The Smartest Guys in the Room.....are crooks

[admin]

As I sit on a sunday night, watching ENRON, THE SMARTEST GUYS IN THE ROOM on CBC, The Passionate Eye, I am allowed a few thoughts.

First is the thought that from Michael Milken's junk bonds in the 80's, to hedge funds in the '90's, to some of the worse Royalty Trusts, to current Asset Backed Commercial paper crisis, they all have one thing in common.

They all were synthetic schemes cooked up to play games with peoples money by folks who were "the smartest guys in the room" at that time.

They just keep rotating the guys. The game never changes. In the United States, at least the securities and judicial system is attempting to hold some of these guys accountable and responsible. In Canada, we actually have top regulators saying publicly that "we don't want to see our white collar criminals go to jail".

Enron appears in hindsight to be another case of letting the "Emperor with no clothes", pull the wool over everyone's eyes.

In Canada, with our current system of regulators, and private rental cop agencies we call "self regulators", we are providing a perfect breeding ground for the smartest, the richest and the most pathalogically deficient people in the world to work their magic here without consequence.

[admin]

Are investment products lacking transparency?

If transparency is essential to preserve investor confidence, why isn’t there more of it?

By Laura Bobak Investment Exectutive Magazine
January 2008

Let’s face it: many financial products leave clients perplexed.
The fees behind principal-protected notes are confusing;
mutual funds can be elaborate;
the details of hedge funds are vague and opaque;
then there’s the complexity of asset-backed commercial paper.
Although some efforts are being made to clarify fees and the structure of widely used products such as mutual funds (which are also the subject of increased regulation), investor advocates and industry analysts say there’s still a long way to go on the road to industry transparency.

Indeed, in a speech in Toronto this past month, outgoing Bank of Canada Governor David Dodge laid part of the blame for the past summer’s market turmoil on lack of information: “Problems related to information contributed to the market turbulence. We have seen the emergence of increasingly complex structured products, which were developed in response to the demand for higher returns.

“And as these securities have become more complex and opaque, in many cases, it has become harder to assemble and understand all the information needed to determine what kinds of assets are backing the security, the quality of those assets and the counterparty risk involved.”

If clients insist on greater transparency, they’ll get it, Dodge says. Credit-rating agencies should explain more clearly how they rate highly structured products and that their ratings should not be used with the same degree of certainty as ratings for conventional, single-name issuers. Investors [and members of pension funds, taxpayers who fund public treasuries, etc - JFR] also need to be told, Dodge says, that certain instruments do not trade with the same degree of liquidity as others.

There’s also the issue of some investors’ mistaken belief that they are well briefed about their choices. In fact, many do not have the financial literacy to grasp what’s being disclosed, let alone what’s not. And that can result in purchasing products that do more harm than good to their financial situations.

“The best way to deal with risk,” says investor advocate Ken Kivenko, who runs the www.CanadianFundWatch.com Web site, “is really to understand what you are being sold, the fees involved, tax efficiency and how the fund fits into your portfolio’s asset allocation.” [Good advice - did PSP Management follow it in buting ABCP? - JFR]

Canadians are plagued by high fees and a shortage of straight facts, he says: “They’re stabbing you in the front, not in the back, with high fees (salaries in our case) and opaque disclosures (NONE in our case).”

Some investor advocates also say that simply flagging questionable products for investors isn’t good enough. “Transparency is not a substitute for the investment industry’s duty to design products with minimal red flags,” says investor activist Diane Urquhart. “The financial advisor needs to market products without deception. In the retail market, financial literacy is not high. The complexity is so high, people don’t understand transparency, in any case.”

Here’s a look at some of the red flags raised by some of the industry’s murkier products:

Principal-Protected Notes

The lack of transparency in PPNs has led the federal government to announce that, as of April 1, it will require more disclosure both before and after the sale of these interest-bearing deposit products. Clients should understand that fees are high relative to the return, which is linked to the performance of underlying assets such as funds linked to stock market indices or commodities, say investor advocates.

“By and large, even if the PPN has a few good years, those fees just eat away at you,” says Kivenko, who points out that often the underlying products linked to PPNs are Canadian mutual funds, which are themselves plagued with high fees. “If there are fees on top of that for the note, what chance do you have?” he asks.

And although the principal is guaranteed, PPNs are not as low-risk as a GIC because they are not covered by deposit insurance. In addition, clients may not be aware that only a relatively small portion of the amount invested is placed in products with upside potential: the rest is used to cover the principal returned at maturity.

“PPNs are opaque,” Kivenko says. “People don’t have a clue what they’re buying. The people selling them are not always professionals. If it were a mutual fund, you’d have to be a registrant. But we don’t know who is selling PPNs. It could be some guy in the branch in his office with no professional qualifications.”

Kivenko also says it’s unclear who regulates PPNs: “We wrote the government and we said: ‘Who is it?’ We didn’t get an answer — yet.”

Some firms have improved disclosure, Kivenko says, but he’s still concerned, especially since the new regulations proposed by the federal government are principles-based, not mandatory requirements.

“If there’s one product that needed absolute uniform ways of communicating to retail investors,” he adds, “this would be the one.”

Mutual Funds

In comparison to some other products, mutual funds are reasonably good about disclosure, says Dan Hallett, president of Windsor, Ont.-based fund analysis firm Dan Hallett & Associates Inc.

Unlike PPNs, which, Hallett says, have fee disclosure in irregular and illogical places such as in a section entitled “net asset value,” a mutual fund prospectus is easy to compare with documents from other funds.

“If you’ve gone through a few of them, it’s very easy to compare them,” Hallett says. “There’s a lot of irony that regulators continue to pound away at mutual funds and segregated funds, and they are just getting around to PPNs.”

However, Hallett complains that mutual funds no longer have to release statements of portfolio transactions, which in the past could be requested by an investor or through the System for Electronic Document Analysis and Retrieval online at www.sedar.com. Hallett argues that without this information, it’s hard to tell if a portfolio manager is actually sticking to his or her stated investment policy.

Recent regulatory efforts are also falling short, Hallett says. In his view, the proposed two-page Fund Facts document for mutual funds and segregated funds recommended by the Joint Forum of Financial Market Regulators, an umbrella group set up in 1999 to co-ordinate the regulation of financial products, doesn’t improve disclosure in a meaningful way in the areas of “risk” and “suitability.” Hallett says investors could understand their risk level better if shown a chart showing rolling returns or past declines in the fund’s benchmark; this would be preferable to the six-point scale rating risk from very low to high.

Investors also need to know how the advisor is compensated through commissions and trailer fees; whether there is a deferred sales charge; and how high the management expense ratio is compared with other funds in the same category. Clients are also likely to have questions about non-MER expenses, which include trading fees, brokerage commissions and taxes on distributions.

Urquhart says there should be a Web site to which clients can go to see mutual fund portfolio transactions: “You should have the right to receive it if you choose.”

Hedge Funds

These funds should not be sold to retail investors unless these funds are prepared to issue a prospectus in the same manner as mutual funds, Urquhart says.

“It’s an absurdity for a country to allow that to occur,” she adds, speaking of the current regulations allowing minimal disclosure through an offering memorandum. “I don’t want accredited investors to have to play Where’s Waldo.”

Urquhart also suggests that clients who are not privy to the investments held by their funds need to ask questions. How long has the fund been in business? What are the qualifications of the fund managers? How much leverage will the fund take? To what extent will derivatives be used? What are the fees (which are usually 1%-2% plus 20% of the profits above a certain risk-free return, Urquhart estimates)?

“They get 20% of the upside,” she says of fees, “but are they going to pay you back when they lose your money?”

Income Trusts

These trusts are not required to disclose their calculations of distributable cash in a standardized format, an item normally dealt with in the publicly traded companies’ management discussion and analysis.

The murkiness of income trusts has been questioned by the Canadian Institute of Chartered Accountants, which has recommended that trusts be required to use standardized methods of reporting distributable cash. But as of November, only a few trusts have begun using the standard format. The CICA recommends that trusts disclose from what source distributable cash is coming (income, investor capital or debt), and whether the trust’s capital spending is adequate to maintain its operations.

Critics of trusts, such as forensic accountant Al Rosen of Accountability Research Corp. , have complained that many clients don’t understand that they are often merely getting their own money back when trusts make their distributions.

Another scenario, according to Urquhart, is the income trust mutual fund: in a hypothetical example, such a fund could be billed as having a 16% return, when in fact the real return — the amount that remains when the investor’s own money or funds from other sources of financing are subtracted from the amount being paid out — is 5%. And of that 5%, a further three percentage points might well be eaten up by MER fees.

“The customer would not buy that if they knew about the fees,” Urquhart says. “People construe it to be income, and they might be willing to pay higher fees than they should. You shouldn’t have to pay fees to get your own money back.”

Asset-Backed Commercial Paper

One of the reasons investors lost faith in ABCP is that the companies peddling the product released very little information about the underlying assets; this led some investors to stop rolling over their notes.

Hallett says that when he tried to find out about a few ABCP trusts being sold by Coventree Inc. , the firm at the heart of the summer liquidity crisis in Canada, he found very little about the creditworthiness of the underlying assets in the ABCP “information statements” released to investors.

“The disclosure is lacking significantly,” Hallett says. “There’s really no description of the assets.”

As with PPNs, there is also a troubling range in the quality of disclosure among ABCP notes. “It’s not that great,” Hallett says. “That’s the reason we hit this wall of liquidity — because there is no transparency.” IE

[admin]

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February 17, 2008
Arcane Market Is Next to Face Big Credit Test
By GRETCHEN MORGENSON
Few Americans have heard of credit default swaps, arcane financial instruments invented by Wall Street about a decade ago. But if the economy keeps slowing, credit default swaps, like subprime mortgages, may become a household term.

Credit default swaps form a large but obscure market that will be put to its first big test as a looming economic downturn strains companies’ finances. Like a homeowner’s policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts.



The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion — roughly twice the size of the entire United States stock market.

No one knows how troubled the credit swaps market is, because, like the now-distressed market for subprime mortgage securities, it is unregulated. But because swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity.

It is entirely possible that this market can withstand a big jump in corporate defaults, if it comes. But an inkling of trouble emerged in a recent report from the Office of the Comptroller of the Currency, a federal banking regulator. It warned that a significant increase in trading in swaps during the third quarter of last year “put a strain on processing systems” used by banks to handle these trades and make sure they match up.

And last week, the American International Group said that it had incorrectly valued some of the swaps it had written and that sharp declines in some of these instruments had translated to $3.6 billion more in losses than the company had previously estimated. Its stock dropped 12 percent on the news but edged up in the days after.

A.I.G. says it expects to file its year-end financial statements on time by the end of this month with appropriate valuations.

Placing accurate values on these contracts is just one of the uncertainties facing the big banks, insurance companies and hedge funds that create and trade these instruments.

In a credit default swap, two parties enter a private contract in which the buyer of protection agrees to pay the seller premiums over a set period of time; the seller pays only if a particular credit crisis occurs, like a default. These instruments can be sold, on either end of the contract, by the insurer or the insured.

But during the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In December, that number stood at 13 percent. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold.

As investors who have purchased such swaps try to cash them in, they may have trouble tracking down who is supposed to pay their claims.

“This is just a giant insurance industry that is underregulated and not very well reserved for and does not have very good standards as a result,” said Michael A. J. Farrell, chief executive of Annaly Capital Management in New York. “I think unregulated markets that overshadow, in terms of size, the regulated ones are a real question mark.”

Because these contracts are sold and resold among financial institutions, an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim.

In late 2005, at the urging of the Federal Reserve Bank of New York, market participants agreed to advise their trading partners in a swap when they assigned contracts to others. But it is unclear how closely participants adhere to this practice.

It would be as if homeowners, facing losses after a hurricane, could not identify the insurance companies to pay on their claims. Or, if they could, they discovered that their insurer had transferred the policy to another company that could not cover the claim.

Credit default swaps were invented by major banks in the mid-1990s as a way to offset risk in their lending or bond portfolios. At the outset, each contract was different, volume in the market was small and participants knew whom they were dealing with.

Years of a healthy economy and few corporate defaults led many banks to write more credit insurance, finding it a low-risk way to earn income because failures were few. Speculators have also flooded into the credit insurance market recently because these securities make it easier to bet on the health of a company than using corporate bonds.

Both factors have resulted in a market of credit swaps that now far exceeds the face value of corporate bonds underlying it. Commercial banks are among the biggest participants — at the end of the third quarter of 2007, the top 25 banks held credit default swaps, both as insurers and insured, worth $14 trillion, the currency office said, up $2 trillion from the previous quarter.

JPMorgan Chase, with $7.8 trillion, is the largest player; Citibank and Bank of America are behind it with $3 trillion and $1.6 trillion respectively.

But many speculators, particularly hedge funds, have flocked to these instruments to bet on a company failure easily. Before the insurance was developed, such a bet would require selling short a corporation’s bond and going into the market to borrow it to supply to the buyer.

The market’s popularity raises the possibility that undercapitalized participants could have trouble paying their obligations.

“The theme had been that derivatives are an instrument that helps diversify risk and stabilize risk-taking,” said Henry Kaufman, the economist at Henry Kaufman & Company in New York and an authority on the ways of Wall Street. “My own view of that has always been highly questionable — those instruments also encourage significant risk-taking and looking at risk modestly rather than incisively.”

Officials at the International Swaps and Derivatives Association, a trade group, say they are confident that the market will stand up, even under stress.

“During the volatility we have seen in the last eight months, credit default swaps continue to trade, unlike other parts of the credit market that have shut down,” said Robert G. Pickel, chief executive of the association. “Even if we have a series of credit events at the same time, we have the processes in place to enable the market to deliver.”

Such credit problems have been rare recently. The default rate among high-yield junk bonds fell to 0.9 percent in December, a record low.

But financial history is rife with examples of market breakdowns that followed the creation of complex securities. Financial innovation often gets ahead of the mechanics necessary to track trades or regulators’ ability to monitor the market for safety and soundness.

The market for default insurance, like the subprime mortgage securities market, is a product of good economic times and has boomed in recent years. In 2000, $900 billion of credit insurance contracts changed hands. Since then, the face value of the contracts outstanding has doubled every year as new contracts have been written. In the first six months of 2007, the figure rose 75 percent; the market now dwarfs the value of United States Treasuries outstanding.

Roughly one-third of the credit default swaps provided insurance against a default by a specific corporate debt issuer in 2006, according to the British Bankers’ Association. Around 30 percent of the contracts were written against indexes representing baskets of debt from numerous issuers.

But 16 percent were created to protect holders of collateralized debt obligations, complex pools of bonds that have recently experienced problems because of mortgage holdings.

There is no exchange where these insurance contracts trade, and their prices are not reported to the public. Because of this, institutions typically value them based on computer models rather than prices set by the market.

Neither are the participants overseen by regulators verifying that the parties to the transactions can meet their obligations.

The potential for problems in sizing up the financial health of buyers of these securities leads to questions about how these insurance contracts are being valued on banks’ books. A bank that has bought protection to cover its corporate bond exposure thinks it is hedged and therefore does not write off paper losses it may incur on those bond holdings. If the party who sold the insurance cannot pay on its claim in the event of a default, however, the bank’s losses would have to be reflected on its books.

Investors are already reeling from the recognition that major banks inaccurately estimated losses from the mortgage debacle. If further write-downs emerge as a result of hedges that did not work, investor confidence could take another dive.

To be sure, the $45 trillion in credit default swaps is not an exact reflection of what would be lost or won if all the underlying securities defaulted. That figure is impossible to pinpoint since the amounts that are recovered in default situations vary.

But one of the challenges facing participants in the credit default swap market is that the market value amount of the contracts outstanding far exceeds the $5.7 trillion of the corporate bonds whose defaults the swaps were created to protect against.

To the uninitiated trying to understand this complex market, its size might initially seem a comfort, as if there were far more insurance covering the bonds than could ever be needed. But because each contract must be settled between buyer and seller if a default occurs, this imbalance can present a problem.



Typically, settling the agreements has required the delivery of defaulted bonds if the insurance buyer wants to be fully covered. If the insurance contracts exceed the bonds that are available for delivery, problems arise.

For example, when Delphi, the auto parts maker, filed for bankruptcy in October 2005, the credit default swaps on the company’s debt exceeded the value of underlying bonds tenfold. Buyers of credit insurance scrambled to buy the bonds, driving up their price to around 70 cents on the dollar, a startlingly high value for defaulted debt.

Market participants worked out an auction system where settlements of Delphi contracts could be made even if the bonds could not be physically delivered. This arrangement was done at just over 36 cents on the dollar; so buyers of protection on Delphi who did not have the bonds received $366.25 for every $1,000 in coverage they had bought. Had they been valuing their Delphi insurance coverage at $1,000 per bond, they would have had to write off that position by $633.75 per $1,000 bond.

That is why the valuation of these contracts is of such concern to some participants.

As with other securities that trade privately and by appointment, assigning values to credit default swaps is highly subjective. So some on Wall Street wonder how much of the paper gains generated in these instruments by firms and hedge funds last year will turn out to be illusory when they try to cash them in.

“The insurance business is very difficult to quantify risk in,” said Mr. Farrell of Annaly Capital Management. “You have to really read the contract to make sure you are covered. That is going to be the test of the market this year. As defaults kick in and as these events unfold, you are going to find out who has managed this well.”

And who hasn’t.

[admin]

http://www.youtube.com/watch?v=br8mOmH9frE

go to this link for a humorous, yet accurate portrayal of the "rocket science" behind the smartest guys in the room

[admin]

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March 23, 2008
What Created This Monster?
By NELSON D. SCHWARTZ and JULIE CRESWELL
LIKE Noah building his ark as thunderheads gathered, Bill Gross has spent the last two years anticipating the flood that swamped Bear Stearns about 10 days ago. As manager of the world’s biggest bond fund and custodian of nearly a trillion dollars in assets, Mr. Gross amassed a cash hoard of $50 billion in case trading partners suddenly demanded payment from his firm, Pimco.

And every day for the last three weeks he has convened meetings in a war room in Pimco’s headquarters in Newport Beach, Calif., “to make sure the ark doesn’t have any leaks,” Mr. Gross said. “We come in every day at 3:30 a.m. and leave at 6 p.m. I’m not used to setting my alarm for 2:45 a.m., but these are extraordinary times.”

Even though Mr. Gross, 63, is a market veteran who has lived through the collapse of other banks and brokerage firms, the 1987 stock market crash, and the near meltdown of the Long-Term Capital Management hedge fund a decade ago, he says the current crisis feels different — in both size and significance.

The Federal Reserve not only taken has action unprecedented since the Great Depression — by lending money directly to major investment banks — but also has put taxpayers on the hook for billions of dollars in questionable trades these same bankers made when the good times were rolling.

“Bear Stearns has made it obvious that things have gone too far,” says Mr. Gross, who plans to use some of his cash to bargain-shop. “The investment community has morphed into something beyond banks and something beyond regulation. We call it the shadow banking system.”

It is the private trading of complex instruments that lurk in the financial shadows that worries regulators and Wall Street and that have created stresses in the broader economy. Economic downturns and panics have occurred before, of course. Few, however, have posed such a serious threat to the entire financial system that regulators have responded as if they were confronting a potential epidemic.

As Congress and Republican and Democratic presidential administrations pushed for financial deregulation over the last decade, the biggest banks and brokerage firms created a dizzying array of innovative products that experts now acknowledge are hard to understand and even harder to value.

On Wall Street, of course, what you don’t see can hurt you. In the past decade, there has been an explosion in complex derivative instruments, such as collateralized debt obligations and credit default swaps, which were intended primarily to transfer risk.


Bizuayehu Tesfaye/Associated Press

Alan Greenspan, the former chairman of the Federal Reserve. He played a pivotal role in the
regulation of derivatives products and oversight of the increasingly complex mortgage market.
These products are virtually hidden from investors, analysts and regulators, even though they have emerged as one of Wall Street’s most outsized profit engines. They don’t trade openly on public exchanges, and financial services firms disclose few details about them.

Used judiciously, derivatives can limit the damage from financial miscues and uncertainty, greasing the wheels of commerce. Used unwisely — when greed and the urge to gamble with borrowed money overtake sensible risk-taking — derivatives can become Wall Street’s version of nitroglycerin.

Bear Stearns’s vast portfolio of these instruments was among the main reasons for the bank’s collapse, but derivatives are buried in the accounts of just about every Wall Street firm, as well as major commercial banks like Citigroup and JPMorgan Chase. What’s more, these exotic investments have been exported all over the globe, causing losses in places as distant from Wall Street as a small Norwegian town north of the Arctic Circle.

With Bear Stearns forced into a sale and the entire financial system still under the threat of further losses, Wall Street executives, regulators and politicians are scrambling to figure out just what went wrong and how it can be fixed.

But because the forces that have collided in recent weeks were set in motion long before the subprime mortgage mess first made news last year, solutions won’t come easily or quickly, analysts say.

In fact, while home loans to risky borrowers were among the first to go bad, analysts say that the crisis didn’t stem from the housing market alone and that it certainly won’t end there.

“The problem has been spreading its wings and taking in markets very far afield from mortgages,” says Alan S. Blinder, former vice chairman of the Federal Reserve and now an economics professor at Princeton. “It’s a failure at a lot of levels. It’s hard to find a piece of the system that actually worked well in the lead-up to the bust.”

Stung by the new focus on their complex products, advocates of the derivatives trade say they are unfairly being made a scapegoat for the recent panic on Wall Street.

“Some people want to blame our industry because they have a vested interest in doing so, either by making a name for themselves or by hampering the adaptability and usefulness of our products for competitive purposes,” said Robert G. Pickel, chief executive of the International Swaps and Derivatives Association, a trade group. “We believe that there are good investment decisions and bad investment decisions. We don’t decry motor vehicles because some have been involved in accidents.”

Already, legislators in Washington are offering detailed plans for new regulations, including ones to treat Wall Street banks like their more heavily regulated commercial brethren. At the same time, normally wary corporate leaders like James Dimon, the chief executive of JPMorgan Chase, are beginning to acknowledge that maybe, just maybe, new regulations are necessary.

“We have a terribly global world and, over all, financial regulation has not kept up with that,” Mr. Dimon said in an interview on Monday, the day after his bank agreed to take over Bear Stearns at a fire-sale price. “I can’t even describe the seriousness of that. I always talk about how bad things can happen that you can’t expect. I didn’t fathom this event.”

TWO months before he resigned as chief executive of Citigroup last year amid nearly $20 billion in write-downs, Charles O. Prince III sat down in Washington with Representative Barney Frank, the chairman of the House Financial Services Committee. Among the topics they discussed were investment vehicles that allowed Citigroup and other banks to keep billions of dollars in potential liabilities off of their balance sheets — and away from the scrutiny of investors and analysts.

“Why aren’t they on your balance sheet?” asked Mr. Frank, Democrat of Massachusetts. The congressman recalled that Mr. Prince said doing so would have put Citigroup at a disadvantage with Wall Street investment banks that were more loosely regulated and were allowed to take far greater risks. (A spokeswoman for Mr. Prince confirmed the conversation.)

It was at that moment, Mr. Frank says, that he first realized just how much freedom Wall Street firms had, and how lightly regulated they were in comparison with commercial banks, which have to answer to an alphabet soup of government agencies like the Federal Reserve and the comptroller of the currency.

“Not only did Wall Street have so much freedom, but it gave commercial banks an incentive to try and evade their regulations,” Mr. Frank says. When it came to Wall Street, he says, “we thought we didn’t need regulation.”

In fact, Washington has long followed the financial industry’s lead in supporting deregulation, even as newly minted but little-understood products like derivatives proliferated.

During the late 1990s, Wall Street fought bitterly against any attempt to regulate the emerging derivatives market, recalls Michael Greenberger, a former senior regulator at the Commodity Futures Trading Commission. Although the Long-Term Capital debacle in 1998 alerted regulators and bankers alike to the dangers of big bets with borrowed money, a rescue effort engineered by the Federal Reserve Bank of New York prevented the damage from spreading.

“After that, all was forgotten,” says Mr. Greenberger, now a professor at the University of Maryland. At the same time, derivatives were being praised as a boon that would make the economy more stable.

Speaking in Boca Raton, Fla., in March 1999, Alan Greenspan, then the Fed chairman, told the Futures Industry Association, a Wall Street trade group, that “these instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it.”

Although Mr. Greenspan acknowledged that the “possibility of increased systemic risk does appear to be an issue that requires fuller understanding,” he argued that new regulations “would be a major mistake.”

“Regulatory risk measurement schemes,” he added, “are simpler and much less accurate than banks’ risk measurement models.”

Mr. Greenberger, still concerned about regulatory battles he lost a decade ago, says that Mr. Greenspan “felt derivatives would spread the risk in the economy.”

“In reality,” Mr. Greenberger added, “it spread a virus through the economy because these products are so opaque and hard to value.” A representative for Mr. Greenspan said he was preparing to travel and could not comment.

A milestone in the deregulation effort came in the fall of 2000, when a lame-duck session of Congress passed a little-noticed piece of legislation called the Commodity Futures Modernization Act. The bill effectively kept much of the market for derivatives and other exotic instruments off-limits to agencies that regulate more conventional assets like stocks, bonds and futures contracts.

Supported by Phil Gramm, then a Republican senator from Texas and chairman of the Senate Banking Committee, the legislation was a 262-page amendment to a far larger appropriations bill. It was signed into law by President Bill Clinton that December.

Mr. Gramm, now the vice chairman of UBS, the Swiss investment banking giant, was unavailable for comment. (UBS has recently seen its fortunes hammered by ill-considered derivative investments.)

“I don’t believe anybody understood the significance of this,” says Mr. Greenberger, describing the bill’s impact.

By the beginning of this decade, according to Mr. Frank and Mr. Blinder, Mr. Greenspan resisted suggestions that the Fed use its powers to regulate the mortgage market or to crack down on practices like providing loans to borrowers with little, if any, documentation.

“Greenspan specifically refused to act,” Mr. Frank says. “He had the authority, but he didn’t use it.”

Others on Capitol Hill, like Representative Scott Garrett, Republican of New Jersey and a member of the Financial Services banking subcommittee, reject the idea that loosening financial rules helped to create the current crisis.

“I don’t think deregulation was the cause,” he says. “And had we had additional regulation in place, I’m not sure what we’re experiencing now would have been averted.”

Regardless, with profit margins shrinking in traditional businesses like underwriting and trading, Wall Street firms rushed into the new frontier of lucrative financial products like derivatives. Students with doctorates in physics and other mathematical disciplines were hired directly out of graduate school to design them, and Wall Street firms increasingly made big bets on derivatives linked to mortgages and other products.

THREE years ago, many of Wall Street’s best and brightest gathered to assess the landscape of financial risk. Top executives from firms like Goldman Sachs, Lehman Brothers and Citigroup — calling themselves the Counterparty Risk Management Policy Group II — debated the likelihood of an event that could send a seismic wave across financial markets.

The group’s conclusion, detailed in a 153-page report, was that the chances of a systemic upheaval had declined sharply after the Long-Term Capital bailout. Members recommended some nips and tucks around the market’s edges, to ensure that trades were cleared and settled more efficiently. They also recommended that secretive hedge funds volunteer more information about their activities. Yet, over all, they concluded that financial markets were more stable than they had been just a few years earlier.

Few could argue. Wall Street banks were fat and happy. They were posting record profits and had healthy capital cushions. Money flowed easily as corporate default rates were practically nil and the few bumps and bruises that occurred in the market were readily absorbed.

More important, innovative products designed to mitigate risk were seen as having reduced the likelihood that a financial cataclysm could put the entire system at risk.

“With the 2005 report, my hope at the time was that that work would help in dealing with future financial shocks, and I confess to being quite frustrated that it didn’t do as much as I had hoped,” says E. Gerald Corrigan, a managing director at Goldman Sachs and a former New York Fed president, who was chairman of the policy group. “Still, I shudder to think what today would look like if not for the fact that some of the changes were, in fact, implemented.”

ONE of the fastest-growing and most lucrative businesses on Wall Street in the past decade has been in derivatives — a sector that boomed after the near collapse of Long-Term Capital.

It is a stealth market that relies on trades conducted by phone between Wall Street dealer desks, away from open securities exchanges. How much changes hands or who holds what is ultimately unknown to analysts, investors and regulators.

Credit rating agencies, which banks paid to grade some of the new products, slapped high ratings on many of them, despite having only a loose familiarity with the quality of the assets behind these instruments.

Even the people running Wall Street firms didn’t really understand what they were buying and selling, says Byron Wien, a 40-year veteran of the stock market who is now the chief investment strategist of Pequot Capital, a hedge fund.

“These are ordinary folks who know a spreadsheet, but they are not steeped in the sophistication of these kind of models,” Mr. Wien says. “You put a lot of equations in front of them with little Greek letters on their sides, and they won’t know what they’re looking at.”

Mr. Blinder, the former Fed vice chairman, holds a doctorate in economics from M.I.T. but says he has only a “modest understanding” of complex derivatives. “I know the basic understanding of how they work,” he said, “but if you presented me with one and asked me to put a market value on it, I’d be guessing.”

Such uncertainty led some to single out derivatives for greater scrutiny and caution. Most famous, perhaps, was Warren E. Buffett, the legendary investor and chairman of Berkshire Hathaway, who in 2003 said derivatives were potential “weapons of mass destruction.”

Behind the scenes, however, there was another player who was scrambling to assess the growing power, use and dangers of derivatives.

Timothy F. Geithner, a career civil servant who took over as president of the New York Fed in 2003, was trying to solve a variety of global crises while at the Treasury Department. As a Fed president, he tried to get a handle on hedge fund activities and the use of leverage on Wall Street, and he zeroed in on the credit derivatives market.

Mr. Geithner brought together leaders of Wall Street firms in a series of meetings in 2005 and 2006 to discuss credit derivatives, and he pushed many of them to clear and settle derivatives trading electronically, hoping to eliminate a large paper backlog that had clogged the system.

Even so, Mr. Geithner had one hand tied behind his back. While the Fed regulated large commercial banks like Citigroup and JPMorgan, it had no oversight on activities of the investment banks, hedge funds and other participants in the burgeoning derivatives market. And the industry and sympathetic politicians in Washington fought attempts to regulate the products, arguing that it would force the lucrative business overseas.

“Tim has been learning on the job, and he has my sympathy,” said Christopher Whalen, a managing partner of Institutional Risk Analytics, a risk management firm in Torrance, Calif. “But I don’t think he’s enough of a real practitioner to go mano-a-mano with these bankers.”

Mr. Geithner declined an interview request for this article.

In a May 2006 speech about credit derivatives, Mr. Geithner praised the benefits of the products: improved risk management and distribution, as well as enhanced market efficiency and resiliency. As he had on earlier occasions, he also warned that the “formidable complexity of measuring the scale of potential exposure” to derivatives made it hard to monitor the products and to gauge the financial vulnerability of individual banks, brokerage firms and other institutions.

“Perhaps the more difficult challenge is to capture the broader risks the institution might confront in conditions of a general deterioration in confidence in credit and an erosion in liquidity,” Mr. Geithner said in the speech. “Most crises come from the unanticipated.”

WHEN increased defaults in subprime mortgages began crushing mortgage-linked securities last summer, several credit markets and many firms that play substantial roles in those markets were sideswiped because of a rapid loss of faith in the value of the products.

Two large Bear Stearns hedge funds collapsed because of bad subprime mortgage bets. The losses were amplified by a hefty dollop of borrowed money that was used to try to juice returns in one of the funds.

All around the Street, dealers were having trouble moving exotic securities linked to subprime mortgages, particularly collateralized debt obligations, which were backed by pools of bonds. Within days, the once-booming and actively traded C.D.O. market — which in three short years had seen issues triple in size, to $486 billion — ground to a halt.

Jeremy Grantham, chairman and chief investment strategist at GMO, a Boston investment firm, said: “When we had the shot across the bow and people realized something was going wrong with subprime, I said: ‘Treat this as a dress rehearsal. Stress-test your portfolios because the next time or the time after, the shot won’t be across the bow.’ ”

In the fall, the Treasury Department and several Wall Street banks scrambled to try to put together a bailout plan to save up to $80 billion in troubled securities. The bailout fell apart, quickly replaced by another aimed at major bond guarantors. That crisis was averted after the guarantors raised fresh capital.

Yet each near miss brought with it growing fears that the stakes were growing bigger and the risks more dangerous. Wall Street banks, as well as banks abroad, took billions of dollars in write-downs, and the chiefs of UBS, Merrill Lynch and Citigroup were all ousted because of huge losses.

“It was like watching a slow-motion train wreck,” Mr. Grantham says. “After all of the write-downs at the banks in June, July and August, we were in a full-fledged credit crisis with C.E.O.’s of top banks running around like headless chickens. And the U.S. equity market’s peak in October? What sort of denial were they in?”

Finally, last week, with Wall Street about to take a direct hit, the Fed stepped in and bailed out Bear Stearns.

It remains unclear, exactly, what doomsday scenario Federal Reserve officials consider themselves to have averted. Some on Wall Street say the fear was that a collapse of Bear could take other banks, including possibly Lehman Brothers or Merrill Lynch, with it. Others say the concern was that Bear, which held $30 billion in mortgage-related assets, would cause further deterioration in that beleaguered market.

Still others say the primary reason the Fed moved so quickly was to divert an even bigger crisis: a meltdown in an arcane yet huge market known as credit default swaps. Like C.D.O.’s, which few outside of Wall Street had ever heard about before last summer, the credit default swaps market is conducted entirely behind the scenes and is not regulated.

Nonetheless, the market’s growth has exploded exponentially since Long-Term Capital almost went under. Today, the outstanding value of the swaps stands at more than $45.5 trillion, up from $900 billion in 2001. The contracts act like insurance policies designed to cover losses to banks and bondholders when companies fail to pay their debts. It’s a market that also remains largely untested.



While there have been a handful of relatively minor defaults that, in some cases, ended in litigation as participants struggled over contract language and other issues, the market has not had to absorb a bankruptcy of one of its biggest players. Bear Stearns held credit default swap contracts carrying an outstanding value of $2.5 trillion, analysts say.

“The rescue was absolutely all about counterparty risk. If Bear went under, everyone’s solvency was going to be thrown into question. There could have been a systematic run on counterparties in general,” said Meredith Whitney, a bank analyst at Oppenheimer. “It was 100 percent related to credit default swaps.”

Amid the regulatory swirl surrounding Bear Stearns, analysts have questioned why the Securities and Exchange Commission did not send up any flares about looming problems at that firm or others on Wall Street. After all, they say, it was the S.E.C., not the Federal Reserve, that was Bear’s primary regulator.

Although S.E.C. officials were unavailable for comment, its chairman, Christopher Cox, has maintained that the agency has effectively carried out its regulatory duties. In a letter last week to the nongovernmental Basel Committee of Banking Supervision, Mr. Cox attributed the collapse of Bear to “a lack of confidence, not a lack of capital.”

IT’S still too early to assess whether the Federal Reserve’s actions have succeeded in protecting the broader economic system. And experts are debating whether the government’s intervention in the Bear Stearns debacle will ultimately encourage riskier behavior on the Street.

“It showed that anything important is going to be bailed out one way or the other,” says Kevin Phillips, a former Republican strategist whose new book, “Bad Money,” analyzes what he describes as the intersection of reckless finance and poor public policy.

Mr. Phillips says that it’s likely that the Fed’s actions have ushered in a new era in financial regulation.

“What we may be looking at is a rethinking of the whole role of the Federal Reserve and what they represent,” he says. “If they didn’t solve it in this round, I’m not sure they can stretch it out and do it again without creating a new law.”

On Capitol Hill, leading Democrats like Senator Christopher J. Dodd of Connecticut, chairman of the Senate Banking Committee, and Mr. Frank of the House Financial Services Committee are pushing for just that.

Last Thursday, Mr. Frank offered up a raft of suggestions, including requiring investment banks to disclose off-balance-sheet risks while also making the firms subject to audits — much like commercial banks are now. He also wants investment banks to set aside reserves for potential losses to provide a greater cushion during financial panics.

Earlier in the week, Mr. Dodd said the Fed should be given some supervisory powers over the investment banks.

But broad new rules aimed at systemic risk are likely to face strong opposition from both the industry and others traditionally wary of regulation. Analysts expect new, smaller-bore laws aimed at the mortgage industry in particular, which was the first sector hit in the squeeze and which affected Wall Street millionaires as well as millions of ordinary American homeowners.

THERE is an emerging consensus that the ability of mortgage lenders to package their loans as securities that were then sold off to other parties played a key role in allowing borrowing standards to plummet.

Mr. Blinder suggests that mortgage originators be required to hold onto a portion of the loans they make, with the investment banks who securitize them also retaining a chunk. “That way, they don’t simply play hot potato,” he says.

Mr. Grantham agrees. “There is just a terrible risk created when you can underwrite a piece of junk and simply pass it along to someone else,” he says.

Ratings agencies have similarly been under fire ever since the credit crisis began to unfold, and new regulations may force them to distance themselves from the investment banks whose products they were paid to rate.

In the meantime, analysts say, a broader reconsideration of derivatives and the shadow banking system is also in order. “Not all innovation is good,” says Mr. Whalen of Institutional Risk Analytics. “If it is too complicated for most of us to understand in 10 to 15 minutes, then we probably shouldn’t be doing it.”

[admin]

Dear New York Times,

I write to you from the plains of Western Canada with my own answer to the question your good writers posed, namely, "WHAT CREATED THIS MONSTER".

I understand your writers also look at the answers, and I do not wish to take away from their answers, however just to lend my perspective. I come from twenty years inside the brokerage industry.

In short, I feel that the system has been completely taken over by persons bent on short term thinking and a near psychopathic addiction to money and power. They (Martha Stout, THE SOCIOPATH NEXT DOOR) say that nearly on in twenty or twenty five people we meet each day carries with them the invisible secret weapon in that they can do anything, hurt anyone, without fear, anxiety, or conscience to slow them down or stop them.

My experience is that a larger proportion of those individuals gravitate to industries where power and money collect, and finance is one of those industries. I feel from my perspective that nearly one in ten persons in the higher positions in these industries could be carrying this secret weapon with them. They are using this weapon (the ability to harm without conscience) against clients, shareholders, the public, employees. That is problem number one.

Problem number two is part fear, part apathy that allows this 5% or 10% of our population to get away with sociopathic or psychopathic behavior. Recall Stanely Milgram's famous "shock" experiments at Yale University in 1961 or 1962, where subjects were told to administer electric shocks to other "test subjects" who got wrong answers in a memory test. Those who gave the shocks thought they were testing the effects of shocks on memory (if memory serves me) when in fact, it was the people giving the shocks who were the subjects under study, to see how far they would go to hurt their fellow humans when told to do so. In total surprise to all involved, it was found that 62% of the population will nearly blindly follow orders up to and including orders to damage their fellows, when they are under the impression that they are "following orders" or acting on authority from above. This is problem number two. Imagine having 5% to 10% of the workplace with sociopathic tendencies, and those persons scrape, climb and claw their way to the upper echelons of the corporation. Below them we have another 62% of the population who will blindly follow orders from these people. That puts us at very near 70%+ of a large company that may be "the corrupt, leading the blind". Add in another 10% or more, who are too new to know what is even going on around them, another 10% who are too old and jaded to care, and maybe 10% who are simply afraid to say a word because they know what the repercussions are to those who "are not team players". The sociopaths in the company will destroy them, assited blindly by the other 60%, 70%, 80%, or more of the firm. The numbers add up to a nearly negative chance that sociopaths at work will be stopped. We are still only on problem number two.

Problem number three (in my country to your north at least) is that we allow these people to self regulate. To police themselves. To act on the honor system. Big mistake, but they have lobbied hard, worked hard and paid hard to earn this right. So we have the richest, smartest, most morally deficient and perhaps those with a pthalogical addication to money and power, we let those people govern themselves on the honor system. Big problem in my country. We now face the largest bankruptcy in our history due to this, and your country may be in a similar boat. If we should happen to experience another depression like the 1930's, it can be attributed, in my opinion in large part to these problems which are so very easy to fix.

The fourth problem is that due to a combination of the previous, (and a few more), we find ourselves on a slippery slope. We are now on that slippery slope, where, without rules to follow, or without enforcement of those rules (in Canada), and with the richest, smartest, most pathalogically money addicted people running our financial system, there are no limits to the size or the types of frauds and crimes that can be played out with the savings of your country or mine. The imagination of those in charge is the only limitation on what can be dreamt up. The sky is the limit. Remember Key Lay. Remember Bernie Ebbers. He was a milkman up in my province before he found the financial services industry had the "sky is the limit", no rules atmosphere he liked so much.

So these "smartest guys in the room" types, move ahead with dreams, and schemes, inventing whatever comes into their minds and then peddling it along to the public. It strikes me that the newer investments, or the newer schemes they have used in the last decade or two, have come closer and closer to financial alchemy. In a manner similar to the gangs out there who cook up newer, more dangerous synthetic drug combinations to sell to the unsuspecting public, the financial industry has taken a similar bizarre turn into left field, where nearly no one can understand the products, or the concepts, but the con continues.

I refer to them as "Banksters". They are organized, they work in cartel, in syndicate on major deals, and they have a code of silence among each other. In my country the definition of organized crime is "three or more individuals acting in concert to......". The banksters up here (we have five major banks in Canada who control 90% of the market) are very organized. Unfortunately our commerical police force in Canada had only made two convictions (verses 1236 in the US) up to the end of 2007. Those fortunate few who retire from our famous "county mounties", the RCMP, speak in our Canadian Business Magazine that "Canada is a good country for crooks". We may in fact be no different in our problems than your country.

Here is where we are with finance. We are, in exactly the same spot that the tobacco industry was in the 1950's. Making dangerous products that hurt the public. Doing this knowingly because the industry was/is run by pathlogically addicted people whose addiction is to more and more money.

They purchased industry support, systemically corrupted doctors, lawyers, media, and whomever was needed to corrupt to continue with the creation of their knowingly tainted product. Finance is there today. Look back fifty years. See the movie "Tobacco Conspiracy" and recall what history has taught us. (Pharmaceuticals may be in there just between tobacco and finance, but I digress)
Millions are no longer enough. Billions are no longer enough. A lifetime earning living is no longer satisfactory when it can be done in months or years......if you are sick enough, oops, quick enough. If you have gotten this far, I want to thank you a great deal for putting up with a guy from the Prairies. I am proud to be your neighbor and I hope I can borrow a cup of something I need if we get to that next depression.

web.mac.com/lelford (mac site) will point you towards my thoughts, comments and work towards improving this problem in my own country, which is at least ten years behind yours, and www.investoradvocates.ca will give you a web flogg that holds many topics in this area. Finally, to see how truly far behind the world that Canadian investment regulations have fallen, see www.investorvoice.ca for the top research site in the Canada on financial abuse of citizens by the financial industry. Many of these abuses may occur in your country.

[admin]

The New York Times
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April 27, 2008
Triple-A Failure

Illustrations by Christoph Niemann
By ROGER LOWENSTEIN
The Ratings Game

In 1996, Thomas Friedman, the New York Times columnist, remarked on “The NewsHour With Jim Lehrer” that there were two superpowers in the world — the United States and Moody’s bond-rating service — and it was sometimes unclear which was more powerful. Moody’s was then a private company that rated corporate bonds, but it was, already, spreading its wings into the exotic business of rating securities backed by pools of residential mortgages.

Obscure and dry-seeming as it was, this business offered a certain magic. The magic consisted of turning risky mortgages into investments that would be suitable for investors who would know nothing about the underlying loans. To get why this is impressive, you have to think about all that determines whether a mortgage is safe. Who owns the property? What is his or her income? Bundle hundreds of mortgages into a single security and the questions multiply; no investor could begin to answer them. But suppose the security had a rating. If it were rated triple-A by a firm like Moody’s, then the investor could forget about the underlying mortgages. He wouldn’t need to know what properties were in the pool, only that the pool was triple-A — it was just as safe, in theory, as other triple-A securities.

Over the last decade, Moody’s and its two principal competitors, Standard & Poor’s and Fitch, played this game to perfection — putting what amounted to gold seals on mortgage securities that investors swept up with increasing élan. For the rating agencies, this business was extremely lucrative. Their profits surged, Moody’s in particular: it went public, saw its stock increase sixfold and its earnings grow by 900 percent.

By providing the mortgage industry with an entree to Wall Street, the agencies also transformed what had been among the sleepiest corners of finance. No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and — their capital thus replenished — wrote new loans at a much quicker pace.

Mortgage volume surged; in 2006, it topped $2.5 trillion. Also, many more mortgages were issued to risky subprime borrowers. Almost all of those subprime loans ended up in securitized pools; indeed, the reason banks were willing to issue so many risky loans is that they could fob them off on Wall Street.

But who was evaluating these securities? Who was passing judgment on the quality of the mortgages, on the equity behind them and on myriad other investment considerations? Certainly not the investors. They relied on a credit rating.

Thus the agencies became the de facto watchdog over the mortgage industry. In a practical sense, it was Moody’s and Standard & Poor’s that set the credit standards that determined which loans Wall Street could repackage and, ultimately, which borrowers would qualify. Effectively, they did the job that was expected of banks and government regulators. And today, they are a central culprit in the mortgage bust, in which the total loss has been projected at $250 billion and possibly much more.

In the wake of the housing collapse, Congress is exploring why the industry failed and whether it should be revamped (hearings in the Senate Banking Committee were expected to begin April 22). Two key questions are whether the credit agencies — which benefit from a unique series of government charters — enjoy too much official protection and whether their judgment was tainted. Presumably to forestall criticism and possible legislation, Moody’s and S.&P. have announced reforms. But they reject the notion that they should have been more vigilant. Instead, they lay the blame on the mortgage holders who turned out to be deadbeats, many of whom lied to obtain their loans.

Arthur Levitt, the former chairman of the Securities and Exchange Commission, charges that “the credit-rating agencies suffer from a conflict of interest — perceived and apparent — that may have distorted their judgment, especially when it came to complex structured financial products.” Frank Partnoy, a professor at the University of San Diego School of Law who has written extensively about the credit-rating industry, says that the conflict is a serious problem. Thanks to the industry’s close relationship with the banks whose securities it rates, Partnoy says, the agencies have behaved less like gatekeepers than gate openers. Last year, Moody’s had to downgrade more than 5,000 mortgage securities — a tacit acknowledgment that the mortgage bubble was abetted by its overly generous ratings. Mortgage securities rated by Standard & Poor’s and Fitch have suffered a similar wave of downgrades.

Presto! How 2,393 Subprime Loans Become a High-Grade Investment

The business of assigning a rating to a mortgage security is a complicated affair, and Moody’s recently was willing to walk me through an actual mortgage-backed security step by step. I was led down a carpeted hallway to a well-appointed conference room to meet with three specialists in mortgage-backed paper. Moody’s was fair-minded in choosing an example; the case they showed me, which they masked with the name “Subprime XYZ,” was a pool of 2,393 mortgages with a total face value of $430 million.

Subprime XYZ typified the exuberance of the age. All the mortgages in the pool were subprime — that is, they had been extended to borrowers with checkered credit histories. In an earlier era, such people would have been restricted from borrowing more than 75 percent or so of the value of their homes, but during the great bubble, no such limits applied.

Moody’s did not have access to the individual loan files, much less did it communicate with the borrowers or try to verify the information they provided in their loan applications. “We aren’t loan officers,” Claire Robinson, a 20-year veteran who is in charge of asset-backed finance for Moody’s, told me. “Our expertise is as statisticians on an aggregate basis. We want to know, of 1,000 individuals, based on historical performance, what percent will pay their loans?”

The loans in Subprime XYZ were issued in early spring 2006 — what would turn out to be the peak of the boom. They were originated by a West Coast company that Moody’s identified as a “nonbank lender.” Traditionally, people have gotten their mortgages from banks, but in recent years, new types of lenders peddling sexier products grabbed an increasing share of the market. This particular lender took the loans it made to a New York investment bank; the bank designed an investment vehicle and brought the package to Moody’s.

Moody’s assigned an analyst to evaluate the package, subject to review by a committee. The investment bank provided an enormous spreadsheet chock with data on the borrowers’ credit histories and much else that might, at very least, have given Moody’s pause. Three-quarters of the borrowers had adjustable-rate mortgages, or ARMs — “teaser” loans on which the interest rate could be raised in short order. Since subprime borrowers cannot afford higher rates, they would need to refinance soon. This is a classic sign of a bubble — lending on the belief, or the hope, that new money will bail out the old.

Moody’s learned that almost half of these borrowers — 43 percent — did not provide written verification of their incomes. The data also showed that 12 percent of the mortgages were for properties in Southern California, including a half-percent in a single ZIP code, in Riverside. That suggested a risky degree of concentration.

On the plus side, Moody’s noted, 94 percent of those borrowers with adjustable-rate loans said their mortgages were for primary residences. “That was a comfort feeling,” Robinson said. Historically, people have been slow to abandon their primary homes. When you get into a crunch, she added, “You’ll give up your ski chalet first.”

Another factor giving Moody’s comfort was that all of the ARM loans in the pool were first mortgages (as distinct from, say, home-equity loans). Nearly half of the borrowers, however, took out a simultaneous second loan. Most often, their two loans added up to all of their property’s presumed resale value, which meant the borrowers had not a cent of equity.

In the frenetic, deal-happy climate of 2006, the Moody’s analyst had only a single day to process the credit data from the bank. The analyst wasn’t evaluating the mortgages but, rather, the bonds issued by the investment vehicle created to house them. A so-called special-purpose vehicle — a ghost corporation with no people or furniture and no assets either until the deal was struck — would purchase the mortgages. Thereafter, monthly payments from the homeowners would go to the S.P.V. The S.P.V. would finance itself by selling bonds. The question for Moody’s was whether the inflow of mortgage checks would cover the outgoing payments to bondholders. From the investment bank’s point of view, the key to the deal was obtaining a triple-A rating — without which the deal wouldn’t be profitable. That a vehicle backed by subprime mortgages could borrow at triple-A rates seems like a trick of finance. “People say, ‘How can you create triple-A out of B-rated paper?’ ” notes Arturo Cifuentes, a former Moody’s credit analyst who now designs credit instruments. It may seem like a scam, but it’s not.

The secret sauce is that the S.P.V. would float 12 classes of bonds, from triple-A to a lowly Ba1. The highest-rated bonds would have first priority on the cash received from mortgage holders until they were fully paid, then the next tier of bonds, then the next and so on. The bonds at the bottom of the pile got the highest interest rate, but if homeowners defaulted, they would absorb the first losses.

It was this segregation of payments that protected the bonds at the top of the structure and enabled Moody’s to classify them as triple-A. Imagine a seaside condo beset by flooding: just as the penthouse will not get wet until the lower floors are thoroughly soaked, so the triple-A bonds would not lose a dime unless the lower credits were wiped out.

Structured finance, of which this deal is typical, is both clever and useful; in the housing industry it has greatly expanded the pool of credit. But in extreme conditions, it can fail. The old-fashioned corner banker used his instincts, as well as his pencil, to apportion credit; modern finance is formulaic. However elegant its models, forecasting the behavior of 2,393 mortgage holders is an uncertain business. “Everyone assumed the credit agencies knew what they were doing,” says Joseph Mason, a credit expert at Drexel University. “A structural engineer can predict what load a steel support will bear; in financial engineering we can’t predict as well.”

Mortgage-backed securities like those in Subprime XYZ were not the terminus of the great mortgage machine. They were, in fact, building blocks for even more esoteric vehicles known as collateralized debt obligations, or C.D.O.’s. C.D.O.’s were financed with similar ladders of bonds, from triple-A on down, and the credit-rating agencies’ role was just as central. The difference is that XYZ was a first-order derivative — its assets included real mortgages owned by actual homeowners. C.D.O.’s were a step removed — instead of buying mortgages, they bought bonds that were backed by mortgages, like the bonds issued by Subprime XYZ. (It is painful to consider, but there were also third-order instruments, known as C.D.O.’s squared, which bought bonds issued by other C.D.O.’s.)

Miscalculations that were damaging at the level of Subprime XYZ were devastating at the C.D.O. level. Just as bad weather will cause more serious delays to travelers with multiple flights, so, if the underlying mortgage bonds were misrated, the trouble was compounded in the case of the C.D.O.’s that purchased them.

Moody’s used statistical models to assess C.D.O.’s; it relied on historical patterns of default. This assumed that the past would remain relevant in an era in which the mortgage industry was morphing into a wildly speculative business. The complexity of C.D.O.’s undermined the process as well. Jamie Dimon, the chief executive of JPMorgan Chase, which recently scooped up the mortally wounded Bear Stearns, says, “There was a large failure of common sense” by rating agencies and also by banks like his. “Very complex securities shouldn’t have been rated as if they were easy-to-value bonds.”

The Accidental Watchdog

John Moody, a Wall Street analyst and former errand runner, hit on the idea of synthesizing all kinds of credit information into a single rating in 1909, when he published the manual “Moody’s Analyses of Railroad Investments.” The idea caught on with investors, who subscribed to his service, and by the mid-’20s, Moody’s faced three competitors: Standard Statistics and Poor’s Publishing (which later merged) and Fitch.

Then as now, Moody’s graded bonds on a scale with 21 steps, from Aaa to C. (There are small differences in the agencies’ nomenclatures, just as a grande latte at Starbucks becomes a “medium” at Peet’s. At Moody’s, ratings that start with the letter “A” carry minimal to low credit risk; those starting with “B” carry moderate to high risk; and “C” ratings denote bonds in poor standing or actual default.) The ratings are meant to be an estimate of probabilities, not a buy or sell recommendation. For instance, Ba bonds default far more often than triple-As. But Moody’s, as it is wont to remind people, is not in the business of advising investors whether to buy Ba’s; it merely publishes a rating.

Until the 1970s, its business grew slowly. But several trends coalesced to speed it up. The first was the collapse of Penn Central in 1970 — a shattering event that the credit agencies failed to foresee. It so unnerved investors that they began to pay more attention to credit risk.

Government responded. The Securities and Exchange Commission, faced with the question of how to measure the capital of broker-dealers, decided to penalize brokers for holding bonds that were less than investment-grade (the term applies to Moody’s 10 top grades). This prompted a question: investment grade according to whom? The S.E.C. opted to create a new category of officially designated rating agencies, and grandfathered the big three — S.&P., Moody’s and Fitch. In effect, the government outsourced its regulatory function to three for-profit companies.

Bank regulators issued similar rules for banks. Pension funds, mutual funds, insurance regulators followed. Over the ’80s and ’90s, a latticework of such rules redefined credit markets. Many classes of investors were now forbidden to buy noninvestment-grade bonds at all.

Issuers thus were forced to seek credit ratings (or else their bonds would not be marketable). The agencies — realizing they had a hot product and, what’s more, a captive market — started charging the very organizations whose bonds they were rating. This was an efficient way to do business, but it put the agencies in a conflicted position. As Partnoy says, rather than selling opinions to investors, the rating agencies were now selling “licenses” to borrowers. Indeed, whether their opinions were accurate no longer mattered so much. Just as a police officer stopping a motorist will want to see his license but not inquire how well he did on his road test, it was the rating — not its accuracy — that mattered to Wall Street.

The case of Enron is illustrative. Throughout the summer and fall of 2001, even though its credit was rapidly deteriorating, the rating agencies kept it at investment grade. This was not unusual; the agencies typically lag behind the news. On Nov. 28, 2001, S.&P. finally dropped Enron’s bonds to subinvestment grade. Although its action merely validated the market consensus, it caused the stock to collapse. To investors, S.&P.’s action was a signal that Enron was locked out of credit markets; it had lost its “license” to borrow. Four days later it filed for bankruptcy.

Another trend that spurred the agencies’ growth was that more companies began borrowing in bond markets instead of from banks. According to Chris Mahoney, a just-retired Moody’s veteran of 22 years, “The agencies went from being obscure and unimportant players to central ones.”

A Conflict of Interest?

Nothing sent the agencies into high gear as much as the development of structured finance. As Wall Street bankers designed ever more securitized products — using mortgages, credit-card debt, car loans, corporate debt, every type of paper imaginable — the agencies became truly powerful.

In structured-credit vehicles like Subprime XYZ, the agencies played a much more pivotal role than they had with (conventional) bonds. According to Lewis Ranieri, the Salomon Brothers banker who was a pioneer in mortgage bonds, “The whole creation of mortgage securities was involved with a rating.”

What the bankers in these deals are really doing is buying a bunch of I.O.U.’s and repackaging them in a different form. Something has to make the package worth — or seem to be worth — more that the sum of its parts, otherwise there would be no point in packaging such securities, nor would there be any profits from which to pay the bankers’ fees.

That something is the rating. Credit markets are not continuous; a bond that qualifies, though only by a hair, as investment grade is worth a lot more than one that just fails. As with a would-be immigrant traveling from Mexico, there is a huge incentive to get over the line.

The challenge to investment banks is to design securities that just meet the rating agencies’ tests. Risky mortgages serve their purpose; since the interest rate on them is higher, more money comes into the pool and is available for paying bond interest. But if the mortgages are too risky, Moody’s will object. Banks are adroit at working the system, and pools like Subprime XYZ are intentionally designed to include a layer of Baa bonds, or those just over the border. “Every agency has a model available to bankers that allows them to run the numbers until they get something they like and send it in for a rating,” a former Moody’s expert in securitization says. In other words, banks were gaming the system; according to Chris Flanagan, the subprime analyst at JPMorgan, “Gaming is the whole thing.”

When a bank proposes a rating structure on a pool of debt, the rating agency will insist on a cushion of extra capital, known as an “enhancement.” The bank inevitably lobbies for a thin cushion (the thinner the capitalization, the fatter the bank’s profits). It’s up to the agency to make sure that the cushion is big enough to safeguard the bonds. The process involves extended consultations between the agency and its client. In short, obtaining a rating is a collaborative process.

The evidence on whether rating agencies bend to the bankers’ will is mixed. The agencies do not deny that a conflict exists, but they assert that they are keen to the dangers and minimize them. For instance, they do not reward analysts on the basis of whether they approve deals. No smoking gun, no conspiratorial e-mail message, has surfaced to suggest that they are lying. But in structured finance, the agencies face pressures that did not exist when John Moody was rating railroads. On the traditional side of the business, Moody’s has thousands of clients (virtually every corporation and municipality that sells bonds). No one of them has much clout. But in structured finance, a handful of banks return again and again, paying much bigger fees. A deal the size of XYZ can bring Moody’s $200,000 and more for complicated deals. And the banks pay only if Moody’s delivers the desired rating. Tom McGuire, the Jesuit theologian who ran Moody’s through the mid-’90s, says this arrangement is unhealthy. If Moody’s and a client bank don’t see eye to eye, the bank can either tweak the numbers or try its luck with a competitor like S.&P., a process known as “ratings shopping.”

And it seems to have helped the banks get better ratings. Mason, of Drexel University, compared default rates for corporate bonds rated Baa with those of similarly rated collateralized debt obligations until 2005 (before the bubble burst). Mason found that the C.D.O.’s defaulted eight times as often. One interpretation of the data is that Moody’s was far less discerning when the client was a Wall Street securitizer.

After Enron blew up, Congress ordered the S.E.C. to look at the rating industry and possibly reform it. The S.E.C. ducked. Congress looked again in 2006 and enacted a law making it easier for competing agencies to gain official recognition, but didn’t change the industry’s business model. By then, the mortgage boom was in high gear. From 2002 to 2006, Moody’s profits nearly tripled, mostly thanks to the high margins the agencies charged in structured finance. In 2006, Moody’s reported net income of $750 million. Raymond W. McDaniel Jr., its chief executive, gloated in the annual report for that year, “I firmly believe that Moody’s business stands on the ‘right side of history’ in terms of the alignment of our role and function with advancements in global capital markets.”

Using Weather in Antarctica To Forecast Conditions in Hawaii

Even as McDaniel was crowing, it was clear in some corners of Wall Street that the mortgage market was headed for trouble. The housing industry was cooling off fast. James Kragenbring, a money manager with Advantus Capital Management, complained to the agencies as early as 2005 that their ratings were too generous. A report from the hedge fund of John Paulson proclaimed astonishment at “the mispricing of these securities.” He started betting that mortgage debt would crash.

Even Mark Zandi, the very visible economist at Moody’s forecasting division (which is separate from the ratings side), was worried about the chilling crosswinds blowing in credit markets. In a report published in May 2006, he noted that consumer borrowing had soared, household debt was at a record and a fifth of such debt was classified as subprime. At the same time, loan officers were loosening underwriting standards and easing rates to offer still more loans. Zandi fretted about the “razor-thin” level of homeowners’ equity, the avalanche of teaser mortgages and the $750 billion of mortgages he judged to be at risk. Zandi concluded, “The environment feels increasingly ripe for some type of financial event.”

A month after Zandi’s report, Moody’s rated Subprime XYZ. The analyst on the deal also had concerns. Moody’s was aware that mortgage standards had been deteriorating, and it had been demanding more of a cushion in such pools. Nonetheless, its credit-rating model continued to envision rising home values. Largely for that reason, the analyst forecast losses for XYZ at only 4.9 percent of the underlying mortgage pool. Since even the lowest-rated bonds in XYZ would be covered up to a loss level of 7.25 percent, the bonds seemed safe.

XYZ now became the responsibility of a Moody’s team that monitors securities and changes the ratings if need be (the analyst moved on to rate a new deal). Almost immediately, the team noticed a problem. Usually, people who finance a home stay current on their payments for at least a while. But a sliver of folks in XYZ fell behind within 90 days of signing their papers. After six months, an alarming 6 percent of the mortgages were seriously delinquent. (Historically, it is rare for more than 1 percent of mortgages at that stage to be delinquent.)

Moody’s monitors began to make inquiries with the lender and were shocked by what they heard. Some properties lacked sod or landscaping, and keys remained in the mailbox; the buyers had never moved in. The implication was that people had bought homes on spec: as the housing market turned, the buyers walked.

By the spring of 2007, 13 percent of Subprime XYZ was delinquent — and it was worsening by the month. XYZ was hardly atypical; the entire class of 2006 was performing terribly. (The class of 2007 would turn out to be even worse.)

In April 2007, Moody’s announced it was revising the model it used to evaluate subprime mortgages. It noted that the model “was first introduced in 2002. Since then, the mortgage market has evolved considerably.” This was a rather stunning admission; its model had been based on a world that no longer existed.

Poring over the data, Moody’s discovered that the size of people’s first mortgages was no longer a good predictor of whether they would default; rather, it was the size of their first and second loans — that is, their total debt — combined. This was rather intuitive; Moody’s simply hadn’t reckoned on it. Similarly, credit scores, long a mainstay of its analyses, had not proved to be a “strong predictor” of defaults this time. Translation: even people with good credit scores were defaulting. Amy Tobey, leader of the team that monitored XYZ, told me, “It seems there was a shift in mentality; people are treating homes as investment assets.” Indeed. And homeowners without equity were making what economists call a rational choice; they were abandoning properties rather than make payments on them. Homeowners’ equity had never been as high as believed because appraisals had been inflated.

Over the summer and fall of 2007, Moody’s and the other agencies repeatedly tightened their methodology for rating mortgage securities, but it was too late. They had to downgrade tens of billions of dollars of securities. By early this year, when I met with Moody’s, an astonishing 27 percent of the mortgage holders in Subprime XYZ were delinquent. Losses on the pool were now estimated at 14 percent to 16 percent — three times the original estimate. Seemingly high-quality bonds rated A3 by Moody’s had been downgraded five notches to Ba2, as had the other bonds in the pool aside from its triple-A’s.

The pain didn’t stop there. Many of the lower-rated bonds issued by XYZ, and by mortgage pools like it, were purchased by C.D.O.’s, the second-order mortgage vehicles, which were eager to buy lower-rated mortgage paper because it paid a higher yield. As the agencies endowed C.D.O. securities with triple-A ratings, demand for them was red hot. Much of it was from global investors who knew nothing about the U.S. mortgage market. In 2006 and 2007, the banks created more than $200 billion of C.D.O.’s backed by lower-rated mortgage paper. Moody’s assigned a different team to rate C.D.O.’s. This team knew far less about the underlying mortgages than did the committee that evaluated Subprime XYZ. In fact, Moody’s rated C.D.O.’s without knowing which bonds the pool would buy.

A C.D.O. operates like a mutual fund; it can buy or sell mortgage bonds and frequently does so. Thus, the agencies rate pools with assets that are perpetually shifting. They base their ratings on an extensive set of guidelines or covenants that limit the C.D.O. manager’s discretion.

Late in 2006, Moody’s rated a C.D.O. with $750 million worth of securities. The covenants, which act as a template, restricted the C.D.O. to, at most, an 80 percent exposure to subprime assets, and many other such conditions. “We’re structure experts,” Yuri Yoshizawa, the head of Moody’s’ derivative group, explained. “We’re not underlying-asset experts.” They were checking the math, not the mortgages. But no C.D.O. can be better than its collateral.

Moody’s rated three-quarters of this C.D.O.’s bonds triple-A. The ratings were derived using a mathematical construct known as a Monte Carlo simulation — as if each of the underlying bonds would perform like cards drawn at random from a deck of mortgage bonds in the past. There were two problems with this approach. First, the bonds weren’t like those in the past; the mortgage market had changed. As Mark Adelson, a former managing director in Moody’s structured-finance division, remarks, it was “like observing 100 years of weather in Antarctica to forecast the weather in Hawaii.” And second, the bonds weren’t random. Moody’s had underestimated the extent to which underwriting standards had weakened everywhere. When one mortgage bond failed, the odds were that others would, too.

Moody’s estimated that this C.D.O. could potentially incur losses of 2 percent. It has since revised its estimate to 27 percent. The bonds it rated have been decimated, their market value having plunged by half or more. A triple-A layer of bonds has been downgraded 16 notches, all the way to B. Hundreds of C.D.O.’s have suffered similar fates (most of Wall Street’s losses have been on C.D.O.’s). For Moody’s and the other rating agencies, it has been an extraordinary rout.

Whom Can We Rely On?

The agencies have blamed the large incidence of fraud, but then they could have demanded verification of the mortgage data or refused to rate securities where the data were not provided. That was, after all, their mandate. This is what they pledge for the future. Moody’s, S.&P. and Fitch say that they are tightening procedures — they will demand more data and more verification and will subject their analysts to more outside checks. None of this, however, will remove the conflict of interest in the issuer-pays model. Though some have proposed requiring that agencies with official recognition charge investors, rather than issuers, a more practical reform may be for the government to stop certifying agencies altogether.

Then, if the Fed or other regulators wanted to restrict what sorts of bonds could be owned by banks, or by pension funds or by anyone else in need of protection, they would have to do it themselves — not farm the job out to Moody’s. The ratings agencies would still exist, but stripped of their official imprimatur, their ratings would lose a little of their aura, and investors might trust in them a bit less. Moody’s itself favors doing away with the official designation, and it, like S.&P., embraces the idea that investors should not “rely” on ratings for buy-and-sell decisions.

This leaves an awkward question, with respect to insanely complex structured securities: What can they rely on? The agencies seem utterly too involved to serve as a neutral arbiter, and the banks are sure to invent new and equally hard-to-assess vehicles in the future. Vickie Tillman, the executive vice president of S.&P., told Congress last fall that in addition to the housing slump, “ahistorical behavorial modes” by homeowners were to blame for the wave of downgrades. She cited S.&P.’s data going back to the 1970s, as if consumers were at fault for not living up to the past. The real problem is that the agencies’ mathematical formulas look backward while life is lived forward. That is unlikely to change.

Roger Lowenstein, a contributing writer, last wrote for the magazine about the Federal Reserve chief, Ben Bernanke. His new book, “While America Aged,” will be published next month.

[admin]

doom and gloom or realistic thinking? Time will tell. I personally like his reasoning, but then again, my mind may be permanently bent from a few to many years inside a bank...........cheers, advocate

The Great Depression of the 2010s


By Darryl Robert Schoon
May 5 2008 12:22PM


www.drschoon.com

Economics is not rocket science. Neither is power.

Depressions are monetary phenomena caused by central bank issuance of excessive credit. In 1913, the newly created US central bank, the Federal Reserve, began issuing credit-based money in the US. Within ten years, the central bank flow of credit ignited the 1920s US stock market bubble; and shortly thereafter, following the collapse of the bubble in 1929, the world entered its first Great Depression in 1933.

Investment banks are the undoing of central banking. While all banks, central, commercial and investment, view credit as the opportunity to exploit society’s growth and productivity, investment bank exploitation of growth and productivity exposes society to extreme risks - for investment banks use society’s savings to make their volatile and speculative bets.

The speculative risks undertaken by investment banks is done by leveraging the savings of society; and, when investment bank bets are sufficiently large enough and the bets go bad - as they inevitably do as the luck of investment bankers is due more to their proximity to credit than to their ability to foresee the future - it is society that will bear the brunt of the pain in the loss of its savings.

Inevitably, investment bankers cannot resist the temptations of excessive credit and, like the buyers of teaser-rate home mortgages, they will always overreach themselves - an overreaching that will have disastrous consequences for the society whose savings they bet.

The leveraged overreaching by investment banks in the 1920s caused the Great Depression of the 1930s and their more recent overreaching in this decade, the 2000s, is about to cause another Great Depression in the next, the 2010s.

It is the proximity of investment banks to the pools of savings that allows investment banks to profit. By their access to society’s savings, investment banks use society’s wealth as the foundation of their highly leveraged bets in financial markets; and in so doing, they have now placed all of us in harms way.

GOVERNMENT THE DEVICE BY WHICH THE FEW CONTROL THE MANY

The collapse of financial markets in the first Great Depression led to the US Congress to enact laws that would hopefully insure that such a collapse would never again happen. To that end, in 1933 the Glass-Steagall Act was passed by Congress and signed into law.

Acknowledging the role that investment banks had played in the Great Depression, the passage of the Glass-Steagall Act in 1933 separated investment banking and commercial banking to insure that investment bank speculation would not again destabilize commercial banks as it did during the Great Depression leading to the loss of America’s savings.

What bankers hath joined together let no man put asunder

However, in 1999, the US Congress repealed the Glass-Steagall Act and America was once again vulnerable to the highly leveraged shenanigans of Wall Street. This time, however, it was not only the US but the entire world whose futures were to be bet and lost by Wall Street gamblers.

The globalization of financial markets had spread the dangers of US investment banking to banks, insurance companies, and pension funds around the world. Now, the savings of Europe and Asia as well as the US were to be impacted by the wagers of Wall Street who in the 2000s literally bet the house on the possibility that subprime CDOs were actually worth their AAA ratings.

Glass-Steagall, the law enacted in 1933 to prevent another Great Depression was repealed at the behest of bankers. While it is true that at certain times the US government will act in the best interest of society, usually (and usually in the guise of so doing) the US government is the pawn of the special interests that benefit from the trough of government largesse and regulation. The repealing of the Glass-Steagall Act in 1999 was therefore a reversion to the mean.

We are today in the initial stages of another collapse that will lead to another Great Depression. The safeguards put in place to prevent such from happening were not only disassembled in 1999; but, now in 2008, the US government has moved even closer to exposing its citizenry and indeed the world to the speculative carnage and folly of investment banking excess.

THE RULE OF LAW IS A WONDROUS THING - ESPECIALLY IF YOU WRITE THEM.

Bloomberg.com April 8, 2008

As credit markets seized up, the Fed gave the 20 primary dealers in U.S. government bonds the same access to discount- window loans that had previously been reserved for banks. The central bank now auctions as much as $100 billion to lenders a month, and has cut the cost on direct loans to just a quarter- point above the overnight rate on loans between banks.

The US Federal Reserve is now underwriting, i.e. subsidizing, the commercial activities of global private investment banks. The 20 primary dealers in US government bonds include the world’s largest investment banks - BNP Paribas Securities Corp. (French), Barclays Capital Inc (British), Banc of America Securities LLC (USA), UBS Securities LLC (Swiss), Dresdner Kleinwort Wasserstein Securities LLC (German), Daiwa Securities US Inc. (Japan) etc.

In truth, these investment banks are global entities and have no actual nationality no matter what jurisdiction in which they are legally domiciled. As such, they also have no allegiance except to their own self-interests.

QUESTION:

Why is the US government allocating public resources for the benefit of private international investment banks?

ANSWER:

US resources are subsidizing international investment banks through the Federal Reserve Bank, a quasi private entity which was given governmental powers in 1913 (some allege in violation of the US Constitution). That a quasi private bank is bailing out private banks with public monies does make sense. What doesn’t make sense is why the public allows it.

There is much discussion as to the justification and reasons for US, UK, European, and Japanese central banks bailing out private banks with public money. Issues such as moral hazard are now being raised in questioning the right and consequence of so doing.

In truth, such issues are irrelevant. Not that they are in themselves not important, but issues such as moral hazard will have no effect whatsoever on what is going to happen.

Intent is the underlying motive that explains what is about to occur. The intent of private bankers is not public stability, nor growth, nor productivity - it is the pursuit of private profit via the use of public credit and debt.

Today, most governments, especially the US and UK, are controlled by private bankers - which is why government policy continues and will continue to favor the interests of private bankers over the public good.

THE MELTDOWN OF MAMMON

I am sure that in some quarters of the Catholic Church objections were raised (perhaps even on theological grounds) about the torture used by the Church during the Spanish Inquisition; just as today, there have been objections raised by some in the US in regards to the use of torture in its "war on terror".

Objections are always tolerated by those in power as long as the objections do not rise to the level of action. The objection to central bank credit and influence in our monetary affairs is therefore rhetorical. The influence of private bankers and central banking in our monetary affairs will not change until their influence has run its course - which is now about to happen.

The present epoch of central banking will perhaps be known as the period when bankers roamed the earth. Just as during the Jurassic Age, when dinosaurs roamed freely eating whatever and whomever they encountered, bankers did much the same in the present epoch that is now about to end - profiting by the productivity of society and the public and private debts incurred as a result of bankers’ induced credit-based spending.

Bankers achieved their immense power during this era by exploiting flaws in human nature and systemic flaws in the economic system they constructed for their own benefit. But as with all flaws, human or economic, the consequences of so doing are exposed over time. That time has now arrived.

Money is not credit, nor is money created de jure by circulating paper coupons imprinted with a government stamp stating the coupons are now legal tender to be used in the settlement of debts.

The idea that central bank coupons/paper money, sic debt, can be used to settle another debt is astounding. That we have been led to accept it is so is even more astounding. Throughout history, every experiment with paper "money" as a settlement of debt has failed. Our experiment with paper money towards that end will be no different.

The recent correction in the price of gold and silver is just that, a correction in an otherwise direct repudiation of the on-going attempt by governments and bankers to substitute paper coupons for real money.

A paper yen, a paper euro, a paper dollar, when no longer backed and convertible to gold or silver is but a paper coupon masquerading as money - a coupon with an expiration date in invisible ink.

In truth, the bankers’ real gambit is not their bet that paper money can be substituted for gold and silver or that subprime mortgages can be passed off as AAA securities. Their real gambit is that central bank issuance of debt as money and their control of governments will never be discovered by the public.

HUBRIS FOLLY AND DISASTER

The world of credit and debt and all it has created has been made possible by bankers and their debt based system of money and central banking. Its cost, however, will be born by future generations who were not present when the debts were incurred.

Those who utter in pious simplicity those wonderful words, "our children are our future", have no idea what they have done to those very children and their future by spending today what future generations will have to earn tomorrow.

Here, in the US, an entire generation has grown up on the suspect promises of easy credit and paper money. That generation is now beginning to suspect that something is wrong, that the price of their gas, food and healthcare is rapidly rising and their dream of home ownership is a trap from which bankruptcy is increasingly their only escape.

Still, this generation has no idea of how terribly wrong it actually is and why it has happened; and their ignorance of such will give them little comfort during the Great Depression that lies directly ahead.

The chickens are coming home to roost; and they closer they come, the more they are looking like vultures.

[admin]

How High Leverage Has Brought Down the Whole Banking Industry


-- Posted Tuesday, 22 July 2008

On Tuesday, as the S&P 500 briefly touched 1,200, the banking sector represented by KBW Bank Index [$BKX] (or other similar indices) went down to 47 (which had been range bound and traded around 75-90 early this year), and VIX reached 30, it seemed that the stock market was under capitulation similar to the March plummet. The dropping of $BKX was so severe that it broke my technical target of 55 by 8 points.



Now we may see a bear market rally lasting for a few months, similar to post-March capitulation. I still feel Jeremy Grantham's target of 1,100 will be reached sooner than 2010, probably later this year or early next year. I also doubt that funds which have withdrawn money from the market this year, especially in last several weeks, will re-enter the market anytime soon. The worst case scenario is that they may never re-enter the market at all, if these are funds for the baby boomers.



There is an interesting book "Bringing Down the House", which was turned into a movie called "21". It is about a group of MIT students who were trained as card counters to play blackjack at casinos. They acted as a group, and played small when the odds were not clear or not in their favor. But after receiving a signal from his group member, one of them acting as a super-rich guy entered into the table and played huge stakes when the odds were in their favor. This is a typical example of using leverage against casinos.



It turns out to be that this highly leveraged technique is also used by banks, especially investment banks. No one is trying to bring them down as in the case of "Bringing Down the House". All the current troubles for this industry are of their own making. They are the ones who choose to gamble with their own capital, unlike the casinos. They can't blame anyone else but themselves. However, now with the help of their friends in the government, they are arguing that they need unlimited funding protection and bailout from the government, or more accurately, U.S. taxpayers.



To understand leverage, just look at one of the WSJ articles from last Wednesday (7/16). Lehman's (LEH) market cap of $9B is only 40% of their book value of $23B, and it sounds very cheap. But then look at their assets: They have $160B hard-to-value Level 2 assets and $41B impossible-to-value Level 3 assets. The WSJ article applies a 5% haircut on Level 2 and 25% on Level 3 to come up with $19B future write-offs. However, based on analysis from many other public sources, most of the Level 3 assets are MBS CDOs, even if they are AAA rated, the recovery rate is only about 50%. And anything under AAA rating is pretty much wiped out. For Level 2 assets, it would be very lucky if only 10% haircut is true. The combination of both more realistic haircuts will result in $36B additional losses, which would more than wipe out their book value of $23B plus their market cap of $9B. This is leverage in the working, unfortunately at the downside.



Let us also look at Fannie Mae (FNM) and see what the level of leverage they are using. FNM has long-term liabilities of about $580B, according to Yahoo Finance. It has a negative duration mismatch of 14 months between its assets and its liabilities. Due to this mis-match, a 1% drop in interest rate will cause roughly 14/12 or 1.17% loss in value, or $7B (1.17% x $580B). And their market cap is only $10B. We are only talking about pure interest rate risk, not even losses from credit risk due to lending practice, delinquency, foreclosure, etc., which will be much larger than the interest rate risk.



People have drawn parallels between the current failure of IndyMac and the failure of Continental Illinois Bank in 1984, with the expectation that IndyMac will cost FDIC about $4B to $8B, while FDIC has only $52B in its insurance funds. But this comparison has missed the whole S&L crisis, in which losses were much larger than one commercial bank, and FDIC was actually not quite involved. For S&L crisis, the Federal Savings & Loan Insurance Corporation (FSLIC) was the main show, and it had $5.6B in 1984 to pay claims; by 1989 its balance had turned into an $87B deficit. The total number of failed S&L institutions is estimated to be around 1,000, and GAO (US General Accounting Office) has estimated the total losses for S&L to be at $166B for taxpayers.



Today people are trying to estimate how many banks will fail this time. The number probably won't get to the 1,000 mark as in the S&L’s case, and the figure of a few hundred banks has often been mentioned. At the end of this crisis, FDIC will be most likely in the red, similar to FSLIC.



A week ago, Bridgewater Associates issued a report saying that the banking system losses will likely hit $1.6 trillion, but didn't give any breakdowns. This is more than the $1 trillion estimate in my previous article “Will CDS Replace Subprime To Cause $1 Trillion Total Loss For This Credit Crisis?” in January this year. I actually tried to give a breakdown at that time as follows: $500B for OTC (over the counter) credit default swaps (CDS), $250B for subprime, and $250B for everything else such as commercial real estate, leveraged loans, credit card losses, auto loans, etc. Due to the further deterioration of the real estate market and continued losses, I think I underestimated the subprime by about $150B, also I should have included some losses from the next tiers of Alt-A and prime mortgages since the losses have already cut into them, especially Alt-A products. In addition, CDS has become a larger, deeper and wilder threat to the whole banking system day by day, maybe $1 trillion is a better estimate now. Overall, $2 trillion losses for this credit crisis are really not stretching at all.



So far this year, some financial institutions have touched the single-digit territory, such as Fannie Mae, Freddie Mac (FRE), Wachovia (WB) and Bear Stearns. After the current bear market rally for the banking sector, who will be the next round of candidates to join the single-digit club? Investment banks are still the usual suspects, such as Lehman (LEH), UBS (UBS), and possibly even Merrill Lynch (MER) and Citigroup (C) too.



In order to avoid the domino effect of the current credit crisis rippling through the whole banking industry, the Fed is currently holding the bag by bailing out everyone in trouble. And so far we are only talking about residential mortgages and their CDO derivatives. If the next wave of the credit default swap crisis hits, it will be much more complicated than LTCM, much worse than S&L, and much deeper than subprime. With raising capital becoming more difficult these days, banks have to rely more and more on the Fed with balance sheet of only $800B to deal with a $2 trillion problem.



Can the Fed handle the worst monetary crisis in 60 years? Should taxpayers save and bail out the financial institutions in trouble? Did we ask them to use high leverage initially? Have they ever shared the profit with the public at the time when they were making tons of money by using leverage? Why should the whole society have to pay for the bad decision of a few banks at the downside, but never be allowed to participate at the upside?





Thomas Tan, CFA, MBA

Thomast2@optonline.net



Those interested in discovering more about me, my trading strategy and reading many of my other blogs can visit web site at www.Vestopia.com/thomast

[admin]

Money can't fix Fannie and Freddie
DEREK DeCLOET

Globe and Mail


July 26, 2008 at 6:00 AM EDT

Zimbabwe, wracked by hyperinflation, introduced a 100-billion Zimbabwean dollar bank note a week ago. As one of the most worthless bits of paper on the planet, the bill can't buy much – just one or two loaves of bread. But there's always a chance, if you stacked a few of them together, that you could pay for a grungy bungalow in Stockton, Calif., where one in every 25 households got a foreclosure notice between April and June, or in Flint, Mich., where homes once worth six figures receive no bids at all.

As with currency in Zimbabwe, everything about the U.S. housing crisis is marked by large numbers. That's especially true when the topic is Fannie Mae and Freddie Mac, those monuments to American capitalism, or is it socialism? Hard to tell these days.

The twins of U.S. home finance own or guarantee $5.2-trillion (U.S.) in mortgages, slightly less than the gross domestic product of China, India and Russia combined. There's about $1.5-trillion of outstanding debt on the balance sheets of the two companies, as of the end of March, which is a bit more than the economic output of Canada, Spain or Brazil. The notional value of the derivative contracts they've got is about $2.5-trillion – France's GDP – according to Montreal's BCA Research. Too big to fail? Definitely.

As for how much dough they might need to survive as private enterprises – and I use that phrase loosely – that, too, is enormous. Citigroup, UBS and other big banks have been raising money in $5-billion and $10-billion chunks. But in the most pessimistic scenarios, where the housing virus lingers into 2010, Fannie and Freddie could be forced to find $52-billion in new capital by the end of next year, BCA says. They probably couldn't do it. Nationalization would be inevitable.

Numbers, numbers everywhere, but how did it come to this? Maybe the best way to explain it is to begin with another number: $115-million. That's the amount in bonuses that U.S. regulators once tried to retrieve from three former senior Fannie executives, including former CEO Franklin Raines.

Oh, how the Fannie Mae folks had gorged themselves during the glory days. In 2003, Mr. Raines, in addition to his $5.2-million in salary and bonus, got the company to foot the bill for $200,000 in personal travel, $37,000 for personal tax and financial advice, $11.6-million in “incentive plan” payouts, life insurance, pension, stock options – you could run out of breath listing it all. Daniel Mudd, his chief operating officer, got a slightly less lucrative package, still totalling some $7-million, including $80,000 to buy him club memberships.

But hey, weren't these guys worth it? Hadn't they engineered a remarkable growth story? No longer just guaranteeing or packaging mortgages – how boring – Messrs. Raines and Mudd had plunged headlong into investing in them, and without the capital constraints of a normal commercial bank, Fannie nearly doubled its profits between 2000 and 2003.

That turned out to be a sham, and by the end of 2004, Mr. Raines was forced into early retirement in a $10-billion accounting scandal. An investigation was hatched and a U.S. government agency found that Mr. Raines had earned more than $90-million in total compensation from '98 through 2003, and the majority of it, $52-million, was paid for achieving profit targets – with phony profits.

But here's the punchline: When regulators tried to recover the money, Mr. Raines dug in. He and the two other former executives settled the case a few months ago, paying $3-million in fines (which was covered by a company insurance policy). Mr. Raines also donated $1.8-million from the sale of Fannie stock to programs aimed at boosting home ownership and averting foreclosures, and forfeited some stock options that were far out-of-the-money anyway.

And Daniel Mudd? He's now Fannie Mae's CEO.

The message to senior bankers could hardly be clearer. Their's is a sweet one-way deal. When aggressive lending and preposterous accounting bring terrific profits, they can earn enough to live like kings. And when those same lending and accounting practices blow up, others will take the hit and the execs can still live like kings. Hell, they might even get promoted.

If you fix this moral hazard, you can start to fix the U.S. financial system. But even then, it should never again be allowed to spawn two companies like Fannie and Freddie. They grew powerful by wrapping themselves in the flag. Their mission was to promote the American dream of home ownership. And will you look at what a success that was? At the start of 2001, when the U.S. Federal Reserve began a cheap-money policy that sowed the seeds of the housing bubble, the home ownership rate was 67.5 per cent. Today, it's 67.8 per cent and falling as foreclosures grip the country. Meanwhile, U.S. taxpayers and investors suck up billions in losses. What a waste.

[admin]

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July 29, 2008
Write-Down Is Planned at Merrill
By LOUISE STORY
Only 10 days after stunning Wall Street with a huge quarterly loss, Merrill Lynch unexpectedly disclosed another multibillion-dollar write-down on Monday and sought to bolster its finances once again by selling new stock to the public and to an investment company controlled by Singapore.

Moving to purge itself of the tricky mortgage-linked investments that have brought the once-proud firm to its knees, Merrill said that it had sold almost all of the troublesome investments, once valued at nearly $31 billion, at a fire-sale price of 22 cents on the dollar.

As a result, Merrill expects to record a write-down of $5.7 billion for the third quarter. Such an outcome could push Merrill into the red for a fifth consecutive quarter if revenue remains weak and would bring its charges since the credit crisis erupted last summer to more than $45 billion.

The problems at Merrill, the nation’s largest brokerage, underscore how bankers and policy makers are struggling to contain the damage to the financial system and the broader economy caused by the collapse of housing-related debt. The latest news came on a day when the International Monetary Fund said there was no end in sight to the housing slump, a forecast that depressed financial shares as well as the broader market.

To shore up its finances, Merrill said it would raise $8.5 billion in new capital from common shareholders, including $3.4 billion from the investment arm of the Singapore government, Temasek Holdings, which, with an 8.85 percent stake as of June 30, is already Merrill’s largest shareholder. Those shares and a conversion of preferred securities into common stock will dilute the value of stock held by current shareholders by about 40 percent.

John A. Thain, who has struggled to turn Merrill around since becoming chief executive in December, said the sale of the worrisome investments, known as collateralized debt obligations, or C.D.O.’s, was “a significant milestone in our risk reduction efforts.”

The C.D.O.’s have plunged in value over the last year, forcing Merrill to take one write-down after another and sapping investors’ confidence. Merrill’s share price fell 11.6 percent on Monday, before the news of the write-down and stock sale were announced after the close of trading. Merrill is trading near its lowest level in a decade.

But the sale of the C.D.O.’s, to an investment fund based in Dallas, may enable Merrill to move on, investors said.

“What they sold, from a headline standpoint, is certainly constructive because they have reduced risk in a very sensitive area,” said Thomas C. Priore, chief executive of Institutional Credit Partners, a $12 billion hedge fund and C.D.O. manager in New York.

Merrill had been working on the C.D.O. sale and the effort to raise capital before its earnings call but did not finalize the actions until recent days.

Merrill’s sales could cause further write-downs at other Wall Street firms with C.D.O. exposure. If those companies — the likes of Citigroup and Lehman Brothers — have similar C.D.O.’s valued at prices higher than those at which Merrill sold, the firms may be forced to take additional charges to reflect the difference.

Merrill recently moved to raise money by selling its 20 percent stake in Bloomberg L.P., the financial news and data company, for $4.425 billion. Mr. Thain hinted at the C.D.O. sale in the quarterly earnings call, in response to a question from Meredith Whitney, an analyst with Oppenheimer & Company.

“Why not, at this point, be the first to purge assets and get it over with? And, if that means raising capital, raise capital,” Ms. Whitney said.

Mr. Thain responded that Merrill had been selling assets but had not yet sold any C.D.O.’s.

“Your question is a very leading one, and that would certainly be something that we would hope that we could do,” Mr. Thain said.

Merrill sold the investments at a steep loss. The United States super senior asset backed-security C.D.O.’s that Merrill sold were once valued at $30.6 billion. As of the end of second-quarter, Merrill valued them at $11.1 billion — or 36 cents on the dollar. And Merrill sold them for $6.7 billion to an affiliate of Lone Star Funds, the Dallas private equity firm.

Merrill provided 75 percent financing to Lone Star Funds, which means Merrill lent the private equity fund about $5 billion to complete the sale.

The discounted sales will cause the majority of Merrill’s write-down in the third quarter.

Merrill also said it had settled a battle with the reinsurance company XL Capital Assurance, which had insured some of the firm’s C.D.O.’s.

[admin]

I think it was Einstein who said that you needed three things if you were looking for a business partner:

1. smarts
2. hard working
3. honesty

if you have any two without the third you are in trouble. This forum looks at the growing number of people who are smart and hard working, but who too often tend to "take the money from the company and run".
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Billion-dollar bankruptcies highest since 2003
Tue Jul 29, 2008 6:21pm

NEW YORK (Reuters) - Billion-dollar bankruptcies are at their highest in five years only half way through 2008, according to bankruptcy filing tracker BankruptcyData.com.

A total of seven U.S. companies with more than a billion dollars in assets have filed for bankruptcy protection so far this year, it said.

Fremont General Corp, which was one of the largest U.S. providers of subprime mortgages before regulators ordered it to stop making the loans, was the largest filing of the year with $13 billion in pre-petition assets, BankruptcyData.com said. Fremont filed for Chapter 11 bankruptcy protection in May, after arranging to sell bank branches and deposits to CapitalSource Inc.

SemGroup LP, the energy trader which filed for bankruptcy protection from creditors last week, was the second-largest bankruptcy filing of the year with $6 billion in pre-petition assets.

"We seem to be in the midst of a 'perfect storm' leading to more bankruptcies: high levels of debt, high energy and raw materials costs and weakness in the U.S. economy," George Putnam, III of New Generation Research, which publishes BankruptcyData.com said in a statement.

He forecast bankruptcies could peak as early as the middle of 2009 or continue rising well into 2010.

The recent spike in billion-dollar bankruptcies, comes only about half way through 2008 and is well above the previous levels. In 2007 only one company listed more than $1 billion in pre-petition assets, New Century Financial Corp. In 2006, auto parts maker Dana Corp had the largest filing, listing $9 billion in pre-petition assets.

The last year in the previous bankruptcy wave was 2003, when there were 15 billion-dollar bankruptcies filed. The number of billion-dollar bankruptcies peaked in 2001 when there were 25, according to BankruptcyData.com.

But the bankruptcies are not yet as large as the filings in the last wave of corporate bankruptcies. The Enron Corp and Conseco Inc bankruptcy filings in 2001 and 2002 each topped $60 billion. WorldCom still holds the record with its $103.9 billion bankruptcy filing in 2002, according to BankruptcyData.com.

(Editing by Andre Grenon)

[admin]

The New York Times

Scenes From a Merrill Meltdown
July 31, 2008, 4:47 pm


From Michael M. Grynbaum, a DealBook colleague:

When the history of the Great Market Crash of 2008 is written, perhaps the following will make for a fitting epigraph:

“Market is collapsing. No more $2k dinners at CRU!! The Financials are being invicerated! [sic]”

That cri-de-coeur, penned by a Merrill Lynch executive in an e-mail message last November, showed up in an 80-page lawsuit (PDF) filed on Thursday by the state of Massachusetts, which is suing Merrill for misleading investors about toxic auction-rate securities. (Cru is the West Village hot spot whose $78 prix-fixe includes braised Berkshire pork belly and foie gras terrine.)

It was the latest entry in a peculiar genre of poem: the Wall Street confessional. The missives, which first gained notoriety in the Eliot Spitzer era, are making a comeback as a new wave of financial fraud cases pop up in the courts.

Add a few Merrill messages to the canon. Referring to the firm’s auction trading desk, a managing director wrote, “Come on down and visit us in the vomitorium!!” (This came as clients were allegedly advised to snap up the suspect securities.)

Later, after an unfriendly questioner emerged on a sales call, the managing director urged a research analyst: “Shut this guy down. Suggest he call outside this call. He is focusing attention away from your positive message.”

Finally, the same banker used an incriminating metaphor to motivate her sales team.

“The gloves are off and we are not concerned with issuer perception of our abilities and the competition,” she wrote. “Gotta move these microwave ovens!!”

Go to Massachusetts Secretary of the Commonwealth’s Complaint and Exhibits »

[admin]

Wall Street Fat Cats Are Trying to Pocket Billions in Bailout Cash

By Nomi Prins,

AlterNet.

November 7, 2008.



They got us into this mess, and now they want to cash out -- will President Obama stop them?

The election results pretty much confirmed the extent to which Main Street is rightly livid about the Wall Street mentality that led to our financial crisis.

During his historic victory speech, President-elect Obama told supporters, and the rest of the world, "If this financial crisis taught us anything, it's that we cannot have a thriving Wall Street while Main Street suffers." [Never saw that in any of the clips]
But, it seems that Wall Street didn't get that memo. It turns out that the nine banks about to be getting a total equity capital injection of $125 billion, courtesy of Phase I of The Bailout Plan, had reserved $108 billion during the first nine months of 2008 in order to pay for compensation and bonuses (PDF).

Paying Wall Street bonuses was not supposed to be part of the plan. At least that's how Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson explained it to Congress and the American people. So, on Oct. 1, when the Senate, including Obama, approved the $700 billion bailout package, the illusion was that this would magically loosen the credit markets, and with taxpayer-funded relief, banks would first start lending to each other again, and then, to citizens and small businesses. And all would be well.

That didn't happen. Which is why it's particularly offensive that the no-strings-attached money is going to line the pockets of Wall Street execs. The country's top investment bank (which since Sept. 21 calls itself a bank holding company), Goldman Sachs, set aside $11.4 billion during the first nine months of this year -- slightly more than the firm's $10 billion U.S. government gift -- to cover bonus payments for its 443 senior partners, who are set to make about $5 million each, and other employees.

Whereas Wall Street may not believe in higher taxes for the richest citizens, it does believe in higher bonuses for the head honchos. No matter what the market conditions are on the outside, steadfast feelings of entitlement tend to prevail.

Last year, when the financial crisis was just brewing, the top five investment banks paid themselves $39 billion in compensation and bonuses, up 6 percent over 2006. Goldman's CEO, Lloyd C. Blankfein, bagged a record bonus of $60.7 million, including $26.8 million in cash. That amount was nearly double the $38 million that Paulson made at the firm in 2005, the year before he became the Treasury secretary, a post for which he received unanimous approval from the Senate on June 28, 2006.

Two of those firms, Bear Stearns and Lehman Brothers, went bankrupt this year. Bank of America is acquiring a third, Merrill Lynch. Shares in the remaining two, Morgan Stanley and Goldman Sachs, took a 60 percent nosedive this year.

Yet, that didn't stop their campaign contribution money from spewing out. Goldman was Obama's largest corporate campaign contributor, with $874,207. Also in his top 20 were three other recipients of bailout capital: JP Morgan/Chase, Citigroup and Morgan Stanley.

Last week, House Oversight Committee Chairman Henry Waxman, D-Calif., gave the bailout capital recipient firms until Nov 10 to come up with some darn good reasons to be paying themselves so much (PDF). Specifically, he requested detailed information on the total and average compensation per year from 2006 to 2008, the number of employees expected to be paid more than $500,000 in total compensation, and the total compensation projected for the top 10 executives.

Similarly, New York state Attorney General Andrew Cuomo demanded information about this year's bonuses, including a detailed accounting of expected payments to top management and the size of the firms' expected bonus pool before and after knowing that they would be recipients of taxpayer funds.

The deadline Cuomo set for receiving bonus records was Nov. 5. Predictably, the firms in question requested more time as the date approached -- it takes a while to massage numbers, after all.

Meanwhile, they have been subtly releasing data to the media regarding how much lower bonuses will be this year, in order to combat inspection and criticism. This is Wall Street in its best defense mode, projecting an aura of accommodation and self-pity (because it's shedding jobs, too), in order to maintain a status quo state of self-regulation.

House Financial Service Committee Chairman Barney Frank is holding his own oversight hearing on the matter next week, having announced that "any use of the these funds for any purpose other than lending -- for bonuses, for severance pay, for dividends, for acquisitions of other institutions, etc. -- is a violation of the terms" of the bailout plan.

Banks are going to tell Congress that of course they won't use that $125 billion for bonuses -- it will go to shoring up balance sheets and for acquisitions just like they promised. And bonus money will come from earnings, as it always does.

If it sounds like accounting mumbo-jumbo, that's because it is. It doesn't matter where in the balance sheet capital comes from or goes, the point is there's more of it because of taxpayer redistribution in the wrong direction than there would have been otherwise, and that's not just. This begs the larger question: Why pay bonuses in a year of massive financial destruction, anyway?

"Exactly," says Gar Alperovitz, co-author, with Lew Daly, of the new book Unjust Deserts. "We're making homeowners take a big hit, and if there's any justification for any of these bonuses -- which is dubious -- sharing that burden is important."

But that's not quite the sharing that Wall Street wanted from the bailout package. Yet, if "change has come to America," as per Obama's promise, then it's high time for Wall Street to shoulder its part -- starting with this bonus season. A decisive move by Obama on this topic would go a long way toward solidifying the central promise of his campaign

[admin]

here is what I have learned about the smartest guys in the room:

They find themselves in a position as CEO or similar in a large organization. They learn that profits and instant results are what the board and or shareholders desire most. They discover that by promising amazing instant results, they can tie amazing pay packages (millions in extra pay, based on billions of extra profits promised) to these results.
They then cheat their way to amazing instant result in whatever way possible to obtain the millions in extra pay.

They then depart with the extra pay, while the company suffers, or fails entirely due to the now failed profits.

Enron, Nortel, Worldcom, too many stock option deals to list, CIBC, and major bank. As Liz Pulliam Weston of
MSN Money says in her good writing recently:
"In the system we have now, cheaters prosper.............................This isn't just bad for the consumer. It's bad for capitalism. Instead of the most efficient companies winning, the biggest liars are."

see below for further writing, article on CIBC compensation in Post:

CIBC gets flak over pension increase
Could Be Millions

Barbara Shecter, Financial Post

Thursday, February 19, 2009

In an era in which bank executives are handing back bonuses and directors are under pressure to show prudence in granting compensation, Canadian Imperial Bank of Commerce has angered some institutional investors by increasing chief executive Gerry McCaughey's pension payout by what could amount to several million dollars.

The change is contained in the bank's recently released proxy circular document in a series of notes that describe a bump-up in the maximum allowable compensation on which Mr. McCaughey's pension will be based to $2.3-million from $1.9-million.

"That's in the millions of dollars over many years [of retirement]," said Doug Pearce, CEO and chief investment officer of B. C. Investment Management Corp., which manages nearly $80-billion in assets, including bank stocks, on behalf of pensioners in British Columbia. "The boards have told us they want to pay for performance but that doesn't appear to be the case ... because that goes on for the rest of your life."

The proxy document says the change was made to bring Mr. McCaughey's allowable compensation for the pension calculation in line with the standards set by other Canadian banks and large insurance companies. Based on the formula, he could qualify for $1.6-million a year, up nearly $300,000.

Although CIBC continued its policy of withholding consideration of a bonus for the CEO so the board could have the benefit of another year's performance under its belt, and Mr. McCaughey gave up his cash bonus in 2007, Mr. Pearce said the B. C. pension group will be communicating with CIBC to express displeasure about the prospective top-up.

He also expressed displeasure that investors had to "dig so deep" to find the information in the notes of the proxy document.

Canadian banks have fared better than their counterparts in the United States and the United Kingdom in the fallout of the global credit crisis, and have not faltered or been nationalized. But investors have nonetheless been hammered by the impact of bad loans and writedowns and the companies deserve to come under fire for compensation practices that prompt excessive risk-taking, said Stephen Jarislowsky, founder of Montreal-based Jarislowsky Fraser, which manages $52-billion in assets.

CIBC's share price slumped 27% last year, despite a relatively good performance among its peers.

"It's outrageous," Mr. Jarislowsky said of the annual top-up to Mr. McGaughey's pension. "To do it at this moment in time, it shows a complete lack of judgment on the part of the board of directors."

The crisis in the financial sector has unfolded alongside eye-popping bonuses for bankers of troubled companies, prompting shareholders, politicians and regulators around the world to push for changes in incentives that are blamed for the risky behaviour that caused the meltdown.

This month, the chief executives of Royal Bank of Canada and Bank of Montreal handed back bonuses of $5-million and $4.1-million, respectively.

Still, despite such moves and the relatively good performance of Canadian banks, which won praise this week from Barack Obama, the U. S. President, Ottawa nonetheless seems poised to be involved with creating new international guidelines on pay for bankers before the next summit of the G20 nations.

The Canadian Coalition for Good Governance, which represents 43 pensions and other money managers that manage approximately $1.4-trillion of assets on behalf of Canadian investors, has made executive compensation a priority and will be closely scrutinizing the incentive portions of proxy documents.