Paulson’s remark came in response to Lewis’ request for a letter from Fed Chairman Ben Bernanke, acknowledging the government’s insistence that Bank of America acquire Merrill Lynch, despite the brokerage firm’s mounting mega-billion-dollar losses.

This one little phrase probably tells you everything you need to know about Henry Paulson, the man who put the “secret” in Secretary. And this one little phrase certainly tells you everything you need to know about the structure and actual objectives of the bailout campaigns Paulson orchestrated.

Specifically, the Paulson bailouts sought to divert hundreds of billions of taxpayer dollars toward Wall Street finance companies, and to do so as secretly as possible. In the name of “systemic risk,” the former Treasury Secretary dispensed hundreds of billions of dollars to the likes of AIG, Citigroup, and his former employer, Goldman Sachs, without ever seeking or receiving a single vote from an elected official. Thus, as it turns out, the only system genuinely at risk during Paulson’s tenure was the American system of honest and transparent financial markets.

The initial bailout facilities were created and implemented by Paulson and Bernanke, two unelected officials. And none of the initial bailout schemes ever faced scrutiny from elected officials, much less a formal vote. Even though some of the subsequent bailout programs, like the TARP, did face a vote in Congress, the Treasury Secretary continued to champion numerous ex-legislative activities, like the backdoor bailout of Goldman Sachs through the $170 billion bailout of AIG, and the shotgun takeover of Merrill Lynch by Bank of America.

According to the February 26th testimony of Bank of America CEO, Ken Lewis, before New York State Attorney General, Andrew Cuomo, Paulson strong-armed Lewis into completing the Merrill takeover, without disclosing to B of A shareholders that Merrill’s losses were much larger than publicly disclosed.

“Lewis testified that he asked Federal Reserve Chairman Ben S. Bernanke to ‘put something in writing’ regarding the US government’s plan to support pack of America’s acquisition in view of Merrill’s mounting losses,” Bloomberg news reported yesterday. “After Bernanke said he would consider the idea, Paulson called Lewis and said, according to Lewis, ‘First, it would be so watered down, it wouldn’t be as strong as what we were going to say to you verbally, and secondly, this would be a disclosable event and we do not want a disclosable event.”

Inconveniently, non-disclosable events are also illegal events. “Paulson kept the Securities and Exchange Commission, which is responsible for making sure companies disclose material information to their investors, in the dark, according to Cuomo,” Bloomberg news continued. “The allegations [by Cuomo] suggest Paulson and other policymakers may have resorted to breaking securities laws in order to protect a fragile financial system…”

Do the ends justify the means? Yes, if you’re a muckety-muck at Merrill Lynch or Goldman Sachs. No, if you’re anybody else. Paulson’s groundbreaking lawbreaking facilitated the survival of institutions that deserved death, in the process amassing trillions of dollars of fresh liabilities for American taxpayers who deserved to be left alone.

The adverse effects of these criminal acts extend far beyond annoying your California editor. For one thing, bailing out incompetent executives enables the incompetent executives to continue their incompetent behavior. For another thing, lavishing hundreds of billions of dollars upon ailing, functionally bankrupt companies, promotes a web of deception and illusion that impedes the healing process that would lead to a bona fide recovery.

If you hand $10 billion to any bankrupt company in America, that company will seem healthy for a while. The truth of the matter is that the Paulson bailouts, along with subsequent multi-trillion initiatives, have injected various finance companies with short-term stimulants that produce an image of health, while leaving the underlying disease untreated.

The resulting fraud is that diseased corporate entities appear to be recovering. They can pretend they are A-OK once again, while the top brass at these companies can pretend they no longer require government assistance – certainly not any of that dreaded TARP money that imposes limits on obscene executive compensation.

Eventually, as a result of all these falsehoods, investors begin to imagine that they actually see what the finance companies’ CEOs pretend to see. And before you know it, you’ve got a great big rally in bank stocks, fueled by nothing more than deception, hype and hope.

Is your California editor being too hard on the Wall Street boys and girls? He thinks not…and neither does his colleague at the Australia Daily Reckoning, Dan Denning:

“So the banks have returned to profitability have they? If that were true, bank balance sheets would also be recovering. But that’s not true.

“The big three banks reporting recently – Citibank, Goldman Sachs, and JP Morgan – all reported huge revenues from their trading desks. As we reported last week, Goldman’s $6.6 billion in trading revenues was not only 70% of total revenues, but it was also a ten billion dollar improvement on a $4 billion loss in the fourth quarter.

“JP Morgan reported nearly $5 billion in revenues from trading fixed-income securities. And Citigroup reported $4.69 billion in fixed-income trading. In fact, all of Citigroup’s other major operating segments reported declining revenues for the quarter. Its global credit card revenues fell by 10%. Consumer banking revenues were down 18%. And Citi’s Global Wealth Management revenues were down 20%.

“But something magical happened in the fixed-income trading group for Citi. If you dig into the quarterly report, you’ll learn that fixed-income trading revenues were boosted by a net $2.5 billion positive CVA on derivative positions, excluding monoclines, mainly due to the widening of Citi’s CDS spread.

“That takes some sorting out. A CVA is a ‘credit value adjustment.’ As you can learn here, it’s the credit risk premium of a derivative contract. Once you sort it out, you learn that Citi ‘made’ $2.5 billion on a derivatives position designed to profit when the companies own credit default swaps spreads widen.

“Or, in plain English, Citi profited because it made a bet that the cost of insuring itself against a default would go up. The credit default swap market is the place where you can bet on the credit worthiness of a firm, or, essentially, the chance that a firm might default on its bonds. Citi appears to have reported a $2.5 billion trading gain in the fourth quarter precisely because the market thought the company stood a good chance of failing (hence the widening CDS spread).

“As far as we can tell, if you use this kind of perverted logic, the closer Citi gets to bankruptcy, the more money it would ‘make’ on its derivatives. That shows you how bogus the quarterly number was. The company reported declining revenues in its core banking and lending activities. But thanks to fixed income and this handy $2.5 billion CVA, the company was able to report $1.5 billion in net income.

“Also, don’t forget that all of the banks benefitted from what financial sector analyst Meredith Whitney called back door financing.” Whitney described what amounts to Fed-sanctioned front-running of the fixed income market by the banks. The Fed publicly telegraphed its intention to buy $750 billion mortgage-backed securities from Fannie Mae and Freddie Mac and $300 billion in U.S. Treasury bonds. And that was AFTER it announced in late November of last year it would be wading in as a buyer for all agency bonds to support the U.S. mortgage market. In other words, the big banks were able to take positions in the exact securities that they knew the Fed would be buying. Huge profits were not guaranteed, just highly likely.

“Since the financial statements of the banks don’t break trading revenues out a line item basis, it’s hard to say how much money each bank may have made by frontrunning the Fed’s actions in the bond market.

“But from the looks of it, what we have here is a kind of back door subsidy to bank profitability provided by the Fed. First quarter earnings were strongly boosted by an increase in the valuations of mortgage-backed securities that went up with Fed buying. Before you get all excited about the recovery in financial stocks, you may want to keep that in mind.”

And let’s also bear in mind, dear investor, that the AIG bailout may have contributed mightily to Wall Street’s enormous trading profits in the first quarter. According to a widely circulated theory to which we alluded in the March 19, 2009 edition of the Rude Awakening, Paulson bailed out AIG so that AIG could bail out Goldman Sachs and other ailing Wall Street firms.

Whether directly or indirectly, intentionally or unintentionally, the federal government enabled the big Wall Street banks to produce billion-dollar profits in the first quarter. Certainly, the federal government will attempt to repeat the performance in the second quarter. But we suspect the jig is up. We suspect the trading profits of the first quarter were one-off events that will not become two-off events.

As a result, we suspect that finance company earnings will resume their downward trajectory throughout the rest of the year, as adverse real-world trends swamp government-subsidized trading profits.

The truth is that banking profitability is not actually recovering, and neither is the economy. And that means that every stock market rally rests on shaky ground. The nearby chart tells the tale…or at least most of the tale.

Foreclosures have become nearly as numerous as home sales. Unless and until the two lines on the chart above begin to diverge, rather than converge, a recovery in the finance sector will remain a deception, a recovery in the economy will remain a false hope and a recovery in the stock market will remain a dangerous illusion.

And one final thought: Would America be any worse off if Paulson had simply told the truth?

Source: The Recovery That Isn’t

But it doesn’t feel like we’re there just yet…

So far, the Treasury Department, Federal Reserve and FDIC have cobbled together about $2 trillion worth of bailout programs, along with an unknown-trillion-dollars worth of implied and actual guarantees. What do we have to show for all of this financial firepower? Nothing more than a smoldering pile market capitalization and implausible declarations of victory.

Bailouts aren’t all bad, they’re just mostly bad. They’re bad because they tend to subsidize failure, rather than to underwrite future success. Failure consumes capital investment, success multiplies it. Like UN food programs, bailouts tend to land in the hands of crafty despots, rather than needy orphans. In other words, bailouts tend to produce exactly the sort of capital misallocation that prolongs economic stasis and impedes recovery.

When the TARP tosses billions of dollars at a hodgepodge of finance companies, for example, does it actually save anything of long-term economic value or does it merely preserve museum pieces?

The Treasury has funneled $150 billion into the AIG cesspool, but the beleaguered insurance company continues to stink up the place. The company just posted a fresh $25 billion loss in the third quarter, and is probably amassing another multi-billion-dollar losses for next quarter. And yet, somehow, in the tortured logic of the powers that be, it’s okay to waste $150 billion on AIG, but not to waste $25 billion on GM, Chrysler and Ford.

The logic, if you can follow this, is that AIG’s failure would be a “systemic risk,” GM’s failure would merely be a catastrophic. To be clear, GM doesn’t deserve a bailout any more than AIG does…or any less. AIG miscalculated in such a spectacular fashion that it will receive six times the money that GM will NOT receive. Does that make sense?

In some ways, yes. No one wants a systemic risk walking around on the streets. But at the same time, what do we gain over the long term by resuscitating a model of incompetence like AIG, when we could be investing billions in lots of competent enterprises.

If the brain trust at AIG did not realize that policy-holders sometimes file a claim, too bad for AIG. It should go bankrupt. A blind monkey could write an insurance policy without considering the risk of a claim. A blind monkey could also figure out that if you write lots of policies on the identical risk – or family of related risks – you can kiss your actuarial assumptions goodbye. But blind monkeys almost never rise to the top ranks of a major insurance company.

We’ve got nothing against blind monkeys, but we don’t believe they should receive multi-billion bailouts from the Federal Government. Because, you see, when blind monkeys fail, sighted mammals can take their place, and usually operate a business more successfully. That’s called, “Economic Darwinism”…and we could probably use a little more of that about now.

If we’re going to waste $700 billion…or $2 trillion…let’s waste it on the folks who are building successful businesses…not on the folks who have demonstrated a penchant for colossal failure. Alternatively, let’s waste it on the folks who are trying to save their homes. In other words, let’s waste it on the effort to restructure existing mortgages. As a last resort, we could waste $2 trillion subsidizing journalists who write daily financial columns containing the words, “Rude Awakening.” But this would truly be a last resort.

If the government really wanted to INVEST the TARP funds, rather than squander them, it would buy a $25 billion interest in America’s nine BEST companies (whatever those might be). But that’s not the TARP’s mission. The TARP’s mission is to throw good money after bad, with the hope that the bad money becomes good again.

Good luck.

The TARP, itself, is a troubled asset. In fact, this particular tarp is beginning to look an awful lot like a shroud – an ornately embroidered gossamer that the Treasury Department is wrapping around the lifeless remains of the financial sector. The Treasury Department continues to insist that this shroud…er, tarp…will restore the financial sector to new life and vitality. We don’t believe it.

The financial sector is more King Tut than Lazarus. It will not come back to life, at least not in anything resembling its current form; it is dead already. The pyramids and the gold and the perfumes did not make King Tut any less dead. His 5-star Egyptian mummification/spa treatment did not bring him back to life. Likewise, dressing the ashen frame of brain-dead finance companies in $700 billion worth of bailout baubles will serve only one purpose – to send $700 billion into the afterlife as well.

Don’t send your money there too. Beware the financial sector…still.

Source: Bailout Fatigue Syndrome