FedUpUSA

Archive for the ‘Maiden Lane I’ Category

Litigation may be slowly doing the job missed or only partially completed by various governmental investigations into the financial crisis. The Valukas report on the Lehman bankruptcy was revealing, and numerous foreclosure defense attorneys have opened cans of worms that the powers that be would rather pretend simply don’t exist.

The New York Times reports tonight that a case filed last year was unsealed last week. It plumbs a continuing sore point with the public, namely the generous terms of the AIG bailout, both to the company (which defied the government and insisted on remaining largely intact when the plan had been to sell its various units to repay the government funding) and to its credit default swap counterparties. The litigation has the potential to be revealing, particularly if it goes into discovery (various depositions are likely to become public in pre-trial jousting, um, motions). The Times gives an overview:

The lawsuit, filed by a pair of veteran political activists from the La Jolla area of San Diego, asserts that A.I.G. and two large banks engaged in a variety of fraudulent and speculative transactions, running up losses well into the billions of dollars. Then the three institutions persuaded the Federal Reserve Bank of New York to bail them out by giving A.I.G. two rescue loans, which were used to unwind hundreds of failed trades.

The loans were improper, the lawsuit says, because the Fed made them without getting a pledge of high-quality collateral from A.I.G., as required by law.

“To cover losses of those engaged in fraudulent financial transactions is an authority not yet given to the Fed board,” said the plaintiffs, Derek and Nancy Casady, in their complaint, filed in Federal District Court for the Southern District of California.

The lawsuit names A.I.G., Goldman Sachs and Deutsche Bank as defendants, but not the Fed.

The lawsuit itself names other defendants, including Merrill and its successor Bank of America, SocGen, and “Does 1 through 100.”

White shoe types will likely look down their noses at the filing. It makes rather eccentric use of graphics (for instance, including company logos) and includes charts, some of which are very helpful (tables with tabulations and timelines), while others are visual representations of arguments made in the text and hence would be deemed by style snobs to be redundant. It also is somewhat sensationalistic, even heated at points in tone (which does make for more lively reading) and does not unpack its arguments as much as appears to be typical in court filings.

Nevertheless, despite the rough style, there’s some intriguing reading, and the case does a clever job of juxtaposing e-mails and Congressional testimony by AIG executives with various disclosures of the AIG bailout process and the terms of the loan facilities.

To my non-expert eye, the case appears to hinge on the argument that begins on p. 43, that the Fed loans were in violation of the Fed’s authority under the widely-cited “unusual and exigent circumstances” clause. I had taken the reading of former central banker, now Citigroup economist Willem Buiter on this, that it gave the Fed the authority to lend against a dead dog if it chose to.

That appears to be inaccurate, and I wonder if the focus upon this section will embolden the Audit the Fed crowd to have another go at the central bank.

Specifically, the “unusual and exigent” language includes other restrictions, which I read as all being operative:

1. The central bank can lend against “notes, bills, and other drafts of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal reserve bank

2. The “notes, bills, and other drafts of exchange” must be discounted

3. The Federal reserve bank making the loan must obtain evidence that the non-bank party seeking the loan can’t get credit from other banks

4. “….five or more members of the Board of Governors must affirmatively vote to authorize the discount prior to the extension of credit.”

The case focuses on allegedly fraudulent representations made by AIG and the various major dealers in the course of obtaining the financing. But the part I find interesting is the Fed’s evident non-compliance with the requirements of this section, particularly the fact that the central bank lent 100% against the face value of the AIG CDOs, between taking out the CDS and then lending the bailout vehicle Maiden Lane III the funds to buy the CDOs. Interestingly, the SIGTARP investigation missed this issue. If this was at all considered, the argument may have been that the AIG equity in MLIII was tantamount to a discount, but the lawsuit argues that notion is bogus. Since AIG was broke, any money for the AIG equity came from the outside (in fairness, it’s a bit more complex, thanks to reserves set aside over the collateral dispute).

The suit argues that the initial loan was made under false premises, since the loan was secured by all assets of AIG, when the assets were already pledged (all the regulated subs have prior claims on them, both to creditors and policy-holders). The understanding, as depicted in various less-than-official accounts, like the Andrew Ross Sorkin Too Big Too Fail, is that the loans were secured by the equity of the subs. Fine in theory, but in practice, that isn’t what the loan document says, and as important (although not argued in the case) is the amount of the loan was based on what AIG needed to stay afloat, not on any effort to find a market value of the assets pledged and discount that.

In addition, the notion that it was acceptable to lend against stock appears to be based on the discount schedule that the Fed posts and revises from time to time as to the types of collateral that are accepted for lending and the various discount rates established for them. But note that schedule is for depositary institutions. The Fed acted as if it could simply lend against the same assets held by non-depositaries, but the language of the germane section does not appear to support that idea.

The various disclosures of how the Fed lent against pretty much anything the banks could round up, including defaulted securities, is troubling. Defenders of the central bank argue no harm was done since the securities have recovered from crisis lows (well save the ones that went to zero). The problem is that the logic is circular. In many cases, the value of the securities now depends on the fact that the Fed is willing to lend at super low interest rates. So the “market” values are fictive and dependent upon Fed intervention, which is coming at the expense of savers. The interdependence between the Fed’s rescue facilities and its continued interventions is given a free pass, but those of us who are not at the top of the food chain are continuing to pay the cost.

Naked Capitalism

The Federal Reserve has done an excellent job in covering up the trillion dollar banking bailout by essentially pretending it did not occur.  To show how much it doesn’t care, it actually named a few bailout vehicles “Maiden Lane” for the New York Fed’s address in lower Manhattan.  This sounds better than the “New York Fed” being bailed out by the Fed not to conjure up images of a snake eating its own tail.  Like a professional liar, pretending with full conviction is usually a good way of getting away with theft.  The Federal Reserve was one of the largest players in the commercial real estate market bailout.  Many in the U.S. have no idea that their central bank has purchased and supports luxury products like multi-million dollar hotels in California.  They would hesitate at calling it a purchase but they do own the liabilities securing the property.  The bailouts were marketed and branded as a way of helping out the working and middle class.  Given the massive financial destruction that the working and middle class still face it is easy to conclude that the stated policy failed.  Yet looking at banking profits it did succeed for this segment of our economy.  The Federal Reserve doesn’t even bother hiding this massive bailout and even labels these toxic vehicle hotels with its own address.  Let us look closely at the Maiden Lane product.

Maiden Lane – A nice name for a bailout

Source:  Federal Reserve, New York

As we have stated, the Fed doesn’t even bother hiding the fact that they have pursued trillion dollar bailouts to support the banking sector.  The Fed has purchased over $1 trillion in mortgage backed securities alone.  Of course don’t expect to hear about this in the media.  The only talk we have heard about any of this in the mainstream press is when the U.S. Treasury was proudly talking about banks repaying their TARP funds.  This is like giving a gambler $1 million in the hole another million and having him pay you back when he hits blackjack.  This gambler however failed to mention he also was in debt by $100 million.  The Fed on the other hand does conduct complicated banking procedures but in the end it winds up being a bailout for banking gamblers.

The above chart shows the various Maiden Lane Limited Liability Companies (LLCs).  These were designed with differing purposes.  The original Maiden Lane was designed to support the bailout of Bear Stearns:

“Purpose: ML LLC was created to facilitate the merger of JP Morgan Chase & Co. (JPMC) and Bear Stearns Companies, Inc. (Bear Stearns) by purchasing approximately $30 billion in assets from the mortgage desk at Bear Stearns.”

Source:  New York Fed

Now what in the world is in this portfolio?  The Fed doesn’t allow a full audit even today.  But we do know that Maiden Lane I holds assets for JPMorgan that it found to be too risky.  So the Fed essentially gave JPMorgan a $30 billion credit line to the LLC to help unwind whatever was in the portfolio.

We don’t get exact details but we do know it holds a ton of real estate in the battered state of California:

36 percent of the portfolio is located in California.  Of course if you follow the news even slightly you realize that California real estate is one of the worst investments in the last few years.  And this is what the Federal Reserve is backing up.

On further investigation, you realize that a large number of the commercial loans come from hospitality:

This industry has not performed well and is largely overpriced especially if it is in California.  How is this not a bailout?  The Fed tries to keep the data obscure but we can even pull up some of the actual borrowing entities here:

Doesn’t take a genius to make out who was dipping their hand here.  Last time I checked the Hilton and Waldorf were not catering to working and middle class Americans.  The Federal Reserve has been bailing out the wealthy at the expense of everyone else.  How much proof and evidence do people need?  In fact, the Fed flat out doesn’t even care since the media does no reporting on this so they simply put the data where the public can access it if they only wished to do so.

There is absolutely no way the public would have bought into this kind of commercial real estate bailout so that is why it happened behind closed doors.  This is your money at work here.  By the way, the commercial real estate industry has collapsed in the last few years:

Source:  MIT

Maiden Lane was put together in 2008 near the peak of the CRE bubble.  Of the $30 billion portfolio, the Fed put the fair market value at $28.478 billion as of October of 2010.  Apparently this portfolio, a toxic wasteland that JPMorgan did not want to touch without a guarantee has only fallen by 5 percent while the entire industry is down near 50 percent.  This is why if you go back to the first chart the unwinding of this LLC is occurring behind closed doors and they just hope the public has conveniently forgotten.  Remember everyone, TARP was paid back by Wall Street investment banks so nothing more to see here.

My Budget360

By Karl Denninger

The Fed Admits To Breaking The Law

Posted by Karl Denninger