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For Banks, It's Been 800 Days of Christmas

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Last week, JPMorgan Chase (NYSE: JPM  ) applied for a $1.4 billion tax refund -- and not because it overpaid. This is part of a little-known rule squeezed into last year's stimulus package.

See, Washington Mutual, which JPMorgan acquired in 2008, made money hand over fist for most of the last decade, lending money to anyone who smiled. Now that this harebrained experiment has failed (literally), WaMu is due a refund on some of the taxes it paid on those profits. Think of it as a reward for screwing up -- stimulus at its finest.

Other industries have exploited this rule, too. But when the story broke, you could almost hear a collective groan: Holy smokes, yet another gift from taxpayers to banks.

Frankly, I wasn't surprised. On top of the infamous TARP bailout and injections from the Federal Reserve, banks have enjoyed dozens of these seldom-noticed gifts since December 2007. That's why I call it 800 days of Christmas.

Here are four more.  

1. A conveniently timed short-selling ban
From Sept. 19, 2008 until Oct. 9, 2008, the SEC banned short selling financial stocks. Most at the time assumed this would have no long-term material impact. They were dead wrong.

No one wanted short sales banned more than Morgan Stanley (NYSE: MS  ) CEO John Mack. On Sept. 17, Mack sent his employees a memo that said, "We're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down." (Surely, it had nothing to do with the firm running out of cash.) Management, Mack wrote, was "taking every step possible to stop this irresponsible action in the market."

That involved pleading for mercy to SEC chairman Chris Cox, who quickly agreed to ban short sales. (Because nothing cures possible market manipulation like actual market manipulation.)

For Morgan Stanley, the timing couldn't have been better. On Sept. 29, the bank sold 21% of its common stock to Mitsubishi Financial for $9 billion. Without the short-selling ban, Morgan Stanley shares would have traded at a lower price, making the transaction more dilutive to existing shareholders, assuming it was doable at all.

Ditto for Goldman Sachs (NYSE: GS  ) . On Sept. 24, the bank sold $5 billion of equity to Berkshire Hathaway (NYSE: BKR-A  ) (NYSE: BRK-B  ) . The deal included $5 billion of warrants linked to Goldman's then-current common stock price, which was being held up by the short ban. That made raising capital far cheaper than it otherwise would have been.  

Within six weeks of the short ban's removal, Morgan Stanley and Goldman's shares plunged 37% and 54%, respectively, so it's hard to claim the ban wasn't a massive boon. Former Treasury Secretary Hank Paulson agrees, writing in his memoir: "We had to give the market a signal that Morgan Stanley and Goldman Sachs weren't going to fail. The SEC's short-selling ban had bought them a grace period." Lucky them.

2. Tweaks to mark-to-market accounting
In April 2009, the Financial Accounting Standards Board (FASB) relaxed mark-to-market accounting rules, making it easier for banks to value toxic assets however they'd like, rather than relying on market prices.  

Some say this was a good thing. The market was an irrational nutcase, they say, and forcing banks to use market prices bred unreasonable losses. There's some truth to this, but:

  • When market prices were irrationally high during the bubble years, no one complained. Instead, banks used absurdly high market prices to justify eight-figure paydays.
  • This wasn't the most honest of rule changes. Financial firms spent $27.6 million lobbying members of Congress to persuade FASB to act. Thanks to the change, Wells Fargo (NYSE: WFC  ) boosted Q1 2009 capital by $4.4 billion; Citigroup (NYSE: C  ) juiced earnings by $413 million. Not a bad return on investment.
  • We're now clearly past the days of irrational pessimism. So why haven't mark-to-market rules returned to their prior status? If the rules were altered to circumvent panic, and that panic has ended, why are we still here? (Hint: Read previous bullet point.)  

3. Fed buying mortgage-backed securities
In late 2008 and early 2009, the Fed announced plans to buy up $1.25 trillion worth of mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae (known as agency securities).

Banks are one of the largest owners of these securities. So when the Fed intentionally drove up prices, the banks enjoyed guaranteed write-ups. And thanks to interest-free loans from the Fed, banks could load up on these securities while the Fed was still buying, ensuring even more profits. As bank analyst Meredith Whitney put it: 

A lot of the banks got sort of back-door financing from the federal government by this massive agency trade, where they increased their holdings of government-backed securities … and made billions of dollars off of writing those securities up.

How much did banks make? It's hard to know. We do know that banks increased their holdings of Ginnie Mae securities nearly threefold between June 2008 and June 2009, from $41 billion to $114 billion. With the Fed telegraphing its intention to buy this stuff by the ton, you can hardly blame them.  

4. Term auction facility (TAF)
When banks get into trouble, they can tap the Fed's discount window for emergency funding. But banks hate doing this, because it broadcasts their vulnerability.

Easy fix: In December 2007, the Fed rebranded the discount window into an anonymous program called TAF, where banks could borrow away from prying eyes. The Fed is happy to admit as much, writing, "The TAF offers an anonymous source of term funds without the stigma attached to discount window borrowing." At least they're honest.

Nothing surprises me at this point. What do you think should happen to the banks? Let us know in the comment section below.

Check back every Tuesday and Friday for Morgan Housel's columns.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Berkshire Hathaway is a Motley Fool Inside Value pick, as well as a Motley Fool Stock Advisor recommendation. The Fool owns shares of Berkshire Hathaway, and has a disclosure policy.

Read/Post Comments (11) | Recommend This Article (20)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 30, 2010, at 4:34 PM, whereugoing wrote:

    Hey Morgan, who cares!! Your living in the past like some clown from the 60"s. Look forward brother!.

    Think positive worry wart or short seller whatever you are. Gte out from the dump. Prozac can help.

    One more for your pooint of view. BORING. 4 years of the same garbage, Get over it pal it's over!!!

  • Report this Comment On March 30, 2010, at 4:40 PM, cmfhousel wrote:

    Haha, I appreciate the "prozac can help" line. Made me laugh.

    I'm neither a short seller nor am I dwelling on the past. I just think that knowing what happened over the last two years is vital to analyzing the next 50. That's all.

  • Report this Comment On March 30, 2010, at 4:48 PM, MattZN wrote:

    I'm not entirely sure but this is very similar to tax credits Wells Fargo got from its purchase of Wachovia. Basically the government relaxed a rule which had prevented acquirers from being able to write down losses of acquired banking assets as a tax credit. It amounted to a $12-16B (Billion) tax credit for Wells and is one of the reasons why Wells and Citi fought so hard over the Wachovia purchase.

    The government relaxed this rule in order to give incentives to banks to buy other failing banks instead of forcing the FDIC to take on the burden. In this regards it has been a huge success. Consider for a moment what the direct cost to the FDIC would have been if it had been forced to take, say, Wachovia, under receivership? I'd guess the direct cost would have been somewhere north of $50B and it would have been a disaster for depositers in Wachovia who were past the FDIC limit.

    This rule relaxation is probably one of the only reasons why non-failing banks are willing to risk taking on the assets and deposits of failing banks. You don't have to like it, but just looking at one side of the story is a pretty stupid thing to do.


  • Report this Comment On March 30, 2010, at 4:51 PM, cmfhousel wrote:


    Thanks for your comment. The WaMu tax situation is different than the WFC/WB rule you're referring to. That was simply tax credits on future income. The WaMu deal is a straight up tax refund, and applies to many different industries, not just banks buying banks.

  • Report this Comment On March 30, 2010, at 5:40 PM, simonhs wrote:

    The US banking system should copy-paste the Canadian Banking System. All there is to it baby.

  • Report this Comment On March 31, 2010, at 4:46 AM, SPARTANBURG wrote:

    I don't really understand this love affair between government and banks. It seems the government thinks banks can tone the economy faster than industry. That may be true. But toning is much different than producing actual things (products or services). If the U.S. keeps marketing banking for speed and military for destruction than the end product will be a void.

    Thank goodness we still pay for gas with U.S. dollars instead of Euro or Yuan. That would really make our expenses go up. Now we only raise our inflation rate which is spread to all the nice people.

  • Report this Comment On March 31, 2010, at 9:17 AM, BMFPitt wrote:

    Spartanburg - Read any Congressthing's list of top donors and you'll amost certainly see a few banks on the list. Get it now?

  • Report this Comment On March 31, 2010, at 10:28 AM, Rehydrogenated wrote:

    That's a great start to a long list.

  • Report this Comment On March 31, 2010, at 10:48 AM, Bonsaiscrooge wrote:

    Once General, later President, Eisenhower warned people of the power of the "military-industrial complex". Today's "banking-governmental complex" is evidently much more powerful and detrimental, as it has been corroding the US democratic institutions to the core.

  • Report this Comment On March 31, 2010, at 1:36 PM, brickcityman wrote:

    Easy there Bonsaiscrooge... you are close to infringing on my patented description...

    The "Governancial-Industrial-Complex"...

    Here's the breakdown... The large banks and elements of the fed government are so close together they start to merge. None financial industries are still in the "in crowd" as well... About the only group not represented is the Middle and Lower class.

  • Report this Comment On March 31, 2010, at 2:43 PM, whereugoing wrote:

    I thought the Seinfeld reference " clown from the 60's" was funny too!. Thanks Morgan, The point is everybody is aware of the banks mismangement and what they received has been reported over and over.

    Let's move on and talk about the improving economy, strong bank balance sheets instead of re hashing the past. We get it!!

    What I would like to read is where are the banks going. What do they plan on doing when the economy improves and loan losses stablized? What about all that cash? Will they consider a share buy back program. What happens when they make a profit? Currently there is no dividend. Will they start to pay a dividend or will they use the profit to buy back shares? What they received was necessary to be in a position to move forward. If you dwell on the past, you miss tomorrow's opportunity.

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