AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.
...What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.
Here's one of the charts from the Baseline Scenario post by James Kwak, JPM provision for credit losses. As Kwak advises, "Note that these are income statement figures, so they are not cumulative: these are the provisions set aside each quarter, which should reflect the quarterly change in expectations about credit losses (defaults). The question is whether these big investment banks can make enough money from trading and fees to make up for the money they are still losing on credit exposures."
In the short term, it is difficult to say how financial stocks will react as more companies report similar figures. In the end, it would be premature to consider these profits as representing light at the end of the tunnel, the green shoots of the recovery, or whatever other metaphor du jour the bulls want to use on CNBC.
Predictably, add Paul Krugman to the list of people who have questions about these purported signs of the recovery. In addition to the questionable bank numbers, Krugman notes, "Things are still getting worse."
Industrial production just hit a 10-year low. Housing starts remain incredibly weak. Foreclosures, which dipped as mortgage companies waited for details of the Obama administration’s housing plans, are surging again.
The most you can say is that there are scattered signs that things are getting worse more slowly — that the economy isn’t plunging quite as fast as it was. And I do mean scattered: the latest edition of the Beige Book, the Fed’s periodic survey of business conditions, reports that “five of the twelve Districts noted a moderation in the pace of decline.” Whoopee.
The Atlantic just published a great article by Simon Johnson, former chief economist at the IMF. Johnson recognizes the consistent patterns of financial crises, and worries that elite business interests are directing policy. Looking back at his IMF days, he asserts that the political environment is central to whether a country in crisis is prepared for recovery. "Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks." His experiences with developing economies provide striking parallels with the current global economic situation. As he says, "Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms."
The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.
Squeezing the oligarchs, though, is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Kremlin bailout technique—the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large.
Sound familiar? Johnson goes on to discuss the revolving door between Wall Street and Washington, and the cultural pull that Wall Street exerts, influencing beliefs and policy.
Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here. In September 2008, Henry Paulson asked Congress for $700 billion to buy toxic assets from banks, with no strings attached and no judicial review of his purchase decisions. Many observers suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands—indeed, that is the only way that buying toxic assets would have helped anything. Perhaps because there was no way to make such a blatant subsidy politically acceptable, that plan was shelved.
Instead, the money was used to recapitalize banks, buying shares in them on terms that were grossly favorable to the banks themselves. As the crisis has deepened and financial institutions have needed more help, the government has gotten more and more creative in figuring out ways to provide banks with subsidies that are too complex for the general public to understand.
... In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign.
Boris Fyodorov, the late finance minister of Russia, struggled for much of the past 20 years against oligarchs, corruption, and abuse of authority in all its forms. He liked to say that confusion and chaos were very much in the interests of the powerful—letting them take things, legally and illegally, with impunity. When inflation is high, who can say what a piece of property is really worth? When the credit system is supported by byzantine government arrangements and backroom deals, how do you know that you aren’t being fleeced?
It's a long article, and well worth reading. In Johnson's second scenario, he says perhaps the severity of the crisis, and inadequacy of the response, will become apparent more quickly, necessitating a more effective approach. In the end, however, it is difficult not to be profoundly disappointed in President Obama for continuing this policy of coddling Wall Street and re-allocating taxpayer wealth to mega-corporations that made bad loans and investments. This looting of the taxpayer is taking place without promised transparency, and contrary to assurances that this administration would represent citizen interests over those of the corporations and lobbyists, which apparently continue to consolidate their control over the US government agenda.
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