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Goldman Sachs Remains in the Spotlight

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Goldman Sachs has become a magnet for bad publicity.  Last week, I wrote a piece entitled, “Why Bad Publicity Never Hurts Goldman Sachs”.  On March 14, Greg Smith (a Goldman Sachs executive director and head of the firm’s United States equity derivatives business in Europe, the Middle East and Africa) summed-up his disgust with the firm’s devolution by writing “Why I Am Leaving Goldman Sachs” for The New York Times.  Among the most-frequently quoted reasons for Smith’s departure was this statement:

It makes me ill how callously people talk about ripping their clients off.  Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail.

In the wake of Greg Smith’s very public resignation from Goldman Sachs, many commentators have begun to speculate that Goldman’s bad behavior may have passed a tipping point.  The potential consequences have become a popular subject for speculation.  The end of Lloyd Blankfein’s reign as CEO has been the most frequently-expressed prediction.  Peter Cohan of Forbes raised the possibility that Goldman’s clients might just decide to take their business elsewhere:

Until a wave of talented people leave Goldman and go work for some other bank, many clients will stick with Goldman and hope for the best.  That’s why the biggest threat to Goldman’s survival is that Smith’s departure – and the reasons he publicized so nicely in his Times op-ed – leads to a wider talent exodus.

After all, that loss of talent could erode Goldman’s ability to hold onto clients. And that could give Goldman clients a better alternative.  So when Goldman’s board replaces Blankfein, it should appoint a leader who will restore the luster to Goldman’s traditional values.

Goldman’s errant fiduciary behavior became a popular topic in July of 2009, when the Zero Hedge website focused on Goldman’s involvement in high-frequency trading, which raised suspicions that the firm was “front-running” its own customers.   It was claimed that when a Goldman customer would send out a limit order, Goldman’s proprietary trading desk would buy the stock first, then resell it to the client at the high limit of the order.  (Of course, Goldman denied front-running its clients.)  Zero Hedge brought our attention to Goldman’s “GS360” portal.  GS360 included a disclaimer which could have been exploited to support an argument that the customer consented to Goldman’s front-running of the customer’s orders.  One week later, Matt Taibbi wrote his groundbreaking, tour de force for Rolling Stone about Goldman’s involvement in the events which led to the financial crisis.  From that point onward, the “vampire squid” and its predatory business model became popular subjects for advocates of financial reform.

Despite all of the hand-wringing about Goldman’s controversial antics – especially after the April 2010 Senate Permanent Subcommittee on Investigations hearing, wherein Goldman’s “Fab Four” testified about selling their customers the Abacus CDO and that “shitty” Timberwolf deal, no effective remedial actions for cleaning-up Wall Street were on the horizon.  The Dodd-Frank financial “reform” legislation had become a worthless farce.

Exactly two years ago, publication of the report by bankruptcy examiner Anton Valukas, pinpointing causes of the Lehman Brothers collapse, created shockwaves which were limited to the blogosphere.  Unfortunately, the mainstream media were not giving that story very much traction.  On March 15 of 2010, the Columbia Journalism Review published an essay by Ryan Chittum, decrying the lack of mainstream media attention given to the Lehman scandal.  This shining example of Wall Street malefaction should have been an influential factor toward making the financial reform bill significantly more effective than the worthless sham it became.

Greg Smith’s resignation from Goldman Sachs could become the game-changing event, motivating Wall Street’s investment banks to finally change their ways.  Matt Taibbi seems to think so:

This always had to be the endgame for reforming Wall Street.  It was never going to happen by having the government sweep through and impose a wave of draconian new regulations, although a more vigorous enforcement of existing laws might have helped.  Nor could the Occupy protests or even a monster wave of civil lawsuits hope to really change the screw-your-clients, screw-everybody, grab-what-you-can culture of the modern financial services industry.

Real change was always going to have to come from within Wall Street itself, and the surest way for that to happen is for the managers of pension funds and union retirement funds and other institutional investors to see that the Goldmans of the world aren’t just arrogant sleazebags, they’re also not terribly good at managing your money.

*   *   *

These guys have lost the fear of going out of business, because they can’t go out of business.  After all, our government won’t let them.  Beyond the bailouts, they’re all subsisting daily on massive loads of free cash from the Fed.  No one can touch them, and sadly, most of the biggest institutional clients see getting clipped for a few points by Goldman or Chase as the cost of doing business.

The only way to break this cycle, since our government doesn’t seem to want to end its habit of financially supporting fraud-committing, repeat-offending, client-fleecing banks, is for these big “muppet” clients to start taking their business elsewhere.

In the mean time, the rest of us will be keeping our fingers crossed.


 

Getting It Reich

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April 8, 2010

Robert Reich, former Secretary of Labor under President Clinton, has been hitting more than a few home runs lately.   At a time when too many commentators remain in lock-step with their favorite political party, Reich pulls no punches when pointing out the flaws in the Obama administration’s agenda.  I particularly enjoyed his reaction to the performance of Larry Summers on ABC television’s This Week on April 4:

I’m in the “green room” at ABC News, waiting to join a roundtable panel discussion on ABC’s weekly Sunday news program, This Week.

*   *   *

Larry Summers was interviewed just before Greenspan. He said the economy is expanding, that the Administration is doing everything it can to bring jobs back, and that the regulatory reform bills moving on the Hill will prevent another financial crisis.

What?

*   *   *

If any three people are most responsible for the failure of financial regulation, they are Greenspan, Larry Summers, and my former colleague, Bob Rubin.

*   *   *

I dislike singling out individuals for blame or praise in a political system as complex as that of the United States but I worry the nation is not on the right economic road, and that these individuals — one of whom advises the President directly and the others who continue to exert substantial influence among policy makers — still don’t get it.

The direction financial reform is taking is not encouraging.  Both the bill that emerged from the House and the one emerging from the Senate are filled with loopholes that continue to allow reckless trading of derivatives.  Neither bill adequately prevents banks from becoming insolvent because of their reckless trades.  Neither limits the size of banks or busts up the big ones.  Neither resurrects the Glass-Steagall Act. Neither adequately regulates hedge funds.

More fundamentally, neither bill begins to rectify the basic distortion in the national economy whose rewards and incentives are grotesquely tipped toward Wall Street and financial entrepreneurialism, and away from Main Street and real entrepreneurialism.

Is it because our elected officials just don’t understand what needs to be done to prevent another repeat of the financial crisis – or is the unwillingness to take preventative action the result of pressure from lobbyists?  I think they’re just playing dumb while they line their pockets with all of that legalized graft. Meanwhile, Professor Reich continued to function as the only adult in the room, with this follow-up piece:

Needless to say, the danger of an even bigger cost in coming years continues to grow because we still don’t have a new law to prevent what happened from happening again.  In fact, now that they know for sure they’ll be bailed out, Wall Street banks – and those who lend to them or invest in them – have every incentive to take even bigger risks.  In effect, taxpayers are implicitly subsidizing them to do so.

*   *   *

But the only way to make sure no bank it too big to fail is to make sure no bank is too big.  If Congress and the White House fail to do this, you have every reason to believe it’s because Wall Street has paid them not to.

Reich’s recent criticism of the Federal Reserve was another sorely-needed antidote to Ben Bernanke’s recent rise to media-designated sainthood.  In an essay quoting Republican Senator Jim DeMint of South Carolina, Reich transcended the polarized political climate to focus on the fact that the mysterious Fed enjoys inappropriate authority:

The Fed has finally came clean.  It now admits it bailed out Bear Stearns – taking on tens of billions of dollars of the bank’s bad loans – in order to smooth Bear Stearns’ takeover by JP Morgan Chase.  The secret Fed bailout came months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, even months before Lehman Brothers collapsed.  The Fed also took on billions of dollars worth of AIG securities, also before the official government-sanctioned bailout.

The losses from those deals still total tens of billions, and taxpayers are ultimately on the hook.  But the public never knew.  There was no congressional oversight.  It was all done behind closed doors. And the New York Fed – then run by Tim Geithner – was very much in the center of the action.

*   *   *

The Fed has a big problem.  It acts in secret.  That makes it an odd duck in a democracy.  As long as it’s merely setting interest rates, its secrecy and political independence can be justified. But once it departs from that role and begins putting billions of dollars of taxpayer money at risk — choosing winners and losers in the capitalist system — its legitimacy is questionable.

You probably thought that Ron Paul was the only one who spoke that way about the Federal Reserve.  Fortunately, when people such as Robert Reich speak out concerning the huge economic and financial dysfunction afflicting America, there is a greater likelihood that those with the authority to implement the necessary reforms will do the right thing.  We can only hope.



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Watching For Storm Clouds

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October 26, 2009

As the economy continues to flounder along, one need not look very far to find enthusiastic cheerleaders embracing any seemingly positive information to reinforce the belief that this catastrophic chapter in history is about to reach an end.  Meanwhile, others are watching out for signs of more trouble.  The recent celebrations over the return of the Dow Jones Industrial Average to the 10,000 level gave some sensible commentators the opportunity to point out that this may simply be evidence that we are experiencing an “asset bubble” which could burst at any moment.

October 21 brought the latest Quarterly Report from SIGTARP, the Special Investigator General for TARP, who is a gentleman named Neil Barofsky.  Since the report is 256 pages long, it made more sense for Mr. Barofsky to submit to a few television interviews and simply explain to us, the latest results of his investigatory work.  In a discussion with CNN’s Wolf Blitzer on that date, Mr. Barofsky voiced his concern about the potential consequences that could arise because those bailed-out banks, considered “too big to fail” have continued to grow, due to government-approved mergers:

“These banks that were too big to fail are now bigger,” Barofsky said.  “Government has sponsored and supported several mergers that made them larger and that guarantee, that implicit guarantee of moral hazard, the idea that the government is not going to let these banks fail, which was implicit a year ago, is now explicit, we’ve said it.  So if anything, not only have there not been any meaningful regulatory reform to make it less likely, in a lot of ways, the government has made such problems more likely.

“Potentially we could be in more danger now than we were a year ago,” he added.

In comparing where the economy is now, as opposed to this time last year, we haven’t seen much in the way of increased lending by the oversized banks.  In fact, we’ve only seen more hubris and bullying on their part.  Julian Delasantellis expressed it this way in his October 22 essay for the Asia Times:

Now, a year later, things have turned out exactly as expected – except that the roles are reversed.  The rulemakers have not disciplined the corrupted; it’s more accurate to say that the corrupted have abased the rulemakers.  If the intention was that the big investment banks would settle down into a sort of quiet, reserved suburban lifestyle, the reality has been that they’ve acted more like former gangsters placed into the US government’s witness protection program, taking over the numbers racket on the Saturday pee-wee soccer fields.

*   *   *

Obviously, there can’t be any inflation, or any real long-term earnings growth for consumer and business-oriented banks for that matter, as long as the economic crisis continues to destroy capital faster than Obama can ask Bernanke to print it.

These issues are of little concern to operations such as Goldman and Morgan, with their trading strategies and profit profiles essentially divorced from the real economy.  But down here on planetary level, as the little league baseball fields don’t get maintained because the businesses who funded the work go out of business after having their loans called, after elderly people with chest pains have to wait longer for one of the few ambulances on station after rescue service cutbacks, life is changing, changing for the long term, and it sure isn’t pretty.

“Proprietary trading” by banks such as Goldman Sachs and JP Morgan Chase, forms an important part of their business model.  This practice involves trading by those banks, on their own accounts, rather than the accounts of customers.  The possibility of earning lavish bonus payments helps to incentivize risk taking by the traders working on the “prop desks” of those institutions.  Gillian Tett wrote a report for the Financial Times on October 22, wherein she discussed an e-mail she received from a recently-retired banker, who stays in touch with his former colleagues — all of whom remain actively trading the markets.  Ms. Tett observed that this man was “feeling deeply shocked” when he shared his observations with her:

“Forget about the events of the past 12 months … the punters are back punting as aggressively as ever,” he wrote.  “Highly leveraged short-term trades are back in vogue as players … jostle to load up on everything from Reits [real estate investment trusts] and commercial property, commodities, emerging markets and regular stocks and bonds.

“Oh, I am sure the banks’ public relations people will talk about the subdued atmosphere in banking, but don’t you believe it,” he continued bitterly, noting that when money is virtually free — or, at least, at 0.5 per cent — traders feel stupid if they don’t leverage up.

“Any sense of control is being chucked out of the window.  After the dotcom boom and bust it took a good few years for the market to get its collective mojo back [but] this time it has taken just a few months,” he added.  He finished with a despairing question:  “Was October 2008 just a dress rehearsal for the crash when this latest bubble bursts?”

*   *   *

Yet, if you talk at length to traders — or senior bankers — it seems that few truly believe that fundamentals alone explain this pattern.  Instead, the real trigger is the amount of money that central bankers have poured into the system that is frantically seeking a home, because most banks simply do not want to use that cash to make loans.  Hence, the fact that the prices of almost all risk assets are rallying — even as non-risky assets such as Treasuries bounce too.

Now, some western policymakers like to argue — or hope –that this striking rally could be beneficial, in a way, even if it is not initially based on fundamentals.  After all, the argument goes, if markets rebound sharply, that should boost animal spirits in a way that could eventually seep through to the “real” economy.

On this interpretation, the current rally could turn out to be akin to the firelighter that one uses to start a blaze in a pile of damp wood.

*   *   *

So I, like my e-mail correspondent, am growing uneasy.  Perhaps, the optimistic “firelighter-igniting-the-damp-wood” scenario will yet come to play; but we will probably not really know whether the optimists are correct for at least another six months.

Gillian Tett’s “give it six months” approach seems much more sober and rational than what we hear from many of the exuberant commentators appearing on television.  Beyond that, she reminds us that our current situation involves a more important issue than the question of whether our economy can experience sustained growth:  The continued use of leveraged risk-taking by TARP beneficiaries invites the possibility of a return to last year’s crisis-level conditions.  As long as those banks know that the taxpayers will be back to bail them out again, there is every reason to assume that we are all headed for more trouble.



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Pay More Attention To That Man Behind The Curtain

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October 15, 2009

Reading the news these days can cause so much aggravation, I’m surprised more people haven’t pulled out all of their hair.  Regardless of one’s political perspective, there is an inevitable degree of outrage experienced from revelations concerning the role of government malfeasnace in causing and reacting to the financial crisis.  We have come to rely on satire to soothe our anger.  (For a good laugh, be sure to read this.)  Fortunately, an increasing number of commentators are not only exposing the systemic problems that created this catastrophe – they’re actually suggesting some good solutions.

Robert Scheer, editor of Truthdig, recently considered the idea that the debate over healthcare reform might just be a distraction from the more urgent need for financial reform:

The health care issue should never even have been brought up at a time when the economy is reeling and we are running such immense deficits to shore up the banks.  Instead of fixing the economy by saving Americans’ homes and jobs, we are preoccupied with pie-in-the-sky rhetoric on a hot issue that should have been addressed in calmer times.  It came up now because, despite all the hoary partisan posturing, it is a safer subject than the more pressing issue of what to do with Citigroup, AIG and General Motors, which the taxpayers happen to own but do not control.  While Treasury Secretary Timothy Geithner plots in secret with the top bankers who got us into this mess, we are focused on the perennial circus of so-called health care reform.

There is an odd disconnect between the furious public debate over health care reform, with its emphasis on the cost of an increased government role, and the nonexistent discussion about the far more expensive and largely secretive government program to bail out Wall Street.  Why the agitation over the government spending $83 billion a year on health care when at least 20 times that amount has been thrown at the creators of the ongoing financial crisis without any serious public accountability?  On Wednesday, the Wall Street Journal reported that employees of the financial industry that we taxpayers saved are slated to be paid a record $140 billion this year.

Remember, taxpayers:  That $140 billion is your money.  The bailed-out institutions may claim to have repaid their TARP obligations, but they also received trillions in loans from the Federal Reserve — and Ben Bernanke refuses to disclose which institutions received how much.

William Greider wrote a superb essay for the October 26 issue of The Nation, emphasizing the importance of the work undertaken by the Financial Crisis Inquiry Commission, led by Phil Angelides, as well as the investigation being done by the House Committee on Oversight and Government Reform:

Even if Congress manages to act this fall, the debate will not end.  Obama’s plan does not begin to get at the rot in the financial system.  Wall Street’s most notorious practices continue to flourish, and if unemployment rates keep rising through 2010, the public will not set aside its anger.  The Angelides investigators could put the story back on the front page.

*  *  *

Beyond Ponzi schemes and deceitful mortgage lending, a far larger crime may lurk at the center of the crisis — wholesale securities fraud.  “Risk models” reassured unwitting investors who bought millions of bundled mortgage securities and derivatives like credit-default swaps.  But as Christopher Whalen of Institutional Risk Analytics has testified, many of the models lacked real-life markets where they could be tested and verified.  “Clearly, we have now many examples where a model or the pretense of a model was used as a vehicle for creating risk and hiding it,” Whalen said.  “More important, however, is the role of financial models for creating opportunities for deliberate acts of securities fraud.”  That’s what investigators can examine.  What did the Wall Street firms know about the reliability of these models when they sold the securities?  And what did they tell the buyers?

*  *  *

Surely the political system itself is a root cause of the financial crisis.  The swollen influence of financial interests pushed Congress and presidents to repeal regulation and look the other way as reckless excesses developed.  Efforts to restore a more reliable representative democracy can start with Congress.  The power of money could be curbed by new rules prohibiting members of key committees from accepting contributions from the sectors they oversee.  Regulatory agencies, likewise, need internal designs to protect them from capture by the industries they regulate.

The Federal Reserve, having failed in its obligations so profoundly, should be reconstituted as an accountable federal agency, shorn of the excessive secrecy and insider privileges accorded to bankers.  The Constitution gives Congress, not the executive branch, the responsibility for managing money and credit.  Congress must reassert this responsibility and learn how to provide adequate oversight and policy critique.

Reforming the financial system, in other words, can be the prelude to reviving representative democracy.

At The Huffington Post, Robert Borosage warned that the financial industry is waging a huge lobbying battle to derail any attempts at financial reform.  Beyond that, the banking lobbyists will re-write any legislation to make it more favorable to their own objectives:

The banking lobby is nothing if not shameless.  They hope to use the reforms to WEAKEN current law.  They are pushing to make the federal standard the ceiling on reform, stripping the power of states to have higher standards.  Basically, they are hoping to find a way to shut down the independent investigations of state attorneys general like New York’s Eliot Spitzer and Andrew Cuomo or Illinois’ Lisa Madigan.

*  *  *

Historically, the banks, as Senator Dick Durbin decried in disgust, “own the place.”  And they’ve succeeded thus far in frustrating reform, even while pocketing literally hundreds of billions in support from taxpayers.

*  *  *

But this time it could be different.  Backroom deals are no longer safe.  Americans have been fleeced of trillions in the value of their homes and their savings because of Wall Street’s reckless excesses.  Then as taxpayers, they were extorted to ante up literally trillions more to forestall economic collapse by bailing out the banking sector.  Insult was added to that injury when the Federal Reserve refused to tell the Congress who got the money and on what terms.

Legislators would be well advised to understand the cozy old ways of doing business are no longer acceptable.  Americans are livid and paying attention.  Legislators who rely on Wall Street to finance their campaigns and then lead the effort to block or dilute reforms will discover that their constituents know what they have been up to.  Organizations like my own Campaign for America’s Future, the Sunlight Foundation, Americans for Financial Reform, Huffington Post bloggers will make certain the word gets out.  Legislators may discover that Wall Street’s money is a burden, not a blessing.

The most encouraging article I have seen came from Dan Gerstein of Forbes.  His perspective matched my sentiments exactly.  Looking through President Obama’s empty rhetoric, Mr. Gerstein helped provide direction and encouragement to those of us who are losing hope that our dysfunctional government could do anything close to addressing our nation’s financial ills:

The Changer-in-Chief long ago gave up on the idea of dismantling and remaking the crazy-quilt regulatory system that Wall Street (along with its Washington enablers) rigged for its own enrichment at everyone else’s expense.

*  *  *

Instead, Team Obama opted to move around the deck chairs within the existing bureaucracy, daftly hoping this conformist approach would be enough to prevent another titanic meltdown.

*  *  *

In the end, though, the key to success will be countering Wall Street’s influence and putting the politicians’ feet to the ire.  Members of Congress need to know there will be consequences for sticking with the status quo.      . . .  Make clear to every incumbent: Endorse our plan and we’ll give you money and public support; back the banks, and we will run ads against you telling voters you are for corrupt capitalism.

As I have said before, this is all about power.  Right now, Wall Street has the political playing field to itself; it has the money, the access it buys and the fear it implies.  And the public is on the outside, looking incredulous that this rigged system is still in place more than a year after it was exposed.  But if the frustrated middle can organize and mobilize a focused, non-partisan revolt of the revolted — as opposed to the inchoate and polarizing tea party movement — that whole dynamic will quickly change.  And so too, I’m confident, will the voting habits of our elected officials.

Fortunately, individuals like Dan Gerstein are motivating people to stand up and let our elected officials know that they work for the people and not the lobbyists.  Larry Klayman, founder of Judicial Watch, has just written a new book:  Whores: Why And How I Came To Fight The Establishment.  The timing of the book’s release could not have been better.



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The Window Of Opportunity Is Closing

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September 17, 2009

In my last posting, I predicted that President Obama’s speech on financial reform would be “fine-sounding, yet empty”.  As it turned out, many commentators have described the speech as just that.  There weren’t many particulars discussed at all.  As Caroline Baum reported for Bloomberg News:

At times he sounded more like a parent scolding a disobedient child than a president proposing a new regulatory framework.

“We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis,” Obama said in a speech at Federal Hall in New York City.  (“You will not stay out until 2 a.m. again.”)

*   *   *

Obama warned “those on Wall Street” against taking “risks without regard for consequences,” expecting the American taxpayer to foot the bill.  But his words rang hollow.

*   *   *

But you can’t, with words alone, alter the perception — now more entrenched than ever — that the government won’t allow large institutions to fail.

How do you convince bankers they will pay for their risk-taking when they’ve watched the government prop up banks, investment banks, insurance companies, auto companies and housing finance agencies?

They learn by example.  The system of privatized profits and socialized losses has suited them fine until now.

Although the President had originally voiced support for expanding the authority of the Federal Reserve to include the role of “systemic risk regulator”, Ms. Baum noted that Allan Meltzer, professor of political economy at Carnegie Mellon University, believes that Mr. Obama has backed away from that ill-conceived notion:

“The Senate Banking Committee doesn’t want to give the Fed more power,” Meltzer said.   “I’ve never seen such unanimity, and I’ve been testifying before the committee since 1962.”

Ms. Baum took that criticism a step further with her observation that the mission undertaken by any systemic risk regulator would not likely fare well:

Bankers Outfox Regulators

It is fantasy to believe a new, bigger, better regulator will ferret out problems before they grow to system-sinking size.  Those being regulated are always one-step ahead of the regulator, finding new cracks or loopholes in the regulatory fabric to exploit.  When the Basel II accord imposed higher risk- based capital requirements on international banks, banks moved assets off the balance sheet.

What’s more, regulators tend to identify with those they regulate, a phenomenon known as “regulatory capture,” making it highly unlikely that a new regulator would succeed where previous ones have failed.

At this point in the economic crisis, with Federal Reserve chairman Ben Bernanke’s recent declaration that the recession is “very likely over”, there is concern that President Obama’s incipient attempt at enacting financial reform may already be too late.  A number of commentators have elaborated on this theme.  At Credit Writedowns, Edward Harrison made this observation:

If you are looking for reform in the financial sector, the moment has passed.  And only to the degree that the underlying weaknesses in the global financial system are made manifest and threaten the economy will we see any appetite for reform amongst politicians.  So, as I see it, the Obama administration has missed the opportunity for reform.

More important, the following point by Mr. Harrison has been expressed in several recent essays:

Irrespective, I believe the need for reform is clear.  Those gloom & doom economists were right because the economic model which brought us to the brink of disaster in 2008 is the same one we have at present and that necessarily means another crisis will come.

At MSN’s MoneyCentral, Michael Brush shared that same fear in a piece entitled, “Why a meltdown could happen again”:

Some observers say it’s OK that a year has gone by without reform; we don’t want to get it wrong.  But the political reality is that as the urgency passes, it’s harder to pass reforms.

“We have lulled ourselves into the mind-set that we are out of the woods, when we aren’t,” says Cornelius Hurley, the director of the Morin Center for Banking and Financial Law at Boston University School of Law.  “I don’t think time is our friend here. We risk losing the sense of urgency so that nothing happens.”

*   *   *

Douglas Elliott, a former JPMorgan investment banker now with the Brookings Institution, thinks the unofficial deadline for financial-sector reform is now October 2010 — right before the next congressional elections.

That leaves lawmakers a full year to get the job done.

But given all the details they have to work out — and the declining sense of urgency as stocks keep ticking higher — you have to wonder how much progress they’ll make.

On the other hand, back at Credit Writedowns, Edward Harrison voiced skepticism that such a deadline would be met:

You are kidding yourself if you think real reform is coming to the financial sector before the mid-term elections, especially with healthcare, two wars and the need to ensure recovery still on politicians’ plates. Obama could go for real reform in 2011 — or in a second term in 2013.  But, unless economic crisis is at our door, there isn’t a convincing argument which says reform is necessary.

At The Washington Post, Brady Dennis discussed the Pecora Commission of the early 1930s, which investigated the causes of the Great Depression, and ultimately provided a basis for reforms of Wall Street and the banking industry.  Mr. Dennis pointed out how the success of the Pecora Commission was rooted in the fact that populist outrage provided the fuel to help mobilize reform efforts, and he contrasted that situation with where we are now:

“Pecora’s success was his ability to crystallize the anger that a lot of Americans were feeling toward Wall Street,” said Michael Perino, a law professor at St. John’s University and author of an upcoming book about the hearings. “He was able to create a clamor for reform.”

But Pecora also realized that such clamor was fleeting

*   *   *

“We’ve passed the moment when there’s this palpable anger directed at the financial community,” Perino said of the current crisis.  “When you leave the immediate vicinity of the crisis, as you get farther and farther away in time, the urgency fades.”

Unfortunately, we appear to be at a point where it is too late to develop regulations against many of the excesses that led to last year’s financial crisis.  Beyond that, many people who allowed the breakdown to occur (Bernanke, Geithner, et al.) are still in charge and the players who gamed the system with complex financial instruments are back at it again, with new derivatives — even some based on life insurance policies.  Perhaps another harbinger of doom can be seen in this recent Bloomberg article:  “Credit Swaps Lose Crisis Stigma as Confidence Returns”.  Nevertheless, from our current perspective, some of us don’t have that much confidence in our financial system or our leadership.



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Just In Time For Labor Day

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September 7, 2009

Friday’s report from the Bureau of Labor Statistics, concerning non-farm payrolls for the month of August, left many people squirming.  The “green shoots” crowd usually has no trouble cherry-picking through the monthly BLS reports for something they can spin into happy-sounding news, utilizing the “not as bad as expected” approach.  Nevertheless, the August BLS report portrayed unpleasant conditions, not only for the unemployed but for those currently working full-time in the labor force, as well.

The current unemployment level is a living nightmare for the unemployed individuals and their families.  It also brings some degree of discomfort (although less significant) to those people with money to invest, who are waiting for signs of a sustainable economic upturn before heading back out from the sidelines and into the equities markets.  Both groups got an unvarnished look at the latest BLS data from Dave Rosenberg, Chief Economist at Gluskin Sheff in Toronto.  His September 4 economic commentary: Lunch with Dave, gave us a thorough analysis of the BLS report:

While the Obama economics team is pulling rabbits out of the hat to revive autos and housing, there is nothing they can really do about employment; barring legislation that would prevent companies from continuing to adjust their staffing requirements to the new world order of credit contraction. While nonfarm payrolls were basically in line with the consensus, declining 216,000 in August, there were downward revisions of 49,000 and the details were simply awful.  The fact that 65% of companies are still in the process of cutting their staff loads is quite disturbing — even manufacturing employment fell 63,000 in August, to its lowest level since April 1941 (!), despite the inventory replenishment in the automotive sector and all the excitement over the recent 50+ print in the ballyhooed ISM index.  The fact that temp agency employment is still declining, albeit at a slower pace, alongside the flat workweek and jobless claims stuck at 570,000, are all foreshadowing continued weakness in the labour market ahead.  Until we see signs of a sustained turnaround in the jobs market all bets are off over the sustainability of any economic recovery.

Looking at the details of the Household Survey, Rosenberg found “a rather alarming picture” of what is happening in the labor market:

First, employment in this survey showed a plunge of 392,000, but that number was flattered by a surge in self-employment (whether these newly minted consultants were making any money is another story) as wage & salary workers (the ones that work at companies, big and small) plunged 637,000 — the largest decline since March (when the stock market was testing its lows for the cycle).  As an aside, the Bureau of Labor Statistics also publishes a number from the Household survey that is comparable to the nonfarm survey (dubbed the population and payroll-adjusted Household number), and on this basis, employment sank — brace yourself — by over 1 million, which is unprecedented.  We shall see if the nattering nabobs of positivity discuss that particular statistic in their post-payroll assessments; we are not exactly holding our breath.

Second, the unemployment rate jumped to 9.7% from 9.4% in July, the highest since June 1983 and at the pace it is rising, it will pierce the post-WWII high of 10.8% in time for next year’s midterm election.  And, this has nothing to do with a swelling labour force, which normally accompanies a turnaround in the jobs market — the ranks of the unemployed surged 466,000 last month.

The language of the BLS report itself on this subject demonstrates how the current unemployment crisis is not an “equal opportunity” phenomenon:

Among the major worker groups, the unemployment rates for adult men (10.1 percent), whites (8.9 percent), and Hispanics (13.0 percent) rose in August.  The jobless rates for adult women (7.6 percent), teenagers (25.5 percent), and blacks (15.1 percent) were little changed over the month.  The unemployment rate for Asians was 7.5 percent, not seasonally adjusted. (See tables A-1, A-2, and A-3.)The civilian labor force participation rate remained at 65.5 percent in August.  The employment population ratio, at 59.2 percent, edged down over the month and has declined by 3.5 percentage points since the recession began in December 2007.

Dave Rosenberg added the painful reminder that the unemployment picture always lags behind the end of a recession.  How far behind?  Look at this:

Jobless claims started off August at 554k and closed the month at 570k.  So it seems as though we enter September with the prospect of yet another month of declining payrolls because claims have to break decisively below 500k before jobs stop vanishing and below 400k before the unemployment rate stops rising.  Remember, in the early 1990s credit crunch the recession ended in March 1991 and yet the unemployment rate did not peak until June 1992; and in the last cycle, which was an asset deflation phase, the recession ended in November 2001 and yet the jobless rate did not peak until June 2003. So in the last two cycles, it took 15-20 months for the unemployment rate to peak even after the economic downturn officially ended.

At least Mr. Rosenberg had some constructive criticism for the current administration’s efforts at job creation.  It’s one thing to just yell:  “FAIL” and yet, quite another to put some thought into what needs to be done:

Our advice to the Obama team would be to create and nurture a fiscal backdrop that tackles this jobs crisis with some permanent solutions rather than recurring populist short-term fiscal goodies that are only inducing households to add to their burdensome debt loads with no long-term multiplier impacts.  The problem is not that we have an insufficient number of vehicles on the road or homes on the market; the problem is that we have insufficient labour demand.

As for those who are still in the labor force, the situation is also deteriorating, rather than improving.  A report by Carlos Torres for Bloomberg News noted that the “real number” for unemployment is 16.8 percent.  Beyond that, the work week for factory employees is currently 39.8 hours.  It will have to reach 41 hours before we even get a chance to see some changes:

The index of total hours worked, which takes into account changes in payrolls and the workweek, fell 0.3 percent last month to the lowest level since 2003.

“It tells us payrolls aren’t turning positive any time soon,” Joseph LaVorgna, chief  U.S.  economist at Deutsche Bank Securities Inc. in New York, said on a conference call yesterday, referring to the workweek figures. “This wasn’t a friendly report.”

A measure of unemployment, which includes the part-time workers who would prefer a full-time position and people who want work but have given up looking, reached 16.8 percent last month, the highest level in data going back to 1994.

The workweek for factory employees, which held at 39.8 hours last month, leads total payrolls by about three months, LaVorgna said.  Once it reaches at least 41 hours and once payrolls for temporary workers stabilize, then an increase in total employment can be expected months later, he said.

Payrolls for temporary workers started turning down in January 2007, 11 months before the recession began.  They dropped by another 6,500 workers in August, the government’s report showed yesterday.

In other words, the decline in temporary worker payrolls preceded the recession by 11 months!  Worse yet, the payrolls for temporary workers must stabilize before an increase in total employment comes along “months later”.

Meanwhile, at the Financial Times, Sarah O’Connor reports that many people who have jobs must still rely on food stamps to survive:

The number of working Americans turning to free government food stamps has surged as their hours and wages erode, in a stark sign that the recession is inflicting pain on the employed as well as the newly jobless.

*   *   *

The food stamp data suggest that “the labour market problems are more significant than you would expect, given just the unemployment rate”, said John Silvia, chief economist at Wells Fargo.  “For me it suggests the consumer is not going to rebound or contribute to economic growth for the next year, as the consumer would in a traditional economic recovery.”

Consumer spending has traditionally been the engine of the US economy, making up about two thirds of GDP.  Economists fear that people may be unwilling to resume that role.

That conclusion is exactly what the “green shoots” enthusiasts don’t seem to understand.  Those who are well-off enough to pay for their groceries with real money will be focused on paying down their credit cards and saving money before they go out to buy another television or jet ski.  If these people have little or no “discretionary income”, then the High Frequency Trading computers on Wall Street can talk to each other all they want — but the stock values will not go up.

Happy Labor Day!



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The Big Lie Gets Some Blowback

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September 3, 2009

My favorite “blowback” story of the week resulted from the ill-advised decisions by people at The New York Times and the Financial Times to trumpet talking points apparently “Fed” (pun intended) to them by the Federal Reserve.  Both publications asserted that the TARP program has already returned profits for the Untied States government.  The Financial Times claimed the profit so far has been $14 billion.  The New York Times, reporting the amount as $18 billion, claimed that “taxpayers have begun seeing profits from the hundreds of billions of dollars in aid that many critics thought might never be seen again.”  So where is my check?  Anyone with a reasonable degree of intelligence, who bothered to completely read through either of these articles, could quickly recognize yet another rendition of The Big Lie.  The blowback against these articles was swift and harsh.  Matt Taibbi’s critique was short and sweet:

This is sort of like calculating the returns on a mutual fund by only counting the stocks in the fund that have gone up.  Forgetting for a moment that TARP is only slightly relevant in the entire bailout scheme — more on that in a moment — the TARP calculations are a joke, apparently leaving out huge future losses from AIG and Citigroup and others in the red.  Since only a small portion of the debt has been put down by the best borrowers, and since the borrowers in the worst shape haven’t retired their obligations yet, it’s crazy to make any conclusions about TARP, pure sophistry.

*   *   *

The other reason for that is that it’s only a tiny sliver of the whole bailout picture.  The real burden carried by the government and the Fed comes from the various anonymous bailout facilities — the TALF, the PPIP, the Maiden Lanes, and so on.       .  .  .

And there are untold trillions more the Fed has loaned out in the last 18 months and which we are not likely to find out much about, unless the recent court ruling green-lighting Bloomberg’s FOIA request for those records actually goes through.

Over at The Business Insider, John Carney also quoted Matt Taibbi’s piece, adding that:

We simply don’t know how to value the mortgage backed securities the Fed bought.  We don’t know how much the government will wind up paying on the backstops of Citi and Bear Stearns assets.  And we don’t know how much more money might have to be pumped into the system to keep it afloat.

At another centrist website called The Moderate Voice, Michael Silverstein pointed out that any news reporter with a conscience ought to feel a bit of shame for participating in such a propaganda effort:

I’ve been an economics and financial writer for 30 years.  I used to enjoy my work.  I used to take pride in it.  The markets were kinky, sure, but that made the writing more fun.

*   *   *

That’s not true anymore.  Reportage about the economy and the markets — at least in most mainstream media — now largely consists of parroting press releases from experts of various stripes or government spokespeople.  And the result is not just infuriating for a long-term professional in this field, but outright embarrassing.

A perfect example was yesterday’s “good news” supposedly showing that our economic masters were every bit as smart as they think they are.  A few banks have repaid their TARP loans, part of the $4 trillion that government has sunk into our black hole banking system.

*   *   *

The $74 billion the government has been repaid is less than two percent of the $4 trillion the government has borrowed or printed to keep incompetent lenders from going down.  Less than two percent!  Even this piddling sum was generated by a manipulated stock market rally that allowed banks shares to soar, bringing a lot of money into bank coffers, almost all of which they added to reserves before paying back a few billion to the government.

Rolfe Winkler at Reuters joined the chorus criticizing the sycophantic cheerleading for these claims of TARP profitability:

A very dangerous misconception is taking root in the press, that in addition to saving the world financial system, the bank bailout is making taxpayers money.

“As big banks repay bailout, U.S.sees profit” read the headline in the New York Times on Monday.  The story was parroted on evening newscasts.

*   *   *

Taxpayers should keep that in mind whenever they see misguided reports that they are making money from bailouts.  The truth is that the biggest banks are still insolvent and, ultimately, their losses are likely to be absorbed by taxpayers.

As the above-quoted sources have reported, the ugly truth goes beyond the fact that the Treasury and the Federal Reserve have been manipulating the stock markets by pumping them to the stratosphere  —  there is also a coordinated “happy talk” propaganda campaign to reinforce the “bull market” fantasy.  Despite the efforts of many news outlets to enable this cause, it’s nice to know that there are some honest sources willing to speak the truth.  The unpleasant reality is exposed regularly and ignored constantly.  Tragically, there just aren’t enough mainstream media outlets willing to pass along the type of wisdom we can find from Chris Whalen and company at The Institutional Risk Analyst:

Plain fact is that the Fed and Treasury spent all the available liquidity propping up Wall Street’s toxic asset waste pile and the banks that created it, so now Main Street employers and private investors, and the relatively smaller banks that support them both, must go begging for capital and liquidity in a market where government is the only player left.  The notion that the Fed can even contemplate reversing the massive bailout for the OTC markets, this to restore normalcy to the monetary models that supposedly inform the central bank’s deliberations, is ridiculous in view of the capital shortfall in the banking sector and the private sector economy more generally.

Somebody ought to write that on a cake and send it over to Ben Bernanke, while he celebrates his nomination to a second term as Federal Reserve chairman.



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A Helluva Read

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August 31, 2009

We are constantly being bombarded with predictions and opinions about where the economy is headed.  Since last fall’s financial crisis, people have seen their home values reduced to shocking levels; they’ve seen their investments take a nosedive and they’ve watched our government attempt to respond to crises on several fronts.  There have been numerous programs including TARP, TALF, PPIP and quantitative easing, that some of us have tried to understand and that others find too overwhelming to approach.  When one attempts to gain an appreciation of what caused this crisis, it quickly becomes apparent that there are a number of different theories being espoused, depending upon which pundit is doing the talking.  One of my favorite explanations of what caused the financial crisis came from William K. Black, Associate Professor of Economics and Law at the University of Missouri – Kansas City School of Law.  In his lecture:  The Great American Bank Robbery (which can be seen here) Black explains that we have a culture of corruption at the highest levels of our government, which, combined with ineptitude, allowed some of the sleaziest people on Wall Street to nearly destroy our entire financial system.

William Black recently participated in a conference with a group of experts associated with the Economists for Peace and Security and the Initiative for Rethinking the Economy.  The panel included authorities from all over the world and met in Paris on June 15 – 16.  A report on the meeting was prepared by Professor James K. Galbraith and was published by The Levy Economics Institute of Bard College.  The paper, entitled Financial and Monetary Issues as the Crisis Unfolds, is available here.  At 16 pages, the document goes into great detail about what has been going wrong and how to address it, in terms that are understandable to the layperson.  Here’s how the report was summarized in the Preface:

Despite some success in averting a catastrophic collapse of liquidity and a decline in output, the group was pessimistic that there would be sustained economic recovery and a return of high employment.  There was general consensus among the group that the pre-crisis financial system should not be restored, that reviving the financial sector first was not the way to revive the economy, and that governments should not pursue exit strategies that permit a return to the status quo. Rather, the crisis exposes the need for profound reform to meet a range of physical and social objectives.

As to the question of where we are now, at the current stage of the economic crisis, Professor Galbraith recalled one panel member’s analogy to the eye of a hurricane:

The first wall of the storm has passed over us:  the collapse of the banking system, which engendered panic and a massive public sector rescue effort.  At rest in the eye, we face the second:  the bankruptcy of states, provinces, cities, and even some national governments, from California, USA, to Belgium.  Since this is a slower process involving weaker players, complicated questions of politics, fairness, and solidarity, and more diffused system risk, there is no assurance that the response by capable actors at the national or transnational level will be either timely or sufficient, either in the United States or in Europe.

There is plenty to quote from in this document, especially in light of the fact that it provides a good deal of sound, constructive criticism of our government’s response to the crisis.  Additionally, the panel offered solutions you’re not likely to hear from politicians, most of whom are in the habit of repeating talking points, written by lobbyists.

Focusing on the situation here in the United States, the report gave us some refreshing criticism, especially in the current climate where commentators are stumbling over each other to congratulate Ben Bernanke on his nomination to a second term as Federal Reserve chairman:

American participants were almost equally skeptical of the effectiveness of the U.S.approach to date.  As one put it, “Diabetes is a metabolic disease.”  Elements of a metabolic disease can be treated (here, “stimulus” plays the role of insulin), but the key to success is to deal with the underlying metabolic problem.  In the economic sphere, that problem lies essentially with the transfer of resources and power to the top and the dismantling of effective taxing power over those at the top of the system.  (The speaker noted that the effective corporate tax rate for the top 20 firms in the United States is under 2 percent.)  The effect of this is to create a “trained professional class of retainers” who devote themselves to preserving the existing (unstable) system.  Further, there were massive frauds in the origination of mortgages, in the ratings processes that led to securitization, and in the credit default swaps that were supposed to insure against loss.  In the policy approach so far, there is a consistent failure to address,                 analyze, remedy, and prosecute these frauds.

*   *   *

Meanwhile, major legislation from health care to bank reform continues to be written in consultation with the lobbies; as one speaker noted, legislation on credit default swaps was being prepared by “Jamie Dimon and his lobbyists.”

One of the gravest dangers to economic recovery, finally, lies precisely in the crisis-fatigue of the political classes, in their lack of patience with a deep and intractable problem, and with their inflexible commitment to the preceding economic order.  This feeds denial of the problem, a deep desire to move back to familiar rhetorical and political ground, and the urge to declare victory, groundlessly and prematurely.  As one speaker argued, the U.S.discussion of  “green shoots” amounts to little more than politically inspired wishful thinking — a substitute for action, at least so far as hopes for the recovery of employment are concerned.

Lest I go on, quoting the whole damned thing, I’ll simply urge you to take a look at it.  At the conclusion of the paper was the unpleasant point that some of the damage from this crisis has been irreversible.  There was an admonition that before undertaking reconstruction of the damage, some careful planning should be done, inclusive of the necessary safeguards to make it possible to move forward.

Whether or not anyone in Washington will pay serious attention to these findings is another issue altogether.  Our system of legalized graft in the form of lobbying and campaign contributions, guarantees an uphill battle for anyone attempting to change the status quo.

Invoking Thomas Paine

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August 24, 2009

In January of 1776, Thomas Paine wrote a 48-page pamphlet, entitled:  Common Sense, in which he argued the case that the American colonies should be independent from Britain.  He published the pamphlet anonymously, providing only a hint of authorship with the statement:  “Written by an Englishman”.  This aspect of Paine’s pamphlet brings to mind the debate over the issue of anonymity in the blogosphere, which became quite heated-up this past weekend.  As it turned out, a writer for one of Rupert Murdoch’s newspapers, who uses the surname “Whitehouse”, targeted the Zero Hedge website, accusing its publisher (who uses the pseudonym:  Tyler Durden  —  i.e. Brad Pitt’s character from the movie Fight Club) of being a fellow who was “banned from the securities industry” for making $780 on an “insider” trade.  For whatever reason, Naked Capitalism’s Yves Smith (whose real name is Susan Webber) saw fit to write a posting (now removed from the site) critical of the “messianic zeal and strident tone” of the material at Zero Hedge, despite the fact that Tyler Durden has written many guest posts for her own Naked Capitalism site.  She also criticized the use of pseudonyms by bloggers, particularly at financial sites — because the practice “raises questions about credibility”.  She differentiated her own situation with the explanation that her true identity could be ascertained with only “a modicum of digging”.  Making a point more supportive of Zero Hedge, she shared her suspicion about the motive behind the attempt to identify Tyler Durden as a disgraced trader:

. . . this story is appearing now precisely because Durden is getting to close to some even more damaging stories than he has provided thus far.

Ms. Smith (or Webber) believes that “Tyler Durden” is actually a pseudonym used by a number of writers at Zero Hedge.

As a result of that posting, Naked Capitalism lost one of its best contributors:  Leo Kolivakis of Pension Pulse, whose final contribution to Naked Capitalism can be found here.  Mr. Kolivakis then immediately joined the team at Zero Hedge, providing this explanation.  When reading his posting, be sure to read the comments, which are always entertaining at Zero Hedge.

I enjoy both Naked Capitalism and Zero Hedge and I will continue to keep them both on my blogroll, despite this dust-up.  In response to the intrigue concerning the identity of Tyler Durden, his cohort, Marla Singer submitted this proposed op-ed piece to The New York Times, reminding readers of the anonymous writings by Thomas Paine.

This past weekend brought us another invocation of Thomas Paine, with the publication of a piece entitled:  “Common Sense 2009”, which appeared in The Huffington Post.  The author did not conceal his identity, since he has made a point of generating controversy about himself throughout his life.   He was none other than Larry Flynt.  Flynt began with the explanation that last fall’s financial crisis was caused by the fact that “the financial elite had bribed our legislators to roll back the protections enacted after the Stock Market Crash of 1929”.  He rightfully criticized President Obama for attempting to lay part of the blame for this disaster on “Main Street”.  Beyond that, he noted how Obama continues to facilitate the same bad behavior that started this mess:

To date, no serious legislation has been offered by the Obama administration to correct these problems.

Instead, Obama wants to increase the oversight power of the Federal Reserve.  Never mind that it already had significant oversight power before our most recent economic meltdown, yet failed to take action.  Never mind that the Fed is not a government agency but a cartel of private bankers that cannot be held accountable by Washington.  Whatever the Fed does with these supposed new oversight powers will be behind closed doors.

Obama’s failure to act sends one message loud and clear:  He cannot stand up to the powerful Wall Street interests that supplied the bulk of his campaign money for the 2008 election.  Nor, for that matter, can Congress, for much the same reason.

Larry Flynt then offered a bold solution to break the hold of the plutocracy that has been controlling our country for too long:

I’m calling for a national strike, one designed to close the country down for a day.  The intent?  Real campaign-finance reform and strong restrictions on lobbying.  Because nothing will change until we take corporate money out of politics.  Nothing will improve until our politicians are once again answerable to their constituents, not the rich and powerful.

Let’s set a date.  No one goes to work.  No one buys anything.  And if that isn’t effective — if the politicians ignore us — we do it again.  And again.  And again.

This initiative is a much more effective and constructive use of populist rage than what saw at recent “town hall” meetings and “teabagging” events.  Besides:  If anyone knows what can and cannot be accomplished by “teabagging” –  it’s Larry Flint.

Searching For A Port In A Storm Of Bad Behavior

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August 20, 2009

Since I began complaining about manipulation of the stock markets back on December 18, I’ve been comforted by the fact that a number of bloggers have voiced similar concerns.  At such websites as Naked Capitalism, Zero Hedge, The Market Ticker and others too numerous to mention —  a common theme keeps popping up:  some portion of the extraordinary amounts of money disseminated by the Treasury and the Federal Reserve is obviously being used to manipulate the equities markets.  One paper, released by Precision Capital Management, analyzed the correlation between those days when the Federal Reserve bought back Treasury securities from investment banks and “tape painting” during the final minutes of those trading days on the stock markets.

Eliot “Socks” Spitzer recently wrote a piece for Slate, warning the “small investor” about a “rigged” system, as well as the additional hazards encountered due to routine breaches of the fiduciary duties owed by investment firms to their clients:

Recent rebounds notwithstanding, most people now are asking whether the system is fundamentally rigged.  It’s not just that they have an understandable aversion to losing their life savings when the market crashes; it’s that each of the scandals and crises has a common pattern:  The small investor was taken advantage of by the piranhas that hide in the rapidly moving currents. And underlying this pattern is a simple theme: conflicts of interest that violated the duty the market players had to their supposed clients.

The natural reaction of the retail investor to these hazards and scandals often involves seeking refuge in professionally-managed mutual funds.  Nevertheless, as Spitzer pointed out, the mutual fund alternative has dangers of its own:

Mutual funds charge exorbitant fees that investors have to absorb — fees that dramatically reduce any possibility of outperforming the market and that are set by captive boards of captive management companies, not one of which has been replaced for inadequate performance, violating their duty to guard the interests of the fund investors for whom they supposedly work.

Worse yet, is the fact that mutual funds are now increasing their fees and, in effect, punishing their customers for the poor performance of those funds during the past year.  Financial planner Allan Roth, had this to say at CBS MoneyWatch.com:

After one of the most awful years in the history of the mutual fund industry, when the average U.S. stock fund and international fund fell by 39 percent and 46 percent respectively, you might expect fund companies would give investors a break and lower their fees. But just the opposite is true.

An exclusive analysis for MoneyWatch.com by investment research firm Morningstar shows that over the past year, fund fees have risen in nearly every category.  For stock funds, the fees shot up by roughly 5 percent.

*   *   *

Every penny you pay in fees, of course, lowers your return.  In fact, my research indicates that each additional 0.25 percent in annual fees pushes back your financial independence goal by a year.

What’s more, the only factor that is predictive of a fund’s relative performance against similar funds is fees.  A low-cost domestic stock fund is likely to outperform an equivalent high-cost fund, just as a low-cost bond fund is likely to outperform an equivalent high-cost fund.   . . .  As fund fees increase, performance decreases.  In fact, fees explained nearly 60 percent of the U.S. stock fund family performance ratings given by Morningstar.  Numerous studies done to predict mutual fund performance indicate that neither the Morningstar rating nor the track record of the fund manager were indicative of future performance.

Another questionable practice in the mutual fund industry — the hiring of “rookies” to manage the funds — was recently placed under the spotlight by Ken Kam for the MSN TopStocks blog:

In this market, it’s going to take skill to make back last year’s losses.  After a 40% loss, it takes a 67% gain just to get back to even. You would think that mutual funds would put their most experienced managers and analysts to work right now.  But according to Morningstar, the managers of 28 out of 48 unique healthcare funds, almost 60%, (see data) have less than five years with their fund.  I think you need to see at least a five-year track record before you can even begin to judge a manager’s worth.

I’m willing to pay for good management that will do something to protect me if the market crashes again.  But I want to see some evidence that I am getting a good manager before I trust them with my money.  I want to see at least a five-year track record.  If I paid for good management and I got a rookie manager with no track record instead, I would be more than a little upset.

Beyond that, John Authers of Morningstar recently wrote an article for the Financial Times, explaining that investors will obtain better results investing in a stock index fund, rather than an “actively managed” equity mutual fund, whether or not that manager is a rookie:

For decades, retail savers have invested in stocks via mutual funds that are actively managed to try to beat an index.  The funds hold about 100 stocks, and can raise or lower their cash holdings, but cannot bet on stocks to go down by selling them short.

This model has, it appears, been savaged by a flock of sheep.

Index investing, which cuts costs by replicating an index rather than trying to beat it, has been gaining in popularity.

Active managers argued that they could raise cash, or move to defensive stocks, in a downturn.  Passive funds would track their index over the edge of the cliff.

But active managers, in aggregate, failed to do better than their indices in 2008.

So …  if you have become too frustrated to continue investing in stocks, be mindful of the fact that equity-based mutual funds have problems of their own.

As for other alternatives:  Ian Wyatt recently wrote a favorable piece about the advantages of exchange-traded funds (ETFs) for  SmallCapInvestor.com.  Nevertheless, if the stocks comprising those ETFs (and the ETFs themselves) are being traded in a “rigged” market, you’re back to square one.  Happy investing!

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