The New Trough

Editor's note: The online version of this story has been amended to reflect developments since the publication of the print edition.

On October 13th, when the U.S. Treasury Department announced the team of "seasoned financial veterans" that will be handling the $700 billion bailout of Wall Street, one name jumped out: Reuben Jeffery III, who was initially tapped to serve as chief investment officer for the massive new program.

On the surface, Jeffery looks like a classic Bush appointment. Like Treasury Secretary Henry Paulson, he's an alum of Goldman Sachs, having worked on Wall Street for 18 years. And as chairman of the Commodity Futures Trading Commission from 2005 to 2007, he proudly advocated "flexibility" in regulation - a laissez-faire approach that failed to rein in the high-risk trading at the heart of the meltdown.

Bankers watching bankers, regulators who don't believe in regulating - that's all standard fare for the Bush crew. What's most striking about Jeffery's resume, however, is an item omitted when his new job was announced: He served as executive director of Paul Bremer's infamous Coalition Provisional Authority in Baghdad, during the early days of the Iraq War. Part of his job was to hire civilian staff, which made him an integral part of the partisan machine that filled the Green Zone with Young Republicans, investment bankers and Dick Cheney interns. Qualifications weren't a big issue back then, because the staff's main function was to hand over stacks of taxpayer money to private contractors, who were the ones actually running the occupation. It was this nonstop cash conveyor belt that earned the Green Zone a reputation, in the words of one CPA official, as "a free-fraud zone." During Senate hearings last year, when Jeffery was asked what he had learned from his experience at the CPA, he said he thought that contracts should be handed out with more "speed and flexibility" - the same philosophy he cited back when he was in charge of regulating Wall Street traders.

The Bush Administration has since reversed the Jeffery appointment, perhaps thinking better of giving a CPA alum such a central role in the Wall Street bailout. Still the original impulse underscores the many worrying parallels between the administration's approach to the financial crisis and its approach to the Iraq War. Under cover of an emergency, Treasury is rapidly turning into an economic Green Zone, overrun with private companies collecting lucrative contracts. Fittingly, one of the first to line up at the new trough was none other than the law firm of Bracewell & Giuliani - yes, that Giuliani. The firm's chairman, Patrick Oxford, could scarcely conceal his glee over the prospect of cashing in on the bailout. "This one," he told reporters, "is very, very big." At least four times bigger, in fact, than the post-9/11 homeland-security bubble, from which Giuliani and his various outfits have profited so extravagantly. Even bigger, potentially, than the price tag for the Iraq War itself.

In Iraq, the contractors were tasked with reconstructing the country from the mess made by U.S. missiles. After years of corruption born of no-bid contracts and paltry oversight, many Iraqis are still waiting for the lights to come back on. Today, a new team of contractors is lining up to reconstruct the U.S. economy - reconstruct it from the mess made by the very banks, brokers and law firms that are now applying for contracts. And it's not at all clear that America can survive their assistance.

See if any of this sounds familiar: As soon as the bailout was announced, it became clear that Treasury officials would hire outsiders to perform their jobs for them - at a profit. Private companies wanting to help manage the bailout were given just two days to apply for massive, multiyear contracts. Since it was such a mad rush - after all, the entire economy was about to implode - there was no time for an open bidding process. Nor was there time to draft rigorous rules to make sure that those applying don't have serious conflicts of interest. Instead, applicants were asked to disclose their conflicts and to explain - and this is not a joke - their "philosophy in fulfilling your duty to the Treasury and the U.S. taxpayer in light of your proprietary interests and those of other clients." In other words, an open invitation to bullshit about how much they love their country and how they can be trusted to regulate themselves.

The first major contract to be awarded in the bailout was for legal advice - and the choice Treasury made was Halliburton-esque in its audacity. Six law firms were invited to bid, but four declined, either because they didn't want the contract or because they had too many conflicts of interest. Rep. Barney Frank, chairman of the House Financial Services Committee, said the fact that so many law firms chose not to bid "shows that the guidelines are sufficiently rigorous."

Or it may just show that the bidder who won the contract - Simpson Thacher & Bartlett - takes a more relaxed approach to conflicts than its colleagues. The law firm is a Wall Street heavy hitter, having brokered some of the biggest bank mergers in recent years. It also provided legal support to companies trading mortgage-backed securities - the "financial weapons of mass destruction," as Warren Buffett called them, that detonated the banking industry. More to the point, it was hired to provide legal services to the Treasury in its negotiations to spend $250 billion of the bailout money purchasing equity in America's banks. The first stage of the plan involves buying stakes in nine of the country's top banks. Incredibly, Simpson Thacher has represented seven of the nine: JPMorgan, Bank of New York Mellon, Bank of America, Citigroup, Morgan Stanley, Goldman Sachs and Merrill Lynch.

According to its contract, Simpson Thacher has agreed not to represent any of the banks "against the U.S." when they negotiate with Treasury for the equity money. However, the firm has retained the right to represent banks when they apply for other parts of the $700 billion bailout not covered by its contract. (It has promised to erect a "firewall" to stem the flow of "confidential information" to those clients.) The firm will also continue to work for the banks on a range of other lucrative deals - and that's where the problem lies. Take Lee Meyerson, Simpson Thacher's lead lawyer on the bailout negotiations, who is specifically named in the contract as "essential" to the project. As the company's hotshot attorney, Meyerson has personally represented three of the nine banks that were bailed out in the first round, in addition to many others that will surely apply for cash injections. One of the bailed-out banks is Bank of New York Mellon, whose $29 billion merger Meyerson helped negotiate. Mergers like that can bill in the millions. Is Simpson Thacher able to put aside its loyalties to its biggest clients and negotiate deals for the taxpayer that could exact real costs from those very clients?

It might be possible to set aside concerns about divided loyalties if it were clear that Simpson Thacher is helping Treasury to wrangle the best deals possible for U.S. taxpayers. But the firm's first test - the deal to give $125 billion to the nine big banks to ease the "credit crunch" that is crippling the economy - wasn't exactly reassuring. Secretary Paulson promised that the banks won't just "hoard" the money - they will quickly "deploy it" through the economy in the form of badly needed loans. There is just one hitch: Neither Paulson nor Simpson Thacher got that "deploy" part in writing - nor did they put in place any mechanism to require the banks to spend their taxpayer billions. Apparently, the part about lending the money to homeowners and small businesses was sort of implied.

"There is no obligation for banks to lend the money one way or the other," Jennifer Zuccarelli, a Treasury spokeswoman, tells Rolling Stone. "But the banks have the understanding" that the money is intended for loans. "We're not looking to control their operations."

Unfortunately, many of the banks appear to have no intention of wasting the money on loans. "At least for the next quarter, it's just going to be a cushion," said John Thain, the chief executive of Merrill Lynch. Gary Crittenden, chief financial officer of Citigroup, had an even better idea: He hinted that his company would use its share of the cash - $25 billion - to buy up competitors and swell even bigger. The handout, he told analysts, "does present the possibility of taking advantage of opportunities that might otherwise be closed to us."

And the folks at Morgan Stanley? They're planning to pay themselves $10.7 billion this year, much of it in bonuses - almost exactly the amount they are receiving in the first phase of the bailout. "You can imagine the devilish grins on the faces of Morgan Stanley employees," writes Bloomberg columnist Jonathan Weil. "Not only did we, the taxpayers, save their company...we funded their 2008 bonus pool."

It didn't have to be this way. Five days before Paulson struck his deal with the banks, British Prime Minister Gordon Brown negotiated a similar bailout - only he extracted meaningful guarantees for taxpayers: voting rights at the banks, seats on their boards, 12 percent in annual dividend payments to the government, a suspension of dividend payments to shareholders, restrictions on executive bonuses, and a legal requirement that the banks lend money to homeowners and small businesses.

In sharp contrast, this is what U.S. taxpayers received: no controlling interest, no voting rights, no seats on the bank boards and just five percent in dividend payouts to the government, while shareholders continue to collect billions in dividends every quarter. What's more, golden parachutes and bonuses already promised by the banks will still be paid out to executives - all before taxpayers are paid back.

No wonder it took just one hour for Paulson to convince all nine CEOs to accept his offer - less than seven minutes per bank. Not even the firms' own lawyers could have drafted a sweeter deal.

The day after it met with the nation's top banks, Treasury announced that it had selected the firm that would receive the juiciest contract of all: that of "master custodian." The winning company will be to the bailout what Halliburton is to the military: the contractor of contractors. It will purchase toxic debts from Wall Street, service them and auction them off in the future - a so-called "end-to-end process." The contract is for a minimum of three years.

Seventy firms applied for the gig; the winner was Bank of New York Mellon. Describing the scope of the megacontract, bank president Gerald Hassell said, "It's the ultimate outsourcing - because the Federal Reserve and the Treasury do not have the mechanics to run the entire program, and we're essentially the general contractor across the entire program. It's going to cross our entire company."

This raises an interesting point: Has the Treasury partially nationalized the private banks, as we have been told? Or is it the other way around? Is it Treasury that has been partially privatized by Wall Street, its massive rescue plan now entirely in the hands of a private bank it is directly subsidizing?

Shortly after receiving the contract, Hassell told investors that his institution is now well-positioned to profit from the market meltdown. "There's a lot of new business that's going on even in this chaotic marketplace," he said, "and so some of those things have been very positive to us." Just how positive, we don't know, because Treasury has blacked out the 10 lines of the "master custodian" contract that reveal how much Bank of New York Mellon will be paid. Though Treasury says it will release the information eventually, the secrecy goes beyond anything the Bush administration attempted in Iraq. Even Halliburton's dodgy contracts came with price tags attached.

Still, when the terms of the contract do become public, they may turn out to be surprisingly modest. Goldman Sachs has apparently offered to fulfill at least one bailout contract for free. Altruism may not be their only motivation. The real money at stake in the bailout lies not in payment for the work but in how the work is done. Think about it: If you're the one selling your debts to the government, wouldn't you also want to help decide which debts are eligible and how much they're worth? "The financial firms with assets to sell are in many instances the same firms the Treasury will rely on to value and manage the assets it is buying," The New York Times observed. "That is an invitation for these firms to set the price too high or to indulge in other mischief at the taxpayers' expense."

Bank of New York Mellon has a bad record for mischief. It is embroiled in a $22.5 billion money-laundering lawsuit in Moscow and has been forced to pay out a $14 million settlement in a related case. Though the bank's "master custodian" contract with Treasury prohibits unethical conduct, the arrangement seems rife with opportunities for abuse. According to its most recent earnings report, Bank of New York Mellon holds $1.2 billion in subprime mortgage securities. That means that in addition to the $3 billion it will receive as part of the equity program, it will also be eligible to apply for taxpayer money from the program it is being paid to administer. Neither the bank nor Treasury would comment on this direct conflict of interest.

On the same day that he allocated the first $125 billion to the banks, Secretary Paulson announced the largest federal budget deficit in U.S. history. Buried in his statement was a preview of the next phase of the financial disaster. The deficit numbers, he declared, reinforce the need to "pursue policies that promote economic growth and fiscal responsibility, and address entitlement reform." He was referring to Americans who feel entitled to receive Social Security in their old age and Medicaid when they are sick. Those programs, Paulson implied, might not be able to survive the budget crisis he is currently creating for the next administration.

This is why the stakes of the bailout are so high: Unless we get a good deal, there will be nothing left over after the banks are done feeding to pay for the meager services now provided in exchange for taxation, let alone for the more ambitious initiatives promised on the campaign trail. The spiraling cost of saving Wall Street from its bad bets is already being used as an excuse for why we can't solve our many other crises, from health care to climate change.

There is a better way to fix a broken financial system. Treasury's plan to buy up the toxic debts never made sense and should be immediately scrapped - a move that would also handily get rid of most of the crony contractors. As for purchasing equity in banks, the next round of deals - and there will be more - has to start from the premise that the banks are bankrupt and will therefore accept whatever terms we choose to impose, including real regulatory oversight. The possibilities of what could be done if a chunk of the banking system were genuinely under public control - from a moratorium on home foreclosures to mandatory investment in green community redevelopment - are limitless.

Because here is what George Bush and Henry Paulson are hoping we won't figure out: When a society no longer has enough money to pay for its most pressing needs, there are worse things than discovering you own the banks.