A point sharply made in an op ed piece in the New York Times by the retiring Barofsky and a point made here last December.

The wildest most universal and undisputable conclusion was that “Too big to fail institutions” remained; in fact they have only grown and have an uneven playing field, which will ensure that they continue to grow and continue to be too big to fail. Meaning our leaders have failed in the most important mission following the bailout—to ensure it doesn’t happen again.

Darrell Issa, chairman of the House Committee on Oversight and Government Reform, showed slides illustrating the interest rate advantage the five largest banks, who control 50% of total banking assets, have over its competitors and Barofsky added that that didn’t include the perception of too big to fail. Wouldn’t you want your money in an institution that you knew would not be allowed to fail by the government?

This is not a political argument on free market solutions. There was one free market solution—let them fail, after that all bets were off and every effort should have been made to ensure minimal impact on the economy, which should have meant making massive loan modifications quickly so the foreclosure issue wouldn’t be hanging over the housing market like the sword of Damocles for the past two and a half years with no resolution in site. TARP, at least the way it was drawn up, bailed out the banks from the perceived failure of subprime loans. Now they appear to be collecting on them again, double dipping.

 An important point made by Barofsky was that TARP was only able to pass due to language that ensured that it would be in the words of the Fed, “conducted to…, restore the flow of credit to American families and businesses, and support economic recovery and job creation in the aftermath of the crisis.”

Barofsky notes, “These Main Street-oriented goals were not, as the Treasury Department is now suggesting, mere window dressing that needed only to be taken “into account.” Rather, they were a central part of the compromise [which convinced] reluctant members of Congress to cast a vote that in many cases proved to be political suicide.”

But shortly after it passed Treasury decided to fund banks directly rather than purchase toxic assets. But no conditions to meet the broader mandates of TARP were included. Why?

Before TARP was passed we pointed out that it was akin to buying deep out-of-the-money options but paying the price of deep in-the-money options. We asked what premium we were receiving for that cost. The answer was to restore the flow of credit to American families and businesses. It didn’t happen.

More to come.

Let’s first consult history. During the recent financial crisis while the Troubled Asset Relief Program (TARP) was shoveling boatloads of billions into the financial community, the regulated clearinghouse needed exactly —$0— TARP dollars. An accident? Luck?  Divine Intervention?

More history.  Many decades ago we Humans noticed that we share many common dangers. Our lives, our health, our homes etc. were at risk. But, instead of saying “every man for himself,” we pooled the risk at modest cost to each of us, and the insurance industry was born.

Clearing does the same thing. All traders contribute to a clearing pool just in case one or more of them defaults. Once a defaulter’s deposits are exhausted, the rest cover the remaining shortfall, which has always been sufficient without ruining them.

The liquidation of Lehman Bros. losses on cleared derivatives trades went smoothly (dealing with the remaining mess continues).

 The cleared derivatives market demands collateral from its users and monitors exposures like a high school hall monitor polices smoking. Falling behind? Pay up NOW or get out NOW.

How can this possibly be a threat to the economy? Are we better off with the old system where staying current on one’s obligation was replaced with a handshake, or a letter of credit from an equally troubled bank, or a keep-well from a parent organization that might perish along with its sub, or a “It’s OK, I met the counterparty’s CEO at Davos and he seemed like a nice guy,” or “Don’t ask Bernie for collateral, the Madoffs have been around for decades”?

 Clearing is a light-years improvement over the slap-dash prior regime. If pooling risk for everyone’s protection is bad, I have a number of insurance policies I need to cancel.

Philip McBride Johnson is a former CFTC chairman and long-time observer of the industry. You can reach him at philipmcbridejohnson@gmail.com

Below is a video we found that attempts to explain the bank bailouts in a straightforward way. While it is definately done tongue-in-cheek throughout most of it, it raises some good questions. While we are not vouching for the validity of everything it claims, much of it sounds familiar to the massage we heard from former FDIC Chairman Bill Isaac when we interviewed him in July 2010, be sure to check out his comments as well.

After you watch the video and read what Isaac says, we would love to hear your thoughts on the subject. Were the bailouts necessary? Should TARP be considered a success?

The Financial Crisis Inquiry Commission, which released its report on the crisis says the money was for proprietary trades of Goldman. While I am sure this is not shocking news to anyone—more is to pity—as one of the numerous unanswered or unsatisfactorily answered questions from the financial crisis was why was AIG bailed out in the first place.

We pointed out at the time that it seemed to be a bailout of AIG’s counterparties who had already seen the generosity of the Federal Reserve,  Treasury and Congress.

 While the report could be dismissed by some as Monday morning quarterbacking the main conclusion is an important one: the crisis could have been avoided.

 “Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs. The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done. If we accept this notion, it will happen again” said Phil Angelides, Chairman of the Commission.

We know this thanks to the Dodd-Frank Act, which requires the Federal Reserve to post transaction level details of the 13 facilities and programs instituted by the Fed to help alleviate the global credit crisis.

If you are one of those folks who, in hindsight, are doubting the seriousness of the situation perhaps you should read the opening graph in the Fed release. “The Federal Reserve Board on Wednesday posted detailed information on its public website about more than 21,000 individual credit and other transactions conducted to stabilize markets during the recent financial crisis… .”

Yes, they said more than 21,000 transactions. And $3.3 trillion is a lot of money, much more than the $700 billion allocated to TARP that served to distract people from the already ongoing efforts of the Fed to bailout global banking institutions. So the situation was and is serious but here is where the Fed goes off the tracks: “conducted to…, restore the flow of credit to American families and businesses, and support economic recovery and job creation in the aftermath of the crisis.”

See it is pretty clear that credit is not flowing to American families and businesses and economic recovery appears pretty far off as does job creation. American families and American businesses did not have access to these numerous facilities and programs, only large banks did and when they got the money they did not loan it out, they unloaded their toxic assets and bought Treasuries making a tidy profit. See when the government allows you to borrow money for free and then purchase U.S. Treasuries guaranteeing roughly 4%, why would you do anything else with that money? A point made here and in numerous veniews by commentor Sharp Pencil aka former CFTC Chairman Philip McBride Johnson.  

How can the Fed claim the operations were conducted to restore the flow of credit to American families and businesses? At least without acknowledging that it has failed if that was indeed its purpose. They are precise in their language when they want to be. Was there any provisions or conditions on these credit facilities to restore the flow of credit to American families and businesses? I couldn’t find it in the report.

Since the anger regarding the bailout has grown, there has been a philosophical battle brewing between those who are worried the Fed has no accountability and those that say the Fed must be able to maintain its independence.

One result of the former’s argument is the fact that we have this report. As to the latter’s argument, you can understand the need that the Fed needs to be independent from short-term political expedience. But given the extent to which monies and credit were doled out to non U.S. institutions and individual investment banks, one has to ask the question “Independent from who?”

We have pointed out here on numerous occasions that the bailout is all about the massive credit facilities created by the Fed and long-term zero interest rate policy but many people still equate the bailout with TARP not the three-year and counting crisis management by the Federal Reserve.

The Dodd-Frank Act may be a success if for no other reason, it helps people to understand this.

Not only was the editorial interesting but the responses to it have been as well. Much of it questions Buffett’s sanity if not his motives. They point out that Buffett’s investments, particularly in GE, benefited from the TARP. One suggests what Buffett would say under the influence of truth serum.

I liked the piece if for no other reason than it stressed the seriousness of the situation the economy was in. During the recent election there was criticism that financial reform was heavy handed and our future Speaker of the House compared financial reform to killing an ant with a nuclear weapon. The problem with a catastrophe averted is that once it is averted, people like to say what was the big deal? 

First off I give Buffett credit for pointing out the seriousness of the crisis, but little else. We had pointed out the seriousness of the situation more than a year before the Lehman flashpoint. One only needs to look at the numerous actions by the Federal Reserve as far back as 2007 in addressing the bank solvency issue. They took actions not done since the Great Depression to try and correct the problem so no one should suggest there was not a major problem. But any honest examination of the issue has to start in the summer of 2007 not the fall of 2008 and has to point out the months of denial. The big question remains was the actions taken correct and why was the risk allowed to build up prior to the flashpoint? 

And critics are correct in objecting to the fawning over Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, both of whom reassured us that what was happening would not happen just months before it did. Paulson’s relationship and communications with the major financial players on Wall Street during this crisis still has not been appropriately examined. We pointed out before that if their analysis of what was needed were correct, then the first appropriate response from them should have been to offer their resignations.

The bottom line is that the financial crisis in all of its forms running up to the September 2008 flashpoint is a big deal. It represents a huge failure of policy.

Thanking the government for the bailout is akin to thanking someone for driving you to the hospital in the car they ran you over with. We are not even sure if they took the best rout.

The occasion was the official end of TARP and in a sense the story is correct in that TARP will not cost as much as first thought and much of the money paid out in TARP loans has been repaid. But it doesn’t ask some critical questions, like was it necessary in the first place. Former FDIC Chairman and current chairman of LECG Global Financial Services  Bill Isaac has made the point on numerous occasions that the FDIC and Federal Reserve could have provided the capital infusions to banks on their own without a massive legislative effort and would have executed it more efficiently. If you recall the Treasury required some banks to take funds even if they didn’t request or need them. They didn’t want to isolate problem banks — which on the face of it is silly.

Isaac adds that they also could have done it without creating the panic and firestorm in the fall of 2008, which he says is the biggest cost of the legislation.

One has to remember as well that the Treasury never did implement TARP as it was written, choosing to do a capital infusion instead of purchasing toxic assets as first planned by the legislation. Many experts agree that this was a better approach and I would defer to their judgment on that, however, the idea that Congress can pass a major and controversial piece of legislation and then a Secretary of the Treasury execute a vastly different plan with the money allocated for that policy is disturbing.

The underlying problem between perception and reality regarding TARP is quite easy. Those at least partially responsible for the financial crisis, the large investment banks, received a massive bailout and are now profitable —hugely so with the balance sheets and bonuses to prove it while the rest of the country is mired in tough economic times with double digit unemployment. How is that appropriate? How can that result be defined as a success?

 The FT piece also does not address all of the other ramification of TARP and the various policies enacted to address the credit crisis. Isaac in an op ed piece for CNBC discusses this and cites  work from John Talbott that attempts to tally the entire cost of TARP and related bailouts. We also tend to forget that the Federal Reserve was working feverishly creating products to help bailout the financial sector and offset the crisis more than a year before the Lehman Bros. debacle brought the crisis to a head.

Though I would agree with Isaac that many of the figures provided are exaggerated–Talbott puts the price tag of the various bailouts and their related consequences at a hair under $15 trillion–all of them are not and the figures are huge.  As we noted here at the time, if the situation is as serious as people claim, then it would be appropriate to explain it rationally in detail rather than rely on scare tactics and vague warnings of impending doom.

We still feel that is the case and we are still waiting for an honest accounting of the financial crisis that we are still mired in.

In typical form this would be more complex, involving the U.S. Treasury increasing its ownership stake to 90% from 80% before unwinding completely. According to the FT the Treasury would convert $49 billion in preferred shares to common shares — that is what would up its total — before selling those common shares over a period of time.

 The problem is such a move would dilute shares, as if AIG shareholders hadn’t been diluted enough (see AIG chart below). According to the FT the Treasury would account for this by offering warrants that would allow outside shareholders the right to buy AIG stock in the future at a discount to the current price.

None of these plans are official or have been confirmed and would have to be approved by the AIG board once there is a plan. The idea would be to repay taxpayers for the $182 billion in public money use to save AIG.

The problem is and always has been that AIG was not being saved, it was their counterparties being saved, the investment banks who were being saved concurrently with TARP funds. Goldman was being paid out on both ends and has returned to profitability and large bonuses, which is more than AIG shareholders and the rest of us have gotten. It would be good to remember that when politicians begin talking about the success of TARP and how the banks have paid back loans.

The story concludes that bankers, regulators and insiders involved are surprised at the resilancy of the stock. Huh. Take another look at the chart. In June 2009 AIG did a 1-20 reverse stock split, meaning the current price is under $2, based on previous values. Dilute away.

It is understandable that certain interests would be for it and against it. And powerful interests who would be most affected by it would lobby legislators to moderate that impact.

But the various camps are still playing it up in the most superficial analysis of greedy Wall Street firms vs. Main Street or out of control government vs. innovative business leaders who create jobs.

People on the right are pretending that we didn’t face a crisis of enormous proportions that caused credit markets to seize up and people on the left seem to confuse social policy with sound regulation. And everyone should be banned from the Wall Street vs. Main Street cliché.

 WE know one thing for sure: the institutions that rely on our free market principles to earn profits needed to be bailed out because they grew too big and to interconnected to fail. And it is debatable as to whether the “too big to fail” dilemma has been adequately resolved.

One critic of the legislation, former FDIC Chairman Bill Isaac, has put forward a possible solution to the too big to fail dilemma. It isn’t part of the legislation but is worth the read. He has criticized both sides of the debate and points out the reality that if one of the major investment banking institutions gets in trouble, they will still be bailed out.

What I like about Isaac’s idea is that it addresses a specific problem. The legislation is more than 2,000 pages and addresses many things unrelated to the crisis. It even establishes “New Offices of Minority and Women Inclusion at the federal financial agencies. That  may  be a good thing and I understand that superfluous amendments are part of the legislative sausage making process but seeing that this was brought on by a crisis that could have risen to the proportion of the Great Depression (and still could) a little better focus by legislators would have been nice.

Perhaps that will be the job of the regulators who will write the rules applying the legislative mandates. A good deal of the serious reaction to the legislation points out that how financial reform eventually plays out will depend on that.

No one likes being preached to and the rule has a sense of the CFTC protecting the retail masses from themselves. Many letters were from individual traders who noted that they were trading for years and could take care of themselves.

While many of the letters were prompted by the Forex Dealers Coalition (FXDC), a group of forex dealers opposed to the rule, that  provided traders a link to post comments and suggested talking points, 5,000 is still a huge number. The Commission received a total of 4,659 comments in 2006 when it was looking at potential changes in its Commitment of Traders report. Prior to that the most comments received on a particular issue was slightly more than 1,000.

It got me thinking about the Refco bankruptcy and how the customers of the unregulated Refco FX affiliate ended up taking a bath. They shouldn’t have because there was a buyer for those accounts but the Creditors  Committee did not approve it. Why a judge didn’t force the matter, I never could understand but customers ended up getting a fraction of their money back when they could have been made whole.

What I was thinking about is that if this rule was in affect back then — as least theoretically — those customers would have had to fund their account at a much higher level and hence would have lost much more money. It is theoretical because they probably would have transferred the account to an overseas broker that offered the leverage level they wanted but if it was the only game in town, they would have had to put more money in their account, trade less or simply get out. 

While lower leverage may be prudent, requiring traders to use prudence is not the role of the regulator. That is what margin calls are for. The main role of the regulator is to ensure fair markets. The retail public does not need a regulator to be a nag, protecting them from risky behavior — people will select the risk level appropriate to them — they need a regulator to ensure a fair market place. Perhaps requiring segregation like in futures would be an appropriate step. At least one of the comment letters mentioned that.

It has nearly been one and  half years since the Congress passed the Troubled Asset Relief Program (TARP), which allocated $700 billion to bail out our banking industry. In addition to that the Federal Reserve has made available around  $2 trillion in various special  auction facilities to help keep the banking industry afloat yet Congress and the regulators are still trying to put together regulatory reform. Firms that were the beneficiaries of TARP money are now spending millions to lobby against greater reform.

Remember the problem of “too big too fail”?

When a retail trader opens up a forex account for a few thousands dollars, over trades and blows up, the rest of us are not required to bail him out. Large investment banks were bailed out and now are passing out bonuses and spending money lobbying Congress. Regulators need to keep their eye on the ball. The retail public does not need to be protected from themselves, they need to be protected from once again being on the hook  for someone else’s losses.