Financing Failure

Vern McKinley American Enterprise Institute April 16, 2012 To start….

Anticipated Question

• We are in 2012 and the bailouts were in 2008 and 2009.

• A number of books came out in 2009 and 2010

• Why did it take so long for you to put together a book on the bailouts?

Our Government (FDIC) Would Not Cooperate Our Government (Fed) Would Not Cooperate (Cont..)

Our Government (FHFA) Would Not Cooperate (Cont..) Information: Narrative of Great Depression • For many years, labeled as a failing of capitalism and bailouts supposedly helped • Decades later, an alternative narrative that the government and in particular the caused the crisis and made it worse as new information analyzed – Friedman and Schwartz (1963) – Rothbard (1963) Who Told the Bailout Story in 2008 and 2009? • Bailout agencies: Federal Reserve, Treasury, Federal Deposit Insurance Corp.

• Politicians like ex-Senator Bennett: “Congress's finest moment.”

• Cafeteria Capitalists: Picking and choosing cafeteria style when they like capitalism

Common Narrative

• All manner of terrible consequences for Main Street flowed from large failure • Interventions by the Federal Reserve, Treasury, FDIC saved us from another Depression • Challenges faced by Federal Reserve, Treasury, FDIC were unprecedented

Early Books on the Financial Crisis • Too Big to Fail (2009), Andrew Ross Sorkin, New York Times • In Fed We Trust (2009), David Wessel, Wall Street Journal • By necessity, largely accepted the narrative of the agencies, politicians and cafeteria capitalists Examples of New Information • Secretary Paulson’s book (February 2010) • Lehman Examiner’s Report (March 2010) • GAO Report on FDIC Systemic Risk Exception (April 2010) • Congressional Oversight Panel AIG (June 2010) • Financial Crisis Inquiry Commission (September 2010 to February 2011) • McKinley v. FDIC (September 2010) • McKinley v. Board of Governors (November 2010)

New Information (Cont.) • Dodd-Frank Sec. 1109 mandated disclosures (December 2010) • SIGTARP report (January 2011) • McKinley v. FDIC II (February 2011) • Bloomberg Supreme Court case (March 2011) • GAO Report on Federal Reserve interventions (July 2011) • McKinley v. FHFA (September 2011)

Themes Throughout History--Quotes • Nothing new under the sun

• Fly by the seat of your pants: to proceed or work by feel or instinct without formal guidelines or experience

• Story of Chicken Little and stories by regulators, financial institutions

Systemic Risk/Contagion/ Domino Theory • Contagion—idea that if one large bank failure is allowed to happen, will have a cascade of financial institution failures (good and bad). • Argue this adversely impacts the entire economy (Main Street), not just financial institutions • case, Federal Reserve used ‘contagion’ and FOIA request for details on expected contagion.

Knickerbocker Trust (1907)

• Bank of United States (1930)

Franklin National Bank (1974)

Franklin National Fizzles Out “The entire financial world can breathe more easily, not only in this country but abroad.” --Arthur Burns, Chairman of the Federal Reserve Source: Time Magazine, October 21, 1974 Domino Theory History Repeats • 1907 Knickerbocker Trust—concerns regarding failure • 1930 Bank of United States-10 banks in NY • 1975 Franklin National Bank-disruption in NY and international money markets • 1980 First Pennsylvania--touch off a crisis in confidence that would snowball into other bank failures in the US and abroad • 1984 Continental Illinois—66 banks failed, 113 at risk • 1998 Long Term Capital Management—disorderly fire- sale liquidation following a set of cascading cross defaults

Chicken Little Stories

• Story of Chicken Little – Acorn on the head – Panic and misdiagnosed the situation – Imagined harm that wasn’t there – Also spread panic to others • Notion of promoting financial stability by telling stories about how inherently unstable the financial system is

Carrying on the Tradition

• Fed Governor Kroszner (Bear): “I think that it is not just the direct exposure to Bear Stearns but the turmoil that this could cause in the entire credit default swaps market.” • Chairman Bernanke (Fannie and Freddie): “…the catastrophe that would occur if we did not take these actions.” • Timothy Geithner (AIG): “If you default on those commitments, then you will end up defaulting on all commitments and the firm will come collapsing down and fail.”

Carrying on the Tradition (cont.)

• Neel Kashkari (Washington Mutual): “We were saying that’s great, we can all be tough, and we can be so tough that we plunge the financial system into the Great Depression.” • FDIC Memo (Wachovia): “…failure of Wachovia would lead investors to doubt the financial strength of other institutions.” • Jim Wilkinson (TARP): “This is only going to work if you scare the sh** out of them.” • Secretary Paulson (TARP): “This is going to be far worse than the Great Depression in the ’30s…”

Carrying on the Tradition (cont.)

Chairman Bernanke (Citigroup): “…a Citigroup failure had the potential to block access to ATMs and halt the issuing of paychecks by many companies and governments.” Chairman Bernanke (GW Lectures--AIG): “..failure of AIG, in our estimation, would have been basically the end.”

Analysis—Seat-of-the-Pants: Bear Stearns (March 2008) • “Coryann Stefansson just called and said that this is the info (still preliminary and probably not super accurate but kind of in the ball park at least) that she has about the exposure of major banks to Bear…She also said that [REDACTED] should be on the list, but nobody could confirm it.” • “Sorry if my details are sketchy but will try to provide more substance as we get information.” • “I must say that I am not that comfortable with the accuracy, but we got the info from the teams.” • “We have pulled together the exposure #s of the [large financial institutions] to [Bear Stearns] but the information is from the last monthly reports from the firm that are prepared by the exam teams. Board staff did not go out this week for a request on more current exposure information.” • “Here is a report we received where [Bear Stearns] tried to identify the counterparties that they owed money to. The[y] claimed it was inexact (their systems are not set up to run that way), but ordinally [sic] correct. Looks like it is only derivatives. Will provide more clarity as I can.” Analysis—Seat-of-the-Pants: AIG (September 2008) • “Do you guys have an expert on AIG?” • “What do you know about AIG? Have you produced memos on them anytime recently?” • “We don't have an expert on the company, but I do believe we have done some work on their credit exposures.” • “Anyone in your group know much about AIG?” • “Given how dire the situation with AIG is, Jim and I thought we should probably follow up to get more information on their risk profile, etc. sometime tomorrow.” • “I found very little on the derivatives activities of AIG, which is frustrating. They don't seem to say much in the 10-Ks/10-Qs.” • “Can one of you guys give me a call so we can coordinate the work on AIG and hopefully reduce overlap?” • “Sorry.....need to get an understanding of lehman bros exposures at the firm and aig...... without going to the firm.....anychance u all have reports lying around.” What Documents Show—Speculation • Bear Stearns—LFIs and CDS market (Fed) • Fannie and Freddie—choice of conservatorship over (FHFA) • Lehman—detected early, insolvent, bailout? • AIG—counterparty analysis, no connection between failure and consequences, likely insolvent (Fed) • Wachovia—very general analysis, speculation, 30 minute meeting (FDIC) • Citigroup—general analysis, speculation (FDIC)

Common Sense

• John Stewart (Daily Show: January 2010): “I’m not an economist, but these are some fragile f***ing businesses…what, are our banks made of balsa wood held together by baby tears?” • Emerging market economies have fragile financial systems. • US financial system is not so fragile.

Were We Saved From Another Great Depression? • Not the objective of the Federal Reserve, but maintaining “maximum employment.” • McKinley’s rule: Based on economic cycle the past 100 years in the US, deeper the financial crisis/recession, the greater the number and seriousness of policy screw- ups in Washington (primarily the Fed). A Final Notable Quote

• “[The Federal Reserve System] blames all problems on external influences beyond its control and takes credit for any and all favorable occurrences. It thereby continues to promote the myth that the private economy is unstable, while its behavior continues to document the reality that government is today the major source of economic instability.” Dodd-Frank

• Phases—denial, acceptance/panic, bailout, reform legislation • Two parts to Dodd-Frank re: bailouts – “Put a stop to taxpayer bailouts once and for all” – Financial Stability Oversight Council (FSOC) • What do we do now?

Follow Up

• www.independent.org • www.amazon.com • www.scribd.com/vernmckinley (over 5000 pages of documents from litigation and FOIA requests, including emails, minutes and memos) • http://www.judicialwatch.org/blog/categor y/financial-crisis/ • [email protected]