Too Big To Fail

As prospects before BP get darker by the day, and the likelihood of bankruptcy grows, the TBTF propaganda begins. Evidence A - Bloomberg headline: "BP Demise Would Threaten U.S. Energy Security, Industry." Just as the failure of bankrupt banks was supposed to lead to the destruction of capitalism, so the bankruptcy of BP plc is now supposed to lead to the degeneration of US energy independence. And who in their mind would force the Chapter 11 of a systemically important company? Once again, free market capitalism is about to walk out through the back door...

Dylan Ratigan draws some rather obvious parallels between AIG and the recent TBTF banking episode, and the possible fate of BP, whose failure would doom, among others, the retirement funds of Scottish widows, as we noted previously in disclosing the key holders of BP stock. Will the US president be willing to push BP to the point where a bankruptcy of BP results in international diplomatic outcry over what could be the next TBTF precedent? Surely BP is aware of this catch 22, and is thus willing to apply the modern version of American capitalism: "the risk taker uses the leverage of their size and importance to so many people to transfer the risk they've created to the government and future generations, while keeping the rewards of all the risks that they've taken, negligent repair, you pick the thing - they keep the money, you keep the problem. This seems to have become the new version of American capitalism: extortion and bribery." In this clip, in which Ratigan tears apart BP's Darryl Willis (worth watching in itself to see how TV anchors don't always have to bow down to their guests, David Faber feel free to take notice), BP seems to have painted itself in a diplomatic corner: "We will pay claims until we are done paying claims... We are going to pay the damages caused by this spill to every person who has been hurt, harmed and damaged." Alas, this does not leave much maneuvering room for the former oil giant. As for the question of how BP can afford to pay a $10 billion dividend in light of what seems to be a tide of approaching claims payments, Willis does not provide an answer. BP's CDS spread, however, does.

First posted 17 November 2008, this column's analysis is more relevant than ever. It asks why investors rush to government securities when the US was at the epicentre of the financial crisis? This column attributes the paradox to key emerging market economies’ exchange practices, which require reserves most often invested in US government securities. America’s exorbitant privilege comes with a cost and a responsibility that US policy makers should bear in mind as they address financial reform. - Carmen Reinhart and Vince Reinhart

Senators Brown and Kaufman, who as we previously noted presented a "Too Big To Fail" amendment to the finreg bill, have now officially filed this proposal, whose primary purpose is to cap the size of the massive banking monoliths. It will be interesting to see who votes for and against this amendment to see just how far the long hand of Wall Street reached. Below is an FAQ on the proposed Size and Leverage Limits as proposed by the senators.

Enacting a credible bankruptcy process to solve the too-big-to-fail problem, clarifying the Fed's umbrella supervision and financial stability roles, and enhancing market discipline are steps we must take to lower the probability of a future crisis. We could simplify the entire financial regulatory legislative initiative by focusing on these three key elements. We do not need huge new bureaucracies, or a complete restructuring of our regulatory agencies. - Charles Plosser

At our firm we frequently receive calls from clients and readers asking about the likelihood of the passage by the Congress in Washington of reform legislation regarding over-the-counter (OTC) derivatives, financial regulation and/or mortgage securitization. Our answer is small to none given the political trends and the state of the lobbies in Washington, most specifically the large bank lobby that protects the Sell Side monopoly in OTC derivatives and securities. The fact that Senator Richard Shelby (R-AL) is still apparently not comfortable with the entirely watered down House proposal to reform OTC derivatives, for example, tells you all you need to know. Stick a fork in it.

The difference between the world when Volcker was Fed chairman and today is the end of Glass Steagall. Instead of bailing out simple lenders, the Fed now faces the task of managing and saving giant securities and securitization platforms that are too big to manage in a rational fashion. Don't fool yourself into thinking that JPM chief Jamie Dimon or any CEO of a TBTF bank has the slightest idea what is really happening within their enterprise.

Even as Tim Geithner was boldly lying today on national TV, claiming that he abhors the concept of too big to fail, and condemns moral hazard, behind everybody's back he, together with the entire Obama administration, was trying to pass a law that would shift TBTF from a temporary program into officially canonized law. This is a scandal that has gotten little recognition in most of the MSM: in essence it guarantees that the massive mega banks like Goldman Sachs, BofA, and JPM will take on so much disproportionate risk the next time around (and with a moral-hazard encouraging Federal Reserve as risk regulator virtually guarantees their implosion) that not only will they blow up spectacularly once again, but that their bailout next time around will surely force America, already strapped with trillions of new upcoming debt courtesy of stimulus after stimulus, into sovereign insolvency.

"The middle class became a resource to be pulled from - "the turkey at the thanksgiving dinner" - the middle class has gotten shakier and shakier, it has become hollowed out. The middle class makes us who we are. The middle class gives us political stability. It is safe to walk our streets because we have a middle class. And every time we hollow [the middle class] out we take the risk that something of what we know as America begins to die. That's what scares me." - Elizabeth Warren

The government is STILL defending too big to fail on several ridiculous grounds.

There was a time when the US would not guarantee the existence of every bank in perpetuity. When weak organizations, with or without untenable balance sheets would have to adapt to survive or simply disappear. It was known as capitalism. And it was about to change completely. However before it did, in those fateful nights before Lehman was not given the taxpayer capital "get out of bankruptcy free" card that Hank Paulson and Ben Bernanke subsequently handed out with such abandon to all other financial firms, Dick Fuld attempted to warn Chairman Ben and Secretary Hank about what would happen if Goldman got its wish of destroying its number one competitor in fixed income capital markets.

The recent addition of legacy loans to TALF caused CMBX spreads to turn on the nitrous and rip like all the commercial real estate concerns over the past 6 months have disappeared (especially in the top-most AAA tranche). Between financials, whose stocks have doubled on average, and CMBX (whose spreads have halved), there is, at this point, no doubt as to what lengths the administration is willing to go to funnel every single printed dollar into these otherwise doomed industries.

hat tip Verne