Newt Gingrich was the only member of government who sounded like he had a clue about what was going on this past week, Paulson and Bernanke included. Gingrich recognized, correctly, that the main thrust of the Paulson plan was to give more power to well… Paulson.
But since the bill was defeated on Monday, Gingrich has been talking as though tweaking the Paulson plan on a couple of things would be enough to get it through next time. One tweak, he suggests, would be to have the government insure the bad loans on the books of financial institutions. This is somehow supposed to be an improvement on the plan that would make it acceptable to Republicans (along with the removal of mark-to-market accounting).
Well, insurance is actually already a part of the bill that was just defeated (Section 102). Section 102 would guarantee bad loans (sorry, troubled assets) by creating risk-based premiums to cover anticipated claims.
So, rather than buying bad loans, which at least has the remote chance that the government would get the price increase if they ever recovered their value, the government is proposing to guarantee them. That means if these troubled assets got less troubled, even positively robust, the banks — not the government — would get the price increase. But if they don’t get better, who picks up the tab? The government.
An insurance fund offers the prospect of all kinds of interesting shenanigans. Banks could claim to make losses, while actually taking in profits. They could keep doing that for another whole cycle. The possibilities are endless for savvy professionals with degrees in math and sophisticated risk-models.
Why would I suspect these respectable institutions of doing any such thing? Because that’s just what they’ve been doing for a long time — as the ongoing FBI investigations into over two dozen of the firms involved in the bail- outs is showing.
So when I read that Barack Obama also wants to ‘do something’ about insurance, I have to wonder at this bi-partisan interest. Especially when I know that the Treasury Secretary’s former bank, Goldman Sachs, made huge profits from derivative trading and created the complex structures that have got the banks into such a mess. Goldman has behaved almost like a hedge fund over the last two decades, setting up some of the most questionable financial structures for clients that range from media moghul Robert Maxwell (who swindled pensioners), to Enron (we know how that went), to Fannie and Freddie (ditto), Ghana’s Ashanti Gold (which was ruined by the disastrous hedge portfolio Goldman created) and AIG ( now under FBI investigation).
My suspicions mount when I find that Goldman has turned itself into a commercial bank that can take in deposits; that it was showing signs of having taken a hit before it did so; that Warren Buffett is so certain about Goldman’s future growth he’s taken a multibillion dollar stake in it; that Buffett’s firm General Re was involved in fraud with AIG; that Goldman was the counterparty in a lot of AIG’s credit default contracts; that AIG continues to be under investigation for insurance fraud dating back to the 1990s; that Goldman is also a large government contractor and has been involved in fraud there too, including on sales of bonds to municipalities.
And now Obama wants to raise the amount of money that government insurance on deposits in banks would back, from $100,000 to $250,000. Who could be against that, right?
Actually, they could. Raising the amount of money insured certainly is good for the banks. It encourages depositors to keep money in them, which helps keep capital in the system and lets the banks keep lending and making money.
It also seems to be good for depositors. Their money now has the full faith and credit of the US government behind it. If the banks lose the money, the government fund (FDIC) pays.
The only problem in this is that FDIC is tax-payer money, so ultimately it’s the tax-payer who foots the bill. By spreading risk, insurance can actually create a moral hazard problem, encouraging the very practices it is supposedly insuring against. That is, the fact that the deposits are insured, makes the banks much more willing to make risky investments with your money. You go along because you’re getting higher interest rates. In the competition for getting higher and higher interest rates, the banks do riskier things and they get right back into the mess they’re in now.
But it gets worse. The deposit insurance fund is already nearly depleted from repeated bail-outs of failed banks. So where does the money to replenish it come from, right now, should there be claims? (You know there will be claims… and lots of them coming. And insurance will encourage even more).
Put another way: who will insure the insurers?