U.S. ‘too-big-to-fail’ banks bigger than ever before – now holding $8.5 trillion in assets

Five banks — JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co., and Goldman Sachs Group Inc. — held US$8.5-trillion in assets at the end of 2011, equal to 56% of the U.S. economy, according to central bankers at the Federal Reserve. David Paul Morris/Bloomberg

Bloomberg News | Apr 16, 2012

by David J. Lynch

Two years after U.S. President Barack Obama vowed to eliminate the danger of financial institutions becoming “too big to fail,” the nation’s largest banks are bigger than they were before the nation’s credit markets seized up and required unprecedented bailouts by the government.

Five banks — JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co., and Goldman Sachs Group Inc. — held US$8.5-trillion in assets at the end of 2011, equal to 56% of the U.S. economy, according to central bankers at the Federal Reserve.

Five years earlier, before the financial crisis, the largest banks’ assets amounted to 43% of U.S. output. The Big Five today are about twice as large as they were a decade ago relative to the economy, sparking concern that trouble at a major bank would rock the financial system and force the government to step in as it did in 2007 with the Fed-assisted rescue of Bear Stearns Cos. by JPMorgan and in 2008 with Citigroup and Bank of America after the Lehman Brothers bankruptcy, the largest in U.S. history.

“Market participants believe that nothing has changed, that too-big-to-fail is fully intact,” said Gary Stern, former president of the Federal Reserve Bank of Minneapolis.

That specter is eroding faith in Obama’s pledge that taxpayer-funded bailouts are a thing of the past. It is also exposing him to criticism from Federal Reserve officials, Republicans and Occupy Wall Street supporters, who see the concentration of bank power as a threat to economic stability.

US banks are back and bigger than ever

From ‘too big to fail’ to even bigger in just four years

Banks grow despite Obama’s bid to end too-big-to-fail idea

As weaker firms collapsed or were acquired, a handful of financial giants emerged from the crisis. Since then, JPMorgan, Goldman Sachs and Wells Fargo have continued to grow internally and through acquisitions from European banks, reeling from government austerity measures related to the rising cost of public debt in Greece, Spain, Portugal, Ireland and Italy.

‘Few Massive Firms’

The industry’s evolution defies the president’s January 2010 call to “prevent the further consolidation of our financial system.” Embracing new limits on banks’ trading operations, Obama said then that taxpayers wouldn’t be well “served by a financial system that comprises just a few massive firms.”

Simon Johnson, a former chief economist of the International Monetary Fund, blames a “lack of leadership at Treasury and the White House” for the failure to fulfill that promise. “It’d be safer to break them up,” he said.

The Obama administration rejects the criticism, citing new safeguards to head off further turmoil in the banking system. Treasury Secretary Timothy Geithner said in a February 2 speech that the U.S. “financial system is significantly stronger than it was before the crisis.” He credits new regulations, including tougher capital and liquidity requirements that limit risk-taking by the biggest banks, authority to take over failing big institutions and prohibitions on the largest banks acquiring competitors.

Angering Taxpayers

The government’s financial system rescue, beginning with the 2008 Troubled Asset Relief Program, angered millions of taxpayers and helped give rise to the Tea Party movement. Banks and bailouts remain unpopular: By a margin of 52% to 39%, respondents in a February Pew Research Center poll called the bailouts “wrong” and 68% said banks have a mostly negative impact on the country.

Banks Cite Changes

The banks say they have increased their capital backstops in response to regulators’ demands, making them better able to ride out unexpected turbulence. JPMorgan, whose chief executive officer, Jamie Dimon, acknowledged public “hostility” toward bankers in a March 30 letter to shareholders, boasted April 13 of a “fortress balance sheet.” Bank of America, which was about 50% larger at the end of 2011 than five years earlier, says it has boosted capital and liquidity while increasing to 29 months the amount of time the bank could operate without external funding.

“We’re a much stronger company than we were heading into the crisis,” said Jerry Dubrowski, a Bank of America spokesman. The bank says it plans to shrink by year-end to US$1.75-trillion in risk-weighted assets, a measure regulators use to calculate how much capital individual banks must hold.

Still, the banking industry has become increasingly concentrated since the 1980s. Today’s 6,291 commercial banks are less than half the number that existed in 1984, according to the Federal Deposit Insurance Corp. The trend intensified during the crisis as JPMorgan acquired Bear Stearns and Washington Mutual; Bank of America bought Merrill Lynch; and Wells Fargo took over Wachovia in deals encouraged by the government.

“One of the bad outcomes, the adverse outcomes of the crisis, was the mergers that were of necessity undertaken when large banks were at risk,” said Donald Kohn, vice chairman of the Federal Reserve from 2006-2010. “Some of the biggest banks got a lot bigger and the market got more concentrated.”

Concerns Voiced

In recent weeks, at least four current Fed presidents — Esther George of Kansas City, Charles Plosser of Philadelphia, Jeffrey Lacker of Richmond and Richard Fisher of Dallas — have voiced similar worries about the risk of a renewed crisis.

The annual report of the Federal Reserve Bank of Dallas was devoted to an essay by Harvey Rosenblum, head of the bank’s research department, “Why We Must End Too Big to Fail — Now.”

A 40-year Fed veteran, Rosenblum wrote in the report released last month: “TBTF institutions were at the center of the financial crisis and the sluggish recovery that followed. If allowed to remain unchecked, these entities will continue posing a clear and present danger to the U.S. economy.”

Dodd-Frank

The alarms come almost two years after Obama signed into law the Dodd-Frank financial-regulation act. The law required the largest banks to draft contingency plans or “living wills” detailing how they would be unwound in a crisis. It also created a financial-stability council headed by the Treasury secretary, charged with monitoring the system for excessive risk-taking.

The new protections represent an effort to avoid a repeat of the crisis and subsequent recession in which almost 9 million workers lost their jobs and the U.S. government committed US$245-billion to save the financial system from collapse.

The goal of policy makers is to ensure that if one of the largest financial institutions fails in the next crisis, shareholders and creditors will pay the tab, not taxpayers.

“Two or three years from now, Goldman Sachs should be like MF Global,” said Dennis Kelleher, president of the nonprofit group Better Markets, who doubts the government would allow a company such as Goldman to repeat MF Global Holdings Ltd.’s Oct. 31 collapse.

New Regulations

Dodd-Frank, the most comprehensive rewriting of financial regulation since the 1930s, subjected the largest banks to higher capital requirements and closer scrutiny. The law also barred federal officials from providing specific types of assistance that were used to prevent such firms from failing in 2008. Instead, the Fed will work with the FDIC to put major banks and other large institutions through the equivalent of bankruptcy.

“If a large financial institution should ever fail, this reform gives us the ability to wind it down without endangering the broader economy,” Obama said before signing the act on July 21, 2010. “And there will be new rules to make clear that no firm is somehow protected because it is too big to fail.”

‘Completely Unrealistic’

Officials at the Treasury Department, the Fed and other agencies have spent the past two years drafting detailed regulations to make that vision a reality.

Yet the big banks stayed big or, in some cases, grew larger. JPMorgan, which held US$2-trillion in total assets when Dodd-Frank was signed, reached US$2.3-trillion by the end of 2011, according to Federal Reserve data.

For Lacker, the banks’ living wills are the key to placing the financial system on sounder footing. Done right, they may require institutions to restructure to make their orderly resolution during a crisis easier to accomplish, he said.

Neil Barofsky, Treasury’s former special inspector general for the Troubled Asset Relief Program, calls the idea of winding down institutions with more than US$2-trillion in assets “completely unrealistic.”

It’s likely that more than one bank would face potential failure during any crisis, he said, which would further complicate efforts to gracefully collapse a giant bank. “We’ve made almost no progress on ending too big to fail,” he said.

Bankers’ Responses

Dimon dismisses such concerns as “chatter” and says U.S. banks need heft to meet the needs of their globally active clients. Since 2007, the bank has added more than 80,000 workers, equal to the current combined payrolls of Nike Inc. and Colgate Palmolive Co.

In his annual letter to shareholders, Dimon said JPMorgan will spend almost US$3-billion “over the next few years” and devote 3,000 full-time employees to complying with regulations that arose from the crisis.

That regulatory burden could promote further industry consolidation, according to Wilbur Ross, chairman of WL Ross & Co., a private-equity firm.

“We think the little tiny banks, the 90-odd percent of banks that are under US$1.5-billion in deposits, are pretty much an obsolete phenomenon,” he told Bloomberg Television on March 14. “We think they’ll all have to merge with each other, be acquired by bigger banks or something.”

Implicit Guarantee

Jake Siewert, a spokesman for Goldman Sachs, and Mary Eshet, a spokeswoman for Wells Fargo, declined to comment. Spokesmen for JPMorgan and Citigroup didn’t respond to e-mailed requests for comment.

Even with policy makers’ claims that the next crisis will be handled differently, investors still regard the largest banks as protected by an implicit government guarantee. One sign of that attitude is that investors continue to demand from the biggest banks lower interest payments in return for deposits.

That gives larger banks a funding advantage over their smaller rivals. In 2011, funding costs for banks with more than US$10-billion in assets were about one-third less than for the smallest banks, according to the FDIC. That gap was only slightly narrower than the 37% advantage the largest banks enjoyed when Dodd-Frank was signed.

US$250-Billion Boost

For 28 global banks in 2009, that benefit translated into a cumulative US$250-billion, according to Andrew Haldane, the Bank of England’s executive director for financial stability.

“Markets have come to believe that what the government did in 2008 and 2009 isn’t a one-time deal, that the government will somehow come to the rescue of these big financial firms,” Kevin Warsh, a former member of the Fed’s Board of Governors, said on the March 28 “Charlie Rose” TV show.

Credit-rating companies Standard & Poor’s and Moody’s say they anticipate the U.S. government would rescue large banks in a future crisis. Both cut the major banks’ debt ratings by one level late last year, while retaining them as investment grade credits.

Last month, 15 of the 19 largest U.S. financial institutions passed a Fed “stress test” designed to measure their ability to withstand a deep recession.

Richard Spillenkothen, the Fed’s director of banking supervision and regulation from 1991 to 2006, said regulators are moving in the right direction.

“We’ve made progress. I don’t think we’ve totally resolved it,” said Spillenkothen. “The proof will be in the next crisis.”

Bank Of America Sues Itself In Unusual Foreclosure Case

huffingtonpost.com | Apr 10, 2012

WASHINGTON — Bank of America is suing itself for foreclosure.

“It’s crazy,” housing data analyst Michael Olenick told HuffPost. “They shouldn’t be suing themselves.”

Over the past two years, the nation’s largest banks and the Obama administration have repeatedly vowed to clean up the foreclosure fraud mess. In February, banks agreed to pay $25 billion and overhaul their foreclosure processes as part of a 50-state investigation into bank wrongdoing, resulting from practices that included robo-signing.

Foreclosure Frenzy: Bank Of America Sues Bank Of America

But in Florida’s Palm Beach County alone, Bank of America has sued itself for foreclosure 11 times since late March, according to foreclosure fraud activist Lynn Szymoniak, who forwarded one such foreclosure filing, dated March 29, 2012, to The Huffington Post. (A white-collar crime expert, Szymoniak was recently awarded $18 million for her work helping the government recover $95 million as a result of bank foreclosure problems in North Carolina.)

In the March 29 filing, Bank of America is seeking to foreclose on a condominium and names the condo owner and Bank of America as defendants in the suit. The company is literally seeking damages from itself in order to foreclose on the condo owner.

“We are servicing the first mortgage on behalf of an investor and we own the second mortgage,” Bank of America spokeswoman Jumana Bauwens told HuffPost. “Naming the second-lien holder in the suit is necessary to eliminate the junior interest,” Bauwens said.

“This just strikes me as classic robo foreclosure,” Professor Alan White of Valparaiso University Law School told HuffPost. White, a predatory lending expert who tracks and analyzes data on loan modifications and foreclosures, said that lawyers for the bank likely performed an electronic title search to see if any other liens on the property existed and simply wrote down the name of whatever bank came up in the search. Lawyers and paralegals who perform these tasks typically fill out dozens of such forms a day, White told HuffPost.

“I’m sure the paralegal who did this did 100 others that day,” he said.

Banks have been caught suing themselves before. In 2009, Dow Jones columnist Al Lewis uncovered a case in which Wells Fargo had sued itself in connection with a foreclosure in Florida’s Hillsborough County. The bank owned both the first and second liens on the property and ended up hiring two separate attorneys to deal with the snafu — one to bring the lawsuit and another to defend itself.

The Bank of America self-suits seems to have emerged from a scenario that investors have complained about for years involving home equity loans. Big banks like Bank of America service mortgages on behalf of other investors. Bank of America processes payments, negotiates with borrowers and operates the foreclosure process but does not actually own the loan. Many properties from the housing bubble had an additional home equity loan, or second lien. Banks could charge higher interest rates on these second liens because they were riskier loans — the second lien is supposed to eat losses before anything happens to the first lien.

When a bank brings a foreclosure case in court, it has to notify whoever owns the second lien that it is taking action. In this case, Bank of America owns the second lien.

But meticulous attorneys would not ordinarily let their clients sue themselves. “It is a little bit mindless on the part of the lawyer,” White said. “They don’t need to sue themselves.”

An ugly foreclosure story, starring Bank of America

After homeowner Dirma Rodriguez fell behind on her payments, the Bank of America lowered her monthly obligation, but then sold her house at a foreclosure auction last September. (Associated Press)

Dirma Rodriguez wonders how a house she’d been paying on for years, and which is specially modified for her severely disabled daughter, could be taken from her.

You might wonder why Bank of America found it smarter to sell at a loss than to work out reasonable terms with Rodriguez, who made mortgage payments for more than 20 years without incident.

Los Angeles Times | Apr 13, 2012

by Gale Holland

Dirma Rodriguez had five minutes to gather her things and vacate the West Adams house she and her severely disabled daughter had lived in for more than 25 years.

As a property manager changed the locks, Rodriguez fluttered back and forth from the yard — where a pile of stuff lay by the kitchen stove — to her car, where her daughter, Ingrid Ortiz, sat screaming and crying.

How Rodriguez and Ortiz ended up in this predicament is a long, messy story that resounds with a misery all too common in this age of foreclosure.

Rodriguez took out a loan to retrofit her house for her special-needs daughter. After she fell behind on her payments, the Bank of America lowered her monthly obligation, but then sold the house at a foreclosure auction last September. The new owner, a house flipper from El Segundo called West Ridge Rentals, moved to evict the family.

I came upon Rodriguez’s story through Occupy Fights Foreclosure, the latest offshoot of the 99% movement. Occupy interceded to stop her eviction March 26, and it just may have saved her home for good. Bank of America said last week it is considering a loan modification that would return the home to Rodriguez and her family.

But how did it come to this? Bank of America took a $45-billion bailout from taxpayers when it got into financial trouble. Why couldn’t the bank have shown Rodriguez — a widow whose life was already a trial — the same courtesy when she got squeezed?

“I would pray to God the executives from Bank of America would come over here and see what I have to deal with,” Rodriguez said through a Spanish-speaking Occupier last week.

Ortiz, now 27, has cerebral palsy and does not speak. Her vision is poor, and she can walk with leg braces, but she generally finds it easier to slide around the house on her knees. She often cries and wails loudly.

The stucco house on South Rimpau Boulevard, which Rodriguez keeps immaculate, is custom-conditioned for Ortiz, with gleaming floor tiles to ease her movements and a wheelchair ramp. In the summer, Rodriguez spreads a blanket on the lawn so Ingrid can enjoy the sun and gaze at the dozens of unblemished rose bushes her mother planted in honor of her quinceañera.

Given the circumstances, it’s hard to picture Rodriguez spending her loan money on a cruise. Or finding another place where Ortiz could live comfortably.

“I built all this house so she could have a castle,” Rodriguez said through a translator last week. Two portraits of a smiling Ortiz in a white quinceañera dress with rosebud trim hung nearby. “This is the only world she knows,” her mother said.

Bank of America inherited Rodriguez’s loan from Countrywide. After her payment jumped, and she fell behind, the bank placed her in a trial loan modification. She made her payments faithfully for 13 months and was awaiting a permanent modification package when the bank sold her home out from under her, she says.

How and why this came to pass is in dispute. Rodriguez says the bank began returning her payments, then put her into foreclosure without notice. Bank of America spokesman Rick Simon said she received ample notification, and the foreclosure was aboveboard.

Getting at the truth is complicated by “advocates” that Rodriguez brought in to try to save her home. One of them, G & G Financial of Los Angeles, earned a grade of “F” from the Better Business Bureau for allegedly charging homeowners advance fees to work on loan modifications, which is illegal in California. A man who answered the phone at G & G hung up on me when I tried to ask about Rodriguez’s case.

Another company, Golden Global Investments of Van Nuys, said through an employee that it helped Rodriguez fight eviction. But West Ridge lawyer Alan Dettelbach says no one was in court for Rodriguez when the eviction proceeding was heard.

Bank of America’s assertion that the foreclosure was proper might be more persuasive if it and four other banks hadn’t just signed a $25-billion settlement with the federal government and state attorneys general over shoddy, and possibly illegal, foreclosure practices. Or if it had established more of a record of helping longtime homeowners hang on to their properties.

Bank of America was the only lender that joined a 2009, $1.1-million city pilot program to help homeowners in the North San Fernando Valley obtain loan modifications. But as of February, the bank could find no “eligible borrowers,” city staff reported to the City Council.

Really? REALLY? There’s not a single Bank of America borrower in North Hollywood or Sun Valley deserving of a break?

Rodriguez owed $457,000 on the house; West Ridge picked it up for $300,100. You might wonder why Bank of America found it smarter to sell at a loss than to work out reasonable terms with Rodriguez, who made mortgage payments for more than 20 years without incident.

Basically, the bulk of the loss falls not on Bank of America, the loan servicer, but on the loan’s owner — in Rodriguez’s case, Freddie Mac.

Dettelbach, the attorney, said West Ridge is willing to walk away if the bank repays its money plus costs. Simon, the spokesman, said the bank has to be certain Rodriguez can afford the payments before they agree to a modification.

“We are certainly sympathetic to the situation involving her daughter and the renovations that have been done to the home,” Simon said in an email.

“I don’t want a free house. I just want to make my payments,” Rodriguez said.

JPMorgan Chase Presents Leadership Award to Peter Thiel at First Annual StartOut LGBT Entrepreneurship Awards

Jack Stephenson, director of mobile, e-commerce and payments at JPMorgan Chase; Peter Thiel, technology entrepreneur and PayPal co-founder; and StartOut Founder Darren Spedale at last night’s StartOut LGBT Entrepreneurship Awards ceremony in San Francisco. (Photo: Business Wire)

marketwatch.com | Mar 9, 2012

SAN FRANCISCO, Mar 09, 2012 (BUSINESS WIRE) — JPMorgan Chase & Co. JPM -0.90% presented the Leadership Award yesterday to keynote speaker Peter Thiel at StartOut’s First Annual LGBT Entrepreneurship Awards in San Francisco. StartOut, a nationwide non-profit organization dedicated to fostering and developing entrepreneurship within the LGBT community, held the awards ceremony at San Francisco’s W Hotel at an event honoring business leaders for both their accomplishments and their personal commitments to the entrepreneurial and LGBT communities.

Jack Stephenson, director of mobile, e-commerce and payments at Chase, presented the award to technology entrepreneur, investor, philanthropist and PayPal co-founder Thiel. “As a pioneer and visionary, Peter has helped to build the next generation of tech entrepreneurs both in Silicon Valley and across the globe,” said Mr. Stephenson. “His leadership and achievements have been an inspiration to the LGBT entrepreneurial community, and we’re proud to honor him tonight surrounded by such exceptional talent and innovative spirit.”

With approximately one million LGBT-owned small businesses nationwide, the LGBT market is helping boost the nation’s economic recovery, accounting for more than $600 billion in consumer spending annually.* StartOut is playing an important role in supporting entrepreneurs who develop and grow small businesses, which are the growth engine of the U.S. economy.

StartOut founder Darren Spedale, who kicked off the awards ceremony, said, “Tonight’s event marks the first time that entrepreneurs in the LGBT community are officially recognized for their dedication, passion, and commitment to creating a positive environment where startups and growing businesses founded by LGBT individuals can support each other and thrive.” He added, “Visionaries like Peter Thiel are demonstrating the very best of what great entrepreneurs can achieve. They have paved the way for others in the LGBT entrepreneurial community, as well as the future generation of entrepreneurs and investors whose creativity and vision will take us all to the next level.”

The evening’s other StartOut award honorees include former E*TRADE COO and Lesbian Equity Foundation Founder Kathy Levinson; TopGuest Founder and CEO Geoff Lewis; and Founder and CEO of SynapticMash Ramona Pierson.

About StartOut: StartOut is a 501(c)(3) nationwide organization dedicated to fostering and developing entrepreneurship within the LGBT community. StartOut is creating the next generation of LGBT business leaders by helping aspiring entrepreneurs start new companies, helping current entrepreneurs to grow and expand their businesses, and engaging successful entrepreneurs as role models and mentors for new entrepreneurs. www.startout.org

About Chase Mobile Banking

Chase is a leader in the industry with more than 15 million total registered mobile customers that use its products to help manage their financial lives. Chase’s mobile banking products offer complete coverage with native apps available for iPhone, iPad, Android and Blackberry customers. Downloadable in all smartphone app stores, the products allow customers to track their investment products, account activity, deposit checks, make person-to-person payments and pay bills and credit cards securely and conveniently. A division of JPMorgan Chase & Co., Chase Mobile Banking complements Chase’s online banking, telephone banking, and its network of nearly 5,500 branches and more than 17,200 ATMs.

Upper classes ‘more likely to lie and cheat’

Psychologists suggested that the findings could help explain the origins of the banking crisis – with self-confident, wealthy bankers more likely to indulge in reckless behaviour Photo: REUTERS

Members of the upper classes are more likely to lie, cheat and even break the law than people from less privileged backgrounds, a study has found.

Telegraph | Feb 27, 2012

By John Bingham

In contrast, members of the “lower” classes appeared more likely to display the traditional attributes of a gentleman.

It suggests that the traditional notion of the upper class “cad” or “bounder” could have a scientific basis.

But psychologists at the University of California in Berkeley, who carried out the study, also suggested that the findings could help explain the origins of the banking crisis – with self-confident, wealthy bankers more likely to indulge in reckless behaviour.

The team lead by Dr Paul Piff, asked several groups of people from different social backgrounds to perform a series of tasks designed to identify different traits such as honesty and consideration for others.

Each person was asked a series of questions about their wealth, schooling, social background, religious persuasions and attitudes to money in an attempt to put them into different classes.

The tasks included asking participants to pretend to be an employers conducting a job interview to test whether they would lie or sidestep awkward facts in pay negotiation.

They were told that the job might become redundant within six months but were encouraged conceal this from the interview candidate.

There was also an online game involving rolling dice in which participants they were asked to report their own score, thinking they would be in line for a cash prize for a higher score – and that no one was checking.

Members of another group were given a series of made-up scenarios in which people spoke about doing something unethical at work to benefit themselves and then questioned to assess how likely they were to do likewise.

The scientists also carried out a series of observations at a traffic junction in San Francisco.

Different drivers’ social status was assessed on the basis of what car they were driving as well as visible details such as their age.

Those deemed to be better off appeared more likely to cut up other drivers and less likely to stop for pedestrians.

Overall the study, published in the Proceedings of the National Academy of Sciences, concluded that those from richer or powerful backgrounds appeared greedier, more likely to lie in negotiation and more likely to cheat.

Being in a higher social class – either by birth or attainment – had a “causal relationship to unethical decision-making and behaviour”, they concluded.

Dr Piff concluded that having an elevated social rank were more likely to display “self focused” behaviour patterns than those from more modest backgrounds, were less aware of others, and were less good at identifying the emotions of others.

He said that the findings appeared to bear out the teachings of Aristotle, Plato and Jesus that greed is at the root unethical behaviour.

“On the one hand, lower-class individuals live in environments defined by fewer resources, greater threat and more uncertainty,” he said.

“It stands to reason, therefore, that lower-class individuals may be more motivated to behave unethically to increase their resources or overcome their disadvantage.

“A second line of reasoning, however, suggests the opposite prediction: namely, that the upper class may be more disposed to the unethical.

“Greater resources, freedom, and independence from others among the upper class give rise to self-focused social cognitive tendencies, which we predict will facilitate unethical behaviour.

“Historical observation lends credence to this idea. For example, the recent economic crisis has been attributed in part to the unethical actions of the wealthy.

“Religious teachings extol the poor and admonish the rich with claims like, ‘It will be hard for a rich person to enter the kingdom of heaven’.”

The Secret Meeting That Launched the Federal Reserve

President Woodrow Wilson signing the Federal Reserve Act in 1913. Source: Woodrow Wilson Birthplace Foundation, painting by Wilbur G. Kurtz Sr.

“I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world — no longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men.”

- President Woodrow Wilson reflecting in 1916 on his approval of the Federal Reserve Act in 1913. Quoted in “National Economy and the Banking System,” Senate Documents Co. 3, No. 23, Seventy-sixth Congress, First session, 1939

“Since I entered politics, I have chiefly had men’s views confided to me privately. Some of the biggest men in the United States, in the Field of commerce and manufacture, are afraid of something. They know that there is a power somewhere so organized, so subtle, so watchful, so interlocked, so complete, so pervasive, that they better not speak above their breath when they speak in condemnation of it.”

- President Woodrow Wilson, The New Freedom, 1913

bloomberg.com | Feb 15, 2012

By Gregory DL Morris

Although it may seem shocking to watch the 112th Congress, there was a time when national leaders were swift and decisive in getting things done. In November 1910, in the space of less than two weeks, a group of government and business leaders fashioned a powerful new financial system that has survived a century, two world wars, a Great Depression and many recessions.

Of course, the Jekyll Island conference, which met that month, was dodgy even by the standards of the Gilded Age: a self-selected handful of plutocrats secretly meeting at a private resort island to draw up a new framework for the nation’s banking system. Add in the gnarly live oaks and dripping Spanish moss of coastal Georgia, and the baronial becomes baroque.

The group’s original plan wasn’t ratified by Congress, but one very much like it was adopted and became the basis of the Federal Reserve system that remains in place today.

At the time, the Panic of 1907 was still fresh in everyone’s mind. J.P. Morgan had resolved that panic by locking the heads of major banks in his library overnight, and strong-arming them into a deal to provide sufficient liquidity to end the runs on banks and brokerages.

No one was happy with that expediency, and in 1908 Congress passed the Aldrich-Vreeland Act, which formed the National Monetary Commission. Senator Nelson Aldrich, a Rhode Island Republican and sponsor of the act, embarked on a fact-finding mission to Europe, where he met with government ministers and bankers.

The panic had shown that the existing financial system, founded on government bonds, was brittle and ponderous. But, although voters were eager for a more robust and responsive system, there was no support at the time for a central bank either from the public or from industrialists. Both were suspicious of such government interference.

The Jekyll Island collaborators knew that public reports of their meeting would scupper their plans. The idea of senior officials from the Treasury, Congress, major banks and brokerages (along with one foreign national) slipping off to design a new world order has struck generations of Americans as distasteful at best and undemocratic at worst — and would have been similarly received at the time. So the meeting of the minds was planned under the ruse of a gentlemen’s duck-hunting expedition.

Aldrich, an archetype of his age, was a personal friend of Morgan, and Aldrich’s daughter was married to John D. Rockefeller Jr. He found in the European central banks a useful model. Although the financial system in the U.S. was functional enough to stoke the engines of a growing industrial economy, it was a classic example of the persistence of interim solutions. The models Aldrich found in Europe were more efficient and effective.

What he lacked was a way to graft those characteristics onto the American economy without retarding it. Hence the duck hunt.

Aldrich invited men he knew and trusted, or at least men of influence who he felt could work together. They included Abram Piatt Andrew, assistant secretary of the Treasury; Henry P. Davison, a business partner of Morgan’s; Charles D. Norton, president of the First National Bank of New York; Benjamin Strong, another Morgan friend and the head of Bankers Trust; Frank A. Vanderlip, president of the National City Bank; and Paul M. Warburg, a partner in Kuhn, Loeb & Co. and a German citizen.

The men made their way to the island by private railway car and ferry.

In Vanderlip, Aldrich had found the tactician to design a functional American central bank. Vanderlip was born a farm boy in Aurora, Illinois, put himself through college, and worked his way up the Chicago financial ladder. He became personal assistant to Treasury Secretary Lyman Gage, and in 1898 made his mark managing loans to the government to finance the Spanish-American War.

As Bertie Charles Forbes related in his 1916 book, “Men Who Are Making America”:

Vanderlip knew more about government bonds than any other man living. He knew other banks would like to be relieved of all the red tape incidental to buying and putting up bonds to cover circulation, depositing reserves to cover note issues &c. He began to dictate a circular letter to be sent broadcast to the country’s 4,000 national banks.

That was exactly the kind of perspicacity Aldrich was seeking. The collaborators spent 10 days on Jekyll Island. What emerged was an idea for something called the National Reserve Association, which would act as a central bank, issuing currency and holding member banks’ reserves. While it would handle government debt, it would be a private institution. The U.S. Treasury would have a seat on the board, but would exercise no further oversight.

The reserve association was brought to Congress as the “Aldrich plan,” and it got nowhere. There was opposition in both parties, from populist William Jennings Bryan, a Nebraska Democrat, to progressive Robert La Follette, a Wisconsin Republican.

Woodrow Wilson ran for president opposed to the bankers’ club but committed to financial reform. There followed a blizzard of proposals from every part of the political spectrum. Eventually, Carter Glass, a Virginia Democrat and the chairman of the House banking committee, drafted what would become the Federal Reserve Act with the help of Robert Latham Owen, an Oklahoma Democrat. The act became law at the end of 1913.

Although the Glass-Owen bill was a compromise, the core of the Aldrich plan remained. There were many minor detail changes from the Jekyll Island accords, but the major one was a more prominent role given to the Treasury. (To this day the debate continues as to whether the Fed is truly independent, or should be.) Benjamin Strong, one of the Jekyll Island cohorts, became the first president of the New York Federal Reserve in 1914.

Today, a central bank is the global standard. All 187 members of the International Monetary Fund have them. In November 2010, Fed Chairman Ben S. Bernanke held a press conference on Jekyll Island to celebrate the centennial of the meeting. Aldrich and his colleagues would have been proud of their accomplishment — but mortified by the publicity.

(Gregory DL Morris is a member of the editorial board of the Museum of American Finance, a Smithsonian affiliate, and a contributor to the Echoes blog. The opinions expressed are his own.)

Europe moves ahead with fiscal union, deep economic integration

Germany’s Chancellor Angela Merkel addresses a news conference at the end of an European Union summit in Brussels December 9, 2011. Europe divided on Friday in a historic rift over building a closer fiscal union to preserve the euro, with an overwhelming majority of countries led by Germany and France agreeing to forge ahead with a separate treaty, leaving the EU’s third biggest economy Britain isolated. Reuters

New pact will have stricter debt rules and enforcement

Reuters | Dec 9, 2011

By Luke Baker and Mark John

BRUSSELS, Dec 9 (Reuters) – Europe secured an historic agreement to draft a new treaty for deeper economic integration in the euro zone on Friday, but Britain, the region’s third largest economy, refused to join the other 26 countries in a fiscal union and was isolated.

The outcome of a two-day European Union summit left financial markets uncertain whether and when more decisive action would be taken to stem a debt crisis that began in Greece in 2009, spread to Portugal, Ireland, Italy and Spain and now threatens France and even economic powerhouse Germany.

A new treaty could take three months to negotiate and may require risky referendums in countries such as Ireland.

Two ECB sources told Reuters the European Central Bank would keep purchases of euro zone government bonds capped for now and take no extra firefighting action. Debt markets were wary. Interbank lending rates eased but Italian 10-year bond yields rose to around 6.5 percent.

Twenty-six of the 27 EU leaders agreed to pursue a tougher budget discipline regime with automatic sanctions for deficit sinners in the single currency area, but Britain said it could not accept proposed EU treaty amendments after failing to secure concessions for itself.

“This is a breakthrough to a union of stability,” German Chancellor Angela Merkel said. “We will use the crisis as a chance for a new beginning.”

After 10 hours of talks that ran into the early hours of Friday, all 17 members of the euro zone and nine of the 10 outsiders resolved to negotiate a new agreement alongside the EU treaty.

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Britain’s few allies melted away in the Brussels dawn. All the other nine non-euro states said they wanted to take part in the fiscal union process, subject to parliamentary approval.

The rift, which could widen into a permanent divide between London and the continental mainland, occurred 20 years to the day after European leaders agreed at the Maastricht summit to create the single currency, with Britain opting to stay out.

Prime Minister David Cameron insisted at a news conference that it remained in Britain’s interest to stay in the EU and take advantage of its single market.

One senior EU diplomat called Cameron’s negotiating tactics “clumsy”. Among other things, he had sought a veto on a proposed financial transaction tax, which may now be voted through by a majority over the objections of the City of London financial centre.

NO BIG BAZOOKA

ECB President Mario Draghi called the EU’s decision a step forward for the stricter budget rules he has said are necessary for the euro zone to emerge stronger from the turmoil.

“It’s going to be the basis for a good fiscal compact and more discipline in economic policy in the euro area members,” Draghi said. “We came to conclusions that will have to be fleshed out more in the coming days.”

Two ECB sources said the bank’s governing council decided on Thursday to keep bond buying limited to around 20 billion euros a week and there was no need to review the decision in the light of the summit outcome.

“You will see some further purchases but not the huge bazooka that some people in the markets and the media are awaiting,” one central banker said on condition of anonymity.

French President Nicolas Sarkozy told reporters the ECB’s move to provide unlimited three-year funds to cash-starved European banks would be more effective, by enabling them to continue buying government bonds.

“This means that each state can turn to its banks, which will have liquidity at their disposal,” he said.

Analysts said the notion that commercial banks could step up their purchases of government bonds looked optimistic given the same banks are being asked to deleverage and recapitalise if necessary.

“SEETHES, SULKS, GLOATS”

Merkel said the world would see that Europe had learned from its mistakes and avoided “lousy compromise”.

Sarkozy sounded elated at having united a big group around the euro zone as the EU’s core, long a French objective.

“This is a summit that will go down in history,” he said. “We would have preferred a reform of the treaties among 27. That wasn’t possible given the position of our British friends. And so it will be through an intergovernmental treaty of 17, but open to others.”

One EU diplomat summed up the outcome as: “Britain seethes, Germany sulks, and France gloats.”

Active ECB support will be vital in the coming days with markets doubting the strength of Europe’s financial firewalls to protect vulnerable economies such as Italy and Spain, which have to roll over hundreds of billions of euros in debt next year.

Traders said the ECB bought Italian bonds on Friday to steady markets.

The euro rallied in Europe and U.S. shares gained, but analysts said the summit had done little to convince markets that a solution to the crisis was at hand.

Asked if the euro was safe now, Polish Prime Minister Donald Tusk said: “I’m not sure.”

BRITAIN OUTSIDE?

Britain refused to allow its partners to amend the EU treaty, demanding guarantees in a protocol protecting its financial services industry, roughly one-tenth of the country’s economy. Sarkozy described Cameron’s demand as unacceptable.

Cameron hinted London may now try to prevent the others from using the executive European Commission and the European Court of Justice, saying: “Clearly the institutions of the European Union belong to the European Union, they belong to the 27.”

But European Council President Herman Van Rompuy, who chaired the summit, said the EU institutions would be fully involved in the new treaty, which would be signed in early March at the latest. The euro zone plus nine may hold a summit without Britain as early as January, diplomats said.

The rift may increase pressure from Eurosceptics within Cameron’s Conservative party and outside it for Britain to hold a referendum on leaving the EU, which it joined in 1973. The prime minister strongly opposes such a course, which he has said would be disastrous for British interests.

Britain conducts more than half of its trade within the EU and could suffer on a broad range of financial regulation issues if the other countries decided to move forward as 26.

Van Rompuy said the summit’s key achievement was to tighten fiscal limits, including the need for countries to bring budgets close to balance.

“It means reinforcing our rules on excessive deficit procedures by making them more automatic. It also means that member states would have to submit their draft budgetary plans to the (European) Commission,” Van Rompuy said.

But a new treaty will take weeks of wrangling as countries like Finland and Slovakia oppose a Franco-German drive to take decisions on future bailouts by an 85 percent supermajority to avoid being taken hostage by a single small country.

LAST-CHANCE SALOON?

In a meeting billed by some as a last chance to save the euro, the leaders also took several decisions on the permanent bailout fund, the European Stability Mechanism, which will come into force a year early in July 2012.

The ESM’s capacity will be capped at 500 billion euros ($666 billion), less than had been suggested was possible before the summit, and the facility will not get a banking licence, as Van Rompuy originally had proposed, due to German opposition.

It also was agreed that EU countries would provide up to 200 billion euros in bilateral loans to the International Monetary Fund (IMF) to help it tackle the crisis, with 150 billion euros of the total coming from the euro zone countries.

Cameron’s decision to stay out of the treaty-change camp could spell problems for Britain. Deeper integration on the continent could involve changes to the single market and financial regulation, both of which could have a profound impact on the British economy.

“Cameron was clumsy in his manoeuvring,” a senior EU diplomat said. It may be possible that Britain will shift its position in the days ahead if it discovers that isolation really is not a viable course of action, diplomats said.

EU parliament’s political families meet with Chinese Communist Party

Xie Duo from the Central Bank of China believes the euro is stable (Photo: EUobserver)

euobserver.com | Nov 9, 2011

By Philip Ebels

BRUSSELS – A three-day forum of political heavyweights from the EU and China ended on Wednesday with kind words at a half-hour press conference.

The EU-China High-Level Group, the second of its kind after a first encounter in Beijing last year, brought together the leaders of the big European political families and representatives of the Communist Party of China (CPC).

“We discussed EU-China co-operation, social development and reforms, the construction of democracy and legal systems, sustainable development, and global economic governance,” said MEP Reinhard Buetikofer of the Greens, who chaired the meeting.

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The discussions were held in “a spirit of co-operation”, accoring to MEP Veronique De Keyser of the Socialist group in the parliament.

“Participants from both sides understand that only with constructive dialogue, mutual trust and tolerance can we enhance understanding, avoid misjudgement and lay a solid foundation for our partnership,” said Li Jinjun, deputy minister of the central committee of the CPC.

“To us Europeans, the forum has been a success. There is an evolution in the quality and the openness of the speeches. It is the liberty of the tone that marks this forum’s success,” said De Keyser.

“We used to just make our statements without there being much debate at all. But this time around, we really had an exchange of views, and I think that is great progress. [The forum] doesn’t lead to any concrete political outcome but it does add to understanding.” said Markus Loening, vice-president of the European Liberal Democrat and Reform party and German commissioner on human rights.

The forum’s busy programme, held nearly entirely behind closed doors, included a meeting with Jerzy Buzek, president of the European parliament, and speeches from several MEPs and EU trade commissioner Karel de Gught and social affairs commissioner Laszlo Andor.

“The EU is committed to help China’s transition towards an open society, support China’s economic and social reforms, and integrate China even further into the world trading system,” said Andor.

Ways in which China might be able to help the EU, however, were not explored as much, according to De Keyser: “We didn’t talk much about how or whether China could contribute to the European bail-out fund, [the European Financial Stability Fund]. That subject wasn’t on the programme.”

True to the spirit of the meetings, Xie Duo, director-general of the financial market department of the People’s Bank of China, said that he trusts the euro will survive the crisis.

“We think that the crisis is temporary. We believe that European governments will find the way out of the crisis. We believe that the euro will be strong and stable. The Central Bank of China supports the European Central Bank and the International Monetary Fund for their support to the euro currency,” he said.

He further stated that the best way to stimulate the global economy is to stimulate growth at home (see video). “We also face a lot of problems in China. If we can successfully control the inflation in China, if we can successfully transform our economic development model, it will help the world economic recovery.”

Goldman Sachs conquers Europe

While ordinary people fret about austerity and jobs, the eurozone’s corridors of power have been undergoing a remarkable transformation

What price the new democracy? Goldman Sachs conquers Europe

Independent | Nov 18, 2011

by Stephen Foley

The ascension of Mario Monti to the Italian prime ministership is remarkable for more reasons than it is possible to count. By replacing the scandal-surfing Silvio Berlusconi, Italy has dislodged the undislodgeable. By imposing rule by unelected technocrats, it has suspended the normal rules of democracy, and maybe democracy itself. And by putting a senior adviser at Goldman Sachs in charge of a Western nation, it has taken to new heights the political power of an investment bank that you might have thought was prohibitively politically toxic.

This is the most remarkable thing of all: a giant leap forward for, or perhaps even the successful culmination of, the Goldman Sachs Project.

It is not just Mr Monti. The European Central Bank, another crucial player in the sovereign debt drama, is under ex-Goldman management, and the investment bank’s alumni hold sway in the corridors of power in almost every European nation, as they have done in the US throughout the financial crisis. Until Wednesday, the International Monetary Fund’s European division was also run by a Goldman man, Antonio Borges, who just resigned for personal reasons.

Even before the upheaval in Italy, there was no sign of Goldman Sachs living down its nickname as “the Vampire Squid”, and now that its tentacles reach to the top of the eurozone, sceptical voices are raising questions over its influence. The political decisions taken in the coming weeks will determine if the eurozone can and will pay its debts – and Goldman’s interests are intricately tied up with the answer to that question.

Simon Johnson, the former International Monetary Fund economist, in his book 13 Bankers, argued that Goldman Sachs and the other large banks had become so close to government in the run-up to the financial crisis that the US was effectively an oligarchy. At least European politicians aren’t “bought and paid for” by corporations, as in the US, he says. “Instead what you have in Europe is a shared world-view among the policy elite and the bankers, a shared set of goals and mutual reinforcement of illusions.”

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This is The Goldman Sachs Project. Put simply, it is to hug governments close. Every business wants to advance its interests with the regulators that can stymie them and the politicians who can give them a tax break, but this is no mere lobbying effort. Goldman is there to provide advice for governments and to provide financing, to send its people into public service and to dangle lucrative jobs in front of people coming out of government. The Project is to create such a deep exchange of people and ideas and money that it is impossible to tell the difference between the public interest and the Goldman Sachs interest.

Mr Monti is one of Italy’s most eminent economists, and he spent most of his career in academia and thinktankery, but it was when Mr Berlusconi appointed him to the European Commission in 1995 that Goldman Sachs started to get interested in him. First as commissioner for the internal market, and then especially as commissioner for competition, he has made decisions that could make or break the takeover and merger deals that Goldman’s bankers were working on or providing the funding for. Mr Monti also later chaired the Italian Treasury’s committee on the banking and financial system, which set the country’s financial policies.

With these connections, it was natural for Goldman to invite him to join its board of international advisers. The bank’s two dozen-strong international advisers act as informal lobbyists for its interests with the politicians that regulate its work. Other advisers include Otmar Issing who, as a board member of the German Bundesbank and then the European Central Bank, was one of the architects of the euro.

Perhaps the most prominent ex-politician inside the bank is Peter Sutherland, Attorney General of Ireland in the 1980s and another former EU Competition Commissioner. He is now non-executive chairman of Goldman’s UK-based broker-dealer arm, Goldman Sachs International, and until its collapse and nationalisation he was also a non-executive director of Royal Bank of Scotland. He has been a prominent voice within Ireland on its bailout by the EU, arguing that the terms of emergency loans should be eased, so as not to exacerbate the country’s financial woes. The EU agreed to cut Ireland’s interest rate this summer.

Picking up well-connected policymakers on their way out of government is only one half of the Project, sending Goldman alumni into government is the other half. Like Mr Monti, Mario Draghi, who took over as President of the ECB on 1 November, has been in and out of government and in and out of Goldman. He was a member of the World Bank and managing director of the Italian Treasury before spending three years as managing director of Goldman Sachs International between 2002 and 2005 – only to return to government as president of the Italian central bank.

Mr Draghi has been dogged by controversy over the accounting tricks conducted by Italy and other nations on the eurozone periphery as they tried to squeeze into the single currency a decade ago. By using complex derivatives, Italy and Greece were able to slim down the apparent size of their government debt, which euro rules mandated shouldn’t be above 60 per cent of the size of the economy. And the brains behind several of those derivatives were the men and women of Goldman Sachs.

The bank’s traders created a number of financial deals that allowed Greece to raise money to cut its budget deficit immediately, in return for repayments over time. In one deal, Goldman channelled $1bn of funding to the Greek government in 2002 in a transaction called a cross-currency swap. On the other side of the deal, working in the National Bank of Greece, was Petros Christodoulou, who had begun his career at Goldman, and who has been promoted now to head the office managing government Greek debt. Lucas Papademos, now installed as Prime Minister in Greece’s unity government, was a technocrat running the Central Bank of Greece at the time.

Goldman says that the debt reduction achieved by the swaps was negligible in relation to euro rules, but it expressed some regrets over the deals. Gerald Corrigan, a Goldman partner who came to the bank after running the New York branch of the US Federal Reserve, told a UK parliamentary hearing last year: “It is clear with hindsight that the standards of transparency could have been and probably should have been higher.”

When the issue was raised at confirmation hearings in the European Parliament for his job at the ECB, Mr Draghi says he wasn’t involved in the swaps deals either at the Treasury or at Goldman.

It has proved impossible to hold the line on Greece, which under the latest EU proposals is effectively going to default on its debt by asking creditors to take a “voluntary” haircut of 50 per cent on its bonds, but the current consensus in the eurozone is that the creditors of bigger nations like Italy and Spain must be paid in full. These creditors, of course, are the continent’s big banks, and it is their health that is the primary concern of policymakers. The combination of austerity measures imposed by the new technocratic governments in Athens and Rome and the leaders of other eurozone countries, such as Ireland, and rescue funds from the IMF and the largely German-backed European Financial Stability Facility, can all be traced to this consensus.

“My former colleagues at the IMF are running around trying to justify bailouts of €1.5trn-€4trn, but what does that mean?” says Simon Johnson. “It means bailing out the creditors 100 per cent. It is another bank bailout, like in 2008: The mechanism is different, in that this is happening at the sovereign level not the bank level, but the rationale is the same.”

So certain is the financial elite that the banks will be bailed out, that some are placing bet-the-company wagers on just such an outcome. Jon Corzine, a former chief executive of Goldman Sachs, returned to Wall Street last year after almost a decade in politics and took control of a historic firm called MF Global. He placed a $6bn bet with the firm’s money that Italian government bonds will not default.

When the bet was revealed last month, clients and trading partners decided it was too risky to do business with MF Global and the firm collapsed within days. It was one of the ten biggest bankruptcies in US history.

The grave danger is that, if Italy stops paying its debts, creditor banks could be made insolvent.  Goldman Sachs, which has written over $2trn of insurance, including an undisclosed amount on eurozone countries’ debt, would not escape unharmed, especially if some of the $2trn of insurance it has purchased on that insurance turns out to be with a bank that has gone under. No bank – and especially not the Vampire Squid – can easily untangle its tentacles from the tentacles of its peers. This is the rationale for the bailouts and the austerity, the reason we are getting more Goldman, not less. The alternative is a second financial crisis, a second economic collapse.

Shared illusions, perhaps? Who would dare test it?

Borneo mines lure Rothschild into the wild

Financier and co-chairman of Bumi Plc Nathaniel Rothschild (L) sits with Bakrie & Brothers Chief Executive Officer Bobby Gafur Umar following an agreement between Bumi Resources and Vallar Plc in Singapore, in this handout photo dated November 15, 2010. It was supposed to be a union of two legendary business dynasties, one West, one East. Rothshild, the 40-year-old scion of the storied European banking family, forged a deal in 2010 with the Bakrie brothers, one of Indonesia’s mightiest business families, to create an international coal-mining titan. That deal in November 2010 seemed incredible from the start; the dream of creating the world’s biggest thermal coal company, with mines in Indonesian Borneo, and aiming to be one of the biggest listed companies on the London exchange. Now a year later the partnership could be on the brink of collapse. This week Rothschild called for a “radical cleaning up” of the balance sheet and corporate culture at the Bakrie brothers chronically indebted flagship, PT Bumi Resources, his partner in the London-listed coal venture, Bumi Plc. Reuters

“What we are creating here is the largest exporter of thermal coal to China,” Rothschild, whose ancestors advised generations of European royalty and helped to bankroll Britain’s war against Napoleonic France, declared at the time.

Indonesia has some of the world’s largest deposits of coal, gold, copper, tin and natural gas, spread across the archipelago of 17,000 islands. The legacy of harsh colonialism by the Dutch for over three hundred years has left many Indonesians with a distrust of foreign motives.

Reuters | Nov 12, 2011

By Janeman Latul, Saeed Azhar and Clara Ferreira Marques

JAKARTA/LONDON (Reuters)- It was supposed to be a union of two legendary business dynasties, one West, one East. Nathaniel Philip Rothshild, the 40-year-old scion of the storied European banking family, forged a deal a year ago with the Bakrie brothers, one of Indonesia’s mightiest business families, to create an international coal-mining titan.

That deal last November seemed incredible from the start; the dream of creating the world’s biggest thermal coal company, with mines in Indonesian Borneo, and aiming to be one of the biggest listed companies on the London exchange. Now a year later the partnership could be on the brink of collapse.

This week Rothschild called for a “radical cleaning up” of the balance sheet and corporate culture at the Bakrie brothers chronically indebted flagship, PT Bumi Resources, his partner in the London-listed coal venture, Bumi Plc.

In a letter written to Ari Hudaya, Chief Executive of both Bumi Plc and Jakarta-listed PT Bumi Resources, Rothschild said the partnership’s goal of entering the FTSE-100 in 2012 was still attainable. But he was not satisfied with progress so far with his Indonesian partners, who remain “over-leveraged,” which was a major factor in the “corporate governance discount” on the Jakarta’s firm’s stock price.

The leaked letter was a stunning rebuke to top Bakrie lieutenant Ari Hudaya. Hudaya’s dual role as CEO of both the Bakries’ PT Bumi Resources and the Bumi Plc joint venture required “closer evaluation and scrutiny,” Rothschild wrote in the letter, published on the Financial Times website.

Rothschild knew he was dealing with one of Southeast Asia’s most powerful and controversial families, and one with chronic debt issues. Over the past two decades, he has flirted with risk and emerging market powerbrokers, ranging from an oil venture in Iraqi Kurdistan to a friendship with Muammar Gaddafi’s son Saif al-Islam, who has been trying to flee Libya after the death of his father.

In the process, Rothschild has shed the party-hard reputation of his university years — the Sunday Times Rich List anointed him Britain’s richest hedge fund manager and he is estimated to be worth around a billion pounds. He has emerged as a serious dealmaker with a contacts book to rival that of his father, Baron Rothschild, and spends the equivalent of around a month each year in his private jet “N4T.”

On the Indonesian side, Aburizal Bakrie, the oldest of the brothers, headed the group until 2004, when he joined President Susilo Bambang Yudhoyono’s administration. He left after repeatedly clashing with reformers in Yudhoyono’s government and now heads Indonesia’s biggest political party, Golkar. He is a likely presidential candidate in the 2014 Indonesian elections.

The strain in relations between the future Baron Rothschild and a family that may boast a future president after their hopeful beginning a year ago illustrates some of the difficulties in doing business in Indonesia.

Southeast Asia’s largest economy is brimming with opportunities, though it does means navigating through opaque regulations, erratic business relationships, changing policies and deeply entrenched corruption. The World Bank ranks it 129 out of 183 countries in ease of doing business.

GLOBAL MARKET SELL-OFF

For the Bakries, the allure of the deal with Rothschild was to get that prized listing on the London exchange. As Rothschild noted in his letter, their shares on the Jakarta exchange have underperformed, despite the attractiveness of the coal assets.

Rothschilds’ company Vallar became Bumi Plc and was relisted on the London Stock Exchange in June — just ahead of a global market sell-off. The stock dropped steadily from the start as markets fell, until it hit 8.50 pounds. That price triggered a margin call from Bakrie lenders who demanded repayment on loans worth $1.3 billion.

The Bakries brought in a new investor at the end of October to fix that problem, Indonesian coal miner and investment banker Samin Tan. They sold half their original 47 percent stake in Bumi Plc to Tan in a complex deal that featured special purpose share-holding vehicles.

The deal did not dilute Rothschild’s 10 percent stake in Bumi Plc, and Rothschild in his letter said he fully supports Tan’s entrance into the partnership. What he objected to, Rothschild said, was that Hudaya had refused to call in Bumi Resources’ own loans to others to repay debt. Bumi Plc owns a 29 per cent stake in PT Bumi Resources, which in turn controls the lucrative mines.

Chris Fong, a spokesman for the Bakrie family, told Reuters Rothschild’s letter had taken them by surprise.

“Nat Rothschild hasn’t addressed these issues with us,” Fong said, referring to a passage in the letter in which Rothschild said the Bakries also wanted a transformation in the management of Bumi Resources.

“If he wants to raise any issues, as a shareholder and board member, we would expect him to follow accepted corporate governance procedures and raise concerns at the board level and at the appropriate time.”

The two sides, according to knowledgeable sources in both camps, had been taking each other by surprise of late.

Rothschild, thousands of miles away in Europe, had called the Bakries after Reuters first broke news in late October of an impending deal with Tan, but he could get no confirmation of the deal.

“The family left Rothschild in the dark until the news that Samin Tan was nearing a deal and he called the family about it,” said a source close to the Bakries with direct knowledge of the situation. “The group didn’t think he needed to know about this, that he should only know when a deal was done.”

Eton-educated Rothschild insisted in an interview last month with Reuters that he had no issue with the Bakries, and that he had “total confidence” in the family.

The latest turns in the Bakries’ fortunes seems to be following a script written three years ago during the 2008 global financial crisis. They fended off a $1.2 billion margin call then by selling stakes in group firms, many of them with buy-back clauses, to lenders and investors.

Like then, the Bakries’ latest debt refinancing also ensured the prized Borneo mines would remain in Indonesian hands.

LEGACY OF DISTRUST

Indonesia has some of the world’s largest deposits of coal, gold, copper, tin and natural gas, spread across the archipelago of 17,000 islands. The legacy of harsh colonialism by the Dutch for over three hundred years has left many Indonesians with a distrust of foreign motives.

The Borneo coal mines at the heart of the deal with Rothschild once belonged to global energy companies Rio Tinto, BP and BHP Billiton, who sold them to the Bakries in 2001 and 2003, after coming under pressure from resource nationalists to divest their assets to local interests.

“Our contacts at the time told us these deals undervalued the companies at pennies on the dollar,” said the U.S. Ambassador to Indonesia, Cameron Hume, in a November 2007 classified diplomatic cable released by Wikileaks. Bakrie group executives, Hume added, have said they hoped to do more of these “value-oriented acquisitions.”

“In the mining sector, cabinet minister Aburizal Bakrie has been most successful in using nationalism for his private personal gain,” Hume noted in that cable.

Aburizal Bakrie’s Golkar party at the time was making resource nationalism an issue in the run-up to the 2009 presidential election, threatening to review energy contracts with foreign oil companies.

So it caused ripples of surprise and interest when Nirwan Bakrie celebrated his 59th birthday last year by announcing that the coal assets held by PT Bumi Resources would be injected into Rothschild’s London-listed investment vehicle Vallar.

Rothschild put up 100 million pounds of his own money, but the new company’s biggest asset would seem to be worth the price. The KPC mines in East Kalimantan province in Indonesia’s part of Borneo island are among the world’s largest open pit mines, with 4.5 billion tonnes of proven reserves. Bumi Plc expects coal sales this year of 77 million tonnes, which would make it the world’s largest thermal coal exporter.

“What we are creating here is the largest exporter of thermal coal to China,” Rothschild, whose ancestors advised generations of European royalty and helped to bankroll Britain’s war against Napoleonic France, declared at the time.

For Rothschild, the venture was an opportunity to become a key player in the global coal industry, and to cement his image as a buccaneering financier in the mold of his 19th Century forbears.

For the Bakrie family, who escaped financial collapse twice before in 1998 and 2008, the London listing gave it instant credibility and a global profile.

“We needed the London listing to establish a presence in the international capital market … we wanted to show the world that Indonesia owns a global champion in coal,” Nirwan Bakrie told Reuters in Jakarta last month.

SEEDS OF MISTRUST

But not long after that hopeful beginning, seeds of mistrust were sown. In March, three months before Bumi Plc’s London listing, the Bakrie group’s holding company, Bakrie & Brothers, along with affiliated firm Long Haul, consolidated some of their debt through a $1.35 billion loan arranged by Credit Suisse and backed by their stake in Bumi Plc.

Rothschild and his advisors asked for the details at the time but were told those were private and had no relevance to their joint venture in Bumi Plc, sources close to the Bakrie family said.

By early October, Bumi Plc’s falling share price triggered the margin call on that loan, plunging the Bakries into a new debt crisis and ultimately leading to the Tan deal.

According to several sources close to Bakrie family, the Bakries believed Rothschild was ready to buy their now cheapened stake in Bumi Plc if the group was pushed into default.

“He already was looking for a new local partner to replace the Bakries here … but the coal mining world is small in Indonesia and those local partners declined to do a deal with him,” one source said. “I think this guy is not a good partner.”

The Rothschild camp denies those claims.

With the mistrust apparently deepening, Ari Hudaya, the CEO of Bumi Resources and Bumi Plc and the target of Rothschild’s disgruntlement in his letter, called Rothschild on October 17 on his Blackberry.

He had just met with the Bumi Resources board inside the Bakrie Tower in Jakarta’s financial district, whose dark tinted windows afford views of a volcano outside the capital. They had decided to cancel a $2 billion deal announced in June that would have given Bumi Plc 75 percent of Bumi Resources Minerals (BRM), the Bakries’ latest mining exploration venture, with promising assets from copper and zinc in the jungles of Indonesia to African diamonds.

Bumi Plc said later in a regulatory announcement from London the deal was canceled due to “continuing market uncertainties,” which was affecting the share prices of the companies involved.

The decision left Rothschild with a less diversified mining firm, and closing off what seemed an easy and promising entrance to new mining frontiers.

FRIEND OF BAKRIES

The Bakries had first tried to do a loan deal with Glencore, Reuters reported last month. The commodity trading giant was keen to get a tighter grip on their Indonesian coal marketing rights and keep out rival trader Vitol.

But because lenders wanted the deal to involve an equity stake, the Bakries turned to Tan, who controls Borneo Lumbung Energi and investment bank PT Renaissance Capital. The two sides were no strangers, since Tan had advised the Bakries on their 2003 mine purchases and then tried to buy Bumi’s key mines himself in a failed deal several years ago.

Like the Bakries, Tan comes from Sumatra, born into a family of fish traders. He was a partner at accountancy firm Deloitte, before setting up his own investment firm.

“The deal is not only about Bakrie,” Tan told Reuters, when asked about the risk of any deal with the Bakries, adding he had prepared some “safety measurement.”

Investors were not impressed, given that Tan is financing it with a loan from Standard Chartered that boosts his Borneo Lumbung Energi’s debt profile. The firm’s stock crashed as much as 17 percent on the day of the deal, and several banks have since downgraded their investment ratings on the miner, from “buy” to “hold” or “reduce.”

Investment banks have said it shouldn’t not hurt Bumi Plc, and the London stock has steadied this month along with the rest of the market.

Weeks before his scathing letter to his Indonesian partner, Rothschild had told Reuters he was confident he would continue to have a relationship with the Bakries for a long time to come.

“In 10 years’ time, I expect to still have the same type of strong and trusting relationship that I have with the Bakries today.”