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Financial Reform Bill Exposed As Hoax

June 28th, 2010 Posted in Uncategorized
Jun, 28 2010
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June 28, 2010

You don’t have to look too far to find damning criticism of the so-called financial “reform” bill.  Once the Kaufman-Brown amendment was subverted (thanks to the Obama administration), the efforts to solve the problem of financial institutions’ growth to a state of being “too big to fail” (TBTF) became a lost cause.  Dylan Ratigan, who had been fuming for a while about the financial reform charade, had this to say about the product that emerged from reconciliation on Friday morning:

It means that the same people who brought you these horrible changes — rising wealth discrepancy, massive unemployment and a crumbling infrastructure – have now further institutionalized the policies that will keep the causes of these problems firmly in place.

The best trashing of this bill came from Tyler Durden at Zero Hedge:

Congrats, middle class, once again you get raped by Wall Street, which is off to the races to yet again rapidly blow itself up courtesy of 30x leverage, unlimited discount window usage, trillions in excess reserves, quadrillions in unregulated derivatives, a TBTF framework that has been untouched and will need a rescue in under a year, non-existent accounting rules, a culture of unmitigated greed, and all of Congress and Senate on its payroll.  And, sorry, you can’t even vote some of the idiots that passed this garbage out:  after all there is a retiring lame duck in charge of it all.  We can only hope his annual Wall Street (i.e. taxpayer funded) annuity will satisfy his conscience for destroying any hope America could have of a credible financial system.

*   *   *

In other words, the greatest theatrical production of the past few months is now over, it has achieved nothing, it will prevent nothing, and ultimately the financial markets will blow up yet again, but not before the Teleprompter in Chief pummels the idiot public with address after address how he singlehandedly was bribed, pardon, achieved a historic event of being the only president to completely crumble under Wall Street’s pressure on every item that was supposed to reign in the greatest risktaking generation (with Other People’s Money) in history.

Robert Lenzner of Forbes focused his criticism of the bill on the fact that nothing was done to limit the absurd leverage used by the banks to borrow against their capital.  After all, at the January 13 hearing of the Financial Crisis Inquiry Commission, Lloyd Bankfiend of Goldman Sachs and JP Morgan’s Dimon Dog admitted that excessive leverage was a key problem in causing the financial crisis.  As I discussed in “Lev Is The Drug”:

Lloyd Blankfein repeatedly expressed pride in the fact that Goldman Sachs has always been leveraged to “only” a  23-to-1 ratio.  The Dimon Dog’s theme was something like:  “We did everything right  . . . except that we were overleveraged”.

At Forbes, Robert Lenzner discussed the ugly truth about how the limits on leverage were excised from this bill:

The capitulation on this matter of leverage is extraordinary evidence of Wall Street’s power to influence Congress through its lobbying dollars.  It is another example of the public servants serving the agents of finance capitalism.  After pumping in gobs of sovereign credit to replace the credit that had been wiped out and replace the supply of credit to the economic system, a weak reform bill will just be an invitation to drum up the leverage that caused the crisis in the first place.

Another victory for the lobbyists came in their sabotage of the prohibition on proprietary trading (when banks trade with their own money, for their own benefit).  The bill provides that federal financial regulators shall study the measure, then issue rules implementing it, based on the results of that study.  The rules might ultimately ban proprietary trading or they may allow for what Jim Jubak of MSN calls the “de minimus” (trading with minimal amounts) exemption to the ban.  Jubak considers the use of the de minimus exemption to the so-called ban as the likely outcome.  Many commentators failed to realize how the lobbyists worked their magic here, reporting that the prop trading ban (referred to as the “Volcker rule”) survived reconciliation intact.  Jim Jubak exposed the strategy employed by the lobbyists:

But lobbying Congress is only part of the game.  Congress writes the laws, but it leaves it up to regulators to write the rules.  In a mid-June review of the text of the financial-reform legislation, the Chamber of Commerce counted 399 rule-makings and 47 studies required by lawmakers.

Each one of these, like the proposed de minimus exemption of the Volcker rule, would be settled by regulators operating by and large out of the public eye and with minimal public input.  But the financial-industry lobbyists who once worked at the Federal Reserve, the Treasury, the Securities and Exchange Commission, the Commodities Futures Trading Commission or the Federal Deposit Insurance Corp. know how to put in a word with those writing the rules.  Need help understanding a complex issue?  A regulator has the name of a former colleague now working as a lobbyist in an e-mail address book.  Want to share an industry point of view with a rule-maker?  Odds are a lobbyist knows whom to call to get a few minutes of face time.

At the Naked Capitalism website, Yves Smith served up some more negative reactions to the bill, along with her own cutting commentary:

I want the word “reform” back.  Between health care “reform” and financial services “reform,” Obama, his operatives, and media cheerleaders are trying to depict both initiatives as being far more salutary and far-reaching than they are.  This abuse of language is yet another case of the Obama Administration using branding to cover up substantive shortcomings.  In the short run it might fool quite a few people, just as BP’s efforts to position itself as an environmentally responsible company did.

*   *   *

So what does the bill accomplish?  It inconveniences banks around the margin while failing to reduce the odds of a recurrence of a major financial crisis.

The only two measures I see as genuine accomplishments, the Audit the Fed provisions, and the creation of a consumer financial product bureau, do not address systemic risks.  And the consumer protection authority was substantially watered down.  Recall a crucial provision, that banks be required to offer plain vanilla variants of products, was axed early on.

So there you have it.  The bill that is supposed to save us from another financial crisis does nothing to accomplish that objective.  Once this 2,000-page farce is signed into law, watch for the reactions.  It will be interesting to sort out the clear-thinkers from the Kool-Aid drinkers.





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Ignoring The Root Cause

June 17th, 2010 Posted in Uncategorized
Jun, 17 2010
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June 17, 2010

The predominant criticism of the so-called “financial reform” bill is its failure to address the problems caused by the existence of financial institutions considered “too big to fail”.  In an essay entitled, “Creating the Next Crisis” economist Simon Johnson discussed the consequences of this legislative let-down:

On the critical dimension of excessive bank size and what it implies for systemic risk, there was a concerted effort by Senators Ted Kaufman and Sherrod Brown to impose a size cap on the largest banks – very much in accordance with the spirit of the original “Volcker Rule” proposed in January 2010 by Obama himself.  In an almost unbelievable volte face, for reasons that remain somewhat mysterious, Obama’s administration itself shot down this approach.  “If enacted, Brown-Kaufman would have broken up the six biggest banks in America,” a senior Treasury official said.  “If we’d been for it, it probably would have happened.  But we weren’t, so it didn’t.”

*   *   *

The US financial sector received an unconditional bailout – and is not now facing any kind of meaningful re-regulation.  We are setting ourselves up, without question, for another boom based on excessive and reckless risk-taking at the heart of the world’s financial system.  This can end only one way:  badly.

One would assume that an important lesson learned from the 2008 financial crisis was the idea that a corporation shouldn’t be permitted to blackmail the country with threats that its own financial collapse would have such a dire impact on society-at-large that the corporation should be bailed out by the taxpayers.  The resulting problem is called “moral hazard” because such businesses are encouraged to act irresponsibly by virtue of the certainty that they will be bailed out if their activities prove self-destructive.

Gonzalo Lira wrote a piece for the Naked Capitalism blog, explaining how the moral hazard resulting from the “too big to fail” doctrine is facilitating a state of corporate anarchy:

In a nutshell, in this era of corporate anarchy, corporations do not have to abide by any rules — none at all.  Legal, moral, ethical, even financial rules are irrelevant.  They have all been rescinded in the pursuit of profit — literally nothing else matters.

As a result, corporations currently exist in a state of almost pure anarchy — but an anarchy directly related to their size:  The larger the corporation, the greater its absolute freedom to do and act as it pleases.  That’s why so many medium-sized corporations are hell-bent on growth over profits:  The biggest of them all, like BP and Goldman Sachs, live in a positively Hobbesian State of Nature, free to do as they please, with nary a consequence.

Good-old British Petroleum – the latest beneficiary of the “too big to fail doctrine”  — can rely on its size to avoid any sanctions it considers unacceptable because too many “small people” might lose their jobs if BP can’t stay fat and happy.  Gonzalo Lira’s analysis went a step further:

Worst of all, BP realizes that, if it finally cannot get a handle on the oil spill disaster, they can simply fob it off on the U.S. Government — in other words, the people of the United States will wind up cleaning BP’s mess.  BP knows that no one will hold it accountable — BP knows that it will get away with it.

*   *   *

This era of corporate anarchy is reaching a crisis point — we can all sense it.  Yet the leadership in the United States and Europe is making no effort to solve the root problem.  Perhaps they don’t see the problem.  Perhaps they are beholden to corporate masters.  Whatever the case, in his speech, President Obama made ridiculous references to “clean energy” while ignoring the cause of the BP oil spill disaster, the cause of the financial crisis, the cause of the spiralling health-care costs — the corporate anarchy that underlines them all.

This era of corporate anarchy is wrecking the world — literally, if you’ve been tuning in to images of the oil billowing out a mile down in the Gulf of Mexico.

Mr. Lira discussed how a leadership void has been helping corporate anarchy overtake democratic capitalism:

Obama is a corporatist — he’s one of Them.  So there’ll be more bullshit talk about “clean energy” and “energy independence”, while the root cause — corporate anarchy — is left undisturbed.

The failure of President Obama to take advantage of the opportunity to address this “root cause” in his Oval Office address concerning the Deepwater Horizon disaster, inspired Robert Reich to make this comment:

Whether it’s Wall Street or health insurers or oil companies, we are approaching a turning point.  The top executives of powerful corporations are pursuing profits in ways that menace the nation.  We have not seen the likes not since the late nineteenth century when the “robber barons” of finance, oil, and the giant trusts ran roughshod over America.  Now, as then, they are using their wealth and influence to buy off legislators and intimidate the regions that depend on them for jobs.  Now, as then, they are threatening the safety and security of our people.

One of my favorite commentators, Paul Farrell of MarketWatch, recently warned us about the consequences of allowing corporate anarchy to destroy democratic capitalism:

The rise of uncontrolled corporate greed killed the “Invisible Hand,” the “soul” of capitalism that Adam Smith saw in 1776 as a divine force serving “the common good.”  Today the system has no moral compass.  Wall Street’s insatiable greed has destroyed capitalism from within, turning America’s economy into a soulless zombie.

The “Invisible Hand” Adam Smith saw as essential to capitalism in “The Theory of Moral Sentiments” died in endless battles fought by 261,000 lobbyists each wanting a bigger piece of the $1.7 trillion federal budget pie plus favorable laws protecting, vesting and increasing the power and wealth of their special interest clients.  Future historians will call this ideological battle replacing democracy the new “American Capitalists Anarchy.”

*   *   *

As a New York Times reviewer put it:  Nations like “China and Russia are using what he calls ‘state capitalism’ to advance the interests of their companies at the expense of their American rivals.”  Global pandemic?

Unfortunately while America wastes trillions to bail out inefficient too-stupid-to-fail banks, our competition is bankrolling healthy state-controlled corporations to destroy us  . . .

If we ever reach the point when the watered-down “financial reform” bill finally becomes law, the taxpayers should insist that their government move on to address the “root cause” of corporate anarchy by taking up campaign finance reform.  That should be one hell of a fight!



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The Poisonous Bailout

June 10th, 2010 Posted in Uncategorized
Jun, 10 2010
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June 10, 2010

The adults in the room have spoken.  The Congressional Oversight Panel – headed by Harvard Law School professor Elizabeth Warren – created to oversee the TARP program, has just issued a report disclosing the ugly truth about the bailout of AIG:

The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace.

Note the present tense in that statement.  Not only did the bailout have a poisonous effect on the marketplace at the time –it continues to have a poisonous effect on the marketplace.  The 300-page report includes the reason why the AIG bailout continues to have this poisonous effect:

The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America‘s largest financial institutions and to assure repayment to the creditors doing business with them.

And that, dear readers, is precisely what the concept of “moral hazard” is all about.  It is the reason why we should not continue to allow financial institutions to be “too big to fail”.  Bad behavior by financial institutions is encouraged by the Federal Reserve and Treasury with assurance that any losses incurred as a result of that risky activity will be borne by the taxpayers rather than the reckless institutions.  You might remember the pummeling Senator Jim Bunning gave Ben Bernanke during the Federal Reserve Chairman’s appearance before the Senate Banking Committee for Bernanke’s confirmation hearing on December 3, 2009:

.  .  .   you have decided that just about every large bank, investment bank, insurance company, and even some industrial companies are too big to fail.  Rather than making management, shareholders, and debt holders feel the consequences of their risk-taking, you bailed them out.  In short, you are the definition of moral hazard.

With particular emphasis on the AIG bailout, this is what Senator Bunning said to Bernanke:

Even if all that were not true, the A.I.G. bailout alone is reason enough to send you back to Princeton.  First you told us A.I.G. and its creditors had to be bailed out because they posed a systemic risk, largely because of the credit default swaps portfolio.  Those credit default swaps, by the way, are over the counter derivatives that the Fed did not want regulated.  Well, according to the TARP Inspector General, it turns out the Fed was not concerned about the financial condition of the credit default swaps partners when you decided to pay them off at par.  In fact, the Inspector General makes it clear that no serious efforts were made to get the partners to take haircuts, and one bank’s offer to take a haircut was declined.  I can only think of two possible reasons you would not make then-New York Fed President Geithner try to save the taxpayers some money by seriously negotiating or at least take up U.B.S. on their offer of a haircut.  Sadly, those two reasons are incompetence or a desire to secretly funnel more money to a few select firms, most notably Goldman Sachs, Merrill Lynch, and a handful of large European banks.

Hugh Son of Bloomberg BusinessWeek explained how the Congressional Oversight Panel’s latest report does not have a particularly optimistic view of AIG’s ability to repay the bailout:

The bailout includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury Department and up to $52.5 billion to buy mortgage-linked assets owned or backed by the insurer through swaps or securities lending.

AIG owes about $26.6 billion on the credit line and $49 billion to the Treasury.  The company returned to profit in the first quarter, posting net income of $1.45 billion.

‘Strong, Vibrant Company’

“I’m confident you’ll get your money, plus a profit,” AIG Chief Executive Officer Robert Benmosche told the panel in Washington on May 26.  “We are a strong, vibrant company.”

The panel said in the report that the government’s prospects for recovering funds depends partly on the ability of AIG to find buyers for its units and on investors’ willingness to purchase shares if the Treasury Department sells its holdings.  AIG turned over a stake of almost 80 percent as part of the bailout and the Treasury holds additional preferred shares from subsequent investments.

“While the potential for the Treasury to realize a positive return on its significant assistance to AIG has improved over the past 12 months, it still appears more likely than not that some loss is inevitable,” the panel said.

Simmi Aujla of the Politico reported on Elizabeth Warren’s contention that Treasury and Federal Reserve officials should have attempted to save AIG without using taxpayer money:

“The negotiations would have been difficult and they might have failed,” she said Wednesday in a conference call with reporters.  “But the benefits of crafting a private or even a joint public-private solution were so superior to the cost of a complete government bailout that they should have been pursued as vigorously as humanly possible.”

The Treasury and Federal Reserve are now in “damage control” mode, issuing statements that basically reiterate Bernanke’s “panic” excuse referenced in the above-quoted remarks by Jim Bunning.

The release of this report is well-timed, considering the fact that the toothless, so-called “financial reform” bill is now going through the reconciliation stage.  Now that Blanche Lincoln is officially the Democratic candidate to retain her Senate seat representing Arkansas – will the derivatives reform provisions disappear from the bill?  In light of the information contained in the Congressional Oversight Panel’s report, a responsible – honest – government would not only crack down on derivatives trading but would also ban the trading of “naked” swaps.  In other words:  No betting on defaults if you don’t have a potential loss you are hedging – or as Phil Angelides explained it:  No buying fire insurance on your neighbor’s house.  Of course, we will probably never see such regulation enacted – until after he next financial crisis.



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Delaying A Tough Decision

June 3rd, 2010 Posted in Uncategorized
Jun, 03 2010
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June 3, 2010

A recent article by David Lightman for the McClatchy Newspapers bemoaned the fact that the Senate took off for a ten-day break without voting on the “Jobs Bill” passed by the House of Representatives (H.R.4213).   Mr. Lightman’s piece expressed particular concern about the fact that a summer jobs program for approximately 330,000 “at-risk youths” has been hanging in the balance between deficit distress and economic recovery efforts.  Of particular concern is the fact that time is of the essence for keeping the youth jobs program alive for this summer:

The longer the wait, the less the program can reduce joblessness among the nation’s most vulnerable population.  Unemployment among 16- to 19-year-olds was 25.4 percent in April.

“Summer’s only so long, and it is a summer youth program,” said Mark Mattke, the work force strategy and planning director at the Spokane Area Workforce Development Council.  More than 5,700 people in Washington state got summer jobs through government programs last year.

Financial expert, Janet Tavakoli, recently wrote an essay for The Huffington Post, discussing the cause-and-effect relationship between hard economic times and the crime rate.  With municipal budget cutbacks reducing the ranks of our nation’s law enforcement personnel, a failure to extend unemployment benefits, as provided by the Jobs Bill, could be a dangerous experiment.  Ms. Tavakoli discussed how the current recession has precipitated an increase in Chicago’s street crime:

Last summer gang violence ruled the night at Leland and Sheridan, a neighborhood in the process of gentrifying.

In the upscale Lincoln Park area, just a little further south of this unrest, men alone at night were accosted by groups of three to six men and severely beaten, robbed, and hospitalized.  Seven muggings occurred in a five-day period from July 30 to August 4, 2009.

This kind of activity was unusual for these areas of Chicago until last summer.

Current Escalating Violent Crime and Chicago’s Prime Lakefront Areas

Shootings are way up in Chicago, and ordinary citizens — along with shorthanded police — are angry.  Chicago has a gun ban, yet on Wednesday, May 19, Thomas Wortham IV, a Chicago police officer and Iraq War veteran, was shot when four gang members attempted to steal the new motorcycle the officer had brought to show his father, a retired police officer.  Shots were fired, and his father saw the skirmish, ran for his gun, and managed to get off a few rounds.  Two gang members were shot while two sped away dragging his fallen son’s body some distance in the process.

Nine people were shot on Sunday night (May 24), and Chicago is currently in the grips of a massive crime wave that has overwhelmed our under funded police force.

Gangland violence and shootings now occur up and down Chicago’s lakefront.

*   *   *

This escalation and geographical spread of violence is new, and I believe it is related to our Great Recession and budget issues.  I don’t believe that Chicago is alone in its budget problems.  If new patterns in Recession-related-violence have not yet affected other major cities in the U.S. the way they have affected Chicago, they may affect them soon.  It is also likely that crime is being underreported as crime-fighting budgets are cut.

Given the current momentum for deficit hawkishness, the Senate’s break before the vote on this bill could be advantageous.  After all, the bill barely passed in the House.  Our Senators need to carefully consider the consequences of the failure to pass this bill.  David Leonhardt of The New York Times presented a reasoned argument to his readers from the Senate on June 1, recommending passage of the Jobs Bill:

It would still add about $54 billion to the deficit over the next decade. On the other hand, it could also do some good.  Among other things, it would cut taxes for businesses, expand summer jobs programs and temporarily extend jobless benefits for some of today’s 15 million unemployed workers.

*   *   *

Including the jobs bill, the deficit is projected to grow to about $1.3 trillion next year (and that’s assuming the White House can persuade Congress to make some proposed spending cuts and repeal the Bush tax cuts for the affluent).  To be at a level that economists consider sustainable, the deficit needs to be closer to $400 billion.  Only then would normal economic growth be able to pay it off.

So Congress would need to find almost $900 billion in savings.  By voting down the jobs bill, it would save more than $50 billion by 2015 and get 7 percent of the way to the goal.  That’s not nothing.  In a nutshell, it’s the case against the bill.

*   *   *

Of course, even if the bill is not very expensive, it is worth passing only if it will make a difference.  And economists say it will.

Last year’s big stimulus program certainly did.  The Congressional Budget Office estimates that 1.4 million to 3.4 million people now working would be unemployed were it not for the stimulus.  Private economists have made similar estimates.

There are two arguments for more stimulus today.  The first is that, however hopeful the economic signs, the risk of a double-dip recession remains. Financial crises often bring bumpy recoveries.  The recent troubles in Europe surely won’t help.

The second argument is that the economy has a terribly long way to go before it can be considered healthy.  Here is a sobering way to think about the situation:  If the next four years were to bring job growth as fast as the job growth during the best four years of the 1990s boom — which isn’t likely — the unemployment rate would still be higher in 2014 than when the recession began in late 2007.

Voters may not like deficits, but they really do not like unemployment.

Looking at the problem this way makes the jobs bill seem like less of a tough call.  Luckily, the country’s two big economic problems — the budget deficit and the job market — are not on the same timeline.  The unemployment rate is near a 27-year high right now.  Deficit reduction can wait a bit, given that lenders continue to show confidence in Washington’s ability to repay the debt.

Remember that by way of Maiden Lane III, “Turbo” Tim Geithner, as president of the New York Fed, gave away $30 billion of taxpayer money to the counterparties of AIG – even though most of them didn’t need it.  A “clawback” of that money from those banks (including Goldman Sachs – a $19 billion recipient) could pay for more than half the cost of the Jobs Bill.   If the $30 billion wasted on Maiden Lane III can be so easily forgotten – why not spend $54 billion to avoid a “double-dip” recession and a hellish increase in street crime?



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Your Sleazy Government At Work

May 31st, 2010 Posted in Uncategorized
May, 31 2010
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May 31, 2010

Although the cartoon above appeared in my local paper, it came to my attention only because Barry Ritholtz posted it on his website, The Big Picture.  Congratulations to Jim Morin of The Miami Herald for creating one of those pictures that’s worth well over a thousand words.

Forget about all that oil floating in the Gulf of Mexico.  President Obama, Harry Reid and “Countrywide Chris” Dodd are too busy indulging in an orgy of self-congratulation over the Senate’s passage of a so-called “financial reform” bill (S. 3217) to be bothered with “the fishermen’s buzzkill”.  Meanwhile, many commentators are expressing their disappointment and disgust at the fact that the banking lobby has succeeded in making sure that the taxpayers will continue to pick up the tab when the banks go broke trading unregulated derivatives.

Matt Taibbi has written a fantastic essay for Rolling Stone, documenting the creepy battle over financial reform in the Senate.  The folks at Rolling Stone are sure getting their money’s worth out of Taibbi, after his landmark smackdown of Goldman Sachs and his revealing article exposing the way banks such as JP Morgan Chase fleeced Jefferson County, Alabama.  In his latest “must read” essay, Taibbi provides his readers with an understandable discussion of what is wrong with derivatives trading and Wall Street’s efforts to preserve the status quo:

Imagine a world where there’s no New York Stock Exchange, no NASDAQ or Nikkei:  no open exchanges at all, and all stocks traded in the dark.  Nobody has a clue how much a share of  IBM costs or how many of them are being traded.  In that world, the giant broker-dealer who trades thousands of IBM shares a day, and who knows which of its big clients are selling what and when, will have a hell of a lot more information than the day-trader schmuck sitting at home in his underwear, guessing at the prices of stocks via the Internet.

That world exists.  It’s called the over-the-counter derivatives market. Five of the country’s biggest banks, the Goldmans and JP Morgans and Morgan Stanleys, account for more than 90 percent of the market, where swaps of all shapes and sizes are traded more or less completely in the dark.  If you want to know how Greece finds itself bankrupted by swaps, or some town in Alabama overpaid by $93 million for deals to fund a sewer system, this is the explanation:  Nobody outside a handful of big swap dealers really has a clue about how much any of this shit costs, which means they can rip off their customers at will.

This insane outgrowth of  jungle capitalism has spun completely out of control since 2000, when Congress deregulated the derivatives market.  That market is now roughly 100 times bigger than the federal budget and 20 times larger than both the stock market and the GDP.  Unregulated derivative deals sank AIG, Lehman Brothers and Greece, and helped blow up the global economy in 2008.  Reining in derivatives is the key battle in the War for Finance Reform.  Without regulation of this critical market, Wall Street could explode another mushroom cloud of nuclear leverage and risk over the planet at any time.

At The New York Times, Gretchen Morgenson de-mystified how both the Senate’s “financial reform” bill and the bill passed by the House require standardized derivatives to be traded on an exchange or a “swap execution facility”.  Although these proposals create the illusion of reform – it’s important to keep in mind that old maxim about gambling:  “The house always wins.”  In this case, the ability to “front-run” the chumps gives the house the power to keep winning:

But the devil is always in the details — hence, two 1,500-page bills — and problems arise in how the proposals define what constitutes a swap execution facility, and who can own one.

Big banks want to create and own the venues where swaps are traded, because such control has many benefits.  First, it gives the dealers extremely valuable pretrade information from customers wishing to buy or sell these instruments.  Second, depending on how these facilities are designed, they may let dealers limit information about pricing when transactions take place — and if an array of prices is not readily available, customers can’t comparison-shop and the banks get to keep prices much higher than they might be on an exchange.

*   *   *

Finally, lawmakers who are charged with consolidating the two bills are talking about eliminating language that would bar derivatives facilities from receiving taxpayer bailouts if they get into trouble.  That means a federal rescue of an imperiled derivatives trading facility could occur.  (Again, think A.I.G.)

Surely, we beleaguered taxpayers do not need to backstop any more institutions than we do now.  According to Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, Va., only 18 percent of the nation’s financial sector was covered by implied federal guarantees in 1999.  By the end of 2008, his bank’s research shows, the federal safety net covered 59 percent of the financial sector.

In a speech last week, Mr. Lacker said that he feared we were going to perpetuate the cycle of financial crises followed by taxpayer bailouts, in spite of Congressional reform efforts.

“Arguably, we will not break the cycle of regulation, bypass, crisis and rescue,”  Mr. Lacker said, “until we are willing to clarify the limits to government support, and incur the short-term costs of confirming those limits, in the interest of building a stronger and durable foundation for our financial system.  Measured against this gauge, my early assessment is that progress thus far has been negligible.”

Negligible progress, 3,000 pages notwithstanding.

When one considers what this legislation was intended to address, the dangers posed by failing to extinguish those systemic threats to the economy and what the Senate bill is being claimed to remedy  —  it’s actually just a huge, sleazy disgrace.  Matt Taibbi’s concluding words on the subject underscore the fact that not only do we still need real financial reform, we also need campaign finance reform:

Whatever the final outcome, the War for Finance Reform serves as a sweeping demonstration of how power in the Senate can be easily concentrated in the hands of just a few people.  Senators in the majority party – Brown, Kaufman, Merkley, even a committee chairman like Lincoln – took a back seat to Reid and Dodd, who tinkered with amendments on all four fronts of  the war just enough to keep many of them from having real teeth.  “They’re working to come up with a bill that Wall Street can live with, which by definition makes it a bad bill,” one Democratic aid eexplained in the final, frantic days of negotiation.

On the plus side, the bill will rein in some forms of predatory lending, and contains a historic decision to audit the Fed.  But the larger, more important stuff – breaking up banks that grow Too Big to Fail, requiring financial giants to pay upfront for their own bailouts, forcing the derivatives market into the light of day – probably won’t happen in any meaningful way.  The Senate is designed to function as a kind of ongoing negotiation between public sentiment and large financial interests, an endless tug of war in which senators maneuver to strike a delicate mathematical balance between votes and access to campaign cash.  The problem is that sometimes, when things get really broken, the very concept of a middle ground between real people and corrupt special interests becomes a grotesque fallacy.  In times like this, we need our politicians not to bridge a gap but to choose sides and fight.  In this historic battle over finance reform, when we had a once-in-a-generation chance to halt the worst abuses on Wall Street, many senators made the right choice.  In the end, however, the ones who mattered most picked wrong – and a war that once looked winnable will continue to drag on for years, creating more havoc and destroying more lives before it is over.

The sleazy antics by the Democrats who undermined financial reform (while pretending to advance it) will not be forgotten by the voters.  The real question is whether any independent candidates can step up to oppose the tools of Wall Street, relying on the nickels and dimes from “the little people” to wage a battle against the kleptocracy.






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Moment Of Truth

May 24th, 2010 Posted in Uncategorized
May, 24 2010
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May 24, 2010

Now that the Senate has passed its own version of a financial reform bill (S. 3217), the legislation must be reconciled with the House version before the bill can be signed into law by the President.  At this point, there is one big problem:  the President doesn’t like the bill because it actually has more teeth than an inbred, moonshine-drinking, meth head.  One especially objectionable provision in the eyes of the Administration and its kindred of the kleptocracy, Ben Bernanke, concerns the restrictions on derivatives trading introduced by Senator Blanche Lincoln.

Eric Lichtblau and Edward Wyatt of The New York Times wrote an article describing the current game plan of financial industry lobbyists to remove those few teeth from the financial reform bill to make sure that what the President signs is all gums:

The biggest flash point for many Wall Street firms is the tough restrictions on the trading of derivatives imposed in the Senate bill approved Thursday night.  Derivatives are securities whose value is based on the price of other assets like corn, soybeans or company stock.

The financial industry was confident that a provision that would force banks to spin off their derivatives businesses would be stripped out, but in the final rush to pass the bill, that did not happen.

The opposition comes not just from the financial industry.  The chairman of the Federal Reserve and other senior banking regulators opposed the provision, and top Obama administration officials have said they would continue to push for it to be removed.

And Wall Street lobbyists are mounting an 11th-hour effort to remove it when House and Senate conferees begin meeting, perhaps this week, to reconcile their two bills.  Lobbyists say they are already considering the possible makeup of the conference panel to focus on office visits and potential fund-raising.

The article discussed an analysis provided to The New York Times by Citizens for Responsibility and Ethics in Washington, a nonpartisan group:

The group’s analysis found that the 14 freshmen who serve on the House Financial Services Committee raised 56 percent more in campaign contributions than other freshmen.  And most freshmen on the panel, the analysis found, are now in competitive re-election fights.

“It’s definitely not accidental,” said Melanie Sloan, the director of the ethics group. “It appears that Congressional leaders are deliberately placing vulnerable freshmen on the Financial Services Committee to increase their ability to raise money.”

Take Representative John Adler, Democrat of New Jersey.  Mr. Adler is a freshman in Congress with no real national profile, yet he has managed to raise more than $2 million for his re-election, more than any other freshman, the analysis found.

That is due in large part, political analysts say, to his spot on the Financial Services Committee.

An opinion piece from the May 24 Wall Street Journal provided an equally-sobering outlook on this legislation:

The unifying theme of the Senate bill that passed last week and the House bill of last year is to hand even more discretion and authority to the same regulators who failed to foresee and in many cases created the last crisis.  The Democrats who wrote the bill are selling it as new discipline for Wall Street, but Wall Street knows better.  The biggest banks support the bill, and the parts they don’t like they will lobby furiously to change or water down.

Big Finance will more than hold its own with Big Government, as it always does, while politicians will have more power to exact even more campaign tribute.  The losers are the overall economy, as financial costs rise, and taxpayers when the next bailout arrives.

At The Huffington Post, Mary Bottari discussed the backstory on Blanche Lincoln’s derivatives reform proposal and the opposition it faces from both lobbyists and the administration:

The Obama Administration Wants to Kill the Best Provisions

Lincoln’s proposal has come under fire from all fronts.  Big bank lobbyists went ballistic of course and they will admit that getting her language pulled from the bill is still their top priority.  Behind the scenes, it is also the top priority of the administration and the Federal Reserve.  Believe it or not the administration is fighting to preserve its ability to bailout any financial institutions that gets in trouble, not just commercial banks.  Yep that is right.  Instead of clamping down Wall Street gambling, the administration wants to keep reckless institutions on the teat of the Federal Reserve.

The battle lines are drawn.  The biggest threat to the Lincoln language now is the Obama administration and the Federal Reserve.  There will no doubt be a move to strip out the strong Lincoln language in conference committee where the House and Senate versions of the bank reform bill now go to be aligned.

Meanwhile, President Obama continues to pose as the champion of the taxpayers, asserting his bragging rights for the Senate’s passage of the bill.  Jim Kuhnhenn of MSNBC made note of Obama’s remark, which exhibited the Executive Spin:

The financial industry, Obama said, had tried to stop the new regulations “with hordes of lobbyists and millions of dollars in ads.”

In fact, the lobbyists have just begun to fight and Obama is right in their corner, along with Ben Bernanke.



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Banking Lobby Tools In Senate Subvert Reform

May 20th, 2010 Posted in Uncategorized
May, 20 2010
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May 20. 2010

The financial pseudo-reform bill is being exposed as a farce.  Thanks to its tools in the Senate, the banking lobby is on the way toward defeating any significant financial reform.  Although Democrats in the Senate (and the President himself) have been posing as reformers who stand up to those “fat cat bankers”, their actions are speaking much louder than their words.  What follows is a list of the Senate Democrats who voted against both the Kaufman – Brown amendment (to prevent financial institutions from being “too big to fail”) as well as the amendment calling for more Federal Reserve transparency (sponsored by Republican David Vitter to comport with Congressman Ron Paul’s original “Audit the Fed” proposal – H.R. 1207 – which was replaced by the watered-down S. 3217 ):

Akaka (D-HI), Baucus (D-MT), Bayh (D-IN), Bennet (D-CO), Carper (D-DE), Conrad (D-ND), Dodd (D-CT), Feinstein (D-CA), Gillibrand (D-NY), Hagan (D-NC), Inouye (D-HI), Johnson (D-SD), Kerry (D-MA), Klobuchar (D-MN), Kohl (D-WI), Landrieu (D-LA), Lautenberg (D-NJ), Lieberman (ID-CT), McCaskill (D-MO), Menendez (D-NJ), Nelson (D-FL), Nelson (D-NE), Reed (D-RI), Schumer (D-NY), Shaheen (D-NH), Tester (D-MT), Udall (D-CO) and Mark Warner (D-VA).

I wasn’t surprised to see Senator Chuck Schumer on this list because, after all, Wall Street is located in his state.  But how about Senator Claire McCaskill?  Remember her performance at the April 27 hearing before the Senate Permanent Subcommittee on Investigations?   She really went after those banksters – didn’t she?  Why would she suddenly turn around and support the banks in opposing those two amendments?   I suppose the securities and investment industry is entitled to a little payback, after having given her campaign committee $265,750.

I was quite disappointed to see Senator Amy Klobuchar on that list.  Back on June 19, 2008, I included her in a piece entitled “Women to Watch”.  Now, almost exactly two years later, we are watching her serve as a tool for the securities and investment industry, which has given her campaign committee $224,325.  On the other hand, another female Senator whom I discussed in that same piece, Maria Cantwell of Washington, has been standing firm in opposing attempts to leave some giant loopholes in Senator Blanche Lincoln’s amendment concerning derivatives trading reform.  The Huffington Post described how Harry Reid attempted to use cloture to push the financial reform bill to a vote before any further amendments could have been added to strengthen the bill.  Notice how “the usual suspects” – Reid, Chuck Schumer and “Countrywide Chris” Dodd tried to close in on Cantwell and force her capitulation to the will of the kleptocracy:

There were some unusually Johnsonian moments of wrangling on the floor during the nearly hour-long vote.  Reid pressed his case hard on Snowe, the lone holdout vote present, with Bob Corker and Mitch McConnell at her side.  After finding Brown, he put his arm around him and shook his head, then found Cantwell seated alone at the opposite end of the floor.  He and New York’s Chuck Schumer encircled her, Reid leaning over her with his right arm on the back of her chair and Schumer leaning in with his left hand on her desk.  Cantwell stared straight ahead, not looking at the men even as she spoke.  Schumer called in Chris Dodd, who was unable to sway her.  Feingold hadn’t stuck around.  Cantwell, according to a spokesman, wanted a guarantee on an amendment that would fix a gaping hole in the derivatives section of the bill, which requires the trades to be cleared, but applies no penalty to trades that aren’t, making Blanche Lincoln’s reform package little better than a list of suggestions.

*   *   *

“I don’t think it’s a good idea to cut off good consumer amendments because of cloture,” said Cantwell on Tuesday night.

Other amendments offered by Democrats would ban banks from proprietary trading, cap ATM fees at 50 cents, impose new limits on the payday lending industry, prohibit naked credit default swaps and reinstate Glass-Steagall regulations that prohibit banks from owning investment firms.

“We need to eliminate the risk posed to our economy by ‘too big to fail’ financial firms and to reinstate the protective firewalls between Main Street banks and Wall Street firms,” said Feingold in a statement after the vote.  Feingold supported the amendment to reinstate Glass-Steagall, among others.

“Unfortunately, these key reforms are not included in the bill,” he said.  “The test for this legislation is a simple one — whether it will prevent another financial crisis.  As the bill stands, it fails that test.  Ending debate on the bill is finishing before the job is done.”

Russ Feingold’s criticisms of the bill were consistent with those voiced by economist Nouriel Roubini (often referred to as “Doctor Doom” because he was one of the few economists to anticipate the scale of the financial crisis).  Barbara Stcherbatcheff of CNBC began her report on Dr. Roubini’s May 18 speech with this statement:

Current efforts to reform financial regulation are “cosmetic” and won’t prevent another crisis, economist Nouriel Roubini told an audience on Tuesday at the London School of Economics.

The current mid-term primary battles have fueled a never-ending stream of commentary following the same narrative:  The wrath of the anti-incumbency movement shall be felt in Washington.  Nevertheless, Dylan Ratigan seems to be the only television commentator willing to include “opposition to financial reform” as a political liability for Congressional incumbents.  Yves Smith raised the issue on her Naked Capitalism website with an interesting essay focused on this theme:

Why have political commentators been hesitant to connect the dots between the “no incumbent left standing” movement and the lack of meaningful financial reform?

Her must-read analysis of the “head fakes” going on within the financial reform wrangling concludes with this thought:

So despite the theatrics in Washington, I recommend lowering your expectations greatly for the result of financial reform efforts.  There have been a few wins (for instance, the partial success of the Audit the Fed push), but other measures have for the most part been announced with fanfare and later blunted or excised.  Even though the firestorm of Goldman-related press stiffened the spines of some Senators and produced a late-in-process flurry of amendments, don’t let a blip distract you from the trend line, that as the legislative process proceeds apace, the banks will be able to achieve an outcome that leaves their dubious business models and most important, the rich pay to industry incumbents, largely intact.

As always, it’s up to the voting public with the short memory to unseat those tools of the banking lobby.  Our only alternative is to prepare for the next financial crisis.



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Avoiding The Stock Market

May 18th, 2010 Posted in Uncategorized
May, 18 2010
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May 18, 2010

In the wake of the stock market’s “flash crash” on May 6, there have been an increasing number of reports that retail investors (“Ma and Pa”) are pulling their money out of stocks.  Beyond that, some commentators have stepped forward to speak out and advise retail investors to steer clear of the stock market, due to the volatility caused by “high-frequency trading” or HFT.  One recent example of this was Felix Salmon’s video message, which appeared at The Huffington Post.

HFT involves a practice wherein firms are paid a small “rebate” (approximately one-half cent per trade) by the exchanges themselves when the firms buy and sell stocks.  The purpose of paying firms to make such trades (often selling a stock for the same price they paid for it) is to provide liquidity for the markets.  As a result, retail investors would not have to worry about getting stuck in a “roach motel” – not being able to get out once they got in – after buying a stock.  Many firms involved in high-frequency trading (Goldman Sachs, RGM Advisors, Tradebot Systems and others) have their computer servers “co-located” in the same building as the exchange, in order to get each of their orders processed a few nanoseconds faster than orders coming from further distances (albeit at the speed of light).  The Zero Hedge website has been critical of HFT for quite a while.  They recently published this informative piece on the subject, pointing out how HFT firms caused the catastrophe on May 6:

. . .  when the selling in size commences they all just shut down.  So much for providing liquidity when it is needed.

At The Market Ticker website, Karl Denninger explained how HFT platforms often use “predatory algorithms” to drive a stock’s price up to the full extent of a customer’s limit order (a practice called “frontrunning”):

Let’s say that there is a buyer willing to buy 100,000 shares of BRCM with a limit price of $26.40.  That is, the buyer will accept any price up to $26.40.

But the market at this particular moment in time is at $26.10, or thirty cents lower.

So the computers, having detected via their “flash orders” (which ought to be illegal) that there is a desire for Broadcom shares, start to issue tiny (typically 100 share lots) “immediate or cancel” orders – IOCs – to sell at $26.20.  If that order is “eaten” the computer then issues an order at $26.25, then $26.30, then $26.35, then $26.40.  When it tries $26.45 it gets no bite and the order is immediately canceled.

Now the flush of supply comes at, big coincidence, $26.39, and the claim is made that the market has become “more efficient.”

Nonsense; there was no “real seller” at any of these prices!  This pattern of offering was intended to do one and only one thing – manipulate the market by discovering what is supposed to be a hidden piece of information – the other side’s limit price!

The extent to which frontrunning takes place was the subject of a recent conversation between Larry Tabb of Tabb Group and Erin Burnett on CNBC.  The Zero Hedge website provided this analysis of the video clip:

The funniest bit of the exchange occurs at 3:35 into the clip, when Tabb publicly discloses that front-running is not only legal but occurs all the time on open exchanges. When Erin Burnett, who unfortunately still thinks that the Deutsche Mark is used in Germany, asks who is doing the front running, Tabb says “It could be anyone.”

A recent piece by Josh Lipton at the Minyanville website focused on the activity of retail investors since the recent “flash crash”:

Specifically, during the past week through May 12, your friends and neighbors pulled $2.8 billion out of US stock funds, according to the latest data from the professional number crunchers at Lipper FMI.

To put that stat in context, we called up Robert Adler, the head of Lipper FMI Americas, for a chat this morning.  He tells us that’s the most investors have pulled out, in fact, since March 11, 2009.

At the same time, says Adler, investors plowed $16.6 billion into money-market funds.  “That’s the first inflows money market funds have seen in the last 16 weeks,” he says.

*   *   *

“There was an about-face this past week by investors,” Adler says, noting that such outflows from both equity and bond funds, and a sharp reversal in money market funds, demonstrate a clear and dramatic shift in sentiment.

The analyst is quick to emphasize, however, that one week doesn’t make a trend.  “We have to wait another week to see whether this was simply event driven or if this is the beginning of a new trend,” he says.

The current risk-aversion experienced by retail investors is compounded by the ugly truth that stocks are currently overvalued.  Shawn Tully of Fortune made this very clear in a May 17 commentary, wherein he provided us with a sage bit of prognostication:

Here’s how I see the odds.  The chances are about one in three that we suffer a huge, wrenching correction in the next year or two similar to the one in 1987.  That possibility is so high because stocks are so startlingly expensive.  Another high probability event is that markets go on a long sideways grind, with smaller drops along the way.  What’s extremely unlikely is that the market rises substantially from current levels and stays there for any extended period.

Whatever happens in the next couple of years, the odds are overwhelming that investors who buy stocks today will reap puny returns for 10 years.  For example, if you’d purchased shares at today’s PE of 22 in early 2003, you would have gotten a return of around 3% a year, barely enough to compensate for inflation, let alone buy the blood pressure medication you’d need to survive the scary ride of stock ownership.

Now let’s look out a decade or two.  The evidence is extremely strong that price matters, and matters a lot:  except in rare cases, buying stocks when they are pricey — when the Shiller PE exceeds 20 — leads to puny returns ten years later.

Not that you’d ever know that from the happy talk from Wall Street.  So screen the noise out, and follow the numbers.  They’ll eventually get better for investors.  But to get back there, we may revisit October of 1987.

Considering the unlimited number of awful news events unfolding in America and around the world right now, we could be headed for a market crash much worse that that of October, 1987.  Cheers!




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Doctor Doom Writes A Prescription

May 6th, 2010 Posted in Uncategorized
May, 06 2010
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May 6, 2010

As I discussed on April 26, expectations for serious financial reform are pretty low.  Worse yet, Lloyd Blankfein (CEO of Goldman Sachs) felt confident enough to make this announcement, during a conference call with private wealth management clients:

“We will be among the biggest beneficiaries of reform.”

So how effective could “financial reform” possibly be if Lloyd Bankfiend expects to benefit from it?  Allan Sloan of Fortune suggested following the old Wall Street maxim of “what they promise you isn’t necessarily what you get” when examining the plans to reform Wall Street:

President Obama talks about “a common sense, reasonable, nonideological approach to target the root problems that led to the turmoil in our financial sector and ultimately in our entire economy.”  But what we’ll get from the actual legislation isn’t necessarily what we hear from the Salesman-in-Chief.

Sloan offered an alternative by providing “Six Simple Steps” to help fix the financial system.  He wasn’t alone in providing suggestions overlooked by our legislators.

Nouriel Roubini (often referred to as “Doctor Doom” because he was one of the few economists to anticipate the scale of the financial crisis) has written a new book with Stephen Mihm entitled, Crisis Economics:  A Crash Course in the Future of Finance.  (Mihm is a professor of economic history and a New York Times Magazine writer.)  An excerpt from the book recently appeared in The Telegraph.  The idea of fixing our “sub-prime financial system” was introduced this way:

Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel.  Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.

*   *   *

Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis.  Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again.  The crisis was less a function of sub-prime mortgages than of a sub-prime financial system.  Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out.  The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.

Roubini and Mihm had nothing favorable to say about CDOs, which they referred to as “Chernobyl Death Obligations”.  Beyond that, the authors called for more transparency in derivatives trading:

Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis.  So-called over-the-counter derivatives — better described as under-the-table — must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted.  Moreover, the regulation of derivatives should be consolidated under a single regulator.

Although derivatives trading reform has been advanced by Senators Maria Cantwell and Blanche Lincoln, inclusion of such a proposal in the financial reform bill faces an uphill battle.  As Ezra Klein of The Washington Post reported:

The administration, the Treasury Department, the Federal Reserve, and even the FDIC are lockstep against it.

The administration, Treasury and the Fed are also fighting hard against a bipartisan effort to include an amendment in the financial reform bill that would compel a full audit of the Federal Reserve.  I’m intrigued by the possibility that President Obama could veto the financial reform bill if it includes a provision to audit the Fed.

Jordan Fabian of The Hill discussed Congressman Alan Grayson’s theory about why Treasury Secretary Tim Geithner opposes a Fed audit:

But Grayson, who is known for his tough broadsides against opponents, indicated Geithner may have had a role in enacting “secret bailouts and loan guarantees” to large corporations, while New York Fed chairman during the Bush administration.

“It’s one of the biggest conflict of interests I have ever seen,” he said.

With the Senate and the administration resisting various elements of financial reform, the recent tragedy in Nashville provides us with a reminder of how history often repeats itself.  The concluding remarks from the Roubini – Mihm piece in The Telegraph include this timely warning:

If we strengthen the levees that surround our financial system, we can weather crises in the coming years. Though the waters may rise, we will remain dry.  But if we fail to prepare for the inevitable hurricanes — if we delude ourselves, thinking that our antiquated defences will never be breached again — we face the prospect of many future floods.

The issue of whether our government will take the necessary steps to prevent another financial crisis continues to remain in doubt.



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Too Cute By Half

April 29th, 2010 Posted in Uncategorized
Apr, 29 2010
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April 29, 2010

On April 15, I discussed the disappointing performance of the Financial Crisis Inquiry Commission (FCIC).  The vapid FCIC hearings have featured softball questions with no follow-up to the self-serving answers provided by the CEOs of those too-big–to-fail financial institutions.

In stark contrast to the FCIC hearings, Tuesday brought us the bipartisan assault on Goldman Sachs by the Senate Permanent Subcommittee on Investigations.  Goldman’s most memorable representatives from that event were the four men described by Steven Pearlstein of The Washington Post as “The Fab Four”, apparently because the group’s most notorious member, Fabrice “Fabulous Fab” Tourre, has become the central focus of the SEC’s fraud suit against Goldman.   Tourre’s fellow panel members were Daniel Sparks (former partner in charge of the mortgage department), Joshua Birnbaum (former managing director of Structured Products Group trading) and Michael Swenson (current managing director of Structured Products Group trading).  The panel members were obviously over-prepared by their attorneys.  Their obvious efforts at obfuscation turned the hearing into a public relations disaster for Goldman, destined to become a Saturday Night Live sketch.  Although these guys were proud of their evasiveness, most commentators considered them too cute by half.  The viewing public could not have been favorably impressed.  Both The Washington Post’s Steven Pearlstein as well as Tunku Varadarajan of The Daily Beast provided negative critiques of the group’s testimony.  On the other hand, it was a pleasure to see the Senators on the Subcommittee doing their job so well, cross-examining the hell out of those guys and not letting them get away with their rehearsed non-answers.

A frequently-repeated theme from all the Goldman witnesses who testified on Tuesday (including CEO Lloyd Bankfiend and CFO David Viniar) was that Goldman had been acting only as a “market maker” and therefore had no duty to inform its customers that Goldman had short positions on its own products, such as the Abacus-2007AC1 CDO.  This assertion is completely disingenuous.  When Goldman creates a product and sells it to its own customers, its role is not limited to that of  “market-maker”.  The “market-maker defense” was apparently created last summer, when Goldman was defending its “high-frequency trading” (HFT) activities on stock exchanges.  In those situations, Goldman would be paid a small “rebate” (approximately one-half cent per trade) by the exchanges themselves to buy and sell stocks.  The purpose of paying Goldman to make such trades (often selling a stock for the same price they paid for it) was to provide liquidity for the markets.  As a result, retail (Ma and Pa) investors would not have to worry about getting stuck in a “roach motel” – not being able to get out once they got in – after buying a stock.  That type of market-making bears no resemblance to the situations which were the focus of Tuesday’s hearing.

Coincidentally, Goldman’s involvement in high-frequency trading resulted in allegations 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.)  The Zero Hedge website focused on the language of the disclaimer Goldman posted on its “GS360” portal.  Zero Hedge found some language in the GS360 disclaimer which could arguably have been exploited to support an argument that the customer consented to Goldman’s front-running of the customer’s orders.

At Tuesday’s hearing, the Goldman witnesses were repeatedly questioned as to what, if any, duty the firm owed its clients who bought synthetic CDOs, such as Abacus.  Alistair Barr of MarketWatch contended that the contradictory answers provided by the witnesses on that issue exposed internal disagreement at Goldman as to what duty the firm owed its customers.  Kurt Brouwer of MarketWatch looked at the problem this way :

This distinction is of fundamental importance to anyone who is a client of a Wall Street firm.  These are often very large and diverse financial services firms that have — wittingly or unwittingly — blurred the distinction between the standard of responsibility a firm has as a broker versus the requirements of an investment advisor.  These firms like to tout their brilliant and objective advisory capabilities in marketing brochures, but when pressed in a hearing, they tend to fall back on the much looser standards required of a brokerage firm, which could be expressed like this:

Well, the firm made money and the traders made money.  Two out of three ain’t bad, right?

The third party referred to indirectly would be the clients who, all too frequently, are left out of the equation.

A more useful approach could involve looking at the language of the brokerage agreements in effect between Goldman and its clients.  How did those contracts define Goldman’s duty to its own customers who purchased the synthetic CDOs that Goldman itself created?  The answer to that question could reveal that Goldman Sachs might have more lawsuits to fear than the one brought by the SEC.



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