Explain it again, slowly

April 14, 2009 11:37 AM

The headline in today’s Financial Times was “Goldman push to repay U.S. taxpayer.”


The story detailed how Goldman Sachs was planning to sell common stock to raise $5 billion to pay back the $10 billion in money it received through the TARP (Troubled Asset Relief Program) bailout. No where in the story did it talk about paying back the $12.9 billion it received from the bailout of AIG provided by U.S. taxpayers.


Many of the financial institutions receiving TARP money also benefited from the bailout of AIG, which is particularly disturbing to some because it involved trading in over-the-counter credit default swaps. There are many benefits to OTC markets but they are available only to institutional traders because bilateral trading involves taking on counterparty risk. In essence you are declaring, ‘I am a big boy, I am self insured.’


Fed Chairman Ben Bernanke in a speech he made today at Morehouse College cited the reasons for the government bailout of AIG. While he provided an exhaustive list, his arguments were not convincing. Perhaps if there where more bankruptcies and fewer bailouts and forced mergers it would be easier to believe him  when he says that he would prefer to let the market work.


 As an editor, one of the first things I tell my reporters is not to be afraid to ask questions when you don’t understand what a source is talking about. Sounds simple but we are often embarrassed to ask what seem to be elemental questions regarding terms people use or explanations that make no sense when it appears everyone around us knows what the speaker is talking about. Chances are most of the other people are also afraid to ask the simple question for fear of looking foolish or uniformed. In the end you get jargon and other nonsense being tossed about in boardrooms, congressional hearing rooms and business media outlets that very few people understand, if, in fact, it is understandable in the first place.


When we are presented with a crisis, an emergency that requires immediate action, that is when it is particularly important to ask those simple “why” questions. If, in fact, our very financial system was on the brink of ruin, then the specific details and reasons should be made apparent in precise detail. No vague warnings of impending doom.


But did anyone say to Treasury Secretary Henry Paulson or Bernanke when various bailout proposals were first contemplated: “I want you to slowly, with great detail explain why we should provide bailout money to institutions engaged in over-the-counter trading — trading that by definition is less regulated precisely because these institutions are supposed to have the size and wherewithal to weather a failure by a counterparty.” How many in Congress were afraid to ask, “Exactly what will happen if we do not bail these institutions out? How did you come to that conclusion? Is there a way to make funds available directly to the “so called” innocent bystanders avoiding a systemic breakdown and allow the institutions who were wrong to face the consequences of their poor decisions?” Or perhaps, “Given what has occurred, is the system worth saving?”


Individual bank accounts are protected by the FDIC and the actual insurance policies are subject to segregation similar to futures accounts so can we be sure what was being protected wasn’t simply the large institutions themselves. If the point was to avoid the collateral damage caused by a systemic breakdown, why couldn’t the money be directly allocated to those at risk, bypassing those responsible for the breakdown?


How is it that these leaders were so sure of the consequences of not providing a bailout but did not do anything to prevent it when the risk was piling up? If we knew of the interconnectedness of large financial institutions — as Bernanke noted in his speech today — how is it that regulations in recent years were being relaxed instead of tightened? How is it banks were allowed to increase leverage rather than be forced to reduce it?



About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.