classical economics
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Myth of Good Intentions
By Wayne Jett
© April 28, 2009

    On April 23, the Attorney General of New York, Andrew Cuomo, notified Congress and the Securities & Exchange Commission of evidence gathered in his investigation of the merger of Bank of America and Merrill Lynch. Cuomo’s letter disclosed testimony of Ken Lewis, BAC’s CEO, regarding BAC’s decision to proceed with the merger without exercising the Material Adverse Condition (MAC) clause even though Merrill’s fourth quarter loss was about $7 billion larger than disclosed to shareholders before their vote approving the merger. Cuomo’s letter does not say so, but acting in that manner appears to violate federal securities laws requiring disclosure of facts material to shareholders’ interests.
    Lewis testified he acted as he did, according to Cuomo’s letter, because Treasury secretary Henry M. Paulson Jr. told him the federal government would remove BAC’s board and management, including Lewis, from office unless BAC proceeded to close the merger without disclosing Merrill’s financial condition. “Secretary Paulson has informed us,” Cuomo’s letter states, “that he made the threat at the request of [Federal Reserve] chairman Bernanke.” Cuomo writes Bernanke declined to be questioned, citing a “bank examination” privilege.
    Since these revelations, responses have ranged from consternation that a CEO (Lewis) and board so clearly violated duties of disclosure and protection of shareholder interest, to proposal of RICO litigation charging conspiracy to commit wire fraud and securities law violations, to suggestion that a grand jury be impaneled to consider indictment of Paulson.
Searching for a Pattern
    In surveying this potentially consequential scene, the two most surprising aspects are (1) that any law enforcement official saw fit to question these parties and then actually disclosed what was learned, and (2) that anyone is “shocked, shocked” Paulson used government power to strong-arm financial transactions.
    Take a look backward at the events of 2008, as one major financial institution after another met its demise:

•    In March, Federal Reserve chairman Ben Bernanke and Treasury secretary Henry M. Paulson Jr. assisted J. P. Morgan Chase’s takeover of Bear Stearns, the fifth largest investment bank in the U. S., by injecting $55 billion from the Fed to sweeten the deal for Chase. Despite BSC closing on Friday above $32 per share, two days later on Sunday Paulson reportedly insisted that Chase offer no more than $2 per share. Heavy trading in far out-of-the-money puts and undelivered shares sold short preceded Paulson’s actions by days, making hundreds of million for insiders.
•    In early September, within days after a respected Lehman Bros. analyst opined both Fannie Mae and Freddie Mac were viable in cash flow and capitalization and their share prices rose sharply in response, Paulson indirectly seized control of both mortgage giants on a Sunday and imposed his demand for warrants comprising 79.9% of equity, thereby destroying common shareholders and again rewarding naked short sellers.
•    In mid-September, naked short sellers destroyed Lehman’s share price as the SEC stood idle, forcing Lehman into liquidation bankruptcy, likely the penalty paid for getting in the way of Paulson’s plans for Fannie and Freddie.
•    Also in mid-September, AIG was treated to the same naked short selling destruction of its share price, Paulson again took control, finished off common holders by repeating his demand for warrants comprising 79.9% of equity, and installed a former Goldman Sachs executive as new CEO to funnel TARP bailout money through AIG into Goldman and other big financial firms.

    Did no one notice a pattern? Did no one see apparent violations of securities laws in these events, or apparent abuse of federal power in actions that pushed IndyMac into FDIC liquidation, Wachovia into acquisition by Wells Fargo, or Washington Mutual into J. P. Morgan Chase at fire-sale prices?
SEC Missing (Everything)
    Cuomo relates that Paulson admitted he did not keep SEC chairman Christopher Cox “in the loop” of his discussions with Lewis about the BAC merger with Merrill. This is unsurprising, since Cox publicly announced back in March, 2008, that he attended a meeting with Paulson and Bernanke regarding Bear Stearns, but would not do so again because he needed to remain objective as a securities regulator. Ideally, Cox’s statement might have meant he intended to enforce securities laws to protect shareholder rights, but in reality he simply got out of Paulson’s way.
    Cox did not have to be kept “in the loop” to know what Paulson was doing; the SEC has subpoena power and could question Paulson just as Cuomo did. But SEC commissioners and staff “stood down” and allowed Paulson his way, permitting the Wall Street titan latitude to ignore securities laws as no other Treasury secretary as no other cabinet official would be.
Robbing Investors vs. Saving the Nation
    Does anyone remain so naïve as to believe that a Treasury secretary fresh from Wall Street is entitled to a conclusive presumption of beneficial intent in all his actions dealing billions to friends and destruction to enemies? The same query applies to Timothy Geithner, Paulson’s sidekick in 2008 and presently his successor at Treasury.
    What kind of government second-guesses officials gathering intelligence from terrorists, but gives total license to revolving door financiers dealing with trillions of taxpayer dollars? New SEC chair Mary Schapiro announced investigations of several hundred hedge funds, but is likely to stay far away from the action of Wall Street’s power play in Washington, D.C. While this continues, U. S. financial markets will remain unhealthy as investors plead with Congress for reform. ~