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Face It

July 15th, 2010 Posted in Uncategorized
Jul, 15 2010
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July 15, 2010

Despite Washington’s festival of self-congratulation, now that the so-called financial “reform” bill is finally becoming law, the public is not being fooled.  Rich Miller of Bloomberg News reported that almost eighty percent of the public accepts the premise I discussed on June 28 — that the financial “reform” bill is a hoax.  Mr. Miller examined the results of a Bloomberg National Poll, which measured the public’s reaction to the financial reform bill and here’s what was revealed:

Almost four out of five Americans surveyed in a Bloomberg National Poll this month say they have just a little or no confidence that the measure being championed by congressional Democrats will prevent or significantly soften a future crisis.  More than three-quarters say they don’t have much or any confidence the proposal will make their savings and financial assets more secure.

A plurality — 47 percent — says the bill will do more to protect the financial industry than consumers; 38 percent say consumers would benefit more.

*   *   *

Skepticism about the financial bill, which may be approved this week, cuts across political party lines.  Seven in 10 Democrats have little or no confidence the proposals will avert or significantly lessen the impact of another financial catastrophe; 68 percent doubt it will make their savings more secure.

The Bloomberg poll also revealed that approximately 60 percent of the respondents felt that the $700 billion TARP bailout was a waste of money.  This sentiment was bolstered by a recent report from the Congressional Oversight Panel, disclosing that TARP did nothing for the 690 smaller banks, with assets of less than $100 billion each, which received TARP money.  Ronald Orol of MarketWatch provided this summary:

The report said “there is little evidence” that the capital injections led small banks to increase lending.

It also said small-bank TARP recipients have a disproportionately larger exposure to commercial real-estate losses than their big bank counterparts.  They are also having a difficult time making dividend payments to the government, a requirement of TARP, and this problem will increase over time, the report said.

The bottom line in reports such as these is usually a variation on the theme presented by pollster J. Ann Selzer, president of the firm that conducted the Bloomberg poll on public response to the financial reform bill:

“The mood of the American public is highly skeptical toward government and its ability to do right by the average person      . . .”

With the public mood at such a skeptical level about government, now is a good time to face up to the reason why our government has become so dysfunctional:  It is systemically corrupt.  Legalized graft has become the predominant force behind nearly all political decision-making.  If a politician has concerns that a particular compromise could upset his or her constituents, there will always be a helpful lobbyist to buy enough advertising propaganda (in the form of campaign ads) to convince the sheeple that the pol is acting in the public’s best interests.

Eric Alterman recently wrote a great (albeit turgid) article for The Nation, discussing institutionalized sleaziness in Washington.  Despite Alterman’s liberal bias, the systemic corruption he discusses should outrage conservative and independent voters as well as liberals.  Here are some of Alterman’s important points about ugly realities that the public has been reluctant to face:

Of course when attempting to determine why the people’s will is so frequently frustrated in our system, any author would be remiss if he did not turn first and foremost to the power of money.  The nonpartisan Center for Responsive Politics calculated that approximately $3.47 billion was spent lobbying the federal government in 2009, up from $3.3 billion the previous year.  By the final quarter of the year, lobbies were handing out $20 million a day.  The most generous spreaders of wealth were in the pharmaceutical and health products industries, whose $266.8 million set a record for “the greatest amount ever spent on lobbying efforts by a single industry for one year” according to CRP.  At one point, PhRMA employed forty-eight lobbying firms, in addition to in-house lobbyists, with a total of 165 people overall, according to the Sunlight Foundation’s Paul Blumenthal.

Max Baucus (D, Montana), who wrote the original Senate healthcare bill, raised roughly $2 million from the health sector in the past five years, according to opensecrets.org, despite running in a low-cost media market with marginal opposition.

*   *   *

Financial power need not be justified merely on the basis of the votes it sways.  Rather, it can define potential alternatives, invent arguments, inundate with propaganda and threaten with merely hypothetical opposition.  Politicians do not need to “switch” their votes to meet the demands of this money.  They can bury bills; they can rewrite the language of bills that are presented; they can convince certain Congressmen to be absent on the days certain legislation is discussed; they can confuse debate; they can bankroll primary opposition.  The manner and means through which money can operate is almost as infinite as its uses in any bordello, casino or Wall Street brokerage.

The banal, pretexted debates, focused on liberal vs. conservative, left vs. right, etc. are simply smokescreens for the real problem:  the disastrous consequences that governmental  influence peddling has on society.  Political corruption is bipartisan and in Washington it is almost universal.   Campaign finance reform is just one battle to be fought in the war against institutionalized government corruption.  It’s time for all of the Jack Abramoffs and their elected cronies to be rounded-up and tossed into the slammer.  The public needs to face this ugly reality and demand that laws be enforced, loopholes be closed and bribery be stopped.  We are just beginning to taste the consequences of ignoring these problems.  Failure to take control of this situation now runs a serious risk of unimaginable repercussions.




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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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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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I Knew This Would Happen

May 27th, 2010 Posted in Uncategorized
May, 27 2010
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May 27, 2010

It was almost a year ago when I predicted that President Obama would eventually announce the need for a “second stimulus”.  Once the decision was made to drink the Keynesian Kool-Aid with the implementation of last year’s economic stimulus package, we were faced with the question of how much to drink.  As I expected, our President took the half-assed, yet “moderate” approach of limiting the stimulus effort to less than what was admitted as the cost of the TARP program, as well as approving  the waste of stimulus funds on “pork” projects, ill-suited to stimulate economic recovery.  In that July 9, 2009 piece, I discussed the fact that liberal economist, Paul Krugman, was not alone in claiming that $787 billion would not be an adequate amount to jump-start the economy back to firing on all cylinders.  I pointed out that a survey of economists conducted by Bloomberg News in February of 2009 revealed a consensus opinion that an $800 billion stimulus would prove to be inadequate.  The February 12, 2009 Bloomberg article by Timothy Homan and Alex Tanzi revealed that:

Even as Obama aims to create 3.5 million jobs with a stimulus plan, economists foresee an unemployment rate exceeding 8 percent through next year.

As we now reach the mid-point of that “next year”, the unemployment rate is at 9.9 percent.  Those economists were right.  Beyond that, some highly-respected economists, including Robert Shiller, are discussing the risk of our experiencing a “double-dip” recession.  As a result, Larry Summers, Director of the President’s National Economic Council, is advocating the passage of a new set of spending measures, referred to as the “second stimulus”.  To help offset the expense, the President has asked Congress to grant him powers to cut unnecessary spending, as would be accomplished with a “line item veto”.  The Financial Times described the situation this way :

The combined announcements were made amid rising concern that centrist Democrats, or those representing marginal districts, might vote against the spending measures, which include more loans for small businesses, an extension of unemployment insurance and aid to states to prevent hundreds of thousands more teachers from being laid off.

*   *   *

Taken together, Mr Summers’s speech and Mr Obama’s announcement show an administration walking a fine line between the need to signal strong medium-term fiscal discipline and not jeopardising what they fear may be a fragile recovery.

Because they couldn’t get it right the first time, the President and his administration have placed themselves in the position of seeking piecemeal stimulus measures.  If they had done it right, we would probably be enjoying economic recovery and a boost in the ranks of the employed at this point.  As a result, this half-assed, piecemeal approach will likely prove more costly than doing it right on the first try.  With mid-term elections approaching, deficit hawks have their knives sharpened for anything that can be described as an “entitlement” (unless that entitlement inures to the benefit of a favored Wall Street institution).  Harold Meyerson of The Washington Post challenged the logic of the deficit hawks with this argument:

Those who oppose the jobs bills in the House and Senate this week should be compelled to answer some questions, starting with:  Absent more stimulus, what do they see as the plausible engine of economic recovery?  What effect will laying off as many as 300,000 teachers have on the education of American children?  And, more elementally, don’t they know there’s a recession on?

Marshall Auerback of the Roosevelt Institute picked up where Harold Meyerson left off, as this recent posting at the New Deal 2.0 website demonstrates:

In fact, full employment is also the best “financial stability” reform we could implement, because with jobs growth comes higher income growth and a corresponding ability to service debt.  That means less write-offs for banks and a correspondingly smaller need to provide government bailouts.

Fiscal austerity, by contrast, won’t cut it.  Our elites seem think that you can cut “wasteful government spending” (that is, reduce private demand further) and cut wages and hence private incomes and not expect major multiplier effects to make things significantly worse.  Of course, that “wasteful”, “unsustainable” spending never seems to apply to the Department of  Defense, where we always seem to be able to appropriate a few billion, whenever necessary.  “Affordability” principles never extend to the Pentagon, it appears.

The fact that we are still in the midst of a severe recession (rather than a robust economic recovery as is often claimed) accounts for the rationale asserted by Larry Summers in advocating a second stimulus amounting to approximately $200 billion in spending measures.  Here’s how Summers explained the proposal in a May 24 speech at the Johns Hopkins School of Advanced International Studies:

It has in recent years been essential for the federal deficit to increase as the economy has gone into recession and has been severely constrained by demand.

And I cannot agree with those who suggest that it somehow threatens the future to provide truly temporary, high-bang-for-the-buck jobs and growth measures.

Rather, assuring as rapid a recovery as possible strengthens our future economy, our future prosperity, with many benefits, including a greater ability to manage our debts.

On the other hand, those who recognize the fiscal and growth benefits of strong expansionary policies must also recognize that it is simultaneously desirable to provide confidence that deficits will come down to sustainable levels as recovery is achieved.  Such confidence both spurs recovery by reducing capital costs and reduces the risk of financial accidents.

To put the point differently:  It is not possible to imagine sound budgets in the absence of economic growth and solid economic performance.

*   *   *

It is important to recognize that the ultimate consequences of stimulus for indebtedness depend critically on the macroeconomic conditions.  When the economy is demand constrained, the impact of a dollar of tax cuts or expansionary investment will be at its highest and the impact on deficits at its lowest.
*   *   *

In areas where the government has a significant opportunity for impact, it would be pennywise and pound foolish not to take advantage of our capacity to encourage near-term job creation.   This explains the logic of the Recovery Act’s success and the rationale for taking additional targeted actions to increase confidence in our economic recovery.

Consider the package currently under consideration in Congress to extend unemployment and health benefits to those out of work and support to states to avoid budget cuts as a case in point.

It would be an act of fiscal shortsightedness to break from the longstanding practice of extending these provisions at a moment when sustained economic recovery is so crucial to our medium-term fiscal prospects.

So, here we are at the introduction of the second stimulus plan.  Despite the denial by President Obama that he would seek a second stimulus, he has Larry Summers doing just that.  Last year, the public and the Congress had the will – not to mention the sense of urgency – to approve such measures.  This time around, it might not happen and that would be due to the leadership flaw I observed last year:

President Obama should have done it right the first time.  His penchant for compromise — simply for the sake of compromise itself — is bound to bite him in the ass on this issue, as it surely will on health care reform — should he abandon the “public option”.  The new President made the mistake of assuming that if he established a reputation for being flexible, his opposition would be flexible in return.  The voting public will perceive this as weak leadership.  As a result, President Obama will need to re-invent this aspect of his public image before he can even consider presenting a second economic stimulus proposal.

At this point, Obama’s “flexibility” is often viewed by the voting public as a lack of existential authenticity, sincerity or — worse yet —  credibility.  As a result, I would expect to see more articles like the recent piece by Carol Lee at Politico, entitled, “Obama:  Day for ‘partnership’ passed”.

Here comes the makeover!






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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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Failed Financial Reform And Failed Justice

April 26th, 2010 Posted in Uncategorized
Apr, 26 2010
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April 26, 2010

As the long-awaited financial reform legislation finally seems to be headed toward enactment, the groans of disappointment are loud and clear.  My favorite reporter at The New York Times, Gretchen Morgenson, did a fine job of exposing the shortcomings destined for inclusion in this lame bill:

Unfortunately, the leading proposals would do little to cure the epidemic unleashed on American taxpayers by the lords of finance and their bailout partners.  The central problem is that neither the Senate nor House bills would chop down big banks to a more manageable and less threatening size.  The bills also don’t eliminate the prospect of future bailouts of interconnected and powerful companies.

Too big to fail is alive and well, alas.  Indeed, several aspects of the legislative proposals sanction and codify the special status conferred on institutions that are seen as systemically important.  Instead of reducing the number of behemoth firms assigned this special status, the bills would encourage smaller companies to grow large and dangerous so that they, too, could have a seat at the bailout buffet.

*   *   *

It is disappointing that none of the current proposals call for breaking up institutions that are now too big or on their way there.  Such is the view of Richard W. Fisher, president of the Federal Reserve Bank of Dallas.

“The social costs associated with these big financial institutions are much greater than any benefits they may provide,” Mr. Fisher said in an interview last week.  “We need to find some international convention to limit their size.”

*   *   *

Edward Kane, a finance professor at Boston College and an authority on financial institutions and regulators, said that it was not surprising that substantive changes for both groups are not on the table.  After all, powerful banks want to maintain their ability to privatize gains and socialize losses.

“To understand why defects in in solvency detection and resolution persist, analysts must acknowledge that large financial institutions invest in building and exercising political clout,” Mr.Kane writes in an article, titled “Defining and Controlling Systemic Risk,” that he is scheduled to present next month at a Federal Reserve conference.

But regulators, eager to avoid being blamed for missteps in oversight, also have an interest in the status quo, Mr. Kane argues.  “As in a long-running poker game in which one player (here, the taxpayer) is a perennial and relatively clueless loser,” he writes, “other players see little reason to disturb the equilibrium.”

At Forbes, Robert Lenzner focused on the human failings responsible for the bad behavior of the big banks with his emphasis on the notion that “a fish stinks from the head”:

No well-intentioned reform bill that will pass Congress can prevent the mind-blowing stupidity, hubris and denial utilized by the big fish of Wall Street from stinking from the head.

*   *   *

Transparency won’t help if the Obama plan does not absolutely require all derivatives to be registered at the Securities and Exchange Commission.  It’s an invitation for abuse as five major market making banks like JPMorgan Chase account for 95% of all derivatives transactions and a very large share of their profits.  We haven’t seen evidence that they police themselves satisfactorily.

Derivatives expert Janet Tavakoli recently expressed her disgust over the disingenuousness of the current version of this legislation:

Our proposed “financial reform” bill is a sham, and the health of our society and our economy is at stake.

Ms. Tavakoli referred to the recent Huffington Post article by Dan Froomkin, which highlighted the criticism of the financial reform legislation provided by Professor William Black (the former prosecutor from the Savings and Loan crisis, whose execution was called for by Charles Keating).  Froomkin embraced the logic of economist James Galbraith, who emphasized that rather than relying on the expertise of economists to shape financial reform, we should be looking to the assistance of criminologists.  William Black reinforced this idea:

Criminologists, Black said, are trained to identify the environments that produce epidemics of fraud — and in the case of the financial crisis, the culprit is obvious.

“We’re looking at incentive structures,” he told HuffPost.  “Not people suddenly becoming evil.  Not people suddenly becoming crazy.  But people reacting to perverse incentive structures.”

CEOs can’t send out a memo telling their front-line professionals to commit fraud, “but you can send the same message with your compensations system, and you can do it without going to jail,” Black said.

Criminologists ask “fundamentally different types of question” than the ones being asked.

Back at The New York Times, Frank Rich provided us with a rare example of mainstream media outrage over the lack of interest in prosecuting the fraudsters responsible for the financial disaster that put eight million people out of work:

That no one at Lehman Brothers has yet been held liable for its Enronesque bookkeeping deceit is appalling.  That we still haven’t seen the e-mail and documents that would illuminate A.I.G.’s machinations with Goldman and the rest of its counterparties amounts to a cover-up.  That investigative journalists have consistently been way ahead of the authorities, the S.E.C. included, in uncovering Wall Street’s foul play is a scandal.  If this culture remains in place, the whole crisis will have gone to waste.

Unfortunately, the likelihood that any significant financial reform will be enacted as a result of the financial crisis is about the same as the likelihood that we will see anyone doing a “perp walk” for the fraudulent behavior that caused the meltdown.  Don’t expect serious reform and don’t expect justice.



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Unrealistic Expectations

April 22nd, 2010 Posted in Uncategorized
Apr, 22 2010
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April 22, 2010

Newsweek’s Daniel Gross is back at it again.  His cover story for Newsweek’s April 9 issue is another attempt to make a preemptive strike at writing history.  You may remember his cover story for the magazine’s July 25 issue, entitled:  “The Recession Is Over”.  During the eight months since the publication of that article, the sober-minded National Bureau of Economic Research, or NBER —  which is charged with making the determination that a recession has ended – has yet to make such a proclamation.

The most recent cover story by Daniel Gross, “The Comeback Country” has drawn plenty of criticism.  (The magazine cover used the headline “America’s Back” to introduce the piece.)  At The Huffington Post, Dan Dorfman discussed the article with Olivier Garret, the CEO of Casey Research, an economic and investment consulting firm.  Garret described the Newsweek cover story as “fantasy journalism” and he shared a number of observations with Dan Dorfman:

“You know when a magazine like Newsweek touts a bullish economic recovery on its cover, just the opposite is likely to be the case,” he says.  “It sees superficial signs of improvement, but it’s ignoring the big picture.”

*   *   *

Meanwhile, Garret sees additional signs of economic anguish.  Among them:  More foreclosures and delinquencies of real estate properties will plague construction spending; banks haven’t yet cleaned up their balance sheets; private debt is no longer going down as it did in 2009; both short and long term rates should be headed higher, and many companies, he says, tell him they’re reluctant to invest and hire.

He also sees some major corporate bankruptcies, worries about the country’s ability to repay its debt, looks for rising cost of capital, which should further slow the economy, and expects a spreading sovereign debt crisis.

*  *  *

Many economists are projecting GDP growth in the range of 3% to 4% in the first quarter and similar growth for the entire year.  Much too optimistic, Garret tells me.  His outlook (which would clobber the stock market if he’s right):  up 0.4%-0.5% in the first quarter after revisions and between 0% and 1% for all of 2010.

“Fantasy economies only work in the mind, not in real life,” he says.

Given his bleak economic outlook, Garret expects a major market adjustment, say about a 10% to 20% decline in stock prices over the next six months.  He figures it could be triggered by one event, such as as an extension of the sovereign debt crisis.

David Cottle of The Wall Street Journal had this reaction to the Newsweek article:

Therefore, when you see a cover such as Newsweek’s recent effort, yelling “America’s Back” in no uncertain terms, it’s quite tempting to stock up on bonds, cash, tinned goods and ammunition.

Now, in fairness to the author, Daniel Goss, he makes the good point that the U.S. economy is growing at a clip that has consistently surprised gloomy forecasters.  It is.  The turnaround we’ve seen since Lehman Brothers imploded has been remarkable, if not entirely satisfying, he says, and he is quite right.  At the very least, U.S. growth is all-too-predictably leaving the European version in the dust.  Goss is also pretty upfront about the corners of the U.S. economy that have so far failed to keep up:  job creation and the housing market being the most obvious.

However, the problem with all these ‘back to normal’ pieces, and Goss’s is only one of many creeping out as the sky resolutely fails to fall in, is that the ‘normal’ they want to go back to was, in reality, anything but.

The financial sector remains unreformed, the global economy remains dangerously unbalanced.  The perilous highways that brought us to 2007 have not been sealed off in favor of straighter, if slower, roads.  Of course it would be great for us all if America were ‘back’ and so we must hope Newsweek’s cover doesn’t join the ranks of those which cruel history renders unintentionally hilarious .

But back where?  That’s the real question.

Meanwhile, the Pew Research Center has turned to Americans themselves to find out just how “back” America really is.  This report from April 20 didn’t seem to resonate so well with the rosy picture painted by Daniel Gross:

Americans are united in the belief that the economy is in bad shape (92% give it a negative rating), and for many the repercussions are hitting close to home.  Fully 70% of Americans say they have faced one or more job or financial-related problems in the past year, up from 59% in February 2009.  Jobs have become difficult to find in local communities for 85% of Americans.  A majority now says that someone in their household has been without a job or looking for work (54%); just 39% said this in February 2009. Only a quarter reports receiving a pay raise or a better job in the past year (24%), while almost an equal number say they have been laid off or lost a job (21%).

As economic conditions continue to deteriorate for middle-class Americans, the first few months of 2009 are already looking like “the good old days”.   The “comeback” isn’t looking too good.



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The Goldman Fallout

April 19th, 2010 Posted in Uncategorized
Apr, 19 2010
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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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Financial Crisis Inquiry Disappointment

April 15th, 2010 Posted in Uncategorized
Apr, 15 2010
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April 15, 2010

The Financial Crisis Inquiry Commission (FCIC) has been widely criticized for its lame efforts at investigating the causes of the financial crisis.  As I pointed out on January 11, a number of commentators had been expressing doubt concerning what the FCIC could accomplish before the commission held its first hearing.  At this point — just three months later — we are already hearing the question of whether it might be “time to pull the plug on the FCIC”.   Writing for the Center for Media and Democracy’s PRWatch.org website, Mary Bottari posed that question as the title to her critical piece, documenting the commission’s “lackluster performance”:

The FCIC is a 10-person panel assembled to report on the meltdown to President Obama later this year.  The New York Times reported last week what was becoming increasingly obvious: the commission was in shambles.  The commission waited eight months before having its first hearing.  A top investigator resigned due to delays in hiring staff, no subpoenas have been issued and partisan infighting means few new documents have been released that would aid reporters in piecing together the crime scene, even if  FCIC investigators are not up to the task.  Worse, it seems like the majority of staff  have been borrowed from the complicit Federal Reserve.

These problems were on full display in last week’s hearings.  The three days of hearings were marked by some heat, but little light.

The FCIC’s failure to issue any subpoenas became a major point of criticism by Eliot Spitzer, who had this to say in a recent posting for Slate :

The Financial Crisis Inquiry Commission has so far been a waste.  Some momentary theater has been provided by the witnesses who have tried to excuse, explain, or occasionally admit their role in the cataclysm of the past two years.  While this has ginned up some additional public outrage, it hasn’t deepened our knowledge about what critical players knew or did.  There is a simple reason for this:  The commission has not issued a single subpoena.  Any investigator will tell you that you must get the documentary evidence before you examine the witnesses.  The evidence is waiting to be seized from the Fed, AIG, Goldman Sachs, and on down the line.  Yet not one subpoena.

Rather than accept Robert Rubin’s simple disclaimers about Citigroup, why hasn’t the FCIC combed through the actual communications among the board, the executive committee, the audit committee, and the risk-management committee?  Why hasn’t the FCIC collected AIG’s e-mails with the Fed and Goldman Sachs?  Unless the subpoenas are issued, we will lose the chance to make the record.

As Binyamin Appelbaum pointed out in The Washington Post back on January 8, if a financial reform bill is eventually passed, it will likely be signed into law before the mid-term elections in November – one month before the FCIC is required to publish its findings.  As a result, there is a serious question as to whether the commission’s efforts will contribute anything to financial reform legislation.  Given the FCIC’s unwillingness to exercise its subpoena power, we are faced with the question of why the commission should even bother wasting its time and the taxpayers’ money on an irrelevant, ineffective exercise.

Although Mary Bottari’s essay discussed the possibility that the FCIC might still “get its act together”, the cynicism expressed by Eliot Spitzer provided a much more realistic assessment of the situation:

Americans have been betrayed by Washington over financial reform.  Our leaders have failed to get the evidence, failed to push back when clearly inadequate explanations were provided, and failed to explore the structural reforms that will work.  Pretend tears will drip from bankers’ eyes after the consumer protection agency is created.  Then their wolfish teeth will slowly break into a grin, the pure delight that Washington has failed to do anything meaningful to restructure the banking sector.

Just when it was beginning to appear as though we might actually see some meaningful financial reform find its way into law, we have been reminded that Washington has its own ways – which benefit the American public only by rare coincidence.




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Financial Reform Might Actually Happen

April 12th, 2010 Posted in Uncategorized
Apr, 12 2010
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April 12, 2010

The long-overdue need for financial reform is finally getting some serious attention in Washington.  As banking lobbyists continue to grease palms in the Senate, we are beginning to hear a number of novel ideas from some clever commentators, focused on preventing another financial crisis.

On April 9, John Mauldin published a thought-provoking essay entitled, “Reform We Can Believe In”.  At one point in the piece, Mauldin considered the question that has been hanging over our heads for the past eighteen months:

What happens if we do nothing?

What happens when we have the next credit crisis, when a major sovereign government defaults, as I think will happen?  It will be a body blow to many banks, especially in Europe.  Once again, we could have banks worried about lending to each other or taking letters of credit, which would be a disaster for world trade and the recovery we are now in.

That we (and Europe and Britain) have taken so long to enact real reform has the potential to really put the world at risk.  In the next crisis, we will not have the tools available to stem the tide that we did the last time.  Rates are already low.  Do you think we could pass another TARP?  The Fed’s balance sheet is already bloated.  It could get much worse unless we get financial reforms that have some bite.

All this debating about a consumer protection agency and where it should be and all the other trivia is wasting time.  Fix the big things. Credit default swaps. Too big to fail.  Leverage. Then worry about the details.

Although I left out Mauldin’s suggestion to “leave the Fed alone” from that last paragraph, his essay contains a fantastic explanation of how the Federal Reserve System is organized.  Best of all, Mauldin spent plenty of time reflecting on Milton Friedman’s suggestion that we program a computer to set monetary policy, instead of leaving that authority with the Fed:

Let me be clear.  There are a lot of things not to like about the Federal Reserve System.  I think it was Milton Friedman who said we would be better off with a computer determining monetary policy.  A quote from an interview with him is instructive.  When asked “Do you still think it would be a good idea to have a computer run monetary policy?” he answered:

“Yes.  Of course it depends very much on how the computer is programmed.  I am not saying that any computer program would do.  In speaking of that, I have had in mind the idea that a computer would produce, for example, a constant rate of growth in the quantity of money as defined, let us say, by M2, something like 3% to 5% per year.  There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare.

“In any event, the computer program would certainly prevent any major disasters either way, any major inflation or any major depressions.  One of the great defects of our kind of monetary system is that its performance depends so much on the quality of the people who are put in charge.  We have seen that in the history of our own Federal Reserve System.

Another perspective on financial reform came from Jim McTague in the April 12 edition of Barron’s.  He began with the remark that both the House and Senate reform bills lack adequate measures for “efficient and intelligent policing”.  Nevertheless, the solution he embraced was simple:

The aptly named Richard Vigilante, who recently co-wrote a book called Panic with Minneapolis-based hedge-fund legend Andrew Redleaf, suggests this approach:  Force all firms managing other people’s money to publish their investment positions in detail before the market opens; this would include hedge funds.  Then, the short sellers could punish ineptness before it spreads by betting heavily against a particular institution’s stupid decisions.

“Bankers would hate it.  It’s their worst nightmare,” says Vigilante, whom I met with at Firehook bakery on Washington’s Farragut Square.  If the system had been in place in 2006, short sellers would have stamped out the smoldering subprime mania before it had a chance to spread, he asserts.

His suggestion is both brilliant and a model of simplicity — it could protect consumers against all kinds of risky financial products — but it will never become reality.

Bankers would scream about the need to protect their proprietary-trading information.  And, as was the case with health-insurance “reform,” Congress is bent on ramming a bill, no matter how flawed, through the legislative sausage works in order to mollify an uncommonly angry electorate before Nov. 2.  To entertain new ideas at this juncture, even good ones, would upset the ambitious timetable.

Like health care, the new financial regulatory regime is built atop the cracked masonry of the old one.  The same flatfoots who were on patrol when the subprime caper went down will be given larger beats to walk.  They will be overseen by a brain trust, a Council of Regulators, culled from their ranks, who, like chemical sniffers, would seek to uncover systemic threats to the volatile financial system.  In fact, COR is the core of the whole scheme.

The proposal for a Council of Regulators has drawn a good deal of criticism, primarily because it would be chaired by the Treasury Secretary.  Matthew Bishop and Michael Green, authors of The Road From Ruin, had this to say about a Council of Regulators in a recent Huffington Post piece:

Indeed, with the Treasury Secretary in the chair, would this council really face down the political leaders and try to stop an emerging bubble spreading a feelgood factor across the nation (as bubbles do, before they burst)?  Even in his pomp Alan Greenspan knew that a Fed chairman couldn’t risk being too gloomy about the economy and keep his job. What chance then of a Treasury Secretary, a cabinet member, being so bold?

Rather than another layer on top of the dysfunctional existing regulatory system, America needs to sweep away its absurd proliferation of regulators and replace them with a powerful super regulator, independent of day-to-day politics and empowered to do the job properly.

Regardless of what the final product will include – one thing is becoming increasingly likely:  Some semblance of financial reform legislation will eventually become enacted.  It won’t be perfect but anything will be better than what we have now.  (Well, almost anything  .  .  .)



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