Thursday, September 30, 2010

Should the Taxpayer Take AIG Off the Fed's Hands? A Response to Chris Whalen

Former New York Fed ("FRBNY") "management trainee" R. Christopher Whalen has a post up on Zero Hedge urging the public to bail out said FRBNY. In AIG: Time for Treasury Secretary Geithner to Clean Up the Mess he says:

The fact is that the “loans” by the Fed to AIG were really private equity investments and thus illegal under the Federal Reserve Act. . .

The Treasury should issue debt to the Fed in exchange for these assets and the ownership would ultimately shift to the Federal Financing Bank (FFB). The FFB is the part of the Treasury that ultimately holds all financial investments by the government, including the stakes in AIG, General Motors and Citigroup. . .

And it will show the world that the American people are starting to take ownership of a problem we all helped to create.

So let's get his point of view straight. He believes that the FRBNY acted illegally when it invested in AIG. (That would imply that the counterparty payments of tens of billions of dollars to Goldman Sachs and many other counterparties stemmed from an illegal transaction and, while I am not a lawyer, have questionable legality.)

He then asserts that "the American people" "helped" to create this mess and therefore should, through the Treasury of the government of the United States, take this mess off of the New York Fed's hands.

Who is Chris Whalen that he wants us to bail out the New York Fed, even though he believes it acted illegally in acquiring the asset he wants us to acquire from it?

A bio of him states:

In 1984, he was hired as a management trainee by the Federal Reserve Bank of New York, where he worked in the bank supervision and foreign exchange departments. He subsequently worked in the fixed income department of Bear, Stearns & Co, in London.

After returning to the United States in 1988, Christopher spent a decade providing risk management and loan workout services to multinational companies and government agencies operating in Latin America. His clients included the U.S. Export-Import Bank, Toshiba Corp, Kroll Associates and Weyerhaeuser.

Mr. Whalen went on to co-found Institutional Risk Analytics. From this perch he opines on various financial matters in a generally interesting weekly post. The core business of IRA relates to understanding the non-obvious risks in the financial system. He recently gave an interview to the hard money-oriented King World News, in which he decried what he viewed as serious financial problems in various large financial institutions.

However well-meaning Mr. Whalen is in his views, they strike this humble blogger as seriously misguided. The division of AIG ("AIGFP") that wrote the unfunded credit default swaps that are said to have nearly brought the entire company down was based in London. The American people had nothing to do with AIGFP. The American people never heard of credit default swaps till the crisis and had nothing to do with their creation, lack of oversight of them by regulators (see, Brooksley Born for more info), and have no responsibility to take even a dollar of losses from what might turn out to be an ill-timed investment in AIG by the New York Fed.

Many, and I dare say most, people are unaware that the New York Fed is a private company owned by such stockholders as J. P. Morgan Chase. It pays dividends to these stockholders.
(It is also true that Fed profits are generally remitted to the Treasury.)

Nonetheless, the bottom line is that we have what I view as an unseemly attitude here. Mr. Whalen has been banging the gong about poor lending practices. He believes that the FRBNY, then headed by Timothy Geithner, acted illegally in rescuing AIG from apparent collapse. He now wants you and me to take this asset off the New York Fed's hands. Mr. Whalen got his career start at the FRBNY. It appears in this case that he is inappropriately blaming the public for an illegal action of the New York Fed (at least, in his view) to bail out a multinational company, said bailout allowing payment of a London-based subsidiary's bets with large, sophisticated financial counterparties of tens of billions of dollars at 100 cents on the dollar in several tranches over several months. Now it's our problem?

Does Mr. Whalen, who I have followed for several years and thought was a free market-oriented person, really believe that the U. S. Government should increase its ownership in private corporations?

As far as the Fed, it made sure that Goldman, Deutsche Bank and many other fat cats received their payments in full from AIG, and since then the Fed has continued to pamper these same companies with ultra-cheap money which they can then lend out at a profit or "invest" for a spread profit in Treasuries or governmentally-guaranteed mortgage-backed securities.

My point of view is that the ultimate lender to these banks about which I am most concerned is the individual or small business. We are being hosed by a bank rate of interest on our loan to the bank (which we usually call a "deposit") that the Fed is doing its best to make sure is below the rate at which prices rise.

Since the New York Fed and the FOMC appear to have the financial institutions' interests more at heart than the interests of the public at large that supports these institutions with their loans (deposits) and investment funds, then increasingly I agree with the British journalist Ambrose Evans-Pritchard, who has now concluded a two-part essay titled Shut Down the Fed. (Click HERE for what might be Part I, the above being subtitled "Part II without a link to any Part I).

I disagree with Mr. Whalen. I believe that AIG is his former bosses' problem. What happened at the New York Fed should stay at the New York Fed. And if said action was indeed illegal, why in his post did he not call for a special prosecutor to investigate the actions of Timothy Geithner, Henry Paulson and all others involved in the bailout?

In the bigger picture, it is disappointing to see that one more supposedly independent voice is now advocating continuance and ratification of the process of socializing the losses that were generated in pursuit of private gain.

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