Cleaning up the mess that remains

September 14, 2009

At least the Obama administration isn’t saying “Mission Accomplished.”

In marking the anniversary of Lehman Brothers’ demise, the administration understandably focused on how far we’ve come since, and on the various exit strategies in the works.

Lehman Brothers has been at the center of the narrative of what went wrong last year, and that makes it much easier for the administration to tell a story of triumph rather than the more uncomfortable legacy of dysfunctional companies and hidden toxic assets.

Coinciding with President Barack Obama’s speech in New York, the Treasury released a paper today, titled “The Next Phase of Government Financial Stabilization and Rehabilitation Policies.”

Its summary reads like a check list of emergency programs that are no longer needed now that the worst of the crisis is past. The insurance program for money market funds and the federal guarantee of qualifying bank debt can be tied directly to the fallout from Lehman’s spectacular end.

But last year’s turmoil didn’t begin and end with Lehman. Change the anniversary’s focus to, say, the government’s seizure of Fannie Mae and Freddie Mac that occurred a week earlier, or to American International Group, just a day after, and it’s clear that some of the messier legacies of the credit crisis still haunt the current administration a year later.

The government arguably isn’t any closer to figuring out what to do with the two giant housing finance companies than the previous administration was on September 7, 2008, when it announced Fannie and Freddie would be put into conservatorship.

Today, nothing was mentioned about what to do with the companies — nationalize them, split them into a good bank/bad bank structure, or wind them down — even though the government’s stake in their business has increased substantially. As of the second quarter, the two companies have drawn down close to $100 billion from the government’s $400 billion preferred share equity lines.

Moreover, the government has become the biggest buyer of the mortgage bonds they guarantee. The Federal Reserve has invested more than $800 billion in the mortgage bonds guaranteed by the government-sponsored enterprises, while the Treasury has snapped up $171.8 billion.

Leaving this market is going to be one of the diciest exit strategies for the government, since it is sure to push up mortgage rates at a time when the housing market may finally be starting to show signs of bottoming.

Then there’s AIG. Not withstanding the curious case of a soaring stock price in August, its prospects a year later still look grim. This week, Wells Fargo strategist John Hall said a case could be made that the company has “virtually no tangible book value at the moment” and that while the company theoretically could earn its way out of its troubles, “we think that scenario is probably a remote possibility.”

When the government pledged an $85 billion loan to keep the insurer afloat, most thought it would just be a stop-gap measure to get the company through the drought in credit markets.

The bailout price tag eventually swelled to around $180 billion, and the Federal Reserve is sitting on a cesspool of assets in the Maiden Lane II and III accounts that house toxic collateralized debt obligations and mortgage-related debt.

And this leads to the still nagging problem of toxic assets in general. They’re still out there. The immediacy of the crisis a year ago shifted priorities away from removing toxic assets to channeling funds directly into financial institutions teetering on the brink.

Focusing on the Lehman anniversary allows the Obama administration, as well as many on Wall Street, to tell a cleaner story of returning to some sense of normalcy, after decisive action and taxpayer support helped pull the financial system back from the brink.

It’s a good story, and much of it is true — except for the messier details that could keep the government on the hook well after Wall Street moves onto the next big thing.


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