Bailout Backlash and the Fed’s $2 Trillion Secret

The public is angry. The anger is rising. The dangers to our economy are escalating while confidence, trust and credibility are collapsing for both government and business institutions. Whatever else Wednesday’s mammoth action by the Fed suggests, we know this: After $8 trillion of support for financial institutions by multiple federal agencies, the Federal Reserve Board has concluded that the program has not worked, and much more is needed.

I emphasize this: I do not oppose bailouts, I oppose bailouts that are poorly managed, poorly structured and, far too often, conducted with secrecy. I have warned since my column in 2007 about the cascading financial crisis that would spread from sector to sector, bank to bank and consumer to consumer and have called, repeatedly, for direct action to benefit real people such as a temporary freeze on foreclosures. What I continue to most strongly oppose are top-down bailouts, where $8 trillion goes to financial institutions that continue to raise their interest rates and cut credit lines for even their most creditworthy consumer and business customers.

In this note, I would like to address disclosure issues. The banks and investment houses must be far more direct, comprehensive and honest in disclosing information to Congress, to regulators, to the public and to investors. In olden days, markets were based on prices applied to entities with ascertained value and trading was done as the value of those very ascertainable assets would rise and fall.

Today we have a new, and in my view vile, phenomenon: the securitization of everything, where clusters of mortgages, credit card accounts, etc. are bunched together and traded like Nasdaq stocks. This removes the value proposition and makes these securitized instruments impossible to value, and they are traded based on whims, rumors and mindless speculation until some dumb slob is the last guy buying overvalued and bubbled assets. This last guy is the slob holding the bag at the end, and now the bag is being handed to taxpayers.

Also, this securitization de-links the original buyer from the original seller, which makes rational renegotiation impossible. The guy or gal who took out the mortgage no longer deals with the bank that sold it; that bank has sold it to someone else, who sold it to someone else, who sold it to someone else. This makes renegotiation of terms impossible in many cases, forcing some preventable foreclosures, which further destroys the housing market in foreclosed communities, and which multiplies ultimate losses, which multiplies ultimate bailouts.

The second problem, in brief, is that financial institutions invented and began trading financial derivative instruments that were not based on the value of the original asset, or even on the value of the securitized basket of assets, but were valued on alleged value in “hedging” the risk. Yet if we can’t intelligently value the original asset, or the securitized combination of assets, we cannot value the hedge, i.e., the derivative instruments.

In principle, we need to restore the relationship between the actual asset and the value the market determines for that asset. While I have one of those fancy degrees from one of those great schools that are in vogue today, I am old-fashioned. I believe, simply, that we should emphasize trading what we can value, with full disclosure of what the assets are, and full understanding of what tradable assets such as securitized baskets of assets and derivatives are.

Today, far too many of these instruments remain secret. Far too many financial CEOs don’t even understand the complex assets their firms are trading (and losing money from, and seeking bailouts for). Regulators such as the Securities and Exchange Commission (SEC) have failed so dismally they’re almost farcical. Congress can barely understand the complexities of these assets, let alone policy.

And Treasury and the Fed are dumping huge amounts of money, $8 trillion and counting, into the very institutions that caused the problem in ways that neither the public, the Congress, consumers, investors or even regulators understand. And now we read stories such as the ridiculous $50 billion Ponzi scheme of Mr. Madoff that only proves the failure of financial, regulatory and political institutions to serve the people who are the boss and who pay for the bailouts.

Truth, justice, integrity and common sense begin with disclosure. As Justice Brandeis said, “sunshine is the best disinfectant.” I would add secrecy is the enemy of common sense and integrity and the friend of corruption and incompetence. This is why I vehemently oppose the Federal Reserve keeping secret how at least $2 trillion of the bailout has been used and this is why I support the Freedom of Information Act challenge by Bloomberg business news seeking disclosure.

There are surely valid reasons for selective non-disclosure, but these cases should be rare, and keeping secret $2 trillion of spending is ridiculous, absurd and anti-democratic.

This is the public’s money, and the public has a right to know. This is one of the most vital and urgent and expensive financial policies in world history, literally, and the leaders in Congress and the banking committees have a need, and right, to know.

Show me $2 trillion of secretly spent money and I will show you trouble, bad news and probably mismanagement.

Show me $2 trillion of secretly spent money and I will show you public outrage, and public backlash, and public rage at a time of national economic hardship that will only increase with time.

Show me $2 trillion of secretly spent money and I will show a policy outcome that by definition will probably be irrational in a nation where our very democracy is based on informed public debate, and the checks and balances of a government the Founders deliberately constructed with divided powers.

Finally, for now, I have a warning about, and am increasingly troubled by, practices that are more akin to a banana republic than the world’s greatest democracy. Trillions of dollars are thrown around like monopoly money. Titans of Wall Street trade financial instruments that even they do not understand. Even an incredible, gigantic, $50 billion Ponzi scheme victimizes investors who are supposed to be experts, while the SEC is so incompetent it is the moral equivalent of criminal negligence.

Let’s stop the practices that have taken us into this abyss and start with the honest, full, effective, responsible and comprehensive disclosure that is the precondition to cleaning up this multitrillion-dollar morass.