What a delicious irony this is—last week, just as President Obama was publicly bashing the stupidity of the banks and big Wall Street firms for doling out bonuses and receiving “taxpayer assistance, then going out and renovating bathrooms or offices,” senior members of his economic team were privately begging for input from Wall Street. The administration was conducting around-the-clock discussions and interviews with senior Wall Street executives, including many from the same firms he was theoretically appalled with, about how to fix the lingering financial crisis.
While populism may feel good, it doesn’t actually solve the problems we face. Inside these firms are many decent, hardworking, and, above all, incredibly smart people.
The discussions, which I first reported on CNBC, centered around the creation of a “bad bank,” which, as initially envisioned, would essentially purchase the estimated $1 trillion to $4 trillion of toxic mortgages and mortgage securities that have been clogging the financial system for at least two years. These securities have been the main source of the banking system’s woes; every quarter, firms like Bank of America and Citigroup have taken huge losses on these assets, which remain on their balance sheets because if you tried to sell them, no one would buy them at a fair price. These losses are at the heart of the country’s economic problems: If banks keep losing money, they can’t lend to individuals and businesses. The economic system, in short, is shutting down.
But if the government steps in as a buyer, the big financial firms could sell this toxic debt at marginally higher prices, get the problem stuff off their books and start lending again. It’s a plan being pushed by the new chief of the Federal Deposit Insurance Corporation, Sheila Bair, and if you believe her, it’s a win-win for everyone: Wall Street gets the bad debt off its books, and if the government buys the mortgages and mortgage-related debt at 40 cents on the dollars, chances are that the prices of the securities will rise once the markets and the economy recovers.
Sounds good, right? The markets loved it, rising around 200 points when the first reported on CNBC. But then reality set in. Through the latter half of last week, senior members of the Obama administration put aside their populist ranting and began asking the people who know something about the mortgage market about what they thought. According to executives who have had direct conversations with members of the president’s economic team, there are many problems with buying and, more importantly, pricing securities when there’s no real market. For one thing, there is nothing like the NYSE in the mortgage market—prices are determined between sellers and “vulture investors,” who are willing to buy mortgage bonds and snap up the securities on the cheap—so cheap that the sale itself could leave many banks insolvent.
There are other issues, Wall Street executives warned. The old Resolution Trust Corporation, which bought insolvent S&L’s during the late 1980s and early 1990s, took on a liability of close to $400 million. We’re talking possibly trillions here, and that’s just counting mortgage debt. If there is a deep recession, auto loans and credit-card debt will begin to blow up as well, and where will the money come from?
Meanwhile, many firms have their own complex models to price the bonds, but this is more an art than a science since the bonds themselves are comprised of scores of mortgages—some of which are paying, some of which are not, and some of which could go into default in the future. Of course, the Treasury, the FDIC, or the Fed can always bite the bullet and buy the $1 trillion to $2 trillion of securities and mortgages at a level sufficiently above the market price that doesn’t plunge the banking system into insolvency.
But can they sell a bailout of that magnitude to the American people?
It’s unclear if the government bureaucrats fully understood and digested what the Wall Street wise men said, though initial reports suggest they did. Earlier in the week, the bad bank concept was front and center in the government’s bailout planning. Later in the week, as I reported on CNBC, the momentum had shifted. The bad bank idea hit a snag. On Friday, a Treasury Department spokesman described the plan as one of many options and remedies that will be unveiled at some point, possibly as early as this week.
According to one person with knowledge of the matter, the bad bank will likely be one aspect of a “kitchen-sink approach.” There simply isn’t enough money to buy all the bad debt from the banks, so that idea will be supplemented with the purchasing or guaranteeing of mortgages directly from individuals, additional guarantees of bad debt on the banks’ books, and possibly the infusion of more capital—along the lines of what the government did for Citigroup and, most recently, Bank of America.
The moral of this story isn’t simply whether a bad bank is a good or a bad idea, it’s whether the constant attacks against Wall Street by the president and the media (including, at times, myself) is good for the country. Or are we just demonizing the people we need to get us out of a mess, which, admittedly, they put us into in the first place. Wall Street traders, bankers, and salesmen can be a loathsome bunch (just go to any bar or restaurant where they congregate) and they make for incredibly easy targets—whether it’s John Thain’s $35,000 commode, or as reported on the front page of The New York Post, former Citigroup founder Sandy Weill’s continued use of the company jet even as his firm is sucking in billions of federal bailout aid. More than anything else, their business model of taking enormous risk has plunged the country into possibly the worst financial crisis since the Great Depression.
So while populism may feel good, it doesn’t actually solve the problems we face. Inside these firms are many decent, hardworking, and, above all, incredibly smart people. Whether we like it or not, the people who had the knowledge to create all these fancy derivatives and mortgage-backed bonds—the CMOs, CDOs, and the rest of the crap plaguing the big banks—may be the only people with the knowledge we need to save the financial system before we start seeing breadlines. In short: They know where the bodies are buried.
Does the president understand any of this? Possibly. Even as he indulges in Wall Street bashing, his economic advisers regularly meet with top Wall Street executives about the financial meltdown, and have apparently taken their advice. (In addition to changing direction on the bad-bank plan, several Wall Street executives advised the president that it would be ruinous to raise taxes, which may be the reason Obama has shelved a reversal of the Bush-era tax cuts. At least for now.) He is also bringing senior Wall Streeters into his inner circle. Last week, Citigroup announced that top investment banker Michael Froman joined the Obama administration as its deputy national security and economic advisor. And it must be noted that just as Obama was attacking bonuses from bailout-addicted companies like Citigroup, Froman was receiving one. But in Froman’s case, he donated his entire bonus to charity—splitting it between pediatric-cancer research in memory of his 10-year-old son who died recently from brain cancer, and organizations that help individuals and families affected by the economic crisis.
So maybe its time for a moratorium on Wall Street bashing and a little more outreach to some very smart people about how to fix the banking crisis. It’s gotten so bad that friends of mine who work on the Street (and are lucky enough not to be among the tens of thousands laid off) are afraid to say where they work when they attend parties with non-Wall Street types. But think of it this way: If we can join forces with Joseph Stalin to defeat a common enemy in World War II, we can certainly make nice with some investment bankers who can save us from another Great Depression.
Charles Gasparino appears as a daily member of CNBC's ensemble. He is also a columnist for Trader Monthly magazine, and a freelance writer for The New York Post, Forbes and other publications.