Eliot Spitzer on regulatory discretion and Fed's secret loan program

Slate ran a column by Eliot Spitzer, the former NY attorney general and governor, in which he discussed how the government and big banks deceived the public with their $7 trillion loan program.

In a previous post on the secret loan program, I discussed the idea of and role played by regulatory discretion.  I noted that ultra transparency is necessary as it would end the possibility of a secret loan program in the future as well as provide the information the market needs to assess the banks in the aftermath of the distortions to the bank balance sheets caused by regulatory discretion (think extend and pretend).

Mr. Spitzer focuses on the issue of disclosure.  He leaves no doubt that even if the secret loan program did not violate the law (and there is plenty of reason to think that statements made to the public misrepresented what was going on) they violate the spirit of the law.

During the deepest, darkest period of the financial cataclysm, the CEOs of major banks maintained in statements to the public, to the market at large, and to their own shareholders that the banks were in good financial shape, didn’t want to take TARP funds, and that the regulatory framework governing our banking system should not be altered. Trust us, they said. 

Yet, unknown to the public and the Congress, these same banks had been borrowing massive amounts from the government to remain afloat. 

The total numbers are staggering: $7.7 trillion of credit—one-half of the GDP of the entire nation. $460 billion was lent to J.P. Morgan, Bank of America, Citibank, Wells Fargo, Goldman Sachs, and Morgan Stanley alone—without anybody other than a few select officials at the Fed and the Treasury knowing. 

This was perhaps the single most massive allocation of capital from public to private hands in our history, and nobody was told. This was not TARP: This was secret Fed lending. And although it has since been repaid, it is clear why the banks didn’t want us to know about it: They didn’t want to admit the magnitude of their financial distress. 

The banks’ claims of financial stability and solvency appear at a minimum to have been misleading—and may have been worse. Misleading statements and deception of this sort would ordinarily put a small-market player or borrower on the wrong end of a criminal investigation. 

So where are the inquiries into the false statements made by the bank CEOs? And where are the inquiries about the Fed and Treasury officials who stood by silently as bank representatives made claims that were false, misleading, or worse?

All of the representations were also being made by the regulators.  Just look at the borrowing being done at the same time the stress tests were conducted.

Only now, because of superb analysis done by Bloomberg reporters—who litigated against the Fed and the banks for years to get the information—are we getting a full picture of the Fed and Treasury lending. 

The reporters also calculated that recipient banks and other borrowers benefited by approximately $13 billion simply by taking advantage of the “spread” between their cost of capital in these almost interest-free loans and their ability to lend the capital. 

In addition to the secrecy, what is appalling is that these loans were made with no strings attached, no conditions, and no negotiation to achieve any broader public purpose. 

Even if one accepts the notion that the stability of the financial system could not be sacrificed, those who dispensed trillions of dollars to private parties made no apparent effort to impose even minimal obligations to condition the loans on the structural reforms needed to prevent another crisis, made no effort to require that those responsible for creating the crisis be relieved of their jobs, took zero steps towards the genuine mortgage-reform that is so necessary to begin a process of economic renewal. 

The dollars lent were simply a free bridge loan so the banks could push onto others the responsibility for the banks’ own risk-taking. 

If ever there was an event to justify the darkest, most conspiratorial view held by many that the alliance of big money on Wall Street and big government produces nothing but secret deals that profit insiders—this is it. 

So what to do?

Mr. Spitzer, at a minimum banks should be required to provide ultra transparency.  They should be required to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

With this disclosure, market participants, particularly taxpayers and policymakers, could see if and to what extent the Fed was propping up the financial system.