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Magic Show Returns to Wall Street

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Quantitative easing is back.  For those of you who still aren’t familiar with what quantitative easing is, I have provided a link to this short, funny cartoon, which explains everything.

The first two phases of quantitative easing brought enormous gains to the stock market.  In fact, that was probably all they accomplished.  Nevertheless, if there had been no QE or QE 2, most people’s 401(k) plans would be worth only a fraction of what they are worth today.  The idea was that the “wealth effect” provided by an inflated stock market would both enable and encourage people to buy houses, new cars and other “big ticket” items – thus bringing demand back to the economy.  Since the American economy is 70 percent consumer-drivendemand is the engine that creates new jobs.

It took a while for most of us to understand quantitative easing’s impact on the stock market.  After the Fed began its program to buy $600 billion in mortgage-backed securities in November of 2008, some suspicious trading patterns began to emerge.  I voiced my own “conspiracy theory” back on December 18, 2008:

I have a pet theory concerning the almost-daily spate of “late-day rallies” in the equities markets.  I’ve discussed it with some knowledgeable investors.  I suspect that some of the bailout money squandered by Treasury Secretary Paulson has found its way into the hands of some miscreants who are using this money to manipulate the stock markets.  I have a hunch that their plan is to run up stock prices at the end of the day before those numbers have a chance to settle back down to the level where the market would normally have them.  The inflated “closing price” for the day is then perceived as the market value of the stock.  This plan would be an effort to con investors into believing that the market has pulled out of its slump.  Eventually the victims would find themselves hosed once again at the next “market correction”.

Felix Salmon eventually provided this critique of the obsession with closing levels and – beyond that – the performance of a stock on one particular day:

Or, most invidiously, the idea that the most interesting and important time period when looking at the stock market is one day.  The single most reported statistic with regard to the stock market is where it closed, today, compared to where it closed yesterday.  It’s an utterly random and pointless number, but because the media treats it with such reverence, the public inevitably gets the impression that it matters.

In March of 2009, those suspicious “late day rallies” returned and by August of that year, the process was explained as the “POMO effect” in a paper by Precision Capital Management entitled, “A Grand Unified Theory of Market Manipulation”.

By the time QE 2 actually started on November 12, 2010 – most investors were familiar with how the game would be played:  The New York Fed would conduct POMO auctions, wherein it would purchase Treasury securities – worth billions of dollars – on an almost-daily basis.  After the auctions, the Primary Dealers would take the sales proceeds to their proprietary trading desks, where the funds would be leveraged and used to purchase stocks.  Thanks to QE 2, the stock market enjoyed another nice run.

This time around, QE 3 will involve the purchase of mortgage-backed securities, as did QE 1.  Unfortunately, the New York Fed’s  new POMO schedule is not nearly as informative as it was during QE1 and QE 2, when we were provided with a list of the dates and times when the POMO auctions would take place.  Back then, the FRBNY made it relatively easy to anticipate when you might see some of those good-old, late-day rallies.  The new POMO schedule simply informs us that  “(t)he Desk plans to purchase $23 billion in additional agency MBS through the end of September.”  We are also advised that with respect to the September 14 – October 11 time frame,  “(t)he Desk plans to purchase approximately $37 billion in its reinvestment purchase operations over the noted monthly period.”

It is pretty obvious that the New York Fed does not want the “little people” partaking in the windfalls enjoyed by the prop traders for the Primary Dealers as was the case during QE 1 and QE 2.  This probably explains the choice of language used at the top of the website’s POMO schedule page:

In order to ensure the transparency of its agency mortgage-backed securities (MBS) transactions, the Open Market Trading Desk (the Desk) at the New York Fed will publish historical operational results, including information on the transaction prices in individual operations, at the end of each monthly period shown in the table below.

In other words, the New York Fed’s idea of transparency does not involve disclosure of the scheduling of its agency MBS transactions before they occur.  That information is none of your damned business!

Return of the POMO Junkies

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Most investors have been lamenting the recent stock market swoon.  The Dow Jones Industrial Average has given up all of the gains earned during 2012.  The economic reports keep getting worse by the day.  Yet, for some people all of this is good news  .   .   .

You might find them scattered along the curbs of Wall Street   . . .  with glazed eyes  . . .  British teeth  . . .  and mysterious lesions on their skin.  They approach Wall Street’s upscale-appearing pedestrians, making such requests as:  “POMO?”   . . .  “Late-day rally?”  . . .   “Animal Spirits?”  These desperate souls are the “POMO junkies”.  Since the Federal Reserve concluded the last phase of quantitative easing in June of 2011, the POMO junkies have been hopeless.  They can’t survive without those POMO auctions, wherein the New York Fed would purchase Treasury securities – worth billions of dollars – on a daily basis.  After the auctions, the Primary Dealers would take the sales proceeds to their proprietary trading desks, where the funds would be leveraged and used to purchase high-beta, Russell 2000 stocks.  You saw the results:  A booming stock market – despite a stalled economy.

Since I first wrote about the POMO junkies last summer, they have resurfaced on a few occasions – only to slink back into the shadows as the rumors of an imminent Quantitative Easing 3 were debunked.

The recent spate of awful economic reports and the resulting stock market nosedive have rekindled hopes that the Federal Reserve will crank-up its printing press once again, for the long-awaited QE 3.  Economist John Hussman discussed this situation on Monday:

At this point, the S&P 500 has achieved a cumulative total return of less than 10% since April 2010. Meanwhile, of course, there remains a great deal of faith in the “Bernanke put,” because even though it’s fairly obvious that QE has done nothing durable for the economy or the financial markets over the last couple of years, a hit of QE might at least be good for a few months of “risk on” delirium.  If the American public can’t get thoughtful economic leadership, at least Wall Street’s speculative junkies can hope for a little taste of Q from Sugar Daddy.

One of the problems with QE here, however, is that it would essentially represent fiscal policy for the benefit of speculators, at taxpayer expense.  To see this, note that the 10-year Treasury yield is now down to less than 1.5%.  One wonders how Bernanke would be able to argue, with a straight face, that this is not low enough.  Nevertheless, a 10-year bond has a duration of 8 years – meaning that each 100 basis point fluctuation in interest rates is associated with a change of about 8% in the price of the bond.  So if you buy the bond and hold it for a full year, an interest rate change of of 1.5/8 = .1875, or less than 20 basis points, is enough to wipe out the annual interest and leave you with a negative total return.

*   *   *

“QE3 – subsidizing banks and bond speculators at taxpayer expense” – there’s a pithy slogan.  That doesn’t mean the Fed will refrain from more of its recklessness (which will be nearly impossible to reverse when it becomes necessary to do so), but does anyone actually believe by now that QE would improve the economy, durably elevate risky assets beyond a few months, or materially relieve global debt strains?

Obviously, the POMO junkies have no such concerns.  Beyond that, the Federal Reserve’s “third mandate” – keeping the stock market bubble inflated – will be the primary factor motivating the decision, regardless of whether those asset prices hold for more than a few months.

The POMO junkies are finally going to score.  As they do, a tragic number of retail investors will be led to believe that the stock market has “recovered”, only to learn – a few months down the road – that the latest bubble has popped.


 

From Disappointing To Creepy

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It was during Barack Obama’s third month in the White House, when I realized he had become the “Disappointer-In-Chief”.  Since that time, the disappointment felt by many of us has progressed into a bad case of the creeps.

Gretchen Morgenson of The New York Times has been widely praised for her recent report, exposing the Obama administration’s vilification of New York State Attorney General Eric Schneiderman for his refusal to play along with Team Obama’s efforts to insulate the fraud-closure banks from the criminal prosecution they deserve.  The administration is attempting to pressure each Attorney General from every state to consent to a settlement of any and all claims against the banksters arising from their fraudulent foreclosure practices.  Each state is being asked to release the banks from criminal and civil liability in return for a share of the $20 billion settlement package.  The $20 billion is to be used for loan modifications.  Leading the charge on behalf of the administration are Shaun Donovan, the Secretary of Housing and Urban Development, as well as a number of high-ranking officials from the Justice Department, led by Attorney General Eric Hold-harmless.  Here are some highlights from Ms. Morgenson’s article:

Mr. Schneiderman and top prosecutors in some other states have objected to the proposed settlement with major banks, saying it would restrict their ability to investigate and prosecute wrongdoing in a variety of areas, including the bundling of loans in mortgage securities.

*   *   *

Mr. Schneiderman has also come under criticism for objecting to a settlement proposed by Bank of New York Mellon and Bank of America that would cover 530 mortgage-backed securities containing Countrywide Financial loans that investors say were mischaracterized when they were sold.

The deal would require Bank of America to pay $8.5 billion to investors holding the securities; the unpaid principal amount of the mortgages remaining in the pools totals $174 billion.

*   *   *

This month, Mr. Schneiderman sued to block that deal, which had been negotiated by Bank of New York Mellon as trustee for the holders of the securities.

The passage from Gretchen Morgenson’s report which drew the most attention concerned a statement made to Schneiderman by Kathryn Wylde.  Ms. Wylde is a “Class C” Director of the Federal Reserve Bank of New York.  The role of a Class C Director is to represent the interests of the public on the New York Fed board.  Barry Ritholtz provided this reaction to Ms. Wylde’s encounter with Mr. Schneiderman:

If the Times report is accurate, and the quote below represents Ms. Wylde’s comments, than that position is a laughable mockery, and Ms. Wylde should resign effective immediately.

The quote in question, which was reported to have occurred at Governor Hugh Carey’s funeral (!?!)  was as follows:

“It is of concern to the industry that instead of trying to facilitate resolving these issues, you seem to be throwing a wrench into it.  Wall Street is our Main Street — love ’em or hate ’em.  They are important and we have to make sure we are doing everything we can to support them unless they are doing something indefensible.”

I do not know if Ms. Wylde understands what her proper role should be, but clearly she is somewhat confused.  She appears to be far more interested in representing the banks than the public.

Robert Scheer of Truthdig provided us with some background on Obama’s HUD Secretary, Shaun Donovan, one of the administration’s arm-twisters in the settlement effort :

Donovan has good reason not to want an exploration of the origins of the housing meltdown:  He has been a big-time player in the housing racket for decades.  Back in the Clinton administration, when government-supported housing became a fig leaf for bundling suspect mortgages into what turned out to be toxic securities, Donovan was a deputy assistant secretary at HUD and acting Federal Housing Administration commissioner.  He was up to his eyeballs in this business when the Clinton administration pushed through legislation banning any regulation of the market in derivatives based on home mortgages.

Armed with his insider connections, Donovan then went to work for the Prudential conglomerate (no surprise there), working deals with the same government housing agencies that he had helped run.  As The New York Times reported in 2008 after President Barack Obama picked him to be secretary of HUD, “Mr. Donovan was a managing director at Prudential Mortgage Capital Co., in charge of its portfolio of investments in affordable housing loans, including Fannie Mae and the Federal Housing Administration debt.”

Obama has been frequently criticized for stacking his administration with people who regularly shuttle between corporations and the captured agencies responsible for regulating those same businesses.  Risk management guru, Christopher Whalen lamented the consequences of Obama’s cozy relationship with the Wall Street banks – most tragically, those resulting from Obama’s unwillingness to adopt the “Swedish solution” of putting the insolvent zombie banks through temporary receivership:

The path of least resistance politically has been to temporize and talk.  But by following the advice of Rubin and Summers, and avoiding tough decisions about banks and solvency, President Obama has only made the crisis more serious and steadily eroded public confidence.  In political terms, Obama is morphing into Herbert Hoover, as I wrote in one of my first posts for Reuters.com, “In a new period of instability, Obama becomes Hoover.”

Whereas two or three years ago, a public-private approach to restructuring insolvent banks could have turned around the economic picture in relatively short order, today the cost to clean up the mess facing Merkel, Obama and other leaders of western European nations is far higher and the degree of unease among the public is growing.  You may thank Larry Summers, Robert Rubin and the other members of the “do nothing” chorus around President Obama for this unfortunate outcome.

We are now past the point of blaming Obama’s advisors for the President’s recurrent betrayal of the public interest while advancing the goals of his corporate financiers.  Yves Smith of Naked Capitalism has voiced increasingly harsh appraisals of Obama’s performance.  By August 22, it became clear to Ms. Smith that the administration’s efforts to shield the fraud-closure banks from liability exposed a scandalous degree of venality:

It is high time to describe the Obama Administration by its proper name:  corrupt.

Admittedly, corruption among our elites generally and in Washington in particular has become so widespread and blatant as to fall into the “dog bites man” category.  But the nauseating gap between the Administration’s propaganda and the many and varied ways it sells out average Americans on behalf of its favored backers, in this case the too big to fail banks, has become so noisome that it has become impossible to ignore the fetid smell.

*   *   *

Team Obama bears all the hallmarks of being so close to banks and big corporations that it has lost all contact with and understanding of mainstream America.

The latest example is its heavy-handed campaign to convert New York state attorney general Eric Schneiderman to a card carrying member of the “be nice to our lords and masters the banksters” club.  Schneiderman was the first to take issue with the sham of the so-called 50 state attorney general mortgage settlement.  As far as the Administration is concerned, its goal is to give banks a talking point and prove to them that Team Obama is protecting their backs in a way that the chump public hopefully won’t notice.

*   *   *

Yet rather than address real, serious problems, senior administration officials are instead devoting time and effort to orchestrating a faux grass roots campaign to con a state AG into thinking his supporters are deserting him because he has dared challenge the supremacy of the banks.

I would include Eric Schneiderman in a group with Elizabeth Warren and Maria Cantwell as worthy challengers to Barack Obama in the 2012 Presidential Election.  I wish one of them would step forward.


 

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Another Cartoon For The Bernank To Hate

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Those of us who found it necessary to explain quantitative easing during the course of a blog posting, have struggled with creating our own definitions of the term.  On October 18, 2010, I started using this one:

Quantitative easing involves the Federal Reserve’s purchase of Treasury securities as well as mortgage-backed securities from those privileged, too-big-to-fail banks.

What I failed to include in that description was the fact that the Fed was printing money to make those purchases.  I eventually resorted to simply linking the term to the definition of quantitative easing at Wikipedia.org.

Suddenly, in November of 2010, a cartoon – posted on YouTube – became an overnight sensation.  It was a 6-minute discussion between two little bears, which explained how “The Ben Bernank” was trying to fix a broken economy by breaking it more.

We eventually learned a few things about the cartoon’s creator, Omid Malekan, who produced the clip for free on the xtranormal.com website.  Kevin Depew, the Editor-in-Chief of Minyanville, interviewed Malekan within days of the cartoon’s debut.  Malekan expressed his disgust with what he described as “the Washington-Wall Street Complex” and the revolving door between the financial industry and those agencies tasked to regulate it.  David Weigel of Slate interviewed Malekan on November 22, 2010 (eleven days after the cartoon was made).  At that point, we learned a bit about the political views of the 30-year-old, former stock trader-turned-real estate manager:

I’m all over the map.  Socially, I’m pretty liberal.  Economically, I’m fairly free-market oriented.  I generally prefer to vote third party, because it’s just good for the country if we get another voice in there.  To me none of this is really partisan because things are the same under both parties.  Ben Bernanke was appointed by Bush and re-appointed by Obama, so they both have basically the same policies.  The problem, really, is that monetary policy is now removed from people in general.  People like Bernanke don’t have to get elected.  There’s a disconnect between them and the people their decisions are affecting.

One month later, Malekan was interviewed by “Evan” of The Point Blog at the Sam Adams Alliance.  On this occasion, the animator explained his decision to put “the” in front of so many proper names, as well as his reference to Ben Bernanke as “The Bernank”.  Malekan had this to say about the popularity of the cartoon:

To be fully honest, I had no idea this would get the wide audience that it did.  Initially when I made it, it was to explain it to a select group of friends of mine.  And any other straggler that happened to see it, and I never thought that would be over 3 million people.  But, the main reason was cause I think monetary policy is important to everybody because it’s monetary policy.  Unlike fiscal policy or regulation, monetary policy, because of the way it impacts interest rates and the dollar, impacts every single person that buys and sells and earns dollars.  So I think it’s something that everybody should be paying attention to, but most people don’t because it’s not ever presented to them in a way they could hope to understand it.

Omid Malekan produced another helpful cartoon on January 28.  The new six-minute clip, “Bank Bailouts Explained” provides the viewer with an understanding of what many of us know as Maiden Lane III – as well as how the other “backdoor bailouts” work, including the true cost of Zero Interest Rate Policy (ZIRP) to the taxpayers.  This cartoon is important because it can disabuse people of the propaganda based on the claim that the Wall Street megabanks – particularly Goldman Sachs – owe the American taxpayers nothing because they repaid the TARP bailouts.  I discussed this obfuscation back on November 26, 2009:

For whatever reason, a number of commentators have chosen to help defend Goldman Sachs against what they consider to be unfair criticism.  A recent example came to us from James Stewart of The New Yorker.  Stewart had previously written a 25-page essay for that magazine, entitled “Eight Days” — a dramatic chronology of the financial crisis as it unfolded during September of 2008.  Last week, Stewart seized upon the release of the recent SIGTARP report to defend Goldman with a blog posting which characterized the report as supportive of the argument that Goldman owes the taxpayers nothing as a result of the government bailouts resulting from that near-meltdown.  (In case you don’t know, a former Assistant U.S. District Attorney from New York named Neil Barofsky was nominated by President Bush as the Special Investigator General of the TARP program.  The acronym for that job title is SIGTARP.)   In his blog posting, James Stewart began by characterizing Goldman’s detractors as “conspiracy theorists”.  That was a pretty weak start.  Stewart went on to imply that the SIGTARP report refuted the claims by critics that, despite Goldman’s repayment of the TARP bailout, it did not repay the government the billions it received as a counterparty to AIG’s collateralized debt obligations.  Stewart referred to language in the SIGTARP report to support the spin that because “Goldman was fully hedged on its exposure both to a failure by A.I.G. and to the deterioration of value in its collateralized debt obligations” and that “(i)t repaid its TARP loans with interest, bought back the government’s warrants at a nice profit to the Treasury” Goldman therefore owes the government nothing — other than “a special debt of gratitude”.  One important passage from page 22 of the SIGTARP report that Stewart conveniently ignored, concerned the money received by Goldman Sachs as an AIG counterparty by way of Maiden Lane III, at which point those credit default obligations (of questionable value) were purchased at an excessive price by the government.  Here’s that passage from the SIGTARP report:

When FRBNY authorized the creation of Maiden Lane III in November 2008, it lent approximately $24.6 billion to the newly formed limited liability company, and AIG provided Maiden Lane III approximately $5 billion in equity.  These funds were used to purchase CDOs from AIG counterparties worth an estimated fair value of $29.6 billion at the time of the purchases, which were done in three stages on November 25, 2008, December 18, 2008, and December 22, 2008.  AIGFP’s counterparties were paid $27.1 billion, and AIGFP was paid $2.5 billion per an agreement between AIGFP and FRBNY.  The $2.5 billion represented the amount of collateral that AIGFP had previously paid to the counterparties that was in excess of the actual decline in the fair value as of October 31, 2008.

FRBNY’s loan to Maiden Lane III is secured by the CDOs as the underlying assets.  After the loan has been repaid in full plus interest, and, to the extent that there are sufficient remaining cash proceeds, AIG will be entitled to repayment of the $5 billion that the company contributed in equity, plus accrued interest.  After repayment in full of the loan and the equity contribution (each including accrued interest), any remaining proceeds will be split 67 percent to FRBNY and 33 percent to AIG.

The end result was a $12.9 billion gift to “The Goldman Sachs”.

Thanks to Mr. Malekan, we now have a cartoon that explains how all of AIG’s counterparties were bailed out at taxpayer expense, along with an informative discourse about the other “backdoor bailouts”.

Omid Malekan has his own website here.  You should make a point of regularly checking in on it, so you can catch his next cartoon before someone takes the opportunity to spoil all of the jokes for you.  Enjoy!


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Senator Kaufman Will Be Missed

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Ted Kaufman filled Joe Biden’s seat representing the state of Delaware in the United States Senate on January 15, 2009, when Biden resigned to serve as Vice-President.  Kaufman’s 22-month term as Senator concluded on November 15, when Chris Coons was sworn in after defeating Christine O’Donnell in the 2010 election.

Senator Kaufman served as Chairman of the Congressional Oversight Panel – the entity created to monitor TARP on behalf of Congress.  The panel’s November Oversight Report was released at the COP website with an embedded, five-minute video of Senator Kaufman’s introduction to the Report.  At the DelawareOnline website, Nicole Gaudiano began her article about Kaufman’s term by pointing out that C-SPAN ranked Kaufman as the 10th-highest among Senators for the number of days (126) when he spoke on the Senate floor during the current Congressional session.  Senator Kaufman was a high-profile advocate of financial reform, who devoted a good deal of effort toward investigating the causes of the 2008 financial crisis.

On November 9, Senator Kaufman was interviewed by NPR’s Robert Siegel, who immediately focused on the fact that aside from the Securities and Exchange Commission’s civil suit against Goldman Sachs and the small fine levied against Goldman by FINRA, we have yet to see any criminal prosecutions arising from the fraud and other violations of federal law which caused the financial crisis.  Kaufman responded by asserting his belief that those prosecutions will eventually proceed, although “it takes a while” to investigate and prepare these very complex cases:

When you commit fraud on Wall Street or endanger it, you have good attorneys around you to kind of clean up after you.  So they clean up as they go.  And then when you actually go to trial, these are very, very, very complex cases.  But I still think we will have some good cases.  And I also think that if isn’t a deterrent, they will continue to do that.  And I think we have the people in place now at the Securities Exchange Commission and the Justice Department to hold them accountable.

We can only hope so   .  .  .

Back on March 17, I discussed a number of reactions to the recently-released Valukas Report on the demise of Lehman Brothers, which exposed the complete lack of oversight by the Federal Reserve Bank of New York — the entity with investigators in place inside of Lehman Brothers after the collapse of Bear Stearns.  The FRBNY had the perfect vantage point to conduct effective oversight of Lehman.  Not only did the FRBNY fail to do so — it actually helped Lehman maintain a false image of being financially solvent.  It is important to keep in mind that Lehman CEO Richard Fuld was a class B director of the FRBNY during this period.  Senator Kaufman’s reaction to the Valukas Report resulted in his widely-quoted March 15 speech from the Senate floor, in which he emphasized that the government needs to return the rule of law to Wall Street:

We all understood that to restore the public’s faith in our financial markets and the rule of law, we must identify, prosecute, and send to prison the participants in those markets who broke the law.  Their fraudulent conduct has severely damaged our economy, caused devastating and sustained harm to countless hard-working Americans, and contributed to the widespread view that Wall Street does not play by the same rules as Main Street.

*   *   *

Many have said we should not seek to “punish” anyone, as all of Wall Street was in a delirium of profit-making and almost no one foresaw the sub-prime crisis caused by the dramatic decline in housing values.  But this is not about retribution.  This is about addressing the continuum of behavior that took place — some of it fraudulent and illegal — and in the process addressing what Wall Street and the legal and regulatory system underlying its behavior have become.

As part of that effort, we must ensure that the legal system tackles financial crimes with the same gravity as other crimes.

The nagging suspicion that those nefarious activities at Lehman Brothers could be taking place “at other banks as well” became a key point in Senator Kaufman’s speech:

Mr. President, I’m concerned that the revelations about Lehman Brothers are just the tip of the iceberg.  We have no reason to believe that the conduct detailed last week is somehow isolated or unique.  Indeed, this sort of behavior is hardly novel.  Enron engaged in similar deceit with some of its assets.  And while we don’t have the benefit of an examiner’s report for other firms with a business model like Lehman’s, law enforcement authorities should be well on their way in conducting investigations of whether others used similar “accounting gimmicks” to hide dangerous risk from investors and the public.

Within a few months after that speech by Senator Kaufman, a weak financial reform bill was enacted to appease (or more importantly:  deceive) the outraged taxpayers.  Despite that legislative sham, polling results documented the increased public skepticism about the government’s ability or willingness to do right by the American public.

On October 20, Sam Gustin interviewed economist Joseph Stiglitz for the DailyFinance website.  Their discussion focused on the recent legislative attempt to address the causes of the financial crisis.  Professor Stiglitz emphasized the legal system’s inability to control that type of  sleazy behavior:

The corporations have the right to give campaign contributions.  So basically we have a system in which the corporate executives, the CEOs, are trying to make sure the legal system works not for the companies, not for the shareholders, not for the bondholders – but for themselves.

So it’s like theft, if you want to think about it that way.  These corporations are basically now working now for the CEOs and the executives and not for any of the other stakeholders in the corporation, let alone for our broader society.

You look at who won with the excessive risk-taking and shortsighted behavior of the banks.  It wasn’t the shareholder or the bondholders.  It certainly wasn’t American taxpayers.  It wasn’t American workers.  It wasn’t American homeowners.  It was the CEOs, the executives.

*   *   *

Economists focus on the whole notion of incentives.  People have an incentive sometimes to behave badly, because they can make more money if they can cheat.  If our economic system is going to work then we have to make sure that what they gain when they cheat is offset by a system of penalties.

And that’s why, for instance, in our antitrust law, we often don’t catch people when they behave badly, but when we do we say there are treble damages. You pay three times the amount of the damage that you do.  That’s a strong deterrent.

For now, there are no such deterrents for those CEOs who nearly collapsed the American economy and destroyed 15 million jobs.  Robert Scheer recently provided us with an update about what life is now like for Sandy Weill, the former CEO of Citigroup.  Scheer’s essay – entitled “The Man Who Shattered Our Economy” revealed that Weill just purchased a vineyard estate in Sonoma, California for a record $31 million.  That number should serve as a guidepost when considering the proposition expressed by Professor Stiglitz:

If our economic system is going to work then we have to make sure that what they gain when they cheat is offset by a system of penalties.

What are the chances of that happening?


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Everyone Knew About Lehman Brothers

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March 19, 2010

A March 18 report by Henny Sender at the Financial Times revealed that former officials from Merrill Lynch had contacted the Securities and Exchange Commission as well as the Federal Reserve of New York to complain that Lehman Brothers had been incorrectly calculating a key measure of its financial health.  The regulators received this warning several months before Lehman filed for bankruptcy in September of 2008.  Apparently Lehman’s reports of robust financial health were making Merrill look bad:

Former Merrill Lynch officials said they contacted regulators about the way Lehman measured its liquidity position for competitive reasons.  The Merrill officials said they were coming under pressure from their trading partners and investors, who feared that Merrill was less liquid than Lehman.

*   *   *

In the account given by the Merrill officials, the SEC, the lead regulator, and the New York Federal Reserve were given warnings about Lehman’s balance sheet calculations as far back as March 2008.

*   *   *

The former Merrill officials said they contacted the regulators after Lehman released an estimate of its liquidity position in the first quarter of 2008.  Lehman touted its results to its counterparties and its investors as proof that it was sounder than some of its rivals, including Merrill, these people said.

*   *   *

“We started getting calls from our counterparties and investors in our debt.  Since we didn’t believe the Lehman numbers and thought their calculations were aggressive, we called the regulators,” says one former Merrill banker, now at another big bank.

Could the people at Merrill Lynch have expected the New York Fed to intervene and prevent the accounting chicanery at Lehman?  After all, Lehman’s CEO, Richard Fuld, was also a class B director of the New York Fed.  Would any FRBNY investigator really want to make trouble for one of the directors of his or her employer?  This type of conflict of interest is endemic to the self-regulatory milieu presided over by the Federal Reserve.  When people talk about protecting “Fed independence”, I guess this is what they mean.

The Financial Times report inspired Yves Smith of Naked Capitalism to emphasize that the New York Fed’s failure to do its job, having been given this additional information from Merrill officials, underscores the ineptitude of the New York Fed’s president at the time — Tim Geithner:

The fact that Merrill, with a little digging, could see that Lehman’s assertions about its financial health were bogus says other firms were likely to figure it out sooner rather than later.  That in turn meant that the Lehman was extremely vulnerable to a run.  Bear was brought down in a mere ten days.  Having just been through the Bear implosion, the warning should have put the authorities in emergency preparedness overdrive.  Instead, they went into “Mission Accomplished” mode.

This Financial Times story provides yet more confirmation that Geithner is not fit to serve as a regulator and should resign as Treasury Secretary.  But it may take Congress forcing a release of the Lehman-related e-mails and other correspondence by the New York Fed to bring about that outcome.

Those “Lehman-related e-mails” should be really interesting.  If Richard Fuld was a party to any of those, it will be interesting to note whether his e-mail address was “@LehmanBros”, “@FRBNY” or both.

The Lehman scandal has come to light at precisely the time when Ben Bernanke is struggling to maintain as much power for the Federal Reserve as he can — in addition to getting control over the proposed Consumer Financial Protection Agency.  One would think that Bernanke is pursuing a lost cause, given the circumstances and the timing.  Nevertheless, as Jesse of Jesse’s Cafe Americain points out — Bernanke may win this fight:

The Fed is the last place that should receive additional power over the banking system, showing itself to be a bureaucracy incapable of exercising the kind of occasionally stern judgment, the tough love, that wayward bankers require.  And the mere thought of putting Consumer Protection under their purview makes one’s skin crawl with fear and the gall of injustice.

They may get it, this more power, not because it is deserved, but because politicians themselves wish to have more power and money, and this is one way to obtain it.

The next time the financial system crashes, the torches and pitchforks will come out of the barns and there will be a serious reform, and some tar and feathering in congressional committees, and a few virtual lynchings.  The damage to the people of the middle class will be an American tragedy.  But this too shall pass.

It’s beginning to appear as though it really will require another financial crisis before our graft-hungry politicians will make any serious effort at financial reform.  If economist Randall Wray is correct, that day may be coming sooner than most people expect:

Another financial crisis is nearly certain to hit in coming months — probably before summer.  The belief that together Geithner and Bernanke have resolved the crisis and that they have put the economy on a path to recovery will be exposed as wishful thinking.

Although that may sound a bit scary, we have to look at the bright side:  at least we will finally be on a path toward serious financial reform.



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Deceptive Oversight

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March 17, 2010

March 16 brought us a few more provocative essays about the Lehman Brothers scandal.  The most prominent subject discussed in the reactions to the Valukas Report has been the complete lack of oversight by the Federal Reserve Bank of New York — the entity with investigators in place inside of Lehman Brothers after the collapse of Bear Stearns.  The FRBNY had the perfect vantage point to conduct effective oversight of Lehman.  Not only did the FRBNY fail to do so — it actually helped Lehman maintain a false image of being financially solvent.  It is important to keep in mind that Lehman CEO Richard Fuld was a class B director of the FRBNY during this period.  Does that sound like a conflict of interest to anyone besides me?  The Securities and Exchange Commission (under the direction of Christopher Cox at the time) has become another subject of scrutiny for its own dubious semblance of oversight.

Eliot Spitzer and William Black (a professor of economics and law at the University of Missouri – Kansas City) recently posted a great article at the New Deal 2.0 website.  Among the memorable points from that piece is the assertion that accounting is “the weapon of choice” for financial deception.  The Valukas Report has exposed such extensive accounting fraud at Lehman, it will be impossible for the Federal Reserve Bank of New York to feign ignorance of that activity.  Another memorable aspect of the Spitzer – Black piece is its reference to those “too big to fail” financial institutions as “SDIs” or systemically dangerous institutions.  Here is some of what Spitzer and Black had to say about how the FRBNY became enmeshed in Lehman’s sleazy accounting tactics:

The FRBNY knew that Lehman was engaged in smoke and mirrors designed to overstate its liquidity and, therefore, was unwilling to lend as much money to Lehman.  The FRBNY did not, however, inform the SEC, the public, or the OTS  (which regulated an S&L that Lehman owned) of what should have been viewed by all as ongoing misrepresentations.

The Fed’s behavior made it clear that officials didn’t believe they needed to do more with this information. The FRBNY remained willing to lend to an institution with misleading accounting and neither remedied the accounting nor notified other regulators who may have had the opportunity to do so.

*   *   *

The FRBNY acted shamefully in covering up Lehman’s inflated asset values and liquidity.

The consequences of the New York Fed’s involvement in this scam were discussed in an article by Andrew Ross Sorkin from the March 16 edition of The New York Times.  (You may recall that Andrew Ross Sorkin is the author of the book, Too Big To Fail.)  He pointed out that the consequences of the Lehman scandal could be very far-reaching:

Indeed, it now appears that the federal government itself either didn’t appreciate the significance of what it saw (we’ve seen that movie before with regulators waving off tips about Bernard L. Madoff).  Or perhaps they did appreciate the significance and blessed the now-suspect accounting anyway.

*   *   *

There’s a lot riding on the government’s oversight of these accounting shenanigans.  If Lehman Brothers executives are sued civilly or prosecuted criminally, they may actually have a powerful defense:  a raft of government officials from the S.E.C. and Fed vetted virtually everything they did.

On top of that, Lehman’s outside auditor, Ernst &Young, and a law firm, Linklaters, signed off on the transactions.

The problems at Lehman raise even larger questions about the vigilance of the SEC and Fed in overseeing the other Wall Street banks as well.

The question as to whether similar accounting tricks were being performed at “other Wall Street banks as well” opens a very huge can of worms.  It’s time for the government to step back and assess the larger picture of what the systemic problem really is.  In a speech before the Senate, Delaware Senator Ted Kaufman emphasized that the government needs to return the rule of law to Wall Street:

We all understood that to restore the public’s faith in our financial markets and the rule of law, we must identify, prosecute, and send to prison the participants in those markets who broke the law.  Their fraudulent conduct has severely damaged our economy, caused devastating and sustained harm to countless hard-working Americans, and contributed to the widespread view that Wall Street does not play by the same rules as Main Street.

*   *   *

Many have said we should not seek to “punish” anyone, as all of Wall Street was in a delirium of profit-making and almost no one foresaw the sub-prime crisis caused by the dramatic decline in housing values.  But this is not about retribution.  This is about addressing the continuum of behavior that took place — some of it fraudulent and illegal — and in the process addressing what Wall Street and the legal and regulatory system underlying its behavior have become.

As part of that effort, we must ensure that the legal system tackles financial crimes with the same gravity as other crimes.

The nagging suspicion that those nefarious activities at Lehman Brothers could be taking place “at other banks as well” became a key point in Senator Kaufman’s speech:

Mr. President, I’m concerned that the revelations about Lehman Brothers are just the tip of the iceberg.  We have no reason to believe that the conduct detailed last week is somehow isolated or unique.  Indeed, this sort of behavior is hardly novel.  Enron engaged in similar deceit with some of its assets.  And while we don’t have the benefit of an examiner’s report for other firms with a business model like Lehman’s, law enforcement authorities should be well on their way in conducting investigations of whether others used similar “accounting gimmicks” to hide dangerous risk from investors and the public.

We can only hope that a continued investigation into the Lehman scandal will result in a very bright light directed on those privileged plutocrats who consider themselves above the law.



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Doubts Concerning The Stock Market Rally

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August 6, 2009

As of today (Wednesday night) the current “bear market rally” continues to surprise people with its longevity.  On the other hand, many news outlets, including The Washington Times and CNBC are declaring a “New Bull Market”.  There seems to be no shortage of commentators proclaiming that the market indices will continue to climb forever.

Back on planet earth, there is a good deal of commentary about the suspicious activity behind this rally.  In my last posting, I discussed the “Plunge Protection Team” or PPT.  Rather than repeat all that, for the benefit of those unfamiliar with the PPT, I will quote the handy definition at the Hamzei Analytics website:

Plunge Protection Team has been the “Working Group” established by law in 1988 to buy the markets should declines get out of control.  It is suspected by many market watchers that PPT has become far more interventionist than was originally intended under the law.  There are no minutes of meetings, no recorded phone conversations, no reports of activities, no announcements of intentions.  It is a secret group including the Chairman of the Federal Reserve, the Secretary of the Treasury, the Head of the SEC, and their surrogates which include some of the large Wall Street firms.  The original objective was to prevent disastrous market crashes.  Lately it seems, they buy the markets when they decide the markets need to be bought, including the equity markets.  Their main resource is the money the Fed prints.  The money is injected into markets via the New York Fed’s Repo desk, which easily shows up in the M-3 numbers, warning intervention was near.  As of April 2006, M-3 is longer reported.

Many of us have looked to the PPT as the driving force behind this rally.  News sources have claimed that the rally is the result of money “coming into the markets from the sidelines” — implying that crisis-wary investors had finally thrown caution to the wind and jumped into the equities markets to partake in the orgy of newfound wealth.  The cash accumulating in the investors’ money market accounts was supposedly being invested in stocks.  This propaganda was quickly debunked by the folks at the Zero Hedge website, with the following revelation:

Most interesting is the correlation between Money Market totals and the listed stock value since the March lows:  a $2.7 trillion move in equities was accompanied by a less than $400 billion reduction in Money Market accounts!

Where, may we ask, did the balance of $2.3 trillion in purchasing power come from?  Why the Federal Reserve of course, which directly and indirectly subsidized U.S.banks (and foreign ones through liquidity swaps) for roughly that amount.  Apparently these banks promptly went on a buying spree to raise the all important equity market, so that the U.S. consumer whose net equity was almost negative on March 31, could have some semblance of confidence back and would go ahead and max out his credit card.

Similar skepticism was voiced by Karl Denninger of The Market Ticker website:

So once again we have The Fed blowing bubbles, this time in the equity markets, with (another) wink and a nod from Congress.  This explains why there has been no “great rush” for individual investors to “get back in”, and it explains why the money market accounts aren’t being drained by individuals “hopping on the bus”, despite the screeching of CNBC and others that you better “buy now or be priced out”, with Larry Kudlow’s “New Bull Market” claim being particularly offensive.

Unfortunately the banksters on Wall Street and the NY Fed did their job too well – by engineering a 50% rally off the bottom in March while revenues continue to tank, personal income is in the toilet and tax receipts are in freefall they have exposed the equity markets for what they have (unfortunately) turned into — a computer-trading rigged casino with the grand lever-meister being housed at the NY Fed.

*   *   *

No, real buying is just that – real buying from real retail investors who believe in the forward prospects for the economy and business, not funny-money Treasury and MBS buying by The Fed from “newly created bank reserves” funneled back into the market via high-speed computers.  The latter is nothing more than a manufactured ramp job that will last only until “the boyz” get to the end of their rope (and yes,that rope does have an end) as the fractional creation machine does run just as well in reverse, and as such “the boyz” cannot allow the trade to run the wrong way lest it literally destroy them (10:1 or more leverage is a real bitch when its working against you!)

Is it coming to an end now?  Nobody can be certain when, but what is certain is that over the last week or so there have been signs of heavy distribution – that is, the selling off of big blocks of stock into the market by these very same “boyz.”  This is not proof that the floor is about to disappear, but it is an absolute certainty that these “players” are protecting themselves from the possibility and making sure that if there is to be a bagholder, it will be you.

Many commentators, including Joseph Saluzzi of Themis Trading, have explained how the practice of computer-driven “High-Frequency Trading” has added approximately 70 percent of “volume” to the equities markets.  This is accomplished because the exchanges pay a quarter-of-a-penny rebate to High-Frequency Trading firms for each order they place, waiving all transaction fees.  As a result, the “big boy” firms, such as J.P. Morgan and Goldman Sachs, will make trades with their own money, buying and selling shares at the same price, simply for the rebates.  Those pennies can add up to hundreds of millions of dollars.

I recently came across a very interesting paper (just over eight pages in length) entitled:  A Grand Unified Theory of Market Manipulation, published by Precision Capital Management.  The paper describes a tug of war between Treasury Secretary Ben Bernanke and the New York Fed, that is playing out in the equities and Treasury securities markets.  The authors suggest that if Bernanke’s biggest threat is high long-term Treasury yields (interest rates), the easiest way to prevent or postpone a yield ramp would be to kill the stock market rally and create a “flight to safety in Treasuries” – situation that lowers long-term yields.  The paper describes how the New York Fed facilitates “painting the tape” in the stock markets to keep the rally alive.  For those of you who don’t know what that expression means, here’s a definition:

An illegal action by a group of market manipulators buying and/or selling a security among themselves to create artificial trading activity, which, when reported on the ticker tape, lures in unsuspecting investors as they perceive an unusual volume.

After causing a movement in the security, the manipulators hope to sell at a profit.

Instead of accusations that the PPT is the culprit doing the tape painting during the final minutes of the trading day, we again see a focus on the New York Fed as the facilitator of this practice.  Here’s the explanation given in the paper by Precision Capital Management:

The theory for which we have the greatest supporting evidence of manipulation surrounds the fact that the Federal Reserve Bank of New York (FRNY) began conducting permanent open market operations (POMO) on March 25, 2009 and has conducted 42 to date.  Thanks to Thanassis Strathopoulos and Billy O’Nair for alerting us to the POMO Effect discovery and the development of associated trading edges.  These auctions are conducted from about 10:30 a.m. to 11:00 a.m. on pre-announced days.  In such auctions, the FRNY permanently purchases Treasury securities from selected dealers, with the total purchase amount for a day ranging from about $1.5 B to $7.5 B.  These days are highly correlated with strong paint-the-tape closes, with the theory being that the large institutions that receive the capital interjections are able to leverage this money by 100 to 500 times and then use it to ramp equities.

As for the all-important question of how the authors expect this to play out, they focus on what might happen at the market close on August 5:

And, while it is a bit early to favor one side or the other, we are currently leaning toward a nervous Bernanke and the need to ramp Treasuries at the expense of equities into August 9.  Equities have had more than a nice run and can suffer a bit of a correction.  Key will be watching the close on Wednesday.  A failed POMO paint the tape close could signal that an equities correction of at least a few weeks has gotten underway.

What we saw on Wednesday afternoon was just that.  At approximately 3 p.m. there was an effort to push the S&P 500 index into positive territory for the first time that day, which succeeded for just a few minutes.  The index then dropped back down, closing .29 percent lower than the previous close.  Does this mean that a market correction is underway?  Time will tell.  With the S&P 500 index at 1002 as I write this, many experts consider the market to be “overbought”.  Fund manager Jeremy Grantham, who has been entrusted to invest over $89 billion of his customers’ hard-inherited money, is of the opinion that the current fair value for the S&P 500 should be just below 880.  Thus, there is plenty of room for a correction.  The answer to the question of whether that correction is now underway should be something we will learn rather quickly.

Somebody Really Loves Goldman Sachs

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May 17, 2009

The recent article about Treasury Secretary “Turbo” Tim Geithner by Jo Becker and Gretchen Morgenson, appearing in the April 26 edition of The New York Times, seems to have helped fan the flames of the current outrage concerning the Federal Reserve Bank of New York.  Turbo Tim was president of the New York Fed during the five years prior to his appointment as Treasury Secretary.  Becker and Morgenson pointed out many of the ways in which “conflict of interest” seems to be one of the cornerstones of that institution:

The New York Fed is, by custom and design, clubby and opaque.  It is charged with curbing banks’ risky impulses, yet its president is selected by and reports to a board dominated by the chief executives of some of those same banks. Traditionally, the New York Fed president’s intelligence-gathering role has involved routine consultation with financiers, though Mr. Geithner’s recent predecessors generally did not meet with them unless senior aides were also present, according to the bank’s former general counsel.

By those standards, Mr. Geithner’s reliance on bankers, hedge fund managers and others to assess the market’s health — and provide guidance once it faltered — stood out.

The New York Fed is probably the most important of the nation’s twelve Federal Reserve Banks, since its jurisdiction includes the heart of America’s financial industry.  As the Times piece pointed out, this resulted in the same type of “revolving door” opportunities as those enjoyed by members of Congress who became lobbyists and vice versa:

A revolving door has long connected Wall Street and the New York Fed.  Mr. Geithner’s predecessors, E. Gerald Corrigan and William J. McDonough, wound up as investment-bank executives.  The current president,William C. Dudley, came from Goldman Sachs.

The New York Fed’s current chairman, Stephen Friedman, has become a subject of controversy these days, because of his position as director and shareholder of Goldman Sachs.   Goldman sought and received expedited approval to become a “bank holding company” last September, thus coming under the jurisdiction of the Federal Reserve and becoming eligible for the ten billion dollars in TARP bailout money it eventually received.  After Goldman became subject to the New York Fed’s oversight (with Friedman as the New York Fed chairman) the Fed made decisions that impacted Goldman’s financial state.  Although this controversy was discussed here and here by The Wall Street Journal, that publication’s new owner, Rupert Murdoch, now requires a $104 annual on-line subscription fee to read his publication over the Internet. Sorry Rupert:  Homey don’t play that.  Although Slate provided us with an interesting essay on the Friedman controversy by Eliot “Socks” Spitzer, the best read was the commentary by Robert Scheer, editor of Truthdig.  Here are some important points from Scheer’s article, “Cashing In on ‘Government Sachs’ “:

When N.Y. Fed Chairman Stephen Friedman bought stock in the company that he once headed, and where he still serves as a director, he was already in violation of Federal Reserve policy and was hoping for a waiver to permit him to hold his existing multi-million-dollar stock stash and to remain on the Goldman board.  The waiver was requested last October by Timothy Geithner, then the president of the N.Y. Fed and now Treasury secretary.  Yet,without having received that waiver, Friedman went ahead in December and purchased 37,300 additional shares.  With shares he added in January, after the waiver was granted, he ended up with 98,600 shares in Goldman Sachs, worth a total of $13,330,720 at the close of trading on Tuesday.

*    *    *

As Jerry Jordan, former president of the Fed Bank in Cleveland, told the Journal in reference to Friedman’s obvious conflict of interest, “He should have resigned.”

Unfortunately, this was not the view during the reign of Geithner, who argued that Friedman needed to remain chairman of the N.Y. Fed board to find a suitable replacement for Geithner as he moved on to be secretary of the Treasury.  Friedman chose a fellow former Goldman Sachs exec for the job.

*    *    *

Geithner is a protege of former Goldman Sachs chairman Rubin.  And it was therefore not surprising when he picked Mark Patterson, a registered lobbyist for Goldman Sachs, to be his chief of staff at the Treasury Department.  That appointment was made on the same day that Geithner announced new rules for limiting the influence of registered lobbyists.  Need more be said?

Yes, there are a couple more things:  Goldman Sachs was the second largest contributor to Barack Obama’s Presidential election campaign, with a total of $980,945 according to OpenSecrets.org.  President Obama nominated Gary Gensler of Goldman Sachs to become Chairman of the Commodity Futures Trading Commission.  As Ken Silverstein reported for Harpers, this nomination has stalled, since a “hold” was placed on the nomination by Vermont Senator Bernie Sanders.  Mr. Silverstein quoted from the statement released by the office of Senator Sanders concerning the rationale for the hold:

Mr. Gensler worked with Sen. Phil Gramm and Alan Greenspan to exempt credit default swaps from regulation, which led to the collapse of A.I.G. and has resulted in the largest taxpayer bailout in U.S.history.   He supported Gramm-Leach-Bliley, which allowed banks like Citigroup to become “too big to fail.”  He worked to deregulate electronic energy trading, which led to the downfall of Enron and the spike in energy prices.  At this moment in our history, we need an independent leader who will help create a new culture in the financial marketplace and move us away from the greed, recklessness and illegal behavior which has caused so much harm to our economy.

“Change you can believe in”, huh?