Too Big to Bailout

A modest proposal to restructure our financial system so that the big dogs topple when they need to

By John Sakowicz

This is the eighth of a multipart series on the state of the economy and how we got here.

On Tuesday, Jan. 20, 2009, Barack Hussein Obama was sworn in as the 44th president of the United States to the cheers of an estimated 2 million Americans who came to our nation's capital to celebrate the event. I was there.

For one magnificent day, all was right in the world. After all, what was there not to be happy about? A young, hip, progressive, Harvard-educated black man was sworn in as president. The First Family moved that day into the White House, a structure built by slaves during an earlier, shameful chapter in our nation's history. Crowds cheered in the streets. Crowds cheered in the Mall. Two million flag-waving Americans cheered in the frigid and bright day.

It's not too much to say people were more than happy; they were insane with joy. The era of the predator nation of George W. Bush—the eight years during which 5 percent of the population came to own or control 70 percent of our nation's wealth—was over. After eight unholy years of George Bush, starting with the stolen election in Florida in 2000 and ending with the two overseas wars and the worst recession since the Great Depression, it felt as if Barack Hussein Obama were somehow anointed, some sort of savior.

It was a magnificent day. Except on Wall Street.

Make That London, Too

Even before the first glass of Champagne was lifted to toast our new president at the first inaugural luncheon, the black holes on the balance sheets of our nation's banks started to open wide—again. And like yaws in some primordial universe, those black holes swallowed billions more in market capitalization—again.

Billions more gone. Shareholder equity. Bondholder obligations. Bailout money. Gone, disappeared—again.

Yes, there may have been happiness on the faces of 2 million Americans in Washington, but on the morning of Tuesday, Jan. 20, 2009, there was fear in the trading rooms of Wall Street.

On this otherwise magnificent day, stock markets suffered their worst Inauguration Day losses in more than a century. The Dow fell 332 points, or 4 percent. Even worse, the banking sector fell more than 15 percent, its biggest one-day drop in two decades. Inaugural or not, it was just another trading day on Wall Street.

Investors worried that it didn't matter who was president. Obama or Bush. Investors worried that the Obama team had no quick fix.

Some banks fell more than others. State Street Bank, the country's biggest money manager for institutional accounts, fell 59 percent. Even after all the terrible news of last year, this number was hard to believe. (For the record, State Street Bank received $2 billion in bailout money in the waning days of the Bush administration. It begs the question: Where did the money go?)

Citigroup, now called "Citimorgue" by many of us in the hedge fund community, fell 20 percent to close at under $3 a share. Citi's stock has fallen 85 percent in the last year. Citigroup's market capitalization is now about $20 billion. But this follows more than $45 billion in bailout money that the Bush administration poured into Citi. Forty-five billion! Whoa. Where did the bailout money go? Since this bailout money is taxpayer money—our money—I'll ask again: Where did our fucking money go?

On Tuesday, Jan. 20, 2009, Bank of America also fell about 29 percent. Shares of JPMorgan Chase, Morgan Stanley, Wells Fargo and several other big banks—what are called "money center banks"—each fell by double digits. Incidentally, all of the above received beaucoup bucks in bailout money.

Think the regional banks were immune on this magnificent day? Nope. Regions Financial, which has banks in 16 states, reported a $6.2 billion loss for the fourth quarter. Its shares fell 24 percent.

Think foreign banks were doing any better?

Nope. The Royal Bank of Scotland, the U.K.'s second biggest bank, fell 60 percent, to close at a new low. The stock fell on fears that the Royal Bank of Scotland will report a 28 billion pound sterling loss—about $39 billion!—as well as due to fears that the Chancellor of the Exchequer will have to nationalize the bank. Prime Minister Gordon Brown and other members of his team began speaking in dire tones. I spoke with Stephen Beard, a leading British lawmaker, who referred to the "growing lack of confidence, almost panic, traveling around the world right now, like an epidemic virus."

Beard suggested that the Chancellor of the Exchequer would have to nationalize not just the Royal Bank of Scotland, but also the big insurance conglomerate Lloyd's of London and maybe even some other banks, like those in Ireland.

Finally, as if on cue, after the close of markets in New York, Allied Irish Banks and Bank of Ireland each fell by more than 50 percent in after-hours trading. The pound sterling also fell sharply to new lows against the euro and the dollar on fears that the Chancellor of the Exchequer would indeed have to nationalize the banking system in the U.K.

No Honeymoon

Poor Obama. The honeymoon was over before it began.

After all the big bailouts—$750 billion in TARP monies, the $1.5 trillion in new liabilities on the books at the Federal Reserve Bank, the commercial paper buying programs and foreign currency swaps and refinancing the Reserve Bank's Term Auction Facility—after all that, Wall Street was saying that banks still needed more capital. The downward spiral had turned into another crisis of confidence, just like the one that preceded the last twist of the downward spiral. The problem was as basic as it gets. My favorite banking analyst on the Street these days, Meredith Whitney at Oppenheimer, said it all: "Because banks haven't been able to raise capital on their own, the Feds have to give it to them."

By "the Feds," of course, she means us; it's our money the Feds are giving banks, more than $2 trillion in the last year and $13 trillion in national debt and counting—debt incurred on behalf of future generations of taxpayers, our children and grandchildren and our great-grandchildren.

Whitney continues: "The credit picture continues to devolve as our banking industry's balance sheets continue to weaken. High-risk assets on balance sheets continue to devalue as the banking industry continues to deleverage through the forced liquidation of those very same assets. The net result is that more and more capital is needed to put up against those high-risk assets that remain on balance sheets—assets worth less and less, if they're worth anything at all."

Indeed, it appears as if the Feds might even have to nationalize our own banking system, just like in the U.K. "Creeping nationalization," is what Chris Dodd, chair of the Senate Banking Committee calls it. And if we go that route, look for the dollar and the U.S. economy to fall even further, just like in the U.K. Welcome to Washington, Mr. President.

Let It Go

No one knows anything. Nothing is normal. There are no quick fixes. Everything is strange. There is no floor under home prices, no ceiling on unemployment. There's just an array of proposed "solutions," each of which can create a future, unknowable financial and economic multiple universes, posing its own unknowable risks and dangers.

Indeed, the situation in Washington and on Wall Street is so strange that even the best and brightest among us, like President Obama, are drawing a blank. I think the solution is: Let it go. Let the banks fail. "Too big to fail," you say? I say they're too big to bail out.

I've got some agreement from another one of our old friends, billionaire hedge fund manager and guru George Soros. Last week, I listened to Soros speak on a "squawk box call" from the World Economic Forum in Devos, Switzerland. Soros said not to make distinctions between good banks and bad banks. The marketplace will make the distinction. Good banks will survive. Bad banks will fail.

He said Obama's talk about creating a Big Bad Bank, managed by the Feds, onto whose balance sheets can be shoveled all of Wall Street's toxic debt, is crazy talk.

Crazy talk, because there is almost no end to toxic debt. Soros said that the Feds will never be able to sell toxic assets, much less manage them, because "toxic assets are typically unique. They are not like other classes of securities, like stocks and bonds. Almost every CMO, CDO and SIV is a unique class of securities. Same with swaps and derivatives. And as such, they're not fungible, not a commodity."

He continued, "And when the day is done, that's all money really is. Money is just another kind of commodity—the world's biggest commodity market, for sure, but a commodity market nonetheless. And for something to trade, it must be fungible. It must be a commodity."

In other words, Soros was telling us that all those toxic assets don't trade because it's a total "dealer market," meaning you can't find them described in any contract or sets of contracts, won't find them on any exchange, can't clear them through any clearinghouse, won't find them regulated by any agency, can't price them and can't fit them into value or risk-management models. Is it any wonder you can't find buyers?

Toxic assets were created first and foremost to earn mega-fees and mega-commissions for Wall Street, with little thought given to who would eventually end up owning them and what they would be worth, if anything.

Old New Values

How about creating two new classes of securities going forward into the future and forever more? In that Jan. 28 squawk box call, Soros called them "uniform transparent mortgages" and "uniform transparent bonds." Uniform. Transparent. In other words, Soros believes mortgage-backed securities should be identical. And he believes that all bonds should be identical, because if you can compare them, you can price them. And if you can price them, you can trade them. That's the key.

"Stimulus is for suckers," economist Jamie Galbraith told me last year. "The standard liberal line of 'borrow and spend' is not the same as 'investment,' nor does it address the moral crisis created by the predator nation we have become.

"To end what is not just an economic crisis but an existential crisis," he stressed, "we must create a new economy based not just on new technologies but also on new values.

I agree. So does Soros. "Accountability" and "transparency" aren't just words you throw around during campaign season. They're words we must use to describe a new Wall Street. Assume Wall Street can't police itself, because it obviously can't.

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We should make securities fungible again, like they once were. Innovation is not necessarily a good thing on Wall Street. Stop the newfangled scams. Standardize stuff. Raise disclosure requirements. Protect investors, especially institutional investors, like pensions and endowments, who chase returns like tweakers chase crank—they can't seem to stop themselves. Lower the banking industry's debt-to-capital ratio to where it once was before the craziness started, 12-to-1, and reform Wall Street's compensation structure, which is perverse. Finally, bring back the Glass-Steagall Act.

Walls and fences in a zoo are a good thing. It's all so goddamn simple.

John Sakowicz is a Sonoma County investor who was a cofounder of the multibillion-dollar offshore hedge fund Battle Mountain Research Group. Go to www.ukiahvalley.tv to see Sakowicz in action. Ryan Morris assisted with research for this article.