Field Trip to Maiden Lane: Home at Last on the Fed's Balance Sheet

Welcome to Maiden Lane, where the tripe vendors of Wall Street hawk their wares.

Maiden Lane runs right past the foot of the N.Y. Fed, and this address hosts the most poisonous assets on its balance sheet.

As any anti-Fed Reservist among you will agree, the Reserve’s balance sheet is nothing but the stomach lining of the poorly run banks…only there’s no acid (free-roaming liquidity) left to do any digesting.

Before I tell you what this costs us to hold this stuff, let’s take a look at what it is.

Meet Maiden Lane I, Maiden Lane II, and Maiden Lane III… some of the ugliest portfolios you may ever meet.

In Maiden Lane I, we’ve got the commercial and residential mortgages that JPMorgan didn’t want. That’s right, when the guv’ment colluded in the hookup, it didn’t throw the baby out with the bathwater. It rescued the baby to spare JP from being a new surrogate father dupe. JP, you see, knew enough about the Florida and California housing markets to want no part in shouldering that burden. It was already nursing too many of its own sunny-state-sour-mortgage bastards. Too bad banks aren’t more like rats, hamsters, and other rodent ilk that can just swallow the unwanted babies up.

Maiden Lane II, a wily female with a lotta curves, has more Alt-A mortgages and subprimes than she can sell. In fact, she’s in hot water with her pimp right now. We’re talking $937 million as of Dec. 31, 2008. I don’t see her working that debt off anytime soon — nor paying back the $180 million she’s already lost — no matter how many PPIP pimping sessions happen with the Wells Fargos and hedge funds hard by the ol’ Sunset Strip. The Fed says she’s worth a whopping $11.4 billion, but we expect the private market will treat the Fed like a huckster selling a kneecapped racehorse. You’re lucky to get 25 cents on the dollar for this.

The newest balance sheet abomination, little Maiden Lane III, was born on Oct. 31. The genes, if you will, are the worst recessives: asset-backed securities issued circa 2006 and commercial CDOs circa 2007. A third of this baby’s “silver spoon” worth is pure speculation grade, viz. most likely to default. All told, $26.65 billion of this $26.8 billion problem child are valued using mathematical models — not tangible market prices. We’re afraid of what will happen when this tyke hits the “terrible 2s.”

Somehow I have trouble seeing who will want to buy the bowls of porridge these Maiden Laners make. In the meantime, just cross your fingers that the principal on these things gets returned.

How Much Does It Cost You?

In just taking the sop from AIG and Bear Stearns — the cream of the failed capitalist crop — the Federal Reserve took on $74 billion in subprime and bad lease refuse. On April 23, it reported a yet-unrealized loss of $9.6 billion.

We’re not down the toilet yet, but we may have to use TARP money just to pay back our own central bank. Is this really what Mr. Treasury Secretary wanted?

Meanwhile, we who are on the hook — despite the best efforts of the Freedom of Information Act and a Bloomberg News lawsuit — are not allowed to see the names of the banks involved, the specific amounts they requested, or the “assets” the banks are offering as collateral. The only reason we know anything about AIG is that the Fed owns 80% of it.

Why aren’t we allowed to know? Not some kind of “It’s unconstitutional” argument. Simply this. The government, trying really hard to paint the pig, doesn’t want to a) trigger a bank run or b) ruffle the shareholders’ feathers one bit.

But the big thing to note here is that the Treasury is now bailing the Fed out. Meanwhile, it’ll try to distract you by drawing out this “bank industry stress test” to maximum media effect.

The Stress Test Sham

On Friday, we learned what methods the Fed regulators employed to test the top 19 banks in the United States. Meanwhile, it tells the banks privately whether the institution merited a “pass” or “fail” grade. And the regulators, despite the Obama-Geithner injunction to transparency, are asking the banks to stay on the QT and very hush-hush.

Only on May 4, will we, the Treasury shareholders, be told the results.

The whole dog-and-pony show was for us and us alone, and we’ll be the last to learn the truth. The information, they say, “could alarm depositors and investors.”

What does it matter if the stock market drops 300 points in one day or over the course of a week? Joe the average shareholder isn’t a day trader and will still be either up on a passed bank or down on a failed one. End of story.

This consolation just in from Northwestern University researchers: An upcoming article in the journal Psychological Science touts: “Denial Can Bring Marital Bliss.”

Its concluding point: “If denial paints a partner better than they really are, the relationship is bound to be satisfying, as long as no one is slapped in the face with reality.”

We’ve been slapped in the face with reality. And when the government botches its delivery of denial, like a nurse bad with the needle, we know the drawing of cash to come is really going to hurt.

How did we fall so low? Wasn’t there a time when we loved Wall Street?

When the Romance of the Street Went Sour

From our long-suffering, early-rising coffee drinker Eric Fry, over at Rude Awakening:

“Specifically, the Paulson bailouts sought to divert hundreds of billions of taxpayer dollars toward Wall Street finance companies, and to do so as secretly as possible. In the name of ‘systemic risk,’ the former Treasury secretary dispensed hundreds of billions of dollars to the likes of AIG, Citigroup, and his former employer, Goldman Sachs, without ever seeking or receiving a single vote from an elected official. Thus, as it turns out, the only system genuinely at risk during Paulson’s tenure was the American system of honest and transparent financial markets.”

Yes, Eric, that was the great problem. And this same man asked for a lighter whip to be laid on the back of Wall Street…by lobbying the rule change that let banks leverage themselves to the hilt — eating their own tripe, the same they were selling to everyone else. (We’ll leave aside his role in the Bank of America/Merrill Lynch morass, for now).

But we still don’t get at the true root of the problem until we look at another revenue stream. Because, let’s face it, what marriage doesn’t come down to finances?

This cash flow doesn’t come from the central bank. It’s the one that flows straight into political action committees and individual campaign coffers.

Federal Election Commission Pulls Back the Curtain

In a lovely snippet on the threat of a full-scale Senate probe, in the penetrating Ferdinand Pecora style of the 1930s, we found a treasure trove of good stuff already uncovered.

Consider this.

In the past 20 years of elections, who do you think came out as the biggest political contributor?

The energy companies, yesterday’s super villain?

Nope. Guess again.

How about the pharmaceutical industry?

No dice.

Financial services topped the charts.

Just looking at the past two years alone, we see sobering numbers.

The financial giants in grey bespoke largess donated $463.5 million. The energy companies, the ones Congress was just scolding when oil ran up over $100 a barrel, donated only $75.6 million.

Breaking it down to our two initial banking survivors of the subprime fallout, Citibank and Goldman Sachs, gets even fishier.

In 20 years, Goldman Sachs foisted over $30.9 million in donation dough. Citibank was almost as generous, at $25.8 million. The only company who rained down more congressional support? AT&T, which always seems to be keeping pesky antitrust cases at bay.

But use your imagination and think about it for a sec. If you’re the CFO for a large financial outfit, doesn’t $30.9 million spread out over 20 years seem like the best insurance policy you could ask for?

That’s a measly $1.545 million per year in premium.

Heck, that’s proved way more functional than AIG’s great insurance policies for Wall Street! Was not Goldman Sachs one of AIG’s biggest counterparties? Our money’s on Maiden Lane III being created especially to honor it.

Good thing Goldman Sachs is doing so well, and is ready to pay back that TARP money, eh? It may well be why it was in such a rush to be the first to give bailout money back. But you may be amused to learn that the payback date depends in part on the results of those so-secretive stress tests.

From our vantage point, GS can’t be as healthy as it appears. By changing the calendar month of reporting, it erased the reality of a $1.5 billion loss, for example. That wasn’t illegal, and it was the result of its bank holding company conversion, but it was extremely convenient — destroying any easy attempt of shareholders to compare quarters.

There has also been suggestion that Goldman’s Q1 2009 was so plump and juicy thanks to AIG transfer payments, but we’ve not yet run the fine-toothed comb over that Goldman 10-Q to qualify the speculation. However, either way you cut it, there were some big one-time hedges that paid out, but there’s no reason to think they’ll pay again.

There’s always the ever-paying hedge — or should we said hegemony — of letting the government just pick a little out of your pocket.

Samantha Buker

April 28, 2009

The Daily Reckoning