Sunday, 4 April 2010

When the Fed People Act Responsibly

Dialectics is the investigation of the relation between the whole and the part. In the past couple of times that I wrote about the illegality of the Fed’s actions, I put them in the context of a larger development of social decay.

But there are also the parts. Like the individual lines in a painting or sentences in a story, they shape our comprehension of the big picture.

On Thursday, under pressure from Congress, the Federal Reserve Bank of New York released more information about its holdings. I am quoting a few passages from a related Wall Street Journal article, followed by my comments in blue.

  • The Federal Reserve Bank of New York lifted a veil of secrecy on the troubled mortgage assets it purchased as part of the 2008 rescue of Bear Stearns Cos. and American International Group Inc.
That’s very good. We’re all for transparency. What did the newly released data show?

  • The data show the government is now in the same situation as many U.S. banks: dealing with a portfolio of loans and property that have lost their value, and which borrowers are struggling to pay off.
No surprise there. Unloading junk unto the Federal Reserve is like throwing garbage in the ocean. The garbage might not be in front of your eyes, but it is there in the environment and will be returned to you in due time.

  • For months, the regional Fed bank has been under pressure from lawmakers to make public details of the assets in three special-purpose companies that were created to take on roughly $80 billion in troubled mortgage positions previously held by Bear Stearns and AIG ... As of the end of 2009, the New York Fed was owed about $62 billion by three Maiden Lane vehicles.
The New York Fed has invested $80 billion in troubled “positions”; the paper cannot bring itself to call them securities. Now if you invest $80 billion in fixed income securities, you should be “owed” $80 billion. But the New York Fed is owed “about” $62 billion. The missing $18 billion must have been straight write down, money down the rat hole, as explained next.

  • One loan controlled by the government is $12.75 million in financing Bear Stearns provided to the owner of the 167-room Radisson Hotel in Jacksonville, Fla. The hotel is owned by a venture controlled by Philadelphia real-estate investment company AMC Delancy Group Inc. Kenneth Balin, AMC chairman and chief executive, said he believed Bear provided the loan with plans to include it in a debt pool known as a securitization. But that never happened, leaving Bear, and now the government, with the note.
Bear Stearns provided the loan with plans to include it in a debt pool known as securitization.

In case you don’t follow the technical jargon, Bear Stearns lent $12.75 million to AMC Delancy group without, no doubt, much of any review or analysis. Why? Because it was planning to bundle the loan with other equally shaky loans, say one for $12.25 million and another for $25 million, and sell the pool, now a “callateralized debt obligation or CDO” for more than its par value of $50 million, to say, $55 million. That is what Countrywide also did. And Citi. And Washington Mutual. You get the idea. That is what drove the “boom” that preceded the crash.

Alas, all the good things must come to an end. Bear went under before it could sell the junk to the public.

  • Mr. Balin said that loan was used to refinance debt borrowed in 2004, when it bought and renovated the hotel property.
This is the confirmation, if any was needed, that the current “note” is a junk bond that replaced another junk bond. The interesting thing is that the Journal does not say when the refinancing took place. My guess would be sometime in 2006.

  • Mr. Baling said that, so far, he gives top marks to those overseeing the loan on behalf of the U.S. taxpayer. “The people that are handling this note are behaving responsibly,” Mr. Balin said.
Here, the Journal abdicates its responsibility of honestly reporting the event by not telling us the Mr. Balin winked. In fact, it adds a wink of its own by bringing in the U.S. taxpayers.

Nasser, but you were not there. How do you know that he winked?

The man must have winked because he is mocking us.

He has a $12.75 million loan that he cannot repay. But the original lender is gone and the loan has somehow ended up on the books of the Federal Reserve Bank of New York, which “oversees” it. And what a marvelously accurate word that is, the “oversee”, the ultimate mot juste.

You see, the New York Fed cannot foreclose the loan, else it would be in possession of a Florida hotel. No one would buy the loan because it is junk. So, what other option is there if Mr. Balin is not paying, which he is not? The answer is, Nothing. The bank has to oversee the loan, the way a loyal agent would oversee an estate, until such time that Florida real estate market recovers. Then Mr. Balin would approach the Fed with an offer that the bank cannot refuse. He will buy his note at some deep discount and the New York Fed would announce another step towards the anxiously awaited goal of reducing its balance sheet.

  • Noting guest-satisfaction surveys, Mr. Baling added: “It’s a beautiful hotel”
I told you, the man is mocking us.

One critical item that I do not understand is how this note ended up on the balance sheet of the New York Fed. I thought that Bear Stearns was taken over by JPMorganChase, so this security should have been on the bank’s balance sheet.

But that is not entirely accurate. Come to think of it, I actually do understand.