Creating Jobs in USA

September 2, 2010

Sankarshan Acharya
Pro-Prosperity.Com and Citizens for Development

September 2, 2010

To:       Honorable President Barack Obama

Cc:       Honorable House Speaker Nancy Pelosi

Honorable Senators Harry Reid and Richard J. Durbin

Honorable Chairman, House Oversight and Government Affairs Committee

Honorable Chairman, Financial Crisis Enquiry Commission

Sub:     FCIC Hearings: Why Lehman Brothers was not rescued? The Answer Offers the Idea for Creating Massive Employment Once Again.

Dear President Obama,

As the biggest financial institutions tottered in 2008, did the regulators have an overriding common principle, maybe tacit, to pick the ones that deserved to survive to absorb the others? 

The Financial Crisis Inquiry Commission posed this profound question, yesterday, to the prominent witnesses from J.P. Morgan & Chase, Lehman Brothers, Federal Reserve Bank of New York, and Law Firms. 

The FCIC could not arrive at a common principle that underlay the regulatory rescue effort in 2008. 

Here is a rational inference about the common principle behind the regulatory choice, and a method of further testing the hypothesis using confidential trading data that can be subpoenaed from market making financial institutions and the market Clearing House:  The institutions picked as the saviors like JPMC and Goldman Sachs were prominently present in the advisory boards of the regulatory agencies (FDIC, FRB-NY and BOG-FRS, and Treasury) and held enormously large net short interests in the very securities that were held long by the other financial institutions that were sacrificed (Lehman Brothers, AIG, Fannie Mae, Freddie Mac, Washington Mutual, Lehman Brothers, Wachovia and Merrill Lynch). 

Lehman, Merrill, Bear Stearns, and Washington Mutual had accumulated large portfolios of mortgage loans and mortgage backed securities by borrowing, notably, from Bank of America, Citigroup and JPMC.  The borrowers had submitted collaterals and so had collateralized debt obligations (CDOs) with their lenders.  The lenders had short-sold the same mortgage backed securities that the borrowers were holding to lower the marked-to-market equity values of the borrowers.  The lenders could then issue margin calls like JPMC acknowledged yesterday that it did to Lehman Brothers which collapsed as a result. 

Whether or not JPMC tacitly influenced the FRB-NY’s decision to not rescue Lehman Brothers can be tested by looking at JPMC’s short interests on Lehman securities including common stock.  Similarly, whether Washington Mutual and Bear Stearns collapsed because of the vested short interests of the lending institutions can be tested with the private trading data.      

The private trading books of the large financial institutions may not tell the whole truth.  It is because such an institution can sell securities short through a wholly owned, leveraged subsidiary and then shut down the subsidiary through a prearranged bankruptcy with the lender-parent, thus wiping out the short positions.  The Clearing House should, however, have all the data including the details of the extinguished subsidiaries.  This is the valuable information that can be used to establish a profound truth that the FCIC is seeking about whether the savior banks named so by the regulators during the Great Recession did indeed have vested short interests in the securities held or issued by the others that were sacrificed or simply usurped through FDIC. 

In the case of Washington Mutual, the total shares held by investors soon after its seizure by the FDIC was one billion more than the number of shares issued by the company.  In the case of Freddie and Fannie, I saw the shares held were 20% higher than the outstanding. 

If a large financial institution can create billions of shares of a highly solvent rival bank and sell the virtually created shares in the open market and at the same time tacitly advice the FRB-NY to not rescue the rival by rigging a liquidity crisis, then this will be an unconstitutional usurpation with the government support of hard earned capital of persevering households who have invested in the failing bank.   Whether or not such things happened should be rigorously tested with trading data obtained from the market Clearing House. 

Fannie and Freddie could not be literally sacrificed due to the Chinese threat at the time.  But they were depressed to the ground through conservatorship and a lethal funding of preferred stock at 10% annual dividend.  The Federal Reserve could have lent this money to Fannie and Freddie at the same rate of .125% as it does to banks.  But the regulators have made a convoluted arrangement to wipe out the profits of Fannie and Freddie: let the government borrow money from banks at 4% while the Fed creates the same funds for banks at 0.125%.    Fannie and Freddie were taken to conservatorship after they were forced to buy about $400 billion of toxic bank assets.  Whether or not the bank “advisors” tacitly nudged the regulators to ensure that Fannie and Freddie never show any profits can be tested if the same advisors or their affiliate subsidiaries were short in securities issued by these two institutions.

Finding the truth will help develop the single most job-creating bill: close the FDIC and provide Safe Banking.

After listening to the testimonies before the FCIC from the FDIC and other regulatory agencies today, it is very obvious that the primary goal of the FDIC is to minimize the cost to the Deposit Insurance Fund (DIF)

So, what is the best policy for the FDIC to achieve its goal of minimizing the cost to the DIF?  The answer is to pick one bank and to let it acquire the rest of the banks.  The DIF will then have no cost as long as the single existing gigantic bank remains solvent.  The FDIC goal will then lead to a recommendation to the Congress to close this gigantic bank while it remains solvent! 

The FDIC goal is thus very weird.  It simply ignores the antitrust laws, the panic it spreads, and the systemic risk it creates while unconstitutionally usurping (indeed destroying) the hard-earned private capital invested in the closed rival banks. 

Indeed, the FDIC goal since its existence has led to fewer banks that are growing larger over time with arranged acquisitions of rival banks (big and small).  Extrapolating this current reality into the future should show that the U.S. will ultimately have one gigantic bank after it takes over the rest.    

The Congress cannot obviously follow the FDIC advice to close the last remaining largest bank, simply to reduce the cost to the DIF.  The Congress will rather follow the anti-trust laws to break the largest remaining bank, and even contemplate closing the FDIC that has pursued for an unsustainable goal leading to a nightmarish predicament. 

Given the above potential reality in the future, what is optimal policy for the Congress now?  The answer is to close the FDIC now and to provide Safe Banking to investors at the lowest possible cost to taxpayers and highest possible growth in capital as well as economic growth. 

Closing the FDIC now will obviate the ongoing unconstitutional usurpation of the hard-earned private capital invested in banks being closed by the FDIC to accomplish its unsustainable goal.  Closing the FDIC now will also prevent formation of one unwanted gigantic bank with no competition.  

The above argument should make it clear that the FDIC goal is the source of unconstitutional usurpation (destruction) of hard earned private capital, cause of investor panics and systemic risk leading to flow of funds to government bonds and decimation of investments in the risky real projects that generate employment.

So the single most compelling job-creating bill feasible now is to have Safe Banking without Federal deposit insurance.  This bill that should be enacted urgently to rejuvenate the trust in U.S. banking and finance that had once made the nation the most favored destination of private capital for economic growth and prosperity.   

               

With profound regards,

Sankarshan Acharya