A tale on why federal regulators in the US should not have near as much power - they used it to force a very risky merger between Bank of American and Merill Lynch, and forced banks to accept the TARP (bailout) money. And so now we've got a situation where the banks want to stay the hell away from the TARP funds and the government, and we have to deal with the unintended consequences of stupid government action. But these consequences were foreseen by the private banks.
The first article deals with Bank of America:
http://online.wsj.com/article/SB124078909572557575.html
Spoiler Alert, click show to read:Busting Bank of America
A case study in how to spread systemic financial risk.
The cavalier use of brute government force has become routine, but the emerging story of how Hank Paulson and Ben Bernanke forced CEO Ken Lewis to blow up Bank of America is still shocking. It's a case study in the ways that panicky regulators have so often botched the bailout and made the financial crisis worse.
In the name of containing "systemic risk," our regulators spread it. In order to keep Mr. Lewis quiet, they all but ordered him to deceive his own shareholders. And in the name of restoring financial confidence, they have so mistreated Bank of America that bank executives everywhere have concluded that neither Treasury nor the Federal Reserve can be trusted.
Mr. Lewis has told investigators for New York Attorney General Andrew Cuomo that in December Mr. Paulson threatened him not to cancel a deal to buy Merrill Lynch. BofA had discovered billions of dollars in undisclosed Merrill losses, and Mr. Lewis was considering invoking his rights under a material adverse condition clause to kill the merger. But Washington decided that America's financial system couldn't withstand a Merrill failure, and that BofA had to risk its own solvency to save it. So then-Treasury Secretary Paulson, who says he was acting at the direction of Federal Reserve Chairman Bernanke, told Mr. Lewis that the feds would fire him and his board if they didn't complete the deal.
Mr. Paulson told Mr. Lewis that the government would provide cash from the Troubled Asset Relief Program (TARP) to help BofA swallow Merrill. But since the government didn't want to reveal this new federal investment until after the merger closed, Messrs. Paulson and Bernanke rejected Mr. Lewis's request to get their commitment in writing.
"We do not want a disclosable event," Mr. Lewis says Mr. Paulson told him. "We do not want a public disclosure." Imagine what would happen to a CEO who said that.
After getting the approval of his board, Mr. Lewis executed the Paulson-Bernanke order without informing his shareholders of the material events taking place at Merrill. The merger closed on January 1. But investors and taxpayers had to wait weeks to learn that the government had invested another $20 billion plus loan portfolio insurance in BofA, and that Merrill had lost a staggering $15 billion in the last three months of 2008.
This was the second time in three months that Washington had forced Bank of America to take federal money. In his testimony to the New York AG's office, Mr. Lewis noted that an earlier TARP investment in his bank had a "dilutive effect" on existing shareholders and was not requested by BofA. "We had not sought any funds. We were taking 15 [billion dollars] at the request of Hank [Paulson] and others," Mr. Lewis testified.
But it is the Merrill deal that raises the most troubling questions. Evaluating the policy of Messrs. Bernanke and Paulson on their own terms, this transaction fundamentally increased systemic risk. In order to save a Wall Street brokerage, the feds spread the risk to one of the country's largest deposit-taking banks. If they were convinced that Merrill had to be saved, then they should have made the public case for it. And the first obligation of due diligence is to make sure that their Merrill "rescuer" of choice -- BofA -- had the capacity to bear the losses. Instead they transplanted the Merrill risk to BofA shareholders, the bank's depositors and the taxpayers who ensure those deposits. And then they had to bail out BofA too.
Messrs. Bernanke and Paulson also undermined the transparency that is a vital source of investor confidence. Disclosure is not a luxury to be enjoyed only when markets are rising. It is the foundation of the American regulatory system and a reason investors have long sought to keep their money within U.S. borders. Could either man have believed that their actions wouldn't eventually come to light, with all of the repercussions for their bank rescue plans?
Mr. Paulson told Mr. Cuomo's investigators that he also kept former SEC Chairman Christopher Cox out of the loop while forcing BofA to rescue Merrill. Mr. Cox wasn't the only one. Mr. Paulson and Mr. Bernanke both sit on the Financial Stability Oversight Board, comprised of federal regulators who oversee TARP. Two days after Mr. Lewis told the dynamic duo that Merrill's losses were exploding and that he was looking for a way out, Mr. Bernanke chaired and Mr. Paulson attended a meeting of this board. Minutes of the meeting show no mention of BofA or Merrill.
At the next meeting on January 8, a week after the merger had closed, the minutes again make no mention of either regulator telling their colleagues that they had committed tens of billions of dollars. Yet the minutes helpfully note that among the topics discussed were "coordination, transparency and oversight."
Meeting minutes suggest Messrs. Bernanke and Paulson finally informed fellow board members at 4:30 p.m. on January 15, after news outlets had already reported a pending new taxpayer investment in BofA. What exactly did Mr. Bernanke and Mr. Paulson tell their colleagues about their plans for TARP prior to January 15?
Let's hope they treated their government colleagues better than they've treated Ken Lewis, whom they hung out to dry. After making him an offer he could hardly refuse, they've let him endure a public flogging from shareholders and the press, lengthy discussions with prosecutors, plus new hiring and compensation rules that limit his bank's ability to compete.
No wonder no banker in his right mind trusts the Fed or Treasury, and no wonder nobody but Pimco and other Treasury favorites is eager to invest in the TALF, the PPIP, or any of the other programs that require trusting the government as a business partner.
The political class has spent the last few months blaming bankers for everything that has gone wrong in the financial system, and no doubt many banks have earned public scorn. But Washington has been complicit every step of the way, from the Fed's easy money to the nurturing of Fannie Mae and Freddie Mac, and since last autumn with regulatory and Congressional panic that is making financial repair that much harder. The men who nearly ruined Bank of America have some explaining to do.
The second, with Wells Fargo:
http://money.cnn.com/2009/04/19/news...tune/index.htm
Spoiler Alert, click show to read:Though a national force, the mortgage arm began losing ground to competitors in 2003 because it stayed away from the industry's riskiest products. It also alienated brokers by calling attention to what Wells saw as abusive practices.
Cara Heiden, co-head of the mortgage operation, says Wells' computer programs began flagging subprime mortgage applications from customers who could qualify for prime-priced loans. (Subprime loans carry higher rates and therefore pay higher fees to brokers.) "We would send the borrowers a prime-priced product - and cc the broker," she says. Predictably, Wells lost share, though its business continued to grow. Wells also dramatically cut back its roster of brokers, from a high of more than 25,000 in 2006 to just 8,100 today. Last year Wells regained the No. 1 position in the market for U.S. mortgage originations, with a 16% share. That should grow with the purchase of Wachovia, whose share, excluding the Pick-A-Payment business, was about 3%.
In the banking industry, loyal customers translate into cheap sources of capital. A family with a mortgage, a checking account, and a brokerage account is less likely to leave to chase higher CD rates, for example. As a result, Wells excels at making money the old-fashioned way, on the spread between deposit and lending rates. (Think: Borrow cheap, lend dear.) Its average cost of funds in the fourth quarter was just over 1.5%, compared with an industry average of 2.1%. "If you're the low-cost producer in any business - and money is your raw material in banking - you've got a hell of an edge," says Buffett, who caused a 20%-plus jump in Wells shares in March simply by expressing confidence in the bank on TV. "If you have a half-point edge - and they get that edge now on the Wachovia assets as well - half a point on $1 trillion is $5 billion a year."
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Whether Wachovia's assets give Wells a critical edge or irreparably dull its momentum has been the biggest question mark surrounding the San Francisco bank for months. It is fitting that an epic acquisition would define Wells Fargo's future, because it has been a bank-buying machine for years. Founded in 1852, the modern Wells became takeover bait itself. In 1998, Norwest, the Minneapolis bank then headed by Kovacevich, bought Wells Fargo, assumed its name, and moved the headquarters to San Francisco. Kovacevich had once been a hotshot banker at Citibank, but after CEO John Reed passed him over for a key promotion, he moved to Norwest in 1986. The Minnesota bank bought more than 150 community banks, often in bad economic periods, in places like Colorado, Texas, and Arizona. Despite persistent speculation that he would pounce again after buying Wells, Kovacevich didn't make another big move, preferring to solidify his position west of the Mississippi.
Then came the crisis of last autumn, beginning with the collapse of Lehman Brothers and the government-arranged sales of Washington Mutual and Merrill Lynch. On the last weekend of September the FDIC conducted a forced auction for Wachovia, with Citigroup and Wells Fargo as the two bidders. Citi won that round, agreeing to pay $2 billion for Wachovia's banking franchise, with the government guaranteeing a portion of the losses Citi would assume. Wells thought it could pay more, so after two days, with Kovacevich in Manhattan negotiating with regulators and Stumpf in San Francisco leading a team of 300 numbers crunchers, Wells offered to pay $15.4 billion for all of Wachovia - without any help from Washington. Or so they thought.
Two weeks later, on Oct. 13, Kovacevich was sitting at a long conference table with eight other bank chiefs in Washington, listening to Treasury Secretary Hank Paulson tell them why they should take the government's money. Kovacevich says he protested, telling Paulson that compelling banks to accept TARP funds would lead to unintended consequences. It would erode confidence in the banking sector by making investors question the healthiest banks rather than instilling confidence in the neediest. Other industries undoubtedly would come to expect a bailout themselves. Still, Kovacevich took the money.
His displeasure leaked to the public, but what hasn't been reported is exactly how Paulson flipped the seasoned banker so quickly. In what an observer in the room describes as a "true Godfather moment," Paulson told all the assembled bankers, "Your regulator is sitting right there" - actually the industry's two biggest overlords were in attendance: John Dugan, comptroller of the currency, and FDIC chairwoman Sheila Bair - "and you're going to get a call tomorrow telling you you're undercapitalized and that you won't be able to raise money in the private markets."
For Kovacevich this broadside was the horse's head on his pillow. He and his bank were in an unfamiliar position of vulnerability. Wells had just agreed to buy Wachovia, a bank it had coveted for years, and it needed the government's approval - and, critically, the ability to raise money - to complete the deal. Reflecting on the episode with righteous indignation, Kovacevich points out that each of his warnings to Paulson was later validated. Yet he turns sheepish in explaining his decision. "You want to do what your country and your regulators want," he says quietly in his office, decorated with miniature replicas of Wells Fargo's iconic stagecoaches. "There was no ambiguity," he says, as to what was expected of him.
As the autumn progressed, the markets had begun to lump Wells Fargo in with every other big bank, and justifiably so. Investors were concerned that Wachovia's problems were so severe that Wells had bitten off more than it could chew. Wells Fargo set out to raise equity to finance the deal, but potential investors wanted to know why, if the government had just injected $25 billion into Wells, it needed additional money to buy Wachovia. It was a good question.
Kovacevich says the bank's regulators specifically asked Wells to go ahead with the fundraising so that Wells would have a bigger capital cushion. At $12.6 billion, Wells raised more money than any non-IPO on record, but less than the maximum $20 billion target it had set. The Wachovia deal closed on the last day of the year (for $12.5 billion, nearly $3 billion less than the original offer price), and Wells that day wrote down $37 billion of a $94 billion Wachovia loan portfolio.
The large write-down, a banking term referring to the reduction of the value of an asset, removed a significant amount of risk from Wells Fargo's balance sheet - but not enough for Wells' critics. The write-down had the effect of weakening what had become a key ratio investors had begun to watch called tangible common equity, or TCE. It measures a bank's capital cushion without giving it any credit for ephemeral assets like goodwill. As a result of the deal, Wells had a TCE ratio of 2.7%, less than the 3% that many banking investors consider a bare minimum for healthy banks.
As recently as October, Wells had claimed it didn't need additional capital. Yet here it was, a recipient of the government's money and still undercapitalized by one important measure. The new burden of TARP began to chafe in February, when word got out that Wells was hosting its annual "recognition event" for top-performing mortgage brokers in Las Vegas. A populist rage ensued at the boondoggle by a TARP recipient, and Wells promptly canceled the event. CEO Stumpf wrote a defiant letter to employees, which Wells published as an ad in national newspapers, saying that the real victims of the controversy were the hospitality-industry workers of Las Vegas. If Wells hadn't been on the map before, its gestures of rebellion were starting to draw attention and curiosity: Just who are these cowboys?
By late February the heat grew more substantial. The Treasury Department announced it would conduct confidential stress tests of the country's 19 biggest banks to understand how well they could survive an even deeper recession. (Kovacevich earned headlines weeks later for his remarks calling the move "asinine" on the grounds that regulators routinely conduct stress tests at banks.) Suddenly no bank was considered safe. Wells shares briefly fell below $8 - from more than $40 in the fall - and after relatively healthy competitors J.P. Morgan, U.S. Bank, and PNC Financial all cut their dividends, Wells did too, by 85%.
Edit: Even better - the TARP oversight board (COP), charged with seeing what was done with all the money, is being used for the personal anti-bank crusading of its chair, Elizabeth Warren.
Spoiler Alert, click show to read:But the Congressional Oversight Panel Report seems to have come to a more controversial conclusion. The COP argued that historical lessons show that the most effective response to banking crises has involved a combination of ousting "failed management" and liquidating banks. The April report takes on the Treasury's responses in these areas and questions how effectively it has implemented its goals in dealing with the crisis.
The report essentially argues for nationalization on the grounds that, under government reorganization, bad assets can be removed, failed managers can be ousted or replaced and business segments can be spun off from the institutions. "Depositors and some bondholders are protected, and institutions can emerge from government control with the same corporate identity but healthier balance sheets," the report argues, parroting a position that has been staked out by many prominent economic pundits.
Clearly, this is Elizabeth Warren's particular crusade against the banks, since a majority of panel members dissented from the direction the report took and two refused to sign off on it at all. Her letters to Secretary Geithner and Chairman Bernanke stop just short of attacking them for trying to restart the market for asset-backed securities. These markets have been an important part of the financial intermediation system for decades, funding student loans, consumer credit and small businesses. But Professor Warren has had a long-standing antipathy to consumer credit markets.
The sad thing is that the COP now seems completely politicized and fractured at a time when there are important questions to be asked.
CR
