“Heads I win, Tails the Taxpayers Lose”: Toxic Asset Rip-Off

That’s how analysts describe the trillion-dollar toxic-asset buy-up program proposed this weekend by the Obama Administration: “the president is putting forth his idea to have the Treasury become the new AIG. In order to get hedge funds to buy up toxic debt, Obama is proposing that the Treasury provide loans up front and insurance against potential losses on the back end. It’s what Paul Krugman called ‘heads I win, tails the taxpayers lose.’ By the way, it may cost another $1 trillion.”

The Treasury Secretary claims taxpayers won’t lose a full trillion, because the assets aren’t as worthless as their current market prices suggest. But if that’s true, why does he continue to insist on federal accounting rules that force banks to value their assets at the current depressed market prices? Either the accounting rules are right — in which case taxpayers will end up losing a trillion dollars — or they are wrong, amplifying financial panics — in which case the rules should be repealed, so that banks, not taxpayers, will be able to take the risk of holding the assets. (If these accounting rules, known as “mark-to-market” accounting, had been in place in the late 1980s, “every major commercial bank would have collapsed,” wiping out the economy).

It’s not even clear that all these bailouts are needed. As William Seidman, the banking official who helped clean up the S&L Crisis as head of the RTC, notes, the government’s $170 billion AIG bailout was absurdly expensive and wasteful. “We paid off huge debts that AIG had in the swaps market, which we probably did not have to do. We bought a number of assets from AIG at high prices, which we probably did not have to do.”

That includes a huge unneeded windfall for the investment bank formerly headed by Treasury Secretary Paulson, Goldman Sachs, which received billions of dollars from taxpayers that it did not even need, through the AIG bailout. As James Piereson notes,

“Goldman wound up receiving $12.9 billion in December from AIG in an initial payout from the TARP money. Thus, taxpayer funds were used not so much to bail out AIG, but rather its “counterparties,” including Goldman and a dozen or so other major banks. Now, in an interview with the press on Friday, Goldman’s chief financial officer has declared that the company was never in jeopardy from a collapse of AIG — that it held some $7.5 billion in collateral against its AIG account and that it had hedged the remaining $2.5 billion in its net exposure using credit-default swaps with other parties. . .David Viniar, Goldman’s chief financial officer, insisted that the company would not have been damaged if AIG had been allowed to collapse. Even so, the company profited handsomely from the payout from AIG, courtesy of the American taxpayer. Goldman could not turn down the payout without damaging its shareholders, Mr. Viniar said. In other words, if the U.S. government — via AIG — was going to offer a gift, Goldman was not in a position to turn it down. Which raises the question: What then was the point of the AIG rescue? The claim by Paulson et al that a collapse of AIG would bring down the international financial system was entirely unsubstantiated. Congress passed the bailout bill under pressure from the financial authorities that they had to act to ‘save the system.’ It turns out that this was far from being true. The lesson from this is that everyone — most especially members of Congress — should look skeptically upon claims that this or that institution is ‘too big to fail’ or that a catastrophe awaits of a major financial institution is not bailed out.”

Politicians frequently claim the sky will fall if their proposals are not implemented, even when they know that is not true. Obama claimed the $800 billion stimulus package was needed to avert “disaster” and “irreversible decline.” But the Congressional Budget Office, controlled by his own Congressional allies, admitted that the stimulus package will shrink the economy over the long run, in reports released both before and after the bill’s passage.

While pushing through $8 trillion in bailouts, and trillions more in debt from massive budget increases, the Obama administration has ignored inexpensive possible remedies for the financial crisis like reform of “mark-to-market” accounting rules. Many commentators are now calling for relaxation of those rules in order to stem the financial crisis, including former FDIC Chairman William Isaac, Congressmen Ed Perlmutter (D-CO) and Paul Kanjorski (D-PA), the Wall Street Journal, John Berlau, Jeff Miller, Holman Jenkins, Newt Gingrich, and the Republican Study Committee