Wednesday, September 18, 2013

Lloyd Blankfein: The Fed Should Taper

In an wide-ranging exclusive interview, CNBC's Andrew Ross Sorkin talks with Lloyd Blankfein, Goldman Sachs chairman & CEO, about cuts in the Fed's bond-buying program; the move higher in interest rates; the trade in gold; the best candidate to head the Fed; joining the Dow, and how regulations are impacting the banking industry.

Interview is from Chicago on CNBC's Squawk Box, September 18, 2013.

Thursday, September 12, 2013

The Fed Could Have Saved Lehman Brothers With a Temporary Guarantee of Lehman's Good Assets

Even after five years, there has been little acknowledgement of how the Lehman bankruptcy could have been avoided on September 15, 2008. A deal to spin off Lehman's bad assets to a Maiden Lane special purpose vehicle had been forged by Wall Street firms willing to lend the funds to make it possible. However, the sale of Lehman's good assets to Barclays Bank failed for lack of a temporary Fed guarantee of Lehman’s trading book. It may go done as the biggest mistake in the history of the Fed.

By Robert Stowe England

The Federal Reserve could have prevented the bankruptcy of Lehman Brothers in September 2008 by briefly guaranteeing the trades on Lehman’s good assets. The Fed guarantee was needed for only about 30 to 60 days to allow time for a vote by Barclay’s board of directors on Barclay management’s decision to acquire Lehman’s good assets.

By Saturday, September 13, a deal had been put together under direction of Treasury Secretary Hank Paulson and New York Fed President Timothy Geithner to break Lehman into a good bank and bad bank – and to sell the good assets to Barclays. The U.K. bank had agreed to buy Lehman’s good assets if Lehman disposed of what was then thought to be $40 billion to $50 billion in bad assets.

Paulson had already been successful in bringing together major Wall Street firms to back a deal to dispose of Lehman’s bad assets, so the disposition of the good assets in a sale to Barclays was all that needed to be done to complete the rescue.

The heads of the major Wall Street firms, meeting at the New York Fed Friday night, September 12, worked all night to hammer out an agreement to lend a newly-created special purpose vehicle $37 billion to buy the Lehman’s bad assets, hoping to eventually to recoup their loan principal when the troubled assets were later sold off. A who’s who of banking were present: Jamie Dimon from JPMorgan Chase, John Mack from Morgan Stanley, Lloyd Blankfein from Gold man Sachs, Vikram Pandit from Citigroup, John Thain from Merrill Lynch, Brady Dougan from Credit Suisse, and Robert Kelly from the Bank of New York Mellon.

The special purpose vehicle would be similar to the Maiden Lane vehicle set up to acquire the bad assets of Bear Stearns in March 2008, making it possible for JPMorgan Chase to acquire the failing investment bank. The Federal Reserve Bank of New York, which is adjacent to Maiden Lane in the financial district, loaned the first Maiden Lane LLC the funds to buy the troubled assets of Bear Stearns. (Maiden Lane II and III were set up after the Lehman Brothers to dispose of bad assets from AIG.)

After the multi-bank rescue agreement was reached, however, a parallel effort underway among some of the bank chiefs to value the assets of Lehman reported that they thought the value of Lehman’s bad assets was only $27 billion. This meant the banks would be $10 billion short, assuming valuations never recovered. Yet, after some bickering amongst themselves and prodding by Treasury, the banks held firm in their willingness to do the deal. Barclays agreed to contribute some of its shares to the new entity to reduce the potential shortfall.

On Sunday, September 14, at 8 am, Barclays chief executive officer John Varley and Diamond told Paulson, Geithner, and Securities and Exchange Commission Chairman Christopher Cox that the Financial Services Authority had declined to approve the deal. Geithner and FSA chairman Collum McCarthy, who said he had not rejected the deal outright but was wary of guaranteeing the trade during the time it would take for Barclays shareholders to vote on the deal. The FCIC reports that the New York Fed, meaning Geithner, had required that the Lehman’s obligations be guaranteed from the time of the sale until the transaction closed.[i] Geithner insisted that Barclays guarantee the trades, which had required of JPMorgan Chase during the time between its agreeing to purchase Bear Stearns and the closing of the transaction.

According to the FSA, “Barclays would have had to provide a (possibly unlimited) guarantee for an undefined period of time, covering prior and future exposures and liabilities of Lehman that would continue to apply including in respect of all transactions entered into prior to the purchase, even in the event the transaction failed.”[ii]

Geithner asked McCarthy for a waiver on the shareholder vote so that the board could immediately accept the deal. McCarthy said that the waiver could only be granted by Chancellor of the Exchequer Alistair Darling. At 10 am Paulson called Darling to break the logjam with information that Wall Street bankers would buy lend the funds to buy the bad assets. Darling refused to grant a waiver. Paulson told Lehman’s outside council: “We have the consortium – the British government won’t do it. Darling said the he did not want to spread the U.S. cancer to the U.K.”

Here is where things are muddy about why the Fed would not guarantee the trades. Paulson told the FCIC that a Fed guarantee was out of the question since the shareholders could reject the acquisition and the Fed would be in possession of an insolvent bank.[iii] Paulson was worried that a run on Lehman would continue during the time shareholders were voting, and the Fed would have to provide liquidity for Lehman, as repo lenders and other parties withdrew funds from the bank. Lehman’s general counsel Thomas Baxter told the FCIC that Barclays knew full well they would have to guarantee the trades because of the JPMorgan Chase/Bear Stearns precedent. Baxter said he believed that the U.K. regulators refused to go along with waiving the shareholder vote because the U.K. government was uncomfortable with the deal.

Did anyone tell Barclays and the U.K. regulators that the Fed could not guarantee the trades? Was the option actually considered to make the deal possible? Without the Fed as a guarantor and with no other guarantor in sight, the deal to sell Lehman's good assets fell through and, with it, the agreement by the consortium of Wall Street banks to buy the bad assets.

It would appear that the guarantee option was not palatable because Paulson and Bernanke were worried that it would not be sufficient to stop the ongoing run on Lehman Brothers, as nervous markets waited for a shareholder vote. If the U.K. authorities had decided to waive the shareholder vote, then there would have been no waiting period for financial markets. So, Baxter’s hunch seems persuasive. The U.K. government was too worried about contagion to waive the shareholder vote. Paulson appears to have been worried that if the liquidity squeeze continued at Lehman after the Fed guarantee its trades and the Fed ended up owning Lehman Brothers, it could have had serious market fallout for Washington’s ability to manage the financial crisis.

It seems there was a bad case of jitters in both London and Washington. The jitters are more defensible on the part of the United Kingdom since the atmosphere of crisis had so far been contained to the United States. For U.S. authorities, however, the failure to act – to have the Fed guarantee Lehman’s trades in the good bank – revealed that the authorities had not come even close to understanding the fallout that would follow.

Since it is difficult to know how an alternative history would play out, it’s hard to know with certainty whether both the U.K. and U.S. financial regulators by their inaction and inflexibility actually made the situation worse than it turned out to be. However, it’s also hard to imagine that if the Fed had guaranteed Lehman’s trades, and the U.K. authorities accelerated the shareholder voting process down to a week to 10 days, that it could have turned out worse than it did. Even if the Fed ended up owning Lehman, as Paulson feared, would it have been worse than what actually happened?

When Lehman declared bankruptcy on September 15, 2008, it froze up financial markets around the globe and threatened to collapse global finance and plunge the world into a depression as regulators struggled to find ways to unfreeze the markets.

Since September 2008, neither Paulson nor Bernanke have indicated whether or not they seriously vetted the idea having the Fed guarantee Lehman's trades and were prepared for the refusal of U.K. authorities to allow Barclays to guarantee the trades. Or, conversely, that they sufficiently considered the worst-case scenarios that would occur if Lehman failed. In fact, we know very little about the details of any of the options that were under consideration by Paulson and Bernanke in the waning days and hours of Lehman have surfaced. Paulson in his book, On The Brink, reported that he and Bernanke in daily one-on-one meetings at Treasury discussed possible options for rescuing Lehman. Paulson said the options were few but never identified any of them. Nor was any information on the options being considered by Paulson and Bernanke revealed in the work of the Financial Crisis Inquiry Commission, including its conclusions about what caused the crisis.

If Bernanke and Paulson had already considered the potential use of the Fed guarantee option before the 11th hour and rejected it, we do not know. We do know that the Fed’s chief counsel Scott Alvarez had prepared a list of options for consideration by Bernanke and Paulson, but we do not know what they were. If the two had discussed and had already rejected a Fed guarantee on legal grounds before the Lehman crisis erupted into public view, it might explain why it was not seriously considered at the last minute, when it was so desperately needed.

Curiously, in spite of the facts on the record, the perception emerged at the time of the crisis that the Lehman deal failed for the lack of a loan guarantee by the Fed to buy Lehman’s bad assets and not by the lack of a guarantee of Lehman’s trades to help facilitate Lehman’s good assets. This view that the failure of the Fed to guarantee a loan to buy the bad assets was based in part on statements made by Bernanke that the Fed could not make loans without sufficient collateral – this marking the difference between the Fed’s role in Bear Stearns, where it actually did lend money, and the Lehman case, where it was not necessary for the Fed to lend money to acquire the bad assets. Fed loans could have come into play if the run on Lehman had continued after a deal had been struck to sale the good bank to Barclays and have Wall Street firms lend money to buy the bad assets.

The Financial Crisis Inquiry Commission in its conclusions found the regulators shouldered a good deal of blame for the crisis – but stopped short of pinpointing specific actions that were at fault.

Bernanke indicated in subsequent testimony that he did not think the Fed had legal authority to engage in unsecured guarantees, meaning they could not guarantee assets if the collateral was insufficient to cover the Fed’s exposure. In April 2010, in testimony before the House Financial Services Committee, he stated: “At the time, neither the Federal Reserve nor any other agency had the authority to provide capital or an unsecured guarantee, and thus no means of preventing Lehman’s failure existed.”

The irony is that after the devastating fallout from Lehman’s failure, the Fed did guarantee assets in a number of efforts to unfreeze the markets and prevent the failure of more large banks. In its biggest gambit, the Fed took part in an effort with Treasury and the FDIC to ring-fence or guarantee most of an enormous $306 billion Citigroup portfolio of troubled mortgage assets that threatened to bring down the bank. Under the agreement, Citigroup would take the first $29 billion in losses, while Treasury was on the hook for $5 billion from TARP funds and the FDIC for $10 billion. The Fed was on the hook as guarantor of last resort for the remaining $272 billion. Importantly, the value of those assets at the time of the guarantee were unlikely sufficient to cover the Fed’s exposure.

Carnegie-Mellon University professor of economics Allan Meltzer, author of an acclaimed history of the Federal Reserve System, did not hold back in his rebuke of the Fed’s treatment of Lehman. “After 30 years of bailing out almost all large financial firms, the Fed made the horrendous mistake of changing its policy in the midst of a recession,” he wrote a year after the crisis. “Allowing Lehman to fail without warning is one of the worst blunders in Federal Reserve history.”

Mr. England is author of Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, published by Praeger and available at

[i] Financial Crisis Inquiry Report, Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, Official Government Edition, January 2011, p. 335.
[ii] Financial Crisis Inquiry Report, p. 336.
[iii] On the Brink, pp. 209-210.

Tuesday, September 10, 2013

Weill: Fed 'keeping rates too low, too long'

Sandy Will was guest host on Squawk Box on CNBC on September 10, 2013.

Unedited Transcript form CNBC:

more from our guest host sandy weill, of the weill cornell medical college. hopefully you saw that interview we had a little while ago. i'm glad i'm here this time. you do have a much more nuanced view. i'm going to try to summarize a little bit. it provides a capital that allows us to deliver the prosperity for this country. i don't think if you could figure out a way to do it quickly and easily with good regulations, you're open to a lot of different things, basically more capital and, you know, better lending standards. absolutely correct. but the -- to tarnish bankers and put them all in the same penalty box, which we talked about earlier doesn't help anyone. or they can't trade and they're not going to be able to trade. what will happen to our capital markets? right. how do you determine what is for customer and for your own account? i also picked up on -- listen closely and, you know, people that are saying, look, the sequester's killing basic science and it's really bad for science. you said this is the new reality. right. we need public/private partnerships, with need philanthropy, the corporate sector to step up. you also said the private sector, they hold people accountable for the money they put into things. sort of implying it isn't the accountability with the public sector. there'll be more. yeah, there'll be more. with all of that in mind, i look at the fed. has there ever been a fed that's been this activist? and do you think it has been a net posztive to be this involved with the private sector? has it gone beyond the point of helping where it's hindering the private sector? i think if the fed and treasury didn't act the way they did in the bottom of the crisis -- right. our conversations would be very different. and when did they overstay their welcome, the fed? i think they're doing keeping rates too low too long. a year too long? i don't know. there's qe-1. but keeping short-term interest rates zero and having the return on six-month treasury bills being one basis point is not a good way. we're forcing people to take more risk. and we're forcing the wrong people to take more risk. we're forcing the pension funds in the united states to take more risk, to get the kind of return they need. we're forcing individuals to take more risk because, you know, they're not getting a return over the rate of inflation. and they should. when they announce the -- as a banker and someone who knows -- i hope they start tailoring this thing back. do you remember what your thought was when -- that was shock and awe. i think that was good then. this was only how long was that? six months? more than that. a year? so we've had 12 times 85. and the deficit has gone from 1.3 trillion to $500 billion. that was a sequester that everyone hates so much. they're not going to raise rates. no, they're going to stop the taper. maybe another year and a half away. i think they should loosen the short-term rates. that's way off. they're talking about 2015 or 2016 for that. i think keeping rates that low affects everything else. and how steep a yield curve can you have? and i think it's really unfair to savers. savers are paying the price. front page of the wall street journal today, lenders, buyers feel rates squeeze. some of the big banks are saying that actually they're going to start losing money, laying people off as a result of all this, right? that's the flip side. well, i think of the, you know, if they go back on the buyback program, qe-3, i think you'll see even a steeper yield curve if they keep rates at zero. ultimately. well, we've seen the ten-year go from 1.6% to 3% in a very fast period of time. once this thing starts, you know, and 3% ten-year is way below the long-term average. what about -- which i think was more like 5%. you've seen the size of the balance sheet now. u.s. balance sheet. the fed's balance sheet and what it's grown to. it's big. it is very big. it's profitable. it is profitable, but what if we start losing money on it. if freights went up enough, all the bonds they're holding would be worth much less. correct. but i don't think they mark to market. yeah, probably not. the other banks -- but can they -- we're not past the point of no return. we can extricate ourselves from this? i think so. and we'll be okay? i think our economy has done incredibly well. when you think about all the uncertainties about taxes, ability deficits, about what the government policy is going to be, how much free cash is in corporate balance sheets today that they're not spending because they're unsure of the future and yet the economy's growing, it's not just housing market going but housing prices increasing, automobile sales are terrific, what's happening coming out of silicon valley and other places with new ideas and new products, it's unbelievable. happens nowhere else. if you were in charge of the executive branch and the legislative branch -- that would be good. it would. how would you fix things? you think the economy's doing pretty well and it's being held back. is it being held back or self-inflicted? i think i would look at the tax code, which everybody -- so we've got to fix that? is a problem based on the world today. corporate tax code. the corporate and the individual tax cut. i mean, there's too big a spread between the bottom level of workers and the top level. i think you don't make that better by taking money from the top and giving it to the bottom without any benefit which is what we talk about sometimes. i think if you want to really squeeze the difference, we should change our immigration policy and let these people that get their ph.d.s in the united states from foreign countries, give them green cards, you'll have more bright people competing for those jobs which will drive down the top, create more new companies, more new places that can hire people. and reduce the spread between the bottom and the very successful. well, we're going to -- when are we going to do the corporate individual tax reform? are you optimistic? god knows. i'm not optimistic. i think we have a couple more elections maybe to go through before republican party becomes one party again. and then they're going to be the ones that need to help orchestrate that? well, usually it's been the opposite party that does the things that makes things better. so -- you know, maybe you'd have a democrat in the government that understands more and leads the reform with -- a guy that talks like this with, perhaps the republican

Wednesday, September 4, 2013

Berkowitz: Feds Should Honor Junior Preferred Equity Contracts for Fannie Mae and Freddie Mac

David Faber of CNBC interviews Bruce Berkowitz of Fairholme Capital Capital Management on September 4, 2013.

This week marks the 5-year anniversary of the U.S Government placing Fannie Mae and Freddie Mac into conservatorship. Bruce Berkowitz, Fairholme Capital Management, reveals why he believes the government should release Fannie Mae and Freddie Mac from conservatorship and restore the rights of junior preferred shareholders.