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Sunday, August 2, 2009

Some Perspective on TARP, Bank Profits, and the Economy

The second quarter's earning reports are nearly over and there has been a remarkable turnaround by many of the nation's banks and financial services companies. Many posted profits and some even posted rather robust profits. For instance, Goldman Sachs reported second quarter profits of $3.44 billion. Yet, when you look behind the numbers, it's clear that Goldman benefitted tremendously from government assistance and used barely little of that assistance to filter into the economy.

This week, Wall Street superpower Goldman Sachs announced second quarter net profits of $3.44 billion, far exceeding expectations. Earnings per share also rose, to $4.93 from $4.58 a year ago. This is a promising sign that the battered financial industry is on the mend, but it should be noted that Goldman didn’t do it alone. In fact, at least some of these profits were made possible by guarantees, low-cost loans and other assistance from the federal government.

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Goldman also benefited from artificially inexpensive debt thanks to the FDIC’s Temporary Liquidity Guarantee Program (TLGP). This program put a federal guarantee behind bonds issued by Goldman and other banks, including Bank of America and JP Morgan Chase, making them far more attractive to investors. For example, when Goldman sold $5 billion of 3.5 year bonds in November, it was able to attract buyers while offering a yield only 200 basis points higher than ultra-safe Treasuries with similar maturities. Altogether, Goldman issued $28 billion in debt using this program between November and April.

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Finally, it should be noted that Goldman Sachs and other major financial players are benefiting from a Federal Reserve program that allows them to borrow funds overnight for close to zero percent. Designed to catalyze economic activity and keep interest rates low for businesses and consumers, the program has also boosted bank profits by widening the spread between the cost of their incoming and outgoing capital.

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Shrewd business decisions by Goldman traders (along with a reduced field of competitors) were undoubtedly responsible for a good share of the profits being crowed about by the firm this week. Notably, the firm cashed in on profit margins for commodity and foreign exchange trading that, according to the Financial Times, now stand ”between two and eight times higher than before the height of the financial
crisis.


So, what do we have? Godman received $10 billion in TARP funds. They received government guarantees on their debt. The government's bailout of AIG put an extra $11 billion into their pockets. They received access to low interest government loans. Furthermore, they benefitted from nearly zero percent short term Fed interest rates. What did they use all of this cheap money for? They used it to beef up their trading desks in commodities and currencies. Little if any of this money was filtered back into the economy in the form of business, commercial, and residential loans. In fact, Goldman has unloaded all its sub prime mortgage divisions. They still have a commercial mortgage division but all of commercial real estate has amounted to $15 billion for the first six months of the year. So, essentially, the government gave Goldman Sachs a big fat bailout and then Goldman used that money in a way that lined its own pockets while doing little for the rest of the economy. In fact, given that some of their profits were due to commodities trading you could even say they hurt all other Americans by speculating up the price of oil.

Then, there's Citigroup. Citigroup made $4.29 billion this past quarter. Yet, that profit was made entirely, and then some, by their sale of Salomon Smith Barney which they sold for $6.7 billion to Morgan Stanley Dean Witter. Of course, had they gone into bankruptcy they still would have sold Salomon Smith Barney but it would be sold for much less. By infusing Citigroup with $40 billion, the government allowed the company to stay afloat and continue operations. Those operations largely consist of investment banking and trading. The company's profits have little to do with any loans they are making. Much like Goldman, Citigroup took their bailout and pocketed it to increase their own profits without having much of that filter into the economy at large.

Then, there's Bank of America. Bank of America's profits fell but still posted of just over $7 billion in profits. Yet, it was all of its consumer operations that saw contractions. In the meantime, investment banking, mergers, and trading operations increased. In mid last year, Bank of America cut off its wholesale mortgage residential lending operations. It still has a retail residential mortgage division but those operations are being reduced not increased.

Next, let's look at Chase Bank. Chase Bank also posted unexpectedly robust earnings. Those earnings were created almost entirely from investment banking activities. Chase dissolved their wholesale residential mortgage operation in the fall of last year. They still have a retail residential mortgage operation and they still have a commercial mortgage division. (though again commercial mortgages have been non existent this year) Yet, it is their investment banking division that is making them all their money right now. In other words, the tax payers gave Chase billions so they could buy out WAMU and help other companies complete mergers that they were involved in. Little of that money filtered back into the economy at large.

Finally, there's mortgage giants Fannie Mae and Freddie Mac. Last fall, the taxpayers gave those two companies a bailout of nearly $50 billion. In fact, the bailout became so large that the government now is a majority owner in the two companies. In fact, the current market cap is about one fiftieth of the government's injection of the two. They were saved presumably to unfreeze the credit markets. Yet, since their bailout, all both have done is make credit more difficult to get. They've created break points for credit scores in the beginning of the year. They created new break points for condominiums. At the beginning of May, both created new rules for appraisals that have created an extra layer of headaches. It's now nearly impossible for anyone to get a loan with a loan to value of over 80% with either.

In fact, the access for residential mortgages continues to get more and more difficult. All that's happened since the bailout of both is that the difficulties have come more slowly. In other words, credit has continued to tighten only the tightening has slowed down.

Finally, there is the issue of loan modifications. Banks have done about one tenth of the loan modifications that the president wanted done by now, about 500,000. The situation has gotten so critical that Barney Frank has threatened to re introduce the so called cramdown rule which would allow bankruptcy judges to force loan modifications on bankruptcy proceedings. As such, these banks are so reluctant to modify loans for struggling borrowers that Frank wants to take out of their hands.

The president is fond of saying that TARP saved the financial sector from the brink of collapse. That maybe so but the financial was saved in order to continue activities that line the pockets if the players in the financial system and few others. The president is also fond of saying that the credit market has loosened. That's just nonsense. Commercial mortgages are non existent. Residential mortgages continue to be more and more difficult to get.

There's an irony here. The president attacked the Republicans for being too close to big business and their relationship didn't filter to the rest of the country. That's exactly what the TARP bailout, and all other financial bailouts, has created. Financial institutions like Goldman, Chase, Bank of America, and Citigroup were kept afloat rather than having to go through the dififculties of bankruptcy. It cost taxpayers $750 billion. The massive cost was justified because we were told that these institutions were necessary to the rest of the economy. Yet, we all saved these companies from themselves and all they've done is continue to engage in activities that make money for themselves that does little else for the rest of the economy. If the president claims that we saved the financial system from the brink of disaster, that might be true. If the president claims that by doing so, that has helped the economy at large, the evidence simply doesn't back him up. As such, the president has done exactly what he demonized his political opponents for doing.

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