04.02.13 8:45 AM ET
How Washington Gifts the 1 Percent
Thanks to the Fed’s absurd monetary policy and widespread crony capitalism, the 1 percent has roared back from the recession. David Stockman on how the collapse of auto company Delphi epitomizes the rotten central bank policies that transfer vast windfalls to the richest Americans. An adaptation from his new book, The Great Deformation.
In a state of feverish panic after the Lehman failure, the Bernanke Fed expanded its balance sheet at a pace that sober historians someday will describe as simply berserk. As of the week ending September 3, 2008, the Fed’s balance sheet stood at $906 billion, a level it had taken since 1914 to build up.
Now, driven by the panicked demands for relief from Wall Street speculators and their agents occupying the U.S. Treasury department, the Fed pumped out fresh cash at the rate of $700 million per hour, adding another $900 billion to its balance sheet in just seven weeks. Ninety-four years of reasonably deliberative history was thus replicated in three fortnights of panic inside the Eccles Building.
And still the madness continued. After 13 weeks the Fed’s balance sheet stood at $2.25 trillion, nearly tripling in the blink of a historical eye. This mad money printing was supposed to jump-start the Main Street economy but it couldn’t. After a three-decade borrowing spree, household debt of $13 trillion represented 200 percent of annual wage and salary income, compared with a pre-1980 average of 80 percent. Likewise, business sector debt had soared from $4 trillion to more than $11 trillion in the decade leading up to the crisis.
Main Street was thus saturated with excess debt and did not need zero percent interest rates because there were few solvent borrowers left. So the Fed’s massive liquidity flood stayed trapped inside the canyons of Wall Street, where it enabled wave after wave of leveraged speculations as soon as the fast money figured out that the crisis was over and that the Bernanke put would prop up the price of risk assets at all hazards.
Using essentially zero cost short-term funding, speculators soon piled into busted securities and loans, confident that the Fed would keep rates ultralow while aggressively reflating stocks, junk bonds, and all manner of risk assets. The unspeakable fortunes that were extracted from the ruins of the nation’s largest auto supplier provide a stark yet typical demonstration of how our current rotten central bank policies transfer vast windfalls to the 1 percent.
Delphi was comprised of the former parts divisions—radiators, axles, lighting, interiors—that had been spun out of GM in the late 1990s by investment bankers claiming it would make GM look more “focused” and “manageable.” In truth, Delphi was a dumping ground for $10 billion of GM’s debt, pension, and health-care obligations, as well as dozens of hopelessly unprofitable UAW plants and billions more of hidden liabilities such as parts warranties.
Not surprisingly, Delphi hit the wall early, entering Chapter 11 in the fall of 2005. That this spin-off company was intended all along to be a financial beast of burden for GM is evident in its reported financials for its prior six years of existence as an independent company. During that period its sales totaled $165 billion, mostly to GM, but it recorded a $6 billion cumulative net loss and generated negative operating free cash flow. Indeed, saddled with $60 per hour UAW labor costs against nonunion competition at $15 per hour, it was kept alive only by an intra-industry Ponzi scheme: Delphi floated bad trade credit to GM and GM massively overpaid Delphi for parts.
Delphi was thus an economic train wreck that had no prospect of honest rehabilitation. Under pressure from GM and the UAW, it remained mired in bankruptcy court for the next four years yet was ultimately able to emerge from Chapter 11 only because the White House auto task force saw fit to pump billions of taxpayer money into its corpse as part of the GM bailout.
The first-order effect of this terrible abuse of state power, of course, was a few more $60 per hour UAW jobs in Saginaw, Michigan, and a few less $15 per hour nonunion jobs in Tennessee and Alabama. But the real evil of the bailout lay in its rebuke to free-market discipline and the powerful message conveyed by the White House fixers that failure in the marketplace no longer mattered, and that fortunes could be minted from speculating in the crappy paper of even complete zombies like Delphi.
After Delphi was unnecessarily resuscitated with what turned out to be $13 billion of taxpayer money, including $5 billion from TARP and $6 billion from the Pension Benefit Guaranty Corp.’s takeover of Delphi’s busted pensions, the plunder began in earnest. A marauding band of hedge fund speculators were able to scalp an astounding $4 billion profit from a company that under the rules of the free market and bankruptcy law would never have seen the light of day after its original Chapter 11 filing. Indeed, just one of the investors, a so-called vulture fund named Elliot Capital, appears to have realized a 4,400 percent gain, or $1.3 billion, on its Delphi investment, which was taken public in an IPO in the fall of 2011.
The particulars of this case, in fact, reek with the stench of crony capitalism. They powerfully illuminate how the Fed’s boom and bust cycling of the financial markets wantonly showers ill-gotten wealth on the 1 percent. According to the SEC filings, Elliot Capital picked up its Delphi position for $0.67 per share in the midst of the auto industry collapse and while both GM and Delphi were still in Chapter 11. It had the good fortune to sell stock to the public two years later at $22 per share.
Perforce, what the filings do not disclose is that in the interim, Elliot Capital and its confederates had gained control of the Delphi bankruptcy by buying up the so-called fulcrum securities for cents on the dollar. They then threatened to paralyze GM by not shipping certain irreplaceable precision-engineered parts like steering gears where GM technically owned the tooling but it was physically hostage in Delphi plants.
Needless to say, in a regular way a bankruptcy judge would have come down on the Elliot Gang like a ton of bricks for contempt, a tough judge might have even figuratively put them in shackles. But under the ad hoc rules of crony capitalism, the law counts for little and political hardball is the modus operandi. This meant that the hedge funds were literally able to strong-arm the Obama White House into providing the $13 billion bailout to the Delphi estate. Even auto czar Steve Rattner, who was himself busily fleecing the taxpayers, described the hedge fund position as an “extortion demand by the Barbary pirates.”
The winnings of the Elliot Gang are an obscene lesson in how crony capitalism and Fed money printing perverts the free market. Without the $13 billion fiscal transfer Delphi would never have emerged from bankruptcy, and without the flood of liquidity from the Fed there would have been no frothy stock market on which to unload the Delphi IPO.
As it happened, however, the other vultures in the Elliot Gang had a good feed, too. In particular, a credit-oriented hedge fund and spin-off from Goldman Sachs called Silver Point gained a $900 million profit from the deal. This was not an atypical result: it was one of the most adroit speculators in the busted loans and bonds of overleveraged train wrecks miraculously brought back to life by the Fed’s flood of fresh money.
Another huge winner was John Paulson’s fund. This time its “big short” was against the American taxpayer, and the gain was a reputed $2.6 billion. But the most egregious windfall was the $400 million gain racked up by Third Point Capital. This hedge fund is run by one Daniel Loeb, who had been an Obama supporter in 2008 but had since noisily denounced the president for unfairly picking on the 1 percent.
Given the history here, this might have put an uninformed observer in mind of biting the hand that feeds you. Except Loeb didn’t stop with his supercilious but widely circulated critique of Obama’s purported “class war.” Instead, he held fund-raisers for Romney and contributed $500,000 to the GOP campaign.
In so doing, Loeb helped clarify why crony capitalism is so noxious and pervasive. It turned out that another winner from the Elliot Gang’s 40X return on the carcass of Delphi was an allegedly passionate opponent of the GM bailout; that is, the author of a famously penned New York Times op-ed called “Let Detroit Go Bankrupt.”
The ease with which the vultures made their billions from this crony capitalist raid on the U.S. Treasury is evident in Mitt Romney’s purported $15 million of Delphi winnings. Based on the timing of this saga, it appears they were obtained while Romney was on the chicken-dinner circuit honing his anti–big government rhetoric for the upcoming presidential campaign. Call it the Detroit Job.
It goes without saying that with friends like these the free market does not need any enemies. More important, under the financial repression and Wall Street–coddling policies of the Fed there is no free market left. Instead, it has been supplanted by a continuous and destructive cycle of boom and bust emanating from the monetary depredations of the state’s central banking branch.
In the process of inflating stocks, leverage, and speculation to absurd heights, the Fed finally loses control, transforming the financial markets into economic killing fields. Yet in its subsequent panicked reflation maneuvers, it then fosters a vulture capitalist harvest of such magnitude as to be unthinkable on the free market. This is the absurd end game of Greenspan’s “wealth effects” monetary policy and his specious claim that bubbles can’t be detected but only left to burst. This is how recovery for the 1 percent happens.