The AIG fiasco was just a warm-up. Turbo Timmy’s latest coup could wind up costing taxpayers trillions – and the country hardly noticed.

Back in April 2009, yours truly wrote a piece titled “The AIG Connection – Far Worse Than You Think”.

In that missive, it was clarified how the Fed and Treasury used AIG as a “beard”... a sort of false-front money conduit through which to funnel cash to other players on Wall Street. Here is the gist:

As soon as the government stepped in to bail out AIG lock, stock and barrel, the AIG execs stopped caring about profitability. The game of being a viable business was toast, and the taxpayer was on the hook for everything. So it looks like AIG’s traders were ordered to unwind many of their mind-bendingly complex deals at firesale prices that were massively favorable to the parties on the other side of the trades.

Now, if you’re a muckety-muck high up in the Treasury Department, think how efficient this setup is.

What you really want to do is write big fat taxpayer-funded checks for all your buddies. Billions for Goldman, billions for Morgan Stanley, heck, billions for those European guys who are always so nice when you hop across the pond... billions for everyone.

The trouble is, writing all those checks would be a public relations disaster. People would be furious. Congress would go crazy. More than likely they’d give you major grief and try to block your efforts, just like they did with the multiple tries it took to pass the original TARP plan.

So writing many checks is a political no-go... but what if you could just focus your bailout efforts on ONE player? What if you could shovel hundreds of billions into one overly complex black hole... and then let all that money trickle out to your friends via the back door?

At the time, some considered this an overly cynical analysis. But now, lo and behold, fresh evidence has come to light...

In late 2008, the regulator in charge of the AIG bait-and-switch was the  Federal Reserve Bank of New York. And the head of the Federal Reserve Bank of New York at the time? None other than Tim Geithner, aka “Turbo Timmy,” the current Treasury Secretary.

Under the Federal Reserve Bank of New York’s direction – and thus Geithner’s – AIG was ordered to pay out, at 100 cents on the dollar, on $62.1 billion worth of credit-default swaps. And then the Federal Reserve Bank of New York did something even more extraordinary. It told AIG to shut up about it.

AIG was a financial carcass at the time... the equivalent of a busted out casino. Why did they have to honor their bets at 100 cents on the dollar, with taxpayer-supplied cash no less? Because the Federal Reserve Bank of New York, under Geithner, told them to.

The government rescued AIG for fear of what might happen to the global financial system in the event of another Lehman-sized shock. This course of action, if questionable, is at least logically defensible.

But why demand that AIG, essentially defunct, pay off a bunch of gamblers in full? (Bloomberg reports that the NY Fed “ordered” AIG not to negotiate.) And why did Geithner demand secrecy?

A series of e-mails between AIG and the New York Fed have proven to be the smoking gun. As Bloomberg reports, “The email exchanges... show that the regulator pressed the company to keep details out of the public eye.”

California Rep. Darrell Issa, ranking member of the House Oversight and Government Reform Committee, further notes that “It appears that the New York Fed deliberately pressured AIG to restrict and delay the disclosure of important information.”

It's just like we thought: They were handing out back-door bailout checks and didn’t want anyone to know.

Don’t Blame Timmy – He Was Powdering His Nose

The “spin” coming out of the White House on this is pure comedy gold. Treasury flaks have tried to argue that, even though Geithner was head of the New York Fed at the time of the AIG con job, he was “recused from working on issues involving specific companies, including AIG.” This thoughtful recusal came “in anticipation of his nomination” as Treasury Secretary.

So we are supposed to swallow the notion that near the height of the global financial meltdown... at the white-hot center of an issue involving hundreds of billions of dollars in taxpayer funds... resulting in a strong-arm decision of highly dubious (if not criminal) intent on the part of the Federal Reserve Bank of New York... the guy in charge (Geithner) was off powdering his nose?

This is the classic “I’m not a criminal, I’m just criminally stupid” defense. And you and I would be stupid to buy a word of it.

We Ain’t Seen NOTHIN’ Yet

The AIG debacle, together with the uncovered e-mails, shows Washington’s thought process laid bare. When it comes to bailing out connected Wall Street players, the government’s preference is to treat taxpayers like mushrooms: “Smother 'em with B.S. and keep 'em in the dark.”

But you know what? We ain’t seen nothin’ yet.

On Christmas Eve – Dec. 24, 2009, a date selected for maximum stealth – Turbo Timmy unveiled plans for perhaps the grandest taxpayer rip-off of all: An unlimited bailout of Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac, as you probably know, are two “quasi-government entities” that sit at the heart of the great housing debacle. These twin monoliths long enjoyed private corporation status even as they reaped the benefits of an implicit government guarantee. The result has been the absolute worst of both worlds.

Between mom-and-apple-pie loving politicians, reams of feel-good housing propaganda, and one of the most ruthless lobbying machines in Washington, Fannie and Freddie mutated themselves into out-of-control juggernauts. For years they just grew and grew, like radioactive monsters from a B-grade Japanese horror movie, until finally growing big enough (and unwieldy enough) to devastate the nation.

As former general counsel to the Treasury Peter Wallison has observed, “It turns out it was impossible to regulate [Fannie and Freddie]... they were too powerful.” (That’s what happens when you combine crony capitalism, political demagoguery and Wall Street cheerleading on an epic scale.)

But back to Christmas Eve...

To Infinity and Beyond!

Prior to the Treasury’s stealth maneuver on Dec. 24, a limit had been imposed on the total amount of bailout funds available for Fannie Mae and Freddie Mac. That limit was initially $200 billion each, or $400 billion in total – no small sum.

On Christmas Eve Treasury said it was lifting the caps – stating willingness to provide an unlimited amount of funds – in order to “leave no uncertainty about the Treasury’s commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.”

This is a major milestone. Until now, the government’s purse strings were held by Congress. We may have been spending money like drunken sailors before, but at least Congress – and, by extension, the elected representatives that you and I send to Washington – had to approve it.

No longer. Now Turbo Timmy can write checks as big as he wants – for apparently infinite amounts – without the prior approval of Congress. Remember the old battle cry, “No taxation without representation?” Well, forget the King of England. Turbo Timmy is the new Bailout King... and we taxpayers get to bow down.

Huge Losses Coming

Here is another interesting question. Why did Treasury do it? After all, by some measures a $400 billion ceiling ($200 billion each) seemed plenty high in terms of bailout funds being funneled towards Fan and Fred. Why raise that ceiling to infinity (i.e. unlimited funds)?

After all, the housing market is now recovering... isn’t it? Things are supposed to be getting better now... aren’t they? By official estimates, Fan and Fred have only required $51 billion and $60 billion, respectively, in rescue funds thus far. Those amounts are well below the $200-billion-per ceiling that was already in place. What gives?

The only logical reason for Treasury to do this – to raise the cap on Fan and Fred assistance – is if it expects huge additional waves of losses to come rolling down the pike. Having taken less than $120 billion in combined funds thus far, Treasury clearly expects Fannie and Freddie to swallow up MORE than $400 billion over time... maybe a LOT more.

Does this make any sense to you? Things are supposed to be improving! Wall Street says so! Why would the loss exposures on these government-run giants be expected to triple... or quadruple... or worse?

The Government’s Enron

Here is what your humble editor believes. The AIG bait-and-switch worked so well, the government is now planning to use it on the entire U.S. housing market. Fannie and Freddie have become the new go-to conduit for unlimited misappropriation of taxpayer funds.

Recall the basic idea behind the AIG scam. The government appears to bail out one entity in order to “save the system,” but in reality uses the carcass of that entity as a “beard” to funnel cash to connected players on Wall Street.

In this new, unlimited scam, the government is preparing to use Fannie and Freddie as off-balance-sheet entities in order to continue propping up the U.S. housing market... to the tune of trillions if need be.

Remember the Enron fiasco? Remember all those off-balance-sheet entities with crazy Star-Wars-themed names like “Death Star” and “Chewco” that Enron used to hide losses and bolster fake profits? Enron died, but the trickery lived on. The megabanks later got into the same act with SPVs (“special purpose vehicles”), SIVs (“special investment structures”), and even super-SIVs (don’t ask).

What you need to know about off-balance-sheet entities is this: It’s criminal accounting, plain and simple. A balance sheet is a balance sheet. A liability is a liability. You can’t change that fact, but you can hide it. You can use deception and trickery to fool gullible investors.

Use of these entities has worked well for the too-big-to-fail megabanks – who are more powerful than ever now, after all! – and the government is making the same play with Fannie and Freddie.

Just as with an off-balance-sheet entity, the government is not forced to fiscally recognize the trillions of dollars in mortgage liabilities taken on by the twin behemoths... and now, thanks to Turbo Timmy’s Christmas Eve coup, the government has the ability to pump unlimited funds into the housing market, via Fan and Fred, with no concern for congressional approval whatsoever.

Cheers on Wall Street

Would you be surprised to hear Wall Street is very happy about this news – overjoyed, even, by the developments as outlined above?

Thanks to the sleight-of-hand at Treasury, plus the Fed’s renewed commitment to do nothing (or at least very little) in the face of rampant speculation and looming inflation, investors are cheering. The action in the Dow Jones U.S. Construction Index captures the mood – pure euphoria.

Some insist the jubilant mood is due to true expectations of economic recovery. Your humble editor begs to differ. At this point, Wall Street is not celebrating the triumph of “green shoots,” but instead the triumph of gaming the system.

As recent data show, the realistic outlook for housing, jobs and the U.S. economy remains bleak. Evidence still abounds that we are coming off a stimulus “sugar high” (as Mohamed El Erian of Pimco has dubbed it) and not a whole lot more. John Hussman further spells out what is likely to be the result of the Fannie and Freddie bail-out coup:

This policy [of unlimited assistance] is likely to lead to far more delinquencies. Whether it will lead to far more foreclosures depends on the nations' capacity and willingness to shoulder multiple insolvencies in order to protect bondholders, mortgage our national wealth to China and other large purchasers of U.S. Treasuries, or alternatively, massively inflate away the dollar value of the underlying loans. The much-vaunted TARP money that has “profitably” come back to the Treasury is a tiny sliver of what has been committed to defend the private bondholders of financial institutions from losses. Either the debt we create to save these bondholders will stand as a claim on our future national production and a diversion of our ability to spend public resources for the benefit of the public, or we must inflate it away. There is no third option. This does not deserve legislative discussion?

Banana Republic, Here We Come

No, the reason to be excited now – if one is able to ride the paper gravy train, that is – is because the backroom deal makers have won. They have shown, with little room for doubt, that the government can and will do what it takes to rescue Wall Streeters at all costs... even if it means sacrificing the health of the real economy in true banana republic fashion.

And so why worry? Why worry if a tidal wave of “Alt-A” mortgage resets is coming? Why worry that current policies continue to starve the real economy of credit and jobs, while at the same time encouraging banks to hold back on loans and ramp up their trading desk activity?

There is no reason to worry, you see, because Washington has finally proven adept at taking care of its own. It no longer matters if the real economy goes to hell, because the Fed and Treasury’s access to funds is unlimited now! No matter what, planet paper will be first and foremost... no matter what, planet paper will be saved.

We have learned all the wrong lessons in spades. “Too big to fail” has worked... the culprits of the last crisis are now as big and bold as ever (on the risk-taking side if not the lending side)... bad policies (in regard to propping up the U.S. housing market) now have blank-check support... and we as taxpayers have handed over our fiscal birthright to Turbo Timmy for a mess of pottage without even knowing it.

One can almost forgive the crooked denizens of Washington and Wall Street for rubbing their hands together with glee. If American citizens are willing to tolerate this, perhaps they are willing tolerate anything. If the taxpayer, the hard worker, the honest saver, has not grown furious by now, perhaps he never will.

Agree? Disagree? Speak now or hold your peace: justice@taipandaily.com.

Other Related Topics: AIG , Bank Bailout , Justice Litle , Macro Trader

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