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Two Years Too Late

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October 11, 2010

Greg Gordon recently wrote a fantastic article for the McClatchy Newspapers, in which he discussed how former Treasury Secretary Hank Paulson failed to take any action to curb risky mortgage lending.  It should come as no surprise that Paulson’s nonfeasance in this area worked to the benefit of Goldman Sachs, where Paulson had presided as CEO for the eight years prior to his taking office as Treasury Secretary on July 10, 2006.  Greg Gordon’s article provided an interesting timeline to illustrate Paulson’s role in facilitating the subprime mortgage crisis:

In his eight years as Goldman’s chief executive, Paulson had presided over the firm’s plunge into the business of buying up subprime mortgages to marginal borrowers and then repackaging them into securities, overseeing the firm’s huge positions in what became a fraud-infested market.

During Paulson’s first 15 months as the treasury secretary and chief presidential economic adviser, Goldman unloaded more than $30 billion in dicey residential mortgage securities to pension funds, foreign banks and other investors and became the only major Wall Street firm to dramatically cut its losses and exit the housing market safely.  Goldman also racked up billions of dollars in profits by secretly betting on a downturn in home mortgage securities.

By now, the rest of that painful story has become a burden for everyone in America and beyond.  Paulson tried to undo the damage to Goldman and the other insolvent, “too big to fail” banks at taxpayer expense with the TARP bailouts.  When President Obama assumed office in January of 2009, his first order of business was to ignore the advice of Adam Posen (“Temporary Nationalization Is Needed to Save the U.S. Banking System”) and Professor Matthew Richardson.  The consequences of Obama’s failure to put those “zombie banks” through temporary receivership were explained by Karen Maley of the Business Spectator website:

Ireland has at least faced up to the consequences of the reckless lending, unlike the United States.  The Obama administration has adopted a muddle-through approach, hoping that a recovery in housing prices might mean that the big US banks can avoid recognising crippling property losses.

*   *   *

Leading US bank analyst, Chris Whalen, co-founder of Institutional Risk Analytics, has warned that the banks are struggling to cope with the mountain of problem home loans and delinquent commercial property loans.  Whalen estimates that the big US banks have restructured less than a quarter of their delinquent commercial and residential real estate loans, and the backlog of problem loans is growing.

This is eroding bank profitability, because they are no longer collecting interest on a huge chunk of their loan book.  At the same time, they also face higher administration and legal costs as they deal with the problem property loans.

Banks nursing huge portfolios of problem loans become reluctant to make new loans, which chokes off economic activity.

Ultimately, Whalen warns, the US government will have to bow to the inevitable and restructure some of the major US banks.  At that point the US banking system will have to recognise hundreds of billions of dollars in losses from the deflation of the US mortgage bubble.

If Whalen is right, Ireland is a template of what lies ahead for the US.

Chris Whalen’s recent presentation, “Pictures of Deflation” is downright scary and I’m amazed that it has not been receiving the attention it deserves.  Surprisingly — and ironically – one of the only news sources discussing Whalen’s outlook has been that peerless font of stock market bullishness:  CNBC.   Whalen was interviewed on CNBC’s Fast Money program on October 8.  You can see the video here.  The Whalen interview begins at 7 minutes into the clip.  John Carney (formerly of The Business Insider website) now runs the NetNet blog for CNBC, which featured this interview by Lori Ann LoRocco with Chris Whalen and Jim Rickards, Senior Managing Director of Market Intelligence at Omnis, Inc.  Here are some tidbits from this must-read interview:

LL:  Chris, when are you expecting the storm to hit?

CW:  When the too big to fail banks can no longer fudge the cost of restructuring their real estate exposures, on and off balance sheet. Q3 earnings may be the catalyst

LL:  What banks are most exposed to this tsunami?

CW:  Bank of America, Wells Fargo, JPMorgan, Citigroup among the top four.  GMAC.  Why do we still refer to the ugly girls — Bank of America, JPMorgan and Wells Fargo in particular — as zombies?  Because the avalanche of foreclosures and claims against the too-big-too-fail banks has not even crested.

*   *   *

LL:  How many banks to expect to fail next year because of this?

CW:  The better question is how we will deal with the process of restructuring.  My view is that the government/FDIC can act as receiver in a government led restructuring of top-four banks.  It is time for PIMCO, BlackRock and their bond holder clients to contribute to the restructuring process.

Of course, this restructuring could have and should have been done two years earlier — in February of 2009.  Once the dust settles, you can be sure that someone will calculate the cost of kicking this can down the road — especially if it involves another round of bank bailouts.  As the saying goes:  “He who hesitates is lost.”  In this case, President Obama hesitated and we lost.  We lost big.



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The Goldman Fallout

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April 19, 2010

In the aftermath of the disclosure concerning the Securities and Exchange Commission’s fraud suit against Goldman Sachs, we have heard more than a little reverberation of Matt Taibbi’s “vampire squid” metaphor, along with plenty of concern about which other firms might find themselves in the SEC’s  crosshairs.

As Jonathan Weil explained for Bloomberg News :

As Wall Street bombshells go, the lawsuit that the Securities and Exchange Commission filed against Goldman Sachs Group Inc. is about as big as it gets.

At The Economist, there was a detectable scent of schadenfreude in the discussion, which reminded readers that despite Lloyd Blankfein’s boast of having repaid Goldman’s share of the TARP bailout, not everyone has overlooked Maiden Lane III:

IS THE most powerful and controversial firm on Wall Street about to get the comeuppance that so many think it deserves?

*   *   *

The charges could hardly come at a worse time for Goldman.  The firm has been under fire on a number of fronts, including over the handsome payout it secured from the New York Fed as a derivatives counterparty of American International Group, an insurer that almost failed in 2008.  In a string of negative articles over the past year, Goldman has been accused of everything from double-dealing for its own advantage to planting its own people in the Treasury and other agencies to ensure that its interests were looked after.

At this point, those who criticized Matt Taibbi for his tour de force against Goldman (such as Megan McArdle) must be experiencing a bit of remorse.  Meanwhile, those of us who wrote items appearing at GoldmanSachs666.com are exercising our bragging rights.

The complaint filed against Goldman by the SEC finally put to rest the tired old lie that nobody saw the financial crisis coming.  The e-mails from Goldman VP, Fabrice Tourre, made it perfectly clear that in addition to being aware of the imminent collapse, some Wall Street insiders were actually counting on it.  Jonathan Weil’s Bloomberg article provided us with the translated missives from Mr. Tourre:

“More and more leverage in the system.  The whole building is about to collapse anytime now,” Fabrice Tourre, the Goldman Sachs vice president who was sued for his role in putting together the deal, wrote on Jan. 23, 2007.

“Only potential survivor, the fabulous Fab …  standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”

A few weeks later, Tourre, now 31, e-mailed a top Goldman trader:  “the cdo biz is dead we don’t have a lot of time left.”  Goldman closed the Abacus offering in April 2007.

Michael Shedlock (a/k/a Mish) has quoted a number of sources reporting that Goldman may soon find itself defending similar suits in Germany and the UK.

Not surprisingly, there is mounting concern over the possibility that other investment firms could find themselves defending similar actions by the SEC.  As Anusha Shrivastava reported for The Wall Street Journal, the action in the credit markets on Friday revealed widespread apprehension that other firms could face similar exposure:

Credit markets were shaken Friday by the news as investors tried to figure out whether other firms or other structured finance products will be affected.

Investors are concerned that the SEC’s action may create a domino effect affecting other firms and other structured finance products.  There’s also the worry that this regulatory move may rattle the recovery and bring uncertainty back to the market.

“Credit markets are seeing a sizeable impact from the Goldman news,” said Bill Larkin, a portfolio manager at Cabot Money Management, in Salem, Mass.  “The question is, has the S.E.C. discovered what may have been a common practice across the industry?  Is this the tip of the iceberg?”

*  *  *

The SEC’s move marks “an escalation in the battle to expose conflicts of interest on Wall Street,” said Chris Whalen of Institutional Risk Analytics in a note to clients.  “Once upon a time, Wall Street firms protected clients and observed suitability …  This litigation exposes the cynical, savage culture of Wall Street that allows a dealer to commit fraud on one customer to benefit another.”

The timing of this suit could not have been better – with the Senate about to consider what (if anything) it will do with financial reform legislation.  Bill Black expects that this scandal will provide the necessary boost to get financial reform enacted into law.  I hope he’s right.



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Lacking Reform

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January 4, 2010

David Reilly of Bloomberg News did us all a favor by reading through the entire, 1,270-page financial reform bill that was recently passed by the House of Representatives.  The Wall Street Reform and Consumer Protection Act (HR 4173) was described by Reilly this way:

The baby of Financial Services Committee Chairman Barney Frank, the House bill is meant to address everything from too-big-to-fail banks to asleep-at-the-switch credit-ratings companies to the protection of consumers from greedy lenders.

After reading the bill, David Reilly wrote a commentary piece for Bloomberg entitled:  “Bankers Get $4 Trillion Gift from Barney Frank”.  Reilly seemed surprised that banks opposed this legislation, emphasizing that “they should cheer for its passage by the full Congress in the New Year” because of the bill’s huge giveaways to the banking industry and Wall Street.  Here are some of Reilly’s observations on what this bill provides:

—  For all its heft, the bill doesn’t once mention the words “too-big-to-fail,” the main issue confronting the financial system.  Admitting you have a problem, as any 12-stepper knows, is the crucial first step toward recovery.

— Instead, it supports the biggest banks.  It authorizes Federal Reserve banks to provide as much as $4 trillion in emergency funding the next time Wall Street crashes.  So much for “no-more-bailouts” talk.  That is more than twice what the Fed pumped into markets this time around.  The size of the fund makes the bribes in the Senate’s health-care bill look minuscule.

— Oh, hold on, the Federal Reserve and Treasury Secretary can’t authorize these funds unless “there is at least a 99 percent likelihood that all funds and interest will be paid back.”   Too bad the same models used to foresee the housing meltdown probably will be used to predict this likelihood as well.

More Bailouts

— The bill also allows the government, in a crisis, to back financial firms’ debts.  Bondholders can sleep easy  — there are more bailouts to come.

— The legislation does create a council of regulators to spot risks to the financial system and big financial firms. Unfortunately this group is made up of folks who missed the problems that led to the current crisis.

— Don’t worry, this time regulators will have better tools.  Six months after being created, the council will report to Congress on “whether setting up an electronic database” would be a help. Maybe they’ll even get to use that Internet thingy.

— This group, among its many powers, can restrict the ability of a financial firm to trade for its own account.  Perhaps this section should be entitled, “Yes, Goldman Sachs Group Inc., we’re looking at you.”

My favorite passage from Reilly’s essay concerned the proposal for a Consumer Financial Protection Agency:

— The bill isn’t all bad, though.  It creates a new Consumer Financial Protection Agency, the brainchild of Elizabeth Warren, currently head of a panel overseeing TARP.  And the first director gets the cool job of designing a seal for the new agency.  My suggestion:  Warren riding a fiery chariot while hurling lightning bolts at Federal Reserve Chairman Ben Bernanke.

The cover story for the December 30 edition of Business Week explained how this bill became so badly compromised.  Alison Vekshin and Dawn Kopecki wrote the piece, explaining how the New Democrat Coalition, which “has 68 fiscally conservative, pro-business members who fill 15 of the party’s 42 seats on the House Financial Services Committee” reshaped this bill.  The New Democrats fought off proposed changes to derivatives trading and included an amendment to the Consumer Financial Protection Agency legislation giving federal regulators more discretion to override state consumer protection laws than what was initially proposed.  Beyond that, “non-financial” companies such as real estate agencies and automobile dealerships will not be subject to the authority of the new agency.  The proposed requirement for banks to offer “plain-vanilla” credit-card and mortgage contracts was also abandoned.

One of my pet peeves involves Democrats’ claiming to be “centrists” or “moderates” simply because they enjoy taking money from lobbyists.  Too many people are left with the impression that a centrist is someone who lacks a moral compass.  The Business Week story provided some insight about how the New Democrat Coalition gets … uh … “moderated”:

Since the start of the 2008 election cycle, the financial industry has donated $24.9 million to members of the New Democrats, some 14% of the total funds the lawmakers have collected, according to the Center for Responsive Politics.  Representative Melissa Bean of Illinois, who has led the Coalition’s efforts on regulatory reform, was the top beneficiary, with donations of $1.4 million.

As the financial reform bill is being considered by the Senate, the U.S. Chamber of Commerce has stepped up its battle against the creation of a Consumer Financial Protection Agency.  The Business Week article concluded with one lawmaker’s perspective:

“My greatest fear for the last year has been an economic collapse,” says Representative Brad Miller (D-N.C), who sits on Frank’s House Financial Services Committee.  “My second greatest fear was that the economy would stabilize and the financial industry would have the clout to defeat the fundamental reforms that our nation desperately needs.  My greatest fear seems less likely … but my second greatest fear seems more likely every day.”

The dysfunction that preserves this unhealthy status quo was best summed up by Chris Whalen of Institutional Risk Analytics:

The big banks pay the big money in Washington, the members of Congress pass new laws to enable the theft from the public purse, and the servile Fed prints money to keep the game going for another day.

As long as Congress is going through the motions of passing “reform” legislation, they should do us all a favor and take on the subject of lobbying reform.  Of course, the chances of that ever happening are slim to none.



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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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