Dishonest Money: CHAPTER 3 The Bailout by Joseph Plummer

 

Dishonest Money: CHAPTER 3 The Bailout by Joseph Plummer

 

CHAPTER 3
The Bailout

Enough with the set up, let’s take a look at the Federal Reserve System in action. Limiting our focus to a period of roughly 20 years (1970 through 1990), we’ll pick out some of the more interesting and well-documented bailouts.

 

While reading, keep in mind that there are “bigger and better” bailouts in the works right now. As long as it’s profitable for the financial elite to make these kinds of “mistakes,” the stories that follow will never end.

Penn Central Railroad

 

In 1970, Penn Central was America’s largest railroad. It employed 96,000 people, had a weekly payroll of $20 million, and was on the verge of bankruptcy. If ever there was a candidate for a “protect the public” bailout, this was it. One thing to keep in mind as we proceed, many of the large banks that had loaned Penn Central into inescapable debt also had bank officers on Penn Central’s board of directors. In other words, Penn Central was “mismanaged into insolvency” by the very banks it owed money to. They helped dig the giant hole from which the company (and the bankers) would eventually be rescued.

 

The House Banking and Currency Committee Chairman, Wright Patman, conducted an investigation in 1972 and found:

 

The banks provided large loans for disastrous expansion and diversification projects. They loaned additional millions to the railroad so it could pay dividends to its stockholders. This created the false appearance of prosperity and artificially inflated the market price of its stock long enough to dump it on the unsuspecting public. Thus, the banker- managers were able to engineer a three-way bonanza for themselves. They:

(1) received dividends on essentially worthless stock,

(2) earned interest on the loans which provided the money to pay those dividends, and

(3) were able to unload 1.8 million shares of stock – after the dividends, of course, – at unrealistically high prices. (Emphasis added.)

Even if the railroad had been permitted to go into bankruptcy, the bankers would have been protected. Penn Central’s assets would have been sold off and, as in any liquidation, the banks would have been paid first. The stockholders, on the other hand, could only hope to get some scraps (if anything remained at all) after the company’s debts had been cleared. (Knowing this, the individual bankers who engineered the crisis had already dumped most of their stock prior to public disclosure of the railroad’s problems.)

 

But why go the bankruptcy route when the Federal Reserve System had been created for precisely this kind of situation? En masse, they descended on Congress; Penn Central’s executives, bankers, union representatives, even the Navy Department, all speaking of the dire threat to the “public interest” -even national security -should Penn Central be allowed to go under. Congress patriotically responded by ordering an immediate pay raise of 13 ½ percent for all union employees, adding yet another financial burden to the already failed company. And with the “Emergency Rail Services Act” they authorized $125 million in federal loan guarantees.

 

Of course neither of these moves solved the underlying cause of Penn’s financial problems and the railroad was “nationalized” (“…a euphemism for becoming a black hole into which tax dollars disappear”-Griffin) in 1971. By 1973 it had been split into two divisions: Amtrak and Conrail. Amtrak handled passenger services and Conrail handled freight.

 

By 1998, Congress had dumped $21 Billion into Amtrak and its liabilities still exceeded its assets by roughly $14 billion. In 2002, it was burning up roughly $25,000 per hour (24 hours a day, 7 days a week) of taxpayer’s money.

 

Fortunately, the government sold Conrail in 1987. Since returning to the private sector, it has managed to turn a profit. Now it pays taxes instead of just consuming them.

Lockheed

 

Also in 1970, the nation’s largest defense contractor, Lockheed Corporation, found itself mired in nearly half a billion dollars of debt. To save the giant from bankruptcy, and of course save the banks from losing a huge asset and stream of income, a group of concerned interests descended on Congress. The banks, Lockheed management, stockholders and labor unions all explained how jobs would be lost, sub contractors would be put out of business and national security jeopardized if Lockheed was unable to borrow more money and fast. (…Money that no bank wanted to loan absent a government guarantee.)

 

The government responded with a bailout plan of $250 million in loan guarantees, increasing the company’s debt by over 50%. But wouldn’t this insane increase in debt put the company at even greater risk of insolvency? Under normal circumstances it would, but not in this case. Why? Because now the government (on the hook for $250 million) had all the incentive in the world to steer lucrative defense contracts to Lockheed so it could pay its bills. Again, rewarding failure and punishing success. Those contractors that operated their business more efficiently didn’t have the added leverage of saying, “If we fail, then you (the government) have to come up with hundreds of millions of dollars.” It would be foolish to think that didn’t come into play when deciding who was awarded a contract and who wasn’t.

 

Lockheed did eventually go on to pay back its loans, but in this case it really wouldn’t have mattered if they didn’t. As G. Edward Griffin explains:

 

…every bit of the money used to pay back the loans came from defense contracts which were awarded by the same government which was guaranteeing those loans. …Taxpayers were doomed to pay the bill either way.

First Pennsylvania Bank

 

When a bank has loaned itself so far into a hole it cannot escape, the FDIC has a few ways it can intervene:

1) The payoff option: Insured depositors are paid off and the bank is allowed to slide into bankruptcy and its assets are liquidated. If you’re a small bank with no political clout, this is what you’re likely to get.

2) The sell off option: The insured depositors are paid off and arrangements are made to have a larger bank assume control of the failed bank’s assets and liabilities. The bank’s name changes, but there is no interruption in service and few people notice what has occurred. Maybe you’re a medium-sized bank, maybe you’ve got a little more clout; in either case, this is a better option if you can get it.

3) The bailout option: The bank does not close and ALL depositors (insured and not insured) are paid off. If you’re fortunate enough to secure this option, odds are you’re a very large and well-connected bank. The significance of all depositors being paid off is this: Large banks are apt to have many uninsured accounts. (That is, accounts exceeding $100,000 each and accounts held outside the US.) Since the FDIC only charges participating banks a percentage of insured deposits, the large bank ends up collecting on insurance it never had to pay for. That huge savings gives an even bigger competitive edge to the larger banks. But that should come as no surprise; it’s exactly the way the Jekyll Island group wanted it.

 

As you might have guessed by now, First Pennsylvania Bank was a BIG bank. In 1980, with assets exceeding $9 billion, it ranked 23rd in the nation. After bungling itself into insolvency, its final move was predictable. (The bankers went to Washington with their bailout request.) As if warnings of catastrophic consequences in Philadelphia were not enough, they spun tales of an international financial crisis should First Penn not be saved. First Penn, they claimed, would act as the first falling domino in a string of collapses that would circle the entire globe.

 

Needless to say, nobody wanted to be responsible for refusing to do whatever they could to avert such a catastrophe. In response, the FDIC granted First Penn a one-year $325 million interest-free loan. That, by itself, saved the bank a couple million per month. After the interest-free year, the loan converted to about half the market rate (many millions more saved). Banks that were tied to First Penn loaned an additional $175 million and offered a 1 billion line of credit. (The FDIC insisted on this move. It wanted to show that the banking industry had faith in the bailout.) The Federal Reserve offered those banks low interest funds to make sure there was plenty of faith to go around. In the end, failure was again rewarded and everyone made lots of money (except the citizens who subsidized it all).

Continental Illinois

 

Sad to say, First Penn was literally child’s play compared to Continental Illinois. With 12,000 employees, offices in countries all around the world, and $42 billion in assets, it ranked 7th in the nation. For a while, it seemed unstoppable.

 

(Continental Illinois’) “…net income on loans had literally doubled in just five years and by 1981 had rocketed to an annual figure of $254 million.

 

It had become the darling of the market analysts and even had been named by Dun’s review as one of the five best managed companies in the country. These opinion leaders failed to perceive that the spectacular performance was due, not to an expertise in banking or investment, but to the financing of shaky business enterprises and foreign governments which could not obtain loans anywhere else.”

 

Continental Illinois had invested heavily in Argentina, Mexico, and a string of high-risk businesses. In 1982, as the Argentine and Mexican debt crisis came to a head and a series of corporations went into bankruptcy, the bank was hit hard. But just as Penn Central Railroad had done 12 years earlier, the bank did all it could to project an image of “business as usual.” It continued to pay dividends that it really couldn’t afford and it made good use of what the bank’s chairman called “The Continental Illinois Reassurance Brigade.” (That would be the bank’s employees, all around the world, doing what they could to calm the nerves of its depositors and stockholders.)

 

The move worked for a while, but by 1984 the bank’s bad loans had reached $2.7 billion and that figure was growing. With literally hundreds of millions of dollars in lost revenue, paying stockholders and maintaining an image of prosperity was becoming increasingly difficult. It was just a matter of time. News of the bank’s shaky financial situation began to trickle out (a rumor here, a rumor there) and before long, the floodgates were blown wide open.

The World’s First Electronic Bank Run

 

To see Continental Illinois from the outside, you’d never know what was happening. You’d never know, as the sun rose on Wednesday May 9th 1984, that a bank run of historic proportions was underway. On that one day, 1 billion dollars in Asian money was withdrawn silently, electronically. By Friday, the bank was forced to borrow $3.6 billion from The Federal Reserve to cover escalating withdrawals and by the following Friday, total withdrawals exceeded $6 billion!

 

The Continental run was like some modernistic fantasy: there were no throngs of hysterical depositors, just cool nightmare flashes on computer screens… –Ron Chernow

 

Inside the bank, all was calm, the teller lines moved as always, and bank officials recall no visible sign of trouble – except in the wire room. Here the employees knew what was happening as withdrawal order after order moved on the wire, bleeding Continental to death…. –Irvine Sprague

 

Now would be a good time to mention: If Continental would have been allowed to collapse, its stockholders would have been wiped out, its depositors would have lost a fortune, and the financial world would have been badly shaken. But who says that would have been a bad thing? The losses would have stirred anger and the anger would have driven demands for change. It would be near impossible to hide and excuse the inherently fraudulent nature of the system under such scrutiny and legitimate outrage. The long-term benefits to our nation (of undoing the flawed system) would have been enormous. But of course, no such thing was ever considered. “The System” had been created for a reason and this was it. It was time for the Fed and FDIC to work their magic which means it was time for the citizens to pay.

 

Earlier we mentioned large banks are most likely to be bailed out (have ALL their depositors paid off) AND are also most likely to benefit the most from a bailout as they’re apt to carry many uninsured deposits. Continental proved to be a shining example. A full 96% of Continental’s exposure was uninsured when help arrived. Or to put it another way, the bank had only paid to insure 4%, but now “to protect the public” it would be covered 100%.

 

The final bailout package was a whopper. Basically, the government took over Continental Illinois and assumed all of its losses. Specifically, the FDIC took $4.5 billion in bad loans and paid Continental $3.5 billion for them. The difference was then made up by the infusion of $1 billion in fresh capital in the form of stock purchase. The bank, therefore, now had the federal government as a stockholder controlling 80% of its shares, and its bad loans had been dumped onto the taxpayer. …By 1984, “unlimited liquidity support” had translated into the staggering sum of $8 billion. By early 1986, the figure had climbed to $9.24 billion and was still rising. While explaining this fleecing of the taxpayer to the Senate Banking Committee, Fed Chairman Paul Volcker said:”The operation is the most basic function of the federal reserve. It was why it was founded.”

 

Behind the creation of all this money sat the Federal Reserve System. Interesting that the Fed is known as the “Lender of Last Resort” when, in reality, it has no money to lend. No money, that is, until it creates some out of thin air, pours it into our economy and, through the hidden tax of inflation, confiscates purchasing power right out of our pockets.

 

As G. Edward Griffin explains “…the system was created at Jekyll Island to manufacture whatever amount of money might be necessary to cover the losses of the cartel.” And that is exactly what it does – for the “big guys.” If you’re a little guy, don’t expect any favors.

 

During the first 6 months of 1984, while Continental was getting the royal treatment, 43 smaller banks learned the following lesson first hand: As a small bank, the only deposits that are covered are the ones you paid to insure and you can rest assured you won’t receive any bailout offers. If you’re in trouble, you’ve got little choice but sell out to a larger bank. (Score another advantage for the Jekyll Island conspirators. Drive out or buy out the competition; either way, they win.)

The Housing Market

 

Up until now, we’ve seen how the penalties of mismanagement and fraud (in business and banking) can be turned into great rewards. Now we’ll have a look at the Savings and Loan industry (S&L) and how government promises of “A house on every lot” led to S&L bailouts of epic proportions. Suffice to say: “You ain’t seen nothin’ yet.”

 

During the Great Depression, Marxists blamed the capitalist system for the country’s dire financial situation. Spouting visions of a socialist utopia, they were starting to gain popular support. Many of our nation’s politicians, formerly champions of personal responsibility and individualism, quickly learned the advantages of preaching government paternalism.

 

Suddenly, it was more than “OK” to push for socialist policies in America, it was now politically profitable. There seemed to be something in it for everybody. The elites were more than happy to consider implementing a planned economy; after all it was they, the wealthy and well-connected intellectuals, who would be in charge of the planning. The politicians had everything to gain. Not only could they vastly expand the power and control of government (which in turn increased their own power and control) they could do so under the banner of “doing what was right for the country.” Last but not least, a large percentage of the population (financially crushed and demoralized by what they were told was the “instability of the free market”) was ready to accept just about anything. So many Americans were ruined by the Depression; it wasn’t too hard to sell the idea of a little government help.

 

Franklin Delano Roosevelt (FDR) came to represent the epitome of the new American politician.

 

Earlier in his political career, he had been the paragon of free enterprise and individualism. He spoke out against big government and for the free market, but in mid life he reset his sail to catch the shifting political wind. He went down in history as a pioneer of socialism in America. …While the Marxists were promising a chicken in every pot, (Roosevelt’s) new dealers were winning elections by pushing for a house on every lot.

 

Through the FHA (Federal Housing Authority), private home loans would now be subsidized by the federal government. At first, many people who might not have been able to afford a home did benefit from FHA assistance. However, it wasn’t long before these new “FHA subsidized” buyers began to drive up the price of homes and that offset any real advantage.

 

As another step to help the housing market, banks were required to pay less interest to their depositors than S&Ls. This drove deposits into the S&Ls, increasing the amount of money available for home loans, but it also decreased the amount of loan capital available for all other industries. (Great if your business is part of the home industry; not so great for everyone else competing for the same investment dollars.)

 

It was also about this time the FDIC (mentioned earlier) and the FSLIC (Federal Savings and Loan Insurance Corporation) first came into being. If there were to be losses, the people no longer had to worry; “The government would pay for it.” Too few realized, then as today, that the government doesn’t pay for anything. Every dollar is confiscated in one way or another from what others have earned. Consider the irony of government forcing you to give it money (or taking it through inflation) so it can protect you from losing your money.

 

Unfortunately, government solutions are always wasteful and often counterproductive. Even if you accept the idea that government programs and policies are intended to serve us (rather than intended to secure and expand the power of the elite) you don’t have to be a genius to calculate the dismal results.

 

The war on drugs, the war on terror, a house on every lot; whatever “solution” the government comes up with, it tends to create more problems than it solves. And with more problems come more proposed solutions, more demands for increased funding, more demands for greater control. In short: The more the government fails the more money and power it confiscates. If those who benefit from this backward system aren’t “failing on purpose,” they ought to be.

 

The consequences of government meddling in the housing market took a long time to manifest, but by the time they arrived, the results were disastrous. The costs of complying with government regulations alone have been estimated at 60% of ALL S&L profits. In addition:

 

…the healthy component of the industry must spend over a billion dollars each year for extra premiums into the so-called insurance fund to make up for the failures of the unhealthy component, a form of penalty for success. When some of the healthy institutions attempted to convert to banks to escape this penalty, the regulators said no. Their cash flow was needed to support the bailout fund.

 

As the Federal Reserve began raising interest rates, the S&Ls (to continue attracting depositors) had to offer more attractive rates themselves. By December of 1980 S&Ls were paying nearly 16% on their money-market certificates. This would be fine if they then loaned that money out at a higher percentage, but they weren’t. In fact, the average rate they were earning on new mortgage loans was only 12.9%. Worse, many of their old mortgage loans were only producing 7% or 8% and still others were in default (paying nothing at all.) Simple math illustrates the S&Ls were already broke and only going deeper in the hole.

 

Under normal conditions, few people would want to put their money in a failing institution. But with S&L deposits fully insured, “normal conditions” didn’t exist. The only thing that mattered to those making deposits was that hefty 16% risk-free return on their money. Brokerage firms with huge blocks of cash to invest were especially happy with the arrangement. Backed by the “full faith and credit” of the US government, there was nothing to lose and everything to gain by putting their money into the S&Ls.

 

By now, we all know what backs the “full faith and credit of the federal government.” Consumer Reports, wise to the scheme, put it this way: “Behind the troubled banks… stands “the full faith and credit” of the government – in effect, a promise, sure to be honored by Congress, that all citizens will chip in through taxes or inflation to make all depositors whole.”

 

Using clever accounting techniques (read that as fraudulent accounting techniques), an all-out effort to make the S&Ls look healthy and prosperous was put into play. This only postponed the inevitable and greatly increased the final carnage. Over a period of just 6 years (1980 – 1986), 664 insured S&Ls went belly up. The government, true to form, was in way over its head. It simply couldn’t afford to close all the thrifts because it didn’t have the funds to pay off their depositors. In March of 1986, the FSLIC had only 3 pennies for every dollar of insured deposits. Just prior to 1987, that dropped to two-tenths of 1 penny for every dollar.

 

Keeping the S&Ls in business was costing the FSLIC $6 million per day. By 1988…the thrift industry as a whole was losing 9.8 million per day, and the unprofitable ones—the corpses which were propped up by the FSLIC—were losing $35.6 million per day. And, still the game continued.

 

By 1989, the FSLIC no longer had two-tenths of a penny for every dollar, instead it now had nothing. It too was insolvent.

 

The time had come for the government to spring into action (and boy did it.) With the passage of “The Financial Institutions Reform and Recovery Act” (FIRREA), $300 billion was allocated to “protect the public.” $225 billion would come directly from taxes or inflation and $75 billion would be siphoned off the healthy savings and loans. It was by far the biggest bailout ever. And, of course, with the enormous failure came an excuse to add more controls (more government) to the whole inexcusable mess. We now would have the Resolution Trust Oversight Board, the Resolution Funding Corporation, The Office of Thrift Supervision, and the Oversight Board for the Home Loan Banks. On signing the bill, President Bush (Sr.) proudly announced:

 

This legislation will safeguard and stabilize America’s financial system and put in place permanent reforms so these problems will never happen again. Moreover, it says to tens of millions of savings-and-loan depositors, ‘you will not be the victim of others’mistakes. We will see—guarantee— that your insured deposits are secure.

 

Would you be surprised to discover the bailout estimate was a little low? Probably not since Congress ALWAYS gives low-ball estimates to get their bills passed. (Once a bill is signed into law, that’s when the figures start to magically adjust themselves upward.) How much is a little low? $10 billion? $25 billion? $100 billion? No, more like $225 billion. Yep, by the time all was said and done the total bailout cost sat at just over half a trillion dollars. (Roughly $525 billion total.)

 

It sure is good to know that we “will not be the victim of others’ mistakes.”

Cooking the Books

 

The world of “government regulation” is really a sight to behold. What would be blatant criminal activity if you or I did it becomes an accepted (and encouraged) way of doing business when our government protectors are at the helm. Now is as good a time as any to provide some examples of how the government helped the S&Ls cook the books.

 

Cooking the books is all about making income or assets look bigger than they actually are. (It can also include making liabilities and losses look smaller than they actually are, but for now let’s focus on the “assets” end.) Any fool knows it’s great to have assets and the S&Ls needed all the assets they could get. So the government, in its infinite wisdom, decided it was OK for the S&Ls to put a dollar value on the amount of “community good will” they had. (That is not a joke.) Poof, just like that they created $2.5 Billion dollars worth of assets for themselves. Add it to the books!

 

Another asset problem the S&Ls had: They found themselves “upside down” on many of their loans. In other words, Pete borrowed $125,000 to purchase his home, but because of falling real estate prices, Pete’s house was now only worth about $85,000. In the real world, the S&L only had an asset worth $85,000 backing the $125,000 loan. That little inconvenience was overcome by allowing them to ignore true market value and instead list value based on the original loan amount. Add it to the books!

 

We know the FSLIC had promised to bail out the ailing S&Ls should they get themselves into trouble. Surely there were some assets that could be squeezed out of that “full faith and credit” right? Absolutely! “Certificates of net worth” were issued based on the government’s promise to pay and the S&Ls were allowed to then list the value of those certificates as assets. Add it to the books!

 

But clever accounting tricks (fraud) can only achieve so much.

 

The moment of truth arrives when the S&Ls have to liquidate some of their holdings, such as in the sale of their mortgages or foreclosed homes… That is when the inflated bookkeeping value is converted into the true market value, and the difference has to be entered into the ledger as a loss. But not in the never-never land of socialism where government is the great protector. Dennis Tucker explains:

 

“The FSLIC permits the S&L which sold the mortgage to take the loss over a 40-year period. Most companies selling an asset at a loss must take the loss immediately: only S&Ls can engage in this patent fraud. Two failing S&Ls could conceivably sell their lowest-yielding mortgages to one another, and both would raise their net worth! This dishonest accounting in the banking system is approved by the highest regulatory authorities.”

 

A lot of people have heard of the Savings and Loan crisis, some might even understand who has ultimately had to “pay the costs of others’ mistakes,” but too few have heard about the role government played in the scandal. That of course should come as no surprise. Nor should it come as a surprise there aren’t calls in Congress for a full investigation into what caused the disaster. Banks, S&Ls and other federally regulated industries contribute large amounts of cash to the election campaigns of those who write our regulatory laws. –No need to start poking around there. Economist Hans Sennholz summed up the S&L debacle this way:

 

The real cause of the disaster is the very financial structure that was fashioned by legislators and guided by regulators; they together created a cartel that, like all other monopolistic concoctions, is playing mischief with its victims.

 

And G. Edward Griffin agrees:

 

The Savings and Loan industry is really a cartel within a cartel. It could not function without Congress standing by to push unlimited amounts of money into it. And Congress could not do that without the banking cartel called the Federal Reserve System standing by as the “lender of last resort” to create money out of nothing for Congress to borrow. This comfortable arrangement between political scientists and monetary scientists permits Congress to vote for any scheme it wants, regardless of the cost. If politicians tried to raise that money through taxes, they would be thrown out of office. But being able to “borrow” it from the Federal Reserve System…allows them to collect it through the hidden mechanism of inflation, and not one voter in a hundred will complain.

 

Fast forward to September of 2008 and we arrive at the biggest and best financial crisis ever engineered. Predictably, we also arrive at the biggest and best “banker bailout” ever stolen from the pockets of U.S. taxpayers.

 

Despite massive public opposition, on October 3, 2008, Treasury Secretary Henry Paulson was able to ram a 700 billion dollar “Troubled Asset Relief Program” through Congress. (Intense pressure from voters had initially defeated efforts to enact the TARP legislation. It seems Paulson overcame that pressure by telling legislators there would be chaos in the streets, and even martial law, if they refused to pass the bill.)[1][1]

 

Both the crisis and the bailout are still unfolding. low estimates for the final cost run well over 5 TRILLION dollars. To give you an idea of how much money that is, if you spent 1 million dollars per day, it would take you nearly 14,000 years to reach $5 trillion…

 

So far we’ve witnessed how the bailout game is played. We’ve seen failure and fraud rewarded, accountability avoided, and the enormous costs heaped onto the backs of the American people. Would you believe me if I said everything outlined until now is only a small part of the game? It’s true. …And in the next few chapters we’re going to highlight the real objectives of the system and the unspeakable costs of allowing it to survive.

 

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[1] [1] Representative Brad Sherman’s speech before the House of Representatives: “Many of us were told in private conversations that if we voted against this bill on Monday that the sky would fall, the market would drop two or three thousand points the first day, another couple of thousand the second day, and a few members were even told that there would be martial law in America if we voted no.”  Senator James Inhofe, in a radio interview with Tulsa Oklahoma’s 1170 KFAQ, named Paulson specifically as the source of the “martial law” comment.