counterpart risk in the future, believing that the government provides an invisible safety net underneath high-wire risk taking.

Even short of a repeat crisis, we know that the implied government guarantee for TBTF institutions constitutes a massive subsidy to Citigroup and its brethren via lowered borrowing costs and collateral costs.  This subsidy provides huge advantages over smaller financial firms, but, more troublingly sets the taxpayer up for unlimited liability for private institutions, with little discernible public benefit.  Citigroup, the big red umbrella, is still not paying us citizens for the giant insurance policy we offer them.

I don’t criticize the government, and neither does the SIGTARP, for preventing a Citigroup collapse in the Fall of 2008.  I do blame the US government, and thankfully SIGTARP does too, for allowing TBTF banks to continue their invisible but nevertheless powerful draw on free taxpayer support.

Ultimately, as SIGTARP rightly (and depressingly) points out, we cannot know the cost of this Citigroup bailout until we know the cost of the next bailout, partly born out of this one.

Two concluding thoughts make me optimistic, however.

First, although SIGTARP is part of the government, it plays the ombudsman role fairly, critically analyzing what other parts of the government have, and have not, done since the acute crisis subsided.  There’s hope in a system which can criticize itself and thus correct its future course.  Course change is hard, but a report like SIGTARP’s makes it possible.  I made this thematic point in an earlier post, but it’s worth emphasizing.  I’m not sure we’re improving, but I am sure that critical thinkers within the system, like SIGTARP, give us a chance at improvement.

Second, throughout the narrative of Citigroup’s near collapse and rescue, we see instances of massive government intervention but not a massive government power grab.  This too bears remembering.  The United States has a tradition of public official respect for private enterprise, which is both understood and credible  – but not always recognized by politicians wanting to score points. [7]

A market collapse and an overwhelming government bailout naturally give rise to conspiracy theories on the political fringes.  Many, if not most, societies in the rest of the world would fit the Citigroup events into a conspiratorial, but ultimately unhelpful narrative.  The specific history of Citigroup as told to us by the SIGTARP, however, reminds us that even if the government did not get everything right, they actually did pretty well, considering.


Please also see SIGTARP Part I – Truth in Government

SIGTARP Part II – Biggest Banks Still Too Big To Fail

SIGTARP Part IV – Which Small Banks are Going Under Next?

and SIGTARP Part V – The AIG Bailout

[1] Assuming you like wonkish reviews of the government’s response to the 2008 Credit Crunch as much as I do.

[2] Special Inspector General for the Troubled Asset Relief Program, aka SIGTARP, aka Norse God of Financial Accountability.

[3] Both Treasury Secretary Hank Paulson and FDIC Chair Sheila Bair used this description in written and spoken statements.

[4]A banking institution had to be “healthy and viable” to be considered a “Qualifying Financial Institution,” as only “Qualifying Financial Institutions” could receive this capital infusion.

[5] As, in the end, it turned out.  When the $300B guarantee program unwound in the Fall of 2009, only Citigroup had suffered losses.  So we’ve got that going for us.  Which is nice.

[6] In pointing this out we get to share SIGTARP’s undoubted chuckle about the ‘special sauce’ of proprietary information Citigroup keeps from its competitors, which contributed to one of the most catastrophic losses in human financial history.  Seriously, guys?  No one wants your special recipe of assets that contribute to financial Armageddon for your bank.

[7] Anti-market and anti-government cranks both see vast conspiracies and vindication of their own warped views in the events of 2008, but thankfully they mostly troll the Internet commentary pages and do not reflect, you know, reality.

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