Opening Bell: Justice Under Bush

‘A reflection of the environment of greed’; Will the Fed raise its debt?; To eat, or worry about the birds; etc.

The New York Times devotes its column one on A1 to a look at how the Justice Department has effectively gotten out of the corporate-prosecution game, relying instead on something called “deferred prosecutions” to slap the wrists of wrongdoers.

In a major shift of policy, the Justice Department, once known for taking down giant corporations, including the accounting firm Arthur Andersen, has put off prosecuting more than 50 companies suspected of wrongdoing over the last three years.

Instead, many companies, from boutique outfits to immense corporations like American Express, have avoided the cost and stigma of defending themselves against criminal charges with a so-called deferred prosecution agreement, which allows the government to collect fines and appoint an outside monitor to impose internal reforms without going through a trial. In many cases, the name of the monitor and the details of the agreement are kept secret.

Deferred prosecutions have become a favorite tool of the Bush administration (former AG John Ashcroft’s firm has gotten more than $50 million to be an outside corporate cop for one company). But some legal experts now wonder if the policy shift has led companies, in particular financial institutions now under investigation for their roles in the subprime mortgage debacle, to test the limits of corporate anti-fraud laws.

Defenders of deferred prosecutions say they minimize the “collateral damage” that would result from convicting an entire company, as happened when it indicted accounting rogue Arthur Andersen for its crimes on behalf of Enron and 28,000 people lost their jobs.

The Times says most of the agreements end with charges dismissed within three years. It reports speculation about how Justice might apply them to “investigations against financial companies in the mortgage lending scandal,” and quotes Neil Power, the head of the FBI’s economics-crime unit sounding like a bug-eyed lefty raging at the corporate machine. This is a high-ranking Bush administration official, mind you, and thus gets our Mr. Power, Prepare Your Resume Quote of the Day:

Mr. Power said the investigations were a reflection of the “environment of greed” that allowed companies to package mortgages into securities they sold to investors without sufficient documentation of the borrower’s ability to repay. One line of criminal inquiry focuses on whether bond companies gave accurate information to investors.

“What we’re looking at,” he said, “is the fact that they may be performing accounting fraud.”

Small-biz SOS

In economic news, an index of small-business sentiment plunged to its lowest level twenty-eight years. The WSJ puts the news on A6 and third in its A1 Business & Finance column, and Bloomberg says “companies are cutting back as sales and profits deteriorate, signaling the economic slump may worsen” and that “the slowdown may not help alleviate inflation as more respondents planned to boost prices to cover rising costs.”

USA Today:

Many small firms reported getting hurt by weaker sales, inflation and higher energy costs. Small businesses that reported weaker earnings outnumbered those with earnings gains by 33%. The survey found “no evidence” of NFIB members ailing from credit and cash-flow problems arising from the housing slump and tighter bank lending. “It is a Wall Street issue,” the survey states.

Pending home sales dropped twenty-one percent in February from a year ago and 1.9 percent from the month before, surprising economists who had predicted a small rebound.

A federal energy agency sharply raised its estimate for the average price of oil this year to $101 a barrel from $84 three months ago. The WSJ says the agency is “usually a price bear.”

Can the Fed go broke?

What if the Federal Reserve runs out of money? That’s what officials are now making contingency plans for in case the credit crisis fails to let up in the next few months, The Wall Street Journal reports in an A3 scoop.

The Fed has lent so much cash to banks and investment banks—about $300 billion of its $790 billion in Treasury bills and bonds—that Wall Street fears the central bank may hit a wall soon, as the values of junk assets it’s accepting as collateral continue to decline.

The Journal notes that the Fed can always effectively print its own money, but that would plunge the federal-funds rate, something it would “contemplate… only in dire circumstances. The Bank of Japan took this step this decade after years of economic stagnation.”

One way the Fed is planning to get around that is by having Treasury issue more debt than it needs to fund the government and deposit that with the Fed. Or the Fed might raise its own debt for the first time ever.

A subprime lawsuit

The Journal takes a front-page look at one of the earliest subprime lenders to fail and how depositors who lost just about everything are now suing the investment banks who packaged its loans.

The bank, American Business Financial Services,

funded its operation partly by selling notes directly to the public, pitching them in newspaper ads and mass mailings that promised high interest rates. When it went under, these notes, which carried no collateral and weren’t insured, became worthless.

Now a bankruptcy trustee is trying to recover money from the investment banks that turned the lender’s loans into securities. His claim: They helped keep the lender alive—and paying them fees—by enabling it to overstate the value of assets on its books.

The list of defendants includes Bear Stearns and Morgan Stanley. The WSJ says the plaintiffs claim that Wall Street knew it was underwriting the securities incorrectly, implying that the bank would earn more money than the Street knew it would.

Crops v. conservation

The NYT has a good page-one story that says the commodities boom, which has seen soaring prices for everything from wheat, corn, oil, and more, is hurting a twenty-three-year-old conservation program that pays farmers not to farm land, preserving it for wildlife habitats. It notes about 8 percent of all cropland is in the Conservation Reserve Program.

The Times quotes a Baltimore banker, who says he yelled at the Agriculture Secretary last month in a meeting: ““We’re in a crisis here. Do we want to eat, or do we want to worry about the birds?”

The program has had a number of positive effects, especially for hunters and environmentalists—the Times says the duck population, for instance, rose by two million quackers. But the government paid out $1.8 billion last year to keep an area bigger than New York State (37 million acres) uncultivated.

Farmers sign long-term contracts to conserve their land, and some are rumbling to get out.

“Another nine months of wheat at today’s prices and there will be political pressure on this program like you wouldn’t believe,” (a Minnesota farmer) said.

That pressure is exactly what the bakers and their allies are aiming for, saying the Conservation Reserve costs taxpayers and hurts consumers.

“This program is taking money out of your pocket twice a day,” said Jay Truitt, vice president for government affairs for the National Cattlemen’s Beef Association. “Do you think it’s right for you to pay so there’s more quail in Kansas?”

A roof over their head

The Bush administration is gearing up to expand a federal program called FHASecure to help 100,000 struggling homeowners stay in their houses, the WSJ scoops on A1. In exchange for lenders writing down their loans, the government would take on the risk of borrowers’ defaulting on them. The paper says the Democrats will likely oppose the move as not going far enough.

The WSJ says the administration plan would be paid for by Federal Housing Administration mortgage insurance instead of taxpayer funds, where the Dems plan would cost between $10 billion and $20 billion initially. The story doesn’t say where that FHA money comes from. It would seem it didn’t just magically appear, and so would have gone into the Treasury at some point, making the Bush plan also a use of taxpayer money, but we can’t tell from this story.

The administration plan could help many Republicans who are nervous about appearing unresponsive to the housing crisis, but are nonetheless uncertain about embracing a deeper and more costly role for government, especially if they’re seen to aid investors, speculators and reckless borrowers. The White House hopes it will encourage wavering Republicans to head off more ambitious Democratic legislation designed to help one million homeowners…

Since its creation, FHASecure has faced steady criticism from lenders and Democrats, who contend it has helped less than 3,000 delinquent borrowers. They say the majority of homeowners in the program would have qualified for government insurance even in good times. HUD says the program has been a success because it has helped homeowners before they became delinquent.

Bankers have also complained that it’s too difficult for needy homeowners to qualify. Under current standards, borrowers must have made six consecutive monthly payments and any default must have been caused by a resetting adjustable-rate mortgage.

FHA in the red

We’re not sure how this affects the above-mentioned FHA program, but the Times says on C1 that the agency is running a deficit that could hamper its efforts to help homeowners and force taxpayers to subsidize it for the first time. It says the shortfall is the first in the agency’s seventy-four years and is a result of shortfalls in the “seller-financed down payment loan program,” which is being hit by high delinquencies and foreclosures.

Under the program, a home seller arranges to cover the buyer’s down payment — using financial help from a nonprofit company—but typically adds that sum or more to the total cost of the house. The arrangement has been particularly attractive to financially struggling buyers and to owners in depressed housing markets, according to Congressional officials.

In 2000, such mortgages made up less than 2 percent of F.H.A.-insured loans, officials say. By 2007, statistics show, they accounted for 35 percent of F.H.A. loans.

Housing officials say these mortgages have foreclosure rates two to three times those of others, leaving the agency reeling from the losses.

Widespread panic

The Financial Times and others report that the International Monetary Fund predicts losses of about $945 billion from the credit meltdown, and says the “systemic” risks—read, massive financial panic— are still high despite the Fed’s activism.

The estimate is set out in a gloomy Global Financial Stability Report, which challenges the more optimistic tone in the markets since the rescue of Bear Stearns by the Federal Reserve and JP Morgan Chase. The report says “systemic risks have risen sharply” since October.

Mr Caruana, a former governor of the Bank of Spain, told reporters that the Bear rescue “helped to reduce the possibility of a tail event in the financial system”—in other words, it made a truly catastrophic outcome less likely.

But he said “funding strains remain high and balance sheet pressures on financial institutions continue.” Mr Caruana said there had been a “collective failure to appreciate the extent of leverage in the financial system” and that balance sheet strains could limit banks’ capacity to lend.

The WSJ notes the IMF number in the middle of its A10 story on the Group of Seven countries coming together to endorse initiatives that would make the financial markets “less secretive and better supervised.”

Boat missed

The NYT’s David Leonhardt notes that most people didn’t participate in the boom of the last several years.

The bigger problem is that the now-finished boom was, for most Americans, nothing of the sort. In 2000, at the end of the previous economic expansion, the median American family made about $61,000, according to the Census Bureau’s inflation-adjusted numbers. In 2007, in what looks to have been the final year of the most recent expansion, the median family, amazingly, seems to have made less—about $60,500.

This has never happened before, at least not for as long as the government has been keeping records. In every other expansion since World War II, the buying power of most American families grew while the economy did. You can think of this as the most basic test of an economy’s health: does it produce ever-rising living standards for its citizens?

The columnist advocates some old-fashioned government investments in research and infrastructure to turn that nasty trend around, and notes without advocating higher taxes that rich folks have been getting the biggest tax cuts at the same time they’re making a higher percentage of the money.

Quick hits

The FDA says the number of deaths from Chinese-tainted blood-thinner heparin, is more than triple what it previously estimated, the WSJ reports.

The WSJ reports on B4 on the proliferation of two-tier wage systems at American factories, and not just carmakers, as unions try to preserve existing employees’ compensation levels. It says Goodyear’s new contract allows it to pay new workers $13 an hour with fewer benefits for the first three years—and prevent higher pay packages even as those workers become long-time employees.

File under Good Timing: Private-equity firm Apollo Management is going for a $418 million IPO, the WSJ says on C1.

The latest move nonetheless comes at an awkward time for their breed of money-management firms. Private-equity shops like Apollo were able to feast on easily available debt to fund a spate of huge corporate buyouts over the past three years. But many of those deals are already in trouble, such as Apollo’s own $1.3 billion purchase of retailer Linens ‘n Things and an ill-fated $6.65 billion purchase of real-estate firm Realogy Corp.

Citigroup is about to dump $12 billion of leverage loans and bonds at a big loss to a group of private-equity firms, the papers report. The group would buy the loans at about ninety cents on the dollar, the FT says, while the NYT says it would be in the mid-eighty-cent range.

The papers say it’s a bid to reduce the troubled bank’s swollen balance sheet of iffy loans, and the WSJ calls it the biggest sale of such loans in “recent memory” and a sign “that this corner of the credit markets is thawing, albeit it at a bargain-basement price.”

Morgan Stanley CEO John Mack is calling the end of the financial crisis, saying we’re in the “top of the ninth inning,” which the FT helpfully notes is the “last part of a baseball game.”

The chairman and chief executive of Morgan Stanley said the investment bank would consider buying portfolios of leveraged loans and mortgage assets as their prices and potential returns were becoming attractive.

The Los Angeles Times says unemployment-benefits phone lines are so swamped that sixty-two percent of calls in January and thirty-three percent in February weren’t getting through.

The outlook could get worse. Last week the number of unemployment claims jumped 21% to 40,000, compared with the same week in 2007, and the state’s unemployment rate rose to 5.7% in February from 5% a year earlier. On Friday the U.S. Labor Department reported that 80,000 nonfarm jobs were lost in March, the biggest decline in five years.

Former Fed Chairman Paul Volcker slapped at current Fed chief Bernanke for “toeing ‘the very edge’ of the bank’s legal authority” in bailing out Bear Stearns, the NYT says. Such drama out of the Fed boys these days.

There’s only one way to solve this: Cage match! I’d pay $49.95 on Pay-Per-View to see that.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.