Tuesday, March 31, 2009

On Bucket Shops and Crises

Compliments of Naked Capitalism, here is a large excerpt from an article in today's Financial Times (London), by Eric Dinallo, New York State's Superintendent of Insurance, on some historical background relating to Credit Default Swaps.

Many compare this financial crisis to the stock market crash of 1929, but it is closer to the credit freeze and bank panic of 1907....

The bank panic of 1907 is remembered for J.P. Morgan forcing all the bankers to stay in a room until they agreed to contribute to fixing the crisis. What has been forgotten is one major cause of the crisis – unregulated speculation on the prices of securities by people who did not own them. These betting parlours, or fake exchanges, were called bucket shops because the bets were literally placed in buckets.

The states responded in 1908 by passing anti-bucket shop and gambling laws, outlawing the activity that helped to ruin that economy.

What has that got to do with today’s crisis? Credit default swaps are the rocket fuel that turned the subprime mortgage fire into a conflagration....AIG Financial Products, the unit that sold almost $500bn (€379bn, £353bn) of them, may therefore be viewed as the biggest bucket shop in history.

Credit default swaps started out as essentially an insurance policy. If you owned a bond in a company and were concerned it might default, you bought the swap to protect yourself....Banks bought them to reduce the amount of capital they were required to hold against investments – in other words, to avoid regulation. Because they owned the swap, banks claimed they no longer had the risk of a default of the bond. Others bought swaps without owning the bond to place a bet on a company’s future.

But there was serious concern that swaps violated the old bucket shop laws. Thus, the Commodity Futures Modernisation Act of 2000 exempted credit default swaps from these laws. The act also exempted them from regulation by the Commodities and Futures Trading Commission and the Securities and Exchange Commission. Unregulated, the market grew enormously.

Thus, one of the major causes of the financial crisis was not how lax our regulation, or how hard we enforced, but what we chose not to regulate.

Indeed, what we decided was old fashioned and in need of modernisation was, in fact, an effective check on an activity that for 100 years had been illegal, for good reason. As a result, we modernised ourselves into this ice age.

The fear in 2000 was that if we regulated credit default swaps and required holding sufficient capital, the market would go where unregulated sellers could make more money. We forgot that the biggest competitive advantage of the US financial system has always been safety, security and transparency. If we destroy that perception, the long-term cost to our society is incalculable.

While I am sure that Mr. Dinallo's historical facts are correct, perhaps some points may be added.

One is that the buildup of debt is similar to 1929, and not to 1907; the global nature of the current situation is like that of the Great Depression, not thatof 1907; and there was intense stock speculation both in 1906-7 and in 1927-9.  There are many parents to the current problem.  In addition, what we have now that is unique to today is intense government money printing and borrowing to "stimulate" the economy. 

The recommendation from EBR has been and is to simply ban credit default swaps.  If you don't like the loan, don't make it.  If it's to large for you to make but you like it, find partners.  And make lots of loans, thus obtaining your protection.  Unfortunately, the G30, which is led by an AIG Vice President and has Paul Volcker as a figurehead Chairman of the Board; and which is sponsored by Riskmetrics, is getting its way in that Timothy Geithner is using its industry-friendly viewpoint in his proposal for regulation rather than real reform of the financial industry.  Thus will the seeds be ready to turn into tinder to fuel the next "banking" crisis.

Copyright (C) Long Lake LLC 2009

Monday, March 30, 2009

Where Has All the Money Gone?

The world has gone mad today,
And good's bad today,
And black's white today,
And day's night today . . .
Anything goes.

-Cole Porter, "Anything Goes"

Shortly after Barack Obama gave an interview to the New York Times in which he confided that Team Obama pays no attention to bloggers, the blogger barbarians are at the gates of the castle of Big Finance.  This time, they have the law with them.  It has now been revealed that NY Att'y Gen'l Cuomo is squeezing BofA's CEO Ken Lewis; BofA has been sued for enabling the alleged Cosmo scam on Long Island; and now it appears that the law is coming down on AIG, initially in the person of Joseph Cassano, who ran the AIG Financial Products division that (in) famously sold credit default swaps (i.e., insurance against bonds defaulting) without reserves. And so on and so forth.  As with Watergate, the revelations are beginning to cascade.  Perhaps people will reflect that Bernard Madoff was not just some scamster but was a founder of the NASDAQ, a major player in it, and that the NASDAQ per se largely functions as a scam from the standpoint of the average "investor".  And why are Citi and BofA reported to be buying broken CDOs at 30 cents on the dollar while carrying them on their books at 80-90 cents?

Why does Chris Whalen of the Institutional Risk Analytics, who testifies before Congress and does business in the financial arena in America, say in a post this week that:

 As we said of Mexico two decades ago, Americans now live in a Mafia State that is beyond control.
Our political class is entirely captive of Wall Street, the result of decades of corruption and moral decay. Our nation's capital is controlled by a criminal gang that masquerades as an elected government. . .

"Based on our projections and channel checks, we think that maybe the Fed staff got it wrong and put down the likely loss rate instead of the fanciful LT recovery rate embraced by Bernanke, Geithner and Summers. Truth is, the LT recovery or "Loss Given Default" (LGD) rate experience of 20-30% (which are the LT LGD rates used by Moody's, S&P for internal loss rate projections) are holding true in this cycle as in previous economic downturns and may actually be optimistic compared with the actual realized loss."

With most of the RES and CRE collateral we see in the channel trading in the 30s, it is only a matter of time before the markets force Bernanke, Geithner and Summers to abandon their desire to subsidize the large, insolvent banks and finally embrace liquidation. As we told our friend David Kotok at Cumberland Advisers, just remember to buy the bonds, not the equity, no matter what investment situation you may be considering during most of 2009. In the current environment, be a creditor, not a shareholder.

DoctoRx here.  Now that financial company insiders have been able to both sell and short-sell more stock at inflated prices after the last manipulated rally, the truth comes out.  The CEO of Morgan Stanley is reported yesterday to say to his employees that 2009 will be tough, and in the last fewdays Tim Geithner has said that the banks are not in fact all that well-capitalized, a fact supported by the CEOs of BofA and JPMorgan Chase.  And as far as the bonuses go, not to worry, as predicted here recently:

Bank of America May Raise Investment Bankers’ Salaries by 70% 

By Jacqueline Simmons and Josh Fineman

March 27 (Bloomberg) -- Bank of America Corp. plans to increase some investment bankers’ salaries by as much as 70 percent following the takeover of Merrill Lynch & Co., people familiar with the proposal said.

Bank of America, which has received $45 billion of taxpayers’ money, may raise the annual base pay for some managing directors to about $300,000 from $180,000, said the people, who declined to be identified because the final numbers are still under discussion. Salaries for less-senior directors would climb to about $250,000 from $150,000, and vice presidents would get $200,000, up from about $125,000, the people said.

“We regularly review our compensation programs,” Bank of America said in an e-mailed statement. “Such a review is particularly appropriate during such challenging times. While various alternatives are being considered, no decisions have been reached.”

DoctoRx here:  The anonymous Email is an obvious lie.  The only non-decision may be the exact salary numbers.

Adjusted for inflation/deflation, the stock crash of the last 17 months is worse than that of the Great Depression at the same time frame, and the same things are happening.  Spain is in deflation, with an unemployment rate of 14%; its Prime Minister said the unemployed may as well just f--- because there's no work to be had.  Mish at www.globaleconomicanalysis.blogspot.com has two recent posts, one about banks walking away from foreclosures because the properties aren't worth foreclosing on; and one on cities abandoning parts of their own municipalities and shrinking.  The accounting standards board, FASB, is revealed to be a bunch of lap dogs.  Last year, it refused to implement its rule requiring the Citis of the world to take on-balance sheet their SIVs, providing a pitiful non-reason for its reversal.  Now we have:

 Mark-to-Market Lobby Buoys Bank Profits 20% as FASB May Say Yes 

March 30 (Bloomberg

Four days after U.S. lawmakers berated Financial Accounting Standards Board ChairmanRobert Herz and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting that may improve profits at banks such as Citigroup Inc. by more than 20 percent.

The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.

FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging from Bank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.

Officials at Norwalk, Connecticut-based FASB were under “tremendous pressure” and “more or less eviscerated mark-to- market accounting,” said Robert Willens, a former managing director at Lehman Brothers Holdings Inc. . .

Please review the first paragraph immediately above.  Bloomberg says that this rule change would "improve profits" at Citigroup.  WRONG.  It would improve reported profits.  Economic profits cannot be changed by an accounting change.  Who will be fooled by FASB's supine behavior?  Only the small investor, that's who.

The noose and the cops are closing in on the Establishment.  Newsweek's pitiful attempt to smear Paul Krugman went nowhere.  Felix Salmon at Portfolio.com reported:

Newsweek's Fearful Krugman Profile

Evan Thomas has a profile of Paul Krugman on the cover of Newsweek. The 2,825-word article has six on-the-record quotes about Krugman; none of them -- not even the one from his mother -- are particularly flattering. No one is quoted saying a single nice thing about Krugman's economics or his opinions.

Salmon got it right with his title.  Newsweek and the Establishment are afraid of the truth.  While DoctoRx and Dr. Krugman have different political philosophies (big vs. small government), Dr. Krugman believes in "speaking truth to power", as his party liked to say when they were out of power.  As this blog has noted on numerous occasions, Dr. Krugman has been critical of Barack Obama's economic policies before Mr. Obama became President Obama.  

One can pick one's preferred time of when things went seriously, structurally wrong.  The Left goes back to Reagan.  I would more simply go back to the Asian contagion, when the average U. S. stock peaked around 1997-98, but the bubble was then perpetrated.  Ever since then, bubbles have been blown and burst.  However, there are now no bubbles left in the stock market, as all stock groups are in well-defined downtrends, and forget about real estate.  Only gold and Treasuries/government mortgage-backed securities are in defined up-trends.  One suspects that that's where the big money has been flowing, as the public continues to disbelieve that these markets are toppy. Even the ad for gold in the Super Bowl was for the public to sell its gold, not to buy it, and thus did not signify a top.

Some major unanswered questions include:  

1.  How will the financial fraud on the public, which is well on its way to being revealed for all to see and is thus coming to a climax, be resolved;

2.  In the midst of the worst financial crisis since the 1930s, how did America get as President the single least experienced President in its modern history, whose political career most resembled that of Robert Morse in "How to Succeed in Business Without Really Trying"?  (Remember the song, "Oh, I Believe in You . . .?);

3.  How much wealth will be/is left after all that has been looted by the banksters  and the insider/CEO has been revealed;


4.  Where have the looters been stashing their gains?

For individual investors, their pecuniary interest is actually most importantly revealed by #4.  This is where technical analysis, with trend-following rather than assuming reversion to the mean, may help.  After all, if you're a looter, your wealth has to be somewhere.  It's not logical for it to be sitting in T-bills just waiting for stocks to bottom "tomorrow" if you know that you and your ilk have appropriated for yourselves more than the public can imagine.  If it's in T-bills, it's to protect capital against deflation; in deflationary bananas, stocks have no bottom.  Back to Whalen:

"As global deflation proceeds, those with cash shall be king . . ."

This could be the financial equivalent of Watergate, and potentially more consequential.

Copyright (C) Long Lake LLC 2009

G20 Meeting a Success!

A columnist has pronounced that the Empire is striking back.  Despite media gloom about the failure-in-the-making of the upcoming G20 meeting, Anatole Kaletsky has reported on a leaked G20 communique as follows in the (London) Times Online:

All for one: summiteers are united in a time of crisis

Far from being doomed to failure, as widely reported in Britain, this week's G20 summit appears to be assured of success. Many of the substantive decisions have already been agreed and Thursday's three-hour summit will be less of a negotiating session than a ceremonial endorsement of action already under way. According to people closely involved in the preparations, agreement has been reached on all the main issues on the agenda. These can be divided into four: saving the world economy from collapse with fiscal and monetary stimulus; saving banks from collapse with government financial support; saving vulnerable countries from collapse with help from the International Monetary Fund; and saving the global financial system from another crisis after the present one is past. . .

In addition, the G20 countries have been unexpectedly successful in co-ordinating their interest rate reductions and monetary stimulus measures. Rates have been slashed in almost all developed countries - and after the further half-point cut that the European Central Bank is expected to announce on the day of the London summit, all of the G7 advanced economies in the world will have adopted a near-zero interest rate regime. Such a policy would have been inconceivable in the eurozone and even in Britain a few months ago. Even harder to imagine was that the monetary authorities would co-ordinate their actions as closely as they have, with the British, US, Swiss and Japanese central banks all announcing within a space of three weeks that they would start “printing money” to allow their governments to finance higher borrowing at zero cost.

DoctoRx here.  Some of us will be a mite suspicious of a columnist who breathlessly applauds governments printing money so that they can borrow at a zero interest rate.

Certainly the global stock markets, which have been selling off hard since Asia opened today, do not share Mr. Kaletsky's view that all this "stimulus" will stimulate much.  But we can at least hope that his optimism is well-placed.

Copyright (C) Long Lake LLC 2009

Auto Makers, Banks, and Bailouts

30 years ago, the Federal Government "bailed out" Chrysler with a loan. Taxpayers eventually made some money on that loan.
Thus began the age of bailouts, with bondholders of the poorly-run bank Continental Illinois being made whole due to years of hard work by the Feds after the bank collapsed, then the bailout of Mexico's bondholders in 1995 in and end-run around Congress, the bailout of Wall Street in the 1998 LTCM collapse, etc.

Now we read this about Chrysler (WSJ):

The government said it would provide Chrysler with capital for 30 days to cut a workable arrangement with Fiat SpA, the Italian auto maker that has a tentative alliance with Chrysler.
If the two reach a definitive alliance agreement, the government would consider investing up to $6 billion more in Chrysler. If the talks fail, the company would be allowed to collapse.

Just as with Citigroup and its ilk today, one wonders if it would not have been better if Chrysler had been left to die in 1979. Think of how many investors have lost how many dollars propping this corpse up for the last three decades.

(EBR might praise the administration for making a tough decision on the automakers, except that at least these companies actually make products people use, employ skilled labor, and are victims of the worst economic banana since the Great Depression; whereas those who caused this banana are receiving trillions of dollars in aid. While in the bailout mode, why not give a little less to Big Finance and more so the automakers can ride out this downturn, Mr. President?)

It is past time for a people-centric financial policy built on equity rather than debt. Policies in that direction will in and of themselves render "banking" what it was in the 1950s, a small utility-like part of the economy without the swagger and pretense of all the "Masters of the Universe" bull----.

Copyright (C) Long Lake LLC 2009

Sunday, March 29, 2009

More on AIG and Geithner as Scammer-in-Chief

Zero Hedge has posted on its own web site and as a guest post at Naked Capitalism some explosive charges regarding the mechanism by which AIG allegedly raped shareholders, with the approval of Mr. Geithner.

The language is harsh and the conclusions appear reasonable, at least to this non-trader in the securities described.

The simplest way to read this is to go to www.zerohedge.blogspot.com:

SUNDAY, MARCH 29, 2009

Exclusive: AIG Was Responsible For The Banks' January & February Profitability

Zero Hedge is rarely speechless, but after receiving this email from a correlation desk trader, we simply had to hold a moment of silence for the phenomenal scam that continues unabated in the financial markets, and now has the full oversight and blessing of the U.S. government, which in turns keeps on duping U.S. taxpayers into believing everything is good.
The above is enough of a teaser.  Non-technical people can skim over what they don't understand.  There is a layman's explanation later after a bunch of technical stuff.

Copyright (C) Long Lake LLC 2009

Monday Morning Musings

The current Newsweek has some condescending and surprising comments from a head honcho, Even Thomas, in an article on Nobel winner Paul Krugman.

Krugman, who is justly famed for a lifetime of accomplishments, is, according to Thomas, merely enjoying a Warholian moment:  "Krugman is having his 15 minutes and enjoying it . . ."  (Just to remind people, Warhol suggested that in the future, due to media everywhere, anybody would be famous for 15 minutes, even if he/she had done little or nothing to deserve a few minutes in the limelight.  I would instead ask, what has Even Thomas ever done to allow him to disparage a Nobel winner?

More substantively, look at the tile and subheading, and then some text:
 Obama’s Nobel Headache

Paul Krugman has emerged as Obama's toughest liberal critic. He's deeply skeptical of the bank bailout and pessimistic about the economy. Why the establishment worries he may be right.

Copyright (C) Long Lake LLC 2009

Just Following Orders

"Moral hazard" in financial systems refers to such things as encouraging risky behavior to recur by bailing out those who take risk and lose.  Here is a new form of it.  David Kotok, chief economist for Cumberland Advisors, a large investment firm, writes a column today ("PPIP:  Heads or Tails?) in "The Big Picture" which describes the Obama-Geithner latest bailout plan (The "PPIP") for the financial community in these summary terms:

 As a money manager for our clients, the Cumberland firm will look at PPIP and may use it on behalf of clients after we have reviewed an official form of an offering document. As a private citizen concerned about my country and its policy direction, I think this reeks and stinks.

I understand his reasoning.  Unfortunately, it is that of an underling and a weasel.  Presumably Mr. Kotok needs a job.  Otherwise he should resign rather than participate in what he knows is a reeking and stinking rip-off of America.

Copyright (C) Long Lake LLC 2009

A Good Deed Doer

Please consider clicking on the bio of the first female editor of the Stanford University Law Review, which that describes the life and career of one of the government heroes (actually, heroines) of the financial crisis, a woman with the memorable name of Brooksley Born.  The linked article, from "Stanford Magazine" is both thorough and interesting from more than just the financial angle:

Prophet and Loss

Brooksley Born warned that unchecked trading in the credit market could lead to disaster, but power brokers in Washington ignored her. Now we're all paying the price.

Copyright (C) Long Lake LLC 2009

Saturday, March 28, 2009

Dropping the Bull

Things are seldom what they seem;
Skim milk masquerades as cream . . .

Black sheep dwell in every fold;
All that glitters is not gold;
Storks turn out to be but logs;
Bulls are but inflated frogs . . .

Gild the farthing if you will;
Yet it is a farthing still.

- From "Things Are Seldom What They Seem", Gilbert and Sullivan, HMS Pinafore, 1878

Here are several bits of news either reported, or in one case seen by me in the past 48 hours alone:

Bank of America Accused in Ponzi Lawsuit

Published: March 27, 2009

Bank of America effectively set up a branch in a Long Island office that helped Nicholas Cosmo carry out a $380 million Ponzi scheme, according to a class-action lawsuit filed in federal court.

The lawsuit, filed in Federal District Court in Brooklyn late Thursday, contends that Bank of America “established, equipped and staffed” a branch office in the headquarters of Mr. Cosmo’s firm, Agape Merchant Advance. As a result, the lawsuit contends that the bank knowingly “assisted, facilitated and furthered” Mr. Cosmo’s fraudulent scheme.

“Bank of America was at the epicenter of this scheme,” said the lawsuit, which seeks $400 million in damages from the bank and other defendants. “Without Bank of America’s participation, the scheme would not have succeeded and grown to such an enormous size.”

Mr. Cosmo surrendered to authorities at a Long Island train station in January in connection with a suspected Ponzi scheme involving what Mr. Cosmo called “private bridge loans” that promised investors returns of 48 percent to 80 percent a year. Many of his 1,500 investors were blue-collar workers and civil servants.

DoctoRx here. Could this be a nuisance suit? Could it be an Enron moment? We'll see. Next, from the Zero Hedge blog:

Merrill Traders Mismarked P&Ls By Up To $7 Billion To Game Bonus

We are surprised to have missed this the first time around. On
page 4 of the Cuomo accusations against Merrill (and Lewis), the Attorney General raises a huge allegation against Merrill's trader employees: the AG claims that traders "willfully" manipulated their P&Ls, potentially by up to $7 billion, in order to make it seem they were more profitable in advance of the early mid-December bonus evaluation, knowing full well they would subsequently remark their books lower, having been already paid for the previous fake P&L number.

(From the complaint): The Office has also learned that, less than a week after Merrill voted its premature bonuses, Merrill determined that it would incur an unexpected additional $7 billion in losses for the fourth quarter of 2008, beyond the $8 billion it was already anticipating (Id. at Ex. D at 9-11 and Ex. H at 128-29). It appears that some of these losses may have been booked by Merrill employees who marked down their portfolios only after their 2008 bonuses were set (Id. at Ex. W). Despite the gargantuan unexpected losses, Merrill did not reconsider its bonus awards (which had been voted but not yet paid out) and Bank of America neither requested nor demanded that Merrill reduce its bonus pool (!d. at Ex. C at 106-07, Ex. D at 115-17, Ex. E at 86, and Ex. H at 28). Again, these material developments were undisclosed to the company's shareholders or to the legislators considering how to salvage the American banking system (!d. at Ex. C at 146-49).

(Back to Zero Hedge): As any derivatives trader will attest, this calendar "straddle" as it is lovingly called by some, is by far the oldest trick in the book, where multivariate models' inputs are jiggered in order to spew one number, only to have the correction subsequently "discovered" and fixed at the bank's expense while the bonus has already been pocketed. It is also a reason why many banks have pushed their bonus determination late into the subsequent year so that they are able to have at least semi-audited numbers serve as the basis for bonuses.

If Cuomo pursues this avenue successfully and obtains proof of malfeasance, the consequences would be much more dire than a mere slap on the wrist and bonus disgorgement, as mark manipulation does have criminal connotations associated with it, for both the perpetrator and the enabler/supervisor (emph added).

DoctoRx here. Is Attorney General Cuomo engaging in a frivolous pursuit? Next:

From Naked Capitalism:

We're not quite as healthy as we thought we were. Oops. (WSJ)

J.P. Morgan Chase Chief Executive James Dimon said...that March was a little tougher than the first two months of the year....Bank of America...CEO Kenneth Lewis also said that March had been a tougher month for his bank. [Convenient that they dumped this on Friday afternoon, and at the close of a very good week].Readers may recall that a few weeks ago, Dimon and Lewis---along with Citi's Vikram Pandit---said the first two months of the year had been very good:

Pandit, March 10th: “We are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007.”

Dimon, March 11th: "Jamie Dimon, the chief executive of JPMorgan Chase, said Wednesday that the bank was profitable in January and February..."

Lewis, March 12th: "We have been profitable for the first two months of the year,” Lewis told reporters after a speech in Boston today.

DoctoRx here. All investors recall that twice last year, the SEC arbitrarily squeezed the short-sellers by putting in selective restrictions on short sales of financial companies. The second of these was so blatant a form of market manipulation that such "financials" as IBM were included in the ban. What happened a few weeks ago was in relation to the Geithner bail-out and goosed the stocks big-time. Now, also in March, we get the real news. The truth is that banking is a poor business now, with the (important) exception that the Fed is doing everything it can to keep the banks enjoying a huge net interest margin. More stock market manipulation.

Next, more on the legal front, again from Zero Hedge:

Cuomo Pitting Thain vs. Lewis: One of Them Will be in Big (Legal) Trouble

Turns out NY AG Andrew Cuomo is pretty smart: he is seeking a court order that will force John Thain to testify as to what really happened in early December when Merrill bonuses were paid out ahead of posting a huge loss, or otherwise he will hold the former Merrill chief in contempt and possible further legal escalation.

Thain has claimed he is worried he would be sued by BofA (BAC) if he does talk to Cuomo, so the fan of gold-plated commodes is between a rock and very angry attorney general. Cuomo's strategy is likely to catch Lewis in perjury, since the BofA boss claimed in congress - on the record - that he had no control over the whole Merrill bonus fiasco.

Gasparino reports that BofA HR chief Andrew Smith in fact had full supervision and control over who gets what among the top 15 people at Merrill, meaning that Lewis could be in very hot water here.

Back to DoctoRx. We will see. Next, the biggest banking recipients of bailouts apparently are carrying securitized mortgages at very high prices on their balance sheets (courtesy of a recent analysis by Goldman, Sachs) while simultaneously buying similar securities at much lower prices. Assuming this is true, it is doubly galling, because the cover story for all these bailouts is that taxpayers need to give these companies money so the companies can turn around and lend us back that money. Why are they buying securities at all; don't they have enough? (The truth is that in a poor economy, banks mostly want to lend to people or companies who are financially strong enough that they do not need to borrow.) From the New York Post:


. . . the banks' purchase of so-called AAA-rated mortgage-backed securities, including some that use alt-A and option ARM as collateral, is raising eyebrows among even the most seasoned traders. Alt-A and option ARM loans have widely been seen as the next mortgage type to see increases in defaults.

Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids.

DoctoRx again. Next, commentary from the $80 Billion hedge fund, Bridgewater, which admits that the latest bank bailout plan is a rip-off:

Hedge fund Bridgewater mulls U.S toxic asset plan

NEW YORK (Reuters) - Bridgewater Associates Inc, one of the world's biggest hedge-fund managers, said on Tuesday it might be interested in participating in the U.S. Treasury's public-private investment program, calling it a "big transfer of money from the government to the banks and to the buyers."

. . . Bridgewater said: "From a macro perspective, this is a big transfer of money from the government to the banks (who are getting the higher prices for their assets) and to the buyers (who are probably going to get a heck of a deal because of the non-recourse loan and the easy access to leverage).

"If the government was operating in an economic way, it would not do this deal -- it would deal with the banks' finances separately and sell this insurance (i.e. the implied put arising from the non-recourse loan) for what it's worth," Bridgewater said in the letter.

DoctoRx here. Finally, just in case you were under any illusion that anything material is changing for the better anywhere in the financial system, comes this news from the WSJ:

Risk Officers Remain at Insurer's Helm

Inside American International Group Inc., a group of top executives called the Credit Risk Committee oversaw some of the company's biggest bets, such as the insurer's foray into credit-default swaps.

But even after a $173 billion government bailout, this group, which reviewed and approved risk-taking decisions, remains largely unchanged. At least five of the 10 committee members have served for years, according to internal company documents. Some served as far back as 2003 and 2004, the documents show.

Even amid change at AIG, much of the company's day-to-day infrastructure remains in place.

DoctoRx with final comments. There's an unending stream now of this sort of stuff. Not to forget that Bernard Madoff was one of the founders of NASDAQ, which for years has existed almost solely to transfer money from investors and speculators to corporate insiders and the financial community writ large.

World trade is collapsing, perhaps faster than in the Great Depression. The net worth of individuals is down 20% year on year, also rivaling that of the Depression (when fewer people owned stocks or homes). At least four experts on financial/economic crises in emerging nations liken the U. S. to these countries. These experts are:

Ken Rogoff, former Chief Economist to the IMF; now Professor at Harvard;
Simon Johnson, former Chief Economist to the IMF; now Professor at MIT;
Nouriel Roubini, former adviser to U. S. Treasury Department under Clinton/Summers; now (as before) Professor at NYU Stern School of Business;
and Desmond Lachman, with prior senior roles at IMF and then investment banking.

Looking at the current news items, how can these serious people easily be rebutted?

Copyright (C) Long Lake LLC 2009

Friday, March 27, 2009

The Intelligentsia Opines: U. S. as Russia-tina

Two recent articles have surfaced, each written by former IMF economists, one of whom is also an MIT professor and the other of whom has spent time with Big Finance, each comparing the U. S. to such countries as Argentina or Russia during their various economic crises. Here are links to each with small snippets. The first of these is very well written and easily digested in one sitting.

From "The Quiet Coup", by Dr. Simon Johnson (published by The Atlantic Monthly)

(Intro): The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time. . .

Becoming a Banana Republic
In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). . .

From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.

The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man).

Similarly, Desmond Lachman pens "Re-Emerging as an Emerging Market" (Washington Post), which begins:

Back in the spring of 1998, when Boris Yeltsin was still at Russia's helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to "emerging markets" throughout Asia, Eastern Europe and Latin America, and I thought I'd seen it all. Yet I still recall the shock I felt at a meeting in Russia's dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia's economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia's economic czar at the time.

At the time, I could not imagine that anything remotely similar could happen in the United States. Indeed, I shared the American conceit that most emerging-market nations had poorly developed institutions and would do well to emulate Washington and Wall Street. These days, though, I'm hardly so confident. Many economists and analysts are worrying that the United States might go the way of Japan, which suffered a "lost decade" after its own real estate market fell apart in the early 1990s. But I'm more concerned that the United States is coming to resemble Argentina, Russia and other so-called emerging markets, both in what led us to the crisis, and in how we're trying to fix it.

Finally, another Obama supporter (gingerly) criticizes him for his latest bail-out plan, in a Naked Capitalism post:

Guest Post: The new bailouts are an end-run around Congress

Submitted by Edward Harrison of the site Credit Writedowns

Edward Harrison here. What follows is a post I wrote for Credit Writedowns last night. Before I present the post, I want to make a few editorial comments, however.

First, for full disclosure, I support Barack Obama. I voted for him, campaigned for him and contributed to his run for office. I am happy to see him as President.

Nevertheless, he is now making policy that affects us all. As a blogger, I am required to show some objectivity in analyzing his policy decisions. I am not altogether content with that policy and my articles do reflect this.

The Harrison article is a bit lengthy and thinly edited. It presents the Obama-Geithner bank bailout plan in the context of another end-run around Congress, namely the 1995 Mexico bailout engineered by Treasury and the IMF; the legality of the current plan is questioned. It is presented here because it documents the continued flow of Obama supporters who have seen that his policies toward Big Finance are essentially those of George W. Bush, and have begun to criticize him by name. This continuity of policy has been emphasized by this blog since its founding. I continue to believe that Mr. Geithner belongs elsewhere, and should be replaced by someone more adversarial to large complex financial institutions.

Copyright (C) Long Lake LLC 2009

Thursday, March 26, 2009

Thursday Evening Potpourri

Here are some snippets from articles and blog posts from the past day, with comments.  My takeaway from them is consistent with my conclusion from last night's post, which is that somehow, despite a Dow that is south of 8000, the bulls are feeling frisky.  Let's hope they are correct!

U.S. Economy: GDP Slumps 6.3% Before Possible ‘Turning Point’ 

By Shobhana Chandra

March 26 (Bloomberg) -- The U.S. economy shrank at a 6.3 percent annual pace in the fourth quarter, the worst performance since 1982, in what may be the depths of the recession.

The contraction in gross domestic product was larger than the previously estimated 6.2 percent drop, the Commerce Department said today in Washington. A report from the Labor Department showed the number of people collecting jobless benefit this month climbed to a record 5.56 million.

“We’re at a turning point,” Michael Darda, chief economist at MKM Partners LP in Greenwich, Connecticut, said in an interview with Bloomberg Radio. “There are some glimmers of hope. By the fourth quarter, maybe even the third quarter, we’ll be pleasantly surprised by the economic data.”

Recent reports show retail sales, residential construction and home sales have improved, indicating last quarter’s slump may give way to smaller declines in growth. A let-up in the recession would set the stage for President Barack Obama’s stimulus plan and Federal Reserve measures to take hold in the second half of the year.

Stocks climbed, extending the biggest monthly rally since 1987, on mounting speculation the economy may be past the worst of the downturn. 

Comment:  Being past the worst of the downturn is both unlikely, per the ECRI weekly leading indicators; and almost irrelevant to the stock market.  For example, see (from where, I forget!):

Both the new and old fourth-quarter GDP readings were the worst since the first quarter of 1982, when the economy, hit by a severe recession, contracted at a 6.4 percent pace.

Comment:  Let us say that the economy will now contract more slowly than the 6.3% annual rate reported for Q4 2008.  Clearly in 1982, a 6.4% represented the bottom, though the economy stayed in recession into 1983.  When did the stock market bottom in 1982?  Was it in the first quarter, when the pace of recession weakened?  No.  Was it in the second quarter?  No.  It was actually halfway through the third quarter, in August 1982, when the Fed loosened their tight money policy to rescue Mexico.  Stocks soared, as did zero coupon bonds.  If one was safely invested in bonds, as I was, there was no rush to get into stocks (though I did rush in immediately, where I stayed for the next 18 years).  

By analogy, there is now no rush to buy stocks even if the pace of the economic decline has seen its worst.

What's going on fundamentally?  Here's a factual but non-cheery data point:

March 26 (Bloomberg) -- JPMorgan Chase & Co. will delay contributions to 401(k) retirement plans for salaried employees until the end of the year and may reduce the payments, according to a person who received a company memo on the changes. . .

U.S. companies are cutting back matching contributions to employee retirement plans to save cash, and the trend is growing, according to a survey by Spectrem Group. The survey of 150 U.S. companies found that 34 percent have reduced or eliminated retirement-plan contributions since January 2008. In the next 12 months, 29 percent intend to scale back or eliminate their match, the survey showed.

At least 148 U.S. employers have stopped or reduced 401(k) matching contributions since June 2008, including General Motors Corp., Eastman Kodak Co., Motorola Inc., Sears Holdings Corp. Hewlett-Packard Co. and Xerox Corp., according to the Pension Rights Center, which is pushing for retirement savings alternatives to the 401(k).

Comment:  So, if you are working for JPMorgan Chase, which allegedly is the strongest of the "big four" mega-financial companies still standing (AIG, Fannie/Freddie not really standing), and you see this A) sign of financial weakness by your employer and B) hit to your retirement, are you going to A) spend more or B) save more?  (No prize for the right answer, in keeping with the New Frugality . . .)

The same not only goes for employees of Hewlett-Packard, which supposedly is doing well, but for employees of almost every company that has not (yet) cut back on its pension contribution.
Somehow it just doesn't seem likely that Americans are, tomorrow or the next day, about to become free spenders again.  Au contraire.


The Nasdaq Composite is the first of the major three U.S. indices to blow the all-clear whistle, it seems. It touched being flat year-to-date today, which is fairly remarkable considering it hit its low not even a month ago. Granted, it never plummeted as far as the Dow and the S&P 500 -- it helps not to have financials in your index -- but its ascent has still been fairly remarkable.

Comment:  The above, from the estimable Paul Kedrosky at his Infectious Greed blog, is one in a series of recently bullish comments from an admitted bear.  Note the language, which implicitly suggests that the author believes that the other major indices (Dow 30 and S&P 500) will follow to breakeven at least.  He could just as properly have said somberly:  "The 'NAZ', that hotbed of speculative froth that only bothers to pay a dividend when, as with Microsoft, everyone and his brother knows that the company is no longer a growth vehicle, struggled back to breakeven on the year, even though broader and more important indices remain mired in negative territory, and all these indices have been horrible performers for investors on any time frame you care to name up to a dozen years."  But he didn't phrase it that way at all. 
Further comment on the comment:  This suggests to me that more and more bears have capitulated, having been worn out by the lengthy bear market, and that they are looking past the bottom.  
Further comment etc.:  How an index getting to neutral in any way sounds an "all-clear whistle" is a confusing concept.  

Next, from Barry Ritholtz's "The Big Picture" blog, is a skewering of the MSM's interpretation of the latest housing data.  Mr. Ritholtz has published some of the most incisive comments on the housing bubble for years.  He begins his post with the following quotes, then comments (all from him in italics).

WSJ: Sales of new homes rose in February for the first time in seven months, the Commerce Department reported Wednesday, another sign that the housing market is thawing

Bloomberg: Purchases of new homes in the U.S. unexpectedly rose in February from a record low as plummeting prices and cheaper mortgage rates lured some buyers. Sales increased 4.7 percent to an annual pace of 337,000 . . .

Marketwatch: The U.S. housing sector continues to see signs of improvement. The latest government data showed new home sales climbed in February for the first time in seven months, sending shares of home-building companies soaring. . .

(Ritholtz now writing):  Note that the month over month data at 4.7% — plus or minus 18.3% — is statistically insignificant. (i.e., meaningless). The reported data does not inform us if sales improved month-over-month or not. It is a range, from down -13.6% to plus 23%. Since “zero” is part of that range, we can draw no conclusion. As the Census Department itself notes, “the change is not statistically significant; that is, it is uncertain whether there was an increase or decrease.”

The data does however, tell us that the year-over-year sales fell 41.1% plus or minus 7.9% gives us a range of -49% to -33.2%. The entire range is negative, therefore we can conclude sales fell year-over-year.

These are facts. This is data. This is how you interpret it. Most of the MSM reports (WSJ, Marketwatch, Bloomberg) were simply wrong. . .

(Ritholtz again (bolding his point)):  Let me remind (Ed:  you) that many of these folks incorrectly misinformed you that Housing wasn’t getting worse in 2006, 2007 and 2008 — just as Home sales and prices went into an historic freefall. Now, these same folks are misinforming you that Housing has turned around and is improving. That is simply unsupported by the data.

Comment from DoctoRx now:  Good for Barry.  The housing stocks peaked in spring 2005.  The market knew bad times were coming.  That it took 4 years from the stock peak for housing starts to finally go low enough to allow inventory to begin to align with demand is horrifying.  It would be a real failure of the free market - except that there is no free market in housing.  Rather, demand is artificially pumped up in a variety of ways.

Finally, a comment on what is happening in America (from a suscription-only site):

Third Willed

Emanuel Derman | Mar 26, 2009

I was reading Yahoo Finance and came across the following Associated Press release:

"Democrats are looking for a way to respond to the public's outrage over taxpayer money being used to bankroll big bonuses for financial executives without alienating an industry whose cooperation is crucial to the nation's economic recovery.The House Financial Services Committee planned to endorse on Thursday a bill that would let Treasury Secretary Timothy Geithner and financial regulators decide whether an institution was spending too much money rewarding its employees.

The measure would exempt institutions that agree to participate in a government-sponsored program aimed at buying up $1 trillion of bad debt, or "toxic assets," sitting on the books of major banks. Geithner proposed the new investment program on Monday."

This is the third-world stuff that dreams are Madoff: the threat that if you are not a GSE (Geithner Sponsored Enterprise) you will not be exempt from arbitrary legislation.

Comment:  The above Derman post states that he is from South Africa; he knows what it's like to live in a third-world regime.

That's enough for now, methinks . . .

Copyright (C) Long Lake LLC 2009