Peter, Paul, and
Barney:
An Evolving Essay On the Hidden Agenda of the U.S. Government Bailout
Bob Jensen at
Trinity Universitys
U.S. National Debt Clock ---
http://www.usdebtclock.org/
Also see
http://www.brillig.com/debt_clock/
The unbooked entitlements have a present well over $100 trillion.
But who's counting?
The Real National Debt (booked + unbooked entitlements) 2008
Source ---
http://www.pgpf.org/about/nationaldebt/
American Experience: The Crash of 1929 (Video) ---
http://www.pbs.org/wgbh/amex/crash/
Iowa Sen. Charles Grassley suggested that AIG
executives should accept responsibility for the collapse of the insurance giant
by resigning or killing themselves. The Republican lawmaker's harsh comments
came during an interview Monday with Cedar Rapids, Iowa, radio station WMT . . .
Sen. Charles Grassley wants AIG executives to apologize for the collapse of the
insurance giant — but said Tuesday that "obviously" he didn't really mean that
they should kill themselves. The Iowa Republican raised eyebrows with his
comments Monday that the executives — under fire for passing out big bonuses
even as they were taking a taxpayer bailout — perhaps should "resign or go
commit suicide." But he backtracked Tuesday morning in a conference call with
reporters. He said he would like executives of failed businesses to make a more
formal public apology, as business leaders have done in Japan.
Noel Duara, "Grassley: AIG execs
should repent, not kill selves," Yahoo News, March 17, 2009 ---
http://news.yahoo.com/s/ap/20090317/ap_on_re_us/grassley_aig
From the CFO Journal's Morning Ledger on March 30, 2018
Barclays to pay $2 billion to
resolve securities claims.
Barclays PLC agreed to pay $2
billion in civil penalties to resolve U.S. Justice Department claims that
the U.K. lender fraudulently sold mortgage securities that helped fuel the
financial crisis, causing investors “enormous losses,” the government said
Thursday.
Bob
Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
The root cause of the fraud was
the ability of lenders (often felon criminals) to issue mortgages ten or more
times the value of the real estate collateral and then sell those mortgages
upstream to Fannie Mae, Freddie Mack, and Wall Street Banks without bearing any
risk of 1005 certain defaults on those mortgages. These default risks became the
poison of the mortgages later sold in CDO bond portfolios that later brought
down Bear Stearns, Lehman Bros,, Merrill Lynch, etc.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Video: Is Anyone Minding the Store at the Federal Reserve? ---
http://www.silverbearcafe.com/private/05.09/mindingthestore.html
U.S.
Debt/Deficit Clock ---
http://www.usdebtclock.org/
The Obama Debt Tracker
He added $1.7 trillion of debt in his first year
http://www.treasurydirect.gov/NP/BPDLogin?application=np
Video of Detroit in Ruins ---
http://www.youtube.com/watch?v=1hhJ_49leBw
Video: Steve Wynn Takes On Washington ---
http://www.infowars.com/steve-wynn-takes-on-washington/
Debate Assignment: Should We
Never Pay Down the National Deficit or Debt (even partly)?
http://www.cs.trinity.edu/~rjensen/temp/NationalDeficit-Debt.htm
A Pissing Contest Between Bob and Jagdish: An Illustration of How to Lie
With Statistics ---
http://www.cs.trinity.edu/~rjensen/temp/LieWithStatistics01.htm
"Why Are Some Sectors (Ahem, Finance) So Scandal-Plagued?" by Ben W.
Heineman, Jr., Harvard Business Review Blog, January 10, 2013 ---
Click Here
http://blogs.hbr.org/cs/2013/01/scandals_plague_sectors_not_ju.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
The trouble with crony capitalism isn't capitalism. It's the cronies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#CronyCapitalism
Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit
rating agencies) ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of
Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Mortgage Fraud Task Force Stats: Did You See This? WOW ---
http://www.senseoncents.com/2013/08/mortgage-fraud-task-force-stats-did-you-see-this-wow/
Inside Job: 2010 Oscar-Winning Documentary Now Online ---
Click Here
http://www.openculture.com/2011/04/inside_job.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+OpenCulture+%28Open+Culture%29
In late February, Charles Ferguson’s film – Inside
Job – won the Academy Award for Best Documentary. And now the film
documenting the causes of the 2008 global financial meltdown has made its
way online (thanks to the Internet Archive). A corrupt financial industry,
its corrosive relationship with politicians, academics and regulators, and
the trillions of damage done, it all gets documented in this film that runs
a little shy of 2 hours.
To watch the film, you will need to do the
following. 1.) Look at the bottom of the film. 2.) Click the forward button
twice so that it moves beyond the initial trailer and the Academy Awards
ceremony. 3.) Wait for the little circle to stop spinning. And 4.) click
play to watch film.
Inside Job (now listed in our Free Movie
Collection) can be purchased on DVD at Amazon. We all love free, but let’s
remember that good projects cost real money to develop, and they could use
real financial support. So please consider buying a copy.
Hopefully watching or buying this film won’t be a
pointless act, even though it can rightly feel that way. As Charles Ferguson
reminded us during his Oscar acceptance speech, we are three years beyond
the Wall Street crisis and taxpayers (you) got fleeced for billions. But
still not one Wall Street exec is facing criminal charges. Welcome to your
plutocracy…
Bob Jensen's threads on the global financial meltdown and its aftershocks
are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Wharton: Not Too Big To
Fail: Why Lehman Had to Go Bankrupt ---
http://knowledge.wharton.upenn.edu/article/the-good-reasons-why-lehman-failed/
Essay
Appendix A: Pending Disaster in the U.S.
Appendix B: The Trillion
Dollar Bet in 1993
Appendix C: Don't Blame Fair Value Accounting Standards
(except in terms of executive bonus payments)
This includes a bull crap case based on an article by the former head of the
FDIC
Appendix D: The
End of Capitalism, Economics, and Investment Banking as We Know It
Appendix E: Greatest Swindle
in the History of the World
Your Money at
Work, Fixing Others’ Mistakes (includes a great NPR public radio audio module)
Appendix F: Christopher Cox Waits Until Now
to Tell Us His Horse Was Lame All Along
S.E.C. Concedes Oversight Flaws Fueled Collapse
And This is the Man Who Wants Accounting Standards to Have Fewer Rules
Appendix G: Why
the Trillion-Dollar Bankster Bailout Won't Work
Appendix H: Where were the auditors?
The aftermath will leave the large auditing firms in a precarious state?
Appendix I: 1999 Quote
from The New York Times
''If they fail, the government will have to step up and bail them out the way it
stepped up and bailed out the thrift industry.''
Appendix J: Will the large auditing
firms survive the 2008 banking meltdown?
Appendix K: Why not
bail out everybody and everything?
Appendix L: The
trouble with crony capitalism isn't capitalism. It's the cronies.
Appendix M: Reinventing
the American Dream
Appendix N:
Accounting Fraud at Fannie Mae
Appendix O: If Greenspan Caused
the Subprime Real Estate Bubble, Who Caused the Second Bubble That's About to
Burst?
Harvard Professors Says Economists are a Huge Part of the Problem
Appendix P: Meanwhile
in the U.K., the Government Protects Reckless Bankers
Appendix Q: Bob Jensen's Primer on Derivatives
(with great videos from CBS)
Appendix R: Accounting Standard Setters Bending to Industry and
Government Pressure to Hide the Value of Dogs
Appendix S: Fooling
Some People All the Time
Appendix T: Regulations
Recommendations
Appendix U: Subprime:
Borne of Greed, Sleaze, Bribery, and Lies (including the credit rating agencies)
Appendix V: Implications for Educators,
Colleges, and Students
Appendix W: The End
Appendix X: How
Scientists Help Cause Our Financial Crisis
Appendix Y: The
Bailout's Hidden Agenda Details
Appendix Z: What's
the rush to re-inflate the stock market?
The Commission's Final Report ---
http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_full.pdf
American History of Fraud and White Collar Crime ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
"The Financial Crisis, From A-Z," by Tunku Varadarajan, Forbes,
November 10, 2008 ---
http://www.forbes.com/opinions/2008/11/09/financial-crisis-tarp-oped-cx_tv_1110varadarajan.html
Jensen Comment
This is a clever use of the alphabet and an understanding of what happened.
Shielding Against Validity Challenges in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
-
With a Rejoinder from the 2010 Senior Editor of The Accounting Review
(TAR), Steven J. Kachelmeier
- With Replies in Appendix 4 to Professor Kachemeier by Professors
Jagdish Gangolly and Paul Williams
- With Added Conjectures in Appendix 1 as to Why the Profession of
Accountancy Ignores TAR
- With Suggestions in Appendix 2 for Incorporating Accounting Research
into Undergraduate Accounting Courses
What went wrong in accounting/accountics research?
---
http://faculty.trinity.edu/rjensen/theory01.htm#WhatWentWrong
The Sad State of Accountancy Doctoral
Programs That Do Not Appeal to Most Accountants ---
http://faculty.trinity.edu/rjensen/theory01.htm#DoctoralPrograms
AN ANALYSIS OF THE EVOLUTION OF RESEARCH
CONTRIBUTIONS BY THE ACCOUNTING REVIEW: 1926-2005 ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm#_msocom_1
Bob Jensen's threads on accounting theory
---
http://faculty.trinity.edu/rjensen/theory01.htm
Tom Lehrer on Mathematical Models and
Statistics ---
http://www.youtube.com/watch?v=gfZWyUXn3So
Systemic problems of accountancy (especially the
vegetable nutrition paradox) that probably will never be solved ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews
The Financial Crisis Cost Every American $70,000, Fed Study Says ---
Click Here
Jensen Comment
The root causes were as follows:
1. A nationwide super bubble of real estate prices
that inspired buyers speculate in real estate (land and buildings) financed
with subprime mortgages. Buyers intended to turn the properties over before
subprime rates on mortgages gave way to higher rates --- Z
https://en.wikipedia.org/wiki/Subprime_lending
2. Fraud entered into real estate and mortgage lending every step of the
way. The major catalyst was government policy of buying mortgages (think
Fanny Mae and Freddie Mack) with zero percent of the default risk borne by
issuers of mortgages. Many fraudsters started issuing mortgages way above
property values. For example, a criminal lender in Phoenix issued a mortgage
for over $100,000 to a woman on welfare who purchased a shack for $3,500.
Greedy real estate appraisers went wild in overvaluing properties for
fraudulent lenders and buyers. The government and Wall Street investment
bank bought up hundreds of billions of dollars in
poisoned
mortgages (where buyers had no hope of paying off the debt).
3. The Wall Street investment banks (like Lehman Bros. and Merrill Lynch)
who realized they were holding huge amounts of poisoned mortgages tried to
diversify the risk by including them in portfolios of solid mortgages. These
portfolios were then sold as
collateralized debt obligation (CDO) bonds to buyers such as Saudi
Arabia. But the CDO bonds were sold with recourse such that when the USA
real estate bubble burst those investment banks did not have enough
liquidity to buy the CDO bonds back. Then came the government bailout in
which some banks (think Goldman) were bailed out by the government and some
were forced into bankruptcy (think Lehman Bros.) While all of this was going
ton deeply troubled banks were getting fraudulent AAA credit ratings from
greedy credit raters (think Moodys).
What happened before, during, and after the 2008
government bailout is explained in much detail at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The Financial Crisis Cost Every American $70,000, Fed Study Says ---
Click Here
A New Definition of Life on the Edge
Loss of dollar purchasing power since 1775 ---
http://manualofideas.com/blog/2009/03/declining_value_of_us_dollar_s.html
Peter Schiff
is a widely-known economist who predicted the financial crisis well ahead of
most everybody, but nobody listened when he blared out warnings throughout
the media, some of which are on YouTube
No, the main issue with Schiff seems to be that he
hasn't changed his tune (in 2009) --- and it
isn't a pleasant tune to listen to. He thinks the "phony economy" of the U.S. is
headed for even harder times. He believes that the crisis-fighting measures
coming out of Washington are merely delaying the inevitable, debasing the dollar
and loading future taxpayers with huge debts.
Justin Fox, "Excluding the
Extremist: Peter Schiff predicted the credit collapse long before the
'experts." So why is it so hard to hear him now," Time Magazine, June 1,
2009, Page 48.
Barney Frank: I've destroyed the economy, my work
here is done.
Washington Times headline, Nov. 29, 2011
Barney's Rubble ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Oh, and don't forget Fannie Mae and Freddie Mac,
those two government-sponsored mortgage giants that engineered the 2008 subprime
mortgage fiasco and are now on the public dole. The Fed kept them afloat by
buying over a trillion dollars of their paper. Now, part of the Treasury's
borrowing from the public covers their continuing large losses.
George Melloan, "Hard Knocks From Easy
Money: The Federal Reserve is feeding big government and harming
middle-class savers," The Wall Street Journal, July 6, 2010 ---
http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t
"Did Harvard (and then President Larry Summers) Ignore Warnings on
Harvard's Investments?" Inside Higher Ed, November 29, 2009 ---
http://www.insidehighered.com/news/2009/11/30/qt#214304
Senior Harvard University
officials -- especially then-president Lawrence Summers -- repeatedly ignored
warnings that the university's investment strategies were placing far too much
cash (needed for short-term spending) in risky investments,
The Boston Globe reported. The placement of
the cash in risky investments has been a key reason why Harvard, which even
after investment losses is by far the wealthiest university in the world, has
been forced to make many cuts in the last year; such cash reserves, had the
advice been followed, would have been easily accessible. Summers declined to
comment for the article, but a friend of his familiar with the Harvard
investment strategy noted that conditions changed after Summers left the
presidency and that the university had the time to change its strategy prior to
last year's Wall Street collapse.
Jensen Comment
There were advanced warnings before the fall, especially those of Peter Schiff
---
http://en.wikipedia.org/wiki/Peter_Schiff
But he missed the early timing and thus is still not a billionaire.
Larry Summers resigned from Harvard in a clash with feminists and is now the
chief economic advisor to President Obama.
Wave Goodbye to this nation's top
economic advisor
"Lawrence Summers Will Leave White House Post and Return to Harvard,"
Chronicle of Higher Education, September 21, 2010 ---
http://chronicle.com/blogPost/Lawrence-Summers-Will-Leave/27092/
An entire generation's prosperity vanishing, food
stamp use exploding. Welcome to the jobless future. This month's jobs numbers
drive home the point. The unemployment rate fell at the fastest rate for years —
great news, right? Wrong. The vast majority of the gains — 75% — came from (wait
for it) "temporary help services." See what just happened? We subtracted
thousands of real jobs — and replaced them with low-value, no-future McJobs
instead.
"Solve America's Employment Crisis With a Netflix Prize," Harvard
Business School, December 4, 2009 ---
http://blogs.harvardbusiness.org/haque/2009/12/solve_americas_employment_cris.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE
"Why I don’t like Larry Summers," by Massimo Pigliucci, Rationally
Speaking, July 22, 2011 ---
http://rationallyspeaking.blogspot.com/2011/07/why-i-dont-like-larry-summers.html
I have to admit to a profound
dislike for former Harvard President and former Obama (and Clinton)
advisor Larry Summers. Besides the fact that, at least going by a number
of reports of people who have known him, he can only be characterized as
a dick, he represents precisely what is wrong with a particularly
popular mode of thinking in this country and, increasingly, in the rest
of the world.
Lawrence was famously forced to resign as
president of Harvard in 2006 because of a no-confidence vote by the
faculty (wait, academics still have any say in how universities are run?
Who knew) because of a variety of reasons, including his conflict with
academic star Cornel West, financial conflict of interests regarding his
dealings with economist Andrei Shleifer, and particularly his remarks to
the effect that perhaps the scarcity of women in science and engineering
is the result of innate intellectual differences (for a critical
analysis of that particular episode see Cornelia Fine’s
Delusions of Gender and the
corresponding
Rationally Speaking podcast).
Now I have acquired yet another reason to dislike
Summers, while reading Debra Satz’s
Why Some Things Should not Be for Sale:
The Moral Limits of Markets,
which I highly recommend to my libertarian friends, as much as I realize
of course that it will be entirely wasted on them. The book is a
historical and philosophical analysis of ideas about markets, and makes
a very compelling case for why thinking that “the markets will take care
of it” where “it” is pretty much anything of interest to human beings is
downright idiotic (as well as profoundly unethical).
But I’m not concerned here with Satz’s book per
se, as much as with the instance in which she discusses for her
purposes, a memo written by Summers when he was chief economist of the
World Bank (side note to people who still don’t think we are in a
plutocracy: please simply make the effort to track Summers’ career and
his influence as an example, or check
this short video by one of my favorite
philosophers, George Carlin). The memo was intended for internal WB use
only, but it caused a public uproar when the, surely not left-wing,
magazine The Economist leaked it to the public. Here is an
extract from the memo (emphasis mine):
“Just between you and me, shouldn’t
the World Bank be encouraging more migration of the dirty industries to
the less developed countries? I can think of three reasons:
1. The measurement of the costs of
health-impairing pollution depends on the foregone earnings from
increased morbidity and mortality. From this point of view a given
amount of health-impairing pollution should be done in the country with
the lowest cost, which will be the country with the lowest wages. I
think the economic logic behind dumping a load of toxic waste in the
lowest wage country is impeccable and we should face up to that.
2. The costs of pollution are
likely to be non-linear as the initial increments of pollution probably
have very low cost ... Only the lamentable facts that so much pollution
is generated by non-tradable industries (transport, electrical
generation) and that the unit transport costs of solid waste are so high
prevent world-welfare enhancing trade in air pollution and waste.
3. The demand for a clean
environment for aesthetic and health reasons is likely to have very high
income elasticity ... Clearly trade in goods that embody aesthetic
pollution concerns could be welfare enhancing.
The problem with the arguments
against all of these proposals for more pollution in least developed
countries (intrinsic rights to certain goods, social concerns, lack of
adequate markets, etc.) could be turned around and used more or less
effectively against every Bank proposal for liberalization.”
Now, pause for a minute, go back to
the top of the memo, and read it again. I suggest that if you find
nothing disturbing about it, your empathic circuitry needs a major
overhaul or at the very least a serious tuneup. But it’s interesting to
consider why.
As both The Economist (who
called the memo “crass”) and Satz herself note, the economic logic of
the memo is indeed impeccable. If one’s only considerations are economic
in nature, it does make perfect sense for less developed countries to
accept (for a — probably low — price) the waste generated by richer
countries, for which in turn it makes perfect sense to pay a price to
literally get rid of their shit.
And yet, as I mentioned, the leaking of the memo
was accompanied by an outcry similar to the one generated by the equally
infamous “Ford
Pinto memo” back in 1968. Why? Here I
actually have a take that is somewhat different from, though
complementary to, that of Satz. For her, there are three ethical
objections that can be raised to the memo: first, she maintains that
there is unequal vulnerability of the parties involved in the bargain.
That is, the poor countries are in a position of marked disadvantage and
are easy for the rich ones to exploit. Second, the less developed
countries likely suffer from what she calls weak agency, since they tend
to be run by corrupt governments whose actions are not in the interest
of the population at large (whether the latter isn’t also true of
American plutocracy is, of course, a matter worth pondering). Third, the
bargain is likely to result in an unacceptable degree of harm to a
number of individuals (living in the poor countries) who are not going
to simultaneously enjoy any of the profits generated from the
“exchange.”
Continued in article
Video: Peter Schiff was right 2006-2007 (CNBC edition) ---
http://www.youtube.com/watch?v=Z0YTY5TWtmU
Five Speaker Videos from the Stanford
Graduate School of Business (on the economic crisis and leadership) [Scroll
Down]
Top 5 Speaker Videos for 2009 ---
http://www.gsb.stanford.edu/news/top-videos.html?cmpid=alumni&source=gsbtoday
"The dominant public policy
imperative motivating reform is to address the moral hazard risk created by what
we did, what we had to do in the crisis to save the economy," Treasury Secretary
Timothy F. Geithner said in an interview. That's from today's Washington Post.
The "moral hazard risk" arises when government encourages people to gamble by
suggesting that government will rescue them if they fail. By bailing out the
banks, the federal government has essentially declared to the world that they
will do it again. That created a moral hazard. It's refreshing to know that
Administration is aware of...
John Stossel, "Geithner Moral
Hazard," ABC News, August 28, 2009 ---
http://blogs.abcnews.com/johnstossel/2009/08/geithner-moral-hazard.html
Ten (now eleven) Trillion and Counting
(a full-length PBS Frontline video) ---
http://www.pbs.org/wgbh/pages/frontline/tentrillion/view/
All of the federal government's efforts to
stem the tide of the financial meltdown have added hundreds of billions of
dollars to an already staggering national debt, a sum that is expected to double
over the next 10 years to more than $23 trillion. In Ten Trillion and Counting,
FRONTLINE traces the politics behind this mounting debt and investigates what
some say is a looming crisis that makes the current financial situation pale in
comparison
This
is a great learning resource: Very Effective
Visual Guide to the Federal Reserve," Simoleon Sense, May 22, 2009 ---
http://www.simoleonsense.com/
Jensen Comment
The Fed's easy credit and low-interest policies of the past two decades got us
into this financial crisis, and the Fed's approach to getting us out of this
mess is like putting gasoline on political fire.
I’d
been working for the bank for about five weeks when I woke up on the balcony of
a ski resort in the Swiss Alps. It was midnight and I was drunk. One of my
fellow management trainees was urinating onto the skylight of the lobby below
us; another was hurling wine glasses into the courtyard. Behind us, someone had
stolen the hotel’s shoe-polishing machine and carried it into the room; there
were a line of drunken bankers waiting to use it. Half of them were dripping
wet, having gone swimming in all their clothes and been too drunk to remember to
take them off. It took several more weeks of this before the bank considered us
properly trained. . . . By the time I arrived on Wall Street in 1999, the link
between derivatives and the real world had broken down. Instead of being used to
reduce risk, 95 per cent of their use was speculation - a polite term for
gambling. And leveraging - which means taking a large amount of risk for a small
amount of money. So while derivatives, and the financial industry more broadly,
had started out serving industry, by the late 1990s the situation had reversed.
The Market had become a near-religious force in our culture; industry, society,
and politicians all bowed down to it. It was pretty clear what The Market didn’t
like. It didn’t like being closely watched. It didn’t like rules that governed
its behaviour. It didn’t like goods produced in First-World countries or workers
who made high wages, with the notable exception of financial sector employees.
This last point bothered me especially.
Philipp Meyer,
American Rust (Simon & Schuster, 2009) ---
http://search.barnesandnoble.com/American-Rust/Philipp-Meyer/e/9780385527514/?itm=1
American excess: A Wall Street trader tells all - Americas, World - The
Independent
http://www.independent.co.uk/news/world/americas/american-excess--a-wall-street-trader-tells-all-1674614.html
Jensen Comment
This book reads pretty much like an update on the derivatives scandals featured
by Frank Partnoy covering the Roaring 1990s before the dot.com scandals broke.
There were of course other insiders writing about these scandals as well ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
It would seem that bankers and investment bankers do not learn from their own
mistake. The main cause of the scandals is always pay for performance schemes
run amuck.
A growing concern for Fed policy
makers is a weakening in the US dollar against major currencies. The price of
the euro in US-dollar terms climbed from a low of $1.27 in November last year to
around $1.41 in May and $1.43 in early June — an increase of 12.6% from
November. The major currencies dollar index fell to 78.89 in May from 82.3 in
April — a fall of 4.1%. If the declining trend in the US dollar were to
consolidate, this could cause foreign holders of US-dollar assets to divest into
non-dollar-denominated assets and precious metals.
Frank Shostak, "The Fed Might Have
Painted Itself into a Corner," Mises Institute, June 12, 2009 ---
http://mises.org/story/3518
Let me conclude with a political note. The main reason for
reform is to serve the nation. If we don’t get major financial reform now, we’re
laying the foundations for the next crisis. But there are also political reasons
to act. For there’s a populist rage building in this country, and President
Obama’s kid-gloves treatment of the bankers has put Democrats on the wrong side
of this rage. If Congressional Democrats don’t take a tough line with the banks
in the months ahead, they will pay a big price in November.
Paul Krugman, Bubbles and
the Banks," The New York Times, January 7, 2010 ---
http://www.nytimes.com/2010/01/08/opinion/08krugman.html?hpw
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 5, 2012
BofA Takes New Crisis-Era Hit
by:
Dan Fitzpatrick, Christian Berthelsen and Robin Sidel
Sep 29, 2012
Click here to view the full article on WSJ.com
Click here to view the
video on WSJ.com
TOPICS: Contingent Liabilities
SUMMARY: "Bank of America Corp. agreed to pay $2.43 billion to
settle claims it misled investors about the acquisition of troubled
brokerage firm Merrill Lynch & Co...." during the financial crisis in 2008.
At the time it acquired Merrill Lynch in September 2008, BofA became the
biggest U.S. bank; the value of the bank then fell by more than half by the
time the acquisition of Merrill Lynch closed 3 months later. These losses
were not disclosed by then CEO Ken Lewis and his management team to
shareholders before they voted on the merger transaction with Merrill.
CLASSROOM APPLICATION: The article addresses accounting for
litigation contingent liabilities. The related video clearly discusses the
history of the transactions.
QUESTIONS:
1. (Introductory) To whom did Bank of America Corp. (BofA) agree to
pay $2.43 billion dollars?
2. (Introductory) For what losses did BofA agree to make this
payment?
3. (Advanced) How could losses have occurred and a payment of $2.4
billion be required if "Bank of America executives now say Merrill...has
become a big profit contributor... [and that] it's clear that Merrill is a
significant positive any way you want to look at it..."?
4. (Advanced) What accounting standards provide the requirements to
account for costs such as this $2.4 billion payment by BofA?
5. (Advanced) According to the article, BofA has "set aside more
than $42 billion in litigation expenses, payouts and reserves...[which]
includes $1.6 billion taken in the third quarter [of 2012]...." According to
the related video, what period will be affected by $1.6 billion being
recorded as an expense related to this $2.43 billion settlement? Explain
your answer.
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
BofA-Merrill: Still A Bottom-Line Success
by David Benoit
Sep 28, 2012
Online Exclusive
"BofA Takes New Crisis-Era Hit," by Dan Fitzpatrick, Christian Berthelsen and
Robin Sidel, The Wall Street Journal, September 29, 2012 ---
http://professional.wsj.com/article/SB10000872396390443843904578024110468736042.html?mod=djem_jiewr_AC_domainid&mg=reno-wsj
Bank of America Corp. agreed to pay $2.43 billion
to settle claims it misled investors about the acquisition of troubled
brokerage firm Merrill Lynch & Co., in the latest financial-crisis
aftershock to rattle the banking sector.
The payment is the largest settlement of a
shareholder claim by a financial-services firm since the upheaval of 2008
and 2009. It also ranks as the eighth-largest securities class-action
settlement, behind payouts like the $7.2 billion settlement with
shareholders of Enron Corp. and the $6.1 billion pact with WorldCom Inc.
investors, both in 2005.
The deal is a sign that U.S. banks' battle to
contain the high cost of the crisis continues to escalate, despite a
four-year slog of lawsuits, losses and profit-sapping regulations. Bank of
America's total exposure to crisis-era litigation is "seemingly
never-ending," said Sterne Agee & Leach Inc. in a note Friday.
Is the era that produced all of this legal exposure
"history?" the Sterne Agee & Leach analysts said. "Unlikely."
The settlement ends a three-year fight with a group
of five plaintiffs, including the State Teachers Retirement System of Ohio
and the Teacher Retirement System of Texas. They accused the bank and its
officers of making false or misleading statements about the health of Bank
of America and Merrill Lynch and were planning to seek $20 billion if the
case went to trial as scheduled on Oct. 22.The size of the pact highlights
how hasty acquisitions engineered during the height of the financial crisis
by Kenneth Lewis, then the bank's chief executive, are still haunting the
company four years later. Decisions to buy mortgage lender Countrywide
Financial Corp. and Merrill have forced Bank of America, run since 2010 by
Chief Executive Brian Moynihan, to set aside more than $42 billion in
litigation expenses, payouts and reserves, according to company figures. The
funds are meant to absorb a litany of Merrill-related lawsuits and claims
from investors who say Countrywide wasn't honest about the quality of
mortgage-backed securities it issued before the crisis.
That total includes $1.6 billion taken in the third
quarter to help pay for the Merrill settlement announced Friday and a
landmark $8.5 billion agreement reached last year with a group of
high-profile mortgage-bond investors.
The company's shares lost more than half their
value between when Bank of America announced its late-2008 plan to purchase
Merrill Lynch and the date the deal closed 3½ months later, wiping out $70
billion in shareholder value. The shares have fallen further since then, and
investors who owned the shares won't be made whole by the settlement.
"We find it simply amazing the sheer magnitude of
value destruction over the years," said Sterne Agee in the note issued
Friday. And "the bill is surely set to increase" as the research firm
expects the bank to reach other legal settlements over the next 12 to 24
months. Bank of America is still engaged in a legal clash with bond insurer
MBIA Inc.,
MBI +3.91%
which has alleged that Countrywide wasn't honest about the quality of
mortgage-backed securities it issued before the financial crisis.
The move to buy Merrill over one weekend in
September 2008 was initially hailed as a rare piece of good news during a
week when much of Wall Street appeared to be teetering on the brink. It also
vaulted the Charlotte, N.C., lender to the top of the U.S. banking heap,
capping a goal pursued over two decades by Mr. Lewis and his predecessor,
Hugh McColl.
The Merrill deal, initially valued at $50 billion
in Bank of America stock, was the "deal of a lifetime," Mr. Lewis said on
the day it was announced.
But the agreement soon became a problem as analysts
questioned whether Mr. Lewis paid too much and Merrill's losses spiraled out
of control in the weeks before the deal closed. Investor fears stemming from
the financial crisis sent shares of Bank of America and other financial
companies into free fall, and the deal was worth roughly $19 billion at its
completion on Jan. 1, 2009.
Mr. Lewis and his top executives made the decision
not to say anything publicly about the mounting problems before shareholders
signed off on the merger—a decision that formed the basis of a number of
Merrill-related suits, including an action brought by the Securities and
Exchange Commission. The bank also didn't disclose that it sought $20
billion in U.S. aid to digest Merrill, or that the deal allowed Merrill to
award up to $5.8 billion in performance bonuses. When Bank of America
threatened to pull out of the deal because of the losses, then-Treasury
Secretary Henry Paulson told Mr. Lewis that current management would be
removed if the deal wasn't completed.
The legal scrutiny surrounding the Merrill
acquisition contributed to Mr. Lewis's decision to step down at the end of
2009. Mr. Lewis's lawyer declined to comment.
"Any way you slice it, $2.4 billion is a big
number," says Kevin LaCroix, a lawyer at RT ProExec, a firm that focuses on
management-liability issues.
Bank of America executives now say Merrill, unlike
Countrywide, has become a big profit contributor, while the company
continues to work to absorb massive losses in its mortgage division. The
divisions inherited from Merrill produced $31.9 billion in net income
between 2009 and 2011 and $164.4 billion in revenue. Bank of America's total
net income over the period was just $5.5 billion, on $326.8 billion in
revenue, reflecting in part the hefty losses tied to the Countrywide deal.
"I think it's clear that Merrill is a significant
positive any way you want to look at it," said spokesman Jerry Dubrowski.
The settlement doesn't end all Merrill-related
headaches. The New York attorney general's office still is pursuing a
separate civil fraud suit relating to the Merrill takeover that began under
former Attorney General Andrew Cuomo. Defendants in that case include the
bank, Mr. Lewis and former Chief Financial Officer Joe Price. A spokesman
for New York State Attorney General Eric Schneiderman declined to comment.
It isn't known how much all shareholders will
receive as a result of the Merrill settlement announced Friday. The amount
shareholders receive will ultimately depend on how long they held the shares
and how much they paid. Mr. Lewis, also a shareholder, won't receive a
payout because defendants in the suit are excluded from the class that the
court certified.
But because the decline in Bank of America stock
was so steep—the shares fell from $32 to $14 between Sept. 12, 2008, the day
before the Merrill acquisition was announced, and the Jan. 1, 2009,
closing—no shareholders can expect to recover their full losses.
Before the settlement was reached, a targeted
recovery for at least three million shareholders who were part of the class
was $2.52 a share, said a spokesman for Ohio Attorney General Mike DeWine.
The State Teachers Retirement System of Ohio and the Ohio Public Employees
Retirement System, which held between 18 million and 20 million shares, now
expect to recover $1.19 per share, or roughly $20 million.
Continued in article
CDO ---
http://en.wikipedia.org/wiki/Collateralized_debt_obligation
Countrywide Financial ---
http://en.wikipedia.org/wiki/Countrywide_Financial
Those Poisoned CDOs
"Bank of America Ordered to Unseal Documents in MBIA Case," by Dan Freed,
The Street, June 4, 2013 ---
http://www.thestreet.com/story/11804771/1/bank-of-america-ordered-to-unseal-documents-in-mbia-case.html
Update November 22, 2016
Treasury Secretary Hank
Paulson's Bank of America Extortion Scheme (Hustle) Finally Laid to Rest
From the CFO Journal's Morning Ledger
on November 23, 2016
Do the Hustle? Nope
The government’s Hustle
case against Bank of America Corp. is
finally dead. The case, in which the government accused the bank’s
Countrywide Financial Corp. unit of
churning out shoddy mortgage securities in the run-up to the financial
crisis, already was thrown out by a U.S. appeals court in May. The U.S.
attorney’s office in Manhattan, which had first brought the case in 2012,
then asked the appeals court to reconsider its decision, a request that was
denied.
Jensen Comment
A better word for "Hustle" is Treasury Department
"Extortion." When the economy collapsed in 2007 due to poisoned mortgages
BofA had no poisoned mortgages. Then Treasury Secretary Hank Paulson came
calling like an extortionist according to former BofS CEO Ken Lewis. Paulson
gave BofA no choice but to buy Countrywide Financial with its millions of
poisoned mortgages. The secret intent was to give Countrywide deeper pockets
so that the Federal Government could turn around a sue BofA billions for all
the financial crimes of Countrywide Financial.
There was never any doubt about the high crimes of
Countrywide Financial on the main streets of cities and towns across the
USA. Countrywide issued millions of mortgages to borrowers having no hope of
meeting their mortgage obligations.
It makes me feel good that Paulson finally got his just
dessert. I only wish he would be sued. As the former CEO of Goldman Sachs he
bailed out Goldman with milk and honey and pissed on BofA. Now he's retired
on his millions from Goldman and seemingly can't be touched for his
extortion crimes.
CDO ---
https://en.wikipedia.org/wiki/Collateralized_debt_obligation
"Goldman Reaches $5 Billion Settlement Over Mortgage-Backed Securities:
Pact marks largest settlement in history of Wall Street firm," by Justin
Baer and Chelsey Dulaney, The Wall Street Journal, January 14, 2016 ---
http://www.wsj.com/articles/goldman-reaches-5-billion-settlement-over-mortgage-backed-securities-1452808185?mod=djemCFO_h
Goldman Sachs Group Inc. agreed to the largest
regulatory penalty in its history, resolving U.S. and state claims stemming
from the Wall Street firm’s sale of mortgage bonds heading into the
financial crisis.
In settling with the Justice Department and a
collection of other state and federal entities for more than $5 billion,
Goldman will join a list of other big banks in moving past one of the
biggest, and most costly, legal headaches of the crisis era.
Goldman said litigation legal expenses stemming
from the accord would trim its fourth-quarter earnings by about $1.5
billion, after taxes. The firm is scheduled to report results Wednesday.
“We are pleased to have reached an agreement in
principle to resolve these matters,” Lloyd Blankfein, Goldman’s chief
executive, said in a statement.
Government officials previously won
multibillion-dollar settlements from J.P. Morgan Chase & Co., Bank of
America Corp. and Citigroup Inc. The probes examined how Wall Street sold
bonds tied to residential mortgages, and whether banks deceived investors by
misrepresenting the quality of underlying loans.
The government’s inquiry into Goldman related to
mortgage-backed securities the firm packaged and sold between 2005 and 2007,
the years when the housing market was soaring and investor demand for
related bonds was still strong.
Continued in article
New Rules
for CDOs
"Statement at Open Meeting: Asset-Backed Securities Disclosure and
Registration," by Commissioner Kara M. Stein, SEC, August 27, 2014 ---
http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370542772431#.VBgvYBZS7rx
I begin my remarks by echoing others and commending the work of the team
that has been working on this rule, including Rolaine Bancroft, Hughes
Bates, Michelle Stasny, Kayla Florio, Heather Mackintosh, Silvia Pilkerton,
Robert Errett, Max Rumyantsev, and Kathy Hsu.
Heather and Sylvia have been working on the data tagging and preparing EDGAR
to accept this new data. This is no small endeavor.
I want to give a special thank you to Paula Dubberly, who retired last year
from the SEC and is in the audience today. She has been a champion for
investors through her leadership on asset-backed securities regulation from
the development of the initial Reg AB proposal through the rules that are
being considered today.
This rule is an important step forward in completing the mandated Dodd-Frank
Act rulemakings.[1]
The financial crisis revealed investors’ inability to actually assess pools
of loans that had been sliced and diced, sometimes multiple times, by being
securitized, re-securitized, or combined in a dizzying array of complex
financial instruments. The securitization market was at the center of the
financial crisis. While securitization structures provided liquidity to
nearly every sector in the U.S. economy, they also exposed investors to
significant and non-transparent risks due to poor lending practices and poor
disclosure practices.
As we now know, offering documents failed to provide timely and complete
information for investors to assess the underlying risks of the pool of
assets.[2]
Without sufficient and accurate loan level details, analysts and investors
could not gauge the quality of the loans – and without an ability to
distinguish the good from the bad, the secondary market collapsed.
Congress responded and required the Commission to promulgate rules to
address a number of weaknesses in the securitization process.[3]
Six years after the financial crisis, the securitization markets continue to
recover. While certain asset classes have rebounded, others continue to
struggle.
The rule the Commission issues today partially addresses the Congressional
mandate. In effect, today’s rules provide investors with better information
on what is inside the securitization package. The rules today do for
investors what food and drug labeling does for consumers – provide a list of
ingredients.
This rule also addresses certain critical flaws that became apparent in the
securitization process, including a dearth of quality information and
insufficient time to make informed assessments of the underlying
investments. This rule is an important step toward providing investors with
tools and data to better understand the underlying risks and appropriately
price the securities.
There are several important and laudable aspects of today’s rule that merit
specific mentioning.
First, the rule requires the underlying loan information to be standardized
and available in a tagged XML format to ensure maximum utility in analysis.[4]
As noted in the Commission’s 2010 Proxy Plumbing Release: “If issuers
provided reportable items in interactive data format, shareholders may be
able to more easily obtain information about issuers, compare information
across different issuers, and observe how issuer-specific information
changes over time as the same issuer continues to file in an interactive
format.”[5]
The same is true for underlying loan information. Investors can unlock the
value and efficiency that standardized, machine readable data allows.
Today’s rule also improves disclosures regarding the initial offering of
securities and significantly, for the first time, requires periodic updating
regarding the loans as they perform over time. This information will
provide a more nuanced and evolving picture of the underlying assets in a
portfolio to investors.
The rule also requires that the principal executive officer of the ABS
issuer certify that the information in the prospectus or report is
accurate. These kinds of certifications provide a key control to help
ensure more oversight and accountability.
As for the privacy concerns that prompted a re-proposal, the staff has
worked hard to balance investor needs for loan level data with concerns that
the data could lead to identification of individual borrowers. I believe
the rule achieves a workable balance between these two competing needs,
while still providing invaluable public disclosure.
Finally, I believe that the new disclosure rule will provide investors with
the necessary tools to see what is “under the hood” on auto loan
securitizations. In its latest report on consumer debt and credit, the
Federal Reserve Bank of New York noted a recent spike in subprime auto
lending. As the report shows, although consumer auto debt balances have
risen across the board, the real growth has been in riskier loans.[6]
The disclosure and reporting changes that the Commission is adopting today
will help investors see the quality of the loans in a portfolio and the
performance of those loans over time.
While today’s rules are an important step forward, more work needs to be
done regarding conflicts of interest. We now know that many firms who were
structuring securitizations before the financial crisis were also betting
against those same securitizations.
In April 2010, the Commission charged the U.S broker-dealer of a large
financial services firm for its role in failing to disclose that it allowed
a client to select assets for an investment portfolio while betting that the
portfolio would ultimately lose its value. Investors in the portfolio lost
more than $1 billion.[7]
In October 2011, the Commission sued the U.S broker-dealer of a large
financial services firm for among other things, selling investment products
tied to the housing market and then, for their own trading, betting that
those assets would lose money. In effect, the firm bet against the very
investors it had solicited. An experienced collateral manager commented
internally that a particular portfolio was “horrible.” While investors lost
virtually all of their investments in the portfolio, the firm pocketed over
$160 million from bets it made against the securitization it created.[8]
The Dodd-Frank Act directed the Commission to adopt rules prohibiting
placement agents, underwriters, and sponsors from engaging in a material
conflict of interest for one year following the closing of a securitization
transaction. Those rules were required to be issued by April 2011.[9]
The Commission initially proposed these rules in September 2011, and still
has not completed them.[10]
We need to complete these rules as soon as possible, hopefully, by the end
of this year. These rules will provide investors with additional confidence
that they are not being hoodwinked by those packaging and selling those
financial instruments.
Unfortunately, the Commission has put on hold its work to provide investors
with a software engine to aid in the calculation of waterfall models.
Although the final rule provides for a preliminary prospectus at least three
business days before the first sale, this is reduced from the proposal,
which provided for a five-day period. With only three days to conduct due
diligence and make an investment determination, such a software engine could
be an important and much needed tool for investors to use in analyzing the
flow of funds. Such waterfall models can help investors assess the cash
flows from the loan level data. We should return to this important
initiative to provide investors with the mathematical logic that forms the
basis for the narrative disclosure within the prospectus.
CDO ---
https://en.wikipedia.org/wiki/Collateralized_debt_obligation
From the CFO Journal's
Morning Ledger on March 22, 2016
Former Lehman CFO tells her side of the firm’s collapse
Erin Montella’s new memoir offers a unique perspective
on the events that led to the financial crisis. “Full Circle,” which was
released
Sunday
on Amazon.com, tells the story of how Ms. Montella rose to become the
highest-ranking woman on Wall Street in 2008, only to resign from the firm
six months after being named CFO. She accepted the position only after
becoming convinced she could make the role more important, “something close
to the CEO heir apparent.”
"JPMorgan to pay $1.42 billion cash to settle most Lehman claims," by
Jonatan Stemel, Reuters, January 25, 2016 ---
http://www.reuters.com/article/us-jpmorgan-lehman-idUSKCN0V4049
JPMorgan Chase & Co (JPM.N) will pay $1.42 billion
in cash to resolve most of a lawsuit accusing it of draining Lehman Brothers
Holdings Inc of critical liquidity in the final days before that investment
bank's September 2008 collapse.
The settlement was made public on Monday, and
requires approval by U.S. Bankruptcy Judge Shelley Chapman in Manhattan.
It resolves the bulk of an $8.6 billion lawsuit
accusing JPMorgan of exploiting its leverage as Lehman's main "clearing"
bank to siphon billions of dollars of collateral just before Lehman went
bankrupt on Sept. 15, 2008, triggering a global financial crisis.
Lehman's creditors charged that JPMorgan did not
need the collateral and extracted a windfall at their expense.
Monday's settlement also resolves Lehman's
challenges to JPMorgan's decision to close out thousands of derivatives
trades following the bankruptcy, court papers showed.
The accord would permit a further $1.496 billion to
be distributed to the creditors, including a separate $76 million deposit,
court papers showed.
Continued in article
"Goldman Reaches $5 Billion Settlement Over Mortgage-Backed Securities:
Pact marks largest settlement in history of Wall Street firm," by Justin
Baer and Chelsey Dulaney, The Wall Street Journal, January 14, 2016 ---
http://www.wsj.com/articles/goldman-reaches-5-billion-settlement-over-mortgage-backed-securities-1452808185?mod=djemCFO_h
Goldman Sachs Group Inc. agreed to the largest
regulatory penalty in its history, resolving U.S. and state claims stemming
from the Wall Street firm’s sale of mortgage bonds heading into the
financial crisis.
In settling with the Justice Department and a
collection of other state and federal entities for more than $5 billion,
Goldman will join a list of other big banks in moving past one of the
biggest, and most costly, legal headaches of the crisis era.
Goldman said litigation legal expenses stemming
from the accord would trim its fourth-quarter earnings by about $1.5
billion, after taxes. The firm is scheduled to report results Wednesday.
“We are pleased to have reached an agreement in
principle to resolve these matters,” Lloyd Blankfein, Goldman’s chief
executive, said in a statement.
Government officials previously won
multibillion-dollar settlements from J.P. Morgan Chase & Co., Bank of
America Corp. and Citigroup Inc. The probes examined how Wall Street sold
bonds tied to residential mortgages, and whether banks deceived investors by
misrepresenting the quality of underlying loans.
The government’s inquiry into Goldman related to
mortgage-backed securities the firm packaged and sold between 2005 and 2007,
the years when the housing market was soaring and investor demand for
related bonds was still strong.
Continued in article
New Rules
for CDOs
"Statement at Open Meeting: Asset-Backed Securities Disclosure and
Registration," by Commissioner Kara M. Stein, SEC, August 27, 2014 ---
http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370542772431#.VBgvYBZS7rx
I begin my remarks by echoing others and commending the work of the team
that has been working on this rule, including Rolaine Bancroft, Hughes
Bates, Michelle Stasny, Kayla Florio, Heather Mackintosh, Silvia Pilkerton,
Robert Errett, Max Rumyantsev, and Kathy Hsu.
Heather and Sylvia have been working on the data tagging and preparing EDGAR
to accept this new data. This is no small endeavor.
I want to give a special thank you to Paula Dubberly, who retired last year
from the SEC and is in the audience today. She has been a champion for
investors through her leadership on asset-backed securities regulation from
the development of the initial Reg AB proposal through the rules that are
being considered today.
This rule is an important step forward in completing the mandated Dodd-Frank
Act rulemakings.[1]
The financial crisis revealed investors’ inability to actually assess pools
of loans that had been sliced and diced, sometimes multiple times, by being
securitized, re-securitized, or combined in a dizzying array of complex
financial instruments. The securitization market was at the center of the
financial crisis. While securitization structures provided liquidity to
nearly every sector in the U.S. economy, they also exposed investors to
significant and non-transparent risks due to poor lending practices and poor
disclosure practices.
As we now know, offering documents failed to provide timely and complete
information for investors to assess the underlying risks of the pool of
assets.[2]
Without sufficient and accurate loan level details, analysts and investors
could not gauge the quality of the loans – and without an ability to
distinguish the good from the bad, the secondary market collapsed.
Congress responded and required the Commission to promulgate rules to
address a number of weaknesses in the securitization process.[3]
Six years after the financial crisis, the securitization markets continue to
recover. While certain asset classes have rebounded, others continue to
struggle.
The rule the Commission issues today partially addresses the Congressional
mandate. In effect, today’s rules provide investors with better information
on what is inside the securitization package. The rules today do for
investors what food and drug labeling does for consumers – provide a list of
ingredients.
This rule also addresses certain critical flaws that became apparent in the
securitization process, including a dearth of quality information and
insufficient time to make informed assessments of the underlying
investments. This rule is an important step toward providing investors with
tools and data to better understand the underlying risks and appropriately
price the securities.
There are several important and laudable aspects of today’s rule that merit
specific mentioning.
First, the rule requires the underlying loan information to be standardized
and available in a tagged XML format to ensure maximum utility in analysis.[4]
As noted in the Commission’s 2010 Proxy Plumbing Release: “If issuers
provided reportable items in interactive data format, shareholders may be
able to more easily obtain information about issuers, compare information
across different issuers, and observe how issuer-specific information
changes over time as the same issuer continues to file in an interactive
format.”[5]
The same is true for underlying loan information. Investors can unlock the
value and efficiency that standardized, machine readable data allows.
Today’s rule also improves disclosures regarding the initial offering of
securities and significantly, for the first time, requires periodic updating
regarding the loans as they perform over time. This information will
provide a more nuanced and evolving picture of the underlying assets in a
portfolio to investors.
The rule also requires that the principal executive officer of the ABS
issuer certify that the information in the prospectus or report is
accurate. These kinds of certifications provide a key control to help
ensure more oversight and accountability.
As for the privacy concerns that prompted a re-proposal, the staff has
worked hard to balance investor needs for loan level data with concerns that
the data could lead to identification of individual borrowers. I believe
the rule achieves a workable balance between these two competing needs,
while still providing invaluable public disclosure.
Finally, I believe that the new disclosure rule will provide investors with
the necessary tools to see what is “under the hood” on auto loan
securitizations. In its latest report on consumer debt and credit, the
Federal Reserve Bank of New York noted a recent spike in subprime auto
lending. As the report shows, although consumer auto debt balances have
risen across the board, the real growth has been in riskier loans.[6]
The disclosure and reporting changes that the Commission is adopting today
will help investors see the quality of the loans in a portfolio and the
performance of those loans over time.
While today’s rules are an important step forward, more work needs to be
done regarding conflicts of interest. We now know that many firms who were
structuring securitizations before the financial crisis were also betting
against those same securitizations.
In April 2010, the Commission charged the U.S broker-dealer of a large
financial services firm for its role in failing to disclose that it allowed
a client to select assets for an investment portfolio while betting that the
portfolio would ultimately lose its value. Investors in the portfolio lost
more than $1 billion.[7]
In October 2011, the Commission sued the U.S broker-dealer of a large
financial services firm for among other things, selling investment products
tied to the housing market and then, for their own trading, betting that
those assets would lose money. In effect, the firm bet against the very
investors it had solicited. An experienced collateral manager commented
internally that a particular portfolio was “horrible.” While investors lost
virtually all of their investments in the portfolio, the firm pocketed over
$160 million from bets it made against the securitization it created.[8]
The Dodd-Frank Act directed the Commission to adopt rules prohibiting
placement agents, underwriters, and sponsors from engaging in a material
conflict of interest for one year following the closing of a securitization
transaction. Those rules were required to be issued by April 2011.[9]
The Commission initially proposed these rules in September 2011, and still
has not completed them.[10]
We need to complete these rules as soon as possible, hopefully, by the end
of this year. These rules will provide investors with additional confidence
that they are not being hoodwinked by those packaging and selling those
financial instruments.
Unfortunately, the Commission has put on hold its work to provide investors
with a software engine to aid in the calculation of waterfall models.
Although the final rule provides for a preliminary prospectus at least three
business days before the first sale, this is reduced from the proposal,
which provided for a five-day period. With only three days to conduct due
diligence and make an investment determination, such a software engine could
be an important and much needed tool for investors to use in analyzing the
flow of funds. Such waterfall models can help investors assess the cash
flows from the loan level data. We should return to this important
initiative to provide investors with the mathematical logic that forms the
basis for the narrative disclosure within the prospectus.
Bob Jensen's threads on CDO accounting scandals and new rules ---
http://faculty.trinity.edu/rjensen/theory02.htm#CDO
Breaking the Bank Frontline
Video
In Breaking the Bank, FRONTLINE producer Michael Kirk
(Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile
interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to
reveal the story of two banks at the heart of the financial crisis, the rocky
merger, and the government’s new role in taking over — some call it
“nationalizing” — the American banking system.
Simoleon Sense, September 18,
2009 ---
http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Update November 23, 2016
Treasury Secretary Hank Paulson's Bank of America Extortion Scheme (Hustle)
Finally Laid to Rest
From the CFO Journal's Morning Ledger
on November 23, 2016
Do the Hustle? Nope
The government’s Hustle
case against Bank of America Corp. is
finally dead. The case, in which the government accused the bank’s
Countrywide Financial Corp. unit of
churning out shoddy mortgage securities in the run-up to the financial
crisis, already was thrown out by a U.S. appeals court in May. The U.S.
attorney’s office in Manhattan, which had first brought the case in 2012,
then asked the appeals court to reconsider its decision, a request that was
denied.
Jensen Comment
A better word for "Hustle" is Treasury Department
"Extortion." When the economy collapsed in 2007 due to poisoned mortgages
BofA had no poisoned mortgages. Then Treasury Secretary Hank Paulson came
calling like an extortionist according to former BofS CEO Ken Lewis. Paulson
gave BofA no choice but to buy Countrywide Financial with its millions of
poisoned mortgages. The secret intent was to give Countrywide deeper pockets
so that the Federal Government could turn around a sue BofA billions for all
the financial crimes of Countrywide Financial.
There was never any doubt about the high crimes of
Countrywide Financial on the main streets of cities and towns across the
USA. Countrywide issued millions of mortgages to borrowers having no hope of
meeting their mortgage obligations.
It makes me feel good that Paulson finally got his just
dessert. I only wish he would be sued. As the former CEO of Goldman Sachs he
bailed out Goldman with milk and honey and pissed on BofA. Now he's retired
on his millions from Goldman and seemingly can't be touched for his
extortion crimes.
U.S. loan relief program
may have made things worse
The Obama administration’s $75 billion program to
protect homeowners from foreclosure has been widely pronounced a disappointment,
and some economists and real estate experts now contend it has done more harm
than good. Since President Obama announced the program in February, it has
lowered mortgage payments on a trial basis for hundreds of thousands of people
but has largely failed to provide permanent relief. Critics increasingly argue
that the program, Making Home Affordable, has raised false hopes among people
who simply cannot afford their homes.
Peter S. Goodman, "U.S. loan program may have made things worse," MSNBC,
January 1, 2010 ---
http://www.msnbc.msn.com/id/34663078/ns/business-the_new_york_times/
Selling the debt in the left pocket to the right pocket: The Fed is
all smoke and mirrors
"Fed Is Buying 61 Percent of U.S. Government Debt," by Bob Adelmann, The New
American, March 29, 2012
http://thenewamerican.com/economy/commentary-mainmenu-43/11357-fed-is-buying-61-of-us-government-debt
In his attempt to explode the myth that there is
unlimited demand for U.S. government debt, former Treasury official Lawrence
Goodman
explained that there
is high perceived demand because the Federal Reserve is doing most
of the buying.
Wrote Goodman,
Last year the Fed
purchased a stunning 61% of the total net Treasury issuance, up from
negligible amounts prior to the 2008 financial crisis.
This not only creates
the false impression of limitless demand for U.S. debt but also blunts any
sense of urgency to reduce supersized budget deficits.
What about Japan and China? Aren’t they the major
purchasers of U.S. debt? Not any more, notes Goodman. Foreign purchases of
U.S. debt dropped to less than 2 percent of GDP (Gross Domestic Product)
from almost 6 percent just three years ago. And private sector investors —
banks, money market and bond mutual funds, individuals and corporations —
have cut their buying way back as well, to less than 1 percent of GDP, down
from 6 percent. This serves to hide the fact that the government can’t find
outside buyers willing to accept rates of return that are below the
inflation rate (“negative interest”) given the precarious financial
condition of the government. It also hides the impact of $1.3 trillion
deficits from the public who would likely get much more concerned if real,
true market rates of interest were being demanded for purchasing U.S. debt,
as such higher rates would increase the deficit even further. Finally it
takes pressure off Congress to “do something” because there is no public
clamor over the matter, at least for the moment.
One of those promoting the myth that buyers of U.S.
debt must exist because interest rates are so low is none other than one of
those recently seated at the Federal Reserve’s Open Market Committee table,
Alan
Blinder. Now a professor of economics at Princeton
University, Blinder was vice chairman of the Fed in the mid-nineties and
should know all about the Fed’s manipulations and machinations in the money
markets. Apparently not.
On January 19 Blinder
wrote in the Wall Street Journal that
Strange as it may seem
with trillion-dollar-plus deficits, the U.S. government doesn’t have a
short-run borrowing problem at all. On the contrary, investors all over the
world are clamoring to lend us money at negative real interest rates.
In purchasing power
terms, they are paying the U.S. government to borrow their money!
Blinder
repeated the error in front of the Senate Banking
Committee just one week later: "In fact, world financial markets are eager
to lend the United States government vast amounts at negative real interest
rates. That means that, in purchasing power terms, they are paying us to
borrow their money!"
Aggressive promotion of a myth never makes it a
fact. All it does is hide, for a period, the reality that the world isn’t
willing to lend to the United States at negative interest rates. This places
the burden on the Fed to make the myth appear real by expanding its own
balance sheet and gobbling up U.S. debt.
There are going to be consequences. As Goodman put
it,
The failure by officials
to normalize conditions in the U.S. Treasury market and curtail ballooning
deficits puts the U.S. economy and markets at risk for a sharp
correction…. [Emphasis added.]
In other words, budget
deficits often take years to build or reduce, while financial markets react
rapidly and often unexpectedly to deficit spending and debt.
The
recent
release by the Congressional Budget Office (CBO)
of future inflation expectations provides little assurance either as it
mimics the line that inflation will stay low for the foreseeable future: "In
CBO’s forecast, the price index for personal consumption expenditures
increases by just 1.2 percent in 2012 and 1.3 percent in 2013."
With the Fed continuing to buy U.S. government
debt, which keeps interest rates artificially low, when will reality set in?
Amity Shlaes has the answer.
Writing in Bloomberg last week, Shlaes explains:
The thing about [price]
inflation is that it comes out of nowhere and hits you….
[It] has happened to us
before. In World War I … the CPI [Consumer Price Index] went from 1 percent
for 1915 to 7 percent in 1916 and 17 percent in 1917….
In 1945, all seemed
well. Inflation was at 2 percent, at least officially. Within two years that
level hit 14 percent.
All appeared calm in
1972, too, before inflation jumped to 11 percent by 1974 and stayed high for
the rest of the decade….
One thing is clear:
pretty soon, we’ll all be in deep water.
Doug Casey agrees: “Don’t think there are no
consequences to our unwise fiscal and monetary course; a potentially ugly
tipping point is more likely than not at some point.”
Coninued in article
I don't want to make this statement of fact seem political.
It applies no matter what political side is in power!
The Science of Macroeconomics is quite literally blameless.
If the economy improves and unemployment drops,
Obama can take credit. If it fails to improve and unemployment rises, though, he
can say he averted an even worse showing. Republicans will take the opposite
tack—attributing any improvement to the natural resilience of the economy and
blaming the administration if things get worse. And neither side will really
know who's right. I have long been a believer in the value of economics in
understanding the world. But the chief effect of the current crisis is to raise
the possibility that economists—at least those macroeconomists, who study the
broad economy—don't have a blessed clue.
"Baffled by the Economy: Why being a macroeconomist means
never having to say you're sorry," by Steve Chapman, Reason Magazine,
June 11, 2009 ---
http://www.reason.com/news/show/134059.html
The budget should be balanced, the Treasury
should be refilled, public debt should be reduced, the arrogance of officialdom
should be tempered and controlled, and the assistance to foreign lands should be
curtailed lest Rome become bankrupt. People must again learn to work, instead of
living on public assistance.
Taylor Caldwell, A Pillar of Iron
(wrongly attributed to
Cicero in 55 B.C.)
Five Speaker Videos from the Stanford Graduate School of Business (on the
economic crisis and leadership) [Scroll Down]
Top 5 Speaker Videos for 2009 ---
http://www.gsb.stanford.edu/news/top-videos.html?cmpid=alumni&source=gsbtoday
Great PBS Video on the Crash of 1929 ---
http://www.pbs.org/wgbh/americanexperience/crash/
Yale School of Management Cosponsors NYC Roundtable Discussion on the
Financial Crisis (Full Video Now Available)
http://mba.yale.edu/news_events/CMS/Articles/6608.shtml
Collateralized Debt Obligation ---
http://en.wikipedia.org/wiki/Collateralized_debt_obligation
"CDOs Are Back: Will They Lead to Another Financial Crisis?"
Knowledge@wharton, April 10, 2013 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=3230
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Wall Street’s Math Wizards Forgot a Few Variables
What wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/
Bob Jensen's threads on CDOs ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Saturn (Now Defunct Automobile): A Wealth of Lessons from Failure,"
University of Pennsylvania's Knowledge@Wharton, October 28, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2366
Did the Cash for Clunkers Program cost taxpayers $24,000 for each success
story?
"(Lots of) Cash for Clunkers," by Steven D. Levitt (University of Chicago
economics professor and principal author of Freakonomics,
Superfreakonomics, and the Freakonomics Blog at The New York
Times), November 2, 2009 ---
http://freakonomics.blogs.nytimes.com/2009/11/02/lots-of-cash-for-clunkers/
Edmunds.com reports that its
statistical analysis of the Cash for Clunkers
program finds that the program generated only 125,000 extra new vehicle
sales, meaning that the cost to the U.S. government was $24,000 for each of
those new cars.
The reason the cost per incremental car is so high
is that, according to Edmunds.com’s modeling, 82 percent of the vehicles
purchased under the program would have been bought this year anyway, even
without the subsidy. So Cash for Clunkers mostly just turned out to be a
gift from the government to people who happened to be in the market for a
new car at the right time. The auto manufacturers and dealers did not end up
getting a very big chunk of the money ultimately, although they did get paid
earlier rather than later in the year.
Is this surprising? Not to an economist. It is
relatively easy to move around the timing of when someone purchases a
durable good, but much harder to affect whether they buy a durable good or
not.
For the second time in a week, I am deeply
disappointed at the response of the Department of Transportation to research
into areas of relevance to the department. The first case was Secretary
LaHood’s response to my research on car seats. Here is what the agency had
to say in response to the Edmunds.com analysis:
“It is unfortunate that Edmunds.com has had
nothing but negative things to say about a wildly successful program
that sold nearly 250,000 cars in its first four days alone,” said Bill
Adams, spokesman for the Department of Transportation.
The right response, it seems to me, is either to
say 1) that this new evidence convinces us not to do the program again, or
2) that this analysis is wrong. That’s
the response that Macon Phillips had on the
White House blog (who knew the White House had a blog!):
The Edmunds analysis rests on the assumption
that the market for cars that didn’t qualify for Cash for Clunkers was
completely unaffected by this program. In other words, all the other
cars were being sold on Mars, while the rest of the country was caught
up in the excitement of the Cash for Clunkers program. This analysis
ignores not only the price impacts that a program like Cash for Clunkers
has on the rest of the vehicle market, but the reports from across the
country that people were drawn into dealerships by the Cash for Clunkers
program and ended up buying cars even though their old car was not
eligible for the program.
I’m not sure whether this argument is empirically
important or not, but at least it is actually engaging in a meaningful way
with the Edmunds.com analysis.
Jensen Comment
My objection to the Cash for Clunkers Program was not how much it cost in terms
of subsidies to some buyers (like me) and most dealers, although the benefits to
buyers are probably overstated when compared to deals that are not being made by
dealers. My objection is that the program destroyed perfectly good cars needed
badly by poor people around the world such as poor people in Latin America and
South America. Mathematicians would call the degree of impact epsilon with
respect to reducing global warming and fuel consumption.
The
so-called "jobs created" were mostly temporary since backlogged vehicle
inventories are now growing and growing and growing.
A very small example was the cash for clunkers
program in the US that ended a short time ago. The 19th century French essayist
Frederic Bastiat discussed facetiously the gain to an economy when a boy breaks
the windows of a shopkeeper since that creates work for the glazier to repair
them, and the glazier then spends his additional income on food and other
consumer goods. The moral of that story is to hire boys to go around breaking
windows! The clunkers program was hardly any better than that (see our
discussion of the clunkers program on August 24th).
Gary Becker, Nobel Prize Winning
Economist, "How Much Should We Care About Government Deficits?" The
Becker-Posner Blog, September 15, 2009 ---
http://www.becker-posner-blog.com/archives/2009/09/how_much_should.html
Also see Gary Becker, "The Cash for Clunkers Program: A Bad Idea at the
Wrong Time, The Becker-Posner Blog, August 24, 2009 ---
http://www.becker-posner-blog.com/archives/2009/08/the_cash_for_cl.html
The burden on the government budget that this
imposes depends on the interest rates on the debt. At an average interest rate
of 5%, that means 5% of GDP would go to servicing the debt, which is a little
less than 20% of total federal government spending. This might be manageable but
it is not trivial. On the other hand, if average interest rates were only 3%,
servicing costs would be far more tolerable. In fact, the US has been paying
about 3% on its debt, so even a considerable increase of the debt to 100% of GDP
would still be manageable. But if the Fed starts raising real interest rates to
head off the inflation potential in the $800 billion of excess reserves, the
debt burden could become a major problem. Another factor is the savings rates
coming from the Asian countries, like China. If their savings decline sharply,
that too would raise world interest rates and increase the debt burden for all
countries.
Gary Becker, Nobel Prize Winning
Economist, "How Much Should We Care About Government Deficits?" The
Becker-Posner Blog, September 15, 2009 ---
http://www.becker-posner-blog.com/archives/2009/09/how_much_should.html
Mortgage Fraud Increasing
Despite the attention paid to mortgage fraud committed
by borrowers and lenders since declines in the real estate values and the
subprime loan crisis triggered severe problems in the banking industry, the
number of Federal Bureau of Investigation’s (FBI) investigations of mortgage
fraud and associated financial crimes is increasing. “The FBI has experienced
and continues to experience an exponential rise in mortgage fraud
investigations,” John Pistole, Deputy Director, told the Senate Judiciary
Committee in April.
AccountingWeb, August 18, 2009 ---
http://www.accountingweb.com/topic/mortgage-loan-fraud-increasing
Jensen Comment
I think mortgage fraud will continue to rise as long as remote third parties
like Fannie Mae, Freddie Mac, and FHA continue to buy up mortgages negotiated by
banks and mortgage companies basking in moral hazard. The biggest hazards are
fraudulent real estate appraisals and lies about income in mortgage
applications. We need to bring back George Bailey (James Stewart) in It's a
Wonderful Life ---
http://en.wikipedia.org/wiki/It%27s_a_Wonderful_Life
The banks that negotiate the mortgages should have to hang on to those
mortgages.
Watch the video at
http://www.youtube.com/watch?v=MJJN9qwhkkE
Bob Jensen's fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"The FHA's Bailout Warning: Whoops, there it is," The Wall
Street Journal, November 13, 2009 ---
Click Here
Critics of Fannie Mae and Freddie Mac were waved
off as cranks and assured that the companies wouldn't need a taxpayer
bailout right up until the moment that they did. Some $112 billion later and
counting, this political history may be repeating itself with the Federal
Housing Administration, which yesterday announced that its capital reserve
ratio has fallen to 0.53%.
That cushion is far below the 2% of its liabilities
that Congress mandates, itself a 50 to 1 leverage ratio, and down from 3%
last autumn. The FHA's mortgage guarantees in 2009 are four times higher
than they were in 2007. Nearly 18% of its loans are 30 days or more past
due, while mortgages guaranteed in 2007 are "on par with FHA's worst-ever
books from the early 1980s," according to the Department of Housing and
Urban Development's report to Congress. The financial deterioration is the
result of the agency's plunge into high-risk loans over the last two years,
asking dangerously low down payments of 3.5% from unqualified borrowers.
The FHA strikes a note of optimism by claiming that
its book of business is improving and that "the just-completed actuarial
studies show that FHA's capital reserve ratio will not dip below zero under
most of the economic scenarios considered." The Administration has also made
some modest reforms. Still, if housing values don't recover, or if by some
chance the agency can't outrun its problems, the report admits that the FHA
could ask taxpayers for $1.6 billion in 2012. Judging from history, that's
probably a low-ball estimate.
Congress doesn't mind because these liabilities are
technically off budget, until they aren't. This was all so predictable—and,
ahem, predicted.
Are economists worse than the Keystone Cops?
"The Financial Crisis and the Systemic Failure of Academic Economics," 2008
Dahlem Report on the Economic Crisis ---
http://www.cs.trinity.edu/~rjensen/temp/Dahlem_Report_EconCrisis021809.pdf
Abstract:
The economics profession appears to have been unaware of the long build-up
to the current worldwide financial crisis and to have significantly
underestimated its dimensions once it started to unfold. In our view, this
lack of understanding is due to a misallocation of research efforts in
economics. We trace the deeper roots of this failure to the profession’s
insistence on constructing models that, by design, disregard the key
elements driving outcomes in real-world markets. The economics profession
has failed in communicating the limitations, weaknesses, and even dangers of
its preferred models to the public. This state of affairs makes clear the
need for a major reorientation of focus in the research economists
undertake, as well as for the establishment of an ethical code that would
ask economists to understand and communicate the limitations and potential
misuses of their models.
Two Videos Damning Capitalism: One Stupid, One Smart
Michael Moore cheered the bankruptcy of General Motors and absolutely
despises the comeback of General Motors
He has a relatively long list (some lucrative to him) leftist documentaries ---
http://en.wikipedia.org/wiki/Michael_Moore
His documentary Sicko got it wrong --- Cuba is not the dream country of
equity and quality in health care for the masses
Now he has a new documentary entitled: Capitalism: A Love Story
The Stupid Video
"Michael Moore Gets It Wrong," by John Stossel, ABC News, July 11,
2009 ---
http://blogs.abcnews.com/johnstossel/2009/07/michael-moore-gets-it-wrong.html
Michael Moore has been
working on
another documentary. This time, he’s taking on
capitalism:
"The wealthy, at some
point, decided they didn't have enough wealth. They wanted more -- a lot more.
So they systematically set about to fleece the American people out of their
hard-earned money."
How ridiculous is that?
The wealthy, and everyone else, almost always decide that they don’t have enough
wealth. People ask their bosses for raises. We invest in stocks hoping for
bigger returns than Treasury Bonds bring. “Greed” is a constant. The beauty of
free markets, when government doesn’t meddle in them, is that they turn this
greed into a phenomenal force for good. The way to win big money is to serve
your customers well. Profit-seeking entrepreneurs have given us better
products, shorter work days, extended lives, and more opportunities to write the
script of our own life.
On Thursday, Moore
announced the title of the movie:
Capitalism: A Love Story.
It’s a title I might have
picked to make a point opposite of what I assume Moore has in mind.
Moore also fails to
understand is that it was not “capitalism” run amok that caused today’s
financial problems. In reality, it was a combination of
ill-conceived
government policies and an
overzealous Federal Reserve artificially lowering
interest rates to fuel a bubble in the housing market. Then it was government
that took money from taxpayers and
forced banks to accept it.
Moore ought to understand
that, because he makes a good point when he says his movie will be about "the
biggest robbery in the history of this country - the massive transfer of U.S.
taxpayer money to private financial institutions."
That is indeed robbery.
It sure doesn’t sound like capitalism.
The Smart Video
Better Video Damning "Managerial Capitalism" and It's Free Online ---
Click Here
http://snipurl.com/managerialcapitalism [fora_tv]
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Being Honest About Being Dishonest
Democrats openly admit that most of the stimulus money is going to counties that
voted for Obama
A new study released by USA Today also finds that
counties that voted for Obama received about twice as much stimulus money per
capita as those that voted for McCain. "The stimulus bill is designed to help
those who have been hurt by the economic downturn.... Do you see disparity out
there in where the money is going? Certainly," a Democratic congressional
staffer knowledgeable about the process told FOXNews.com.
John Lott, "ANALYSIS: States Hit
Hardest by Recession Get Least Stimulus Money," Fox News, July 19,
2009---
http://www.foxnews.com/story/0,2933,533841,00.html
Their report,
"Dreaming with BRICs: The Path to 2050," predicted that within 40
years, the economies of Brazil, Russia, India and China - the BRICs
- would be larger than the US, Germany, Japan, Britain, France and
Italy combined. China would overtake the US as the world's largest
economy and India would be third, outpacing all other industrialised
nations.
"Out of the shadows," Sydney Morning Herald, February 5, 2005
---
http://www.smh.com.au/text/articles/2005/02/04/1107476799248.html
The first economist, an early
Nobel Prize Winning economist, to raise the alarm of entitlements in
my head was Milton Friedman. He has written extensively about the
lurking dangers of entitlements. I highly recommend his fantastic
"Free to Choose" series of PBS videos where his "Welfare of
Entitlements" warning becomes his principle concern for the future
of the Untied States 25 years ago ---
http://www.ideachannel.com/FreeToChoose.htm
Our legislators did
not heed his early warnings, and now we are no longer "free to
choose." |
Alan Blinder ---
http://en.wikipedia.org/wiki/Alan_Blinder
Disclaimer
I've never been a fan of the progressive scholarship of Alan Blinder. He's been
a promoter of low (virtually zero) interest rates for megabanks that I think are
turning into a disaster in this economic recovery. Ben Bernanke can do no wrong
in the eyes of Professor Blinder. In my opinion, the real Bernanke-Blinder
disaster is their support of restraining the government budget deficit with
Zimbabwe economics that entails printing more greenbacks (over $2 trillion to
date) rather than taxing or borrowing what is needed to fight the deficit.
Actually the government does not add to the money supply by literally printing
greenbacks. But having the Fed buy up over 60% of the new government debt is
tantamount to printing greenbacks.
Taxing and borrowing to support government spending are going out of
style.
The main problem with Zimbabwe economics is that it does little to restrain the
excesses of government spending --- which we are now witnessing in the economic
mess in Greece. Greece, of course, cannot simply print Euros to continue to feed
government spending excesses. Greece has to get out of the Euro Zone to engage
in the Zimbabwe economics of Benanke and Blinder. Of course all of Europe might
soon engage in Zimbabwe economics to pay its debts. Taxing and borrowing to
support government spending are going out of style.
The budget should be balanced, the Treasury
should be refilled, public debt should be reduced, the arrogance of officialdom
should be tempered and controlled, and the assistance to foreign lands should be
curtailed lest Rome become bankrupt. People must again learn to work, instead of
living on public assistance.
Taylor Caldwell, A Pillar of Iron
(wrongly attributed to Cicero in 55 B.C.)
But under my philosophy of sharing all sides of arguments, I forward the
following case.
Teaching Case from The Wall Street Journal Accounting Weekly Review on
May 25, 2012
The Long and Short of Fiscal Policy
by:
Alan S. Blinder
May 22, 2012
Click here to view the full article on WSJ.com
TOPICS: Governmental Accounting, Income Tax, Tax Laws, Tax Policy,
Taxation
SUMMARY: Alan S. Blinder "...is a former vice chairman of the
Federal Reserve [and is now] a professor of economics and public affairs at
Princeton University." This opinion page piece provides a clear explanation
of macroeconomic effects of budget deficits, tax cuts, and spending cuts,
emphasizing the "macroeconomic effects of budget deficits in the short and
long runs."
CLASSROOM APPLICATION: The article is useful in either a tax course
or a governmental accounting class. The related article presents letters to
the editor with more Republican viewpoints than Mr. Blinder's.
QUESTIONS:
1. (Advanced) What are budget deficits?
2. (Introductory) Why can budget deficit spending be beneficial for
the U.S. economy in the short run?
3. (Introductory) Why are budget deficits bad for the U.S. economy
in the long run?
4. (Advanced) What tax law changes are imminent in January 2013?
How do they relate to the comic graphic associated with this opinion piece?
In your answer, comment on the size of these changes relative to the total
economy.
5. (Introductory) How might specific choices in spending be more
helpful than other possible choices? In your answer, explain the use of
return on investment in these decisions, defining that finance concept as
well.
6. (Introductory) What is the biggest cost component that could
most readily reduce the long term budget deficit problem we face in the
U.S.?
7. (Introductory) What does Mr. Blinder recommend as a plan for our
national fiscal policy?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Perhaps the 2013 Fiscal Cliff Presents an Opportunity
by Letters to the Editor: Carroll Hoke, Frank Peel, and Keith Colonna
Mar 23, 2012
Page: A14
"The Long and Short of Fiscal Policy," by: Alan S. Blinder, The Wall Street
Journal, May 22, 2012 ---
http://online.wsj.com/article/SB10001424052702303360504577408490648029470.html?mod=djem_jiewr_AC_domainid
Can we talk about the federal budget deficit?
Better yet, can we think about it? For there has been a lot more talking
than thinking. One persistent point of confusion arises from the radically
different macroeconomic effects of larger budget deficits in the short and
long runs.
In the short run—let's say within a year or so—a
larger deficit, whether achieved by spending more or taxing less, boosts
economic growth by increasing aggregate demand. It's pretty simple. If the
government spends more money without raising anyone's taxes to pay the
bills, that adds to total demand directly.
That's true, by the way, whether you like the
specific expenditures or hate them. Similarly, cutting somebody's taxes
without also cutting spending raises spending indirectly—again, whether you
like the tax cut or not.
A second layer of subtlety recognizes that some
types of spending and some types of tax cuts have larger effects on spending
than others, and similarly, that some types are more sharply targeted on job
creation than others. Such details matter in designing a cost-effective
stimulus package. But for present purposes, let's keep it simple: Higher
spending or lower taxes speed up growth by adding to demand.
So, as long as the government can borrow on
reasonable terms, the crucial short-run question is: Does the economy need
more or less demand? For the last several years, the answer has been clear:
more. Bolstering demand was the rationale for fiscal stimulus under
President Bush in 2008 and under President Obama in 2009. It remains a
persuasive rationale for further stimulus today.
But that's not going to happen. Instead, the
operational budget objective for the coming months is to ensure that we
don't shoot ourselves in the collective foot with fiscal austerity while the
economy is still weak. Sounds foolish, but we could make that grievous error
either by letting ourselves fall off the so-called fiscal cliff that awaits
us in January (tax increases and spending cuts amounting to 3.5%-4% of GDP),
or by crashing headlong into the national debt ceiling, as we almost did
last summer.
But don't we need to reduce the deficit—and by
large amounts? Yes, we do, but that's in the long run, where the effects of
larger deficits are mostly harmful to economic growth. In the jargon, more
government borrowing tends to "crowd out" private borrowers by pushing
interest rates up. Those crowded-out borrowers include both consumers who
want to buy cars and businesses that want to buy equipment. In the latter
case, higher government budget deficits take a toll on growth by slowing
down capital formation.
There is an important exception, however, which is
highly germane to today's situation. Suppose government borrowing is used to
finance productive investments in public capital—such as highways, bridges,
and tunnels. Right now, the U.S. government can borrow for 10 years at under
2% per annum. At these super-low interest rates, you don't have to be a
genius to find many public infrastructure projects with strongly positive
net present values. Borrowing to make such investments will enhance long-run
growth, not retard it. And I can't, for the life of me, understand why we
are not doing more of it.
But other types of spending, and any tax cut that
does not boost capital formation enough, will slow down growth. And that's
the fundamental indictment of large deficits.
To think clearly about how to shrink the long-run
deficit, we must understand its origins. Looking ahead, the lion's share of
projected future deficits comes from rising health-care expenditures.
Some of this cost escalation stems from heavier
usage—consuming more health services per capita. But most of it comes from
ever-rising relative prices; health care just keeps getting more expensive
relative to almost everything else. The good news is that, if we could
somehow limit health-care inflation to the overall inflation rate, much of
the long-run budget problem would virtually vanish. The bad news is that
nobody knows how to do that.
Given this ignorance, President Obama's health-care
reform law, which Republicans want to repeal and the Supreme Court may
vacate, takes a sensible approach to cost control. It includes—either on an
experimental, small-scale, or pilot basis—virtually every cost-containment
idea that has been suggested. The pragmatic attitude is: Let's try
everything and go with what works.
But what about the middle, between the short run
and the long run? When should the federal
government get serious about paring its deficit? There is no formulaic
answer, but U.S. Treasury borrowing rates will provide a clue. When they
start rising on a sustained basis, it will be time to push deficits down.
Another important clue will be the health of the economy.
The government should stop supporting aggregate demand when the
economy is strong enough to stand on its own two feet.
Continued in article
Jensen Comment
What Blinder does not admit to is that government borrowing rates are not
allowed to go up as long as the Fed buys over 60% of the new debt issues in its
Zimbabwe economic policy. I think I'm going to throw up!
Alan Blinder is all smoke and mirrors in an election year.
Bob Jensen's threads on The Greatest Swindle in the History of the World
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bernanke's money printing press
On March 18, the Federal Reserve announced it would purchase up to $300 billion
of long-term bonds as well as $750 billion of mortgage-backed securities. Of all
the Fed's moves, this "quantitative easing" gets money into the economy the
fastest -- basically by cranking the handle of the printing press and flooding
the market with dollars (in reality, with additional bank credit). Since these
dollars are not going into home building, coal-fired electric plants or auto
factories, they end up in the stock market. A rising market means that banks are
able to raise much-needed equity from private money funds instead of from the
feds. And last Thursday, accompanying this flood of new money, came the
reassuring results of the bank stress tests. The next day Morgan Stanley raised
$4 billion by selling stock at $24 in an oversubscribed deal. Wells Fargo also
raised $8.6 billion that day by selling stock at $22 a share, up from $8 two
months ago. And Bank of America registered 1.25 billion shares to sell this
week. Citi is next. It's almost as if someone engineered a stock-market rally to
entice private investors to fund the banks rather than taxpayers.
Andy Kessler, "Was It a Sucker's
Rally? You can have a jobless recovery but you can't have a profitless one,"
The Wall Street Journal, May 12, 2009 ---
http://online.wsj.com/article/SB124208415028908497.html
Bernanke is insanely printing hundreds of millions of dollars that do not
arise from taxes or borrowing
We remember that 2003 debate because it turns out
we played a part in it. The Fed recently released the transcripts of its 2003
FOMC meetings, and what a surprise to find a
Journal
editorial the subject of an insider rebuttal from
none other than Ben Bernanke, then a Fed Governor and now Chairman. We had run
an editorial on monetary policy on the same day as the Dec. 9, 2003 FOMC
meeting, and Mr. Bernanke clearly didn't take well to our warning about "Speed
Demons at the Fed."We reprint nearby both Mr.
Bernanke's comments and
our
editorial from that day. Readers can judge who got
the better of the argument, but far more important is what Mr. Bernanke's
reasoning tells us about the Fed today. Our guess is that it won't reassure
holders of dollar assets
"Bernanke at the Creation: What the Fed Chairman said at the
onset of the credit bubble, and the lesson for today," The Wall Street
Journal, June 23, 2009 ---
http://online.wsj.com/article/SB124572415681540109.html
Video on the Long-term Disaster of Beranke's Money Supply
Printing Press That Will Kick in Hyperinflation ---
http://www.youtube.com/watch?v=dlHBYQrCnIk
Will the U.S. become Zimbabwe? ---
http://faculty.trinity.edu/rjensen/entitlements.htm
Can you see why I believe this is a sucker's rally?
The stock market still has big hurdles to clear. You
can have a jobless recovery, but you can't have a profitless recovery. Consider:
Earnings are subpar (and may get worse with more concessions to labor
unions), Treasury's last auction was a bust because of
weak demand, the dollar is suspect, the stimulus is pork, the latest budget
projects a $1.84 trillion deficit, the administration is berating investment
firms and hedge funds saying "I don't stand with them," California is dead
broke, health care may be nationalized, cap and trade will bump electric bills
by 30% . . . Shall I go on? Until these issues are resolved, I don't see the
stock market going much higher. I'm not disagreeing with the Fed's policies --
but I won't buy into a rising stock market based on them. I'm bullish when I see
productivity driving wealth.
Andy Kessler, "Was It a Sucker's
Rally? You can have a jobless recovery but you can't have a profitless one,"
The Wall Street Journal, May 12, 2009 ---
http://online.wsj.com/article/SB124208415028908497.html
Jensen Comment
Nobody can be counted on to predict the stock market and the unpredictable
shocks that affect it. One shock that will ultimately drive equity market prices
up is inflation, and inflation is inevitable with Obama's annual egalitarian
deficits of $2 trillion or more. One problem with inflation is that nobody can
accurately predict just when the stock market will make huge upward moves for
Zimbabwe-like inflation. A second problem is that paper profits on equity are
not real profits. They're probably losses in spending power. If these huge Obama
deficits continue in the future, both debt and equity will have to be indexed
for inflation when investors cease to be suckers. For many years investors in
high-inflation nations like Brazil stopped being suckers. Virtually all security
investments in Brazil are indexed for inflation.
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire.
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
Bob Jensen’s threads on impending disaster ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
Once the spigot is turned on it's almost never turned off: That's
how special appropriations become entitlements
Several university presidents and higher-education officials went to Capitol
Hill on Tuesday to thank lawmakers for committing more ($21.5
billion) funds for scientific research, but they
worried about what might happen to their budgets if that commitment didn't
continue.
Paul Baskey, "Universities Are Wary
of Drawbacks to a Huge Boost in Federal Spending," Chronicle of Higher
Education, March 25, 2009 ---
http://chronicle.com/daily/2009/03/14470n.htm?utm_source=at&utm_medium=en
Jensen Comment
This is the same argument that will be raised by virtually all recipients of the
2009 massive Stimulus (Recovery) Act handouts to states, education/research
institutions, welfare programs, public works projects, etc. Once the spigot is
turned on such handouts are hard to stop in future budget years. They become
entitlements that will make President Obama's promise to reduce the Year 2012
budget deficit a complete and utter failure. Both logic and sob stories make it
virtually impossible to turn the spigots off once they've been turned on. This
is one of the common problems of budgeting in general except for Zero-Based
Budgeting that almost never takes place in industry and probably has never taken
place in state and federal governments.
Bob Jensen's threads on the entitlements disaster are at
http://faculty.trinity.edu/rjensen/Entitlements.htm
Tim Geithner Draws a Big Laugh and Lots of Sighs In China
U.S. Treasury Secretary Timothy Geithner on Monday
reassured the Chinese government that its huge holdings of dollar assets are
safe and reaffirmed his faith in a strong U.S. currency. A major goal of
Geithner's maiden visit to China as Treasury chief is to allay concerns that
Washington's bulging budget deficit and ultra-loose monetary policy will fan
inflation, undermining both the dollar and U.S. bonds. China is the biggest
foreign owner of U.S. Treasury bonds. U.S. data shows that it held $768 billion
in Treasuries as of March, but some analysts believe China's total U.S.
dollar-denominated investments could be twice as high. "Chinese assets are very
safe," Geithner said in response to a question after a speech at Peking
University, where he studied Chinese as a student in the 1980s. His answer drew
loud laughter from his student audience, reflecting skepticism in China about
the wisdom of a developing country accumulating a vast stockpile of foreign
reserves instead of spending the money to raise living standards at home.
Glenn Somerville, Reuters,
June 1, 2009 ---
Click Here
The salary of the chief
executive of a large corporation is not a market award for achievement. It is
frequently in the nature of a warm personal gesture by the individual to
himself.
John Kenneth Galbraith ---
Click Here
The total return of the S&P 500 index fell by nearly 40%
last year, the second-worst performance by America’s stockmarket since 1825 ---
http://www.simoleonsense.com/us-stockmarket-returns-since-1825/
But Wall Street's pay packages in 2009 are shooting for all time highs ---
Click Here
Bob Jensen's threads on outrageous compensation ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Instead of adding more regulating agencies, I think
we should simply make the FBI tougher on crime and the IRS tougher on cheats
Our Main Financial Regulating Agency: The SEC Screw
Everybody Commission
One of the biggest regulation failures in history is the way the SEC failed to
seriously investigate Bernie Madoff's fund even after being warned by Wall
Street experts across six years before Bernie himself disclosed that he was
running a $65 billion Ponzi fund.
I’m deeply suspicious that there was possibly too much
“experience” of a different type as well as “inexperience” cited as the main
cause of the SEC’s negligence. The Inspector General’s Report leaves a lot to be
desired.
"Statement by SEC Chairman: Statement on the Inspector
General's Report Regarding the Bernard Madoff Fraud," by SEC Chairman Mary
Shapiro, SEC Speech, September 4, 2009 ---
http://sec.gov/news/speech/2009/spch090409mls.htm
Inspector General's Report ---
http://sec.gov/news/speech/2009/spch090409mls.htm
Swanson Acknowledged in
Testimony that If He Had Carefully Reviewed the Complaint, He Would Have
Investigated
Additional Red Flags That Were
Raised Swanson stated the Hedge Fund Manager’s complaint and the 2001
articles mean something different to him today than they did at the time of
the examination in 20032004, noting, “I didn’t know anything, very little
anyway, about hedge funds and mutual funds and how they operated.” Id. at p.
39. Swanson admitted that to someone who understood the hedge fund world,
Madoff’s failure to charge money management fees “would probably be a little
surprising.” Id. at p. 37. Swanson now reads the Hedge Fund Manager’s
complaint to “indicate to me … [BMIS] may be not trading as much in options
as they’re saying they’re doing,” and the red flag about the auditor to
“signal some level of a lack of independence with respect to the auditor.”
Id. at pgs. 37-38. Swanson testified that if he had reviewed the complaint,
he would have wanted to look into the auditor issue. Swanson Testimony Tr.
at p. 50. McCarthy and Donohue also thought that the allegation that the
auditor was a related party to the principal was noteworthy and something
that should have been followed up upon. Donohue Testimony Tr. at p. 42;
McCarthy Testimony Tr. at p. 58. As Donohue explained, “His statement that
the auditor of the firm is a related party to the principal would indicate
that there are potential conflicts with the firm and the auditor.” Donohue
Testimony Tr. at p. 42. However, during the course of the examination, the
exam team did not examine whether the auditor of the firm was a related
party to the principal.
. . .
ALLEGATIONS OF CONFLICT OF
INTEREST OR IMPROPER INFLUENCE ARISING FROM THE RELATIONSHIP BETWEEN ERIC
SWANSON AND SHANA MADOFF (Pages 389-404)
After his sworn testimony
on June 19, 2009, Swanson provided supplemental information to the
Office of the Inspector General, stating that he had a vague
recollection that, “prior to 2005, he and Mr. McCarthy discussed the
appropriateness of working on matters involving Madoff in light of their
participation in the compliance breakfasts, and that neither he nor
McCarthy determined that they should be recused.” Letter dated June 19,
2009 from Michael Wolk, Counsel to Swanson, to IG Kotz, at p. 2, at
Exhibit 183. Swanson also stated that he “took comfort in the fact that
Lori Richards, Director, Office of Compliance Inspections and
Examinations, was aware that the breakfasts were sponsored by the
Securities Industry Association (SIA).” Id.
Jensen Comment
This part of the Inspector General's report relies a lot upon Eric Swanson's
claims of not being able to remember much about his early-on relationships
with Shana Madoff. About this part of the Report I am very suspicious.
However, early news accounts are also somewhat inconsistent.
"Ponzi Schemer's Label-Whoring Niece Married SEC
Lawyer," by Owen Thomas, December 16, 2008 ---
http://gawker.com/5111942/ponzi-schemers-label+whoring-niece-married-sec-lawyer
Shana Madoff, whose uncle Bernie Madoff stands
accused of defrauding investors of $50 billion (later raised to over
$65 billion), is the wife of Eric Swanson, a former
top lawyer at the Securities and Exchange Commission. A goy, but
well-placed!
So well-placed that SEC chairman Christopher Cox is
now elaborately raising his eyebrows about the relationship — especially
since Shana Madoff worked as the compliance lawyer at Bernard L. Madoff
Investment Securities, and met Swanson at a trade association event. . . .
Swanson resigned from the SEC in 2006, and the
couple married in 2007. But they clearly dated for a while before that.
Some have suggested that Shana Madoff is a
"shopaholic." So not technically true! Why, she married the manager of a
men's clothing store in 1997, but that didn't work out. A 2004 New York
profile detailed her simultaneous affection for Narciso Rodriguez and
aversion to actually going out and shopping. Instead of trying on clothes at
the store, she had salespeople messenger the entire collection to her
office, and charge her only for what she didn't return. The article mentions
her having a boyfriend. Was that Swanson, whom one SEC colleague said
conducted a review of Madoff's firm in 1999 and 2004?
A spokesman for Swanson — they get flacks quickly
these days, don't they — told ABC News that he "did not participate in any
inquiry of Bernard Madoff Securities or its affiliates while involved"
(it was later shown that he was very involved in the Madoff
"investigation" while at the SEC) with Shana Madoff.
How convenient!
But that could be said about pretty much all of his
coworkers. The SEC first fielded complaints about the Madoff firm in 1999,
but never opened a formal investigation that would have allowed it to
subpoena records. In 2006, Bernard Madoff registered as an investment
advisor with the SEC, but the agency never conducted a standard review. Are
you beginning to get a picture of why Shana Madoff, who was charged with
keeping the company out of trouble with regulators, was so busy she couldn't
even go shopping?
Swanson was at the commission in 2003 when the
agency was examining the Madoff firm. More
importantly, he was also part (leader) of the SEC
team that was conducting the actual inquiry into the firm . . .
What does all this mean? Nothing, according to Shana
Madoff or her husband, whom she married in 2007. A spokesman for Shana Madoff
and one for Swanson confirm that both knew each other professionally during the
time of the examination.
"Madoff Victims Claim Conflict of Interest at SEC," CNBC, December 15,
2008 ---
http://www.cnbc.com/id/28242487
Madoff Timeline ---
http://www.madoff-help.com/wp-content/uploads/2009/06/timeline.pdf
"Madoff Inquiry Was Fumbled by S.E.C., Report Says," by David Stout, The
New York Times, September 2, 2009 ---
http://www.nytimes.com/2009/09/03/business/03madoff.html?_r=1&hp
In a damning report on the S.E.C.’s performance,
the agency’s inspector general, H. David Kotz, said numerous “red flags” had
been missed by the agency, including some warnings sounded by journalists,
well before Mr. Madoff’s
Ponzi scheme imploded in 2008.
Mr. Kotz concluded that, “despite numerous credible
and detailed complaints,” the S.E.C. never properly investigated Mr. Madoff
“and never took the necessary, but basic, steps to determine if Madoff was
operating a Ponzi scheme.”
“Had these efforts been made with appropriate
follow-up at any time beginning in June of 1992 until December 2008, the
S.E.C. could have uncovered the Ponzi scheme well before Madoff confessed,”
the report concluded.
That Mr. Madoff’s scheme, estimated to have fleeced
as much as $65 billion from investors who ranged from the famous to
middle-class people who entrusted him with their life savings, was not
caught earlier was not because of his cleverness, the report said. Rather,
it was because the S.E.C. fumbled three agency exams and two investigations
because of inexperience, incompetence and lack of internal communications.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Ponzi Schemer's Label-Whoring Niece Married SEC
Lawyer," by Owen Thomas, December 16, 2008 ---
http://gawker.com/5111942/ponzi-schemers-label+whoring-niece-married-sec-lawyer
Shana Madoff, whose uncle Bernie Madoff stands
accused of defrauding investors of $50 billion (later raised to over
$65 billion), is the wife of Eric Swanson, a former
top lawyer at the Securities and Exchange Commission. A goy, but
well-placed!
So well-placed that SEC chairman Christopher Cox is
now elaborately raising his eyebrows about the relationship — especially
since Shana Madoff worked as the compliance lawyer at Bernard L. Madoff
Investment Securities, and met Swanson at a trade association event. (Can
you imagine what a swinging scene that was?)
Swanson resigned from the SEC in 2006, and the
couple married in 2007. But they clearly dated for a while before that.
Some have suggested that Shana Madoff is a
"shopaholic." So not technically true! Why, she married the manager of a
men's clothing store in 1997, but that didn't work out. A 2004 New York
profile detailed her simultaneous affection for Narciso Rodriguez and
aversion to actually going out and shopping. Instead of trying on clothes at
the store, she had salespeople messenger the entire collection to her
office, and charge her only for what she didn't return. The article mentions
her having a boyfriend. Was that Swanson, whom one SEC colleague said
conducted a review of Madoff's firm in 1999 and 2004?
A spokesman for Swanson — they get flacks quickly
these days, don't they — told ABC News that he "did not participate in any
inquiry of Bernard Madoff Securities or its affiliates while involved"
(it was later shown that he was veru involved in the Madoff
"investigation" while at the SEC) with Shana Madoff.
How convenient!
But that could be said about pretty much all of his
coworkers. The SEC first fielded complaints about the Madoff firm in 1999,
but never opened a formal investigation that would have allowed it to
subpoena records. In 2006, Bernard Madoff registered as an investment
advisor with the SEC, but the agency never conducted a standard review. Are
you beginning to get a picture of why Shana Madoff, who was charged with
keeping the company out of trouble with regulators, was so busy she couldn't
even go shopping?
Swanson was at the commission in 2003 when the
agency was examining the Madoff firm. More
importantly, he was also part of the SEC team that was conducting the actual
inquiry into the firm . . . What does all
this mean? Nothing, according to Shana Madoff or her husband, whom she married
in 2007. A spokesman for Shana Madoff and one for Swanson confirm that both knew
each other professionally during the time of the examination.
"Madoff Victims Claim Conflict of Interest at SEC," CNBC, December 15,
2008 ---
http://www.cnbc.com/id/28242487
Madoff Timeline ---
http://www.madoff-help.com/wp-content/uploads/2009/06/timeline.pdf
CBS Sixty Minutes on June 14, 2009 ran a rerun that is
devastatingly critical of the SEC. If you’ve not seen it, it may still be
available for free (for a short time only) at
http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
The title of the video is “The Man Who Would Be King.”
Also see
http://www.fraud-magazine.com/FeatureArticle.aspx
Between 2002 and 2008 Harry Markopolos repeatedly told
(with indisputable proof) the Securities and Exchange Commission that Bernie
Madoff's investment fund was a fraud. Markopolos was ignored and, as a result,
investors lost more and more billions of dollars. Steve Kroft reports.
Markoplos makes the SEC look truly incompetent or
outright conspiratorial in fraud.
I'm really surprised that the SEC survived after Chris
Cox messed it up so many things so badly.
As Far as Regulations Go
An annual report issued by
the Competitive Enterprise Institute (CEI) shows that the U.S. government
imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the
$1.2 trillion generated by individual income taxes, and amounts to $3,849 for
every American citizen. According the 2009 edition of Ten Thousand Commandments:
An Annual Snapshot of the Federal Regulatory State, the government issued 3,830
new rules last year, and The Federal Register, where such rules are listed,
ballooned to a record 79,435 pages. “The costs of federal regulations too often
exceed the benefits, yet these regulations receive little official scrutiny from
Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report.
“The U.S. economy lost value in 2008 for the first time since 1990,” Crews said.
“Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on
Americans beyond the $3 trillion officially budgeted” through the regulations.
Adam Brickley,
"Government Implemented Thousands of New Regulations Costing $1.17 Trillion in
2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487
Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the
regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur
Levitt to Chris Cox do absolutely nothing to change my belief ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
How do industries leverage the regulatory agencies?
The primary control mechanism is to have high paying jobs waiting in industry
for regulators who play ball while they are still employed by the government. It
happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so
many people work for the FBI and IRS, it's a little harder for industry to
manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of
the worst offenders whereas other agencies often deal with top management of the
largest companies in America.
Why Obama's Big Spending, Big Taxing Regime Will Cripple the U.S. Economy
Before any article on savings and investment can
really make sense, it must first define what savings and investment really mean.
Saving is the process of transforming present goods into future goods. Present
goods are consumption goods and future goods are capital goods. When we save, we
transfer purchasing power from consumption to the production of capital goods,
many of which will then be used to produce more capital goods. (This is why
growth is sometimes called forgone consumption.) Investment in more capital (the
material means of production) makes for increased future consumption, i.e.,
higher living standards. It needs little imagination to realise that taxing
savings amounts to taxing future living standards. What needs to be remembered
is that when defined in real terms, investment and savings are (a) always equal
and (b) saving is clearly the only means by which resources can be directed from
consumption to investment. To put it another way: The function of savings is to
redirect resources from the production of consumption goods to the production of
capital goods.
"Why Obama's Big Spending, Big Taxing Regime Will Cripple the
U.S. Economy," Seeking Alpha, March 23, 2009 ---
http://seekingalpha.com/article/127312-why-obama-s-big-spending-big-taxing-regime-will-cripple-the-u-s-economy
Not a single county in the entire state
(California) voted for the tax-and-spend propositions
on yesterday's referendum ballot, not even the peculiar folks who live in Nancy
Pelosi's far-left 8th Congressional District who persist in sending the Wicked
Witch of the West to the Nation's Capitol to wage war on the CIA and the
nation's taxpayers. The only measure voters did approve was one to freeze
salaries of senior public officials during budget emergencies.
Michael Reagan, "Terminating the
Terminator," Townhall, May 20, 2009 ---
http://townhall.com/columnists/MichaelReagan/2009/05/20/terminating_the_terminator
Jensen Comment
What's worse in many respects is that California voters sent a message to
President Obama that taxing the middle class (the only way to raise serious
deficit-cutting revenue) to halt deficit-induced halt hyperinflation of the U.S.
dollar will not be supported by voters.
See
http://townhall.com/columnists/MattTowery/2009/05/21/california,_here_we_come
A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
The inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)
2001 Economic Crisis Prediction of George W. Bush (video) ---
http://www.youtube.com/watch?v=cMnSp4qEXNM&NR=1
The government should create, issue, and circulate
all the currency and credits needed to satisfy the spending power of the
government and the buying power of consumers. By adoption of these principles,
the taxpayers will be saved immense sums of interest. Money will cease to be
master and become the servant of humanity.
Abraham Lincoln (I wonder why this
just does not work in Zimbabwe where Robert Mugabe adopted Lincoln's fiscal
policy?)
The Abraham Lincoln School of Finance in Action
Zimbabwe's central bank will introduce a 100 trillion Zimbabwe dollar banknote,
worth about $33 on the black market, to try to ease desperate cash shortages,
state-run media said on Friday.
KyivPost,
January 16, 2009 ---
http://www.kyivpost.com/world/33522
Who stands between the Obama and the Abraham Lincoln School of Finance?
If China won't lend trillions more to the U.S., Obama may have to print those
trillions of dollars: Watch inflation/trade deficits soar like a NASA
rocket
The Chinese prime minister, Wen Jiabao, expressed
unusually blunt concern on Friday about the safety of China’s $1 trillion
investment in American government debt, the world’s largest such holding, and
urged the Obama administration to provide assurances that the securities would
maintain their value in the face of a global financial crisis.
Michael Wines and Keith Bradsher,
"China’s Leader Says He Is ‘Worried’ Over U.S. Treasuries," The New York
Times, March 13, 2009 ---
http://www.nytimes.com/2009/03/14/world/asia/14china.html?_r=1&hp
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
And while you are at it, you might read another book
published the same year as Hayek's book was: The Great Transformation by
Karl Polanyi. It is Polanyi who is truly in the tradition of Adam Smith in that
he incorporates ethics and sociological considerations into his economics. Smith
was a moral philosopher before he was an economist. Hayek was used as a
spokesperson by the ultra-conservative anti-Keynesians of the time. Life
magazine even put out a cartoon version of Hayek's book. Academics might want to
get a fuller picture and read both Polanyi and Hayek to understand two major
currents of thought at the time.
Sue Ravenscroft, Iowa State University
The US government is on a “burning platform” of
unsustainable policies and practices with fiscal deficits, chronic healthcare
underfunding, immigration and overseas military commitments threatening a crisis
if action is not taken soon.
David M. Walker, Former Chief
Accountant of the United States ---
http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt
for entitlements (over five times the booked national debt and soaring with new
entitlements) ---
http://faculty.trinity.edu/rjensen/entitlements.htm
South Park's animated cartoon solutions to the economic crisis Part 1 ---
http://www.youtube.com/watch?v=Qx_sH_G38oY
South Park's animated cartoon solutions to the economic crisis Part 2 ---
http://www.youtube.com/watch?v=KUIDG0n74J0
South Park's animated cartoon solutions to the economic crisis Part 3 ---
http://www.youtube.com/watch?v=UbFcYuJ_H8c
Question
What caused the credit crisis and why can't credit be unlocked after throwing
over $1 trillion at the big banks?
Great answers on Video --- this is a
must-see video for you, your family, and your students who want to understand
these banking failures
The Short and Simple Video About What Caused the Credit Crisis ---
http://vimeo.com/3261363
Also at
http://www.youtube.com/watch?v=Q0zEXdDO5JU
Ed Scribner forwarded the above links
The 2008-2009 Economic Downfall
Great Graphic:
Infographic: Anatomy of the Crash
http://www.simoleonsense.com/infographic-anatomy-of-the-crash/
Bob Jensen's threads on the downfall ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Questions
Although all 50 states are in deep financial troubles, what state is in the
worst shape at the moment and is unable to pay its bills?
Hint: The state in deepest trouble is not California, although California is in
dire straights!
How did accountants hide the pending
disasters?
Watch the Video
This module on 60 Minutes on December 19 was one of the most worrisome episodes
I've ever watched
It appears that a huge number of cities and towns and some states will default
on bonds within12 months from now
"State Budgets: The Day of Reckoning Steve Kroft Reports On The Growing
Financial Woes States Are Facing," CBS Sixty Minutes, December 19, 2010 ---
http://www.cbsnews.com/stories/2010/12/19/60minutes/main7166220.shtml
The problem with that, according to Wall Street
analyst Meredith Whitney, is that no one really knows how deep the holes
are. She and her staff spent two years and thousands of man hours trying to
analyze the financial condition of the 15 largest states. She wanted to find
out if they would be able to pay back the money they've borrowed and what
kind of risk they pose to the $3 trillion municipal bond market, where state
and local governments go to finance their schools, highways, and other
projects.
"How accurate is the financial information that's
public on the states? And municipalities," Kroft asked.
"The lack of transparency with the state disclosure
is the worst I have ever seen," Whitney said. "Ultimately we have to use
what's publicly available data and a lot of it is as old as June 2008. So
that's before the financial collapse in the fall of 2008."
Whitney believes the states will find a way to
honor their debts, but she's afraid some local governments which depend on
their state for a third of their revenues will get squeezed as the states
are forced to tighten their belts. She's convinced that some cities and
counties will be unable to meet their obligations to municipal bond holders
who financed their debt. Earlier this year, the state of Pennsylvania had to
rescue the city of Harrisburg, its capital, from defaulting on hundreds of
millions of dollars in debt for an incinerator project.
"There's not a doubt in my mind that you will see a
spate of municipal bond defaults," Whitney predicted.
Asked how many is a "spate," Whitney said, "You
could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This
will amount to hundreds of billions of dollars' worth of defaults."
Municipal bonds have long been considered to be
among the safest investments, bought by small investors saving for
retirement, and held in huge numbers by big banks. Even a few defaults could
affect the entire market. Right now the big bond rating agencies like
Standard & Poor's and Moody's, who got everything wrong in the housing
collapse, say there's no cause for concern, but Meredith Whitney doesn't
believe it.
"When individual investors look to people that are
supposed to know better, they're patted on the head and told, 'It's not
something you need to worry about.' It'll be something to worry about within
the next 12 months," she said.
No one is talking about it now, but the big test
will come this spring. That's when $160 billion in federal stimulus money,
that has helped states and local governments limp through the great
recession, will run out.
The states are going to need some more cash and
will almost certainly ask for another bailout. Only this time there are no
guarantees that Washington will ride to the rescue.
Continued in article
The Government' Recipe for Off-Budget Debt
"US Government 'hiding true amount of debt'," by Gregory Bresiger, news,com ---
http://www.news.com.au/business/breaking-news/us-government-hiding-true-amount-of-debt/story-e6frfkur-1225926567256#ixzz106MjZzOz
Bob Jensen's threads on the economic
crisis ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The Sad State of Government Accounting and
Accountability ---
http://faculty.trinity.edu/rjensen/theory02.htm#GovernmentalAccounting
Question
Who more than anybody else is at fault for wiping out shareholders in AIG, Bear
Stearns, Merrill Lynch, CitiBank, Bank of America, Washington Mutual, Fannie
Mae, Freddie Mack, etc.
Answers
I primarily blame the CPA auditors, internal auditors, and credit rating
agencies that failed to disclose the off-balance-sheet risks that fee-loving
bankers had created. The auditors and credit rating agencies have a fiduciary
and professional responsibility to disclose to investors the extent of looming
uncollectable investments. For many years auditors have been knowingly
understating banks' bad debt risks and failing to warn investors about such
banking risks. I also think auditors, along with credit rating agencies, knew
full well about the financial risks of their huge clients but were afraid to
jeopardize their fees by blowing whistles.
Question
What more than anything else saved United Airlines and who is primarily at fault
for wiping out the shareholders of United Airlines in 2002?
Answer
In December 2002 United Airlines filed Chapter 11 Bankruptcy. In order to get
United's airplanes back in the air, the single most important saving device was
to have Uncle Sam's taxpayers take over the lifetime retirement obligations to
be paid to United's retired pilots, flight attendants, mechanics, passenger
agents, and ground crews. This saved United Airlines with the help of some major
wage concessions of existing employees who decided that keeping their jobs was
the most important thing to them.
Once again the auditors are primarily at fault for not warning investors soon
enough that United Airlines was not a viable going concern and would not be able
to meet its unbooked liabilities called Off-Balance-Sheet-Financing (OBSF) by
accountants. If investors had been warned years earlier, the stock market
would've forced United Airlines to become more serious about pricing and funding
of retirement obligations. But since investors were not forewarned by the
auditors and credit rating agencies, the equity holders (many of them United
Airlines employees) got wiped out by the 2002 declaration of bankruptcy.
Question
What more than anything else will save General Motors in 2009 and who is
primarily at fault for wiping out the shareholders of General Motors?
In 2009 or 2010 filed General Motors will most likely declare Chapter 11
Bankruptcy. It will be Deja Vu United Airlines. In order to get GM's vehicles
back on the road, the single most important saving device was to have Uncle
Sam's taxpayers take over the retirement obligations (pensions and health care
obligations) to be paid to GM's retired management and factory workers and GMAC
retired employees as well. This will save GM with the help of some major wage
concessions of existing GM employees who eventually decide that keeping their
jobs was the most important thing to them.
Once again the auditors are primarily at fault for not warning investors soon
enough that General Motors was not a viable going concern and would not be able
to meet its unbooked liabilities called Off-Balance-Sheet-Financing (OBSF). If
investors had been warned years earlier, the stock market would've forced
General Motors to become more serious about pricing and funding of retirement
obligations. But since investors were not forewarned by the auditors and credit
rating agencies, the equity holders (many of them being huge investment funds)
got wiped out by the forthcoming 2009 declaration of bankruptcy.
In fairness, the accountants did give more warning about OBSF unfunded
retirement obligations in GM's case relative the United Airlines. Accountants
did disclose some years ago that about $1,500 of each new vehicle sold went
toward current funding of for retirement and health care of GM's retired
workers. It's been widely known for some time that GM's retirement obligations
were badly underfunded. What made it especially difficult for GM is that it's
major foreign competitors were making longer-lasting vehicles that beat GM
prices. The reason Toyota, Subaru, Nissan, etc. could undercut GM prices is that
these foreign automakers did not have the serious unbooked OBSF obligations that
GM carried on its back.
Question
What are the two secret numbers that you will never hear mentioned by Uncle
Sam's current leaders like President Obama, House Speaker Pelosi, and Senate
Leader Reid?
Answer
They will never mention the extent of Uncle Sam's unbooked OBSF liabilities.
Accountants have no accurate estimates of these liabilities, but the former
Chief Accountant of the United States, David Walker, estimates that these are
about $60 trillion at the moment. They may well be $100 trillion in four years
if Congress is successful in legislating tens of trillions of dollars in new
entitlements for education, energy, welfare, and health care.
Uncle Sam's leaders are now focusing our attention on problems with the annual
spending deficit (which may well approach $ trillion at the end of 2009) and the
booked National Debt (which may well approach $12 trillion by the end of 2009).
But these booked items will not break the back of Uncle Sam. What will break the
back of Uncle Sam is what broke the back of United Airlines and General Motors.
It's the unbooked OBSF debt which the companies, auditors, and credit rating
agencies tried to keep secret.
Uncle
Sam saved United Airlines by taking over United's OBSF retirement debt. Uncle
Sam will probably do the same for GM, Ford, and Chrysler unfunded OBSF debt. But
who will save Uncle Sam from its $60-$100 trillion of unfunded and unbooked OBSF
debt?
Answer
Only the Abraham Lincoln School of Finance (see Lincoln’s quote below) will save
Uncle Sam from its unsustainable OBSF
You,
your family, and your students may learn a great deal from the links to David
Walker's warning videos and the most worrisome CBS Sixty Minutes module ever
produced ---
http://faculty.trinity.edu/rjensen/entitlements.htm
The US government is on a “burning platform” of unsustainable
policies and practices with fiscal deficits, chronic healthcare underfunding,
immigration and overseas military commitments threatening a crisis if action is
not taken soon.
David M. Walker,
Former Chief Accountant of the United States ---
http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt
for entitlements (over five times the booked national debt and soaring with new
entitlements) ---
http://faculty.trinity.edu/rjensen/entitlements.htm
A democracy cannot exist as a permanent form of government. It can only exist
until the voters discover that they can vote themselves largesse from the public
treasury. From that moment on, the majority always votes for the candidates
promising the most benefits from the public treasury, with the result that a
democracy always collapses over loose fiscal policy, always followed by a
dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm
(where the debt clock in real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for updates by the
second) ---
http://www.brillig.com/debt_clock/
America,
what is happening to you?
“One thing seems probable to me,” said Peer
Steinbrück, the German finance minister, in September 2008....“the United States
will lose its status as the superpower of the global financial system.” You
don’t have to strain too hard to see the financial crisis as the death knell for
a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida,
"How the Crash Will Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
The inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)
From the Abraham Lincoln School of Finance
The government should create, issue, and circulate all the currency and credits
needed to satisfy the spending power of the government and the buying power of
consumers. By adoption of these principles, the taxpayers will be saved immense
sums of interest. Money will cease to be master and become the servant of
humanity.
Abraham Lincoln
(I wonder why this just does not work in Zimbabwe where Robert Mugabe adopted
Lincoln's fiscal policy?)
For
the sake of future America, we’d better hope that Lincoln was correct. But
Lincoln’s fiscal policy sure did not work for Zimbabwe.
Facing mounting criticism of a spending package packed
with billions of dollars in earmarks, the Obama administration made a vow
Sunday: This president will bring a halt to pork-laden bills.
"Obama budget director: We'll cut pork after '09 spending bill,"
CNN, March 8, 2009 ---
http://www.cnn.com/2009/POLITICS/03/08/obama.earmarks/index.html
Jensen Comment
If you believe this, I have a great deal on ocean front property in Arizona just
for you. I'll also let you have the Brooklyn Bridge for $5,000.
Fannie Mae and Freddie Mac, the two troubled
companies at the heart of the nation’s mortgage market, are set to pay their
employees “retention bonuses” totaling $210 million, despite calls from
lawmakers to cancel the payments. The bonuses, which were made public on Friday,
were defended by the companies’ federal regulator, James B. Lockhart, who said
he intended to let them proceed , , , Mr. Lockhart declined to discuss his
conversations with the White House, which declined to comment on Friday. “This
is a de facto White House endorsement of these payments, which is a little odd
considering that everyone spent days talking about how they were shocked by the
bonuses given to A.I.G.,” said Karen Shaw Petrou, a managing partner at Federal
Financial Analytics, a consulting firm in Washington and a longtime observer of
the companies. “It’s also a tempest in a teapot. We should worry less about $210
million in bonuses, and more about the fact that these companies are sitting
atop $5 trillion of risks, and if they stumble, the American economy could
disappear.”
Charles Duhigg, "Big Bonuses at
Fannie and Freddie Draw Fire," The New York Times, April 3, 2009 ---
http://www.nytimes.com/2009/04/04/business/04bonus.html?_r=1
New restrictions proposed for ratings agencies --
including Moody's, Fitch and Standard & Poor's -- could have unintended
consequences, warn experts in the United States. Europe, however, has clamped
down on the agencies, whose stamps of approval on a broad spectrum of subprime
mortgage securities helped pave the way to the credit crash of 2007 and the
continuing global recession.
"Reforming the Ratings Agencies: Will the U.S. Follow Europe's
Tougher Rules?" Knowledge@Wharton
, May 27, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2242
Simoleon Sense
Reviews Janet Tavakoli’s Dear Mr. Buffett ---
http://www.simoleonsense.com/simoleon-sense-reviews-janet-tavakolis-dear-mr-buffett/
What’s The Book (Dear Mr. Buffett) About
Dear Mr. Buffett,
chronicles the agency problems, poor regulations, and participants which led to
the current financial crisis. Janet accomplishes this herculean task by
capitalizing on her experiences with derivatives, Wall St, and her relationship
with Warren Buffett. One wonders how she managed to pack so much material in
such few pages!
Unlike many books which only analyze past events, Dear Mr.
Buffett, offers proactive advice for improving financial markets. Janet is
clearly very concerned about protecting individual rights, promoting honesty,
and enhancing financial integrity. This is exactly the kind of character we
should require of our financial leaders.
Business week once called Janet the Cassandra of Credit
Derivatives. Without a doubt Janet should have been listened to. I’m confident
that from now on she will be.
Closing thoughts
Rather than a complicated book on financial esoterica, Janet has
created a simple guide to understanding the current crisis. This book is a must
read for all students of finance, economics, and business. If you haven’t read
this book, please do so.
Warning –This book is likely to infuriate you, and that’s a good
thing!
Janet provides indicting evidence and citizens may be tempted to
initiate vigilante like witch trials. Please
consult with your doctor before taking this financial medication.
Continued in article
September 1, 2009 reply from Rick Lillie
[rlillie@CSUSB.EDU]
Hi Bob,
I am reading Dear Mr. Buffett, What an Investor
Learns 1,269 Miles from Wall Street, by Janet Tavakoli. I am just about
finished with the book. I am thinking about giving a copy of the book to
students who perform well in my upper-level financial reporting classes.
I agree with the reviewer’s comments about
Tavakoli’s book. Her explanations are clear and concise and do not require
expertise in finance or financial derivatives in order to understand what
she (or Warren Buffet) says. She explains the underlying problems of the
financial meltdown with ease. Tavakoli does not blow you over with “finance
BS.” She does in print what Steve Kroft does in the 60 Minutes story.
Tavakoli delivers a unique perspective throughout
the book. She looks through the eyes of Warren Buffett and explains issues
as Buffett sees them, while peppering the discussion with her experience and
perspective.
The reviewer is correct. Tavakoli lets the finance
world, along with accountants, attorneys, bankers, Congress, and regulators,
have it with both barrels!
Tavakoli’s book is the highlight of my summer
reading.
Best wishes,
Rick Lillie
Rick Lillie, MAS, Ed.D., CPA Assistant Professor of
Accounting Coordinator - Master of Science in Accountancy (MSA) Program
Department of Accounting and Finance College of Business and Public
Administration CSU San Bernardino 5500 University Pkwy, JB-547 San
Bernardino, CA. 92407-2397
Telephone Numbers: San Bernardino Campus: (909)
537-5726 Palm Desert Campus: (760) 341-2883, Ext. 78158
For technical details see the following book:
Structured Finance and Collateralized Debt Obligations: New Developments in
Cash and Synthetic Securitization (Wiley Finance) by Janet M. Tavakoli
(2008)
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30,
2009 ---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this
video (a little over 5 Mbs) using a free updated version of RealMedia ---
Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP
Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
I was not aware how fraudulent the credit derivatives markets had become. I
always viewed credit derivatives as an unregulated insurance market for credit
protection. But in 2007 and 2008 this market turned into a betting operation
more like a rolling crap game on Wall Street.
Bob Jensen's Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on the current economic crisis are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
For credit derivative problems see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Also see "Credit Derivatives" under the C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
Bob Jensen's
free tutorials and videos on how to account for derivatives under FAS 133 and
IAS 39 ---
http://faculty.trinity.edu/rjensen/caseans/000index.htm
Outrageous Bonus Frenzy
AIG now says it paid out more than $454 million in
bonuses to its employees for work performed in 2008. That is nearly four times
more than the company revealed in late March when asked by POLITICO to detail
its total bonus payments. At that time, AIG spokesman Nick Ashooh said the firm
paid about $120 million in 2008 bonuses to a pool of more than 6,000 employees.
The figure Ashooh offered was, in turn, substantially higher than company CEO
Edward Liddy claimed days earlier in testimony before a House Financial Services
Subcommittee. Asked how much AIG had paid in 2008 bonuses, Liddy responded: “I
think it might have been in the range of $9 million.”
Emon Javers, "AIG bonuses four times
higher than reported," Politico, May 5, 2009 ---
http://www.politico.com/news/stories/0509/22134.html
"Let's Move Their Cheese: We can get better bank management for a
fraction of the cost," The Wall Street Journal on May 6, 2009 ---
http://online.wsj.com/article/SB124157594861790347.html
Incentives work, all right. Just look at
the way our bankers come back to bonuses, finding in every occasion a good
opportunity to cut themselves a slice of largess. Their determination is
unrelenting, monomaniacal. It's like Republicans returning to tax cuts, the
universal solution to every problem.
Some institutions, we read, are struggling
to free themselves from the TARP, because of its exuberance-chilling
compensation limits. Others have decimated their workforces, apparently so
they might continue to shower money on the favored ones. Still other
institutions have signaled that they would rather borrow at higher rates of
interest than accept the compensation limits that come with cheaper federal
loans. And certain banks are on track to return to pre-recession
compensation levels this year, according to a story last week in the New
York Times. Goldman Sachs, for example, set aside $4.7 billion for
compensation in the first quarter alone.
Another way incentives work is this: They
have kept the debate over incentives from getting off the dime for years.
There is no amount of shame that will deter the bonus class from pressing
their demand, no scandal that will put it off limits, no public outrage over
AIG or Enron or really expensive Merrill Lynch trash cans that will silence
the managers' monotonous warble: "Attract and retain top talent!"
And there is no possible objection to
inflated compensation you can make that will not be instantly maligned as
senseless populism.
In truth, however, the verdict has been in
for years. Pay for performance systems, at least as they exist in many
places, are a recipe for disaster.
What they have "incentivized" executives
to do, in countless cases, is not to perform, but to game the system, to
smooth the numbers, to take insane risks with other people's money, to do
whatever had to be done to ring the bell and send the dollars coursing their
way into the designated bank account.
It may well be true that those in our
bonus class are geniuses, but in far too many cases their fantastic brain
power is focused not on serving shareholders or guiding our economy but
simply on getting that bonus.
One might say that events of the last year
had proved this fairly conclusively.
Or one could quote the immortal words of
Franklin Raines, the onetime CEO of Fannie Mae, as they were recorded by
Business Week in 2003: "My experience is where there is a one-to-one
relation between if I do X, money will hit my pocket, you tend to see people
doing X a lot. You've got to be very careful about that. Don't just say: 'If
you hit this revenue number, your bonus is going to be this.' It sets up an
incentive that's overwhelming. You wave enough money in front of people, and
good people will do bad things."
Will they ever. They might, for example,
pull an accounting fraud of the kind Fannie Mae itself was accused of
committing in 2004, in which earnings were allegedly manipulated to, ahem,
hit certain revenue numbers and make the bonuses go bang.
They might rig the game to take the credit
-- and reap the rewards -- when good luck befalls an entire industry. If
they're bankers, they might even try to claim that their firm's recovery,
made possible by TARP money and government guarantees, was actually a fruit
of their personal ingenuity. Bring on the billions!
Of course, they will also threaten to
leave if they don't get exactly what they want. Take last week's news story
about the supersuccessful energy trading unit of Citibank, whose star trader
scored $125 million in 2005, owns a castle in Germany, and collects Julian
Schnabel paintings. This merry band of traders is apparently thinking about
a white-collar walkout should the government refuse to lift its compensation
restrictions.
At first one feels pity for Citi and its
resident geniuses, brought to these straits by the interfering hand of
government. But then it dawns on you: Should a company receiving billions of
public dollars really be gambling on speculative energy trades? After all,
the bank's ordinary, everyday deposits would have to be made good by you and
me through the FDIC should one of their bright traders pull a Nick Leeson
someday.
Besides, why is Citi so anxious to give in
to these guys? It can't be that hard to "retain top talent" when New York is
awash with unemployed bankers and traders who are no doubt anxious for a
chance to prove their own brilliance.
Here's a Wall Street solution to Wall
Street's problems: Let's offshore trading operations to lands where ethics
are more highly esteemed -- Norway, for instance. And while we're at it,
let's replace our gold-plated, Lear-jetting American CEOs with thrifty
Europeans, who may not write management books but who will do the work
better, and for a fraction of the cost.
Bob Jensen's threads on outrageous compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
"The Bailout of AIG: Mission Accomplished?" by Francine McKenna,
re:TheAuditors, September 17, 2012 ---
http://retheauditors.com/2012/09/17/the-bailout-of-aig-mission-accomplished/
On Friday September 14, the US government announced
the completion of the sale of AIG stock taxpayers bought during the
financial crisis bailout of the insurer. The government took in $20.7
billion for the sale and is no longer the majority owner of the company. At
the peak of the crisis, taxpayers owned almost 80% of AIG.
Andrew Ross Sorkin, New York Times reporter, CNBC
host, and author of “Too Big To Fail” used his
DealBook column to ask
former Special Inspector General of TARP Neil Barofsky if he was
satisfied, finally. Sorkin says the US Treasury made a profit on the AIG
transaction.
As we approach the four-year anniversary of the
collapse of Lehman Brothers and the rescue of A.I.G. next week, sadly,
much of the public — and people like Mr. Barofsky, as well-intentioned
as he is — are still criticizing and debating the merits of the bailout.
It’s almost become a cottage industry.
In his book, Mr. Barofsky wrote, “Treasury’s
desperate attempt to bail out Wall Street was setting the country up for
potentially catastrophic losses.”
As distasteful as the rescue effort was, it
should be clear by now that without it, we faced an economic Armageddon.
And the results thus far of bailing out the big banks, and A.I.G.,
indicate a profit.
Treasury never uses the term “profit” to describe
what taxpayers would receive. The
GAO did in a report in May
when it estimated the proceeds that could be realized at various sale
prices.
I wrote in American Banker about Sorkin’s claim
that the bank bailouts prevented “financial system Armageddon” and his
debate with Barofsky. I think “profit” is not only the wrong term but an
answer to the wrong question.
It can never be proven that the crisis bailouts
saved us from financial Armageddon. That’s the logical fallacy of
asserting a claim with no way to disprove the opposite, so saying we
made a profit on the deal is the next best thing. The New
York Times’ Andrew Ross Sorkin claims,
if you combine Treasury actions and “positive returns” on Federal
Reserve activities, the Treasury is now “on a path to actually turn a
profit.” That’s where the debate starts.
Former Special Inspector General for the
Troubled Asset Relief Program Neil Barofsky says, “Not
so fast.” I
agree. If your intention is to try to prove
or disprove the government PR claims that the taxpayer has made an
accounting profit on any of the bailouts, or
even broken even, you must remember this: That’s not why the government
supposedly did what they did. And on the two counts of failing to
unfreeze credit and failing to help homeowners – how the bailouts were
justified to Congress – the government is guilty.
Treasury never uses the term “profit,” even in
press releases. The term it does use, “positive return,” is a
non-Generally Accepted Accounting Principles metric. Treasury has sunk
to the level of a social commerce IPO like Groupon, whose infamous Consolidated
Segment Operating Income (CSOI) – which was slammed
by the Securities and Exchange Commission –
glossed over losses to convince investors there was a gain instead.
“Yves Smith” at Naked Capitalism also points out
that AIG enjoyed a tax benefit that negates Treasury”s claim. Who reported
that deal? Andrew Ross Sorkin in February.
In a February article, “Bending
the Tax Code, and Lifting A.I.G.’s Profit,”
Sorkin described how AIG was allowed to retain $26.2 billion of net
operating losses that should have been wiped out as a part of the rescue
of the company as well as an additional $9 billion of “unrealized loss
on investments.” That increased AIG’s fourth quarter and hence fiscal
year earnings by a remarkable $17.7 billion, which dwarfs the mere $1.6
billion its operations produced that quarter. And the article includes
this juicy bit:
Analysts at Bank of
America and JPMorgan Chase last year estimated that the tax benefits
from the losses propped up A.I.G. stock by $5 to $6 a share. Its shares
closed at $28.66 on Monday, just shy of the $29 mark that the government
says
it needs to sell
its shares to break even.
General Motors, another bailout “success story” –
because saving GM supposedly averted jobs and economic disaster in Detroit –
also benefited from the IRS rule change regarding retention of net operating
loss carry forwards and “fresh start” accounting. I wrote about that in
Forbes in November of 2010.
Reporting profits means new GM doesn’t lose the
valuable deferred tax assets they carried over from old GM, thanks to a
last minute fix from the US Treasury in
September. The accountants can pull dollars from a cookie jar valuation
allowance to prop up earnings when needed.
The IPO would probably have never passed even a
minimal “smell test” by the SEC’s Division of Corporate Finance if
”fresh start accounting” hadn’t put millions
in goodwill on their balance sheet. That gave
GM a positive balance in shareholder’s equity. In a perverse example of
accounting chicanery, the better GM does the less valuable that asset
is.
Read the rest of my column about the AIG share sale
at
American Banker.
Iowa Sen. Charles Grassley suggested that AIG
executives should accept responsibility for the collapse of the insurance giant
by resigning or killing themselves. The Republican lawmaker's harsh comments
came during an interview Monday with Cedar Rapids, Iowa, radio station WMT . . .
Sen. Charles Grassley wants AIG executives to apologize for the collapse of the
insurance giant — but said Tuesday that "obviously" he didn't really mean that
they should kill themselves. The Iowa Republican raised eyebrows with his
comments Monday that the executives — under fire for passing out big bonuses
even as they were taking a taxpayer bailout — perhaps should "resign or go
commit suicide." But he backtracked Tuesday morning in a conference call with
reporters. He said he would like executives of failed businesses to make a more
formal public apology, as business leaders have done in Japan.
Noel Duara, "Grassley: AIG execs
should repent, not kill selves," Yahoo News, March 17, 2009 ---
http://news.yahoo.com/s/ap/20090317/ap_on_re_us/grassley_aig
"AIG, Surprise: Moneymaker Its profits for taxpayers cast doubt on the
notion that it behaved recklessly before the panic struck," by Holman W.
Jenkins, Jr., The Wall Street Journal, August 31, 2012 ---
http://professional.wsj.com/article/SB10000872396390443618604577623373568029572.html?mg=reno64-wsj#mod=djemEditorialPage_t
AIG's bailout is getting the revisionist
treatment. The rescue hasn't been the dismal federal experience that,
say, GM's has been. Taxpayers are showing a $5 billion profit on their
53% stake in the insurer, as of yesterday's closing price.
What's more, in the last few days, the New York
Fed liquidated the last of the complex mortgage derivatives it acquired
from AIG's counterparties as part of the bailout. Such transactions and
related fees have netted the government about $18 billion.
This is good news but requires some revising of
theories of the crisis itself. The "toxic" and "shaky" housing
derivatives that got AIG in trouble turn out, even amid the worst
housing slump in 70 years, not to have been the crud many assumed they
were.
A lot of renditions skip over this part,
dismissing AIG's pre-crash mortgage activities as "reckless," thereby
making a mystery of how the refinancing of AIG could be paying off so
handsomely for taxpayers. Taxpayers are making out because they bought
valuable assets on the cheap.
This is as it should be. But let's remember how
AIG got in trouble. It wrote insurance to guarantee the very senior
portions of securities derived from underlying mortgages—that is, the
portions already designed to withstand a sizeable increase in defaults.
AIG failed not because of the failure of these
securities to keep paying as expected, but because of its own promise to
fork up cash collateral if the market price of these securities fell or
if the rating agencies downgraded what they had previously rated
Triple-A.
In the systemic panic that climaxed with the
Lehman failure, both things happened in spades, even as AIG itself no
longer could raise the cash to make good on its commitments. Some now
claim AIG could have waved off the collateral calls, citing exceptional
circumstances. But even that wouldn't have changed the fact that,
because of the panic, AIG itself was no longer trusted despite being
chock-full of good assets.
We'll never know if the company might have
finessed its way out of its jam (quite possibly its counterparties,
including Goldman Sachs, would have acted to keep AIG afloat if the
alternative of a government bailout weren't available). Instead AIG
turned to taxpayers to finance the collateral calls it couldn't finance
itself, and taxpayers took advantage.
For all the desire to name villains and blame
bad incentives for the financial crisis, notice that panic itself was
the key player. Panic is a variable about which it's disconcertingly
hard for government to do anything useful in advance.
Panic is systemic—an uncertainty or loss of
trust in how the system will behave. Here's a simple but relevant
example: What happens to the market value of mortgages if investors lose
confidence in the legal system to permit them to foreclose on borrowers
who stop paying?
We don't need to retread the history. Letting
Lehman fail was a disaster because the rescue of Bear Stearns had
conditioned the market to believe Washington wouldn't permit major
institutional failures. The mixed signals sent about Fannie and Freddie
only undermined the effort to recruit fresh capital to other financial
institutions distressed by uncertainty over the value of mortgage
securities.
AIG is the most dramatic example of the general
case. A lot of things become good or bad collateral depending on what
the government is expected to do. It's not too strong to say Washington
had to bail out AIG because the market was uncertain whether Washington
would bail out AIG. (An additional complexity we won't go into is how
the Fed's QE exercises subsequently boosted the bailout's profits.)
Let us be careful here: A host of private and
public behaviors contributed to the housing bubble and meltdown, whose
losses were destined to be felt widely. Our system has no problem
accommodating the failure of individual institutions, even very big
ones. But systemic panic always comes to the door of government. It
can't be otherwise.
Governments can try to duck this burden, as
European governments have done, only by renouncing the ability to print
money and so soiling their own credit that substituting their own credit
for the financial system's is no longer an option. Make no mistake: This
would be a real cure for too-big-to-fail if the Europeans were inclined
to let the chips fall. They're not. Instead the self-disabling
governments want Germany to supply the bailout.
Continued in article
Outrageous Bonus Frenzy
AIG now says it paid out more than $454 million in
bonuses to its employees for work performed in 2008. That is nearly four times
more than the company revealed in late March when asked by POLITICO to detail
its total bonus payments. At that time, AIG spokesman Nick Ashooh said the firm
paid about $120 million in 2008 bonuses to a pool of more than 6,000 employees.
The figure Ashooh offered was, in turn, substantially higher than company CEO
Edward Liddy claimed days earlier in testimony before a House Financial Services
Subcommittee. Asked how much AIG had paid in 2008 bonuses, Liddy responded: “I
think it might have been in the range of $9 million.”
Emon Javers, "AIG bonuses four times
higher than reported," Politico, May 5, 2009 ---
http://www.politico.com/news/stories/0509/22134.html
Bob Jensen's threads on AIG are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Search for the term "AIG"
Professor Ketz Asserts Other Comprehensive Income (OCI from FAS 130)
may be More Important to Study Than Reported Income
"Citigroup Remains in Critical Condition," by: J. Edward Ketz , SmartPros,
May 2009 ---
http://accounting.smartpros.com/x66534.xml
Note that all Citigroup dollar amounts are in millions of dollars such that
$(27,684) is really a $27,684,000,000 billion loss.
The stress tests conducted by the Fed are a farce
inasmuch as the stress isn't too strenuous. That the Fed ascertained
additional capital requirements for several banks merely points out the
obvious - the banking sector remains in serious trouble.
That the financial industry was and remains in
trouble is not revelatory to those who pay attention to fair value
measurements. Take Citigroup for instance. This firm, once a giant among
banks, now gasps for its existence.
Citi’s reported net income was $(27,684) for 2008
(all accounting numbers in millions of dollars). While this is a smelly
number, the odor grows worse when one adjusts it for various items that
bypass the income statement.
Ever since the FASB invented the comprehensive
income statement in a political move to get business enterprises to do some
accounting for items they didn’t want to disclose, I have advocated that
investors use comprehensive income instead of net income. Comprehensive
income includes relevant items that have had a real economic impact on the
business entity; therefore, investors will find these items informative.
For fiscal 2008, Citi shows unrealized losses on
its available-for-sale securities of $(10,118). It also shows a loss on the
foreign currency translation adjustment of $(6,972), a loss on its cash flow
hedges of $(2,026), and a loss for additional pension liability adjustment
of $(1,419). This makes Citi’s comprehensive income $(48,219).
But the bad news doesn’t end there. The pension
footnote (footnote 9) shows the expected rate of return is 7.75%. While this
is what is required per FAS 87, it is nonsense. Did anybody know the 2008
rate of return in (say) 2005? The FASB should get rid of such fantasyland
assumptions and require business enterprises to employ the actual rate of
return. If Citi had done so on its pension assets, it would have had an
actual return of (5.42)%, so we shall adjust downward the 2008 income by
another $1,370.
The most interesting item is Citi’s move with
respect to its investments. It reports debt securities in its 2007
held-to-maturity portfolio of only $1. By year end 2008, however, this
amount mushroomed to $64,459. Clearly, Citi is shielding these debt
instruments from fair value accounting and the reporting of additional
losses. Footnote 16 indicates that these losses for 2008 amounted to
$(4,082).
Another item concerns the firm’s deferred income
tax assets. For 2008, Citi discloses $52,079 in deferred income tax assets
and a valuation allowance of zero. Given that Citi paid no federal income
taxes in 2007 or 2008 and likely will pay no federal income taxes in the
near future, if ever, how can the company justify a valuation allowance of
zero? Whatever amount it should be would further reduce the profits of the
firm. Since we don’t know how to estimate this valuation allowance
correctly, we shall continue to hold its balance at zero, even though this
is clearly wrong.
Putting these considerations together, Citigroup
has an adjusted income in 2008 of $(53,671). This is still an estimate but
clearly it is more nearly accurate than the reported number. And it reveals
that Citi lost twice as much as it reported.
Recently, we have been hearing how Citi has turned
things around and that the first quarter in 2009 returns Citi to the black
column with a profit of $1,593. Don’t believe a word of it!
Items in comprehensive income shows a modest gain
in the available-for-sale portfolio of $20, gains on cash flow hedges of
$1,483, and a gain because of the pension liability adjustment of $66.
Unfortunately, these gains are wiped out by a loss in the foreign currency
translation adjustment of $(2,974). Comprehensive remains ugly at $(225).
We don’t have any disclosure in the quarterly
report about actual versus expected returns on pension assets, so we cannot
adjust them to show the truth.
But, the strategy to move debt securities from
available-to-sale to held-to-maturity paid off significantly. First quarter
results show a staggering loss on these securities of $(7,772).
So far, the adjusted earnings for Citigroup for the
first quarter of 2009 is $(7,584). Don’t tell me that Citi has improved its
operations.
Further, these numbers have been improved by an
eccentricity in FAS 157. For some silly reason, the board allows entities to
show a gain on their liabilities if the firm’s own credit risk has
increased. This takes a perfectly good notion of fair value of liabilities
to an absurd result. Failing companies might be able to make liabilities
disappear by claiming a sufficiently high increase in their own credit
ratings! Utter rubbish—and the FASB should amend its statement.
Citi disclosed in a conference call that the first
quarter results include a gain of $2,700 because of this increase in its own
nonperformance risk. This gain is total nonsense, so I would adjust
quarterly income further, giving Citi adjusted earnings of $(10,284).
Citigroup suffered a cardiac arrest in 2008, and it
remains in critical condition. Any other conclusion is propaganda or self
deception. And forget the stress tests; they are so flawed that Lehman
Brothers might pass them. The Fed says that Citi needs another $5,500 in
capital to weather any additional economic crises it might face. It isn’t
true. Citi needs a lot more capital than that just to weather current
conditions. If a real crisis occurs, Citi will become a flat-liner; it might
die anyway.
If you want to protect your portfolio, don’t listen
to the optimistic forecasts coming from Washington and don’t stop at the
reported income number. Look at the fair value disclosures within SEC
filings, adjust reported earnings for these fair value gains and losses, and
then you will obtain the truth.
Poor government workers who sacrifice so much just to serve President
Obama:
Biding time before their book royalties eventually flow
Lawrence Summers, a top economic adviser to President
Barack Obama, pulled in more than $2.7 million in speaking fees paid by firms at
the heart of the financial crisis, including Citigroup, Goldman Sachs, JPMorgan,
Merrill Lynch, Bank of America Corp. and the now-defunct Lehman Brothers. He
pulled in another $5.2 million from D.E. Shaw, a hedge fund for which he served
as managing director from October 2006 until joining the administration. Thomas
E. Donilon, Obama’s deputy national security adviser, was paid $3.9 million by
the power law firm O’Melveny & Myers to represent clients including two firms
that received federal bailout funds: Citigroup and Goldman Sachs. He also
disclosed that he’s a member of the Trilateral Commission and sits on the
steering committee of the supersecret Bilderberg group. Both groups are favorite
targets of conspiracy theorists. And White House Counsel Greg Craig earned $1.7
million in private practice representing an exiled Bolivian president, a
Panamanian lawmaker wanted by the U.S. government for allegedly murdering a U.S.
soldier and a tech billionaire accused of securities fraud and various
sensational drug and sex crimes. Those are among the associations detailed in
personal financial disclosure statements released Friday night by the White
House.
Kenneth P. Vogel, "W.H. team
discloses TARP firm ties," Politico, April 3, 2009 ---
http://www.politico.com/news/stories/0409/20889.html
Wave Goodbye to this nation's top economic
advisor
"Lawrence Summers Will Leave White House Post and Return to Harvard,"
Chronicle of Higher Education, September 21, 2010 ---
http://chronicle.com/blogPost/Lawrence-Summers-Will-Leave/27092/
I can't believe The New York Times published this Op-Ed from a former
(ten-year) CEO of the Federal Reserve Bank of St. Louis
This WSJ-like heresy would never appear on NBC or MSNBC
"Stop the Bailouts ," by William Poole, The New York Times,
February 28, 2009 ---
http://www.nytimes.com/2009/03/01/opinion/01poole.html?_r=2&ref=todayspaper
THE fundamental causes
of this recession, unique in the experience of the United States, were
mortgage defaults and the consequent insolvency of major financial firms.
These insolvencies, and especially fear of them, damaged normal credit
mechanisms.
The self-correcting nature of markets will
ultimately prevail. We should not underestimate the power of monetary
policy; with the sharp increase in the nation’s money stock starting in
September, monetary policy is now extraordinarily expansionary. I believe,
though without great confidence, that the recession will end in the second
half of this year.
Federal policy is damaging the economy’s
prospects.
It fails to provide the needed tax incentives for investment in factories
and equipment, incentives that were central to efforts to revive the economy
during the Kennedy-Johnson era and under Ronald Reagan. But government
spending can’t lead the way to sustained recovery, because its stimulating
effect will be offset by anticipated higher taxes and the need to finance
the deficit.
Heavy-handed federal intervention into the
management of companies from banks to auto makers will also delay recovery.
And misguided efforts to help distressed homeowners by permitting courts to
rewrite the terms of mortgages will cause banks to limit mortgage lending,
which will prevent housing from contributing to the recovery.
The unrelenting anger across the country
over bailouts of corporations and households that made unwise and even
irresponsible financial decisions is influencing federal policy. Punitive
measures, like forcing companies receiving federal dollars to cancel
employee events, will increase uncertainty over where the government will
strike next in its effort to deflect public outrage. Instead of more
bailouts, we need a clear and consistent path to fundamental reform of our
financial system.
William Poole is a senior fellow at the Cato Institute and the
president and chief executive of the Federal Reserve Bank of St. Louis from
1998 to 2008.
A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
The inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)
A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
America Bought a Pig in a Poke
It's like going on a spending binge
at the Titanic's passenger store just after hitting the iceberg
Alas, that opportunity was squandered. Mr Obama
ceded control of the stimulus to the fractious congressional Democrats, allowing
a plan that should have had broad support from both parties to become a divisive
partisan battle. More serious still was Mr Geithner’s financial-rescue blueprint
which, though touted as a bold departure from the incrementalism and uncertainty
that had plagued the Bush administration’s Wall Street fixes, in fact looked
depressingly like his predecessors’ efforts: timid, incomplete and short on
detail. Despite talk of trillion-dollar sums, stock markets tumbled. Far from
boosting confidence, Mr Obama seems at sea.
. . . Mr Obama’s team must recognise this or they, like their predecessors, will
come to be seen as part of the problem, not the solution.
"The Obama Rescue," The Economist, February 14, 2008, Page
13 ---
http://www.economist.com/opinion/displaystory.cfm?story_id=13108724&CFID=45050187&CFTOKEN=28690481
Barack Obama promised to get the economy's mojo working
again with the passage of an almost $800 billion stimulus package. Wall Street
responded with a Bronx Cheer and a 300 drop in the Dow Jones Industrial Average.
What gives? . . . It is unclear how many more boondoggles will be uncovered in
the 1000+ page bill. People are still pouring through its mass of pages. Few, if
any, members of Congress read the bill before it was passed. Scare tactics well
known to every salesman were used to facilitate its passage. The President
proclaimed the sky was falling. An economic catastrophe was just around the
corner. Congress had to do "something" immediately to forestall disaster. There
was no time to read the fine print or to deliberate in a thoughtful manner. And
in lemming like fashion, the Democrats poured over the cliff. It was their
prerogative they claimed. After all, as Mr. Obama declared, "We won the
election."
Ken Connor, "Pork and Pitchforks ,"
Townhall, February 22, 2009 ---
http://townhall.com/columnists/KenConnor/2009/02/22/pork_and_pitchforks
IOUSA (the most frightening movie in American history) ---
(see a 30-minute version of the documentary at
www.iousathemovie.com
).
A Must Read for All Americans --- The Fact Accountant That Liberals
Progressives Will Never Interview or Even Discuss
The most important article for the world to read now is the following interview
with a former Andersen Partner and former Chief Accountant of the United States:
"Debt Crusader David Walker sounds the alarm for America's financial
future," Journal of Accountancy, March 2009 ---
http://www.journalofaccountancy.com/Issues/2009/Mar/DebtCrusader.htm
David Walker is a man on a mission. As
U.S. comptroller general, he used the bully pulpit to fuel a campaign of
town hall meetings highlighting the country’s ballooning federal deficit.
The Fiscal Wake-Up Tour and the publicity it generated begat the documentary
I.O.U.S.A. Walker hopes the film will do for fiscal irresponsibility what Al
Gore’s An Inconvenient Truth did for global warming—mobilize new citizen
activists and pressure politicians to act.
A year ago, Walker stepped away from the
five-plus remaining years on his term as comptroller general and head of the
Government Accountability Office. He had been recruited by billionaire Pete
Peterson, a co-founder of the private- equity fund The Blackstone Group, to
become president and CEO of Peterson’s foundation. The Peter G. Peterson
Foundation, a nonprofit to which Peterson has pledged $1 billion, focuses on
issues such as the deficit, savings levels, entitlement benefits, health
care costs, and the nation’s tax system.
Walker talked with the JofA recently about
the deficit and the financial crisis. What follow are excerpts from that
conversation.
JofA: What did you hope to
accomplish when you set out on your speaking tour and got involved with the
documentary I.O.U.S.A., and what progress has been made on those goals?
Walker: I have been to over 42 states,
giving speeches, participating in town hall meetings, meeting with business
community leaders, local television and radio stations, and editorial boards
with the objective of trying to state the facts and speak the truth about
the deteriorating financial condition of the United States government and
the need for us to start making some tough choices on budget controls, tax
policy, entitlement reform and spending constraints. And the good news is
that people get it. The American people are a lot smarter than many people
give them credit for—especially elected officials
Well, a lot has happened since we started
the Fiscal Wake-Up Tour. Two significant events would be the 60 Minutes
piece, which ran twice in 2007, and that led to the commercial documentary
I.O.U.S.A. (see a 30-minute version of the documentary at
www.iousathemovie.com
). So there’s a lot more visibility on our issue, and I think that’s
encouraging. The other thing that has happened is the recent market meltdown
and bailouts of some very venerable institutions in the financial services
industry have served to bring things home to America. The concept of “too
big to fail” is just not reality anymore, and when you take on too much debt
and you don’t have adequate cash flow, some very bad things can happen.
Here’s the key. The factors that led to
the mortgage-based subprime crisis exist for the federal government’s
finances. Therefore, we must take steps to avoid a super subprime crisis,
which frankly would have much more disastrous effects not only domestically
but around the world.
JofA:
How does the economic crisis affect your message and the outlook for the
kind of wide-scale changes you think need to be made?
Walker:
What’s critical is that we take advantage of the teachable moment associated
with the market meltdown and the failure of some of the most prominent
financial institutions in the country to help the American people know that
nobody can live beyond his means forever. And that goes for government, too.
We have a new president, and therefore we
have an opportunity to press the reset button, and I hope President Obama
will do two things: That he will assure Americans that he will do what it
takes to turn the economy around. I think it is critically important that he
also focus on the future and be able to put a mechanism in place like a
fiscal future commission so that once we turn the corner on the economy, we
have a set of recommendations Congress and the president would be able to
consider about budget controls, tax reform, entitlement reform—things that
are clear and compelling that we need to act on.
Individuals need to understand that the
government has overpromised and under-delivered for far too long. It is
going to have to engage in some dramatic and fundamental reform of existing
entitlement programs, spending policies and tax policies. The government
will be there to provide a safety net through Social Security, a foundation
of retirement security, and it will be there to help those that are in need.
In general, most individuals are going to have to assume more responsibility
for their own financial future, and the earlier they understand that the
better off they are going to be. They need to have a financial plan, a
budget, make prudent use of debt, save, invest their savings for specified
purposes and, very importantly, preserve their savings for the intended
purpose, including retirement income.
I believe the government policies are
going to have to encourage people to work longer by increasing the
eligibility ages for many government programs. So if people want to retire
at an earlier age, they are going to have to plan, save, invest and preserve
those savings for retirement purposes.
JofA:
You’ve called the current U.S. health care system unsustainable. How can the
system be fixed without negatively affecting the care Americans need?
Walker:
Our current health care system is not really a system. It’s an amalgamation
of a bunch of different things that have occurred over the years, and it’s
unacceptable and unsustainable. We spend twice per capita what any other
country on the Earth does. We have the highest uninsured population of any
industrialized nation. We have below average health care outcomes. So the
value of the equation just does not compute.
We are going to need to do two things on
health care. We are going to need to take some steps quickly to reduce the
rate of increase in health care cost. We are also going to have to better
target taxpayer subsidies and tax preferences for health care.
We are also going to end up needing to
move toward trying to achieve comprehensive health care reform that
accomplishes four key goals. First: achieve universal coverage for basic and
essential health care—based on broad-based societal needs, not unlimited
individual wants—that’s affordable and sustainable over time and that avoids
taxpayer-funded heroic measures. Secondly, the federal government has to
have a budget for health care. We are the only nation on Earth dumb enough
to write a blank check for health care. It could bankrupt the country. We
have to have constraints. Thirdly, we need national evidence-based practice
standards for the practice of medicine and for the issuance of prescription
drugs to improve consistency, enhance quality, reduce costs and dramatically
reduce litigation risks. And last, but certainly not least, we have to
require personal responsibility and accountability for our own health and
wellness in a whole range of areas including obesity.
JofA:
What drives you?
Walker: My family has been in this country
since the 1680s, and I have ancestors who fought and died in the American
Revolution. So I care very deeply about this country, and I am a big history
buff. I believe you need to study history in order to learn from it in order
not to make some of the same mistakes that others have made in the past.
Secondly, I am only the second person in
my direct Walker line to graduate from college. My dad was the first.
Therefore, I am somewhat of an example of what someone can accomplish in
this great country if you get an education, if you have a positive attitude,
if you work hard, if you have good morals and ethical values.
My personal mission in life is to be able
to make a difference, to try and make a difference in the lives of others,
to try and help make sure our country stays strong, that the American dream
stays alive, and that the future will be better for my children and my
grandchildren.
Links to David Walkers videos, including his famous CBS
Sixty Minutes bell ringer that is far more frightening and sobering than
anything Rush Limbaugh is screaming about. You never, ever hear Keith
Olbermann, Jon Stewart, Barack Obama, Nancy Pelosi, or Harry Reid so much as
whisper the name of David Walker ---
http://faculty.trinity.edu/rjensen/entitlements.htm
"Obama's Economic Fish Stories: On unemployment, the president
claims that the stimulus bill was several times more potent than his chief
economic adviser estimates. Such statements hurt his credibility," by
Michael J. Boskin, The Wall Street Journal, July 21, 2010 ---
http://online.wsj.com/article/SB10001424052748703724104575378751776758256.html?mod=djemEditorialPage_t
A president's most valuable asset—with voters,
Congress, allies and enemies—is credibility. So it is unfortunate when
extreme exaggeration emanates from the White House.
All presidents wind up saying some things that make
even their own economists cringe (often the brainchild of political advisers
unconstrained by economic principles, facts or arithmetic). Usually,
economic advisers manage to correct these problematic statements before
delivery. Sometimes they get channeled into relatively harmless nonsense,
such as President Gerald Ford's "Whip Inflation Now" buttons. Other times
they produce damaging policies, such as President Richard Nixon's wage and
price controls. The most illiterate statement was President Jimmy Carter's
late-1970s plea to the Federal Reserve to lower interest rates to combat
high inflation, the exact opposite of what it should do. Not surprisingly,
the value of the dollar collapsed.
President Obama says "every economist who's looked
at it says that the Recovery Act has done its job"—i.e., the stimulus bill
has turned the economy around. That's nonsense. Opinions differ widely and
many leading economists believe that its impact has been small. Why? The
expectation of future spending and future tax hikes to pay for the stimulus
and Mr. Obama's vast expansion of government are offsetting the direct
short-run expansionary effect. That is standard in all macroeconomic
theories.
So, as I and others warned in 2008, the permanent
government expansion and higher tax rate agenda is a classic example of what
not to do during bad economic times. Worse yet, all the subsidies, bailouts,
regulations and mandates are forcing noncommercial decisions on the economy,
which now awaits literally thousands of new diktats as a result of things
like ObamaCare and the financial reform bill. The uncertainty is impeding
investment and hiring.
The president does not say that economists agree
that the high future taxes to finance the stimulus will hurt the economy.
(The University of Chicago's Harald Uhlig estimates $3.40 of lost output for
every dollar of government spending.) Either the president is not being told
of serious alternative viewpoints, or serious viewpoints are defined as only
those that support his position. In either case, he is being ill-served by
his staff.
Mr. Obama's economic statements are increasingly
divorced not only from competing viewpoints but from those of his own
economic advisers. It is surprising how many numerically challenged
pronouncements come from this most scripted and political of White Houses.
One slip is eventually forgiven, but when a pattern emerges, no one believes
it is an accident.
For example, on the anniversary of the stimulus
bill, Mr. Obama declared, "It is largely thanks to the Recovery Act that a
second Depression is no longer a possibility." Yet his Council of Economic
Advisers just estimated the stimulus bill's effect on GDP at its trough was
1%-2%.
The most common definition of a depression is a
long period in which GDP or consumption declines at least 10%. The decline
in GDP in the recent recession was 3.8%, in consumption 2%. No one disputes
the recession was severe, but to reach a 10% GDP decline requires tripling
the administration's estimate (three times their 2% effect) added to the
actual 3.8% decline. On the alternative consumption standard, the math is
even more absurd. The depression statement isn't credible. The stimulus bill
has assumed certain mystic powers in administration discourse, but revoking
the laws of arithmetic shouldn't be one of them.
The recession would have been worse if not for the
Fed's monetary policy and quantitative easing. Also important were the
unmentioned automatic stabilizers—taxes falling more than income, cushioning
declines in after-tax incomes and consumption—which were far larger than the
spending and tax rebates in the stimulus bill. Arguing that all these
policies (including injecting capital into banks, which was necessary but
done poorly) may have prevented a depression is perhaps still an
exaggeration but at least is within hailing distance of plausibility. On
that scale, the effect of the stimulus was puny.
On his recent "Recovery Tour," Mr. Obama boasted,
"The stimulus bill prevented the unemployment rate from "getting up to . . .
15%." But the president's own chief economic adviser, Christina Romer, has
estimated that the stimulus bill reduced peak unemployment by one percentage
point—i.e., since the unemployment rate peaked at 10.1%, it prevented the
unemployment rate from rising to just over 11%. So Mr. Obama claims that the
stimulus bill was several times more potent than his chief economic adviser
estimates.
Perhaps the most serious disconnect concerns the
impending expiration of the 2001 and 2003 tax cuts, which will raise the top
two income tax rates and the rates on dividends and capital gains. If these
growth inhibiting tax increases occur—about $75 billion in tax increases
next year, $1.4 trillion over 10 years—there will be serious economic
damage.
In the most recent issue of the American Economic
Review, Ms. Romer (and her husband David H. Romer) conclude that "tax
increases are highly contractionary . . . tax cuts have very large and
persistent positive output effects." Their estimates imply the tax increases
would depress GDP by roughly half the growth rate in this so-far-anemic
recovery.
If Mr. Obama is really serious about a second
stimulus, by far the best thing he can do is have Congress quickly extend
the expiring Bush tax cuts, combined with real spending cuts set to take
effect as the economy improves.
The president badly needs to make more realistic
pronouncements. No one expects him to say his policies have failed (although
most have delivered far less than claimed at large cost). A little candor
about the results of experimentation in uncharted waters would go a long
way. But at the very least, his staff needs to avoid putting these
exaggerations on the teleprompter. It undermines confidence and raises
concerns about competence. It's doing nobody any good—not the economy and
certainly not Mr. Obama.
Mr. Boskin is a professor of economics at Stanford University and a
senior fellow at the Hoover Institution. He chaired the Council of Economic
Advisers under President George H.W. Bush.
Harvard professor says economists are a huge part of the problem ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#LiquidityBubble
Stephen A. Marglin is a professor of economics at Harvard
University. His latest book is The Dismal Science: How Thinking Like an
Economist Undermines Community (Harvard University Press, 2007).
Fractal ---
http://en.wikipedia.org/wiki/Fractal
Question
Why do markets misbehave? How should you measure market risk? And what’s wrong
with academic finance?
These are a few questions that polymath Benoit
Mandelbrot addresses in the fascinating book The Misbehavior of Markets.
Mandelbrot suggests all of these questions can be properly understood by
rejecting the standard assumptions of academic finance and instead using a
“fractal view” of risk and markets.
"The Misbehavior of Markets," Simoleon Sense, April 6, 2009 ---
http://www.simoleonsense.com/
Fractals are at the heart of this book. Fractal
geometry is a form of mathematics developed by Mandelbrot that deals with
rough but highly self-similar structures like trees, coastlines, and
mountains. Fractals have helped explain a wide range of natural phenomena
and revolutionized computer graphics, influencing movies like Star Wars
Episode III. There is room for more applications in this early science, and
fractals may help explain the jagged but predictably irrational patterns in
the stock market, claims Mandelbrot.
In this book, Mandelbrot contends that fractals are
the key to modeling the market. The interesting part is that Mandelbrot does
not merely explain why he’s right but he goes to great length to explain why
others-those using the standard theories of academic finance-are wrong.
Mandelbrot offers interesting history, anecdotes, trivia, and beautiful
illustrations to make his case. The stock market does not act like a random
walk, he says, but rather it’s like the flight of an arrow down an infinite
hallway. It sounds a bit abstract at first, but this is exactly where the
book shines. There are stories and illustrations that make such abstract
concepts easily understandable. I literally felt smarter after reading each
chapter…
Winning the Lotto jackpot has become a key factor in
my retirement plan.
New Yorker Cartoon
"Two billion more bourgeois," The Economist, February 14, 2009, Page
18 ---
http://www.economist.com/opinion/displaystory.cfm?story_id=13109687&CFID=45050187&CFTOKEN=28690481
PEOPLE love to mock the middle class. Its
narrow-mindedness, complacency and conformism are the mother lode of
material for sitcom writers and novelists. But Marx thought “the
bourgeoisie…has played a most revolutionary part” in history. And although
The Economist rarely sees eye to eye with the father of communism,
on this Marx was right.
During the past 15 years a new middle
class has sprung up in emerging markets, producing a silent revolution in
human affairs—a revolution of wealth-creation and new aspirations. The
change has been silent because its beneficiaries have gone about
transforming countries unobtrusively while enjoying the fruits of success.
But that success has been a product of growth. As growth collapses, the way
the new middle class reacts to the thwarting of its expectations could
change history in a direction that is still impossible to foresee.
The new middle consists of people with
about a third of their income left for discretionary spending after
providing basic food and shelter. They are neither rich, inheriting enough
to escape the struggle for existence, nor poor, living from hand to mouth,
or season to season. One of their most important characteristics is variety:
middle-class people vary hugely by background, profession and income. As our
special report in this week’s issue argues, their numbers do not grow
gently, shadowing economic growth and rising 2%, or 5%, or 10% a year. At
some point, they surge. That happened in China about ten years ago. It is
happening in India now. In emerging markets as a whole, it has propelled the
middle class from a third of the developing world’s population in 1990 to
over half today. The developing world is no longer simply poor.
As people emerge into the middle class,
they do not merely create a new market. They think and behave differently.
They are more open-minded, more concerned about their children’s future,
more influenced by abstract values than traditional mores. In the words of
David Riesman, an American sociologist, their minds work like radar, taking
in signals from near and far, not like a gyroscope, pivoting on a point.
Ideologically they lean towards free markets and democracy, which tend to be
better than other systems at balancing out varied and conflicting interests.
A poll we commissioned for our special report on the middle class in the
developing world finds that such people are happier, more optimistic and
more supportive of democracy than are the poor.
These attitudes transform countries and
economies. The middle class is more likely to invest in new products and new
technologies than the rich, who tend to defend their existing assets. It is
better able than the poor to leap barriers to entry into business and can
therefore set up companies big enough to generate jobs. With its aspirations
and capacity for delayed gratification, the middle class is more likely to
invest in education and other sources of human capital, which are vital to
prosperity. For years, policymakers have tied economic success to the rich
(“trickle-down economics”) and to the poor (“inclusive growth”). But it is
the middle class that is the real motor of economic growth.
Now the middle class everywhere is under a
great threat. Its members have flourished in places and countries that have
opened up to the world economy—the eastern seaboard of China, southern
India, metropolitan Brazil. They are products of globalisation, and as
globalisation goes into reverse they may well be hit harder than the rich or
poor. They work in export industries, so their jobs are unsafe. They have
started to borrow, so are hurt by the credit crunch. They have houses and
shares, so their wealth is diminished by falling asset prices.
What will they do when the music stops?
Those at the bottom of the ladder do not have far to fall. But what happens
if you have clambered up a few rungs, joined the new middle class and now
face the prospect of slipping back into poverty? History suggests
middle-class people can behave in radically different ways. The rising
middle class of 19th-century Britain agitated peacefully for the vote; in
Latin America in the 1990s the same sorts of people backed democracy. Yet
the middle class also supported fascist governments in Europe in the 1930s
and initially backed military juntas in Latin America in the 1980s.
Nobody can be sure what direction today’s
new bourgeoisie of some 2.5 billion people will take if its aspirations are
dashed. If the downturn lasts only a year or two the attitudes of such
people may survive the pain of retrenchment. But a prolonged crash might
well undo much of the progress the developing world has lately made towards
democracy and political stability. It is hard to imagine the stakes being
higher.
Question: What's $2+$3,269,999,999,998?
Accountant What would you like it to total? We strive to keep our
clients happy.
Politician: I voted for $789,000,000 but I've never been real good with big
numbers having lots of commas.
Economist: Why it's 33 Yen in terms of the anticpated foreign exchange rate ten
years from now.
Congressional Budget Office:
$3,270,000,000,000 --- but please don't tell on us
All of the major news outlets are reporting that
the stimulus bill voted out of conference committee last night has a meager $789
billion price tag. This number is pure fantasy. No one believes that the
increased funding for programs the left loves like Head Start, Medicaid, COBRA,
and the Earned Income Tax Credit is in anyway temporary. No Congress under
control of the left will ever cut funding for these programs. So what is the
true cost of the stimulus if these spending increases are made permanent? Rep.
Paul Ryan (R-WI) asked the Congressional Budget Office to estimate the impact of
permanently extending the 20 most popular provisions of the stimulus bill. What
did the CBO find? As you can see from the table below, the true 10 year cost of
the stimulus bill $2.527 trillion in in spending with another $744 billion cost
in debt servicing. Total bill for the Generational Theft Act: $3.27 trillion.
"True Cost of Stimulus: $3.27 Trillion," Heritage Foundation, February 12,
2009 ---
http://blog.heritage.org/2009/02/12/true-cost-of-stimulus-327-trillion/
Jensen Comment
The above article has a pretty good summary table --- the best that I've seen to
date.
The US government is on a “burning platform” of
unsustainable policies and practices with fiscal deficits, chronic healthcare
underfunding, immigration and overseas military commitments threatening a crisis
if action is not taken soon.
David M. Walker, Former Chief
Accountant of the United States ---
http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt
for entitlements (over five times the booked national debt and soaring with new
entitlements) ---
http://faculty.trinity.edu/rjensen/entitlements.htm
Delay is preferable to error.
Thomas Jefferson
Are economists worse than the Keystone Cops?
"The Financial Crisis and the Systemic Failure of Academic Economics," 2008
Dahlem Report on the Economic Crisis ---
http://www.cs.trinity.edu/~rjensen/temp/Dahlem_Report_EconCrisis021809.pdf
Abstract:
The economics profession appears to have been unaware of the long build-up
to the current worldwide financial crisis and to have significantly
underestimated its dimensions once it started to unfold. In our view, this
lack of understanding is due to a misallocation of research efforts in
economics. We trace the deeper roots of this failure to the profession’s
insistence on constructing models that, by design, disregard the key
elements driving outcomes in real-world markets. The economics profession
has failed in communicating the limitations, weaknesses, and even dangers of
its preferred models to the public. This state of affairs makes clear the
need for a major reorientation of focus in the research economists
undertake, as well as for the establishment of an ethical code that would
ask economists to understand and communicate the limitations and potential
misuses of their models.
The first major model of systematic risk and
diversification theory was the 1959 Princeton thesis of Harry Markowitz. But the
model was totally impractical since we could not and still cannot
invert matrices with 500 or more rows and columns. Along came Bill Sharpe
and others who tried to approximate the Markowitz model with the much more
practical CAPM. With simplification a model almost always sacrifices accuracy
and robustness. The CAPM has had some good applications and some disastrous
applications such as the Trillion Dollar Bet disaster of Long Term Capital
Management ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#LTCM
Whenever I get news about increased interest in
mathematical models (especially economics and finance) professors on Wall
Street, I think back to "The Trillion Dollar Bet" in 1993 (Nova
on PBS Video) a bond trader, two Nobel Laureates, and their doctoral
students who very nearly brought down all of Wall Street and the U.S. banking
system in the crash of a hedge fund known as
Long Term Capital Management where the biggest and most prestigious firms
lost an unimaginable amount of money ---
http://en.wikipedia.org/wiki/LTCM
The blame for bad decisions that use models must fall on
the analysts who apply the model and not on the people that merely derive the
seminal model as long as the model builders point out all know limitations of
their models. There are some instances of research that should perhaps be banned
such as research that could put cheap and effective biological weapons of mass
destruction in the hands of any teenager in the world who has a basement
laboratory or effective date rape drugs that can be generated quickly, cheaply,
and easily from bananas and tomatoes.
There is also a question of enforcement of a ban on
research and model building. For example, if we’d had a ban on development of
nuclear fission in the U.S., what would’ve prevented Russia, Germany, and Japan
from development of nuclear fission in 1940? If David Li was not allowed to
invent the credit risk diversification model, who’s to say that China could not
invent such a model?
I think the limitations of Li’s model were well known to
the bankers who used the disastrous model. In reality it is like the Black Swan
theory that a model has a known miniscule (epsilon) chance of disaster but the
rewards of using the model seemed to greatly outweigh the risks ---
http://en.wikipedia.org/wiki/Black_Swan_Theory
The CDO bond risks
became compounded when so many investment banks commenced to crumble mortgage
contracts into diversified CDO bonds dictated by David Li’s model. CDO bond
sellers and holders commenced to use this model that essentially leaves out the
covariance terms for interactive defaults on investments. The chances that
everything would blow up seemed negligible at the time. Probably the best
summary of what happens appears in “In Plato’s Cave.”
Also see
"In Plato's Cave: Mathematical models are
a powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Shielding Against Validity Challenges in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
-
With a Rejoinder from the 2010 Senior Editor of The Accounting Review
(TAR), Steven J. Kachelmeier
- With Replies in Appendix 4 to Professor Kachemeier by Professors
Jagdish Gangolly and Paul Williams
- With Added Conjectures in Appendix 1 as to Why the Profession of
Accountancy Ignores TAR
- With Suggestions in Appendix 2 for Incorporating Accounting Research
into Undergraduate Accounting Courses
Warnings from a Theoretical Physicist With an Interest in Economics and
Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models,"
by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html
. . .
In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the way
millions of people and companies interact in a handful of pretty equations.
The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the probabilities of
all possible futures and responding in an optimal way to unexpected shocks.
Surreal Models
Surreal as such models might seem, they have played
a significant role in informing policy at the world’s largest central banks.
Unfortunately, they don’t work very well, and they proved spectacularly
incapable of accommodating the way markets and the economy acted before,
during and after the recent crisis.
Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.
Take, for example, a 2012 (and still somewhat
preliminary)
study by a group of
economists, social scientists, mathematicians and physicists examining the
causes of the housing boom and subsequent collapse from 2000 to 2006.
Starting with data for the Washington D.C. area, the study’s authors built
up a computational model mimicking the behavior of more than two million
potential homeowners over more than a decade. The model included detail on
each individual at the level of race, income, wealth, age and marital
status, and on how these characteristics correlate with home buying
behavior.
Led by further empirical data, the model makes some
simple, yet plausible, assumptions about the way people behave. For example,
homebuyers try to spend about a third of their annual income on housing, and
treat any expected house-price appreciation as income. Within those
constraints, they borrow as much money as lenders’ credit standards allow,
and bid on the highest-value houses they can. Sellers put their houses on
the market at about 10 percent above fair market value, and reduce the price
gradually until they find a buyer.
The model captures things that dynamic stochastic
general equilibrium models do not, such as how rising prices and the
possibility of refinancing entice some people to speculate, buying
more-expensive houses than they otherwise would. The model accurately fits
data on the housing market over the period from 1997 to 2010 (not
surprisingly, as it was designed to do so). More interesting, it can be used
to probe the deeper causes of what happened.
Consider, for example, the assertion of some
prominent economists, such as
Stanford University’s
John Taylor, that the
low-interest-rate policies of the
Federal Reserve were
to blame for the housing bubble. Some dynamic stochastic general equilibrium
models can be used to support this view. The agent- based model, however,
suggests that
interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom and
bust do become smaller, but only marginally.
Leverage Boom
A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were able
to borrow as much as 100 percent of the value of a house -- a form of easy
credit that had a big effect on housing demand. In the model, freezing
leverage at historically normal levels completely eliminates both the
housing boom and the subsequent bust.
Does this mean leverage was the culprit behind the
subprime debacle and the related global financial crisis? Not necessarily.
The model is only a start and might turn out to be wrong in important ways.
That said, it makes the most convincing case to date (see my
blog for more
detail), and it seems likely that any stronger case will have to be based on
an even deeper plunge into the messy details of how people behaved. It will
entail more data, more agents, more computation and less elegance.
If economists jettisoned elegance and got to work
developing more realistic models, we might gain a better understanding of
how crises happen, and learn how to anticipate similarly unstable episodes
in the future. The theories won’t be pretty, and probably won’t show off any
clever mathematics. But we ought to prefer ugly realism to beautiful
fantasy.
(Mark Buchanan, a theoretical physicist and the author of “The Social
Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually
Looks Like You,” is a Bloomberg View columnist. The opinions expressed are
his own.)
Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned mortgages
---
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The
rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Wall Street’s Math Wizards Forgot a Few Variables
What wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/
An Excellent Presentation on the Flaws of Finance, Particularly the Flaws
of Financial Theorists
A recent topic on the AECM listserv concerns the limitations of accounting
standard setters and researchers when it comes to understanding investors. One
point that was not raised in the thread to date is that a lot can be learned
about investors from the top financial analysts of the world --- their writings
and their conferences.
A Plenary Session Speech at a Chartered Financial Analysts Conference
Video: James Montier’s 2012 Chicago CFA Speech The
Flaws of Finance ---
http://cfapodcast.smartpros.com/web/live_events/Annual/Montier/index.html
Note that it takes over 15 minutes before James Montier begins
Major Themes
- The difference between physics versus finance models is that physicists
know the limitations of their models.
- Another difference is that components (e.g., atoms) of a physics model
are not trying to game the system.
- The more complicated the model in finance the more the analyst is trying
to substitute theory for experience.
- There's a lot wrong with Value at Risk (VaR) models that regulators
ignored.
- The assumption of market efficiency among regulators (such as Alan
Greenspan) was a huge mistake that led to excessively low interest rates and
bad behavior by banks and credit rating agencies.
- Auditors succumbed to self-serving biases of favoring their clients over
public investors.
- Banks were making huge gambles on other peoples' money.
- Investors themselves ignored risk such as poisoned CDO risks when they
should've known better. I love his analogy of black swans on a turkey farm.
- Why don't we see surprises coming (five
excellent reasons given here)?
- The only group of people who view the world realistically are the
clinically depressed.
- Model builders should stop substituting
elegance for reality.
- All financial theorists should be forced to
interact with practitioners.
- Practitioners need to abandon the myth of optimality before the fact.
Jensen Note
This also applies to abandoning the myth that we can set optimal accounting
standards.
- In the long term fundamentals matter.
- Don't get too bogged down in details at the expense of the big picture.
- Max Plank said science advances one funeral at a time.
- The speaker then entertains questions from the audience (some are very
good).
James Montier is a very good speaker from England!
Mr. Montier is a member of GMO’s asset allocation
team. Prior to joining GMO in 2009, he was co-head of Global Strategy at
Société Générale. Mr. Montier is the author of several books including
Behavioural Investing: A Practitioner’s Guide to Applying Behavioural
Finance; Value Investing: Tools and Techniques for Intelligent Investment;
and The Little Book of Behavioural Investing. Mr. Montier is a visiting
fellow at the University of Durham and a fellow of the Royal Society of
Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc.
in Economics from Warwick University
http://www.gmo.com/america/about/people/_departments/assetallocation.htm
There's a lot of useful information in this talk for accountics scientists.
Bob Jensen's threads on what went wrong with accountics research are at
http://faculty.trinity.edu/rjensen/theory01.htm#WhatWentWrong
Remember when the 2007/2008 severe economic collapse was caused by "street
events":
Fraud on Main Street
Issuance of "poison" mortgages (many
subprime)
that lenders knew could never be repaid by borrowers.
Lenders didn't care about loan defaults because they sold the poison mortgages
to suckers like Fannie and Freddie.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
For low income borrowers the Federal Government forced Fannie and Freddie to buy
up the poisoned mortgages ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Math Error on Wall Street
Issuance of CDO portfolio bonds laced with a portion of
healthy mortgages and a portion of poisoned mortgages.
The math error is based on an assumption that risk of poison can be diversified
and diluted using a risk diversification formula.
The risk diversification formula is called the
Gaussian copula function
The formula made a fatal assumption that loan defaults would be random events
and not correlated.
When the real estate bubble burst, home values plunged and loan defaults became
correlated and enormous.
Fraud on Wall Street
All the happenings on Wall Street were not merely innocent
math errors
Banks and investment banks were selling CDO bonds that they knew were
overvalued.
Credit rating agencies knew they were giving AAA high credit ratings to bonds
that would collapse.
The banking industry used powerful friends in government to pass its default
losses on to taxpayers.
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Warnings from a Theoretical Physicist With an Interest in Economics and
Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models,"
by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html
. . .
In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the way
millions of people and companies interact in a handful of pretty equations.
The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the probabilities of
all possible futures and responding in an optimal way to unexpected shocks.
Surreal Models
Surreal as such models might seem, they have played
a significant role in informing policy at the world’s largest central banks.
Unfortunately, they don’t work very well, and they proved spectacularly
incapable of accommodating the way markets and the economy acted before,
during and after the recent crisis.
Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.
Take, for example, a 2012 (and still somewhat
preliminary)
study by a group of
economists, social scientists, mathematicians and physicists examining the
causes of the housing boom and subsequent collapse from 2000 to 2006.
Starting with data for the Washington D.C. area, the study’s authors built
up a computational model mimicking the behavior of more than two million
potential homeowners over more than a decade. The model included detail on
each individual at the level of race, income, wealth, age and marital
status, and on how these characteristics correlate with home buying
behavior.
Led by further empirical data, the model makes some
simple, yet plausible, assumptions about the way people behave. For example,
homebuyers try to spend about a third of their annual income on housing, and
treat any expected house-price appreciation as income. Within those
constraints, they borrow as much money as lenders’ credit standards allow,
and bid on the highest-value houses they can. Sellers put their houses on
the market at about 10 percent above fair market value, and reduce the price
gradually until they find a buyer.
The model captures things that dynamic stochastic
general equilibrium models do not, such as how rising prices and the
possibility of refinancing entice some people to speculate, buying
more-expensive houses than they otherwise would. The model accurately fits
data on the housing market over the period from 1997 to 2010 (not
surprisingly, as it was designed to do so). More interesting, it can be used
to probe the deeper causes of what happened.
Consider, for example, the assertion of some
prominent economists, such as
Stanford University’s
John Taylor, that the
low-interest-rate policies of the
Federal Reserve were
to blame for the housing bubble. Some dynamic stochastic general equilibrium
models can be used to support this view. The agent- based model, however,
suggests that
interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom and
bust do become smaller, but only marginally.
Leverage Boom
A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were able
to borrow as much as 100 percent of the value of a house -- a form of easy
credit that had a big effect on housing demand. In the model, freezing
leverage at historically normal levels completely eliminates both the
housing boom and the subsequent bust.
Does this mean leverage was the culprit behind the
subprime debacle and the related global financial crisis? Not necessarily.
The model is only a start and might turn out to be wrong in important ways.
That said, it makes the most convincing case to date (see my
blog for more
detail), and it seems likely that any stronger case will have to be based on
an even deeper plunge into the messy details of how people behaved. It will
entail more data, more agents, more computation and less elegance.
If economists jettisoned elegance and got to work
developing more realistic models, we might gain a better understanding of
how crises happen, and learn how to anticipate similarly unstable episodes
in the future. The theories won’t be pretty, and probably won’t show off any
clever mathematics. But we ought to prefer ugly realism to beautiful
fantasy.
(Mark Buchanan, a theoretical physicist and the author of “The Social
Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually
Looks Like You,” is a Bloomberg View columnist. The opinions expressed are
his own.)
Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned mortgages
---
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
History
(Long Term
Capital Management and CDO Gaussian Coppola failures)
Repeats Itself in Over a Billion Lost in MF Global
"Models
(formulas) Behaving Badly Led to MF’s Global Collapse – People Too,"
by Aaron Task, Yahoo Finance, November 21, 2011 ---
http://finance.yahoo.com/blogs/daily-ticker/models-behaving-badly-led-mf-global-collapse-people-174954374.html
"The entire system has been utterly destroyed by
the MF Global collapse," Ann Barnhardt, founder and CEO of Barnhardt Capital
Management, declared last week in a letter to clients.
Whether that's hyperbole or not is a matter of
opinion, but MF Global's collapse — and the inability of investigators to
find about $1.2 billion in "missing" customer funds, which is twice the
amount previously thought — has only further undermined confidence among
investors and market participants alike.
Emanuel Derman, a professor at Columbia University
and former Goldman Sachs managing director, says
MF Global was undone by
an over-reliance on short-term funding, which dried up as revelations of its
leveraged bets on European sovereign debt came to light.
In the accompanying video, Derman says MF Global
was much more like Long Term Capital Management than Goldman Sachs, where he
worked on the risk committee for then-CEO John Corzine.
A widely respected expert on risk management,
Derman is the author of a new book
Models. Behaving. Badly: Why Confusing Illusion with Reality Can Lead to
Disaster, on Wall Street and in Life.
As discussed in the accompanying video, Derman says
the "idolatry" of financial models puts Wall Street firms — if not the
entire banking system — at risk of catastrophe. MF Global was an extreme
example of what can happen when the models — and the people who run them --
behave badly, but if Barnhardt is even a little bit right, expect more
casualties to emerge.
Jensen Comment
MF Global's auditor (PwC) will now be ensnared, as seems appropriate in this
case, the massive lawsuits that are certain to take place in the future ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
America Bought a Pig in a Poke: It's like going on a spending binge at
the Titanic's store just after hitting the iceberg
Barack Obama promised to get the economy's mojo working
again with the passage of an almost $800 billion stimulus package. Wall Street
responded with a Bronx Cheer and a 300 drop in the Dow Jones Industrial Average.
What gives? . . . It is unclear how many more boondoggles will be uncovered in
the 1000+ page bill. People are still pouring through its mass of pages. Few, if
any, members of Congress read the bill before it was passed. Scare tactics well
known to every salesman were used to facilitate its passage. The President
proclaimed the sky was falling. An economic catastrophe was just around the
corner. Congress had to do "something" immediately to forestall disaster. There
was no time to read the fine print or to deliberate in a thoughtful manner. And
in lemming like fashion, the Democrats poured over the cliff. It was their
prerogative they claimed. After all, as Mr. Obama declared, "We won the
election."
Ken Connor, "Pork and Pitchforks ,"
Townhall, February 22, 2009 ---
http://townhall.com/columnists/KenConnor/2009/02/22/pork_and_pitchforks
Lou Dobb's Video on Where the Pork is Embedded in the Stimulus Sausage
---
http://www.thehopeforamerica.com/play.php?id=340
But Lou fails to look at the
long-term, multi-year entitlement links in this string of sausage.
The National Debt has continued to increase an average
of $3.93(now $6) billion per day since September 28, 2007!
The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/
History of the National Debt ---
http://en.wikipedia.org/wiki/National_Debt
Entitlements ---
http://faculty.trinity.edu/rjensen/entitlements.htm
History of the National Debt ---
http://en.wikipedia.org/wiki/National_Debt
You cannot legislate the poor into freedom by
legislating the wealthy out of freedom. What one person receives without working
for, another person must work for without receiving. The government cannot give
to anybody anything that the government does not first take from somebody else.
When half of the people get the idea that they do not have to work because the
other half is going to take care of them, and when the other half gets the idea
that it does no good to work because somebody else is going to get what they
work for, that my dear friend, is about the end of any nation. You cannot
multiply wealth by dividing it.
Ronald
Reagan
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
Professor Schiller at Yale asserts housing
prices are still overvalued and need to come down to reality
The median value of a U.S. home in 2000 was $119,600.
It peaked at $221,900 in 2006. Historically, home prices have risen annually in
line with CPI. If they had followed the long-term trend, they would have
increased by 17% to $140,000. Instead, they skyrocketed by 86% due to Alan
Greenspan’s irrational lowering of interest rates to 1%, the criminal pushing of
loans by lowlife mortgage brokers, the greed and hubris of investment bankers
and the foolishness and stupidity of home buyers. It is now 2009 and the median
value should be $150,000 based on historical precedent. The median value at the
end of 2008 was $180,100. Therefore, home prices are still 20% overvalued.
Long-term averages are created by periods of overvaluation followed by periods
of undervaluation. Prices need to fall 20% and could fall 30%.....
Watch the video on Yahoo Finance ---
Click Here
See the chart at
http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
Also see Jim Mahar's blog at
http://financeprofessorblog.blogspot.com/2009/02/shiller-house-prices-still-way-too-high.html
Jensen Comment
In the worldwide move toward fair value accounting that replaces cost allocation
accounting, the above analysis by Professor Schiller is sobering. It suggests
how much policy and widespread fraud can generate misleading "fair values" in
deep markets with many buyers and sellers, although the housing market is a bit
more like the used car market than the stock market. Each house and each used
car are unique, non-fungible items that are many times more difficult to update
with fair value accounting relative to fungible market securities and new car
markets.
The government gave them 105% for their
$200,000 subprime mortgage.
They then sold the house for $37,000, got married, and are escaping from
California.
So are we now that we flipped the doghouse!
It is apparent that we've learned nothing from
several millennia of monetary destruction. The persistent demonstration that
capital, not paper, is the basis for prosperity has fallen on deaf ears. Daily,
we face the sad spectacle of government officials, pundits, and even Nobel
laureates (read that Paul Klugman from the Zimbabwe School of
Finance) telling us that printing money is the answer
to an economic downturn.
"Printing Like Mad," Mises Economic Blog, February 15, 2009 ---
http://blog.mises.org/archives/009457.asp
I started saving up in the barn to buy a new
snow shovel in about six years.
Question
As of December 2008, what do Zimbabwe and the United States have in common?
Answer
Rather than taxing or borrowing to cover deficit spending, both governments are
simply printing more money?
What's wrong with that?
First look at what it did to Zimbabwe. Then read about Gresham's Law ---
http://en.wikipedia.org/wiki/Gresham%27s_Law
The instant the Federal Reserve announced this new funding policy in December,
the U.S. dollar plunged in value relative to foreign currencies. The reason is
obvious.
Zimbabwe's central bank will introduce a 100
trillion Zimbabwe dollar banknote, worth about $33 on the black market, to try
to ease desperate cash shortages, state-run media said on Friday.
KyivPost, January 16, 2009 ---
http://www.kyivpost.com/world/33522
Jensen Comment
This is a direct result of raising money by simply printing it, and the U.S.
should take note since this is how our Federal government has decided to pay for
anticipated trillion-dollar budget deficits ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
The United States will "look like a banana republic"
unless it gains control over its budget deficit and federal debt, economist
Allen Sinai warned Congress on Thursday. "The deficit and debt prospects under
almost any scenario are daunting," Mr. Sinai, chief global economist for
Decision Economics Inc., told the Senate Budget Committee. "This territory is
uncharted, with no real historical analogue to this kind of financial situation
for a major global economic power." Asked by committee Chairman Kent Conrad,
North Dakota Democrat, whether the U.S. government's creditworthiness is at
risk, Mr. Sinai replied, "Unequivocally yes." Richard Berner, chief U.S.
economist at Morgan Stanley, told the committee one measure of America's
creditworthiness -- credit default swap spreads -- already shows some
deterioration. The worse a nation's credit rating becomes, the more its CDS
spread rises. U.S. sovereign CDS spreads have widened to about 0.6 percent from
0.1 percent last summer, Mr. Berner noted. "So the message is that you ignore
global investors at your peril," he told the committee.
David M. Dixon, "Congress warned about debt U.S.
advised to gain control," The Washington Times, January 16, 2009 ---
http://washingtontimes.com/news/2009/jan/16/policies-on-debt-a-risk-to-economy/
"Economics has met the enemy, and it is economics," by Ira Basen,
Globe and Mail, October 15, 2011 ---
http://www.theglobeandmail.com/news/politics/economics-has-met-the-enemy-and-it-is-economics/article2202027/page1/
Thank you Jerry Trites for the heads up.
After Thomas Sargent learned on Monday morning that
he and colleague Christopher Sims had been awarded the Nobel Prize in
Economics for 2011, the 68-year-old New York University professor struck an
aw-shucks tone with an interviewer from the official Nobel website: “We're
just bookish types that look at numbers and try to figure out what's going
on.”
But no one who'd followed Prof. Sargent's long,
distinguished career would have been fooled by his attempt at modesty. He'd
won for his part in developing one of economists' main models of cause and
effect: How can we expect people to respond to changes in prices, for
example, or interest rates? According to the laureates' theories, they'll do
whatever's most beneficial to them, and they'll do it every time. They don't
need governments to instruct them; they figure it out for themselves.
Economists call this the “rational expectations” model. And it's not just an
abstraction: Bankers and policy-makers apply these formulae in the real
world, so bad models lead to bad policy.
Which is perhaps why, by the end of that interview
on Monday, Prof. Sargent was adopting a more realistic tone: “We experiment
with our models,” he explained, “before we wreck the world.”
Rational-expectations theory and its corollary, the
efficient-market hypothesis, have been central to mainstream economics for
more than 40 years. And while they may not have “wrecked the world,” some
critics argue these models have blinded economists to reality: Certain the
universe was unfolding as it should, they failed both to anticipate the
financial crisis of 2008 and to chart an effective path to recovery.
The economic crisis has produced a crisis in the
study of economics – a growing realization that if the field is going to
offer meaningful solutions, greater attention must be paid to what is
happening in university lecture halls and seminar rooms.
While the protesters occupying Wall Street are not
carrying signs denouncing rational-expectations and efficient-market
modelling, perhaps they should be.
They wouldn't be the first young dissenters to call
economics to account. In June of 2000, a small group of elite graduate
students at some of France's most prestigious universities declared war on
the economic establishment. This was an unlikely group of student radicals,
whose degrees could be expected to lead them to lucrative careers in
finance, business or government if they didn't rock the boat. Instead, they
protested – not about tuition or workloads, but that too much of what they
studied bore no relation to what was happening outside the classroom walls.
They launched an online petition demanding greater
realism in economics teaching, less reliance on mathematics “as an end in
itself” and more space for approaches beyond the dominant neoclassical
model, including input from other disciplines, such as psychology, history
and sociology. Their conclusion was that economics had become an “autistic
science,” lost in “imaginary worlds.” They called their movement
Autisme-economie.
The students' timing is notable: It was the spring
of 2000, when the world was still basking in the glow of “the Great
Moderation,” when for most of a decade Western economies had been enjoying a
prolonged period of moderate but fairly steady growth.
Some economists were daring to think the
unthinkable – that their understanding of how advanced capitalist economies
worked had become so sophisticated that they might finally have succeeded in
smoothing out the destructive gyrations of capitalism's boom-and-bust cycle.
(“The central problem of depression prevention has been solved,” declared
another Nobel laureate, Robert Lucas of the University of Chicago, in 2003 –
five years before the greatest economic collapse in more than half a
century.)
The students' petition sparked a lively debate. The
French minister of education established a committee on economic education.
Economics students across Europe and North America began meeting and
circulating petitions of their own, even as defenders of the status quo
denounced the movement as a Trotskyite conspiracy. By September, the first
issue of the Post-Autistic Economic Newsletter was published in Britain.
As The Independent summarized the students'
message: “If there is a daily prayer for the global economy, it should be,
‘Deliver us from abstraction.'”
It seems that entreaty went unheard through most of
the discipline before the economic crisis, not to mention in the offices of
hedge funds and the Stockholm Nobel selection committee. But is it ringing
louder now? And how did economics become so abstract in the first place?
The great classical economists of the late 18th and
early 19th centuries had no problem connecting to the real world – the
Industrial Revolution had unleashed profound social and economic changes,
and they were trying to make sense of what they were seeing. Yet Adam Smith,
who is considered the founding father of modern economics, would have had
trouble understanding the meaning of the word “economist.”
What is today known as economics arose out of two
larger intellectual traditions that have since been largely abandoned. One
is political economy, which is based on the simple idea that economic
outcomes are often determined largely by political factors (as well as vice
versa). But when political-economy courses first started appearing in
Canadian universities in the 1870s, it was still viewed as a small offshoot
of a far more important topic: moral philosophy.
In The Wealth of Nations (1776), Adam Smith
famously argued that the pursuit of enlightened self-interest by individuals
and companies could benefit society as a whole. His notion of the market's
“invisible hand” laid the groundwork for much of modern neoclassical and
neo-liberal, laissez-faire economics. But unlike today's free marketers,
Smith didn't believe that the morality of the market was appropriate for
society at large. Honesty, discipline, thrift and co-operation, not
consumption and unbridled self-interest, were the keys to happiness and
social cohesion. Smith's vision was a capitalist economy in a society
governed by non-capitalist morality.
But by the end of the 19th century, the new field
of economics no longer concerned itself with moral philosophy, and less and
less with political economy. What was coming to dominate was a conviction
that markets could be trusted to produce the most efficient allocation of
scarce resources, that individuals would always seek to maximize their
utility in an economically rational way, and that all of this would
ultimately lead to some kind of overall equilibrium of prices, wages, supply
and demand.
Political economy was less vital because government
intervention disrupted the path to equilibrium and should therefore be
avoided except in exceptional circumstances. And as for morality, economics
would concern itself with the behaviour of rational, self-interested,
utility-maximizing Homo economicus. What he did outside the confines of the
marketplace would be someone else's field of study.
As those notions took hold, a new idea emerged that
would have surprised and probably horrified Adam Smith – that economics,
divorced from the study of morality and politics, could be considered a
science. By the beginning of the 20th century, economists were looking for
theorems and models that could help to explain the universe. One historian
described them as suffering from “physics envy.” Although they were dealing
with the behaviour of humans, not atoms and particles, they came to believe
they could accurately predict the trajectory of human decision-making in the
marketplace.
In their desire to have their field be recognized
as a science, economists increasingly decided to speak the language of
science. From Smith's innovations through John Maynard Keynes's work in the
1930s, economics was argued in words. Now, it would go by the numbers.
Continued in a long article
Mathematical Analytics in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm#Analytics
Federal securities class action lawsuits increased 19 percent
in 2008, with almost half involving firms in the financial services sector
according to the annual report prepared by the Stanford Law School Securities
Class Action Clearinghouse in cooperation with Cornerstone Research ---
http://securities.stanford.edu/scac_press/20080106_YIR08_Press_Release.pdf
Especially note the 2008 Year in Review link at
http://securities.stanford.edu/clearinghouse_research/2008_YIR/20080106.pdf
"Fed Cuts Key Rate to a Record Low," by Edmund L. Andrews and Jackie Calmes,
The New York Times, December 16, 2008 ---
http://www.nytimes.com/2008/12/17/business/economy/17fed.html?_r=1&scp=1&sq=printing
money&st=cse
In effect, the Fed is stepping in as a
substitute for banks and other lenders and acting more like a bank itself.
“The Federal Reserve will employ all available tools to promote the
resumption of sustainable economic growth,” it said. Those tools include
buying “large quantities” of mortgage-related bonds, longer-term Treasury
bonds, corporate debt and even consumer loans.
The move came as President-elect Barack
Obama summoned his economic team to a four-hour meeting in Chicago to map
out plans for an enormous economic stimulus measure that could cost anywhere
from $600 billion to $1 trillion over the next two years.
The two huge economic stimulus programs,
one from the Fed and one from the White House and Congress, set the stage
for a powerful but potentially risky partnership between Mr. Obama and the
Fed’s Republican chairman, Ben S. Bernanke.
“We are running out of the traditional
ammunition that’s used in a recession, which is to lower interest rates,”
Mr. Obama said at a news conference Tuesday. “It is critical that the other
branches of government step up, and that’s why the economic recovery plan is
so essential.”
Financial markets were electrified by the
Fed action. The Dow Jones industrial average jumped 4.2 percent, or 359.61
points, to close at 8,924.14.
Investors rushed to buy long-term Treasury
bonds. Yields on 10-year Treasuries, which have traditionally served as a
guide for mortgage rates, plunged immediately after the announcement to 2.26
percent, their lowest level in decades, from 2.51 percent earlier in the
day.
Yields on investment-grade corporate bonds
edged down to 7.215 percent on Tuesday, from 7.355 on Monday. Yields on
riskier high-yielding corporate bonds remained in the stratosphere at 22.493
percent, almost unchanged from 22.732 on Monday.
By contrast, the dollar dropped sharply
against the euro and other major currencies for the second consecutive day —
a sign that currency markets were nervous about a flood of newly printed
dollars.
Some analysts predict that the Treasury will have to sell $2 trillion worth
of new securities over the next year to finance its existing budget deficit,
a new stimulus program and to refinance about $600 billion worth of maturing
government debt.
For the moment, Mr. Obama and Mr. Bernanke
appear to be on the same page, though that could abruptly change if the
economy starts to revive. Fed officials have already assumed that Congress
will pass a major spending program to stimulate the economy, and they are
counting on it to contribute to economic growth next year.
In more normal times, the Fed might easily
start raising interest rates in reaction to a huge new spending program, out
of concern about rising inflation.
But data on Tuesday provided new evidence
that the biggest threat to prices right now was not inflation but deflation.
The federal government reported on Tuesday
that the Consumer Price Index fell 1.7 percent in November, the steepest
monthly drop since the government began tracking prices in 1947. The decline
was largely driven by the recent plunge in energy prices, but even the
so-called core inflation rate, which excludes the volatile food and energy
sectors, was essentially zero.
Mr. Obama’s goal is to have a package
ready when the new Congress convenes on Jan. 6. His hope is that the House
and Senate, with their bigger Democratic majorities, can agree quickly on a
plan for Mr. Obama to sign into law soon after he is sworn into office two
weeks later.
The Fed, in a statement accompanying its
rate decision, acknowledged that the recession was more severe than
officials had thought at their last meeting in October.
“Over all, the outlook for economic
activity has weakened further,” the central bank said.
“Labor market conditions have
deteriorated, and the available data indicate that consumer spending,
business investment and industrial production have declined.”
The central bank added: “The committee
anticipates that weak economic conditions are likely to warrant
exceptionally low levels of the federal funds rate for some time.”
With fewer than 10 days until Christmas,
retailers from Saks Fifth Avenue to Wal-Mart have been slashing prices to
draw in consumers, who have sharply reduced their spending over the last six
months. On Tuesday, Banana Republic offered customers $50 off on any
purchases that total $125. The clothing retailer DKNY offered customers $50
off any purchase totaling $250.
Ian Shepherdson, an analyst at High
Frequency Economics, said falling energy prices were likely to bring the
year-over-year rate of inflation to below zero in January.
The Fed has already announced or outlined
a range of unorthodox new tools that it can use to keep stimulating the
economy once the federal funds rate effectively reaches zero. On Tuesday,
Fed officials said they stood ready to expand them or create new ones to
relieve bottlenecks in the credit markets.
All of the tools involve borrowing by the
Fed, which amounts to printing money in vast new quantities, a process the
Fed has already started.
Since September, the Fed’s balance sheet has ballooned from about $900
billion to more than $2 trillion as it has created money and lent it out. As
soon as the Fed completes its plans to buy mortgage-backed debt and consumer
debt, the balance sheet will be up to about $3 trillion.
“At some point, and without knowing the
timing, the Fed is going to have to destroy all that money it is creating,”
said Alan Blinder, a professor of economics at Princeton and a former vice
chairman of the Federal Reserve.
“Right now, the crisis is created by the
huge demand by banks for hoarding cash. The Fed is providing cash, and the
banks want to hoard it. When things start returning to normal, the banks
will want to start lending it out. If that much money is left in the
monetary base, it would be extremely inflationary.”
This is the thing I’ve been afraid of ever since I
realized that Japan really was in the dreaded, possibly mythical liquidity trap.
You can read my 1998 Brookings Paper on the issue
here.
Incidentally, there were a bunch of us at Princeton
worrying about the Japan problem in the early years of this decade. I was one;
Lars Svensson, currently at Sweden’s Riksbank, was another; a third was a guy
named Ben Bernanke. I wonder whatever happened to him?
Paul Krugman, "ZIRP," The New York Times, December 16, 2008
---
http://krugman.blogs.nytimes.com/2008/12/16/zirp/?scp=8&sq=printing money&st=cse
How much to bail out the banks now? $3.5 trillion by one estimate
America, what is happening to you?
A federal program to guarantee or buy bad assets from
the ailing U.S. bank sector could come with a $3.5 trillion price tag. That
would push the accumulated costs of rescuing the financial markets over the last
year through various federal loan, stock purchase, debt guarantee and other
programs close to $9 trillion and counting, with practically no end in sight for
the bad news battering the banking industry. That figure doesn't count the $825
billion economic stimulus plan also under consideration. "We expect massive
federal intervention into the financial sector from the new administration in
the coming months," says Keefe Bruyette & Woods analyst Frederick Cannon, who
calculated the $3.5 trillion figure, which is one-quarter of the banking
sector's $14 trillion in combined assets.
Liz Moyer, "A TARP In The Trillions?"
Forbes, January 21, 2009 ---
http://www.forbes.com/2009/01/21/tarp-banking-treasury-biz-wall-cx_lm_0121tarp.html
Jensen Comment
The estimate is now almost double the above figure.
So how much are we talking about in
the already-existing toxic paper already held by Fannie, Freddie, and the most
poisoned banks?
Estimates place these at $6 trillion, which is well over half our out-of-control
existing National Debt ---
http://online.wsj.com/article/SB123396703401759083.html?mod=djemEditorialPage
Plus another $3,6 trillion maybe
America, what is happening to you?
Much has been made of the subprime debacle. But few seem to be willing to talk
about another looming crisis: credit card debt. People like Nouriel Roubini, the
professor who has predicted much of this crisis, have estimated that you could
have losses of as much as $3.6 trillion, which would bankrupt the industry. What
do you make of that number? And since credit card defaults are correlated to
employment, what happens if unemployment goes as high as 10 percent or more?
What is the highest unemployment level that you’ve used in your forecasting
models? And do you have adequate reserves for your worst-case situation? If your
assumptions are wrong, what happens?
Andrew Ross Sorkin, "Up Next for
Bankers: A Flogging," The New York Times, February 9, 2009 ---
http://www.nytimes.com/2009/02/10/business/10sorkin.html?_r=1&partner=permalink&exprod=permalink
As it has so often in recent months, the market
elation that greeted the Federal Reserve's epic monetary easing earlier this
week has turned to worry. Stocks fell off again yesterday, but the big news of
the week has been the slide in the dollar. The nearby chart shows the
greenback's story since September. From its dangerous summer lows, the buck
soared at the height of the credit panic as investors looked for safety in a
hurricane. But the dollar has fallen like Newton's apple in December, as
Chairman Ben Bernanke and his comrades signaled that they are willing to cut
interest rates to near-zero and print as much money as it takes to prevent a
deflation.
"A Dollar Referendum Currency markets reflect a lack of faith in Bernanke,"
The Wall Street Journal, December 19, 2008 ---
http://online.wsj.com/article/SB122965017184420567.html
A few quick facts about Wall Street bonuses. The
pretext for the political outrage was the New York comptroller's report this
week on the aggregate data for bonuses in 2008. That "irresponsible" bonus pool
of $18 billion was for every worker in the New York financial industry, from top
dogs to secretaries. This bonus pool fell 44% in 2008, the largest percentage
decline in 30 years. The average bonus was $112,000; bonuses typically make up
most of an employee's salary on Wall Street. The comptroller estimates that this
decline will cost New York State $1 billion in lost tax revenue and New York
City $275 million. Both city and state may have to announce layoffs.
"'Idiots' Indeed," The Wall Street Journal, January 31,
2009 ---
http://online.wsj.com/article/SB123336371503735447.html?mod=djemEditorialPage
Jensen Comment
Although this puts our bonus contempt somewhat in a new light, it also does not
lesson opinion that John Thain and the other crooks who declared themselves
multi-million bonuses are one of the reasons that America now despises Wall
Street. Actually Thain wanted a $10 million bonus while captain of his sinking
ship (Merrill Lynch).
Bob Jensen's threads on outrageous executive compensation ---
http://online.wsj.com/article/SB123336371503735447.html?mod=djemEditorialPage
Rep. Manzullo Questions Bailout Czar Neel Kashkari (Watch a
Butt Get Chewed Out) ---
http://www.youtube.com/watch?v=UP73cK3GXdo
Bob Jensen's threads on outrageous executive compensation ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Bank of America ---
http://en.wikipedia.org/wiki/Bank_of_America
BofA was riding high after the 2009 financial crises until it acquired the
disasters called Countrywide and Merrill Lynch!
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 5, 2012
BofA Takes New Crisis-Era Hit
by:
Dan Fitzpatrick, Christian Berthelsen and Robin Sidel
Sep 29, 2012
Click here to view the full article on WSJ.com
Click here to view the
video on WSJ.com
TOPICS: Contingent Liabilities
SUMMARY: "Bank of America Corp. agreed to pay $2.43 billion to
settle claims it misled investors about the acquisition of troubled
brokerage firm Merrill Lynch & Co...." during the financial crisis in 2008.
At the time it acquired Merrill Lynch in September 2008, BofA became the
biggest U.S. bank; the value of the bank then fell by more than half by the
time the acquisition of Merrill Lynch closed 3 months later. These losses
were not disclosed by then CEO Ken Lewis and his management team to
shareholders before they voted on the merger transaction with Merrill.
CLASSROOM APPLICATION: The article addresses accounting for
litigation contingent liabilities. The related video clearly discusses the
history of the transactions.
QUESTIONS:
1. (Introductory) To whom did Bank of America Corp. (BofA) agree to
pay $2.43 billion dollars?
2. (Introductory) For what losses did BofA agree to make this
payment?
3. (Advanced) How could losses have occurred and a payment of $2.4
billion be required if "Bank of America executives now say Merrill...has
become a big profit contributor... [and that] it's clear that Merrill is a
significant positive any way you want to look at it..."?
4. (Advanced) What accounting standards provide the requirements to
account for costs such as this $2.4 billion payment by BofA?
5. (Advanced) According to the article, BofA has "set aside more
than $42 billion in litigation expenses, payouts and reserves...[which]
includes $1.6 billion taken in the third quarter [of 2012]...." According to
the related video, what period will be affected by $1.6 billion being
recorded as an expense related to this $2.43 billion settlement? Explain
your answer.
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
BofA-Merrill: Still A Bottom-Line Success
by David Benoit
Sep 28, 2012
Online Exclusive
"BofA Takes New Crisis-Era Hit," by Dan Fitzpatrick, Christian Berthelsen and
Robin Sidel, The Wall Street Journal, September 29, 2012 ---
http://professional.wsj.com/article/SB10000872396390443843904578024110468736042.html?mod=djem_jiewr_AC_domainid&mg=reno-wsj
Bank of America Corp. agreed to pay $2.43 billion
to settle claims it misled investors about the acquisition of troubled
brokerage firm Merrill Lynch & Co., in the latest financial-crisis
aftershock to rattle the banking sector.
The payment is the largest settlement of a
shareholder claim by a financial-services firm since the upheaval of 2008
and 2009. It also ranks as the eighth-largest securities class-action
settlement, behind payouts like the $7.2 billion settlement with
shareholders of Enron Corp. and the $6.1 billion pact with WorldCom Inc.
investors, both in 2005.
The deal is a sign that U.S. banks' battle to
contain the high cost of the crisis continues to escalate, despite a
four-year slog of lawsuits, losses and profit-sapping regulations. Bank of
America's total exposure to crisis-era litigation is "seemingly
never-ending," said Sterne Agee & Leach Inc. in a note Friday.
Is the era that produced all of this legal exposure
"history?" the Sterne Agee & Leach analysts said. "Unlikely."
The settlement ends a three-year fight with a group
of five plaintiffs, including the State Teachers Retirement System of Ohio
and the Teacher Retirement System of Texas. They accused the bank and its
officers of making false or misleading statements about the health of Bank
of America and Merrill Lynch and were planning to seek $20 billion if the
case went to trial as scheduled on Oct. 22.The size of the pact highlights
how hasty acquisitions engineered during the height of the financial crisis
by Kenneth Lewis, then the bank's chief executive, are still haunting the
company four years later. Decisions to buy mortgage lender Countrywide
Financial Corp. and Merrill have forced Bank of America, run since 2010 by
Chief Executive Brian Moynihan, to set aside more than $42 billion in
litigation expenses, payouts and reserves, according to company figures. The
funds are meant to absorb a litany of Merrill-related lawsuits and claims
from investors who say Countrywide wasn't honest about the quality of
mortgage-backed securities it issued before the crisis.
That total includes $1.6 billion taken in the third
quarter to help pay for the Merrill settlement announced Friday and a
landmark $8.5 billion agreement reached last year with a group of
high-profile mortgage-bond investors.
The company's shares lost more than half their
value between when Bank of America announced its late-2008 plan to purchase
Merrill Lynch and the date the deal closed 3½ months later, wiping out $70
billion in shareholder value. The shares have fallen further since then, and
investors who owned the shares won't be made whole by the settlement.
"We find it simply amazing the sheer magnitude of
value destruction over the years," said Sterne Agee in the note issued
Friday. And "the bill is surely set to increase" as the research firm
expects the bank to reach other legal settlements over the next 12 to 24
months. Bank of America is still engaged in a legal clash with bond insurer
MBIA Inc.,
MBI +3.91%
which has alleged that Countrywide wasn't honest about the quality of
mortgage-backed securities it issued before the financial crisis.
The move to buy Merrill over one weekend in
September 2008 was initially hailed as a rare piece of good news during a
week when much of Wall Street appeared to be teetering on the brink. It also
vaulted the Charlotte, N.C., lender to the top of the U.S. banking heap,
capping a goal pursued over two decades by Mr. Lewis and his predecessor,
Hugh McColl.
The Merrill deal, initially valued at $50 billion
in Bank of America stock, was the "deal of a lifetime," Mr. Lewis said on
the day it was announced.
But the agreement soon became a problem as analysts
questioned whether Mr. Lewis paid too much and Merrill's losses spiraled out
of control in the weeks before the deal closed. Investor fears stemming from
the financial crisis sent shares of Bank of America and other financial
companies into free fall, and the deal was worth roughly $19 billion at its
completion on Jan. 1, 2009.
Mr. Lewis and his top executives made the decision
not to say anything publicly about the mounting problems before shareholders
signed off on the merger—a decision that formed the basis of a number of
Merrill-related suits, including an action brought by the Securities and
Exchange Commission. The bank also didn't disclose that it sought $20
billion in U.S. aid to digest Merrill, or that the deal allowed Merrill to
award up to $5.8 billion in performance bonuses. When Bank of America
threatened to pull out of the deal because of the losses, then-Treasury
Secretary Henry Paulson told Mr. Lewis that current management would be
removed if the deal wasn't completed.
The legal scrutiny surrounding the Merrill
acquisition contributed to Mr. Lewis's decision to step down at the end of
2009. Mr. Lewis's lawyer declined to comment.
"Any way you slice it, $2.4 billion is a big
number," says Kevin LaCroix, a lawyer at RT ProExec, a firm that focuses on
management-liability issues.
Bank of America executives now say Merrill, unlike
Countrywide, has become a big profit contributor, while the company
continues to work to absorb massive losses in its mortgage division. The
divisions inherited from Merrill produced $31.9 billion in net income
between 2009 and 2011 and $164.4 billion in revenue. Bank of America's total
net income over the period was just $5.5 billion, on $326.8 billion in
revenue, reflecting in part the hefty losses tied to the Countrywide deal.
"I think it's clear that Merrill is a significant
positive any way you want to look at it," said spokesman Jerry Dubrowski.
The settlement doesn't end all Merrill-related
headaches. The New York attorney general's office still is pursuing a
separate civil fraud suit relating to the Merrill takeover that began under
former Attorney General Andrew Cuomo. Defendants in that case include the
bank, Mr. Lewis and former Chief Financial Officer Joe Price. A spokesman
for New York State Attorney General Eric Schneiderman declined to comment.
It isn't known how much all shareholders will
receive as a result of the Merrill settlement announced Friday. The amount
shareholders receive will ultimately depend on how long they held the shares
and how much they paid. Mr. Lewis, also a shareholder, won't receive a
payout because defendants in the suit are excluded from the class that the
court certified.
But because the decline in Bank of America stock
was so steep—the shares fell from $32 to $14 between Sept. 12, 2008, the day
before the Merrill acquisition was announced, and the Jan. 1, 2009,
closing—no shareholders can expect to recover their full losses.
Before the settlement was reached, a targeted
recovery for at least three million shareholders who were part of the class
was $2.52 a share, said a spokesman for Ohio Attorney General Mike DeWine.
The State Teachers Retirement System of Ohio and the Ohio Public Employees
Retirement System, which held between 18 million and 20 million shares, now
expect to recover $1.19 per share, or roughly $20 million.
Continued in article
Breaking the Bank Frontline
Video
In Breaking the Bank, FRONTLINE producer Michael Kirk
(Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile
interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to
reveal the story of two banks at the heart of the financial crisis, the rocky
merger, and the government’s new role in taking over — some call it
“nationalizing” — the American banking system.
Simoleon Sense, September 18,
2009 ---
http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Update November 23, 2016
Treasury Secretary Hank Paulson's Bank of
America Extortion Scheme (Hustle) Finally Laid to Rest
From the CFO Journal's Morning Ledger
on November 23, 2016
Do the Hustle? Nope
The government’s Hustle
case against Bank of America Corp. is
finally dead. The case, in which the government accused the bank’s
Countrywide Financial Corp. unit of
churning out shoddy mortgage securities in the run-up to the financial
crisis, already was thrown out by a U.S. appeals court in May. The U.S.
attorney’s office in Manhattan, which had first brought the case in 2012,
then asked the appeals court to reconsider its decision, a request that was
denied.
Jensen Comment
A better word for "Hustle" is Treasury Department
"Extortion." When the economy collapsed in 2007 due to poisoned mortgages
BofA had no poisoned mortgages. Then Treasury Secretary Hank Paulson came
calling like an extortionist according to former BofS CEO Ken Lewis. Paulson
gave BofA no choice but to buy Countrywide Financial with its millions of
poisoned mortgages. The secret intent was to give Countrywide deeper pockets
so that the Federal Government could turn around a sue BofA billions for all
the financial crimes of Countrywide Financial.
There was never any doubt about the high crimes of
Countrywide Financial on the main streets of cities and towns across the
USA. Countrywide issued millions of mortgages to borrowers having no hope of
meeting their mortgage obligations.
It makes me feel good that Paulson finally got his just
dessert. I only wish he would be sued. As the former CEO of Goldman Sachs he
bailed out Goldman with milk and honey and pissed on BofA. Now he's retired
on his millions from Goldman and seemingly can't be touched for his
extortion crimes.
Merrill Lynch had a friend in Hank Paulson, but he was no friend to Bank
of America shareholders
The ex-US Treasury Secretary has admitted telling the
Bank of America boss he might lose his job if he walked away from a merger from
Merrill Lynch. The former US Treasury Secretary says the merger was necessary
Hank Paulson warned the bank's chief executive Kenneth Lewis that the Federal
Reserve could oust him and the board if the rescue did not proceed. But Mr.
Paulson insisted that remarks he made were "appropriate." Bank of America bought
Merrill during the height of the financial crisis and suffered severe losses.
"Paulson admits bank merger threat," BBC News, July 15,
2009 ---
http://news.bbc.co.uk/2/hi/business/8152858.stm
Jensen Comment
Paulson's claim that his threats were "appropriate" comes as little comfort to
Bank of America shareholders who will be losing greatly because of the threats.
Bank of America is now paying a steep (fatal?) price for having purchased the
fraudulent Countrywide and Merrill Lynch companies. The poison-laced Countrywide
was a lousy investment decision. However, then CEO Kenneth D. Lewis contends
that then Treasury Secretary Hank Paulson held a gun to his head and forced BofA
to buy the deeply corrupt and poison-laced Merrill Lynch.
CDO ---
http://en.wikipedia.org/wiki/Collateralized_debt_obligation
Countrywide Financial ---
http://en.wikipedia.org/wiki/Countrywide_Financial
Those Poisoned CDOs
"Bank of America Ordered to Unseal Documents in MBIA Case," by Dan Freed,
The Street, June 4, 2013 ---
http://www.thestreet.com/story/11804771/1/bank-of-america-ordered-to-unseal-documents-in-mbia-case.html
Jensen Comment
Arguably the worst decision in the 2008 economic bailout was Bank of America's
decision to buy the bankrupt Countrywide Financial. BofA then CEO Lewis claims
to this day that Treasury Secretary Hank Paulsen held a gun to his head and said
buy Countrywide Financial or else. Countrywide has been nothing but a cash flow
hemorrhage for BofA ever since.
"BofA plunges as AIG sues for $10 billion "fraud," by Jonathan Stempel
and Joe Rauch, Reuters, August 8, 2011 ---
http://www.reuters.com/article/2011/08/08/us-bankofamerica-aig-lawsuit-idUSTRE7772LN20110808
Bank of America Corp shares plunged more than 20
percent on Monday, capping a three-day rout in which the largest U.S. bank
lost nearly one-third of its market value.
Monday's decline was triggered by a $10 billion
lawsuit from American International Group Inc alleging a "massive" mortgage
fraud.
The action raised new concerns about burgeoning
losses related to the bank's $2.5 billion purchase of Countrywide Financial
Corp in 2008 and prompted questions about the stability of the bank's
management team.
"The bank just can't get its hands around the
liabilities it's facing," said Paul Miller, an analyst at FBR Capital
Markets.
He said investors fear the bank will have to raise
equity to cover potential losses, diluting existing shareholdings.
Bank of America spokesman Jerry Dubrowski countered
that the bank has adequate reserves to buy back mortgages if necessary and
is comfortable with its strategic plans.
"We don't think we need to raise capital to run our
businesses," he said. "We have the right strategy and management team in
place."
In a separate court filing on Monday AIG,
challenged an $8.5 billion agreement Bank of America reached in late June to
end litigation by several large investors who bought securities backed by
subprime Countrywide loans.
New York Attorney General Eric Schneiderman and
other investors have previously tried to block that accord, saying the
settlement amount is too small.
Bank of America shares closed down $1.66 at $6.51
after earlier plunging to $6.31, their lowest since March 2009. More than
$30 billion of the company's market value has been wiped out since August 3.
Monday's drop came amid a broad market selloff, led
by financial stocks, on the first trading day after Standard & Poor's
downgraded its rating of U.S. government debt.
The shares of Citigroup Inc, another large bank,
fell 16.4 percent to $27.95.
The cost of insuring Bank of America debt against
default, an indicator of potential trouble at companies, rose roughly 50
percent on Monday to a level higher than several of the bank's main rivals,
data provider Markit said.
It now costs $310,000 a year to insure the bank's
bonds for five years, compared with $143,000 for the bonds of JP Morgan
Chase & Co, the second largest U.S. bank.
CONFIDENCE AND TRUST
AIG's lawsuit also upped the ante for Bank of
America Chief Executive Brian Moynihan, who is struggling to contain losses
from the Countrywide deal engineered by his predecessor, Kenneth Lewis.
"Brian Moynihan and the management team have not
gained the confidence and trust of investors," said Jonathan Finger, whose
Finger Interests Number One Ltd in Houston owns BofA stock and was a vocal
critic of Lewis.
Moynihan is scheduled to participate in a public
conference call on Wednesday hosted by Fairholme Capital Management LLC, one
of its largest shareholders.
"Brian will have to give the performance of his
life," said Tony Plath, a professor at the University of North Carolina at
Charlotte, where Bank of America is based.
Moynihan's saving grace might be that the bank's
board has no obvious candidates to replace him, said Miller of FBR Capital
Markets.
Some large investors appeared to have avoided some
of the debacle.
Hedge fund manager David Tepper, who has made a
fortune betting against financial company shares, sold nearly half of his
stake in Bank of America during the second quarter, according to a
regulatory filing from his company, Appaloosa Management.
"Bank of America's stock price will remain under
duress," said Michael Mullaney, who helps invest $9.5 billion at Fiduciary
Trust Co in Boston and who said his company has sold nearly all its BofA
shares.
Continued in article
Thain Pain: Merrill Lynch Bonuses of Over $1 Million to 696
Executives
Rewarded for making their company so profitable for shareholders? (Barf Alert!)
Merrill Lynch quietly paid out at least one million
dollars bonus each to about 700 top executive even when the investment house was
bleeding with losses last year, a probe has revealed. They were part of 3.6
billion dollars in the firm's bonus payments in December before the announcement
of its fourth quarterly losses and takeover by Bank of America, the
investigation by the New York state Attorney General's office showed. "696
individuals received bonuses of one million dollars or more," New York Attorney
General Andrew Cuomo said of the Merrill scandal in a letter to a lawmaker
heading the House of Representatives financial services committee.
"Merrill bonuses made 696 millionaires: probe," Yahoo News,
February 11, 2009 ---
http://news.yahoo.com/s/afp/20090211/bs_afp/usbankingjusticeprobecompanymerrillbofa_20090211201133
John Alexander Thain (born May 26, 1955) was the
last chairman and chief executive officer of Merrill Lynch before its merger
with Bank of America. Thain was designated to become president of global
banking, securities, and wealth management at the newly combined company,
but he resigned on January 22, 2009. Bank of America lost
confidence in Thain after he failed to tell the bank about mounting losses at
Merrill in late 2008. The Associated Press
identified him as the best paid among the executives of the S&P 500 companies in
2007. On December 8, 2008, Thain gave up on pursuing a controversial bonus of
$10 million from the compensation committee at Merrill.[2] Thain also decided to
accelerate payments of bonus to employees at Merrill, giving out between $3
billion and $4 billion using money that appeared to come directly from the $15
billion Bank of America and Merrill Lynch had received from US government
taxpayers (via the Troubled Assets Relief Program). Thain has additionally
become infamous for spending $1.22 million in corporate funds to decorate his
office, even as he was asking the government for a bailout of his troubled
company.
Quoted from Wikipedia ***
http://en.wikipedia.org/wiki/John_Thain
Thain has since been fired by Bank of America and has agreed to pay for over $1
million spent redecorating his new office.
My
question is how Bank of America could buy Merrill without audit verification of
Merrill’s 2008 losses and cash flows --- these should've never been a surprise
to Bank of America unless Bank of America was plain stupid about accounting. The
final settlement price at a minimum could've been contingent on an audit of 2008
earnings.
Added Jensen Comment
I've never been a big fan of Merrill Lynch after repeated disclosures emerged
about the repeated frauds instigated by employees of Merrill in the 1990s. Just
do a word search on "Merrill" and note the number of frauds that are documented,
not the least of which is the Orange County massive derivatives instruments
fraud ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Good Bank, Bad Bank by Dr. Seuss ---
http://thereformedbroker.com/2009/01/29/good-bank-bad-bank-by-dr-seuss/
The Short and Simple Video About What Caused the Credit Crisis ---
http://vimeo.com/3261363
Also at
http://www.youtube.com/watch?v=Q0zEXdDO5JU
Ed Scribner forwarded the above links
"Six Errors on the Path to the Financial Crisis," by Alan S. Blinder,
The New York Times, January 24, 2009 ---
http://www.nytimes.com/2009/01/25/business/economy/25view.html?_r=1&ref=business
My list of errors has
six whoppers, in chronologically order. I omit
mistakes that became clear only in hindsight,
limiting myself to those where prominent voices
advocated a different course at the time. Had these
six choices been different, I believe the inevitable
bursting of the housing bubble would have caused far
less harm.
WILD
DERIVATIVES
In 1998, when Brooksley E.
Born, then chairwoman of the
Commodity Futures Trading Commission,
sought to extend its
regulatory reach into the derivatives world, top
officials of the Treasury Department, the Federal
Reserve and the Securities and Exchange Commission
squelched the idea. While her specific plan may not
have been ideal, does anyone doubt that the
financial turmoil would have been less severe if
derivatives trading had acquired a zookeeper a
decade ago?
SKY-HIGH LEVERAGE
The second error came in 2004, when the S.E.C. let
securities firms raise their leverage sharply.
Before then, leverage of 12 to 1 was typical;
afterward, it shot up to more like 33 to 1. What
were the S.E.C. and the heads of the firms thinking?
Remember, under 33-to-1 leverage, a mere 3 percent
decline in asset values wipes out a company. Had
leverage stayed at 12 to 1, these firms wouldn’t
have grown as big or been as fragile.
A SUBPRIME SURGE
The next error came in stages,
from 2004 to 2007, as subprime lending grew from a
small corner of the mortgage market into a large,
dangerous one. Lending standards fell disgracefully,
and dubious transactions became common.
Why wasn’t this
insanity stopped? There are two answers, and each
holds a lesson. One is that bank regulators were
asleep at the switch. Entranced by laissez faire-y
tales, they ignored warnings from those like Edward
M. Gramlich, then a Fed governor, who saw the
problem brewing years before the fall.
The other answer
is that many of the worst subprime mortgages
originated outside the banking system, beyond the
reach of any federal regulator. That regulatory hole
needs to be plugged.
FIDDLING ON FORECLOSURES
The government’s continuing failure to do anything
large and serious to limit foreclosures is tragic.
The broad contours of the foreclosure tsunami were
clear more than a year ago — and people like
Representative
Barney Frank, Democrat of
Massachusetts, and
Sheila C. Bair, chairwoman
of the
Federal Deposit Insurance Corporation,
were sounding alarms.
Yet the Treasury
and Congress fiddled while homes burned. Why?
Free-market ideology, denial and an unwillingness to
commit taxpayer funds all played roles. Sadly, the
problem should now be much smaller than it is.
LETTING
LEHMAN
GO
The next whopper came in
September, when Lehman Brothers, unlike
Bear Stearns before it,
was allowed to fail. Perhaps it was a case of
misjudgment by officials who deemed Lehman neither
too big nor too entangled — with other financial
institutions — to fail. Or perhaps they wanted to
make an offering to the moral-hazard gods.
Regardless, everything fell apart after Lehman.
People in the
market often say they can make money under any set
of rules, as long as they know what they are. Coming
just six months after Bear’s rescue, the Lehman
decision tossed the presumed rule book out the
window. If Bear was too big to fail, how could
Lehman, at twice its size, not be? If Bear was too
entangled to fail, why was Lehman not?
After Lehman went
over the cliff, no financial institution seemed
safe. So lending froze, and the economy sank like a
stone. It was a colossal error, and many people said
so at the time.
TARP’S DETOUR
The final major error is mismanagement of the
Troubled Asset Relief Program,
the $700 billion bailout fund.
As I wrote here last month, decisions of
Henry M. Paulson Jr.,
the former Treasury secretary, about using the
TARP’s first $350 billion were an inconsistent mess.
Instead of pursuing the TARP’s intended purposes, he
used most of the funds to inject capital into banks
— which he did poorly.
To
illustrate what might have been, consider Fed
programs to buy
commercial paper and
mortgage-backed securities. These facilities do
roughly what TARP was supposed to do: buy troubled
assets. And they have breathed some life into those
moribund markets. The lesson for the new Treasury
secretary is clear: use TARP money to buy troubled
assets and to mitigate foreclosures.
Six fateful
decisions — all made the wrong way. Imagine what the
world would be like now if the housing bubble burst
but those six things were different: if derivatives
were traded on organized exchanges, if leverage were
far lower, if subprime lending were smaller and done
responsibly, if strong actions to limit foreclosures
were taken right away, if Lehman were not allowed to
fail, and if the TARP funds were used as directed.
All of this was
possible. And if history had gone that way, I
believe that the financial world and the economy
would look far less grim than they do today.
Jensen Comment
Alan Blinder missed some whoppers.
- The SEC was authorized to regulate investment banking and consistently
failed to do so through several crises, including the dot-com crisis of the
1990s and credit default swap crisis commencing in 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#SEC
Also so see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
This is an admitted failure of SEC Directors from Arthur Levitt though
Christopher Cox.
- The Federal Reserve failed in regulating investment banks. Alan
Greenspan belatedly admitted that he was largely at fault.
"‘I made a mistake,’ admits Greenspan," by Alan Beattie and James
Politi, Financial Times, October 23, 2008 ---
http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1
“I made a mistake in
presuming that the self-interest of organisations, specifically banks
and others, was such that they were best capable of protecting their own
shareholders,” he said.
In the second of two days of tense
hearings on Capitol Hill, Henry Waxman, chairman of the House of
Representatives, clashed with current and former regulators and with
Republicans on his own committee over blame for the financial crisis.
Mr Waxman said Mr Greenspan’s Federal
Reserve – along with the Securities and Exchange Commission and the US
Treasury – had propagated “the prevailing attitude in Washington... that
the market always knows best.”
Mr Waxman blamed the Fed for failing
to curb aggressive lending practices, the SEC for allowing credit rating
agencies to operate under lax standards and the Treasury for opposing
“responsible oversight” of financial derivatives.
Christopher Cox, chairman of the
Securities and Exchange Commission, defended himself, saying that
virtually no one had foreseen the meltdown of the mortgage market, or
the inadequacy of banking capital standards in preventing the collapse
of institutions such as Bear Stearns.
Mr Waxman accused the SEC chairman of
being wise after the event. “Mr Cox has come in with a long list of
regulations he wants... But the reality is, Mr Cox, you weren’t doing
that beforehand.”
Mr Cox blamed the fact that
Congressional responsibility was divided between the banking and
financial services committees, which regulate banking, insurance and
securities, and the agriculture committees, which regulate futures.
“This jurisdictional split threatens
to for ever stand in the way of rationalising the regulation of these
products and markets,” he said.
Mr Greenspan accepted that the crisis
had “found a flaw” in his thinking but said that the kind of heavy
regulation that could have prevented the crisis would have damaged US
economic growth. He described the past two decades as a “period of
euphoria” that encouraged participants in the financial markets to
misprice securities.
He had wrongly assumed that lending
institutions would carry out proper surveillance of their
counterparties, he said. “I had been going for 40 years with
considerable evidence that it was working very well”.
Continued in the article
Jensen Comment
In other words, he assumed the agency theory model that corporate
employees, as agents of their owners and creditors, would act hand and
hand in the best interest for themselves and their investors. But agency
theory has a flaw in that it does not understand Peter Pan.
Peter Pan, the manager of Countrywide Financial on Main
Street, thought he had little to lose by selling a fraudulent mortgage
to Wall Street. Foreclosures would be Wall Street’s problems and not his
local bank’s problems. And he got his nice little commission on the sale
of the Emma Nobody’s mortgage for $180,000 on a house worth less than
$100,000 in foreclosure. And foreclosure was almost certain in Emma’s
case, because she only makes $12,000 waitressing at the Country Café. So
what if Peter Pan fudged her income a mite in the loan application along
with the fudged home appraisal value? Let Wall Street or Fat Fannie or
Foolish Freddie worry about Emma after closing the pre-approved mortgage
sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter
Pan is more concerned with his own conventional mortgage on his precious
house just two blocks south of Main Street. This is what
happens when risk is spread even farther than Tinkerbell can fly!
Read about the extent of cheating, sleaze,
and subprime sex on Main Street in
Appendix U.
March 1, 2009 reply from Henry Schwarzbach
[henryschwarzbach@gmail.com]
What happened is exactly what agency
theory posits. The fly by night mortgage brokers were agents for the
investment banks. They were given incentives to originate mortgages
which could provide benefits for divergent behavior, fraudlent
applications. There was great assemetry since the bankers had no
primary info on the borrowers. Agency theory tells us that we can
reduce agency costs with proper incentives (e.g. the originators
could be pentalized for late payments and defaults.) and/or
monitoring. What existed was a system with no incentives or
monitoring to reduce the very high agency cost. Mortgage brokers and
investment banks both enriched themselves at the expense of the
investors. That's exactly what agency theory would predict.
Henry Schwarzbach PhD
URI College of Business
7 Lippitt Road Kingston, RI 02881
Phone 401 874-4327 Email:
henrys@uri.edu
3. U.S auditing standards explicitly require
careful estimation of bad debts. The auditing firms failed the world when
auditing sub-prime mortgage receivables, the collateralized debt obligation
(CDOs) investments, and the credit derivative instruments sold to insure
those investments? Where were the auditing firms that were paid millions to
audit commercial and investment banks as well as Fannie Mae and Freddie
Mack?
See
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
4, Subprime: Borne of Sleaze, Bribery, and Lies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Much of this began with good intentions to make housing credit available to
minorities and poor people in general, but politicians figured out how to
play Robin Hood with taxpayer money and used Congressional power over Fannie
Mae and Freddie Mack to do just that.
"Busted At Last: KB Home, Countrywide (now owned by Bank of America) Hit
With $2.8 Billion Racketeering Charge," Money News, May 8, 2009 ---
http://moneynews.newsmax.com/headlines/kb_home_countrywide/2009/05/08/212443.html
Homeowners brought a federal racketeering
lawsuit on Thursday against KB Home (KBH.N), the former Countrywide
Financial Corp and appraiser LandSafe Inc, accusing the companies of
operating a scheme to fraudulently inflate sales prices of KB homes in
Arizona and Nevada.
The lawsuit, filed in federal court in Phoenix,
claims the three companies colluded to overprice as many as 14,000 homes
in the two states by an average of $20,000, for an estimated total of
$2.8 billion between 2006 and the present. The plaintiffs seek class
action status and triple damages.
A KB Home spokeswoman said the Los
Angeles-based home builder had not seen the lawsuit and had no comment.
Calabasas, California-based Countrywide, which was acquired last year by
Bank of America (BAC.N), could not be reached for comment.
The lawsuit contends that KB and Countrywide
formed the joint venture Countrywide KB Home Loans to "rig and falsify"
appraised values of the homes they were selling and financing in the two
states.
The joint venture steered prospective buyers of
KB Homes to hand-picked appraisers at Countrywide subsidiary LandSafe
who would "come in with the appraisal at whatever number was necessary
to close the deal," the lawsuit said.
LandSafe appraisers "blatantly falsified" sales
prices for comparable properties, using prices from homes as much as 10
miles away, and citing comparable properties that were in different
planned communities, the suit said.
The homes were generally priced between
$250,000 and $350,000 -- inflated sums that homeowners discovered when
they attempted to sell their homes and hired independent appraisers,
said plaintiffs attorney Steve Berman of Hagens Berman Sobol Shapiro LLP
in Seattle.
"Most of these people were underwater from the
get-go," said Berman.
The Hagens firm filed a similar lawsuit against
KB and Countrywide earlier this year in California, citing claims under
the Racketeer Influenced and Corrupt Organizations Act and violation of
the state's unfair competition law.
The case is Nathaniel Johnson v. KB Home et
al., 2:09-CV-00972-MHB, in U.S. District Court in Arizona.
Bob Jensen's threads on Rotten to the Core are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on Countrywide Financial (now owned by Bank of
America) fraud are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Professor Schiller at Yale assets housing prices are still overvalued
and need to come down to reality
The median value of a U.S. home in 2000 was
$119,600. It peaked at $221,900 in 2006. Historically, home prices have
risen annually in line with CPI. If they had followed the long-term trend,
they would have increased by 17% to $140,000. Instead, they skyrocketed by
86% due to Alan Greenspan’s irrational lowering of interest rates to 1%, the
criminal pushing of loans by lowlife mortgage brokers, the greed and hubris
of investment bankers and the foolishness and stupidity of home buyers. It
is now 2009 and the median value should be $150,000 based on historical
precedent. The median value at the end of 2008 was $180,100. Therefore, home
prices are still 20% overvalued. Long-term averages are created by periods
of overvaluation followed by periods of undervaluation. Prices need to fall
20% and could fall 30%.....
Watch the video on Yahoo Finance ---
Click Here
See the chart at
http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
Also see Jim Mahar's blog at
http://financeprofessorblog.blogspot.com/2009/02/shiller-house-prices-still-way-too-high.html
Jensen Comment
In the worldwide move toward fair value accounting that replaces cost
allocation accounting, the above analysis by Professor Schiller is sobering.
It suggests how much policy and widespread fraud can generate misleading
"fair values" in deep markets with many buyers and sellers, although the
housing market is a bit more like the used car market than the stock market.
Each house and each used car are unique, non-fungible items that are many
times more difficult to update with fair value accounting relative to
fungible market securities and new car markets.
Thain
Pain: Merrill Lynch Bonuses of Over $1 Million to Each of 696 Executives
Rewarded for making their company so profitable for shareholders? (Barf
Alert!)
Merrill Lynch quietly paid out at least one million
dollars bonus each to about 700 top executive even when the investment house
was bleeding with losses last year, a probe has revealed. They were part of
3.6 billion dollars in the firm's bonus payments in December before the
announcement of its fourth quarterly losses and takeover by Bank of America,
the investigation by the New York state Attorney General's office showed.
"696 individuals received bonuses of one million dollars or more," New York
Attorney General Andrew Cuomo said of the Merrill scandal in a letter to a
lawmaker heading the House of Representatives financial services committee.
"Merrill bonuses made 696 millionaires: probe," Yahoo News,
February 11, 2009 ---
http://news.yahoo.com/s/afp/20090211/bs_afp/usbankingjusticeprobecompanymerrillbofa_20090211201133
Long Time WSJ Defenders of Wall Street's Outrageous Compensation Morph
Into Hypocrites
At each stage of the disaster, Mr. Black told me --
loan officers, real-estate appraisers, accountants, bond ratings agencies --
it was pay-for-performance systems that "sent them wrong." The need for new
compensation rules is most urgent at failed banks. This is not merely
because is would make for good PR, but because lavish executive bonuses
sometimes create an incentive to hide losses, to take crazy risks, and even,
according to Mr. Black, to "loot the place through seemingly normal
corporate mechanisms." This is why, he continues, it is "essential to
redesign and limit executive compensation when regulating failed or failing
banks." Our leaders may not know it yet, but this showdown between rival
populisms is in fact a battle over political legitimacy. Is Wall Street the
rightful master of our economic fate? Or should we choose a broader form of
sovereignty? Let the conservatives' hosannas turn to sneers. The market god
has failed.
Thomas Frank, "Wall Street Bonuses Are an Outrage: The public
sees a self-serving system for what it," The Wall Street Journal,
February 4, 2009 ---
http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion
Bob Jensen's threads on outrageous compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance
5. Congress, perhaps intentionally under the leadership of President
Obama, is now turning the economic crisis into a perfect storm to bailout
spendthrift state governments, ailing companies and unions such as American
automobile manufacturers and the United Auto Workers, most anybody else with
a sob story.
Cartoon link forwarded by David
Fordham
http://blogs.indystar.com/varvelblog/archives/2008/11/feeding_time.html
|
The problem
with the current bailout is that the government may be giving money
to companies that don't have a long-term future: zombies. On paper,
for example, the Treasury Dept. says it invests Troubled Asset
Relief Program (TARP) money only in "healthy banks—banks that are
considered viable without government investment" because "they are
best positioned to increase the flow of credit in their
communities." That's the right idea. In practice, though, the
criteria aren't so stringent. Banks like Citigroup still aren't
strong enough to lend. "The bailout model is socialism," says R.
Christopher Whalen, senior vice-president for consultancy
Institutional Risk Analytics. He advocates selling failed
institutions in pieces, as was done to resolve the savings and loan
crisis in the late '80s and early '90s. In fact, Washington may be
moving toward something like that with Citigroup. When a big
employer runs into trouble, it's tempting to keep it going at any
cost. Economists call this "lemon socialism"—the investment of
public money in the worst companies rather than the best. The
impulse is misguided, says Yale University economics professor
Eduardo M. Engel. "You don't want to protect the jobs," he says.
"What you want to protect is workers' income during the transition
from one job to another."
Peter Coy, "A New Menace
to the Economy: 'Zombie' Debtors Call them "zombie" companies. Many
more has-been companies will be feeding off taxpayers, investors,
and workers—sapping the lifeblood of healthier rivals," Business
Week, January 15, 2008 ---
http://www.businessweek.com/magazine/content/09_04/b4117024316675.htm?link_position=link2
|
The Perfect (Stimulus) Storm: $646,214 per saved government job
"$646,214 Per Government Job Spending where unemployment is already low," by
Alan Reynolds, The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310498020322323.html?mod=djemEditorialPage
After subtracting what House Democrats
hope to spend on government payrolls, health, education and welfare,
only a fifth of the original $550 billion is left for notoriously slow
infrastructure projects, such as rebuilding highways and the electricity
grid.
The Obama administration claims the
stimulus bill will "create or save three or four million jobs over the
next two years . . . with over 90% [of those jobs] in the private
sector." To prove it, they issued a report from Christina Romer,
chairman of the Council of Economic Advisers, and Jared Bernstein, chief
economic adviser to Vice President Joe Biden. Its key estimates,
however, were simply lifted from an outdated paper by Mark Zandi of
Moody's economy.com.
Mr. Zandi's current estimates have
government employment growing by 330,400 over two years as a result of
the House bill (compared with 244,000 in Bernstein-Romer paper). Yet
even that updated figure still amounts to only 8.3% of total jobs added,
even though state and local governments are to receive 39% of the funds
($214.5 billion). Spending
$214.5 billion to create or save 330,400 government jobs implies that
taxpayers are being asked to spend $646,214 per job.
Does that make sense?
Simulations with his macroeconomic
model, according to Mr. Zandi, reveal that "every dollar spent on
unemployment benefits generates an estimated $1.63 in near-term GDP." By
contrast, such "multipliers" simulate that tax cuts for business or
investors would add only 30-38 cents on the dollar.
But econometric models are parables,
not facts. The big multipliers for transfer payments and tiny
multipliers for capital taxes in Mr. Zandi's model reveal more about the
way the model was constructed than about the way the economy works. If
model builders make Keynesian assumptions, their model will generate
Keynesian results. Yet as Harvard economist Robert Barro recently
pointed out on this page, contemporary academic economic research does
not support the multipliers used to justify the House stimulus bill.
In the March 2006 IMF Research
Bulletin, economist Giovanni Ganelli summarized recent International
Monetary Fund research on fiscal policy. Several studies find that
reductions in government spending "can have expansionary effects, since
they can contribute to a consumption and investment boom owing to
altered expectations regarding future taxation."
A 2002 study of U.S. data by Roberto
Perotti of Università Bocconi did find that the effect of debt-financed
spending increases was somewhat positive, but the multiplier effect was
much less than one. A 2004 IMF study of recessions in advanced economies
likewise found that "multipliers are unlikely to exceed unity." A 2006
study of U.S. data by IMF economist Magda Kandil found the effect of
"fiscal expansion appears insignificant on aggregate demand and economic
activity."
Continued in article
Video Lecture: John Maynard Keynes and Hayek: Bruce Caldwell
---
http://www.youtube.com/watch?v=t4a_SkJzoIg
Video Rap: Keynes and Hayek Rap from PBS ---
http://www.pbs.org/newshour/bb/business/july-dec09/keynes_12-16.html
Also see
http://financeprofessorblog.blogspot.com/2009/12/keynes-and-hayek-rap-from-pbs.html
The Perfect (Stimulus) Storm
A new analysis shows that California would get a
whopping $21.5 billion under an economic stimulus plan that's expected to be
approved by the House next week, making it the biggest winner among the 50
states. That's according to the National Conference of State Legislatures, which
analyzed the new spending proposals offered by House leaders.
Rob Hotakainen , "California could reap
$21.5 billion from U.S. stimulus plan," The Sacramento Bee, January
24, 2009 ---
http://www.sacbee.com/capitolandcalifornia/story/1569761.html
The Less-Than-Perfect (Stimulus) Storm for Illinois
None of the funds provided by this Act may
be made available to the State of Illinois, or any agency of the State,
unless (1) the use of such funds by the State is approved in legislation
enacted by the State after the date of the enactment of this Act, or (2) Rod
R. Blagojevich no longer holds the office of Governor of the State of
Illinois.
Draft of the Stimulus Act
I’m unaware of any previous case of the Congress
dangling a bag of money over state legislators’ heads like this before. I’d
also be surprised if it fails, no matter how commanding Blagojevich looks on
“The View.” Illinois is not really in the position to turn down cash right
now.
David Weigel, "Starving Out Blago," The Washington Independent,
January 26, 2009 ---
http://washingtonindependent.com/27252/starving-out-blago
The Perfect (Stimulus) Storm for Construction After the Recession
An analysis by Forbes publications of where
most jobs will be created singles out engineering, accounting,
nursing, and information technology, along with construction
managers, computer-aided drafting specialists, and project managers.
Unemployment rates among most of these specialists are not high. The
rebuilding of "crumbling roads, bridges, and schools" highlighted by
in various speeches by President Obama is likely to make greater use
of unemployed workers in the construction sector. However, such
spending will be a small fraction of the total stimulus package, and
it is not easy for workers who helped build residential housing to
shift to building highways . . . The likelihood that such a rapid
and large public spending program will be of low efficiency is
compounded by political realities. Groups that have lots of
political clout with Congress will get a disproportionate amount of
the spending with only limited regard for the merits of the spending
they advocate compared to alternative ways to spend the stimulus.
The politically influential will also redefine various projects so
that they can fall under the "infrastructure" rubric. A report
called Ready to Go by the U.S. Conference of Mayors lists $73
billion worth of projects that they claim could be begun quickly.
These projects include senior citizen centers, recreation
facilities, and much other expenditure that are really private
consumption items, many of dubious value, that the mayors call
infrastructure spending. Recessions would be a good time to increase
infrastructure spending only if these projects can mainly utilize
unemployed resources. This does not seem to be the case in most of
the so-called infrastructure spending proposed under various
stimulus plans.
Nobel Laureate Gary Becker,
The Becker-Posner Blog, January 18, 2009 ---
http://www.becker-posner-blog.com/
The Perfect (Stimulus) Storm for Signing Up Voters for the Democratic
Party
The House Democrats’ trillion dollar spending bill,
approved on January 21 by the Appropriations Committee and headed to the
House floor next week for a vote, could open billions of taxpayer dollars to
left-wing groups like the Association of Community Organizations for Reform
Now (ACORN). ACORN has been accused of perpetrating voter registration fraud
numerous times in the last several elections; is reportedly under federal
investigation; and played a key role in the irresponsible schemes that
caused a financial meltdown that has cost American taxpayers hundreds of
billions of dollars since last fall. House Republican Leader John Boehner
(R-OH) and other Republicans are asking a simple question: what does this
have to do with job creation? Are Congressional Democrats really going to
borrow money from our children and grandchildren to give handouts to ACORN
in the name of economic “stimulus?” Incredibly, the Democrats’ bill makes
groups like ACORN eligible for a $4.19 billion pot of money for
“neighborhood stabilization activities.” Funds for this purpose were
authorized in the Housing and Economic Recovery Act, signed into law in
2008. However, these funds were limited to state and local governments. Now
House Democrats are taking the unprecedented step of making ACORN and other
groups eligible for these funds:
Rick Moran, "ACORN eligible for billions from stimulus plan,"
American Thinker, January 26, 2009 ---
http://www.americanthinker.com/blog/2009/01/acorn_eligible_for_billions_fr.html
Jensen Comment
Keith Olbermann correctly points out that ACORN will not get the funds
directly but must bid competitively for such funds. What he does not explain
is why ACORN disserves to be allowed to bid for billions of bailout funds
given its biased political activities.
The group (ACORN) that pushed banks into the
risky loans that brought the economy down is now eligible for a huge chunk
of stimulus cash. The stimulus plan does create jobs — for community
activists.
"ACORN's Seed Money," Investor's Business Daily,
January 27, 2009 ---
http://www.ibdeditorials.com/IBDArticles.aspx?id=317952439188615
Jensen Comment
It's never too late to give jobs to register fictitious people to vote for
Democrats. Soon ACORN will have stimulus funds to register more Democrats.
"Another Bogus ACORN Lawsuit," by Michelle Malkin, Townhall,
November 13, 2009 ---
http://townhall.com/columnists/MichelleMalkin/2009/11/13/another_bogus_acorn_lawsuit
ACORN is doing what it does best:
playing the victim, blaming everyone else for its self-inflicted wounds,
perpetuating false narratives and defending the entitlement industry to
the death.
On Thursday, the disgraced welfare
rights organization filed suit over a congressional funding ban passed
in September after nationwide undercover sting videos exposed ACORN's
criminal element.
The group and its web of nonprofit,
tax-exempt affiliates have collected an estimated $53 million in
government funds since 1994. This pipeline is apparently a
constitutionally protected right. According to ACORN's lawyers at the
far-left Center for Constitutional Rights, the congressional funding ban
constitutes a "bill of attainder" -- an act of the legislature declaring
a person(s) guilty of a crime without trial.
Now cue the world's smallest violin
and pass the Kleenex: ACORN's lawyers say the group has suffered
cutbacks and layoffs as a result of the punitive funding ban. The
congressional persecution means ACORN can no longer teach
first-time-homebuyer indoctrination classes and -- gasp -- the loss of
an $800,000 contract to conduct "outreach" on "asthma."
Message: The demons in the House who
defunded ACORN (345 of them, including 172 Democrats) are cutting off
oxygen to poor people!
"It's not the job of Congress to be
the judge, jury and executioner," CCR lawyer Jules Lobel moaned as he
equated the House's act of fiscal responsibility with the death penalty.
"It is outrageous to see Congress
violating the Constitution for purposes of political grandstanding," CCR
Legal Director Bill Quigley seethed without a shred of irony.
"Congress bowed to FOX News and joined
in the scapegoating of an organization that helps average Americans
going through hard times to get homes, pay their taxes and vote. Shame
on them," ACORN head Bertha Lewis piled on in an affidavit lamenting the
loss of state, local and private foundation grants, which she blamed on
the resolution. It "gave the green light for others to terminate our
funds, as well."
What ACORN's sob-story tellers leave
out is the inconvenient fact that nonprofits were bailing on ACORN long
before undercover journalists Hannah Giles and James O'Keefe and
BigGovernment.com publisher Andrew Breitbart entered the scene. Internal
ACORN records from a Washington, D.C., meeting held last August noted
that more than $2 million in foundation money was being withheld as a
result of the group's embezzlement scandal involving founder Wade
Rathke's brother, Dale -- reportedly involving upward of $5 million.
Rathke admitted he suppressed
disclosure of his brother's massive theft -- first discovered in 2000 --
because "word of the embezzlement would have put a 'weapon' into the
hands of enemies of ACORN." In other words: The protection of ACORN's
political viability came before the protection of members' dues (and
taxpayers' funds).
A small group of ACORN executives
helped cover up Dale Rathke's crime by carrying the amount he embezzled
as a "loan" on the books of Citizens Consulting Inc. CCI, the accounting
and financial management arm of ACORN and its affiliates, is housed in
the same building as the national ACORN headquarters in New Orleans.
It's also home to ACORN International, now operating under a different
name, which Wade Rathke continues to head.
ACORN brass cooked up a "restitution"
plan to allow the Rathkes to pay back a measly $30,000 a year in
exchange for secrecy about the deal. ACORN's lawyers issued a decree to
its employees to keep their "yaps" shut. Dale Rathke kept his job and
his $38,000 annual salary until the story leaked to donors and board
members outside the Rathke circle.
In June 2008, the left-wing Catholic
Campaign for Human Development cut off grant money to ACORN "because of
questions that arose about financial management, fiscal transparency and
organizational accountability of the national ACORN structures." In
November 2008 -- ahem, more than a year before the congressional ACORN
funding ban was passed -- CCHD voted unanimously to extend and make
permanent its ban on funding of ACORN organizations. "This decision was
made because of serious concerns regarding ACORN's lack of financial
transparency, organizational performance and questions surrounding
political partisanship," according to Bishop Roger Morin.
Did ACORN's lawyers call that
withdrawal of funding "political grandstanding" and "scapegoating," too?
The lawsuit over the congressional
funding ban is just the latest desperate legal measure to distract from
ACORN's long-festering ethics and financial scandals. ACORN's attorneys
have sued Giles, O'Keefe, Breitbart and former ACORN/Project Vote
whistleblower Anita MonCrief. And they'll sue anyone else who gets in
the way of rehabilitating the scandal-plagued enterprise's image.
It took decades to build up its
massive coffers and intricate web of affiliates across the country. It
will take months and years to untangle the entire operation. And it will
take time, money and relentless sunshine to dismantle the
government-subsidized partisan racket.
ACORN can never be "reformed."
It is constitutionally corrupt. Sue me.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
The Perfect (Stimulus) Storm for Transfer Payments to Medicaid and the
Poor
Another "stimulus" secret is that some $252 billion
is for income-transfer payments -- that is, not investments that arguably
help everyone, but cash or benefits to individuals for doing nothing at all.
There's $81 billion for Medicaid, $36 billion for expanded unemployment
benefits, $20 billion for food stamps, and $83 billion for the earned income
credit for people who don't pay income tax. While some of that may be
justified to help poorer Americans ride out the recession, they aren't job
creators.
"A 40-Year Wish List You won't believe what's in
that stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage
The Perfect (Stimulus) Storm for Amtrak, Artists, Child Care
Businesses, and Global Warming Research
We've looked it over, and even we can't quite
believe it. There's $1 billion for Amtrak, the federal railroad that hasn't
turned a profit in 40 years; $2 billion for child-care subsidies; $50
million for that great engine of job creation, the National Endowment for
the Arts; $400 million for global-warming research and another $2.4 billion
for carbon-capture demonstration projects. There's even $650 million on top
of the billions already doled out to pay for digital TV conversion coupons.
"A 40-Year Wish List You won't believe what's in that
stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage
The Perfect (Stimulus) Storm for Democrats in Congress
This is supposed to be a new era of bipartisanship,
but this bill was written based on the wish list of every living -- or dead
-- Democratic interest group. As Speaker Nancy Pelosi put it, "We won the
election. We wrote the bill." So they did. Republicans should let them take
all of the credit.
"A 40-Year Wish List You won't believe what's in that
stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage
Jensen Comment
Of course it goes without saying that it's already been a perfect (stimulus)
storm for bankers and Wall Street executives who brought on this chaos by
reckless investment in fraudulent subprime mortgages. They inadvertently
created an excuse for the largest populist spending spree in the history of
the world.
The Perfect (Stimulus) Storm for a Universal Healthcare Entitlement in
the United States
The more we dig into the pile of spending and tax
favors known as the "stimulus bill," the more amazing discoveries we make.
Namely, Democrats have apparently decided that the way to gun the economy is
to spend even more on health care. This is notable because if there has been
one truly bipartisan idea in Washington, it's that the U.S. as a whole
spends too much on health care. President Obama has been talking up
entitlement reform as a way to free up the money for his other social
priorities. But it turns out that Congress is using the stimulus as cover
for a massive expansion of federal entitlements.
"The Entitlement Stimulus: More giant steps
toward government," The Wall Street Journal, January 29, 2009 ---
http://online.wsj.com/article/SB123318915075926757.html?mod=djemEditorialPage
Jensen Comment
On January 28, ABC News reported how the Canadian Universal Health Care Plan
was so much more efficient in terms of accounting efficiency, largely
because third party billing in the U.S. has become a quagmire. However, what
ABC failed to mention, probably deliberately, is that over half of the
average Canadian's salary is taxed mostly for health care. Much has been
made about the months or years Canadians wait for non-emergency medical
treatments. But seldom does the liberal U.S. press mention the enormous tax
bill that goes with the Canadian Universal Health Care Plan. Taxpayers need
not worry in the United States however. The new entitlement payment plan in
the U.S. simply entails printing money rather than taxing or borrowing ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
The Perfect (Stimulus) Storm for Fannie Mae and Freddie Mac
Although shareholders in Fannie and Fred sucked gas, the companies
themselves are being bailed out
"Fan and Fred's Lunch Tab A quarter-trillion dollars, and rising,"
The Wall Street Journal, January 29, 2009 ---
http://online.wsj.com/article/SB123318925593626697.html?mod=djemEditorialPage
It seems a lifetime ago, but it's only been six
months since the Congressional Budget Office put a $25 billion price tag
on the legislation to bail out Fannie Mae and Freddie Mac. At the time,
then CBO Director Peter Orszag told Congress that there was a "probably
better than 50%" chance that the government would never have to spend a
dime to shore up the two government-sponsored mortgage giants.
So much for that. In the past few days Fannie
and Freddie have requested a combined $51 billion from the Treasury to
compensate for losses in their loan portfolios. This comes on top of the
$13.8 billion that Freddie needed in November.
The latest requests take the tab to $70 billion
or so -- but that's not the end of the story by a long shot. Earlier
this month, CBO released its biannual budget outlook. And largely
ignored underneath the $1.2 trillion deficit estimate for fiscal 2009
was the little matter of a $238 billion charge for rescuing Fan and
Fred. To put that in perspective, $238 billion is more than the entire
federal budget deficit in fiscal 2007
The CBO's $238 billion estimate represents its
guess of the long-term cost of paying for the guarantees that Fannie and
Freddie write on their mortgage-backed securities. Nor is that just a
post-bubble hangover. The last $38 billion of that is for losses on new
business this year. And for all anyone knows, that number, like the
earlier estimates, is wildly optimistic.
For starters, that $238 billion doesn't include
$18 billion that the CBO expected the Treasury to lend the wonder twins
this year. But in any case we're already well beyond $18 billion on that
score: As of this week they've already requested $70 billion since the
fiscal year began -- and we still have eight months to go. So you can
add $70 billion to the $238 billion, which gets us to $308 billion --
and even that might be conservative. Rajiv Setia, an analyst at
Barclays, figures the duo will need $120 billion from Treasury this year
alone, which would mean another $50 billion on top of the $70 billion
already requested.
Back when the bailout was being debated last
July, Senator Jon Tester (D., Mont.) worried that the Fan and Fred
bailout could cost $1 trillion. Given that the two companies combined
have more than $5 trillion in debt and mortgage backed securities
outstanding, Mr. Tester's guess isn't looking worse than anyone else's.
At that same time, Senator Kent Conrad (D.,
N.D.) said that the CBO's $25 billion estimate would be "very helpful to
those who want to advance this legislation." And no doubt it was. A
spokeswoman for Fannie promoter Barney Frank said then, "we especially
like that there is less than a 50% chance that it will be used." The CBO
had figured that there was a 5% chance that losses would reach the $100
billion cap on the credit line created by the July law. Now CBO's best
guess is more than double that.
The bigger picture here is that politicians
like Mr. Frank have been telling us for years that Fannie and Freddie's
federal subsidy was a free lunch. We are now slowly, and painfully,
learning the price of Mr. Frank's famous desire to "roll the dice" with
Fan and Fred. Keep that in mind the next time you hear a politician
propose a taxpayer guarantee. The only sure thing is that the taxpayers
will pay.
Barney's Rubble ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Accounting Fraud (when Frank Raines was CEO) at Fannie Mae ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Glenn Beck Explain's What's Wrong With Obama's Stimulus Program
(video) ---
http://www.thehopeforamerica.com/play.php?id=249
Quotations forwarded by Jagdish
In my many years I have come
to a conclusion that one useless man is a shame, two is a law firm and three or
more is a congress.
John Adams
If you don't read the newspaper you are uninformed, if you do read the
newspaper you are misinformed.
Mark Twain
Suppose you were an idiot. And suppose you were a member of Congress. But
then I repeat myself.
Mark Twain
I contend that for a nation to try to tax itself into prosperity is like a
man standing in a bucket and trying to lift himself up by the handle.
Winston Churchill
A government which robs Peter to pay Paul can always depend on the support of
Paul.
George Bernard Shaw
A liberal is someone who feels a great debt to his fellow man, which debt he
proposes to pay off with your money.
G. Gordon Liddy
Democracy must be something more than two wolves and a sheep voting on what
to have for dinner.
James Bovard, Civil Libertarian (1994)
Foreign aid might be defined as a transfer of money from poor people in rich
countries to rich people in poor countries.
Douglas Casey, Classmate of Bill Clinton at Georgetown University
Giving money and power to government is like giving whiskey and car keys to
teenage boys.
P.J. O'Rourke, Civil Libertarian
Government is the great fiction, through which everybody endeavors to live
at the expense of everybody else.
Frederic Bastiat, French Economist (1801-1850)
Government's view of the economy could be summed up in a few short phrases:
If it moves, tax it. If it keeps moving, regulate it. And if it stops moving,
subsidize it.
Ronald Reagan (1986)
I don't make jokes. I just watch the government and report the facts.
Will Rogers
13. If you think health care is expensive now, wait until you see what it costs
when it's free!
P.J. O'Rourke
In general, the art of government consists of taking as much money as
possible from one party of the citizenry to give to the other.
Voltaire (1764)
Just because you do not take an interest in politics doesn't mean politics
won't take an interest in you!
Pericles (430 B.C.)
No man's life, liberty, or property is safe while the legislature is in
session.
Mark Twain (1866)
Talk is cheap ... except when Congress does it.
Anonymous
The government is like a baby's alimentary canal, with a happy appetite at
one end and no responsibility at the other.
Ronald Reagan
The inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.
Winston Churchill (Good thing
Obama sent Churchill's bust back to the U.K. from the Oval Office and replaced
it with a bust of Lincoln who wrote that Government should print all the money
it needs without taxation and borrowing)
The only difference between a tax man and a taxidermist is that the
taxidermist leaves the skin.
Mark Twain
The ultimate result of shielding men from the effects of folly is to fill
the world with fools.
Herbert Spencer,
English Philosopher (1820-1903)
There is no distinctly native American criminal class ... save Congress.
Mark Twain
What this country needs are more unemployed politicians.
Edward Langley, Artist (1928-1995)
A government big enough to give you everything you want, is strong enough to
take everything you have.
Thomas Jefferson
Madoff made off with $50 Billion!
Where did it go?
Who will pay it back?
"Ponzi Schemer's Label-Whoring Niece Married SEC
Lawyer," by Owen Thomas, December 16, 2008 ---
http://gawker.com/5111942/ponzi-schemers-label+whoring-niece-married-sec-lawyer
Shana Madoff, whose uncle Bernie Madoff
stands accused of defrauding investors of $50 billion
(later raised to over $65 billion), is the
wife of Eric Swanson, a former top lawyer at the Securities and
Exchange Commission. A goy, but well-placed!
So well-placed that SEC chairman
Christopher Cox is now elaborately raising his eyebrows about
the relationship — especially since Shana Madoff worked as the
compliance lawyer at Bernard L. Madoff Investment Securities,
and met Swanson at a trade association event. (Can you imagine
what a swinging scene that was?)
Swanson resigned from the SEC in 2006,
and the couple married in 2007. But they clearly dated for a
while before that.
Some have suggested that Shana Madoff
is a "shopaholic." So not technically true! Why, she married the
manager of a men's clothing store in 1997, but that didn't work
out. A 2004 New York profile detailed her simultaneous affection
for Narciso Rodriguez and aversion to actually going out and
shopping. Instead of trying on clothes at the store, she had
salespeople messenger the entire collection to her office, and
charge her only for what she didn't return. The article mentions
her having a boyfriend. Was that Swanson, whom one SEC colleague
said conducted a review of Madoff's firm in 1999 and 2004?
A spokesman for Swanson — they get
flacks quickly these days, don't they — told ABC News that he
"did not participate in any inquiry of Bernard Madoff Securities
or its affiliates while involved" (it was later shown
that he was veru involved in the Madoff "investigation" while at
the SEC) with Shana Madoff. How
convenient!
But that could be said about pretty
much all of his coworkers. The SEC first fielded complaints
about the Madoff firm in 1999, but never opened a formal
investigation that would have allowed it to subpoena records. In
2006, Bernard Madoff registered as an investment advisor with
the SEC, but the agency never conducted a standard review. Are
you beginning to get a picture of why Shana Madoff, who was
charged with keeping the company out of trouble with regulators,
was so busy she couldn't even go shopping?
Swanson was at the commission in 2003
when the agency was examining the Madoff firm.
More importantly, he was also part of the SEC team that was
conducting the actual inquiry into the firm . . .
What does all this mean? Nothing, according to
Shana Madoff or her husband, whom she married in 2007. A spokesman
for Shana Madoff and one for Swanson confirm that both knew each
other professionally during the time of the examination.
"Madoff Victims Claim Conflict of Interest at SEC," CNBC,
December 15, 2008 ---
http://www.cnbc.com/id/28242487
Madoff Timeline ---
http://www.madoff-help.com/wp-content/uploads/2009/06/timeline.pdf
Larry Brown's Ponzi hypothetical is now turning into Ponzi reality
Madoff made off with $50 Billion!
Where did it go?
Who will pay it back?
A Tale of Four Investors
Forwarded by Dennis Beresford
Four investors made different
investment decisions 10 years ago. Investor one was extremely risk
averse so he put $1 million in a safe deposit box. Today he still
has $1 million. Investor two was a bit less risk averse so she
bought $1 million of 6% Fanny Mae Preferred. She put the $15,000
she received in dividends each quarter in a safe deposit box. After
receiving 40 dividends, she recently sold her investment for $20,000
so she now has $620,000 in her safe deposit box. Investor three was
less risk averse so he bought and held a $1 million well diversified
U.S. stock portfolio which he recently sold for $1 million, putting
the $1 million in his safe deposit box. Investor four had a friend
who knew someone who was able to invest her $1 million with Bernie
Madoff. Like clockwork, she received a $10,000 check each and every
month for 120 months. She cashed all the checks, putting the money
in her safe deposit box. She was outraged to learn that she will no
longer receive her monthly checks. Even worse, she lost all her
principal. She only has $1,200,000 in her safe deposit box. She
hopes the government will bail her out.
Lawrence D. Brown
J. Mack Robinson Distinguished Professor of Accounting
Georgia State University
December 18, 2008
|
"Madoff 'Victims' Do Math, Realize They Profited," SmartPros,
January 2009 ---
http://accounting.smartpros.com/x64396.xml
The many Bernard Madoff investors who withdrew
money from their accounts over the years are now wrestling with an ethical
and legal quandary. What they thought were profits was likely money stolen
from other clients in what prosecutors are calling the largest Ponzi scheme
in history. Now, they are confronting the possibility they may have to pay
some of it back.
The issue came to the forefront this week as about
8,000 former Madoff clients began to receive letters inviting them to apply
for up to $500,000 in aid from the Securities Investor Protection Corp.
Lawyers for investors have been warning clients to
do some tough math before they apply for any funds set aside for the
victims, and figure out whether they were a winner or loser in the scheme.
Hundreds and maybe thousands of investors in
Madoff's funds have been withdrawing money from their accounts for many
years. In many cases, those investors have withdrawn far more than their
principal investment.
"I had a call yesterday from a guy who said, 'I've
taken out more money then I originally put in, but I still had $1 million
left with Madoff. Should I file a $1 million claim?'" said Steven Caruso, a
New York attorney specializing in securities and investment fraud.
"I'm hard-pressed to give advice in that
situation," Caruso said.
Among the options: Get in line with other victims
looking for restitution. Keep quiet and hope nobody notices. Return the
money. Or hire a lawyer and fight to keep profits that were probably
fraudulent.
No one knows yet how many people will emerge as net
winners in the scandal, but the numbers appear to be substantial. Many of
Madoff's long-term investors have, over time, cashed out millions of dollars
of their supposed profits, which routinely amounted to 11 percent to 15
percent per year.
Jonathan Levitt, a New Jersey attorney who
represents several former Madoff clients, said more than half of the victims
who called his office looking for help have turned out to be people whose
long-term profits exceeded their principal investment.
"There are a lot of net winners," he said.
Asked for an example, Levitt said one caller, whom
he declined to name, invested $1.8 million with Madoff more than a decade
ago, then cashed out nearly $3 million worth of "profits" as the years went
by.
On paper, he still had $4 million invested with
Madoff when the scheme collapsed, but it now looks as if that figure was
almost entirely comprised of fictitious profits on investments that were
never actually made, leaving his claim to be owed anything unclear.
Other attorneys report getting similar calls.
Under federal law, the court-appointed trustee
trying to unravel Madoff's business can demand that people who profited from
the scheme return some or all of the money.
These so-called "clawbacks" are generally limited
to payouts over the last six years, but could still amount to big bucks for
some investors.
When a hedge fund run by the Bayou Group collapsed
and was revealed to be a Ponzi scheme in 2005, the trustee handling the case
sought court orders forcing investors to return false profits. Many experts
anticipate a similar process in the Madoff case.
Applying for the aid could give the trustee
evidence he needs to initiate a clawback claim. On the other hand, investors
who ignore the letter would most likely forfeit any chance of recovering
lost funds.
No matter how they respond, it may only be a matter
of time before investors wiped out in the scandal turn on those who
unknowingly enjoyed the fruits of the fraud.
"The sharks are all circling," Caruso said.
Some hedge funds that had billions of dollars
invested with Madoff are already going through years worth of records,
trying to figure out which of their investors withdrew more than they put
in.
That data could be used by the fund managers to
defend themselves against lawsuits, or go after clients deemed to have
profited from the scheme and get them to return the cash.
The future is equally cloudy for investors who
cashed out entirely before Madoff's arrest.
Continued in article
NY Post's video quiz on top scandals ---
http://www.nypost.com/entertainment/comicsgames/popjax_game.htm?gameId=1149
Bonus Question
Why are there two prices ($100 versus $5,000) for a good massage?
Madoff enjoyed "frequent massages" during work, hurled vicious insults at
underlings and physically fell to pieces as his scheme unraveled. Eleanor
Squillari, his secretary reveals in an explosive Vanity Fair article.....a
shocking, inside look at the day-to-day operations of Madoff's investment
firm....his lusty penchant for the ladies as he bilked billions. The 70-year-old
Madoff had a roving eye ...." I caught him scouting the escort pages alongside
pictures of scantily clad women." Madoff had numbers for "masseuses" in his
address book....Madoff would playfully "try to pat me on the ass" and say, "You
know it excites you" when he would exit his office bathroom zipping his fly.
Squillari said. "..... clients would frequently complain about the lack of
customer service..... Bernie would say, "Most of these customers are a pain in
the ass." As it became clear to her uber-controlling boss that he couldn't stop
his world from crashing, he started to physically buckle... "He seemed to be in
a coma. He was bunkered down in his palatial Manhattan pad with his wife, who
had been "handl[ing] all the invoices that came in," Squillari said.
Dan Mangan, "BERNIE MADOFF'S LUST
FOR LADIES & MONEY (unzipped scammer liked 'massages' from females" New York
Post, May 6, 2009 ---
http://www.nypost.com/seven/05062009/news/nationalnews/lust_for_ladies__money_167836.htm?page=0
Swine Flew: Madoff's Piggy Bank
For months lawyers and investors have been
asking convicted conman Bernie Madoff, "Where's the money?" We got a
partial answer to that question Wednesday from Irving Picard, the
trustee liquidating Madoff Investment Securities LLC: Madoff turned
his investment firm into his "personal piggy bank," using tens of
millions of dollars in client funds to cover costs for employees and
family members, court papers say. Madoff used money from his firm to
pay loans, satisfy capital calls, fund real estate purchases and
hire employees for his children, wife, brother and workers,
according to a filing by Picard (see below). "He essentially used
BLMIS as his 'personal piggy bank,' having BLMIS pay for his lavish
lifestyle and that of his family," David Sheehan, a lawyer for
Picard, wrote in a legal brief filed in U.S. Bankruptcy Court in New
York. "Madoff used BLMIS to siphon funds which were, in reality,
other people's money, for his personal use and the benefit of his
inner circle. Plain and simple, he stole it."
"Where is Madoff's money?" The Deal, May 7,
2009 ---
http://www.thedeal.com/dealscape/2009/05/madoff_piggy_bank_money.php
Jensen Comment
But ohhh those massages.
"Ponzi Schemer's Label-Whoring Niece Married SEC
Lawyer," by Owen Thomas, December 16, 2008 ---
http://gawker.com/5111942/ponzi-schemers-label+whoring-niece-married-sec-lawyer
Shana Madoff, whose uncle Bernie Madoff
stands accused of defrauding investors of $50 billion
(later raised to over $65 billion), is the
wife of Eric Swanson, a former top lawyer at the Securities and
Exchange Commission. A goy, but well-placed!
So well-placed that SEC chairman
Christopher Cox is now elaborately raising his eyebrows about
the relationship — especially since Shana Madoff worked as the
compliance lawyer at Bernard L. Madoff Investment Securities,
and met Swanson at a trade association event. (Can you imagine
what a swinging scene that was?)
Swanson resigned from the SEC in 2006,
and the couple married in 2007. But they clearly dated for a
while before that.
Some have suggested that Shana Madoff
is a "shopaholic." So not technically true! Why, she married the
manager of a men's clothing store in 1997, but that didn't work
out. A 2004 New York profile detailed her simultaneous affection
for Narciso Rodriguez and aversion to actually going out and
shopping. Instead of trying on clothes at the store, she had
salespeople messenger the entire collection to her office, and
charge her only for what she didn't return. The article mentions
her having a boyfriend. Was that Swanson, whom one SEC colleague
said conducted a review of Madoff's firm in 1999 and 2004?
A spokesman for Swanson — they get
flacks quickly these days, don't they — told ABC News that he
"did not participate in any inquiry of Bernard Madoff Securities
or its affiliates while involved" (it was later shown
that he was veru involved in the Madoff "investigation" while at
the SEC) with Shana Madoff. How
convenient!
But that could be said about pretty
much all of his coworkers. The SEC first fielded complaints
about the Madoff firm in 1999, but never opened a formal
investigation that would have allowed it to subpoena records. In
2006, Bernard Madoff registered as an investment advisor with
the SEC, but the agency never conducted a standard review. Are
you beginning to get a picture of why Shana Madoff, who was
charged with keeping the company out of trouble with regulators,
was so busy she couldn't even go shopping?
Swanson was at the commission in 2003
when the agency was examining the Madoff firm.
More importantly, he was also part of the SEC team that was
conducting the actual inquiry into the firm . . .
What does all this mean? Nothing, according to
Shana Madoff or her husband, whom she married in 2007. A spokesman
for Shana Madoff and one for Swanson confirm that both knew each
other professionally during the time of the examination.
"Madoff Victims Claim Conflict of Interest at SEC," CNBC,
December 15, 2008 ---
http://www.cnbc.com/id/28242487
Madoff Timeline ---
http://www.madoff-help.com/wp-content/uploads/2009/06/timeline.pdf
All Reported Trades in Madoff's Investment Fund Were Fakes for 28 Years:
How could the "auditors" not be complicit in the Ponzi fraud?
"BERNIE'S FAKE TRADES REGULATORS: NO TRACE OF MADOFF STOCK BUYS SINCE
1960s," by James Doran, The New York Post, January 16, 2009 ---
http://www.nypost.com/seven/01162009/business/bernies_fake_trades_150467.htm
The mystery surrounding Bernard Madoff's alleged
$50 billion Ponzi scheme deepened further yesterday after the securities
industry's watchdog said there was no evidence that the accused swindler
ever traded a single share on behalf of his clients, suggesting financial
irregularities going back to the 1960s.
Officials at the Financial Industry Regulatory
Authority, known as FINRA, told The Post that after examining more than 40
years' worth of financial records from Madoff's now-defunct broker dealer,
there are no signs that Bernard L. Madoff Investment Securities ever traded
shares on behalf of the investment-advisory business at the center of the
scandal.
The startling findings contradict statements that
Madoff's advisory clients received showing hundreds, if not thousands of
trades, completed by the broker dealer every year.
"Our investigations of Bernard Madoff's broker
dealership showed no evidence that any shares were ever traded on behalf of
his investment advisory business," a FINRA spokesman said, adding that the
regulator has looked at Madoff's books going back to 1960.
Ira Lee Sorkin, a Madoff lawyer, declined to
comment.
Madoff was arrested last month after his sons said
their father had confessed to them that his investment-advisory business was
a Ponzi scheme that had bilked $50 billion out of wealthy friends,
vulnerable charities and universities. Madoff remains free on $10 million
bail.
While his advisory business is at the center of the
scandal, all signs point to Madoff's broker dealer being a legitimate
business that traded shares wholesale on behalf of investment banks, mutual
funds and other institutions.
Madoff was previously vice chairman of FINRA's
predecessor NASD. He was also a member of the Nasdaq stock exchange, where
he served as chairman of its trading committee.
Richard Rampell, a Florida-based certified
accountant who counts as clients several of Madoff's victims, said his
review of dozens of statements supports FINRA's findings.
"Everything I saw on those statements told me that
Madoff was clearing his own trades," he said. "There was no third party
mentioned on any of those statements."
Steve Harbeck, CEO of Securities Industry
Protection Corp., the outfit overseeing the Madoff bankruptcy to ensure
clients get some sort of compensation, said his findings are similar to
FINRA's.
"I do not have any evidence to contradict that," he
said. "This is an amazing story that something like this could have gone on
undetected for so long."
Harbeck added that he believed Madoff has been
defrauding clients for at least 28 years. "I have seen evidence to that end
and I have nothing to contradict it," he said.
Question
If Madoff's stock trades were faked for 28 years, where did the cash come from
to pay some investors?
Answer
The definition of a Ponzi scheme depends upon new investors paying cash to pay
earlier investors ---
http://en.wikipedia.org/wiki/Ponzi
This almost eliminates the amount of $50 billion Madoff stole that can be
recovered for the latest investors in his investment fund.
Why Madoff's Hedge Fund Could Be Audited by
Non-registered Auditors
We all know that Bernie Madoff's brokerage firm was
audited by an obscure 3-person accounting firm that is not registered with the
Public Company Accounting Oversight Board. This was permitted because the SEC
exempted privately owned brokerage firms from the SOX requirement that firms are
audited by registered accountants. Floyd Norris reports, in today's NY Times,
that the SEC has now quietly rescinded that exemption. As a result, firms that
audit broker-dealers for fiscal years that end December 2008 or later will have
to be registered. However, under another SOX provision, PCAOB is allowed to
inspect only audits of publicly held companies. NYTimes,
Oversight for Auditor of Madoff.
"Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law
Professor Blog, January 9, 2008 ---
http://lawprofessors.typepad.com/securities/
Why Madoff's Hedge Fund Could Be Audited by Non-registered Auditors
We all know that Bernie Madoff's brokerage firm was
audited by an obscure 3-person accounting firm that is not registered with the
Public Company Accounting Oversight Board. This was permitted because the SEC
exempted privately owned brokerage firms from the SOX requirement that firms are
audited by registered accountants. Floyd Norris reports, in today's NY Times,
that the SEC has now quietly rescinded that exemption. As a result, firms that
audit broker-dealers for fiscal years that end December 2008 or later will have
to be registered. However, under another SOX provision, PCAOB is allowed to
inspect only audits of publicly held companies. NYTimes,
Oversight for Auditor of Madoff.
"Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law
Professor Blog, January 9, 2008 ---
http://lawprofessors.typepad.com/securities/
Ruth was just due to get her hair
and nails done: That's not suspicious or anything
Ruth Madoff Withdrew $15.5 Million From Madoff Brokerage Before Bust
Joe Weisenthal,
The New York Times, February 11, 2009 ---
Click Here
|
"We need to
get out there and get names and get unified so that we can go to the
government and make our case," she said. "Everybody has a horror
story, everybody has bills, and everybody is devastated."
Joe Bruno quoting a Madoff Hedge Fund investor, "Madoff investors
hope for bailout," Associated Press, December 18, 2008
http://www.google.com/hostednews/ap/article/ALeqM5hfAsiWtv09AYdmjEEn6e8BEaI-tgD955ECK80
But government program limits claims to
$500,000 even if claims are honored.
|
Moral of the
story: If you want to design such a scheme (with
unlimited claims) and get away with it,
make it legal — like investments in subprime mortgages, or
investments in energy from water. Then involve as many people as
possible, so that it becomes “too big to fail.” Some of the $700
billion bailout money may actually be used to rescue some of your
investors.
Utpal Bhattacharya, "Do Bailouts Encourage Ponzi Schemes?" The
New York Times, December 18, 2008 ---
http://economix.blogs.nytimes.com/2008/12/18/do-bailouts-encourage-ponzi-schemes/?hp
Utpal Bhattacharya is finance professor at the Kelley School of
Business at Indiana University.
Banks Secretive About How Bailout
Money is Spent
But after receiving billions in aid from
U.S. taxpayers, the nation's largest banks say they can't track
exactly how they're spending the money or they simply refuse to
discuss it. "We've lent some of it. We've not lent some of it. We've
not given any accounting of, 'Here's how we're doing it,'" said
Thomas Kelly, a spokesman for JPMorgan Chase, which received $25
billion in emergency bailout money. "We have not disclosed that to
the public. We're declining to." The Associated Press contacted 21
banks that received at least $1 billion in government money and
asked four questions: How much has been spent? What was it spent on?
How much is being held in savings, and what's the plan for the rest?
None of the banks provided specific answers.
"Where'd the Bailout Money Go? Shhhh, It's a Secret,"
AccountingWeb, December 22, 2008 ---
http://accounting.smartpros.com/x64188.xml
"How to spend $350 billion in 77
days: In two-and-a-half months, the Treasury has used up half
of the money from the Troubled Asset Relief Program. Here's how it
came and went so fast," by Jeanne Sahadi, CNN, December 19,
2008 ---
http://money.cnn.com/2008/12/19/news/economy/tarp_tale_of_first350b/
By Friday, Oct.
3, Congress had passed a 451-page bill that President Bush
signed into law within hours. The law granted Treasury up to
$700 billion, half of which was made available right away.
Since then,
Treasury has:
- sent checks totaling $168
billion in varying amounts to 116 banks;
- committed another $82
billion to capitalize more banks;
- bought $40 billion in
preferred shares of American International Group (AIG,
Fortune 500) so the troubled insurer could pay off an
earlier loan from the Federal Reserve;
- committed $20 billion to
back any losses that the Federal Reserve Bank of New York
might incur in a new program to
lend money to owners of securities backed by credit card
debt, student loans, auto loans and small business loans;
- committed to invest
$20 billion in Citigroup on top of $25 billion the bank
had already received;
- committed $5 billion as a
loan loss backstop to Citigroup;
- agreed to
loan $13.4 billion to GM and Chrysler to get them
through the next few months.
That next $350B? Maybe not yet,
Hank
Now, it's likely that Treasury
will ask for the second tranche of $350 billion.
Beleaguered Citigroup is upgrading its
mile-high club with a brand-new $50 million corporate jet - only this time, it's
the taxpayers who are getting screwed. Even though the bank's stock is as cheap
as a gallon of gas and it's burning through a $45 billion taxpayer-funded
rescue, the airhead execs pushed through the purchase of a new Dassault Falcon
7X, according to a source familiar with the deal.
Jennifer Gould Keil and
Chuck Bennett, "Just Plane Despicable," New York Post, January 26,
2009 ---
http://www.nypost.com/seven/01262009/news/nationalnews/just_plane_despicable_152033.htm
Jensen Comment
After Citi's executives pay themselves millions in bonuses they'll need a fast
way to get out of town.
The problem with the
current bailout is that the government may be giving money to companies that
don't have a long-term future: zombies. On paper, for example, the Treasury
Dept. says it invests Troubled Asset Relief Program (TARP) money only in
"healthy banks—banks that are considered viable without government investment"
because "they are best positioned to increase the flow of credit in their
communities." That's the right idea. In practice, though, the criteria aren't so
stringent. Banks like Citigroup still aren't strong enough to lend. "The bailout
model is socialism," says R. Christopher Whalen, senior vice-president for
consultancy Institutional Risk Analytics. He advocates selling failed
institutions in pieces, as was done to resolve the savings and loan crisis in
the late '80s and early '90s. In fact, Washington may be moving toward something
like that with Citigroup. When a big employer runs into trouble, it's tempting
to keep it going at any cost. Economists call this "lemon socialism"—the
investment of public money in the worst companies rather than the best. The
impulse is misguided, says Yale University economics professor Eduardo M. Engel.
"You don't want to protect the jobs," he says. "What you want to protect is
workers' income during the transition from one job to another."
Peter Coy,
"A New Menace to the Economy: 'Zombie' Debtors Call them "zombie"
companies. Many more has-been companies will be feeding off taxpayers,
investors, and workers—sapping the lifeblood of healthier rivals," Business
Week, January 15, 2008 ---
http://www.businessweek.com/magazine/content/09_04/b4117024316675.htm?link_position=link2
So how much are we
talking about in the already-existing toxic paper already held by
Fannie, Freddie, and the most poisoned banks?
Estimates place these at $6 trillion, which is well over half our
out-of-control existing National Debt ---
http://online.wsj.com/article/SB123396703401759083.html?mod=djemEditorialPage
|
At the same
time, HUD pressured the federally subsidized giants to lower their
loan-to-value ratios and other underwriting requirements to
accommodate minority borrowers. HUD Secretary Andrew Cuomo even
admitted that the administration was mandating a policy of
"affirmative action" lending (his words, not ours).And it was
Clinton who initially spread the subprime rot to Wall Street. To
help Fannie and Freddie reach their "affirmative action" lending
quotas, HUD in 1995 let them get affordable-housing credit for
buying subprime securities that included loans to low-income
borrowers.Less than two years later, Freddie partnered with Wall
Street investment banker Bear Stearns to issue the first
securitizations of low-income CRA loans.There's even a press release
still available on the Web that memorializes the historic deal,
which dumped hundreds of millions of dollars in the risky loans on
the market — a down payment on the hundreds of billions that were to
follow.
"The Subprime Lending Bias," Investors Business Daily,
December 19, 2008 ---
http://www.ibdeditorials.com/IBDArticles.aspx?id=314582096700459
Bank of
America (BoA) has received an extra $20bn in US government funding
and a guarantee back-stopping the losses on $118bn of its most toxic
assets in the latest bail-out of a major US financial institution.
James Quinn,
"Bank of America to receive $138bn lifeline from US," Telegraph,
January 16, 2009 ---
Click Here
Jensen Comment
The shame is that BoA owned the mortgage brokering company,
Countrywide Financial, that caused much of the mess with crappy
sub-prime loans . |
For those who like a simple (yeah right) explanation of the financial crisis
---
http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/2008/12/05/origins-of-the-economic-crisis-in-one-chart/
Lesson One: What Really Lies Behind the Financial Crisis?
According to Siegel: Financial firms bought, held and
insured large quantities of risky, mortgage-related assets on borrowed money.
The irony is that these financial giants had little need to hold these
securities; they were already making enormous profits simply from creating,
bundling and selling them. 'During dot-com IPOs of the early 1990s, the firms
that underwrote the stock offerings did not hold on to those stocks,' Siegel
says. 'They flipped them. But in the case of mortgage-backed securities, the
financial firms decided these were good assets to hold. That was their fatal
flaw.'
"Lesson One: What Really Lies Behind the Financial Crisis?" Knowledge@Wharton,
January 21, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2148
Jensen Comment
Lesson Two of what lies behind the financial crisis is that investment banks and
others like AIG wrote credit derivatives on the on the CDO collateralized debt
obligations that used mortgage backed securities as collateral. The companies
that wrote these derivatives did not have the insurance reserves to cover the
melt down of those CDOs. To avoid bankruptcy of giants such as AIG, the U.S.
treasury gave billions in bailout funds to cover the credit derivatives.
See Appendix E ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
I think there was a hidden agenda with respect to why Hank Paulson's first
billions in bailout funds went to cover the credit derivative obligations.
See Appendix Y ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails
How much to bail out the banks now? $3.5 trillion by one estimate
A federal program to guarantee or buy bad assets from
the ailing U.S. bank sector could come with a $3.5 trillion price tag. That
would push the accumulated costs of rescuing the financial markets over the last
year through various federal loan, stock purchase, debt guarantee and other
programs close to $9 trillion and counting, with practically no end in sight for
the bad news battering the banking industry. That figure doesn't count the $825
billion economic stimulus plan also under consideration. "We expect massive
federal intervention into the financial sector from the new administration in
the coming months," says Keefe Bruyette & Woods analyst Frederick Cannon, who
calculated the $3.5 trillion figure, which is one-quarter of the banking
sector's $14 trillion in combined assets.
Liz Moyer, "A TARP In The Trillions?"
Forbes, January 21, 2009 ---
http://www.forbes.com/2009/01/21/tarp-banking-treasury-biz-wall-cx_lm_0121tarp.html
Robert Shiller visits Google’s Mountain View, CA
headquarters to discuss his book “The Subprime Solution: How Today’s Global
Financial Crisis Happened, and What to Do About It.” This event took place on
October 30, 2008, as part of the Authors@Google series. The subprime mortgage
crisis has already wreaked havoc on the lives of millions of people and now it
threatens to derail the U.S. economy and economies around the world. In The
Subprime Solution, best-selling economist Robert Shiller reveals the origins of
this crisis and puts forward bold measures to solve it. He calls for an
aggressive response–a restructuring of the institutional foundations of the
financial system that will not only allow people once again to buy and sell
homes with confidence, but will create the conditions for greater prosperity in
America and throughout the deeply interconnected world economy. Robert J.
Shiller is the best-selling author of “Irrational Exuberance” and “Subprime
Solution” (both Princeton), among other books. He is the Arthur M. Okun
Professor of Economics at Yale University.
"Authors@Google: Robert Shiller," January 8, 2009 ---
http://www.ritholtz.com/blog/2009/01/authorsgoogle-robert-shiller/
"AIG, Surprise: Moneymaker Its profits for taxpayers cast doubt on
the notion that it behaved recklessly before the panic struck," by Holman W.
Jenkins, Jr., The Wall Street Journal, August 31, 2012 ---
http://professional.wsj.com/article/SB10000872396390443618604577623373568029572.html?mg=reno64-wsj#mod=djemEditorialPage_t
AIG's bailout is getting the revisionist treatment.
The rescue hasn't been the dismal federal experience that, say, GM's has
been. Taxpayers are showing a $5 billion profit on their 53% stake in the
insurer, as of yesterday's closing price.
What's more, in the last few days, the New York Fed
liquidated the last of the complex mortgage derivatives it acquired from
AIG's counterparties as part of the bailout. Such transactions and related
fees have netted the government about $18 billion.
This is good news but requires some revising of
theories of the crisis itself. The "toxic" and "shaky" housing derivatives
that got AIG in trouble turn out, even amid the worst housing slump in 70
years, not to have been the crud many assumed they were.
A lot of renditions skip over this part, dismissing
AIG's pre-crash mortgage activities as "reckless," thereby making a mystery
of how the refinancing of AIG could be paying off so handsomely for
taxpayers. Taxpayers are making out because they bought valuable assets on
the cheap.
This is as it should be. But let's remember how AIG
got in trouble. It wrote insurance to guarantee the very senior portions of
securities derived from underlying mortgages—that is, the portions already
designed to withstand a sizeable increase in defaults.
AIG failed not because of the failure of these
securities to keep paying as expected, but because of its own promise to
fork up cash collateral if the market price of these securities fell or if
the rating agencies downgraded what they had previously rated Triple-A.
In the systemic panic that climaxed with the Lehman
failure, both things happened in spades, even as AIG itself no longer could
raise the cash to make good on its commitments. Some now claim AIG could
have waved off the collateral calls, citing exceptional circumstances. But
even that wouldn't have changed the fact that, because of the panic, AIG
itself was no longer trusted despite being chock-full of good assets.
We'll never know if the company might have finessed
its way out of its jam (quite possibly its counterparties, including Goldman
Sachs, would have acted to keep AIG afloat if the alternative of a
government bailout weren't available). Instead AIG turned to taxpayers to
finance the collateral calls it couldn't finance itself, and taxpayers took
advantage.
For all the desire to name villains and blame bad
incentives for the financial crisis, notice that panic itself was the key
player. Panic is a variable about which it's disconcertingly hard for
government to do anything useful in advance.
Panic is systemic—an uncertainty or loss of trust
in how the system will behave. Here's a simple but relevant example: What
happens to the market value of mortgages if investors lose confidence in the
legal system to permit them to foreclose on borrowers who stop paying?
We don't need to retread the history. Letting
Lehman fail was a disaster because the rescue of Bear Stearns had
conditioned the market to believe Washington wouldn't permit major
institutional failures. The mixed signals sent about Fannie and Freddie only
undermined the effort to recruit fresh capital to other financial
institutions distressed by uncertainty over the value of mortgage
securities.
AIG is the most dramatic example of the general
case. A lot of things become good or bad collateral depending on what the
government is expected to do. It's not too strong to say Washington had to
bail out AIG because the market was uncertain whether Washington would bail
out AIG. (An additional complexity we won't go into is how the Fed's QE
exercises subsequently boosted the bailout's profits.)
Let us be careful here: A host of private and
public behaviors contributed to the housing bubble and meltdown, whose
losses were destined to be felt widely. Our system has no problem
accommodating the failure of individual institutions, even very big ones.
But systemic panic always comes to the door of government. It can't be
otherwise.
Governments can try to duck this burden, as
European governments have done, only by renouncing the ability to print
money and so soiling their own credit that substituting their own credit for
the financial system's is no longer an option. Make no mistake: This would
be a real cure for too-big-to-fail if the Europeans were inclined to let the
chips fall. They're not. Instead the self-disabling governments want Germany
to supply the bailout.
Continued in article
New Financial Terms forwarded by my good neighbors
Subject: New Financial Terms
CEO- Chief Embezzlement Officer
CFO - Corporate Fraud Officer
BULL MARKET- A random market movement causing investors to
mistake themselves for financial geniuses.
BEAR MARKET- a 6-to-18-month period when the kids get no
allowance, the wife gets no jewelry, and the husband gets no sex.
VALUE INVESTING- The art of buying low and selling lower.
P/E RATIO- The percentage of investors wetting their pants
as the market keeps crashing.
BROKER - What my financial planner has made me.
STANDARD & POOR- Your life in a nutshell.
STOCK ANALYST- Idiot who just downgraded your stock.
STOCK SPLIT- When your ex-wife and her lawyer split your
assets equally between themselves.
MARKET CORRECTION- The day after you buy stocks.
CASH FLOW- The movement your money makes as it disappears
down the toilet.
YAHOO! - What you yell after selling it to some poor
sucker for $240 per share.
WINDOWS- What you jump out of when you're the sucker who
bought Yahoo at $240 per share.
INSTITUTIONAL INVESTOR- Past year investor who's now
locked up in a nuthouse.
PROFIT - Archaic word no longer in use.
To which David Albrecht added the following:
Here's another list, from:
http://247wallst.com/2008/11/26/new-bear-market/
Below is the long list:
- "201/K": What used to be your 401/K, but cut in at least
half.
- "I.R.A.": This is the paramilitary group you want to sick on
thepeople who created the over-the-counter instruments and
financialderivatives that are making this financial mess much worse than
itshould have been.
- "IPO": The acronym that one yells when they see their
brokerage accounts or discover the balance of the 201/K. "I’m Pissed
Off!"
- "Short Squeeze": This is what you think your chair is doing
to you when you try to calculate the new balance of your investments.
- "Foreclosure": The time that the stock market stops dropping
each day.
- "Stock Broker": The value of your shares each day.
- "Discount Broker": The value of your shares of the brokerage
firm you own.
- "Bond Broker": That guy who puts up court money to get you
out of jail.
- "Market Sell-off": Daily news reports.
- "Selling Short": The notion you get every time you decide to
not go with one of your winning stock picks.
- "Dollar Cost Averaging": Sticking with a strategy that isn’t
working.
- "Market Crash": The last sound of Alec Baldwin jumping out of
the window
at the end of this SNL commercial.
- "Market Rally": A church vigil for investors praying for this
stock market selling to end.
- "Bailout": What investors have been doing for weeks and
weeks.
- "Credit Default Swap": When you trade canceled credit cards
with your friends and family.
- "Treasury Bill": $700 billion to $3 trillion that your kids
will have to pay for this mess, plus interest.
- "Over The Counter Derivative": The same stuff meth is made
with.
- “CDO”: Community Debt Onus
- "Financial Adviser": Bookie.
- "Hedge Fund": The money, jewelry, and silver coins you buried
in your back yard or stuck in a safe.
- "Analyst": Your proctologist’s trainee.
- "Risk Manager": The guy who rubber-stamped AAA ratings as the
second coming.
- "Underwriter": That creepy guy that works for the funeral
home.
- "Margin Call": What your former financial adviser keeps
calling you about.
- "Options Expiration Date": When you decide to give up on the
stock market forever.
- "Recession-Proof": That really strong and cheap booze that
everyone is drinking now; formerly called rot gut.
- "Stock Split": What you think happened with your shares when
you see the share price each week. But it didn’t split.
- "Bottom Sniffing": When bottom fishing doesn’t work.
- "52-Week Low": How you feel each new day when you get home.
- "TARP": What you sleep under after you lost your job, car,
and house.
- "Going Private": Telling your friends you are out of the
stock market but aren’t really out.
- "Private Equity": What Eliot Spitzer got in trouble over.
- "Resistance": Almost every penny price increment above the
current price.
- "Support": Tomorrow’s new resistance.
- "Gap and Crap": When the market opens up and almost
immediately sells off. That’s actually a real term used.
- "Poison Pill": What investors want to take when they see
their 201/K balance.
- "Junk Bond": Government agency investments.
- "DJIA": Down Jones Industrial Average
- "Blue Chip": The color of your skin around that broken piece
of knuckle you got slamming your first into your desk or keyboard.
- "Penny Stock": Former DJIA and S&P 500 index components that
have been kicked out of the index.
- "Reiterated Guidance": The new absolute best case scenario
for future earnings.
- "Microsoft": A Man’s libido after talking about the current
stock market.
- "Socialism": The new-age definition of Free Market Capitalism
- "Recession": A mild downturn in the economy where some
friends and neighbors become jobless.
- "Depression": A mild downturn in the economy that has now
turned horrible, and now you are jobless along with friends and
neighbors.
We don't have a moment to spare, but evidently we
have $1 trillion (to spare).
Jacob Sullum, "The New Era of
Irresponsibility," Reason Magazine, February 4, 2009 ---
http://www.reason.com/news/show/131468.html
"Washington and the Jobs Market: The U.S. needs to stop pouring
money into a Keynesian cul-de-sac," The Wall Street Journal, November
7, 2009 ---
Click Here
A familiar definition of insanity is to
keep doing the same thing and expecting different results. So in the wake of
yesterday's report that the national jobless rate climbed to 10.2% in
October, we suppose we can expect the political class to demand another
"stimulus." Maybe if Congress spends another $787 billion in the name of job
creation, it can get the jobless rate up to 12% or 13%.
It's hard to imagine a more complete
repudiation of Keynesian stimulus than the evidence of the last year's job
market. We've now had two examples of such stimulus—President Bush's $160
billion effort in February 2008 and President Obama's mega-version a year
later—and neither has made even the smallest dent in employment. As the
nearby chart shows, Mr. Obama's economic advisers sold the stimulus by
saying it would keep the jobless rate below 8%. Actual results may differ,
as they say.
The economy shed another 190,000 jobs in
October, taking the total job losses to 3.5 million since January. The
larger measure of joblessness that includes marginal and part-time workers
jumped 0.5% to 17.5%. And the average hours worked in a week stayed the same
at 33.0, which means that millions of Americans working part-time will have
to become full-time before employers start hiring new workers.
Job creation typically lags coming out of
recession, and there were some signs of hope in the October report.
Temporary employment increased for the third month in a row, often a key
early sign of a healthier jobs market. The job losses for August and
September were also revised lower. But with an economic recovery clearly
under way, corporate earnings rising and productivity soaring, we should be
seeing a sharper turn in the job market.
The White House says the stimulus created
as many as one million new jobs, but this is single-entry economic
bookkeeping. No one doubted that such spending would create some jobs and
"save" others, especially in government. But such spending isn't free. Every
dollar in new government spending is taxed or borrowed from the private
economy, which might have put it to better use.
If the government takes $1 from Paul, who
would have invested it in a new business, and gives it to Peter, who spends
it on a new lawn mower, the government records it as a net gain for economic
growth via consumption. But the economy is hardly more productive as a
result. Especially with so much of the Obama stimulus going to transfer
payments—such as Medicaid and jobless benefits—the net effect on job
creation has probably been negative. The ballyhooed Keynesian multiplier
that every dollar of government spending yields 1.5 times that in economic
growth has been exposed again as false.
The policy lesson here is for both
political parties. President Bush's cave-in to Democrats in 2008 meant that
there was no debate in Washington over policies that might have produced a
much better stimulus at that early point in the recession. Like so much else
in Mr. Bush's final year, he lost his policy bearings and forgot the lesson
of 2003: A stimulating tax cut needs to be immediate, permanent and at the
margin of the next dollar earned. Instead, for the last two years, the U.S.
and most of the world have been pouring money into a Keynesian cul-de-sac.
Not that businesses can expect anything
better now from Washington. Congress's panicked response this week has been
to extend and expand the $8,000 first-time home-buyer credit and to add
another 20 weeks in jobless benefits.
Continued in article
Video Lecture: John Maynard Keynes and Hayek: Bruce Caldwell
---
http://www.youtube.com/watch?v=t4a_SkJzoIg
Video Rap: Keynes and Hayek Rap from PBS ---
http://www.pbs.org/newshour/bb/business/july-dec09/keynes_12-16.html
Also see
http://financeprofessorblog.blogspot.com/2009/12/keynes-and-hayek-rap-from-pbs.html
A Famous Economist Explains What's Wrong With Obama's Stimulus Program
But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best
Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory
of Employment, Interest and Money." The financial crisis and possible depression
do not invalidate everything we have learned about macroeconomics since 1936.
Much more focus should be on incentives for people and businesses to invest,
produce and work. On the tax side, we should avoid programs that throw money at
people and emphasize instead reductions in marginal income-tax rates --
especially where these rates are already high and fall on capital income.
Eliminating the federal corporate income tax would be brilliant. On the spending
side, the main point is that we should not be considering massive public-works
programs that do not pass muster from the perspective of cost-benefit analysis.
Just as in the 1980s, when extreme supply-side views on tax cuts were
unjustified, it is wrong now to think that added government spending is free.
Robert J. Barro, "Government
Spending Is No Free Lunch: Now the Democrats are peddling voodoo
economics," The Wall Street Journal, January 22, 2009 ---
http://online.wsj.com/article/SB123258618204604599.html?mod=djemEditorialPage
Robert Barro is an economics professor at Harvard
University and a senior fellow at Stanford University's Hoover Institution.
Back in the 1980s, many commentators
ridiculed as voodoo economics the extreme supply-side view that
across-the-board cuts in income-tax rates might raise overall tax revenues.
Now we have the extreme demand-side view that the so-called "multiplier"
effect of government spending on economic output is greater than one -- Team
Obama is reportedly using a number around 1.5.
To think about what this means, first
assume that the multiplier was 1.0. In this case, an increase by one unit in
government purchases and, thereby, in the aggregate demand for goods would
lead to an increase by one unit in real gross domestic product (GDP). Thus,
the added public goods are essentially free to society. If the government
buys another airplane or bridge, the economy's total output expands by
enough to create the airplane or bridge without requiring a cut in anyone's
consumption or investment.
The explanation for this magic is that
idle resources -- unemployed labor and capital -- are put to work to produce
the added goods and services.
If the multiplier is greater than 1.0, as
is apparently assumed by Team Obama, the process is even more wonderful. In
this case, real GDP rises by more than the increase in government purchases.
Thus, in addition to the free airplane or bridge, we also have more goods
and services left over to raise private consumption or investment. In this
scenario, the added government spending is a good idea even if the bridge
goes to nowhere, or if public employees are just filling useless holes. Of
course, if this mechanism is genuine, one might ask why the government
should stop with only $1 trillion of added purchases.
What's the flaw? The theory (a simple
Keynesian macroeconomic model) implicitly assumes that the government is
better than the private market at marshaling idle resources to produce
useful stuff. Unemployed labor and capital can be utilized at essentially
zero social cost, but the private market is somehow unable to figure any of
this out. In other words, there is something wrong with the price system.
John Maynard Keynes thought that the
problem lay with wages and prices that were stuck at excessive levels. But
this problem could be readily fixed by expansionary monetary policy, enough
of which will mean that wages and prices do not have to fall. So, something
deeper must be involved -- but economists have not come up with
explanations, such as incomplete information, for multipliers above one.
A much more plausible starting point is a
multiplier of zero. In this case, the GDP is given, and a rise in government
purchases requires an equal fall in the total of other parts of GDP --
consumption, investment and net exports. In other words, the social cost of
one unit of additional government purchases is one.
This approach is the one usually applied
to cost-benefit analyses of public projects. In particular, the value of the
project (counting, say, the whole flow of future benefits from a bridge or a
road) has to justify the social cost. I think this perspective, not the
supposed macroeconomic benefits from fiscal stimulus, is the right one to
apply to the many new and expanded government programs that we are likely to
see this year and next.
What do the data show about multipliers?
Because it is not easy to separate movements in government purchases from
overall business fluctuations, the best evidence comes from large changes in
military purchases that are driven by shifts in war and peace. A
particularly good experiment is the massive expansion of U.S. defense
expenditures during World War II. The usual Keynesian view is that the World
War II fiscal expansion provided the stimulus that finally got us out of the
Great Depression. Thus, I think that most macroeconomists would regard this
case as a fair one for seeing whether a large multiplier ever exists.
I have estimated that World War II raised
U.S. defense expenditures by $540 billion (1996 dollars) per year at the
peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war
raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier
was 0.8 (430/540). The other way to put this is that the war lowered
components of GDP aside from military purchases. The main declines were in
private investment, nonmilitary parts of government purchases, and net
exports -- personal consumer expenditure changed little. Wartime production
siphoned off resources from other economic uses -- there was a dampener,
rather than a multiplier.
We can consider similarly three other U.S.
wartime experiences -- World War I, the Korean War, and the Vietnam War --
although the magnitudes of the added defense expenditures were much smaller
in comparison to GDP. Combining the evidence with that of World War II
(which gets a lot of the weight because the added government spending is so
large in that case) yields an overall estimate of the multiplier of 0.8 --
the same value as before. (These estimates were published last year in my
book, "Macroeconomics, a Modern Approach.")
There are reasons to believe that the
war-based multiplier of 0.8 substantially overstates the multiplier that
applies to peacetime government purchases. For one thing, people would
expect the added wartime outlays to be partly temporary (so that consumer
demand would not fall a lot). Second, the use of the military draft in
wartime has a direct, coercive effect on total employment. Finally, the U.S.
economy was already growing rapidly after 1933 (aside from the 1938
recession), and it is probably unfair to ascribe all of the rapid GDP growth
from 1941 to 1945 to the added military outlays. In any event, when I
attempted to estimate directly the multiplier associated with peacetime
government purchases, I got a number insignificantly different from zero.
As we all know, we are in the middle of
what will likely be the worst U.S. economic contraction since the 1930s. In
this context and from the history of the Great Depression, I can understand
various attempts to prop up the financial system. These efforts, akin to
avoiding bank runs in prior periods, recognize that the social consequences
of credit-market decisions extend well beyond the individuals and businesses
making the decisions.
But, in terms of fiscal-stimulus
proposals, it would be unfortunate if the best Team Obama can offer is an
unvarnished version of Keynes's 1936 "General Theory of Employment, Interest
and Money." The financial crisis and possible depression do not invalidate
everything we have learned about macroeconomics since 1936.
Much more focus should be on incentives
for people and businesses to invest, produce and work. On the tax side, we
should avoid programs that throw money at people and emphasize instead
reductions in marginal income-tax rates -- especially where these rates are
already high and fall on capital income. Eliminating the federal corporate
income tax would be brilliant. On the spending side, the main point is that
we should not be considering massive public-works programs that do not pass
muster from the perspective of cost-benefit analysis. Just as in the 1980s,
when extreme supply-side views on tax cuts were unjustified, it is wrong now
to think that added government spending is free.
Keynes: The Rise, Fall, and Return of the 20th Century's Most
Influential Economist by Peter Clarke (Bloomsbury; 2009, 211
pages; $20). Examines the life and legacy of the British economist (1883-1946).
Denny Beresford forwarded the following link. I don't know how long it will
be a free download.
"The Crash: What Went Wrong? How did the most dynamic and sophisticated
financial markets in the world come to the brink of collapse? The Washington
Post examines how Wall Street innovation outpaced Washington regulation.,"
The Washington Post, January 2009 ---
http://www.washingtonpost.com/wp-srv/business/risk/index.html
Jensen Comment
The above site has three links to AIG and what went wrong with their credit
default swaps.
Part 1 "The Beautiful Machine" ---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/28/AR2008122801916.html
Part 2 "A Crack in the System"---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/29/AR2008122902670.html
Part 3 "Downgrades and Downfall"---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/30/AR2008123003431.html
Few forecast these (2008 economic meltdown)
events; although, in an outbreak of retrospective
foresight, an increasing number now claim they saw it coming. The reality is
that among all the banks, investors, academics and policy-makers, only a handful
were able to identify ahead of time the causes and potential scale of the
crisis. (The Handful were - Bill White, formerly of both the Bank of Canada and
the Bank for International Settlements; Harvard University’s Ken Rogoff; Nouriel
Roubini of New York University; Wynne Godley of Cambridge; and Bernard Connolly
of AIG Financial Products). I came across
this paper
by Caludio Borio of BIS.
Amol Agrawal, Mostly Economics Blog, December
19, 2008 ---
http://mostlyeconomics.wordpress.com/
Jensen Comment
Hindsight: This 2006 video makes fools out of
Ben Stein and Art Laffer and makes a hero out of Peter Schiff.
To this I might add Peter Schiff. Arthur Laffer's
preditions in 2006 predictions became a sick joke. Also you
Ben Stein
lovers may have second thoughts watching him proclaim, in 2006, that the
subprime problem is going to be a "tiny" problem.
Watch Peter Schiff
make fools out of
Art Laffer,
Ben Stein, and other finance “experts” in this video.
Watch Ben Stein recommend that you invest heavily in Merrill
Lynch before its shares tanked. Some of these popular media "experts" need to
spend more time studying and reading and less time broadcasting
poorly-researched advice to investors. Peter Schiff, on the other hand, does his
homework. This video is really revealing about the advice we get on television.
The video is available at the Financial Rounds Blog,
November 18 at
http://financeprofessorblog.blogspot.com/2008/11/peter-schiff-prophet-from-past.html
Update on the bet Art Laffer made with Peter Schiff ---
Listen to Laffer try to weasel out of paying up ---
http://www.youtube.com/watch?v=z3WjgKUf-kA
"What Exactly is Nouriel Roubini Good For?" by Justin Fox, Harvard
Business Review Blog, May 26, 2010 ---
http://blogs.hbr.org/fox/2010/05/what-exactly-is-nouriel-roubini.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE
If you're like me, you've seen and heard a lot of
economist Nouriel Roubini lately. Just in the past couple of weeks, the NYU
professor known as Dr. Doom has been interviewed on
NPR's Morning Edition, in
the FT, in
Der Spiegel, on
HBO's Real Time with Bill Maher. Not to mention
CNBC, but then he's
always on CNBC. (Wanna know where he'll be next? Check the
Twitter.)
It's partly that Roubini has a new book out, but
also just that markets are in crisis (or something approaching it) yet again
and so reporters and TV hosts turn again to the man who predicted
the last crisis. Or so the story usually goes. In fact, Roubini didn't
exactly predict the crisis that began in mid-2007. As Damien Hoffman has
documented, Roubini spent several years predicting
a very different sort of crisis — one in which foreign central banks
diversifying their holdings out of Treasuries sparked a run on the dollar —
only to turn in late 2006 to warning of a U.S. housing bust and a global
"hard landing."
He still didn't give a perfectly clear or (in
retrospect) accurate vision of how exactly this would play out. Who could?
The global economy is an awfully complicated thing. And once the troubles
became apparent to all in the summer of 2007, Roubini adroitly adjusted his
forecasts to rapidly changing circumstances, weaving a gloomy but realistic
course between those who at every turn hinted that the worst was over and
the growing ranks (especially in early 2009) who predicted an uninterrupted
slide into economic and financial chaos.
Continued in article
Is the U.S. Dollar About to Plunge in a Crash?
"Face-Off: The Dollar’s Doldrums." Newsweek Magazine, June 22, 2009 ---
http://www.newsweek.com/id/201975
Last fall, the dollar surged as the world
turned to U.S. Treasuries as a safe haven. But its recent decline has some
wondering: is the dollar headed for a crash?
Peter Schiff : Absolutely!
"At some point, the world will want out of the U.S. economy, and the
dollar will rapidly lose value. The bailouts and stimulus have only worsened
our problems. We can't afford our huge government because we don't produce
enough, so we spend borrowed money. We're sealing the fate of our currency
by printing it into oblivion."
Brad Setser: Not so fast.!
"Whenever a country runs a large trade deficit for a long period of time,
there's some risk for a disorderly correction. But there are two things
mitigating that risk: the trade deficit has come down signif- icantly, and
our savings rate has gone up. If sustained, together they reduce the risk of
a crash and the needed adjustment is smaller."
Our (Newweek's) Verdict
The potential for a crash depends on what happens abroad, as the dollar's
value is relative to that of other currencies. As long as the U.S. doesn't
get left behind in a global recovery, the dollar will be fine.
Schiff is president of Euro Pacific Capital and author
of Crash Proof.
Setser is a fellow for Geoeconomics at the Council on Foreign Relations.
Jensen Comment
Since Newsweek Magazine is owned by NBC, Newsweek would never take
a position that made President Obama's policies look bad. To do otherwise might
not keep the GOP buried beneath its 2008 ashes. No other nation is entering into
trillion-dollar deficits for the next 10 years. I side with Peter Schiff 100%,
although the timing of the dollar's crash is very unpredictable. Peter Schiff
correctly predicted (and publically warned the public) well in advance that
there would be a subprime mortgage crisis and an economic collapse. But the
funds he manages did not make excess profits on these correct predictions due
largely to the fact that he predicted treasury yields would soar and the dollar
would crash long before major events transpired (if they do indeed transpire).
It's one thing to correctly predict economic happenings and quite another to
predict their timings.
One of the Most Enlightening Debates I've Ever Watched
Video of Peter Schiff Making Accurate Predictions in 2007 ---
http://www.youtube.com/watch?v=2I0QN-FYkpw
He makes Art Laffer and Ben Stein look like they should’ve instead been limited
to making commercials with Shaq. Keep in mind that at the time Bush was still
President of the United States, although the Democrats had the majorities in the
House and Senate.
I find the above video to be incredible in making
us lose your faith in “financial experts.”
Treasury statistics indicate that, at the end of
2006, foreigners held 44% of federal debt held by the public. About 66% of that
44% was held by the central banks of other countries, in particular the central
banks of Japan and China. In total, lenders from Japan and China held 47% of the
foreign-owned debt. This exposure to potential financial or political risk
should foreign banks stop buying Treasury securities or start selling them
heavily was addressed in a recent report issued by the Bank of International
Settlements which stated, "'Foreign investors in U.S. dollar assets have seen
big losses measured in dollars, and still bigger ones measured in their own
currency. While unlikely, indeed highly improbable for public sector investors,
a sudden rush for the exits cannot be ruled out completely." ---
http://en.wikipedia.org/wiki/United_States_public_debt
The
Community Reinvestment Act of 1977 coerces banks into making loans based on
political correctness, and little else, to people who can't afford them.
Enforced like never before by the Clinton administration, the regulation
destroyed credit standards across the mortgage industry, created the subprime
market, and caused the housing bubble that has now burst and left us with the
worst housing and banking crises since the Great Depression.
"Stop Covering Up And Kill The CRA," Investor's Business Daily,
November 28, 2008 ---
http://www.ibdeditorials.com/IBDArticles.aspx?id=312766781716725
Jensen Comment
The CRA was not the sole cause of the housing bubble, but when combined with
Rep. Barney Frank's later coercion of Freddie Mac and Fannie Mae to buy the high
risk political correctness mortgages, the CRA added a lot of air to the housing
bubble.
Mortgage Backed Securities are like boxes of
chocolates. Criminals on Wall Street and one particular U.S. Congressional
Committee stole a few chocolates from the boxes and replaced them with turds.
Their criminal buddies at Standard & Poors rated these boxes AAA Investment
Grade chocolates. These boxes were then sold all over the world to investors.
Eventually somebody bites into a turd and discovers the crime. Suddenly nobody
trusts American chocolates anymore worldwide. Hank Paulson now wants the
American taxpayers to buy up and hold all these boxes of turd-infested
chocolates for $700 billion dollars until the market for turds returns to
normal. Meanwhile, Hank's buddies, the Wall Street criminals who stole all the
good chocolates are not being investigated, arrested, or indicted. Momma always
said: "Sniff the chocolates first Forrest." Things generally don't pass the
smell test if they came from Wall Street or from Washington DC.
Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html
Forrest Gump's Momma
The Sleazy Subprime Mortgage Lending Companies Have a New (actually
renewed old) Scheme to Make Billions at Taxpayer Expense
As if they haven't done enough damage. Thousands of
subprime mortgage lenders and brokers—many of them the very sorts of firms that
helped create the current financial crisis—are going strong. Their new strategy:
taking advantage of a long-standing federal program designed to encourage
homeownership by insuring mortgages for buyers of modest means. You read that
correctly. Some of the same people who propelled us toward the housing market
calamity are now seeking to profit by exploiting billions in federally insured
mortgages. Washington, meanwhile, has vastly expanded the availability of such
taxpayer-backed loans as part of the emergency campaign to rescue the country's
swooning economy.
Chad Terhune and Robert Berner,
"FHA-Backed Loans: The New Subprime The same people whose reckless practices
triggered the global financial crisis are onto a similar scheme that could cost
taxpayers tons more," Business Week, November 19, 2008 ---
http://www.businessweek.com/magazine/content/08_48/b4110036448352.htm?link_position=link2
Jensen Comment
That's right. The greedy slime balls "Borne of Sleaze, Bribery, and Lies" are
resurfacing with Barney Frank's blessing ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
"Financial Reversals: Everything bad is good
again," by Jacob Sullum, Reason Magazine, November 19,
2008 ---
http://www.reason.com/news/show/130142.html
"Proposed new Bailout Plan," by Andreas Hippin, Bloomberg,
November 20, 2008 ---
http://www.wallstreetoasis.com/forums/proposed-new-bailout-plan
The Somali pirates, renegade Somalis known for
hijacking ships for ransom in the Gulf of Aden, are negotiating a purchase
of Citigroup.
The pirates would buy Citigroup with new debt and
their existing cash stockpiles, earned most recently from hijacking numerous
ships, including most recently a $200 million Saudi Arabian oil tanker. The
Somali pirates are offering up to $0.10 per share for Citigroup, pirate
spokesman Sugule Ali said earlier today. The negotiations have entered the
final stage, Ali said. ``You may not like our price, but we are not in the
business of paying for things. Be happy we are in the mood to offer the
shareholders anything," said Ali.
The pirates will finance part of the purchase by
selling new Pirate Ransom Backed Securities. The PRBS's are backed by the
cash flows from future ransom payments from hijackings in the Gulf of Aden.
Moody's and S&P have already issued their top
investment grade ratings for the PRBS's.
Head pirate, Ubu Kalid Shandu, said "we need a bank
so that we have a place to keep all of our ransom money. Thankfully, the
dislocations in the capital markets has allowed us to purchase Citigroup at
an attractive valuation and to take advantage of TARP capital to grow the
business even faster." Shandu added, "We don't call ourselves pirates. We
are coastguards and this will just allow us to guard our coasts better."
"New Michael Lewis Book on Financial World Will Be Published in March,"
by Julie Bosmanian, New York Times, January 14, 2014 ---
http://www.nytimes.com/2014/01/15/business/media/new-michael-lewis-book-on-financial-world-will-be-published-in-march.html?partner=socialflow&smid=tw-nytimesbusiness&_r=0
Michael Lewis, whose colorful reporting on
money and excess on Wall Street has made him one of the country’s most
popular business journalists, has written a new book on the financial world,
his publisher said on Tuesday.
The book, titled “Flash Boys,” will be released by
W.W. Norton & Company on March 31. A spokeswoman for Norton said the new
book “is squarely in the realm of Wall Street.”
Starling Lawrence, Mr. Lewis’s editor, said in a
statement: “Michael is brilliant at finding the perfect narrative line for
any subject. That’s what makes his books, no matter the topic, so indelibly
memorable.”
Mr. Lewis is the author of “Moneyball,” “Liar’s
Poker” and “The Big Short.”
Jensen Comment
His books are both humorous and well-researched.
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.
"The End," by Michael Lewis December 2008 Issue The era that
defined Wall Street is finally, officially over. Michael Lewis, who chronicled
its excess in Liar’s Poker, returns to his old haunt to figure out what went
wrong.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#TheEnd
Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek
Explanation of the Meltdown on Wall Street!
Now I asked
Gutfreund about his biggest decision. “Yes,” he said. “They—the
heads of the other Wall Street firms—all said what an awful thing it was
to go public (beg for a government
bailout) and how could you do such a
thing. But when the temptation arose, they all gave in to it.” He agreed
that the main effect of turning a partnership into a corporation was to
transfer the financial risk to the shareholders. “When things go wrong,
it’s their problem,” he said—and obviously not theirs alone. When a Wall
Street investment bank screwed up badly enough, its risks became the
problem of the U.S. government. “It’s laissez-faire until you get in
deep shit,” he said, with a half chuckle. He was out of the game.
This is a must read to understand what went wrong on Wall Street ---
especially the punch line!
"The End," by Michael Lewis December 2008 Issue The era that defined Wall
Street is finally, officially over. Michael Lewis, who chronicled its excess
in Liar’s Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
To this day, the willingness of a Wall Street
investment bank to pay me hundreds of thousands of dollars to dispense
investment advice to grownups remains a mystery to me. I was 24 years
old, with no experience of, or particular interest in, guessing which
stocks and bonds would rise and which would fall. The essential function
of Wall Street is to allocate capital—to decide who should get it and
who should not. Believe me when I tell you that I hadn’t the first clue.
I’d never taken an accounting course, never run
a business, never even had savings of my own to manage. I stumbled into
a job at Salomon Brothers in 1985 and stumbled out much richer three
years later, and even though I wrote a book about the experience, the
whole thing still strikes me as preposterous—which is one of the reasons
the money was so easy to walk away from. I figured the situation was
unsustainable. Sooner rather than later, someone was going to identify
me, along with a lot of people more or less like me, as a fraud. Sooner
rather than later, there would come a Great Reckoning when Wall Street
would wake up and hundreds if not thousands of young people like me, who
had no business making huge bets with other people’s money, would be
expelled from finance.
When I sat down to write my account of the
experience in 1989—Liar’s Poker, it was called—it was in the spirit of a
young man who thought he was getting out while the getting was good. I
was merely scribbling down a message on my way out and stuffing it into
a bottle for those who would pass through these parts in the far distant
future.
Unless some insider got all of this down on
paper, I figured, no future human would believe that it happened.
I thought I was writing a period piece about
the 1980s in America. Not for a moment did I suspect that the financial
1980s would last two full decades longer or that the difference in
degree between Wall Street and ordinary life would swell into a
difference in kind. I expected readers of the future to be outraged that
back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid
$3.1 million; I expected them to gape in horror when I reported that one
of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost
$250 million; I assumed they’d be shocked to learn that a Wall Street
C.E.O. had only the vaguest idea of the risks his traders were running.
What I didn’t expect was that any future reader would look on my
experience and say, “How quaint.”
I had no great agenda, apart from telling what
I took to be a remarkable tale, but if you got a few drinks in me and
then asked what effect I thought my book would have on the world, I
might have said something like, “I hope that college students trying to
figure out what to do with their lives will read it and decide that it’s
silly to phony it up and abandon their passions to become financiers.” I
hoped that some bright kid at, say, Ohio State University who really
wanted to be an oceanographer would read my book, spurn the offer from
Morgan Stanley, and set out to sea.
Somehow that message failed to come across. Six
months after Liar’s Poker was published, I was knee-deep in letters from
students at Ohio State who wanted to know if I had any other secrets to
share about Wall Street. They’d read my book as a how-to manual.
In the two decades since then, I had been
waiting for the end of Wall Street. The outrageous bonuses, the slender
returns to shareholders, the never-ending scandals, the bursting of the
internet bubble, the crisis following the collapse of Long-Term Capital
Management: Over and over again, the big Wall Street investment banks
would be, in some narrow way, discredited. Yet they just kept on
growing, along with the sums of money that they doled out to
26-year-olds to perform tasks of no obvious social utility. The
rebellion by American youth against the money culture never happened.
Why bother to overturn your parents’ world when you can buy it, slice it
up into tranches, and sell off the pieces?
At some point, I gave up waiting for the end.
There was no scandal or reversal, I assumed, that could sink the system.
The New Order The crash did more than wipe out
money. It also reordered the power on Wall Street. What a Swell Party A
pictorial timeline of some Wall Street highs and lows from 1985 to 2007.
Worst of Times Most economists predict a recovery late next year. Don’t
bet on it. Then came Meredith Whitney with news. Whitney was an obscure
analyst of financial firms for Oppenheimer Securities who, on October
31, 2007, ceased to be obscure. On that day, she predicted that
Citigroup had so mismanaged its affairs that it would need to slash its
dividend or go bust. It’s never entirely clear on any given day what
causes what in the stock market, but it was pretty obvious that on
October 31, Meredith Whitney caused the market in financial stocks to
crash. By the end of the trading day, a woman whom basically no one had
ever heard of had shaved $369 billion off the value of financial firms
in the market. Four days later, Citigroup’s C.E.O., Chuck Prince,
resigned. In January, Citigroup slashed its dividend.
From that moment, Whitney became E.F. Hutton:
When she spoke, people listened. Her message was clear. If you want to
know what these Wall Street firms are really worth, take a hard look at
the crappy assets they bought with huge sums of borrowed money, and
imagine what they’d fetch in a fire sale. The vast assemblages of highly
paid people inside the firms were essentially worth nothing. For better
than a year now, Whitney has responded to the claims by bankers and
brokers that they had put their problems behind them with this
write-down or that capital raise with a claim of her own: You’re wrong.
You’re still not facing up to how badly you have mismanaged your
business.
Rivals accused Whitney of being overrated;
bloggers accused her of being lucky. What she was, mainly, was right.
But it’s true that she was, in part, guessing. There was no way she
could have known what was going to happen to these Wall Street firms.
The C.E.O.’s themselves didn’t know.
Now, obviously, Meredith Whitney didn’t sink
Wall Street. She just expressed most clearly and loudly a view that was,
in retrospect, far more seditious to the financial order than, say,
Eliot Spitzer’s campaign against Wall Street corruption. If mere scandal
could have destroyed the big Wall Street investment banks, they’d have
vanished long ago. This woman wasn’t saying that Wall Street bankers
were corrupt. She was saying they were stupid. These people whose job it
was to allocate capital apparently didn’t even know how to manage their
own.
At some point, I could no longer contain
myself: I called Whitney. This was back in March, when Wall Street’s
fate still hung in the balance. I thought, If she’s right, then this
really could be the end of Wall Street as we’ve known it. I was curious
to see if she made sense but also to know where this young woman who was
crashing the stock market with her every utterance had come from.
It turned out that she made a great deal of
sense and that she’d arrived on Wall Street in 1993, from the Brown
University history department. “I got to New York, and I didn’t even
know research existed,” she says. She’d wound up at Oppenheimer and had
the most incredible piece of luck: to be trained by a man who helped her
establish not merely a career but a worldview. His name, she says, was
Steve Eisman.
Eisman had moved on, but they kept in touch.
“After I made the Citi call,” she says, “one of the best things that
happened was when Steve called and told me how proud he was of me.”
Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called Whitney again and
asked her, as I was asking others, whom she knew who had anticipated the
cataclysm and set themselves up to make a fortune from it. There’s a
long list of people who now say they saw it coming all along but a far
shorter one of people who actually did. Of those, even fewer had the
nerve to bet on their vision. It’s not easy to stand apart from mass
hysteria—to believe that most of what’s in the financial news is wrong
or distorted, to believe that most important financial people are either
lying or deluded—without actually being insane. A handful of people had
been inside the black box, understood how it worked, and bet on it
blowing up. Whitney rattled off a list with a half-dozen names on it. At
the top was Steve Eisman.
Steve Eisman entered finance about the time I
exited it. He’d grown up in New York City and gone to a Jewish day
school, the University of Pennsylvania, and Harvard Law School. In 1991,
he was a 30-year-old corporate lawyer. “I hated it,” he says. “I hated
being a lawyer. My parents worked as brokers at Oppenheimer. They
managed to finagle me a job. It’s not pretty, but that’s what happened.”
He was hired as a junior equity analyst, a
helpmate who didn’t actually offer his opinions. That changed in
December 1991, less than a year into his new job, when a subprime
mortgage lender called Ames Financial went public and no one at
Oppenheimer particularly cared to express an opinion about it. One of
Oppenheimer’s investment bankers stomped around the research department
looking for anyone who knew anything about the mortgage business.
Recalls Eisman: “I’m a junior analyst and just trying to figure out
which end is up, but I told him that as a lawyer I’d worked on a deal
for the Money Store.” He was promptly appointed the lead analyst for
Ames Financial. “What I didn’t tell him was that my job had been to
proofread the documents and that I hadn’t understood a word of the
fucking things.”
Ames Financial belonged to a category of firms
known as nonbank financial institutions. The category didn’t include
J.P. Morgan, but it did encompass many little-known companies that one
way or another were involved in the early-1990s boom in subprime
mortgage lending—the lower class of American finance.
The second company for which Eisman was given
sole responsibility was Lomas Financial, which had just emerged from
bankruptcy. “I put a sell rating on the thing because it was a piece of
shit,” Eisman says. “I didn’t know that you weren’t supposed to put a
sell rating on companies. I thought there were three boxes—buy, hold,
sell—and you could pick the one you thought you should.” He was
pressured generally to be a bit more upbeat, but upbeat wasn’t Steve
Eisman’s style. Upbeat and Eisman didn’t occupy the same planet. A hedge
fund manager who counts Eisman as a friend set out to explain him to me
but quit a minute into it. After describing how Eisman exposed various
important people as either liars or idiots, the hedge fund manager
started to laugh. “He’s sort of a prick in a way, but he’s smart and
honest and fearless.”
“A lot of people don’t get Steve,” Whitney
says. “But the people who get him love him.” Eisman stuck to his sell
rating on Lomas Financial, even after the company announced that
investors needn’t worry about its financial condition, as it had hedged
its market risk. “The single greatest line I ever wrote as an analyst,”
says Eisman, “was after Lomas said they were hedged.” He recited the
line from memory: “ ‘The Lomas Financial Corp. is a perfectly hedged
financial institution: It loses money in every conceivable interest-rate
environment.’ I enjoyed writing that sentence more than any sentence I
ever wrote.” A few months after he’d delivered that line in his report,
Lomas Financial returned to bankruptcy.
Continued in article
Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999,
ISBN 0340767006)
Lewis writes in Partnoy’s earlier whistleblower
style with somewhat more intense and comic portrayals of the major
players in describing the double dealing and break down of integrity on
the trading floor of Salomon Brothers.
Reply from Tom Hood
Thanks Bob for the Michael Lewis article, “The End” – great explanation of
the mess we a re in and how we got here. Just found this one that does a
great job of summarizing the mess – visually
http://flowingdata.com/2008/11/25/visual-guide-to-the-financial-crisis/
Tom Hood, CPA.CITP, CEO & Executive Director, Maryland Association of CPAs
443-632-2301,
http://www.macpa.org
Check out our blogs for CPAs
http://www.cpasuvvess.com
http://www.newcpas.com
http://www.cpaisland.com
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30,
2009 ---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this
video (a little over 5 Mbs) using a free updated version of RealMedia ---
Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP
Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
From the Financial Clippings Blog on October 22, 2008 ---
http://financeclippings.blogspot.com/
I
wrote earlier
that credit rating agencies seem to be run like protection rackets..
from
CNBC
In a hearing today before the House Oversight
Committee, the credit rating agencies are being portrayed as
profit-hungry institutions that would give any deal their blessing for
the right price.
Case in point: this instant message exchange between two unidentified
Standard & Poor's officials about a mortgage-backed security deal on
4/5/2007:
Official #1: Btw (by the way) that deal is ridiculous.
Official #2: I know right...model def (definitely) does not capture half
the risk.
Official #1: We should not be rating it.
Official #2: We rate every deal. It could be structured by cows and we
would rate it.
A former executive of Moody's says
conflicts of interest got in the way of rating agencies properly valuing
mortgage backed securities.
Former Managing Director Jerome Fons, who worked at Moody's until August
of 2007, says Moody's was focused on "maxmizing revenues," leading it to
make the firm more "issuer friendly."
The three firms that dominate the $5 billion-a-year
credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch
Ratings - have been faulted for failing to identify risks in subprime mortgage
investments, whose collapse helped set off the global financial crisis. The
rating agencies had to downgrade thousands of securities backed by mortgages as
home-loan delinquencies have soared and the value of those investments
plummeted. The downgrades have contributed to hundreds of billions in losses and
writedowns at major banks and investment firms. The agencies are crucial
financial gatekeepers, issuing ratings on the creditworthiness of public
companies and securities. Their grades can be key factors in determining a
company's ability to raise or borrow money, and at what cost which securities
will be purchased by banks, mutual funds, state pension funds or local
governments. A yearlong review by the SEC, which issued the results last summer,
found that the three big (credit rating) agencies failed to rein in conflicts of
interest in giving high ratings to risky securities backed by subprime
mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November
19, 2008 ---
http://accounting.smartpros.com/x63855.xml
Jensen Comment
It’s beginning to look like Wall Street is rearing up once again to prevent the
SEC from imposing reforms on credit rating agencies. In spite of the crisis, it
will once again be business as usual with the credit rating agencies having
conflicts of interest not in the interest of investors.
Fraud and incompetence among credit rating
agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
A
democracy cannot exist as a permanent form of government. It can only exist
until the voters discover that they can vote themselves largesse from the
public treasury. From that moment on, the majority always votes for the
candidates promising the most benefits from the public treasury, with the
result that a democracy always collapses over loose fiscal policy, always
followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that
had this to say about 2000 years after "The Fall of the Athenian Republic"
and about the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt
clock in real time is a few months behind)
This leads to contemplation of democracy versus a "social
contract."
The broad mass of a nation will more easily fall
victim to a big lie than to a small one.
Adolph Hitler, Mein Kampf.
Bankers (Men in Black)
bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby.
Council on Foreign Relations, as quoted by Avital Louria Hahn,
"Missing: How Poor Risk-Management Techniques Contributed to
the Subprime Mess," CFO
Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Jensen Comment
Now that the Government is going to bail out these speculators with
taxpayer funds makes it all the worse. I received an email
message claiming that if you had purchased $1,000 of AIG
stock one year ago, you would have $42 left; with Lehman, you
would have $6.60 left; with Fannie or Freddie, you would have
less than $5 left. But if you had purchased $1,000 worth of beer
one year ago, drank all of the beer, then turned in the cans for
the aluminum recycling REFUND, you would have had $214. Based on
the above, the best current investment advice is to drink
heavily and recycle. It's called the 401-Keg. Why let others
gamble your money away when you can piss it away on your own? |
High-ranking members of Congress were flown to a
lush Caribbean resort this month for a three-day conference planned and paid for
by several of the country's most powerful corporations - a violation of federal
ethics rules, critics say. . . . Officials with those companies were
observed at the conference - sometimes acting as featured speakers at daily
seminars and freely mingling among the pols at social events.
Citigroup - which just last week received a massive
bailout from the federal government - was one of the conference's biggest
sponsors, ponying up $100,000 to help finance
the event, according to one of the lobbyists at the gathering.
Ginger Adams Otis, "SHADY ISLAND
'HOUSE' PARTY POLS' TRIP TO CARIBBEAN SKIRTED RULES," New York Post,
November 30, 2008 ---
http://www.nypost.com/seven/11302008/news/regionalnews/shady_island_house_party_141513.htm
Hitler's Credit Crisis ---
http://www.youtube.com/watch?v=bNmcf4Y3lGM
The current financial turmoil shows that private
sector can bankrupt nation states. The US government has committed more than $5
trillion and the UK has committed around £500 billion, nearly one-third of their
respective GDPs, to support the financial sector. The bailouts may stabilise the
financial sector and help economic recovery but they have also created new moral
hazards. In the absence of effective regulation and accountability, company
directors, who have already behaved badly, will continue to behave recklessly
and play their selfish games, at virtually no cost to themselves. Leaders of
major industrialised countries have paid little attention to moral hazards and
how bailouts reward bad behaviour. There is an urgent need to address the moral
hazards problem.
Prem Sikka, "Hold them to account: The traditional mechanisms for disciplining,"
The Guardian, November 18, 2008 ---
http://www.guardian.co.uk/commentisfree/2008/nov/18/marketturmoil-banks
However, the looting of the taxpayers, which was
initially $700 billion for Wall Street and has now ballooned to an estimated
$1.8 (now closer to $5) trillion and is not over yet, was not labeled as corruption by our media.
Instead, it was called a “rescue” and was demanded by many anchors and
reporters. We were told it would stabilize the markets and help ordinary people.
It didn’t. Kevin Howley, Associate Professor of Communication at DePauw
University, says this was deliberate propaganda on their part. He comments that
“…the phrase ‘bailout’―with its connotation that the government is letting Wall
Street off the hook for questionable business practices―has given way to a far
more agreeable term― ‘rescue plan.’ This phrasing appeals to the basic decency
of the American people and suggests that we’re all in this thing together.” In a
real-life corruption case, which was just as suspiciously timed as the financial
crisis itself, Alaska Senator Ted Stevens was indicted and then convicted in
this election year on all seven charges of making false statements on Senate
financial documents. One of the charges was that he had received a $1,000
Alaskan sled dog puppy that he valued at only $250 and claimed had come from a
charity. This is chicken feed compared to what the politicians and their
appointees have done by bringing the U.S. to the point of bankruptcy. But can we
ever expect the Department of Justice to turn on the politicians for these
financial crimes? Not likely.
Cliff Kincaid, "The Financial
“Rescue” that Bankrupted America," Accuracy in the Media, November 9,
2008 ---
http://www.aim.org/aim-column/the-financial-rescue-that-bankrupted-america/
This sure beats having the government buy the garbage!
If your executives got you into garbage investments, pay their bonuses in
garbage.
From the "Best of the Web Today" newsletter of The Wall Street Journal
on December 19, 2008
A Financial Innovation Everyone Should Love
"Credit Suisse Group AG's investment bank has found a
new way to reduce the risk of losses from about $5 billion of its most
illiquid loans and bonds: using them to pay employees' year-end bonuses,"
Bloomberg reports:
The bank will use leveraged loans and commercial
mortgage- backed debt, some of the securities blamed for generating the
worst financial crisis since the Great Depression, to fund executive
compensation packages, people familiar with the matter said. The new
policy applies only to managing directors and directors, the two most
senior ranks at the Zurich-based company, according to a memo sent to
employees today.
"While the solution we have come up with may not
be ideal for everyone, we believe it strikes the appropriate balance
among the interests of our employees, shareholders and regulators and
helps position us well for 2009," Chief Executive Officer Brady Dougan
and Paul Calello, CEO of the investment bank, said in the memo.
The securities will be placed into a so-called
Partner Asset Facility, and affected employees at the bank,
Switzerland's second biggest, will be given stakes in the facility as
part of their pay. Bonuses will take the first hit should the securities
decline further in value.
This is such a great idea, we're
surprised it took this long for someone to think of it. And contrary to the
memo, this does seem "ideal for everyone." Shareholders gets relief from the
risk associated with imprudent investments. Credit Suisse executives get
their bonuses despite having made those imprudent investments--and if the
risk pays off, they get the reward. What's not to like?
Not only have individual financial institutions
become less vulnerable to shocks from underlying risk factors, but also the
financial system as a whole has become more resilient.
Alan Greenspan in 2004 as quoted by Peter S.
Goodman, Taking a Good Look at the Greenspan Legacy," The New York Times,
October 8, 2008 ---
http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html?em
The problem is not that the contracts
failed, he says. Rather, the people using them got greedy. A lack of
integrity spawned the crisis, he argued in a speech a week ago at Georgetown
University, intimating that those peddling derivatives were not as reliable
as “the pharmacist who fills the prescription ordered by our physician.”
But others hold a starkly different view
of how global markets unwound, and the role that Mr. Greenspan played in
setting up this unrest.
“Clearly, derivatives are a centerpiece of
the crisis, and he was the leading proponent of the deregulation of
derivatives,” said Frank Partnoy, a law professor at the University of San
Diego and an expert on financial regulation.
The derivatives market is $531 trillion,
up from $106 trillion in 2002 and a relative pittance just two decades ago.
Theoretically intended to limit risk and ward off financial problems, the
contracts instead have stoked uncertainty and actually spread risk amid
doubts about how companies value them.
If Mr. Greenspan had acted differently
during his tenure as Federal Reserve chairman from 1987 to 2006, many
economists say, the current crisis might have been averted or muted.
Over the years, Mr. Greenspan helped
enable an ambitious American experiment in letting market forces run free.
Now, the nation is confronting the consequences.
Derivatives were created to soften — or in
the argot of Wall Street, “hedge” — investment losses. For example, some of
the contracts protect debt holders against losses on mortgage securities.
(Their name comes from the fact that their value “derives” from underlying
assets like stocks, bonds and commodities.) Many individuals own a common
derivative: the insurance contract on their homes.
On a grander scale, such contracts allow
financial services firms and corporations to take more complex risks that
they might otherwise avoid — for example, issuing more mortgages or
corporate debt. And the contracts can be traded, further limiting risk but
also increasing the number of parties exposed if problems occur.
Throughout the 1990s, some argued that
derivatives had become so vast, intertwined and inscrutable that they
required federal oversight to protect the financial system. In meetings with
federal officials, celebrated appearances on Capitol Hill and heavily
attended speeches, Mr. Greenspan banked on the good will of Wall Street to
self-regulate as he fended off restrictions.
Ever since housing began to collapse, Mr.
Greenspan’s record has been up for revision. Economists from across the
ideological spectrum have criticized his decision to let the nation’s real
estate market continue to boom with cheap credit, courtesy of low interest
rates, rather than snuffing out price increases with higher rates. Others
have criticized Mr. Greenspan for not disciplining institutions that lent
indiscriminately.
But whatever history ends up saying about
those decisions, Mr. Greenspan’s legacy may ultimately rest on a more deeply
embedded and much less scrutinized phenomenon: the spectacular boom and
calamitous bust in derivatives trading.
Bob Jensen's timeline of derivatives scandals and the evolution of
accounting standards for accounting for derivatives financial instruments
can be found at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
"‘I made a mistake,’ admits Greenspan," by Alan Beattie
and James Politi, Financial Times, October 23, 2008 ---
http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1
“I made a mistake in
presuming that the self-interest of organisations, specifically banks and
others, was such that they were best capable of protecting their own
shareholders,” he said.
In the second of two days of tense
hearings on Capitol Hill, Henry Waxman, chairman of the House of
Representatives, clashed with current and former regulators and with
Republicans on his own committee over blame for the financial crisis.
Mr Waxman said Mr Greenspan’s Federal
Reserve – along with the Securities and Exchange Commission and the US
Treasury – had propagated “the prevailing attitude in Washington... that the
market always knows best.”
Mr Waxman blamed the Fed for failing to
curb aggressive lending practices, the SEC for allowing credit rating
agencies to operate under lax standards and the Treasury for opposing
“responsible oversight” of financial derivatives.
Christopher Cox, chairman of the
Securities and Exchange Commission, defended himself, saying that virtually
no one had foreseen the meltdown of the mortgage market, or the inadequacy
of banking capital standards in preventing the collapse of institutions such
as Bear Stearns.
Mr Waxman accused the SEC chairman of
being wise after the event. “Mr Cox has come in with a long list of
regulations he wants... But the reality is, Mr Cox, you weren’t doing that
beforehand.”
Mr Cox blamed the fact that Congressional
responsibility was divided between the banking and financial services
committees, which regulate banking, insurance and securities, and the
agriculture committees, which regulate futures.
“This jurisdictional split threatens to
for ever stand in the way of rationalising the regulation of these products
and markets,” he said.
Mr Greenspan accepted that the crisis had
“found a flaw” in his thinking but said that the kind of heavy regulation
that could have prevented the crisis would have damaged US economic growth.
He described the past two decades as a “period of euphoria” that encouraged
participants in the financial markets to misprice securities.
He had wrongly assumed that lending
institutions would carry out proper surveillance of their counterparties, he
said. “I had been going for 40 years with considerable evidence that it was
working very well”.
Continued in the article
Jensen Comment
In other words, he assumed the agency theory model that corporate employees,
as agents of their owners and creditors, would act hand and hand in the best
interest for themselves and their investors. But agency theory has a flaw in
that it does not understand Peter Pan.
Long Time WSJ Defenders of Wall Street's Outrageous Compensation Morph
Into Hypocrites
At each stage of the disaster, Mr. Black told me --
loan officers, real-estate appraisers, accountants, bond ratings agencies -- it
was pay-for-performance systems that "sent them wrong." The need for new
compensation rules is most urgent at failed banks. This is not merely because is
would make for good PR, but because lavish executive bonuses sometimes create an
incentive to hide losses, to take crazy risks, and even, according to Mr. Black,
to "loot the place through seemingly normal corporate mechanisms." This is why,
he continues, it is "essential to redesign and limit executive compensation when
regulating failed or failing banks." Our leaders may not know it yet, but this
showdown between rival populisms is in fact a battle over political legitimacy.
Is Wall Street the rightful master of our economic fate? Or should we choose a
broader form of sovereignty? Let the conservatives' hosannas turn to sneers. The
market god has failed.
Thomas Frank,
"Wall Street Bonuses Are an Outrage: The public sees a self-serving system
for what it," The Wall Street Journal, February 4, 2009 ---
http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion
Bob Jensen's threads on outrageous compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Bob Jensen's threads on the Bailout mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance
Peter Pan, the manager of Countrywide Financial on Main Street, thought he had
little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures
would be Wall Street’s problems and not his local bank’s problems. And he got
his nice little commission on the sale of the Emma Nobody’s mortgage for
$180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was
almost certain in Emma’s case, because she only makes $12,000 waitressing at the
Country Café. So what if Peter Pan fudged her income a mite in the loan
application along with the fudged home appraisal value? Let Wall Street or Fat
Fannie or Foolish Freddie worry about Emma after closing the pre-approved
mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter Pan is
more concerned with his own conventional mortgage on his precious house just two
blocks south of Main Street. This is what happens when risk is
spread even farther than Tinkerbell can fly!
Read about the extent of cheating, sleaze, and
subprime sex on Main Street in
Appendix U.
The Saturday Night Live Skit (now banned) on the Bailout ---
http://patdollard.com/2008/10/it-is-here-the-banned-snl-skit-cannot-hide-from-louie/
Banks and homeowners aren't the only
ones looking to Washington for help these days. The nation's automakers are
bleeding red ink. Given the Big Three's outsize role in the U.S. economy, it may
make sense for taxpayers to lend Detroit a helping hand, argue David Kiley and
David Welch in a provocative essay. While Republicans in Washington have been
expanding the role of government in financial services, microcredit pioneer
Muhammad Yunus, of Bangladesh's Grameen Bank, is advocating a market-based
solution to the financial crisis.
Monica Gagnier, "The Fed's Next
Step," Business Week's Insider Newsletter, October 17, 2008
Jensen Comment
The latest trend is that government will bail out failing industries like banks,
automobile manufacturers, and airlines. And why not? The
government can spend trillions doing so without costing taxpayers a penny
---
http://faculty.trinity.edu/rjensen/2008bailout.htm#NationalDebt
On the left side, there is
nothing right... And on the right side, there is nothing left.
The December 31, 2008 Statement of Financial
Position (a fancy phrase for the balance sheet) of every investment bank.
The meanings in English are so varied for some words like "right" and "left."
Fat Fannie and Fearless Freddie leaned too far to the left on the left end of
the Congressional roof and fell into a pile of leftist Acorns.
Now there's nothing left but millions of empty homes left behind when the
owners left.
Governmental Accounting 101
Tutorial, by Dr. Seuss
Because of future property taxes, insurance costs, and upkeep costs, it's not
clear to accountants if Fannie and Freddie should put their foreclosed homes on
the right-side or the left-side of the balance sheet. But now that Freddie and
Fannie are owned by the government, the GAO tells us that on balance sheets the
left goes right and the right goes left. It's so confusing, but then in the
Federal Government's balance sheet nearly everything bad is left out entirely so
who cares what appears of the left versus what appears on the right. Nothing is
correct in the first place.
A more palatable approach would
be for the government to drive a Warren Buffett style hard bargain, in which,
rather than buying anything from banks, the government would invest in them in a
form, such as purchase of newly issued preferred stock, or bonds with a long
maturity, that would augment the banks' capital and thus enable banks to make
more loans. That would avoid conferring a windfall on the banks by overpaying
them for their bad securities; no one thinks Buffett is conferring a windfall on
Goldman Sachs. After the industry was back on its feet, the government could
sell the bank stocks or bonds that it had acquired.
Richard Posner, "The $700+ Billion Bailout," The Becker-Posner Blog,
September 28, 2008 ---
http://www.becker-posner-blog.com/
Jensen Comment
This appears to be a solution the government is belatedly adopting.
Current U.S. budget policy is
unsustainable because it violates the intertemporal budget constraint. While the
resulting fiscal gap will eventually be eliminated whether we like it or not,
the big issue in current budget debate is whether the ultimately unavoidable
course corrections should start now or be left for later. This paper argues that
concerns of generational equity, which often are relied on by those demanding a
prompt course correction, do not convincingly settle the issue, given empirical
uncertainties about future generations' circumstances. However, efficiency
issues create powerful grounds for urging a course correction sooner rather than
later, on three main grounds: to eliminate the risk of a catastrophic fiscal
collapse, achieve the advantages of tax smoothing, and smooth adjustments to the
consumption made possible by various government outlays. Political economy
considerations suggest that the risk of a catastrophic fiscal collapse may be
significant even though in principle it could easily be avoided.
Danial Shaviro, "The Long-Term
Fiscal Gap: Is the Main Problem Generational Inequity?" ---
Click Here
Also see Paul Caron's blog from the NYU Law School on January 15, 2009 ---
Click Here
As we've documented the myriad ways
that Washington encouraged the housing bubble, the media and Democrats continue
to search for evidence to blame it all on "deregulation." One alleged
perpetrator, the
Gramm-Leach-Bliley Act, was released without charges after the record
revealed that Joe Biden voted for it and Bill Clinton signed it. More to the
point, investment banks were already free, prior to the 1999 law, to invest in
the same assets that have wreaked such havoc today.
Editors of The Wall Street Journal, October 18, 2008 ---
http://online.wsj.com/article/SB122428201410246019.html?mod=djemEditorialPage
Video Links (humor) forwarded by Jagdish Gangolly
The Long Johns - George Parr
http://www.youtube.com/watch?v=aKxVPrUIpBY
Credit Crunch
http://www.youtube.com/watch?v=DXJtnqXubK0&feature=related
subprime derivatives
http://www.youtube.com/watch?v=0YNyn1XGyWg&feature=related
From Vanderbilt University (you have to watch
this video to the ending to appreciate it)
A Keynote Speech by Leo Melamed ---
Click Here
http://www.owen.vanderbilt.edu/vanderbilt/About/owen-newsroom/owen-podcasts/podcasts/FIC-Melamed-keynote.html
Who is Leo Melamed? ---
http://en.wikipedia.org/wiki/Leo_Melamed
Bob Jensen's Primer on Derivatives ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Primer
A second paper in this series will examine the
theoretical justifications for the importance of the stock market as perhaps the
central financial institution in the United States.
"Who Needs the Stock Market? Part I: The Empirical
Evidence," by Lawrence E. Mitchell George Washington University - Law School,
SSRN, October 30, 2008 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1292403
Data on historical and current
corporate finance trends drawn from a variety of sources present a
paradox. External equity has never played a significant role in
financing industrial enterprises in the United States. The only American
industry that has relied heavily upon external financing is the finance
industry itself. Yet it is commonly accepted among legal scholars and
economists that the stock market plays a valuable role in American
economic life, and a recent, large body of macroeconomic work on
economic development links the growth of financial institutions
(including, in the U.S, the stock market) to growth in real economic
output. How can this be the case if external equity as represented by
the stock market plays an insignificant role in financing productivity?
This paradox has been largely ignored in the legal and economic
literature.
This paper surveys the history of
American corporate finance, presents original and secondary data
demonstrating the paradox, and raises questions regarding the structure
of American capital markets, the appropriate rights of stockholders, the
desirable regulatory structure (whether the stock market should be
regulated by the Securities and Exchange Commission or the Commodities
Futures Trading Commission, for example), and the overall relationship
between finance and growth.
The answers to these questions are
particularly pressing in light of a dramatic increase in stock market
volatility since the turn of the century creating distorted incentives
for long-term corporate management, especially trenchant in light of the
recent global financial collapse.
A second paper in this series will
examine the theoretical justifications for the importance of the stock
market as perhaps the central financial institution in the United
States.
"The Financial Crisis, From A-Z," by Tunku Varadarajan, Forbes,
November 10, 2008 ---
http://www.forbes.com/opinions/2008/11/09/financial-crisis-tarp-oped-cx_tv_1110varadarajan.html
Few forecast these (2008 economic meltdown)
events; although, in an outbreak of retrospective
foresight, an increasing number now claim they saw it coming. The reality is
that among all the banks, investors, academics and policy-makers, only a handful
were able to identify ahead of time the causes and potential scale of the
crisis. (The Handful were - Bill White, formerly of both the Bank of Canada and
the Bank for International Settlements; Harvard University’s Ken Rogoff; Nouriel
Roubini of New York University; Wynne Godley of Cambridge; and Bernard Connolly
of AIG Financial Products). I came across
this paper
by Caludio Borio of BIS.
Amol Agrawal, Mostly Economics Blog, December
19, 2008 ---
http://mostlyeconomics.wordpress.com/
Jensen Comment
Hindsight: This 2006 video makes fools out of
Ben Stein and Art Laffer and makes a hero out of Peter Schiff.
To this I might add Peter Schiff. Arthur Laffer's
preditions in 2006 predictions became a sick joke. Also you
Ben Stein
lovers may have second thoughts watching him proclaim, in 2006, that the
subprime problem is going to be a "tiny" problem.
Watch Peter Schiff
make fools out of
Art Laffer,
Ben Stein, and other finance “experts” in this video.
Watch Ben Stein recommend that you invest heavily in Merrill
Lynch before its shares tanked. Some of these popular media "experts" need to
spend more time studying and reading and less time broadcasting
poorly-researched advice to investors. Peter Schiff, on the other hand, does his
homework. This video is really revealing about the advice we get on television.
The video is available at the Financial Rounds Blog,
November 18 at
http://financeprofessorblog.blogspot.com/2008/11/peter-schiff-prophet-from-past.html
Update on the bet Art Laffer made with Peter Schiff ---
Listen to Laffer try to weasel out of paying up ---
http://www.youtube.com/watch?v=z3WjgKUf-kA
Introductory Comment
Henry Paulson knows his $700 billion (read that $1 trillion) bailout plan is not
going to save the banks that are now submerged in nearly-worthless mortgaged
investments. I think Jonathon Weil (see Appendix
G) hit the nail on the head as to why Paulson chose this particular
bailout proposal. Paulson is really buying time while leaders in Congress dine
on crow instead of lobster. Read this as meaning that Paulson is saving us from
runaway populism al Barney Frank and Chris Dodd. But Paulson cannot save the
banks that are truly submerged. Read the following in
Appendix G.
The plan goes like this: Treasury will pay
financial institutions above-market prices for garbage assets nobody else
wants. Then, through the magic of mark-to-Paulson accounting, everybody else
that owns similar stuff will use those same prices, or marks, to value the
trash on their own balance sheets.
Shazam! Banks and insurance companies write up the
asset values on their books. They post big profits. Their capital goes up.
Everyone gets fooled. And nobody knows the difference.
Except, we do. And that's why the plan
probably won't work.
Still, give Paulson and Federal Reserve Chairman
Ben Bernanke credit for ingenuity. At the same time banks are begging
regulators to suspend mark-to-market accounting rules so they can avoid
disclosing more losses, Paulson and Bernanke instead devise a way to abuse
the same rules for the same banks' benefit.
Jensen Comment
But most bankrupted banks will stay in business. Some will be bought out at
bargain basement prices by stronger banks. Some will simply have new owners.
The original owners (shareholders) will suck gas in either of these two
outcomes.
November 12, 2008 Update:
Paulson finally came to his senses and opted for direct investment in banks
via loans and equity rather than buying up all the junk mortgages owned by
troubled banks.
A more palatable approach would
be for the government to drive a Warren Buffett style hard bargain, in which,
rather than buying anything from banks, the government would invest in them in a
form, such as purchase of newly issued preferred stock, or bonds with a long
maturity, that would augment the banks' capital and thus enable banks to make
more loans. That would avoid conferring a windfall on the banks by overpaying
them for their bad securities; no one thinks Buffett is conferring a windfall on
Goldman Sachs. After the industry was back on its feet, the government could
sell the bank stocks or bonds that it had acquired.
Richard Posner, "The $700+ Billion Bailout," The Becker-Posner Blog,
September 28, 2008 ---
http://www.becker-posner-blog.com/
Finally, the "too big to fail"
approach to banks and other companies should be abandoned as new long-term
financial policies are developed. Such an approach is inconsistent with a free
market economy. It also has caused dubious company bailouts in the past, such as
the large government loan years ago to Chrysler, a company that remained weak
and should have been allowed to go into bankruptcy. All the American auto
companies are now asking for handouts too since they cannot compete against
Japanese, Korean, and German carmakers. They will probably get these subsidies,
even though these American companies have been badly managed. A "too many to
fail" principle, as in the present financial crisis, may still be necessary on
hopefully rare occasions, but failure of badly run big financial and other
companies is healthy and indeed necessary for the survival of a robust free
enterprise competitive system.
Nobel Laureate Gary Becker, "The $700+ Billion Bailout," The
Becker-Posner Blog, September 28, 2008 ---
http://www.becker-posner-blog.com/
What will happen to some of the banks that are submerged
in bad debts?
Hundreds of banks
will have three options if they are not transfused with bailout billions:
-
They can (or will be forced
to) close their doors. This will rarely happen except in the case of a few
remote banks among Sarah Palin’s constituency.
-
They will sell out at
bargain-basement prices to stronger banks. To date the largest (record
holder) of the banks infested with trash mortgage securities is the WaMu
system of banks that sold really cheap to JP Morgan. Wachovia may become a
new record breaker in this department. The badly injured parties in these
deals are shareholders that get wiped out, which translates in some respects
to wounded mutual funds and pension funds. CREF is so big and so diversified
that losses on Wachovia probably won’t be felt much in your eventual
retirement checks. You should worry more about what the $55+ trillion in the
Federal Government’s liabilities will do to your future ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
-
They can continue to
operate in bankruptcy and screw their shareholders and creditors. Then they
can get shareholders who will be buying into pretty good deals or they won’t
buy in to save the bankrupted banks.
Keep in mind
that none of the above outcomes will damage depositors unless they had
account balances above $100,000. Those depositors will be paid off when
Congress makes it $56+ trillion or more. See
Appendix A
Actually the best solution, in my opinion, is not bail the banks out with
billions. Read about the best options in the following article:
“Bridge Loan to Nowhere,” by Thomas Ferguson & Robert
Johnson, The Nation, September 22, 2008 ---
http://www.thenation.com/doc/20081006/ferguson_johnson
Everett Dirksen,
as Minority Senate Leader beginning in 1959, is most widely noted for a
quotation that he never made in these exact words: "A billion here, a billion
there, pretty soon, you're talking real money". What he really meant to say was
"A trillion here and a trillion there means you can't possibly be talking about
real money."
The National Debt
Clock ---
http://www.brillig.com/debt_clock/
At the above site it appears to be a fixed number.
But now hit your refresh button to see how much it's changed in just a few
seconds.
At 9:34 a.m. on September 23, 2008 it was $9,734,361,140,920.08 trillion
At 9:35 a.m. on September 23, 2008 it was $9,734,365,595,383.82 trillion
What was added in that minute was mostly added to pay the interest on the
National Debt.
The annual amount of interest per year on the above number at 6% is
$584,061,935,723.03 billion
This translates to well over a million dollars a minute,
most of which is funded by adding to the National Debt.
There's no real money
here since the U.S. Government never intends to pay off the National Debt,
not one farthing.
There's a greatly increased chance in 2008 that U.S. debt will receive a lowered
credit rating, which will greatly increase the cost of out national debt each
minute.
But the National
Debt is only the amount we have actually borrowed on notes because the U.S.
needed cash to pay current bills due. Every accountant knows that the unbooked
liabilities can be much, much larger because we've not yet needed to currently
borrow the money to pay bills that are coming in to us or our grandchildren in
the future.
Because U.S.
Government accounting is in such chaos (the GAO will not even sign off on its
annual audits of the Pentagon), nobody on earth really knows what our total
liabilities are. The former top accountant in the Federal government estimates
that the total is well in excess of $55+ trillion (present value discounted)
before the 2008 deficit is factored in.
See
Appendix A
for details.
It really doesn't matter since the present $55+ trillion U.S. Government
mortgage is really a problem passed on to our unborn grandchildren who, by 2050,
will be street beggars in Brazil, China, India, and Russia ---
http://faculty.trinity.edu/rjensen/entitlements.htm
Their report, "Dreaming with BRICs: The Path to
2050," predicted that within 40 years, the economies of Brazil, Russia,
India and China - the BRICs - would be larger than the US, Germany, Japan,
Britain, France and Italy combined. China would overtake the US as the
world's largest economy and India would be third, outpacing all other
industrialised nations.
"Out of the shadows," Sydney Morning Herald, February 5, 2005 ---
http://www.smh.com.au/text/articles/2005/02/04/1107476799248.html
In the end, Mr. Bush’s appearance
(address to the nation urging an added $700 billion to bailout the bankers)
was just another reminder of something that has been worrying us throughout this
crisis: the absence of any real national leadership, including on the campaign
trail. Given Mr. Bush’s shockingly weak performance, the only ones who could
provide that are the two men battling to succeed him. So far, neither John
McCain nor Barack Obama is offering that leadership. What makes it especially
frustrating is that this crisis should provide each man a chance to explain his
economic policies and offer a concrete solution to the current crisis.
Editorial, The New York Times,
September 25, 2008 ---
http://www.nytimes.com/2008/09/25/opinion/25thu1.html?_r=1&oref=slogin
"Pittsburgh Public Schools officials say they want to
give struggling children a chance, but the district is raising eyebrows with a
policy that sets 50 percent as the minimum score a student can receive for
assignments, tests and other work," reports the Pittsburgh Post-Gazette . . . Of
course, there's an obvious (better) solution
to this: Make the minimum score 100% instead of 50%. That ensures that
Pittsburgh students will have the highest grades in the country (as long as no
other school district learns the secret), and also that there will be no
awkwardness, since no one will know any math.
"Eyebrows raised over city school policy that sets 50% as minimum
score: 1+1=3? In city schools, it's half right," Pittsburgh Post-Gazette,
September 22, 2008 ---
http://www.post-gazette.com/pg/08266/914029-298.stm
Jensen Comment
Actually
the Pittsburgh schools learned about the 10% Rule in Texas and decided to one-up
the Lone Star State with a 50% Rule.
This gave
Hank Paulson
an idea. What if a homeowner made no payments on a sub-prime mortgage? Why not
give 50% minimum credit for each non-payment to lower the amount owed.? That way
the bailout recoveries won't look so bad since the government can thereby
receive half of what is owing to it with each bailed out mortgage. This will
appeal to Congress since there is public aversion to receiving zero on bailed
out mortgages. Yikes! I'm beginning to think like an accountant selling tax
shelters.
What did the top executives of the failed banks and AIG earn
receive in pay per year? ---
http://finance.yahoo.com/career-work/article/105862/What-the-Wall-Street-Titans-Earned
From the Financial Clippings Blog on October 22, 2008 ---
http://financeclippings.blogspot.com/
I
wrote earlier
that credit rating agencies seem to be run like protection rackets..
from
CNBC
In a hearing today before the House Oversight
Committee, the credit rating agencies are being portrayed as
profit-hungry institutions that would give any deal their blessing for
the right price.
Case in point: this instant message exchange between two unidentified
Standard & Poor's officials about a mortgage-backed security deal on
4/5/2007:
Official #1: Btw (by the way) that deal is ridiculous.
Official #2: I know right...model def (definitely) does not capture half
the risk.
Official #1: We should not be rating it.
Official #2: We rate every deal. It could be structured by cows and we
would rate it.
A former executive of Moody's says
conflicts of interest got in the way of rating agencies properly valuing
mortgage backed securities.
Former Managing Director Jerome Fons, who worked at Moody's until August
of 2007, says Moody's was focused on "maxmizing revenues," leading it to
make the firm more "issuer friendly."
The three firms that dominate the $5 billion-a-year
credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch
Ratings - have been faulted for failing to identify risks in subprime mortgage
investments, whose collapse helped set off the global financial crisis. The
rating agencies had to downgrade thousands of securities backed by mortgages as
home-loan delinquencies have soared and the value of those investments
plummeted. The downgrades have contributed to hundreds of billions in losses and
writedowns at major banks and investment firms. The agencies are crucial
financial gatekeepers, issuing ratings on the creditworthiness of public
companies and securities. Their grades can be key factors in determining a
company's ability to raise or borrow money, and at what cost which securities
will be purchased by banks, mutual funds, state pension funds or local
governments. A yearlong review by the SEC, which issued the results last summer,
found that the three big (credit rating) agencies failed to rein in conflicts of
interest in giving high ratings to risky securities backed by subprime
mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November
19, 2008 ---
http://accounting.smartpros.com/x63855.xml
Jensen Comment
It’s beginning to look like Wall Street is rearing up once again to prevent the
SEC from imposing reforms on credit rating agencies. In spite of the crisis, it
will once again be business as usual with the credit rating agencies having
conflicts of interest not in the interest of investors.
Bob Jensen's threads on historic abuses by credit rating agencies are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
"Economists Urge Congress Not to Rush on Rescue Plan," by Matthew
Benjamin, Bloomberg, September 26, 2008 ---
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aNhbZSQz2Vws
More than 150 U.S. economists, including three
Nobel Prize winners, urged Congress to hold off on passing a $700 billion
financial market rescue plan until it can be studied more closely.
In a Sept. 24 letter to Congressional leaders, 166
academic economists said they oppose Treasury Secretary Henry Paulson's plan
because it's a ``subsidy'' for business, it's ambiguous and it may have
adverse market consequences in the long term. They also expressed alarm at
the haste of lawmakers and the Bush administration to pass legislation.
``It doesn't seem to me that a lot decisions that
we're going to have to live with for a long time have to be made by
Friday,'' said Robert Lucas, a University of Chicago economist and 1995
Nobel Prize winner who signed the letter. ``The situation may get urgent,
but it's not urgent right now. Right now it's a financial sector problem.''
The economists who signed the letter represent
various disciplines, including macroeconomics, microeconomics, behavioral
and information economics, and game theory. They also span the political
spectrum, from liberal to conservative to libertarian.
Continued in article
Also see Senator Jim Bunning's incredible Senate Floor speech on September
26, 2008 ---
Click Here
And see a Nobel Economist's (Stiglitz) very negative response to the bailout
plan ---
http://www.thenation.com/doc/20081013/stiglitz
The United States is almost back in the credit
pyramid
scheme!
The mechanics of Hank Paulson's bailout plan for bankers ---
http://www.redstate.com/diaries/blackhedd/2008/oct/04/the-mechanics-of-the-paulson-rescue-plan/
On October 3, 2005 Bush signed the $700 billion bankers' bailout bill, with half the money subject to a
Congressional veto, Congressional aides said. Under the plan, the Treasury
secretary receives $250 billion immediately and could have an additional $100
billion if he certifies it is also needed. What do you think the chances are
that he’ll eventually say: “Nah, that first $250 billion is more than enough?”
Treasury Secretary Henry Paulson came up with a
cockamamie bailout that he claimed would end up making money for the US
Treasury. However, backroom Democrats connived to siphon off any repayment of
the people’s money back to the treasury by adding one small inocuous line to the
agreement----a line that would end up stealing money from any repayments and
giving it to left-wing political advocacy groups like
ACORN, the National Urban
League and the Hispanic atrocity---La Raza. Instead of trying to help the
economy, the Democrats want to loot taxpayers for their left-wing political
constituents. It’s business as usual for the Democrats.
Free Republic, September 27, 2008
---
http://www.freerepublic.com/focus/f-news/2091697/posts
Here's some more about ACORN ---
http://www.rottenacorn.com/index.html
They Don't Fall Far From the Tree ---
http://www.thetimesonline.com/articles/2008/10/04/columnists/mark_kiesling/doc1a3a97a75d06708b862574d70007769d.txt
What if you were buying an albino horse for your kid that had a Bush Stables
sticker price of $7,000? You offer $2,500 plus another $1,000 if Hi Ho Silver
lasts for more than a month.
Instantly the Masked Man whips out the contract and says “sign here." He
hurriedly scoops up the $2,500 and races out the door while the heavens are
playing the William Tell Overture ---
http://hk.youtube.com/watch?v=krKTMKnTGsE
With such an eager
horse trader aren’t you the least bit suspicious about that original $700
billion sticker price?
Of course there is that added $350 billion kicker that Congress might
additionally offer if and only if the first $350 billion is doing such a good
job. I think we should spend another $350 billion only if the first $350 billion
is doing a rotten job keeping us out a deep economic depression.
Sarah Palin was utterly naive when becoming a vice presidential candidate.
She believed that meaningful Congressional reforms were actually possible. She
did not truly understand how House Speaker Pelosi controls Congressional voting
by doling out
earmarked corruption and, now, bailout corruption. An even worse problem
with Palin is that, yikes, she wants to balance the Federal Budget. I mean how
naive can can the a hockey mom be?
In reality the added $350 billion option is for any remaining bad car and
motorcycle loans held by local banks, some
pork for
Byrd’s nests in West
Virginia, and millions of new seeds for Barney Frank's
Acorn farm. To avoid a
Congressional veto, Nancy Pelosi gets a new Airbus to fly
nonstop back and forth to San Francisco for the next eight years, and Sarah Palin gets a saddle for a snow goose on her return flight to Alaska. Because she
has such large glasses, there’s no need for a goggles in Palin’s courtesy
appropriation.
This time of year it’s growing very cold when riding a snow goose near the
arctic. There’s a good possibility that Pelosi will instead drop Palin off in
Fairbanks if the hockey mom political reformer promises to never leave Alaska henceforth and
forevermore. At this point Pelosi’s offer looks like the best option available
to Gov. Palin. Alaska’s Governor might even bag a moose or two while the Airbus
is on its landing approach. There's precedent here. Nancy Pelosi booted reformer
Jeff Flake
of the House Judiciary Committee because he's repeatedly tried to end earmark
fraud in Congress. Sorry Jeff! No free ride for lowlifes on the Speaker's
Airbus.
But why should we worry? The two presidential candidates are offering tax
reductions rather than increases, so even if the ultimate cost of the bailout is
$5 trillion that’s just a trifle in annual interest to add to the million+
dollars a minute taxpayers are already paying in interest on the present
National Debt. It’s a relief now that Bank America will get a bailout
appropriation of $200 billion to cover the fraud losses on its wholly owned
Subsidiary, Countrywide Financial. Countrywide can once again offer you a sweet
sub-prime mortgage and extend your credit card limit to $5 million. The United
States is back in the credit
pyramid
business.
This trillion dollar (probably) bailout proposal before
Congress is beginning to smell
like the bottom of a lobster boat. The trouble is that both Democrats and
Republicans love to dine on lobster dinners paid for by their lobbyist friends.
Maybe the lobster analogy is even better than I thought since the Men in
Black (bankers) are now trying to get their claws into us on the way down --- sort of like
getting clawed by a big one before you can dump him in the pot.
I’m told that
bankers are now furiously combing the books to find out how many defaulted car
loans then can sell to the government.
But my hunch is that, in
relative proportions, the amount of the National Debt held by the Men in
Black on Wall Street is negligible. The Men in Black were heavy
speculators seeking higher commissions and higher returns that is paid out
on our National Debt.
Bankers (Men in Black)
bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby.
Council on Foreign Relations, as quoted by Avital Louria Hahn,
"Missing: How Poor Risk-Management Techniques Contributed to
the Subprime Mess," CFO
Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Jensen Comment
Now that the Government is going to bail out these speculators with
taxpayer funds makes it all the worse. I received an email
message claiming that if you had purchased $1,000 of AIG
stock one year ago, you would have $42 left; with Lehman, you
would have $6.60 left; with Fannie or Freddie, you would have
less than $5 left. But if you had purchased $1,000 worth of beer
one year ago, drank all of the beer, then turned in the cans for
the aluminum recycling REFUND, you would have had $214. Based on
the above, the best current investment advice is to drink
heavily and recycle. It's called the 401-Keg. Why let others
gamble your money away when you can piss it away on your own? |
Causes of the Bubble
Video
Looking back at the events leading up to the 2008 crisis by Michael Burry
Vanderbilt University Chancellor's Lecture
April 5, 2011
Thank you Jim Mahar for the heads up
http://financeprofessorblog.blogspot.com/2011/04/video-looking-back-at-events-leading-up.html
Jensen Comment
Michael Burry is the physician who anticipated the subprime scandal and made a
fortune on short positions.
PwC's Appeal to Upgrade the Shameful Valuation Profession Smitten With
Non-independence and Unreliability
Jensen Comment
Tom Selling repeatedly assumes there is a valuation profession of men and women
in white robes and gold halos who can be called upon to reliably and
independently valuate such things as troubled loan investments having no deep
markets. Bob Jensen argues that the valuation profession is one of the
least-independent and least-reliable professions in the world, especially in the
USA as evidenced in part by the shameful valuations of mortgage collateral on
tens of millions of properties, thereby enabling subprime mortgages that never
should have been granted in the first place. Furthermore credit rating agencies
that value securities participated wildly in overvaluing poisoned CDO bonds that
brought down some of the big investment banks of Wall Street like Bear Sterns,
Merrill Lynch, and Lehman Bros.
In the article below, PwC calls the valuation profession shameful and calls
for major upgrades that, while falling short of issuing white robes with gold
halos, would go a long way toward improving a rotten profession.
"PwC Calls for New Approach to Valuations," by Tammy Whitehouse,
Compliance Week, November 26, 2013 ---
http://www.complianceweek.com/pwc-calls-for-new-approach-to-valuations/article/322671/
The largely unregulated valuation profession could
use a shake-up, in the view of some who rely on valuations to achieve
regulatory compliance.
PwC recently published two white papers calling on
the valuation profession to up their game in terms of unifying themselves
under a single professional framework and improving their standards. The
financial reporting world needs greater quality and consistency, the Big 4
firms says, as financial reporting grows increasingly reliant on valuations
to help prepare and audit financial statements steeped in fair value
measurements. One paper focuses on the need for the valuation profession to
unify itself under a single professional infrastructure, while the other
addresses the need for better valuation standards.
The message is consistent with one delivered
earlier by Paul Beswick, now chief accountant at the Securities and Exchange
Commission. “The fragmented nature of the profession creates an environment
where expectation gaps can exist between valuators, management, and
auditors, as well as standard setters and regulators,” he said at a 2011
accounting conference. The SEC and the Public Company Accounting Oversight
Board both have called on preparers and auditors to pay closer attention to
the valuations they are relying on and not simply accept them at face value.
“Historically, the valuation profession hasn't been
front and center in capital markets,” says John Glynn, U.S. valuation
services leader for PwC. “The accounting model didn't have as many pieces
measured at fair value as we have today. Some of the questions about the
professional infrastructure that didn't matter previously have become more
apparent.”
The valuation profession is governed by a number of
different professional organizations, PwC says, each with different
credentialing and membership requirements and none of them specific to the
needs of capital markets. “To maintain its professional standing in an
increasingly rigorous environment and promote greater confidence in its
work, the valuation profession needs to address questions about the quality,
consistency, and reliability of its valuations, particularly those performed
for financial reporting purposes,” PwC writes. “A key element to
successfully addressing such questions is having a leading global standard
setter that issues technical valuation standards governing the performance
of valuations for financial reporting purposes.”
The answer is not necessarily a new regulatory
channel, says Glynn. “We need to give the valuation profession a way to
build a self-regulatory mechanism,” he says. “One or or more of the
professional organizations need to agree to build something that is focused
on building a high-quality infrastructure to support the valuation
professionals that are working in public capital markets, particularly
around financial reporting.” That should include education requirements,
accreditations, certifications, as well as professional standards and
performance standards developed under a robust system of due process, he
says. The International Valuations Standards Council is showing potential to
become a leader in driving the profession to a unified, global valuation
approach, Glynn says.
"Ex-IndyMac Executives Found Liable for
Negligent Loans," by Edvard Pettersson, Bloomberg News, December 8,
2012 ---
http://www.bloomberg.com/news/2012-12-08/indymac-executives-found-liable-for-negligent-loans.html
Three former IndyMac Bancorp Inc. executives must
pay $169 million in damages to federal regulators for making negligent loans
to homebuilders as the real estate market was deteriorating, a jury decided.
The federal court jury in Los Angeles issued the
verdict against Scott Van Dellen, the former chief executive officer of
IndyMac’s Homebuilder Division; Richard Koon, the unit’s former chief
lending officer; and Kenneth Shellem, the former chief credit officer.
Jurors yesterday found them liable for negligence and breach of fiduciary
duty.
The jury awarded the damages to the Federal Deposit
Insurance Corp., which brought the lawsuit in 2010.
The FDIC, which took over the failed subprime
mortgage lender in 2008, alleged the men caused $500 million in losses at
the homebuilders unit by continuing to push for growth in loan production
without regard for credit quality and despite being aware a downturn in the
real estate market was imminent.
The agency said the executives made loans to
homebuilders that weren’t creditworthy or didn’t provide sufficient
collateral.
“Today’s verdict is the result of a deliberate
effort by the government to scapegoat a few men for the impact that the
unforeseen and unprecedented housing collapse in 2007 had at IndyMac,” Kirby
Behre, a lawyer for Shellem and Koon, said in an e-mailed statement after
yesterday’s verdict.
“Mr. Shellem and Mr. Koon used the utmost care in
making loan decisions, and there is no doubt that all of the loans at issue
would have been repaid except for the housing crash,” Behre said.
Robert Corbin, a lawyer for Van Dellen, didn’t
immediately return a call to his office yesterday after regular business
hours seeking comment on the verdict.
The verdict was reported earlier by the Los Angeles
Daily Journal.
The case is FDIC v. Van Dellen, 10-04915, U.S.
District Court, Central District of California (Los Angeles).
To read about the sleaze go to
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
"Understanding the Great Recession," by Lawrence J. Christiano, Martin
Eichenbaum, and Mathias Trabandt, SSRN, April 2, 2014 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2474797
Abstract:
We argue that the vast bulk of movements in
aggregate real economic activity during the Great Recession were due to
financial frictions interacting with the zero lower bound. We reach this
conclusion looking through the lens of a New Keynesian model in which
firms face moderate degrees of price rigidities and no nominal
rigidities in the wage setting process. Our model does a good job of
accounting for the joint
behavior of labor and goods markets, as well as inflation, during the
Great Recession. According to the model the observed fall in total
factor productivity and the rise in the cost of working capital played
critical roles in accounting
for the small size of the drop in inflation that occurred during the
Great Recession.
An Excellent Presentation on the Flaws of Finance, Particularly the Flaws
of Financial Theorists
A recent topic on the AECM listserv concerns the limitations of accounting
standard setters and researchers when it comes to understanding investors. One
point that was not raised in the thread to date is that a lot can be learned
about investors from the top financial analysts of the world --- their writings
and their conferences.
A Plenary Session Speech at a Chartered Financial Analysts Conference
Video: James Montier’s 2012 Chicago CFA Speech The
Flaws of Finance ---
http://cfapodcast.smartpros.com/web/live_events/Annual/Montier/index.html
Note that it takes over 15 minutes before James Montier begins
Major Themes
- The difference between physics versus finance models is that physicists
know the limitations of their models.
- Another difference is that components (e.g., atoms) of a physics model
are not trying to game the system.
- The more complicated the model in finance the more the analyst is trying
to substitute theory for experience.
- There's a lot wrong with Value at Risk (VaR) models that regulators
ignored.
- The assumption of market efficiency among regulators (such as Alan
Greenspan) was a huge mistake that led to excessively low interest rates and
bad behavior by banks and credit rating agencies.
- Auditors succumbed to self-serving biases of favoring their clients over
public investors.
- Banks were making huge gambles on other peoples' money.
- Investors themselves ignored risk such as poisoned CDO risks when they
should've known better. I love his analogy of black swans on a turkey farm.
- Why don't we see surprises coming (five
excellent reasons given here)?
- The only group of people who view the world realistically are the
clinically depressed.
- Model builders should stop substituting
elegance for reality.
- All financial theorists should be forced to
interact with practitioners.
- Practitioners need to abandon the myth of optimality before the fact.
Jensen Note
This also applies to abandoning the myth that we can set optimal accounting
standards.
- In the long term fundamentals matter.
- Don't get too bogged down in details at the expense of the big picture.
- Max Plank said science advances one funeral at a time.
- The speaker then entertains questions from the audience (some are very
good).
James Montier is a very good speaker from England!
Mr. Montier is a member of GMO’s asset allocation
team. Prior to joining GMO in 2009, he was co-head of Global Strategy at
Société Générale. Mr. Montier is the author of several books including
Behavioural Investing: A Practitioner’s Guide to Applying Behavioural
Finance; Value Investing: Tools and Techniques for Intelligent Investment;
and The Little Book of Behavioural Investing. Mr. Montier is a visiting
fellow at the University of Durham and a fellow of the Royal Society of
Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc.
in Economics from Warwick University
http://www.gmo.com/america/about/people/_departments/assetallocation.htm
There's a lot of useful information in this talk for accountics scientists.
Bob Jensen's threads on what went wrong with accountics research are at
http://faculty.trinity.edu/rjensen/theory01.htm#WhatWentWrong
Darrell Duffie: Big Risks Remain In the Financial System
A Stanford theoretician of financial risk looks at how to fix the "pipes and
valves" of modern finance
Stanford Graduate School of Business, May 2013
Click Here
http://www.gsb.stanford.edu/news/headlines/darrell-duffie-big-risks-remain-financial-system?utm_source=Stanford+Business+Re%3AThink&utm_campaign=edfd4f11fb-Stanford_Business_Re_Think_Issue_Thirteen5_17_2013&utm_medium=email&utm_term=0_0b5214e34b-edfd4f11fb-70265733&ct=t%28Stanford_Business_Re_Think_Issue_Thirteen5_17_2013%29
. . .
In March, Duffie and the Squam Lake Group proposed
a dramatic new restriction on executive pay at “systemically important”
financial institutions. Duffie argues that top bank executives still have
lopsided incentives to take excessive risks. The proposal: Force them to
defer 20 percent of their pay for five years, and to forfeit that money
entirely if the bank’s capital sinks to unspecified but worrisome levels
before the five years is up.
“On most issues,” Duffie said, “the banks would be
glad to see me go away.”
Jensen Comment
Squam Lake and its 30 islands is in the Lakes Region of New Hampshire ---
http://en.wikipedia.org/wiki/Squam_Lake
It is better known as "Golden Pond" after Jane Fonda, her father (Henry) and
Katherine Hepburn appeared in the Academy Award winning movie called "On
Golden Pond" that was filmed on Squam Lake. Professor Duffie now has some
"golden ideas" for finance reforms.
"Woman Who Couldn’t Be Intimidated by Citigroup Wins $31 Million," by
Bob Ivry, Bloomberg News, May 31, 2012 ---
file:///C:/Documents and Settings/rjensen/My Documents/My Web Sites/images
Sherry Hunt never expected to be a senior manager
at a Wall Street bank. She was a country girl, raised in rural Michigan by a
dad who taught her to fish and a mom who showed her how to find wild
mushrooms. She listened to Marty Robbins and Buck Owens on the radio and
came to believe that God has a bigger plan, that everything happens for a
reason.
She got married at 16 and didn’t go to college.
After she had her first child at 17, she needed a job. A friend helped her
find one in 1975, processing home loans at a small bank in Alaska. Over the
next 30 years, Hunt moved up the ladder to mortgage-banking positions in
Indiana, Minnesota and Missouri, Bloomberg Markets magazine reports in its
July issue.
On her days off, when she wasn’t fishing with her
husband, Jonathan, she rode her horse, Cody, in Wild West shows. She
sometimes dressed up as the legendary cowgirl Annie Oakley, firing blanks
from a vintage rifle to entertain an audience. She liked the mortgage
business, liked that she was helping people buy houses.
In November 2004, Hunt, now 55, joined
Citigroup (C) Inc. as a vice president in the
mortgage unit. It looked like a great career move. The housing market was
booming, and the New York- based bank, the
sixth-largest lender in the U.S. at the time, was responsible for 3.5
percent of all home loans. Hunt supervised 65 mortgage underwriters at
CitiMortgage Inc.’s sprawling headquarters in O’Fallon, Missouri, 45 minutes
west of St. Louis.
Avoiding Fraud
Hunt’s team was responsible for protecting
Citigroup from fraud and bad investments. She and her colleagues inspected
loans Citi wanted to buy from outside brokers and lenders to see whether
they met the bank’s standards. The mortgages had to have properly signed
paperwork, verifiable borrower income and realistic appraisals.
Citi would vouch for the quality of these loans
when it sold them to investors or approved them for government mortgage
insurance.
Investor demand was so strong for mortgages
packaged into securities that Citigroup couldn’t process them fast enough.
The Citi stamp of approval told investors that the bank would stand behind
the mortgages if borrowers quit paying.
At the mortgage-processing factory in O’Fallon,
Hunt was working on an assembly line that helped inflate a housing bubble
whose implosion would shake the world. The O’Fallon mortgage machinery was
moving too fast to check every loan, Hunt says.
Phony Appraisals
By 2006, the bank was buying mortgages from outside
lenders with doctored tax forms, phony appraisals and missing signatures,
she says. It was Hunt’s job to identify these defects, and she did, in
regular reports to her bosses.
Executives buried her findings, Hunt says, before,
during and after the financial crisis, and even into 2012.
In March 2011, more than two years after Citigroup
took $45 billion in bailouts from the U.S. government and
billions more from the
Federal Reserve -- more in total than any other
U.S. bank -- Jeffery Polkinghorne, an O’Fallon
executive in charge of loan quality, asked Hunt and a colleague to stay in a
conference room after a meeting.
The encounter with Polkinghorne was brief and
tense, Hunt says. The number of loans classified as defective would have to
fall, he told them, or it would be “your asses on the line.”
Hunt says it was clear what Polkinghorne was asking
-- and she wanted no part of it.
‘I Wouldn’t Play Along’
“All a dishonest person had to do was change the
reports to make things look better than they were,” Hunt says. “I wouldn’t
play along.”
Instead, she took her employer to court -- and won.
In August 2011, five months after the meeting with Polkinghorne, Hunt sued
Citigroup in Manhattan federal court, accusing its home-loan division of
systematically violating U.S. mortgage regulations.
The U.S.
Justice Department decided to join her suit in
January. Citigroup didn’t dispute any of Hunt’s facts; it didn’t mount a
defense in public or in court. On Feb. 15, 2012, the bank agreed to pay
$158.3 million to the U.S. government to settle the case.
Citigroup admitted approving loans for government
insurance that didn’t qualify under Federal Housing Administration rules.
Prosecutors kept open the possibility of bringing criminal charges, without
specifying targets.
‘Pure Myth’
Citigroup behaving badly as late as 2012 shows how
a big bank hasn’t yet absorbed the lessons of the credit crisis despite
billions of dollars in bailouts, says
Neil Barofsky, former special inspector general of
the Troubled Asset Relief Program.
“This case demonstrates that the notion that the
bailed-out banks have somehow found God and have reformed their ways in the
aftermath of the financial crisis is pure myth,” he says.
As a reward for blowing the whistle on her
employer, Hunt, the country girl turned banker, got $31 million out of the
settlement paid by Citigroup.
Hunt still remembers her first impressions of
CitiMortgage’s O’Fallon headquarters, a complex of three concrete-and-glass
buildings surrounded by manicured lawns and vast parking lots. Inside are
endless rows of cubicles where 3,800 employees trade e-mails and conduct
conference calls. Hunt says at first she felt like a mouse in a maze.
“You only see people’s faces when someone brings in
doughnuts and the smell gets them peeking over the tops of their cubicles,”
she says.
Jean Charities
Over time, she came to appreciate the camaraderie.
Every month, workers conducted the so-called Jean Charities. Employees
contributed $20 for the privilege of wearing jeans every day, with the money
going to local nonprofit organizations. With so many workers, it added up to
$25,000 a month.
“Citi is full of wonderful people, conscientious
people,” Hunt says.
Those people worked on different teams to process
mortgages, all of them focused on keeping home loans moving through the
system. One team bought loans from brokers and other lenders. Another team,
called underwriters, made sure loan paperwork was complete and the mortgages
met the bank’s and the government’s guidelines.
Yet another group did spot-checks on loans already
purchased. It was such a high-volume business that one group’s assignment
was simply to keep loans moving on the assembly line.
Powerful Incentive
Still another unit sold loans to
Fannie Mae,
Freddie Mac and Ginnie Mae, the
government-controlled companies that bundled them into securities for sale
to investors. Those were the types of securities that blew up in 2007,
igniting a global financial crisis.
Workers had a powerful incentive to push mortgages
through the process even if flaws were found: compensation. The pay of
CitiMortgage employees all the way up to the division’s chief executive
officer depended on a high percentage of approved loans, the government’s
complaint says.
By 2006, Hunt’s team was processing $50 billion in
loans that Citi-Mortgage bought from hundreds of mortgage companies. Because
her unit couldn’t possibly review them all, they checked a sample.
When a mortgage wasn’t up to federal standards --
which could be any error ranging from an unsigned document to a false income
statement or a hyped-up appraisal -- her team labeled the loan as defective.
Missing Documentation
In late 2007, Hunt’s group estimated that about 60
percent of the mortgages Citigroup was buying and selling were missing some
form of documentation. Hunt says she took her concerns to her boss, Richard
Bowen III.
Bowen, 64, is a religious man, a former Air Force
Reserve Officer Training Corps cadet at Texas Tech University in Lubbock
with an attention to detail that befits his background as a certified public
accountant. When he saw the magnitude of the mortgage defects, Bowen says he
prayed for guidance.
In a Nov. 3, 2007,
e-mail, he alerted Citigroup executives, including
Robert Rubin, then chairman of Citigroup’s
executive committee and a former
Treasury secretary; Chief Financial Officer
Gary Crittenden; the bank’s senior risk officer;
and its chief auditor.
Bowen put the words “URGENT -- READ IMMEDIATELY --
FINANCIAL ISSUES” in the subject line.
“The reason for this urgent e-mail concerns
breakdowns of internal controls and resulting significant but possibly
unrecognized financial losses existing within our organization,” Bowen
wrote. “We continue to be significantly out of compliance.”
No Change
There were no noticeable changes in the mortgage
machinery as a result of
Bowen’s warning, Hunt says.
Just a week after Bowen sent his e-mail, Sherry and
Jonathan were driving their Toyota Camry about 55 miles (89 kilometers) per
hour on four-lane Providence Road in Columbia,
Missouri, when a
driver in a Honda Civic hit them head-on. Sherry broke a foot and her
sternum. Jonathan broke an arm and his sternum.
Doctors used four bones harvested from a cadaver
and titanium screws to stabilize his neck.
“You come out of an experience like that with a
commitment to making the most of the time you have and making the world a
better place,” Sherry says.
Three months after the accident, attorneys from
Paul, Weiss, Rifkind, Wharton & Garrison LLP, a
New York law firm representing Citigroup, interviewed Hunt. She had no idea
at the time that it was related to Bowen’s complaint, she says.
Home Computer
The lawyers’ questions made her search her memory
for details of loans and conversations with colleagues, she says. She
decided to take notes from that time forward on a spreadsheet she kept on
her home computer.
Bowen’s e-mail is now part of the archive of the
Financial Crisis Inquiry Commission, a panel created by Congress in 2009.
Citigroup’s
response to the
commission, FCIC records show, came from
Brad Karp, chairman of
Paul Weiss.
He said Citigroup had reviewed Bowen’s issues,
fired a supervisor and changed its underwriting system, without providing
specifics.
Continued in article
A CBS Sixty Minutes Blockbuster (December 4, 2011)
"Prosecuting Wall Street"
Free download for a short while
http://www.cbsnews.com/8301-18560_162-57336042/prosecuting-wall-street/?tag=pop;stories
Note that this episode features my hero Frank Partnoy
Key provisions of Sarbox with respect to the Sixty Minutes revelations:
The act also covers issues such as
auditor independence,
corporate governance,
internal control assessment, and enhanced financial disclosure.
Sarbanes–Oxley Section 404: Assessment of internal control ---
http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Sarbanes.E2.80.93Oxley_Section_404:_Assessment_of_internal_control
Both the corporate CEO and the external auditing firm are to
explicitly sign off on the following and are subject (turns out to be a
ha, ha joke) to huge fines and jail time for egregious failure to do
so:
- Assess both the design and operating
effectiveness of selected internal controls related to significant
accounts and relevant assertions, in the context of material
misstatement risks;
- Understand the flow of transactions,
including IT aspects, in sufficient detail to identify points at
which a misstatement could arise;
- Evaluate company-level (entity-level)
controls, which correspond to the components of the
COSO framework;
- Perform a fraud risk assessment;
- Evaluate controls designed to
prevent or detect fraud, including management override of
controls;
- Evaluate controls over the period-end
financial
reporting process;
- Scale the assessment based on the size and
complexity of the company;
- Rely on management's work based on factors
such as competency, objectivity, and risk;
- Conclude on the adequacy of internal
control over financial reporting.
Most importantly as far as the CPA auditing firms are concerned is
that Sarbox gave those firms both a responsibility to verify that
internal controls were effective and the authority to charge more
(possibly twice as much) for each audit. Whereas in the 1990s auditing
was becoming less and less profitable, Sarbox made the auditing industry
quite prosperous after 2002.
There's a great gap between the theory of Sarbox and its enforcement
In theory, the U.S. Justice Department (including the FBI) is to enforce
the provisions of Section 404 and subject top corporate executives and audit
firm partners to huge fines (personal fines beyond corporate fines) and jail
time for signing off on Section 404 provisions that they know to be false.
But to date, there has not been one indictment in enormous frauds where the
Justice Department knows that executives signed off on Section 404 with
intentional lies.
In theory the SEC is to also enforce Section 404, but the SEC in Frank
Partnoy's words is toothless. The SEC cannot send anybody to jail. And the
SEC has established what seems to be a policy of fining white collar
criminals less than 20% of the haul, thereby making white collar crime
profitable even if you get caught. Thus, white collar criminals willingly
pay their SEC fines and ride off into the sunset with a life of luxury
awaiting.
And thus we come to the December 4 Sixty Minutes module that features
two of the most egregious failures to enforce Section 404:
The astonishing case of CitiBank
The astonishing case of Countrywide (now part of Bank of America)
The Astonishing Case of CitiBank
What makes the Sixty Minutes show most interesting are the whistle
blowing revelations by a former Citi Vice President in Charge of Fraud
Investigations
- What has to make the CitiBank revelations the most embarrassing
revelations on the Sixty Minutes blockbuster emphasis that top
CItiBank executives were not only informed by a Vice President in Charge of
Fraud Investigation of huge internal control inadequacies, the outside U.S.
government top accountant, the U.S. Comptroller General, sent an official
letter to CitiBank executives notifying them of their Section 404 internal
control failures.
- Eight days after receiving the official warning from the government, the
CEO of CitiBank flipped his middle finger at the U.S. Comptroller General
and signed off on Section 404 provisions that he'd also been informed by his
Vice President of Fraud and his Internal Auditing Department were being
violated.
http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html
- What the Sixty Minutes show failed to mention is that the
external auditing firm of KPMG also flipped a bird at the U.S. Comptroller
General and signed off on the adequacy of its client's internal controls.
- A few months thereafter CitiBank begged for and got hundreds of billions
in bailout money from the U.S. Government to say afloat.
- The implication is that CitiBank and the other Wall Street corporations
are just to0 big to prosecute by the Justice Department. The Justice
Department official interviewed on the Sixty Minutes show sounded
like hollow brass wimpy taking hands off orders from higher authorities in
the Justice Department.
- The SEC worked out a settlement with CitiBank, but the fine is such a
joke that the judge in the case has to date refused to accept the
settlement. This is so typical of SEC hand slapping settlements --- and the
hand slaps are with a feather.
The astonishing case of Countrywide (now part of Bank of America)
- Countrywide Financial before 2007 was the largest issuer of mortgages on
Main Streets throughout the nation and by estimates of one of its own
whistle blowing executives in charge of internal fraud investigations over
60% of those mortgages were fraudulent.
- After Bank of America purchased the bankrupt Countrywide, BofA top
executives tried to buy off the Countrywide executive in charge of fraud
investigations to keep him from testifying. When he refused BofA fired him.
- Whereas the Justice Department has not even attempted to indict
Countrywide executives and the Countrywide auditing firm of Grant Thornton
(later replaced by KPMG) to bring indictments for Section 404 violations,
the FTC did work out an absurdly low settlement of $108 million for 450,000
borrowers paying "excessive fees" and the attorneys for those borrowers ---
http://www.nytimes.com/2011/07/21/business/countrywide-to-pay-borrowers-108-million-in-settlement.html
This had nothing to do with the massive mortgage frauds committed by
Countrywide.
- Former Countrywide CEO Angelo Mozilo settled the SEC’s Largest-Ever
Financial Penalty ($22.5 million) Against a Public Company's Senior
Executive
http://sec.gov/news/press/2010/2010-197.htm
The CBS Sixty Minutes show estimated that this is less than 20% of what he
stole and leaves us with the impression that Mozilo deserves jail time but
will probably never be charged by the Justice Department.
I was disappointed in the CBS Sixty Minutes show in that it completely
ignored the complicity of the auditing firms to sign off on the Section 404
violations of the big Wall Street banks and other huge banks that failed.
Washington Mutual was the largest bank in the world to ever go bankrupt. Its
auditor, Deloitte, settled with the SEC for Washington Mutual for
$18.5 million. This isn't even a hand slap relative to the billions lost by
WaMu's investors and creditors.
No jail time is expected for any partners of the negligent auditing firms.
.KPMG settled for peanuts with Countrywide for
$24 million of negligence and New Century for
$45 million of negligence costing investors billions.
"Citigroup Finds Obeying the
Law Is Too Darn Hard: Jonathan Weil," by Jonothan Weil, Bloomberg
News, November 2 , 2011 ---
http://www.bloomberg.com/news/2011-11-02/citigroup-finds-obeying-the-law-is-too-darn-hard-jonathan-weil.html
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on how white collar crime pays even if you get caught
---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
"Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank
Partnoy, New York Review of Books, November 10, 2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
Thank you Robert Walker for the heads up!
"Wall Street's Gullible Occupiers The protesters have been sold a bill of
goods. Reckless government policies, not private greed, brought about the
housing bubble and resulting financial crisis," by Peter J. Wallison, The
Wall Street Journal, October 12, 2011 ---
http://online.wsj.com/article/SB10001424052970203633104576623083437396142.html?mod=djemEditorialPage_t
There is no mystery where the Occupy Wall Street
movement came from: It is an offspring of the same false narrative about the
causes of the financial crisis that exculpated the government and brought us
the Dodd-Frank Act. According to this story, the financial crisis and
ensuing deep recession was caused by a reckless private sector driven by
greed and insufficiently regulated. It is no wonder that people who hear
this tale repeated endlessly in the media turn on Wall Street to express
their frustration with the current conditions in the economy.
Their anger should be directed at those who
developed and supported the federal government's housing policies that were
responsible for the financial crisis.
Beginning in 1992, the government required Fannie
Mae and Freddie Mac to direct a substantial portion of their mortgage
financing to borrowers who were at or below the median income in their
communities. The original legislative quota was 30%. But the Department of
Housing and Urban Development was given authority to adjust it, and through
the Bill Clinton and George W. Bush administrations HUD raised the quota to
50% by 2000 and 55% by 2007.
It is certainly possible to find prime borrowers
among people with incomes below the median. But when more than half of the
mortgages Fannie and Freddie were required to buy were required to have that
characteristic, these two government-sponsored enterprises had to
significantly reduce their underwriting standards.
Fannie and Freddie were not the only
government-backed or government-controlled organizations that were enlisted
in this process. The Federal Housing Administration was competing with
Fannie and Freddie for the same mortgages. And thanks to rules adopted in
1995 under the Community Reinvestment Act, regulated banks as well as
savings and loan associations had to make a certain number of loans to
borrowers who were at or below 80% of the median income in the areas they
served.
Research by Edward Pinto, a former chief credit
officer of Fannie Mae (now a colleague of mine at the American Enterprise
Institute) has shown that 27 million loans—half of all mortgages in the
U.S.—were subprime or otherwise weak by 2008. That is, the loans were made
to borrowers with blemished credit, or were loans with no or low down
payments, no documentation, or required only interest payments.
Of these, over 70% were held or guaranteed by
Fannie and Freddie or some other government agency or government-regulated
institution. Thus it is clear where the demand for these deficient mortgages
came from.
The huge government investment in subprime
mortgages achieved its purpose. Home ownership in the U.S. increased to 69%
from 65% (where it had been for 30 years). But it also led to the biggest
housing bubble in American history. This bubble, which lasted from 1997 to
2007, also created a huge private market for mortgage-backed securities (MBS)
based on pools of subprime loans.
As housing bubbles grow, rising prices suppress
delinquencies and defaults. People who could not meet their mortgage
obligations could refinance or sell, because their houses were now worth
more.
Accordingly, by the mid-2000s, investors had begun
to notice that securities based on subprime mortgages were producing the
high yields, but not showing the large number of defaults, that are usually
associated with subprime loans. This triggered strong investor demand for
these securities, causing the growth of the first significant private market
for MBS based on subprime and other risky mortgages.
By 2008, Mr. Pinto has shown, this market consisted
of about 7.8 million subprime loans, somewhat less than one-third of the 27
million that were then outstanding. The private financial sector must
certainly share some blame for the financial crisis, but it cannot fairly be
accused of causing that crisis when only a small minority of subprime and
other risky mortgages outstanding in 2008 were the result of that private
activity.
When the bubble deflated in 2007, an unprecedented
number of weak mortgages went into default, driving down housing prices
throughout the U.S. and throwing Fannie and Freddie into insolvency. Seeing
these sudden losses, investors fled from the market for privately issued MBS,
and mark-to-market accounting required banks and others to write down the
value of their mortgage-backed assets to the distress levels in a market
that now had few buyers. This raised questions about the solvency and
liquidity of the largest financial institutions and began a period of great
investor anxiety.
The government's rescue of Bear Stearns in March
2008 temporarily calmed the market. But it created significant moral hazard:
Market participants were led to believe that the government would rescue all
large financial institutions. When Lehman Brothers was allowed to fail in
September, investors panicked. They withdrew their funds from the
institutions that held large amounts of privately issued MBS, causing banks
and others—such as investment banks, finance companies and insurers—to hoard
cash against the risk of further withdrawals. Their refusal to lend to one
another in these conditions froze credit markets, bringing on what we now
call the financial crisis.
Continued in article
CDO ---
https://en.wikipedia.org/wiki/Collateralized_debt_obligation
"JPMorgan to pay $1.42 billion cash to settle most Lehman claims," by
Jonatan Stemel, Reuters, January 25, 2016 ---
http://www.reuters.com/article/us-jpmorgan-lehman-idUSKCN0V4049
JPMorgan Chase & Co (JPM.N) will pay $1.42 billion
in cash to resolve most of a lawsuit accusing it of draining Lehman Brothers
Holdings Inc of critical liquidity in the final days before that investment
bank's September 2008 collapse.
The settlement was made public on Monday, and
requires approval by U.S. Bankruptcy Judge Shelley Chapman in Manhattan.
It resolves the bulk of an $8.6 billion lawsuit
accusing JPMorgan of exploiting its leverage as Lehman's main "clearing"
bank to siphon billions of dollars of collateral just before Lehman went
bankrupt on Sept. 15, 2008, triggering a global financial crisis.
Lehman's creditors charged that JPMorgan did not
need the collateral and extracted a windfall at their expense.
Monday's settlement also resolves Lehman's
challenges to JPMorgan's decision to close out thousands of derivatives
trades following the bankruptcy, court papers showed.
The accord would permit a further $1.496 billion to
be distributed to the creditors, including a separate $76 million deposit,
court papers showed.
Continued in article
"Goldman Reaches $5 Billion Settlement Over Mortgage-Backed Securities:
Pact marks largest settlement in history of Wall Street firm," by Justin
Baer and Chelsey Dulaney, The Wall Street Journal, January 14, 2016 ---
http://www.wsj.com/articles/goldman-reaches-5-billion-settlement-over-mortgage-backed-securities-1452808185?mod=djemCFO_h
Goldman Sachs Group Inc. agreed to the largest
regulatory penalty in its history, resolving U.S. and state claims stemming
from the Wall Street firm’s sale of mortgage bonds heading into the
financial crisis.
In settling with the Justice Department and a
collection of other state and federal entities for more than $5 billion,
Goldman will join a list of other big banks in moving past one of the
biggest, and most costly, legal headaches of the crisis era.
Goldman said litigation legal expenses stemming
from the accord would trim its fourth-quarter earnings by about $1.5
billion, after taxes. The firm is scheduled to report results Wednesday.
“We are pleased to have reached an agreement in
principle to resolve these matters,” Lloyd Blankfein, Goldman’s chief
executive, said in a statement.
Government officials previously won
multibillion-dollar settlements from J.P. Morgan Chase & Co., Bank of
America Corp. and Citigroup Inc. The probes examined how Wall Street sold
bonds tied to residential mortgages, and whether banks deceived investors by
misrepresenting the quality of underlying loans.
The government’s inquiry into Goldman related to
mortgage-backed securities the firm packaged and sold between 2005 and 2007,
the years when the housing market was soaring and investor demand for
related bonds was still strong.
Continued in article
New Rules
for CDOs
"Statement at Open Meeting: Asset-Backed Securities Disclosure and
Registration," by Commissioner Kara M. Stein, SEC, August 27, 2014 ---
http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370542772431#.VBgvYBZS7rx
I begin my remarks by echoing others and commending the work of the team
that has been working on this rule, including Rolaine Bancroft, Hughes
Bates, Michelle Stasny, Kayla Florio, Heather Mackintosh, Silvia Pilkerton,
Robert Errett, Max Rumyantsev, and Kathy Hsu.
Heather and Sylvia have been working on the data tagging and preparing EDGAR
to accept this new data. This is no small endeavor.
I want to give a special thank you to Paula Dubberly, who retired last year
from the SEC and is in the audience today. She has been a champion for
investors through her leadership on asset-backed securities regulation from
the development of the initial Reg AB proposal through the rules that are
being considered today.
This rule is an important step forward in completing the mandated Dodd-Frank
Act rulemakings.[1]
The financial crisis revealed investors’ inability to actually assess pools
of loans that had been sliced and diced, sometimes multiple times, by being
securitized, re-securitized, or combined in a dizzying array of complex
financial instruments. The securitization market was at the center of the
financial crisis. While securitization structures provided liquidity to
nearly every sector in the U.S. economy, they also exposed investors to
significant and non-transparent risks due to poor lending practices and poor
disclosure practices.
As we now know, offering documents failed to provide timely and complete
information for investors to assess the underlying risks of the pool of
assets.[2]
Without sufficient and accurate loan level details, analysts and investors
could not gauge the quality of the loans – and without an ability to
distinguish the good from the bad, the secondary market collapsed.
Congress responded and required the Commission to promulgate rules to
address a number of weaknesses in the securitization process.[3]
Six years after the financial crisis, the securitization markets continue to
recover. While certain asset classes have rebounded, others continue to
struggle.
The rule the Commission issues today partially addresses the Congressional
mandate. In effect, today’s rules provide investors with better information
on what is inside the securitization package. The rules today do for
investors what food and drug labeling does for consumers – provide a list of
ingredients.
This rule also addresses certain critical flaws that became apparent in the
securitization process, including a dearth of quality information and
insufficient time to make informed assessments of the underlying
investments. This rule is an important step toward providing investors with
tools and data to better understand the underlying risks and appropriately
price the securities.
There are several important and laudable aspects of today’s rule that merit
specific mentioning.
First, the rule requires the underlying loan information to be standardized
and available in a tagged XML format to ensure maximum utility in analysis.[4]
As noted in the Commission’s 2010 Proxy Plumbing Release: “If issuers
provided reportable items in interactive data format, shareholders may be
able to more easily obtain information about issuers, compare information
across different issuers, and observe how issuer-specific information
changes over time as the same issuer continues to file in an interactive
format.”[5]
The same is true for underlying loan information. Investors can unlock the
value and efficiency that standardized, machine readable data allows.
Today’s rule also improves disclosures regarding the initial offering of
securities and significantly, for the first time, requires periodic updating
regarding the loans as they perform over time. This information will
provide a more nuanced and evolving picture of the underlying assets in a
portfolio to investors.
The rule also requires that the principal executive officer of the ABS
issuer certify that the information in the prospectus or report is
accurate. These kinds of certifications provide a key control to help
ensure more oversight and accountability.
As for the privacy concerns that prompted a re-proposal, the staff has
worked hard to balance investor needs for loan level data with concerns that
the data could lead to identification of individual borrowers. I believe
the rule achieves a workable balance between these two competing needs,
while still providing invaluable public disclosure.
Finally, I believe that the new disclosure rule will provide investors with
the necessary tools to see what is “under the hood” on auto loan
securitizations. In its latest report on consumer debt and credit, the
Federal Reserve Bank of New York noted a recent spike in subprime auto
lending. As the report shows, although consumer auto debt balances have
risen across the board, the real growth has been in riskier loans.[6]
The disclosure and reporting changes that the Commission is adopting today
will help investors see the quality of the loans in a portfolio and the
performance of those loans over time.
While today’s rules are an important step forward, more work needs to be
done regarding conflicts of interest. We now know that many firms who were
structuring securitizations before the financial crisis were also betting
against those same securitizations.
In April 2010, the Commission charged the U.S broker-dealer of a large
financial services firm for its role in failing to disclose that it allowed
a client to select assets for an investment portfolio while betting that the
portfolio would ultimately lose its value. Investors in the portfolio lost
more than $1 billion.[7]
In October 2011, the Commission sued the U.S broker-dealer of a large
financial services firm for among other things, selling investment products
tied to the housing market and then, for their own trading, betting that
those assets would lose money. In effect, the firm bet against the very
investors it had solicited. An experienced collateral manager commented
internally that a particular portfolio was “horrible.” While investors lost
virtually all of their investments in the portfolio, the firm pocketed over
$160 million from bets it made against the securitization it created.[8]
The Dodd-Frank Act directed the Commission to adopt rules prohibiting
placement agents, underwriters, and sponsors from engaging in a material
conflict of interest for one year following the closing of a securitization
transaction. Those rules were required to be issued by April 2011.[9]
The Commission initially proposed these rules in September 2011, and still
has not completed them.[10]
We need to complete these rules as soon as possible, hopefully, by the end
of this year. These rules will provide investors with additional confidence
that they are not being hoodwinked by those packaging and selling those
financial instruments.
Unfortunately, the Commission has put on hold its work to provide investors
with a software engine to aid in the calculation of waterfall models.
Although the final rule provides for a preliminary prospectus at least three
business days before the first sale, this is reduced from the proposal,
which provided for a five-day period. With only three days to conduct due
diligence and make an investment determination, such a software engine could
be an important and much needed tool for investors to use in analyzing the
flow of funds. Such waterfall models can help investors assess the cash
flows from the loan level data. We should return to this important
initiative to provide investors with the mathematical logic that forms the
basis for the narrative disclosure within the prospectus.
"Weekly Book List, June 13, 2011," Chronicle of Higher Education,
June 12, 2011 ---
http://chronicle.com/article/Weekly-Book-List-June-13/127897/?sid=cr&utm_source=cr&utm_medium=en
Economics
Corporate Governance Failures: The Role of Institutional Investors
in the Global Financial Crisis edited by James P. Hawley, Shyam J.
Kamath, and Andrew T. Williams (University of Pennsylvania Press; 344 pages;
$69.95). Writings on such topics as the limits of corporate governance in
dealing with asset bubbles.
From Financial Crisis to Global Recovery by Padma Desai
(Columbia University Press; 254 pages; $27.50). Considers the origins of the
contemporary crisis and the prospects for recovery; includes comparative
discussion of the Great Depression.
Bob Jensen's threads on the economic crisis ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"What Caused the Bubble? Mission accomplished: Phil Angelides succeeds in
not upsetting the politicians," by Holman W, Jenkins, Jr., The Wall
Street Journal, January 29. 2011 ---
http://online.wsj.com/article/SB10001424052748704268104576108000415603970.html#mod=djemEditorialPage_t
The 2008 financial crisis happened because no one
prevented it. Those who might have stopped it didn't. They are to blame.
Greedy bankers, incompetent managers and
inattentive regulators created the greatest financial breakdown in nearly a
century. Doesn't that make you feel better? After all, how likely is it that
some human beings will be greedy at exactly the same time others are
incompetent and still others are inattentive?
Oh wait.
You could almost defend the Financial Crisis
Inquiry Commission's (FCIC) new report if the question had been who, in
hindsight, might have prevented the crisis. Alas, the answer is always going
to be the Fed, which has the power to stop just about any macro trend in the
financial markets if it really wants to. But the commission was asked to
explain why the bubble happened. In that sense, its report doesn't seem even
to know what a proper answer might look like, as if presented with the
question "What is 2 + 2?" and responding "Toledo" or "feral cat."
The dissenters at least propose answers that might
be answers. Peter Wallison focuses on U.S. housing policy, a diagnosis that
has the advantage of being actionable.
The other dissent, by Keith Hennessey, Bill Thomas
and Douglas Holtz-Eakin, sees 10 causal factors, but emphasizes the
pan-global nature of the housing bubble, which it attributes to ungovernable
global capital flows.
That is also true, but less actionable.
Let's try our hand at an answer that, like Mr.
Wallison's, attempts to be useful.
The Fed will make errors. International capital
flows will sometimes be disruptive. Speculators will be attracted to hot
markets. Bubbles will be a feature of financial life: Building a bunch of
new houses is not necessarily a bad idea; only when too many others do the
same does it become a bad idea. On that point, not the least of the
commission's failings was its persistent mistaking of effects for causes,
such as when banks finally began treating their mortgage portfolios as hot
potatoes to be got rid of.
If all that can't be changed, what can? How about
the incentives that invited various parties to shovel capital into housing
without worrying about the consequences?
The central banks of China, Russia and various
Asian and Arab nations knew nothing about U.S. housing. They poured hundreds
of billions into it only because Fannie and Freddie were perceived as
federally guaranteed and paid a slightly higher yield than U.S. Treasury
bonds. (And one of the first U.S. actions in the crisis was to assure China
it wouldn't lose money.)
Borrowers in most states are allowed to walk away
from their mortgages, surrendering only their downpayments (if any) while
dumping their soured housing bets on a bank. Change that even slightly and
mortgage brokers and home builders would find it a lot harder to coax people
into more house than they can afford.
Mortgage middlemen who don't have "skin in the
game" and feckless rating agencies have also been routine targets of blame.
But both are basically ticket punchers for large institutions that should
have and would have been assessing their own risk, except that their own
creditors, including depositors, judged them "too big to fail," creating a
milieu where they could prosper without being either transparent or
cautious. We haven't even tried to fix this, say by requiring banks to take
on a class of debtholder who would agree to be converted to equity in a
bailout. Then there'd be at least one sophisticated marketplace demanding
assurance that a bank is being run in a safe and sound manner. (Sadly, the
commission's report only reinforces the notion that regulators are
responsible for keeping your money safe, not you.)
The FCIC Chairman Phil Angelides is not stupid, but
he is a politician. His report contains tidbits that will be useful to
historians and economists. But it's also a report that "explains" poorly.
His highly calculated sound bite, peddled from one interview to the next,
that the crisis was "avoidable" is worthless, a nonrevelation. Everything
that happens could be said to happen because somebody didn't prevent it. So
what? Saying so is saying nothing.
Mr. Angelides has gone around trying to convince
audiences that the commission's finding was hard hitting. It wasn't. It was
soft hitting. More than any other goal, it strives mainly to say nothing
that would actually be inconvenient to Barack Obama, Harry Reid, Barney
Frank or even most Republicans in Congress. In that, it succeeded.
"The Mortgage Crisis: Some Inside Views Emails show that risk managers at
Freddie Mac warned about lower underwriting standards—in vain, and with lessons
for today," by Charles W. Calomiris, The Wall Street Journal, October
28, 2011 ---
http://online.wsj.com/article/SB10001424053111903927204576574433454435452.html?mod=djemEditorialPage_t
Occupy Wall Street is denouncing banks and Wall
Street for "selling toxic mortgages" while "screwing investors and
homeowners." And the federal government recently announced it will be suing
mortgage originators whose low-quality underwriting standards produced
ballooning losses for Fannie Mae and Freddie Mac.
Have they fingered the right culprits?
There is no doubt that reductions in
mortgage-underwriting standards were at the heart of the subprime crisis,
and Fannie and Freddie's losses reflect those declining standards. Yet the
decline in underwriting standards was largely a response to mandates,
beginning in the Clinton administration, that required Fannie Mae and
Freddie Mac to steadily increase their mortgages or mortgage-backed
securities that targeted low-income or minority borrowers and "underserved"
locations.
The turning point was the spring and summer of
2004. Fannie and Freddie had kept their exposures low to loans made with
little or no documentation (no-doc and low-doc loans), owing to their
internal risk-management guidelines that limited such lending. In early
2004, however, senior management realized that the only way to meet the
political mandates was to massively cut underwriting standards.
The risk managers complained, especially at Freddie
Mac, as their emails to senior management show. They refused to endorse the
move to no-docs and battled unsuccessfully against the reduced underwriting
standards from April to September 2004. Here are some highlights:
On April 1, 2004, Freddie Mac risk manager David
Andrukonis wrote to Tracy Mooney, a vice president, that "while you, Don [Bisenius,
a senior vice president] and I will make the case for sound credit, it's not
the theme coming from the top of the company and inevitably people down the
line play follow the leader."
Risk managers had already experimented with lower
lending standards and knew the dangers. In another email that day, Mr.
Bisenius wrote to Michael May (another senior vice president), "we did
no-doc lending before, took inordinate losses and generated significant
fraud cases. I'm not sure what makes us think we're so much smarter this
time around."
On April 5, Mr. Andrukonis wrote to Chief Operating
Officer Paul Peterson, "In 1990 we called this product 'dangerous' and
eliminated it from the marketplace." He also argued that housing prices were
already high and unlikely to rise further: "We are less likely to get the
house price appreciation we've had in the past 10 years to bail this program
out if there's a hole in it."
Donna Cogswell, a colleague of Mr. Andrukonis,
warned that Fannie and Freddie's decisions to debase underwriting standards
would have widespread ramifications for the mortgage market. In a Sept. 7
email to Freddie Mac CEO Dick Syron and others, she specifically described
the ramifications of Freddie Mac's continuing participation in the market as
effectively "mak[ing] a market" in no-doc mortgages.
Ms. Cogswell's Sept. 4 email to Mr. Syron and
others also anticipated the potential human costs of the mortgage crisis.
She tried to sway management by appealing to their decency: "[W]hat better
way to highlight our sense of mission than to walk away from profitable
business because it hurts the borrowers we are trying to serve?"
Politics—not shortsightedness or incompetent risk
managers—drove Freddie Mac to eliminate its previous limits on no-doc
lending. Commenting on what others referred to as the "push to do more
affordable [lending] business," Senior Vice President Robert Tsien wrote to
Dick Syron on July 14, 2004: "Tipping the scale in favor of no cap [on
no-doc lending] at this time was the pragmatic consideration that, under the
current circumstances, a cap would be interpreted by external critics as
additional proof we are not really committed to affordable lending."
Sensing that his warnings were being ignored, Mr.
Andrukonis wrote to Michael May on Sept. 8: "At last week's risk management
meeting I mentioned that I had reached my own conclusion on this product
from a reputation risk perspective. I said that I thought you and or Bob
Tsien had the responsibility to bring the business recommendation to Dick [Syron],
who was going to make the decision. . . . What I want Dick to know is that
he can approve of us doing these loans, but it will be against my
recommendation."
The decision by Fannie and Freddie to embrace
no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for
example, total subprime and Alt-A mortgage originations were $395 billion.
In 2004, they rose to $715 billion. By 2006, they were more than $1
trillion.
In a painstaking forensic analysis of the sources
of increased mortgage risk during the 2000s, "The Failure of Models that
Predict Failure," Uday Rajan of the University of Michigan, Amit Seru of the
University of Chicago and Vikrant Vig of London Business School show that
more than half of the mortgage losses that occurred in excess of the rosy
forecasts of expected loss at the time of mortgage origination reflected the
predictable consequences of low-doc and no-doc lending. In other words, if
the mortgage-underwriting standards at Fannie and Freddie circa 2003 had
remained in place, nothing like the magnitude of the subprime crisis would
have occurred.
Taxpayer losses at Fannie and Freddie alone may
exceed $300 billion. The costs of the financial collapse and recession
brought on by the mortgage bust are immeasurably higher. Unfortunately, the
Obama administration has perpetuated the low underwriting standards that
gave us the crisis and encouraged the postponement of foreclosures by
lending support to various states' efforts to sue originators for robo-signing
violations.
Continued in article
Jensen Comment
And then the subprime crisis was followed by the biggest swindle in the history
of the world ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
At this point time in 2011 there's only marginal benefit in identifying all
the groups like credit agencies and CPA audit firms that violated
professionalism leading up to the subprime crisis. The credit agencies,
auditors, Wall Street investment banks, Fannie Mae, and Freddie Mack were all
just hogs feeding on the trough of bad and good loans originating on Main
Streets of every town in the United States.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon
by the Hogs With Their Noses in the Trough Up to and Including Wall Street and
Fannie and Freddie.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks All Would've Been Avoided
The most interesting question in my mind is what might've prevented the poison (uncollectability)
in the real estate loans from being concocted in the first place. What
might've prevented it was for those that approved the loans (Main Street banks
and mortgage companies in towns throughout the United States) to have to bear
all or a big share of the losses when borrowers they approved defaulted.
Instead those lenders that approved the loans easily passed those loans up
the system without any responsibility for their reckless approval of the
loans in the first place. It's easy to blame Barney Frank for making it
easier for poor people to borrow more than they could ever repay. But the fact
of the matter is that the original lenders like Countrywide were approving
subprime mortgages to high income people that also could not afford their
payments once the higher prime rates kicked in under terms of the subprime
contracts. If lenders like Countrywide had to bear a major share of the bad debt
losses the lenders themselves would've been more responsible about only
approving mortgages that had a high probability of not going into default.
Instead Countrywide and the other Main Street lenders got off scott free until
the real estate bubble finally burst.
And why would a high income couple refinance a fixed rate mortgage with a
risky subprime mortgage that they could not afford when the higher rates kicked
in down the road? The answer is that the hot real estate market before the crash
made that couple greedy. They believed that if they took out a subprime loan
with a very low rate of interest temporarily that they could turn over their
home for a relatively huge profit and then upgrade to a much nicer mansion on
the hill from the profits earned prior to when the subprime rates kicked into
higher rates.
When the real estate bubble burst this couple got left holding the bag and
received foreclosure notices on the homes that they had gambled away. And the
Wall Street investment banks, Fannie, and Freddie got stuck with all the poison
that the Main Street banks and mortgage companies had recklessly approved
without any risk of recourse for their recklessness.
If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon
by the Hogs With Their Noses in the Trough Up to and Including Wall Street and
Fannie and Freddie.
Bob Jensen's threads on this entire mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Inside Job: 2010 Oscar-Winning Documentary Now Online ---
Click Here
http://www.openculture.com/2011/04/inside_job.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+OpenCulture+%28Open+Culture%29
In late February, Charles Ferguson’s film – Inside
Job – won the Academy Award for Best Documentary. And now the film
documenting the causes of the 2008 global financial meltdown has made its
way online (thanks to the Internet Archive). A corrupt financial industry,
its corrosive relationship with politicians, academics and regulators, and
the trillions of damage done, it all gets documented in this film that runs
a little shy of 2 hours.
To watch the film, you will need to do the
following. 1.) Look at the bottom of the film. 2.) Click the forward button
twice so that it moves beyond the initial trailer and the Academy Awards
ceremony. 3.) Wait for the little circle to stop spinning. And 4.) click
play to watch film.
Inside Job (now listed in our Free Movie
Collection) can be purchased on DVD at Amazon. We all love free, but let’s
remember that good projects cost real money to develop, and they could use
real financial support. So please consider buying a copy.
Hopefully watching or buying this film won’t be a
pointless act, even though it can rightly feel that way. As Charles Ferguson
reminded us during his Oscar acceptance speech, we are three years beyond
the Wall Street crisis and taxpayers (you) got fleeced for billions. But
still not one Wall Street exec is facing criminal charges. Welcome to your
plutocracy…
Bob Jensen's threads on the global financial meltdown and its aftershocks
are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Washington’s Financial Disaster," by Frank Partnoy, The New York
Times, January 29, 2011 ---
http://www.nytimes.com/2011/01/30/opinion/30partnoy.html?_r=1&nl=todaysheadlines&emc=tha212
THE long-awaited Financial Crisis Inquiry
Commission report, finally published on Thursday, was supposed to be the
economic equivalent of the 9/11 commission report. But instead of a lucid
narrative explaining what happened when the economy imploded in 2008, why,
and who was to blame, the report is a confusing and contradictory mess, part
rehash, part mishmash, as impenetrable as the collateralized debt
obligations at the core of the crisis.
The main reason so much time, money and ink were
wasted — politics — is apparent just from eyeballing the report, or really
the three reports. There is a 410-page volume signed by the commission’s six
Democrats, a leaner 10-pronged dissent from three of the four Republicans,
and a nearly 100-page dissent-from-the-dissent filed by Peter J. Wallison, a
fellow at the American Enterprise Institute. The primary volume contains
familiar vignettes on topics like deregulation, excess pay and poor risk
management, and is infused with populist rhetoric and an anti-Wall Street
tone. The dissent, which explores such root causes as the housing bubble and
excess debt, is less lively. And then there is Mr. Wallison’s screed against
the government’s subsidizing of mortgage loans.
These documents resemble not an investigative
trilogy but a left-leaning essay collection, a right-leaning PowerPoint
presentation and a colorful far-right magazine. And the confusion only
continued during a press conference on Thursday in which the commissioners
had little to show and nothing to tell. There was certainly no Richard
Feynman dipping an O ring in ice water to show how the space shuttle
Challenger went down.
That we ended up with a political split is not
entirely surprising, given the structure and composition of the commission.
Congress shackled it by requiring bipartisan approval for subpoenas, yet
also appointed strongly partisan figures. It was only a matter of time
before the group fractured. When Republicans proposed removing the term
“Wall Street” from the report, saying it was too pejorative and imprecise,
the peace ended. And the public is still without a full factual account.
For example, most experts say credit ratings and
derivatives were central to the crisis. Yet on these issues, the reports are
like three blind men feeling different parts of an elephant. The Democrats
focused on the credit rating agencies’ conflicts of interest; the
Republicans blamed investors for not looking beyond ratings. The Democrats
stressed the dangers of deregulated shadow markets; the Republicans blamed
contagion, the risk that the failure of one derivatives counterparty could
cause the other banks to topple. Mr. Wallison played down both topics. None
of these ideas is new. All are incomplete.
Another problem was the commission’s sprawling,
ambiguous mission. Congress required that it study 22 topics, but
appropriated just $8 million for the job. The pressure to cover this wide
turf was intense and led to infighting and resignations. The 19 hearings
themselves were unfocused, more theater than investigation.
In the end, the commission was the opposite of
Ferdinand Pecora’s famous Congressional investigation in 1933. Pecora’s
10-day inquisition of banking leaders was supposed to be this commission’s
exemplar. But Pecora, a former assistant district attorney from New York,
was backed by new evidence of widespread fraud and insider dealings,
shocking documents that the public had never seen or imagined. His fierce
cross-examination of Charles E. Mitchell, the head of National City Bank,
Citigroup’s predecessor, put a face on the crisis.
This commission’s investigation was spiritless and
sometimes plain wrong. Richard Fuld, the former head of Lehman Brothers, was
thrown softballs, like “Can you talk a bit about the risk management
practices at Lehman Brothers, and why you didn’t see this coming?” Other
bankers were scolded, as when Phil Angelides, the commission’s chairman,
admonished Lloyd Blankfein, the chief executive of Goldman Sachs, for
practices akin to “selling a car with faulty brakes and then buying an
insurance policy on the buyer of those cars.” But he couldn’t back up this
rebuke with new evidence.
The report then oversteps the facts in its
demonization of Goldman, claiming that Goldman “retained” $2.9 billion of
the A.I.G. bailout money as “proprietary trades.” Few dispute that Goldman,
on behalf of its clients, took both sides of trades and benefited from the
A.I.G. bailout. But a Goldman spokesman told me that the report’s assertion
was false and that these trades were neither proprietary nor a windfall. The
commission’s staff apparently didn’t consider Goldman’s losing trades with
other clients, because they were focused only on deals with A.I.G. If they
wanted to tar Mr. Blankfein, they should have gotten their facts right.
Lawmakers would have been wiser to listen to
Senator Richard Shelby of Alabama, who in early 2009 proposed a bipartisan
investigation by the banking committee. That way seasoned prosecutors could
have issued subpoenas, cross-examined witnesses and developed cases.
Instead, a few months later, Congress opted for this commission, the last
act of which was to coyly recommend a few cases to prosecutors, who already
have been accumulating evidence the commissioners have never seen.
There is still hope. Few people remember that the
early investigations of the 1929 crash also failed due to political battles
and ambiguous missions. Ferdinand Pecora was Congress’s fourth chief
counsel, not its first, and he did not complete his work until five years
after the crisis. Congress should try again.
Frank Partnoy is a law professor at the University of San Diego and the
author of “The Match King: Ivar Kreuger, the Financial Genius Behind a
Century of Wall Street Scandals.”
Jensen Comment
Professor Partnoy is one of my all-time fraud fighting heroes. He was at one
time an insider in marketing Wall Street financial instrument derivatives
products and, while he was one of the bad guys, became conscience-stricken about
how the bad guys work. Although his many books are somewhat repetitive, his
books are among the best in exposing how the Wall Street investment banks are
rotten to the core.
Frank Partnoy has been a a strong advocate of regulation of the derivatives
markets even before Enron's energy trading scams came to light. His testimony
before the U.S. Senate about Enron's infamous Footnote 16 ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm#Senator
I quote Professor Partnoy's books frequently in my Timeline of Derivative
Financial Instruments Frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Every now and then the so-called "quants" in economics and finance make
enormous mistakes. Probably the best known mistake, before the trillion-dollar
CDO mistakes that came to light the collapse of the real estate market in 2007,
was the "Trillion Dollar Bet" made by two Nobel Prize winning quants and their
partners in Long-Term Capital Management (LTCM) that came within a hair of
destroying most big banks and investment firms on Wall Street ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
Whenever I get news of increased power of quants
on Wall Street, I think back to "The Trillion Dollar Bet" (Nova
on PBS Video) a bond trader, two Nobel Laureates, and their doctoral
students who very nearly brought down all of Wall Street and the U.S. banking
system in the crash of a hedge fund known as
Long Term Capital
Management where the biggest and most prestigious firms lost an unimaginable
amount of money ---
http://en.wikipedia.org/wiki/LTCM
The Trillion Dollar Bet transcripts are free ---
http://www.pbs.org/wgbh/nova/transcripts/2704stockmarket.html
However, you really have to watch the graphics in the video to appreciate this
educational video ---
http://www.pbs.org/wgbh/nova/stockmarket/
Warnings from a Theoretical Physicist With an Interest in Economics and
Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models,"
by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html
. . .
In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the way
millions of people and companies interact in a handful of pretty equations.
The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the probabilities of
all possible futures and responding in an optimal way to unexpected shocks.
Surreal Models
Surreal as such models might seem, they have played
a significant role in informing policy at the world’s largest central banks.
Unfortunately, they don’t work very well, and they proved spectacularly
incapable of accommodating the way markets and the economy acted before,
during and after the recent crisis.
Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.
Take, for example, a 2012 (and still somewhat
preliminary)
study by a group of
economists, social scientists, mathematicians and physicists examining the
causes of the housing boom and subsequent collapse from 2000 to 2006.
Starting with data for the Washington D.C. area, the study’s authors built
up a computational model mimicking the behavior of more than two million
potential homeowners over more than a decade. The model included detail on
each individual at the level of race, income, wealth, age and marital
status, and on how these characteristics correlate with home buying
behavior.
Led by further empirical data, the model makes some
simple, yet plausible, assumptions about the way people behave. For example,
homebuyers try to spend about a third of their annual income on housing, and
treat any expected house-price appreciation as income. Within those
constraints, they borrow as much money as lenders’ credit standards allow,
and bid on the highest-value houses they can. Sellers put their houses on
the market at about 10 percent above fair market value, and reduce the price
gradually until they find a buyer.
The model captures things that dynamic stochastic
general equilibrium models do not, such as how rising prices and the
possibility of refinancing entice some people to speculate, buying
more-expensive houses than they otherwise would. The model accurately fits
data on the housing market over the period from 1997 to 2010 (not
surprisingly, as it was designed to do so). More interesting, it can be used
to probe the deeper causes of what happened.
Consider, for example, the assertion of some
prominent economists, such as
Stanford University’s
John Taylor, that the
low-interest-rate policies of the
Federal Reserve were
to blame for the housing bubble. Some dynamic stochastic general equilibrium
models can be used to support this view. The agent- based model, however,
suggests that
interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom and
bust do become smaller, but only marginally.
Leverage Boom
A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were able
to borrow as much as 100 percent of the value of a house -- a form of easy
credit that had a big effect on housing demand. In the model, freezing
leverage at historically normal levels completely eliminates both the
housing boom and the subsequent bust.
Does this mean leverage was the culprit behind the
subprime debacle and the related global financial crisis? Not necessarily.
The model is only a start and might turn out to be wrong in important ways.
That said, it makes the most convincing case to date (see my
blog for more
detail), and it seems likely that any stronger case will have to be based on
an even deeper plunge into the messy details of how people behaved. It will
entail more data, more agents, more computation and less elegance.
If economists jettisoned elegance and got to work
developing more realistic models, we might gain a better understanding of
how crises happen, and learn how to anticipate similarly unstable episodes
in the future. The theories won’t be pretty, and probably won’t show off any
clever mathematics. But we ought to prefer ugly realism to beautiful
fantasy.
(Mark Buchanan, a theoretical physicist and the author of “The Social
Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually
Looks Like You,” is a Bloomberg View columnist. The opinions expressed are
his own.)
Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned mortgages
---
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Learning From Mistakes
"School for quants: Inside UCL’s Financial Computing Centre, the planet’s
brightest quantitative analysts are now calculating our future," by Sam
Knight, Financial Times Magazine, March 2, 2012 ---
http://www.ft.com/intl/cms/s/2/0664cd92-6277-11e1-872e-00144feabdc0.html#axzz1oEeYcqi8
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On a recent winter’s afternoon, nine computer
science students were sitting around a conference table in the engineering
faculty at University College London. The room was strip-lit, unadorned, and
windowless. On the wall, a formerly white whiteboard was a dirty cloud,
tormented by the weight of technical scribblings and rubbings-out upon it. A
poster in the corner described the importance of having a heterogenous
experimental network, or Hen.
Every now and again, though, the discussion became
comprehensible. The students discussed annoyances – so much data about
animals! – and possibilities. One of the PhD students, Ilya Zheludev, talked
about “Wikipedia deltas” – records of deleted sections from the online
encyclopaedia. Immediately, the students hit on the idea of tracking the
Wikipedia entries of large companies and seeing what was deleted, and when.
The mood of the meeting was casual and exacting at
the same time. Galas, who is from Gdansk and once had ambitions to be a
hacker, is something of a giant at the Financial Computing Centre. One of
the first students to enrol in 2009, he has a gift for writing extremely
large computer programs. In order to carry out his own research, Galas has
built an electronic trading platform that he estimates would satisfy the
needs of a small bank. As a result, what he says goes. Galas closed the
meeting by giving the undergraduates a hard time about the overall messiness
of their programming. “I like beauty!” he declared, staring around the room.
The Financial Computing Centre at UCL, a
collaboration with the London School of Economics, the London Business
School and 20 leading financial institutions, claims to be the only
institute of its kind in Europe. Each year since its establishment in late
2008, between 600 and 800 students have applied for its 12 fully funded PhD
places, which each cost the taxpayer £30,000 per year. Dozens more
applicants come from the financial industry, where employers are willing to
subsidise up to five years of research at the tantalising intersection of
computers, data and money.
As of this winter, the centre had about 60 PhD
students, of whom 80 per cent were men. Virtually all hailed from such
forbiddingly numerate subjects as electrical engineering, computational
statistics, pure mathematics and artificial intelligence. These realms of
knowledge contain concepts such as data mining, non-linear dynamics and
chaos theory that make many of us nervous just to see written down. Philip
Treleaven, the centre’s director, is delighted by this. “Bright buggers,” he
calls his students. “They want to do great things.”
In one sense, the centre is the logical culmination
of a relationship between the financial industry and the natural sciences
that has been deepening for the past 40 years. The first postgraduate
scientists began to crop up on trading floors in the early 1970s, when
rising interest rates transformed the previously staid calculations of bond
trading into a field of complex mathematics. The most successful financial
equation of all time – the Black-Scholes model of options pricing – was
published in 1973 (the authors were awarded a Nobel prize in 1997).
Continued in article
Bob Jensen's threads on The Greatest Swindle in the History of the World
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
What really caused the financial crisis beginning in 2007 ---
http://www.wsj.com/articles/notable-quotable-what-really-caused-the-financial-crisis-1423785060?tesla=y
Jensen Comment
The above article (blaming government regulation) is wrong, and most other
articles (blaming Wall Street) on this topic are wrong.
The primary cause of the financial crisis was fraud on Main Street. This
fraud was enabled by letting Main Street banks and other mortgage lending
companies to make high risk (often subprime) mortgage loans and sell them to
Fannie, Freddie, and Wall Street banks without retaining any of the bad debt
(default) risk. This encouraged reckless lending and outright fraud (e.g.,
property appraisal fraud). One of the best examples is how a woman on welfare
got a $100,000+ mortgage on a $10,000 shack ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Marvene is a poor and unemployed elderly woman who lost her
shack to foreclosure in 2008.
That's after Marvene stole over $100,000 when she refinanced her $10,000
(current value) shack with a subprime mortgage in 2007.
Marvene wants to steal some more or at least get her shack back for free.
Both the Executive and Congressional branches of the U.S. Government want to
give more to poor Marvene.
Why don't I feel the least bit sorry for poor Marvene?
Somehow I don't think she was the victim of unscrupulous mortgage brokers and
property value appraisers.
More than likely she was a co-conspirator in need of $75,000 just to pay
creditors bearing down in 2007.
She purchased the shack for $3,500 about 40 years ago ---
http://online.wsj.com/article/SB123093614987850083.html
Wall Street investment banks like Lehman Bros and various others exacerbated
the fraud by slicing and dicing the financial risk of these subprime loans into
collateralized (CDO) bonds on the basis of a flawed Gaussian copula formula.
Can the
2008 investment banking failure
be traced to a math error?
Recipe for Disaster: The
Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's
formula, known as a
Gaussian copula function, looked like an
unambiguously positive breakthrough, a piece of financial technology that
allowed hugely complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities, expanding
financial markets to unimaginable levels.
His method was adopted
by everybody from bond investors and Wall Street banks to ratings agencies and
regulators. And it became so deeply entrenched—and was making people so much
money—that warnings about its limitations were largely ignored.
Then the model fell apart." The
article goes on to show that correlations are at the heart of the problem.
"The reason that
ratings agencies and investors felt so safe with the triple-A tranches was that
they believed there was no way hundreds of homeowners would all default on their
loans at the same time. One person might lose his job, another might fall ill.
But those are individual calamities that don't affect the mortgage pool much as
a whole: Everybody else is still making their payments on time.
But not all calamities
are individual, and tranching still hadn't solved all the problems of
mortgage-pool risk. Some things, like falling house prices, affect a large
number of people at once. If home values in your neighborhood decline and you
lose some of your equity, there's a good chance your neighbors will lose theirs
as well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree to
which one variable moves in line with another—and measuring it is an important
part of determining how risky mortgage bonds are."
I would highly recommend reading the
entire thing that gets much more involved with the
actual formula etc.
The “math error” might truly be have
been an error or it might have simply been a gamble with what was perceived as
miniscule odds of total market failure. Something similar happened in the case
of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management
formed by Nobel Prize winning economists and their doctoral students who took
similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is
ignorance in model building or risk taking using the model?
Bob Jensen's threads on the economic collapse and subsequent bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The Bailout's Hidden, Albeit Noble, Agenda (for
added details see Appendix Y)
This section of the Essay with additional details is reproduced in Appendix Y
--- Click Here
September 20, 2008 message from Ganesh M. Pandit, DBA, CPA, CMA
[profgmp@HOTMAIL.COM]
Yesterday, on CNBC, one of the anchors asked a
question: "Who is it that the U.S. Government is bailing out with billions
of dollars? The U.S. financial institutions or the governments of various
countries that are concerned about the impact of the bad loans and the
related financial instruments on the banks in their own countries?"
Does anybody have any opinion about that?
Ganesh M Pandit
Adelphi University
September 21, 2008 reply from Bob Jensen
Hi Ganesh,
The answer to your question turns out to be quite obscure and complicated as
Hank Paulson gives upwards of of
$500 billion in bailout funds to save CitiBank and
AIG while giving zero bailout funds to Washington Mutual Bank (the largest bank
failure in the history of the world), Lehman Brothers, and Merrill Lynch. I
think the answer is that both Hank Paulson and the U.S. Congress that so
willingly voted for the bailout funding have a Hidden Agenda that I've never
seen them explain to the public. If I'm correct,
it's a noble Hidden Agenda to save the United States of America!
If Hank Paulson or Nancy Pelosi really explained this Hidden Agenda it would
reveal how fragile the economic future of America has become and would be
counterproductive to virtually all of Barack Obama's spending promises during
his campaign. I do wish, however, that Paulson, Pelosi, and Obama would
explain it to Senator Waxman so he would shut his yap.
As events unfolded I've re-written my answer to you, Ganesh, due to questions
arising that suggest a U.S. Government Hidden Agenda in the Bailout Program that
commenced in late in 2008 after it became possible that the subprime mortgage
scandal was going to drag down both the U.S. economy into a total collapse from
which it might never emerge. Clues about a Hidden Agenda are suggested in the
following questions concerning bailout funding that has emerged. These questions
include the following: while Hank Paulson, as Secretary of the Treasury, was
responsible for obtaining and spending the bailout funds:
- Why did Paulson give $85 billion to bail out American Insurance
Group (AIG) and later increased it to over $100 billion in spite of
evidence that AIG's historic record of accounting fraud (hundreds of
billions), settlements by AIG's independent auditor, PwC, for
alleged complicity and incompetence in the audit (for which PwC
settled a $1.4 billion shareholder lawsuit for close to $100
million, and other lesser settlements such as Ernst & Young's
consulting settlement for $1 million? You can read more about AIG's
accounting fraud at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
- As of November 2008, 2008 there were
22 banks that Paulson elected to let fail rather than to bail
out. Why did Paulson give out upwards of $300 billion to bail out CitiBank while letting Washington Mutual (WaMu), Lehman Brothers,
and Merrill Lynch fail or be bought out for a dime on the dollar
that wiped out shareholders in WaMu, Lehman, and Merrill while
saving shareholders of CitiBank? It's important to note that
CitiBank's bailout commenced privately early in 2007 long before
Paulson ever suspected the U.S. Government would eventually bail out
any banks. Citicorp was seeking bailout funds from wealthy Arabs
long before it sought out government funding. Its also important to
note that WaMu is the largest FDIC failed bank in the history of the
world, while CitiBank is the largest saved bank in the history of
the world.
To answer such questions about why some banks (and AIG) get hundreds of
billions from Hank Paulson to save creditors and shareholders and other banks
get zero in bail out funds, I begin with some important definitions.
Chocolate
This is a mortgage issued on Main Street, USA that is highly likely to be
paid in full. If an occasional default takes place, a chocolate mortgage
balance is well below the collateral value of the real estate in
foreclosure such that the unpaid balance is fully paid by the sale of the
collateral.
Turd
This is a mortgage issued on Main Street, USA that is highly likely not to
be paid in full. If a common default takes place, a turd mortgage is well
below the collateral value of the real estate in foreclosure such that the
unpaid balance is not able to be paid in full when the property is
foreclosed. Furthermore, political pressure from Congress may prevent many
foreclosures of turd mortgages.
Mortgaged Back Securities (MBSs) that were sliced up into Collateralized Debt
Obligations (CDOs)
This is a box of supposed chocolates bundled into a single security with an
AAA investment grade rating that was sold by Wall Street investment banks
who purchased the mortgage notes and bundled them up into CDO securities
that were in term sold at relatively high profits to investors, particularly
investors in foreign nations.
Questions
What's a financial long bet and how does it win or lose?
What's the distinction between a long bet speculation versus hedge?
From The Wall Street Journal Accounting Weekly Review on April 1,
2011
Hedge Funds Had Bets Against Japan
by: Gregory Zuckerman and Tom Lauricella
Date: Mar 15, 2011
SUMMARY: The catastrophe in Japan has placed renewed focus on the
country's already fragile economy-and brought unexpected profits to
investors who have long bet that the nation eventually will be dragged
down by its debt problems.
DISCUSSION:
- What is a hedge fund? How is a hedge fund different from mutual
funds or individual investing? What type of investor would invest in
such funds? What are the risk levels involved with investing in
hedge funds?
- How did these hedge funds 'bet against Japan'? Why did some
investors think it wise to invest this way? How has the earthquake
in Japan impacted this type of investment?
- What were the issues facing Japan before the earthquake? How has
the earthquake changed the situation? What is the long-term outlook
for business in the country? What are Japan's borrowing levels? How
would this impact investment in the country by businesses? By
individuals?
"Hedge Funds Had Bets Against Japan," by: Gregory Zuckerman and Tom
Lauricella, The Wall Street Journal, March 15, 2011 ---
http://online.wsj.com/article/SB10001424052748703363904576200990107993916.html?mod=djem_jie_360
The catastrophe in Japan has placed renewed
focus on the country's already fragile economy—and brought unexpected
profits to investors who have long bet that the nation eventually will
be dragged down by its debt problems.
In recent years, a chorus of voices has warned
that Japan is facing an inevitable crisis to be brought on by a stagnant
economy, a shrinking population and the worst debt profile of any major
industrialized country.
Hedge-fund managers from Kyle Bass of Hayman
Advisors LP in Dallas to smaller firms like Commonwealth Opportunity
Capital have made money since the earthquake on long-held bets on
Japan's government and corporate bonds.
Though the economic toll of the earthquake is
far from clear, the immediate response in the financial markets has been
a decline in stock prices, with the Nikkei Stock Average down 7.8% in
two days (including Friday, when the quake hit near the end of the
trading day). The price for insuring against a default by Japan on its
government debt, a popular way to position for a financial crisis in
Japan, has jumped. But in a move that runs counter to the expectations
of some long-term Japan bears, the yen has strengthened on expectations
that Japanese investors and corporations will be buying yen as they
bring money home in coming weeks and months.
The price for insuring $10 million of Japanese
sovereign debt for five years in the credit-default-swap market soared
to $103,000 on Monday, from $79,000 on Friday, according to data
provider Markit.
Reflecting the skepticism about Japan's
outlook, even before the disaster, the net notional amount of Japanese
debt being insured in the swaps market had surged to $7.4 billion from
$4.1 billion a year ago, according to data from the Depository Trust &
Clearing Corp. through March 4. The number of contracts outstanding has
more than doubled.
Fresh DTCC data are due on Tuesday and will
include only the early effects of the earthquake.
Credit-default swaps of many corporate bonds
have become even more valuable, rewarding those that bet on them. Among
the biggest moves was in Tokyo Electric Power Co., owner of the
nuclear-power plants crippled by the earthquake.
Commonwealth Opportunity Capital, a $90 million
hedge fund in Los Angeles, made a profit of several million dollars on
Tokyo Electric on Monday, from an investment of less than $200,000. The
annual cost of protecting $10 million of Tokyo Electric's debt jumped to
$240,000 on Monday from $40,700 on Friday.
"Nobody wants bad things to happen to people,"
said Adam Fisher, who helps run Commonwealth Opportunity Capital. He
said the firm has been betting against Japanese corporate bonds for two
years. "But it shows how fragile that heavily levered nation is; there's
very little margin for error."
Betting against Japan has been a losing
proposition for many investors for years. Despite all the debt problems,
bond prices have continued to move higher partly because deflation, not
inflation, has been the concern. Also, domestic investors own most of
the government's debt and have been reluctant to sell.
But now, facing at least a short-term hit to
the economy from the earthquake and the likely need to issue more debt
to pay for reconstruction efforts, Japan is seeing its problems
magnified.
"Japan's choices are very, very bad," said John
Mauldin, president of Millennium Wave Advisors. "Japan has an aging
population, which is saving less, their savings rate will go negative
sometime in the next few years at which point they will have to
significantly reduce their spending, increase taxes or print money or
some combination of the three.
"In the grand scheme of things, does the
earthquake technically move it up further? Yes, but they were already
well down the path."
Continued in article
Jensen Comment
Note how long positions on national debt are often a losing proposition
unless they are hedges. In hedging situations these gains and losses are
offset by gains and losses on the hedged items to the extent that the
hedging contracts are effective. For example, a hedge fund might invest in
U.S. Treasury bonds paying a fixed rate. There is no cash flow risk on
interest payments or repayment of the face value of the bonds. However,
there is value risk since the price of these outstanding bonds in the
financial markets goes up and down daily. The hedge fund can lock in fixed
value by entering into a fair value hedge such as by entering into a plain
vanilla interest rate swap in which the fixed-amount interest payments are
swapped for variable rate payments. The value of the bonds plus the value of
the swap is thereby locked into a fixed value for which there is no value
risk. However, when hedging value risk the investor has inevitably taken on
cash flow risk. It's impossible to hedge both fair value risk and cash flow
risk. Investors must choose between one or the other.
Hedging against debt default entire is an extreme form of fair value
hedging and is usually done with a different type of hedging contract. Here
the investor is not so much concerned with interim interest payments (or
interim changes in value due to shifts in market interest rates) as he/she
is concerned with possible default on payback of the entire principal of the
debt. In other words it's more like insurance against a creditor declaring
bankruptcy to get out of repayment of all or a great portion of debt
repayment.
Credit Default Swap ---
http://en.wikipedia.org/wiki/Credit_default_swap
A credit default swap (CDS) can almost be
thought of as a form of insurance. If a borrower of money does not repay
her loan, she "defaults." If a lender has purchased a CDS on that loan
from an insurance company, the lender can then use the default as a
credit to swap it in exchange for a repayment from an insurance company.
However, one does not need to be the lender to profit from this
situation. Anyone (usually called a
speculator) can purchase a CDS. If a borrower
does not repay his loan on time and defaults not only does the lender
get paid by the insurance company, but the speculator gets paid as well.
It is in the lender's best interest that he gets his money back, either
from the borrower, or from the insurance company if the borrower is
unable to pay back his loan. However, it is in the speculator's best
interest that the borrower never repay his loan and default because that
is the only way that the speculator can then take that default, turn it
into a credit, and swap it for a cash payment from an insurance company.
A more technical way of looking at it is that a
credit default swap (CDS) is a
swap contract and agreement in which the
protection buyer of the CDS makes a series of payments (often referred
to as the CDS "fee" or "spread") to the protection seller and, in
exchange, receives a payoff if a credit instrument (typically a
bond or loan) experiences a
credit event. It is a form of
reverse trading.
A credit default swap is a bilateral contract
between the buyer and seller of protection. The CDS will refer to a
"reference entity" or "reference obligor", usually a corporation or
government. The reference entity is not a party to the contract. The
protection buyer makes quarterly premium payments—the "spread"—to the
protection seller. If the reference entity defaults, the protection
seller pays the buyer the
par
value of the bond in exchange for physical
delivery of the bond, although settlement may also be by cash or auction.
A default is referred to as a "credit
event" and includes such events as failure to
pay, restructuring and bankruptcy.[2]
Most CDSs are in the $10–$20 million range with maturities between one
and 10 years.
A holder of a bond may “buy protection” to
hedge its risk of default. In this way, a CDS is similar to credit
insurance, although CDS are not similar to or subject to regulations
governing casualty or life insurance. Also, investors can buy and sell
protection without owning any debt of the reference entity. These “naked
credit default swaps” allow traders to speculate on debt issues and the
creditworthiness of reference entities. Credit default swaps can be used
to create synthetic long and short positions in the reference entity.
Naked CDS constitute most of the market in
CDS.
In addition, credit default swaps
can also be used in capital structure arbitrage.
Credit default swaps have existed since the
early 1990s, but the market increased tremendously starting in 2003. By
the end of 2007, the outstanding amount was $62.2 trillion, falling to
$38.6 trillion by the end of 2008.
Most CDSs are documented using standard forms
promulgated by the
International Swaps and Derivatives Association (ISDA),
although some are tailored to meet specific needs.
Credit default swaps have many variations.[2]
In addition to the basic, single-name swaps, there are basket default
swaps (BDS), index CDS, funded CDS (also called a credit linked notes),
as well as loan only credit default swaps (LCDS). In addition to
corporations or governments, the reference entity can include a special
purpose vehicle issuing
asset backed securities.
Credit default swaps are not traded on an
exchange and there is no required reporting of transactions to a
government agency.
During the
2007-2010 financial crisis the lack of
transparency became a concern to regulators, as was the trillion dollar
size of the market, which could pose a
systemic risk to the economy.
In March 2010, the DTCC Trade
Information Warehouse (see
Sources of Market Data) announced it would
voluntarily give regulators greater access to its credit default swaps
database
Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes
bad due to having turds mixed in chocolates in a diversified portfolio, the
"counterparty" who purchased the CDO will recover the value fraudulently
invested in turds. On September 30, 2008 Gretchen Morgenson of The New
York Times aptly explained that the huge CDO underwriter of CDOs was the
insurance firm called AIG. She also explained that the first $85 billion
given in bailout money by Hank Paulson to AIG was to pay the counterparties
to CDS swaps. She also explained that, unlike its casualty insurance
operations, AIG had no capital reserves for paying the counterparties for
the the turds they purchased from Wall Street investment banks.
"Your Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson,
The New York Times, September 20, 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
Also see "A.I.G., Where Taxpayers’ Dollars Go to Die," The New York Times,
March 7, 2009 ---
http://www.nytimes.com/2009/03/08/business/08gret.html
What Ms. Morgenson failed to explain, when Paulson eventually gave over
$100 billion for AIG's obligations to counterparties in CDS contracts, was
who were the counterparties who received those bailout funds. It turns out
that most of them were wealthy Arabs and some Asians who we were getting
bailed out while Paulson was telling shareholders of WaMu, Lehman Brothers,
and Merrill Lynch to eat their turds.
You tube has a lot of videos about a CDS. Go to YouTube and read in the
phrase "credit default swap" ---
http://www.youtube.com/results?search_query=Credit+Default+Swaps&search_type=&aq=f
In particular note this video by Paddy Hirsch ---
http://www.youtube.com/watch?v=kaui9e_4vXU
Paddy has some other YouTube videos about the financial crisis.
Bob Jensen's discussion of accounting rules for credit default swaps
can be found under the C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Credit default swaps turned into a disaster for AIG and the U.S.
Government when black swans flew over in 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The Commission's Final Report ---
http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_full.pdf
(This report is really more of a misleading whitewash of government agencies
and Congress relative to the real causes of the subprime disaster.)
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's discussion of accounting rules for credit default swaps
can be found under the C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Collateralized Debt Obligation (CDO) ---
http://en.wikipedia.org/wiki/CDOs
"Sleight of hand: BofA moves dodgy Merrill derivatives to bank,"
by Mark December, The New York Post, October 21, 2011 ---
http://www.nypost.com/p/news/business/sleight_of_hand_uy96iNSbW99JHMRnbxgvfL
A plan by beleaguered Bank of America to foist
trillions of dollars of funky Merrill Lynch derivatives onto its
depositors is raising eyebrows on Wall Street.
The rarely used move will likely save the bank
millions of dollars in collateral but could put depositors’ cash behind
the eight ball.
The move also brought to light fissures between
the nation’s top banking regulators, the Federal Deposit Insurance Corp.
and the Federal Reserve, in the wake of new regulations meant to curb
the free-wheeling habits that fostered the worst crisis in a generation
back in 2008.
At issue is BofA’s decision to shift what
sources say is some $55 trillion in derivatives at Merrill Lynch to the
retail bank unit, which houses trillions in deposits insured by the
FDIC.
Critics say the move potentially imperils
everyday depositors by placing their money and savings at risk should
BofA run into trouble.
Sources say that the derivative transfers from
Merrill to BofA’s bank subsidiary were sparked by credit-rating
downgrades to the bank holding company and are meant to help BofA avoid
having to fork over more money to post as collateral to its derivative
counterparties.
BofA officials who have talked privately say
the move was requested by its counterparties and shouldn’t be perceived
as problematic for the bank giant, sources said.
A BofA spokesman declined to comment.
For weeks, BofA CEO Brian Moynihan has been
dogged about the health of one of the nation’s largest banking
franchises and its massive exposures to toxic debt after its shotgun
mergers with Merrill and Countrywide Financial during the credit crisis
three years ago.
Under Moynihan, BofA has been attempting to
right the bank’s ship and convince shareholders that the firm is healthy
and doesn’t need to raise fresh capital to backstop against potential
losses from faulty foreclosures and other mortgage-related lawsuits.
In the third quarter, BofA posted profit of
$6.23 billion, or 56 cents a share, down 15 percent from the same period
a year ago.
The bank’s shares gained 1 percent yesterday,
to $6.47. They are off 51 percent this year.
BofA’s third-quarter performance comes as fears
persist about the big bank’s ability to make money amid stiff economic
headwinds and a host of potential land mines that could see it shelling
out billions.
The derivatives transfer has irked officials at
the FDIC which, sources said, was informed of BofA’s plan to shift the
contracts to a retail deposit-taking entity just last week.
One source says that the FDIC is in the process
of reviewing the transfer and will relay its opinion to the Federal
Reserve.
But ultimately it’s the Fed that has the final
say on authorizing any transfers.
Neither the Fed nor the FDIC would comment on
BofA’s plans, which were first reported by Bloomberg.
Continued in article
Jensen Comment
What is more bizarre is that BofA really did not want to buy Merrill Lynch
at any price in the 2008 Bailout after digging deeper into the financial
records of CDO-battered Merrill Lynch.. Then Treasury Secretary Hank Paulson
for some unknown reason did not want throw Merrill Lynch under the bus in
the same manner that he threw Bear Stearns under the bus. In my opinion,
both of these giants should have been ground up in the tires of the bus.
After the subprime collapse then BofA CEO, Ken Lewis, most certainly did
not want to use BofA money to stop the free fall of Merrill Lynch. However,
U.S. Treasury Secretary Hank Paulson resorted to personal blackmail
according to Ken Lewis.
"Bank Chief Tells of U.S. Pressure to Buy Merrill Lynch," by Louise
Story and Jo Becker, The New York Times, June 11. 2009 ---
http://www.nytimes.com/2009/06/12/business/12bank.html
Of course once BofA decided to concede to Paulson's demands does not
condone the alleged behavior of BofA executives or Merrill Lynch executives
in closing the deal.
"Ken Lewis BLASTS Merrill Lynch-Bank Of America Merger Lawsuit, Calls It
'Implausible'," by David B. Caruso, August 21, 2010 ---
http://www.huffingtonpost.com/2010/08/21/ken-lewis-blasts-merrill-_n_690215.html
Actually BofA was in great shape well into the subprime mortgage crisis.
BofA had been smart enough in 2007 to hold none of the poisoned mortgages
and CDOs that plagued most of the big banks and brokerage houses like
Merrill Lynch. But in a twist of fate BofA became drawn to the fire sale
pricing of big outfits like Countrywide and Merrill Lynch that were dying
from subprime poison. BofA just did not look these gift horses in the mouth
until it was too late to get them out of the BofA stables. There's no excuse
for the stupid purchase of Countrywide which left BofA will millions of
defaulted mortgages. There is purportedly an excuse for the purchase of
Merrill Lynch. Ken Lewis was a chicken sh*t. Ironically, he eventually lost
his job anyway.
Now it appears that BofA wants to pass trillions in Merrill Lynch CDO
losses on to depositors who will pay for these losses in nickels and dimes
of daily bank charges for things like debit cards for the next 1,000 years.
In reality, the counterparties to the CDO contracts should've absorbed the
loan loss poison, but Treasury Secretary Paulson and President George Bush
did not want to piss off the investors who finance U.S. Government budget
deficits --- especially our friends in Asia and the Middle East and large
banks like Goldman that had bought these poison-laced CDO bonds.
Ironically, it is now BofA depositors who will now be paying off the bad
debts that rightfully belonged to sovereign funds of Asia and the Middle
East as well as derivatives contract counterparties at Goldman.
Credit Default Swaps (CDS) ---
http://en.wikipedia.org/wiki/Credit_default_swap
"Global Financial Stability Report: Old Risks, New Challenges"
International Monetary Fund
April 2013
http://www.docstoc.com/docs/154106200/IMF Report
The Global Financial Stability Report (GFSR)
assesses key risks facing the global financial system. In normal times,
the report seeks to play a role in preventing crises by highlighting
policies that may mitigate systemic risks, thereby contributing to
global financial stability and the sustained economic growth of the
IMF’s member countries. Risks to financial stability have declined since
the October 2012 GFSR, providing support to the economy and prompting a
rally in risk assets. These favorable conditions reflect a combination
of deeper policy commitments, renewed monetary stimulus, and continued
liquidity support. The current report analyzes the key challenges facing
financial and nonfinancial firms as they continue to repair their
balance sheets and unwind debt overhangs. The report also takes a closer
look at the sovereign credit default swaps market to determine its
usefulness and its susceptibility to speculative excesses. Lastly, the
report examines the issue of unconventional monetary policy (“MP-plus”)
and its potential side effects, and suggests the use of macroprudential
policies, as needed, to lessen vulnerabilities, allowing country
authorities to continue using MP-plus to support growth while protecting
financial stability.
The analysis in this report has been
coordinated by the Monetary and Capital Markets (MCM) Department under
the general direction of José Viñals, Financial Counsellor and Director.
The project has been directed by Jan Brockmeijer and Robert Sheehy, both
Deputy Directors; Peter Dattels and Laura Kodres, Assistant Directors;
and Matthew Jones, Advisor. It has benefited from comments and
suggestions from the senior staff in the MCM department.
Individual contributors to the report are: Ali
Al-Eyd, Sergei Antoshin, Serkan Arslanalp, Craig Botham, Jorge A.
Chan-Lau, Yingyuan Chen, Ken Chikada, Julian Chow, Nehad Chowdhury, Sean
Craig, Reinout De Bock, Jennifer Elliott, Michaela Erbenova, Jeanne
Gobat, Brenda González-Hermosillo, Dale Gray, Sanjay Hazarika, Heiko
Hesse, Changchun Hua, Anna Ilyina, Tommaso Mancini-Griffoli, S. Erik
Oppers, Bradley Jones, Marcel Kasumovich, William Kerry, John Kiff,
Frederic Lambert, Rebecca McCaughrin, Peter Lindner, André Meier, Paul
Mills, Nada Oulidi, Hiroko Oura, Evan Papageorgiou, Vladimir Pillonca,
Jaume Puig, Jochen Schmittmann, Miguel Segoviano, Jongsoon Shin, Stephen
Smith, Nobuyasu Sugimoto, Narayan Suryakumar, Takahiro Tsuda, Kenichi
Ueda, Nico Valckx, and Chris Walker. Martin Edmonds, Mustafa Jamal,
Oksana Khadarina, and Yoon Sook Kim provided analytical support. Gerald
Gloria, Nirmaleen Jayawardane, Juan Rigat, Adriana Rota, and Ramanjeet
Singh were responsible for word processing. Eugenio Cerutti, Ali
Sharifkhani, and Hui Tong provided database and programming support.
Joanne Johnson and Gregg Forte of the External Relations Department
edited the manuscript and the External Relations Department coordinated
production of the publication.
This particular issue draws, in part, on a
series of discussions with banks, clearing organizations, securities
firms, asset management companies, hedge funds, standards setters,
financial consultants, pension funds, central banks, national
treasuries, and academic researchers. The report reflects information
available up to April 2, 2013.
The report benefited from comments and
suggestions from staff in other IMF departments, as well as from
Executive Directors following their discussion of the Global Financial
Stability Report on April 1, 2013. However, the analysis and policy
considerations are those of the contributing staff and should not be
attributed to the Executive Directors, their national authorities, or
the IMF.
Jensen Comment
Note that much of this report deals with the state of Credit Default Swaps.
CitiBank Foreign Investment Shareholders
Although CitiBank is one of the largest banks in the world with millions of
shareholders, it's important to note that CitiBank in particular has a high
proportion of wealthy Arabs and some wealthy Chinese investors who invested
billions in 2007 and 2008 to help keep CitiBank from failing. Hence these
wealthy Arab and Chinese investors not only bought MBS-CDO investments that
unexpectedly contained turds, they also bought heavily into CitiBank common
stock that they predicted would be a high return investment. Saudi Arabian
prince Alwaleed bin Talal, has a major stake (billions of dollars) in
Citigroup.
Recently, the investment arm of the Abu Dhabi
government agreed to invest $7.5 Billion into Citigroup – a company that
makes its money through riba. The move exposes the reality of the “Islamic
Banking” initiative supported by the same government. Shar’iah compliant
transactions cannot come into reality without courts and governments that
solely abide by what Allah (swt) has revealed. Islamic economics cannot
exist without an Islamic State.
"CitiBank Bailout: A Failed Investment," The Politically Aware Muslim,"
December 14, 2007 ---
http://awaremuslim.blogspot.com/2007/12/citibank-bailout-failed-investment.html
"CitiBank Bailout is $14 B From China, Kuwait," by Henry Sender,
Financial Times (UK), January 11 2008 ---
http://johnibii.wordpress.com/2008/01/12/citibank-bailout-is-14-b-from-china-kuwait/
Subprime Mortgage Fraud as
Explained by Forrest Gump
Mortgage Backed Securities are like boxes of
chocolates. Criminals on Wall Street and one particular U.S. Congressional
Committee stole a few chocolates from the boxes and replaced them with turds.
Their criminal buddies at Standard & Poors rated these boxes AAA Investment
Grade chocolates. These boxes were then sold all over the world to investors.
Eventually somebody bites into a turd and discovers the crime. Suddenly nobody
trusts American chocolates anymore worldwide. Hank Paulson now wants the
American taxpayers to buy up and hold all these boxes of turd-infested
chocolates for $700 billion dollars until the market for turds returns to
normal. Meanwhile, Hank's buddies, the Wall Street criminals who stole all the
good chocolates are not being investigated, arrested, or indicted. Momma always
said: "Sniff the chocolates first Forrest." Things generally don't pass the
smell test if they came from Wall Street or from Washington DC.
Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html
Unbooked Entitlements Debt
This is the amount owing for future entitlement obligations of the United
States for which money has not been borrowed or set aside from taxes to meet
these obligations, including unfunded military retirement pay, Veterans
Administration benefits, Social Security benefits, Medicare benefits, the
Medicare drug program, etc. The amount is unknown, but experts set this
obligation between $40 and $65 trillion --- See
Appendix A.
Booked National Debt
This is the debt of the United States that has been borrowed and interest
expense is charged for debt that has not been paid. This booked national
debt is now over $10 trillion. This was growing at a rate of nearly $4
billion per day, but it is much higher now that the bail out funds are being
borrowed as well and are not funded by taxpayers.
The National Debt has continued
to increase an average of $3.93 billion per day since September 28, 2007!
The National Debt Amount This Instant (Refresh your browser
for updates by the second) ---
http://www.brillig.com/debt_clock/
History of the National Debt ---
http://en.wikipedia.org/wiki/National_Debt
Entitlements ---
http://faculty.trinity.edu/rjensen/entitlements.htm
History of the National Debt ---
http://en.wikipedia.org/wiki/National_Debt
Foreign Investment Bankers (FIBs)
I define this group as comprised of
foreign sovereign wealth funds, foreign banks, and foreign individuals
holding more than a billion of U.S. Treasury Bonds that comprise most of the
$10 trillion current booked U.S. National Debt. These foreign "bankers" now
hold nearly 50% of what the U.S. Government currently owes. We rely heavily
on them to also buy the new U.S. Treasury borrowings that average well over
$4 billion per day. They buy this debt at relatively low interest rates due
to the historic tradition of U.S. debt as being "risk free" ---
http://en.wikipedia.org/wiki/Risk-free_interest_rate
Though a truly risk-free asset exists only in
theory, in practice most professionals and academics use short-dated
government
bonds of the currency in question. For USD
investments, usually
US Treasury bills are used, while a common
choice for EUR investments are
German government bills
or
Euribor rates.
The mean real interest rate of US treasury bills during the 20th century
was 0.9% p.a. (Corresponding figures for Germany are inapplicable due to
hyperinflation during the 1920s.)
These securities are considered to be risk-free
because the likelihood of these governments
defaulting is extremely low, and because the
short maturity of the bill protects the investor from interest-rate risk
that is present in all
fixed rate bonds (if interest rates go up soon
after the bill is purchased, the investor will miss out on a fairly
small amount of
interest before
the bill matures and can be reinvested at the new interest rate).
Since this interest rate can be obtained with
no risk, it is implied that any additional risk taken by an investor
should be rewarded with an interest rate higher than the risk-free rate
(on an after-tax basis, which may be achieved with preferential tax
treatment; some local government US bonds give below the risk-free
rate).
Since news of the subprime mortgage scandal and the roughly $1 trillion
being borrowed for the bail out of the financial industry, the U.S. Treasury
bonds are becoming more risky in terms of the rising slope of their yield
curves. This means that the cost of borrowing more National Debt is
increasing.
The 2008 Bailout's Hidden Agenda
I speculate that the Hidden Agenda of Hank Paulson, Nancy Pelosi, Senator
Dodd, Senator Reid, and others directly engaged in obtaining the bail out
funding is to first save the FIBs, those foreign investors upon whom we
depend too heavily for obtaining both new and rolled over National Debt
at relatively low (and less steep yield curve) interest rates. The FIBs hold nearly
$5 trillion of the present National Debt and buy nearly half of the $4+
billion debt added each day on average to the National Debt. If the FIBs
commence to demand higher interest rates for new U.S. Treasury Bonds and for
maturing bonds that need to be rolled over (refinanced), the United States
of America is in deep, deep trouble because for the last eight years of the
Bush Administration, the U.S. Government's credit bubble has been ballooning
to the point of bursting when the growth in GDP can no longer absorb such
billions in debt added each day.
For evidence of this Hidden Agenda first consider the $100 billion of bailout
funds give to AIG at the blink of an eye. If AIG declared bankruptcy and could
not meet its CDS credit swap obligations to reimburse chocolate investors
who got turds, the investors hit the hardest would be the FIBs foreign investors
who now hold the lion's share of our National Debt. When Wall Street either
knowingly or unknowingly sold mortgage backed security turds and chocolates, the
FIBs would be very, very angry if we did not pay billions to buy back those
turds or otherwise repay the FIBs for their losses. Hence we gave AIG the
bailout funds to make good on the credit derivate insurance against bad mortgage
investments. This probably also accounts for the bailout funding given to Bear
Stearns.
Apparently Washington Mutual, Lehman Brothers, and Merrill Lynch were stupid
enough to keep high proportions of turds in their own portfolios. Perhaps these
were CDO investments that they had not yet unloaded on the FIBs. Whatever the
reason, wiping out the shareholder value in those companies would not impact the
cost of our National Debt nearly as much as if we let AIG fail. Since the
"Hidden Agenda" was to hold down the cost of our National Debt, AIG got bailed
out, and the others got nothing other than what it took the FDIC to make good on
banking demand deposits (checking accounts) held by customers. For example,
unlike AIG shareholders, the WaMu shareholders were wiped out.
Now Consider Citibank. For several years CitiBank has been in trouble and
FIBs from the Middle East and Asia have been investing billions in CitiBank
common stock. They in fact held large voting blocks of power in CitiBank. If
Hank Paulsen did not guarantee upwards of $300 million for the mortgage turds
held by CitiBank, the FIB foreign investors in CitiBank would be wiped out much
like the investors in WaMu were wiped out. But the "Hidden Agenda" dictates that
we keep the FIBs happy since they hold nearly 50% of our $10 trillion National
Debt.
If the FIBs decided to significantly raise the interest rates required to
roll over maturing National Debt and to purchase new U.S. Treasury Bonds, the
entire future of the United States of America is at stake. All the promises,
dreams, and plans of our new President Obama and the huge majority of Democratic
Party legislators would be dashed since the U.S. worldwide interest rate would
be much higher and no longer be viewed as risk-free. Programs such as national
health care, increased aid to states for human services, and a modernized
military force would be dashed all due to turds created by Turds on Main Street
such as mortgage brokers and banks on Main Street and Wall Street scammers who
sold them off to the FIBs and others in chocolate boxes.
I’ve often wondered why Hank Paulson never tried to explain this in the
Congressional Hearings questioning his judgment for bailing out only selected
outfits like Bear Stearns, AIG, and CitiBank. Now I think I have an answer, and
if you discover anybody who has written something similar I would really like to
know, because the media still does not seem to understand why CitiBank (the
largest saved bank in the world) is more important to the Treasury Department
than Washington Mutual (the largest bank failure in the world).
All of this of course begs the question of why the
Bailout's Hidden Agenda remains hidden when Hank Paulsen and other
leaders are asked to explain why the "fat cats" of AIG and CitiBank get bailed
out for upwards of $500 billion and the small shareholders of WaMu, Lehman, and
Merrill Lynch are told to take a hike? I think the reason is that virtually all
our leaders in Washington DC prefer not to explain or dwell upon how our booked
National Debt and our unbooked entitlement obligations have put the United
States of America in a terribly deep hole in which the
only hope of crawling back out rests in the hands of the foreign investors,
particularly those in China (which owns nearly 10% of the Federal Debt), Japan,
Singapore, and wealthy Middle Eastern oil producing states. The best we can hope
for now is continued rolling over of U.S. Treasury Bonds at the lowest possible
rates such tat our low cost of capital remains lower than the long-term fixed
rates of interest needed to revive the real estate market in the U.S. See
Appendix A.
If the cost of the National Debt should rise higher than the low interest
rate that the U.S. Government may soon be setting for home owners refinancing
their mortgages and buyers seeking new long term mortgages, then the only way
out of the deep hole may be slow the rate of increase in the National Debt with
destructive inflation that comes with printing money to pay the difference
between the borrowing rates and the spending rates of the U.S. Government.
Zimbabwe has shown us how destructive inflation can become when a nation tries
to pay its debts by simply printing more currency.
Hence I conclude that the Hidden Agenda is a noble cause to save the good
faith and credit of the United States when the National Debt is increasing $4
billion to $6 billion a day and greater deficits to come when the U.S. Congress
intends to deficit finance over the next eight years at unsurpassed billions
separating tax revenues from program expenditures.
Even if the FIBs continue to give the U.S. a great deal on borrowing rates
for the National Debt, we are in deeper trouble due to our unbooked entitlements
debt that will be coming increasingly expensive as the baby boomers age ---
http://faculty.trinity.edu/rjensen/entitlements.htm
"Uncle Sam's Credit Line Running Out," by Randall Forsyth, Barron's,
November 11, 2008 ---
http://online.barrons.com/article/SB122633310980913759.html
We Can't Tax Our Way Out of the Entitlement
Crisis," by R. Glenn Hubbard, The Wall Street Journal, August 21,
2008; Page A13 ---
http://online.wsj.com/article/SB121927694295558513.html
We can also secure a firm
financial footing for Social Security (and Medicare) without choking off
economic growth or curtailing our flexibility to pursue other spending
priorities. Three actions are essential: (1) reduce entitlement spending
growth through some form of means testing; (2) eliminate all nonessential
spending in the rest of the budget; and (3) adopt policies that promote
economic growth. This 180-degree difference from Mr. Obama's fiscal plan
forms the basis of Sen. McCain's priorities for spending, taxes and health
care.
The problem with Mr. Obama's
fiscal plans is not that that they lack vision. On the contrary, the vision
is plain enough: a larger welfare state paid for by higher taxes. The
problem is not even that they imply change. The problem is that his plans
are statist.
While the candidate is
sending a fiscal "Ich bin ein Berliner" message to Americans, European
critics of his call for greater spending on defense are the canary in the
coal mine for what lies ahead with his vision for the United States.
Professor R. Glenn Hubbard is Dean of the
College of Business at Columbia University and a member of the President's
Council of Economic Advisors.
Bob Jensen's threads on the "Entitlement
Crisis" are at
http://faculty.trinity.edu/rjensen/entitlements.htm
Bob Jensen's threads on entitlements are at
http://faculty.trinity.edu/rjensen/entitlements.htm
It may well be that the U.S. Treasury pledge most of the bailout money to AIG
and CitiBank because "they are just too big to fail" in a sense that failure of
these two might bring down the entire world wide financial house of cards. I
just don't think this is the case since CitiBank could've saved the CitiBank
creditors without saving the shareholders. This is essentially what happened
when Freddie Mac and Fannie Mae shareholders were wiped out.
Question
What's the significance of the off-balance sheet liabilities in CitiBank versus
the U.S. Treasury?
Answer
Both CitiBank and the U.S. Treasury have managed to keep more of their debts off
balance sheet than they have booked on the balance sheet. According to the
former top accountant in the U.S., David Walker, the total debt of the U.S. is
about $55 trillion (now in excess of $100 trillion), of which $11 trillion is booked on the balance sheet as
National Debt --- See Appendix A.
The total debt of CitiBank is over $2 trillion with slightly over half being
booked on the balance sheet. Some analysts argued that Citibank had a handle on
its total debt before the meltdown, but this is no longer the case ---
http://www.monkeybusinessblog.com/mbb_weblog/2008/07/citi-off-balanc.html
What's sad is that even saving the shareholders in Citibank in order to
prevent shareholder wipeouts of the shareholders from China, Singapore, Japan,
and the Middle East, that may not be enough to keep the interest rates on the
U.S. National Debt as low as we would like.
"The issuance issue," The Economist, Nov. 2--Dec. 5, 2008, Page 77 ---
http://www.economist.com/finance/displaystory.cfm?story_id=12700894
“ROLL up, roll up. Get your government bonds here.
They may not pay much, but they’re safe. Buy ’em now in case stockmarkets
don’t last.”
As the recession deepens, finance ministers round
the world may be forced to resort to the tactics of the market stallholder.
Politicians hope that deficit financing will be the way to stimulate the
economy. But someone has to buy all those bonds.
They are easy to sell at the moment. The prices of
risky assets like shares and corporate bonds have been plunging. Banks are
so desperate for the security of government paper that they are accepting
yields close to zero on three-month Treasury bills. Yields on American
ten-year Treasury bonds have fallen to around 3%, their lowest in a
generation. British government bonds, or gilts, with the same maturity are
returning about 4%, despite the rise in the budget deficit planned by
Alistair Darling, the chancellor.
Government-bond markets are benefiting from the
deteriorating economic outlook, which is leading some forecasters to predict
both a recession and a brief period of deflation in 2009. A nominal yield of
3-4% looks attractive in real terms if prices are falling.
A surge in supply could be matched by higher
demand. The potential precedent is Japan, where nearly two decades of fiscal
deficits and a deteriorating debt-to-GDP ratio have not stopped investors
from buying bonds at yields of less than 2%.
But is this really an encouraging example? Most
Americans and Europeans would not consider low government-bond yields to be
adequate compensation for the nearly two decades of sluggish economic growth
that Japan has suffered. And Japan is different from America and Britain: it
runs current-account surpluses and thus has not been dependent on foreign
capital. The Anglo-American economies rely on the kindness of strangers.
There has been no sign, so far, that foreigners are
tiring of funding the American deficit. Indeed, the dollar has risen against
most currencies (the yen is a notable exception) in recent months. Being the
world’s largest economy has helped, as has the flight out of emerging-market
currencies. But Britain does not have the same advantages. The pound was
treated for many years as a high-yielding version of the euro. That is no
longer so after recent rate cuts and sterling has suffered against both the
euro and the dollar.
Mr Islam reckons overseas investors have been
buying around 30% of recent gilt issuance. Given the losses they have
already suffered through the pound’s fall, will they step up their
purchases, especially as the growth rate of global foreign-exchange reserves
is slowing?
So domestic investors may be required to shoulder
the burden. Pension funds may be eager to add to their holdings, given the
losses they have suffered on shares and in alternative asset classes, such
as hedge funds and private equity.
But retail investors may also be needed. A rise in
the savings rate is widely forecast as the economy slows (although this is
likely to be driven by a fall in borrowing more than by a surge in savings
itself). If, as many economists forecast, the Bank of England cuts
short-term rates to 2%, British savers could be tempted by the allure of
government bonds yielding 3-4%. The same may be true in America, where
money-market funds are already offering paltry returns. This will be a big
change of habit: according to Morgan Stanley, America’s net Treasury-bond
purchases, outside those by the finance industry, have been zero since 1992.
Perhaps a more cautious generation of investors
will rediscover the virtues of government debt, as they did in the 1930s and
1940s. “People will be buying bonds as Christmas presents,” predicts Matt
King, a credit strategist at Citigroup.
Paradoxically, the real problem for governments may
only occur if they manage to revive their economies. At that point,
deflation worries will disappear and investors will switch to riskier
assets. Given the deficits in both Britain and America, it seems unlikely
that any cyclical rebound will be strong enough to bring the budget back to
balance. In 2010 or 2011, issuing government bonds may prove a much harder
(and more expensive) task.
This above section of the Essay with additional details and replies from
readers is reproduced in
Appendix Y --- Click Here
Great Public Sector Reform Speech ---
http://njn.net/television/webcast/ontherecord.html
The Bailout's Hidden Noble and Ignoble Agendas
Aesop: We hang the petty thieves and appoint
the great ones to public office.
Bankers bet with their bank's capital, not
their own. If the bet goes right, they get a huge bonus; if it
misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital
Louria Hahn, "Missing: How Poor Risk-Management Techniques
Contributed to the Subprime Mess," CFO Magazine, March 2008,
Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to bail out these crooks with taxpayer
funds makes it all the worse.
The bourgeoisie can
be termed as any group of people who are discontented with what they
have, but satisfied with what they are
Nicolás Dávila |
That some bankers have ended up in prison is not a
matter of scandal, but what is outrageous is the fact that all the others are
free.
Honoré de Balzac
In the Opinion of Economics Professor Meltzer from Carnegie-Mellon University
"Preventing the Next Financial Crisis: Don't be fooled by the bond
market. Banks are holding prices down because they can buy Treasurys with free
money from the Fed," The Wall Street Journal, by Alan H. Meltzer,
October 22, 2009 ---
http://online.wsj.com/article/SB10001424052748704224004574489251193581802.html?mod=djemEditorialPage
The United States is headed toward a new
financial crisis. History gives many examples of countries with high actual
and expected money growth, unsustainable budget deficits, and a currency
expected to depreciate. Unless these countries made massive policy changes,
they ended in crisis. We will escape only if we act forcefully and soon.
As long ago as the 1960s, then French
President Charles de Gaulle complained that the U.S. had the "exorbitant
privilege" of financing its budget deficit by issuing more dollars. Massive
purchases of dollar debt by foreigners can of course delay the crisis, but
today most countries have their own deficits to finance. It is unwise to
expect them, mainly China, to continue financing up to half of ours for the
next 10 or more years. Our current and projected deficits are too large
relative to current and prospective world saving to rely on that outcome.
Worse, banks' idle reserves that are
available for lending reached $1 trillion last week. Federal Reserve
Chairman Ben Bernanke said repeatedly in the past that excess reserves would
run down when banks and other financial companies repaid their heavy
short-term borrowing to the Fed. The borrowing has been repaid but idle
reserves have increased. Once banks begin to expand loans or finance even
more of the massive deficits, money growth will rise rapidly and the dollar
will sink to new lows. Do we have to wait for a crisis before we replace
promises with effective restraint?
Many market participants reassure
themselves that inflation won't come by noting the decline in yields on
longer-term Treasury bonds and the spread between nominal Treasury yields
and index-linked TIPS that protect against inflation. They measure
expectations of higher inflation by the difference between these two rates,
and imply long-term investors aren't demanding higher interest rates to
protect themselves against it. But those traditional inflation-warning
indicators are distorted because the Fed lends money at about a zero rate
and the banks buy Treasury securities, reducing their yield and thus the
size of the inflation premium.
Further, the Fed is buying massive amounts
of mortgages to depress and distort the mortgage rate. This way of
subsidizing bank profits and increasing their capital bails out these
institutions but avoids going to Congress for more money to do so. It
follows the Fed's usual practice of protecting big banks instead of the
public.
The administration admits to about $1
trillion budget deficits per year, on average, for the next 10 years. That's
clearly an underestimate, because it counts on the projected $200 billion to
$300 billion of projected reductions in Medicare spending that will not be
realized. And who can believe that the projected increase in state spending
for Medicaid can be paid by the states, or that payments to doctors will be
reduced by about 25%?
While Chinese government purchases of our
debt may delay a dollar and debt crisis, they also delay any effective
program to reduce the size of that crisis. It is far better to begin
containing the problem before we blow a hole in the dollar and start another
downturn.
A weak economy is a poor time to reduce
current government spending or raise tax rates, but we don't require
draconian immediate changes. We do need a fully specified, multi-year
program to restore fiscal probity by reducing spending, and a budget rule
that limits the size and frequency of deficits. The plan should be announced
in a rousing speech by the president. The emphasis should be on reducing
government spending.
The Obama administration chooses to blame
outsize deficits on its predecessor. That's a mistake, because it hides a
structural flaw: We no longer have any way of imposing fiscal restraint and
financial prudence. Federal, state and local governments understate future
spending and run budget deficits in good times and bad. Budgets do not
report these future obligations.
Except for a few years in the 1990s, both
parties have been at fault for decades, and the Obama administration is one
of the worst offenders. Its $780 billion stimulus bill, enacted earlier this
year, has been wasteful and ineffective. The Council of Economic Advisers
was so pressed to justify the spending spree that it shamefully invented a
number called "jobs saved" that has never been seen before, has no agreed
meaning, and no academic standing.
One reason for the great inflation of the
1970s was that the Federal Reserve gave primacy to reducing unemployment.
But attempts to tame inflation later didn't last, and the result was a
decade of high and rising unemployment and prices. It did not end until the
public accepted temporarily higher unemployment—more than 10.5% in the fall
of 1982—to reduce inflation.
Another error of the 1970s was the
assumption there was a necessary trade-off along a stable Phillips Curve
between unemployment and inflation—in other words, that more inflation was
supposed to lower unemployment. Instead, both rose. The Fed under Paul
Volcker stopped making those errors, and inflation fell permanently for the
first time since the 1950s.
Both errors are back. The Fed and most
others do not see inflation in the near term. Neither do I. High inflation
is unlikely in 2010. That's why a program beginning now should start to
lower excess reserves gradually so that the Fed will not have to make its
usual big shift from excessive ease to severe contraction that causes a
major downturn in the economy.
A steady, committed policy to reduce
future inflation and lower future budget deficits will avoid the crisis that
current policies will surely bring. Low inflation and fiscal prudence is the
right way to strengthen the dollar and increase economic well being.
Dr. Meltzer is professor of political economy at Carnegie Mellon
University and the author of the multi-volume "A History of the Federal
Reserve" (University of Chicago, 2004 and 2010).
Breaking the Bank Frontline
Video
In Breaking the Bank, FRONTLINE producer Michael Kirk
(Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile
interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to
reveal the story of two banks at the heart of the financial crisis, the rocky
merger, and the government’s new role in taking over — some call it
“nationalizing” — the American banking system.
Simoleon Sense, September 18,
2009 ---
http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"The Triumph of Propaganda," by Nemo Almen, American Thinker,
January 2, 2011 ---
http://www.americanthinker.com/2011/01/the_triumph_of_propaganda.html
Does anyone
remember what happened on Christmas Eve last year? In one of the most
expensive Christmas presents ever, the government
removed the $400 billion limit on their Fannie and
Freddie guaranty. This act increased taxpayer liabilities by
six trillion dollars; however, the news was lost
in the holiday cheer. This is one instance in a broader campaign to
manipulate the public perception, gradually depriving us of independent
thought.
Consider another example: what news story broke on April 16, 2010? Most of
us would say the SEC's
lawsuit against Goldman Sachs. Goldman is the
market leader in "ripping the client's face off," in this instance creating
a worst-of-the-worst pool of securities so Paulson & Co could bet against
it. Many applauded the SEC for this action. Never mind that singling out
one vice president (the "Fabulous Fab") and one instance of fraud is like
charging Al Capone with tax evasion. The dog was wagged.
Very
few caught the real news that day, namely the damning
complicity of the SEC in the Stanford Ponzi
scheme. Clearly, Stanford was the bigger story, costing thousands of
investors
billions of dollars while Goldman later settled
for half a
billion. Worse, the SEC knew about Stanford since
1997, but instead of shutting it down, people left the SEC to
work
for Stanford. This story should have caused
widespread outrage and reform of the SEC; instead it was buried in the back
pages and lost to the public eye.
Lest we
think the timing of these was mere coincidence, the Goldman lawsuit was
settled on July 15, 2010, the same day the financial reform package
passed. The government threw Goldman to the
wolves in order to hide its own shame. When the government had its desired
financial reforms, it let Goldman settle. These examples demonstrate a
clear pattern of manipulation. Unfortunately, our propaganda problem runs
far deeper than lawsuits and Ponzi schemes.
Here is a
more important question: which companies own half of all
subprime and
Alt-A (liar loan) bonds? Paul Krugman writes that
these companies were "mainly out of the picture during the housing bubble's
most feverish period, from 2004 to 2006. As a result, the agencies played
only a minor role in the epidemic of bad lending."[iii] This phrase is
stupefying. How can a pair of companies comprise half of a market and yet
have no major influence in it? Subprime formed the core of the financial
crisis, and Fannie and Freddie (the "agencies") formed the core of the
subprime market. They were not "out of the picture" during the subprime
explosion, they were the picture. The fact that a respectable Nobel
prize-winner flatly denies this is extremely disturbing.
Amazingly, any attempt to hold the government accountable for its role in
the subprime meltdown is dismissed as right-wing
propaganda. This dismissal is left-wing
propaganda. It was the government that initiated securitization as a tool
to dispose of
RTC assets. Bill Clinton ducks all
responsibility, ignoring how his administration imposed arbitrary
quotas on any banks looking to merge as Attorney
General Janet Reno "threatened legal action against lenders whose racial
statistics raised her suspicions."[iv] Greenspan fueled the rise of
subprime derivatives by lowering rates,[v] lowering reserves,[vi] and
beating down reasonable
opposition. And at the center of it all were
Fannie and Freddie
bribing officials, committing
fraud,
dominating private-sector
competition, and expanding to a
six-trillion-dollar debacle. The fact that these facts are dismissed as
propaganda shows just how divorced from reality our ‘news' has become. Yes,
half of all economists are employed by the
government, but this is no reason to flout one's
professional responsibility. As a nation we need to consider all the facts,
not just those that are politically expedient.
Continued in article
Nemo Almen is the author of
The Last Dodo: The Great Recession and our Modern-Day Struggle for Survival.
Bob Jensen's Rotten to the
Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Is stock market still a chump's game? Small
investors won't have a fair shot until a presumption of integrity is restored.
It's not clear that Obama's proposed remedy will resolve the conflicts," by
Eliot Spitzer, Microsoft News, August 19, 2009 ---
http://articles.moneycentral.msn.com/Investing/Extra/is-stock-market-still-a-chumps-game.aspx
Link forwarded by Steve Markoff
[smarkoff@KIMSTARR.ORG]
One of America's great
accomplishments in the last half-century was the so-called "democratization"
of the financial markets.
No longer just for the upper
crust, investing became a way for the burgeoning middle class to accumulate
wealth. Mutual funds exploded in size and number, 401k plans made savings
and investing easy, and the excitement of participating in the growth of our
economy gripped an ever larger percentage of the population.
Despite a backdrop of
doubters -- those who knowingly asserted that outperforming the average was
an impossibility for the small investor -- there was a growing consensus
that the rules were sufficient to protect the mom-and-pop investor from the
sharks that swam in the water.
That sense of fair play in
the market has been virtually destroyed by the bubble burstings and market
drops of the past few years.
Recent rebounds
notwithstanding, most people now are asking whether the system is
fundamentally rigged. It's not just that they have an understandable
aversion to losing their life savings when the market crashes; it's that
each of the scandals and crises has a common pattern: The small investor was
taken advantage of by the piranhas that hide in the rapidly moving currents.
And underlying this pattern is
a simple theme: conflicts of interest that violated the duty the market
players had to their supposed clients.
It is no wonder that
cynicism and anger have replaced what had been the joy of participation in
the capital markets.
Take a quick run through a
few of the scandals:
-
Analysts at major
investment banks promote stocks they know to be worthless, misleading
the investors who rely on their advice yet helping their
investment-banking colleagues generate fees and woo clients.
-
Ratings agencies slap AAA
ratings on debt they know to be dicey in order to appease the issuers --
who happen to pay the fees of the agencies, violating the rating
agency's duty to provide the marketplace with honest evaluations.
-
Executives receive outsized
and grotesque compensation packages -- the result of the perverted
recommendations of compensation consultants whose other business depends
upon the goodwill of the very CEOs whose pay they are opining upon, thus
violating the consultants' duty to the shareholders of the companies for
whom they are supposedly working.
-
Mutual funds charge
exorbitant fees that investors have to absorb -- fees that dramatically
reduce any possibility of outperforming the market and that are set by
captive boards of captive management companies, not one of which has
been replaced for inadequate performance, violating their duty to guard
the interests of the fund investors for whom they supposedly work.
-
"High-speed trading"
produces not only the reality of a two-tiered market but also the
probability of front-running -- that is, illegally trading on
information not yet widely known -- that eats into the possible profits
of the retail clients supposedly being served by these very same market
players, violating the obligation of the banks to get their clients
"best execution" without stepping between their customers and the best
available price.
-
AIG (AIG,
news,
msgs) is bailed out, costing taxpayers
tens of billions of dollars, even though (as we later learned) the big
guys knew that AIG was going down and were able to hedge and cover their
positions. Smaller investors are left holding the stock, and all of us
are left picking up the tab.
The unifying theme is
apparent: Access to information and advice, the very lifeblood of a level
playing field, is not where it needs to be. The small investor still doesn't
have a fair shot.
While there have been
case-specific remedies, the aggregate effect of all the scandals is still to
deny the market the most essential of ingredients: the presumption of
integrity.
The issue confronting those
who wish to solve this problem is that there really is no simple fix.
Bob Jensen's threads on the economic crisis
are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"JPMorgan (read that Chase Bank) faces SEC
lawsuit," by Aline van Duyn and Francesco Guerrera, Financial Times, May 8,
2009 ---
JPMorgan Chase may be sued
by US regulators for violating securities laws and market rules related to
the sale of bonds and interest-rate swaps to Jefferson County, Alabama.
The potential Securities and
Exchange Commission action is the latest twist in a complex debt financing
saga which has already led to charges against Jefferson County officials and
which has left the municipality struggling to avoid default on over $3bn of
debt, much of it taken on to improve its sewage system.
JPMorgan said in a
regulatory filing, made late on Thursday just as the results of bank stress
tests were being released, that it had been told about the SEC action on
April 21. It said it “has been engaged in discussions with the SEC staff in
an attempt to resolve the matter prior to litigation”. The bank had no
further comment on Friday.
Jefferson County is one of
the most indebted municipalities in the US due to its expensive overhaul of
its sewage system. JPMorgan is one of the lenders which has repeatedly
extended the deadline on payments due by Jefferson County on its debt and
derivatives.
A law is currently being
considered that would create a new tax which would provide revenues to pay
the sewer debt. If Jefferson County defaults, it would be the biggest by a
US municipality, dwarfing the problems faced by California’s Orange County
in the 1990s.
The mayor of Birmingham,
Alabama, and two of his friends were last year charged by US regulators in
connection with an undisclosed payment scheme related to municipal bond and
swap deals.
The SEC alleged that Larry
Langford, the mayor, received more than $156,000 in cash and benefits from a
broker hired to arrange bond offerings and swap agreements on behalf of
Jefferson County, where Birmingham is located.
Although the details of the
SEC investigation are not known, it is likely to be related to the payment
scheme through which banks like JPMorgan paid fees to local brokers at the
request of Jefferson County.
The credit crisis has
brought to light numerous problems in the municipal bond markets. Many
borrowers relied on bond insurance to sell their deals, and the collapse in
the credit ratings of bond insurers has made it difficult for many to raise
funds or to do so at low interest rates.
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll,
The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print
The legislation's guidelines for crafting the
rescue plan were clear: the TARP should protect home values and consumer
savings, help citizens keep their homes and create jobs. Above all, with the
government poised to invest hundreds of billions of taxpayer dollars in
various financial institutions, the legislation urged the bailout's
architects to maximize returns to the American people.
That $700 billion bailout has since
grown into a more than $12 trillion commitment by
the US government and the Federal Reserve. About
$1.1 trillion
of that is taxpayer money--the TARP money and an additional $400 billion
rescue of mortgage companies Fannie Mae and Freddie Mac. The TARP now
includes twelve separate programs, and recipients range from megabanks like
Citigroup and JPMorgan Chase to automakers Chrysler and General Motors.
Seven months in, the bailout's impact is
unclear. The Treasury Department has used the
recent "stress test" results it applied to
nineteen of the nation's largest banks to suggest that the worst might be
over; yet the
International Monetary Fund, as well as economists
like New York University professor and economist Nouriel Roubini and New
York Times columnist Paul Krugman
predict greater losses in US markets, rising unemployment and
generally tougher economic times ahead.
What cannot be disputed, however, is the
financial bailout's biggest loser: the American taxpayer. The US government,
led by the Treasury Department, has done little, if anything, to maximize
returns on its trillion-dollar, taxpayer-funded investment. So far, the
bailout has favored rescued financial institutions by
subsidizing their
losses to the tune of $356 billion,
shying away from much-needed management changes and--with the exception of
the automakers--letting companies take taxpayer money without a coherent
plan for how they might return to viability.
The bailout's perks have been no less
favorable for private investors who are now picking over the economy's
still-smoking rubble at the taxpayers' expense. The newer bailout programs
rolled out by Treasury Secretary Timothy Geithner give private equity firms,
hedge funds and other private investors significant leverage to buy "toxic"
or distressed assets, while leaving taxpayers stuck with the lion's share of
the risk and potential losses.
Given the lack of transparency and
accountability, don't expect taxpayers to be able to object too much. After
all, remarkably little is known about how TARP recipients have used the
government aid received. Nonetheless, recent government
reports,
Congressional testimony and
commentaries offer those patient enough to pore over hundreds of pages of
material glimpses of just how Wall Street friendly the bailout actually is.
Here, then, based on the most definitive data and analyses available, are
six of the most blatant and alarming ways taxpayers have been scammed by the
government's $1.1-trillion, publicly funded bailout.
1. By
overpaying for its TARP investments, the Treasury Department provided
bailout recipients with generous subsidies at the taxpayer's expense.
When the Treasury Department ditched its
initial plan to buy up "toxic" assets and instead invest directly in
financial institutions, then-Treasury Secretary Henry Paulson Jr. assured
Americans that they'd get a fair deal. "This is an investment, not an
expenditure, and there is no reason to expect this program will cost
taxpayers anything," he
said in October 2008.
Yet the Congressional Oversight Panel
(COP), a five-person group tasked with ensuring that the Treasury Department
acts in the public's best interest, concluded in its
monthly report for February that
the department had significantly overpaid by tens of billions of dollars for
its investments. For the ten largest TARP investments made in 2008, totaling
$184.2 billion, Treasury received on average only $66 worth of assets for
every $100 invested. Based on that shortfall, the panel calculated that
Treasury had received only $176 billion in assets for its $254 billion
investment, leaving a $78 billion hole in taxpayer pockets.
Not all investors subsidized the
struggling banks so heavily while investing in them. The COP report notes
that private investors received much closer to fair market value in
investments made at the time of the early TARP transactions. When, for
instance,
Berkshire Hathaway invested $5 billion in Goldman Sachs
in September, the Omaha-based company received
securities worth $110 for each $100 invested. And when
Mitsubishi invested in Morgan Stanley
that same month, it received securities worth
$91 for every $100 invested.
As of May 15, according to the
Ethisphere TARP Index, which
tracks the government's bailout investments, its various investments had
depreciated in value by almost $147.7 billion. In other words, TARP's losses
come out to almost $1,300 per American taxpaying household.
2. As the
government has no real oversight over bailout funds, taxpayers remain in the
dark about how their money has been used and if it has made any difference.
While the Treasury Department can make
TARP recipients report on just how they spend their government bailout
funds, it has chosen not to do so. As a result, it's unclear whether
institutions receiving such funds are using that money to increase
lending--which would, in turn, boost the economy--or merely to fill in holes
in their balance sheets.
Neil M. Barofsky, the special inspector
general for TARP, summed the situation up this way in his office's April
quarterly report to Congress: "The American people have a right to know how
their tax dollars are being used, particularly as billions of dollars are
going to institutions for which banking is certainly not part of the
institution's core business and may be little more than a way to gain access
to the low-cost capital provided under TARP."
This lack of transparency makes the
bailout process highly susceptible to fraud and corruption.
Barofsky's report stated that twenty separate
criminal investigations were already underway involving corporate fraud,
insider trading and public corruption. He also
told the Financial Times
that his office was investigating whether banks manipulated their books to
secure bailout funds. "I hope we don't find a single bank that's cooked its
books to try to get money, but I don't think that's going to be the case."
Economist Dean Baker, co-director of the
Center for Economic and Policy Research in Washington, suggested to
TomDispatch in an interview that the opaque and complicated nature of the
bailout may not be entirely unintentional, given the difficulties it raises
for anyone wanting to follow the trail of taxpayer dollars from the
government to the banks. "[Government officials] see this all as a Three
Card Monte, moving everything around really quickly so the public won't
understand that this really is an elaborate way to subsidize the banks,"
Baker says, adding that the public "won't realize we gave money away to some
of the richest people."
3. The
bailout's newer programs heavily favor the private sector, giving investors
an opportunity to earn lucrative profits and leaving taxpayers with most of
the risk.
Under Treasury Secretary Geithner, the
Treasury Department has greatly expanded the financial bailout to troubling
new programs like the Public-Private Investment Program (PPIP) and the Term
Asset-Backed-Securities Loan Facility (TALF). The PPIP, for example,
encourages private investors to buy "toxic" or risky assets on the books of
struggling banks. Doing so, we're told, will get banks lending again because
the burdensome assets won't weigh them down. Unfortunately, the incentives
the Treasury Department is offering to get private investors to participate
are so generous that the government--and, by extension, American
taxpayers--are left with all the downside.
Joseph Stiglitz, the Nobel-prize winning
economist,
described the PPIP program in a
New York Times op-ed this way:
Consider an asset that
has a 50-50 chance of being worth either zero or $200 in a year's time. The
average "value" of the asset is $100. Ignoring interest, this is what the
asset would sell for in a competitive market. It is what the asset is
'worth.' Under the plan by Treasury Secretary Timothy Geithner, the
government would provide about 92 percent of the money to buy the asset but
would stand to receive only 50 percent of any gains, and would absorb almost
all of the losses. Some partnership!
Assume that one of the
public-private partnerships the Treasury has promised to create is willing
to pay $150 for the asset. That's 50 percent more than its true value, and
the bank is more than happy to sell. So the private partner puts up $12, and
the government supplies the rest--$12 in "equity" plus $126 in the form of a
guaranteed loan.
If, in a year's time,
it turns out that the true value of the asset is zero, the private partner
loses the $12, and the government loses $138. If the true value is $200, the
government and the private partner split the $74 that's left over after
paying back the $126 loan. In that rosy scenario, the private partner more
than triples his $12 investment. But the taxpayer, having risked $138, gains
a mere $37."
Worse still, the PPIP can be easily
manipulated for private gain. As economist
Jeffrey Sachs has described it, a
bank with worthless toxic assets on its books could actually set up its
own public-private fund to bid on those assets. Since no true bidder
would pay for a worthless asset, the bank's public-private fund would win
the bid, essentially using government money for the purchase. All the
public-private fund would then have to do is quietly declare bankruptcy and
disappear, leaving the bank to make off with the government money it
received. With the PPIP deals set to begin in the coming months, time will
tell whether private investors actually take advantage of the program's
flaws in this fashion.
The Treasury Department's TALF program
offers equally enticing possibilities for potential bailout profiteers,
providing investors with a chance to double, triple or even quadruple their
investments. And like the PPIP, if the deal goes bad, taxpayers absorb most
of the losses. "It beats any financing that the private sector could ever
come up with," a
Wall Street trader commented
in a recent Fortune magazine story. "I almost want to say it is
irresponsible."
4. The
government has no coherent plan for returning failing financial institutions
to profitability and maximizing returns on taxpayers' investments.
Compare the treatment of the auto industry
and the financial sector, and a troubling double standard emerges. As a
condition for taking bailout aid, the government required Chrysler and
General Motors to present
detailed plans on how the
companies would return to profitability. Yet the Treasury Department
attached minimal conditions to the billions injected into the largest
bailed-out financial institutions. Moreover, neither Geithner nor Lawrence
Summers, one of President Barack Obama's top economic advisors, nor the
president himself has articulated any substantive plan or vision for how the
bailout will help these institutions recover and, hopefully, maximize
taxpayers' investment returns.
The Congressional Oversight Panel
highlighted the absence of such a comprehensive plan in its
January report. Three months into
the bailout, the Treasury Department "has not yet explained its strategy,"
the report stated. "Treasury has identified its goals and announced its
programs, but it has not yet explained how the programs chosen constitute a
coherent plan to achieve those goals."
Today, the department's endgame for the
bailout still remains vague. Thomas Hoenig, president of the Federal Reserve
Bank of Kansas City,
wrote in the Financial Times
in May that the government's response to the financial meltdown has been "ad
hoc, resulting in inequitable outcomes among firms, creditors, and
investors." Rather than perpetually prop up banks with endless taxpayer
funds, Hoenig suggests, the government should allow banks to fail. Only
then, he believes, can crippled financial institutions and systems be fixed.
"Because we still have far to go in this crisis, there remains time to
define a clear process for resolving large institutional failure. Without
one, the consequences will involve a series of short-term events and far
more uncertainty for the global economy in the long run."
The healthier and more profitable bailout
recipients are once financial markets rebound, the more taxpayers will earn
on their investments. Without a plan, however, banks may limp back to
viability while taxpayers lose their investments or even absorb further
losses.
5. The
bailout's focus on Wall Street mega-banks ignores smaller banks serving
millions of American taxpayers that face an equally uncertain future.
The government may not have a long-term
strategy for its trillion-dollar bailout, but its guiding principle, however
misguided, is clear: what's good for Wall Street will be best for the rest
of the country.
On the day the mega-bank stress tests were
officially released, another set of stress-test results came out to much
less fanfare. In its
quarterly report on the health of individual banks and the banking industry
as a whole, Institutional Risk
Analytics (IRA), a respected financial services organization, found that the
stress levels among more than 7,500 FDIC-reporting banks nationwide had
risen dramatically. For 1,575 of the banks, net incomes had turned negative
due to decreased lending and less risk-taking.
The conclusion IRA drew was telling: "Our
overall observation is that US policy makers may very well have been
distracted by focusing on 19 large stress test banks designed to save Wall
Street and the world's central bank bondholders, this while a trend is
emerging of a going concern viability crash taking shape under the radar."
The report concluded with a question: "Has the time come to shift the policy
focus away from the things that we love, namely big zombie banks, to tackle
things that are truly hurting us?"
6. The bailout
encourages the very behaviors that created the economic crisis in the first
place instead of overhauling our broken financial system and helping the
individuals most affected by the crisis.
As Joseph Stiglitz explained in the New
York Times, one major cause of the economic crisis was bank
overleveraging. "Using relatively little capital of their own," he wrote,
banks "borrowed heavily to buy extremely risky real estate assets. In the
process, they used overly complex instruments like collateralized debt
obligations." Financial institutions engaged in overleveraging in pursuit of
the lucrative profits such deals promised--even if those profits came with
staggering levels of risk.
Sound familiar? It should, because in the
PPIP and TALF bailout programs the Treasury Department has essentially
replicated the very over-leveraged, risky, complex system that got us into
this mess in the first place: in other words, the government hopes to repair
our financial system by using the flawed practices that caused this crisis.
Then there are the institutions deemed
"too big to fail." These financial giants--among them AIG, Citigroup and
Bank of America-- have been kept afloat by billions of dollars in bottomless
bailout aid. Yet reinforcing the notion that any institution is "too big to
fail" is dangerous to the economy. When a company like AIG grows so large
that it becomes "too big to fail," the risk it carries is systemic, meaning
failure could drag down the entire economy. The government should force "too
big to fail" institutions to slim down to a safer, more modest size;
instead, the Treasury Department continues to subsidize these financial
giants, reinforcing their place in our economy.
Of even greater concern is the message the
bailout sends to banks and lenders--namely, that the risky investments that
crippled the economy are fair game in the future. After all, if banks fail
and teeter at the edge of collapse, the government promises to be there with
a taxpayer-funded, potentially profitable safety net.
The handling of the bailout makes at least
one thing clear, however. It's not your health that the government is
focused on, it's theirs-- the very banks and lenders whose convoluted
financial systems provided the underpinnings for staggering salaries and
bonuses, while bringing our economy to the brink of another Great
Depression.
Bob Jensen's threads how your money was put to word
(fraudulently) to pay for the mistakes of the so-called professionals of finance
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's threads on why the infamous "Bailout" won't
work ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity
Bob Jensen's "Rotten to the Core" threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
"Lack of Candor and the AIG Bailout: If AIG wasn't too big to fail,
why did the government rescue it? And why do we need to turn the financial
system upside down?" by Peter J. Wallison, The Wall Street Journal,
November 27, 2009 ---
http://online.wsj.com/article/SB10001424052748704779704574551861399508826.html?mod=djemEditorialPage
Since last September, the government's case for
bailing out AIG has rested on the notion that the company was too big to
fail. If AIG hadn't been rescued, the argument goes, its credit default swap
(CDS) obligations would have caused huge losses to its counterparties—and
thus provoked a financial collapse.
Last week's news that this was not in fact the
motive for AIG's rescue has implications that go well beyond the Obama
administration's efforts to regulate CDSs and other derivatives. It's one
more example that the administration may be using the financial crisis as a
pretext to extend Washington's control of the financial sector.
The truth about the credit default swaps came out
last week in a report by TARP Special Inspector General Neil Barofsky. It
says that Treasury Secretary Tim Geithner, then president of the New York
Federal Reserve Bank, did not believe that the financial condition of AIG's
credit default swap counterparties was "a relevant factor" in the decision
to bail out the company. This contradicts the conventional assumption, never
denied by the Federal Reserve or the Treasury, that AIG's failure would have
had a devastating effect.
So why did the government rescue AIG? This has
never been clear.
The Obama administration has consistently argued
that the "interconnections" among financial companies made it necessary to
save AIG and Bear Stearns. Focusing on interconnections implies that the
failure of one large financial firm will cause debilitating losses at
others, and eventually a systemic breakdown. Apparently this was not true in
the case of AIG and its credit default swaps—which leaves open the question
of why the Fed, with the support of the Treasury, poured $180 billion into
AIG.
The broader question is whether the entire
regulatory regime proposed by the administration, and now being pushed
through Congress by Rep. Barney Frank and Sen. Chris Dodd, is based on a
faulty premise. The administration has consistently used the term "large,
complex and interconnected" to describe the nonbank financial institutions
it wants to regulate. The prospect that the failure of one of these firms
might pose a systemic risk is the foundation of the administration's
comprehensive regulatory regime for the financial industry.
Up to now, very few pundits or reporters have
questioned this logic. They have apparently been satisfied with the
explanation that the "interconnectedness" created by those mysterious credit
default swaps was the culprit.
But the New York Fed is the regulatory body most
familiar with the CDS market. If that agency did not believe AIG's failure
would have actually brought down its counterparties—and ultimately the
financial system itself—it raises serious questions about the
administration's credibility, and about the need for its regulatory
proposals. If "interconnections" among financial institutions are indeed the
source of the financial crisis, the administration should be far more
forthcoming than it has been about exactly what these interconnections are,
and how exactly a broad new system of regulation and resolution would
eliminate or reduce them.
The administration's unwillingness or inability to
clearly define the problem of interconnectedness is not the only weakness in
its rationale for imposing a whole new regulatory regime on the financial
system. Another example is the claim—made by Mr. Geithner and President
Obama himself—that predatory lending by mortgage brokers was one of the
causes of the financial crisis.
No doubt some deceptive practices occurred in
mortgage origination. But the facts suggest that the government's own
housing policies—and not weak regulation—were the source of these bad loans.
At the end of 2008, there were about 26 million
subprime and other nonprime mortgages in our financial system. Two-thirds of
these mortgages were on the balance sheets of the Federal Housing
Administration, Fannie Mae and Freddie Mac, and the four largest U.S. banks.
The banks were required to make these loans in order to gain approval from
the Fed and other regulators for mergers and expansions.
The fact that the government itself either bought
these bad loans or required them to be made shows that the most plausible
explanation for the large number of subprime loans in our economy is not a
lack of regulation at the mortgage origination level, but government-created
demand for these loans.
Finally, although there may be a good policy
argument for a new consumer protection agency for financial services and
products, the scope of what the administration has proposed goes far beyond
lending, or even deposit-taking. In the administration's proposed
legislation, the Consumer Financial Protection Agency would cover any
business that provides consumer credit of any kind, including the common
layaway plans and Christmas clubs that small retailers offer their
customers.
Under the guise of addressing the causes of a
global financial crisis, the Obama administration's bill would have
regulated credit counseling, educational courses on finance, financial-data
processing, money transmission and custodial services, and dozens more small
businesses that could not possibly cause a financial crisis. Even Chairmen
Frank and Dodd balked at this overreach. Their bills exempt retailers if
their financial activity is incidental to their other business. Still, many
vestiges of this excess remain in the legislation that is now being pushed
toward a vote.
The lack of candor about credit default swaps, the
effort to blame lack of regulation for the subprime crisis and the excessive
reach of the proposed consumer protection agency are all of a piece. The
administration seems to be using the specter of another financial crisis to
bring more and more of the economy under Washington's control.
With the help of large Democratic majorities in
Congress, this train has had considerable momentum. But perhaps—with the
disclosure about credit default swaps and the AIG crisis—the wheels are
finally coming off.
Bob Jensen's threads on the Greatest Swindle in the World are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
General Moters: Robbing Sam to Pay
Sam
"The Flight of the Money: Where Has It Gone?," by David Kennedy,
Townhall, July 17, 2010 ---
http://townhall.com/columnists/DanKennedy/2010/07/17/the_flight_of_the_money_where_has_it_gone
Two months ago, the “new”
General Motors made possible by government bailouts, theft of shareholders’
equity for forced re-distribution to unions, and managerial change at
government’s gunpoint, was held up as shining example of success – it was
even repaying its debt to Uncle Sam early.
But the week of the
Independence Day, GM announced its urgent need to borrow five billion
dollars, to use in re-paying debt (ie. paying its VISA bill with a new
MasterCard) and as cash reserves to counter anticipated slumping sales.
As Arte Johnson used to say
on “Laugh-In:” v-e-r-y interesting.
If you go to a movie set,
you will see perfect-looking streets, each building front rich in detail,
looking as real as real can be. Yet its only façade. One thin piece of
painted sheetrock propped up. Walk around behind it, there’s nothing there.
That’s GM. State pension
funds in 30-plus states people are counting on, upside down in toto by
trillions. Obama’s stimulus. There are signs stuck here or there with his
logo on them, proclaiming the dirt mound or torn up street his “stimulus at
work.” The sign-maker was stimulated. Who else? That’s this entire economy.
A façade. Walk around behind it: there’s nothing there. No real job
creation, no business investment, no real estate investment, nothing much
happening but very un-hopeful hoarding. Where has all the money gone?
There is flight of capital.
Companies like Ford and Microsoft moving hundreds of millions of dollars to
investments overseas. Mega-investors like Buffett are breaking
long-standing, self-imposed prohibition on investing in non-U.S. companies
in foreign lands. Insurers and health care companies are quietly buying up
land beyond our borders.
A major business story going
unreported: the long, long list of iconic American brand companies closing
countless stores, shops and restaurant locations here while expanding and
opening outlets like mad in other countries. That means they are draining
money out of local economies here and moving it over there. Starbucks.
Wal-Mart. Etc. Can’t you hear this giant sucking sound?
There is capital on strike.
An estimated $2-trillion of excess cash reserves in companies other than
financial institutions – although they are hoarding rather than lending,
too. And this is calculated from examining big, public companies. As
somebody intimately in touch with thousands of small business owners, I can
personally assure you, their reluctance to invest or spend is profound, and,
in aggregate, they are likely keeping trillions more inactive.
Continued in article
Ketz Me If You Can
"GM's IPO: A Way to Reduce the Deficit," by: J. Edward Ketz, SmartPros,
November 2010 ---
http://accounting.smartpros.com/x70813.xml
The ballyhooed IPO by GM has or soon will take
place. This is amazing inasmuch as General Motors transformed itself from a
solid, steady manufacturer with a clean reputation into a troubled U.S.
automaker and then into another twenty-first century accounting fraudster
before almost becoming another bankrupt has-been.
This Phoenix rises with the blessings of the White
House and now appears as a budding star, even though its accounting is as
clean as an 100,000 mile-engine whose oil has never been changed. I wondered
why the Obama administration tinkered with this bankruptcy the way it did
and wondered about the back room deals. But no longer—I have finally figured
out the relationship between GM and Washington.
The SEC flagged GM for accounting issues in 2006,
and the firm confessed to several accounting deficiencies that overstated
earnings by at least $2 billion. Further, it cited problems with its
internal control system, problems that have yet to be rectified four years
later! Its recent S-1 stated, “We have determined that our disclosure
controls and procedures and our internal control over financial reporting
are currently not effective. The lack of effective internal controls could
materially adversely affect our financial condition and ability to carry out
our business plan.” So, the firm that issued accounting lies to the
investment community over the last decade is getting ready to issue a ton of
stock with little assurance that the accounting numbers are worth the
electronic bits they’re written on. What a deal! But wait—there’s more.
General Motors, with the help of its auditor and
investment banker and the White House, discovered—make that created—positive
equity by recognizing a huge amount of accounting goodwill. Many observers
have booed the presence of this goodwill, as much of it is due to FASB’s
idiotic concept of writing down liabilities because of a firm’s own credit
risk. (The FASB needs to realize its role is setter of accounting standards,
not setter of financial analytic methods.) These arguments are all correct,
for the goodwill number is built on whims, at best. GM’s goodwill serves as
a wonderful example why goodwill is really not an asset. But wait—there’s
more.
General Motors faces gargantuan pension obligations
now and in the future. GM itself says in the S-1 that its unfunded
liabilities are around $37 billion, a number I expect to grow rapidly in the
next few years. I wonder why anybody would pay a premium for GM’s stock
given the extent of these pension debts. These liabilities did not get
reduced while GM was in bankruptcy, presumably as a result of the Faustian
deal it made with the White House. I presume the Obama administration did
this to avoid a huge stress on the PBGC if these pension obligations had
been relieved.
Recently we learned through a Wall Street Journal
report that the government allowed GM to keep its tax carryforwards even
though it went into corporate bankruptcy. Clearly, this adds value to GM but
not for the reason most pundits cite. Many marvel that GM’s future profits
will not get taxed for years to come, but I am less optimistic about GM’s
ability to generate future profits. As GM has not and cannot solve its
internal control problems and has not shown much ability to manufacture
anything efficiently over the long haul, I foresee losses in GM’s future.
But, these tax loss carryforwards might be valuable to others, assuming
there are no restrictions on their use by acquiring companies. If GM has
positive equity, it is primarily because somebody else can take advantage of
these carryforwards.
Continued in article
Bob Jensen's threads on the bailout mess ---
http://faculty.trinity.edu/rjensen/2008bailout.htm
Taibbi vs. Goldman Sachs: Whose side are you on?
Place a barf bag in your lap before watching
these videos!
But are they accurate?
In June and July Goldman Sachs put up a pretty good defense.
Now I'm not so sure.
Questions
Why is the SEC still hiding the names of these tremendously lucky naked short
sellers in Bear Sterns and Lehman Bros.?
Was it because these lucky speculators were such good friends of Hank Paulson
and Timothy Geithner?
Or is Matt Taibbi himself a fraud as suggested last summer by Wall Street media
such as
Business Insider?
Jensen Comment
Evidence suggests that the SEC may be protecting these Wall Street thieves!
Or was all of this stealing perfectly legal? If so why the continued secrecy on
the part of the SEC?
Suspicion: The stealing may have taken place in top investors needed by
the government for bailout (Goldman Sachs?)
"Wall Street's Naked Swindle" by Matt
Taibbi
Watch the Video at one of the following sites:
You Tube ---
http://www.youtube.com/watch?v=OqZUbe9KIMs
Google video ---
Click Here
Read the complete article ---
Click Here
Video Updates for Matt Taibbi
GRITtv: Matt Taibbi & Michael Lux: Goldman's Coup
---
http://www.youtube.com/watch?v=nFWjXQLDkXg
"Matt Taibbi's Goldman Sachs Story Is A Joke,"
Joe Weisenthal, Business Insider, July 13, 2009 ---
http://www.businessinsider.com/matt-taibbis-goldman-sachs-story-is-a-joke-2009-7
"Goldman Sachs responds to Taibbi Post," by:
Felix Salmon, Rueters, June 26, 2009 ---
Calls Taibbi "Hysterical" ---
http://blogs.reuters.com/felix-salmon/2009/06/26/goldman-sachs-responds-to-taibbi/
Others Now Argue it Is Not a Joke
"Taibbi's Naked-Shorting Rage: Goldman's Lobbying, SEC's Fail,"l by bobswern.
Daily Kohs, September 30, 2009 ---
http://www.dailykos.com/story/2009/9/30/787963/-Taibbis-Naked-Shorting-Rage:-Goldmans-Lobbying,-SECs-Fail
Now, off we go to Goldman Sachs' notorious lobbying
hubris, the historically-annotated, umpteenth oversight failure of the
Securities Exchange Commission ("SEC"), and what I'm quickly realizing may
well turnout to be the story with regard to it becoming the poster
child for regulatory capture and supervisory breakdown as far as our Wall
Street-based corporatocracy/oligarchy is concerned. Here's the link to
Taibbi's preview blog post: "An
Inside Look at How Goldman Sachs Lobbies the Senate."
Yesterday, as described in this lead-in piece from
the Wall Street Journal, the SEC held a public roundtable discussion
on "New Rules for Lending of Securities." (See link here: "SEC
Weighs New Rules for Lending of Securities.")
SEC Weighs New Rules for Lending of Securities
BY KARA SCANNELL AND CRAIG KARMIN
Wall Street Journal
Saturday, September 26th, 2009
Securities regulators are exploring new
regulations for the multitrillion-dollar securities-lending market, the
first major step regulators have taken in the area in decades.
Securities and Exchange Commission Chairman
Mary Schapiro said she wants to shine a light on the "opaque market."
After many large investors lost millions in last year's credit crunch,
she said, "we need to consider ways to enhance investor-oriented
oversight."
The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants...
Enter Taibbi: "An
Inside Look at How Goldman Sachs Lobbies the Senate."
An Inside Look at How Goldman Sachs Lobbies the
Senate
Matt Taibbi
TruSlant.com
(very early) Tuesday, September 29th, 2009
The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants contend.
Securities lending is central to the practice of short selling, in which
investors borrow shares and sell them in a bet that the price will
decline. Short sellers later hope to buy back the shares at a lower
price and return them to the securities lender, booking a profit.
Lending and borrowing also help market makers keep stock trading
functioning smoothly.
--SNIP--
Later on this week I have a story coming out in
Rolling Stone that looks at the history of the Bear Stearns and Lehman
Brothers collapses. The story ends up being more about naked
short-selling and the role it played in those incidents than I had
originally planned -- when I first started looking at the story months
ago, I had some other issues in mind, but it turns out that there's no
way to talk about Bear and Lehman without going into the weeds of naked
short-selling, and to do that takes up a lot of magazine inches. So
among other things, this issue takes up a lot of space in the upcoming
story.
Naked short-selling is a kind of counterfeiting
scheme in which short-sellers sell shares of stock they either don't
have or won't deliver to the buyer. The piece gets into all of this, so
I won't repeat the full description in this space now. But as this week
goes on I'm going to be putting up on this site information I had to
leave out of the magazine article, as well as some more timely material
that I'm only just getting now.
Included in that last category is some of the
fallout from this week's SEC "round table" on the naked short-selling
issue.
The real significance of the naked
short-selling issue isn't so much the actual volume of the behavior,
i.e. the concrete effect it has on the market and on individual
companies -- and that has been significant, don't get me wrong -- but
the fact that the practice is absurdly widespread and takes place right
under the noses of the regulators, and really nothing is ever done about
it.
It's the conspicuousness of the crime that is
the issue here, and the degree to which the SEC and the other financial
regulators have proven themselves completely incapable of addressing the
issue seriously, constantly giving in to the demands of the major banks
to pare back (or shelf altogether) planned regulatory actions. There
probably isn't a better example of "regulatory capture," i.e. the
phenomenon of regulators being captives of the industry they ostensibly
regulate, than this issue.
Taibbi continues on to inform us that none of the
invited speakers to this government-sponsored event represented stockholders
or companies that could, or have, become targets/victims of naked
short-selling. Also "...no activists of any kind in favor of tougher rules
against the practice. Instead, all of the invitees are (were) either banks,
financial firms, or companies that sell stuff to the first two groups."
Taibbi then informs us that there is only one
panelist invited that's in favor of what may be, perhaps, the most basic
level of regulatory control with regard to this industry practice: a "simple
reform" called "pre-borrowing." Pre-borrowing requires short-sellers to
actually possess the stock shares before they're sold.
It's been proven to work, as last summer the SEC,
concerned about predatory naked short-selling of big companies in the
wake of the Bear Stearns wipeout, instituted a temporary pre-borrow
requirement for the shares of 19 fat cat companies (no other companies
were worth protecting, apparently). Naked shorting of those firms
dropped off almost completely during that time.
The lack of pre-borrow voices invited to this
panel is analogous to the Max Baucus health care round table last
spring, when no single-payer advocates were invited. So who will get to
speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a
hedge fund that has done the occasional short sale, to put it gently),
Credit Suisse, NYSE Euronext, and so on.
Taibbi then tells us of increased efforts by
industry players, specifically noting Goldman Sachs being at the forefront
of this effort, and having "their presence felt."
Taibbi mentioned that he'd received two completely
separate calls from two congressional staffers from different offices--folks
whom Taibbi never met before--who felt compelled to inform him of Goldman's
actions.
We learn that these folks both commented on how
these Goldman folks were lobbying against restrictions on naked
short-selling. One of the aides told Taibbi that they had passed out a "fact
sheet about the issue that was so ridiculous that one of the other staffers
immediately thought to send it to me. "
I would later hear that Senate aides between
themselves had discussed Goldman's lobbying efforts and concluded that
it was one of the most shameless performances they'd ever seen from any
group of lobbyists, and that the "fact sheet" the company had had the
balls to hand to sitting U.S. Senators was, to quote one person familiar
with the situation, "disgraceful" and "hilarious."
Checkout the whole story on his blog. Apparently,
in the upcoming Rolling Stone piece, he gets into the nitty gritty with
regard to how naked short-selling brought down both Bear Stearns and Lehman,
last year.
Should be pretty powerful stuff.
Meanwhile, getting back to the SEC roundtable,
noted above, strike up the fifth item that I've now documented in the past
48 hours where it's becoming self-evident that our elected representatives
and our government agencies aren't even bothering to author the new
regulations and legislation that's so needed to prevent a recurrence of
events such as those we witnessed through the economic/market catastrophes
of the past 24 months; these legislators and high-ranking government
officials are actually having the lobbyists navigate the discussion and
write the damn stuff, too!
How much worse can it get? I really don't want
to know the answer to that rhetorical question. But, with the inmates
running the asylum, we may just find out sooner than we think!
Bailing Out Big Banks Engaged in Sleaze and Sex
"Goldman Laid Down with Dogs," by Ryan Chittum, Columbia Journalism
Review, November 4, 2009 ---
http://www.cjr.org/index.php
This link was forwarded by my friend Larry.
Dean Starkman has been applauding McClatchy’s
series on Goldman Sachs (an Audit funder) for
a couple of
days now. Add another Audit appreciation today.
McClatchy has been doing what Dean has been calling
for for a long time now: Looking much more closely at
how Wall Street
fueled the mortgage crisis and how it
was deeply connected
to the
shadier parts of the
housing industry. Or as McClatchy’s Greg Gordon puts it:
… one of Wall Street’s proudest and most
prestigious firms helped create a market for junk mortgages,
contributing to the economic morass that’s cost millions of Americans
their jobs and their homes.
Today,
McClatchy examines Goldman’s relationship with New
Century Financial, a firm that was something of the canary in the coalmine
of this financial crisis—it was the second-biggest subprime mortgage lender
when it went belly-up in April 2007, which was very, very early. In other
words, it was one of the worst actors in the whole mess:
Perhaps no mortgage lender was more emblematic of
the go-go atmosphere in the sprouting industry that was seizing an
outsize share of the home loan market.
Traversing the country in private jets and
zipping around Southern California in Mercedes Benzes, Porsches and even
a Lamborghini, New Century executives reveled as the firm’s annual
residential mortgage sales rocketed from $357 million in 1996 to nearly
$60 billion a decade later…
What does that have to do with Goldman Sachs and
Wall Street?
For $100 million in mortgages, New Century could
command fees from Wall Street of $4 million to $11 million, ex-employees
told McClatchy. The goal was to close loans fast, bundle them into pools
and sell them to generate money for the next round.
Inside the mortgage company, the former
employees said, pressure was intense to increase the firm’s share of an
exploding market for mortgages that depended almost entirely on Wall
Street’s seemingly unlimited hunger for bigger, faster returns.
Aha! But wait—why did Wall Street want to buy this
trash?
Goldman and other investment banks could put $20
million in the till by taking a 1 percent fee for assembling,
securitizing and selling a $2 billion pool of mostly triple-A rated
bonds backed by subprime loans — and that was just stage one.
That takes you to “The
Giant Pool of Money.” And that was far from the
only juice being squeezed from these lemons. Goldman et al got servicing
fees and the like, plus they “extended lines of credit to New Century —
known as “warehouse loans” — totaling billions of dollars to finance the
issuance of more home loans to other marginal borrowers. Goldman Sachs’
mortgage subsidiary gave the firm a $450 million credit line.”
In other words, Wall Street lent the money to the
predatory firms to create the shady loans so it could buy them from them,
slice them into securities and sell them to the greater fools. This was so
profitable there weren’t enough decent loans to be made. So to feed the
beast, mortgage lenders came up with disastrous inventions like NINJA loans
(No Income, No Jobs, No Assets) and Wall Street, ahem, looked the other way.
It was a vicious circle of profit (virtuous—if you
were one of those who lined their pockets through it) and was interrupted
only when the underlying loans got so bad that borrowers like the ones with
no income, no jobs, and no assets in many instances couldn’t even make a
single payment on the loan. Panic!
McClatchy does well to report on the New Century
culture, helpful in illustrating the lie-down-with-dogs-get-up-with-fleas
thing, writing about the sexualization of some of the work, something
reminds us of
BusinessWeek’s
fascinating story on the subprime
industry’s descent into decadence (the sub headline on that one should be
all that’s needed to entice you to read that one: “The sexual favors,
whistleblower intimidation, and routine fraud behind the fiasco that has
triggered the global financial crisis.”)
But it wasn’t just sex. New Century was giving
kickbacks to mortgage brokers to get their loans, McClatchy quotes a former
top underwriter there as saying.
Let’s not forget, and McClatchy doesn’t,
thankfully, that borrowers were the marks here and took it on the chin:
The loans laid out financial terms that protected
investors but punished homebuyers. They offered above-market interest
rates, typically starting at 8 percent, with provisions that Lee said
were “rigged” to guarantee the maximum 3 percent rise in interest rates
after two years and almost assuredly another 3 percent increase through
ensuing, twice-yearly adjustments.
This is top-notch work by McClatchy. It deserves a
wide airing.
Bob Jensen's threads on Bailing Out Big Banks and Mortgage Companies
Engaged in Sleaze and Sex ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
A Step Back in History
Marvene is a poor and unemployed elderly woman who lost her shack to
foreclosure in 2008.
That's after Marvene stole over $100,000 when she refinanced her shack with a
subprime mortgage in 2007.
Marvene wants to steal some more or at least get her shack back for free.
Both the Executive and Congressional branches of the U.S. Government want to
give more to poor Marvene.
Why don't I feel the least bit sorry for poor Marvene?
Somehow I don't think she was the victim of unscrupulous mortgage brokers and
property value appraisers.
More than likely she was a co-conspirator in need of $75,000 just to pay
creditors bearing down in 2007.
She purchased the shack for $3,500 about 40 years ago ---
http://online.wsj.com/article/SB123093614987850083.html
Marvene Halterman, an unemployed Arizona woman with a
long history of creditors, took out a $103,000 mortgage on her 576
square-foot-house in 2007. Within a year she stopped making payments. Now the
investors with an interest in the house will likely recoup only $15,000.
The Wall Street Journal slide show
of indoor and outdoor pictures ---
http://online.wsj.com/article/SB123093614987850083.html#articleTabs%3Dslideshow
Jensen Comment
The $15,000 is mostly the value of the lot since at the time the mortgage was
granted the shack was virtually worthless even though corrupt mortgage brokers
and appraisers put a fraudulent value on the shack. Bob Jensen's threads on
these subprime mortgage frauds are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Probably the most common type of fraud in the Savings and Loan debacle of the
1980s was real estate investment fraud. The same can be said of the 21st Century
subprime mortgage fraud. Welcome to fair value accounting that will soon have us
relying upon real estate appraisers to revalue business real estate on business
balance sheets ---
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
The Rest of Marvene's Story ---
http://faculty.trinity.edu/rjensen/FraudMarvene.htm
Accounting Implications
CEO to his accountant: "What is our net earnings
this year?"
Accountant to CEO: "What net earnings figure do you want to report?"
The sad thing is that Lehman, AIG, CitiBank, Bear
Stearns, the Country Wide subsidiary of Bank America, Fannie Mae, Freddie
Mac, etc. bought these
subprime mortgages at face value and their Big 4 auditors supposedly
remained unaware of the millions upon millions of valuation frauds in the
investments. Does professionalism in auditing have a stronger stench since
Enron?
Where were the big-time auditors? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
September 30, 1999
Fannie Mae Eases
Credit To Aid Mortgage
Lending
By STEVEN A. HOLMES
In a move that could help increase home
ownership rates among minorities and low-income consumers, the Fannie
Mae Corporation is easing the credit requirements on loans that
it will purchase from banks and other lenders.
The action, which will begin as a pilot
program involving 24 banks in 15 markets -- including the New York
metropolitan region -- will encourage those banks to extend home
mortgages to individuals whose credit
is generally not good enough to qualify for conventional loans. Fannie
Mae officials say they hope to make it a nationwide program by next
spring.
Fannie Mae, the nation's biggest underwriter
of home mortgages, has been under
increasing pressure from the Clinton
Administration to
expand mortgage loans among low and moderate income people and felt
pressure from stock holders to maintain its phenomenal growth in
profits.
In addition, banks, thrift institutions and
mortgage companies have been pressing Fannie Mae to help them make more
loans to so-called subprime borrowers. These borrowers whose incomes,
credit ratings and savings are not good enough to qualify for
conventional loans, can only get loans from finance companies that
charge much higher interest rates -- anywhere from three to four
percentage points higher than conventional loans.
''Fannie Mae has expanded home ownership for
millions of families in the 1990's by reducing down payment
requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief
executive officer. ''Yet there remain too many borrowers whose credit is
just a notch below what our underwriting has required who have been
relegated to paying significantly higher mortgage rates in the so-called
subprime market.''
Demographic information on these borrowers is sketchy. But at least one
study indicates that 18 percent of the loans in the subprime market went
to black borrowers, compared to 5 per cent of loans in the conventional
loan market.
In moving, even tentatively, into this new
area of lending, Fannie Mae is taking on significantly more risk, which
may not pose any difficulties during flush economic times. But the
government-subsidized corporation may run into trouble in an economic
downturn, prompting a government rescue similar to that of the savings
and loan industry in the 1980's.
''From the perspective of many people, including me, this is another
thrift industry growing up around us,'' said Peter Wallison a resident
fellow at the Americ an Enterprise Institute. ''If
they fail, the government will have to step up and bail them out the way
it stepped up and bailed out the thrift industry.''
Under Fannie Mae's pilot program, consumers
who qualify can secure a mortgage with an interest rate one percentage
point above that of a conventional, 30-year fixed rate mortgage of less
than $240,000 -- a rate that currently averages about 7.76 per cent. If
the borrower makes his or her monthly payments on time for two years,
the one percentage point premium is dropped.
Fannie Mae, the nation's biggest underwriter
of home mortgages, does not lend money directly to consumers. Instead,
it purchases loans that banks make on what is called the secondary mark
et. By expanding the type of loans that it will buy, Fannie
Mae is hoping to spur banks to make more loans to people with
less-than-stellar credit ratings.
The best place to begin reading about this 2008 Wall Street bailout is at
http://en.wikipedia.org/wiki/United_States_housing_bubble
It's important to understand how the housing bubble grew and then burst before even
thinking about understanding the bailouts to date and the pending bailouts still
tied up in Congress. Those who are accounting and finance geeks can get a lot
more out of the
Fannie Mae Website and in particular Fannie's Investor Relations site ---
http://www.fanniemae.com/ir/index.jhtml;jsessionid=5PA54Q3LN1BS5J2FQSISFGI?p=Investor+Relations
After previously being caught with accounting fraud for purposes of padding
executive bonuses, having to change auditors from KPMG to PwC (as mandated by
the government), and putting Dennis Beresford in charge of the Audit Committee,
Fannie made a monumental effort to use proper accounting and make full (really
too full) disclosures (but without mentioning Barney Frank by name).
Doctors, hospitals, medical labs, pharmaceutical companies, and medical
equipment dealers get taxpayer dollars by directly billing the Medicare and
Medicaid "programs." When farmers and agri-businesses get their government
checks they come from farm aid/subsidy "programs." There are countless U.S.
Government "programs" that divert taxpayer dollars into corporations annually.
Government diverts a lot of taxpayer dollars to K-12 schools and higher
education through a vast array of education and research "programs."
Sometimes a "program" merely entails government backing of loans in case a
company fails. This was the intent of the Fannie Mae and Freddie Mack
quasi-public corporations. As long as Fannie Mae and Freddie Mack could attract
equity capital and business loans, cash from taxpayers was not necessary. But if
Fannie and Freddie should be on the verge of bankruptcy, loans were in most
cases backed by the U.S. Government and might have to be paid off with taxpayer dollars.
In the case of Fannie and Freddie at the moment, however, there is almost no chance of
having the government pay off troublesome debts and then let Fannie and Freddie try
to continue on their own. Equity shareholders lost their money in Fannie/Freddie
common stock and are not about to invest in
corporations that suddenly have little hope for profits because of Congressional
mandates to lend billions to people who have little chance to pay off their
mortgages owned by Fannie and Freddie.
A one-time government intervention to save a failing company is generally
called a "bailout" instead of a "program." Government intervention can take on a
wide range of forms. In some instances, a government may lend a failing business
cash with an expectation that the loan will be repaid, possibly with interest.
In some instances the government may also insist on options for equity share
ownership in the bailed out company. In other instances the government will
provide a gift in the form of a grant and may or may not receive benefits in
return. For example, government may have an interest in the results of a
research grant that initially is little more than a bailout gift. If Bath Iron
Works was on the verge of bankruptcy, the government would probably give it
contracts for new Navy ships. The military does not want most of its major
suppliers to fail.
Probably the most interesting and successful bailout in history was the U.S.
Government bailout of Chrysler Corporation in 1979.
The Chrysler Corporation on September 7,
1979 petitioned the United States government for US$1.5 billion in loan
guarantees to avoid bankruptcy. At the same time former Ford executive Lee
Iacocca was brought in as CEO. He proved to be a capable public spokesman,
appearing in advertisements to advise customers that "If you find a better
car, buy it." He would also provide a rallying point for Japan-bashing and
instilling pride in American products. His book Talking Straight was a
response to Akio Morita's Made in Japan.
The United States Congress reluctantly
passed the "Chrysler Corporation Loan Guarantee Act of 1979" (Public Law
96-185) on December 20, 1979 (signed into law by President Jimmy Carter on
January 7, 1980), prodded by Chrysler workers and dealers in every
Congressional district who feared the loss of their livelihoods. The
military then bought thousands of Dodge pickup trucks which entered military
service as the Commercial Utility Cargo Vehicle M-880 Series. With such help
and a few innovative cars (such as the K-car platform), especially the
invention of the minivan concept, Chrysler avoided bankruptcy and slowly
recovered.
In February 1982 Chrysler announced the
sale of Chrysler Defense, its profitable defense subsidiary to General
Dynamics for US$348.5 million. The sale was completed in March 1982 for the
revised figure of US$336.1 million.[7]
By the early 1980s, the loans were being
repaid at a brisk pace and new models based on the K-car platform were
selling well. A joint venture with Mitsubishi called Diamond Star Motors
strengthened the company's hand in the small car market. Chrysler acquired
American Motors Corporation (AMC) in 1987, primarily for its Jeep brand,
although the failing Eagle Premier would be the basis for the Chrysler LH
platform sedans. This bolstered the firm, although Chrysler was still the
weakest of the Big Three.
Another significant aspect of Chrysler's
recovery was the revitalization of the company's manufacturing facilities,
led by Richard Dauch[citation needed]. The factories were streamlined with
more efficient machinery, more robots, better paint equipment, and so
on[vague][citation needed]. The resultant improvements in efficiency and
vehicle quality played a big role in saving the company.
In the early 1990s, Chrysler made its
first steps back into Europe, setting up car production in Austria, and
beginning right hand drive manufacture of certain Jeep models in a 1993
return to the UK market. The continuing popularity of Jeep, bold new models
for the domestic market such as the Dodge Ram pickup, Dodge Viper (badged as
"Chrysler Viper" in Europe) sports car, and Plymouth Prowler hot rod, and
new "cab forward" front-wheel drive LH sedans put the company in a strong
position as the decade waned.
- In other words, Chrysler in the 1960s and 1970s borrowed from Paul to
build cars, sold those cars, and used the sales revenues to pay back Paul.
Paul in turn loaned more money to build cars. In the late 1970s Chrysler
fell on hard times when its huge inventory of cars was building up like
bubble about to burst. There were all sorts of problems including the fact
that Chrysler vehicles were inferior to Japanese vehicles, especially the
long-lasting Toyota automobiles. Chrysler cars had notoriously bad gas
mileage.
- The bottom line in 1979 was that Chrysler could not pay off its $1.5
billion loan from Paul on schedule. It tried to borrow money from Peter to
pay Paul, but Peter studied Chrysler's operation and refused to lend money
because Chrysler would bound up in too much fixed cost for building cars
that were inferior to Toyotas.
- Such bailouts of business firms are not common in U.S. history. In the
case of Chrysler, the government was persuaded that too many people would be
thrown out of work, too many lenders would not be repaid, and too many
pensions funds and college endowments would be badly harmed if Chrysler went out of business. But
the bailout was not cash lending from taxpayers
- Peter was most happy to lend money to Chrysler when the U.S. Government
cosigned the notes. But the government wisely put some conditions on
Chrysler before it cosigned the notes. Firstly, Chrysler had to
substantially reduce its fixed costs. Doing so was painful, but Chrysler
lived up to its bargain, closed some manufacturing plants, reduced executive
salaries, outsourced more of its component manufacturing, and terminated
many high-salaried autoworkers and managers. As I recall off the top of my
head, Chrysler reduced its annual fixed costs of over $4 billion to less
than $3 billion. For decades managerial accounting professors have shown how
changed "operating leverage" from both reduced fixed and variable costs
greatly lower the breakeven point as to how much revenue has to be earned to
recover fixed costs and begin to make a profit on each unit sold. Chrysler
really lowered its breakeven sales amount.
- Another condition of the bailout was to the effect that the government
got equity ownership options if and when Chrysler turned itself around. In
effect, taxpayers could profit in Chrysler's good fortunes after the
bailout. There was of course risk that Chrysler would still fail and the
cosigner on the notes would have to pay Peter off with taxpayer funds. But
as luck would have it, Chrysler designed the K-car and CEO Lee Iacocca (who
could sell refrigerators to Eskimos) convinced the public that the K-car was
as good or better than a Toyota and was "American Made." Also Chrysler
successfully expanded its Jeep sales in the U.S. and overseas.
- The bottom line is that Chrysler did recover in the 1980s, the
government did not have to pay Peter, and the government was in a position
to exercise its stock options and return a handsome profit to Chrysler. But
Chrysler managers and employees and shareholders pleaded with the government
not to exercise its stock options.
- Details of the Chrysler bailout are available at
http://uspolitics.about.com/od/economy/a/chryslerBailout.htm
Congress passed the bill 21 December 1979,
but with strings attached. Congress required
Chrysler to obtain private financing for $1.5 billion -- the government
was co-signing the note, not printing the money -- and to obtain another
$2 billion in "commitments or concessions [that] can be arranged by
Chrysler for the financing of its operations." One of those options, of
course, was reduce employees wages; in prior discussions, the union had
failed to budge, but the contingent guarantee moved the union. On 7
January 1980,
Carter signed the legislation (Public Law
86-185):
(Liberal) Economist
John Kenneth Galbraith suggested
that taxpayers be "accorded an
appropriate equity or ownership position" for the loan. "This is thought
a reasonable claim by people who are putting up capital."
Under the leadership of Lee Iacocca,
Chrysler doubled its corporate average miles-per-gallon (CAFE). In 1978,
Chrysler introduced the first domestically produced front-wheel drive
small cars: the Dodge Omni and Plymouth Horizon.
In 1983,
Chrysler paid off the loans that had been
guaranteed by US taxpayers. The Treasury was also
$350 million richer.
The problem in 2008 with AIG, and the huge Wall Street firms like
Bear Stearns, Lehman, Merrill
Lynch, and the others now desperate for liquidity, is that they financed their
long-term mortgage investment portfolios with short term borrowing from Paul
that is now due. Paul refuses to extend the payment maturities, and Peter will
not loan the money to these giants desperate to pay off Paul and stave off
bankruptcy. How they got into this mess is complicated, but the bottom line is
that de-regulation in the Ronald Reagan era allowed these investment companies
to become commercial banks and vice versa. As such they could use short-term
demand deposits from Paul to finance long-term investments like mortgages
purchased from local banks who participated in the sub-prime frauds to make home
loans to people who could not possibly afford to make the payments once the low
starting rates kicked up to higher rates.
So where does AIG's bailout money go?
Remember that AIG, unlike Bear Stearns, Lehman Brothers, and Merrill Lynch, is
primarily an insurance company. As such it entered into heavy
credit default swaps which are derivative financial instruments that protect
against a swap counterparties bad debt losses due to customers' credit
downgrades. For example, if the counterparty holds fixed rate investments such
that values plunge if the customer's credit rating plunges, the counter parties
receive swap payments based the decline in the value of the debt that is
defaulted. Credit default swaps are virtual insurance policies protecting
against a default under the debt instrument. However, because the the debt
itself can be virtual (i.e., no real default loss transpires), counterparties
can speculate using credit default swaps. And unlike insurance contracts, credit
default swaps until very recently are unregulated.
The three firms that dominate the $5 billion-a-year
credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch
Ratings - have been faulted for failing to identify risks in subprime mortgage
investments, whose collapse helped set off the global financial crisis. The
rating agencies had to downgrade thousands of securities backed by mortgages as
home-loan delinquencies have soared and the value of those investments
plummeted. The downgrades have contributed to hundreds of billions in losses and
writedowns at major banks and investment firms. The agencies are crucial
financial gatekeepers, issuing ratings on the creditworthiness of public
companies and securities. Their grades can be key factors in determining a
company's ability to raise or borrow money, and at what cost which securities
will be purchased by banks, mutual funds, state pension funds or local
governments. A yearlong review by the SEC, which issued the results last summer,
found that the three big (credit rating) agencies failed to rein in conflicts of
interest in giving high ratings to risky securities backed by subprime
mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November
19, 2008 ---
http://accounting.smartpros.com/x63855.xml
"Florida stands to lose
$1 billion because of Lehman Brothers' bankruptcy,"
by Sydney P. Freeberg and Connie Humburg, St. Petersburg Times, June 5,
2009
http://www.tampabay.com/news/politics/article1007445.ece
A price tag is now emerging for what last year's
collapse of investment giant Lehman Brothers could cost the state of
Florida: more than $1 billion.
The losses could make Florida and its citizens
among the biggest casualties in the biggest bankruptcy ever.
More than $440 million disappeared from the pension
fund that pays benefits for some 1 million retirees and public employees.
Counties, cities and school districts face a loss
of more than $300 million for roads, sewers and schools.
The state has $290 million less to pay for
everything from hurricane claims to health care, community colleges and care
for infants with disabilities.
While the general losses have been expected, this
is the first public accounting of the magnitude of the Lehman-related public
losses for Florida.
The outlook is bleak in bankruptcy court. In years
to come, the state will be lucky to collect pennies on the dollar.
In an interview, even the ever-optimistic Gov.
Charlie Crist could not muster a sunny side: "It is, to say the least, an
unfortunate situation.''
• • •
Lehman Brothers, which built the nation's railroads
and survived the Great Depression, filed for bankruptcy protection last
September.
Its failure sank banks and stocks, but the fallout
reverberated far beyond Wall Street.
In Florida, Lehman Brothers was an icon of finance
and real estate, managing public assets, selling securities, underwriting
bond deals and handling residential and commercial mortgages.
In the last decade, Florida paid Lehman at least
$27 million in fees for managing public investments and brokering and
underwriting bond deals.
The storied bank hired former Gov. Jeb Bush as a
consultant in June 2007, five months after he left office. As governor, Bush
also served as a trustee for the State Board of Administration, which
invests public money.
Lehman was the dominant Wall Street broker that
sold the SBA $1.4 billion of risky, mortgage-related securities that started
tanking in August 2007.
Bush has said he had nothing to do with those
sales.
"As Governor Bush has stated several times in
response to your inquiries, his role as a consultant to Lehman Brothers was
in no way related to any Florida investments,'' said his spokeswoman, Kristy
Campbell.
"It is unfortunate the St. Petersburg Times
continues to perpetuate this incorrect and baseless conjecture.''
"Your Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson, The
New York Times, September 20, 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
If federal regulators and political
leaders want to earn back some trust, they could do two things. First, they
could provide us with some transparency about whom precisely we are backing
in the recent bailouts.
Take, for example, the rescue on Tuesday
of the American International Group, once the world’s largest insurance
company. It was pretty breathtaking. Since when do insurance companies,
whose business models seem to consist of taking in premiums and stonewalling
claims, deserve rescues from beleaguered taxpayers?
Answer: Ever since the world became
so intertwined that the failure of one company can topple a host of others.
And ever since
credit default swaps, those unregulated derivative
contracts that allow investors to bet on a debt issuer’s financial
prospects, loomed so big on balance sheets that they now drive every bailout
decision.
The deal to save A.I.G. involves a
two-year, $85 billion loan from taxpayers. In exchange, the new owners — us
— get 80 percent of the company. If enough of A.I.G.’s assets are sold for
good prices, we may get our money back.
Credit default swaps, which operate like
insurance policies against the possibility that an issuer of debt will not
pay on its obligations, were the single biggest motivator behind the A.I.G.
deal.
A.I.G. had written $441 billion in credit
insurance on mortgage-related securities whose values have declined; if
A.I.G. were to fail, all the institutions that bought the insurance would
have been subject to enormous losses. The ripple effect could have turned
into a tsunami.
So, the $85 billion loan to A.I.G. was
really a bailout of the company’s counterparties or trading partners.
Now, inquiring minds want to know, whom
did we rescue? Which large, wealthy financial institutions — counterparties
to A.I.G.’s derivatives contracts — benefited from the taxpayers’ $85
billion loan? Were their representatives involved in the talks that resulted
in the last-minute loan?
And did Lehman Brothers not get bailed out
because those favored institutions were not on the hook if it failed?
We’ll probably never know the answers to
these troubling questions. But by keeping taxpayers in the dark, regulators
continue to earn our mistrust. As long as we are not told whom we have
bailed out, we will be justified in suspecting that a favored few are making
gains on our dimes.
A.I.G.’s financial statements provided a
clue to the identities of some of its credit default swap counterparties.
The company said that almost three-quarters of the $441 billion it had
written on soured mortgage securities was bought by European banks. The
banks bought the insurance to reduce the amounts of capital they were
required by regulators to set aside to cover future losses.
Enjoy the absurdity: Billions in
unregulated derivatives that were about to take down the insurance company
that sold them were bought by banks to get around their regulatory capital
requirements intended to rein in risk.
Got that?
Which brings us to Item 2 for policy
makers. Stop pretending that the $62 trillion market for credit default
swaps does not need regulatory oversight.
Warren E. Buffett was not engaging in hyperbole
when he called these things financial weapons of mass destruction.
“The last eight years have been
about permitting derivatives to explode, knowing they were unregulated,”
said
Eric R. Dinallo, New York’s superintendent of
insurance. “It’s about what the government chose not to regulate, measured
in dollars. And that is what shook the world.”
Continued in article
Also see "A.I.G., Where Taxpayers’ Dollars Go to Die," The New York
Times, March 7, 2009 ---
http://www.nytimes.com/2009/03/08/business/08gret.html
Bob Jensen's threads on accounting for credit default swaps are under the
C-terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
These Main Street lenders also lied about the values of the homes
that they knew were appraised way above what could be recovered in foreclosures.
Although I think Wall Street's infectious greed was a huge part of the sub-prime
frauds, the roots of the deception are firmly planted along Main Street USA
(e.g., Countrywide
Financial, a subsidiary of Bank of America) where local lenders passed on (fenced?) fraudulent
loans all the way up the mortgage system.
Many Main Street borrowers themselves who signed sub-prime mortgages, at
almost no down payments, knew full well that for a short while they could make
payments at the early subprime teaser interest rates. But they also knew full
well that they could not sustain mortgage payments once the higher rates kicked
in on their mortgage contracts. But their plan was to sell the house when the
higher interest rates kicked in and profit from the increase in home values
while they paid on the basis of the teaser rates. The flaw was their assumption
that housing values just keep increasing like they did since the end of World
War II. These buyers never counted on the bursting of the sub-prime real
estate bubble.
Congress has
not yet agreed to the additional $700 billion bailout
of other big Wall Street investment
banks, and how far it will go is yet to be decided in, gasp, Congress. The
government did bail out AIG. The 2008 bail out of AIG has hope for taxpayers
that was similar to the hope for Chrysler in 1979. The U.S. Government is
loaning the AIG enormous insurance conglomerate $85 billion with an option to
acquire ownership of 80% of AIG if and when AIG's fortunes are turned around.
Since AIG is so enormous globally, I predict this could be
a very good deal for taxpayers unless our idiotic Congress fails to resell its
AIG shares and attempts to turn the insurance industry into a Fannie Mae fiasco.
Now we come to the 2008 additional proposed bailouts of more banks and
investment banks across the nation borrowed from Paul to buy the same fraudulent
sub-prime mortgages from thousands of local banks around the nation. Many
homeowners at all levels of income and home values cannot possibly pay off these
mortgages. Foreclosures will only return half or less of what Fannie, Freddie,
and the Men in Black on Wall Street paid for the fraudulent mortgages. There's
still much debate on how much mortgage buying conglomerates knew about the
frauds perpetrated on Main Street that were passed on to Fannie, Freddie, and
Wall Street. Most of this is bullshit!
See how it really worked (hit the arrow keys to move forward or
backward) ---
Click Here
The Men in Black on Wall Street knew full well that their sub-prime
mortgages, purchased with short-term debt, had loan values well in excess of
mortgage collateral (due to phony real estate appraisals on Main Street) and
were likely to become non-performing when the cheap starting sub-prime interest
rates kicked up to very high interest rates that made payments well in excess of
what many buyers could afford. The problem is that the Men in Black were too
greedy to care about risks imposed on their own investment banks. Like drug
dealers who cut cocaine bags into crack, the Men in Black cut fraudulent
sub-prime mortgages that they purchased into
CDOs
(collateralized debt obligations) that they then sold for huge
commissions/bonuses to unsuspecting investors (many from across the Atlantic and
Pacific).
In the current environment, I am an ardent supporter of
those who would resist calls to suspend fair value accounting rules. But, when I
was at the SEC, I had a front-row seat on what was perhaps one of the most
brazen abuses of fair value accounting in history. I was reminded of it by
Joseph Stiglitz's recent commentary on CNN.com, in which he
characterized the mortgage securitization craze as
just another pyramid scheme. Keep that in mind as I tell you the story of
Stephen Hoffenberg's $400 million fraud.
Tom Selling, "The Anti-Fair Value
Lobby Has a Point (Even if They Don't Know It)" The Accounting Onion,
September 22, 2008 ---
http://accountingonion.typepad.com/
The greedy, greedy, greedy Men in Black (read that Wall Street bankers) got
their CDO sales commissions/bonuses with no regard that those sales were with
recourse such that when the loans defaulted, the fraudulent loans would
eventually become "junk" or "trash" paper bought back by their employers such as
Bear Stearns, AIG, Lehman, Merrill Lynch, etc. In other
words the Men in Black got their CDO sales
commissions knowing full well shareholders in their banks would ultimately take
a huge hit!!!
Bankers
(Men in Black) bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as
quoted by Avital Louria Hahn, "Missing: How Poor Risk-Management
Techniques Contributed to the Subprime Mess," CFO Magazine,
March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the
Government is going to bail out these speculators with taxpayer funds
makes it all the worse. |
Peter Pan, the manager of Countrywide Financial on Main Street, thought he had
little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures
would be Wall Street’s problems and not his local bank’s problems. And he got
his nice little commission on the sale of the Emma Nobody’s mortgage for
$180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was
almost certain in Emma’s case because she only makes $12,000 waitressing at the
Country Café. So what if Peter Pan fudged her income a mite in the loan
application along with the fudged home appraisal value? Let Wall Street or Fat
Fannie or Foolish Freddie worry about Emma after closing the pre-approved
mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter Pan is
more concerned with his own conventional mortgage on his precious house just two
blocks south of Main Street. This is what happens when risk is
spread even farther than Tinkerbell can fly!
For details see
http://papers.nber.org/papers/w14358
Read about the extent of cheating, sleaze, and subprime
sex on Main Street in Appendix U.
At the moment the initial 2008 Treasury Department bailout plan does not have
conditions anywhere close to the 1979 bailout plan for Chrysler --- which in
many ways were punitive conditions that made Chrysler pay dearly for past
mistakes. In fact the 2008 bailout initially proposed by the Treasury Department
to Congress only entails buying up paper trash owned by the Men in Black from
Wall Street for $700 billion --- way above the recycled worth of the trash.
There were no other conditions in the initial bailout proposal. The Men in Black
who dealt in this trash on Wall Street would still get their millions in
compensation in some form or another. Many of them would stay in the business of
inventing newer types of creative trash that they could foist on investors at
enormous commissions. Along the way they will do some good by inventing creative
financing that brings us such good companies as Google.
Here are some of some of the unmentioned problems in the Treasury Department
bailout plan of 2008 that were not part of the 1979 Chrysler bailout"
- After the 2008 bailout was first proposed, the media and Congress jumped
on the wrong concerns such as the fairness issue of multimillion bailout
rewards to Men in Black who got us into this mess. Concerns are also being
raised that the poor people on Main Street who lost or are losing their
homes are not being compensated. Little mention is made that the people
losing their homes probably put nothing or very little into the homes since
the sub-prime mortgage deals being offered entailed little or no down
payments.
- At the moment in the Autumn of 2008 both the media and Congress are not
looking closely enough into the "trash" or "junk" that the Men in Black are
trying to sell (foist is a better word) to the U.S. Government at values no
doubt much greater than a true fair value --- value that cannot really be
determined in this busted real estate market.
- Ignoring
the more complex derivative financial instruments losers, other "junkers"
are trash paper mortgages on non-performing or under-performing mortgage
investments. A non-performing piece of paper is typically collateral on a
vacant foreclosed house and its lot. Perhaps the loan was for $300,000 on
property that is not selling at the moment for $150,000. These collateral
values and foreclosure prices range across the board, but in the case of a
$300,000 loan the Men in Black will probably negotiate a bailout price of
something like $150,000 or maybe even somewhat less. Now that sounds like a
possibly good deal if the Treasury Department can wait it out until the real
estate market recovers a bit and the property can be sold for more than the
bailout price.
But even really bad accountants know better in the case of real estate and
horses!
- At the moment Congress is not proposing to look closely enough into the
mouth of each horse it will be buying in the bailout. In the case of a
purchased horse the buyer has to feed it, shelter it, pay the veterinarian
bills and tie up money invested. In the case of the bailout "trash paper,"
the Men in Black are darned tired of having to pay the bills on foreclosed
real estate --- the lawyer fees, the property taxes, the casualty insurance
premiums, and the maintenance bills for security, repairs, pest control,
lawn mowing, pool cleaning, and on and on and on. And don't forget the time
value of money lost if $150,000 in cash is tied up for ten years at zero
interest.
- I think the reason the Men in Black are so willing to sell their trash
at discount (call that bailout) prices is that they're smarter than the
media and Congress. The Men in Black suspect they will otherwise have to
give the foreclosed properties away just to get out of all the dreaded home
ownership costs.
- What I fear is that, if the Men in Black are willing to forego a year's
salary or 90% of their severance pay, our naive Congress will take the
Treasury Department's bailout deal. Obama makes a big deal about how many
houses John McCain now owns. Ha! Either Barack Obama or John McCain will
soon have to start paying the ownership costs of 5 million empty houses. The
only thing to do with these burdens will be one of the following:
(1) pay years and years of losing ownership costs until offers are received
somewhere close to bailout prices (probably the McCain solution since with a
rich wife he personally does not pay attention to interim home ownership
costs) or
(2) unload
the houses at way below bailout prices so that taxpayers lose big time or
(3) give the vacant houses to poor people (probably the Obama populist
solution).
- But there's a downside to giving the foreclosed empty houses to poor
people. Most poor people probably cannot afford to pay the property taxes
and the other costs of home ownership. They will sell their magnificent gift
houses for whatever they can get, have some really good times afforded from
the proceeds, and then go back into public housing or apply for rent
subsidies. So much for populism that only brings on a few days of good
times.
- In a bailout purchase of trash paper be careful of what you wish for ---
you may get what you wished for.
The concept of
loan collateral used to mean that the collateral had greater value then the
amount loaned --- so that, in case of default, the collateral would cover
the loan. The roots of this crisis lie in the loans made by mortgage lenders
on Main Street (e.g., Bank of America’s Countrywide Finance that made loans
at phony collateral values when the actual collateral values were way less
than the loan amounts).
- The magnitude of the ultimate loss to taxpayers is likely to be much
less unless the bailout fails to keep the economy out a deep depression
and/or Congress tinkers with the bailout to make it an opportunity to make a
populist wealth transfer from taxpayers to non-taxpayers.
Still, we have to consider potential risks
of these governmental actions. Taxpayers may be stuck with hundreds of
billions, and perhaps more than a trillion, dollars of losses from the
various insurance and other government commitments. Although the media
has nade much of this possibility through headlines like "$750 billion
bailout", that magnitude of loss is highly unlikely as long as the
economy does not fall into a sustained major depression. I consider such
a depression highly unlikely. Indeed, the government may well make money
on its actions, just as the Resolution Trust Corporation that took over
many saving and loan banks during the 1980s crisis did not lose much, if
any, money. By buying assets when they are depressed and waiting out the
crisis, there may be a profit on these assets when they are finally sold
back to the private sector. Making money does not mean the government
involvements were wise, but the likely losses to taxpayers are being
greatly exaggerated. Future moral hazards created by these actions are
certainly worrisome. On the one hand, the equity of stockholders and of
management in Fannie and Freddie, Bears Stern, AIG, and Lehman Brothers
have been almost completely wiped out, so they were not spared major
losses. On the other hand, that makes it difficult to raise additional
equity for companies in trouble because suppliers of equity would expect
their capital to be wiped out in any future forced governmental
assistance program. Furthermore, that bondholders in Bears Stern and
these other companies were almost completely protected implies that
future financing will be biased toward bonds and away from equities
since bondholders will expect protections against governmental responses
to future adversities that are not available to equity participants.
Although the government was apparently concerned that foreign central
banks were major holders of the bonds of the Freddies, I believe it was
unwise to give them and other bondholders such full protection.
Nobel Laureate Gary Becker, The Becker-Posner Blog, September 21,
2008 ---
http://www.becker-posner-blog.com/
Jensen Comment
I think this is baloney, because Becker does not factor in the cost of
"ownership" of millions of empty houses acquired in the bailout. This
will destroy the opportunity to recover what the bad debts in the
bailout's reverse auction initially cost the government. The real
problem is the subsequent costs added to the auctioned costs.
Unregulated investment banking on a large scale has probably ended in
2008 --- See Appendix D of this paper.
Real Estate Nobody Wants
Sharon Little says she was shocked to find out she was
still listed as the owner of a rental property on a busy Cleveland street. She
walked away from the house in 2006 when she declared bankruptcy. Since then,
thieves have stripped the house of siding, copper plumbing, and even windows.
She found out her name was still on the deed only when she got a summons last
October to appear in housing court. "Eventually, they're going to tear this
house down," Little says. "Somebody's going to have to foot the bill, and
frankly I think it should be the bank because it's their house. It's not my
house really, so ..."
Mhari Saito, "Banks Refusing to Take
Back Foreclosed Properties," NPR, March 8, 2009 ---
http://www.npr.org/templates/story/story.php?storyId=101386052
Jensen Comment
The former owner doesn't want the property. The mortgage holder forgave the loan
but does not want title to the foreclosed property. The city by all rights
should take title to the property for back taxes, but the city knows nobody will
even pay the back taxes on the property. These properties are like hazardous
waste sites without the hazardous wastes. It's simply that the value of the
property is less than the cost of property taxes, maintenance, and insurance
with no improvement in the property's value in sight.
That some bankers have ended up in prison is not a matter of
scandal, but what is outrageous is the fact that all the others are
free.
Honoré de Balzac
The bourgeoisie can
be termed as any group of people who are discontented with what they
have, but satisfied with what they are
Nicolás Dávila |
"Fatal Risk: The Must-Read Story Of AIG's Downfall," by John Hemton,
Business Insider, April 18, 2011 ---
http://www.businessinsider.com/fatal-risk-the-must-read-story-of-aigs-downfall-2011-4
There are dozens of books on the financial crisis: I
have read many of them and the Kindle samples for just about all of them.
There are only two I would recommend: those are Bethany McLean and Joe
Nocera’s excellent
All the Devils are Here and the much more
specifically detailed
Fatal Risk from
Roddy Boyd. Roddy's book is solely concerned with the failure of AIG.
Both books start without any strong ideological preconceptions and let the
facts woven into a good story do the talking - and both wind up ambivalent
about many of the major players - with many players having human weaknesses
(gullibility, delusion, arrogance etc) but committing nothing that looks
like a strong case for criminal prosecution. Reading these you can see why
there are so few criminal prosecutions from the crisis. And you will also
see just how extreme the human failings that caused the crisis are.
Continued in article
Bob Jensen's Primer on Derivatives ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Primer
The largest bank failure in history!
How could Deloitte give a thumbs up audit report on these scams known by the
bank's executives?
"Eyes Open, WaMu Still Failed," by Floyd Norris, The New York Times,
March 24, 2011 ---
http://www.nytimes.com/2011/03/25/business/25norris.html?_r=1
At that same bank, executives checking for
fraudulent mortgage applications found that at one bank office 42 percent of
loans reviewed showed signs of fraud, “virtually all of it attributable to
some sort of employee malfeasance or failure to execute company policy.” A
report recommended “firm action” against the employees involved.
In addition to such internal foresight and
vigilance, that bank had regulators who spotted problems with procedures and
policies. “The regulators on the ground understood the issues and raised
them repeatedly,” recalled a retired bank official this week.
This is not, however, a column about a bank that
got things right. It is about Washington Mutual, which in 2008 became the
largest bank failure in American history.
What went wrong? The chief executive, Kerry K.
Killinger, talked about a bubble but was also convinced that Wall Street
would reward the bank for taking on more risk. He kept on doing so, amassing
what proved to be an almost unbelievably bad book of mortgage loans. Nothing
was done about the office where fraud seemed rampant.
The regulators “on the ground” saw problems, as
James G. Vanasek, the bank’s former chief risk officer, told me, but the
ones in Washington saw their job as protecting a “client” and took no
effective action. The bank promised change, but did not deliver. It
installed programs to spot fraud, and then failed to use them. The board
told management to fix problems but never followed up.
WaMu, as the bank was known, is back in the news
because the Federal Deposit Insurance Corporation sued Mr. Killinger and two
other former top officials of the bank last week, seeking to “hold these
three highly paid senior executives, who were chiefly responsible for WaMu’s
higher-risk home-lending program, accountable for the resulting losses.”
Mr. Killinger responded by going on the attack. His
lawyers called the suit “baseless and unworthy of the government.” Mr.
Killinger, they said, deserved praise for his excellent management.
I’ll let the courts sort out whether Mr. Killinger
will become the rare banker to be penalized for making disastrously bad
loans. But I am fascinated by how his bank came to make those loans despite
his foresight.
Answers are available, or at least suggested, in
the mass of documents collected and released by the Senate Permanent
Subcommittee on Investigations, which held hearings on WaMu last year. Mr.
Killinger wanted both the loan book and profits to rise rapidly, and saw
risky loans as a means to those ends.
Moreover, this was a market in which a bank that
did not reduce lending standards would lose a lot of business. A decision to
publicly decry the spread of high-risk lending and walk away from it —
something Mr. Vanasek proposed before he retired at the end of 2005 — might
have saved the bank in the long run. In the short run, it would have
devastated profits.
Ronald J. Cathcart, who became the chief risk
officer in 2006, told a Senate hearing he pushed for more controls but ran
into resistance. The bank’s directors, he said, were interested in hearing
about problems that regulators identified over and over again. “But,” he
added, “there was little consequence to these problems not being fixed.”
There were consequences for him. He was fired in
2008 after he took his concerns about weak controls and rising losses to
both the board and to regulators from the Office of Thrift Supervision.
By early 2007, the subprime mortgage market was
collapsing, and the bank was trying to rush out securitizations before that
market vanished. The Federal Deposit Insurance Corporation, a secondary
regulator, was pushing to impose tighter regulation, but the primary
regulator, the Office of Thrift Supervision, was successfully resisting
allowing the F.D.I.C. to even look at the bank’s loan files.
Continued in article
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Taibbi vs. Goldman Sachs: Whose side are you on?
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Place a barf bag in your lap before watching
these videos!
But are they accurate?
In June and July Goldman Sachs put up a pretty good defense.
Now I'm not so sure.
Questions
Why is the SEC still hiding the names of these tremendously lucky naked short
sellers in Bear Sterns and Lehman Bros.?
Was it because these lucky speculators were such good friends of Hank Paulson
and Timothy Geithner?
Or is Matt Taibbi himself a fraud as suggested last summer by Wall Street media
such as
Business Insider?
Jensen Comment
Evidence suggests that the SEC may be protecting these Wall Street thieves!
Or was all of this stealing perfectly legal? If so why the continued secrecy on
the part of the SEC?
Suspicion: The stealing may have taken place in top investors needed by
the government for bailout (Goldman Sachs?)
"Wall Street's Naked Swindle" by Matt
Taibbi
Watch the Video at one of the following sites:
You Tube ---
http://www.youtube.com/watch?v=OqZUbe9KIMs
Google video ---
Click Here
Read the complete article ---
Click Here
Video Updates for Matt Taibbi
GRITtv: Matt Taibbi & Michael Lux: Goldman's Coup
---
http://www.youtube.com/watch?v=nFWjXQLDkXg
"Matt Taibbi's Goldman Sachs Story Is A Joke,"
Joe Weisenthal, Business Insider, July 13, 2009 ---
http://www.businessinsider.com/matt-taibbis-goldman-sachs-story-is-a-joke-2009-7
"Goldman Sachs responds to Taibbi Post," by:
Felix Salmon, Rueters, June 26, 2009 ---
Calls Taibbi "Hysterical" ---
http://blogs.reuters.com/felix-salmon/2009/06/26/goldman-sachs-responds-to-taibbi/
Others Now Argue it Is Not a Joke
"Taibbi's Naked-Shorting Rage: Goldman's Lobbying, SEC's Fail,"l by bobswern.
Daily Kohs, September 30, 2009 ---
http://www.dailykos.com/story/2009/9/30/787963/-Taibbis-Naked-Shorting-Rage:-Goldmans-Lobbying,-SECs-Fail
Now, off we go to Goldman Sachs' notorious lobbying
hubris, the historically-annotated, umpteenth oversight failure of the
Securities Exchange Commission ("SEC"), and what I'm quickly realizing may
well turnout to be the story with regard to it becoming the poster
child for regulatory capture and supervisory breakdown as far as our Wall
Street-based corporatocracy/oligarchy is concerned. Here's the link to
Taibbi's preview blog post: "An
Inside Look at How Goldman Sachs Lobbies the Senate."
Yesterday, as described in this lead-in piece from
the Wall Street Journal, the SEC held a public roundtable discussion
on "New Rules for Lending of Securities." (See link here: "SEC
Weighs New Rules for Lending of Securities.")
SEC Weighs New Rules for Lending of Securities
BY KARA SCANNELL AND CRAIG KARMIN
Wall Street Journal
Saturday, September 26th, 2009
Securities regulators are exploring new
regulations for the multitrillion-dollar securities-lending market, the
first major step regulators have taken in the area in decades.
Securities and Exchange Commission Chairman
Mary Schapiro said she wants to shine a light on the "opaque market."
After many large investors lost millions in last year's credit crunch,
she said, "we need to consider ways to enhance investor-oriented
oversight."
The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants...
Enter Taibbi: "An
Inside Look at How Goldman Sachs Lobbies the Senate."
An Inside Look at How Goldman Sachs Lobbies the
Senate
Matt Taibbi
TruSlant.com
(very early) Tuesday, September 29th, 2009
The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants contend.
Securities lending is central to the practice of short selling, in which
investors borrow shares and sell them in a bet that the price will
decline. Short sellers later hope to buy back the shares at a lower
price and return them to the securities lender, booking a profit.
Lending and borrowing also help market makers keep stock trading
functioning smoothly.
--SNIP--
Later on this week I have a story coming out in
Rolling Stone that looks at the history of the Bear Stearns and Lehman
Brothers collapses. The story ends up being more about naked
short-selling and the role it played in those incidents than I had
originally planned -- when I first started looking at the story months
ago, I had some other issues in mind, but it turns out that there's no
way to talk about Bear and Lehman without going into the weeds of naked
short-selling, and to do that takes up a lot of magazine inches. So
among other things, this issue takes up a lot of space in the upcoming
story.
Naked short-selling is a kind of counterfeiting
scheme in which short-sellers sell shares of stock they either don't
have or won't deliver to the buyer. The piece gets into all of this, so
I won't repeat the full description in this space now. But as this week
goes on I'm going to be putting up on this site information I had to
leave out of the magazine article, as well as some more timely material
that I'm only just getting now.
Included in that last category is some of the
fallout from this week's SEC "round table" on the naked short-selling
issue.
The real significance of the naked
short-selling issue isn't so much the actual volume of the behavior,
i.e. the concrete effect it has on the market and on individual
companies -- and that has been significant, don't get me wrong -- but
the fact that the practice is absurdly widespread and takes place right
under the noses of the regulators, and really nothing is ever done about
it.
It's the conspicuousness of the crime that is
the issue here, and the degree to which the SEC and the other financial
regulators have proven themselves completely incapable of addressing the
issue seriously, constantly giving in to the demands of the major banks
to pare back (or shelf altogether) planned regulatory actions. There
probably isn't a better example of "regulatory capture," i.e. the
phenomenon of regulators being captives of the industry they ostensibly
regulate, than this issue.
Taibbi continues on to inform us that none of the
invited speakers to this government-sponsored event represented stockholders
or companies that could, or have, become targets/victims of naked
short-selling. Also "...no activists of any kind in favor of tougher rules
against the practice. Instead, all of the invitees are (were) either banks,
financial firms, or companies that sell stuff to the first two groups."
Taibbi then informs us that there is only one
panelist invited that's in favor of what may be, perhaps, the most basic
level of regulatory control with regard to this industry practice: a "simple
reform" called "pre-borrowing." Pre-borrowing requires short-sellers to
actually possess the stock shares before they're sold.
It's been proven to work, as last summer the SEC,
concerned about predatory naked short-selling of big companies in the
wake of the Bear Stearns wipeout, instituted a temporary pre-borrow
requirement for the shares of 19 fat cat companies (no other companies
were worth protecting, apparently). Naked shorting of those firms
dropped off almost completely during that time.
The lack of pre-borrow voices invited to this
panel is analogous to the Max Baucus health care round table last
spring, when no single-payer advocates were invited. So who will get to
speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a
hedge fund that has done the occasional short sale, to put it gently),
Credit Suisse, NYSE Euronext, and so on.
Taibbi then tells us of increased efforts by
industry players, specifically noting Goldman Sachs being at the forefront
of this effort, and having "their presence felt."
Taibbi mentioned that he'd received two completely
separate calls from two congressional staffers from different offices--folks
whom Taibbi never met before--who felt compelled to inform him of Goldman's
actions.
We learn that these folks both commented on how
these Goldman folks were lobbying against restrictions on naked
short-selling. One of the aides told Taibbi that they had passed out a "fact
sheet about the issue that was so ridiculous that one of the other staffers
immediately thought to send it to me. "
I would later hear that Senate aides between
themselves had discussed Goldman's lobbying efforts and concluded that
it was one of the most shameless performances they'd ever seen from any
group of lobbyists, and that the "fact sheet" the company had had the
balls to hand to sitting U.S. Senators was, to quote one person familiar
with the situation, "disgraceful" and "hilarious."
Checkout the whole story on his blog. Apparently,
in the upcoming Rolling Stone piece, he gets into the nitty gritty with
regard to how naked short-selling brought down both Bear Stearns and Lehman,
last year.
Should be pretty powerful stuff.
Meanwhile, getting back to the SEC roundtable,
noted above, strike up the fifth item that I've now documented in the past
48 hours where it's becoming self-evident that our elected representatives
and our government agencies aren't even bothering to author the new
regulations and legislation that's so needed to prevent a recurrence of
events such as those we witnessed through the economic/market catastrophes
of the past 24 months; these legislators and high-ranking government
officials are actually having the lobbyists navigate the discussion and
write the damn stuff, too!
How much worse can it get? I really don't want
to know the answer to that rhetorical question. But, with the inmates
running the asylum, we may just find out sooner than we think!
Bob Jensen's threads on noble and ignoble
agendas of the bailout machine ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#IgnobleAgendas
Bailing Out Big Banks Engaged in Sleaze and Sex
"Goldman Laid Down with Dogs," by Ryan Chittum, Columbia Journalism
Review, November 4, 2009 ---
http://www.cjr.org/index.php
This link was forwarded by my friend Larry.
Dean Starkman has been applauding McClatchy’s
series on Goldman Sachs (an Audit funder) for
a couple of
days now. Add another Audit appreciation today.
McClatchy has been doing what Dean has been calling
for for a long time now: Looking much more closely at
how Wall Street
fueled the mortgage crisis and how it
was deeply connected
to the
shadier parts of the
housing industry. Or as McClatchy’s Greg Gordon puts it:
… one of Wall Street’s proudest and most
prestigious firms helped create a market for junk mortgages,
contributing to the economic morass that’s cost millions of Americans
their jobs and their homes.
Today,
McClatchy examines Goldman’s relationship with New
Century Financial, a firm that was something of the canary in the coalmine
of this financial crisis—it was the second-biggest subprime mortgage lender
when it went belly-up in April 2007, which was very, very early. In other
words, it was one of the worst actors in the whole mess:
Perhaps no mortgage lender was more emblematic of
the go-go atmosphere in the sprouting industry that was seizing an
outsize share of the home loan market.
Traversing the country in private jets and
zipping around Southern California in Mercedes Benzes, Porsches and even
a Lamborghini, New Century executives reveled as the firm’s annual
residential mortgage sales rocketed from $357 million in 1996 to nearly
$60 billion a decade later…
What does that have to do with Goldman Sachs and
Wall Street?
For $100 million in mortgages, New Century could
command fees from Wall Street of $4 million to $11 million, ex-employees
told McClatchy. The goal was to close loans fast, bundle them into pools
and sell them to generate money for the next round.
Inside the mortgage company, the former
employees said, pressure was intense to increase the firm’s share of an
exploding market for mortgages that depended almost entirely on Wall
Street’s seemingly unlimited hunger for bigger, faster returns.
Aha! But wait—why did Wall Street want to buy this
trash?
Goldman and other investment banks could put $20
million in the till by taking a 1 percent fee for assembling,
securitizing and selling a $2 billion pool of mostly triple-A rated
bonds backed by subprime loans — and that was just stage one.
That takes you to “The
Giant Pool of Money.” And that was far from the
only juice being squeezed from these lemons. Goldman et al got servicing
fees and the like, plus they “extended lines of credit to New Century —
known as “warehouse loans” — totaling billions of dollars to finance the
issuance of more home loans to other marginal borrowers. Goldman Sachs’
mortgage subsidiary gave the firm a $450 million credit line.”
In other words, Wall Street lent the money to the
predatory firms to create the shady loans so it could buy them from them,
slice them into securities and sell them to the greater fools. This was so
profitable there weren’t enough decent loans to be made. So to feed the
beast, mortgage lenders came up with disastrous inventions like NINJA loans
(No Income, No Jobs, No Assets) and Wall Street, ahem, looked the other way.
It was a vicious circle of profit (virtuous—if you
were one of those who lined their pockets through it) and was interrupted
only when the underlying loans got so bad that borrowers like the ones with
no income, no jobs, and no assets in many instances couldn’t even make a
single payment on the loan. Panic!
McClatchy does well to report on the New Century
culture, helpful in illustrating the lie-down-with-dogs-get-up-with-fleas
thing, writing about the sexualization of some of the work, something
reminds us of
BusinessWeek’s
fascinating story on the subprime
industry’s descent into decadence (the sub headline on that one should be
all that’s needed to entice you to read that one: “The sexual favors,
whistleblower intimidation, and routine fraud behind the fiasco that has
triggered the global financial crisis.”)
But it wasn’t just sex. New Century was giving
kickbacks to mortgage brokers to get their loans, McClatchy quotes a former
top underwriter there as saying.
Let’s not forget, and McClatchy doesn’t,
thankfully, that borrowers were the marks here and took it on the chin:
The loans laid out financial terms that protected
investors but punished homebuyers. They offered above-market interest
rates, typically starting at 8 percent, with provisions that Lee said
were “rigged” to guarantee the maximum 3 percent rise in interest rates
after two years and almost assuredly another 3 percent increase through
ensuing, twice-yearly adjustments.
This is top-notch work by McClatchy. It deserves a
wide airing.
"The Meltdown That Wasn't:
A primer on credit default swaps, the latest Beltway scapegoat,"
The Wall Street Journal, November
15, 2008 ---
http://online.wsj.com/article/SB122670411909729683.html?mod=djemEditorialPage
On Friday,
the Federal Reserve, SEC and CFTC announced an agreement to begin anointing
"central counterparties" for the credit default swap market. Before the pols
create still more institutions that are too big to fail, and further
endanger taxpayers, they might want to spend time defining the problem they
intend to solve.
The same goes for House Oversight Chairman Henry
Waxman. On Thursday he held his latest hearing designed to blame everything
other than failed housing policy for the credit debacle. Eager to avoid
being scapegoated, hedge-fund managers at the hearing agreed that the credit
default swap market is a problem in need of a regulatory solution. But no
matter how many financiers can be made to swear under the hot lights that
credit default swaps are the problem, reality is not cooperating with this
politically convenient theory. This derivatives market continues to perform
better than the market from which it is derived.
Mr. Waxman's committee exists to stage show trials;
he doesn't have jurisdiction to legislate about credit markets or anything
else. But his media events are helpful to his comrade in exculpation, Barney
Frank. The House Financial Services Chairman is among the most desperate to
blame something other than housing, where he famously vowed to "roll the
dice" with Fannie Mae. He too has fingered credit default swaps and now
promises "sensible" regulation. If he does to this market what he did to
housing, he will again be rolling the dice with other people's money.
Credit default swaps are contracts that insure
against a borrower defaulting on its bonds. The buyer of a CDS contract
essentially pays annual premiums and the seller agrees to pay back the
principal if the issuer of the bonds doesn't. It's different from insurance
in that an investor doesn't actually have to own the underlying bonds -- he
can simply buy a CDS as a way to make a bearish bet on a company or to
offset other risks.
Shattering Beltway illusions, the unregulated CDS
market is holding up better than the regulated bond market. Here we are more
than a year into the credit meltdown and the CDS market is offering more
liquidity than the actual cash market. Eraj Shirvani at Credit Suisse notes
that "over the last 18 months, the CDS market -- not the bond market -- has
been the only functioning market that has consistently allowed market
participants to hedge or express a credit view."
Large investors have often struggled mightily this
autumn to find buyers for their bonds, but they could still trade CDS. The
U.K. government seems to agree this is a good thing. Her Majesty's Treasury
has recognized the CDS market as an efficient mechanism for setting prices
by using it as the benchmark to set the rates in its Credit Guarantee Scheme
for banks.
In the U.S., meanwhile, the market has spoken, and
CDS contracts are the way that investors now price credit. This means
Congress should tread very carefully unless it wants to prolong the
downturn. In an environment in which fewer companies are able to issue bonds
and trading is light, a liquid CDS market that can put a price on credit
will hasten the day when more companies are able to borrow money to build
their businesses. A Congressional overreaction or too heavy a hand from the
New York Fed could delay needed capital from reaching Main Street.
But the Beltway crowd has a vague sense that while
they may not understand this market, financial Armageddon will result when a
major participant fails. Lehman Brothers was supposed to be exhibit A. The
firm was on one end of roughly $5 trillion in CDS contracts, according to
Moody's, and Lehman was itself the subject of $72 billion in CDS, in which
other investors were betting on Lehman's success or failure. Here was the
doomsday scenario, with a major player in CDS going bankrupt.
It turned out to be the meltdown that never melted.
Amazing as it is to Washington ears, those greedy, crazy people running
large financial institutions did a decent job of managing their exposures to
Lehman. When large banks and insurance companies were vulnerable to Lehman,
many had offsetting trades that paid off when Lehman went bust. The net
amount of $6 billion owed by sellers of credit protection on Lehman was far
smaller than expected and was arrived at through the same orderly settlement
auction process that has smoothly managed about a dozen such failures -- and
all without government regulation.
This is not to say that Lehman's failure didn't
damage credit markets. But the problem was not a failure of the CDS market,
nor was Lehman's failure caused by CDS. Toxic mortgages killed Lehman. Once
Lehman went bust, CDS contracts added relatively little stress to other
banks. The stress came from the failure of a big investment bank, which made
people unwilling to lend to other banks.
Identifying major systemic risks in the CDS market
has proven much harder than the pols expected. The big dealers that trade
CDS often demand collateral from customers who owe them money on a trade.
But these big dealers usually don't post collateral when the roles are
reversed and they owe the customer. While this is not necessarily a sweet
deal for small hedge funds doing business with a Goldman or a J.P. Morgan,
it minimizes counterparty risks for the major firms. Also, the large dealers
generally make their money facilitating trades for customers, not betting
one way or another on corporate defaults. So if they sell a lot of credit
protection to one customer, they will seek to buy it from somebody else.
AIG, by contrast, was almost entirely a seller of
CDS. By selling credit protection on mortgage-backed securities, the firm
used CDS to make a big bet on housing, which again is the cause of this
crisis. Meanwhile, the search continues for the major counterparty that
would have been destroyed by AIG's collapse.
As for Mr. Waxman, he should spend more time
investigating the cause, not the effects, of market turmoil. Mr. Frank would
seem to be the perfect witness.
For an in-depth legal study of the Bailout decisions, go to
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1306342
Barney's Rubble
PJ O’Rourke’s Parliament of
Whores ---
http://snipurl.com/parliamentwhores
Barney Frank ---
https://en.wikipedia.org/wiki/Barney_Frank
The Ghost of Barney Frank Returns to Washington
Barney Frank: I've (almost) destroyed the economy,
my work here is done.
Washington Times headline, Nov. 29, 2011
Barney's Rubble ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Ala Barney Frank Elizabeth Warren Wants to Break "Wall Street's"
Stranglehold on the Rental Housing Market ---
https://psmag.com/economics/elizabeth-warren-wants-to-break-wall-streets-stranglehold-on-the-rental-housing-market
Even this leftist news outlet admits, finally at the end of the article, that
there are huge problems with Warren's proposal
The article is misleading from get-go by blaming "Wall Street." In fact mortgage
lending, foreclosures, and re-lending is primarily a government-controlled
operations (think Fannie May and the FHA).
Some might argue that it's better to try something than nothing at all, but in
the end this will add trillions to other proposed government spending by Sen.
Warren, including here proposals for free medical care, green initiatives,
guaranteed annual Income, fee college, reparations for African and Native
Americans, and on and on and on without limits to
government spending.
Elizabeth Warren's strategy for becoming president, like that of the other
announced Democatic Party candidates, is to make over $100+ trillion dollars of
give-aways that will destroy the economy if left unchecked.
"Barney Frank Comes Home to Facts ,"
by Larry Kudlow, Townhall, August
20, 2010 ---
http://townhall.com/columnists/LarryKudlow/2010/08/21/barney_frank_comes_home_to_facts
Oh, and don't forget Fannie Mae and Freddie Mac,
those two government-sponsored mortgage giants that engineered the 2008 subprime
mortgage fiasco and are now on the public dole. The Fed kept them afloat by
buying over a trillion dollars of their paper. Now, part of the Treasury's
borrowing from the public covers their continuing large losses.
George Melloan, "Hard Knocks From Easy
Money: The Federal Reserve is feeding big government and harming
middle-class savers," The Wall Street Journal, July 6, 2010 ---
http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t
"The Mortgage Crisis: Some Inside Views Emails show that risk managers at
Freddie Mac warned about lower underwriting standards—in vain, and with lessons
for today," by Charles W. Calomiris, The Wall Street Journal, October
28, 2011 ---
http://online.wsj.com/article/SB10001424053111903927204576574433454435452.html?mod=djemEditorialPage_t
Occupy Wall Street is denouncing banks and Wall
Street for "selling toxic mortgages" while "screwing investors and
homeowners." And the federal government recently announced it will be suing
mortgage originators whose low-quality underwriting standards produced
ballooning losses for Fannie Mae and Freddie Mac.
Have they fingered the right culprits?
There is no doubt that reductions in
mortgage-underwriting standards were at the heart of the subprime crisis,
and Fannie and Freddie's losses reflect those declining standards. Yet the
decline in underwriting standards was largely a response to mandates,
beginning in the Clinton administration, that required Fannie Mae and
Freddie Mac to steadily increase their mortgages or mortgage-backed
securities that targeted low-income or minority borrowers and "underserved"
locations.
The turning point was the spring and summer of
2004. Fannie and Freddie had kept their exposures low to loans made with
little or no documentation (no-doc and low-doc loans), owing to their
internal risk-management guidelines that limited such lending. In early
2004, however, senior management realized that the only way to meet the
political mandates was to massively cut underwriting standards.
The risk managers complained, especially at Freddie
Mac, as their emails to senior management show. They refused to endorse the
move to no-docs and battled unsuccessfully against the reduced underwriting
standards from April to September 2004. Here are some highlights:
On April 1, 2004, Freddie Mac risk manager David
Andrukonis wrote to Tracy Mooney, a vice president, that "while you, Don [Bisenius,
a senior vice president] and I will make the case for sound credit, it's not
the theme coming from the top of the company and inevitably people down the
line play follow the leader."
Risk managers had already experimented with lower
lending standards and knew the dangers. In another email that day, Mr.
Bisenius wrote to Michael May (another senior vice president), "we did
no-doc lending before, took inordinate losses and generated significant
fraud cases. I'm not sure what makes us think we're so much smarter this
time around."
On April 5, Mr. Andrukonis wrote to Chief Operating
Officer Paul Peterson, "In 1990 we called this product 'dangerous' and
eliminated it from the marketplace." He also argued that housing prices were
already high and unlikely to rise further: "We are less likely to get the
house price appreciation we've had in the past 10 years to bail this program
out if there's a hole in it."
Donna Cogswell, a colleague of Mr. Andrukonis,
warned that Fannie and Freddie's decisions to debase underwriting standards
would have widespread ramifications for the mortgage market. In a Sept. 7
email to Freddie Mac CEO Dick Syron and others, she specifically described
the ramifications of Freddie Mac's continuing participation in the market as
effectively "mak[ing] a market" in no-doc mortgages.
Ms. Cogswell's Sept. 4 email to Mr. Syron and
others also anticipated the potential human costs of the mortgage crisis.
She tried to sway management by appealing to their decency: "[W]hat better
way to highlight our sense of mission than to walk away from profitable
business because it hurts the borrowers we are trying to serve?"
Politics—not shortsightedness or incompetent risk
managers—drove Freddie Mac to eliminate its previous limits on no-doc
lending. Commenting on what others referred to as the "push to do more
affordable [lending] business," Senior Vice President Robert Tsien wrote to
Dick Syron on July 14, 2004: "Tipping the scale in favor of no cap [on
no-doc lending] at this time was the pragmatic consideration that, under the
current circumstances, a cap would be interpreted by external critics as
additional proof we are not really committed to affordable lending."
Sensing that his warnings were being ignored, Mr.
Andrukonis wrote to Michael May on Sept. 8: "At last week's risk management
meeting I mentioned that I had reached my own conclusion on this product
from a reputation risk perspective. I said that I thought you and or Bob
Tsien had the responsibility to bring the business recommendation to Dick [Syron],
who was going to make the decision. . . . What I want Dick to know is that
he can approve of us doing these loans, but it will be against my
recommendation."
The decision by Fannie and Freddie to embrace
no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for
example, total subprime and Alt-A mortgage originations were $395 billion.
In 2004, they rose to $715 billion. By 2006, they were more than $1
trillion.
In a painstaking forensic analysis of the sources
of increased mortgage risk during the 2000s, "The Failure of Models that
Predict Failure," Uday Rajan of the University of Michigan, Amit Seru of the
University of Chicago and Vikrant Vig of London Business School show that
more than half of the mortgage losses that occurred in excess of the rosy
forecasts of expected loss at the time of mortgage origination reflected the
predictable consequences of low-doc and no-doc lending. In other words, if
the mortgage-underwriting standards at Fannie and Freddie circa 2003 had
remained in place, nothing like the magnitude of the subprime crisis would
have occurred.
Taxpayer losses at Fannie and Freddie alone may
exceed $300 billion. The costs of the financial collapse and recession
brought on by the mortgage bust are immeasurably higher. Unfortunately, the
Obama administration has perpetuated the low underwriting standards that
gave us the crisis and encouraged the postponement of foreclosures by
lending support to various states' efforts to sue originators for robo-signing
violations.
Continued in article
"Barney Frank Comes Home to Facts
," by Larry Kudlow, Townhall, August 20, 2010 ---
http://townhall.com/columnists/LarryKudlow/2010/08/21/barney_frank_comes_home_to_facts
Can you teach an old dog new tricks? In politics,
the answer is usually no. Most elected officials cling to their ideological
biases, despite the real-world facts that disprove their theories time and
again. Most have no common sense, and most never acknowledge that they were
wrong.
But one huge exception to this rule is Democrat
Barney Frank, chairman of the House Financial Services Committee.
For years, Frank was a staunch supporter of Fannie
Mae and Freddie Mac, the giant government housing agencies that played such
an enormous role in the financial meltdown that thrust the economy into the
Great Recession. But in a recent CNBC interview, Frank told me that he was
ready to say goodbye to Fannie and Freddie.
“I hope by next year we’ll have abolished Fannie
and Freddie,” he said. Remarkable. And he went on to say that “it was a
great mistake to push lower-income people into housing they couldn’t afford
and couldn’t really handle once they had it.” He then added, “I had been too
sanguine about Fannie and Freddie.”
When I asked Frank about a long-term phase-out plan
that would shrink Fannie and Freddie portfolios and mortgage-purchase
limits, and merge the agencies into the Federal Housing Administration (FHA)
for a separate low-income program that would get government out of
middle-income housing subsidies, he replied: “Larry, that, I think, is
exactly what we should be doing.”
Frank also said that any federal housing guarantees
should be transparently priced and put on budget. But he added that the
private sector must be encouraged to re-enter housing finance just as the
government gradually withdraws from it.
Some would say Frank’s mea culpa is politically
motivated in advance of an election where bailout nation and big government
are public enemies number one and two. Of course, poll after poll shows that
the $150 billion Fan-Fred bailout, which the Congressional Budget Office
estimates could rise to $400 billion, is detested by voters and taxpayers
everywhere.
In fact, these failed government agencies are in
such bad shape that they can’t even pay Uncle Sam the dividends owed under
the conservatorship deal reached two years ago. That’s right. In order to
pay a $1.8 billion dividend on Treasury department stock, Fan and Fred had
to borrow $1.5 billion from -- you guessed it -- the Treasury.
Then there’s this head-scratching detail: In an
absolutely outrageous move last Christmas Eve, President Obama signed off on
$42 million in bonuses for the top twelve Fannie and Freddie executives,
including $6 million apiece for the two CEOs. (Hat tip to attorney Stephen
B. Meister.)
Voters are on to all this.
May 31, 2011 message from Roger Collins
Of possible interest...
http://www.nytimes.com/2011/05/29/books/review/book-review-reckless-endangerment-by-gretchen-morgenson-and-joshua-rosner.html?ref=books
"It’s hardly news that the near meltdown of
America’s financial system enriched a few at the expense of the rest of us.
Who’s responsible? The recent report of the Financial Crisis Inquiry Commission
blamed all the usual suspects — Wall Street banks, financial regulators, the
mortgage giants Fannie Mae and Freddie Mac,
and subprime lenders — which is tantamount to blaming
no one. “Reckless Endangerment” concentrates on particular individuals who
played key roles.
The authors, Gretchen Morgenson, a Pulitzer
Prize-winning business reporter and columnist at The New York Times, and Joshua
Rosner, an expert on housing finance, deftly trace the beginnings of the
collapse to the mid-1990s, when the Clinton administration called for a
partnership between the private sector and Fannie and Freddie to encourage home
buying. The mortgage agencies’ government backing was, in effect, a valuable
subsidy, which was used by Fannie’s C.E.O.,
James A. Johnson, to increase home ownership while
enriching himself and other executives. A 1996 study by the Congressional Budget
Office found that Fannie pocketed about a third of the subsidy rather than
passing it on to homeowners. Over his nine years heading Fannie, Johnson
personally took home roughly $100 million. His successor, Franklin D. Raines,
was treated no less lavishly...."
continued in
article...
Roger
Bob Jensen's threads on earnings management fraud at Fanny Mae ---
http://faculty.trinity.edu/rjensen/Theory02.htm#Manipulation
Bob Jensen's threads on slease in thesubprime scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
$6 billion here, $6 billion there, who cares as long as taxpayers foot the
bill?
"Freddie Mac Loses $4.4B in Third Quarter, Requests $6B More From Treasury,"
Fox News, November 3, 2011 ---
Click Here
http://www.foxnews.com/politics/2011/11/03/freddie-mac-loses-44b-in-third-quarter-requests-6b-more-from-treasury/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+foxnews%2Fpolitics+%28Internal+-+Politics+-+Text%29&utm_content=My+Yahoo
Government-controlled mortgage giant Freddie Mac
has requested $6 billion in additional aid after posting a wider loss in the
third quarter.
Freddie Mac said Thursday that it lost $4.4
billion, or $1.86 per share, in the July-September quarter. That compares
with a loss of $4.1 billion, or $1.25 a share, in the same quarter of 2010.
This quarter's $6 billion request from taxpayers is
the largest since April 2010.
Freddie's losses are increasing mainly for two
reasons: Many homeowners are paying less interest because they are able to
refinance at lower mortgage rates. And failing and bankrupt mortgage
insurers are not paying out as much money when homeowners default.
The government rescued McLean, Va.-based Freddie
Mac and sibling company Fannie Mae in September 2008 after massive losses on
risky mortgages threatened to topple them. Since then, a federal regulator
has controlled their financial decisions.
Taxpayers have spent about $169 billion to rescue
Fannie and Freddie, the most expensive bailout of the 2008 financial crisis.
The government estimates it could cost up to $51 billion more to support the
companies through 2014.
Freddie and Washington-based Fannie own or
guarantee about half of all U.S. mortgages, or nearly 31 million home loans
worth more than $5 trillion. Along with other federal agencies, they backed
nearly 90 percent of new mortgages over the past year.
Charles E. Haldeman Jr., Freddie's chief executive,
said many homeowners are refinancing at lower mortgage rates or are
shortening the terms of their mortgage. While that saves homeowners money,
it is pushing Freddie deeper into the red.
"In fact, borrowers we helped to refinance will
save an average of $2,500 in interest payments during the next year," he
said.
For Freddie, those losses are temporary because
interest rates will remain low for the foreseeable future, said Jim Vogel,
an interest-rate specialist at FTN Financial.
Still, many homeowners are still defaulting on
their mortgages. Unemployment remains stubbornly high at 9.1 percent. The
percentage of those who are late by 90 days or more on their monthly
mortgage payments was virtually unchanged at 3.51 percent in the
July-September quarter.
Another reason Freddie needs more aid is because it
has received less money from mortgage insurers.
Many riskier mortgage loans require insurance,
which is meant to protect lenders and investors from losses if a homeowner
defaults and the lender doesn't recoup costs through foreclosure. The
borrower pays a monthly premium for the insurance, typically a set
percentage of the total mortgage loan. But when those mortgage insurers
fail, they pay out less in claims.
Continued in article
"What the Demise of Fannie Mae and Freddie Mac Means for the Future of
Homeownership," Knowledge@Wharton, March 16, 2011 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2737
By most accounts, the federally sponsored mortgage
giants Fannie Mae and Freddie Mac did not cause the housing and mortgage
crisis. But they were a big part of the problem, prompting a taxpayer
bailout costing more than $130 billion.
Now, seeking to protect taxpayers from future
meltdowns, the Obama administration wants to phase out the two firms over an
unspecified period and leave the lion's share of the mortgage market to
private lenders. It would be a dramatic change, given that the private
market has shriveled in recent years, leaving Fannie, Freddie and the
Federal Housing Administration to back about 90% of all new home loans. The
administration also proposes a reduced role for the FHA, one that would
focus on providing mortgages for the needy.
How would a phase-out of Fannie and Freddie affect
the availability of mortgages, loan rates and home prices? In the end, would
such a dramatic change be good for homeowners or not?
Opinions vary, and no one can know for sure. The
mortgage and housing markets are complex, and a controlled experiment that
removes Fannie and Freddie but leaves everything else the same is obviously
not possible, says Wharton real estate professor
Todd Sinai. "There's a debate over whether Fannie
and Freddie successfully reduced mortgage rates paid by borrowers, or
increased the mortgage availability for borrowers, or whether they just took
their implicit [government] subsidy and generated higher returns for
shareholders," Sinai says. "If Fannie and Freddie were successful in making
mortgage credit cheaper and more available, then eliminating [them] would
have a negative impact on house prices."
It is not clear that the private market can or
would absorb the volume of business done by Fannie and Freddie, which cover
trillions of dollars worth of loans, according to Wharton real estate
professor
Susan M. Wachter. "That's a good question," she
says, noting that even if the private market were to take over, borrowers
would probably not get the attractive deals they can today.
"The 30-year [mortgage] would become more
expensive," she states, adding that some experts predict a three percentage
point rate rise. With the 30-year, fixed-rate loan now averaging around 5%,
that would take it to 8%, raising the monthly payment for every $100,000
borrowed from $537 to $733. This would make the 30-year fixed loan
"noncompetitive" with adjustable-rate loans, Wachter says. ARMs can offer
lower rates because lenders face less risk, given that they can raise rates
as market conditions change
Jack M. Guttentag, an emeritus professor of
finance at Wharton who runs a website called
The Mortgage
Professor, thinks fixed rates might go up only
three quarters of a percentage point rather than three points. But with the
two firms' loan guarantees removed from the market, lenders would probably
demand larger down payments than they have in the past, and be less willing
to provide loans to those with less-than-stellar credit. Indeed, today's
tight lending standards, a reaction to the recent crisis, could become
permanent.
"Things like qualification standards have become
extremely strict," Guttentag says, noting that it is now all but impossible
for a self-employed applicant to get a mortgage. "The biggest part of it
would be the increase in the down payment; 20% would probably become the
minimum throughout the marketplace."
Larger down payments reduce the lender's risk
because borrowers are reluctant to default if they have equity in the home,
and because a smaller loan relative to the home's value makes it easier for
the lender to recover in a foreclosure. Currently, most lenders require 20%
down payments; a few years ago, however, it was possible to get a loan with
nothing down. The Obama administration wants underwriting standards to
require at least 10%, though the FHA would continue to offer low-down
payment loans to certain less-affluent borrowers.
Planning a Phase-out
Fannie, the Federal National Mortgage Association,
was formed as a government agency in 1938 and was converted to a publicly
traded company in 1968. Freddie, the Federal Home Loan Mortgage Corp., is a
publicly traded company created by the government in 1970 to provide
competition for Fannie. Their primary role is to buy and insure mortgages
issued by private lenders. Some loans stay on Fannie and Freddie's books,
but most are bundled into mortgage securities sold to investors like other
types of government and corporate bonds. Fannie and Freddie provide
investors certain guarantees that interest and principal payments will be
made even if homeowners default.
Continued in article
Bob Jensen's threads on Fannie and Freddie are at the following links:
http://faculty.trinity.edu/rjensen/2008Bailout.htm
http://faculty.trinity.edu/rjensen/Theory02.htm#Manipulation
"Taxpayers to Pay for Fannie, Freddie Aid: Treasury Removed Caps on
Assistance," SmartPros, January 13, 2010 ---
http://accounting.smartpros.com/x68543.xml
A recent move by the Treasury Department to remove
$200 billion caps on assistance to Fannie Mae and Freddie Mac eliminates any
doubt that taxpayers will pay for all their losses for the next three years
and appears to be a major step toward formally nationalizing the housing
enterprises, analysts say.
The government took control of the companies, and
effectively much of the U.S. mortgage market, in September 2008 and started
purchasing all their mortgage-backed securities. But the Treasury previously
used the $200 billion caps on aiding each company to try to limit taxpayer
exposure to their mounting losses.
Republicans charge that Treasury has given the
Depression-era companies a "blank check" to pay for burgeoning losses on
defaulting loans.
The two housing enterprises last year guaranteed
and secured nearly 70 percent of new mortgages, primarily made to "prime"
borrowers with the best credit ratings, while the Federal Housing
Administration insured most loans to subprime borrowers, leaving only a tiny
share of the mortgage market in private hands.
In its Christmas Eve statement announcing the
little-noticed changes, the Treasury insisted that it wants to preserve "an
environment where the private market is able to provide a larger source of
mortgage finance."
But analysts say Treasury's move may push off any
return to a normal mortgage market for years -- possibly forever. Treasury
removed the liability caps for three years and loosened restrictions on
Fannie's and Freddie's purchases of their own mortgage securities --
enabling them to maintain their dominant share of the mortgage market.
"These actions would preserve and strengthen the
governments involvement and control over the countrys housing finance system
and make it harder to reintroduce substantial private-sector involvement
later on," said Edward Pinto, a housing consultant and former chief credit
officer at Fannie Mae.
When combined with a separate move by regulators
not to provide common stock as part of executive compensation at Fannie and
Freddie, the administration's recent actions suggest that it is moving to
nationalize the companies, Mr. Pinto said.
Nationalization, or total government control and
ownership of the companies, would wipe out the value of Fannie and Freddie
stock, making it worthless as a way to pay executives. The value of the
stock has plummeted to between $1 and $2 a share in the wake of the
government's takeover.
Treasury spokesman Andrew Williams declined to
elaborate on the Treasury's actions, but denied that nationalization was the
goal.
The administration is preparing to present its
proposals for governing Fannie and Freddie in the future -- a major question
not addressed in financial reform legislation pending in Congress -- when it
presents its budget in February. Options range from fully nationalizing the
enterprises to reprivatizing them or turning them into public "utilities"
like the closely regulated gas and electric companies.
Sen. Bob Corker, Tennessee Republican, questioned
whether the administration was moving toward nationalization in a letter to
Treasury Secretary Timothy F. Geithner this week, urging the Treasury to
incorporate fully in its February budget the cost of any additional Fannie
and Freddie liabilities the government is acquiring.
"Due to the level of support that this
administration and the previous one have created for Fannie Mae and Freddie
Mac, would you not consider your latest move an effective nationalization?"
asked Mr. Corker, a member of the Senate Banking, Housing and Urban Affairs
Committee. "If so, then the liabilities of these two firms should absolutely
be reflected on the balance sheet of the U.S. Treasury."
Fully nationalizing the enterprises would
permanently increase costs for taxpayers and would bloat the government's
balance sheets. Fannie and Freddie currently guarantee about $5.5 trillion
of outstanding mortgages and debts -- nearly as much as the Treasury's own
public debt. If the companies were fully nationalized, the government's
books would have to reflect both the revenues and losses from those
obligations.
But even if the administration and Congress stop
short of formally incorporating the enterprises into the federal government,
the removal of the caps at least for now has eliminated any doubt that the
government stands behind all Fannie and Freddie obligations and will cover
their losses for the next three years.
Treasury reportedly told Mr. Corker that the move
was needed to calm markets.
Apparently, it deemed the certainty of government
backing to be critical at a time when the Federal Reserve has announced that
it will end its program of purchasing $1.25 trillion in Fannie and Freddie
mortgage bonds in March. The Fed's program -- another unprecedented federal
intervention in the mortgage market -- provided most of the funding to
finance prime mortgages in the past year.
Many housing analysts and economists worry that the
Fed's withdrawal from the mortgage market will cause a sharp rise in 30-year
mortgage rates of as much as one percentage point from 5 percent to 6
percent as private investors demand higher yields to compensate for the
increased likelihood of defaults on mortgages.
Nearly one in eight mortgages is in default, with
prime mortgages guaranteed by Fannie and Freddie having taken over subprime
last year as the principal source of delinquencies.
Rapidly rising delinquencies have prompted some
analysts to predict a collapse in the mortgage market once the Fed stops
buying most of Fannie and Freddie's debt. The Treasury's move appears
designed to reassure investors and prevent that from happening.
"When you have someone as big as the Fed was in
2009 walking away cold turkey, there have to be bumps along the road," said
Ajay Rahadyaksha, managing director at Barclays Capital. But he expects
investors to be enticed back into the mortgage market because they have
"massive amounts of cash" to invest.
While full nationalization of the enterprises would
be controversial, and likely provoke overwhelming Republican opposition,
most parties agree that after the massive efforts to prop up the mortgage
market in the past two years it would be difficult for the government to
entirely extricate itself in the future.
Former Treasury Secretary Henry M. Paulson Jr. said
he intended to keep the government's options open when he designed the plan
to take 79.9 percent control of Fannie and Freddie and put them under
government conservatorship.
But he said they should not be returned to their
previous ambiguous structure, where they were owned by private stockholders
even as they carried out a government mission. He said the best structure in
the future might be to turn them into public utilities that funnel the
government's guarantee on mortgage-backed securities for a fee.
The Mortgage Bankers Association and other private
groups have endorsed a permanent federal role in guaranteeing pools of prime
mortgages, perhaps through a revamped Fannie and Freddie.
One reason heavy government involvement is likely
to continue is that Fannie and Freddie -- unlike many banks that received
bailouts from the Treasury -- likely will never be able to fully repay the
nearly $100 billion in assistance they have received so far from taxpayers,
analysts say.
Their losses are growing by the day, and many of
them now are incurred as a result of new mandates from the Treasury and
Congress to spearhead the government's efforts to alleviate the home
foreclosure crisis and make credit available as widely as possible.
For example, Fannie recently said it may liberalize
its rules for mortgages used to buy condominiums in Florida -- an area that
has been plagued with high rates of default and foreclosure, while it is
giving preference to homeowners over investors when it sells foreclosed
properties, even if investors offer a better deal.
Many analysts expect the administration to soon
increase the subsidies the enterprises are providing to homeowners and banks
that renegotiate mortgages to try to avoid foreclosure, and some suspect it
already is using Fannie and Freddie to make loans available to riskier
borrowers.
Mr. Corker said the proliferation of government
mandates for the enterprises has essentially turned them into "a direct
extension of the Treasury Department."
How Fannie Mae creatively managed earnings and cooked the books to give
then CEO Franklin Raines millions and then had to fire Franklin and issued
restated financial statements ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
"The Biggest Losers Behind the
Christmas Eve taxpayer massacre at Fannie and Freddie," The Wall Street
Journal, January 3, 2009 ---
http://online.wsj.com/article/SB10001424052748704152804574628350980043082.html?mod=djemEditorialPage
Happy New Year, readers, but before we get on with
the debates of 2010, there's still some ugly 2009 business to report: To
wit, the Treasury's Christmas Eve taxpayer massacre lifting the $400 billion
cap on potential losses for Fannie Mae and Freddie Mac as well as the limits
on what the failed companies can borrow.
The Treasury is hoping no one notices, and no
wonder. Taxpayers are continuing to buy senior preferred stock in the two
firms to cover their growing losses—a combined $111 billion so far. When
Treasury first bailed them out in September 2008, Congress put a $200
billion limit ($100 billion each) on federal assistance. Last year, the
Treasury raised the potential commitment to $400 billion. Now the limit on
taxpayer exposure is, well, who knows?
The firms have made clear that they may only be
able to pay the preferred dividends they owe taxpayers by borrowing still
more money . . . from taxpayers. Said Fannie Mae in its most recent
quarterly report: "We expect that, for the foreseeable future, the earnings
of the company, if any, will not be sufficient to pay the dividends on the
senior preferred stock. As a result, future dividend payments will be
effectively funded from equity drawn from the Treasury."
The loss cap is being lifted because the government
has directed both companies to pursue money-losing strategies by modifying
mortgages to prevent foreclosures. Most of their losses are still coming
from subprime and Alt-A mortgage bets made during the boom, but Fannie
reported last quarter that loan modifications resulted in $7.7 billion in
losses, up from $2.2 billion the previous quarter.
The government wants taxpayers to think that these
are profit-seeking companies being nursed back to health, like AIG. But at
least AIG is trying to make money. Fan and Fred are now designed to lose
money, transferring wealth from renters and homeowners to overextended
borrowers.
Even better for the political class, much of this
is being done off the government books. The White House budget office still
doesn't fully account for Fannie and Freddie's spending as federal outlays,
though Washington controls the companies. Nor does it include as part of the
national debt the $5 trillion in mortgages—half the market—that the
companies either own or guarantee. The companies have become Washington's
ultimate off-balance-sheet vehicles, the political equivalent of Citigroup's
SIVs, that are being used to subsidize and nationalize mortgage finance.
This subterfuge also explains the Christmas Eve
timing. After December 31, Team Obama would have needed the consent of
Congress to raise the taxpayer exposure beyond $400 billion. By law,
negative net worth at the companies forces them into "receivership," which
means they have to be wound down.
Unlimited bailouts will now allow the Treasury to
keep them in conservatorship, which means they can help to conserve the
Democratic majority in Congress by increasing their role in housing finance.
With the Federal Reserve planning to step back as early as March from buying
$1.25 trillion in mortgage-backed securities, Team Obama is counting on Fan
and Fred to help reflate the housing bubble.
That's why on Christmas Eve Treasury also rolled
back a key requirement of the 2008 bailout—that Fan and Fred begin shrinking
the portfolios of mortgages they own on their own account, which total a
combined $1.5 trillion. Risk-taking will now increase, so that the
government can once again follow Barney Frank's infamous advice that the
companies "roll the dice" on subsidies for affordable housing.
All of which would seem to make the CEOs of Fannie
and Freddie the world's most overpaid bureaucrats. A release from the
Federal Housing Finance Agency that also fell in the Christmas Eve forest
reports that, after presiding over a combined $24 billion in losses last
quarter, Fannie CEO Michael Williams and Freddie boss Ed Haldeman are
getting substantial raises. Each is now eligible for up to $6 million
annually.
Freddie also has one of the world's highest-paid
human resources executives. Paul George's total compensation can run up to
$2.7 million. It must require a rare set of skills to spot executives
capable of losing billions of dollars.
Where is Treasury's pay czar when we actually need
him? You guessed it, Fannie and Freddie are exempt from the rules applied to
the TARP banks. The government gave away the game that these firms are no
longer in the business of making profits when it announced that the CEOs
will be paid entirely in cash, though it is discouraging that practice at
other big banks. Who would want stock in the Department of Housing and Urban
Development?
Meanwhile, these biggest of Beltway losers continue
to be missing from the debate over financial reform. The Treasury still
hasn't offered its long-promised proposals even as it presses reform on
banks that played a far smaller role in the financial mania and panic.
Senate Banking Chairman Chris Dodd (D., Conn.) and ranking Republican
Richard Shelby recently issued a joint statement on their "progress" toward
financial regulatory reform, but their list of goals also doesn't mention
Fannie or Freddie.
Since Mr. Shelby has long argued for reform of
these government-sponsored enterprises, their absence suggests that Mr.
Dodd's longtime effort to protect Fan and Fred is once again succeeding. It
would be worse than a shame if, having warned about the iceberg for years,
Mr. Shelby now joins Mr. Dodd in pretending that these ships aren't sinking.
In today's Washington, we suppose, it only makes
sense that the companies that did the most to cause the meltdown are being
kept alive to lose even more money. The
politicians have used the panic as an excuse to reform everything but
themselves.
The Price for Fannie and Freddie Keeps Going Up: Barney Frank's
decision to 'roll the dice' on subsidized housing is becoming an epic disaster
for taxpayers," by Peter J. Wallison,
The Wall Street Journal,
December 29, 2009 ---
http://online.wsj.com/article/SB10001424052748703278604574624681873427574.html?mod=djemEditorialPage
On Christmas Eve, when most Americans' minds were
on other things, the Treasury Department announced that it was removing the
$400 billion cap from what the administration believes will be necessary to
keep Fannie Mae and Freddie Mac solvent. This action confirms that the
decade-long congressional failure to more closely regulate these two
government-sponsored enterprises (GSEs) will rank for U.S. taxpayers as one
of the worst policy disasters in our history.
Fannie and Freddie's congressional sponsors—some of
whom are now leading the administration's effort to "reform" the financial
system—have a lot to answer for. Rep. Barney Frank (D., Mass.), chairman of
the House Financial Services Committee, sponsored legislation adopted in
2008 that established a new regulatory structure for the GSEs. But by then
it was far too late. The GSEs had begun buying risky loans in 1993 to meet
the "affordable housing" requirements established under congressional
direction by the Department of Housing and Urban Development (HUD).
Most of the damage was done from 2005 through 2007,
when Fannie and Freddie were binging on risky mortgages. Back then, Mr.
Frank was the bartender, denying that there was any cause for concern, and
claiming that he wanted to "roll the dice" on subsidized housing support.
In 2005, the Senate Banking Committee, then
controlled by Republicans, adopted tough regulatory legislation that would
have established more auditing and oversight of the two agencies. But it was
passed out of committee on a partisan vote, and with no Democratic support
it never came to a vote.
By the end of 2008, Fannie and Freddie held or
guaranteed approximately 10 million subprime and Alt-A mortgages and
mortgage-backed securities (MBS)—risky loans with a total principal balance
of $1.6 trillion. These are now defaulting at unprecedented rates,
accounting for both their 2008 insolvency and their growing losses today.
Since 2008, under government control, the two agencies have continued to buy
dicey mortgages in order to stabilize housing prices.
There is more to this ugly situation. New research
by Edward Pinto, a former chief credit officer for Fannie Mae and a housing
expert, has found that from the time Fannie and Freddie began buying risky
loans as early as 1993, they routinely misrepresented the mortgages they
were acquiring, reporting them as prime when they had characteristics that
made them clearly subprime or Alt-A.
In general, a subprime mortgage refers to the
credit of the borrower. A FICO score of less than 660 is the dividing line
between prime and subprime, but Fannie and Freddie were reporting these
mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a
third-quarter 10-Q report in 2008.
An Alt-A mortgage is one in which the quality of
the mortgage or the underwriting was deficient; it might lack adequate
documentation, have a low or no down payment, or in some other way be more
likely than a prime mortgage to default. Fannie and Freddie were also
reporting these mortgages as prime, according to Mr. Pinto.
It is easy to see how this misrepresentation was a
principal cause of the financial crisis.
Market observers, rating agencies and investors
were unaware of the number of subprime and Alt-A mortgages infecting the
financial system in late 2006 and early 2007. Of the 26 million subprime and
Alt-A loans outstanding in 2008, 10 million were held or guaranteed by
Fannie and Freddie, 5.2 million by other government agencies, and 1.4
million were on the books of the four largest U.S. banks.
In addition, about 7.7 million subprime and Alt-A
housing loans were in mortgage pools supporting MBS issued by Wall Street
banks—which had long before been driven out of the prime market by Fannie
and Freddie's government-backed, low-cost funding. The vast majority of
these MBS were rated AAA, because the rating agencies' models assumed that
the losses that are incurred by subprime and Alt-A loans would be within the
historical range for the number of high-risk loans known to be outstanding.
But because of Fannie and Freddie's mislabeling,
there were millions more high-risk loans outstanding. That meant default
rates as well as the actual losses after foreclosure were going to be
outside all prior experience. When these rates began to show up early in
2007, it was apparent something was seriously wrong with assumptions on
which AAA ratings had been based.
Losses, it was now certain, would invade the AAA
tranches of the mortgage-backed securities outstanding. Investors, having
lost confidence in the ratings, fled the MBS market and ultimately the
market for all asset-backed securities. They have not yet returned.
By the end of 2007, the MBS market collapsed
entirely. Assets once carried at par on financial institutions' balance
sheets could not be sold except at distress prices. This raised questions
about the stability and even the solvency of most of the world's largest
financial institutions.
The first major victim was Bear Stearns, the
smallest of the five major Wall Street investment banks but one invested
heavily in risky MBS. The government rescue of Bear Stearns in March 2008
signaled that the U.S. government, and perhaps others, would stand behind
other large financial institutions. The moral hazard this engendered was
deadly when Lehman Brothers' solvency came under challenge. Spreads in the
credit default swap market for Lehman, despite massive short-selling, showed
very little alarm by investors until just before the fateful weekend of
Sept. 13 and 14, when they blew out on fears that the firm might not be
rescued.
By that time it was too late for Lehman's
counterparties to take the protective action that might have cushioned the
shock. As it turned out, however, none of Lehman's largest counterparties
failed—so much for the idea that the financial market is
"interconnected"—but all market participants now realized they had to know
the true financial condition of their counterparties. The result was a
freeze-up in interbank lending.
For most people, that freeze-up is the beginning of
the financial crisis. But its roots go back to 1993, when Fannie and Freddie
began stocking up on subprime and other risky loans while reporting them as
prime.
Why Fannie and Freddie did this is still to be
determined. But the leading candidate is certainly HUD's affordable housing
regulations, which by 2007 required that 55% of all the loans the agencies
acquired had to be made to borrowers at or below the median income, with
almost half of these required to be low-income borrowers.
Another likely reason for Fannie and Freddie's
mislabeling of mortgages was their desire to retain congressional support by
"rolling the dice" while making believe they weren't betting. With the
Federal Housing Administration, Wall Street investment banks, and Fannie and
Freddie all competing for these loans, the bottom of the barrel had long
before been scraped and the financial system set up for a crisis.
What happened was an explosion of loans being made
outside of the regular banking system. It was largely the unregulated sector of
the lending industry and the underregulated and the lightly regulated that did
that.
Barney Frank
Question
How did banks circumvent mortgage regulations in before the subprime scandal
broke?
Jensen Comment
For once I would like to bless
Barney Frank,
although as chairman of the House Financial Services Committee when these
scandals were taking place, he should have stopped this banking house of cards
before this banking fraud came tumbling down. In spite of yelling foul now, Rep.
Frank helped create this pile of "Barney's Rubble." Pardon me for not blessing
Barney now ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Was he left in the dark about mortgage fraud? Wink! Wink!
I'm about to puke!
Hint
They used a ploy much like corporations used to keep real estate and other debt
of the balance sheet before accounting standard setters put an end to the sham.
For example, Avis Car rental at one time avoided putting millions of debt for
financing its cars by creating a sham subsidiary financing subsidiary and then
(in those good old days) did not consolidate the financing subsidiary into the
consolidated balance sheet of Avis. Similarly, Safeway appeared to not own any
stores or have any mortage debt on those stores because all this was hidden in
an unconsolidated subsidiary. It took way to long in the United States for the
FASB to put an end to the sham of off-balance-sheet-financing (OBSF):
FAS 94: Consolidation of All Majority-owned Subsidiaries--an amendment of
ARB No. 51, with related amendments of APB Opinion No. 18 and ARB No. 43,
Chapter 12 (Issued 10/87) ---
http://www.fasb.org/summary/stsum94.shtml
In the case of banks circumventing regulations on selling mortgages,
here's how it worked with sham mortgage company subsidiaries.
"Subprime and the Banks: Guilty as Charged," by Joe Nocera. The New
York Times, October 14, 2009 ---
http://executivesuite.blogs.nytimes.com/2009/10/14/subprime-and-the-banks-guilty-as-charged/
“There has not been a case made that there is an
enforcement problem with banks,” Edward Yingling, the head of the American
Bankers Association, said last week. “There is a problem with enforcement on
nonbanks.”
As I wrote in
my column last week, this has become something of
a mantra for the banking industry. We aren’t the ones who brought
the world to the brink of financial disaster,
they proclaim. It was those awful nonbanks,
the mortgage brokers and originators, who peddled those terrible subprime
loans to unsuspecting or unsophisticated consumers. They’re the ones who
need to be regulated!
Apparently, when you say something long enough and
loud enough, people start to believe it, even when it defies reality. Here,
for instance, is the normally skeptical
Barney Frank on the subject: “What happened
was an explosion of loans being made outside of the regular banking system.
It was largely the unregulated sector of the lending industry and the
underregulated and the lightly regulated that did that.”
To which I can now triumphantly reply: Oh,
really???
Last weekend, after the column was published, an
angry mortgage broker — someone who felt she and her ilk were being unfairly
scapegoated by the banking industry — sent me a series of rather eye-opening
documents. They were a series of fliers and advertisements that had been
sent to her office (and mortgage brokers all over the country) from
JPMorgan Chase, advertising their latest wares.
They were dated 2005, which was before the subprime mortgage boom got
completely out of control. They’re still pretty sobering.
“The Top 10 Reasons to Choose Chase for All Your
Subprime Needs,” screams the headline on the first one. Another was titled,
“Chase No Doc,” and described the criteria for a borrower to receive a
so-called no-document loan. “Got Bank Statements?” asked a third flier. “Get
Approved!” In a number of the fliers, Chase makes it clear to the mortgage
brokers that the bank doesn’t need income or job verification — it just
needs to look at a handful of old bank statements.
“There were mortgage brokers who acted unethically,
absolutely,” my source told me when I called her on Monday. (She asked to
remain anonymous because she still has to work with JPMorgan Chase and the
other big banks.) “But where do you think mortgage brokers were getting the
subprime mortgages they were selling to customers? From the big banks,
that’s where. Chase,
Wells Fargo,
Bank of America — they were all doing it.”
So enough already about how the banks weren’t the
problem. Of course they were. Here’s the evidence,
right here. Read ’em and weep.
August 2018 Update
Wells Fargo & Co. agreed to pay $2.09 billion to settle with the U.S. Justice
Department over the sale of toxic mortgage-backed securities in the lead-up to
the financial crisis.---
https://www.wsj.com/articles/wells-fargo-agrees-to-2-09-billion-settlement-for-crisis-era-mortgage-loans-1533147302?mod=searchresults&page=1&pos=1&mod=djemCFO_h
This is on top of all the subsequent fines paid by Wells Fargo & Co. for
unrelated subsequent crimes. What a lousy company.
Jensen Comment
If you really want to see how sleazy mortgage lending became, read about the on
Marvene's shack in Phoenix. She purchased the shack for $3,500 and later, with
no improvements, got a $103,000 mortgage. When the mortgage was foreclosed,
neighbors bought the shack and tore it down ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on the banking scandals accompanied by taxpayer
bailouts ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"A Missed Opportunity on Financial Reform: How could Fannie Mae and
Freddie Mac have escaped Congress's attention?" by Walter Levitt, The
Wall Street Journal, June 24, 2010 ---
http://online.wsj.com/article/SB10001424052748704853404575322491510468572.html#mod=djemEditorialPage_t
As a lifelong Democrat and public servant to four
presidents, I had hoped the financial reform bill would be the best example
of my party's long-standing reputation for standing on the side of
individual investors.
It's not. The bill, already weakened by deal-making
as it emerged from the Senate, has been bled dry of nearly every meaningful
protection of investors.
Ironically, the authors of this bill are the same
Democrats who normally would have opposed many of its features if they were
in the minority. Now in the majority, these politicians are investor
advocates in their press releases alone.
The Democrats had the chance to do this bill the
right way. They should have been motivated by Congress's previous failure to
adopt meaningful reform, which left investors unprepared for the crisis. And
they had the input of talented leaders and experts who attempted to help
lawmakers deal with systemic risk and gaps in basic investor protections.
Whatever these positive contributions, Congress
more than overwhelmed them with sins of commission and sins of omission. One
of many bad ideas that made it into the bill: Public companies will now have
a wider loophole to avoid doing internal audits investors can trust. This
requirement was the most important pro-investor reform of the last decade,
and it worked. Of the 522 U.S. financial restatements in 2009, 374 were at
small firms not subject to auditor reviews.
But the reform bill about to be passed expands the
number of small companies exempt from Sarbanes-Oxley audit requirements.
When fraud is happening at a public company, small or large, investors care.
Now, thanks to Democratic leadership, investors are less likely to know.
There are many missed opportunities in this bill,
but these are the biggest:
First, Democratic leaders in Congress failed to
revoke the 1975 law that prevents municipal bond issuers from facing the
kind of regulation and scrutiny of the corporate bond market. If the
municipal bond market melts down in the next few years, we'll know who to
blame.
Second, they failed to pass a meaningful
majority-vote or proxy access rule for corporate ballots. Instead, thanks to
Sen. Chris Dodd (D., Conn.), the Senate passed a proxy access rule that is
comically useless: You need 5% of shares to get on the proxy. Very rarely do
investors assemble such large stakes in any company.
Third, New York Sen. Chuck Schumer's wise idea to
let the Securities and Exchange Commission (SEC) become a self-funded agency
will likely be killed by appropriators who are unwilling to give up the
power of the purse.
Fourth, Democratic leaders left in place the
confusing dual regulatory structure of the SEC and the Commodity Futures
Trading Commission. A merger was necessary to eliminate regulatory arbitrage
and corrosive bureaucratic turf battles, yet it didn't happen.
Fifth, Senate Democrats failed to support Rep.
Barney Frank's (D., Mass.) effort to pass a new law to overcome the legal
precedent of the 2008 Supreme Court's Stoneridge decision, which allows
third-party consultants, accountants and other abettors of fraud to avoid
liability. Again, another sellout of investor interests.
Sixth, Congress didn't deal with the massive
problems of Fannie Mae and Freddie Mac. It's one thing to fail to see
trouble before it happens. Now, there's no excuse. The central role played
by these two organizations in the financial crisis is indisputable. Congress
had a chance to fully restrict these agencies from anything but the most
basic market-making activities, and it didn't.
Finally, Democrats could have proposed a law
obligating investment advisers to serve their clients' interests above all
others. That was in the House version of the bill, but the Senate punted the
idea, and it's is likely to end up kicked down the road even further.
The sad reality is that we may not have a chance to
enact these kinds of reforms until after the next major financial crisis.
For those of us who champion the rights of investors, that's too long to
wait—especially since until very recently we didn't think we would have to.
Mr. Levitt, chairman of the Securities and Exchange Commission from
1993 to 2001, now serves as an adviser to the Carlyle Group and Goldman
Sachs.
Bob Jensen's threads on Freddie and Fannie are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"They
Left Fannie Mae, but We Got the Legal Bills," by Grechen Morgenson,
The New York Times, September 5, 2009 ---
http://www.nytimes.com/2009/09/06/business/economy/06gret.html?_r=1&scp=2&sq=gretchen
morgensen&st=cse
I Saw Maxine Kissing Franklin Raines ---
http://www.youtube.com/watch?v=vbZnLxdCWkA
Before Franklin Raines resigned as CEO of Fannie Mae and paid over a
million dollar fine for accounting fraud to pad his bonus, he was the
darling of the liberal members of Congress. Frank Raines was creatively
managing earnings to the penny just enough to get his enormous bonus.
The auditing firm of KPMG was accordingly fired from its biggest
corporate client in history ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Manipulation
Video on the efforts of some members of Congress seeking to cover up
accounting fraud at Fannie Mae ---
http://www.youtube.com/watch?v=1RZVw3no2A4
The Largest Earnings Management Fraud in History and Congressional
Efforts to Cover it Up
Without trying to place the blame on Democrats or Republicans, here are
some of the facts that led to the eventual fining of Fannie Mae
executives for accounting fraud and the firing of KPMG as the auditor on
one of the largest and most lucrative audit clients in the history of
KPMG. The restated earnings purportedly took upwards of a million
journal entries, many of which were re-valuations of derivatives being
manipulated by Fannie Mae accountants and auditors (Deloitte was charged
with overseeing the financial statement revisions.
Fannie Mae may have conducted the largest earnings management scheme in
the history of accounting.
You can read the following at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
.
. . flexibility also gave Fannie the ability to manipulate earnings
to hit -- within pennies -- target numbers for executive bonuses.
Ofheo details an example from 1998, the year the Russian financial
crisis sent interest rates tumbling. Lower rates caused a lot of
mortgage holders to prepay their existing home mortgages. And Fannie
was suddenly facing an estimated expense of $400 million.
Well, in its wisdom, Fannie decided to recognize only $200 million,
deferring the other half. That allowed Fannie's executives -- whose
bonus plan is linked to earnings-per-share -- to meet the target for
maximum bonus payouts. The target EPS for maximum payout was $3.23
and Fannie reported exactly . . . $3.2309. This bull's-eye was worth
$1.932 million to then-CEO James Johnson, $1.19 million to
then-CEO-designate Franklin Raines, and $779,625 to then-Vice
Chairman Jamie Gorelick.
That same year Fannie installed software that allowed management to
produce multiple scenarios under different assumptions that,
according to a Fannie executive, "strengthens the earnings
management that is necessary when dealing with a volatile book of
business." Over the years, Fannie designed and added software that
allowed it to assess the impact of recognizing income or expense on
securities and loans. This practice fits with a Fannie corporate
culture that the report says considered volatility "artificial" and
measures of precision "spurious."
This disturbing culture was apparent in Fannie's manipulation of its
derivative accounting. Fannie runs a giant derivative book in an
attempt to hedge its massive exposure to interest-rate risk.
Derivatives must be marked-to-market, carried on the balance sheet
at fair value. The problem is that changes in fair-value can cause
some nasty volatility in earnings.
So, Fannie decided to classify a huge amount of its derivatives as
hedging transactions, thereby avoiding any impact on earnings. (And
we mean huge: In December 2003, Fan's derivatives had a notional
value of $1.04 trillion of which only a notional $43 million was not
classified in hedging relationships.) This misapplication continued
when Fannie closed out positions. The company did not record the
fair-value changes in earnings, but only in Accumulated Other
Comprehensive Income (AOCI) where losses can be amortized over a
long period.
Fannie had some $12.2 billion in deferred losses in the AOCI balance
at year-end 2003. If this amount must be reclassified into retained
earnings, it might punish Fannie's earnings for various periods over
the past three years, leaving its capital well below what is
required by regulators.
In all, the Ofheo report notes, "The misapplications of GAAP are not
limited occurrences, but appear to be pervasive . . . [and] raise
serious doubts as to the validity of previously reported financial
results, as well as adequacy of regulatory capital, management
supervision and overall safety and soundness. . . ." In an agreement
reached with Ofheo last week, Fannie promised to change the methods
involved in both the cookie-jar and derivative accounting and to
change its compensation "to avoid any inappropriate incentives."
But we don't think this goes nearly far enough for a company whose
executives have for years derided anyone who raised a doubt about
either its accounting or its growing risk profile. At a minimum
these executives are not the sort anyone would want running the U.S.
Treasury under John Kerry. With the Justice Department already
starting a criminal probe, we find it hard to comprehend that the
Fannie board still believes that investors can trust its management
team.
Fannie Mae isn't an ordinary company and this isn't a
run-of-the-mill accounting scandal. The U.S. government had no
financial stake in the failure of Enron or WorldCom. But because of
Fannie's implicit subsidy from the federal government, taxpayers are
on the hook if its capital cushion is insufficient to absorb big
losses. Private profit, public risk. That's quite a confidence game
-- and it's time to call it.
**********************************
:"Sometimes
the Wrong 'Notion': Lender Fannie Mae Used A Too-Simple Standard For
Its Complex Portfolio," by Michael MacKenzie, The Wall Street
Journal, October 5, 2004, Page C3
Lender Fannie
Mae Used A Too-Simple Standard For Its Complex Portfolio
What exactly
did
Fannie Mae do wrong?
Much has been
made of the accounting improprieties alleged by Fannie's regulator,
the Office of Federal Housing Enterprise Oversight.
Some investors
may even be aware the matter centers on the mortgage giant's $1
trillion "notional" portfolio of derivatives -- notional being the
Wall Street way of saying that that is how much those options and
other derivatives are worth on paper.
But
understanding exactly what is supposed to be wrong with Fannie's
handling of these instruments takes some doing. Herewith, an effort
to touch on what's what -- a notion of the problems with that
notional amount, if you will.
Ofheo alleges
that, in order to keep its earnings steady, Fannie used the wrong
accounting standards for these derivatives, classifying them under
complex (to put it mildly) requirements laid out by the Financial
Accounting Standards Board's rule 133, or FAS 133.
For most
companies using derivatives, FAS 133 has clear advantages, helping
to smooth out reported income. However, accounting experts say FAS
133 works best for companies that follow relatively simple hedging
programs, whereas Fannie Mae's huge cash needs and giant portfolio
requires constant fine-tuning as market rates change.
A Fannie
spokesman last week declined to comment on the issue of hedge
accounting for derivatives, but Fannie Mae has maintained that it
uses derivatives to manage its balance sheet of debt and mortgage
assets and doesn't take outright speculative positions. It also uses
swaps -- derivatives that generally are agreements to exchange
fixed- and floating-rate payments -- to protect its mortgage assets
against large swings in rates.
Under FAS 133, if
a swap is being used to hedge risk against another item on the
balance sheet, special hedge accounting is applied to any gains and
losses that result from the use of the swap. Within the application
of this accounting there are two separate classifications:
fair-value hedges and cash-flow hedges.
Fannie's
fair-value hedges generally aim to get fixed-rate payments by
agreeing to pay a counterparty floating interest rates, the idea
being to offset the risk of homeowners refinancing their mortgages
for lower rates. Any gain or loss, along with that of the asset or
liability being hedged, is supposed to go straight into earnings as
income. In other words, if the swap loses money but is being applied
against a mortgage that has risen in value, the gain and loss cancel
each other out, which actually smoothes the company's income.
Cash-flow
hedges, on the other hand, generally involve Fannie entering an
agreement to pay fixed rates in order to get floating-rates. The
profit or loss on these hedges don't immediately flow to earnings.
Instead, they go into the balance sheet under a line called
accumulated other comprehensive income, or AOCI, and are allocated
into earnings over time, a process known as amortization.
Ofheo claims
that instead of terminating swaps and amortizing gains and losses
over the life of the original asset or liability that the swap was
used to hedge, Fannie Mae had been entering swap transactions that
offset each other and keeping both the swaps under the hedge
classifications. That was a no-go, the regulator says.
"The major
risk facing Fannie is that by tainting a certain portion of the
portfolio with redesignations and improper documentation, it may
well lose hedge accounting for the whole derivatives portfolio,"
said Gerald Lucas, a bond strategist at Banc of America Securities
in New York.
The bottom line is that both the FASB and the IASB must someday soon
take another look at how the real world hedges portfolios rather than
individual securities. The problem is complex, but the problem has come
to roost in Fannie Mae's $1 trillion in hedging contracts. How the SEC
acts may well override the FASB. How the SEC acts may be a vindication
or a damnation for Fannie Mae and Fannie's auditor KPMG who let Fannie
violate the rules of IAS 133.
“Capture” of Regulators by Fannie Mae and Freddie Mac," by Nobel
Laureate Gary Becker, Becker-Posner Blog, June 12, 2011 ---
http://www.becker-posner-blog.com/2011/06/capture-of-regulators-by-fannie-mae-and-freddie-mac-becker.html
Political economists describe the process whereby
government officials end up being the servants rather than the masters of
the firms they are regulating as the “capture” by the industry of their
regulators. When regulators are captured, much of what they do is motivated,
consciously or not, by a desire to help the companies they are regulating,
even when the social goals that the regulators should pursue are very
different.
A famous illustration of capture is given by the
way airlines were regulated under the Civil Aeronautics Board (CAB) from
1940 to 1978. Large airlines of those times, like American and Delta,
naturally had a strong incentive to try to keep new airlines from entering
the industry. As a compliant ally of the airline industry, the CAB did not
approve one new interstate airline during this almost 40-year period. Many
airlines entered the industry when President Carter abolished the CAB, and
some of the old standbys, such as Pan Am and Eastern, ceased operations
because they could not adjust to a competitive environment.
An economically disastrous example of the capture
theory is provided by the disgraceful regulation of the two mortgages
housing behemoths, Fannie Mae and Freddie Mac, before and leading up to the
financial crisis. In their fascinating recent book, Reckless Endangerment,
Gretchen Morgenson and Joshua Rosner explore in great detail how Fannie Mae
used political connections and intimidation of anyone who stood in their way
to gain a highly dominant position in the residential mortgage market. The
authors’ show that various government officials, including congressmen and
presidential cabinet members, closed their eyes to what these two
government-supported enterprises (GSE) were doing. They allowed them to take
on enormous risks, while publicly defending their behavior as not being
highly risky.
Fannie Mae was created in 1938 as a government
enterprise that purchased mortgages from banks that loaned money to
homebuyers. It eventually became a private investment company regulated by
the government, where investors expected that the government would help out
if these companies got into trouble. By the beginning of the crisis in 2008,
Fannie and Freddie held or guaranteed about half of the United States’ $12
trillion of assets in the residential mortgage market. In September 2008,
both Fannie and Freddie were taken over by the federal government when they
became insolvent. The loss to taxpayers is likely to be in the hundreds of
billions of dollars because many of the mortgages are subprime and of little
value.
Reckless Endangerment shows how the chief executive
officers of Fannie Mae furthered the reach and reduced the regulatory
control over their company by assiduously courting congressmen, Fed
officials, the Congressional Budget Office, high-level officials of the U.S.
Treasury, the Secretary of Housing and Urban Development, and major
economists. The prominent and well informed congressman, Barney Frank, gets
especially sharp criticism for his continual support of Fannie and Freddie
while he was initially a member, and later chairman, of the House Financial
Services Committee, the powerful committee charged with oversight of the
housing and financial sectors. Barney Frank remained an unwavering supporter
of Fannie and Freddie until 2010, when he admitted that they should have
been more closely regulated. In a bit of irony, he is a principal author of
the 2010 Dodd-Frank act that attempts to reform the financial sector mainly
by giving even greater discretion to the regulators.
Fannie and Freddie had so much money and political
power at their disposal that it became risky for anyone to oppose what they
wanted: large increases in their holdings of subprime and other mortgages,
with no questions asked. Different government agencies that were supposed to
either regulate or oversee these GSEs ended up as advocates instead.
Well-known economists wrote favorable articles downplaying the riskiness of
the holdings of Fannie and Freddie. These articles were sometimes published
in journals or other publications sponsored by these companies.
A few government officials were brave enough to
risk the wrath of Fannie and Freddie. The authors give particular praise to
June O’Neill (I am proud to say she is a former student of mine), who was
then head of the Congressional Budget Office. A member of her staff wrote a
report that was critical of the degree of risk to taxpayers from the assets
held by Fannie and Freddie. These companies tried to get June to suppress
the report- she refused- and then a few members of the House of
Representatives in cahoots with Fannie and Freddie subjected her to vicious
attacks when she steadfastly defended the report in testimony before
Congress.
Continued in article
"Capture Theory and the Financial Crisis," by Richard Posner,
Becker-Posner Blog, June 12, 2011 ---
http://www.becker-posner-blog.com/2011/06/capture-theory-and-the-financial-crisisposner.html
The phenomenon of regulatory capture—the
transformation of a regulatory agency into an anticompetitive tool of the
regulated industry—is real, but I think Fannie Mae and Freddie Mac are more
accurately regarded as examples, though no less unlovely, of something else:
a capitalist-socialist hybrid. They were not regulatory agencies; until they
collapsed during the financial crisis of 2008 and were taken over by the
federal government, they were private corporations that had been chartered
by Congress to promote home ownership. Their status as GSEs
(government-sponsored enterprises) created an expectation that the
government would guarantee their debts. This expectation enabled them to
borrow at lower interest rates than other private corporations. They were
supposed to promote home ownership by buying or guaranteeing home mortgages.
They did that; they also pioneered mortgage securitization—in effect turning
mortgages into bonds, which are more liquid than mortgages and so could be
sold all over the world, bringing more capital into the U.S. residential
real estate market, thus promoting home ownership, just as Congress wanted.
Because of the low interest rates they paid, Fannie and Freddie were
immensely profitable until the financial crisis brought them down.
As Becker points out, Fannie and Freddie were
effective in obtaining congressional and presidential assistance to ward off
threats to their activities and their profits. But I don’t think that that
assistance, unseemly as it was, and perhaps corrupt as well, was the basic
problem of Fannie and Freddie, or the cause of their collapse; nor do I
think their collapse was of any great consequence for the nation.
I don’t think there was ever a good reason to
promote home ownership over renting (so I would favor the abolition of the
deductibility of mortgage interest from federal income tax). It ties up a
lot of the capital of individuals and reduces labor mobility. Maybe it makes
for more responsible citizens by giving people a property interest, but
there must be better candidates for federal largesse. And even if there were
a good reason for government to promote home ownership, federal chartering
of mortgage institutions would not be a sensible means of implementation.
Are the external benefits of home ownership, if any, so great that the
mortgage-interest tax deduction is not subsidy enough? True, the lower the
interest rates that Fannie and Freddie paid to borrow money, the riskier the
mortgage loans they would agree to underwrite by buying or guaranteeing the
loans, but home ownership is not promoted in any meaningful sense by the
granting of mortgages to people likely to default.
Conservative critics led by Peter Wallison of the
American Enterprise Institute lay on Fannie and Freddie a significant
measure of blame for the housing bubble of the early 2000s and the ensuing
financial crisis of September 2008. But these critics have not persuaded me.
Private banks like Morgan Stanley and Goldman Sachs and Countrywide bought
mortgages, securitized them, and sold interests in them (these firms also
bought mortgage-backed securities created by other financial firms)—a
sequence wholly separate from the activities of Fannie and Freddie. It was
an immensely profitable activity, so there is no reason to think that had
there been no Fannie and Freddie the volume of mortgage-backed securities
would have been less than it was. Whether a market has X firms or X – 1 firm
is unlikely to affect the volume of market activity. I don’t think Fannie
and Freddie took more risks than their competitors; the difference is that
they were more deeply committed to the housing market (that was their
mission) than most other firms, so less likely to survive a housing bubble.
The financial crisis might actually have been worse
without Fannie and Freddie. They collapsed and were simply taken over by the
federal government. Had their debts instead been debts of Morgan and Goldman
and other private banks, those banks might have collapsed and been taken
over by the federal government as well, providing daunting challenges to the
government’s ability to run the banking system. The cost to society of the
government’s taking over Fannie and Freddie is hard to estimate. The
takeover resulted in a transfer payment to creditors of Fannie and Freddie
from (ultimately) the federal taxpayer. Had there been no Fannie or Freddie,
other mortgage companies would have had more debt, and the owners of that
debt would also have been bailed out by the federal government, in all
likelihood.
Congress would do well to abolish Fannie and
Freddie. But it won’t. The constellation of political forces that supports
subsidizing home ownership is too strong.
Continued in article
Barney's Rubble ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
The largest earnings management fraud in history and the firing of KPMG
---
http://faculty.trinity.edu/rjensen/Theory02.htm#Manipulation
"They Left Fannie Mae, but We Got the Legal Bills," by Grechen
Morgenson, The New York Times, September 5, 2009 ---
http://www.nytimes.com/2009/09/06/business/economy/06gret.html?_r=1&scp=2&sq=gretchen
morgensen&st=cse
PRECISELY one year ago, we lucky taxpayers
took over Fannie Mae and Freddie Mac, the mortgage finance giants that
contributed mightily to the wild and crazy home-loan-boom-turned-bust. In
that rescue operation, the Treasury agreed to pony up as much as $200
billion to keep Fannie in the black, coughing up cash whenever its
liabilities exceed its assets. According to the company’s most recent
quarterly financial statement, the Treasury will, by Sept. 30, have handed
over $45 billion to shore up the company’s net worth.
It is still unclear what the ultimate cost
of this bailout will be. But thanks to inquiries by Representative Alan
Grayson, a Florida Democrat, we do know of another, simply outrageous cost.
As a result of the Fannie takeover, taxpayers are paying millions of dollars
in legal defense bills for three top former executives, including Franklin
D. Raines, who left the company in late 2004 under accusations of accounting
improprieties. From Sept. 6, 2008, to July 21, these legal payments totaled
$6.3 million.
With all the turmoil of the financial
crisis, you may have forgotten about the book-cooking that went on at Fannie
Mae. Government inquiries found that between 1998 and 2004, senior
executives at Fannie manipulated its results to hit earnings targets and
generate $115 million in bonus compensation. Fannie had to restate its
financial results by $6.3 billion.
Almost two years later, in 2006, Fannie’s
regulator concluded an investigation of the accounting with a scathing
report. “The conduct of Mr. Raines, chief financial officer J. Timothy
Howard, and other members of the inner circle of senior executives at Fannie
Mae was inconsistent with the values of responsibility, accountability, and
integrity,” it said.
That year, the government sued Mr. Raines,
Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100
million in fines and $115 million in restitution from bonuses the government
contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr.
Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation.
When these top executives left Fannie, the
company was obligated to cover the legal costs associated with shareholder
suits brought against them in the wake of the accounting scandal.
Now those costs are ours. Between Sept. 6,
2008, and July 21, we taxpayers spent $2.43 million to defend Mr. Raines,
$1.35 million for Mr. Howard, and $2.52 million to defend Ms. Spencer.
“I cannot see the justification of people
who led these organizations into insolvency getting a free ride,” Mr.
Grayson said. “It goes right to the heart of what people find most
disturbing in this situation — the absolute lack of justice.”
Lawyers for the three executives did not
returns calls seeking comment.
An additional $16.8 million was paid in
the period to cover legal expenses of workers at the Office of Federal
Housing Enterprise Oversight, Fannie’s former regulator. These costs are
associated with defending the regulator in litigation against former Fannie
executives.
This tally of taxpayer legal costs took
several months for Mr. Grayson to extract. On June 4, after Congressional
hearings on the current and future status of Fannie and Freddie, he
requested the information from the Federal Housing Finance Agency, now their
regulator. He got its response on Aug. 26.
A spokeswoman for the agency said it would
not comment for this article.
THE lawyers’ billable hours, meanwhile,
keep piling up. As the F.H.F.A. explained to Mr. Grayson, the $6.3 million
in costs generated by 10 months of legal defense work for Mr. Raines, Mr.
Howard and Ms. Spencer includes not a single deposition for any of them.
Instead, those bills covered 33 depositions of “other parties” relating to
the shareholder suits and requiring the presence of the three executives’
counsel.
One of Mr. Grayson’s questions about these
payments remains unanswered — whether placing Fannie Mae into receivership,
rather than conservatorship, would have negated the agreement to cover the
former executives’ legal costs. Choosing conservatorship allowed Fannie to
stabilize and meant that it was going to continue to operate, not wind down
immediately.
But, Mr. Grayson pointed out: “If these
companies had gone into receivership instead of conservatorship, the trustee
in bankruptcy or the receiver would have been free, legally, to reject these
contracts that called for indemnification. Raines, Howard and Spencer would
have had to pay their own fees.”
When asked about this, Fannie’s regulator,
the F.H.F.A., waffled. “Whether these costs could have been avoided would
depend on the facts and circumstances surrounding any receivership,” it
said. “It is possible that receiverships could have reduced the costs of the
litigation, but by no means certain.”
Mr. Grayson said he intended to find out
whether there are any legal options under the conservatorship to stop paying
for the defense of the Fannie Mae three. “When did Uncle Sam become Uncle
Sap?” he said. “In a situation where billions of losses have already
occurred, is it really asking too much that people pay their own legal
fees?”
While the $6.3 million paid to defend Mr.
Raines, Mr. Howard and Ms. Spencer is a pittance compared with other bills
coming due in the bailout binge, it is still disturbing for these costs to
be covered by those who had nothing to do with the problems and certainly
did not benefit from them. The money may be small, but the episode’s message
looms large: those who presided over this debacle aren’t being held
accountable.
“It is wrong in a very deep sense,” Mr.
Grayson said. “The essence of our society is that people who do good things
are rewarded and people who do bad things are punished. Where is the
punishment for Raines, Howard and Spencer? There is none.”
The Disastrous Bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Henry Waxman's House Committee on Oversight and
Government Reform met Tuesday to examine "The Role of Fannie Mae and Freddie Mac
in the Financial Crisis." Alas, Mr. Waxman didn't come to bury Fan and Fred, but
to bury the truth. The two government-sponsored mortgage giants have long
maintained they were merely unwitting victims of a financial act of God. That
is, while the rest of the market went crazy over subprime and "liar" loans, Fan
and Fred claimed to be the grownups of the mortgage market. There they were, the
fable goes, quietly underwriting their 80% fixed-rate 30-year mortgages when --
Ka-Pow! -- they were blindsided by the greedy excesses of the subprime lenders
who lacked their scruples. But previously undisclosed internal documents that
are now in Mr. Waxman's possession and that we've seen tell a different story.
Memos and emails at the highest levels of Fannie and Freddie management in 2004
and 2005 paint a picture of two companies that saw their market share eroded by
such products as option-ARMs and interest-only mortgages. The two companies were
prepared to walk ever further out on the risk curve to maintain their market
position.
"Whitewashing Fannie Mae: Congress begins its
self-absolution campaign," The Wall Street Journal, December 12, 2008 ---
http://online.wsj.com/article/SB122895461803096429.html?mod=djemEditorialPage
.
Jensen Comment
Henry Waxman will probably go down not only as the most
dangerous senator in the history of the United States. He may also
go down as the most biased, least truthful, and most grandstanding Senator in
U.S. History. I like the cartoon showing Henry Waxman as being against both
business and energy. Now he's out to defend his friends like Rep. Barney Frank
and Sen. Chris Dodd for their despicable roles in forcing Fannie Mae and Freddie
Mac to purchase home mortgages with zero chance of ever being repaid while
knowing full well in advance that the U.S. Government would eventually get stuck
with the bad mortgages.
I Saw Maxine Kissing Franklin Raines (as ) ---
http://www.youtube.com/watch?v=vbZnLxdCWkA
Before Franklin Raines resigned as CEO of Fannie Mae and paid over a million
dollar fine for accounting fraud to pad his bonus, he was the darling of the
liberal members of Congress. Frank Raines was creatively managing earnings to
the penny just enough to get his enormous bonus. The auditing firm of KPMG was
accordingly fired from its biggest corporate client in history ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Manipulation
Read about one of the largest accounting frauds in history that transpired at
Fannie Mae when Franklin Raines was its CEO and buying Congressional favors with
Fannie Mae money. Franklin Raines got fired and paid over a million dollars in
fines. The KPMG auditors were fired from their biggest client in KPMG history
---
http://faculty.trinity.edu/rjensen/Theory01.htm#Manipulation
"The Obama Speech We're Waiting For:
Fannie Mae and Freddie Mac need to get the BP treatment," by William McGurn,
The Wall Street Journal, June 22, 2010 ---
http://online.wsj.com/article/SB10001424052748704895204575320922399530274.html?mod=djemEditorialPage_t
The President: Good evening. As we speak, our
nation faces a multitude of challenges. At home, our top priority is to
recover and rebuild from a recession. Abroad, our brave men and women in
uniform are taking the fight to al Qaeda wherever it exists. Tonight, I want
to speak with you about a battle we're waging against an enemy that is
assaulting the very homes our citizens live in.
In September 2008, Fannie Mae and Freddie Mac
imploded when their losses became unsustainable. In part because so many of
our financial institutions relied on mortgage-backed securities based on bad
loans, a housing crisis exploded into a financial crisis. And Americans
continue to suffer from the effects. Unlike a hurricane or oil spill, where
the damage is obvious to the eye, the damage wrought by Fannie and Freddie
is much more insidious. As president, I have many smart people in my
administration. But you do not need a Nobel Prize to know the problem here.
Fannie and Freddie bought mortgages offered by
banks, which it then resold as mortgaged-backed securities. Banks liked
this, because it meant more money to lend. In the name of enabling ever more
Americans to own their homes, and encouraged by Congress, Fannie and Freddie
expanded into ever more risky mortgages. In the end, these two companies
helped send billions in loans to Americans who lacked the means to pay them
back—while spreading risk throughout our financial system.
Think of these bad loans as a nasty leak polluting
our financial system. While most other large financial firms either have
failed or are now recovering, the damage caused by Fannie and Freddie
continues largely unabated. The Congressional Budget Office says that
plugging these bad loans has already cost taxpayers $145.9 billion, making
them the single largest bailout of all.
Make no mistake: We will fight Fannie and Freddie
with everything we have got for as long as it takes. We will make these two
government-created companies pay for the damage they have caused. In fact,
we are going to make Fannie and Freddie pay with their lives. Tonight I'd
like to lay out our battle plan going forward:
First, the cleanup. For more than three decades
there's been a culture of corruption in the regulatory oversight of these
companies. I inherited a situation in which these firms lobbied and captured
their regulators. Fannie and Freddie's privileged place in the market was
sustained because they were a source of riches for Washington's Republican
and Democratic establishments. Even today we see this oily alliance at work
in the recent decision by Congress to exempt Fannie and Freddie from their
financial reform bill.
Tonight I promise you: We will do whatever it
takes, for as long as it takes, to change this.
One of the lessons we've learned from Fannie and
Freddie is that you cannot combine private profit with taxpayers bearing
risk. For decades we've propped up Fannie and Freddie's near monopoly. And
for decades we have failed to face up to the fact that homeownership is not
the best path for everyone. Time and again, reform has been blocked by
former congressmen of both parties whom these companies hired to spread the
money around and persuade Congress to back off.
So the second thing I will do is meet with the
chairmen of Fannie Mae and Freddie Mac. And I will tell them the day of
reckoning has come. We are going to break up Fannie and Freddie and end the
privileges they enjoy from the government.
You know, for generations, Americans have scrimped
and saved to provide a better life for their families. That is now in
jeopardy. I have met with moms and dads who bought modest houses that were
within their means—and now find their tax dollars going to bail out
neighbors who bought bigger houses not within their means. I have stood with
retirees whose pensions have been devastated. And I have sat in the living
rooms of families who now face foreclosure on homes they were falsely
assured they could afford.
The sadness and the anger they feel is not just
about the money they've lost. It's about a wrenching anxiety that their way
of life may be lost. I am a prayerful man. But I do not believe that the
American people should have to pray that their own government isn't
undermining their homes, their savings, and the lives they have built for
their families.
The financial crisis was not caused by Fannie and
Freddie alone. But fixing them is essential. To this important task, we
bring hope, which comes from the confidence that free men and women in a
free economy will in the end make better decisions than any government. And
tonight we revive that hope by delivering change to two of the fattest cats
Washington has ever known.
Thank you, and may God bless America.
Adjustable Rate Mortgage ---
http://en.wikipedia.org/wiki/Adjustable_Rate_Mortgage
Video: Strong ARM of Mortgage Bubble is Building to Burst:
"Second Financial Economic Crash Coming - Huge & Soon," CBS Sixty Minutes
---
http://www.youtube.com/watch?v=JKlBJavw_X4
"Dear Bank of America, I'd Like to Schedule a Default," by Austin
Hill, Townhall, January 3, 2009 ---
http://townhall.com/columnists/AustinHill/2010/01/03/dear_bank_of_america,_id_like_to_schedule_a_default
Dear Bank of America;
Hi, it’s me, your customer Austin. I’m writing to
schedule my mortgage default.
That’s right, I’m ready to schedule my mortgage
default. Does that sound strange?
Well, believe me, Bank of America, I had hoped that
our relationship wouldn’t come to this. But after months of trying to do
business with you, I’ve decided that it’s probably in my best interest to
just, you know - “walk away” from my mortgage.
How could it ever be in anyone’s best interest to
default on a mortgage? And why would anyone ever want to default on a
mortgage?
Well, here’s the deal: I have one of those
now-famous “Option ARM” loans on my residence – the interest rate is
adjustable, and the loan provides optional payment plans. And yes, Bank of
America, you inherited my loan when Countrywide Lending went down the tubes
in 2008, and you merged your company with theirs.
And here are some other details about me, Bank of
America: I am fortunate to have a great job with a solid income, and I work
under a long term employment contract. While my full time occupation is
being a daily talk show host, I am also a writer and a public speaker, so I
have multiple streams of income. I own real estate in multiple regions of
the U.S., and I’m a big believer in real estate as a long term investment.
And perhaps most interesting for you, Bank of America, I have a great credit
score, and I’m current on all my debt payments.
During the recent real estate “boom,” I took some
equity out of my home. Now, in the aftermath of the real estate “bust,” my
house is slightly “under water” – not by much, but a little. And the
interest rate on my loan won’t begin to move upward for another two years,
so I’m not in any crisis right now.
The value of my property has actually begun to move
upward a bit in the past few months, but it’s going to be a few years before
the value reaches parity with my debt. And that’s why I was thrilled to get
that little note you sent me in the mail last summer, Bank of America.
Remember? You sent me that nice letter asking if I’d like to have my loan
modified to a 30 year, fixed rate mortgage.
I responded quickly to that letter, Bank of
America. And I’ve called repeatedly for over half a year. But here’s the sad
truth that I’ve discovered about you: you’re not really interested in
working with me, because I’m not behind on my payments
With each and every call, Bank of America, I get
the same treatment. Once your customer service representative checks the
data base and realizes that I’m current on my payments, they “transfer my
call” to “another department” – and from there, I’m left on hold. If another
representative picks up, they want to transfer me again. And if I actually
have a conversation with anybody, I’m treated to a person reading through a
litany of “assessment questions” and surveys and evaluations. And then I’m
transferred again.
After repeatedly being told that there is immediate
help available to Bank of America customers who are delinquent, I finally
started asking, “so will you talk to me about a loan modification if I stop
making payments?” And to that question, I’ve repeatedly heard the same
answer: “I could never advise you to not make your payments Mr. Hill” the
representative will say, “I’m just telling you that if you become delinquent
we have help available…”
I’m not the only person who has this disturbing
kind of relationship with you, Bank of America. I discussed this on my talk
show in Boise, Idaho, and was inundated with calls and email detailing the
same sad story. I even addressed this over the holidays on a radio talk show
where I was guest hosting in Phoenix, Arizona – one of the most tumultuous
real estate markets in the country – and got the same response.
I’ve also talked with lots of personal friends
about this, Bank of America. People from Los Angeles to Chicago to
Washington, D.C., and from all walks of life. People with high school
diplomas and M.D.’s and MBA’s and Ph.D’s and J.D.’s. We’re current on our
payments, have great credit, and want to continue our relationships with
you. But you’re not taking our calls.
It’s sad to realize that as you focus on your
“troubled assets,” and ignore those of us with good credit, you’re likely
creating more troubled assets in the process. But that’s the system you’ve
put in place, Bank of America. It’s a system that rewards people’s bad
behavior, while punishing other people’s good behavior.
So after spending half a year trying to take
advantage of the offer you extended to me in the mail, I now understand what
your actual system entails. And I’ve calculated the risks of working within
the system you’ve put in place.
I’m ready to schedule my default. What would you
like to do next?
Bob Jensen's threads on sleaze in granting mortgages ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Mortgage Fraud Increasing
Despite the attention paid to mortgage fraud committed
by borrowers and lenders since declines in the real estate values and the
subprime loan crisis triggered severe problems in the banking industry, the
number of Federal Bureau of Investigation’s (FBI) investigations of mortgage
fraud and associated financial crimes is increasing. “The FBI has experienced
and continues to experience an exponential rise in mortgage fraud
investigations,” John Pistole, Deputy Director, told the Senate Judiciary
Committee in April.
AccountingWeb, August 18, 2009 ---
http://www.accountingweb.com/topic/mortgage-loan-fraud-increasing
Jensen Comment
I think mortgage fraud will continue to rise as long as remote third parties
like Fannie Mae, Freddie Mac, and FHA continue to buy up mortgages negotiated by
banks and mortgage companies basking in moral hazard. The biggest hazards are
fraudulent real estate appraisals and lies about income in mortgage
applications. We need to bring back George Bailey (James Stewart) in It's a
Wonderful Life ---
http://en.wikipedia.org/wiki/It%27s_a_Wonderful_Life
The banks that negotiate the mortgages should have to hang on to those
mortgages.
Watch the video at
http://www.youtube.com/watch?v=MJJN9qwhkkE
Bob Jensen's fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Shareholders in Fannie Mae and Freddie Mac lost virtually everything in spite
of the Federal Government getting stuck with paying off hundreds of billions of
the debts of these two companies now owned by the U.S. Congress.
Now consider some added issues in the 2008 bailouts of Fat Fannie and her smaller brother
Freddie. Fannie and Freddie have the same problem as Bear Stearns, Lehman, Merrill Lynch,
and the others on Wall Street. Fannie and Freddie borrowed from Paul to buy the
same fraudulent sub-prime mortgages from thousands of local banks around the
nation. Many homeowners at all levels of income and home values cannot possibly
pay off these mortgages. Foreclosures will only return half or less of what
Fannie and Freddie paid for the fraudulent mortgages.
In the 2008 Bailout, the U.S. Government has made Freddie and Fannie U.S.
Government Corporations (now Congressionally owned and operated), and there's not much hope
for any corporation owned and managed by the U.S. Congress. Freddie and Fanny
will be mismanaged by Rep. Barney Frank and Senator Chris Dodd in an effort to
provide home ownership to people who cannot afford homes purchased with
conventional mortgages requiring 20% down payments and mortgages that have
balances well below what can be realistically expected in foreclosures.
Watch the video and/or read the text of an expert finance professor from
Stanford University:
Effects of the Government Takeover of
Freddie Mac and Fannie Mae
---
http://news-service.stanford.edu/news/2008/september24/videos/369_flash.html
Business School Finance Professor Darrell Duffie discusses the effects of
having the country’s two largest mortgage finance companies placed into
conservatorship and what it means for taxpayers and the economy. [Details]
[Video]
So, Ganesh, the 2008 bailout money is being paid to the creditors (read that
Paul) who lent short-term funds so that Fannie, Freddie, Lehman Brothers,
Merrill Lynch, and the others could make long-term investments in fraudulent
mortgages purchased from fraudulent mortgage companies (e.g.,
Countrywide
Financial)
at inflated prices with huge probabilities that many of the mortgages would go
into default. Paul gets the bailout money given to Fannie, Freddie, AIG, and
other selected Wall Street giants. In most cases the net cost to taxpayers will
be small and, as is the case in AIG, it could actually be profitable for
taxpayers unless Congress decides to mix
populism with bailouts.
In return for the money Wall Street is trading in its junk (defaulted mortgages)
to the government.
The problem is that Congress may use the bailouts as a ploy for secretive
populism. Instead of minimizing the cost of the bailouts to taxpayers,
Congress
may view this economic crisis as an opportunity to spend trillions providing
suburban dream home ownership to people who would otherwise have to live in housing projects or
have subsidized rent payments. These people will be overjoyed to have home
investments given to them by Barney Frank and Chris Dodd.
Question
When does one fall guy (read that taxpayer) pay for the prosecution and the
defense at the same time?
"Taxpayers May Pay Legal Fees for Mortgage Execs," Fox News, November
6, 2008 ---
http://www.foxnews.com/story/0,2933,447784,00.html
When the government took over mortgage giants
Fannie Mae and Freddie Mac, taxpayers inherited more than just bad debts.
They're also potentially on the hook for tens of millions of dollars in
legal fees for the executives at the center of the housing market's
collapse.
With the Justice Department investigating companies
involved in the mortgage and financial meltdown, executives around the
country are hiring defense lawyers. Like many large companies, Fannie and
Freddie had contracts promising to cover legal bills for their executives.
When the Treasury Department delivered a $200
billion bailout to Fannie and Freddie, that obligation passed to the
government, which may find itself paying for the lawyers defending the
executives against the government's own prosecutors.
"Who'd have thought we might be on the hook for
paying the defense costs when we're also paying the prosecution costs?" said
Doug Heller, executive director of Consumer Watchdog, a Santa Monica,
Calif.-based group that has been critical of the financial bailout packages.
"To defend the economy from the havoc that's been created, we're going to
defend the havoc creators?"
The Bush administration is working to avoid it. The
Federal Housing Finance Agency, which controls Fannie and Freddie, said in
regulatory filings it soon will try to prohibit the two companies from
paying legal fees to their executives. But such a prohibition almost
certainly would lead to a costly court fight over who's responsible for the
bills when the Justice Department comes knocking.
Continued in article
Jensen Comment
I see this as only fair since the government (read that Chris Dodd and Barney
Frank) forced the executives of Fannie and Freddie to buy up mortgages of
borrowers who never intended to make payments on those mortgages.
It was all in the
“nutty” (from Oak Trees) plan
November 12, 2008 Update: Paulson finally came to
his senses and opted for direct investment in banks via loans and equity rather
than buying up all the junk mortgages owned by troubled banks.
I will close this essay with the following quotation about Fat Fannie and her
smaller brother Freddie who are now both owned and operated by Rep. Barney Frank
and Senator Chris Dodd.
The
Community Reinvestment Act of 1977 coerces banks into making loans based on
political correctness, and little else, to people who can't afford them.
Enforced like never before by the Clinton administration, the regulation
destroyed credit standards across the mortgage industry, created the subprime
market, and caused the housing bubble that has now burst and left us with the
worst housing and banking crises since the Great Depression.
"Stop Covering Up And Kill The CRA," Investor's Business Daily,
November 28, 2008 ---
http://www.ibdeditorials.com/IBDArticles.aspx?id=312766781716725
Jensen Comment
The CRA was not the sole cause of the housing bubble, but when combined with
Rep. Barney Frank's later coercion of Freddie Mac and Fannie Mae to buy the high
risk political correctness mortgages, the CRA added a lot of air to the housing
bubble.
"Barney's Rubble," The Wall Street Journal, September 17, 2008 ---
http://online.wsj.com/article/SB122161010874845645.html?mod=todays_us_opinion
Barney Frank didn't like our recent editorial
taking him to task for his longtime defense of Fannie Mae and Freddie Mac,
and the Congressional baron defends himself in his signature style here.
We'd let him have his say without comment except that his "whole story" is,
well, far from the whole truth.
Mr. Frank contends that he favored "very strong
reform" of Fannie Mae and Freddie Mac, even before Democrats took over
Congress after the 2006 elections. To adapt a famous phrase, this depends on
what the meaning of "reform" is. Mr. Frank did support a bill that he and
others on Capitol Hill described as reform. But on the threshold reform
issue -- limiting the size of the portfolios of mortgage-backed securities (MBS)
that the two companies could hold -- Mr. Frank was a stalwart opponent.
In fact, Mr. Frank was publicly arguing for an
increase in the size of their combined $1.4 trillion portfolios right up to
the day they were bailed out. Even now, after he's been proven wrong about a
taxpayer guarantee, he opposes Treasury's planned reduction in the size of
the portfolios starting in 2010, according to a quote attributed to him in
this newspaper last week. "Good luck on that," he reportedly said. Mr.
Frank's spokeswoman hung up the phone when we sought confirmation Tuesday.
Fannie Mayhem: A History A compendium of The Wall
Street Journal's recent editorial coverage of Fannie and Freddie. The MBS
portfolios have long been both the chief source of the systemic risk posed
by the two mortgage giants and of the profits that so handsomely enriched
shareholders and officers alike for decades. Without the extreme leverage
inherent in those portfolios -- which the companies borrowed heavily, at
taxpayer-subsidized rates, to accumulate -- their federal takeover might
never have become necessary.
For years, Mr. Frank and other friends of Fan and
Fred opposed not only bills written to limit the size of their portfolios,
but any bill that in their view gave an independent regulator too much
discretion to order a reduction. This was true of the reform that his House
committee passed last year. Only when the White House caved to Mr. Frank and
dropped its earlier insistence that a reform bill rein in the portfolios did
Mr. Frank move his bill.
In his letter, Mr. Frank also repeats his familiar
claim that Fannie and Freddie are vital because they support "affordable
housing." This is political smoke. The awful irony of Fan and Fred is that
they have done very little to assist affordable housing. Most of the
taxpayer subsidy has gone to enrich shareholders and Fannie managers, as a
2003 study by the Federal Reserve shows.
Mr. Frank says he favored the disclosure of Fannie
and Freddie compensation -- which is nice, but beside the point. The source
of the rich pay packages was the Fannie business model that Mr. Frank fought
so hard to protect. Instead of helping the poor, Mr. Frank was enriching Jim
Johnson, Frank Raines, Angelo Mozilo and Wall Street.
If Mr. Frank thinks his "affordable housing" goals
are so popular, he can always ask Congress to appropriate money for any
housing subsidy he desires. But he knows those votes are hard to come by.
It's much easier to have Fannie and Freddie take inordinate risks, even at
taxpayer expense, so they can pay a political dividend called an "affordable
housing trust fund" (and
ACORN) that politicians will disperse. In opposing genuine
reform of Fan and Fred, Mr. Frank wasn't acting like a principled liberal.
He was protecting corporate giants while hiding their risks from taxpayers
until the middle class got stuck with the bill.
In fairness the problems with Fannie and Freddie are rooted clear back to
Jimmy Carter's Presidency (video) ---
Youtube.com
But some liberal members of the U.S. Congress forced Fannie and Freddie to taken
on risky mortgages that caused the most trouble.
See "Pressured to Take on Risk, Fannie Hit a Tipping Point," by Charles Duhigg,
The New York Times, October 4, 2008 ---
http://www.nytimes.com/2008/10/05/business/05fannie.html?_r=1&hp&oref=slogin
The biggest disaster will be to allow Congressional do-gooders to tinker with
the U.S. economic future and commit our once-strong nation into entitlements
that there's virtually zero chance of ever paying off except with Zimbabwe-like
inflation. How about a cup of coffee for a million U.S. dollars?
Treasury Secretary Henry Paulson came up with a
cockamamie bailout that he claimed would end up making money for the US
Treasury. However, backroom Democrats connived to siphon off any repayment of
the people’s money back to the treasury by adding one small inocuous line to the
agreement----a line that would end up stealing money from any repayments and
giving it to left-wing political advocacy groups like
ACORN , the National Urban
League and the Hispanic atrocity---La Raza. Instead of trying to help the
economy, the Democrats want to loot taxpayers for
their left-wing political constituents. It’s business as usual for the
Democrats.
Free Republic, September 27, 2008
---
http://www.freerepublic.com/focus/f-news/2091697/posts
At the same time, HUD
pressured the federally subsidized giants to lower their loan-to-value ratios
and other underwriting requirements to accommodate minority borrowers. HUD
Secretary Andrew Cuomo even admitted that the administration was mandating a
policy of "affirmative action" lending (his words, not ours).And it was Clinton
who initially spread the subprime rot to Wall Street. To help Fannie and Freddie
reach their "affirmative action" lending quotas, HUD in 1995 let them get
affordable-housing credit for buying subprime securities that included loans to
low-income borrowers.Less than two years later, Freddie partnered with Wall
Street investment banker Bear Stearns to issue the first securitizations of
low-income CRA loans.There's even a press release still available on the Web
that memorializes the historic deal, which dumped hundreds of millions of
dollars in the risky loans on the market — a down payment on the hundreds of
billions that were to follow.
"The Subprime Lending Bias," Investors Business Daily, December 19, 2008
---
http://www.ibdeditorials.com/IBDArticles.aspx?id=314582096700459
Bob Jensen's threads on impending economic doom are at
http://faculty.trinity.edu/rjensen/entitlements.htm
September 21, 2008 reply from Patricia Walters
[patricia@DISCLOSUREANALYTICS.COM]
I think the "bailout effect" covers far more
entities that you mention in your email. Consider the effect of a failure of
AIG on its policyholders and all its creditors, not just banks. Similarly
with the investment banking firms. The effect of Lehman bankruptcy on NYC &
NYS tax revenues is significant, not to mention the lost business by small
businesses that surround Lehman Brothers in NYC and had revenues from sales
of a wide variety of goods & services from its employees. Consider the
effect on employment opportunities for new college graduates in finance.
Now we can look at the effect on all those who
invested in the asset backed securities issued by these firms. The
purchasers were not simply banks in other countries. Purchasers include
small municipalities and other "unsophisticated" investors around the world
who believed these securities were "safe" because the issue had a AAA credit
rating & were insured by companies like AIG.
The ripple effect of failures of these companies
will be considerable.
The other issue is availability of credit going
forward. If banks fail to lend credit then business of all sizes may not be
able to purchase inventory on credit or extend trade credit.
I believe the bailout is to prevent future failures
throughout the economy not just to rescue the specific firms at issue.
September 16, 2008 message from Patricia Walters
[patricia@DISCLOSUREANALYTICS.COM]
I have some "top line" thoughts on accounting & the
credit crisis.
First, I don't believe accounting "causes" crises.
However, in my view, US GAAP accounting rules contributed to the lack of
transparency about the financial position & performance of companies who
engaged in securitizations involving sub-prime mortgages.
So here are some tidbits for thought re: the
failure of financial reporting to provide relevant information for economic
decision-making:
(1) Securitization SPE/VIEs could be moved
off-balance sheet if they were "legally isolated" from the company that
created them. Legal isolation was based on opinions of attorneys. These
vehicles proved not to be legally isolated when "legal isolation" was tested
by the market place.
(2) Models measuring fair values of financial
instruments include assumptions about the characteristics of the
instruments. Rarely, if ever, do they include assumptions about more
fundamental economics, such as real estate prices or general market
collapse. Since the belief was that "real estate prices would always rise",
the possibility of a general collapse of real estate prices would have
received an extremely low weighting even if this variable was included in a
fair value model. There is nothing that accounting rules can do (in my view)
to create a comprehensive & complete list of variables to be included in
fair value models. All we can do is provide guidance on who to estimate fair
values.
(3) Only when defaults started to occur did the
information begin to creep in the financial statements through
(a) more realistic estimates of fair values of
instruments on the books and
(b) through moving back onto the books assets
that had been moved off-balance sheet in SPEs.
On the IFRS front, I wrote a monograph on this
issue for the Institute of Chartered Accountants in Australia. If anyone is
interested in my emailing them a copy, email me off-list.
Regards,
Pat Walters
Fordham University
September 22, 2008 reply from Robert Woodward
[rsw@UNH.EDU]
Does this makes sense?
The core of Secretary Paulson’s proposed Wall
Street bailouts represent an unnecessary transfer of wealth from tax-paying
Americans to financial speculators who, until recently, have earned millions
in gambling profits from the run-up in value of mortgage-based derivatives.
Like all financial instruments, these derivatives
have their prices determined both by real values and speculative
expectations. The real values follow from the cash-flow stream from the
underlying mortgages. But the prices of the derivatives have been driven up,
much like the price of tulip bulbs in the mania of 1636, by the speculative
expectation that their future price increases would be similar to those of
the past. A core issue now facing members of Congress is whether the US
Government should support mortgage core values or a bailout of speculative
losses. Secretary Paulson seems to be concerned solely with negotiating the
price that the Government should pay for the mortgage-based derivatives.
There is a simpler solution. Rather than supporting any percent of what the
financial industry paid for the derivatives, our Government should be
limiting itself to guaranteeing the underlying mortgage payments (or the
payments on a larger percentage of the mortgages) themselves. Let the market
then determine the price of the derivatives.
While guaranteeing mortgage payments would rescue
or bailout some individuals who had speculated about housing prices too
aggressively, it would also prevent foreclosures among working Americans and
curtail the downward spiral in home prices throughout the US more
effectively than a mass rescue of mortgage-based derivatives.
On the side of fairness and equity, guaranteeing
mortgage payments would limit the likelihood that a working American whose
home was foreclosed would be paying higher taxes for 20 years to bailout
financial institutions that once paid too much for a derivative on the
expectation that its price would continue to rise.
Robert S. Woodward, Ph.D.
McKerley Professor of Health Economics
UNH
September 22, 2008 reply from Bob Jensen
Hi Robert,
I liked the
Chrysler bailout because it imposed conditions. Granted there was a lot of
luck and sacrifice in turning Chrysler around in the early 1980s.
Paulson is
not recommending enough conditions in the 2008 bailout.
Ferguson and
Johnson suggest some rather draconian conditions (not quoted below).
“Bridge Loan to Nowhere,” by Thomas Ferguson & Robert Johnson, The
Nation, September 22, 2008 ---
http://www.thenation.com/doc/20081006/ferguson_johnson
In response, the Men in Black (from Wall
Street) have now gone to Congress. They have put a
check for $700 billion and a loaded gun on the table. Sign the check,
they insist, and give us unreviewable power to buy bad assets, or take
responsibility for the collapse of the whole financial system and,
likely, the world economy.
The Men in Black's choice:
just have the government buy the junk, giving Wall Street real
money--our money--in exchange for it. Notice three points about this
one: First, the lucky firms continue merrily in business. Thus far
Paulson and Bernanke's plan does not even pay lip service to reforms. It
is also well to remember that as the crisis hit, Paulson was at work on
a preposterous scheme calling for more deregulation on grounds that New
York faced competition from foreign financial markets. It is obvious
where the former Goldman Sachs CEO's heart lies.
In America's money-driven political system,
leaders of both parties love to pretend that the sound of money talking
is the voice of the people. Both
presidential candidates and Democratic Congressional leaders are mostly
nodding, with the Democrats adding
trademarked noises about balancing off gifts to Wall Street with
mortgage relief, another small economic stimulus program and perhaps
some curbs on executive pay. Meantime, save for a handful of splendid
exceptions, notably Gretchen Morgenstern of the New York Times, American
newspapers just keep giving their readers more reasons to keep deserting
them.
. . .
Congressional Options
It is fine for Democrats to hold out for
mortgage relief and for another stimulus package. The best way to do the
first, probably, is by reviving something like the Home Owners Loan
Corporation that worked so well in the New Deal. That bought mortgages
from people who were in danger of losing their houses and converted them
into obligations that they could afford to repay. This sort of bailout
has the wonderful property of directing public money to the public,
rather than Wall Street. But it would still bail out Wall Street, since
reviving housing and stopping mortgage defaults feeds directly through
to mortgage bonds values and derivatives based on them.
But no one should be fooled by Democratic talk
about mortgage relief and economic stimulus (What's this? The
Nation is supposed to be an ultraliberal magazine that despises
Republicans and loves Obama's planned stimulus giveaway).
The main focus of the design of the bailout must
be the bailout itself. That is the rat hole down which $700 billion and
probably plenty more will soon start disappearing if Congressman Barney
Frank, Senator Dodd and, of course, Senator Obama do not walk the walk
instead of just talking the talk.
The situation is dire, but it is not hopeless.
A flurry of discussions with other central banks and governments may
soon produce claims that international agreements hem in legislators
here. Congress has a straightforward counter to this and any
manipulative threats of economic collapse: Turn the gun around. Move
every bit as speedily as Paulson and Bernanke demand, but pass a bill
that anyone can see protects the public far better than the Men in
Black's proposal. If President Bush--remember him?--refuses to sign it,
make it obvious to voters who's really crashing the system for private
gain. All of the House and a third of the Senate are up for re-election.
Enough votes can probably be found from among Republicans who would like
to survive a Democratic landslide to pass something far better than the
Men in Black's bridge loan to nowhere.
Continued in article
Jensen Comment
Now is not a good time to contend that Sarah Palin is dumber than our
seasoned politicians.
Update in 2009: More of Barney's Rubble
Back when the housing mania was taking off,
Massachusetts Congressman Barney Frank famously said he wanted Fannie Mae and
Freddie Mac to "roll the dice" in the name of affordable housing. That didn't
turn out so well, but Mr. Frank has since only accumulated more power. And now
he is returning to the scene of the calamity -- with your money. He and New York
Representative Anthony Weiner have sent a letter to the heads of Fannie and
Freddie exhorting them to lower lending standards for condo buyers. You read
that right. After two years of telling us how lax lending standards drove up the
market and led to loans that should never have been made, Mr. Frank wants Fannie
and Freddie to take more risk in condo developments with high percentages of
unsold units, high delinquency rates or high concentrations of ownership within
the development.
"Barney the Underwriter: Telling Fannie Mae to take more
credit risk. Now there's an idea," The Wall Street Journal, June 24, 2009 ---
http://online.wsj.com/article/SB124580784452945093.html
Jensen Comment
Remember that Fannie and Freddie are now owned entirely by the Federal
government that can and is simply printing money without having to tax or
borrow. So who cares how much Fannie and Freddie lose loaning to deadbeat
borrowers. Let the credit bubble commence all over again!
Whatever hits the fan will not be distributed
equally.
Anonymous
Jensen Comment
The $20 billion handed secretly to Ken Lewis was not nearly equal to the losses
incurred in the deal. I think Lewis accepted the bribe with his eyes closed and
his ears open to promises of more bribes that failed to materialize.
Collateralized Debt Obligation (CDO) ---
http://en.wikipedia.org/wiki/CDOs
"Sleight of hand: BofA moves dodgy Merrill derivatives to bank," by
Mark December, The New York Post, October 21, 2011 ---
http://www.nypost.com/p/news/business/sleight_of_hand_uy96iNSbW99JHMRnbxgvfL
A plan by beleaguered Bank of America to foist
trillions of dollars of funky Merrill Lynch derivatives onto its depositors
is raising eyebrows on Wall Street.
The rarely used move will likely save the bank
millions of dollars in collateral but could put depositors’ cash behind the
eight ball.
The move also brought to light fissures between the
nation’s top banking regulators, the Federal Deposit Insurance Corp. and the
Federal Reserve, in the wake of new regulations meant to curb the
free-wheeling habits that fostered the worst crisis in a generation back in
2008.
At issue is BofA’s decision to shift what sources
say is some $55 trillion in derivatives at Merrill Lynch to the retail bank
unit, which houses trillions in deposits insured by the FDIC.
Critics say the move potentially imperils everyday
depositors by placing their money and savings at risk should BofA run into
trouble.
Sources say that the derivative transfers from
Merrill to BofA’s bank subsidiary were sparked by credit-rating downgrades
to the bank holding company and are meant to help BofA avoid having to fork
over more money to post as collateral to its derivative counterparties.
BofA officials who have talked privately say the
move was requested by its counterparties and shouldn’t be perceived as
problematic for the bank giant, sources said.
A BofA spokesman declined to comment.
For weeks, BofA CEO Brian Moynihan has been dogged
about the health of one of the nation’s largest banking franchises and its
massive exposures to toxic debt after its shotgun mergers with Merrill and
Countrywide Financial during the credit crisis three years ago.
Under Moynihan, BofA has been attempting to right
the bank’s ship and convince shareholders that the firm is healthy and
doesn’t need to raise fresh capital to backstop against potential losses
from faulty foreclosures and other mortgage-related lawsuits.
In the third quarter, BofA posted profit of $6.23
billion, or 56 cents a share, down 15 percent from the same period a year
ago.
The bank’s shares gained 1 percent yesterday, to
$6.47. They are off 51 percent this year.
BofA’s third-quarter performance comes as fears
persist about the big bank’s ability to make money amid stiff economic
headwinds and a host of potential land mines that could see it shelling out
billions.
The derivatives transfer has irked officials at the
FDIC which, sources said, was informed of BofA’s plan to shift the contracts
to a retail deposit-taking entity just last week.
One source says that the FDIC is in the process of
reviewing the transfer and will relay its opinion to the Federal Reserve.
But ultimately it’s the Fed that has the final say
on authorizing any transfers.
Neither the Fed nor the FDIC would comment on
BofA’s plans, which were first reported by Bloomberg.
Continued in article
Jensen Comment
What is more bizarre is that BofA really did not want to buy Merrill Lynch at
any price in the 2008 Bailout after digging deeper into the financial records of
CDO-battered Merrill Lynch.. Then Treasury Secretary Hank Paulson for some
unknown reason did not want throw Merrill Lynch under the bus in the same manner
that he threw Bear Stearns under the bus. In my opinion, both of these giants
should have been ground up in the tires of the bus.
After the subprime collapse then BofA CEO, Ken Lewis, most certainly did not
want to use BofA money to stop the free fall of Merrill Lynch. However, U.S.
Treasury Secretary Hank Paulson resorted to personal blackmail according to Ken
Lewis.
"Bank Chief Tells of U.S. Pressure to Buy Merrill Lynch," by Louise Story
and Jo Becker, The New York Times, June 11. 2009 ---
http://www.nytimes.com/2009/06/12/business/12bank.html
Of course once BofA decided to concede to Paulson's demands does not condone
the alleged behavior of BofA executives or Merrill Lynch executives in closing
the deal.
"Ken Lewis BLASTS Merrill Lynch-Bank Of America Merger Lawsuit, Calls It
'Implausible'," by David B. Caruso, August 21, 2010 ---
http://www.huffingtonpost.com/2010/08/21/ken-lewis-blasts-merrill-_n_690215.html
Actually BofA was in great shape well into the subprime mortgage crisis. BofA
had been smart enough in 2007 to hold none of the poisoned mortgages and CDOs
that plagued most of the big banks and brokerage houses like Merrill Lynch. But
in a twist of fate BofA became drawn to the fire sale pricing of big outfits
like Countrywide and Merrill Lynch that were dying from subprime poison. BofA
just did not look these gift horses in the mouth until it was too late to get
them out of the BofA stables. There's no excuse for the stupid purchase of
Countrywide which left BofA will millions of defaulted mortgages. There is
purportedly an excuse for the purchase of Merrill Lynch. Ken Lewis was a chicken
sh*t. Ironically, he eventually lost his job anyway.
Now it appears that BofA wants to pass trillions in Merrill Lynch CDO losses
on to depositors who will pay for these losses in nickels and dimes of daily
bank charges for things like debit cards for the next 1,000 years. In reality,
the counterparties to the CDO contracts should've absorbed the loan loss poison,
but Treasury Secretary Paulson and President George Bush did not want to piss
off the investors who finance U.S. Government budget deficits --- especially our
friends in Asia and the Middle East and large banks like Goldman that had bought
these poison-laced CDO bonds.
Ironically, it is now BofA depositors who will now be paying off the bad
debts that rightfully belonged to sovereign funds of Asia and the Middle East as
well as derivatives contract counterparties at Goldman.
"Welcome to the new capitalism," by Star Parker, Townhall, May 4, 2009
---
http://townhall.com/columnists/StarParker/2009/05/04/welcome_to_the_new_capitalism
Frank recently praised Bank of America chairman
(now ex-chairman) Ken Lewis for acting in "the public interest" for caving
in to bribes and threats from former Treasury Secretary Hank Paulson and
Federal Reserve chairman Ben Bernanke regarding B of A's takeover of Merrill
Lynch.
Lewis wanted to back out the deal last year when he
discovered the massive scope of Merrill's losses. But Paulson and Bernanke
decided that Merrill shouldn't fail, so they bribed Lewis with $20 billion
of taxpayer funds, instructed him to conceal the agreement from his
shareholders, and told him his job would be on the line if he didn't play
ball -- which he did.
These sordid details have come to light in an
investigation being conducted by New York State Attorney General Andrew
Cuomo.
So if such behavior is what Barney Frank calls
economic patriotism, what might constitute subversive behavior?
When Congress moved last year to politically
engineer changes in terms of existing mortgages in the name of bailing out
distressed homeowners, Bill Frey, who manages a fund that holds
mortgage-backed securities, protested.
Frey told the New York Times, "Any investor in
mortgage-backed securities has a right to insist that their contract be
enforced."
Contracts? Private property? That's the old
capitalism.
Frank fired off a letter to Frey saying he was
"outraged...that you are actively opposing our efforts to achieve diminution
in foreclosures by voluntary efforts." Frank then clarified his idea of
"voluntary" by summoning Frey to testify in Washington, noting that "if this
cannot be arranged on a voluntary basis, then we will pursue further steps."
The House has passed legislation, which is now in
the Senate, containing Frank's idea of "diminution in foreclosures by
voluntary efforts." It amounts to -- what a surprise -- taxpayer funded
bribes to abrogate existing mortgage contracts and provisions for legal
protection for doing so.
Frey and others managing funds for investors
holding billions in mortgage-backed securities are fighting back. We're not
talking Bernie Madoff here. We're talking about funds that have invested in
these securities on behalf of pension funds and 401Ks.
Financial institutions -- banks like B of A and
Wells Fargo -- originate mortgages and then sell them off to be sliced and
diced up into bonds that individual investors can purchase. This financial
innovation has been a boon for providing capital and liquidity to our
mortgage markets.
The originating bank, however, stays in the picture
to service the loan, collecting and processing the payments. Contractual
agreements exist between the bank and the bondholders that this will be done
in good faith, according to the terms of the original mortgage.
For a host of reasons, mostly massive government
meddling and social engineering, the mortgage market exploded and thus,
we've got homeowners who can't make payments.
The House passed bill proposes to bail these folks
out by paying banks servicing the mortgages $1000 for each one they
re-finance, cutting interest rates and payments. Those who actually own the
loans -- the bondholders -- are left out to pasture. And, the bill protects
servicing banks from lawsuits to which they would normally be exposed for
breaking their contracts.
So taxpayers will subsidize banks to refinance the
bad loans they originated but no longer own, homeowners who borrowed beyond
their means get bailed out, and investors -- the bondholders -- are left to
bear the costs. On top of this, many of these same banks originated second
mortgages on these same homes. The second mortgages, which the banks still
own, bear even higher interest rates because they are allegedly more risky.
Yet, they will be left secure and undisturbed.
Aside from the costs that our society will bear as
law and contracts no longer have meaning, Frey rightly points out that it
all will just make future mortgage borrowing more expensive. Who will take
risks to lend when politicians can change contracts at the drop of a hat?
Welcome to the new capitalism. Where politicians
rule, irresponsible behavior is rewarded, and theft is legal.
August 2018 Update
Wells Fargo & Co. agreed to pay $2.09 billion to settle with the U.S. Justice
Department over the sale of toxic mortgage-backed securities in the lead-up to
the financial crisis.---
https://www.wsj.com/articles/wells-fargo-agrees-to-2-09-billion-settlement-for-crisis-era-mortgage-loans-1533147302?mod=searchresults&page=1&pos=1&mod=djemCFO_h
This is on top of all the subsequent fines paid by Wells Fargo & Co. for
unrelated subsequent crimes. What a lousy company.
"Busting Bank of America: A case study in how to spread systemic
financial risk," The Wall Street Journal, April 27, 2009 ---
http://online.wsj.com/article/SB124078909572557575.html
The cavalier use of brute government force has
become routine, but the emerging story of how Hank Paulson and Ben Bernanke
forced CEO Ken Lewis to blow up Bank of America is still shocking. It's a
case study in the ways that panicky regulators have so often botched the
bailout and made the financial crisis worse.
In the name of containing "systemic risk," our
regulators spread it. In order to keep Mr. Lewis quiet, they all but ordered
him to deceive his own shareholders. And in the name of restoring financial
confidence, they have so mistreated Bank of America that bank executives
everywhere have concluded that neither Treasury nor the Federal Reserve can
be trusted.
Mr. Lewis has told investigators for New York
Attorney General Andrew Cuomo that in December Mr. Paulson threatened him
not to cancel a deal to buy Merrill Lynch. BofA had discovered billions of
dollars in undisclosed Merrill losses, and Mr. Lewis was considering
invoking his rights under a material adverse condition clause to kill the
merger. But Washington decided that America's financial system couldn't
withstand a Merrill failure, and that BofA had to risk its own solvency to
save it. So then-Treasury Secretary Paulson, who says he was acting at the
direction of Federal Reserve Chairman Bernanke, told Mr. Lewis that the feds
would fire him and his board if they didn't complete the deal.
Mr. Paulson told Mr. Lewis that the government
would provide cash from the Troubled Asset Relief Program (TARP) to help
BofA swallow Merrill. But since the government didn't want to reveal this
new federal investment until after the merger closed, Messrs. Paulson and
Bernanke rejected Mr. Lewis's request to get their commitment in writing.
"We do not want a disclosable event," Mr. Lewis
says Mr. Paulson told him. "We do not want a public disclosure." Imagine
what would happen to a CEO who said that.
After getting the approval of his board, Mr. Lewis
executed the Paulson-Bernanke order without informing his shareholders of
the material events taking place at Merrill. The merger closed on January 1.
But investors and taxpayers had to wait weeks to learn that the government
had invested another $20 billion plus loan portfolio insurance in BofA, and
that Merrill had lost a staggering $15 billion in the last three months of
2008.
This was the second time in three months that
Washington had forced Bank of America to take federal money. In his
testimony to the New York AG's office, Mr. Lewis noted that an earlier TARP
investment in his bank had a "dilutive effect" on existing shareholders and
was not requested by BofA. "We had not sought any funds. We were taking 15
[billion dollars] at the request of Hank [Paulson] and others," Mr. Lewis
testified.
But it is the Merrill deal that raises the most
troubling questions. Evaluating the policy of Messrs. Bernanke and Paulson
on their own terms, this transaction fundamentally increased systemic risk.
In order to save a Wall Street brokerage, the feds spread the risk to one of
the country's largest deposit-taking banks. If they were convinced that
Merrill had to be saved, then they should have made the public case for it.
And the first obligation of due diligence is to make sure that their Merrill
"rescuer" of choice -- BofA -- had the capacity to bear the losses. Instead
they transplanted the Merrill risk to BofA shareholders, the bank's
depositors and the taxpayers who ensure those deposits. And then they had to
bail out BofA too.
Messrs. Bernanke and Paulson also undermined the
transparency that is a vital source of investor confidence. Disclosure is
not a luxury to be enjoyed only when markets are rising. It is the
foundation of the American regulatory system and a reason investors have
long sought to keep their money within U.S. borders. Could either man have
believed that their actions wouldn't eventually come to light, with all of
the repercussions for their bank rescue plans?
Mr. Paulson told Mr. Cuomo's investigators that he
also kept former SEC Chairman Christopher Cox out of the loop while forcing
BofA to rescue Merrill. Mr. Cox wasn't the only one. Mr. Paulson and Mr.
Bernanke both sit on the Financial Stability Oversight Board, comprised of
federal regulators who oversee TARP. Two days after Mr. Lewis told the
dynamic duo that Merrill's losses were exploding and that he was looking for
a way out, Mr. Bernanke chaired and Mr. Paulson attended a meeting of this
board. Minutes of the meeting show no mention of BofA or Merrill.
At the next meeting on January 8, a week after the
merger had closed, the minutes again make no mention of either regulator
telling their colleagues that they had committed tens of billions of
dollars. Yet the minutes helpfully note that among the topics discussed were
"coordination, transparency and oversight."
Meeting minutes suggest Messrs. Bernanke and
Paulson finally informed fellow board members at 4:30 p.m. on January 15,
after news outlets had already reported a pending new taxpayer investment in
BofA. What exactly did Mr. Bernanke and Mr. Paulson tell their colleagues
about their plans for TARP prior to January 15?
Let's hope they treated their government colleagues
better than they've treated Ken Lewis, whom they hung out to dry. After
making him an offer he could hardly refuse, they've let him endure a public
flogging from shareholders and the press, lengthy discussions with
prosecutors, plus new hiring and compensation rules that limit his bank's
ability to compete.
No wonder no banker in his right mind trusts the
Fed or Treasury, and no wonder nobody but Pimco and other Treasury favorites
is eager to invest in the TALF, the PPIP, or any of the other programs that
require trusting the government as a business partner.
The political class has spent the last few months
blaming bankers for everything that has gone wrong in the financial system,
and no doubt many banks have earned public scorn. But Washington has been
complicit every step of the way, from the Fed's easy money to the nurturing
of Fannie Mae and Freddie Mac, and since last autumn with regulatory and
Congressional panic that is making financial repair that much harder. The
men who nearly ruined Bank of America have some explaining to do.
Jensen Comment
It is interesting to compare the song Ken Lewis was singing before the
purchase of Merrill Lynch versus the song he's now singing about "his" burdening
BofA with the billions of Merrill Lynch's toxic investments. You can watch and
hear him literally brag that BofA was in stronger shape than all the other large
U.S. banks because it sold most of its sub-prime mortgages to other buyers (like
Fannie, Freddie, and Merrill Lynch) rather than to retain BofA ownership of such
poison. Note his bragging in an interview on CBS Sixty Minutes on October
19, 2009.
I watched the show on October 19, 2008, in a CBS Sixty
Minutes TV module, when Leslie Stahl interviewed the CEO of Bank of America,
Ken Lewis. Mr. Lewis was charming and forceful when he bragged heavily that BofA
was much stronger than the other failing banks and was only accepting some
Bailout money as a “patriotic duty.” He said BofA really had no need for Bailout
cash since his truly giant international bank was in such strong shape even
after the subprime scandal first made the news.
Belatedly, Ken Lewis is claiming that the U.S. Treasury Department and
Federal Reserve teamed up against him and forced him to take on the billions of
Merrill Lynch's poison. If this was indeed the case, it would've been a great
opportunity for Mr. Lewis to make a public stand against the near-ruination of
BofA. Think of what a hero he would've become in the eyes of BofA shareholders
and if he would've drawn a line and dared Paulson to fire him for refusing to
BofA shareholders to gulp down Merrill Lynch poison.
My guess is that Paulson would've instead sweetened the deal by having the
government dilute Merrill Lynch poison such as by making BofA liable for 15% of
Merrill Lynch's subprime and CDO losses.
After the purchasing Merrill Lynch, the sour grapes cry baby Ken Lewis does
not come across as having CEO quality and guts!
Collateralized Debt Obligation (CDO) ---
http://en.wikipedia.org/wiki/CDOs
"Sleight of hand: BofA moves dodgy Merrill derivatives to bank," by
Mark December, The New York Post, October 21, 2011 ---
http://www.nypost.com/p/news/business/sleight_of_hand_uy96iNSbW99JHMRnbxgvfL
A plan by beleaguered Bank of America to foist
trillions of dollars of funky Merrill Lynch derivatives onto its depositors
is raising eyebrows on Wall Street.
The rarely used move will likely save the bank
millions of dollars in collateral but could put depositors’ cash behind the
eight ball.
The move also brought to light fissures between the
nation’s top banking regulators, the Federal Deposit Insurance Corp. and the
Federal Reserve, in the wake of new regulations meant to curb the
free-wheeling habits that fostered the worst crisis in a generation back in
2008.
At issue is BofA’s decision to shift what sources
say is some $55 trillion in derivatives at Merrill Lynch to the retail bank
unit, which houses trillions in deposits insured by the FDIC.
Critics say the move potentially imperils everyday
depositors by placing their money and savings at risk should BofA run into
trouble.
Sources say that the derivative transfers from
Merrill to BofA’s bank subsidiary were sparked by credit-rating downgrades
to the bank holding company and are meant to help BofA avoid having to fork
over more money to post as collateral to its derivative counterparties.
BofA officials who have talked privately say the
move was requested by its counterparties and shouldn’t be perceived as
problematic for the bank giant, sources said.
A BofA spokesman declined to comment.
For weeks, BofA CEO Brian Moynihan has been dogged
about the health of one of the nation’s largest banking franchises and its
massive exposures to toxic debt after its shotgun mergers with Merrill and
Countrywide Financial during the credit crisis three years ago.
Under Moynihan, BofA has been attempting to right
the bank’s ship and convince shareholders that the firm is healthy and
doesn’t need to raise fresh capital to backstop against potential losses
from faulty foreclosures and other mortgage-related lawsuits.
In the third quarter, BofA posted profit of $6.23
billion, or 56 cents a share, down 15 percent from the same period a year
ago.
The bank’s shares gained 1 percent yesterday, to
$6.47. They are off 51 percent this year.
BofA’s third-quarter performance comes as fears
persist about the big bank’s ability to make money amid stiff economic
headwinds and a host of potential land mines that could see it shelling out
billions.
The derivatives transfer has irked officials at the
FDIC which, sources said, was informed of BofA’s plan to shift the contracts
to a retail deposit-taking entity just last week.
One source says that the FDIC is in the process of
reviewing the transfer and will relay its opinion to the Federal Reserve.
But ultimately it’s the Fed that has the final say
on authorizing any transfers.
Neither the Fed nor the FDIC would comment on
BofA’s plans, which were first reported by Bloomberg.
Continued in article
Jensen Comment
What is more bizarre is that BofA really did not want to buy Merrill Lynch at
any price in the 2008 Bailout after digging deeper into the financial records of
CDO-battered Merrill Lynch.. Then Treasury Secretary Hank Paulson for some
unknown reason did not want throw Merrill Lynch under the bus in the same manner
that he threw Bear Stearns under the bus. In my opinion, both of these giants
should have been ground up in the tires of the bus.
After the subprime collapse then BofA CEO, Ken Lewis, most certainly did not
want to use BofA money to stop the free fall of Merrill Lynch. However, U.S.
Treasury Secretary Hank Paulson resorted to personal blackmail according to Ken
Lewis.
"Bank Chief Tells of U.S. Pressure to Buy Merrill Lynch," by Louise Story
and Jo Becker, The New York Times, June 11. 2009 ---
http://www.nytimes.com/2009/06/12/business/12bank.html
Of course once BofA decided to concede to Paulson's demands does not condone
the alleged behavior of BofA executives or Merrill Lynch executives in closing
the deal.
"Ken Lewis BLASTS Merrill Lynch-Bank Of America Merger Lawsuit, Calls It
'Implausible'," by David B. Caruso, August 21, 2010 ---
http://www.huffingtonpost.com/2010/08/21/ken-lewis-blasts-merrill-_n_690215.html
Actually BofA was in great shape well into the subprime mortgage crisis. BofA
had been smart enough in 2007 to hold none of the poisoned mortgages and CDOs
that plagued most of the big banks and brokerage houses like Merrill Lynch. But
in a twist of fate BofA became drawn to the fire sale pricing of big outfits
like Countrywide and Merrill Lynch that were dying from subprime poison. BofA
just did not look these gift horses in the mouth until it was too late to get
them out of the BofA stables. There's no excuse for the stupid purchase of
Countrywide which left BofA will millions of defaulted mortgages. There is
purportedly an excuse for the purchase of Merrill Lynch. Ken Lewis was a chicken
sh*t. Ironically, he eventually lost his job anyway.
Now it appears that BofA wants to pass trillions in Merrill Lynch CDO losses
on to depositors who will pay for these losses in nickels and dimes of daily
bank charges for things like debit cards for the next 1,000 years. In reality,
the counterparties to the CDO contracts should've absorbed the loan loss poison,
but Treasury Secretary Paulson and President George Bush did not want to piss
off the investors who finance U.S. Government budget deficits --- especially our
friends in Asia and the Middle East and large banks like Goldman that had bought
these poison-laced CDO bonds.
Ironically, it is now BofA depositors who will now be paying off the bad
debts that rightfully belonged to sovereign funds of Asia and the Middle East as
well as derivatives contract counterparties at Goldman.
Warren Buffett's lot more
optimistic about the Congressional bailout plan than I am. Who do you want to
believe --- him or me?
Warren Buffett's
informative (in perspective) 24-minute video on this entire bailout question ---
http://www.charlierose.com/shows/2008/10/1/1/an-exclusive-conversation-with-warren-buffett
Also see
http://www.businessweek.com/investor/content/oct2008/pi2008101_890140.htm?link_position=link15
October 4, 2008
message from AECM@LISTSERV.LOYOLA.EDU
For those of you not already
aware of this, "The Snowball" by Alice Schroeder was published this week and
is number two on the Amazon best seller list. It is the definitive work on
Warren Buffett. Mr. Buffett devoted hundreds of hours of times for Alice to
interview him. I'm only about 275 pages into the book but it is a real page
turner and extremely well written. Of course, I may be a little biased as
Alice worked for me at both E&Y and the FASB.
Denny Beresford
"The U.S. government has selected two major accounting firms
to help it manage the $700 billion rescue program for the financial system,"
SmartPros, October 21, 2008 ---
http://lyris.smartpros.com/t/1725105/7762913/5979/0/
The Treasury Department said Tuesday it had chosen
PricewaterhouseCoopers to be the auditor for the program. Ernst & Young will
provide general accounting support.
The two firms will work on the part of the rescue
program that is handling the purchase of troubled assets from banks as a way
of encouraging them to resume more normal lending.
Treasury said that Ernst & Young will be paid
$492,006.95 initially while Pricewaterhouse Coopers will be paid $191,469.27
for its services initially. The two contracts last until Sept. 30, 2011.
In a statement, Treasury said that the two firms
will help the department with accounting and internal control services that
will be needed "to administer the complex portfolio of troubled assets the
department will purchase, including whole loans and mortgage-backed
securities."
The govenrment still must select the five to 10
asset management firms that will actually run the program. Those selections
could come as soon as this week.
Last week, Treasury Secretary Henry Paulson
announced that the government would use $250 billion of the $700 billion
rescue program to make direct purchases of bank stock as a way of boosting
the banks' capital reserves. That will leave $100 billion of the initial
$350 billion in the first phase of the program to purchase troubled assets.
Jensen Comment
Not mentioned here is any appearance of conflict of interest for when a bank
receiving the bailout funding is also audited by PwC or Ernst & Young. There
is potential conflict of interest since virtually all the Big Four
accounting firms will be targeted in shareholder lawsuits filed on behalf of
the failed or failing banks. Pending lawsuits to be filed threaten the
survival of the Big Four auditing firms ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
"Profiting from the recession: Accountancy
firms should not receive any public contracts until there is tangible evidence
that they have cleaned up their act," by Prim Sikka, The Guardian,
October 29, 2008 ---
http://www.guardian.co.uk/commentisfree/2008/oct/29/recession-creditcrunch
The deepening recession is bad news for most
people, but accounting firms must be rubbing their hands. They are going to
make a lot of money from insolvencies. Now a fairy godmother in the shape of
the US Treasury has appeared.
The US government is bailing out banks and
insurance companies. The US legislators have approved another $700bn bailout
as part of the Troubled Asset Relief Programme. The US Treasury secretary
Henry Paulson, former Goldman Sachs chairman, has hired Ernst & Young (E&Y)
and PricewaterhouseCoopers (PwC) to help it with accounting and internal
controls services needed to administer the complex portfolio of troubled
assets that it will purchase. In common with other major firms, PwC and E&Y
are under the spotlight for their audits of distressed banks, tax avoidance
and other practices and their fitness to receive public monies should be
questioned.
Ernst & Young gave a clean bill of health to the
accounts published by Lehman Brothers (page 75), a major casualty of the
financial crisis, and received $31.3m in fees (page 43). PwC are
administrators and could be collecting fees for another ten years. Following
previous violations of auditor independence rules, the US Securities and
Exchange Commission (SEC) prosecuted E&Y and in a withering 69-page judgment
the judge concluded that the firm "committed repeated violation of the
auditor independence standards by conduct that was reckless, highly
unreasonable and negligent".
A 2005 US Senate report (page 6) concluded that E&Y
sold "tax products to multiple clients despite evidence that some ... were
potentially abusive or illegal tax shelters". In May 2007, the US Justice
Department charged four current and former partners of Ernst & Young "with
tax fraud conspiracy and related crimes arising out of tax shelters promoted
by E&Y ... concocted and marketed tax shelter transactions based on false
and fraudulent factual scenarios". In June 2007, a former employee of the
firm pleaded guilty to conspiracy to commit tax fraud and added that "she
and others deliberately concealed information from the IRS, and submitted
false and fraudulent documentation to the IRS". Others are awaiting trial.
In January 2008, North Carolina's superior court threw out an Ernst & Young
inspired tax avoidance scheme that enabled Wal-Mart to shave millions off
its tax bill.
In late 2005, amid allegations of fraud, Refco, a
New York-based hedge-fund, collapsed. A 2007 report by its insolvency
examiner noted that Ernst & Young provided tax advice and that during the
course of its services it "gained substantial knowledge that Refco engaged
in financial statement manipulation during the course of its engagement"
(page 170). The firm eventually resigned but the insolvency examiner said
this was motivated by "its concerns over its own potential liability for
aiding and abetting a fraud" (pages 198-199).
PricewaterhouseCoopers gave a clean bill of health
(page 113) to Freddie Mac, which was bailed out by the US government, and
received $73.3 million in fees (page 86). Following revelations of fraud at
a software manufacturer, earlier this year the SEC banned a former partner
of the firm from practicing because he "did not exercise due professional
care and professional skepticism, and failed to obtain sufficient competent
evidential matter". The firm's audit of Northern Rock was also criticised by
the UK Treasury committee.
A US Senate report (page 7) concluded that
PricewaterhouseCoopers sold potentially abusive or illegal tax shelters". In
common with E&Y it also (page 11) "took steps to conceal their tax shelter
activities from tax authorities and the public, including by failing to
register potentially abusive tax shelters with the IRS".
Earlier this year, the SEC charged former employees
of PwC with 'insider trading'. In August 2007, PwC paid a fine of $2.3m to
settle allegations of kickbacks to secure contracts with government
agencies. In June 2005, the firm paid $41.9m to resolve allegations that it
made false claims to the United States in connection with travel
reimbursement under contracts it had with several federal agencies.
Separately, a judge fined the firm $50,000 for destroying documents related
to a lawsuit in which the firm is accused of fraudulently overbilling
clients.
The government must act to check the catalogue of
predatory practices and encourage responsible corporate behaviour. Major
accountancy firms should not receive any public contracts until there is
tangible evidence that they have cleaned up their act and embraced public
responsibility and accountability.
Bob Jensen's threads on scandals and negligence in each of the large
auditing firms are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
A more palatable approach would
be for the government to drive a Warren Buffett style hard bargain, in which,
rather than buying anything from banks, the government would invest in them in a
form, such as purchase of newly issued preferred stock, or bonds with a long
maturity, that would augment the banks' capital and thus enable banks to make
more loans. That would avoid conferring a windfall on the banks by overpaying
them for their bad securities; no one thinks Buffett is conferring a windfall on
Goldman Sachs. After the industry was back on its feet, the government could
sell the bank stocks or bonds that it had acquired.
Richard Posner, "The $700+ Billion Bailout," The Becker-Posner Blog,
September 28, 2008 ---
http://www.becker-posner-blog.com/
Finally, the "too big to fail"
approach to banks and other companies should be abandoned as new long-term
financial policies are developed. Such an approach is inconsistent with a free
market economy. It also has caused dubious company bailouts in the past, such as
the large government loan years ago to Chrysler, a company that remained weak
and should have been allowed to go into bankruptcy. All the American auto
companies are now asking for handouts too since they cannot compete against
Japanese, Korean, and German carmakers. They will probably get these subsidies,
even though these American companies have been badly managed. A "too many to
fail" principle, as in the present financial crisis, may still be necessary on
hopefully rare occasions, but failure of badly run big financial and other
companies is healthy and indeed necessary for the survival of a robust free
enterprise competitive system.
Nobel Laureate Gary Becker, "The $700+ Billion Bailout," The
Becker-Posner Blog, September 28, 2008 ---
http://www.becker-posner-blog.com/
From The Wall Street Journal Accounting
Weekly Review on November 14, 2008
Small First Get Local Loans
by Anjali Cordeiro
The Wall Street Jouirnal
Nov 11, 2008
Click here to view the full article on WSJ.com
TOPICS: Accounting,
Banking, Cash Flow, Entrepreneurship
SUMMARY: "Small
businesses have been having increasing trouble getting loans as the
credit markets have seized up. But some...are finding that smaller
community banks and credit unions are more open to offering financing."
These smaller banks may have more funds to lend after not having made
some of the investments now plaguing larger banks; may understand
certain business segments within a smaller geographic area rather than
focusing on national trends affecting an industry; and may look more
closely at specific business plans rather than broader measures about
the applicants, such as credit ratings. The article focuses on the
importance of business plans and cash flow strategies in particular.
CLASSROOM
APPLICATION: The article may be used in
entrepreneurship, management accounting, and MBA courses. Questions
focus on defining cash flow and understanding its difference from
profitability.
QUESTIONS:
1. (Introductory) Summarize the experience in making bank
financing applications by Amy Loera for her family's Mexican restaurant
business. What national economic factors currently influence any
business's ability to obtain financing? What national factors are facing
the restaurant industry in particular?
2. (Introductory) What factors about the Tio's Mexican
restaurant and its planned location for expansion, differ from the
issues facing the restaurant industry overall in our nation?
3. (Introductory) What financial information did Ms. Loera
provide for the local credit union to present her application for
financing? Be specific in your answer and describe the time periods
covered.
4. (Advanced) Define the term cash flow. How does cash flow
differ from profitability?
5. (Advanced) How does the need for financing indicate that a
business expects negative cash flow for a certain period of time? How
might this be the case even if a business is profitable from the very
start?
Reviewed By: Judy Beckman,
University of Rhode Island
Moral Hazard: Hedge Fund
ShortsHi Dean,
Thank you for the kind words.
Hedge fund shorts are often used in expectations to re-buy. You might take a
look at the following:
"Subprime crisis: the lay-out of a puzzle: An empirical investigation into the
worldwide financial consequences of the U.S. subprime crisis" ---
http://oaithesis.eur.nl/ir/repub/asset/5163/0509ma281597wm.pdf
. . .
Market neutral strategy: This strategy focusses on
profits made either by arbitrage in a market neutral investment or by
arbitrage over time, for instance investing in futures and shorting the
underlying. This strategy was obtained by the Long-Term Capital Management
fund of Nobel Prize laureates Myron Scholes and Robert C. Merton.
Short selling strategy: The hedge fund shorts
securities in expectation of a rebuy at a lower price at a future date. This
lower price is a result of overconfidence of the other party, who thought
they had bought an undervalued asset.
Special situations: A popular and probably the most
well-known strategy is the behaviour of hedge fund in special situations
like mergers, hostile takeovers, reorganisations or leveraged buy-outs.
Hedge funds often buy stocks from the distressed company, thereby trying to
profit from a difference in the initial offering price and the price that
ultimately has to be paid for the stock of the company.
Timing strategy: The manager of the hedge fund tries
to time his entrance to or exit from a market as good as possible. High
returns can be generated when investing at the start of a bull market or
exiting at the start of a bear market.
Continued in article
Money for Nothing How CEOs and Boards Enrich Themselves While Bankrupting
America
by John Gillespie and David Zweig
Simon and Schuster
http://books.simonandschuster.ca/Money-for-Nothing/John-Gillespie/9781416559931/excerpt_with_id/13802
All eyes are on the CEO, who has gone without sleep
for several days while desperately scrambling to pull a rabbit out of an
empty hat. Staffers, lawyers, advisors, accountants, and consultants scurry
around the company headquarters with news and rumors: the stock price fell
20 percent in the last hour, another of the private equity firms considering
a bid has pulled out, stock traders are passing on obscene jokes about the
company's impending death, the sovereign wealth fund that agreed to put in
$1 billion last fall is screaming at the CFO, hedge fund shorts are
whispering that the commercial paper dealers won't renew the debt tomorrow,
the Treasury and the Fed aren't returning the CEO's calls about bailout
money, six satellite trucks—no, seven now—are parked in front of the
building, and reporters with camera crews are ambushing any passing employee
for sound bites about the prospects of losing their jobs.
Chaos.
In the midst of this, the board of directors—the
supposedly well-informed, responsible, experienced, accountable group of
leaders elected by the shareholders, who are legally and ethically required
to protect the thousands of people who own the company—are . . . where? You
would expect to them to be at the center of the action, but they are merely
spectators with great seats. Some huddle together over a computer screen in
a corner of the boardroom, watching cable news feeds and stock market
reports that amplify the company's death rattles around the world; others
sit beside a speakerphone, giving updates to board colleagues who couldn't
make it in person. Meetings are scheduled, canceled, and rescheduled as the
directors wait, hoping for good news but anticipating the worst.
The atmosphere is a little like that of a family
waiting room outside an intensive care unit—a quiet, intense churning of
dread and resignation. There will be some reminiscing about how well things
seemed to be going not so long ago, some private recriminations about
questions never asked or risks poorly understood, a general feeling of
helplessness, a touch of anger at the senior executives for letting it come
to this, and anticipation of the embarrassment they'll feel when people
whisper about them at the club. Surprisingly, though, there's not a lot of
fear. Few of the directors are likely to have a significant part of their
wealth tied up in the company; legal precedents and insurance policies
insulate them from personal liability. Between 1980 and 2006, there were
only thirteen cases in which outside directors—almost all, other than Enron
and WorldCom, for tiny companies—had to settle shareholder lawsuits with
their own money. (Ten of the Enron outside directors who settled—without
admitting wrongdoing—paid only 10 percent of their prior net gains from
selling Enron stock; eight other directors paid nothing. A number of them
have remained on other boards.) More significant, the CEO who over shadowed
the board will hardly hurt at all, and will probably leave with the tens or
even hundreds of millions of dollars that the directors guaranteed in an
employment contract.
So they sit and wait—the board of directors of this
giant company, who were charged with steering it along the road to profit
and prosperity. In the middle of the biggest crisis in the life of the
company, they are essentially backseat passengers. The controls, which they
never truly used, are of no help as the company hurtles over a cliff, taking
with it the directors' reputations and the shareholders' money. What they
are waiting for is the dull thud signaling the end: a final meeting with the
lawyers and investment bankers, and at last, the formality of signing the
corporate death certificate—a bankruptcy filing, a forced sale for cents on
the dollar, or a government takeover that wipes out the shareholders. The
CEO and the lawyers, as usual, will tell the directors what they must do.
THIS IS NOT JUST A GLOOMY, hypothetical fable about
how an American business might possibly fail, with investors unprotected,
company value squandered, and the governance of enormous and important
companies breaking down. This is, unfortunately, a real scenario that has
been repeated time and again during the recent economic meltdown, as
companies have exploded like a string of one-inch firecrackers. When the
spark runs up the spine of the tangled, interconnected fuses, they blow up
one by one.
Something is wrong here. As Warren Buffett observed
in his 2008 letter to Berkshire Hathaway shareholders, "You only learn who
has been swimming naked when the tide goes out—and what we are witnessing at
some of our largest financial institutions is an ugly sight."
Just look at some of the uglier sights. Merrill
Lynch, General Motors, and Lehman Brothers, three stalwart American
companies, are only a few examples of corporate collapses in which
shareholders were burned. The sleepy complicity and carelessness of their
boards have been especially devastating. Yet almost all the public attention
has focused on the greed or recklessness or incompetence of the CEOs rather
than the negligence of the directors who were supposed to protect the
shareholders and who ought to be held equally, if not more, accountable
because the CEOs theoretically work for them.
Why have boards of directors escaped blame?
Probably because boards are opaque entities to most people, even to many
corporate executives and institutional investors. Individual shareholders,
who might have small positions in a number of companies, know very little
about who these board members are and what they are supposed to be doing.
Their names appear on the generic, straight-to-the-wastebasket proxy forms
that shareholders receive; beyond that, they're ciphers. Directors rarely
talk in public, maintaining a code of silence and confidentiality;
communications with shareholders and journalists are invariably delegated to
corporate PR or investor relations departments. They are protected by a vast
array of lawyers, auditors, investment bankers, and other professional
services gatekeepers who keep them out of trouble for a price. At most,
shareholders might catch a glimpse of the nonexecutive board members if they
bother to attend the annual meeting. Boards work behind closed doors, leave
few footprints, and maintain an aura of power and prestige symbolized by the
grand and imposing boardrooms found in most large companies. Much of this
lack of transparency is deliberate because it reduces accountability and
permits a kind of Wizard of Oz "pay no attention to the man behind the
curtain" effect. (It is very likely to be a man. Only 15.2 percent of the
directors of our five hundred largest companies are women.) The opacity also
serves to hide a key problem: despite many directors being intelligent,
experienced, well-qualified, and decent people who are tough in other
aspects of their professional lives, too many of them become meek, collegial
cheerleaders when they enter the boardroom. They fail to represent
shareholders' interests because they are beholden to the CEOs who brought
them aboard. It's a dangerous arrangement.
On behalf of the shareholders who actually own the
company and are risking their money in anticipation of a commensurate return
on their investments, boards are elected to monitor, advise, and direct the
managers hired to run the company. They have a fiduciary duty to protect the
interests of shareholders. Yet, too often, boards have become enabling
lapdogs rather than trust-worthy watchdogs and guides.
There are, unfortunately, dozens of cases to choose
from to illustrate the seriousness of the situation. Merrill, GM, and Lehman
are instructive because they were companies no one could imagine failing,
although, in truth, they fostered such dysfunctional and conflicted
corporate leadership that their collapses should have been foretold. As you
read their obituaries, viewer discretion is advised. You should think of the
money paid to the executives and directors, as well as the losses in stock
value, not as the company's money, as it is so often portrayed in news
accounts, but as your money—because it is, in fact, coming from your
mutual funds, your 401(k)s, your insurance premiums, your savings account
interest, your mortgage rates, your paychecks, and your costs for goods and
services. Also, think of the impact on ordinary people losing their
retirement savings, their jobs, their homes, or even just the bank or
factory or car dealership in their towns. Then add the trillions of
taxpayers' dollars spent to prop up some of the companies' remains and,
finally, consider the legacy of debt we're leaving for the next generation.
———
DURING MOST OF HIS nearly six years at the top of
Merrill Lynch, Stanley O'Neal simultaneously held the titles of chairman,
CEO, and president. He required such a high degree of loyalty that insiders
referred to his senior staff as the Taliban. O'Neal had hand-picked eight of
the firm's ten outside board members. One of them, John Finnegan, had been a
friend of O'Neal's for more than twenty years and had worked with him in the
General Motors treasury department; he headed Merrill's compensation
committee, which set O'Neal's pay. Another director on the committee was
Alberto Cribiore, a private equity executive who had once tried to hire
O'Neal.
Executives who worked closely with O'Neal say that
he was ruthless in silencing opposition within Merrill and singleminded in
seeking to beat Goldman Sachs in its profitability and Lehman Brothers in
the risky business of packaging and selling mortgage-backed securities. "The
board had absolutely no idea how much of this risky stuff was actually on
the books; it multiplied so fast," one O'Neal colleague said. The colleague
also noted that the directors, despite having impressive rÉsumÉs, were
chosen in part because they had little financial services experience and
were kept under tight control. O'Neal "clearly didn't want anybody asking
questions."
For a while, the arrangement seemed to work. In a
triumphal letter to shareholders in the annual report issued in February
2007, titled "The Real Measure of Success." O'Neal proclaimed 2006 "the most
successful year in [the company's] history—financially, operationally and
strategically," while pointing out that "a lot of this comes down to
leadership." The cocky message ended on a note of pure hubris: "[W]e can and
will continue to grow our business, lead this incredible force of global
capitalism and validate the tremendous confidence that you, our
shareholders, have placed in this organization and each of us."
The board paid O'Neal $48 million in salary and
bonuses for 2006—one of the highest compensation packages in corporate
America. But only ten months later, after suffering a third-quarter loss of
$2.3 billion and an $8.4 billion writedown on failed investments—the largest
loss in the company's ninety-three-year history, exceeding the net earnings
for all of 2006—the board began to understand the real measure of failure.
The directors discovered, seemingly for the first time, just how much risk
Merrill had undertaken in becoming the industry leader in subprime mortgage
bonds and how overleveraged it had become to achieve its targets. They also
caught O'Neal initiating merger talks without their knowledge with Wachovia
Bank, a deal that would have resulted in a personal payout of as much as
$274 million for O'Neal if he had left after its completion—part of his
board-approved employment agreement. During August and September 2007, as
Merrill was losing more than $100 million a day, O'Neal managed to play at
least twenty rounds of golf and lowered his handicap from 10.2 to 9.1.
Apparently due to sheer embarrassment as the
company's failures made headlines, the board finally ousted O'Neal in
October but allowed him to "retire" with an exit package worth $161.5
million on top of the $70 million he'd received during his time as CEO and
chairman. The board then began a frantic search for a new CEO, because, as
one insider confirmed to us, it "had done absolutely no succession planning"
and O'Neal had gotten rid of anyone among the 64,000 employees who might
have been a credible candidate. For the first time since the company's
founding, the board had to look outside for a CEO. In spite of having shown
a disregard for shareholders and a distaste for balanced governance, O'Neal
was back in a boardroom within three months, this time as a director of
Alcoa, serving on the audit committee and charged with overseeing the
aluminum company's risk management and financial disclosure.
At the Merrill Lynch annual meeting in April 2008,
Ann Reese, the head of the board's audit committee, fielded a question from
a shareholder about how the board could have missed the massive risks
Merrill was undertaking in the subprime mortgage-backed securities and
collateralized debt obligations (CDOs) that had ballooned from $1 billion to
$40 billion in exposure for the firm in just eighteen months. Amazingly,
since it is almost unheard of for a director of a company to answer
questions in public, Reese was willing to talk. This was refreshing and
might have provided some insight for shareholders, except that what she said
was curiously detached and unabashed. "The CDO position did not come to the
board's attention until late in the process," she said, adding that
initially the board hadn't been aware that the most troublesome securities
were, in fact, backed by mortgages.
Merrill's new CEO and chairman, John Thain, jumped
in after Reese, saying that the board shouldn't be criticized based on
"20/20 hindsight" even though he had earlier admitted in an interview with
the Wall Street Journal that "Merrill had a risk committee. It just
didn't function." As it happens, Reese, over a cup of English tea, had
helped recruit Thain, who lived near her in Rye, New York. Thain had
received a $15 million signing bonus upon joining Merrill and by the time of
the shareholders' meeting was just completing the $1.2 million refurnishing
of his office suite that was revealed after the company was sold.
Lynn Turner, who served as the SEC's chief
accountant from 1998 to 2001 and later as a board member for several large
public companies, recalled that he spoke about this period to a friend who
was a director at Merrill Lynch in August 2008. "This is a very well-known,
intelligent person," Turner said, "and they tell me, 'You know, Lynn, I've
gone back through all this stuff and I can't think of one thing I'd have
done differently.' My God, I can guarantee you that person wasn't qualified
to be a director! They don't press on the issues. They get into the
boardroom—and I've been in these boardrooms—and they're all too chummy and
no one likes to create confrontation. So they get together five times a year
or so, break bread, all have a good conversation for a day and a half, and
then go home. How in the hell could you be a director at Merrill Lynch and
not know that you had a gargantuan portfolio of toxic assets? If people on
the outside could see the problem, then why couldn't the directors?"
The board was so disconnected from the company that
when Merrill shareholders met in December 2008 to approve the company's sale
to Bank of America after five straight quarterly losses totaling $24 billion
and a near-brush with bankruptcy, not a single one of the nine nonexecutive
directors even attended the meeting. Finance committee chair and former IRS
commissioner Charles Rossotti, reached at home in Virginia by a reporter,
wouldn't say why he wasn't there: "I'm just a director, and I think any
questions you want to have, you should direct to the company." The board
missed an emotional statement by Winthrop Smith, Jr., a former Merrill
banker and the son of a company founder. In a speech that used the word
shame some fourteen times, he said, "Today is not the result of the
subprime mess or synthetic CDOs. They are the symptoms. This is the story of
failed leadership and the failure of a board of directors to understand what
was happening to this great company, and its failure to take action soon
enough . . . Shame on them for not resigning."
When Merrill Lynch first opened its doors in 1914,
Charles E. Merrill announced its credo: "I have no fear of failure, provided
I use my heart and head, hands and feet—and work like hell." The firm died
as an independent company five days short of its ninety-fifth birthday. The
Merrill Lynch shareholders, represented by the board, lost more than $60
billion.
AT A JUNE 6, 2000, stockholders annual meeting,
General Motors wheeled out its newly appointed CEO, Richard Wagoner, who
kicked off the proceedings with an upbeat speech. "I'm pleased to report
that the state of the business at General Motors Corporation is strong," he
proclaimed. "And as suggested by the baby on the cover of our 1999 annual
report, we believe our company's future opportunities are virtually
unlimited." Nine years later, the GM baby wasn't feeling so well, as the
disastrous labor and health care costs and SUV-heavy product strategy caught
up with the company in the midst of skyrocketing gasoline prices and a
recession. GM's stock price fell some 95 percent during Wagoner's tenure;
the company last earned a profit in 2004 and lost more than $85 billion
while he was CEO. Nevertheless, the GM board consistently praised and
rewarded Wagoner's performance. In 2003, it elected him to also chair the
board, and in 2007—a year the company had lost $38.7 billion—it increased
his compensation by 64 percent to $15.7 million.
GM's lead independent director was George M. C.
Fisher, who himself presided over major strategic miscues as CEO and
chairman at Motorola, where the Iridium satellite phone project he initiated
was subsequently written off with a $2.6 billion loss, and later at Kodak,
where he was blamed for botching the shift to digital photography. Fisher
clearly had little use for shareholders. He once told an interviewer
regarding criticism of his tenure at Kodak that "I wish I could get
investors to sit down and ask good questions, but some people are just too
stupid." More than half the GM board was composed of current or retired
CEOs, including Stan O'Neal, who left in 2006, citing time constraints and
concerns over potential conflicts with his role at Merrill that had somehow
not been an issue during the previous five years.
Upon GM's announcement in August 2008 of another
staggering quarterly loss—this time of $15.5 billion—Fisher told a reporter
that "Rick has the unified support of the entire board to a person. We are
absolutely convinced we have the right team under Rick Wagoner's leadership
to get us through these difficult times and to a brighter future." Earlier
that year, Fisher had repeatedly endorsed Wagoner's strategy and said that
GM's stock price was not a major concern of the board. Given that all
thirteen of GM's outside directors together owned less than six
one-hundredths of one percent of the company's stock, that perhaps shouldn't
have been much of a surprise.
Wagoner relished his carte blanche relationship
with GM's directors: "I get good support from the board," he told a
reporter. "We say, 'Here's what we're going to do and here's the time
frame,' and they say, 'Let us know how it comes out.' They're not making the
calls about what to do next. If they do that, they don't need me." What GM's
leaders were doing with the shareholders' dwindling money was doubling their
bet on gas-guzzling SUVs because they provided GM's highest profit margins
at the time. As GM vice chairman Robert Lutz told the New York Times
in 2005: "Everybody thinks high gas prices hurt sport utility sales. In fact
they don't . . . Rich people don't care."
But what seemed good for GM no longer was good for
the country—or for GM's shareholders.
Ironically, GM had been widely praised in the early
1990s for creating a model set of corporate governance reforms in the wake
of major strategic blunders and failed leadership that had resulted in
unprecedented earnings losses. In 1992, the board fired the CEO, appointed a
nonexecutive chairman, and issued twenty-eight structural guidelines for
insuring board independence from management and increasing oversight of
long-term strategy. BusinessWeek hailed the GM document as a "Magna
Carta for Directors" and the company's financial performance improved for a
time. The reform initiatives, however, lasted about as long as the tailfin
designs on a Cadillac. Within a few years, despite checking most of the good
governance structural boxes, the CEO was once again also the board chairman,
the directors had backslid fully to a subservient "let us know how it comes
out" role, and the executives were back behind the wheel.
In November 2005, when GM's stock price was still
in the mid-20s, Ric Marshall, the chief analyst of the Corporate Library, a
governance rating service that focuses on board culture and CEO-board
dynamics, wrote: "Despite its compliance with most of the best practices
believed to comprise 'good governance,' the current General Motors board
epitomizes the sad truth that compliance alone has very little to do with
actual board effectiveness. The GM board has failed repeatedly to address
the key strategic questions facing this onetime industrial giant, exposing
the firm not only to a number of legal and regulatory worries but the very
real threat of outright business failure. Is GM, like Chrysler some years
ago, simply too big to fail? We're not sure, but it seems increasingly
likely that GM shareholders will soon find out."
By the time Wagoner was fired in March 2009, at the
instigation of the federal officials overseeing the massive bailout of the
company, the stock had dropped to the $2 range and GM had already run
through $13.4 billion in taxpayers' money. In spite of this, some directors
still couldn't wean themselves from Wagoner, and were reportedly furious
that his dismissal occurred without their consent. Others were mortified by
what had happened to the company. One prominent director, who had diligently
tried to help the company change course before it was too late, had
eventually quit the board out of frustration with the "ridiculous
bureaucracy and a thumb-sucking board that led to GM making cars that no one
wanted to buy." Another director who left the board recalled asking Wagoner
and his executive team in 2006 for a five-year plan and projections. "They
said they didn't have that. And most of the guys in the room didn't seem to
care."
The GM shareholders, represented by the board, lost
more than $52 billion.
IN A COMPANY as large and complex as Lehman
Brothers, you would expect the board to be seasoned, astute, dynamic, and
up-to-date on risks it was undertaking with the shareholders' money. Yet the
only nonexecutive director, out of ten, with any recent banking experience
was Jerry Grundhofer, the retired head of U.S. Bancorp, who had joined the
board exactly five months before Lehman's spectacular collapse into
bankruptcy. Nine of the independent directors were retired, including five
who were in their seventies and eighties. Their backgrounds hardly seemed
suited to overseeing a sophisticated and complicated financial entity: the
members included a theatrical producer, the former CEO of a Spanish-language
television company, a retired art-auction company executive, a retired CEO
of Halliburton, a former rear admiral who had headed the Girl Scouts and
served on the board of Weight Watchers International, and, until two years
before Lehman's downfall, the eighty-three-year-old actress and socialite
Dina Merrill, who sat on the board for eighteen years and served on the
compensation committee, which approved CEO Richard Fuld's $484 million in
salary, stock, options, and bonuses from 2000 to 2007. Whatever their
qualifications, the directors were well compensated, too. In 2007, each was
paid between $325,038 and $397,538 for attending a total of eight full board
meetings.
The average age of the Lehman board's risk
committee was just under seventy. The committee was chaired by the
eighty-one-year-old economist Henry Kaufman, who had last worked at a Wall
Street investment bank some twenty years in the past and then started a
consulting firm. He is exactly the type of director found on many boards—a
person whose prestigious credentials are meant to reassure shareholders and
regulators that the company is being well monitored and advised. Then they
are ignored.
Kaufman had been on the Lehman board for thirteen
years. Even in 2006 and 2007, as Lehman's borrowing skyrocketed and the firm
was vastly increasing its holdings of very risky securities and commercial
real estate, the risk committee met only twice each year. Kaufman was known
as "Dr. Doom" back in the 1980s because of his consistently pessimistic
forecasts as Salomon Brothers' chief economist, but he seems not to have
been very persuasive with Lehman's executives in getting them to limit the
massive borrowing and risks they were taking on as the mortgage bubble
continued to over-inflate.
In an April 2008 interview, Kaufman offered an
insight that might have been more timely and helpful a few years earlier in
both the Lehman boardroom and Washington, D.C.: "If we don't improve the
supervision and oversight over financial institutions, in another seven,
eight, nine, or ten years, we may have a crisis that's bigger than the one
we have today. . . . Usually what's happened is that financial markets move
to the competitive edge of risk-taking unless there is some constraint."
With little to no internal supervision, oversight, or constraint having been
provided by its board, the bigger crisis for Lehman came sooner rather than
later, and it collapsed just four and a half months later.
After Lehman's demise, Kaufman has continued to
offer advice to others. Without a trace of irony or guilt, he said to
another interviewer in July 2009, "If you want to take risks, you've got to
have the capital to do it. But, you can't do it with other people's money
where the other people are not well informed about the risk taking of that
institution." In his recent book on financial system reform (which largely
blames the Federal Reserve for the financial meltdown and has an entire
section listing his own "prophetic" warnings about the economy), Kaufman
neglects to mention either his role at Lehman or his missing the warning
signs when he personally invested and lost millions in Bernie Madoff's Ponzi
scheme. He does, however, note that "The shabby events of the recent past
demonstrate that people in finance cannot and should not escape public
scrutiny."
Dr. Doom did heed his own economic advice, while
providing an instructive case of exquisite timing—as well as of having your
cake, eating it too, and then patting yourself on the back for warning
others of the caloric dangers of cake. Lehman securities filings show that
about ten months before Lehman stock went to zero, Kaufman cashed in more
than half of the remaining stock options that had been given to him for
protecting shareholders' interests. He made nearly $2 million in profits.
"The Lehman board was a joke and a disgrace," said
a former senior investment banker who now serves as a director for several
S&P 500 companies. "Asleep at the switch doesn't begin to describe it." The
autocratic Richard Fuld, whose nickname at the firm was "the Gorilla," had
joined Lehman in 1969 when his air force career ended after he had a
fistfight with a commanding officer. He served since 1994 as both CEO and
chairman of the board, an inherent conflict in roles that still occurs at 61
percent of the largest U.S. companies.
A lawsuit filed in early 2009 by the New Jersey
Department of Investment alleges that $118 million in losses to the state
pension fund resulted from fraud and misrepresentation by Lehman's
executives and the board. The role of the board is described in scathing
terms:
The supine Board that defendant Fuld handpicked provided no backstop to
Lehman's executives' zealous approach to the Company's risk profile, real
estate portfolio, and their own compensation. The Director Defendants were
considered inattentive, elderly, and woefully short on relevant structured
finance background. The composition of the Board according to a recent
filing in the Lehman bankruptcy allowed defendant "Fuld to marginalize the
Directors, who tolerated an absence of checks and balances at Lehman." Due
to his long tenure and ubiquity at Lehman, defendant Fuld has been able to
consolidate his power to a remarkable degree. Defendant Fuld was both the
Chairman of the Board and the CEO . . . The Director Defendants acted as a
rubber stamp for the actions of Lehman's senior management. There was little
turnover on the Board. By the date of Lehman's collapse, more than half of
the Director Defendants had served for twelve or more years."
John Helyar is one of the authors of Barbarians
at the Gate, which documents the fall of RJR Nabisco in the 1980s. He
also cowrote a five-part series for Bloomberg.com on Lehman Brothers'
collapse. Helyar was a keen observer of those companies' boards when they
folded. "The few people on the Lehman board who actually had relevant
experience were kind of like an all-star team from the 1980s back for an
old-timers' game in which they weren't even up on the new rules and
equipment," Helyar told us. "Fuld selected them because he didn't want to be
challenged by anyone. Most of the top executives didn't understand the risks
they were taking, so can you imagine a septuagenarian sitting in the
boardroom getting a PowerPoint presentation on synthetic CDOs and credit
default swaps?"
In a conference call announcing the firm's 2008
third-quarter loss of $3.9 billion, Fuld told analysts, "I must say the
board's been wonderfully supportive." Four days later the 159-year-old
company declared the largest bankruptcy in U.S. history. The Lehman
shareholders, represented by the board, lost more than $45 billion.
THE DISASTERS at Merrill Lynch, GM, and Lehman were
not isolated instances of hubris, incompetence, and negligence. Similar
stories of boards and CEOs failing to do their jobs on behalf of the
companies' owners can be told about Countrywide, Citigroup, AIG, Fannie Mae,
Bank of America, Washington Mutual, Wachovia, Sovereign Bank, Bear Stearns,
and most of the other companies directly involved in the recent financial
meltdown, as well as many nonfinancial businesses whose governance-related
troubles came to light in the resulting recession. In the short term, the
result has been the loss of hundreds of billions of dollars for
shareholders, and economic devastation for employees and others caught in
the wake. In the long term, a growing crisis of confidence among investors
could cripple our economy, as capital is diverted away from American
corporate debt and equity markets and companies suffocate from lack of
funding.
Investor mistrust takes hold fast and punishes
instantly in the modern economy. Enron, once America's seventh-largest
corporation, crashed in a mere three weeks once the scope of its failures
and corruption was exposed and its investors and creditors began to withdraw
their funds. Today's collapses can happen even faster. Because the companies
are larger, their operations more interconnected, and their financing so
complex and subject to hair-trigger reactions from institutional investors
with enormous trading positions, the impacts are greatly magnified and
reverberate globally. Bear Stearns went from its CEO claiming on CNBC that
"our liquidity position has not changed at all" to being insolvent two days
later.
Of the world's two hundred largest economies, more
than half are corporations. They have more influence on our lives than any
other institution—not just profound economic clout, but also enormous
political, environmental, and civic power. As they have grown in influence,
they have also become more concentrated: In 1950, the 100 largest industrial
companies owned approximately 40 percent of total U.S. industrial assets; by
the 1990s, they controlled 75 percent. Global corporations have assumed the
authority and impact that formerly belonged to governments and churches.
Boards of directors are supposed to be the most important element of
corporate leadership—the ultimate power in this economic universe—and while
some companies have made progress during the past decade in improving
corporate governance, the recurring waves of scandals and the blatant
victimization of shareholders that appear in the wake of economic crashes
prove that our approach to leading corporations is badly in need of
fundamental reform.
Ideally, a board of directors is informed, active,
and advisory, and maintains an open but challenging relationship with the
company's CEO. In reality, this rarely happens. In most cases, board members
are beholden to CEOs for their very presence on the board, for their
renominations, their compensation, their perquisites, their committee
assignments, their agendas, and virtually all their information. Even
well-intentioned directors find themselves hopelessly compromised, badly
conflicted, and essentially powerless. Not that all blame can be put on
bullying, manipulative CEOs; many boards simply fail to do their jobs. They
allow themselves to be fooled by fraudulent accounting; they look away
during the squandering of company resources; they miss obvious strategic
shifts in the marketplace; they are blind to massive risks their firms
assume; they approve excessive executive pay; they neglect to prepare for
crises; they ignore blatant conflicts of interest; they condone a lax
ethical tone. The head of one of the world's largest and most successful
private equity firms told us that he considers the current model of
corporate boards "fundamentally broken."
Continued in article
Hope this helps,
Bob Jensen
Forged mortgage paperwork mess: the next housing shock and toxic mold
threats?
I have written tens of thousands of tidbits over the years. Aside from my
tidbits on wars, deficits/entitlements, and unemployment, I think my most
depressing tidbits are on the corrupted real estate deed registries of virtually
all counties in the 50 states if America. The major reason for this corruption
is that, after the subprime bubble burst in 2008, megabanks and Wall Street
brokerage houses lost track of mortgage paperwork on millions of real estate
parcels. These banks/brokerages then forged new copies of the mortgages, often
with fictitious names of bank officials where the loans originated. When these
properties were then foreclosed or otherwise resold to new buyers, the forged
mortgages became part of recorded deeds, thereby corrupting the deed registries
across the entire United States.
Watch the Video
"Mortgage paperwork mess: the next housing shock?" CBS Sixty Minutes,
April 3, 2011 ---
http://www.cbsnews.com/stories/2011/04/01/60minutes/main20049646.shtml
If there was a question about whether we're headed
for a second housing shock, that was settled last week with news that home
prices have fallen a sixth consecutive month. Values are nearly back to
levels of the Great Recession. One thing weighing on the economy is the huge
number of foreclosed houses.
Many are stuck on the market for a reason you
wouldn't expect: banks can't find the ownership documents.
Who really owns your mortgage?
Scott Pelley explains a bizarre aftershock of the U.S. financial
collapse: An epidemic of forged and missing mortgage documents.
It's bizarre but, it turns out, Wall Street cut
corners when it created those mortgage-backed investments that triggered the
financial collapse. Now that banks want to evict people, they're unwinding
these exotic investments to find, that often, the legal documents behind the
mortgages aren't there
Continued in article
Deed Registry ---
http://en.wikipedia.org/wiki/Registry_of_deeds
Mortgage ---
http://en.wikipedia.org/wiki/Mortgage_loan
Mortgage Backed Security ---
http://en.wikipedia.org/wiki/Mortgage-backed_security
Collateralized Debt Obligation (CDO) or Structured Asset Backed Security
(CABS) ---
http://en.wikipedia.org/wiki/Collateralized_debt_obligation
Registered deeds keep legal track over the years of all real estate in the
United States. Often the owners have taken out mortgages that give lenders
priority claims on the real estate ownership when owners default on mortgage
lending contracts. It's important to note that names of mortgage investors,
along with the property owners, are written into the recorded deeds. Before a
buyer purchases real estate the chronological records of recorded deeds on the
property are generally searched by legal experts who then certify and sometimes
insure that the buyer will have a clear title to the purchased property.
If mortgages referenced in recorded deeds are forged, the recorded deeds are
thereby corrupted. Present owners accordingly do not have clear titles to the
purchased real estate. This includes John and Jane Doe now living in their home
at 123 Main Street. It also includes Fannie Mae, Freddie Mack, Goldman Sachs,
Bank of America, JP Morgan, and most of the other megabanks inside and outside
the United States. All are waiting for former owners to file lawsuits claiming
damages because of forged documents (including lawsuits from owners who simply
abandoned their houses because they could not make the mortgage payments and
those that got forced out by foreclosure proceedings).
The FDIC claims that probably the only way out of this mess is for the large
banks and brokerages who in one way or another are responsible for the document
forgeries to pay tens of billions into a "clean up fund" to be administered by
the government to make claimants accept cash settlements and relinquish their
rights to sue over forged or missing documents. This may be the only way to
clear the titles to registered deeds, including the deeds on millions of empty
homes that now cannot be sold until the titles are cleared of the forged
recorded paperwork.
A Summary of How This Mess Came About
1.
The main cause of this mess roots back to a time when banks and mortgage
companies that initially approve mortgage contracts commenced selling all their
mortgage investments to downstream investors like Fannie Mae, Freddie Mac, Bear
Stearns, Lehman Brothers, Merrill Lynch, and virtually all the large
international banks and Wall Street brokerages. Some like Bank of America did
not directly buy many of these downstream mortgages but later inherited millions
of mortgages such as when Bank of America bought the troubled Countrywide and JP
Morgan bought the troubled Wachovia as part of the TARP deals engineered by the
U.S. Treasury Department. It took until 2011 for the government to finally
mandate that original lenders must retain "some skin" in the mortgages sold
downstream (currently at least 5% of the financial risk skin). That was not the
case when the subprime bubble burst in 2008.
2.
Another leading cause was the common 1990s practice of issuing subprime interest
rate mortgages where interest in the early years was below prime rates with a
clause that higher rates would eventually kick in several years down the road.
Even current owners were tempted to abandon their fixed rate mortgages and
refinance with subprime mortgages with the intent of flipping their homes before
the higher rates kicked in with payments they could not afford. The plan was to
sell their houses at huge gains and move up the hill to bigger houses and better
neighborhoods. All of this was predicated on the assumption that the price
bubble in real estate would never burst. But in 2008 it did burst and millions
of home owners could no longer make their mortgage payments when the subprime
rates gave way to double-digit rates. Low income people defaulted in droves, but
higher income people also defaulted. Some very high income people bought
mansions on the hill at subprime rates hoping to turn those mansions over for
enormous profits as long as housing prices in America kept going up and up. CBS
Sixty Minutes captured the essence of what happened when the bubble burst.
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards"
---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
3.
The eventual downstream owners of these risky subprime mortgages invented a way
of diversifying default risk by putting together and selling portfolios of
mortgages known as Collateralized Debt Obligation portfolios. Buyers included
many wealthy investors in the Middle East and Asia. Forest Gump describes a CDO
portfolio as a box of chocolates with mostly small pieces of good mortgages with
a few turds thrown in (small pieces of mortgages are likely to go into default
by owners who cannot afford their mortgage payments). Note that a CDO portfolio
does not 100% of any mortgage investment. Rather it contains like a 1% piece of
a mortgage spread over 100 CDO portfolios. This is important because this
slicing and dicing shredding of financial risk is where much of the original
paperwork got lost.
Mortgage Backed Securities are like boxes of
chocolates. Criminals (bankers and brokers)
on Wall Street and one particular U.S. Congressional Committee stole a few
chocolates from the boxes and replaced them with turds. Their criminal buddies
at Standard & Poors rated these boxes AAA Investment Grade chocolates. These
boxes were then sold all over the world to investors. Eventually somebody bites
into a turd and discovers the crime. Suddenly nobody trusts American chocolates
anymore worldwide. Hank Paulson now wants the American taxpayers to buy up and
hold all these boxes of turd-infested chocolates for $700 billion dollars until
the market for turds returns to normal. Meanwhile, Hank's buddies, the Wall
Street criminals who stole all the good chocolates are not being investigated,
arrested, or indicted. Momma always said: "Sniff the chocolates first Forrest."
Things generally don't pass the smell test if they came from Wall Street or from
Washington DC.
Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14, 2010. Both videos feature
one of my favorite authors of all time, Michael Lewis, who hhs been writing
(humorously with tongue in cheek) about Wall Street scandals since he was a bond
salesman on Wall Street in the 1980s. The other person featured on in these
videos is a one-eyed physician with Asperger Syndrome who made hundreds of
millions of dollars anticipating the collapse of the CDO markets while the
shareholders of companies like Merrill Lynch, AIG, Lehman Bros., and Bear
Stearns got left holding the empty bags.
4.
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30, 2009
---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this
video (a little over 5 Mbs) using a free updated version of RealMedia ---
Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP
Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
5.
So where does mortgage/deed forgeries enter into the picture.
It turns out that the Wall Street brokerage houses and megabanks that ended up
downstream with the mortgages and then sliced and diced them into new
securitization instruments called Mortgage Backed Obligation (MBO) portfolios
completely lost track of the millions original mortgage paper work that they
were shredding into millions of MBOs. Then when owners defaulted on their
original subprime mortgages the megabanks and brokerages, gasp, could not find
the original paperwork. Even worse, when responsible homeowners sold their homes
and wanted to pay off their mortgages the megabanks and brokerages also could
not find the original paperwork.
Horrors!
What's a megabank to do when new deeds have to be recorded and the current
recorded deeds/mortgages cannot be located. What the megabanks essentially
did was forge new paperwork. Not wanting to implicate their own employees in
this fraud they hired sleazy mortgage servicing companies who in turn hired high
school kids at minimum wage to forge up thousands of names per hour (including
forged notary public signatures). The megabanks now claim they did not know
these forgeries were taking place, but if you believe this I've got some ocean
front property in Arizona and the Brooklyn Bridge that I would like to sell to
those megabanks.
To see how all of this forgery really took place watch the following:
Mortgage paperwork mess: the next housing shock?" CBS Sixty Minutes,
April 3, 2011 ---
http://www.cbsnews.com/stories/2011/04/01/60minutes/main20049646.shtml
If there was a question about whether we're headed
for a second housing shock, that was settled last week with news that home
prices have fallen a sixth consecutive month. Values are nearly back to
levels of the Great Recession. One thing weighing on the economy is the huge
number of foreclosed houses.
Many are stuck on the market for a reason you
wouldn't expect: banks can't find the ownership documents.
Who really owns your mortgage?
Scott Pelley explains a bizarre aftershock of the U.S. financial
collapse: An epidemic of forged and missing mortgage documents.
It's bizarre but, it turns out, Wall Street cut
corners when it created those mortgage-backed investments that triggered the
financial collapse. Now that banks want to evict people, they're unwinding
these exotic investments to find, that often, the legal documents behind the
mortgages aren't there
Continued in article
6.
So where does this leave us now and why is this so serious?
This leaves us with millions of corrupted deed registries containing
references to forged documents. Current owners do not have clear titles to their
properties, including megabanks holding corrupted titles to vacant homes.
Currently 13% of all the houses in America are vacant, including millions of
double wides in mobile home parks and millions of mansions in every county of
the United States. Owners, including megabanks, of these vacant houses do not
have clear title do to forged documents. The houses cannot be sold with
corrupted titles such that they sit vacant year after year.
Mold takes hold in the walls and ceilings of vacant homes that are not
properly cooled and dehumidified in hot summer months and warmed in frigid
winter months. The mold spreads more and more until it reaches toxic levels
where real estate inspectors will not allow the homes to be sold. The bull
dozers have to push through those double wides and even those mansions on the
hill.
Now lawyers are hovering like vultures to commence the lawsuits on behalf of
former owners such as owners thrown out of foreclosed houses and new owners who
do not have clear titles to properties purchased in good faith ---
http://wgroup.ning.com/
The FDIC is proposing a forged document cleanup fund where the megabanks
responsible for using forged paperwork put up tens of billions of dollars into a
fund to pay off the damaged former owners so that titles can be cleared on
millions of homes now having corrupted deeds on file due to those forgeries.
It's a little like how the BP fund in being administered for oil spill damages
to employees and businesses along the Gulf Coast, only the forged mortgage fund
has to be much, much, much larger.
What a mess!
"Woman Who Couldn’t Be Intimidated by Citigroup Wins $31 Million," by
Bob Ivry, Bloomberg News, May 31, 2012 ---
file:///C:/Documents and Settings/rjensen/My Documents/My Web Sites/images
Sherry Hunt never expected to be a senior manager
at a Wall Street bank. She was a country girl, raised in rural Michigan by a
dad who taught her to fish and a mom who showed her how to find wild
mushrooms. She listened to Marty Robbins and Buck Owens on the radio and
came to believe that God has a bigger plan, that everything happens for a
reason.
She got married at 16 and didn’t go to college.
After she had her first child at 17, she needed a job. A friend helped her
find one in 1975, processing home loans at a small bank in Alaska. Over the
next 30 years, Hunt moved up the ladder to mortgage-banking positions in
Indiana, Minnesota and Missouri, Bloomberg Markets magazine reports in its
July issue.
On her days off, when she wasn’t fishing with her
husband, Jonathan, she rode her horse, Cody, in Wild West shows. She
sometimes dressed up as the legendary cowgirl Annie Oakley, firing blanks
from a vintage rifle to entertain an audience. She liked the mortgage
business, liked that she was helping people buy houses.
In November 2004, Hunt, now 55, joined
Citigroup (C) Inc. as a vice president in the
mortgage unit. It looked like a great career move. The housing market was
booming, and the New York- based bank, the
sixth-largest lender in the U.S. at the time, was responsible for 3.5
percent of all home loans. Hunt supervised 65 mortgage underwriters at
CitiMortgage Inc.’s sprawling headquarters in O’Fallon, Missouri, 45 minutes
west of St. Louis.
Avoiding Fraud
Hunt’s team was responsible for protecting
Citigroup from fraud and bad investments. She and her colleagues inspected
loans Citi wanted to buy from outside brokers and lenders to see whether
they met the bank’s standards. The mortgages had to have properly signed
paperwork, verifiable borrower income and realistic appraisals.
Citi would vouch for the quality of these loans
when it sold them to investors or approved them for government mortgage
insurance.
Investor demand was so strong for mortgages
packaged into securities that Citigroup couldn’t process them fast enough.
The Citi stamp of approval told investors that the bank would stand behind
the mortgages if borrowers quit paying.
At the mortgage-processing factory in O’Fallon,
Hunt was working on an assembly line that helped inflate a housing bubble
whose implosion would shake the world. The O’Fallon mortgage machinery was
moving too fast to check every loan, Hunt says.
Phony Appraisals
By 2006, the bank was buying mortgages from outside
lenders with doctored tax forms, phony appraisals and missing signatures,
she says. It was Hunt’s job to identify these defects, and she did, in
regular reports to her bosses.
Executives buried her findings, Hunt says, before,
during and after the financial crisis, and even into 2012.
In March 2011, more than two years after Citigroup
took $45 billion in bailouts from the U.S. government and
billions more from the
Federal Reserve -- more in total than any other
U.S. bank -- Jeffery Polkinghorne, an O’Fallon
executive in charge of loan quality, asked Hunt and a colleague to stay in a
conference room after a meeting.
The encounter with Polkinghorne was brief and
tense, Hunt says. The number of loans classified as defective would have to
fall, he told them, or it would be “your asses on the line.”
Hunt says it was clear what Polkinghorne was asking
-- and she wanted no part of it.
‘I Wouldn’t Play Along’
“All a dishonest person had to do was change the
reports to make things look better than they were,” Hunt says. “I wouldn’t
play along.”
Instead, she took her employer to court -- and won.
In August 2011, five months after the meeting with Polkinghorne, Hunt sued
Citigroup in Manhattan federal court, accusing its home-loan division of
systematically violating U.S. mortgage regulations.
The U.S.
Justice Department decided to join her suit in
January. Citigroup didn’t dispute any of Hunt’s facts; it didn’t mount a
defense in public or in court. On Feb. 15, 2012, the bank agreed to pay
$158.3 million to the U.S. government to settle the case.
Citigroup admitted approving loans for government
insurance that didn’t qualify under Federal Housing Administration rules.
Prosecutors kept open the possibility of bringing criminal charges, without
specifying targets.
‘Pure Myth’
Citigroup behaving badly as late as 2012 shows how
a big bank hasn’t yet absorbed the lessons of the credit crisis despite
billions of dollars in bailouts, says
Neil Barofsky, former special inspector general of
the Troubled Asset Relief Program.
“This case demonstrates that the notion that the
bailed-out banks have somehow found God and have reformed their ways in the
aftermath of the financial crisis is pure myth,” he says.
As a reward for blowing the whistle on her
employer, Hunt, the country girl turned banker, got $31 million out of the
settlement paid by Citigroup.
Hunt still remembers her first impressions of
CitiMortgage’s O’Fallon headquarters, a complex of three concrete-and-glass
buildings surrounded by manicured lawns and vast parking lots. Inside are
endless rows of cubicles where 3,800 employees trade e-mails and conduct
conference calls. Hunt says at first she felt like a mouse in a maze.
“You only see people’s faces when someone brings in
doughnuts and the smell gets them peeking over the tops of their cubicles,”
she says.
Jean Charities
Over time, she came to appreciate the camaraderie.
Every month, workers conducted the so-called Jean Charities. Employees
contributed $20 for the privilege of wearing jeans every day, with the money
going to local nonprofit organizations. With so many workers, it added up to
$25,000 a month.
“Citi is full of wonderful people, conscientious
people,” Hunt says.
Those people worked on different teams to process
mortgages, all of them focused on keeping home loans moving through the
system. One team bought loans from brokers and other lenders. Another team,
called underwriters, made sure loan paperwork was complete and the mortgages
met the bank’s and the government’s guidelines.
Yet another group did spot-checks on loans already
purchased. It was such a high-volume business that one group’s assignment
was simply to keep loans moving on the assembly line.
Powerful Incentive
Still another unit sold loans to
Fannie Mae,
Freddie Mac and Ginnie Mae, the
government-controlled companies that bundled them into securities for sale
to investors. Those were the types of securities that blew up in 2007,
igniting a global financial crisis.
Workers had a powerful incentive to push mortgages
through the process even if flaws were found: compensation. The pay of
CitiMortgage employees all the way up to the division’s chief executive
officer depended on a high percentage of approved loans, the government’s
complaint says.
By 2006, Hunt’s team was processing $50 billion in
loans that Citi-Mortgage bought from hundreds of mortgage companies. Because
her unit couldn’t possibly review them all, they checked a sample.
When a mortgage wasn’t up to federal standards --
which could be any error ranging from an unsigned document to a false income
statement or a hyped-up appraisal -- her team labeled the loan as defective.
Missing Documentation
In late 2007, Hunt’s group estimated that about 60
percent of the mortgages Citigroup was buying and selling were missing some
form of documentation. Hunt says she took her concerns to her boss, Richard
Bowen III.
Bowen, 64, is a religious man, a former Air Force
Reserve Officer Training Corps cadet at Texas Tech University in Lubbock
with an attention to detail that befits his background as a certified public
accountant. When he saw the magnitude of the mortgage defects, Bowen says he
prayed for guidance.
In a Nov. 3, 2007,
e-mail, he alerted Citigroup executives, including
Robert Rubin, then chairman of Citigroup’s
executive committee and a former
Treasury secretary; Chief Financial Officer
Gary Crittenden; the bank’s senior risk officer;
and its chief auditor.
Bowen put the words “URGENT -- READ IMMEDIATELY --
FINANCIAL ISSUES” in the subject line.
“The reason for this urgent e-mail concerns
breakdowns of internal controls and resulting significant but possibly
unrecognized financial losses existing within our organization,” Bowen
wrote. “We continue to be significantly out of compliance.”
No Change
There were no noticeable changes in the mortgage
machinery as a result of
Bowen’s warning, Hunt says.
Just a week after Bowen sent his e-mail, Sherry and
Jonathan were driving their Toyota Camry about 55 miles (89 kilometers) per
hour on four-lane Providence Road in Columbia,
Missouri, when a
driver in a Honda Civic hit them head-on. Sherry broke a foot and her
sternum. Jonathan broke an arm and his sternum.
Doctors used four bones harvested from a cadaver
and titanium screws to stabilize his neck.
“You come out of an experience like that with a
commitment to making the most of the time you have and making the world a
better place,” Sherry says.
Three months after the accident, attorneys from
Paul, Weiss, Rifkind, Wharton & Garrison LLP, a
New York law firm representing Citigroup, interviewed Hunt. She had no idea
at the time that it was related to Bowen’s complaint, she says.
Home Computer
The lawyers’ questions made her search her memory
for details of loans and conversations with colleagues, she says. She
decided to take notes from that time forward on a spreadsheet she kept on
her home computer.
Bowen’s e-mail is now part of the archive of the
Financial Crisis Inquiry Commission, a panel created by Congress in 2009.
Citigroup’s
response to the
commission, FCIC records show, came from
Brad Karp, chairman of
Paul Weiss.
He said Citigroup had reviewed Bowen’s issues,
fired a supervisor and changed its underwriting system, without providing
specifics.
Continued in article
A CBS Sixty Minutes Blockbuster (December 4, 2011)
"Prosecuting Wall Street"
Free download for a short while
http://www.cbsnews.com/8301-18560_162-57336042/prosecuting-wall-street/?tag=pop;stories
Note that this episode features my hero Frank Partnoy
Key provisions of Sarbox with respect to the Sixty Minutes revelations:
The act also covers issues such as
auditor independence,
corporate governance,
internal control assessment, and enhanced financial disclosure.
Sarbanes–Oxley Section 404: Assessment of internal control ---
http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Sarbanes.E2.80.93Oxley_Section_404:_Assessment_of_internal_control
Both the corporate CEO and the external auditing firm are to
explicitly sign off on the following and are subject (turns out to be a
ha, ha joke) to huge fines and jail time for egregious failure to do
so:
- Assess both the design and operating
effectiveness of selected internal controls related to significant
accounts and relevant assertions, in the context of material
misstatement risks;
- Understand the flow of transactions,
including IT aspects, in sufficient detail to identify points at
which a misstatement could arise;
- Evaluate company-level (entity-level)
controls, which correspond to the components of the
COSO framework;
- Perform a fraud risk assessment;
- Evaluate controls designed to
prevent or detect fraud, including management override of
controls;
- Evaluate controls over the period-end
financial
reporting process;
- Scale the assessment based on the size and
complexity of the company;
- Rely on management's work based on factors
such as competency, objectivity, and risk;
- Conclude on the adequacy of internal
control over financial reporting.
Most importantly as far as the CPA auditing firms are concerned is
that Sarbox gave those firms both a responsibility to verify that
internal controls were effective and the authority to charge more
(possibly twice as much) for each audit. Whereas in the 1990s auditing
was becoming less and less profitable, Sarbox made the auditing industry
quite prosperous after 2002.
There's a great gap between the theory of Sarbox and its enforcement
In theory, the U.S. Justice Department (including the FBI) is to enforce
the provisions of Section 404 and subject top corporate executives and audit
firm partners to huge fines (personal fines beyond corporate fines) and jail
time for signing off on Section 404 provisions that they know to be false.
But to date, there has not been one indictment in enormous frauds where the
Justice Department knows that executives signed off on Section 404 with
intentional lies.
In theory the SEC is to also enforce Section 404, but the SEC in Frank
Partnoy's words is toothless. The SEC cannot send anybody to jail. And the
SEC has established what seems to be a policy of fining white collar
criminals less than 20% of the haul, thereby making white collar crime
profitable even if you get caught. Thus, white collar criminals willingly
pay their SEC fines and ride off into the sunset with a life of luxury
awaiting.
And thus we come to the December 4 Sixty Minutes module that features
two of the most egregious failures to enforce Section 404:
The astonishing case of CitiBank
The astonishing case of Countrywide (now part of Bank of America)
The Astonishing Case of CitiBank
What makes the Sixty Minutes show most interesting are the whistle
blowing revelations by a former Citi Vice President in Charge of Fraud
Investigations
- What has to make the CitiBank revelations the most embarrassing
revelations on the Sixty Minutes blockbuster emphasis that top
CItiBank executives were not only informed by a Vice President in Charge of
Fraud Investigation of huge internal control inadequacies, the outside U.S.
government top accountant, the U.S. Comptroller General, sent an official
letter to CitiBank executives notifying them of their Section 404 internal
control failures.
- Eight days after receiving the official warning from the government, the
CEO of CitiBank flipped his middle finger at the U.S. Comptroller General
and signed off on Section 404 provisions that he'd also been informed by his
Vice President of Fraud and his Internal Auditing Department were being
violated.
http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html
- What the Sixty Minutes show failed to mention is that the
external auditing firm of KPMG also flipped a bird at the U.S. Comptroller
General and signed off on the adequacy of its client's internal controls.
- A few months thereafter CitiBank begged for and got hundreds of billions
in bailout money from the U.S. Government to say afloat.
- The implication is that CitiBank and the other Wall Street corporations
are just to0 big to prosecute by the Justice Department. The Justice
Department official interviewed on the Sixty Minutes show sounded
like hollow brass wimpy taking hands off orders from higher authorities in
the Justice Department.
- The SEC worked out a settlement with CitiBank, but the fine is such a
joke that the judge in the case has to date refused to accept the
settlement. This is so typical of SEC hand slapping settlements --- and the
hand slaps are with a feather.
The astonishing case of Countrywide (now part of Bank of America)
- Countrywide Financial before 2007 was the largest issuer of mortgages on
Main Streets throughout the nation and by estimates of one of its own
whistle blowing executives in charge of internal fraud investigations over
60% of those mortgages were fraudulent.
- After Bank of America purchased the bankrupt Countrywide, BofA top
executives tried to buy off the Countrywide executive in charge of fraud
investigations to keep him from testifying. When he refused BofA fired him.
- Whereas the Justice Department has not even attempted to indict
Countrywide executives and the Countrywide auditing firm of Grant Thornton
(later replaced by KPMG) to bring indictments for Section 404 violations,
the FTC did work out an absurdly low settlement of $108 million for 450,000
borrowers paying "excessive fees" and the attorneys for those borrowers ---
http://www.nytimes.com/2011/07/21/business/countrywide-to-pay-borrowers-108-million-in-settlement.html
This had nothing to do with the massive mortgage frauds committed by
Countrywide.
- Former Countrywide CEO Angelo Mozilo settled the SEC’s Largest-Ever
Financial Penalty ($22.5 million) Against a Public Company's Senior
Executive
http://sec.gov/news/press/2010/2010-197.htm
The CBS Sixty Minutes show estimated that this is less than 20% of what he
stole and leaves us with the impression that Mozilo deserves jail time but
will probably never be charged by the Justice Department.
I was disappointed in the CBS Sixty Minutes show in that it completely
ignored the complicity of the auditing firms to sign off on the Section 404
violations of the big Wall Street banks and other huge banks that failed.
Washington Mutual was the largest bank in the world to ever go bankrupt. Its
auditor, Deloitte, settled with the SEC for Washington Mutual for
$18.5 million. This isn't even a hand slap relative to the billions lost by
WaMu's investors and creditors.
No jail time is expected for any partners of the negligent auditing firms.
.KPMG settled for peanuts with Countrywide for
$24 million of negligence and New Century for
$45 million of negligence costing investors billions.
"Citigroup Finds Obeying the
Law Is Too Darn Hard: Jonathan Weil," by Jonothan Weil, Bloomberg
News, November 2 , 2011 ---
http://www.bloomberg.com/news/2011-11-02/citigroup-finds-obeying-the-law-is-too-darn-hard-jonathan-weil.html
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on how white collar crime pays even if you get caught
---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
"Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank
Partnoy, New York Review of Books, November 10, 2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
Thank you Robert Walker for the heads up!
2009 Update on the Socialist
Revolution Without Increased Taxes, Debt, or Civil War
Auntie Bev forwarded the following picture of
one cohort pleading for early stimulus checks, hopefully before
springtime:
Bailout Game Humor (actually an entertaining chronology of
events to date more than a game) ---
http://www.thebailoutgame.us/
Bob Jensen's hints on how to blow up this game ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Breaking the Bank Frontline Video
In Breaking the Bank, FRONTLINE producer Michael Kirk
(Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile
interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to
reveal the story of two banks at the heart of the financial crisis, the rocky
merger, and the government’s new role in taking over — some call it
“nationalizing” — the American banking system.
Simoleon Sense, September 18,
2009 ---
http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Elizabeth Warren, chairwoman of the TARP Congressional
Oversight Panel, saying that former Treasury Secretary Henry Paulson told the
panel that assets given to banks would be returned at equal value. The panel,
however, found that the banks were overpaid by $78 billion.
Time Magazine, February 6, 2009 ---
http://www.time.com/time/quotes
John Carney and Kamelia Angelova,
ClusterStock, January 5, 2010
http://www.businessinsider.com/chart-of-the-day-goods-producing-wrokers-vs-government-payroll-2010-1
"The Great D.C. Migration: Americans move to where your money is,"
The Wall Street Journal, January 20, 2010 ---
http://online.wsj.com/article/SB10001424052748704541004575011293044432552.html
Every day thousands of Americans vote with their
feet on the best places to live and work, and these migration patterns can
tell a lot about state economies—and economic policies. United Van Lines has
released its annual report for 2009, based on those the moving company has
relocated across one state line to another, and the winner is . . .
But first the biggest loser, which was Michigan for
the fourth year in a row. More than two families left the state for every
family that moved in. The fall of GM and Chrysler has obviously hurt. But
two-term Governor Jennifer Granholm has also made her state the test case
for the policy mix of raising taxes on higher incomes, increasing
regulation, and steering taxpayer money at favored programs like job
retraining and renewable energy. It hasn't worked for Michigan, even with
the auto bailouts.
Ms. Granholm continues to be a regular economic
policy adviser to the White House. Yikes.
The next two biggest net losers were Illinois and
New Jersey, while California and New York also continued to have far more
departures than arrivals.
Ten states gained net arrivals: Oregon, Arkansas,
Nevada, Wyoming, Idaho, Colorado, Georgia, New Mexico, Texas and North
Carolina. Of those, only Oregon sways decidedly to the political left and it
has benefited from the economic refugees fleeing California.
Six of the eight states with no income tax were
magnets for families, while eight of the 10 highest income tax states had
more people packing. Democrats in state capitals and Washington have
convinced themselves that "soak the rich" tax policies can help balance
budgets, but the main effect seems to be to stimulate bon voyage parties.
As for the biggest winner, well, our readers won't
be surprised to learn that it was Washington, D.C. by a large margin. United
Van Lines moved nearly seven families to the federal city last year for
every three it moved out. As always when the feds gear up the income
redistribution machine, the imperial city and its denizens get a big cut of
the action.
As in ancient Rome, the provinces are being
required to send tribute to subsidize those living in the capital, which
produces few services save transfer payments. No wonder the provincials are
starting to rebel—even in Massachusetts.
Bob Jensen's threads on the entitlements disasters are at
http://faculty.trinity.edu/rjensen/entitlements.htm
"Principles for Economic Revival Our
prosperity has faded because policies have moved away from those that have
proven to work. Here are the priorities that should guide policy makers as they
seek to restore more rapid growth,"
by GEORGE P. SHULTZ, MICHAEL J. BOSKIN, JOHN F. COGAN, ALLAN MELTZER AND JOHN B.
TAYLOR
The Wall Street Journal, September 16, 2010 ---
http://online.wsj.com/article/SB10001424052748703466704575489830041633508.html
America's financial crisis, deep recession and
anemic recovery have largely been driven by economic policies that have
deviated from proven fact-based principles. To return to prosperity we must
get back to these principles.
The most fundamental starting point is that people
respond to incentives and disincentives. Tax rates are a great example
because the data are so clear and the results so powerful. A wealth of
evidence shows that high tax rates reduce work effort, retard investment and
lower productivity growth. Raise taxes, and living standards stagnate.
Nobel Prize-winning economist Edward Prescott
examined international labor market data and showed that changes in tax
rates on labor are associated with changes in employment and hours worked.
From the 1970s to the 1990s, the effective tax rate on work increased by an
average of 28% in Germany, France and Italy. Over that same period, work
hours fell by an average of 22% in those three countries. When higher taxes
reduce the reward for work, you get
Long-lasting economic policies based on a long-term
strategy work; temporary policies don't. The difference between the effect
of permanent tax rate cuts and one-time temporary tax rebates is also
well-documented. The former creates a sustainable increase in economic
output, the latter at best only a transitory blip. Temporary policies create
uncertainty that dampen economic output as market participants, unsure about
whether and how policies might change, delay their decisions.
Having "skin in the game," unsurprisingly, leads to
superior outcomes. As Milton Friedman famously observed: "Nobody spends
somebody else's money as wisely as they spend their own." When legislators
put other people's money at risk—as when Fannie Mae and Freddie Mac bought
risky mortgages—crisis and economic hardship inevitably result. When minimal
co-payments and low deductibles are mandated in the insurance market,
wasteful health-care spending balloons.
Rule-based policies provide the foundation of a
high-growth market economy. Abiding by such policies minimizes capricious
discretionary actions, such as the recent ad hoc bailouts, which too often
had deleterious consequences. For most of the 1980s and '90s monetary policy
was conducted in a predictable rule-like manner. As a result, the economy
was far more stable. We avoided lengthy economic contractions like the Great
Depression of the 1930s and the rapid inflation of the 1970s.
The history of recent economic policy is one of
massive deviations from these basic tenets. The result has been a crippling
recession and now a weak, nearly nonexistent recovery. The deviations began
with policies—like the Federal Reserve holding interest rates too low for
too long—that fueled the unsustainable housing boom. Federal housing
policies allowed down payments on home loans as low as zero. Banks were
encouraged to make risky loans, and securitization separated lenders from
their loans. Neither borrower nor lender had sufficient skin in the game.
Lax enforcement of existing regulations allowed both investment and
commercial banks to circumvent long-established banking rules to take on far
too much leverage. Regulators, not regulations, failed.
The departures from sound principles continued when
the Fed and the Treasury responded with arbitrary and unpredictable bailouts
of banks, auto companies and financial institutions. They financed their
actions with unprecedented money creation and massive issuance of debt.
These frantic moves spooked already turbulent markets and led to the
financial panic.
More deviations occurred when the government
responded with ineffective temporary stimulus packages. The 2008 tax rebate
and the 2009 spending stimulus bills failed to improve the economy. Cash for
clunkers and the first-time home buyers tax credit merely moved purchases
forward by a few months.
Then there's the recent health-care legislation,
which imposes taxes on savings and investment and gives the government
control over health-care decisions. Fannie Mae and Freddie Mac now sit with
an estimated $400 billion cost to taxpayers and no path to resolution.
Hundreds of new complex regulations lurk in the 2010 financial reform bill
with most of the critical details left to regulators. So uncertainty reigns
and nearly $2 trillion in cash sits in corporate coffers.
Since the onset of the financial crisis, annual
federal spending has increased by an extraordinary $800 billion—more than
$10,000 for every American family. This has driven the budget deficit to 10%
of GDP, far above the previous peacetime record. The Obama administration
has proposed to lock a sizable portion of that additional spending into
government programs and to finance it with higher taxes and debt. The Fed
recently announced it would continue buying long-term Treasury debt, adding
to the risk of future inflation.
There is perhaps no better indicator of the
destructive path that these policy deviations have put us on than the
federal budget. The nearby chart puts the fiscal problem in perspective. It
shows federal spending as a percent of GDP, which is now at 24%, up sharply
from 18.2% in 2000.
Future federal spending, driven mainly by
retirement and health-care promises, is likely to increase beyond 30% of GDP
in 20 years and then keep rising, according to the Congressional Budget
Office. The reckless expansions of both entitlements and discretionary
programs in recent years have only added to our long-term fiscal problem.
As the chart shows, in all of U.S. history, there
has been only one period of sustained decline in federal spending relative
to GDP. From 1983 to 2001, federal spending relative to GDP declined by five
percentage points. Two factors dominated this remarkable period. First was
strong economic growth. Second was modest spending restraint—on domestic
spending in the 1980s and on defense in the 1990s.
The good news is that we can change these
destructive policies by adopting a strategy based on proven economic
principles:
• First, take tax increases off the table. Higher
tax rates are destructive to growth and would ratify the recent spending
excesses. Our complex tax code is badly in need of overhaul to make America
more competitive. For example, the U.S. corporate tax is one of the highest
in the world. That's why many tax reform proposals integrate personal and
corporate income taxes with fewer special tax breaks and lower tax rates.
But in the current climate, with the very
credit-worthiness of the United States at stake, our program keeps the
present tax regime in place while avoiding the severe economic drag of
higher tax rates.
• Second, balance the federal budget by reducing
spending. The publicly held debt must be brought down to the pre-crisis
safety zone. To do this, the excessive spending of recent years must be
removed before it becomes a permanent budget fixture. The government should
begin by rescinding unspent "stimulus" and TARP funds, ratcheting down
domestic appropriations to their pre-binge levels, and repealing entitlement
expansions, most notably the subsidies in the health-care bill.
The next step is restructuring public activities
between federal and state governments. The federal government has taken on
more responsibilities than it can properly manage and efficiently finance.
The 1996 welfare reform, which transferred authority and financing for
welfare from the federal to the state level, should serve as the model. This
reform reduced welfare dependency and lowered costs, benefiting taxpayers
and welfare recipients.
• Third, modify Social Security and health-care
entitlements to reduce their explosive future growth. Social Security now
promises much higher benefits to future retirees than to today's retirees.
The typical 30-year-old today is scheduled to get an inflation-adjusted
retirement benefit that is 50% higher than the benefit for a typical current
retiree.
Benefits paid to future retirees should remain at
the same level, in terms of purchasing power, that today's retirees receive.
A combination of indexing initial benefits to prices rather than to wages
and increasing the program's retirement age would achieve this goal. They
should be phased-in gradually so that current retirees and those nearing
retirement are not affected.
Health care is far too important to the American
economy to be left in its current state. In markets other than health care,
the legendary American shopper, armed with money and information, has kept
quality high and costs low. In health care, service providers, unaided by
consumers with sufficient skin in the game, make the purchasing decisions.
Third-party payers—employers, governments and insurance companies—have
resorted to regulatory schemes and price controls to stem the resulting cost
growth.
The key to making Medicare affordable while
maintaining the quality of health care is more patient involvement, more
choices among Medicare health plans, and more competition. Co-payments
should be raised to make patients and their physicians more cost-conscious.
Monthly premiums should be lowered to provide seniors with more disposable
income to make these choices. A menu of additional Medicare plans, some with
lower premiums, higher co-payments and improved catastrophic coverage,
should be added to the current one-size-fits-all program to encourage
competition.
Similarly for Medicaid, modest co-payments should
be introduced except for preventive services. The program should be turned
over entirely to the states with federal financing supplied by a "no strings
attached" block grant. States should then allow Medicaid recipients to
purchase a health plan of their choosing with a risk-adjusted Medicaid grant
that phases out as income rises.
The 2010 health-care law undermined positive
reforms underway since the late 1990s, including higher co-payments and
health savings accounts. The law should be repealed before its regulations
and price controls further damage availability and quality of care. It
should be replaced with policies that target specific health market
concerns: quality, affordability and access. Making out-of-pocket
expenditures and individual purchases of health insurance tax deductible,
enhancing health savings accounts, and improving access to medical
information are keys to more consumer involvement. Allowing consumers to buy
insurance across state lines will lower the cost of insurance.
• Fourth, enact a moratorium on all new regulations
for the next three years, with an exception for national security and public
safety. Going forward, regulations should be transparent and simple, pass
rigorous cost-benefit tests, and rely to a maximum extent on market-based
incentives instead of command and control. Direct and indirect cost
estimates of regulations and subsidies should be published before new
regulations are put into law.
Off-budget financing should end by closing Fannie
Mae and Freddie Mac. The Bureau of Consumer Finance Protection and all other
government agencies should be on the budget that Congress annually approves.
An enhanced bankruptcy process for failing financial firms should be enacted
in order to end the need for bailouts. Higher bank capital requirements that
rise with the size of the bank should be phased in.
• Fifth, monetary policy should be less
discretionary and more rule-like. The Federal Reserve should announce and
follow a monetary policy rule, such as the Taylor rule, in which the
short-term interest rate is determined by the supply and demand for money
and is adjusted through changes in the money supply when inflation rises
above or falls below the target, or when the economy goes into a recession.
When monetary policy decisions follow such a rule, economic stability and
growth increase.
In order to reduce the size of the Fed's bloated
balance sheet without causing more market disruption, the Fed should
announce and follow a clear and predictable exit rule, which describes a
contingency path for bringing bank reserves back to normal levels. It should
also announce and follow a lender-of-last-resort rule designed to protect
the payment system and the economy—not failing banks. Such a rule would end
the erratic bailout policy that leads to crises.
The United States should, along with other
countries, agree to a target for inflation in order to increase expected
price stability and exchange rate stability. A new accord between the
Federal Reserve and Treasury should re-establish the Fed's independence and
accountability so that it is not called on to monetize the debt or engage in
credit allocation. A monetary rule is a requisite for restoring the Fed's
independence.
These pro-growth policies provide the surest path
back to prosperity.
Mr. Shultz, a former secretary of labor, secretary
of Treasury and secretary of state, is a fellow at Stanford University's
Hoover Institution. Mr. Boskin, a professor of economics at Stanford
University and a senior fellow at the Hoover Institution, chaired the
Council of Economic Advisers under President George H.W. Bush. Mr. Cogan, a
senior fellow at the Hoover Institution, was deputy director of the Office
of Management and Budget under President Ronald Reagan. Mr. Meltzer is
professor of political economy at Carnegie Mellon University. Mr. Taylor, an
economics professor at Stanford and a senior fellow at the Hoover
Institution, was undersecretary of Treasury under President George W. Bush.
Bob Jensen's threads on the bailout are at
http://faculty.trinity.edu/rjensen/2008bailout.htm
"The Triumph of Propaganda," by Nemo Almen, American Thinker,
January 2, 2011 ---
http://www.americanthinker.com/2011/01/the_triumph_of_propaganda.html
Does anyone
remember what happened on Christmas Eve last year? In one of the most
expensive Christmas presents ever, the government
removed the $400 billion limit on their Fannie and
Freddie guaranty. This act increased taxpayer liabilities by
six trillion dollars; however, the news was lost
in the holiday cheer. This is one instance in a broader campaign to
manipulate the public perception, gradually depriving us of independent
thought.
Consider another example: what news story broke on April 16, 2010? Most of
us would say the SEC's
lawsuit against Goldman Sachs. Goldman is the
market leader in "ripping the client's face off," in this instance creating
a worst-of-the-worst pool of securities so Paulson & Co could bet against
it. Many applauded the SEC for this action. Never mind that singling out
one vice president (the "Fabulous Fab") and one instance of fraud is like
charging Al Capone with tax evasion. The dog was wagged.
Very
few caught the real news that day, namely the damning
complicity of the SEC in the Stanford Ponzi
scheme. Clearly, Stanford was the bigger story, costing thousands of
investors
billions of dollars while Goldman later settled
for half a
billion. Worse, the SEC knew about Stanford since
1997, but instead of shutting it down, people left the SEC to
work
for Stanford. This story should have caused
widespread outrage and reform of the SEC; instead it was buried in the back
pages and lost to the public eye.
Lest we
think the timing of these was mere coincidence, the Goldman lawsuit was
settled on July 15, 2010, the same day the financial reform package
passed. The government threw Goldman to the
wolves in order to hide its own shame. When the government had its desired
financial reforms, it let Goldman settle. These examples demonstrate a
clear pattern of manipulation. Unfortunately, our propaganda problem runs
far deeper than lawsuits and Ponzi schemes.
Here is a
more important question: which companies own half of all
subprime and
Alt-A (liar loan) bonds? Paul Krugman writes that
these companies were "mainly out of the picture during the housing bubble's
most feverish period, from 2004 to 2006. As a result, the agencies played
only a minor role in the epidemic of bad lending."[iii] This phrase is
stupefying. How can a pair of companies comprise half of a market and yet
have no major influence in it? Subprime formed the core of the financial
crisis, and Fannie and Freddie (the "agencies") formed the core of the
subprime market. They were not "out of the picture" during the subprime
explosion, they were the picture. The fact that a respectable Nobel
prize-winner flatly denies this is extremely disturbing.
Amazingly, any attempt to hold the government accountable for its role in
the subprime meltdown is dismissed as right-wing
propaganda. This dismissal is left-wing
propaganda. It was the government that initiated securitization as a tool
to dispose of
RTC assets. Bill Clinton ducks all
responsibility, ignoring how his administration imposed arbitrary
quotas on any banks looking to merge as Attorney
General Janet Reno "threatened legal action against lenders whose racial
statistics raised her suspicions."[iv] Greenspan fueled the rise of
subprime derivatives by lowering rates,[v] lowering reserves,[vi] and
beating down reasonable
opposition. And at the center of it all were
Fannie and Freddie
bribing officials, committing
fraud,
dominating private-sector
competition, and expanding to a
six-trillion-dollar debacle. The fact that these facts are dismissed as
propaganda shows just how divorced from reality our ‘news' has become. Yes,
half of all economists are employed by the
government, but this is no reason to flout one's
professional responsibility. As a nation we need to consider all the facts,
not just those that are politically expedient.
Continued in article
Nemo Almen is the author of
The Last Dodo: The Great Recession and our Modern-Day Struggle for Survival.
Bob Jensen's Rotten to the
Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Fannie's Next Big Adventure," The Wall Street Journal, October
, 2009 ---
http://online.wsj.com/article/SB10001424052748703746604574460903449028672.html#articleTabs_comments
Step right up, taxpayer, because Fannie
Mae and Freddie Mac have a new deal for you. And don't worry—it will make
housing more affordable and won't cost a dime. (Pardon us if you've heard
this one before.)
Fan and Fred's latest excellent adventure
is intended to help independent mortgage lenders that have been hard hit in
the wake of the financial panic. These smaller players have seen their costs
of capital rise and access to capital shrink. They never benefited like the
big boys from bailout cash from Uncle Sam or the implicit backing of a
too-big-to-fail guarantee. As a result, the three biggest U.S. mortgage
lenders—Wells Fargo, Bank of America and J.P. Morgan Chase—now make more
than half of all new home loans in the country.
Meanwhile, the Federal Reserve and now
government-run Fannie and Freddie have been pushing mortgage rates down in a
bid to buoy the housing market. These artificially low rates in turn have
lowered the rate at which it's economical for a lender to borrow money to
make home loans; this has also increased the squeeze on independent mortgage
shops.
Thus the latest Fannie brainstorm: Launch
a program to guarantee the short-term debt of these small mortgage lenders,
provided they use the money to make mortgages approved by Fan and Fred. Keep
in mind that Fan and Fred already guarantee the mortgages themselves. So
this new program would pile another taxpayer liability on top of that one by
guaranteeing the short-term debt of independent mortgage companies, too.
Now, some might say that in a world in
which more than 90% of all mortgages are already taxpayer guaranteed, this
is no big deal. If you insure the mortgage product, why not insure the
lenders who created it too? Yet by that logic, the taxpayers might as well
cut out the middle men and simply nationalize the entire mortgage industry.
(On second thought, forget we mentioned that.)
Our point is that piling mortgage
guarantee upon guarantee is going in precisely the wrong policy direction.
If we are ever going to return to a private mortgage market, the feds need
to begin to roll back their guarantees and market share. Yet the more
guarantees that are made, the harder it will be to withdraw. This may be
precisely what Fannie and Freddie and their Congressional patrons want,
since these new guarantees will make it that much harder to reform them and
reduce their sway in the housing market.
This also shows how one policy mistake
typically begets another. Fannie and Freddie's guarantees and subsidies
helped to create the housing disaster, which has led the Fed directly to
purchase mortgage-backed securities and mess up the market for small
mortgage lenders, which in turn is leading Fan and Fred to guarantee the
debt of those small lenders. Market distortion is piled on market distortion
until we have a mortgage industry that can't function without taxpayers
being on the hook for every transaction.
The Chinese must look at all this and
wonder why the crazy Americans think they can give anyone advice about how
to run a market economy.
August 2018 Update
Wells Fargo & Co. agreed to pay $2.09 billion to settle with the U.S. Justice
Department over the sale of toxic mortgage-backed securities in the lead-up to
the financial crisis.---
https://www.wsj.com/articles/wells-fargo-agrees-to-2-09-billion-settlement-for-crisis-era-mortgage-loans-1533147302?mod=searchresults&page=1&pos=1&mod=djemCFO_h
This is on top of all the subsequent fines paid by Wells Fargo & Co. for
unrelated subsequent crimes. What a lousy company.
The "Stimulus Act" really
is a euphemism for a "Socialist Revolution"
On Saturday I was having fun and laughs while playing The Bailout Game above.
Then on Sunday I read the most discouraging article of my entire life. Suddenly
I realized that the phrase "Stimulus Act" really is a euphemism for a "Socialist
Revolution" that takes place without any taxation, government debt, or civil
war. And the way it is evolving is so simple --- why didn't I think of that?
Very soon Uncle Sam will own Wall Street, all U.S. banks, General Motors,
Caterpillar, Mobil-Exxon, ConAgra, all the K-12 schools, the colleges, the
physicians, the hospitals, the news media, the accounting firms, nearly all our real
estate, etc. The last to go will be law firms, but that's only because lawyers
control all three branches of Federal and state governments.
How can such a revolution take place without oppressive taxes, massive
borrowing, and bloodshed? The answer is really so simple that no true Western
scholar could dream of such a brilliant way to finance a revolution. For years
economic theorists have had it all wrong about taxes, debt, and sacrifice. The
simple, albeit amazingly simple, solution was invented by the Zimbabwe School of
Finance. It works in phases:
-
Poison the banks with hundreds of millions Main
Street's toxic
fraudulent investments that are virtually worthless to a point where banks
cannot survive on their own with these investments and the stock market
cannot recover without viable banks. It's so hard to blame all the crooks on
every Main Street in every city and town.
-
After the disaster experience in
Japan, I think it's best to just let the banks fail that are going to fail.
Many companies rise up after declaring bankruptcy and reorganization. This
will be painful for shareholders, including investment funds that hold
shares, but such is the risk of equity investing.
-
Install a money printing press in every branch of every
bank in the nation.
-
When anybody with a sob story wants money, simply print
whatever they request and, above all, don't burden them with obligations to
pay back so they don't become disgruntled voters.
If we overlook his human rights abuses,
Zimbabwe's President Robert Mugabe really deserves the 2009 Nobel Prize in
Economics since his monetary theory underlies the entire U.S. 2009 Stimulus
Bill. Instead the 2009 Nobel Prize will probably go to Lawrence Summers who now
supervises economic taxing, borrowing, and spending of the United States.
Summers did not invent the Zimbabwe Theory of Economics, but he's become the
major implementer.
Zimbabwe's central
bank will introduce a 100 trillion Zimbabwe dollar banknote, worth about $33 on
the black market, to try to ease desperate cash shortages, state-run media said
on Friday.
KyivPost, January 16, 2009 ---
http://www.kyivpost.com/world/33522
The women at Harvard University were correct all along. The
most dangerous man in the entire world is Lawrence Summers ---
http://en.wikipedia.org/wiki/Lawrence_Summers
Lawrence Summers biggest accomplishment will eventually be
to fund a U.S. national health care plan. Canadians have such a plan that they
finance with taxes. Over half of the average Canadian's income each year is
taxed to finance nationalized health care. Larry Summers has a better plan to
finance it without taxes or borrowing. He really is brilliant.
George W. Bush was a spendthrift president who stuck us
with the Medicare Drug Plan, but he was stupid to insist on borrowing to finance
his budget deficits. Bush should've adopted the Mugabe/Summers plan early on to
simply print trillions upon trillions of dollars without taxes or borrowing.
Absolutely brilliant! Why didn't I think of that before now for the bailout
instead of thinking the big and bald Hank Paulson would have a better solution?
The Zimbabwe School of Finance Comes to the U.S.
"Why 'Stimulus' Will Mean Inflation In a global downturn the Fed will have to
print money to meet our obligations," by George Melloan, The Wall Street
Journal, February 6, 2009 ---
http://online.wsj.com/article/SB123388703203755361.html?mod=djemEditorialPage
As Congress blithely ushers its trillion
dollar "stimulus" package toward law and the U.S. Treasury prepares to begin
writing checks on this vast new appropriation, it might be wise to ask a
simple question: Who's going to finance it?
That might seem like a no-brainer, which
perhaps explains why no one has bothered to ask. Treasury securities are
selling at high prices and finding buyers even though yields are low,
hovering below 3% for 10-year notes. Congress is able to assure itself that
it will finance the stimulus with cheap credit. But how long will credit be
cheap? Will it still be when the Treasury is scrounging around in the
international credit markets six months or a year from now? That seems
highly unlikely.
Let's have a look at the credit market.
Treasurys have been strong because the stock market collapse and the
mortgage-backed securities fiasco sent the whole world running for safety.
The best looking port in the storm, as usual, was U.S. Treasury paper. That
is what gave the dollar and Treasury securities the lift they now enjoy.
But that surge was a one-time event and
doesn't necessarily mean that a big new batch of Treasury securities will
find an equally strong market. Most likely it won't as the global economy
spirals downward.
For one thing, a very important cycle has
been interrupted by the crash. For years, the U.S. has run large trade
deficits with China and Japan and those two countries have invested their
surpluses mostly in U.S. Treasury securities. Their holdings are enormous:
As of Nov. 30 last year, China held $682 billion in Treasurys, a sharp rise
from $459 billion a year earlier. Japan had reduced its holdings, to $577
billion from $590 billion a year earlier, but remains a huge creditor. The
two account for almost 65% of total Treasury securities held by foreign
owners, 19% of the total U.S. national debt, and over 30% of Treasurys held
by the public.
In the lush years of the U.S. credit boom,
it was rationalized that this circular arrangement was good for all
concerned. Exports fueled China's rapid economic growth and created jobs for
its huge work force, American workers could raise their living standards by
buying cheap Chinese goods. China's dollar surplus gave the U.S. Treasury a
captive pool of investment to finance congressional deficits. It was argued,
persuasively, that China and Japan had no choice but to buy U.S. bonds if
they wanted to keep their exports to the U.S. flowing. They also would hurt
their own interests if they tried to unload Treasurys because that would
send the value of their remaining holdings down.
But what if they stopped buying bonds not
out of choice but because they were out of money? The virtuous circle so
much praised would be broken. Something like that seems to be happening now.
As the recession deepens, U.S. consumers are spending less, even on cheap
Chinese goods and certainly on Japanese cars and electronic products. Japan,
already a smaller market for U.S. debt last November, is now suffering what
some have described as "free fall" in industrial production. Its two
champions, Toyota and Sony, are faltering badly. China's growth also is
slowing, and it is plagued by rising unemployment.
American officials seem not to have
noticed this abrupt and dangerous change in global patterns of trade and
finance. The new Treasury secretary, Timothy Geithner, at his Senate
confirmation hearing harped on that old Treasury mantra about China
"manipulating" its currency to gain trade advantage. Vice President Joe
Biden followed up with a further lecture to the Chinese but said the U.S.
will not move "unilaterally" to keep out Chinese exports. One would hope not
"unilaterally" or any other way if the U.S. hopes to keep flogging its
Treasurys to the Chinese.
The Congressional Budget Office is
predicting the federal deficit will reach $1.2 trillion this fiscal year.
That's more than double the $455 billion deficit posted for fiscal 2008, and
some private estimates put the likely outcome even higher. That will drive
up interest costs in the federal budget even if Treasury yields stay low.
But if a drop in world market demand for Treasurys sends borrowing costs
upward, there could be a ballooning of the interest cost line in the budget
that will worsen an already frightening outlook. Credit for the rest of the
economy will become more dear as well, worsening the recession. Treasury's
Wednesday announcement that it will sell a record $67 billion in notes and
bonds next week and $493 billion in this quarter weakened Treasury prices,
revealing market sensitivity to heavy financing.
So what is the outlook? The stimulus
package is rolling through Congress like an express train packed with
goodies, so an enormous deficit seems to be a given. Entitlements will go up
instead of being brought under better control, auguring big future deficits.
Where will the Treasury find all those trillions in a depressed world
economy?
There is only one answer. The Obama
administration and Congress will call on Ben Bernanke at the Fed to demand
that he create more dollars -- lots and lots of them. The Fed already is
talking of buying longer-term Treasurys to support the market, so it will be
more of the same -- much more.
And what will be the result? Well, the
product of this sort of thing is called inflation. The Fed's outpouring of
dollar liquidity after the September crash replaced the liquidity lost by
the financial sector and has so far caused no significant uptick in consumer
prices. But the worry lies in what will happen next.
Even when the economy and the securities
markets are sluggish, the Fed's financing of big federal deficits can be
inflationary. We learned that in the late 1970s, when the Fed's deficit
financing sent the CPI up to an annual rate of almost 15%. That confounded
the Keynesian theorists who believed then, as now, that federal spending
"stimulus" would restore economic health.
Inflation is the product of the demand for
money as well as of the supply. And if the Fed finances federal deficits in
a moribund economy, it can create more money than the economy can use. The
result is "stagflation," a term coined to describe the 1970s experience. As
the global economy slows and Congress relies more on the Fed to finance a
huge deficit, there is a very real danger of a return of stagflation. I
wonder why no one in Congress or the Obama administration has thought of
that as a potential consequence of their stimulus package.
A Snowball's Chance in Hell: An Antidote for Zimbabwe Finance
Infection
"Capitalism Needs a Sound-Money Foundation: Let's give the Fed some
competition. Abolish legal tender laws and see whose money people trust," by
Judy Shelton, The Wall Street Journal, February 12, 2009 ---
http://online.wsj.com/article/SB123440593696275773.html?mod=djemEditorialPage
In short, inflation undermines capitalism by
destroying the rationale for dedicating a portion of today's earnings to
savings. Accumulated savings provide the
capital that finances projects that generate higher future returns; it's how
an economy grows, how a society reaches higher levels of prosperity. But
inflation makes suckers out of savers.
If capitalism is to be preserved, it can't be
through the con game of diluting the value of money. People see through such
tactics; they recognize the signs of impending inflation. When we see
Congress getting ready to pay for 40% of 2009 federal budget expenditures
with money created from thin air, there's no getting around it. Our money
will lose its capacity to serve as an honest measure, a meaningful unit of
account. Our paper currency cannot provide a reliable store of value.
So we must first establish a sound foundation for
capitalism by permitting people to use a form of money they trust. Gold and
silver have traditionally served as currencies -- and for good reason. A
study by two economists at the Federal Reserve Bank of Minneapolis, Arthur
Rolnick and Warren Weber, concluded that gold and silver standards
consistently outperform fiat standards. Analyzing data over many decades for
a large sample of countries, they found that "every country in our sample
experienced a higher rate of inflation in the period during which it was
operating under a fiat standard than in the period during which it was
operating under a commodity standard."
Given that the driving force of free-market
capitalism is competition, it stands to reason that the best way to improve
money is through currency competition. Individuals should be able to choose
whether they wish to carry out their personal economic transactions using
the paper currency offered by the government, or to conduct their affairs
using voluntary private contracts linked to payment in gold or silver.
Legal tender laws currently favor government-issued
money, putting private contracts in gold or silver at a distinct
disadvantage. Contracts denominated in Federal Reserve notes are enforced by
the courts, whereas contracts denominated in gold are not. Gold purchases
are subject to taxes, both sales and capital gains. And while the
Constitution specifies that only commodity standards are lawful -- "No state
shall coin money, emit bills of credit, or make anything but gold and silver
coin a tender in payment of debts" (Art. I, Sec. 10) -- it is fiat money
that enjoys legal tender status and its protections.
Now is the time to challenge the exclusive monopoly
of Federal Reserve notes as currency. Buyers and sellers, by mutual consent,
should have access to an alternate means for settling accounts; they should
be able to do business using a monetary unit of account defined in terms of
gold. The existence of parallel currencies operating side-by-side on an
equal legal footing would make it clear whether people had more confidence
in fiat money or money redeemable in gold. If the gold-based system is
preferred, it means that people fully understand that the purpose of money
is to facilitate commerce, not to camouflage fiscal mismanagement.
Private gold currencies have served as the medium
of exchange throughout history -- long before kings and governments took
over the franchise. The initial justification for government involvement in
money was to certify the weight and fineness of private gold coins. That
rulers found it all too tempting to debase the money and defraud its users
testifies more to the corruptive aspects of sovereign authority than to the
viability of gold-based money.
Which is why government officials should not now
have the last word in determining the monetary measure, especially when they
have abused the privilege.
The same values that will help America regain its
economic footing and get back on the path to productive growth -- honesty,
reliability, accountability -- should be reflected in our money. Economists
who promote the government-knows-best approach of Keynesian economics fail
to comprehend the damaging consequences of spurring economic activity
through a money illusion. Fiscal "stimulus" at the expense of monetary
stability may accommodate the principles of the childless British economist
who famously quipped, "In the long run, we're all dead." But it shortchanges
future generations by saddling them with undeserved debt obligations.
There is also the argument that gold-linked money
deprives the government of needed "flexibility" and could lead to falling
prices. But contrary to fears of harmful deflation, the big problem is not
that nominal prices might go down as production declines, but rather that
dollar prices artificially pumped up by government deficit spending merely
paper over the real economic situation. When the output of goods grows
faster than the stock of money, benign deflation can occur -- it happened
from 1880 to 1900 while the U.S. was on a gold standard. But the total
price-level decline was 10% stretched over 20 years. Meanwhile, the gross
domestic product more than doubled.
At a moment when the world is questioning the
virtues of democratic capitalism, our nation should provide global
leadership by focusing on the need for monetary integrity. One of the most
serious threats to global economic recovery -- aside from inadequate savings
-- is protectionism. An important benefit of developing a parallel currency
linked to gold is that other countries could likewise permit their own
citizens to utilize it. To the extent they did so, a common currency area
would be created not subject to the insidious protectionism of sliding
exchange rates.
The fiasco of the G-20 meeting in Washington last
November -- it was supposed to usher in "the next Bretton Woods" -- suggests
that any move toward a new international monetary system based on gold will
more likely take place through the grass-roots efforts of Americans. It may
already be happening at the state level. Last month, Indiana state Sen. Greg
Walker introduced a bill -- "The Indiana Honest Money Act" -- which would,
if enacted, allow citizens the option of paying in or receiving back gold,
silver or the equivalent electronic receipt as an alternative to Federal
Reserve notes for all transactions conducted with the state of Indiana.
It may turn out to be a bellwether. Certainly, it's
a sign of a growing feeling in the heartland that we need to go back to
sound money. We need money that works for the legitimate producers and
consumers of the world -- the savers and borrowers, the entrepreneurs. Not
money that works for the chiselers.
Ms. Shelton, an economist, is author of "Money Meltdown: Restoring
Order to the Global Currency System" (Free Press, 1994).
Timothy Geithner is play an utterly stupid and dangerous
game antagonizing Asia. As a nation, we’re very nearly dead of Asia does not
roll over the massive investments it has already made in our $10+ trillion
national debt.
In 2007, 61.82% of America's public debt was held by foreign investors, most
of them Asian. So the U.S. public debt held by nonresident foreigners is equal
to about 109.39% (113.86%) of GDP.
Geitner had better learn about Hank Paulson's "Hidden Agenda" in the banking
bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails
What went so terribly wrong in three months time?
Good Bank, Bad Bank by Dr. Seuss ---
http://thereformedbroker.com/2009/01/29/good-bank-bad-bank-by-dr-seuss/
I watched the show on October 19, 2008, in a CBS Sixty
Minutes TV module, when Leslie Stahl interviewed the CEO of Bank of America, Ken
Lewis. Mr. Lewis was charming and forceful when he bragged heavily that BofA was
much stronger than the other failing banks and was only accepting some Bailout
money as a “patriotic duty.” He said BofA really had no need for Bailout cash
since his truly giant international bank was in such strong shape even after the
subprime scandal first made the news.
Bank of America indeed no longer held toxic mortgage
investments before the subprime scandal broke, meaning that any such mortgages
and related toxic paper that BofA or its subsidiaries brokered were quickly sold
for a profit to CitiBank, Fannie, Freddie, Bear Stearns, Lehman Brothers,
Merrill Lynch, and
other such buyers of deadly mortgage paper.
Bank of America was destined to become almost the largest
and certainly the most profitable bank in the world!
Buying Countrywide Financial, the nation’s biggest culprit
for generating fraudulent subprime mortgages, was one dumb Lewis decision.
Millions of former
home owners are poised to sue Countrywide. But BofA purchases got even
dumb and dumber. BofA became further infected with Merrill Lynch’s toxic
investments and losing operations. BofA impulsively bought a disreputable sick
horse without first consulting an expert veterinarian ---
http://www.bankofamerica.com/merrill/
Bank of America’s Suicide Dealings
BofA bought out Merrill Lynch after one weekend of
negotiation:
This will make an interesting classroom case for accounting, finance, and
business policy courses around the world
“BofA's Lewis: Accepting bailout money was patriotic,” by Peter Moreira,
Dealscape, October 20, 2008 ---
http://www.thedeal.com/dealscape/2008/10/bofas_lewis_accepting_bailout.php
And Stahl focused
primarily on the Oct. 13 meeting when Paulson summoned the heads of the nine
largest U.S. banks to Washington and told them that the government would invest
in them all, so no bank would be stigmatized as a weak bank. In fact, Stahl
said, Paulson told his former peers (he once headed Goldman, Sachs & Co.) that
it was their patriotic duty to participate.
"I don't remember if he
used the word, but there was an element to that," Lewis replied, "that this was
the right thing for the American financial system, and therefore it was the
right thing for America." Lewis added that he agrees with the secretary's
sentiment that it was a patriotic move.
The investment by the
government will probably last three to five years, after which Lewis expects the
government will sell out. And the move is conditional on no executives at the
banks making more than $500,000 per year, unless the institution pays additional
taxes.
Lewis, a critic of
outlandish executive compensation even though he earned $25 million last year,
also said he supports the restrictions on salary. In fact, when one banker began
to argue with Paulson about the compensation restrictions, Lewis cut his
competitor short, telling him he was out of his mind.
"The importance of this
deal getting done versus these elements of executive comp were just out of
sync," Lewis said. "I mean, this was so much more important. And all of us can
take a little less money."
The final segment of the
report highlighted how BofA pounced on Merrill Lynch & Co., buying the Wall
Street titan for $50 billion after one weekend of negotiation. Does Lewis regret
not waiting for Merrill to go to the wall and buying the company for less money?
"Some think that we
should've waited till Monday and see if they would've gone bankrupt," he said.
"Some think we would've gotten it for, you know, dirt cheap. But my point is,
you would have a tarnished brand. You would've had chaos. You would've had a
court ruling over all the sale of assets. And it was worth it to us to pay a
more market price so that we could not have that happen."
-
Collateralized Debt Obligation (CDO) ---
http://en.wikipedia.org/wiki/CDOs
"Sleight of hand: BofA moves dodgy Merrill derivatives to bank," by
Mark December, The New York Post, October 21, 2011 ---
http://www.nypost.com/p/news/business/sleight_of_hand_uy96iNSbW99JHMRnbxgvfL
A plan by beleaguered Bank of America to foist
trillions of dollars of funky Merrill Lynch derivatives onto its depositors
is raising eyebrows on Wall Street.
The rarely used move will likely save the bank
millions of dollars in collateral but could put depositors’ cash behind the
eight ball.
The move also brought to light fissures between the
nation’s top banking regulators, the Federal Deposit Insurance Corp. and the
Federal Reserve, in the wake of new regulations meant to curb the
free-wheeling habits that fostered the worst crisis in a generation back in
2008.
At issue is BofA’s decision to shift what sources
say is some $55 trillion in derivatives at Merrill Lynch to the retail bank
unit, which houses trillions in deposits insured by the FDIC.
Critics say the move potentially imperils everyday
depositors by placing their money and savings at risk should BofA run into
trouble.
Sources say that the derivative transfers from
Merrill to BofA’s bank subsidiary were sparked by credit-rating downgrades
to the bank holding company and are meant to help BofA avoid having to fork
over more money to post as collateral to its derivative counterparties.
BofA officials who have talked privately say the
move was requested by its counterparties and shouldn’t be perceived as
problematic for the bank giant, sources said.
A BofA spokesman declined to comment.
For weeks, BofA CEO Brian Moynihan has been dogged
about the health of one of the nation’s largest banking franchises and its
massive exposures to toxic debt after its shotgun mergers with Merrill and
Countrywide Financial during the credit crisis three years ago.
Under Moynihan, BofA has been attempting to right
the bank’s ship and convince shareholders that the firm is healthy and
doesn’t need to raise fresh capital to backstop against potential losses
from faulty foreclosures and other mortgage-related lawsuits.
In the third quarter, BofA posted profit of $6.23
billion, or 56 cents a share, down 15 percent from the same period a year
ago.
The bank’s shares gained 1 percent yesterday, to
$6.47. They are off 51 percent this year.
BofA’s third-quarter performance comes as fears
persist about the big bank’s ability to make money amid stiff economic
headwinds and a host of potential land mines that could see it shelling out
billions.
The derivatives transfer has irked officials at the
FDIC which, sources said, was informed of BofA’s plan to shift the contracts
to a retail deposit-taking entity just last week.
One source says that the FDIC is in the process of
reviewing the transfer and will relay its opinion to the Federal Reserve.
But ultimately it’s the Fed that has the final say
on authorizing any transfers.
Neither the Fed nor the FDIC would comment on
BofA’s plans, which were first reported by Bloomberg.
Continued in article
Jensen Comment
What is more bizarre is that BofA really did not want to buy Merrill Lynch at
any price in the 2008 Bailout after digging deeper into the financial records of
CDO-battered Merrill Lynch.. Then Treasury Secretary Hank Paulson for some
unknown reason did not want throw Merrill Lynch under the bus in the same manner
that he threw Bear Stearns under the bus. In my opinion, both of these giants
should have been ground up in the tires of the bus.
After the subprime collapse then BofA CEO, Ken Lewis, most certainly did not
want to use BofA money to stop the free fall of Merrill Lynch. However, U.S.
Treasury Secretary Hank Paulson resorted to personal blackmail according to Ken
Lewis.
"Bank Chief Tells of U.S. Pressure to Buy Merrill Lynch," by Louise Story
and Jo Becker, The New York Times, June 11. 2009 ---
http://www.nytimes.com/2009/06/12/business/12bank.html
Of course once BofA decided to concede to Paulson's demands does not condone
the alleged behavior of BofA executives or Merrill Lynch executives in closing
the deal.
"Ken Lewis BLASTS Merrill Lynch-Bank Of America Merger Lawsuit, Calls It
'Implausible'," by David B. Caruso, August 21, 2010 ---
http://www.huffingtonpost.com/2010/08/21/ken-lewis-blasts-merrill-_n_690215.html
Actually BofA was in great shape well into the subprime mortgage crisis. BofA
had been smart enough in 2007 to hold none of the poisoned mortgages and CDOs
that plagued most of the big banks and brokerage houses like Merrill Lynch. But
in a twist of fate BofA became drawn to the fire sale pricing of big outfits
like Countrywide and Merrill Lynch that were dying from subprime poison. BofA
just did not look these gift horses in the mouth until it was too late to get
them out of the BofA stables. There's no excuse for the stupid purchase of
Countrywide which left BofA will millions of defaulted mortgages. There is
purportedly an excuse for the purchase of Merrill Lynch. Ken Lewis was a chicken
sh*t. Ironically, he eventually lost his job anyway.
Now it appears that BofA wants to pass trillions in Merrill Lynch CDO losses
on to depositors who will pay for these losses in nickels and dimes of daily
bank charges for things like debit cards for the next 1,000 years. In reality,
the counterparties to the CDO contracts should've absorbed the loan loss poison,
but Treasury Secretary Paulson and President George Bush did not want to piss
off the investors who finance U.S. Government budget deficits --- especially our
friends in Asia and the Middle East and large banks like Goldman that had bought
these poison-laced CDO bonds.
Ironically, it is now BofA depositors who will now be paying off the bad
debts that rightfully belonged to sovereign funds of Asia and the Middle East as
well as derivatives contract counterparties at Goldman.
Regulators are split
on what to do next. The Federal Deposit Insurance Corporation is backing a plan
to create what it calls an aggregator bank, which would buy up the loans of BofA,
Citigroup and the rest of our now troubled system, theoretically putting an end
to the escalating losses eating away at the banks' capital. But if the
government buys those assets at current market rates, banks would be forced to
take immediate losses on the sales, doing more harm than if the government just
left the troubled loans where they are. Sources say the Federal Reserve would
prefer to let the banks keep the loans and troubled bonds for now and instead
provide the banks with insurance policies guaranteeing that the government will
swallow a good deal of future credit losses. But a similar deal that the Fed
struck with Citi did little to boost that company's stock or stave off fears
that it may soon go under. That's why a small but growing number of people are
starting to talk about nationalization. Speaker of
the House Nancy Pelosi recently said nationalization, or something close to it,
is a better solution than just buying bad assets ...
"Why Your Bank is Broke," by Stephen Gandel, Time Magazine, February 9,
2009, Beginning on Page 23 ---
Click
Here
But do the math, and you can begin to
understand how really botched this bailout has been. Since October, the
government has deposited $165 billion into the accounts of the nation's
eight
largest banks. Yet those same financial firms are
now worth $418 billion less than they were four months ago, and the
Congressional Budget Office estimates that the government's preferred shares
are worth at least $20 billion less. In Wall Street terms, that's throwing
good money after bad. All told, the government's annualized rate of return
on its investment in the nation's largest banks is -1,096%. That's well
beyond Bernie Madoff territory; he topped out at a mere -100%. (See
pictures of the demise of Bernie Madoff.)
So how could $438 billion — $418 billion
of their money and $20 billion of ours — go poof, just like that? Here's the
easiest explanation: our banking system has sprung a leak.
. . .
TARP does nothing to patch the hole in the
banking system. And it certainly doesn't do anything to encourage banks to
make more loans. Yes, banks have gotten nearly $300 billion in money from
the government, and that's a lot of dough. But it's not free dough. In
return for federal cash, the government has taken preferred-stock shares as
the firm's markers. Unlike common stock, which is the kind you or I would
buy from a broker, preferreds have to eventually be paid back, so they are
really loans, not additional capital. (See
which country has the best bailout plans.)
Say a bank has $5 in capital and $100 in
loans. Now the government gives the bank an additional $100 in preferred
shares and says, "Go make more loans." Well, the bank might then have $200
in loans, but it still has only $5 in common shareholders' equity. The
result: if just 2.5% of its loans go bad, the bank's shareholders are wiped
out. Wisely, the largest banks in the nation lent less in the fourth quarter
of 2008 than in the previous three months — a strategy that has drawn some
complaints. But that hasn't removed the pressure on their shares. That's
because the banks have had to continue to take loan losses. And banks don't
have the option to pass those losses off on the new money they got from the
government. They have to write down their common stockholders' equity first.
And as that capital falls, so go the bank's shares. Some are alarmingly
close to zero.
No bank's stock has fallen more in value
during the past four months than Bank of America's. The combined value of
its shares is now $37 billion. That's $123 billion less than they were worth
at the end of September. In the third quarter, BofA was forced to write down
$4.4 billion in loans, or about 1.8% of its loan portfolio. Compared with
what some of its competitors wrote down, that wasn't a heck of a lot;
Citigroup, for instance, had a $13.2 billion charge in the same quarter,
primarily related to loan losses. But the relatively small loss took BofA's
thin tangible equity, the type of capital that matters most to shareholders,
down to a ratio of just 2.6% of loans, according to FBR. By that measure,
Bofa was a weaker bank than any of its rivals, including Citigroup. But
since the market was so focused on bad loans and the charge-offs banks had
to take, no one seemed to notice BofA's faults.
That is, until the fourth quarter. In
mid-September 2008, in a deal pushed by regulators, BofA agreed to buy
Merrill Lynch. The acquisition actually boosted BofA's capital ratios, but
it also added losses to an already fragile capital structure; Merrill Lynch
lost $15 billion in the fourth quarter alone. Knowledge of the impending
losses forced BofA CEO Ken Lewis to ask the government for an additional $20
billion in TARP funds — on top of the $25 billion it had already received —
as well as about $100 billion in loan guarantees. Without the government
assistance, BofA says, it couldn't have closed the merger.
The Merrill losses, which weren't publicly
revealed until early January, have angered shareholders, some of whom have
sued the company for not informing them sooner. And last week, the losses
also led Lewis to ask Merrill's top executive,
John Thain, to resign for failing to keep BofA
officials apprised of his firm's bottom-line problems. Thain says Lewis knew
all along. (See
pictures of TIME's Wall Street covers.)
. . .
Regulators are split on what to do next.
The Federal Deposit Insurance Corporation is backing a plan to create what
it calls an aggregator bank, which would buy up the loans of BofA, Citigroup
and the rest of our now troubled system, theoretically putting an end to the
escalating losses eating away at the banks' capital. But if the government
buys those assets at current market rates, banks would be forced to take
immediate losses on the sales, doing more harm than if the government just
left the troubled loans where they are. Sources say the Federal Reserve
would prefer to let the banks keep the loans and troubled bonds for now and
instead provide the banks with insurance policies guaranteeing that the
government will swallow a good deal of future credit losses. But a similar
deal that the Fed struck with Citi did little to boost that company's stock
or stave off fears that it may soon go under.
That's why a small but growing number of
people are starting to talk about nationalization. Speaker of the House
Nancy Pelosi recently said nationalization, or something close to it, is a
better solution than just buying bad assets, because if the government
takeovers succeed, then taxpayers get to keep the profits when they
eventually resell the banks. But if the government doesn't turn a
nationalized bank around, it could be very costly to taxpayers.
For the rest of the article ---
Click
Here
Thain Pain:
Merrill Lynch Bonuses of Over $1 Million to Each of 696 Executives
Rewarded for making their company so profitable for shareholders? (Barf Alert!)
Merrill Lynch quietly paid out at least one million
dollars bonus each to about 700 top executive even when the investment house was
bleeding with losses last year, a probe has revealed. They were part of 3.6
billion dollars in the firm's bonus payments in December before the announcement
of its fourth quarterly losses and takeover by Bank of America, the
investigation by the New York state Attorney General's office showed. "696
individuals received bonuses of one million dollars or more," New York Attorney
General Andrew Cuomo said of the Merrill scandal in a letter to a lawmaker
heading the House of Representatives financial services committee.
"Merrill bonuses made 696 millionaires: probe," Yahoo News,
February 11, 2009 ---
http://news.yahoo.com/s/afp/20090211/bs_afp/usbankingjusticeprobecompanymerrillbofa_20090211201133
Jensen Comment
So why can't the government simply buy up the banks (with printed money so
there are no increases in taxes and national debt), turn things around, and make
the banks private once again in the land of milk and honey?
The reason bluntly is that every cohort in the United
States from General Motors to the 50 states to college campuses and now to ACORN have
already been promised hundreds of billions in stimulus money with election
guarantees of no new taxes to pay for such things. The U.S. is maxed out on its
national debt, so the only answer lately has been to print billions of dollars
under the Zimbabwe Theory of Finance. Yes, our government has already been
financing some of the Bailout with billions of this type of printed money ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
Who wants to invest in shares
of a denationalizing bank bursting with Zimbabwe dollars?
Barney’s
Bank is here to stay until China cashes in its share of our national debt and
buys out the entire United States.
Barney Frank now owns Fannie and
Freddie, so he might as well add our nation’s bank to his collection. It will
likely remain so until China decides not to roll over its share of our national
debt and, thereby, purchases nearly all of what was once the United States of
America.
A second problem
is that by taking on the toxic paper (mortgages that will not be repaid) either
by nationalizing banks or by simply buy government buying of toxic paper, the
toxic paper carries with it the huge costs of ownership of millions of
foreclosed homes, including property taxes, security, lawn care, pool cleaning,
heating in cold climates that freeze up pipes, casualty insurance costs, etc.
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#HomeOwnership
Toxic investments now held by banks are like owning the Energizer Bunny --- the
cash flow drain just keeps on going and going and going while trying to sell
tens of millions of homes in a down real estate market.
Some Republicans now propose that
mortgage rates be set at 4% or lower for 30-year mortgages, but this will simply
jumpstart the mortgage brokering racket (with overvalued appraisals) that got us
into this mess. Also banks are not going to make 30-year loans at such low fixed
rates. Fannie Mae and Freddie Mack, now owned by Congress, will have to buy up
those new loans. Currently Freddie and Fannie need trillions to recover from the
toxic paper they already own. If current homeowners can also refinance at such
low rates we're talking tens of trillions of cost in this stupid Republican plan
being pushed by real estate brokers and home builders and especially mortgage
brokers.
"A Republican Fannie Mae The worst mortgage idea since Barney Frank's last
one," The Wall Street Journal, February 6, 2009 ---
http://online.wsj.com/article/SB123388493959055161.html?mod=djemEditorialPage
How's this for a bright idea to boost home
prices and goose the economy: Have two government-chartered entities exploit
Uncle Sam's low borrowing costs to subsidize mortgage rates. Lower borrowing
costs will make housing more affordable and increase demand for unsold
homes. If this sounds hauntingly familiar, that's because it is.
Think Fannie Mae and Freddie Mac, whose
mortgage-rate subsidy helped get us into this mess.
Well, here we go again, though this time
the Republicans are offering the free lunch. Under a proposal endorsed this
week by Senate GOP leader Mitch McConnell, Fannie and Freddie would serve as
the conduit for 30-year mortgages with fixed 4% interest rates. This is
based on an idea that economists Glenn Hubbard and Christopher Mayer first
floated on these pages, targeting a 4.5% fixed rate. Let's just say this
proves we don't agree with everything we publish.
Because 10-year Treasury yields are
currently around 2.9%, the government could in theory borrow the money, lend
it out at 4% and make these mortgages available at minimal cost. These
mortgages would encourage buyers to buy and so stem the decline in home
prices. If they were made available to those refinancing, they could also
help people struggling to pay their mortgage bills or facing resets on
adjustable-rate loans.
That's the theory.
The problems are price-fixing, taxpayer
cost, and a misunderstanding of housing trends. True, the government would
not set the prices of the houses themselves. But by fixing the price of home
financing, the government would be nationalizing one more branch of the
housing market. The feds tried this recently with student loans, and the
result is that the private market largely collapsed. After this
all-too-predictable result, Congress did what comes naturally: It blamed
lenders who withdrew from the market for being "greedy." And it had the
government -- the taxpayer -- become the main lender to students.
If the government wanted to avoid this
fate, it could instead let banks make the loans and subsidize them for the
difference between the 4.5% rate and the market rate. But wait -- if the
government has fixed the price, there is no market rate, so there's no way
to know what a "fair" rate of subsidy is. This was one of the problems with
Congress's 2007 student-loan reform. Lenders and lawmakers had different
ideas about how to define fair compensation, so the lenders walked.
Proponents nonetheless claim this would
help consumers by lowering their mortgage payments and stopping the
house-price decline. In fact, the impact on home prices or housing demand is
likely to be small. Some supporters claim a 4.5% mortgage rate could add 12%
or more to house prices. But other estimates put the home-price boost at
closer to 1%-3%, a tiny improvement in a dismal market. Home prices in many
markets are still too high compared to long-term trends, and they are likely
to keep falling until they get back to that norm.
Mr. Hubbard says 4.5% mortgages could
boost homeownership back to levels last seen in 2004, at the height of the
boom. That seems unlikely. Those who have had their credit destroyed by
foreclosure are probably not the best candidates for jumping back into the
housing pool. Most of the people who would take advantage of these loans
either would have bought a home anyway, because they need one, or already
own a home and want to (but don't need to) lower their rates.
But even if this did happen, it's not
clear why it should. These days even Barney Frank agrees that homeownership
rates were artificially high at the end of the boom. Getting back to those
levels would only presage another bust. That bust would be scheduled for
shortly after this supposedly temporary program ended, assuming it ever
does. Right now, 30-year mortgage rates are hovering around 5.5%. These are
already nearly as low as they've been in a generation. Even if they only
went back up to current levels after the program ended, rates would seem
high to homeshoppers merely because they are higher than they were. So any
new demand generated now would have to be set against the depressed demand
in the future.
Any such program would also have to be
huge -- and hugely expensive. Harvard's Ed Glaeser estimated on these pages
Thursday that a $10 trillion program might cost the Treasury $135 billion or
so. But that assumes that all those mortgages are paid back in full. And
keep in mind the money would have to be borrowed -- in addition to the $3
trillion or so the Treasury will already have to borrow in the next two
years. If interest rates and thus federal borrowing costs rise to the 1990s
average for the 10-year note of 6.5%, look out.
We realize Republicans feel obliged to
have their own "stimulus" plan, and that doing something for housing scores
well in polls. We also remember when the subsidy to Fannie and Freddie was
considered costless too. Tens of billions later, the tab is still growing.
This one could be larger.
Not a single county in the entire state
(California) voted for the tax-and-spend propositions
on yesterday's referendum ballot, not even the peculiar folks who live in Nancy
Pelosi's far-left 8th Congressional District who persist in sending the Wicked
Witch of the West to the Nation's Capitol to wage war on the CIA and the
nation's taxpayers. The only measure voters did approve was one to freeze
salaries of senior public officials during budget emergencies.
Michael Reagan, "Terminating the
Terminator," Townhall, May 20, 2009 ---
http://townhall.com/columnists/MichaelReagan/2009/05/20/terminating_the_terminator
Jensen Comment
What's worse in many respects is that California voters sent a message to
President Obama that taxing the middle class (the only way to raise serious
deficit-cutting revenue) to halt deficit-induced halt hyperinflation of the U.S.
dollar will not be supported by voters.
See
http://townhall.com/columnists/MattTowery/2009/05/21/california,_here_we_come
A democracy cannot
exist as a permanent form of government. It can only exist until the
voters discover that they can vote themselves largesse from the public treasury.
From that moment on, the majority always votes for the candidates promising the
most benefits from the public treasury, with the result that a democracy always
collapses over loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The "Stimulus Bill" has already gone too far after cohorts in the United
States discovered "they can vote themselves largesse from the public treasury."
There's no turning back. The Stimulus Bill morphed into a Perfect (Stimulus)
Storm for a socialist revolution in the United States. Although they did
probably not intend to be the members of the first
Politburo of the United
States, the new Politburo will be comprised of Barack Obama, Nancy Pelosi, Harry
Reid, Chris Dodd, and Barney Frank. Egad! This group cannot say no to anybody
with a sob story!
We'll take Manhattan
the Bronx and Staten
Island too.
Lyrics by Karl Marx and Score by Vladimir Lenin
Sadly your retirement funds will probably head toward the deep south in terms
of real, not Zimbabwe-like dollar, spending power.
I can't believe the liberal-magazine source of this article criticizing
the Obama team: Would you believe the The Nation?
Will liberals attack Obama himself on this one?
"Will Geithner and Summers Destroy the US Economy?" by Christopher
Hayes, The Nation, February 4, 2009 ---
Click Here
That's more or less
what the usually understated
Yves Smith says today about
the preview of the Obama TARP plan, "Team Obama is
taking the cowardly approach of distributing the costs
among the most disenfranchised group in the process,
namely the taxpayer, when there far more obvious and
logical groups to take the hits."
It's not just Smith. I
got an email from a good friend at a hedge fund last
week. He's a *very* moderate guy, and he had this to
say:
The one thing that I
disagree on is that for all the talk of making Tarp
II diff from Tarp I, I don't really see it
happening. An aggregator bank still just takes bad
assets from a bank in exchange for capital. If you
pay market, the banks will be insolvent, so they
won't participate. If you pay above market, you're
basically just injecting capital in to the banks,
which is what they did in Tarp I. Why are they
scared of nationalizing? Citi is an insolvent bank -
wipe the equity, take the company, remove the bad
assets, put the remaining good company back in to
the public markets, repeat for the next insolvent
bank. If they try to let a Citi (or maybe evan a
BofA) earn their way out of this we will end up with
huge parts of the banking system in zombie mode, a
la Japan. That would be very bad and will only
prolong the pain.
This is the where the
rubber of necessity hits the road of The New Politics.
In order to save the American economy, it's increasingly
clear we need to kill off some banks. In words of one
former Wall Streeter, play "good bank, bad bank." But
playing "bad bank" means taking on Wall Street's
power in a concerted way. This is not a question of
technical merits of policy, it's a matter of taking on
entrenched power. Unless the Obama WH can find it within
itself to do it, we may all be very, very screwed.
Jensen Comment
But if we simply allow the banks to fail, only the
government will absorb the toxic mortgages and
foreclosed homes that the banks unload in bankruptcy
court.
The
government will end up with toxic paper one way or
another, toxic paper (mortgages that will not be repaid)
that carries with it the huge costs of ownership of
millions of foreclosed homes, including property taxes,
security, lawn care, pool cleaning, heating in cold
climates that freeze up pipes, casualty insurance costs,
etc. ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#HomeOwnership
Toxic investments now held by banks are like owning the
Energizer Bunny --- the cash flow drain just keeps on
going and going and going while trying to sell tens of
millions of homes in a down real estate market.
I repeat that
some Republicans now propose that mortgage rates be set
at 4% or lower for 30-year mortgages, but this will
simply jumpstart the mortgage brokering racket (with
overvalued appraisals) that got us into this mess. Also
banks are not going to make 30-year loans at such low
fixed rates. Fannie Mae and Freddie Mack, now owned by
Congress, will have to buy up those new loans. Currently
Freddie and Fannie need trillions to recover from the
toxic paper they already own. If current homeowners can
also refinance at such low rates we're talking tens of
trillions of cost in this stupid Republican plan being
pushed by real estate brokers and home builders and
especially mortgage brokers.
"A Republican Fannie Mae The worst mortgage idea since Barney Frank's last
one," The Wall Street Journal, February 6, 2009 ---
http://online.wsj.com/article/SB123388493959055161.html?mod=djemEditorialPage
How's this for a bright idea to boost home
prices and goose the economy: Have two government-chartered entities exploit
Uncle Sam's low borrowing costs to subsidize mortgage rates. Lower borrowing
costs will make housing more affordable and increase demand for unsold
homes. If this sounds hauntingly familiar, that's because it is.
Think Fannie Mae and Freddie Mac, whose
mortgage-rate subsidy helped get us into this mess.
Well, here we go again, though this time
the Republicans are offering the free lunch. Under a proposal endorsed this
week by Senate GOP leader Mitch McConnell, Fannie and Freddie would serve as
the conduit for 30-year mortgages with fixed 4% interest rates. This is
based on an idea that economists Glenn Hubbard and Christopher Mayer first
floated on these pages, targeting a 4.5% fixed rate. Let's just say this
proves we don't agree with everything we publish.
Because 10-year Treasury yields are
currently around 2.9%, the government could in theory borrow the money, lend
it out at 4% and make these mortgages available at minimal cost. These
mortgages would encourage buyers to buy and so stem the decline in home
prices. If they were made available to those refinancing, they could also
help people struggling to pay their mortgage bills or facing resets on
adjustable-rate loans.
That's the theory.
The problems are price-fixing, taxpayer
cost, and a misunderstanding of housing trends. True, the government would
not set the prices of the houses themselves. But by fixing the price of home
financing, the government would be nationalizing one more branch of the
housing market. The feds tried this recently with student loans, and the
result is that the private market largely collapsed. After this
all-too-predictable result, Congress did what comes naturally: It blamed
lenders who withdrew from the market for being "greedy." And it had the
government -- the taxpayer -- become the main lender to students.
If the government wanted to avoid this
fate, it could instead let banks make the loans and subsidize them for the
difference between the 4.5% rate and the market rate. But wait -- if the
government has fixed the price, there is no market rate, so there's no way
to know what a "fair" rate of subsidy is. This was one of the problems with
Congress's 2007 student-loan reform. Lenders and lawmakers had different
ideas about how to define fair compensation, so the lenders walked.
Proponents nonetheless claim this would
help consumers by lowering their mortgage payments and stopping the
house-price decline. In fact, the impact on home prices or housing demand is
likely to be small. Some supporters claim a 4.5% mortgage rate could add 12%
or more to house prices. But other estimates put the home-price boost at
closer to 1%-3%, a tiny improvement in a dismal market. Home prices in many
markets are still too high compared to long-term trends, and they are likely
to keep falling until they get back to that norm.
Mr. Hubbard says 4.5% mortgages could
boost homeownership back to levels last seen in 2004, at the height of the
boom. That seems unlikely. Those who have had their credit destroyed by
foreclosure are probably not the best candidates for jumping back into the
housing pool. Most of the people who would take advantage of these loans
either would have bought a home anyway, because they need one, or already
own a home and want to (but don't need to) lower their rates.
But even if this did happen, it's not
clear why it should. These days even Barney Frank agrees that homeownership
rates were artificially high at the end of the boom. Getting back to those
levels would only presage another bust. That bust would be scheduled for
shortly after this supposedly temporary program ended, assuming it ever
does. Right now, 30-year mortgage rates are hovering around 5.5%. These are
already nearly as low as they've been in a generation. Even if they only
went back up to current levels after the program ended, rates would seem
high to homeshoppers merely because they are higher than they were. So any
new demand generated now would have to be set against the depressed demand
in the future.
Any such program would also have to be
huge -- and hugely expensive. Harvard's Ed Glaeser estimated on these pages
Thursday that a $10 trillion program might cost the Treasury $135 billion or
so. But that assumes that all those mortgages are paid back in full. And
keep in mind the money would have to be borrowed -- in addition to the $3
trillion or so the Treasury will already have to borrow in the next two
years. If interest rates and thus federal borrowing costs rise to the 1990s
average for the 10-year note of 6.5%, look out.
We realize Republicans feel obliged to
have their own "stimulus" plan, and that doing something for housing scores
well in polls. We also remember when the subsidy to Fannie and Freddie was
considered costless too. Tens of billions later, the tab is still growing.
This one could be larger.
Is The Terminator running a type of Ponzi with California's colleges?
"California's Budget Problems Leave Community Colleges Holding IOU's,"
Chronicle of Higher Education, March 6, 2009 ---
http://chronicle.com/weekly/v55/i26/26a00101.htm?utm_source=wb&utm_medium=en
When California approved its budget last month, the
community-college system managed to escape the sharp budget cuts that befell
most other agencies. But the state's fiscal troubles have nonetheless
created a cash crisis for two-year colleges.
As part of its plan to close a $41-billion budget
deficit, California will delay providing $540-million in aid to its
community colleges this year, forcing them to come up with the money for
several months while the state waits for more revenue to come in. Payments
that would normally arrive in the spring will be on hold until July, and
payments scheduled for July will be delayed until October.
The delay affects most state agencies, including
the University of California. But it puts an especially severe strain on the
state's 110 community colleges, which have less room in their budgets for
discretionary spending than their larger counterparts do, and only enough
reserve funds to survive short-term emergencies. At many two-year colleges,
85 percent or more of the budget is committed to salaries and benefits,
making it difficult to weather unexpected dips in revenue.
Continued in article
Jensen Comment
This is less of this IOU concern since the Federal government will soon bail out
California's fiscal mismanagement. Fiscally responsible states were probably
stupid not to get on more of the Recovery Act's porkulus gravy river flowing at
the highest rate flowing into sunny California.
Totally independent of the Recovery Act's bailout of California, President
Obama is now promising every U.S. citizen (and millions of pretenders) a free
year or two of college. Soon tens of millions of folks may collect their Social
Security checks and enroll in college or tech school at no cost for an added
OBSF fringe benefit of retirement. Since so many U.S. workers retire to sunshine
states, the sunshine states may benefit the most from the free education and
training. Schools should gear up for a lot more demand for sewing, fly fishing,
and basket weaving courses.
It's also the sunshine states that will benefit the most from the trillions
about to be spent to avoid home foreclosures since sunshine states baked up the
lion's share of toxic cookies. The sun really does shine down more on some
states than other states. The states with the biggest foreclosure problem are
California, Florida, Arizona, and Nevada. Michigan also has a severe
foreclosure-rate problem, but that is more of problem of high unemployment rates
than in overbuilding of new homes and condos and apartment complexes.
Maybe Nancy Pelosi has been correct all along when wanting to nationalize
the big banks
"Roubini: Nationalizing Banks Is the Best Way to Go," by Henry Blodget,
Yahoo Finance, February 12, 2009 ---
Click Here
From
The
Business Insider,, Feb. 12. 2009:
Nouriel Roubini lays out the four ways to fix
insolvent banking systems. Then he explains why the first three--the ones
we're using--are lousy:
There are four basic approaches to a clean-up of a
banking system that is facing a systemic crisis:
1. Recapitalization together with the
purchase by a government “bad bank” of the toxic assets;
2. Recapitalization together with
government guarantees – after a first loss by the banks – of the toxic
assets;
3. Private purchase of toxic assets
with a government guarantee and/or – semi-equivalently - provision of public
capital to set up a public-private bad bank where private investors
participate in the purchase of such assets (something similar to the US
government plan presented by Tim Geithner today for a Public-Private
Investment Fund);
4. Outright government takeover (call
it nationalization or “receivership" if you don’t like the dirty N-word) of
insolvent banks to be cleaned after takeover and then resold to the private
sector.
Of the four options the first three have serious
flaws: in the bad bank model the government may overpay for the bad assets –
at a high cost for the taxpayer - as the true value of them is uncertain;
and if it does not overpay for the assets many banks are bust as the
mark-to-market haircut they need to recognize is too large for them to bear.
Even in the guarantee (after first loss) model
there are massive valuation problems and there can be very expensive risk
for the tax-payer (an excessive guarantee that is not properly priced by the
first loss of the bank, the fees paid and the value of equity that that the
government receives for the guarantee) as the true value of the assets is as
uncertain as in the purchase of bas assets model. The shady guarantee deals
recently done with Citi and Bank of America were even less transparent than
an outright government purchase of bad asset as the bad asset purchase model
at least has the advantage of transparency of the price paid for toxic
assets.
In the bad bank model the government has the
additional problem of having to manage all the bad assets it purchased,
something that the government does not have much expertise in. At least in
the guarantee model the assets stay with the banks and the banks know better
how to manage and have a greater incentive than the government to eventually
work out such bad assets...
Thus all the schemes that have been so far proposed
to deal with the toxic assets of the banks may be a big fudge that either
does not work or works only if the government bails out shareholders and
unsecured creditors of the banks.
So much for all the plans put forth so far,
including Tim Geithner's latest brainstorm. Now on to the solution.
Note that Nouriel is not recommending the
alternative that Geithner and Summers always invoke when someone suggests
this route: permanent government ownership and operation of the banks. We
all agree that would be a disaster. What Nouriel is talking about is
temporary receivership and restructuring.
Thus, paradoxically nationalization may be a more
market friendly solution of a banking crisis: it creates the biggest hit for
common and preferred shareholders of clearly insolvent institutions and –
most certainly – even the unsecured creditors in case the bank insolvency
hole is too large; it provides a fair upside to the tax-payer. It can also
resolve the problem of avoiding having the government manage the bad assets:
if you selling back all of the assets and deposits of the bank to new
private shareholders after a clean-up of the bank together with a partial
government guarantee of the bad assets (as it was done in the resolution of
the Indy Mac bank failure) you avoid having the government managing the bad
assets. Alternatively, if the bad assets are kept by the government after a
takeover of the banks and only the good ones are sold back in a
re-privatization scheme, the government could outsource the job of managing
and working out such assets to private asset managers if it does not want to
create its own RTC bank to work out such bad assets.
Nationalization also resolves the too-big-too-fail
problem of banks that are systemically important and that thus need to be
rescued by the government at a high cost to the taxpayer. This
too-big-to-fail problem has now become an even-bigger-to-fail problem as the
current approach has lead weak banks to take over even weaker banks. Merging
two zombie banks is like have two drunks trying to help each other to stand
up.
The JPMorgan takeover of insolvent Bear Stearns and
WaMu; the Bank of America takeover of insolvent Countrywide and Merrill
Lynch; and the Wells Fargo takeover of insolvent Wachovia show that the
too-big-to-fail monster has become even bigger. In the Wachovia case you had
two wounded institutions (Citi and Wells Fargo) bidding for a zombie
insolvent one. Why? Because they both knew that becoming even bigger-to-fail
was the right strategy to extract an even larger bailout from the
government. Instead, with nationalization approach the government can
break-up these financial supermarket monstrosities into smaller pieces to be
sold to private investors as smaller good banks.
This “nationalization” approach was the one
successfully taken by Sweden while the current US and UK approach may end up
looking like the zombie banks of Japan that were never properly restructured
and ended up perpetuating the credit crunch and credit freeze. Japan ended
up having a decade long near-depression because of its failure to clean up
the banks and the bad debts. The US, the UK and other economies risk a
similar near depression and stag-deflation (multi-year recession and price
deflation) if they fail to appropriately tackle this most severe banking
crisis.
Jensen Comment
After the disaster experience in
Japan, I think it's best to just let the banks fail that are going to fail. Many
companies rise up after declaring bankruptcy and reorganization. This will be
painful for shareholders, including investment funds that hold shares, but such
is the risk of equity investing.
August 2018 Update
Wells Fargo & Co. agreed to pay $2.09 billion to settle with the U.S. Justice
Department over the sale of toxic mortgage-backed securities in the lead-up to
the financial crisis.---
https://www.wsj.com/articles/wells-fargo-agrees-to-2-09-billion-settlement-for-crisis-era-mortgage-loans-1533147302?mod=searchresults&page=1&pos=1&mod=djemCFO_h
This is on top of all the subsequent fines paid by Wells Fargo & Co. for
unrelated subsequent crimes. What a lousy company.
"Six Errors on the Path to the Financial Crisis," by Alan S. Blinder,
The New York Times, January 24, 2009 ---
http://www.nytimes.com/2009/01/25/business/economy/25view.html?_r=1&ref=business
My list of errors has
six whoppers, in chronologically order. I omit
mistakes that became clear only in hindsight,
limiting myself to those where prominent voices
advocated a different course at the time. Had these
six choices been different, I believe the inevitable
bursting of the housing bubble would have caused far
less harm.
WILD
DERIVATIVES
In 1998, when Brooksley E.
Born, then chairwoman of the
Commodity Futures Trading Commission,
sought to extend its
regulatory reach into the derivatives world, top
officials of the Treasury Department, the Federal
Reserve and the Securities and Exchange Commission
squelched the idea. While her specific plan may not
have been ideal, does anyone doubt that the
financial turmoil would have been less severe if
derivatives trading had acquired a zookeeper a
decade ago?
SKY-HIGH LEVERAGE
The second error came in 2004, when the S.E.C. let
securities firms raise their leverage sharply.
Before then, leverage of 12 to 1 was typical;
afterward, it shot up to more like 33 to 1. What
were the S.E.C. and the heads of the firms thinking?
Remember, under 33-to-1 leverage, a mere 3 percent
decline in asset values wipes out a company. Had
leverage stayed at 12 to 1, these firms wouldn’t
have grown as big or been as fragile.
A SUBPRIME SURGE
The next error came in stages,
from 2004 to 2007, as subprime lending grew from a
small corner of the mortgage market into a large,
dangerous one. Lending standards fell disgracefully,
and dubious transactions became common.
Why wasn’t this
insanity stopped? There are two answers, and each
holds a lesson. One is that bank regulators were
asleep at the switch. Entranced by laissez faire-y
tales, they ignored warnings from those like Edward
M. Gramlich, then a Fed governor, who saw the
problem brewing years before the fall.
The other answer
is that many of the worst subprime mortgages
originated outside the banking system, beyond the
reach of any federal regulator. That regulatory hole
needs to be plugged.
FIDDLING ON FORECLOSURES
The government’s continuing failure to do anything
large and serious to limit foreclosures is tragic.
The broad contours of the foreclosure tsunami were
clear more than a year ago — and people like
Representative
Barney Frank, Democrat of
Massachusetts, and
Sheila C. Bair, chairwoman
of the
Federal Deposit Insurance Corporation,
were sounding alarms.
Yet the Treasury
and Congress fiddled while homes burned. Why?
Free-market ideology, denial and an unwillingness to
commit taxpayer funds all played roles. Sadly, the
problem should now be much smaller than it is.
LETTING
LEHMAN
GO
The next whopper came in
September, when Lehman Brothers, unlike
Bear Stearns before it,
was allowed to fail. Perhaps it was a case of
misjudgment by officials who deemed Lehman neither
too big nor too entangled — with other financial
institutions — to fail. Or perhaps they wanted to
make an offering to the moral-hazard gods.
Regardless, everything fell apart after Lehman.
People in the
market often say they can make money under any set
of rules, as long as they know what they are. Coming
just six months after Bear’s rescue, the Lehman
decision tossed the presumed rule book out the
window. If Bear was too big to fail, how could
Lehman, at twice its size, not be? If Bear was too
entangled to fail, why was Lehman not?
After Lehman went
over the cliff, no financial institution seemed
safe. So lending froze, and the economy sank like a
stone. It was a colossal error, and many people said
so at the time.
TARP’S DETOUR
The final major error is mismanagement of the
Troubled Asset Relief Program,
the $700 billion bailout fund.
As I wrote here last month, decisions of
Henry M. Paulson Jr.,
the former Treasury secretary, about using the
TARP’s first $350 billion were an inconsistent mess.
Instead of pursuing the TARP’s intended purposes, he
used most of the funds to inject capital into banks
— which he did poorly.
To
illustrate what might have been, consider Fed
programs to buy
commercial paper and
mortgage-backed securities. These facilities do
roughly what TARP was supposed to do: buy troubled
assets. And they have breathed some life into those
moribund markets. The lesson for the new Treasury
secretary is clear: use TARP money to buy troubled
assets and to mitigate foreclosures.
Six fateful
decisions — all made the wrong way. Imagine what the
world would be like now if the housing bubble burst
but those six things were different: if derivatives
were traded on organized exchanges, if leverage were
far lower, if subprime lending were smaller and done
responsibly, if strong actions to limit foreclosures
were taken right away, if Lehman were not allowed to
fail, and if the TARP funds were used as directed.
All of this was
possible. And if history had gone that way, I
believe that the financial world and the economy
would look far less grim than they do today.
Jensen Comment
Alan Blinder missed some whoppers.
- The SEC was authorized to regulate investment banking and consistently
failed to do so through several crises, including the dot-com crisis of the
1990s and credit default swap crisis commencing in 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#SEC
Also so see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
This is an admitted failure of SEC Directors from Arthur Levitt though
Christopher Cox.
- The Federal Reserve failed in regulating investment banks. Alan
Greenspan belatedly admitted that he was largely at fault.
"‘I made a mistake,’ admits Greenspan," by Alan Beattie and James
Politi, Financial Times, October 23, 2008 ---
http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1
“I made a mistake in
presuming that the self-interest of organisations, specifically banks
and others, was such that they were best capable of protecting their own
shareholders,” he said.
In the second of two days of tense
hearings on Capitol Hill, Henry Waxman, chairman of the House of
Representatives, clashed with current and former regulators and with
Republicans on his own committee over blame for the financial crisis.
Mr Waxman said Mr Greenspan’s Federal
Reserve – along with the Securities and Exchange Commission and the US
Treasury – had propagated “the prevailing attitude in Washington... that
the market always knows best.”
Mr Waxman blamed the Fed for failing
to curb aggressive lending practices, the SEC for allowing credit rating
agencies to operate under lax standards and the Treasury for opposing
“responsible oversight” of financial derivatives.
Christopher Cox, chairman of the
Securities and Exchange Commission, defended himself, saying that
virtually no one had foreseen the meltdown of the mortgage market, or
the inadequacy of banking capital standards in preventing the collapse
of institutions such as Bear Stearns.
Mr Waxman accused the SEC chairman of
being wise after the event. “Mr Cox has come in with a long list of
regulations he wants... But the reality is, Mr Cox, you weren’t doing
that beforehand.”
Mr Cox blamed the fact that
Congressional responsibility was divided between the banking and
financial services committees, which regulate banking, insurance and
securities, and the agriculture committees, which regulate futures.
“This jurisdictional split threatens
to for ever stand in the way of rationalising the regulation of these
products and markets,” he said.
Mr Greenspan accepted that the crisis
had “found a flaw” in his thinking but said that the kind of heavy
regulation that could have prevented the crisis would have damaged US
economic growth. He described the past two decades as a “period of
euphoria” that encouraged participants in the financial markets to
misprice securities.
He had wrongly assumed that lending
institutions would carry out proper surveillance of their
counterparties, he said. “I had been going for 40 years with
considerable evidence that it was working very well”.
Continued in the article
Jensen Comment
In other words, he assumed the agency theory model that corporate
employees, as agents of their owners and creditors, would act hand and
hand in the best interest for themselves and their investors. But agency
theory has a flaw in that it does not understand Peter Pan.
Long Time WSJ Defenders of Wall Street's Outrageous Compensation Morph
Into Hypocrites
At each stage of the disaster, Mr. Black told me --
loan officers, real-estate appraisers, accountants, bond ratings agencies -- it
was pay-for-performance systems that "sent them wrong." The need for new
compensation rules is most urgent at failed banks. This is not merely because is
would make for good PR, but because lavish executive bonuses sometimes create an
incentive to hide losses, to take crazy risks, and even, according to Mr. Black,
to "loot the place through seemingly normal corporate mechanisms." This is why,
he continues, it is "essential to redesign and limit executive compensation when
regulating failed or failing banks." Our leaders may not know it yet, but this
showdown between rival populisms is in fact a battle over political legitimacy.
Is Wall Street the rightful master of our economic fate? Or should we choose a
broader form of sovereignty? Let the conservatives' hosannas turn to sneers. The
market god has failed.
Thomas Frank,
"Wall Street Bonuses Are an Outrage: The public sees a self-serving system
for what it," The Wall Street Journal, February 4, 2009 ---
http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion
Bob Jensen's threads on outrageous compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Bob Jensen's threads on the Bailout mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance
Peter Pan, the manager of Countrywide Financial on Main
Street, thought he had little to lose by selling a fraudulent mortgage
to Wall Street. Foreclosures would be Wall Street’s problems and not his
local bank’s problems. And he got his nice little commission on the sale
of the Emma Nobody’s mortgage for $180,000 on a house worth less than
$100,000 in foreclosure. And foreclosure was almost certain in Emma’s
case, because she only makes $12,000 waitressing at the Country Café. So
what if Peter Pan fudged her income a mite in the loan application along
with the fudged home appraisal value? Let Wall Street or Fat Fannie or
Foolish Freddie worry about Emma after closing the pre-approved mortgage
sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter
Pan is more concerned with his own conventional mortgage on his precious
house just two blocks south of Main Street. This is what
happens when risk is spread even farther than Tinkerbell can fly!
Read about the extent of cheating, sleaze,
and subprime sex on Main Street in
Appendix U.
3. U.S. auditing standards explicitly require
careful estimation of bad debts. The auditing firms failed the world when
auditing sub-prime mortgage receivables, the collateralized debt obligation
(CDOs) investments, and the credit derivative instruments sold to insure
those investments? Where were the auditing firms that were paid millions to
audit commercial and investment banks as well as Fannie Mae and Freddie
Mack?
See
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
4. Subprime: Borne of Sleaze, Bribery, and Lies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Much of this began with good intentions to make housing credit available to
minorities and poor people in general, but politicians figured out how to
play Robin Hood with taxpayer money and used Congressional power over Fannie
Mae and Freddie Mack to do just that.
Long WSJ Defenders of Wall Street's Outrageous Compensation Turn Into
Hypocrites
At each stage of the disaster, Mr. Black told me --
loan officers, real-estate appraisers, accountants, bond ratings agencies --
it was pay-for-performance systems that "sent them wrong." The need for new
compensation rules is most urgent at failed banks. This is not merely
because is would make for good PR, but because lavish executive bonuses
sometimes create an incentive to hide losses, to take crazy risks, and even,
according to Mr. Black, to "loot the place through seemingly normal
corporate mechanisms." This is why, he continues, it is "essential to
redesign and limit executive compensation when regulating failed or failing
banks." Our leaders may not know it yet, but this showdown between rival
populisms is in fact a battle over political legitimacy. Is Wall Street the
rightful master of our economic fate? Or should we choose a broader form of
sovereignty? Let the conservatives' hosannas turn to sneers. The market god
has failed.
Thomas Frank, "Wall Street Bonuses Are an Outrage: The public
sees a self-serving system for what it," The Wall Street Journal,
February 4, 2009 ---
http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion
Bob Jensen's threads on outrageous compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
5. Congress, perhaps intentionally under the leadership of President
Obama, is now turning the economic crisis into a perfect storm to bailout
spendthrift state governments, ailing companies and unions such as American
automobile manufacturers and the United Auto Workers, most anybody else with
a sob story.
Cartoon link forwarded by David
Fordham
http://blogs.indystar.com/varvelblog/archives/2008/11/feeding_time.html
|
The problem
with the current bailout is that the government may be giving money
to companies that don't have a long-term future: zombies. On paper,
for example, the Treasury Dept. says it invests Troubled Asset
Relief Program (TARP) money only in "healthy banks—banks that are
considered viable without government investment" because "they are
best positioned to increase the flow of credit in their
communities." That's the right idea. In practice, though, the
criteria aren't so stringent. Banks like Citigroup still aren't
strong enough to lend. "The bailout model is socialism," says R.
Christopher Whalen, senior vice-president for consultancy
Institutional Risk Analytics. He advocates selling failed
institutions in pieces, as was done to resolve the savings and loan
crisis in the late '80s and early '90s. In fact, Washington may be
moving toward something like that with Citigroup. When a big
employer runs into trouble, it's tempting to keep it going at any
cost. Economists call this "lemon socialism"—the investment of
public money in the worst companies rather than the best. The
impulse is misguided, says Yale University economics professor
Eduardo M. Engel. "You don't want to protect the jobs," he says.
"What you want to protect is workers' income during the transition
from one job to another."
Peter Coy, "A New Menace
to the Economy: 'Zombie' Debtors Call them "zombie" companies. Many
more has-been companies will be feeding off taxpayers, investors,
and workers—sapping the lifeblood of healthier rivals," Business
Week, January 15, 2008 ---
http://www.businessweek.com/magazine/content/09_04/b4117024316675.htm?link_position=link2
But now we come to the most dangerous
assumption underlying the rumored Obama approach -- the idea that we
need something called Citi and BofA quickly liberated from their
past mistakes so they can go back to serving as the engines of the
economy. They aren't the engines of the economy -- we have a vast
and diversified financial sector. Today's real problem is a shortage
of reliable borrowers, especially given the uncertainty about house
prices. Washington's misguided goal, if you listen closely, seems to
be turning these giant banks into public utilities to "jumpstart
lending" under political duress. That is, shoveling money at an
overleveraged private sector in hopes of stopping the economy from
shrinking and markets from clearing.
Holman W. Jenkins, Jr.,
"Obama's Dangerous Bank Bailout: Restoring Citi and BofA to
greatness shouldn't be the goal," The Wall Street Journal,
February 4, 2009 ---
http://online.wsj.com/article/SB123371119661046143.html?mod=todays_us_opinion
|
Sad, because this is likely to be Obama's
last shot at getting this economy on its feet and running by 2010.
For Americans are not as patient as they were in the 1930s, when FDR
could try one idea, then another, then another for five years, and
continue to roll up massive electoral victories. If Obama gets this
one wrong, and all this pork and welfare fail to generate real
growth, his party could face a wipeout in 2010, and his opportunity
could be lost forever. Does he really want to bet the farm on the
nag Nancy Pelosi just trotted out of the House?
Patrick Buchanan, "Nancy
Pelosi's New Deal." WorldNetDaily, February 3, 2009 ---
http://www.worldnetdaily.com/index.php?fa=PAGE.view&pageId=87870
|
Lou Dobb's Video on Where the Pork is Embedded in the Stimulus Sausage
---
http://www.thehopeforamerica.com/play.php?id=340
Indeed it might not be worth breaking a sweat if
the stimulus bill was going to spend the measly $168 billion that George
Bush's tax rebates threw at the economy last year. Nobody gets upset anymore
if Washington wastes a hundred billion dollars. But coming after four months
of the TARP's dizzying billions spent in futility, we get a president
proposing to spend nearly $1,000,000,000,000 on what he calls "stimulus."
Even a populace numb to its government's compulsive spending woke up to that
fantastic sum. . . . The whole congressional effort is an irrelevant
sideshow; only the final spending number matters. The economics don't
matter, because the real political purpose of the bill is to neutralize this
issue until the economy recovers on its own. Much of its spending is a
massive cash transfer to the party's union constituencies; a percentage of
that cash will flow back into the 2010 congressional races. The bill in
great part is a Trojan horse of Democratic policies not related to anyone's
model of economic stimulus. Finally, if this bill's details are irrelevant
to the presumed multiplier effect of an $800 billion Keynesian stimulus, GOP
Sen. Susan Collins's good-faith participation in it looks rather foolish.
Daniel Henninger, "Exactly How
Does Stimulus Work? Separating economics from theatrics," The Wall Street
Journal, February 12, 2009 ---
http://online.wsj.com/article/SB123440338832275537.html?mod=djemEditorialPage
"This is probably the worst bill that has been put forward since the
1930s," says Harvard University's liberal macroeconomist ---
http://en.wikipedia.org/wiki/Robert_Barro
"An interview with Robert Barro (Harvard Professor of Economics),"
by Conor Clarke, The Atlantic, February 5, 2009 ---
http://business.theatlantic.com/2009/02/an_interview_with_robert_barro.php
I wanted to speak with Professor Barro after
reading his
piece
in the Wall Street Journal about the
multiplier on government spending. The piece, which argued that the
multiplier has historically been much lower than the Obama
administration hopes, produced a tremendous amount of response --
from
Paul Krugman,
Brad DeLong,
Greg Mankiw,
Matt Yglesias, and
Tyler Cowen (some of them several times). And
that response was notable, in part, because it turned into a reflection
on the "standards" of the stimulus debate itself. I was interested to
hear what Barro thought about his critics this debate.
He was admirably patient with my questions:
Conor Clarke: What I am trying to do is sort of apply a barometer to
modern macroeconomics and see where the profession is, because I am sort
of confused by a lot of things.
Robert Barro: [laughs] Probably the fault of the profession.
Well, one thing I am confused by is where all of this resurgent
interest and fiscal policy came from. That's very broad. But where do
you think it came from? When I took macroeconomics in college there was
not a lot about fiscal policy.
It came from the crisis and memories of the Great Depression and the
fact that monetary policy seems to have done not a tremendous amount,
and conventional stuff doesn't look like its going to work anymore. And
it's about grasping at straws to try and find something else.
And I take it from the Wall Street Journal piece you wrote last
week... well, the piece is just specifically about measuring
multipliers, but I take it that you are fairly skeptical in general that
fiscal policy will boost aggregate demand.
Right. There's a big difference between tax rate changes and things that
look just like throwing money at people. Tax rate changes have actual
incentive effects. And we have some experience with those actually
working.
What would you say is the best empirical evidence there?
Well, you know, it worked to expand GDP for example in '63 and '64 with
the Kennedy/Johnson cuts. And then Reagan twice in '81 and '83 and then
in '86. And then the Bush 2003 tax-cutting program. Those all worked in
the sense of promoting economic growth in a short time frame.
I'm the middle of a study where I am trying to estimate this overall,
going back to 1913 -- sort of constructing some measure of the overall
effect of the tax rate at the margin, at the moment. I'm just looking at
that now, actually...
You're talking about the multiplier on a dollar of...
Well both things, but here I'm talking about the tax rate stuff. Get
some measure of the effect of marginal tax rate that comes from the
government -- federal, state, local. And then you can see what it looks
like going down or going up and how the economy responds. And then, in
addition to that, the government might be spending more or less money on
either military stuff or not on military stuff. And we can estimate that
at the same time. With the government spending stuff, the clearest
evidence is in wartime. It's not that it's the most pertinent, but it's
the clearest in terms of evidence because it's the dominating evidence
at those times, especially during the world wars.
Do you read Paul Krugman's blog?
Just when he writes nasty individual comments that people forward.
Oh, well he wrote a series of posts saying he thought the World War
II spending evidence was not good, for a variety of reasons, but I
guess...
He said elsewhere that it was good and that it was what got us out of
the depression. He just says whatever is convenient for his political
argument. He doesn't behave like an economist. And the guy has never
done any work in Keynesian macroeconomics, which I actually did. He has
never even done any work on that. His work is in trade stuff. He did
excellent work, but it has nothing to do with what he's writing about.
I'm not in a position to...
No, of course not.
I'm not in a position to know things like the degree to which Paul
Krugman counts as a relevant expert on new Keynesian economics.
He hasn't done any work on that. Greg Mankiw has worked in that area.
And Greg Mankiw is, I guess, skeptical of spending for the same
reasons that you are: he says that there's some empirical evidence -- I
think he cites the Christina Romer study from 15 years ago -- that a
dollar of tax cutting has a larger impact than...
The Romer evidence is very recent actually. It's an ongoing project.
I thought it's from 1993 or something like that. Maybe that's
something else.
They have a current thing that's going to be presented at Brookings at
the next meeting, where they have some estimates of how the economy
responds to tax changes. It's not really looking at tax rates. It's
looking at tax revenue, which is not the same thing. That's mostly what
Greg was referring to, which is going to be presented in a few months.
I would need to go back and check. But one question, and I think Greg
Mankiw raises this question as well, is, Why does this set of evidence
depart from what seems like the standard Keynesian theory that a dollar
of spending would have a larger multiplier than a dollar of tax cutting?
I don't think it is really confusing at all, because when you cut taxes
there are two different effects. One is that you cut tax rates, and
therefore give people incentives to do things like work and produce more
and pay more -- maybe, depending on what kind of taxes. And then you
also maybe give people more income. This income effect is the one that's
related to this Keynesian multiplier argument, where it's usually argued
that government spending should have a bigger effect. So that's the
income effect. But the tax-rate effect, inducing people to do things
like work and produce more and invest more, is a whole separate effect,
and that could easily be much bigger than the multiplier thing, than the
income thing.
This might just be my confusion, but the inducement to work, is
separate from the idea of boosting aggregate demand and consumption in
the short run.
Oh it's exceptionally different. But the experiment is that the
government is doing something by changing the tax system to lower its
collections -- by, for example, a tax cut. The response of the economy
to that is not going just to isolate this business of giving people
money. It's also going to have these incentive effects, more than tax
rebates, on economic activity. It's going to be a combination of those
two things -- income effects and incentive effects. One piece looks like
this sort of multiplier stuff, which is analogous to government spending
-- probably because the government spending has a first-round effect
where it comes in and directly affects the aggregate demand -- and then
in the second round it sort of looks like a tax cut. That's why the
government spending thing is bigger in textbooks: because it has this
first round in addition to all these subsequent ones.
But all that is just income responses -- people having more or less
income, or the government keeping the money and then that shows up as
people's income. None of that is about responses in terms of incentives
-- incentives changing in response to lower or higher tax rates. And the
evidence that Romer and Romer look at is combining the tax rate stuff
with the income stuff. I didn't know it was possible to do that but,
hey, you get different viewpoints form different people. But the study I
am doing now is intended to include all these things together in one
framework.
And when does this study come out?
Who knows. I mean, it's a big project, we've been working on it for a
while. Part of it is just measuring, back since 1913, the effect of the
tax rate that the federal government or the total government is levying
on people. Measuring that was a big project. But we've sort of finished
that.
I just have two more questions, quickly. One is that you've mentioned
that monetary policies sort of seem to be stuck. And I guess there have
been a couple of people -- Robert Lucas is one that comes to mind and
maybe Greg Mankiw too -- who say there are other kinds of monetary
policy that can still be pursued.
Oh I agree with that. There are things that they can still do. The sort
of standard stuff. They drove the nominal rates on the usual government
paper down to zero, and they drove down the federal funds rate, so they
don't have any more leeway on that. But there is plenty of other stuff
that they can do and that they are doing.
And what is that?
The Federal Reserve is buying up all kinds of other assets, like
long-term government bonds. But they are also buying a lot of private
stuff, and that will presumably have a substantial impact. I mean
there's a downside to doing all this, but it should certainly have
effects. So in that sense they haven't run out of ammunition. I agree
with that.
The last thing is just about the stimulus bills as it stands. Two
things here. One thing is what do you think about the ratio of spending
to tax relief in the bill. And the second is, if you judge it by Larry
Summers standard -- that stimulus be temporary, timely and targeted --
does it clear the bar?
This is probably the worst bill that has been put forward since the
1930s. I don't know what to say. I mean it's wasting a tremendous amount
of money. It has some simplistic theory that I don't think will work, so
I don't think the expenditure stuff is going to have the intended
effect. I don't think it will expand the economy. And the tax cutting
isn't really geared toward incentives. It's not really geared to
lowering tax rates; it's more along the lines of throwing money at
people. On both sides I think it's garbage. So in terms of balance
between the two it doesn't really matter that much.
Well, presumably Larry Summers is not an idiot.
[laughs] That is another conversation. I have known him for 25 years,
and I have opinions about that.
Well, presumably Christina Romer is not an idiot if you're...
They've brought in some reasonable people in terms of economic advisors.
I don't know what impact they're having, and I suppose they have
different views on Keynesian macroeconomics than I have. But I'm giving
you my opinion about it.
I think Geithner is a good appointment. I think he's going to focus on
what really matters, which is the financial system and the housing
market. That's where they should be putting their efforts. That's where
the problems came from.
Fixing the credit market, you mean?
That was the main problem in the Great Depression, too. Though then it
was concentrated on commercial banks which were the main credit vehicle.
That was the main problem in the depression and fixing that was the main
thing that ended the depression.
Well since you brought it up... I have no idea what your views are on
financial economics, but it seems like there's going to be another round
of TARP-like bailouts. Do you have an opinion on how that should be
structured?
That's a hard problem. I mean, they're basically floundering around --
the crew of the previous administration more than the current one. But I
admit they're having a good effect by putting more resources into
assistance. The exact way to do it is pretty tricky. It's not clear what
the best thing to do is. Larry Summers did bring in Jeremy Stein, who is
probably one of the best people in the area. I think he's going to have
a lot of impact on that design. I hope so. That's another person they
hired recently.
From Harvard?
Yeah, he's a Harvard economics department person. He's in the White
House. Summers brought him in to advise particularly on the financial
and housing issues, the design of the new regulations structure. That
was an excellent appointment. That's the stuff that's really going to
count. Not this spending thing. I mean democrats were waiting with all
these ridiculous projects, and now they've got an excuse to bring it
through politically.
Just one last thing. I think Joe Biden and a couple other people have
said there's a fairly wide consensus among economists that fiscal
stimulus in the form of a large spending bill is the way to go, and...
He said first that every economist thought that.
Well, that's Joe Biden hyperbole. But what is the lay of the land
there? Presumably there are economists out there that take this
seriously. And then there are economists out there who think there's a
one-for-one crowding out with any government spending. And I guess,
where does the profession fall on that spectrum?
Most economists haven't really been thinking about this issue, they
haven't really focused on it. It's not their specialty. Most economists
today, they haven't really been thinking about this kind of multiplier
issue. Which goes back to that first question you asked about how come
now we're so worried about this. I don't think most economists are
focused on this, or that they're familiar with the empirical evidence. I
don't think they've really worked on the theory. So I don't know, maybe
they have some opinion that they got from graduate school or something.
I think my sense is that the sentiment has been moving against this kind
of approach both within the economics profession and more broadly. I
think the initial view was that "yeah, this is a terrible situation" --
which I agree with -- "and we've got to do something about this, and
maybe this will work." I think there was support in that sense.
Are there any conditions under which you might think spending could
have a positive effect on output or is it always going to be the case
that as a relative matter that tax cuts are going to be better?
Tax cuts are bound to be better. I think the best evidence for expanding
GDP comes from the temporary military spending that usually accompanies
wars -- wars that don't destroy a lot of stuff, at least in the US
experience. Even there I don't think it's one for one, so if you don't
value the war itself it's not a good idea. You know, attacking Iran is a
shovel-ready project. But I wouldn't recommend it.
President Obama could have made big history here
(Stimulus Bill). Instead he just got a win. It's a missed opportunity. It's
a win because of the obvious headline: Nine days after inauguration, the new
president achieves a major Congressional victory, House passage of an
economic stimulus bill by a vote of 244-188. It wasn't even close. This is
major. But do you know anyone, Democrat or
Republican, dancing in the street over this?
You don't. Because most everyone knows it isn't a good bill, and knows that
its failure to receive a single Republican vote, not one, suggests the old
battle lines are hardening. Back to the Crips versus the Bloods. Not very
inspiring.
"Look at the Time In Congress and the boardroom, failure to
recognize a new era," The Wall Street Journal, January 31, 2009 ---
http://online.wsj.com/article/SB123326587231330357.html?mod=djemEditorialPage
Actually there are millions of people dancing in the street over the
Obama/Pelosi/Reid give away!
A
democracy cannot exist as a permanent form of government. It can only
exist until the voters discover that they can vote themselves largesse
from the public treasury. From that moment on, the majority always votes
for the candidates promising the most benefits from the public treasury,
with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.
Alexander Tyler. 1787 -
Tyler was a Scottish history professor that had this to say about 2000
years after "The Fall of the Athenian Republic" and about the time our
original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm
(where the debt clock in real time is a few months behind)
House Republicans have challenged Speaker Nancy
Pelosi (D-Calif.) to release the details of the expected $500 billion
proposed omnibus appropriations legislation encompassing the nine remaining
spending bills for fiscal year 2009. Entirely separate from the $1.2
trillion Democrat “stimulus” spending bill passed by the House last week
with no Republican support, this additional estimated half-trillion dollar
omnibus spending bill was scheduled for consideration as early as today.
Pelosi removed the bill from the legislative calendar yesterday amid
Democrat fears that the actual omnibus spending bill may help scuttle
passage of the trillion-dollar “stimulus” spending bill already in very deep
trouble...
Connie Hair , "Pelosi Pulls
Omnibus Bill Rumored To Cost $500 Billion," Human Events, February 4,
2009 ---
http://www.humanevents.com/article.php?id=30554
Jensen Comment
It really is silly to worry about how much this new Democratic Party
Congressional monopoly spends. Whatever they spend requires no new taxes or
borrowing. The U.S. has already adopted the Zimbabwe Theory of Finance (read
that just print trillions of dollars whenever they want).
For when the One Great Scorer comes to mark against your name,
He writes both that you lost and how you blew the Game.
Grantlund Rice (as revised by Bob
Jensen)
"How to Spend the Stimulus," by Michael Grunwald,
Time Magazine, February 16, 2009 ---
http://www.time.com/time/magazine/article/0,9171,1877385,00.html
Barack Obama
wanted a bill that would jump-start the economy and invest in the
future. Congress has larded it with wasteful spending and
special-interest tax cuts.
But there have been
more serious critiques of the $900 billion--plus American Recovery and
Reinvestment Act--from more serious critics. The stimulus smorgasbord
does include some head scratchers, like $246 million worth of tax breaks
for movie producers to buy film and $1.4 billion for "rural
waste-disposal programs." Principled conservatives worry that it's so
big, it will institutionalize Big Government; principled liberals worry
that it won't be big enough to resuscitate a flatlined economy. And a
bipartisan chorus--including Clinton Administration budget chief Alice
Rivlin and Reagan Administration economist Martin Feldstein--has argued
that the stimulus package ought to be all about stimulus. Those people
want to focus on fighting the recession, and they don't see Pell Grants,
renewable-energy subsidies, health-care technology and Head Start as the
best ways to do that. "Many of them are worthy, but we can have that
debate another day," argues conservative New York Times columnist David
Brooks.
It really does
matter how the money is spent. But actually, we had that debate in
November, and Obama won. This crisis is an ideal opportunity for him to
start keeping his campaign promises: providing tax relief and health
security to ordinary Americans, restoring our economic competitiveness
and reducing our dependence on environmentally disastrous fossil fuels,
which increases the power of our enemies. It's hard to imagine when
he'll have a better opportunity. Nothing in the historical record
suggests that when Congress has more time to deliberate--and more time
to confer with special-interest lobbyists and local-interest political
advisers--it enacts fair tax policies, sustainable energy policies, wise
infrastructure policies, responsible fiscal policies or any other
policies tainted by long-term thinking or national-interest
considerations. If Obama wants to push 21st century change through
Capitol Hill, he needs to use this emergency.
Continued in article
The "Stimulus Bill" has already gone too
far after special interest (including our colleges) cohorts in the
United States discovered "they can vote themselves largesse from the
public treasury." There's no turning back. The Stimulus Bill morphed
into a Perfect (Stimulus) Storm for a socialist revolution in the United
States.
So our conclusion is that the net stimulus to short-term GDP will not be
zero, and will be positive, but the stimulus is likely to be modest in
magnitude. Some economists have assumed that every $1 billion spent by the
government through the stimulus package would raise short-term GDP by $1.5
billion. Or, in economics jargon, that the multiplier is 1.5. That seems too
optimistic given the nature of the spending programs being proposed. We
believe a multiplier well below one seems much more likely . . . In
addition, although politics play an important part in determining all
government spending, political considerations are especially important in a
spending package adopted quickly while the economy is reeling, and just
after a popular president took office. Many
Democrats saw the stimulus bill as a golden opportunity to enact spending
items they've long desired. For this reason,
various components of the package are unlikely to pass any reasonably
stringent cost-benefit test ... Our own view is that the short-term stimulus
from the legislation before Congress will be smaller per dollar spent than
is expected by many others because the package tries to combine short-term
stimulus with long-term benefits to the economy. Unfortunately, short-term
and long-term gains are in considerable conflict with each other. Moreover,
it is very hard to spend wisely large sums in short periods of time. Nor can
one ever forget that spending is not free, and ultimately it has to be
financed by higher taxes.
Nobel Laureate Gary S. Becker and Kevin M. Murphy,
"There's No Stimulus Free Lunch: It's hard to spend wise and spend
fast," The Wall Street Journal, February 10, 2009 ---
http://online.wsj.com/article/SB123423402552366409.html?mod=djemEditorialPage
The Perfect (Stimulus) Storm for California
A new analysis shows that California would get a
whopping $21.5 billion under an economic stimulus plan that's expected to be
approved by the House next week, making it the biggest winner among the 50
states. That's according to the National Conference of State Legislatures, which
analyzed the new spending proposals offered by House leaders.
Rob Hotakainen , "California could reap
$21.5 billion from U.S. stimulus plan," The Sacramento Bee, January
24, 2009 ---
http://www.sacbee.com/capitolandcalifornia/story/1569761.html
Los Angeles hopes to get $5.5 billion ---
http://www.2theadvocate.com/news/politics/38517612.html
San Francisco might even stop harassing the U.S. military and the Immigration
Service for a day in return for a few billion.
The Less-Than-Perfect (Stimulus) Storm for Illinois (until they
impeached Blago)
None of the funds provided by this Act may
be made available to the State of Illinois, or any agency of the State,
unless (1) the use of such funds by the State is approved in legislation
enacted by the State after the date of the enactment of this Act, or (2) Rod
R. Blagojevich no longer holds the office of Governor of the State of
Illinois.
Draft of the Stimulus Act
I’m unaware of any previous case of the Congress
dangling a bag of money over state legislators’ heads like this before. I’d
also be surprised if it fails, no matter how commanding Blagojevich looks on
“The View.” Illinois is not really in the position to turn down cash right
now.
David Weigel, "Starving Out Blago," The Washington Independent,
January 26, 2009 ---
http://washingtonindependent.com/27252/starving-out-blago
The Perfect (Stimulus) Storm for Construction After the Recession
An analysis by Forbes publications of where
most jobs will be created singles out engineering, accounting,
nursing, and information technology, along with construction
managers, computer-aided drafting specialists, and project managers.
Unemployment rates among most of these specialists are not high. The
rebuilding of "crumbling roads, bridges, and schools" highlighted by
in various speeches by President Obama is likely to make greater use
of unemployed workers in the construction sector. However, such
spending will be a small fraction of the total stimulus package, and
it is not easy for workers who helped build residential housing to
shift to building highways . . . The likelihood that such a rapid
and large public spending program will be of low efficiency is
compounded by political realities. Groups that have lots of
political clout with Congress will get a disproportionate amount of
the spending with only limited regard for the merits of the spending
they advocate compared to alternative ways to spend the stimulus.
The politically influential will also redefine various projects so
that they can fall under the "infrastructure" rubric. A report
called Ready to Go by the U.S. Conference of Mayors lists $73
billion worth of projects that they claim could be begun quickly.
These projects include senior citizen centers, recreation
facilities, and much other expenditure that are really private
consumption items, many of dubious value, that the mayors call
infrastructure spending. Recessions would be a good time to increase
infrastructure spending only if these projects can mainly utilize
unemployed resources. This does not seem to be the case in most of
the so-called infrastructure spending proposed under various
stimulus plans.
Nobel Laureate Gary Becker,
The Becker-Posner Blog, January 18, 2009 ---
http://www.becker-posner-blog.com/
The Perfect (Stimulus) Storm for Labor Unions (Half of Stimulus Goes
to Union)
Almost half of the $820 billion would end up in the
pockets of Democratic-controlled unions, such as the Service Employees
International Union, and federal, state, and municipal employee unions. At
680 pages long, neither Obama nor any member of the House had enough time to
read the entire bill before the House voted. The $820 billion would be
enough to give every unemployed American $75,000. Says Ben Stein: "There has
been pork-barrel politics since there has been politics, but the scale of
this pork is beyond what had ever been imagined before -- and no one can be
sure it will actually do much stimulation. ... This has been a punch in the
solar plexus to the kind of responsible, far-seeing, mature government
processes that are needed to protect America."
"Ben Stein: Half of Stimulus Goes to Unions," NewsMax,
February 1, 2009 ---
Click Here
The Perfect (Stimulus) Storm for Signing Up Voters for the Democratic
Party
The House Democrats’ trillion dollar spending bill,
approved on January 21 by the Appropriations Committee and headed to the
House floor next week for a vote, could open billions of taxpayer dollars to
left-wing groups like the Association of Community Organizations for Reform
Now (ACORN). ACORN has been accused of perpetrating voter registration fraud
numerous times in the last several elections; is reportedly under federal
investigation; and played a key role in the irresponsible schemes that
caused a financial meltdown that has cost American taxpayers hundreds of
billions of dollars since last fall. House Republican Leader John Boehner
(R-OH) and other Republicans are asking a simple question: what does this
have to do with job creation? Are Congressional Democrats really going to
borrow money from our children and grandchildren to give handouts to ACORN
in the name of economic “stimulus?” Incredibly, the Democrats’ bill makes
groups like ACORN eligible for a $4.19 billion pot of money for
“neighborhood stabilization activities.” Funds for this purpose were
authorized in the Housing and Economic Recovery Act, signed into law in
2008. However, these funds were limited to state and local governments. Now
House Democrats are taking the unprecedented step of making ACORN and other
groups eligible for these funds:
Rick Moran, "ACORN eligible for billions from stimulus plan,"
American Thinker, January 26, 2009 ---
http://www.americanthinker.com/blog/2009/01/acorn_eligible_for_billions_fr.html
Jensen Comment
Keith Olbermann correctly points out that ACORN will not get the funds
directly but must bid competitively for such funds. What he does not explain
is why ACORN appeals so much to the Democrats controlling the Bailout
disbursements.
The group (ACORN) that pushed banks into the
risky loans that brought the economy down is now eligible for a huge chunk
of stimulus cash. The stimulus plan does create jobs — for community
activists.
"ACORN's Seed Money," Investor's Business Daily,
January 27, 2009 ---
http://www.ibdeditorials.com/IBDArticles.aspx?id=317952439188615
Jensen Comment
It's never too late to create new jobs to register fictitious and real
street people to vote for
Democrats. Soon ACORN will have stimulus funds to register more Democrats.
The goal is to have only the most liberal Democrats in all three branches of the Federal Government.
Michael Moore may well replace Obama eight years from now.
The Perfect (Stimulus) Storm for Transfer Payments to Medicaid and the
Poor
Another "stimulus" secret is that some $252 billion
is for income-transfer payments -- that is, not investments that arguably
help everyone, but cash or benefits to individuals for doing nothing at all.
There's $81 billion for Medicaid, $36 billion for expanded unemployment
benefits, $20 billion for food stamps, and $83 billion for the earned income
credit for people who don't pay income tax. While some of that may be
justified to help poorer Americans ride out the recession, they aren't job
creators.
"A 40-Year Wish List You won't believe what's in
that stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage
Buried deep inside the massive spending orgy
that Democrats jammed through the House this week lie five words that could
drastically undo two decades of welfare reforms. The very heart of the
widely applauded Welfare Reform Act of 1996 is a cap on the amount of
federal cash that can be sent to states each year for welfare payments. But,
thanks to the simple phrase slipped into the legislation, the new "stimulus"
bill abolishes the limits on the amount of federal money for the so-called
Emergency Fund, which ships welfare cash to states.
Charles Hurt, "Change for the
Worse," New York Post, January 30, 2009 ---
Click Here
The Perfect (Stimulus) Storm for school districts, child care centers
and university campuses
The economic stimulus plan that Congress has
scheduled for a vote on Wednesday would shower the nation’s school
districts, child care centers and university campuses with $150 billion in
new federal spending, a vast two-year investment that would more than double
the Department of Education’s current budget. . . . Critics and supporters
alike said that by its sheer scope, the measure could profoundly change the
federal government’s role in education, which has traditionally been the
responsibility of state and local government.
Sam Dillon, "Stimulus Plan Would
Provide Flood of Aid to Education, "The New York Times, January 31,
2009 ---
http://www.nytimes.com/2009/01/28/education/28educ.html
Jensen Comment
It's beginning to smell like annual entitlements here as recipients become
dependent upon their government checks (which might better be called the
checks and no-balances system of Congressional financing).
Some of the research-and-education spending in
the bill has attracted little attention. Senators barely blinked at the
bill's $3.5-billion for the National Institutes of Health, even adding
$6.5-billion more to the agency's budget during the floor debate. But a
growing number of lawmakers, most of them Republican, were questioning the
$16-billion in Pell money, saying it would do little to create jobs or spur
economic growth. "It's not a question of the merits of Pell funding. It's a
question of whether it creates jobs and qualifies as emergency spending,"
said Alexa Marrero, a spokeswoman for Rep. Howard P. (Buck) McKeon, the top
Republican on the House education committee. "If it doesn't, it needs to be
debated" in the annual appropriations process instead. Some critics go so
far as to say the Pell increase would be an economic loser because it would
put less money into the pockets of taxpayers who aren't attending college.
Kelly Field, "Skeptics Say Billions for Education Won't Stimulate Economy,"
Chronicle of Higher Education, February 13, 2009 ---
http://chronicle.com/weekly/v55/i23/23a00102.htm?utm_source=at&utm_medium=en
Jensen Comment
Much of the pork that has been added to the Stimulus Bill is for very worthy
causes. The question is whether funding for these pork pies should come
under the guise of putting unemployed workers back to work very quickly as
opposed to being funded un the usual non-emergency process in Congress.
Congress is attempting to lard up the emergency legislation with funding
that otherwise might have a more difficult time in the normal process. This
might be more acceptable if the money was actually available from taxes or
borrowing. It is not available, which is why the Stimulus Bill will be
heavily funded by merely printing money like they do in Zimbabwe.
The Perfect (Stimulus) Storm for Amtrak, Artists, Child Care
Businesses, and Global Warming Research
We've looked it over, and even we can't quite
believe it. There's $1 billion for Amtrak, the federal railroad that hasn't
turned a profit in 40 years; $2 billion for child-care subsidies; $50
million for that great engine of job creation, the National Endowment for
the Arts; $400 million for global-warming research and another $2.4 billion
for carbon-capture demonstration projects. There's even $650 million on top
of the billions already doled out to pay for digital TV conversion coupons.
"A 40-Year Wish List You won't believe what's in that
stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage
The Perfect (Stimulus) Storm for Failing Newspapers
Taxpayer cash is going to rescue so many people
these days that it is hard to sort the truly awful ideas from the merely
terrible. Then we heard the doozy out of Pennsylvania, where Governor Ed
Rendell has discussed a state bailout of the company that owns a pair of
Philadelphia newspapers, the Inquirer and the Daily News. Philadelphia Media
Holdings is in default on its loans, having missed debt payments going back
to June. With no buyers knocking on the door, the Philadelphia Bulletin has
reported, owner Brian Tierney went hat-in-hand to the Governor's office to
talk about giving the paper some public help. Mr. Tierney won't comment on
the record, while Mr. Rendell's spokesman tells us the conversations weren't
specific but that state help is a possibility. Times are tough, but as they
say in Philadelphia, this is nuts in eight different ways. Starting as a
business proposition: When McClatchy bought Knight Ridder in 2006, the
Inquirer and the Philadelphia Daily News were spun off and sold for $515
million to investors led by Mr. Tierney, who made his money in advertising
and public relations. The buyers put up around 20% in equity and took on
some $400 million in debt, enough leverage to raise eyebrows even before the
credit crunch. Mr. Tierney is now no different than thousands of other
Americans who borrowed too heavily during the credit mania.
"Bad News in Philadelphia The worst bailout idea so
far: newspapers," The Wall Street Journal, February 2, 2009 ---
http://online.wsj.com/article/SB123353263226537457.html?mod=djemEditorialPage
Jensen Comment
Only newspapers that were unfledging in support of Obama in the 2008
election might be bailed out. That means almost all of them that are about
to go bankrupt, including The New York Times.
The Perfect (Stimulus) Storm for Democrats in Congress
This is supposed to be a new era of bipartisanship,
but this bill was written based on the wish list of every living -- or dead
-- Democratic interest group. As Speaker Nancy Pelosi put it, "We won the
election. We wrote the bill." So they did. Republicans should let them take
all of the credit.
"A 40-Year Wish List You won't believe what's in that
stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage
But the real risk here is to Mr. Obama, and it
isn't from Republicans. It's from his fellow Democrats. Given the miserable
economy and the Beltway's neo-Keynesian policy consensus, a true compromise
would have gathered overwhelming support. But rather than use Mr. Obama's
political capital to craft such a deal, the White House abdicated to Speaker
Nancy Pelosi. House Democrats proceeded to ignore all GOP suggestions as
they wrote the bill, shedding tax cuts while piling on spending for every
imaginable interest group. The bipartisan opposition reflects how much the
Pelosi bill became a vehicle for partisan social policy rather than economic
stimulus.
"A Warning to the President The cost of abdicating to Nancy
Pelosi," The Wall Street Journal, January 30, 2009 ---
http://online.wsj.com/article/SB123327812504331563.html?mod=djemEditorialPage
After decades of watching their extravagant,
wooly-headed, far-left programs languish in never-never land, Democrats are
now realizing their once-forlorn hopes for a return to the good old days.
Massive giveaways for their pet socialist schemes — and payoffs to labor
unions and other financial supporters — will now be the order of the day.
This time they are outdoing their New Deal, Fair Deal, Great Society
overspending extravaganzas, cobbling together an $825 billion package they
laughingly call a stimulus program, allegedly designed to put unemployed
Americans back to work and get the economy back on track.
Michael Reagan, "Unclogging
The Liberal Money Pipeline," The Philadelphia Bulletin, January 30,
2009 ---
http://www.thebulletin.us/articles/2009/01/30/commentary/editorials/doc498284c72d9b0049142444.txt
The Perfect (Stimulus) Storm for a Universal Healthcare Entitlement in
the United States
The more we dig into the pile of spending and tax
favors known as the "stimulus bill," the more amazing discoveries we make.
Namely, Democrats have apparently decided that the way to gun the economy is
to spend even more on health care. This is notable because if there has been
one truly bipartisan idea in Washington, it's that the U.S. as a whole
spends too much on health care. President Obama has been talking up
entitlement reform as a way to free up the money for his other social
priorities. But it turns out that Congress is using the stimulus as cover
for a massive expansion of federal entitlements.
"The Entitlement Stimulus: More giant steps
toward government," The Wall Street Journal, January 29, 2009 ---
http://online.wsj.com/article/SB123318915075926757.html?mod=djemEditorialPage
Jensen Comment
On January 28, ABC News reported how the Canadian Universal Health Care Plan
was so much more efficient in terms of accounting efficiency, largely
because third party billing in the U.S. has become a quagmire.
However, what
ABC failed to mention, probably deliberately, is that over half of the
average Canadian's salary is taxed mostly for health care. Much has been
made about the months or years Canadians wait for non-emergency medical
treatments. But seldom does the liberal U.S. press mention the enormous tax
bill that goes with the Canadian Universal Health Care Plan. Taxpayers need
not worry in the United States however. The new entitlement payment plan in
the U.S. simply entails printing money rather than taxing or borrowing ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
The Perfect (Stimulus) Storm for Welfare Junkies
"The Return of Welfare As We Knew It: The House stimulus bill
endangers Clinton's biggest reform," The Wall Street Journal,
February 10, 2009 ---
http://online.wsj.com/article/SB123422835499665849.html?mod=djemEditorialPage
Twelve years ago, President Bill
Clinton signed a law that he correctly proclaimed would end "welfare as
we know it." That sweeping legislation, the Personal Responsibility and
Work Opportunity Act, eliminated the open-ended entitlement that had
existed since 1965, replacing it with a finite, block grant approach
called the Temporary Assistance to Needy Families (TANF) program.
TANF has been a remarkable success.
Welfare caseloads nationally fell from 12.6 million in 1997 to fewer
than five million in 2007. And yet despite this achievement, House
Democrats are seeking to undo Mr. Clinton's reforms under the cover of
the stimulus bill.
Currently, welfare recipients are
limited to a total of five years of federal benefits over a lifetime.
They're also required to begin working after two years of government
support. States are accountable for helping their needy citizens
transition from handouts to self-sufficiency. Critically, the funds
provided to states are fixed appropriations by the federal government.
Through a little noticed provision of
the stimulus package that has passed the House of Representatives, the
bill creates a fund for TANF that is open-ended -- the same way Medicare
and Social Security are.
In the section of the House bill
dealing with cash assistance to low-income families, the authors
inserted the bombshell phrase: "such sums as are necessary." This is a
profound departure from the current statutory scheme, despite the fact
that, in this particular bill, state TANF spending would be capped. The
"such sums" appropriation language is deliberately obscure. It is a
camel's nose provision intended to reverse Clinton-era legislation and
create a new template for future TANF reauthorizations.
Most liberals have always disliked
welfare reform; critics of TANF believed Mr. Clinton supported it only
to get re-elected. Some asserted it was racist or intended to punish the
poor. Others claimed that the funds to assist single mothers with child
care, transportation and job training were never as generous as were
allegedly promised. Today, the fact that disqualification from the
program is based on failing to secure a job within two years seems
especially harsh given this economic crisis.
There are legitimate objections to the
program that are worth debating. But this is not an open debate: It is a
near secret provision buried deep in a more than 600-page piece of
legislation.
The TANF provisions of the stimulus
bill, like the nearly $100 billion Medicaid provisions, are less about
stimulating the economy, and more about the federal government absorbing
the states' budget problems. State budgets may be swamped with those
needing temporary relief, and a contingency fund could help. But it
should be a definite amount, not a precedent-setting, open-ended amount.
(If the initial TANF allocation is not sufficient, Congress could
appropriate another definite amount.)
The offending language is not in
yesterday's Senate version of the bill, but that provides little
comfort. The attempt to undo welfare reform has not been transparent,
and the conference committee provides the perfect closed-door
environment for slipping in "such sums" language into the final bill
without public scrutiny.
Welfare reform was arguably the most
important legislative development of the mid-1990s. It is bad policy to
jettison it with five words during an economic crisis.
All who are concerned about our
nation's unfunded obligations should be on guard against attempts to
slip "such sums" language into any conference committee bill. Welfare
policy is too important to change with a stealth maneuver.
Mr. Sasse, former U.S. assistant secretary of
Health and Human services, teaches policy at the University of Texas.
Mr. Weems, former vice chairman of the American Health Information
Community, held the position of administrator of the Centers for
Medicare and Medicaid services until last month.
The Perfect (Stimulus) Storm for Fannie Mae and Freddie Mac
Although shareholders in Fannie and Fred sucked gas, the companies
themselves are being bailed out
"Fan and Fred's Lunch Tab A quarter-trillion dollars, and rising,"
The Wall Street Journal, January 29, 2009 ---
http://online.wsj.com/article/SB123318925593626697.html?mod=djemEditorialPage
It seems a lifetime ago, but it's only been six
months since the Congressional Budget Office put a $25 billion price tag
on the legislation to bail out Fannie Mae and Freddie Mac. At the time,
then CBO Director Peter Orszag told Congress that there was a "probably
better than 50%" chance that the government would never have to spend a
dime to shore up the two government-sponsored mortgage giants.
So much for that. In the past few days Fannie
and Freddie have requested a combined $51 billion from the Treasury to
compensate for losses in their loan portfolios. This comes on top of the
$13.8 billion that Freddie needed in November.
The latest requests take the tab to $70 billion
or so -- but that's not the end of the story by a long shot. Earlier
this month, CBO released its biannual budget outlook. And largely
ignored underneath the $1.2 trillion deficit estimate for fiscal 2009
was the little matter of a $238 billion charge for rescuing Fan and
Fred. To put that in perspective, $238 billion is more than the entire
federal budget deficit in fiscal 2007
The CBO's $238 billion estimate represents its
guess of the long-term cost of paying for the guarantees that Fannie and
Freddie write on their mortgage-backed securities. Nor is that just a
post-bubble hangover. The last $38 billion of that is for losses on new
business this year. And for all anyone knows, that number, like the
earlier estimates, is wildly optimistic.
For starters, that $238 billion doesn't include
$18 billion that the CBO expected the Treasury to lend the wonder twins
this year. But in any case we're already well beyond $18 billion on that
score: As of this week they've already requested $70 billion since the
fiscal year began -- and we still have eight months to go. So you can
add $70 billion to the $238 billion, which gets us to $308 billion --
and even that might be conservative. Rajiv Setia, an analyst at
Barclays, figures the duo will need $120 billion from Treasury this year
alone, which would mean another $50 billion on top of the $70 billion
already requested.
Back when the bailout was being debated last
July, Senator Jon Tester (D., Mont.) worried that the Fan and Fred
bailout could cost $1 trillion. Given that the two companies combined
have more than $5 trillion in debt and mortgage backed securities
outstanding, Mr. Tester's guess isn't looking worse than anyone else's.
At that same time, Senator Kent Conrad (D.,
N.D.) said that the CBO's $25 billion estimate would be "very helpful to
those who want to advance this legislation." And no doubt it was. A
spokeswoman for Fannie promoter Barney Frank said then, "we especially
like that there is less than a 50% chance that it will be used." The CBO
had figured that there was a 5% chance that losses would reach the $100
billion cap on the credit line created by the July law. Now CBO's best
guess is more than double that.
The bigger picture here is that politicians
like Mr. Frank have been telling us for years that Fannie and Freddie's
federal subsidy was a free lunch. We are now slowly, and painfully,
learning the price of Mr. Frank's famous desire to "roll the dice" with
Fan and Fred. Keep that in mind the next time you hear a politician
propose a taxpayer guarantee. The only sure thing is that the taxpayers
will pay.
Barney's Rubble ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Accounting Fraud (when Frank Raines was CEO) at Fannie Mae ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
The Perfect (Stimulus) Storm for Greening the Planet
President Obama will use billions of stimulus dollars to reduce carbon
emissions
From the "Best on the Web Today," The Wall Street Journal,
January 28, 2009:
An additional problem is that
whereas global warmists are emotionally consistent--in a
constant state of alarm, accompanied by contempt, even hatred, for
those who dare ask questions--their claims are filled with logical
inconsistencies. A reader spotted a hilarious example in this
Los Angeles Times
article:
Even if by some miracle of
environmental activism global carbon dioxide levels reverted to
pre-industrial levels, it still would take 1,000 years or longer
for the climate changes already triggered to be reversed,
scientists said Monday.The gas that is already there and
the heat that has been absorbed by the ocean will exert their
effects for centuries, according to the analysis, published
Monday in the Proceedings of the National Academy of Science.
Over the long haul, the warming
will melt the polar icecaps more than previously had been
estimated, raising ocean levels substantially, the report said.
And changes in rainfall patterns
will bring droughts comparable to those that caused the 1930s
Dust Bowl to the American Southwest, southern Europe, northern
Africa and western Australia.
"People have imagined that if we
stopped emitting carbon dioxide, the climate would go back to
normal in 100 years, 200 years," lead author Susan Solomon, a
senior scientist at the National Oceanic and Atmospheric
Administration, said in a telephone news conference. "That's not
true." . . .
Solomon said in a statement that
absorption of carbon dioxide by the oceans and release of heat
from the oceans - the one process acting to cool the Earth and
the other to warm it--will "work against each other to keep
temperatures almost constant for more than 1,000 years."
Half of the average Canadian's income is taxed mostly for health care.
This is what it buys
"'Too Old' for Hip Surgery As we inch towards nationalized health care,
important lessons from north of the border," by Nadeem Esmail, The Wall
Street Journal, February 8, 2009 ---
http://online.wsj.com/article/SB123413701032661445.html?mod=djemEditorialPage
President Obama and Congressional
Democrats are inching the U.S. toward government-run health insurance. Last
week's expansion of Schip -- the State Children's Health Insurance Program
-- is a first step. Before proceeding further, here's a suggestion: Look at
Canada's experience.
Health-care resources are not unlimited in
any country, even rich ones like Canada and the U.S., and must be rationed
either by price or time. When individuals bear no direct responsibility for
paying for their care, as in Canada, that care is rationed by waiting.
Canadians often wait months or even years
for necessary care. For some, the status quo has become so dire that they
have turned to the courts for recourse. Several cases currently before
provincial courts provide studies in what Americans could expect from
government-run health insurance.
In Ontario, Lindsay McCreith was suffering
from headaches and seizures yet faced a four and a half month wait for an
MRI scan in January of 2006. Deciding that the wait was untenable, Mr.
McCreith did what a lot of Canadians do: He went south, and paid for an MRI
scan across the border in Buffalo. The MRI revealed a malignant brain tumor.
Ontario's government system still refused
to provide timely treatment, offering instead a months-long wait for
surgery. In the end, Mr. McCreith returned to Buffalo and paid for surgery
that may have saved his life. He's challenging Ontario's government-run
monopoly health-insurance system, claiming it violates the right to life and
security of the person guaranteed by the Canadian Charter of Rights and
Freedoms.
Shona Holmes, another Ontario court
challenger, endured a similarly harrowing struggle. In March of 2005, Ms.
Holmes began losing her vision and experienced headaches, anxiety attacks,
extreme fatigue and weight gain. Despite an MRI scan showing a brain tumor,
Ms. Holmes was told she would have to wait months to see a specialist. In
June, her vision deteriorating rapidly, Ms. Holmes went to the Mayo Clinic
in Arizona, where she found that immediate surgery was required to prevent
permanent vision loss and potentially death. Again, the government system in
Ontario required more appointments and more tests along with more wait
times. Ms. Holmes returned to the Mayo Clinic and paid for her surgery.
On the other side of the country in
Alberta, Bill Murray waited in pain for more than a year to see a specialist
for his arthritic hip. The specialist recommended a "Birmingham" hip
resurfacing surgery (a state-of-the-art procedure that gives better results
than basic hip replacement) as the best medical option. But government
bureaucrats determined that Mr. Murray, who was 57, was "too old" to enjoy
the benefits of this procedure and said no. In the end, he was also denied
the opportunity to pay for the procedure himself in Alberta. He's heading to
court claiming a violation of Charter rights as well.
These constitutional challenges, along
with one launched in British Columbia last month, share a common goal: to
win Canadians the freedom to spend their own money to protect themselves
from the inadequacies of the government health-insurance system.
The cases find their footing in a landmark
ruling on Quebec health insurance in 2005. The Supreme Court of Canada found
that Canadians suffer physically and psychologically while waiting for
treatment in the public health-care system, and that the government monopoly
on essential health services imposes a risk of death and irreparable harm.
The Supreme Court ruled that Quebec's prohibition on private health
insurance violates citizen rights as guaranteed by that province's Charter
of Human Rights and Freedoms.
The experiences of these Canadians --
along with the untold stories of the 750,794 citizens waiting a median of
17.3 weeks from mandatory general-practitioner referrals to treatment in
2008 -- show how miserable things can get when government is put in charge
of managing health insurance.
In the wake of the 2005 ruling, Canada's
federal and provincial governments have tried unsuccessfully to fix the long
wait times by introducing selective benchmarks and guarantees along with
large increases in funding. The benchmarks and the guarantees aren't
ambitious: four to eight weeks for radiation therapy; 16 to 26 weeks for
cataract surgery; 26 weeks for hip and knee replacements and lower-urgency
cardiac bypass surgery.
Canada's system comes at the cost of pain
and suffering for patients who find themselves stuck on waiting lists with
nowhere to go. Americans can only hope that Barack Obama heeds the lessons
that can be learned from Canadian hardships.
Mr. Esmail, based in Calgary, is the director of Health
System Performance Studies at The Fraser Institute.
Jensen Comment
The problem with so much tax for so little health care is that Canada has
not resorted to the Zimbabwe Theory of Finance that will be used to finance
the United States Universal Health Care Plan. Why should Canadians who
currently benefit national health care have to pay something toward their
own care? Let unborn babies eventually pay the price! Who really cares if if
an MRI costs $1 million U.S. Zimbabwe-like dollars? Our great
grandchildren are not yet born. They can't today protest when it might've
counted. Let 'em wait until we're dead and it's too late for them to
protest.
Glenn Beck Explains What's Wrong With Obama's Stimulus Program (video)
---
http://www.thehopeforamerica.com/play.php?id=249
A Famous Economist Explains What's Wrong With Obama's Stimulus Program
But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best
Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory
of Employment, Interest and Money." The financial crisis and possible depression
do not invalidate everything we have learned about macroeconomics since 1936.
Much more focus should be on incentives for people and businesses to invest,
produce and work. On the tax side, we should avoid programs that throw money at
people and emphasize instead reductions in marginal income-tax rates --
especially where these rates are already high and fall on capital income.
Eliminating the federal corporate income tax would be brilliant. On the spending
side, the main point is that we should not be considering massive public-works
programs that do not pass muster from the perspective of cost-benefit analysis.
Just as in the 1980s, when extreme supply-side views on tax cuts were
unjustified, it is wrong now to think that added government spending is free.
Robert J. Barro, "Government
Spending Is No Free Lunch: Now the Democrats are peddling voodoo
economics," The Wall Street Journal, January 22, 2009 ---
http://online.wsj.com/article/SB123258618204604599.html?mod=djemEditorialPage
Robert Barro is an economics professor at Harvard
University and a senior fellow at Stanford University's Hoover Institution.
Back in the 1980s, many commentators
ridiculed as voodoo economics the extreme supply-side view that
across-the-board cuts in income-tax rates might raise overall tax revenues.
Now we have the extreme demand-side view that the so-called "multiplier"
effect of government spending on economic output is greater than one -- Team
Obama is reportedly using a number around 1.5.
To think about what this means, first
assume that the multiplier was 1.0. In this case, an increase by one unit in
government purchases and, thereby, in the aggregate demand for goods would
lead to an increase by one unit in real gross domestic product (GDP). Thus,
the added public goods are essentially free to society. If the government
buys another airplane or bridge, the economy's total output expands by
enough to create the airplane or bridge without requiring a cut in anyone's
consumption or investment.
The explanation for this magic is that
idle resources -- unemployed labor and capital -- are put to work to produce
the added goods and services.
If the multiplier is greater than 1.0, as
is apparently assumed by Team Obama, the process is even more wonderful. In
this case, real GDP rises by more than the increase in government purchases.
Thus, in addition to the free airplane or bridge, we also have more goods
and services left over to raise private consumption or investment. In this
scenario, the added government spending is a good idea even if the bridge
goes to nowhere, or if public employees are just filling useless holes. Of
course, if this mechanism is genuine, one might ask why the government
should stop with only $1 trillion of added purchases.
What's the flaw? The theory (a simple
Keynesian macroeconomic model) implicitly assumes that the government is
better than the private market at marshaling idle resources to produce
useful stuff. Unemployed labor and capital can be utilized at essentially
zero social cost, but the private market is somehow unable to figure any of
this out. In other words, there is something wrong with the price system.
John Maynard Keynes thought that the
problem lay with wages and prices that were stuck at excessive levels. But
this problem could be readily fixed by expansionary monetary policy, enough
of which will mean that wages and prices do not have to fall. So, something
deeper must be involved -- but economists have not come up with
explanations, such as incomplete information, for multipliers above one.
A much more plausible starting point is a
multiplier of zero. In this case, the GDP is given, and a rise in government
purchases requires an equal fall in the total of other parts of GDP --
consumption, investment and net exports. In other words, the social cost of
one unit of additional government purchases is one.
This approach is the one usually applied
to cost-benefit analyses of public projects. In particular, the value of the
project (counting, say, the whole flow of future benefits from a bridge or a
road) has to justify the social cost. I think this perspective, not the
supposed macroeconomic benefits from fiscal stimulus, is the right one to
apply to the many new and expanded government programs that we are likely to
see this year and next.
What do the data show about multipliers?
Because it is not easy to separate movements in government purchases from
overall business fluctuations, the best evidence comes from large changes in
military purchases that are driven by shifts in war and peace. A
particularly good experiment is the massive expansion of U.S. defense
expenditures during World War II. The usual Keynesian view is that the World
War II fiscal expansion provided the stimulus that finally got us out of the
Great Depression. Thus, I think that most macroeconomists would regard this
case as a fair one for seeing whether a large multiplier ever exists.
I have estimated that World War II raised
U.S. defense expenditures by $540 billion (1996 dollars) per year at the
peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war
raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier
was 0.8 (430/540). The other way to put this is that the war lowered
components of GDP aside from military purchases. The main declines were in
private investment, nonmilitary parts of government purchases, and net
exports -- personal consumer expenditure changed little. Wartime production
siphoned off resources from other economic uses -- there was a dampener,
rather than a multiplier.
We can consider similarly three other U.S.
wartime experiences -- World War I, the Korean War, and the Vietnam War --
although the magnitudes of the added defense expenditures were much smaller
in comparison to GDP. Combining the evidence with that of World War II
(which gets a lot of the weight because the added government spending is so
large in that case) yields an overall estimate of the multiplier of 0.8 --
the same value as before. (These estimates were published last year in my
book, "Macroeconomics, a Modern Approach.")
There are reasons to believe that the
war-based multiplier of 0.8 substantially overstates the multiplier that
applies to peacetime government purchases. For one thing, people would
expect the added wartime outlays to be partly temporary (so that consumer
demand would not fall a lot). Second, the use of the military draft in
wartime has a direct, coercive effect on total employment. Finally, the U.S.
economy was already growing rapidly after 1933 (aside from the 1938
recession), and it is probably unfair to ascribe all of the rapid GDP growth
from 1941 to 1945 to the added military outlays. In any event, when I
attempted to estimate directly the multiplier associated with peacetime
government purchases, I got a number insignificantly different from zero.
As we all know, we are in the middle of
what will likely be the worst U.S. economic contraction since the 1930s. In
this context and from the history of the Great Depression, I can understand
various attempts to prop up the financial system. These efforts, akin to
avoiding bank runs in prior periods, recognize that the social consequences
of credit-market decisions extend well beyond the individuals and businesses
making the decisions.
But, in terms of fiscal-stimulus
proposals, it would be unfortunate if the best Team Obama can offer is an
unvarnished version of Keynes's 1936 "General Theory of Employment, Interest
and Money." The financial crisis and possible depression do not invalidate
everything we have learned about macroeconomics since 1936.
Much more focus should be on incentives
for people and businesses to invest, produce and work. On the tax side, we
should avoid programs that throw money at people and emphasize instead
reductions in marginal income-tax rates -- especially where these rates are
already high and fall on capital income. Eliminating the federal corporate
income tax would be brilliant. On the spending side, the main point is that
we should not be considering massive public-works programs that do not pass
muster from the perspective of cost-benefit analysis. Just as in the 1980s,
when extreme supply-side views on tax cuts were unjustified, it is wrong now
to think that added government spending is free.
Keynes: The Rise, Fall, and Return of the 20th Century's Most
Influential Economist by Peter Clarke (Bloomsbury; 2009, 211
pages; $20). Examines the life and legacy of the British economist (1883-1946).
Denny Beresford forwarded the following link. I don't know how long it will
be a free download.
"The Crash: What Went Wrong? How did the most dynamic and sophisticated
financial markets in the world come to the brink of collapse? The Washington
Post examines how Wall Street innovation outpaced Washington regulation.,"
The Washington Post, January 2009 ---
http://www.washingtonpost.com/wp-srv/business/risk/index.html
Jensen Comment
The above site has three links to AIG and what went wrong with their credit
default swaps.
Part 1 "The Beautiful Machine" ---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/28/AR2008122801916.html
Part 2 "A Crack in the System"---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/29/AR2008122902670.html
Part 3 "Downgrades and Downfall"---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/30/AR2008123003431.html
"Everything You Wanted to Know about Credit Default Swaps--but Were Never
Told," by Peter J. Wallison, RGE, January 25, 2009 ----
Click Here
Also see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
"What Is Congress Stimulating? What's most striking is how much "stimulus"
money will be spent on the government itself (and labor unions)," by Daniel
Henninger, The Wall Street Journal, February 5, 2009 ---
http://online.wsj.com/article/SB123379617394050229.html?mod=djemEditorialPage
Contrary to conventional Beltway wisdom,
the House Republicans' zero votes for the Obama presidency's stimulus
"package" is looking like the luckiest thing to happen to the GOP's
political fortunes since Ronald Reagan switched parties. If the GOP line
holds, the party could win back much of the goodwill it dissipated with its
big-government adventures the past eight years.
For starters, notwithstanding the new
president's high approval rating, his stimulus bill (ghost-written by Nancy
Pelosi) has been losing altitude with public opinion by the day. People are
nervous.
Then after Tim Geithner scampered through
the tax minefield and into a Cabinet seat, the Daschle tax bomb went off,
laying open for public view the world of Washington's pay-for-favors that
makes the average Wall Street banker look like Little Bo-Peep.
Conventional wisdom holds that the
Republican refuseniks shot themselves in the foot by staying off the House
stimulus package. Real wisdom holds that congressional Republicans should
consider putting distance between themselves and anything Democratic just
now. The party's crypts are opening.
The Democratic Congressional Campaign
Committee, with an apparently recession-proof cash hoard, is running radio
ads against 28 House Republicans. The theme of the ads is "Putting Families
First."
Families first? The only family standing
at the front of the stimulus pay line is the federal family. Read the bill.
Check your PC's virus program, then pull
down the nearly 700 pages of the American Recovery and Reinvestment Act.
Dive into its dank waters and what is most striking is how much "stimulus"
money is being spent on the government's own infrastructure. This bill isn't
economic stimulus. It's self-stimulus.
(All sums here include the disorienting
zeros, as in the bill.)
Title VI, Financial Services and General
Government, says that "not less than $6,000,000,000 shall be used for
construction, repair, and alteration of Federal buildings." There's enough
money there to name a building after every Member of Congress.
The Bureau of Land Management gets
$325,000,000 to spend fixing federal land, including "trail repair" and
"remediation of abandoned mines or well sites," no doubt left over from the
19th-century land rush.
The Centers for Disease Control and
Prevention are getting $462,000,000 for "equipment, construction, and
renovation of facilities, including necessary repairs and improvements to
leased laboratories."
The National Institute of Standards gets
$357,000,000 for the "construction of research facilities." The Oceanic and
Atmospheric Administration gets $427,000,000 for that. The country is in an
economic meltdown and the federal government is redecorating.
The FBI gets $75,000,000 for "salaries and
expenses." Inside the $6,200,000,000 Weatherization Assistance Program one
finds "expenses" of $500,000,000. How many bureaucrats does it take to
"expense" a half-billion dollars?
The current, Senate-amended version now
lists "an additional amount to be deposited in the Federal Buildings Fund,
$9,048,000,000." Of this, "not less than $6,000,000,000 shall be available
for measures necessary to convert GSA facilities to High-Performance Green
Buildings." High performance?
Sen. Tom Coburn is threatening to read the
bill on the floor of the Senate. I have a better idea: Read it on "Saturday
Night Live."
Such as the amendment to Section 2(3)(F)
of the Longshore and Harbor Workers' Compensation Act, which will permit
payments to guys employed to repair "recreational vessels." Under Incentives
for New Jobs, we find a credit to employ what the bill calls "disconnected
youths," defined as "not readily employable by reason of lacking a
sufficient number of basic skills."
President Obama is saying the bill will
"create or save" three million new jobs. The bad news is your new boss is
Uncle Sam.
Senate Minority Leader Mitch McConnell
says, "Everybody agrees that there ought to be a stimulus package. The
question is: How big and what do we spend it on?"
Sen. McConnell should reconsider. He knows
that the Bush-GOP spending spree cost them control of Congress in 2006.
Thus, "How big?" is not the question his party's constituents (or horrified
independents) want answered. This is a chance for the GOP to climb down from
its big-government dunce chair. Until that reversal is achieved, there is no
hope for this party.
Continued in article
I sure hope my stimulus check
arrives before springtime. I plan to spend it quickly while it still might buy
something of value, maybe faster horses, younger women, and older whiskey.
Sigh! My share of Obama's
give-away won't be large enough to feed horses, give credit cards to younger
women, and detoxify my liver? I guess I'll just fill up my heating oil tank
before the price shoots up to $100 a gallon.
"Subprime goes to college: The new mortgage crisis — how students at
for-profit universities could default on $275 billion in taxpayer-backed student
loans," by Steven Eusnan, The New York Post, June 6, 2010 ---
http://www.nypost.com/p/news/opinion/opedcolumnists/subprime_goes_to_college_FeiheNJfGYtoSwmtl5etJP
Until recently, I thought that there would never again be an
opportunity to be involved with an industry as socially destructive
and morally bankrupt as the subprime mortgage industry. I was wrong.
The for-profit education industry has proven equal to the task.
The for-profit industry has grown at an extreme and unusual rate,
driven by easy access to government sponsored debt in the form of
Title IV student loans, where the credit is guaranteed by the
government. Thus, the government, the students and the taxpayer bear
all the risk, and the for-profit industry reaps all the rewards.
This is similar to the subprime mortgage sector in that the subprime
originators bore far less risk than the investors in their mortgage
paper.
Read more:
http://www.nypost.com/p/news/opinion/opedcolumnists/subprime_goes_to_college_FeiheNJfGYtoSwmtl5etJP#ixzz0q6iq9jsm
Until recently, I thought that there would never again be an
opportunity to be involved with an industry as socially destructive
and morally bankrupt as the subprime mortgage industry. I was wrong.
The for-profit education industry has proven equal to the task.
The for-profit industry has grown at an extreme and unusual rate,
driven by easy access to government sponsored debt in the form of
Title IV student loans, where the credit is guaranteed by the
government. Thus, the government, the students and the taxpayer bear
all the risk, and the for-profit industry reaps all the rewards.
This is similar to the subprime mortgage sector in that the subprime
originators bore far less risk than the investors in their mortgage
paper.
Read more:
http://www.nypost.com/p/news/opinion/opedcolumnists/subprime_goes_to_college_FeiheNJfGYtoSwmtl5etJP#ixzz0q6iq9jsm
Until recently, I thought that there would
never again be an opportunity to be involved with an industry as socially
destructive and morally bankrupt as the subprime mortgage industry. I was
wrong. The for-profit education industry has proven equal to the task.
The for-profit industry has grown at an
extreme and unusual rate, driven by easy access to government sponsored debt
in the form of Title IV student loans, where the credit is guaranteed by the
government. Thus, the government, the students and the taxpayer bear all the
risk, and the for-profit industry reaps all the rewards. This is similar to
the subprime mortgage sector in that the subprime originators bore far less
risk than the investors in their mortgage paper.
A student prepares for an online quiz at home
for the Universtity of Phoenix. In the past 10 years, the for-profit
education industry has grown 5-10 times the historical rate of traditional
post secondary education. As of 2009, the industry had almost 10% of
enrolled students but claimed nearly 25% of the $89 billion of federal Title
IV student loans and grant disbursements. At the current pace of growth,
for-profit schools will draw 40% of all Title IV aid in 10 years.
How has this been allowed to happen?
The simple answer is that they’ve hired every
lobbyist in Washington, DC. There has been a revolving door between the
people who work for this industry and the halls of government. One example
is Sally Stroup. In 2001-2002, she was the head lobbyist for the Apollo
Group — the company behind the University of Phoenix and the largest
for-profit educator. But from 2002-2006 she became assistant secretary of
post-secondary education for the Department of Education under President
Bush. In other words, she was directly in charge of regulating the industry
she had previously lobbied for.
From 1987 through 2000, the amount of total
Title IV dollars received by students of for-profit schools fluctuated
between $2 billion and $4 billion per annum. But when the Bush
administration took over, the DOE gutted many of the rules that governed the
conduct of this industry. Once the floodgates were opened, the industry
embarked on 10 years of unrestricted massive growth. Federal dollars flowing
to the industry exploded to over $21 billion, a 450% increase.
At many major-for profit institutions, federal
Title IV loan and grant dollars now comprise close to 90% of total revenues.
And this growth has resulted in spectacular profits and executive salaries.
For example, ITT Educational Services, or ESI, has a roughly 40% operating
margin vs. the 7%-12% margins of other companies that receive major
government contracts. ESI is more profitable on a margin basis than even
Apple.
This growth is purely a function of government
largesse, as Title IV has accounted for more than 100% of revenue growth.
Here is one of the more upsetting statistics.
In fiscal 2009, Apollo increased total revenues by $833 million. Of that
amount, $1.1 billion came from Title IV federally funded student loans and
grants. More than 100% of the revenue growth came from the federal
government. But of this incremental $1.1 billion in federal loan and grant
dollars, the company only spent an incremental $99 million on faculty
compensation and instructional costs — that’s 9 cents on every dollar
received from the government going toward actual education. The rest went to
marketing and paying executives.
Leaving politics aside for a moment, the other
major reason why the industry has taken an ever increasing share of
government dollars is that it has turned the typical education model on its
head. And here is where the subprime analogy becomes very clear.
There is a traditional relationship between
matching means and cost in education. Typically, families of lesser
financial means seek lower cost colleges in order to maximize the available
Title IV loans and grants — thereby getting the most out of every dollar and
minimizing debt burdens.
The for-profit model seeks to recruit those
with the greatest financial need and put them in high cost institutions.
This formula maximizes the amount of Title IV loans and grants that these
students receive.
With billboards lining the poorest
neighborhoods in America and recruiters trolling casinos and homeless
shelters (and I mean that literally), the for-profits have become
increasingly adept at pitching the dream of a better life and higher
earnings to the most vulnerable of society.
If the industry in fact educated its students
and got them good jobs that enabled them to receive higher incomes and to
pay off their student loans, everything I’ve just said would be irrelevant.
So the key question to ask is — what do these
students get for their education? In many cases, NOT much, not much at all.
At one Corinthian Colleges-owned Everest
College campus in California, students paid $16,000 for an eight-month
course in medical assisting. Upon nearing completion, the students learned
that not only would their credits not transfer to any community or four-year
college, but also that their degree is not recognized by the American
Association for Medical Assistants. Hospitals refuse to even interview
graduates.
And look at drop-out rates. Companies don’t
fully disclose graduation rates, but using both DOE data and
company-provided information, I calculate drop out rates of most schools are
50%-plus per year.
Default rates on student loans are already
starting to skyrocket. It’s just like subprime — which grew at any cost and
kept weakening its underwriting standards to grow.
The bottom line is that as long as the
government continues to flood the for-profit education industry with loan
dollars and the risk for these loans is borne solely by the students and the
government, then the industry has every incentive to grow at all costs,
compensate employees based on enrollment, influence key regulatory bodies
and manipulate reported statistics — all to maintain access to the
government’s money.
Read more:
http://www.nypost.com/p/news/opinion/opedcolumnists/subprime_goes_to_college_FeiheNJfGYtoSwmtl5etJP#ixzz0q6hwLIst
June 6, 2010 reply from
dgsearfoss@comcast.net
Hi Bob,
Equally as bad, if not worse, are the companies
that provide on-line courses to the military. They price their tuition at
exactly the amount that will be covered by the military, set horribly low
levels of expectation as reflected by the “testing” and “grading”, and
virtually none of the “credits” are transferrable to an accredited higher
education institution.
It is a scandal that should be dealt with harshly
by Congress.
Jerry
"Higher education's bubble is about to
burst," by: University of Tennessee Law Professor Glenn Harlan Reynolds,
Washington Examiner, June 6, 2010 ---
http://www.washingtonexaminer.com/opinion/columns/Sunday_Reflections/Higher-education_s-bubble-is-about-to-burst-95639354.html
It's a story of an industry that may sound
familiar.
The buyers think what they're buying will
appreciate in value, making them rich in the future. The product grows more
and more elaborate, and more and more expensive, but the expense is offset
by cheap credit provided by sellers eager to encourage buyers to buy.
Buyers see that everyone else is taking on mounds
of debt, and so are more comfortable when they do so themselves; besides,
for a generation, the value of what they're buying has gone up steadily.
What could go wrong? Everything continues smoothly until, at some point, it
doesn't.
Yes, this sounds like the housing bubble, but I'm
afraid it's also sounding a lot like a still-inflating higher education
bubble. And despite (or because of) the fact that my day job involves higher
education, I think it's better for us to face up to what's going on before
the bubble bursts messily.
College has gotten a lot more expensive. A recent
Money magazine report notes: "After adjusting for financial aid, the amount
families pay for college has skyrocketed 439 percent since 1982. ... Normal
supply and demand can't begin to explain cost increases of this magnitude."
Consumers would balk, except for two things.
First -- as with the housing bubble -- cheap and
readily available credit has let people borrow to finance education. They're
willing to do so because of (1) consumer ignorance, as students (and, often,
their parents) don't fully grasp just how harsh the impact of student loan
payments will be after graduation; and (2) a belief that, whatever the cost,
a college education is a necessary ticket to future prosperity.
Bubbles burst when there are no longer enough
excessively optimistic and ignorant folks to fuel them. And there are signs
that this is beginning to happen already.
A New York Times profile last week described
Courtney Munna, a 26-year-old graduate of New York University with nearly
$100,000 in student loan debt -- debt that her degree in Religious and
Women's Studies did not equip her to repay. Payments on the debt are about
$700 per month, equivalent to a respectable house payment, and a major bite
on her monthly income of $2,300 as a photographer's assistant earning an
hourly wage.
And, unlike a bad mortgage on an underwater house,
Munna can't simply walk away from her student loans, which cannot be
expunged in a bankruptcy. She's stuck in a financial trap.
Some might say that she deserves it -- who borrows
$100,000 to finance a degree in women's and religious studies that won't
make you any money? She should have wised up, and others should learn from
her mistake, instead of learning too late, as she did: "I don't want to
spend the rest of my life slaving away to pay for an education I got for
four years and would happily give back."
But bubbles burst when people catch on, and there's
some evidence that people are beginning to catch on. Student loan demand,
according to a recent report in the Washington Post, is going soft, and
students are expressing a willingness to go to a cheaper school rather than
run up debt. Things haven't collapsed yet, but they're looking shakier --
kind of like the housing market looked in 2007.
So what happens if the bubble collapses? Will it be
a tragedy, with millions of Americans losing their path to higher-paying
jobs?
Maybe not. College is often described as a path to
prosperity, but is it? A college education can help people make more money
in three different ways.
First, it may actually make them more economically
productive by teaching them skills valued in the workplace: Computer
programming, nursing or engineering, say. (Religious and women's studies,
not so much.)
Second, it may provide a credential that employers
want, not because it represents actual skills, but because it's a weeding
tool that doesn't produce civil-rights suits as, say, IQ tests might. A
four-year college degree, even if its holder acquired no actual skills, at
least indicates some ability to show up on time and perform as instructed.
And, third, a college degree -- at least an elite
one -- may hook its holder up with a useful social network that can provide
jobs and opportunities in the future. (This is more true if it's a degree
from Yale than if it's one from Eastern Kentucky, but it's true everywhere
to some degree).
While an individual might rationally pursue all
three of these, only the first one -- actual added skills -- produces a net
benefit for society. The other two are just distributional -- about who gets
the goodies, not about making more of them.
Yet today's college education system seems to be in
the business of selling parts two and three to a much greater degree than
part one, along with selling the even-harder-to-quantify "college
experience," which as often as not boils down to four (or more) years of
partying.
Post-bubble, perhaps students -- and employers, not
to mention parents and lenders -- will focus instead on education that
fosters economic value. And that is likely to press colleges to focus more
on providing useful majors. (That doesn't necessarily rule out traditional
liberal-arts majors, so long as they are rigorous and require a real general
education, rather than trendy and easy subjects, but the key word here is
"rigorous.")
My question is whether traditional academic
institutions will be able to keep up with the times, or whether -- as Anya
Kamenetz suggests in her new book, "DIY U" -- the real pioneering will be in
online education and the work of "edupunks" who are more interested in
finding new ways of teaching and learning than in protecting existing
interests.
I'm betting on the latter. Industries seldom reform
themselves, and real competition usually comes from the outside. Keep your
eyes open -- and, if you're planning on applying to college, watch out for
those student loans.
Examiner contributor Glenn Harlan Reynolds hosts "InstaVision" on
PJTV.com and blogs at Instapundit.com.
He is a professor of law at the University of Tennessee.
Bob Jensen's threads on how for-profit universities operate in the gray
zone of fraud ---
http://faculty.trinity.edu/rjensen/HigherEdControversies.htm#ForProfitFraud
On May 4, 2010, PBS Frontline broadcast an hour-long video called College
Inc. --- a sobering analysis of for-profit onsite and online colleges and
universities.
For a time you can watch the video free online ---
Click Here
http://www.pbs.org/wgbh/pages/frontline/collegeinc/view/?utm_campaign=viewpage&utm_medium=toparea&utm_source=toparea
Bob Jensen's threads on many of the for-profit universities are at
http://faculty.trinity.edu/rjensen/Crossborder.htm
Although there is a gray zone, for-profit colleges should not be confused
with diploma mills ---
http://faculty.trinity.edu/rjensen/FraudReporting.htm#DiplomaMill
"'College, Inc.'," by Kevin Carey, Chronicle of Higher Education,
May 10, 2010 ---
http://chronicle.com/blogPost/College-Inc/23850/?sid=at&utm_source=at&utm_medium=en
PBS broadcast a
documentary on for-profit higher education last
week, titled College, Inc. It begins with the slightly ridiculous
figure of
Michael Clifford, a former cocaine abuser turned
born-again Christian who never went to college, yet makes a living padding
around the lawn of his oceanside home wearing sandals and loose-fitting
print shirts, buying up distressed non-profit colleges and turning them into
for-profit money machines.
Improbably, Clifford emerges from the documentary
looking OK. When asked what he brings to the deals he brokers, he cites
nothing educational. Instead, it's the "Three M's: Money, Management, and
Marketing." And hey, there's nothing wrong with that. A college may have
deep traditions and dedicated faculty, but if it's bankrupt, anonymous, and
incompetently run, it won't do students much good. "Nonprofit" colleges that
pay their leaders executive salaries and run
multi-billion dollar sports franchises have long
since ceded the moral high ground when it comes to chasing the bottom line.
The problem with for-profit higher education, as
the documentary ably shows, is that people like Clifford are applying
private sector principles to an industry with a number of distinct
characteristics. Four stand out. First, it's heavily subsidized. Corporate
giants like the University of Phoenix are now pulling in hundreds of
millions of dollars per year from the taxpayers, through federal grants and
student loans. Second, it's awkwardly regulated. Regional accreditors may
protest that their imprimatur isn't like a taxicab medallion to be bought
and sold on the open market. But as the documentary makes clear, that's
precisely the way it works now. (Clifford puts the value at $10-million.)
Third, it's hard for consumers to know what they're
getting at the point of purchase. College is an experiential good;
reputations and brochures can only tell you so much. Fourth—and I don't
think this is given proper weight when people think about the dynamics of
the higher-education market—college is generally something you only buy a
couple of times, early in your adult life.
All of which creates the potential—arguably, the
inevitability—for sad situations like the three nursing students in the
documentary who were comprehensively ripped off by a for-profit school that
sent them to a daycare center for their "pediatric rotation" and left them
with no job prospects and tens of thousands of dollars in debt. The
government subsidies create huge incentives for for-profit colleges to
enroll anyone they can find. The awkward regulation offers little in the way
of effective oversight. The opaque nature of the higher-education experience
makes it hard for consumers to sniff out fraudsters up-front. And the fact
that people don't continually purchase higher education throughout their
lives limits the downside for bad actors. A restaurant or automobile
manufacturer that continually screws its customers will eventually go out of
business. For colleges, there's always another batch of high-school
graduates to enroll.
The Obama administration has made waves in recent
months by proposing to tackle some of these problems by implementing
"gainful
employment" rules that would essentially require
for-profits to show that students will be able to make enough money with
their degrees to pay back their loans. It's a good idea, but it also raises
an interesting question: Why apply this policy only to for-profits?
Corporate higher education may be the fastest growing segment of the market,
but it still educates a small minority of students and will for a long time
to come. There are plenty of traditional colleges out there that are mainly
in the business of preparing students for jobs, and that charge a lot of
money for degrees of questionable value. What would happen if the gainful
employment standard were applied to a mediocre private university that
happily allows undergraduates to take out six-figure loans in exchange for a
plain-vanilla business B.A.?
The gainful employment standard highlights some of
my biggest concerns about the Obama administration's approach to
higher-education policy. To its lasting credit, the administration has taken
on powerful moneyed interests and succeeded. Taking down the FFEL program
was a historic victory for low-income students and reining in the abuses of
for-profit higher education is a needed and important step.
Continued in article
Jensen Comment
The biggest question remains concerning the value of "education" at the micro
level (the student) and the macro level (society). It would seem that students
in training programs should have prospects of paying back the cost of the
training if "industry" is not willing to fully subsidize that particular type of
training.
Education is another question entirely, and we're still trying to resolve
issues of how education should be financed. I'm not in favor of "gainful
employment rules" for state universities, although I think such rules should be
imposed on for-profit colleges and universities.
What is currently happening is that training and education programs are in
most cases promising more than they can deliver in terms of gainful employment.
Naive students think a certificate or degree is "the" ticket to career success,
and many of them borrow tens of thousands of dollars to a point where they are
in debtor's prisons with their meager laboring wages garnished (take a debtor's
wages on legal orders) to pay for their business, science, and humanities
degrees that did not pay off in terms of career opportunities.
But that does not mean that their education did not pay off in terms of
life's fuller meaning. The question is who should pay for "life's fuller
meaning?" Among our 50 states, California had the best plan for universal
education. But fiscal mismanagement, especially very generous unfunded
state-worker unfunded pension plans, has now brought California to the brink of
bankruptcy. Increasing taxes in California is difficult because it already has
the highest state taxes in the nation.
Student borrowing to pay for pricey certificates and degrees is not a good
answer in my opinion, but if students borrow I think the best alternative is to
choose a lower-priced accredited state university. It will be a long, long time
before the United States will be able to fund "universal education" because of
existing unfunded entitlements for Social Security and other pension
obligations, Medicare, Medicaid, military retirements, etc.
I think it's time for our best state universities to reach out with more
distance education and training that prevent many of the rip-offs taking place
in the for-profit training and education sector. The training and education may
not be free, but state universities have the best chance of keeping costs down
and quality up.
"Wal-Mart Employees Get New College Program—Online," by Marc Parry,
Chronicle of Higher Education, June 3, 2010 ---
http://chronicle.com/blogPost/Wal-Mart-Employees-Get-New/24504/?sid=at&utm_source=at&utm_medium=en
The American Public University System
has been described as a higher-education version
of Wal-Mart: a publicly traded corporation that mass-markets moderately
priced degrees in many fields.
Now it's more than an analogy. Under a deal
announced today, the for-profit online university
will offer Wal-Mart workers discounted tuition and credit for job
experience.
Such alliances are nothing new; see these materials
from
Strayer
and
Capella for other examples. But Wal-Mart is the
country's largest retailer. And the company is pledging to spend $50-million
over three years to help employees cover the cost of tuition and books
beyond the discounted rate, according to the
Associated Press.
"What's most significant about this is that, given
that APU is very small, this is a deal that has the potential to drive
enrollments that are above what investors are already expecting from them,"
Trace A. Urdan, an analyst with Signal Hill Capital Group, told Wired
Campus. "Which is why the stock is up."
Wal-Mart workers will be able to receive
credit—without having to pay for it—for job training in subjects like ethics
and retail inventory management, according to the AP.
Wal-Mart employs 1.4 million people in the U.S.
Roughly half of them have a high-school diploma but no college degree,
according to
The New York Times. A department-level
manager would end up paying about $7,900 for an associate degree, factoring
in the work credits and tuition discount, the newspaper reported.
“If 10 to 15 percent of employees take advantage of
this, that’s like graduating three Ohio State Universities,” Sara Martinez
Tucker, a former under secretary of education who is now on Wal-Mart’s
external advisory council, told the Times.
Jensen Comment
This Wal-Mart Fringe Benefit Should Be Carefully Investigated by Employees
It does not sit well with me!
- I certainly hope that the Wal-Mart contributions toward tuition can
be extended to state-supported colleges and universities having more
respected credits. For example, online degrees from the University of
Wisconsin or the University of Maryland are are likely much more
respected for job mobility and for acceptance into graduate schools.
- Giving credit for "job experience" is an absolute turn off for me.
Most adults have some form of "job experience." This is just not
equivalent to course credit experience in college where students face
examinations and academic projects. Weaker colleges generally use credit
for "job experience" ploy as a come on to attract applicants. But the
credits awarded for job experience are not likely to be transferrable to
traditional colleges and universities.
- The "discounted tuition" in this for-profit online program is likely
to be higher than the in-state tuition from state-supported colleges and
universities.
- I'm dubious about the standards for admission in for-profit colleges
as well as the rigor of the courses. Watch the Frontline video served up
by PBS.
On May 4, 2010, PBS Frontline broadcast an hour-long video called College
Inc. --- a sobering analysis of for-profit onsite and online colleges and
universities.
For a time you can watch the video free online ---
Click Here
http://www.pbs.org/wgbh/pages/frontline/collegeinc/view/?utm_campaign=viewpage&utm_medium=toparea&utm_source=toparea
- The American Public University System is accredited by the North
Central Association accrediting agency that is now under investigation
for weakened standards for college credits.
"Inspector General Keeps the Pressure on a Regional Accreditor," by Eric
Kelderman, Chronicle of Higher Education, May 27, 2010 ---
http://chronicle.com/article/Inspector-General-Keeps-the/65691/?sid=at&utm_source=at&utm_medium=en
The inspector general of the U.S. Department of
Education has reaffirmed a recommendation that the department should
consider sanctions for the Higher Learning Commission of the North Central
Association of Colleges and Schools, one of the nation's major regional
accrediting organizations. In a
report this week, the Office of Inspector General
issued its final recommendations stemming from a
2009 examination of the commission's standards for
measuring credit hours and program length, and affirmed its earlier critique
that the commission had been too lax in its standards for determining the
amount of credit a student receives for course work.
The Higher Learning Commission accredits more than
1,000 institutions in 19 states. The Office of Inspector General completed
similar reports for two other regional accreditors late last year but did
not suggest any sanctions for those organizations.
Possible sanctions against an accreditor include
limiting, suspending, or terminating its recognition by the secretary of
education as a reliable authority for determining the quality of education
at the institutions it accredits. Colleges need accreditation from a
federally recognized agency in order to be eligible to participate in the
federal student-aid programs.
In its examination of the Higher Learning
Commission, the office looked at the commission's reaccreditation of six
member institutions: Baker College, DePaul University, Kaplan University,
Ohio State University, the University of Minnesota-Twin Cities, and the
University of Phoenix. The office chose those institutions—two public, two
private, and two proprietary institutions—as those that received the highest
amounts of federal funds under Title IV, the section of the Higher Education
Act that governs the federal student-aid programs.
It also reviewed the accreditation status of
American InterContinental University and the Art Institute of Colorado, two
institutions that had sought initial accreditation from the commission
during the period the office studied.
The review found that the Higher Learning
Commission "does not have an established definition of a credit hour or
minimum requirements for program length and the assignment of credit hours,"
the report says. "The lack of a credit-hour definition and minimum
requirements could result in inflated credit hours, the improper designation
of full-time student status, and the over-awarding of Title IV funds," the
office concluded in its letter to the commission's president, Sylvia
Manning.
More important, the office reported that the
commission had allowed American InterContinental University to become
accredited in 2009 despite having an "egregious" credit policy.
In a letter responding to the commission, Ms.
Manning wrote that the inspector general had ignored the limitations the
accreditor had placed on American InterContinental to ensure that the
institution improved its standards, an effort that had achieved the intended
results, she said. "These restrictions were intended to force change at the
institution and force it quickly."
Continued in article
Jensen Comment
The most successful for-profit universities advertise heavily about credibility
due to being "regionally accredited." In some cases this accreditation was
initially bought rather than achieved such as by buying up a small, albeit still
accredited, bankrupt not-for-profit private college that's washed up on the
beach. This begs the question about how some for-profit universities maintain
the spirit of accreditation acquired in this manner.
Bob Jensen's threads on assessment are at
http://faculty.trinity.edu/rjensen/assess.htm
Bob Jensen's threads on higher education controversies are at
http://faculty.trinity.edu/rjensen/HigherEdControversies.htm
"'College,
Inc.'," by Kevin Carey, Chronicle of Higher Education, May 10, 2010
---
http://chronicle.com/blogPost/College-Inc/23850/?sid=at&utm_source=at&utm_medium=en
PBS broadcast a
documentary on for-profit higher education
last week, titled College, Inc. It begins with the slightly ridiculous
figure of
Michael Clifford,
a former cocaine abuser turned born-again Christian
who never went to college, yet makes a living padding around the lawn of his
oceanside home wearing sandals and loose-fitting print shirts, buying up
distressed non-profit colleges and turning them into for-profit money machines.
Improbably, Clifford emerges from the documentary looking OK. When asked what he
brings to the deals he brokers, he cites nothing educational. Instead, it's the
"Three M's: Money, Management, and Marketing." And hey, there's nothing wrong
with that. A college may have deep traditions and dedicated faculty, but if it's
bankrupt, anonymous, and incompetently run, it won't do students much good.
"Nonprofit" colleges that pay their leaders executive salaries and run
multi-billion dollar sports franchises
have long since ceded the moral high ground when it
comes to chasing the bottom line.
The problem with for-profit higher education, as the documentary ably shows, is
that people like Clifford are applying private sector principles to an industry
with a number of distinct characteristics. Four stand out. First, it's heavily
subsidized. Corporate giants like the University of Phoenix are now pulling in
hundreds of millions of dollars per year from the taxpayers, through federal
grants and student loans. Second, it's awkwardly regulated. Regional accreditors
may protest that their imprimatur isn't like a taxicab medallion to be bought
and sold on the open market. But as the documentary makes clear, that's
precisely the way it works now. (Clifford puts the value at $10-million.)
Third, it's hard for consumers to know what they're getting at the point of
purchase. College is an experiential good; reputations and brochures can only
tell you so much. Fourth—and I don't think this is given proper weight when
people think about the dynamics of the higher-education market—college is
generally something you only buy a couple of times, early in your adult life.
All of which creates the potential—arguably, the inevitability—for sad
situations like the three nursing students in the documentary who were
comprehensively ripped off by a for-profit school that sent them to a daycare
center for their "pediatric rotation" and left them with no job prospects and
tens of thousands of dollars in debt. The government subsidies create huge
incentives for for-profit colleges to enroll anyone they can find. The awkward
regulation offers little in the way of effective oversight. The opaque nature of
the higher-education experience makes it hard for consumers to sniff out
fraudsters up-front. And the fact that people don't continually purchase higher
education throughout their lives limits the downside for bad actors. A
restaurant or automobile manufacturer that continually screws its customers will
eventually go out of business. For colleges, there's always another batch of
high-school graduates to enroll.
The Obama administration has made waves in recent months by proposing to tackle
some of these problems by implementing
"gainful
employment" rules that would essentially
require for-profits to show that students will be able to make enough money with
their degrees to pay back their loans. It's a good idea, but it also raises an
interesting question: Why apply this policy only to for-profits? Corporate
higher education may be the fastest growing segment of the market, but it still
educates a small minority of students and will for a long time to come. There
are plenty of traditional colleges out there that are mainly in the business of
preparing students for jobs, and that charge a lot of money for degrees of
questionable value. What would happen if the gainful employment standard were
applied to a mediocre private university that happily allows undergraduates to
take out six-figure loans in exchange for a plain-vanilla business B.A.?
The gainful employment standard highlights some of my biggest concerns about the
Obama administration's approach to higher-education policy. To its lasting
credit, the administration has taken on powerful moneyed interests and
succeeded. Taking down the FFEL program was a historic victory for low-income
students and reining in the abuses of for-profit higher education is a needed
and important step.
Continued
in article
Bob
Jensen's threads on many of the for-profit universities are at
http://faculty.trinity.edu/rjensen/Crossborder.htm
Although
there is a gray zone, for-profit colleges should not be confused with diploma
mills ---
http://faculty.trinity.edu/rjensen/FraudReporting.htm#DiplomaMill
Find a
College
College
Atlas ---
http://www.collegeatlas.org/
Among other things the above site provides acceptance rate percentages
Online Distance Education Training and Education ---
http://faculty.trinity.edu/rjensen/Crossborder.htm
For-Profit Universities
Operating in the Gray Zone of Fraud (College, Inc.) ---
http://faculty.trinity.edu/rjensen/HigherEdControversies.htm#ForProfitFraud
Question
Why wasn't your diversified portfolio safe?
The Market God Failed
What happened to the Theory (Law?) of Portfolio Diversification for Investment
Safety?
Your investment broker, pension fund manager, and your finance/economics
professor claimed that the safe investment strategy was to diversify your
portfolio between bonds and stocks, between securities in diverse industries,
between real estate and securities, etc. Some advocated investing in highly
diverse derivative funds like the S&P Index Fund. The securities portfolio
diversification theory (law?) was mathematically formulated in Nobel Prize
winning legendary works of Harry Markowitz, Merton Miller, Jack Treynor, William
Sharpe, John Lintner and Jan Mossin ---
http://en.wikipedia.org/wiki/Capital_Asset_Pricing_Model
Link forwarded by Jim Mahar
"Opportunities in a High Correlation World," by Geof Considine, Seeking Alpha,
February 4, 2009 ---
http://seekingalpha.com/article/118177-opportunities-in-a-high-correlation-world?source=front_page_editors_picks
One of the most striking features of 2008 was the
fact that correlations between most asset classes went up substantially:
everything declined at the same time.
One of the principal motivations behind diversifying is that all of your
holdings will not decline at the same time. Declines in one class will be
buffered by gains in another—or at least lesser losses in others. This
effect has not provided much buffer in 2008.
There are only three correlations in this matrix
(not pictured here) that did not increase between 2007
and 2008—and those are marked in red. The increase in correlations is
substantial: every asset class was sold off at the same time, albeit in
varying degrees.
The upswing in correlations reduces the value of
strategic asset allocation, because benefits of diversification decline as
correlations increase. The “diversification premium” is diminished. Almost
any given asset allocation will look riskier if correlations are higher. On
the other hand, the increase in correlations signal that the market is
treating enormous swathes of the investment landscape as less differentiated
than they really are—and this provides a substantial opportunity.
How might investors deal with this environment? I
see three major areas that have high potential.
1. Tactical asset allocation
At the same time that correlations have gone up,
prices (obviously) have come down dramatically. The stocks of many firms are
very cheap right now. The tactical side of investing (when you buy) is more
important because the strategic side of investing (asset allocation) is at a
low point. As Warren Buffett has famously suggested: be greedy when others
are fearful and fearful when others are greedy. I have personally never seen
an environment in which investors are more uniformly scared than recent
months.
In August of 2007, shortly before the start of the
massive bear market, I showed that there had historically been a strong
negative correlation between returns on major asset classes and market
volatility. This means that market returns are low when volatility goes up,
and vice versa. I also discussed the wide range of evidence suggesting that
market risk was due for a substantial increase. This observation turned out
to be quite prescient. Today, market risk is high and trending downwards—and
this also has implications for returns. Declining volatility has
historically been a positive sign for a range of asset classes.
I am inclined to agree with Jeremy Grantham that
“high quality” stocks will deliver outsized returns over the coming years.
My analysis suggests that the market has become fairly indiscriminate in
separating the high quality from the low quality—and this shows up in the
increase in correlations. Many investors treated almost every asset class as
equally risky—so high quality stocks are available at really good prices.
The challenge of tactical strategies is that they
require more active management. A position that looks attractive today may
not look attractive in several months. Tactical strategies allow investors
to take advantage of opportunities that may be fleeting. Similarly, the
risks associated with an investment can change quickly.
2. Exploit the excessive risk aversion in the
market
The higher correlations we have seen are a
manifestation of excessive risk aversion: investors are trying to get out of
every asset class as fast as they can. Excessive risk aversion can be judged
by the prices at which options are trading—and a conservative way to exploit
this is to sell options. When investors are risk averse, options prices will
be high (and vice versa). Back in November of 2008, I wrote an article in
which I discussed how to judge relative mis-pricing. As one example, I cited
January 2010 call options on JNJ with a strike price of $65 that were
selling at $5.50. My analysis suggested that these options were selling at
too high a price. Today, these options are selling at $3.10. Selling options
as part of a coherent strategy makes sense for the investor or advisor who
understands how to value options.
3. Looking Beyond Index Investing
I have written quite a bit about the merits of
investing in a portfolio of carefully selected individual stocks rather than
buying into market cap weighted indexes. As correlations between the major
indexes have risen, the way to exploit low correlations appears to be via a
judicious combination of individual stocks. An article titled Have
Individual Stocks Become More Volatile? [pdf file] (Campbell et al, 2001)
shows that correlations between individual securities have experienced a
long-term secular decline. This decline should allow for increased
diversification benefits between individual securities.
Further, Fama and French (The Capital Asset Pricing
Model: Theory and Evidence, 2004) [pdf file] showed that portfolios of
low-Beta stocks have historically delivered consistently higher returns than
the CAPM theory suggests (see Figure 2 in that article). Stocks with low
correlations to one another also tend to be low Beta, and Fama and French’s
results suggest that you can obtain more return with less risk than the
market portfolio by building a portfolio out of low-Beta stocks. A challenge
in this type of approach is to manage volatility associated with individual
stocks—but this is not an insurmountable task. I have discussed this
conceptual strategy previously.
The Long View
I fully expect that correlations will settle back
down to historical levels, thereby providing a higher benefit to strategic
asset allocation once again. The current low prices and the high implied
volatilities of many stocks (as reflected in options prices) provide the
ability for selective investors to lay the groundwork for a substantial
boost in portfolio performance. Strategic Asset Allocation is a key part of
long-term planning, but tactical opportunities appear to dominate the near
term. The high correlations (which reduce the value of SAA for the time
being) increase the potential for finding indiscriminate pricing of risk.
When good companies are treated by the market as though they are just as
risky as bad companies, there is an opportunity to pick up the good ones at
low prices and/or short volatility on the good ones (by selling covered
calls, for example). Further, even though correlations between indexes have
increased considerably for the time being, it is still possible to find
groups of stocks that exhibit low correlations to one another—thereby
providing increased diversification benefits.
Jensen Comment
This once again demonstrates the difference between the physical sciences and
the social sciences. Correlations in the physical sciences may have long-term,
albeit sometimes not infinite, permanence to a point where the word "law" often
becomes an acceptable noun. In realms other than the physical sciences, the term
"law" should always be written ink that is more easily erased.
The basic problem in terms of 2008 was that securities and real estate
markets themselves broke down. Causes are complex, although the most significant
cause was probably that Fannie Mae, Freddie Mack, and various Wall Street
investment banks and other large banks purchased (probably knowingly) many
millions of fraudulent mortgages brokered on every Main Street of every town in
the U.S. --- millions of mortgages that had little or no chance of repayment and
loan amounts well in excess of collateral value, thereby negating recovery of
loan balances in foreclosure proceedings. This, along with the re-packaging
(securitization) of such investments comprise what is now called poisonous
investments that threaten the survival of the firms that hold them (other than
Fannie Mae and Freddie Mack that will survive because they're now owned by the
Zimbabwe-like U.S. Congress that turned to printing pork money it needs rather
than tax or borrow).
The smart move now, in early 2009, would be for Congress to let failing banks
fail, but Congress will most likely absorb the trillions in bad debts and allow
the crooks (oops I meant to say bank executives) that caused the problem
to draw a measly $500,000 per year plus millions in new restricted stock awards
in their revived, debt-free, banks.
Beneath those obvious surface causes was a combination of Congressional
efforts to extend home ownership to poor people (read that Barney's ACORN) and
greedy bankers on Wall Street and Main Street who cared more about their
personal compensation than their fiduciary responsibilities to their companies
and the public.
Long Time Wall Street Journal Defenders of Wall Street's Outrageous Compensation Morph
Into Hypocrites
At each stage of the disaster, Mr. Black told me --
loan officers, real-estate appraisers, accountants, bond ratings agencies --
it was pay-for-performance systems that "sent them wrong."
The need for new compensation rules is most urgent at
failed banks. This is not merely because is would make for good PR, but
because lavish executive bonuses sometimes create an incentive to hide
losses, to take crazy risks, and even, according to Mr. Black, to "loot the
place through seemingly normal corporate mechanisms." This is why, he
continues, it is "essential to redesign and limit executive compensation
when regulating failed or failing banks." Our leaders may not know it yet,
but this showdown between rival populisms is in fact a battle over political
legitimacy. Is Wall Street the rightful master of our economic fate? Or
should we choose a broader form of sovereignty? Let the conservatives'
hosannas turn to sneers.
The market god has failed.
Thomas Frank, "Wall Street Bonuses Are an Outrage: The public
sees a self-serving system for what it," The Wall Street Journal,
February 4, 2009 ---
http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion
Bob Jensen's threads on outrageous compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
I can't believe the liberal-magazine source of this article criticizing
the Obama team: Would you believe the The Nation?
Will liberals attack Obama himself on this one?
"Will Geithner and Summers Destroy the US Economy?" by Christopher
Hayes, The Nation, February 4, 2009 ---
Click Here
That's more or less
what the usually understated
Yves Smith says today about
the preview of the Obama TARP plan, "Team Obama is
taking the cowardly approach of distributing the costs
among the most disenfranchised group in the process,
namely the taxpayer, when there far more obvious and
logical groups to take the hits."
It's not just Smith. I
got an email from a good friend at a hedge fund last
week. He's a *very* moderate guy, and he had this to
say:
The one thing that I
disagree on is that for all the talk of making Tarp
II diff from Tarp I, I don't really see it
happening. An aggregator bank still just takes bad
assets from a bank in exchange for capital. If you
pay market, the banks will be insolvent, so they
won't participate. If you pay above market, you're
basically just injecting capital in to the banks,
which is what they did in Tarp I. Why are they
scared of nationalizing? Citi is an insolvent bank -
wipe the equity, take the company, remove the bad
assets, put the remaining good company back in to
the public markets, repeat for the next insolvent
bank. If they try to let a Citi (or maybe evan a
BofA) earn their way out of this we will end up with
huge parts of the banking system in zombie mode, a
la Japan. That would be very bad and will only
prolong the pain.
This is the where the
rubber of necessity hits the road of The New Politics.
In order to save the American economy, it's increasingly
clear we need to kill off some banks. In words of one
former Wall Streeter, play "good bank, bad bank." But
playing "bad bank" means taking on Wall Street's
power in a concerted way. This is not a question of
technical merits of policy, it's a matter of taking on
entrenched power. Unless the Obama WH can find it within
itself to do it, we may all be very, very screwed.
Financial Reporting for Financisl Institutions is an Exercise in
Distortion and Deception
"Distortions In Baffling Financial Statements," by Floyd Norris, The
New York Times, November 10, 2011 ---
http://www.nytimes.com/2011/11/11/business/accounting-for-financial-institutions-is-a-mess.html?_r=1
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Abusive off-balance sheet accounting was a major
cause of the financial crisis. These abuses triggered a daisy chain of
dysfunctional decision-making by removing transparency from investors,
markets, and regulators. Off-balance sheet accounting facilitating the
spread of the bad loans, securitizations, and derivative transactions that
brought the financial system to the brink of collapse.
As in the 1920s, the balance sheets of major
corporations recently failed to provide a clear picture of the financial
health of those entities. Banks in particular have become predisposed to
narrow the size of their balance sheets, because investors and regulators
use the balance sheet as an anchor in their assessment of risk. Banks use
financial engineering to make it appear that they are better capitalized and
less risky than they really are. Most people and businesses include all of
their assets and liabilities on their balance sheets. But large financial
institutions do not.
Click here to read the full chapter.---
http://www.rooseveltinstitute.org/sites/all/files/Off-Balance Sheet
Transactions.pdf
Frank Partnoy is the George E.
Barnett Professor of Law and Finance and is the director of the Center on
Coporate and Securities Law at the University of San Diego. He worked as a
derivatives structurer at Morgan Stanley and CS First Boston during the
mid-1990s and wrote F.I.A.S.C.O.:
Blook in the Water on Wall Street, a
best-selling book about his experiences there. His other books include
Infectious Greed: How Deceit and Risk Corrupted the Financial Markets
and
The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall
Street Scandals.
Lynn Turner has the unique
perspective of having been the Chief Accountant of the Securities and
Exchange Commission, a member of boards of public companies, a trustee of a
mutual fund and a public pension fund, a professor of accounting, a partner
in one of the major international auditing firms, the managing director of a
research firm and a chief financial officers and an executive in industry.
In 2007, Treasury Secretary Paulson appointed him to the Treasury Committee
on the Auditing Profession. He currently serves as a senior advisor to LECG,
an international forensics and economic consulting firm.
The views expressed in this paper are those of the authors and do not
necessarily reflect the positions of the Roosevelt Institute, its officers,
or its directors.
Bob Jensen's threads on OBSF are at
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
For over 15 years Frank Partnoy has been appealing in vain for financial
reform. My timeline of history of the scandals, the new accounting standards,
and the new ploys at OBSF and earnings management is at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance
Bob Jensen's threads on the Bailout and Stimulus Act Mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on accounting theory are at
http://faculty.trinity.edu/rjensen/theory.htm
Renaissance in US Manufacturing (But Not Jobs So Much): Robotics
Explosion
From the Barry Ritholtz Blog on April 12, 2013
http://www.ritholtz.com/blog/2013/04/manufacturing-returns-to-usa/
Fascinating cover story in Time magazine about the
renaissance in US Manufacturing.
What is so interesting about this is while new
businesses are being created, the amount and kinds of jobs that go with this
are very different than what the manufacturing sector produced in the past.
Some takeaways from the article:
• Post-recession, U.S. manufacturing growth is
outpacing other advanced nations;
• 500,000 manufacturing jobs created in the USA
over the past three years;
• U.S. factories access to cheap energy, (oil
and gas from the shale boom) means cheaper costs versus
expensive overseas Oil and costly shipping prices.
• Energy- and resource-intensive industries
(chemicals, wood products, heavy machinery and appliances) do better,
powered by that cheaper homegrown energy.
• New made-in-America economics is centered
largely on cutting-edge technologies (3D printing, specialized metals,
robotics and bioengineering);
• New US factories are “superautomated”
and heavily roboticized;
• Employees typically are required to have
computer skills and specialized training; Minimum of two-year tech
degree, which is likely to rise to four-year degree (eventually);
More machines and fewer workers is the future of
manufacturing in the USA. But looking only at factories misses some of the
new jobs that are related to these industries. Many of the jobs created are
outside the factory floors — R&D, support services, software engineers, data
scientists, user-experience designers, transportation & shipping, etc.
Perhaps this helps to explain why every $1 of
manufacturing activity returns $1.48 to the economy.
Here is an excerpt:
“Today’s U.S. factories aren’t the noisy places
where your grandfather knocked in four bolts a minute for eight hours a
day. Dungarees and lunch pails are out; computer skills and specialized
training are in, since the new made-in-America economics is centered
largely on cutting-edge technologies. The trick for U.S. companies is to
develop new manufacturing techniques ahead of global competitors and
then use them to produce goods more efficiently on superautomated
factory floors. These factories of the future have more machines and
fewer workers—and those workers must be able to master the machines.
Many new manufacturing jobs require at least a two-year tech degree to
complement artisan skills such as welding and milling. The bar will only
get higher. Some experts believe it won’t be too long before employers
expect a four-year degree—a job qualification that will eventually be
required in many other places around the world too.
Understanding this new look is critical if the
U.S. wants to nurture manufacturing and grow jobs. There are
implications for educators (who must ensure that future workers have the
right skills) as well as policymakers (who may have to set new
educational standards). “Manufacturing is coming back, but it’s evolving
into a very different type of animal than the one most people recognize
today,” says James Manyika, a director at McKinsey Global Institute who
specializes in global high tech. “We’re going to see new jobs, but
nowhere near the number some people expect, especially in the short
term.”
If the U.S. can get this right, though, the
payoff will be tremendous. Labor statistics actually shortchange the
importance of manufacturing because they mainly count jobs inside
factories, and related positions in, say, Ford’s marketing department or
at small businesses doing industrial design or creating software for big
exporters don’t get tallied. Yet those jobs wouldn’t exist but for the
big factories. The official figure for U.S. manufacturing employment,
9%, belies the importance of the sector for the overall economy.
Manufacturing represents a whopping 67% of private-sector R&D spending
as well as 30% of the country’s productivity growth. Every $1 of
manufacturing activity returns $1.48 to the economy. “The ability to
make things is fundamental to the ability to innovate things over the
long term,” says Willy Shih, a Harvard Business School professor and
co-author of Producing Prosperity: Why America Needs a Manufacturing
Renaissance. “When you give up making products, you lose a lot of the
added value.” In other words, what you make makes you.”
The full article is well worth your time to read . . . ---
Source:
Made in the USA ---
http://www.time.com/time/magazine/article/0,9171,2140793,00.html
Rana Foroohar and Bill Saporito
Time, April 2013
http://business.time.com/2013/04/11/how-made-in-the-usa-is-making-a-comeback/
Robotics Displacing Labor Even in Higher Education
"The New Industrial Revolution," by Jeffrey R. Young, Chronicle of Higher
Education's Chronicle Review, March 25, 2013 ---
http://chronicle.com/article/The-New-Industrial-Revolution/138015/?cid=cr&utm_source=cr&utm_medium=en
"Rethink Robotics invented a $22,000 humanoid
(i.e. trainable) robot that competes with low-wage workers," by Antonio
Regalado, MIT's Technology Review, January 16, 2013 ---
Click Here
http://www.technologyreview.com/news/509296/small-factories-give-baxter-the-robot-a-cautious-once-over/?utm_campaign=newsletters&utm_source=newsletter-daily-all&utm_medium=email&utm_content=20130116
"Rise of the Robots," by Paul Krugman, The New York Times,
December 8, 2012 ---
http://krugman.blogs.nytimes.com/2012/12/08/rise-of-the-robots/
¶Catherine Rampell and Nick Wingfield write
about the
growing evidence for “reshoring” of manufacturing
to the United States. They cite several reasons: rising wages in Asia; lower
energy costs here; higher transportation costs. In a
followup piece, however, Rampell cites another
factor: robots.
¶The most valuable part of each
computer, a motherboard loaded with microprocessors and memory, is
already largely made with robots, according to my colleague Quentin
Hardy. People do things like fitting in batteries and snapping on
screens.
¶As more
robots are built, largely by other robots, “assembly can be done here as
well as anywhere else,” said Rob Enderle, an analyst based in San Jose,
Calif., who has been following the computer electronics industry for a
quarter-century. “That will replace most of the workers, though you will
need a few people to manage the robots.”
¶Robots mean that labor costs don’t
matter much, so you might as well locate in advanced countries with
large markets and good infrastructure (which may soon not include us, but
that’s another issue). On the other hand, it’s not good news for workers!
¶This is an
old concern in economics; it’s “capital-biased technological change”, which
tends to shift the distribution of income away from workers to the owners of
capital.
¶Twenty years
ago, when I was writing about globalization and inequality, capital bias
didn’t look like a big issue; the major changes in income distribution had
been among workers (when you include hedge fund managers and CEOs among the
workers), rather than between labor and capital. So the academic literature
focused almost exclusively on “skill bias”, supposedly explaining the rising
college premium.
¶But
the college premium hasn’t risen for a while.
What has happened, on the other hand, is a notable shift in income away from
labor:.
"Harley Goes Lean to Build Hogs," by James R. Hagerty, The Wall
Street Journal, September 22, 2012 ---
http://professional.wsj.com/article/SB10000872396390443720204578004164199848452.html?mod=djem_jiewr_AC_domainid&mg=reno64-wsj
If the global economy slips into a deep slump,
American manufacturers including motorcycle maker Harley-Davidson Inc. that
have embraced flexible production face less risk of veering into a ditch.
Until recently, the company's sprawling factory
here had a lack of automation that made it an industrial museum. Now,
production that once was scattered among 41 buildings is consolidated into
one brightly lighted facility where robots do more heavy lifting. The number
of hourly workers, about 1,000, is half the level of three years ago and
more than 100 of those workers are "casual" employees who come and go as
needed.
All the jobs are not going to Asia, They're going to Hal ---
http://en.wikipedia.org/wiki/2001_Space_Oddessey
"When Machines Do Your Job: Researcher Andrew McAfee says advances in
computing and artificial intelligence could create a more unequal society,"
by Antonio Regalado, MIT's Technology Review, July 11, 2012 ---
http://www.technologyreview.com/news/428429/when-machines-do-your-job/
"Raytheon's Missiles Are Now Made by Robots," by Ashlee Vance,
Bloomberg Business Week, December 11, 2012 ---
http://www.businessweek.com/articles/2012-12-11/raytheons-missiles-now-made-by-robots
A World Without Work," by Dana Rousmaniere, Harvard Business Review
Blog, January 27, 2013 ---
Click Here
http://blogs.hbr.org/morning-advantage/2013/01/morning-advantage-a-world-with.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Walter E. Williams ---
http://en.wikipedia.org/wiki/Walter_E._Williams
"Black Unemployment," by Walter E. Williams, Townhall, April
10, 2013 ---
http://townhall.com/columnists/walterewilliams/2013/04/10/black-unemployment-n1561096?utm_source=thdaily&utm_medium=email&utm_campaign=nl
The Cleantech Bust (Frauds)
On January 6, 2014 CBS Sixty Minutes did a depressing module on how the
$150 billion of taxpayer dollars lost in stimulus funding of alternative energy
plants. But pennies of that $150 loss may be recovered. The Chinese are buying
up these empty plants at pennies on the dollar for alternative uses like making
automobile parts to ship to China. USA taxpayers monumentally stimulated the
Chinese economy.
But instead of breakthroughs, the sector suffered a
string of expensive tax-funded flops. Suddenly Cleantech was a dirty word.
"The Cleantech Crash: Despite billions invested by the U.S. government
in so-called “Cleantech” energy, Washington and Silicon Valley have little to
show for it," by Leslie Stahl, CBS News, January 5, 2014 ---
http://www.cbsnews.com/news/cleantech-crash-60-minutes/
The following is a script from "The Cleantech
Crash" which aired on Jan. 5, 2014. Lesley Stahl is the correspondent.
Shachar Bar-On, producer.
About a decade ago, the smart people who funded the
Internet turned their attention to the energy sector, rallying tech
engineers to invent ways to get us off fossil fuels, devise powerful solar
panels, clean cars, and futuristic batteries. The idea got a catchy name: “Cleantech.”
Silicon Valley got Washington excited about it.
President Bush was an early supporter, but the federal purse strings truly
loosened under President Obama. Hoping to create innovation and jobs, he
committed north of a $100 billion in loans, grants and tax breaks to
Cleantech. But instead of breakthroughs,
the sector suffered a string of expensive tax-funded flops. Suddenly
Cleantech was a dirty word.
Investor Vinod Khosla, known as the father of the
Cleantech revolution, has poured over a billion dollars of his own money
into some 50 energy startups. He took us to one in Columbus, Miss. KiOR is a
biofuel company that’s replacing oil drilling with oil making.
Vinod Khosla: Nature takes a million years to
produce our crude oil. KiOR can produce it in seconds.
The company took over this old paper mill, where
logs are picked up by a giant claw, dropped into a shredder and pulverized
into woodchips.
Vinod Khosla: And we take that, add this magic
catalyst-
Lesley Stahl: This is the secret sauce?
Vinod Khosla: Yeah.
Lesley Stahl: You throw that on top of the chips?
Vinod Khosla: And then, out comes something that
looks that looks just like crude oil.
The crude is created through a thermo-chemical
reaction in seconds. And by using wood instead of corn, this biofuel doesn’t
raise food prices which was a concern with ethanol.
Vinod Khosla: It smells like crude, it works like
crude except it's 100 percent renewable.
Then it’s distilled onsite into…
Lesley Stahl: Clean gasoline?
Vinod Khosla: Clean green gasoline.
Lesley Stahl: This goes right into the tank, right?
You don’t have to build a new infrastructure?
Vinod Khosla: Absolutely.
Lesley Stahl: You make it sound almost – sorry –
too good to be true. There must be a downside.
Vinod Khosla: There is no downside.
Well there is: first off, his clean green gasoline
costs much more than what you pay at the pump. And despite hundreds of
millions of dollars invested – including 165 million of Khosla’s own money,
KiOR is still in the red, and the manufacturing is so complex, it is riddled
with delays.
Lesley Stahl: All kinds of glitches.
Vinod Khosla: That always happens but part of
anything, whether you're building a refinery or a solar facility or a
computer factory, you get exactly the same unanticipated glitches.
He’s downplaying the glitches. But the venture
capital model is that for every 10 startups, nine go under. And he says he
expects at least half of his energy companies will fail. But Khosla can take
that gamble. He earned billions with two giant Silicon Valley winners: Sun
Microsystems and Juniper Networks. It was successes like these that gave
Khosla and the other Silicon Valley moneymen the moxie to jump into energy.
Steven Koonin: I think they saw it as a technical
opportunity, thinking that the people in energy are just troglodytes and
they don't understand what they're doing.
Former Energy Department under secretary, Physicist
Steven Koonin, says there was a lot of arrogance. He thought the venture
capitalists and Internet geniuses were underestimating the challenges of the
energy sector.
Lesley Stahl: Like what?
Steven Koonin: Managing risks that have to do with
market, with supply, with operation, with regulation. And in the end, hoping
that you get returns on a 20 or 30-year time scale.
Lesley Stahl: Yeah, but they must’ve known they
weren’t going to get a payoff for 20 or 30 years.
Steven Koonin: I don’t think they understood that.
The average venture capitalist likes to get in and out in about 3 to 5
years.
While other venture capitalists have withdrawn from
the energy sector, Khosla is staying in, but with a lot of help from
taxpayers. Over the years, the federal government has committed north of a
hundred million dollars to his various Cleantech ventures and several states
have pitched in hundreds of millions as well. But his critics say he’s in
over his head.
Robert Rapier: Vinod Khosla is very smart, but
would you let him operate on your heart?
Lesley Stahl: No.
Robert Rapier: No, because that’s not his area of
expertise.
Robert Rapier, a chemical engineer specializing in
Biofuels, says Khosla and almost all the other venture capitalists in
Silicon Valley got caught up in their own hype.
Robert Rapier: He set up a system where he
overpromised and under-delivered and so the public and the politicians all
developed unreasonable expectations.
Lesley Stahl: But hasn’t technology advanced enough
so that somebody like Vinod Khosla could think: “Ah, we can do it more
cheaply, faster."
Robert Rapier: Well yeah, but in the field of
advanced biofuels, he has not done very well. The companies that he’s
brought out are in trouble. Their share prices are down 80, 85 percent. "[Vinod
Khosla] set up a system where he overpromised and under-delivered, and so
the public and the politicians all developed unreasonable expectations."
Lesley Stahl: What about this criticism that what
it takes to be successful in Silicon Valley does not translate into the
energy business? It's such a completely different field.
Vinod Khosla: That's fair criticism. But I am
learning. And I am trying. And they're sitting there doing nothing. They're
being the nay-sayers, the pundits who say why it can't be done. But they
won't try. Now, sure we've done lots of things that failed in energy. But
every time, we learned. Picked ourselves up and tried something new.
Robert Rapier: He’s getting up that learning curve,
but taxpayers funded that. A billionaire came into the energy business –
Lesley Stahl: You’re saying we paid him to learn is
what—
Robert Rapier: We paid him to learn the energy
business.
The federal government has allocated a total of
$150 billion to Cleantech – through loans, grants and tax breaks with little
to show for it.
Lesley Stahl: The taxpayers have lost a lotta money
in the general Cleantech area.
Vinod Khosla: Look, we have to take risks. And
risks mean the risk of losing money. So let me ask you a question. We've
been looking for a cure for cancer for a long time. How much money has the
U.S. government spent? Billions and billions of dollars. Should we stop
looking for a cure for cancer because we haven't found a cure?
But under the Obama Stimulus Act, the government
wasn’t just supporting research. With Cleantech it was shoveling money to
build assembly lines, helping startups in the manufacturing phase. Over half
a billion dollars went to a solar-panel company named Solyndra to build a
factory. When solar was undercut by low prices in China, Solyndra died.
Another half billion in loan guarantees went to
Fisker, a clean car startup that promised to open a plant in Delaware, but
went bankrupt. And in other cases production was ramped up before there was
any demand – as with LG Chem in Michigan. "Look, we have to take risks. And
risks mean the risk of losing money. So let me ask you a question. We've
been looking for a cure for cancer for a long time. How much money has the
U.S. government spent? Billions and billions of dollars. Should we stop
looking for a cure for cancer because we haven't found a cure?"
[Obama: Shovels will soon be moving earth and
trucks will be pouring concrete where we are standing.]
The plant was built with $151 million from the
stimulus to make batteries for electric cars that people never bought. So
the plant went idle and workers were paid tax dollars to sit around and do
nothing.
These loans and grants were administered by the
Energy Department. They wouldn’t give us an interview, but Steven Koonin was
actually the head scientist for the department, approving many of the
stimulus projects.
Lesley Stahl: The government spent about $150
billion into these innovations. Taxpayer dollars. Money well spent?
Steven Koonin: I think there are significant
developments that have come out of that spending that impact our energy
system now. New technologies demonstrated. I think it was good value for the
money.
Lesley Stahl: Well, Solyndra went through over half
a billion dollars before it failed. Then I'm gonna give you a list of other
failures: Abound Energy, Beacon Power, Fisker, V.P.G., Range Fuels, Ener1,
A123. ECOtality. I'm exhausted.
Steven Koonin: As I told you in the beginning, the
energy business is tough.
Lesley Stahl: What happened?
Steven Koonin: Oh, gosh, there are so many reasons.
I put some of the major blame on the government, both the executive branch
and Congress, for an inability to set a thoughtful and consistent energy
policy.
Lesley Stahl: Let me interrupt you. You were the
government. How many of the loans were you involved in?
Steven Koonin: Difficult to know the exact number.
But I would say in the order of 30.
Lesley Stahl: Did you make mistakes?
Steven Koonin: I think I didn’t do as good a job as
I could’ve. In retrospect, I would’ve done things a bit differently.
Lesley Stahl: Part of this was supposed to be
creating new jobs. Everything I've read there were not many jobs created.
Steven Koonin: That's correct.
Lesley Stahl: So what went wrong there?
Steven Koonin: I didn't say it would create jobs.
Other people did.
Lesley Stahl: So you never thought it was gonna
create-
Steven Koonin: I didn't think it mattered as a job
creation, no.
Lesley Stahl: So, is Cleantech dead?
Steven Koonin: There are parts of it that I would
say are on life support right now.
The stimulus investment wasn’t a total bust. It
helped create the successful electric car company Tesla. A few of other
companies are starting to show promise, and loans are being repaid.
But Cleantech was dealt a hammer blow by this:
plentiful, inexpensive and relatively clean domestic natural gas. So by
2012, the moneymen of Silicon Valley were dropping energy from their
portfolios and soon struggling and bankrupt Cleantech companies were on the
auction block at firesale prices. And guess who snatched them up? China! The
most aggressive buyer is arguably this man.
Pin Ni and his autoparts company Wanxiang have made
six big investments in American Cleantech so far, including buying A123,
another electric car battery startup that lost over 130 million tax dollars.
Lesley Stahl: A lot of the companies that you have
bought in the Cleantech area got a lot of federal subsidies. I have the
list.
Pin Ni: A123 did, yes.
Lesley Stahl: Well, Ener1 did –
Pin Ni: Ener1 did, yeah.
Lesley Stahl: Smith Electric Trucks.
Pin Ni: I would think so, yeah.
Lesley Stahl: There's something that just doesn't
feel right about a Chinese company coming in and scooping it all up after
the taxpayers put so much money into it.
Pin Ni: My answer will be: Do we like the
capitalism or not? If we do, that is the capitalism.
Lesley Stahl: But do you think it’s a good
business? Do you think Cleantech is going well?
Pin Ni: Cleantech is not going well.
But China is willing to make a long-term bet on the
technology, and spend what it takes to develop the manufacturing. But here’s
where it gets complicated: this is Wanxiang’s American subsidiary with 27
plants in 13 states and some 6,000 American workers. Pin Ni says every third
car made in the U.S. has Wanxiang parts.
Lesley Stahl: You understand the suspicion around
you, this company that you're here just to take our high-tech-
Pin Ni: Sure. Absolutely.
Lesley Stahl: --technology, you know, and get it
back to China as fast as you can.
Pin Ni: But my simple question is: for what? I'm
not the president of China. I'm the president of Wanxiang America, right? So
whatever we do has to benefit us. We are here to conduct business. We are
here to make money.
And so the irony: that taxpayer money for Cleantech
and jobs ended up with a Chinese company creating Cleantech and Jobs… in
America.
Lesley Stahl: American taxpayers have spent
billions on Cleantech. Have we gotten our money's worth?
Pin Ni: If you measure them by today's standard I
would say definitely not. You didn't see anything come out of it. But if you
view this as a step stone to the future, when you get there, when you look
back, I would say yes.
But Vinod Khosla says if the U.S. government
doesn’t put more money into this technology – when we get there, it will all
be in China. He wants to open KiOR biofuel plants like this in every
defunct paper mill in the country.
Continued in article
Jensen Comment
Vinod Khosla wants to covert all the defunct paper mills into losing biomass
fuel plants with the taxpayers footing the bill. Actually that is not quite
true. If the Fed simply prints another trillion dollars Vinod's fiascos can be
funded for with free money. But Vinod's gasoline will still be $20 per gallon.
Appendix A on a Problem Government Just Will
Not Address:
Pending Economic Disaster in the U.S.
U.S. Debt/Deficit Clock ---
http://www.usdebtclock.org/
Laughing is Optional
Comedian Jon Stewart (The Daily Show on Comedy Central) has generally been a
force for the Democratic Party and was a strong supporter of Barack Obama in the
2008 Presidential Campaign as he hammered on President Bush and GOP Candidate
John McCain. Belatedly Jon Stewart's beginning to see the light on how President
Obama's unrestrained spending and failures of the Stimulus Act are bringing the
U.S. economy to the brink of disaster. Watch his recent interview with Peter
Schiff. Laughing is optional ---
http://www.thedailyshow.com/tagSearchResults.jhtml?term=Peter+Schiff
Jon also ran s how on how NBC is "kissing President Obama's ass" ---
Click Here
http://hotair.com/archives/2009/06/05/video-nbcs-ass-kissing-of-obama-too-much-even-for-jon-stewart/
Also see
http://www.thedailyshow.com/tagSearchResults.jhtml?term=Brian+Williams
Video: David Dreman Warns About 10-12% Inflation,
Simoleon Sense, August 5, 2009 ---
http://www.simoleonsense.com/videodavid-dreman-warns-about-10-12-inflation/
Doom and Gloom
Video From CNN: Julian Robertson Discusses The US Debt And Upcoming Inflation
Expectations ---
http://www.zerohedge.com/article/julian-robertson-discusses-us-debt-and-upcoming-inflation-expectations
"A Short Primer on the National Debt: With a return to
1990s growth rates, the debt-to-GDP ratio could drop to 56.7%, about where it
was in 2000, in just one decade," by John Steele Gordon, The Wall Street
Journal, August 29, 2011 ---
http://online.wsj.com/article/SB10001424053111903480904576510660976229354.html?mod=djemEditorialPage_t
With the national debt certain to be a
front-and-center issue in the 2012 campaign, it is important to understand
the true measure of its size. That size seems to vary considerably in news
reports. Some news organizations use the debt held by the public, others use
total debt. Still others report total future liabilities of the federal
government, without making clear what, exactly, that means.
So, a few definitions. The total national debt of
the United States is the sum of all federal bills, notes and bonds that have
been issued by the Treasury and not yet redeemed. The publicly held debt is
the sum of the Treasury securities held by individuals, financial
institutions and foreign governments. (That's not just the Chinese, by the
way. Both Great Britain and Japan are also major holders of U.S. debt, as
are many other countries in lesser amounts.)
The intra-governmental debt is the sum of Treasury
bonds held by agencies of the federal government, principally the so-called
Social Security Trust Fund. The liabilities equal the future pensions,
health care, Social Security payments, etc., that are promised under current
legislation.
But while the Treasury securities bear the full
faith and credit of the United States and any failure to pay the interest or
redeem the principal in a timely fashion would be a default, the liabilities
are liabilities only so long as current law remains unchanged. If, for
instance, Congress were to adjust the formula by which Social Security
cost-of-living increases were calculated or change the age of eligibility,
future federal liabilities would shrink by trillions of dollars instantly.
Should the intra-governmental debt be counted when
discussing the national debt? I think the answer is yes. As the Social
Security surplus disappears (it did, at least temporarily, in 2010) as the
baby boomers increasingly retire, the Treasury will be asked to redeem more
and more of these federal bonds.
Congress will then have three options: cut spending
elsewhere, raise taxes, or borrow the money in the bond market, thus
converting the intra-governmental debt into publicly held debt. The last of
the three options is the only plausible one and so the intra-governmental
debt should be counted as though it were publicly held debt, as that's
exactly what it will be in the fullness of time.
In absolute numbers, the total public debt as of
Aug. 11 was $9.924 trillion, and the intra-government debt was $4.666
trillion, for a total of $14.587 trillion. That's well over 300 million
times the country's median household income. Stacked as dollar bills, it
would reach 920,953 miles high, almost four times as far from Earth as the
moon.
But while these numbers are fun to play with, they
don't mean much. It's the debt's size relative to gross domestic product
that matters, just as personal debts must be measured against a person's
income before they can be properly evaluated. The GDP of the United States
was $15.003 trillion at the end of the first quarter in 2011. That makes the
public debt equal to 66.1% of GDP and the intra-governmental debt 31.1%.
Total debt is now 97.2% of GDP and climbing rapidly.
And it's the climbing rapidly part that is
worrisome, not the debt's current size relative to GDP. Indeed, the debt has
been substantially higher by that measure in earlier times. In 1946, in the
immediate aftermath of World War II, it was 129.98% of GDP. But while the
debt had increased enormously during the war (it had been 50% of a much
smaller GDP in 1940), it did not increase substantially over the next 15
years. It was $269 billion in 1946 and $286 billion in 1960. The American
economy grew so much in those years that the debt, while slightly up in
absolute terms, was down to only 58% of GDP by 1960.
The debt grew to $370 billion in the next decade,
but again economic growth (and, towards the end of the 1960s, inflation)
continued to reduce it relative to GDP. In 1970 it was a mere 39%, the
lowest it had been since the depths of the Great Depression. And while the
debt nearly tripled in the 1970s (to $909 billion), the raging inflation of
that decade caused the debt to continue to decline to 34.5% of GDP.
When the Federal Reserve under Paul Volcker broke
the back of the 1970s inflation, the debt relative to GDP began to soar.
Why? Because Washington continued to increase spending faster than
government revenues increased (and revenues increased a whopping 99.4% in
the 1980s thanks to the great boom that began in 1983). The debt was 58.15%
of GDP in 1990, a full 24 percentage points above its 1980 low. It continued
to increase dramatically in the early 1990s, reaching 68.91% of GDP in 1994.
But then a Republican Congress was swept into power
that year, the first time the GOP controlled both houses of Congress since
1954, and President Clinton tacked sharply to the center. In the next six
years, while revenues increased 61%, federal outlays increased only 22%. The
years 1998-2000 actually showed the first surpluses in the federal budget in
30 years. And the debt, relative to GDP, declined between 1994 and 2000 to
57.3% from 68.91%.
That decline ended in 2001 following the collapse
of the dot-com bubble and rising unemployment in the resulting recession. By
2003 the debt-to-GDP ratio had risen to 61.7%. Many blame the Bush tax cuts
for adversely impacting federal revenues, causing the debt to spiral
upwards. But that is just not true. Federal revenues declined by almost 12%
in the early years of the decade, but when the tax cuts fully kicked in in
2003, the economy began to grow strongly again and federal revenues
increased 44% in the next four years, while unemployment fell to 4.2% from
6.2%. Federal outlays in those four years increased by only 26.4%, and while
the debt-to-GDP ratio increased to 64.8% by 2007, that was still well below
what it had been in 1994.
Only with the severe recession that officially
began in mid-2007 did the debt-to-GDP ratio begin to soar once more. It
reached 67.7% by Oct. 1, 2008, near the end of the Bush administration. A
year later, under President Obama, it was at 84.4%, a year later still
93.8%. It is headed quickly towards 100% and beyond without fundamental
change in how Washington handles the public fisc.
But a president and a Congress committed to
reforming Washington's ways face no insuperable problem getting the debt
under control. No one expects the United States to pay off its debt (as we
did in the administration of Andrew Jackson, the only time a major country
has ever paid off its national debt). Even in a best-case scenario, the
absolute size of the debt will not get smaller. But if we can summon the
necessary political will, we can dramatically affect the measure of the debt
burden that matters: the debt-to-GDP ratio.
Continued in article
"Bernanke Says Deficit Action Is Key: Fed chairman says investors'
continued faith in U.S. economy could fade quickly without signs that Congress
is crafting plans to align federal expenditures and revenue," by Sudeep
Reddy, The Wall Street Journal, February 26, 2010 ---
http://online.wsj.com/article/SB20001424052748704479404575087290468927762.html#mod=todays_us_page_one
Federal Reserve Chairman Ben Bernanke faced a
barrage of questions about the risks of a rising federal deficit when he
delivered his semiannual economic report to Congress this week.
Mr. Bernanke's repeated response during a pair of
hearings was that markets haven't lost faith in the U.S. economy yet. But he
said the situation could change quickly without a credible plan from
lawmakers to bring projected government spending in line with tax revenue.
"I'm not anticipating anything in the near term,
but it is conceivable that it could lead to a loss of confidence in aspects
of the U.S. economy," Mr. Bernanke told the Senate Banking Committee on
Thursday. "It could affect interest rates. It could affect the value of the
dollar. And those things could directly or indirectly affect the state of
the economy."
With this fiscal year's deficit projected to reach
a record $1.6 trillion, lawmakers pushing for stronger action to rein in the
deficit sought to use the central-bank chief's comments to win support for
their cause.
During his appearances before Congress this week,
the first since his new term began following a tough confirmation battle,
Mr. Bernanke sought to highlight the difficulty of the necessary political
decisions while explaining the economics behind them.
"It's very easy for me to say this, because I don't
have to grapple with these difficult problems," Mr. Bernanke said at
Wednesday's session before House Financial Services Committee members.
"But it is very, very important for Congress and
the administration to come to some kind of program, some kind of plan that
will credibly show how the United States government is going to bring itself
back to a sustainable position," Mr. Bernanke added.
The Fed chairman focused his responses on the
medium-term deficit, allowing that it is acceptable for near-term deficits
to rise while the economy recovers from the deep recession. Mr. Bernanke
said deficits need to be brought down to 2.5% to 3% of the nation's gross
domestic product to be sustainable.
Investors are still buying government debt at low
interest rates, he said, suggesting they are willing to give Congress time
to craft a plan. But he also said they may react sooner without clear
signals from Congress.
If the U.S. were to emerge from its recession and
deficits weren't brought down, Sen. David Vitter (R., La.) asked, "how
quickly would that become a major problem in terms of the economy?"
"It could become a problem tomorrow if bond markets
are not persuaded that Congress is serious about bringing down the deficit
over time," Mr. Bernanke answered.
"Harvard’s Rogoff Sees Sovereign Defaults, ‘Painful’ Austerity," by
Aki Ito and Jason Clenfield, Bloomberg, February 24, 2010 ---
http://mobile.bloomberg.com/apps/news?pid=2065100&sid=aaeViPPUVSw4
Thank you for the heads up Jim Mahar.
Ballooning debt is likely to force several
countries to default and the U.S. to cut spending, according to Harvard
University Professor Kenneth Rogoff , who in 2008 predicted the failure of
big American banks.
Following banking crises, “we usually see a bunch
of sovereign defaults, say in a few years,” Rogoff, a former chief economist
at the International Monetary Fund, said at a forum in Tokyo yesterday. “I
predict we will again.”
The U.S. is likely to tighten monetary policy
before cutting government spending, sending “shockwaves” through financial
markets, Rogoff said in an interview after the speech. Fiscal policy won’t
be curbed until soaring bond yields trigger “very painful” tax increases and
spending cuts, he said.
Global scrutiny of sovereign debt has risen after
budget shortfalls of countries including Greece swelled in the wake of the
worst global financial meltdown since the 1930s. The U.S. is facing an
unprecedented $1.6 trillion budget deficit in the year ending Sept. 30, the
government has forecast.
“Most countries have reached a point where it would
be much wiser to phase out fiscal stimulus,” said Rogoff, who co- wrote a
history of financial crises published in 2009. It would be better “to keep
monetary policy soft and start gradually tightening fiscal policy even if it
meant some inflation.”
Failed Marriage
Rogoff, 56, said he expects Greece will eventually
be bailed out by the IMF rather than the European Union. Greece will
probably announce an austerity program “in a few weeks” that will prompt the
EU to provide a bridge loan which won’t be enough to save the country in the
long run, he said.
“It’s like two people getting married and saying
therefore they’re living happily ever after,” said Rogoff. “I don’t think
Europe’s going to succeed.”
Investors will eventually demand higher interest
rates to lend to countries around the world that have accumulated debt,
including the U.S., he said. The IMF forecast in November that gross U.S.
borrowings will amount to the equivalent of 99.5 percent of annual economic
output in 2011. The U.K.’s will reach 94.1 percent and Japan’s will spiral
to 204.3 percent.
“In rich countries -- Germany, the United States
and maybe Japan -- we are going to see slow growth. They will tighten their
belts when the problem hits with interest rates,” Rogoff said at the forum,
which was hosted by CLSA Asia-Pacific Markets, a unit of Credit Agricole SA,
France’s largest retail bank. Japanese fiscal policy is “out of control,” he
said.
Euro Concerns
So far concerns about the euro zone’s ability to
withstand the deteriorating finances of its member nations have outweighed
the U.S.’s deficit woes, propping up the dollar.
“The more they suck in Greece, the lower the euro
goes, because it’s not a viable plan,” Rogoff said. “Clearly the dollar is
going to go down against the emerging markets -- there’s going to be concern
about inflation and the debt.”
The dollar has surged more than 9 percent against
the euro in the past three months. Ten-year Treasuries yielded 3.72 percent
as of 10:16 a.m. in New York.
The U.S. government will delay any efforts to
contain the deficit until Treasury yields reach around 6 percent to 7
percent, Rogoff said.
“The U.S. is in a state of paralysis in its fiscal
policy,” he said. “Monetary policy will tighten first, and I don’t think
it’s the right mix.”
Fed Exit
The Federal Reserve last week raised the discount
rate charged to banks for direct loans, and plans to end its $1.25 trillion
purchases of mortgage-backed securities in March. President Barack Obama ’s
administration is proposing a $3.8 trillion budget for fiscal 2011 to spur
the recovery.
“When they start tightening monetary policy even a
little bit, it’s going to send shockwaves through the system,” Rogoff said.
In an interview a month before Lehman Brothers
Holdings Inc. went bankrupt in 2008, Rogoff said “the worst is yet to come
in the U.S.” and predicted the collapse of “major” investment banks. His
2009 book “This Time Is Different,” co- written with Carmen M. Reinhart ,
charts the history of financial crises in 66 countries.
“We almost always have sovereign risk crises in the
wake of an international banking crisis, usually in a few years, and that’s
happening,” he said. “Greece is just the beginning.”
Greece’s debt totaled 298.5 billion euros ($405
billion) at the end of 2009, according to the Finance Ministry. That’s more
than five times more than Russia owed when it defaulted in 1998 and
Argentina when it missed payments in 2001.
The cost of protecting Greek bonds from default
surged in January, then declined this month as concern eased over the
country’s creditworthiness. Credit-default swaps on Greek sovereign debt
have fallen to 356 basis points from 428 last month, according to CMA
DataVision. That’s up from 171 at the start of December.
“Greece just highlights that one of those risks is
sovereign default,” said Naomi Fink , a strategist at Bank of
Tokyo-Mitsubishi UFJ Ltd. Still, “it doesn’t justify the situation where
we’re all in a panic and are going back to cash in the post-Lehman shock.”
U.S. Debt/Deficit Clock ---
http://www.usdebtclock.org/
Bob Jensen's threads on looming entitlements disasters ---
http://faculty.trinity.edu/rjensen/entitlements.htm
David Walker ---
http://en.wikipedia.org/wiki/David_M._Walker_(U.S._Comptroller_General)
Niall Ferguson ---
http://en.wikipedia.org/wiki/Niall_Ferguson
Niall Ferguson,
"An Empire at Risk: How Great Powers Fail," Newsweek Magazine
Cover Story, November 26, 2009 ---
http://www.newsweek.com/id/224694/page/1
Please note that this is NBC’s liberal Newsweek Magazine and not Fox News
or The Wall Street Journal.
"N.Y. Fed says municipal bond defaults higher than ratings agency counts,"
by Danielle Douglas, The Washington Post, August 15, 2012 ---
Click Here
http://www.washingtonpost.com/business/economy/ny-fed-says-municipal-bond-defaults-higher-than-ratings-agency-counts/2012/08/15/233bb780-e6f4-11e1-8741-940e3f6dbf48_story.html
Defaults on municipal bonds for decades have been
far higher than reported by rating agencies, bringing into question the true
risk of a common investment widely considered to be safe, according to a
study released Wednesday by the Federal Reserve Bank of New York.
Economists at the agency counted 2,521 muni bond
defaults since 1970, whereas ratings agency Moody’s Investors Service, for
instance, reported 71.
Muni bonds often act as an investment haven for
ordinary Americans, and the new findings reveal they may be more risky than
previously thought. That has been the subject of debate among lawmakers and
others in the wake of a series of bankruptcy filings in California and
elsewhere, as well as the collapse of several municipal projects.
Supporters of muni bonds say that despite a few
high-profile cases, government securities rarely default. Data from the New
York Fed, however, suggests otherwise.
Ratings agencies only track the behavior of the
bonds they rate, presenting a fragmented picture of the entire muni bond
universe. For a more comprehensive look, the New York Fed merged defaults
tracked by the three major rating agencies with unrated bonds reported by
Mergent and S&P Capital IQ.
Researchers found no pattern of spikes in defaults
during recessions, rather defaults appeared to be a “function of
idiosyncratic factors associated with individual projects,” according to the
study.
Muni bonds are a primary way states, towns and even
hospitals and ballparks finance projects. They have become popular partly
because holders of these bonds don’t have to pay state taxes on any gains.
Individual investors, according to the Securities and Exchange Commission,
hold 75 percent of the outstanding bonds in the $3.7 trillion muni market
through mutual funds and exchange-traded funds.
General-obligation bonds, issued by municipalities,
rarely fail because they are backed by tax revenue. But the Fed found bonds
that finance hospitals, stadiums and nursing homes default at much higher
rates because they have a narrower income stream. A sports stadium, for
instance, needs to sell tickets, otherwise it may not generate enough to
meet its debt obligations.
The worst-performing bonds were “industrial
development” bonds that finance projects such as alternative energy plants
or pollution control facilities. These bonds, which comprise nearly
two-thirds of municipal issuance, fail at a 28 percent rate.
Some analysts contend that the study is overstating
the number of defaults since these debts are repaid by corporations rather
than cities or towns.
“There’s an apples-and-oranges comparison that
makes it hard to take their findings and draw any inference into the broader
risks in the muni market,” said Bart Mosley, co-president Trident Municipal
Research, which tracks the bond market.
Continued in article
"Harder to buy US Treasuries," Shanghai Daily, December 18,
2009 ---
http://www.shanghaidaily.com/article/print.asp?id=423054
IT is getting harder for governments to buy United
States Treasuries because the US's shrinking current-account gap is reducing
supply of dollars overseas, a Chinese central bank official said yesterday.
The comments by Zhu Min, deputy governor of the
People's Bank of China, referred to the overall situation globally, not
specifically to China, the biggest foreign holder of US government bonds.
Chinese officials generally are very careful about
commenting on the dollar and Treasuries, given that so much of its US$2.3
trillion reserves are tied to their value, and markets always watch any such
comments closely for signs of any shift in how it manages its assets.
China's State Administration of Foreign Exchange
reaffirmed this month that the dollar stands secure as the anchor of the
currency reserves it manages, even as the country seeks to diversify its
investments.
In a discussion on the global role of the dollar,
Zhu told an academic audience that it was inevitable that the dollar would
continue to fall in value because Washington continued to issue more
Treasuries to finance its deficit spending.
He then addressed where demand for that debt would
come from.
"The United States cannot force foreign governments
to increase their holdings of Treasuries," Zhu said, according to an audio
recording of his remarks. "Double the holdings? It is definitely
impossible."
"The US current account deficit is falling as
residents' savings increase, so its trade turnover is falling, which means
the US is supplying fewer dollars to the rest of the world," he added. "The
world does not have so much money to buy more US Treasuries."
China continues to see its foreign exchange
reserves grow, albeit at a slower pace than in past years, due to a large
trade surplus and inflows of foreign investment. They stood at US$2.3
trillion at the end of September.
U.S. Debt/Deficit Clock ---
http://www.usdebtclock.org/
Accounting in the U.S. Government is all done with smoke
and mirrors
The worst stuff is all off balance sheet
Question
What accounts for the difference between the booked $3.3 trillion in U.S.
"National Debt" owed to foreign investors reported by Newsweek, June 8,
2009 on Page 57 compared to the booked $13.7 trillion in U.S. debt owed to
foreign investors as reported in the CIA's World Fact Book?
Answer
The $13.7 trillion includes a massive amount of state and local public debt held
by nonresidents as well as corporate bonds that are issued by business firms
rather than government jurisdictions. Some of this non-Federal debt is becoming
especially worrisome such as bond obligations of California that may have to be
bailed out by the Federal Government. The massive indebtedness of California is
especially worrisome since California bond defaults could rile foreign investors
that we also depend upon to fund our Federal deficit --- which in 2009 will be
nearly $2 trillion that must be funded in new debt. Hence we have Hillary
Clinton, Nancy Pelosi, and Timothy Geithner recently carrying tin cups around
China.
See the definition of "Debt - External" at
https://www.cia.gov/library/publications/the-world-factbook/docs/notesanddefs.html#2079
Nations are ranked by "external debt" owed to investors
outside their borders ---
http://en.wikipedia.org/wiki/List_of_countries_by_external_debt
Data source: CIA's World Fact Book ---
https://www.cia.gov/library/publications/the-world-factbook/rankorder/2079rank.html
A growing concern for Fed policy
makers is a weakening in the US dollar against major currencies. The price of
the euro in US-dollar terms climbed from a low of $1.27 in November last year to
around $1.41 in May and $1.43 in early June — an increase of 12.6% from
November. The major currencies dollar index fell to 78.89 in May from 82.3 in
April — a fall of 4.1%. If the declining trend in the US dollar were to
consolidate, this could cause foreign holders of US-dollar assets to divest into
non-dollar-denominated assets and precious metals.
Frank Shostak, "The Fed Might Have
Painted Itself into a Corner," Mises Institute, June 12, 2009 ---
http://mises.org/story/3518
U.S. National Debt ---
http://en.wikipedia.org/wiki/Government_debt
The National Debt recently spiked about 10% to over $11 trillion.
U.S. Debt/Deficit Clock ---
http://www.usdebtclock.org/
But as bad as the fiscal picture is, panic-driven
monetary policies portend to have even more dire consequences. We can expect
rapidly rising prices and much, much higher interest rates over the next four or
five years, and a concomitant deleterious impact on output and employment not
unlike the late 1970s. About eight months ago, starting in early September 2008,
the Bernanke Fed did an abrupt about-face and radically increased the monetary
base -- which is comprised of currency in circulation, member bank reserves held
at the Fed, and vault cash -- by a little less than $1 trillion. The Fed
controls the monetary base 100% and does so by purchasing and selling assets in
the open market. By such a radical move, the Fed signaled a 180-degree shift in
its focus from an anti-inflation position to an anti-deflation position.
Arthur B. Laffer, "Get Ready for
Inflation and Higher Interest Rates," The Wall Street Journal, June 10,
2009 ---
http://online.wsj.com/article/SB124458888993599879.html
The Jim Rogers video that everyone seems to be talking
about concerns the
US Dollar and potential inflation ---
http://financeprofessorblog.blogspot.com/2009/06/jim-rogers-video-that-everyone-seems-to.html
And that is before the pending Universal Health Plan is set in motion!
Most of the large media networks are becoming infomercials for the
Democratic Party and President Obama
"A few nights ago, I was up tossing and turning,
trying to figure out exactly what to say," Obama said at the annual Radio and
Television Correspondents Association dinner. "Finally, when I couldn't get back
to sleep, I rolled over and asked Brian Williams what he thought." The punch
line aimed at the NBC Nightly News anchor - who recently hosted a warm and
fuzzy, two-night prime time White House special on Obama - produced guffaws
among the assembled correspondents because it played on a perception, among U.S.
conservatives at least, that the top U.S. networks are in bed with the new
administration.
Sheldon Alberts,
"No room for Republicans on all-Obama U.S. networks," June 23, 2009
---
Click Here
Jensen Comment
What is most dangerous is that these infomercials for Obama never mention that
stacking trillions of dollars on top of trillions of dollars in deficits spells
economic disaster. Commentators virtually all dwell on the egalitarian need for
spending, not the need for fiscal responsibility. Nobody mentions that the
eventual equal distribution of zero is zero.
Obama's trillion-dollar healthcare bill: Pelosi's
version would cost us $3 trillion.
Deroy Murdock, The Washington Times, June 27, 2009 ---
http://www.washingtontimes.com/news/2009/jun/27/obamas-trillion-dollar-bill/
Contrarian guru Marc Faber predicts we'll soon see
inflation of 10 to 20 percent. The numbers will rise so fast because the
government "massively" understates the country's inflation rate, Faber said. To
get a true reading he advises ditching core inflation numbers, including the
Consumer Price Index. "It's a lie what they publish," Faber told CNBC. "If you
underweigh education costs, and if you underweigh health care costs, then you
come to a totally different result," he said.
"Faber: 20 Percent Inflation Coming," MoneyNews, June 25,
2009 ---
http://moneynews.com/streettalk/marc_faber_inflation/2009/06/25/229165.html
Who is funding the Obamacare campaign?
Michelle Malkin, Townhall, June 27, 2009 ---
http://www.washingtontimes.com/news/2009/jun/27/behind-the-scene/
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire.
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
"Stop Insuring Mortgages: The folly of government intervention in
the housing market," by John Stossel, Reason Magazine, December 3, 2009 ---
http://reason.com/archives/2009/12/03/stop-insuring-mortgages
The Federal Housing Administration
announced this week that it wants tougher rules on mortgage lenders. It's
about time.
Maybe FHA got spooked by the recent New
York Times story titled "Easy Loans to Wealthier Areas," which said: "In its
efforts to prop up a shattered housing market, the government is greatly
extending its traditional support of real estate, including guaranteeing the
mortgages of middle-class and even upper-class buyers against default."
The Times explained that San Francisco,
one of the priciest real estate markets in the country, had no
government-insured mortgages two years ago, but now "the government is
guaranteeing an average of six mortgages a week here. ... The Federal
Housing Administration is underwriting loans at quadruple the rate of three
years ago even as its reserves to cover defaults are dwindling."
And some of those loans are surely
questionable.
The Times explains that 27-year-old Mike
Rowland and his friends were able to buy a two-unit apartment building for
almost a million dollars. "They had only a little cash to bring to the table
but, with the federal government insuring the transaction, a large down
payment was not necessary."
"It was kind of crazy we could get this
big a loan," Rowland said.
Yes, it was crazy. Such policies do not
end well. Young Rowland gets that. Even the Times does: "With government
finances already under great strain, the policy expansions are creating new
risks for American taxpayers."
But our leaders plunge ahead, with your
money. Has the administration forgotten that today's financial mess was
precipitated in part by government's moves to encourage mortgage lending to
unqualified or at best unproven borrowers? In the 1990s, the Federal Reserve
Bank of Boston, concerned that blacks and Hispanics were "underserved,"
issued guidelines to banks stating: "Policies regarding applicants with no
credit history or problem credit history should be reviewed. Lack of credit
history should not be seen as a negative factor...."
Soon, the lower standards spilled into the
prime-mortgage market. The risk to lenders seemed small because
government-sponsored Fannie Mae and Freddie Mac happily bought the dubious
loans. An entire financial edifice was built on these securitized mortgages
and derivatives based on them.
Then the good times ended. Interest rates
rose. Home prices flattened and then declined. Then those AAA
mortgage-backed securities became "toxic."
After all that, it's crazy that government
still subsidizes housing rather than letting the market work. The economy
will recover from recession only when it is allowed to discover the real
value of assets like houses. But the government refuses to allow this to
happen. FHA has been blowing air into another bubble, while other agencies
do everything they can to boost prices.
This includes leaning on and bribing banks
to ease mortgage terms for people in default. The Obama administration
announced that it would increase that pressure because "the banks are not
doing a good enough job," said Michael S. Barr, assistant treasury secretary
for financial institutions. Some Democrats want to go further. They demand
that the government compel mediation over defaulted mortgages or empower
judges to change the terms.
This sounds humane, but it is typical
political shortsightedness. When government helps delinquent borrowers to
get easier loan terms, it simultaneously makes it harder for marginal
borrowers to get loans in the first place. That's because lenders must now
factor in the likelihood of a judge changing the terms.
The know-it-alls in Washington "help"
Americans by hurting them.
Why won't the government let housing
prices seek their own level? After a Washington-inflated bubble, that would
seem to be the wise thing to do. Sure, some people get hurt when prices
fall, but others—prospective home-buyers—are helped. By artificially raising
prices, the Realtor-Construction-Banking-Big Government Complex cheats
honest low-income people who would otherwise have been able to afford a
first home without begging the government for help.
"The Real Pending Crisis: Public Pensions," by Bruce Bialosky,
Townhall, November 2, 2009 ---
http://townhall.com/columnists/BruceBialosky/2009/11/02/the_real_pending_crisis_public_pensions
President Obama often states that the
federal budget cannot be balanced without health insurance reform. Even if
that were true, the real crisis that exists already and will only worsen
over time comes from the horrendous obligations taken on by state and local
governments for public employee pension plans.
Keith Richman caught on to this problem
while a California Assemblyman. He has formed the non-profit California
Foundation for Fiscal Responsibility to educate elected officials and the
public on the looming budget disaster. Fortunately, he is not the only one
touting this pending mess. Ron Seeling, the Chief Actuary for CalPERS (the
California public employees’ retirement program), has stated the plan is
unsustainable. CalPERS represents state employees and 1,500 local
governmental entities.
Some would say the pension problem starts
with the unionization of public employees. In California, the major catalyst
was SB400, signed by Gray Davis in his first year in office, 1999. The bill
lowered retirement age for public safety employees to 50 years old and to
non-public safety employees to 55 years old. We are in an era when people
are living on average until around 80 years old.
The law gives the employee pension
benefits of 3.0% of their final income for each year of service. It also
made the 3.0% amount retroactive to the beginning of their employment
period. That means if you work 20 years you receive a pension benefit equal
to 60% of your final income. The problem was compounded by how they
calculated the income on which to base the pension.
Everything including the kitchen sink adds
to the final income level. Things such as auto allowance and bonuses boost
the final number. If the employee did not use vacation pay or holiday pay
for the prior 10 years that adds to the base salary to determine the income.
Understanding that in most private sector jobs when you do not use your
vacation, you lose your vacation, the ability to accumulate vacation time
opens up the system for vast manipulation. Peter Nowicki, the Moraga Orinda
fire chief, retired at age 50. His final salary was a whopping $185,000, but
small compared to his annual pension benefit of $241,000. Making that matter
worse, Nowicki was hired as a consultant to the fire department for an
additional $176,000 per year -- on top of his retirement benefit.
This is not an isolated case. In Los
Angeles County there are over 3,000 people receiving greater than $100,000
per year in pension benefits. In San Francisco, it was found that 25% of
employees’ income spiked up over 10% in the final year of their work. The
San Francisco grand jury found that amount cost the city $132 million.
Some would argue why not game the system?
Let’s say you start working for the government when you are 30 years old and
work for 25 years. Your final income with all the fancy calculations ends up
at $120,000. That means you would receive $90,000 plus full health care
benefits. You can either live on that very nice retirement or you are free
to get another position. After all, being 55 years old, you are still in
your prime earnings years. Where in the private sector are there comparative
opportunities?
These kinds of retirement ages and
benefits are why the estimated unfunded liability is soaring. California has
estimated unfunded pension and health care liabilities ranging from $100 to
$300 billion. The school systems operate under their separate pension
program – CalSTRS. The Los Angeles Unified School System estimate for
unfunded retiree benefits comes in at about $10 billion. That is one school
system, be it the largest, in one state. Estimates show that the LAUSD will
soon carve out 30% of its budget for combined retiree health and pension
benefits.
California may be the worst example, but
not the only example of deplorable financial planning by governmental
entities. The original justification for rich benefits for public employees
centered on lower salaries, but that no longer rings true. A recent analysis
by the U.S. Bureau of Economics shows that federal employees receive
compensation that is double the average of the private sector. Other studies
have shown state and government employees to be receiving like levels of
compensation.
The genesis of this pending disaster comes
from the right of public employees to unionize. This was not always so. The
first opportunity occurred in 1958 in New York City under Mayor Robert
Wagner. President Kennedy instituted the right for federal employees to
unionize in 1962. Since then the right for public employees to unionize has
spread, but is not universal. States that have more restrictive laws have
blocked public employee unions and thus have not suffered the consequences.
In states like California, the public
employee unions fund huge political campaigns. To most observers, the unions
have a stranglehold on the state legislature, Los Angeles and San Francisco
city governments, and most if not all of the school districts in the state.
When the employees control the employers, the results are uncontrollable
obligations.
A recent report stated that children born
today will live an average life span of 100 years. With public employees
retiring at 50 or 55 years of age, it doesn’t take a deep thinker to
extrapolate that these retirement benefit programs are unsustainable.
Private sector employees now receive less
annual income than their public counterparts. Private sector employees will
have to work well into their seventies to pay for these public sector
employees’ retirement benefits which far exceed what the private sector
offers. The public will, little by little, become aware of this upside-down
arrangement. Heroes like Keith Richman are sacrificing to make the public
aware of this coming debacle. Our elected officials need to heed his
warnings.
U.S. Debt/Deficit Clock ---
http://www.usdebtclock.org/
IOUSA (the most frightening movie in American history) ---
(see a 30-minute version of the documentary at
www.iousathemovie.com
).
Bob Jensen's threads on the entitlements crisis ---
http://faculty.trinity.edu/rjensen/entitlements.htm
"Will the Democrats' Massive Borrowing and Spending Binge Kill the U.S.
Economy?" by Gerard Jackson, Seeking Alpha, July 13, 2009 ---
Click Here
Any reasonably intelligent person
understands that if the demand for a product increases then (all things
being equal, as the economist would say) its price will rise. The same holds
in the case of borrowing, except for congressional Democrats. These people
seem to think that economics laws are a vicious Republican plot.
Poll figures are now showing that the
American public is growing alarmed by the Democrats' utterly reckless fiscal
policy. Unfortunately, few people understand just how grave the danger
really is. In less than five months Obama increased the national debt by
more than $800 million and lumbered the economy with a $1.8 trillion deficit
that looks like growing even bigger. (I still get silly emails from Obama
cultists who were evidently screaming into their computer monitors: "Bush
did!" Pathetic doesn't begin to describe these people). In 2003 Thomas
Laubach, the US Federal Reserve’s senior economist, produced New Evidence on
the Interest Rate Effects of Budget Deficits and Debt, a paper containing
calculations for long-term interest rates based on historical evidence. He
concluded that
a percentage point increase in the
projected deficit-to-GDP ratio raises the 10-year bond rate expected to
prevail five years into the future by 20 to 40 basis points, a typical
estimate is about 25 basis points.
As the US deficit has rocketed from 3
percent to 13.5 percent one should therefore expect long-term rates to rise
by at least 2.5 percentage points. In addition, he believes that a 1 percent
rise in the ratio of debt to GDP will raise future rates by 4 to 5 basis
points. It appears that recent movements in long-term rates support Mr
Laubach's thesis. The 20-year treasury bill stood at 3.22 percent on 2
February: by the 8 July it had risen to 4.13 percent. It was the same story
10-year treasuries which rose from 2.46 percent on 2 January to 3.33 percent
on 8 July while the 30-year mortgage rate had risen to 5.32 percent by 2
July as against 4.78 percent for 2 April. The government's insatiable demand
for funds looks very much like it is driving up long-term rates very
quickly.
Obama supporters with their fetish for big
government can always claim that economic conditions in Japan refute Laubach.
Japan has increased its national debt by a colossal amount and yet interest
rates remain ridiculously low. These critics overlooked the economist's
caveat: All things being equal. Just as the price of the a monetary unit
(its purchasing power) is determined by the supply and demand for it, the
same holds for all other economic goods. For example, though US car
production has dropped car prices have not jumped. Why? Because demand fell.
The same holds for Japanese interest
rates. They have not been driven up government borrowing because the private
demand for loans has virtually collapsed. A similar situation prevailed
during the Great Depression. Despite Roosevelt's spending and borrowing
interest rates remained low — but so did business borrowing with the result
that there was a great deal of capital consumption.
Professor Higgs calculated that from 1930
to 1940 net private investment was minus $3.1 billion. (Robert Higgs,
Depression, War, and Cold War, The Independent Institute, 2006, p. 7).
Arthur Lewis calculated that from 1929 to 1938 net capital formation plunged
by minus 15.2 percent (W. Arthur Lewis, Economic Survey 1919-1939, Unwin
University Books, 1970, p. 205). Benjamin M. Anderson estimated that in 1939
there was more than 50 percent slack in the economy. (Benjamin M. Anderson,
Economics and the Public Welfare: A Financial and Economic History of the
United States 1914-1946, LibertyPress, 1979, pp. 479-48). It ought to be
obvious that where a process of capital consumption is underway — as it was
in the 1930s — one should expect to see a rise in the average age of plant
and equipment. This is precisely what happened as shown by the table below.
So where we have a situation in which
extremely low interest rates reign while government borrowing has massively
expanded we should expect to find — as in Japan — that the personal demand
for loans. particularly by business, has plunged. In other words, critics
have been looking at only part of the equation. It just so happens that most
critics of Obama's spending mania have also overlooked a vital point — the
crucial role that interest rates play in raising or lowering the standard of
living.
If the government's fiscal policy imposes
high long-term rates on the economy then prospective highly time-consuming
projects, the ones that do so much to raise real wage rates, would have to
be abandoned. Moreover, existing projects of the same nature would be
eventually phased out. This is called capital consumption. What this means
is that the quantity of savings necessary to prevent the capital structure
from contracting are no longer available. As Hayek observed:
[I]t is quite possible that, after a
period of great accumulation of capital and a high rate of saving, he
rate of profit and the rate of interest may be higher than they were
before — if the rate of saving is insufficient compared with the amount
of capital which entrepreneurs have attempted tp form, or if the demand
for consumers' goods is too high compared with the supply. And for the
same reason the rate of interest and profit may be higher in a rich
community with much capital and a high rate of saving than in an
otherwise similar community with little capital and a low rate of
saving. (Friedrich von Hayek, The Pure Theory of Capital, The University
of Chicago Press, 1975, p. 396).
Added to this is Obama's misguided energy
policy that amounts to a massive tax on production. Once that is also taken
into account one is left looking at economic carnage.
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire.
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
Bob Jensen's threads on pending economic disaster in the U.S. ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
EGADs! Pending Collapse of the Overspending U.S. Economy to Be Financed
With Hot Air
President Barack Obama on Tuesday proposed budget rules that would allow
Congress to borrow tens of billions of dollars and put the nation deeper in debt
to jump-start the administration's emerging health care overhaul. The
"pay-as-you-go" budget formula plan is significantly weaker than a proposal
Obama issued with little fanfare last month. It would carve out about $2.5
trillion worth of exemptions for Obama's priorities over the next decade. His
health care reform plan also would get a green light to run big deficits in its
early years. But over a decade, Congress would have to come up with money to
cover those early year deficits. Obama's latest proposal for addressing deficits
urges Congress to pass a law requiring lawmakers to pay for new spending
programs and tax cuts without further adding to exploding deficits projected to
total about $10 trillion over the next decade.
Andrew Taylor, "Obama: It's OK to
borrow to pay for health care: Obama-proposed budget rules allow deficits
to swell to pay for health care plan," Yahoo News, June 8, 2009 ---
http://finance.yahoo.com/news/Obama-Its-OK-to-borrow-to-pay-apf-15483626.html?.v=13
Jensen Comment
The frightening part of this is that the added $10 trillion does not include the
entitlements obligations of Obama's Universal Health Plan. That will add up to
another $100 trillion to the current $100 trillion in entitlements obligations.
President Obama's deficit spending playbook is straight
out of
Alice in Wonderland. The King says"
"Begin at the beginning and go on till you come to the
end: then stop."
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
President Obama's deficit spending playbook is straight
out of
Alice in Wonderland. The King says"
"Begin at the beginning and go on till you come to the
end: then stop."
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
The projected U.S. budget annual budget spending deficits
are now standing in the way of economic recovery. Deficits are also restraining
our national sovereignty and public policy as we now have to beg on our hands
and knees for foreign investors in Asia and the Middle East to invest trillions
more in in our Treasury bonds. For example, efforts to tax or otherwise restrain
imports from Asia (think automobiles) and the Middle East (think oil) could
spell disaster since we must beg most to those parts of the world to invest in
government debt to fund our Federal trillion-dollar deficits. This, in turn,
greatly increases our own troubling foreign trade deficits.
Worse yet, we worry about foreign investors not rolling
over what they've already invest in our public and private "external debt." That
could lead to having to monetize our National Debt (read than print money) that
almost immediately translates to Zimbabwe-like disastrous price inflation and
destruction of the U.S. currency in foreign exchange markets.
Although the media tends to avoid serious discussion of
deficit reduction, some big spenders in government are at last owning up to the
pending time bomb of trillion-dollar deficit spending.
"Bernanke Urges Deficit Reduction," by Brian
Blackstone, The Wall Street Journal, June 3, 2009 ---
http://online.wsj.com/article/SB124403584900281215.html
U.S. Federal Reserve Chairman Ben Bernanke
on Wednesday urged lawmakers to commit to reducing the nearly $2 trillion
budget deficit, warning that the government can't borrow "indefinitely" to
meet the growing demand on its resources.
Mr. Bernanke also reiterated that the pace
of economic contraction appears to be slowing, setting the stage for a
return to growth later this year.
"Unless we demonstrate a strong commitment
to fiscal sustainability in the longer run, we will have neither financial
stability nor healthy economic growth," Mr. Bernanke said in prepared
testimony to the House Budget Committee. (Read the full remarks.)
The White House estimates that the budget
deficit will reach around $1.8 trillion this year and fall to about $900
billion by 2011. That, Mr. Bernanke said, will push the debt-to-GDP ratio
from 40% before the financial crisis began to 70% by 2011, which would be
the highest since after World War II.
"Certainly, our economy and financial
markets face extraordinary near-term challenges, and strong and timely
actions to respond to those challenges are necessary and appropriate," Mr.
Bernanke told the House panel.
However, the retirement of the Baby Boom
generation will place even more of a burden on entitlement programs like
Social Security and Medicare, and "we will not be able to continue borrowing
indefinitely to meet those demands," he said.
Mr. Bernanke suggested that fiscal
concerns may already be having an effect in the markets. Yields on
longer-term Treasury securities and fixed-rate mortgages have risen, he
noted.
"These increases appear to reflect
concerns about large federal deficits but also other causes, including
greater optimism about the economic outlook, a reversal of flight-to-quality
flows, and technical factors related to the hedging of mortgage holdings,"
he said.
Mr. Bernanke adhered closely to the Fed's
cautiously upbeat outlook for the economy. Consumer spending, he said, has
been flat since the start of the year and sentiment has improved. Housing,
he said, "has also shown some signs of bottoming" and lean inventories
should eventually spur production.
Still, he cautioned that even when an
upturn begins, growth will remain below its long-run potential "for a
while."
"Sizable" job losses, he said, should
continue for "the next few months," pushing the unemployment rate higher.
The government releases May payroll figures Friday. Economists expect
another payroll decline of over 500,000, raising the jobless rate past 9%.
Against that backdrop of widening economic
slack, inflation should fall over the next year compared to 2008, Mr.
Bernanke said, though an improving economy and stable inflation expectations
"should limit further declines in inflation."
Meanwhile, Mr. Bernanke said the ability
of banks to raise new capital "suggests that investors are gaining greater
confidence in the banking system."
But while financial conditions have
improved since the start of the year, they remain under stress and continue
to act as a brake on the economy, he said.
Question
Would much smaller budget deficits forestall economic disaster in the United
States?
Answer
The benefit of deficit reduction is contingent upon many factors. The immediate
benefit is linked to Gross Domestic Product such that the ideal situation would
be a combination of a surge in GDP coupled with significant deficit spending
reductions such as when the surge in GDP greatly increases tax revenues. A
plunge in GDP caused, in part, by dysfunctional taxation and deficit reduction
would be very worrisome.
However, all that is written about the booked National
Debt, booked External Debt, and annual deficit spending pales relative to the
time bomb (usually not mentioned in the media now pushing for added social
programs) of unbooked off-balance sheet entitlements obligations that are
contracted or otherwise promised but are not yet due such as baby boomer Social
Security benefits, Medicare obligations (including drug benefits), Medicaid
obligations, military pensions, veterans medical benefits, welfare programs,
etc. Milton Freedman was a wise man 40 years ago when he said that unfunded
entitlement obligations should be avoided as long as we were "free to choose."
The idea behind Social Security was that it should be funded by the Social
Security Trust Fund which did indeed build up over the years.
The problem with the Social Security Trust Fund is that
Congress unwisely commenced to massively "borrow" from it to fund other programs
with no intention of taxing to replace the borrowings. Social Security benefits
were initially envisioned as being like pension funds where money was taken from
both a worker and an employer during all his/her working years to fund eventual
small retirement benefits to be collected by that worker.
Congress, however, added unfunded hemorrhages to the Social
Security Trust Fund such as the funding of monthly benefits to millions of
disabled citizens, including people disabled at birth or at very young ages who
never contributed a dime to the Social Security Trust Fund. Other unfunded
entitlements were added decades ago such as the funding of education for
dependents of soldiers who died while in military service. The point is that
unfunded entitlements have been steeped upon what commenced as a funded Social
Security "Retirement" Program. The unfunded drains were for worthy causes such
as disability benefits that should've been part of the General Fund legislation
rather than the Social Security Trust Fund that was not intended for anything
other than Social Security retirement benefits.
Accounting in the U.S. Government is all done with smoke
and mirrors
Congress like funding disability benefits from the Social Security Trust Fund
because that kept the billions spent each year out of the calculation of the
budget deficits. The estimated $1.8 trillion projected budget deficit would soar
if we added all the payments to millions of disabled citizens that slip out the
back door from the Social Security Trust Fund. Accounting in the U.S. Government
is all done with smoke and mirrors.
Another huge problem is that added payroll tax funds
collected for Medicare hospital, physician, and rehab benefits plus Medicare
Drug benefits were collected over the years from workers and employers with
vastly under-computed estimates of the soaring inflation in the medical sector
of the economy. As a result there's a huge mismatch between what was collected
in Medicare taxes versus what is now being paid out to our aging workers and
retirees like me and my wife.
Whereas the U.S. National Debt is booked at $11 trillion
dollars, the unbooked entitlements debt was estimated in 2007 by the former
Chief Accountant of the United States, David Walker, to be in excess of $55
trillion (now in excess of $100 trillion) for entitlements already in place. Pending entitlements such as
universal health and drug coverage will make this unfunded and unbooked
obligation soar.
Bob Jensen's threads on pending entitlements disaster
are at
http://faculty.trinity.edu/rjensen/entitlements.htm
Video on the Long-term Disaster of Beranke's Money Supply
Printing Press That Will Kick in Hyperinflation ---
http://www.youtube.com/watch?v=dlHBYQrCnIk
Will the U.S. become Zimbabwe? ---
http://faculty.trinity.edu/rjensen/entitlements.htm
The National Debt has continued to increase an average
of $3.93 (now $6) billion per day since September 28, 2007!
The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/
History of the National Debt ---
http://en.wikipedia.org/wiki/National_Debt
Entitlements ---
http://faculty.trinity.edu/rjensen/entitlements.htm
Overpopulation ---
http://en.wikipedia.org/wiki/Overpopulation
History of the National Debt ---
http://en.wikipedia.org/wiki/National_Debt
A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/
As she trashes her currency, America will continue
to lose political capital both domestically and abroad. After all, a -12%
three-month swan dive in the US Dollar has hacked over $90 Billion of value from
the Chinese position in US Treasuries. Creditors and citizenry hush yourselves!
All the while, 17 out of 23 Chinese economists polled are calling holding those
Treasuries a “great risk” this morning. I know, I know… an economist or a
billion US Dollars ain't what it used to be… At some point, China’s
interpretation of the arithmetic is going to really matter.
Seeking Alpha, June 1, 2009 ---
http://seekingalpha.com/article/140651-china-s-arithmetic-when-it-comes-to-the-dollar
The Congressional Budget Office believes that the
Treasury will have to borrow nearly $2 trillion this year. None of that is new
news, but what is beginning to emerge is a picture of a government which has
narrowed its options for improving the economy down to one. Either GDP turns
sharply up next year or the deficit will become an unmanageable burden. The
Treasury will have to default on interest payments if sharply raising taxes in
2010 and 2011 does not bring IRS receipts to historic highs. That would not
appear to be likely with unemployment moving toward 10% and American corporate
earnings badly crippled.
"A $1 Trillion A Year Deficit Interest Rate Payment," 21/7 Wall
Street, June 1, 2009 ---
http://247wallst.com/2009/06/01/a-1-trillion-a-year-deficit-interest-rate-payment/#more-36179
Not a single county in the entire state
(California) voted for the tax-and-spend propositions
on yesterday's referendum ballot, not even the peculiar folks who live in Nancy
Pelosi's far-left 8th Congressional District who persist in sending the Wicked
Witch of the West to the Nation's Capitol to wage war on the CIA and the
nation's taxpayers. The only measure voters did approve was one to freeze
salaries of senior public officials during budget emergencies.
Michael Reagan, "Terminating the
Terminator," Townhall, May 20, 2009 ---
http://townhall.com/columnists/MichaelReagan/2009/05/20/terminating_the_terminator
Jensen Comment
What's worse in many respects is that California voters sent a message to
President Obama that taxing the middle class (the only way to raise serious
deficit-cutting revenue) to halt deficit-induced halt hyperinflation of the U.S.
dollar will not be supported by voters.
See
http://townhall.com/columnists/MattTowery/2009/05/21/california,_here_we_come
This is America today―a country that is losing its
ability to manufacture things but has to continue to pander to rich Arabs and
the Chinese Communists for money just to survive. In addition to our jobs,
savings and investments, it looks like our sovereignty and national pride are
being sacrificed as part of this process. Whether the financial meltdown has
been engineered or not―and there are major questions about its timing, just six
weeks before the national elections―it will be up to President Obama to manage
America’s transition into this New Global Order. With his background in Marxism
and extensive Wall Street contacts and associations, he seems perfectly suited
for the task. But the powers that be, including those in the media, have simply
assumed that the American people will meekly go along with the demise of their
nation. That may be a miscalculation, if they manage to find a voice or voices
in the media.
Cliff Kincai, "Fed Bails Out Rich
Arabs in Citigroup Deal,"Canadian Free Press, November 25, 2008 ---
http://canadafreepress.com/index.php/article/6518
Jensen Comment
What Cliff Kincai and the rest of the world must be made to realize is that if
the U.S. government is to bail out Detroit's automakers, state governments,
butchers, bakers, and candlestick makers, it can only do so if trillions more in
bailout money are borrowed from the Middle East and Asia. Asia and the Middle
East could put an end to the United States in an instant by merely not rolling
matured Treasury bonds over or investing in the vast amount of our National Debt
that they now hold and are being relied upon to finance the present bailout of
just about every aspect of the U.S. Economy ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
I'm not saying that it is necessarily proper to bail out "Rich Arabs" who
invested in Citigroup, but would you try to squash the children of your boss,
your banker, and and your owner who can in turn squish you like a bug on the
windshield? Since the Democratic Party had a majority in the House and Senate
before the 2008 election, you should ask their leaders why they are not
objecting to the bailout of "Rich Arabs" while they're stalling on bailing out
Detroit's automakers. I think it's because our legislators know where the
trillions more in National Debt most be borrowed on top of the 45% if the
National Debt now held outside the U.S.
We can’t even pay the interest on the National Debt without borrowing to pay the
interest!
China now owns nearly 10% of the U.S. National Debt. Rich Arabs also own
hundreds of billions of this debt.
Federal Revenue and Spending Book of Charts (Great Charts on Bad Budgeting) ---
http://www.heritage.org/research/features/BudgetChartBook/index.html
Accounting in the proposed Universal Health Plan is all
done with smoke and mirrors
Congress liked funding disability benefits from the Social Security Trust Fund
because that kept the billions spent each year out of the calculation of the
budget deficits. The estimated $1.8 trillion projected budget deficit would soar
if we added all the payments to millions of disabled citizens that slip out the
back door from the Social Security Trust Fund. Accounting in the U.S. Government
is all done with smoke and mirrors.
Another huge problem is that added payroll tax funds
collected for Medicare hospital, physician, and rehab benefits plus Medicare
Drug benefits were collected over the years from workers and employers with
vastly under-computed estimates of the soaring inflation in the medical sector
of the economy. As a result there's a huge mismatch between what was collected
in Medicare taxes versus what is now being paid out to our aging workers and
retirees like me and my wife.
Whereas the U.S. National Debt is booked at $11 trillion
dollars, the unbooked entitlements debt was estimated in 2007 by the former
Chief Accountant of the United States, David Walker, to be in excess of $55
trillion (now in excess of $100 trillion) for entitlements already in place. Pending entitlements such as
universal health and drug coverage will make this unfunded and unbooked
obligation soar.
The Jim Rogers video that everyone seems to be talking
about concerns the
US Dollar and potential inflation ---
http://financeprofessorblog.blogspot.com/2009/06/jim-rogers-video-that-everyone-seems-to.html
And that is before the pending Universal Health Plan is set in motion!
President Obama's deficit spending playbook is straight
out of
Alice in Wonderland. The King says"
"Begin at the beginning and go on till you come to the
end: then stop."
President Obama Campaigned On a Phony Promise of No New
Taxes for the Middle Class (the joke's on yew)
The accounting explained in the proposed Universal Health Plan is all smoke and
mirrors
Our President is embarking on a huge campaign to convince us that the U.S.
health care system is broken. No surprise here! But now Obama wants to
permanently disable the economy in the depths of a recession in a futile attempt
to fix health care. The plan is to add $2,000-$4,000 in annual tax to every U.S.
worker in addition to what each worker is contributing for family health care in
his/her employer's health care plan. The plan on surface sounds great in an
effort to not increase the annual deficit for the poor and/or unemployed.
But wait! Instead of adding spending stimulus money to each
worker, President Obama plans to take $2,000-$4,000 away, thereby reducing about
$250 billion in spending from an economy that in reality is still in a
recession. This means less rather than more people finding jobs, almost no
possibility for businesses to earn a profit, and more years of economic
depression. So what will Congress do when unemployment gets worse instead of
better? Why it will add $2,000-$4,000 of stimulus money back to each worker.
Thus, the Universal Health Plan plan ostensibly coming
from taxpayers runs full circle and adds another trillion in less than ten years
to our staggering National Debt if we can persuade our trembling creditors in
the Middle East and Asia to loan us another trillion dollars.
But wait! It gets worse! Now a universal health care plan
for every person in the U.S. will be an entitlement.
There will be no way to turn back as the economy plunges into a permanent dark
hole ---
http://faculty.trinity.edu/rjensen/entitlements.htm
Why couldn't Congress have at least waited to tax the middle class until after
the economy had recovered and unemployment was back down in the 4% range?
Unemployment at 10% can only get worse by taking $250 million of consumer
dollars annually out of the hands of small and large businesses and putting it
down the limitless hole of the health sector.
At some point we will be like Canada where half of every
tax dollar goes toward medical care. But Canada eased into this system in boom
times rather than when the economy was plunging into a dark hole. Also Canada
has fewer unemployed people and lots of oil --- the main exporter of oil to the
United State. With massive trade deficits already, what does the U.S. export to
pay for health care? I suggest that we export the U.S. Congress, but nobody
wants it!
But wait! It gets worse. Medicare is already over a
trillion dollars in the hole and has been reducing quality of medical care by
reducing what it will pay hospitals, medical labs, and physicians for medical
services. The new Universal Health Plan will be even more in the hole, thereby
reducing quality of services even further.
The United States might soon be providing some of the worst
health care services in the world because of the low amounts given to sick
patients to pay for such services and laws against using their own private funds
for higher quality services (on the grounds that this creates inequities between
the rich and the poor). Of course the rich will simply fly off to India,
Switzerland, Sweden, or China for their surgeries. Only the middle class and the
poor will be stuck with inferior and underfunded U.S. medical services.
But wait! It gets worse. Medicare, like most government
spending programs, is already riddled with fraud. Rushing into an enormous
program doling out trillions of dollars will make Medicare and the Pentagon look
like small cheese crumbles. President Obama is pinning a lot of hopes of his
Universal Health Plan on cost savings. When the rats come out of the woodwork to
steal from the new big wedge of cheese added to the economy don't count of those
promised savings!
President Obama's deficit spending playbook is straight out
of
Alice in Wonderland. The King says"
"Begin at the beginning and go on till you come to the
end: then stop."
Candidate Obama Promised No New Taxes on the Middle Class: The
Joke's on Yew in the Form of Higher Prices
An annual report issued by the Competitive
Enterprise Institute (CEI) shows that the U.S. government imposed $1.17 trillion
in new regulatory costs in 2008. That almost equals the $1.2 trillion generated
by individual income taxes, and amounts to $3,849 for every American citizen.
According the 2009 edition of Ten Thousand Commandments: An Annual Snapshot of
the Federal Regulatory State, the government issued 3,830 new rules last year,
and The Federal Register, where such rules are listed, ballooned to a record
79,435 pages. “The costs of federal regulations too often exceed the benefits,
yet these regulations receive little official scrutiny from Congress,” said CEI
Vice President Clyde Wayne Crews, Jr., who wrote the report. “The U.S. economy
lost value in 2008 for the first time since 1990,” Crews said. “Meanwhile, our
federal government imposed a $1.17 trillion ‘hidden tax’ on Americans beyond the
$3 trillion officially budgeted” through the regulations.
Adam Brickley, "Government
Implemented Thousands of New Regulations Costing $1.17 Trillion in 2008," CNS
News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487
From The Wall Street Journal Accounting Weekly Review on June 18, 2009
Historic Overhaul of Finance Rules
by Damian
Paletta
The Wall Street Journal
Jun 18, 2009
Click here to view the full article on WSJ.com
TOPICS: Banking,
Bankruptcy, Collateralized Debt Obligations, Disclosure, Disclosure
Requirements, Financial Reporting, Hedge Funds, Investment Banking,
Regulation, SEC, Securities and Exchange Commission, Securitization,
Treasury Department
SUMMARY: "Obama
urged policy makers to rewrite the rules governing U.S. finance, unveiling
proposals that would affect nearly every aspect of banking and markets." The
Wall Street Journal's "Condensed Version" (see related article) makes clear
that the Federal Reserve Board will see an increase in power in expanding
its regulatory oversight to "all U.S. financial firms that meet 'certain
minimum size thresholds'....[covering both] parent companies and all
subsidiaries, including unregulated units and those based overseas." The
intent is for at least one governmental unit to have a perspective on the
safety of the overall financial system, including international
implications, as opposed to a focus on individual banks and other entities.
The SEC's role is retained, though it no longer has supervisory authority
over Wall Street investment banks, and its registration and data collection
authority is expanded to cover hedge funds, private-equity funds and
venture-capital funds. The online version of this article contains links to
documents associated with the reforms after the stock market crash of 1929,
including articles discussing the formation of the Securities and Exchange
Commission in 1934.
CLASSROOM APPLICATION: The
articles introduce the new financial regulatory regime and help condense
complex points for students. Questions focus on the section of the white
paper, "Financial Regulatory Reform: A New Foundation" that covers
establishment of comprehensive regulation of financial markets.
QUESTIONS:
1. (Introductory)
Who has proposed this "sweeping overhaul of the financial regulatory
system"? How will change stemming from this proposal move forward?
2. (Introductory)
Access the links to documents associated with the reforms after the stock
market crash of 1929 available through the online version of this article.
What are some parallels to the momentous change that occurred then? What are
some differences in today's situation?
3. (Advanced)
WSJ articles published when the SEC was established in 1934 expressed
concerns about stymied economic growth from "meddling" by government
regulators. How do those concerns compare to some expressed today? Be
specific in describing at least two individual opinions and naming the
holders of those positions.
4. (Introductory)
Access the reform proposal document, Financial Regulatory Reform: A New
Foundation, issued by the Treasury Dept. and available at
http://online.wsj.com/public/resources/documents/finregfinal06172009.pdf
Focus on the introduction and the component related to establishing
"comprehensive regulation of financial markets." What is "securitization"?
What roles do credit rating agencies have in that process?
5. (Advanced)
What problems arose in the financial crisis with the work of credit rating
agencies and financial firms' reliance on credit ratings?
6. (Advanced)
Summarize the accounting requirements for securitization transactions.
7. (Advanced)
The regulatory proposal recommends requiring loan originators to retain a
significant economic interest in the credit risk associated with securitized
items. Do you think that will change the accounting for these transactions?
Explain.
8. (Introductory)
Another recommendation is that "the SEC should continue its efforts to
increase the transparency and standardization of securitization markets and
be given clear authority to require robust reporting by issuers of asset
backed securities (ABS)." What disclosures are recommended under this
section 3 heading? Given what you know about the current process, how will
these new disclosure requirements be established?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Obama's Financial Reform Plan: The Condensed Version
by Susan Davis and Reporters of the WSJ Washington Bureau
Jun 18, 2009
Online Exclusive
Medical Insurance Benefits Provided by Employers Will Soon Become Taxed as Added
Wages for Each Employee
"Health Care Reform Bound To Anger Some (especially employees becoming
personally taxed to pay the medical costs of the uninsured)" by Linda Young,
All Headline News, June 5, 2009 ---
http://www.allheadlinenews.com/articles/7015405508
Taxing employer provided health insurance
might provide an incentive to move to a national single payer plan. That's
because the average annual premiums for a health insurance policy are around
$8,000 for an individual and $12,000 for a family policy. Although most
employees pay a portion of that premium, their share usually averages around
$75 to $200 per month, leaving employers to pay the remainder of the average
$666 to $1,000 per month premium cost.
The argument for taxing employer provided
health insurance benefits is basically that workers who have it are actually
getting another $8,000 to $12,000 in their paycheck every year tax free and
that not having to pay the full cost for health care leaves workers unaware
of the true costs of health care.
According to the congressional Joint
Committee on Taxation, private-sector businesses spend about $518 billion a
year on their employees health insurance. Those benefits are not taxed now,
but if workers did have to pay taxes on those benefits, it would bring in
about $246 billion in revenue each year and that is money that could be used
to help pay for health care reform, critics argue.
Slightly more than half of all businesses
in the U.S. provide health insurance coverage for their employees. And the
majority of Americans who have health insurance have it through their
employer or through their spouse or domestic partner's employer because it
is so expensive.
Expense is the main reason that almost 90
million people went without health coverage during part or all of 2006 to
2007, according to Families USA. That amounts to more than one in three
non-elderly Americans and four out of five of those Americans were in
working families, Families USA notes.
But workers with employer provided health
insurance who might balk at being taxed should know that the cost of
treating people without health insurance who can't afford to pay for care is
being tacked on to the price of health insurance policies.
According to a recent report by Families
USA, health care providers pass this cost along to health insurers who pass
it on to policy holders. This cost amounts to a hidden health tax of about
$1,017 on family coverage and about $368 on individual policies.
The Families USA report found uninsured
Americans received $116 billion worth of care from hospitals, doctors and
other providers and those costs were covered in three basic ways.
The uninsured paid for, on average, more
than one-third (37 percent) of the total costs of the care they received out
of their own pockets. Third-party sources, such as government programs and
charities, paid for another 26 percent of that care. The remaining amount,
approximately $42.7 billion in 2008, was unpaid and constituted
uncompensated care. Tens of millions of Americans lack health insurance and
millions of others who have insurance either can't afford to use it or end
up with thousands of dollars of costs out of pocket for deductibles and
co-pays. In addition, health costs contribute to more than half of all
bankruptcies in the U.S.
That is among the reasons why some people
are still pushing for a single payer, non-profit health insurance system.
But the health insurance industry has lobbied hard to avoid that and so far,
Congressional lawmakers now working on health care reform have been
unwilling to consider single payer.
Read more:
http://www.allheadlinenews.com/articles/7015405508#ixzz0HkRQGzWq&C
Jensen Comment
President Obama is also saying that over the next decade up to $300 billion
annually can be saved by centralized record technology and increased
billing/payments efficiency. This, however, overlooks the likelihood of
massive fraud that now drags down Medicare. Can you imagine all the scooters
sold by the Scooter Store to teenage joy riders? Can you imagine the
increase in taxpayer-funded "pain killers" on the streets of America?
Bob Jensen's threads on pending entitlements disaster
are at
http://faculty.trinity.edu/rjensen/entitlements.htm
More on the Greatest Swindles of the World
If the left-of-left Obama worshipper Rep. Dennis Kucinich voted against an
Obama, Pelosi, Waxman, Gore-promoted bill there must be a catch ---
http://www.clevelandleader.com/node/10478
There is a catch --- this is a record-breaking corporate welfare package
that more then doubles our electricity bills
"The Carbonated Congress Orszag nails it: The 'largest corporate welfare
program' ever," The Wall Street Journal, July 3, 2009 ---
http://online.wsj.com/article/SB124657758880989227.html
President Obama is calling the climate
bill that the House passed last week an "extraordinary" achievement, and so
it is. The 1,200-page wonder manages the supreme feat of being both hugely
expensive while doing almost nothing to reduce carbon emissions.
The Washington press corps is playing the
bill's 219-212 passage as a political triumph, even though one of five
Democrats voted against it. The real story is what Speaker Nancy Pelosi,
House baron Henry Waxman and the President himself had to concede to secure
even that eyelash margin among the House's liberal majority. Not even Tom
DeLay would have imagined the extravaganza of log-rolling, vote-buying,
outright corporate bribes, side deals, subsidies and policy loopholes. Every
green goal, even taken on its own terms, was watered down or given up for
the sake of political rents.
Begin with the supposed point of the
exercise -- i.e., creating an artificial scarcity of carbon in the name of
climate change. The House trimmed Mr. Obama's favored 25% reduction by 2020
to 17% in order to win over Democrats leery of imposing a huge upfront tax
on their constituents; then they raised the reduction to 83% in the
out-years to placate the greens. Even that 17% is not binding, since it
would be largely reached with so-called,
offsets, through which some businesses
subsidize others to make emissions reductions that probably would have
happened anyway.
Even if the law works as intended, over
the next decade or two real U.S. greenhouse emissions might be reduced by 2%
compared to business as usual. However, consumers would still face higher
prices for electric power, transportation and most goods and services as
this inefficient and indirect tax flowed down the energy chain.
The sound bite is that this policy would
only cost households "a postage stamp a day." But that's true only as long
as the program doesn't really cut emissions. The goal here is to tell voters
they'll pay nothing in order to get the cap-and-tax bureaucracy in place --
even though the whole idea is to raise prices to change American behavior.
At the same time -- wink, wink -- Democrats tell the greens they can tighten
the emissions vise gradually over time.
Meanwhile, Congress had to bribe every
business or interest that could afford a competent lobbyist. Carbon permits
are valuable, yet the House says only 28% of the allowances would be
auctioned off; the rest would be given away. In March, White House budget
director Peter Orszag told Congress that "If you didn't auction the permit,
it would represent the largest corporate welfare program that has ever been
enacted in the history of the United States."
Naturally, Democrats did exactly that. To
avoid windfall profits, they then chose to control prices, asking state
regulators to require utilities to use the free permits to insulate
ratepayers from price increases. (This also obviates the anticarbon
incentives, but never mind.) Auctions would reduce political favoritism and
interference, as well as provide revenue to cut taxes to offset higher
energy costs. But auctions don't buy votes.
Then there was the peace treaty signed
with Agriculture Chairman Colin Peterson, which banned the EPA from studying
the carbon produced by corn ethanol and transferred farm emissions to the Ag
Department, which mainly exists to defend farm subsidies. Not to mention the
310-page trade amendment that was introduced at 3:09 a.m. When Congress
voted on the bill later that day, the House clerk didn't even have an
official copy.
The revisions were demanded by
coal-dependent Rust Belt Democrats to require tariffs on goods from
countries that don't also reduce their emissions. Democrats were thus
admitting that the critics are right that this new energy tax would send
U.S. jobs overseas. But instead of voting no, their price for voting yes is
to impose another tax on imports from China and India, among others. So a
Smoot-Hawley green tariff is now official Democratic policy.
Mr. Obama's lobbyists first acquiesced to
this tariff change to get the bill passed. Afterwards the President said he
disliked "sending any protectionist signals" amid a world recession, but he
refused to say whether this protectionism was enough to veto the bill. Then
in a Saturday victory lap, he talked about green jobs and a new clean energy
economy, but he made no reference to cap and trade -- no doubt because he
knows that energy taxes are unpopular and that the bill faces an even
tougher slog in the Senate.
Mr. Obama wants something tangible to take
to the U.N. climate confab in Denmark in December, but the more important
issue is what this exercise says about his approach to governance. The
President seems to believe that the Carter and Clinton Presidencies failed
by fighting too much with Democrats in Congress. So his solution is to
abdicate his agenda to Congress -- first the stimulus, now cap and trade,
and soon health care. We wish he had told us he was running to be Prime
Minister.
Of all the proposals in President Barack Obama's
breathtakingly ambitious agenda to foster long-term economic decline, by far the
biggest is the Waxman-Markey energy-rationing bill, which the House of
Representatives passed with the narrowest of majorities late Friday evening.
This bill by House Energy and Commerce Committee Chairman Henry Waxman
(D-Beverly Hills) and Representative Edward Markey (D-Mass.) is more damaging
than the $787 billion stimulus, the proposed huge increases in federal spending
and corresponding increases in the national debt, the takeover of GM and
Chrysler, and the proposed tax hikes on the wealthy - combined. Enacting
Waxman-Markey (H. R. 2454 . . .
Myron Ebell, "Waxman-Markey is Hilarious, but the Joke is on Us," Townhall, June
29, 2009 ---
http://townhall.com/columnists/MyronEbell/2009/06/29/waxman-markey_is_hilarious,_but_the_joke_is_on_us
EU: Climate Deal Pointless Without China, India
The chances of concluding a new global climate change
pact remain dim unless China, India and Brazil make significant cuts in carbon
dioxide emissions as well a senior Swedish climate change official said
Thursday. Lars-Erik Liljelund, special climate change adviser to the Swedish
government, said cuts from richer countries in the 27-nation bloc or planned
cuts in the United States will not be enough to meet aims to cut at least 25
percent of emission from 1990 levels. "The problem at the moment is that if you
take the contributions made so far by the United States, the European Union and
Japan then we don't come up to that minus 25 percent," he told reporters. He
said cuts from those richer countries and regions would only reach two-thirds of
that minimum target.
Newsmax, July 2, 2009 ---
http://moneynews.newsmax.com/investing/china_india_climate/2009/07/02/231487.html
CNN Video: Former Secretary of State Colin Powell tells CNN's John King that
he's concerned about President Obama's spending.---
http://www.realclearpolitics.com/video/2009/07/03/colin_powell_concerned_with_obamas_spending.html
"As U.S. Spending Balloons,
Concerns Grow over Size and Cost of Debt," International Herald Tribune via
SmartPros, May 5, 2009 ---
http://accounting.smartpros.com/x66461.xml
The U.S. debt clock is
ticking faster than ever, and Wall Street is getting worried.
As the administration of
President Barack Obama racks up an unprecedented spending bill for bank
bailouts, Detroit rescues, health care overhauls and stimulus plans, the
bond market is starting to push up the cost of trillions of dollars in
borrowing for the government.
Last week, the yield on
10-year Treasury notes rose to its highest level since November, briefly
touching 3.17 percent, a sign that investors are demanding larger returns on
the masses of U.S. debt being issued to finance an economic recovery.
While that yield is still
low by historical standards - it averaged about 5.7 percent in the late
1990s - investors are starting to wonder whether the United States is headed
for a new era of rising market interest rates as the government borrows,
borrows and borrows some more.
Already, in the first six
months of this fiscal year, the U.S. government deficit is running at $956.8
billion, or nearly one- seventh of gross domestic product - proportional
levels not seen since World War II, according to Wrightson ICAP, a research
firm.
Debt held by the public is
projected by the Congressional Budget Office to rise from 41 percent of
gross domestic product in 2008 to 51 percent in 2009 and to a peak of about
54 percent in 2011 before declining again in the following years. For all of
2009, the administration probably needs to borrow about $2 trillion.
The rising bill has prompted
warnings from the Treasury that the Congressionally mandated debt ceiling of
$12.1 trillion will most likely be breached in the second half of this year.
Last week, the Treasury
Borrowing Advisory Committee, a group of industry executives that advises
the Treasury on its financing needs, warned about the consequences of higher
deficits at a time when tax revenue was "collapsing" by 14 percent in the
first half of the fiscal year.
"Given the outlook for the
economy, the cost of restoring a smoothly functioning financial system and
the pending entitlement obligations to retiring baby boomers," a report from
the committee said, "the fiscal outlook is one of rapidly increasing debt in
the years ahead."
While the real long-term
interest rate will not rise immediately, the committee concluded, "such a
fiscal path could force real rates notably higher at some point in the
future."
In some ways, ballooning
deficits should not matter. Deficits are a useful way for governments to use
public spending to stimulate the economy when private demand is weak. That
works as long as a country closes its deficit and pays back its borrowings
after its economy starts to recover.
The trouble is that
government borrowing risks crowding out private investment, driving up
interest rates and potentially slowing a recovery still trying to take hold.
That is why the Federal Reserve announced an extraordinary policy this year
to buy back existing long-term debt - $300 billion over six months - to
drive down yields. The strategy worked for a while, but now the effect of
that decision appears to be wearing off as long-term interest rates tick up
again.
Then there is the concern
that the interest the government must pay on its debt obligations may become
unsustainable or weigh on future generations. The Congressional Budget
Office expects interest payments to more than quadruple in the next decade
as Washington borrows and spends, to $806 billion by 2019 from $172 billion
next year.
"You're just paying more and
more interest and having to borrow more and more money to pay the interest,"
said Charles S. Konigsberg, chief budget counsel for the Concord Coalition,
which advocates lower deficits. "It diverts a tremendous amount of
resources, of taxpayer dollars."
Of course, no one is
suggesting the United States will have problems paying the interest on its
debt. On Wednesday, even as it announced its huge financing needs for the
latest quarter, the Treasury said financial markets could accommodate the
flood of new bonds. "We feel confident that we can address these large
borrowing needs," said Karthik Ramanathan, the Treasury's acting assistant
secretary for financial markets.
One worry, however, is that
there are fewer eager lenders to buy all that American debt. Most of the
world is in recession, and other countries have rising borrowing needs as
well. As other nations' surpluses turn to deficits, America will face
competition in global financial markets for its borrowing needs. For the
moment, the United States is actually benefiting from a flight to quality
into Treasury securities brought on by the global financial crisis, which
helped reduce rates to record lows over the winter. But the influx will not
continue forever.
China has lent immense sums
to the United States - about two- thirds of its central bank's $1.95
trillion in foreign reserves is believed to be in U.S. securities - but it
has begun to voice concerns about America's financial health.
To calm nerves and fill the
deficit hole, the government is getting creative. The Treasury is speeding
up its auction calendar, holding more frequent sales of government debt and
selling the debt in expanded amounts. It is now holding sales of its 30-year
bond each month, up from four times annually.
It is also resuscitating
previously discontinued bonds, like the seven-year note and the three-year
note, to try to mop up any available money all along the yield curve. There
is even talk of issuing billions of dollars in a new 50-year bond, though
the idea has not won official approval.
On a second front, the
Treasury and the Federal Reserve are trying to bolster the mechanics of the
market to make sure every auction goes smoothly. With such enormous sums
involved, every additional basis point on the interest rate the government
pays could mean extra billions of dollars for the taxpayer.
A
democracy cannot exist as a permanent form of government. It can only exist
until the voters discover that they can vote themselves largesse from the public
treasury. From that moment on, the majority always votes for the candidates
promising the most benefits from the public treasury, with the result that a
democracy always collapses over loose fiscal policy, always followed by a
dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for updates by the
second) ---
http://www.brillig.com/debt_clock/
"The Financial Crisis as a Symbol of the Failure of Academic Finance?
(A Methodological Digression)," by Hans J. Blommestein, SSRN, September 23, 2009
---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1477399
The failure of academic finance can be considered
one of the symbols of the financial crisis. Two important underlying reasons
why academic finance models systematically fail to account for real-world
phenomena follow directly from two conventions: (a) treating economics not
as a 'true' social science (but as a branch of applied mathematics inspired
by the methodology of classical physics); and (b) using economic models as
if the empirical content of economic theories is not very low. Failure to
understand and appreciate the inherent weaknesses of these 'conventions' had
fatal consequences for the use and interpretation of key academic finance
concepts and models by market practitioners and policymakers. Theoretical
constructs such as the efficient markets hypothesis, rational expectations,
and market completeness were too often treated as intellectual dogmas
instead of (parts of) falsifiable hypotheses. The situation of capture via
dominant intellectual dogmas of policymakers, investors, and business
managers was made worse by sins of omission - the failure of academics to
communicate the limitations of their models and to warn against (potential)
misuses of their research - and sins of commission - introducing (often
implicitly) ideological or biased features in research programs Hence, the
deeper problem with finance concepts such as the 'efficient markets
hypothesis' and 'ratex theory' is not that they are based on assumptions
that are considered as not being 'realistic'. The real issue at stake with
academic finance is not a quarrel about the validity of the assumption of
rational behavior but the inherent semantical insufficiency of economic
theories that implies a low empirical content (and a high degree of
specification uncertainty). This perspective makes the scientific approach
advocated by Friedman and others less straightforward. In addition, there is
wide-spread failure to incorporate the key implications of economics as a
social science. As response to these 'weaknesses' and challenges, five
suggested principles or guidelines for future research programmes are
outlined.
Economics and Finance Videos of Possible Interest
Great PBS Video on the Crash of 1929 ---
http://www.pbs.org/wgbh/americanexperience/crash/
Video: Yale School of Management Cosponsors NYC Roundtable Discussion on
the Financial Crisis (Full Video Now Available)
http://mba.yale.edu/news_events/CMS/Articles/6608.shtml
Video: "Advice for President Obama" from the Department of Economics at
Cornell University ---
http://www.cornell.edu/video/?VideoID=410
Evan Davis talks to Warren Buffett ---
http://news.bbc.co.uk/2/hi/business/8322957.stm
Video: Fora.Tv on Institutional Corruption & The Economy Of Influence ---
http://www.simoleonsense.com/video-foratv-on-institutional-corruption-the-economy-of-influence/
Stop Imitating Hyper-inflated Zimbabwe: The U.S. Treasury Should
Cease Monetizing the Debt
The U.S. should borrow or tax to pay its debts, but stop printing money to pay
deficit-driven debt
"Don't Monetize the Debt: The president of the Dallas Fed on inflation risk
and central bank independence," by Mary Anastasia O'Grady, The Wall Street
Journal, May 23, 2009 ---
http://online.wsj.com/article/SB124303024230548323.html
From his perch high atop the palatial
Dallas Federal Reserve Bank, overlooking what he calls "the most modern,
efficient city in America," Richard Fisher says he is always on the lookout
for rising prices. But that's not what's worrying the bank's president right
now.
His bigger concern these days would seem
to be what he calls "the perception of risk" that has been created by the
Fed's purchases of Treasury bonds, mortgage-backed securities and Fannie Mae
paper.
Mr. Fisher acknowledges that events in the
financial markets last year required some unusual Fed action in the
commercial lending market. But he says the longer-term debt, particularly
the Treasurys, is making investors nervous. The looming challenge, he says,
is to reassure markets that the Fed is not going to be "the handmaiden" to
fiscal profligacy. "I think the trick here is to assist the functioning of
the private markets without signaling in any way, shape or form that the
Federal Reserve will be party to monetizing fiscal largess, deficits or the
stimulus program."
The very fact that a Fed regional bank
president has to raise this issue is not very comforting. It conjures up
images of Argentina. And as Mr. Fisher explains, he's not the only one
worrying about it. He has just returned from a trip to China, where "senior
officials of the Chinese government grill[ed] me about whether or not we are
going to monetize the actions of our legislature." He adds, "I must have
been asked about that a hundred times in China."
A native of Los Angeles who grew up in
Mexico, Mr. Fisher was educated at Harvard, Oxford and Stanford. He spent
his earliest days in government at Jimmy Carter's Treasury. He says that
taught him a life-long lesson about inflation. It was "inflation that
destroyed that presidency," he says. He adds that he learned a lot from then
Fed Chairman Paul Volcker, who had to "break [inflation's] back."
Mr. Fisher has led the Dallas Fed since
2005 and has developed a reputation as the Federal Open Market Committee's (FOMC)
lead inflation worrywart. In September he told a New York audience that
"rates held too low, for too long during the previous Fed regime were an
accomplice to [the] reckless behavior" that brought about the economic
troubles we are now living through. He also warned that the Treasury's $700
billion plan to buy toxic assets from financial institutions would be "one
more straw on the back of the frightfully encumbered camel that is the
federal government ledger."
In a speech at the Kennedy School of
Government in February, he wrung his hands about "the very deep hole [our
political leaders] have dug in incurring unfunded liabilities of retirement
and health-care obligations" that "we at the Dallas Fed believe total over
$99 trillion." In March, he is believed to have vociferously objected in
closed-door FOMC meetings to the proposal to buy U.S. Treasury bonds. So
with long-term Treasury yields moving up sharply despite Fed intentions to
bring down mortgage rates, I've flown to Dallas to see what he's thinking
now.
Regarding what caused the credit bubble,
he repeats his assertion about the Fed's role: "It is human instinct when
rates are low and the yield curve is flat to reach for greater risk and
enhanced yield and returns." (Later, he adds that this is not to cast
aspersions on former Fed Chairman Alan Greenspan and reminds me that these
decisions are made by the FOMC.)
"The second thing is that the regulators
didn't do their job, including the Federal Reserve." To this he adds what he
calls unusual circumstances, including "the fruits and tailwinds of
globalization, billions of people added to the labor supply, new factories
and productivity coming from places it had never come from before." And
finally, he says, there was the 'mathematization' of risk." Institutions
were "building risk models" and relying heavily on "quant jocks" when "in
the end there can be no substitute for good judgment."
What about another group of alleged
culprits: the government-anointed rating agencies? Mr. Fisher doesn't mince
words. "I served on corporate boards. The way rating agencies worked is that
they were paid by the people they rated. I saw that from the inside." He
says he also saw this "inherent conflict of interest" as a fund manager. "I
never paid attention to the rating agencies. If you relied on them you got .
. . you know," he says, sparing me the gory details. "You did your own
analysis. What is clear is that rating agencies always change something
after it is obvious to everyone else. That's why we never relied on them."
That's a bit disconcerting since the Fed still uses these same agencies in
managing its own portfolio.
I wonder whether the same bubble-producing
Fed errors aren't being repeated now as Washington scrambles to avoid a
sustained economic downturn.
He surprises me by siding with the
deflation hawks. "I don't think that's the risk right now." Why? One factor
influencing his view is the Dallas Fed's "trim mean calculation," which
looks at price changes of more than 180 items and excludes the extremes.
Dallas researchers have found that "the price increases are less and less.
Ex-energy, ex-food, ex-tobacco you've got some mild deflation here and no
inflation in the [broader] headline index."
Mr. Fisher says he also has a group of
about 50 CEOs around the U.S. and the world that he calls on, all off the
record, before almost every FOMC meeting. "I don't impart any information, I
just listen carefully to what they are seeing through their own eyes. And
that gives me a sense of what's happening on the ground, you might say on
Main Street as opposed to Wall Street."
It's good to know that a guy so obsessed
with price stability doesn't see inflation on the horizon. But inflation and
bubble trouble almost always get going before they are recognized. Moreover,
the Fed has to pay attention to the 1978 Full Employment and Balanced Growth
Act -- a.k.a. Humphrey-Hawkins -- and employment is a lagging indicator of
economic activity. This could create a Fed bias in favor of inflating. So I
push him again.
"I want to make sure that your readers
understand that I don't know a single person on the FOMC who is rooting for
inflation or who is tolerant of inflation." The committee knows very well,
he assures me, that "you cannot have sustainable employment growth without
price stability. And by price stability I mean that we cannot tolerate
deflation or the ravages of inflation."
Mr. Fisher defends the Fed's actions that
were designed to "stabilize the financial system as it literally fell apart
and prevent the economy from imploding." Yet he admits that there is
unfinished work. Policy makers have to be "always mindful that whatever you
put in, you are going to have to take out at some point. And also be mindful
that there are these perceptions [about the possibility of monetizing the
debt], which is why I have been sensitive about the issue of purchasing
Treasurys."
He returns to events on his recent trip to
Asia, which besides China included stops in Japan, Hong Kong, Singapore and
Korea. "I wasn't asked once about mortgage-backed securities. But I was
asked at every single meeting about our purchase of Treasurys. That seemed
to be the principal preoccupation of those that were invested with their
surpluses mostly in the United States. That seems to be the issue people are
most worried about."
As I listen I am reminded that it's not
just the Asians who have expressed concern. In his Kennedy School speech,
Mr. Fisher himself fretted about the U.S. fiscal picture. He acknowledges
that he has raised the issue "ad nauseam" and doesn't apologize. "Throughout
history," he says, "what the political class has done is they have turned to
the central bank to print their way out of an unfunded liability. We can't
let that happen. That's when you open the floodgates. So I hope and I pray
that our political leaders will just have to take this bull by the horns at
some point. You can't run away from it."
Voices like Mr. Fisher's can be a problem
for the politicians, which may be why recently there have been rumblings in
Washington about revoking the automatic FOMC membership that comes with
being a regional bank president. Does Mr. Fisher have any thoughts about
that?
This is nothing new, he points out,
briefly reviewing the history of the political struggle over monetary policy
in the U.S. "The reason why the banks were put in the mix by [President
Woodrow] Wilson in 1913, the reason it was structured the way it was
structured, was so that you could offset the political power of Washington
and the money center in New York with the regional banks. They represented
Main Street.
"Now we have this great populist fervor
and the banks are arguing for Main Street, largely. I have heard these
arguments before and studied the history. I am not losing a lot of sleep
over it," he says with a defiant Texas twang that I had not previously
detected. "I don't think that it'd be the best signal to send to the market
right now that you want to totally politicize the process."
Speaking of which, Texas bankers don't
have much good to say about the Troubled Asset Relief Program (TARP),
according to Mr. Fisher. "Its been complicated by the politics because you
have a special investigator, special prosecutor, and all I can tell you is
that in my district here most of the people who wanted in on the TARP no
longer want in on the TARP."
At heart, Mr. Fisher says he is an
advocate for letting markets clear on their own. "You know that I am a big
believer in Schumpeter's creative destruction," he says referring to the
term coined by the late Austrian economist. "The destructive part is always
painful, politically messy, it hurts like hell but you hopefully will allow
the adjustments to be made so that the creative part can take place." Texas
went through that process in the 1980s, he says, and came back stronger.
This is doubtless why, with Washington
taking on a larger role in the American economy every day, the worries
linger. On the wall behind his desk is a 1907 gouache painting by Antonio De
Simone of the American steam sailing vessel Varuna plowing through stormy
seas. Just like most everything else on the walls, bookshelves and table
tops around his office -- and even the dollar-sign cuff links he wears to
work -- it represents something.
He says that he has had this painting
behind his desk for the past 30 years as a reminder of the importance of
purpose and duty in rough seas. "The ship," he explains, "has to maintain
its integrity." What is more, "no mathematical model can steer you through
the kind of seas in that picture there. In the end someone has the wheel."
He adds: "On monetary policy it's the Federal Reserve."
Bob Jensen's threads on the Entitlements Crisis are at
http://faculty.trinity.edu/rjensen/entitlements.htm
"Examiner Editorial: Banana republic budgeting should shame Obama, Congress,"
Examiner Editorial, San Francisco Examiner, April 6, 2009 ---
http://www.sfexaminer.com/opinion/Examiner-Editorial-Banana-republic-budgeting-should-shame-Obama-Congress-42510242.html
It was surely an act of hubris for President Obama
to ask Congress to approve a $3.6 trillion federal budget for 2010 that runs
a trillion-dollars worth of red ink its first year and then projects
half-trillion deficits every year thereafter for a decade. Congress has
never before been asked to consider spending of such magnitude, not even
during wartime. Obama’s budget proposal also included provisions committing
the nation to far-reaching policy changes that are certain to drive federal
taxes higher, send gasoline and electricity costs soaring, socialize doctors
and patients by putting Washington bureaucrats in charge of health care, and
make Uncle Sam the Daddy Warbucks of college tuition for everybody. The
ultimate result will be a doubling of the national debt, a burden that will
fall on our children and grandchildren. In short, this was a budget proposal
of historic significance to every living American and for millions yet to be
born. So how did Congress deal with this landmark legislation? The House of
Representatives gave opponents exactly 20 minutes to present an alternative,
then gaveled the Obama measure to approval. The Senate approved it after
considering a handful of amendments. But note that even before the 2010
budget was approved, this Congress had approved spending more than $1.2
trillion, or $24 billion per day. That’s $1 billion every hour since the
111th Congress convened in January. Odds are that not even King Solomon –
whose riches dazzled monarchs and tyrants throughout the ancient world –
exhausted the fruit of the labor of his subjects and slaves at so
breathtaking a pace as this president and this Congress. And they are doing
it based on decisions most often made by Democratic leaders behind closed
doors, who then run roughshod over the Republican minority. Is this really
what Senate Majority Leader Harry Reid and House Speaker Nancy Pelosi meant
when they promised during the 2006 campaign “the most open and honest
Congress ever”? And was Obama simply lying during the 2008 campaign when he
promised a “net spending reduction” in Washington?
These actions are not going unnoticed beyond the
Washington Beltway. More than 300 Tea (“Taxed Enough Already”) Party
protests are planned for April 15 in cities from one end of America to the
other. There have already been nearly 100 such protests since before a
televised rant by CNBC reporter Rick Santelli about wasteful spending in the
Obama economic stimulus package in February. Looks like change may indeed be
coming, but it will be far from what Obama, Pelosi and Reid had in mind.
Hi David Fordham,
Your long message involves much more than your original question about why we
refer to the National Debt as "Debt."
Below I will describe a "hidden agenda" about why Hank Paulson elected to
save AIG and not Lehman Brothers. I will also predict that the U.S. will one day
give China its entire Navy.
The U.S. Government has two types of financial obligations.
Booked Debt = National Debt ---
http://en.wikipedia.org/wiki/National_Debt
This is simply the cash we've borrowed (treasury bonds, savings
bonds, etc.) upon which we are paying interest of slightly less than a million
dollars a minute at the moment. Due to budget deficits National Debt will double
in the next few years from the present level of between $10 and $11 trillion.
Most of the interest on our National Debt is being funded with more borrowing
rather than taxation. This is one of the main reasons why the U.S. Budget has
become the mother of all Ponzi schemes.
Unbooked Debt = Entitlement obligations that are not yet booked ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
Entitlement obligations are not yet booked but in most cases
they are already legislated and can be measured with reasonable accuracy by
actuarial methods, including obligations for military retirement, Veterans
medical benefits, Social Security retirement and disability pay, Congressional
retirement and medical benefits, Medicare, a portion of Medicaid, etc.
Entitlements also include many contingency obligations such when the President
declares disaster areas of the country after hurricanes, tornados, forest fires,
etc. The government also has millions of pending lawsuits.
Former Controller General, David Walker, places the unbooked debt at around
$60 trillion, but it will soon explode to $100 trillion under proposed
entitlement programs for universal education, universal health care, and massive
environmental protection legislation being proposed. Since U.S. voters will
almost never vote for massive tax increases, the Government has little choice
for legislated entitlements other than adding to the National Debt or
Zimbabwe-style printing of money that spells economic disaster.
Until David Walker got serious about the magnitude of the unbooked
obligations, I don't think anybody tried to seriously measure this unbooked
debt. Now David is trying his best to warn the public about how these
entitlements may destroy the United States unless we start taxing to pay for
them.
IOUSA (the most frightening movie in American history) --- (see a 30-minute
version of the documentary at
www.iousathemovie.com
).
A Must Read for All Americans
The most important article for the world to read now is the following interview
with a former Andersen Partner and former Chief Accountant of the United States:
"Debt Crusader David Walker sounds the alarm for America's financial future,"
Journal of Accountancy, March 2009 ---
http://www.journalofaccountancy.com/Issues/2009/Mar/DebtCrusader.htm
The good news about entitlement obligations is that, until they come due, we
are not usually paying interest. The bad news is that legislated entitlements
are so massive before we legislate the proposed Obama entitlements. Universal
health care is the mother of all entitlements unless U.S. voters are willing to
devote half their incomes to a universal health care tax (which is how Canada
and European nations fund health care). U.S. voters are not likely to accept
such a 50% universal health care tax.
Thus far most of the stimulus outflows to date have been with borrowed money,
although a small portion was printed money. There's a huge difference in terms
of inflation. Printed money directly boosts inflation and angers former
investors in our National Debt such as China, Germany, and oil-rich rich Arabs.
It would be curtains for the United States if those investors stopped rolling
over their investments in our National Debt. Of course they don't want to see
their investments go up in smoke.
Hank Paulson's Suspected Hidden Agenda
It's not likely that cash-rich nations like China, Germany, and oil-Arabs will
destroy their own investments in our National Debt by not rolling over the debt
at maturity dates. However, they are likely to be less willing to add trillions
more investing in our newer annual spendthrift deficits.
I think what perplexed Hank Paulson, as Treasury Secretary, was that AIG's
main problem was undercapitalized credit derivative obligations that insured
toxic CDO mortgage bonds purchased by the same investors who hold much of our
National Debt.
If Paulson allowed AIG's credit derivative defaults to really piss off
investors needed for added National Debt, the U.S. Treasury would have been in
deep, deep trouble. We had to keep those investors content by making good on
AIG's trillions in credit derivatives. And thus we bailed out AIG.
Lehman Bothers was an investor counterparty in AIG's credit derivatives, but
Lehman was not obligated to China, Germany, and oil-Arabs like AIG was obligated
to investors in our National Debt. Hence, Paulson could let Lehman fail without
the same massive repercussions on our issuance of new Treasury Bonds.
That was my "Hidden Agenda" speculation early on, although I don't claim to
be the only one suspecting a hidden bailout agenda for AIG ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails
There are two ways to really piss off investors in our massive National Debt.
The first way is to print money that has an indirect effect of greatly
cheapening their investments of dear dollars in our National Debt. The second
way is to not make good credit insurance (credit derivatives) purchased from
U.S. companies like AIG.
I suspect that if we continue to become better allies with China, we will
find innovative methods for reducing our National Debt. One way will be to give
China the U.S. Navy. I'm not really trying to be funny here. I only hope that
China also takes on the entitlement obligations that accompany the U.S. Navy.
The United States will "look like a banana republic"
unless it gains control over its budget deficit and federal debt, economist
Allen Sinai warned Congress on Thursday. "The deficit and debt prospects under
almost any scenario are daunting," Mr. Sinai, chief global economist for
Decision Economics Inc., told the Senate Budget Committee. "This territory is
uncharted, with no real historical analogue to this kind of financial situation
for a major global economic power." Asked by committee Chairman Kent Conrad,
North Dakota Democrat, whether the U.S. government's creditworthiness is at
risk, Mr. Sinai replied, "Unequivocally yes." Richard Berner, chief U.S.
economist at Morgan Stanley, told the committee one measure of America's
creditworthiness -- credit default swap spreads -- already shows some
deterioration. The worse a nation's credit rating becomes, the more its CDS
spread rises. U.S. sovereign CDS spreads have widened to about 0.6 percent from
0.1 percent last summer, Mr. Berner noted. "So the message is that you ignore
global investors at your peril," he told the committee.
David M. Dixon, "Congress warned about debt U.S.
advised to gain control," The Washington Times, January 16, 2009 ---
http://washingtontimes.com/news/2009/jan/16/policies-on-debt-a-risk-to-economy/
Everett Dirksen,
as Minority Senate Leader beginning in 1959, is most widely noted for a
quotation that he never made in these exact words: "A billion here, a billion
there, pretty soon, you're talking real money". What he really meant to say was
"A trillion here and a trillion there means you can't possibly be talking about
real money."
The National Debt
Clock ---
http://www.brillig.com/debt_clock/
At the above site it appears to be a fixed number.
But now hit your refresh button to see how much it's changed in just a few
seconds.
At 9:34 a.m. on September 23, 2008 it was $9,734,361,140,920.08 trillion
At 9:35 a.m. on September 23, 2008 it was $9,734,365,595,383.82 trillion
What was added in that minute was mostly added to pay the interest on the
National Debt.
The annual amount of interest per year on the above number at 6% is
$584,061,935,723.03 billion
This translates to well over a million dollars a minute,
most of which is funded by adding to the National Debt.
There's no real money
here since the U.S. Government never intends to pay off the National Debt,
not one farthing.
There's a greatly increased chance in 2008 that U.S. debt will receive a lowered
credit rating, which will greatly increase the cost of out national debt each
minute.
But the National
Debt is only the amount we have actually borrowed on notes because the U.S.
needed cash to pay current bills due. Every accountant knows that the unbooked
liabilities can be much, much larger because we've not yet needed to currently
borrow the money to pay bills that are coming in to us or our grandchildren in
the future.
Because U.S.
Government accounting is in such chaos (the GAO will not even sign off on its
annual audits of the Pentagon), nobody on earth really knows what our total
liabilities are. The former top accountant in the Federal government estimates
that the total is well in excess of $55+ trillion (present value discounted)
before the 2008 deficit is factored in.
I could not
even make a wild guess about how much of the National Debt is held by banks
across the U.S.. Certainly a large portion of it is held to get a “risk
free” cash return in lieu of keeping cash in demand deposit checking
accounts. U.S. Treasury Bills are popular cash equivalents.
A huge
proportion of our National Debt is held by our friends in the Middle East
and Asia. If you plan to watch that 1981 movie entitled “Rollover,” bring
along a crying towel ---
http://en.wikipedia.org/wiki/Rollover_(film)
OPEC could probably put the U.S. out of business in an hour if it was so
inclined.
How long will Japan, China, and OPEC keep rolling this
debt over instead of calling in their chips? China may be especially upset
if we impose increased tariffs. This is crazy as China roars toward
capitalism and the U.S. reverses course toward socialism.
Treasury statistics indicate that, at
the end of 2006, foreigners held 44% of federal debt held by the public.
About 66% of that 44% was held by the central banks of other countries, in
particular the central banks of Japan and China. In total, lenders from
Japan and China held 47% of the foreign-owned debt. This exposure to
potential financial or political risk should foreign banks stop buying
Treasury securities or start selling them heavily was addressed in a recent
report issued by the Bank of International Settlements which stated,
"'Foreign investors in U.S. dollar assets have seen big losses measured in
dollars, and still bigger ones measured in their own currency. While
unlikely, indeed highly improbable for public sector investors, a sudden
rush for the exits cannot be ruled out completely."
---
http://en.wikipedia.org/wiki/United_States_public_debt
But my hunch
is that, in relative proportions, the amount of the National Debt held by
the Men in Black on Wall Street is negligible. The Men in Black were heavy
speculators seeking higher commissions and higher returns that is paid out
on our National Debt.
Bankers (Men in Black)
bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby.
Council on Foreign Relations, as quoted by Avital Louria Hahn,
"Missing: How Poor Risk-Management Techniques Contributed to
the Subprime Mess," CFO
Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Government is going to bail out these speculators with
taxpayer funds makes it all the worse. |
A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/
Question
As of December 2008, what do Zimbabwe and the United States have in common?
Answer
Rather than taxing or borrowing to cover deficit spending, both governments are
simply printing more money?
What's wrong with that?
First look at what it did to Zimbabwe. Then read about Gresham's Law ---
http://en.wikipedia.org/wiki/Gresham%27s_Law
The instant the Federal Reserve announced this new funding policy in December,
the U.S. dollar plunged in value relative to foreign currencies. The reason is
obvious.
Zimbabwe's central bank will introduce a 100
trillion Zimbabwe dollar banknote, worth about $33 on the black market, to try
to ease desperate cash shortages, state-run media said on Friday.
KyivPost, January 16, 2009 ---
http://www.kyivpost.com/world/33522
Jensen Comment
This is a direct result of raising money by simply printing it, and the U.S.
should take note since this is how our Federal government has decided to pay for
anticipated trillion-dollar budget deficits ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
The United States will "look like a banana republic"
unless it gains control over its budget deficit and federal debt, economist
Allen Sinai warned Congress on Thursday. "The deficit and debt prospects under
almost any scenario are daunting," Mr. Sinai, chief global economist for
Decision Economics Inc., told the Senate Budget Committee. "This territory is
uncharted, with no real historical analogue to this kind of financial situation
for a major global economic power." Asked by committee Chairman Kent Conrad,
North Dakota Democrat, whether the U.S. government's creditworthiness is at
risk, Mr. Sinai replied, "Unequivocally yes." Richard Berner, chief U.S.
economist at Morgan Stanley, told the committee one measure of America's
creditworthiness -- credit default swap spreads -- already shows some
deterioration. The worse a nation's credit rating becomes, the more its CDS
spread rises. U.S. sovereign CDS spreads have widened to about 0.6 percent from
0.1 percent last summer, Mr. Berner noted. "So the message is that you ignore
global investors at your peril," he told the committee.
David M. Dixon, "Congress warned about debt U.S.
advised to gain control," The Washington Times, January 16, 2009 ---
http://washingtontimes.com/news/2009/jan/16/policies-on-debt-a-risk-to-economy/
"Mr. Wen's Debt Bomb," The Wall Street Journal, March 18, 2009 ---
http://online.wsj.com/article/SB123734170930865121.html
President Obama's stimulus plan and new
budget will require an additional $3 trillion to $4 trillion in new
borrowing over the next two or three years, and that's if the economy
recovers smartly. Adding it all up, Federal Reserve Chairman Ben Bernanke
last week estimated that U.S. public debt-to-GDP would reach 60% over the
next few years, up from 40% before the financial panic hit -- and the
highest level since the aftermath of World War II. He must be an optimist.
As the nearby chart shows, Mr. Obama's budget anticipates a decade of
outlays far above postwar spending and revenue averages. And even that
assumes, implausibly, that most "stimulus" spending will be temporary.
That's a lot of T-bills to flog, and the
world is taking note. Our colleagues at MarketWatch reported last week that
the cost to buy insurance against U.S. sovereign debt default has surged in
the past year. The spreads on credit default swaps for U.S. government debt
hit 97 basis points last week -- or $97,000 to buy insurance on $10 million
in debt -- nearly seven times higher than a year ago and 60% higher than the
end of 2008.
Mr. Wen called on the U.S. to "maintain
its credibility, honor its commitments and guarantee the safety of Chinese
assets." Little wonder: China, like other trading nations, has a big stake
in this fiscal free-for-all. Although it doesn't release detailed data,
roughly two-thirds of Beijing's $1.9 trillion foreign-exchange reserves are
likely parked in U.S. Treasury debt.
The Obama Administration revealed its
sensitivity on the issue by responding quickly, with Presidential spokesman
Robert Gibbs saying Friday "there's no safer investment in the world than in
the United States." Mr. Obama added Saturday that "not just the Chinese
government, but every investor can have absolute confidence in the soundness
of investments in the United States."
The White House is almost certainly right
that the U.S. won't default; the consequences would be too dire. But there
are risks well short of formal debt repudiation. As the supply of U.S. debt
increases, investors may demand a higher yield and interest rates would
rise, reducing the tradable value of current Treasury bonds. The other
temptation will be to inflate away the debt, which would also devalue
dollar-denominated assets.
What Mr. Wen is really saying is that even
the U.S. national balance sheet has limits. The dollar is the world's
reserve currency, so the U.S. has the rare privilege among nations of being
able to borrow (and then repay its debts) in its own currency. America also
remains the world's main safe haven in a crisis, as the flight to the dollar
and T-bills in recent months underscores.
But reserve currency status isn't a
birthright and it can vanish when nations are irresponsible. Deficits are
sometimes necessary to finance tax cuts and investments that promote
economic growth. The tragedy of Mr. Obama's $787 billion stimulus and $410
billion 2009 budget is that they spend principally on transfer payments that
have little growth payback. The U.S. received another foreign rebuke on this
score this weekend, when German Chancellor Angela Merkel and other Europeans
rejected Mr. Obama's calls for a comparable spending binge on the Continent.
Mr. Wen may have been trying to placate
his domestic Chinese audience, which is suffering through its own economic
slowdown. Or perhaps he was trying to repay Treasury Secretary Timothy
Geithner for his nomination-hearing comments on Chinese currency
"manipulation." Mr. Wen doesn't have much room to lecture the U.S., having
done too little in his nearly six years in office to liberalize the Chinese
economy.
But the Chinese Premier is right to warn
the U.S. political class that the global demand for American debt will
continue only if the U.S. runs economic policies that make U.S.-dollar
assets worth the risk.
Bob Jensen's threads on entitlements are at
http://faculty.trinity.edu/rjensen/Entitlements.htm
The US government is on a “burning platform” of unsustainable
policies and practices with fiscal deficits, chronic healthcare underfunding,
immigration and overseas military commitments threatening a crisis if action is
not taken soon.
David M. Walker,
Former Chief Accountant of the United States ---
http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt
for entitlements ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
The Perfect (Stimulus) Storm for a Universal Healthcare Entitlement in the
United States
The more we dig into the pile of spending and tax
favors known as the "stimulus bill," the more amazing discoveries we make.
Namely, Democrats have apparently decided that the way to gun the economy is to
spend even more on health care. This is notable because if there has been one
truly bipartisan idea in Washington, it's that the U.S. as a whole spends too
much on health care. President Obama has been talking up entitlement reform as a
way to free up the money for his other social priorities. But it turns out that
Congress is using the stimulus as cover for a massive expansion of federal
entitlements.
"The Entitlement Stimulus: More giant steps
toward government," The Wall Street Journal, January 29, 2009 ---
http://online.wsj.com/article/SB123318915075926757.html?mod=djemEditorialPage
Jensen Comment
On January 28, ABC News reported how the Canadian Universal Health Care Plan was
so much more efficient in terms of accounting efficiency, largely because third
party billing in the U.S. has become a quagmire. However, what ABC failed to
mention, probably deliberately, is that over half of the average Canadian's
salary is taxed mostly for health care. Much has been made about the months or
years Canadians wait for non-emergency medical treatments. But seldom does the
liberal U.S. press mention the enormous tax bill that goes with the Canadian
Universal Health Care Plan. Taxpayers need not worry in the United States
however. The new entitlement payment plan in the U.S. simply entails printing
money rather than taxing or borrowing ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
"Fed Cuts Key Rate to a Record Low," by Edmund L. Andrews and Jackie Calmes,
The New York Times, December 16, 2008 ---
http://www.nytimes.com/2008/12/17/business/economy/17fed.html?_r=1&scp=1&sq=printing
money&st=cse
In effect, the Fed is stepping in as a
substitute for banks and other lenders and acting more like a bank itself.
“The Federal Reserve will employ all available tools to promote the
resumption of sustainable economic growth,” it said. Those tools include
buying “large quantities” of mortgage-related bonds, longer-term Treasury
bonds, corporate debt and even consumer loans.
The move came as President-elect Barack
Obama summoned his economic team to a four-hour meeting in Chicago to map
out plans for an enormous economic stimulus measure that could cost anywhere
from $600 billion to $1 trillion over the next two years.
The two huge economic stimulus programs,
one from the Fed and one from the White House and Congress, set the stage
for a powerful but potentially risky partnership between Mr. Obama and the
Fed’s Republican chairman, Ben S. Bernanke.
“We are running out of the traditional
ammunition that’s used in a recession, which is to lower interest rates,”
Mr. Obama said at a news conference Tuesday. “It is critical that the other
branches of government step up, and that’s why the economic recovery plan is
so essential.”
Financial markets were electrified by the
Fed action. The Dow Jones industrial average jumped 4.2 percent, or 359.61
points, to close at 8,924.14.
Investors rushed to buy long-term Treasury
bonds. Yields on 10-year Treasuries, which have traditionally served as a
guide for mortgage rates, plunged immediately after the announcement to 2.26
percent, their lowest level in decades, from 2.51 percent earlier in the
day.
Yields on investment-grade corporate bonds
edged down to 7.215 percent on Tuesday, from 7.355 on Monday. Yields on
riskier high-yielding corporate bonds remained in the stratosphere at 22.493
percent, almost unchanged from 22.732 on Monday.
By contrast, the dollar dropped sharply
against the euro and other major currencies for the second consecutive day —
a sign that currency markets were nervous about a flood of newly printed
dollars.
Some analysts predict that the Treasury will have to sell $2 trillion worth
of new securities over the next year to finance its existing budget deficit,
a new stimulus program and to refinance about $600 billion worth of maturing
government debt.
For the moment, Mr. Obama and Mr. Bernanke
appear to be on the same page, though that could abruptly change if the
economy starts to revive. Fed officials have already assumed that Congress
will pass a major spending program to stimulate the economy, and they are
counting on it to contribute to economic growth next year.
In more normal times, the Fed might easily
start raising interest rates in reaction to a huge new spending program, out
of concern about rising inflation.
But data on Tuesday provided new evidence
that the biggest threat to prices right now was not inflation but deflation.
The federal government reported on Tuesday
that the Consumer Price Index fell 1.7 percent in November, the steepest
monthly drop since the government began tracking prices in 1947. The decline
was largely driven by the recent plunge in energy prices, but even the
so-called core inflation rate, which excludes the volatile food and energy
sectors, was essentially zero.
Mr. Obama’s goal is to have a package
ready when the new Congress convenes on Jan. 6. His hope is that the House
and Senate, with their bigger Democratic majorities, can agree quickly on a
plan for Mr. Obama to sign into law soon after he is sworn into office two
weeks later.
The Fed, in a statement accompanying its
rate decision, acknowledged that the recession was more severe than
officials had thought at their last meeting in October.
“Over all, the outlook for economic
activity has weakened further,” the central bank said.
“Labor market conditions have
deteriorated, and the available data indicate that consumer spending,
business investment and industrial production have declined.”
The central bank added: “The committee
anticipates that weak economic conditions are likely to warrant
exceptionally low levels of the federal funds rate for some time.”
With fewer than 10 days until Christmas,
retailers from Saks Fifth Avenue to Wal-Mart have been slashing prices to
draw in consumers, who have sharply reduced their spending over the last six
months. On Tuesday, Banana Republic offered customers $50 off on any
purchases that total $125. The clothing retailer DKNY offered customers $50
off any purchase totaling $250.
Ian Shepherdson, an analyst at High
Frequency Economics, said falling energy prices were likely to bring the
year-over-year rate of inflation to below zero in January.
The Fed has already announced or outlined
a range of unorthodox new tools that it can use to keep stimulating the
economy once the federal funds rate effectively reaches zero. On Tuesday,
Fed officials said they stood ready to expand them or create new ones to
relieve bottlenecks in the credit markets.
All of the tools involve borrowing by the
Fed, which amounts to printing money in vast new quantities, a process the
Fed has already started.
Since September, the Fed’s balance sheet has ballooned from about $900
billion to more than $2 trillion as it has created money and lent it out. As
soon as the Fed completes its plans to buy mortgage-backed debt and consumer
debt, the balance sheet will be up to about $3 trillion.
“At some point, and without knowing the
timing, the Fed is going to have to destroy all that money it is creating,”
said Alan Blinder, a professor of economics at Princeton and a former vice
chairman of the Federal Reserve.
“Right now, the crisis is created by the
huge demand by banks for hoarding cash. The Fed is providing cash, and the
banks want to hoard it. When things start returning to normal, the banks
will want to start lending it out. If that much money is left in the
monetary base, it would be extremely inflationary.”
This is the thing I’ve been afraid of ever since I
realized that Japan really was in the dreaded, possibly mythical liquidity trap.
You can read my 1998 Brookings Paper on the issue
here. Incidentally, there were a bunch of us at
Princeton worrying about the Japan problem in the early years of this decade. I
was one; Lars Svensson, currently at Sweden’s Riksbank, was another; a third was
a guy named Ben Bernanke. I wonder whatever happened to him?
Paul Krugman, "ZIRP," The New York Times, December 16, 2008
---
http://krugman.blogs.nytimes.com/2008/12/16/zirp/?scp=8&sq=printing money&st=cse
As it has so often in recent months, the market
elation that greeted the Federal Reserve's epic monetary easing earlier this
week has turned to worry. Stocks fell off again yesterday, but the big news of
the week has been the slide in the dollar. The nearby chart shows the
greenback's story since September. From its dangerous summer lows, the buck
soared at the height of the credit panic as investors looked for safety in a
hurricane. But the dollar has fallen like Newton's apple in December, as
Chairman Ben Bernanke and his comrades signaled that they are willing to cut
interest rates to near-zero and print as much money as it takes to prevent a
deflation.
"A Dollar Referendum Currency markets reflect a lack of faith in Bernanke,"
The Wall Street Journal, December 19, 2008 ---
http://online.wsj.com/article/SB122965017184420567.html
Am I the only guy in this country who’s fed up with
what’s happening? Where the hell is our outrage? We should be screaming bloody
murder. We’ve got a gang of clueless bozos steering our ship of state right over
a cliff, we’ve got corporate gangsters stealing us blind, and we can’t even
clean up after a hurricane much less build a hybrid car. But instead of getting
mad, everyone sits around and nods their heads when the politicians say, "Stay
the course." . . . Name me a government leader who can articulate a plan for
paying down the debt, or solving the energy crisis, or managing the health care
problem. The silence is deafening. But these are the crises that are eating away
at our country and milking the middle class dry. I have news for the gang in
Congress and the Senate. We didn’t elect you to sit on your asses and do nothing
and remain silent while our democracy is being hijacked and our greatness is
being replaced with mediocrity. What is everybody so afraid of? That some
bonehead on Fox News will call them a name? Give me a break. Why don’t you guys
show some spine for a change? I honestly don’t think any of you have one! . . .
The most famous business leaders are not the innovators but the guys in
handcuffs. While we’re fiddling in Iraq , the Middle East is burning and nobody
seems to know what to do. And the press is waving ‘pom-poms’ instead of asking
hard questions. That’s not the promise of the ‘ America ‘ my parents and yours
traveled across the ocean for. I’ve had enough. How about you?
Lee Iococca (the former and
successful CEO of Chrysler) as quoted in Jim Sinclair's Mailbox on
December 20, 2008 ---
http://www.jsmineset.com/
Another trillion for a bailout of the Men in Black is not trivial relative
to the nation’s booked debt of nearly $10 trillion.
A huge proportion of our National Debt is held by our friends in the Middle
East and Asia. If you plan to watch that 1981 movie entitled “Rollover,” bring
along a crying towel --- http://en.wikipedia.org/wiki/Rollover_(film)
OPEC could probably put the U.S. out of business in an hour if it was so
inclined since its member nations hold such a large proportion of our National
Debt.
See ---
http://en.wikipedia.org/wiki/Rollover_(film)
In 2007, 61.82% of America's public debt was held by foreign investors,
most of them Asian. So the U.S. public debt held by nonresident foreigners is
equal to about 109.39% (113.86%) of GDP.
"U.S. debt approaches insolvency In 2007, 61.82% of America's public debt was
held by foreign investors, most of them Asian," Spero News, December 19, 2008
---
http://www.speroforum.com/a/17305/US-debt-approaches-insolvency
In the United States, the danger of
debt insolvency is growing, putting at risk the currency reserves of foreign
countries, China chief among them. According to new figures published by
Bloomberg in recent days (Nov. 25,
2008 [1]),
the American government has employed a total of 8.549 trillion dollars to
stop the financial crisis. This means a total of about 24-25.4 trillion
dollars of direct or indirect public debt weighing on American taxpayers.
The complete tally must also include the debt - about 5-6 trillion dollars -
of Fannie Mae and Freddie Mac, which are now quasi-public companies, because
79.9% of their capital is controlled by a public entity, the Federal Housing
Finance Agency, which manages them as a public conservatorship.
In 2007, public debt in the United
States was 10.6 trillion dollars, compared to a GDP (gross domestic product)
of 13.811 trillion dollars. In just one year, direct and indirect public
debt have grown to more than 100% of GDP, reaching 176.9% to 184.2%. These
percentages exclude the debt guaranteed by policies underwritten by AIG,
also nationalized, and liabilities for health spending (Medicaid and
Medicare) and pensions (Social Security)[2].
By way of comparison, the Maastricht accords require member states of the
European Union (EU) to reduce their public debt to no more than 60% of GDP.
Again by way of comparison, in one of the EU countries with the largest
public debt, Italy, public debt in 2007 was equal to 104% of GDP.
In 2007, 61.82%
[3] of America's
public debt was held by foreign investors, most of them Asian. So the U.S.
public debt held by nonresident foreigners is equal to about 109.39%
(113.86%) of GDP. According to a study by the International Monetary Fund,
countries with more than 60% of their public debt held by nonresident
foreigners run a high risk of currency crisis and insolvency, or debt
default. On the historical level, there are no recent examples of countries
with currencies valued at reserve status that have lapsed into public debt
insolvency. There are also few or no precedents of such a vast and rapid
expansion of public debt.
The United States also runs large deficits
in its public balance sheet and balance of trade. Families and businesses
are also deeply in debt: in 2007, American private debt was equal to a
little more than 100% of GDP. At the moment, it is not clear how much of
America's private debt has been "nationalized" with the recent bailouts.
In the early months of next year, when the
official data are published, the United States will run a serious risk of
insolvency. This would involve, in the first place, a valuation crisis for
the dollar. After this, the United States could face a social crisis like
that in Argentina in 2001. A crisis in U.S. public debt would likely have a
severe impact on the Asian countries that are the main exporters to the
United States, China first among them. Chinese monetary authorities, thanks
to a steeply undervalued artificial exchange rate, at about 55% of its fair
value, have limited imports (including food) and have achieved an export
surplus. This has allowed them to accumulate a large stockpile of dollar
reserves. In a currency crisis, China risks losing much of the value of its
accumulated currency reserves. At the same time, pressure on imports (wheat,
other grains, and meat) have led to inflation in the prices of food, the
most important expenditure for more than 900 million Chinese. This is
nothing more than a small confirmation of the recent statements of the pope,
in his message for the World Day for Peace, where the pontiff calls the
current financial system and its methods "based upon very short-term
thinking," without depth and breadth (nos. 10-12), preoccupied with creating
wealth from nothing and leading the planet to its current disaster.
[4]
[1] See Bloomberg, 2008, 11-25 16:35:48.130 GMT “U.S.
Pledges Top $8.5 Trillion to Ease Frozen Credit (Table)”
[2] In this case, exluding AIG policies, one arrives at a
total equal to 429.37 of GDP.
[3] Cf.
Economic crisis: US, China and the coming monetary storm
[4] Cf. AsiaNews.it 11/2/2008
Message for Peace
2009: the poor, wealth of the world;
Global solidarity to fight poverty and build peace, says Pope
Bob Jensen's threads on the Bailout's Hidden Agenda are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails
Question
What former Andersen partner, who watched the Andersen accounting firm implode
alongside its client Enron, has been traveling for years around the United
States warning that the United States economy will implode unless we totally
come to our senses?
Hints:
David Walker was the top accountant,
Controller General, of the United States Government.
He was a featured plenary speaker a few years back at an annual meeting of the
American Accounting Association.
See his "State of the Profession of Accountancy"
piece in the October 2005 edition of the Journal of Accountancy.
Also see
http://www.aicpa.org/pubs/jofa/jul2006/walker.htm
Videos About Off-Balance-Sheet Financing to an Unimaginable
Degree
Truth in Accounting or Lack Thereof in the Federal Government (Former
Congressman Chocola) ---
http://www.youtube.com/watch?v=NWTCnMioaY0
Part 2 (unfunded liabilities of $55 trillion plus) ---
http://www.youtube.com/watch?v=1Edia5pBJxE
Part 3 (this is a non-partisan problem being ignored in election promises) ---
http://www.youtube.com/watch?v=lG5WFGEIU0E
Watch the Video of the non-sustainability of the U.S. economy (CBS Sixty
Minutes TV Show Video) ---
http://www.youtube.com/watch?v=OS2fI2p9iVs
Also see "US Government Immorality Will Lead to Bankruptcy" in the CBS interview
with David Walker ---
http://www.youtube.com/watch?v=OS2fI2p9iVs
Also at Dirty Little Secret About Universal Health Care (David Walker) ---
http://www.youtube.com/watch?v=KGpY2hw7ao8
Ernie Hanson (University of Wisconsin) informed me that David Walker
resigned as Controller General effective March 12, 2008 and now is president and
CEO of The Peter G. Peterson Foundation.
Here's the rest of the story
"You Can't Take It With You," by Peter Peterson, Newsweek, April 7,
2008, Page 56 ---
http://www.newsweek.com/id/129572
The turning point
in my life came before I was born. It was the day in 1912 when my Greek
immigrant father came to America. He came as a teenager, without a penny or
a word of English, and with only a third-grade education.
He took a job as a
railroad dishwasher. He worked, ate and slept in a steaming caboose and
saved everything he made. With his savings he opened a restaurant, and kept
it open 24 hours a day, seven days a week for 25 years in my hometown of
Kearney, Neb. His hard work and thrift gave me extraordinary opportunities.
Had I been born in a different country, at a different time, I would never
have had the chances that gave me such good fortune.
I have lived the
American Dream—I went to college, worked in the corporate world, served in
government and became an investment banker. And that led to a second turning
point, on June 21, 2007, at 9:30 a.m. That was the day the Blackstone
Group—a private-equity, asset-management and financial-advisory firm that I
cofounded—went public. In an hour I became an instant billionaire.
What to do with so
much money? I have much more than enough, and there seems little prospect
that I can take it with me. So again I turn to my father's example. When he
had built a modest net worth, he gave generously to his old home in Greece
and to the less fortunate in his beloved new home. Tears would come to his
eyes when he sang "God Bless America." He so loved America for its
possibilities.
I believe today
that those possibilities are shrinking, endangering the American Dream.
Personal myopia, political cowardice, fiscal fantasy and journalistic
neglect are all at work. So I have chosen to put much of my wealth ($1
billion over the next several years and much of my remaining estate) into a
new foundation, one that I hope will explain the undeniable, unsustainable
and yet politically untouchable long-term challenges we face. Headed by
The Honorable
David M. Walker,
who served as the comptroller general of the United States from 1998 to
2008, the foundation will propose workable solutions and build up the public
will to put them into effect. I cannot think of anything more important than
trying in this way to preserve the possibilities of the American Dream for
my children's and grandchildren's generations, and generations yet to come.
Let me summarize
three such challenges. First, as 78 million baby boomers reach retirement
age, the costs of Social Security and Medicare will skyrocket, leaving us
with unfunded promises of more than $44 trillion in today's dollars—equal to
about three times our entire gross domestic product. Income taxes would have
to double to pay for it—an unthinkable burden.
Second, our
current-account deficits are unprecedented, fed by record trade deficits.
Such dependence on foreign capital is dangerous. America as a country, and
Americans as a people, must be persuaded to save more.
Third, our
health-care costs are metastasizing. We already spend more than twice as
much per capita as other developed nations, with no appreciable differences
in health outcomes or longevity. These ballooning costs threaten the very
competitiveness of American industry.
These challenges
all require sacrifice. That means everyone. We fat cats will have to pay
more taxes. The government will have to spend less. Everyone will have to
save more. I'm not sure if we remember how to give up something for the
long-term general good. Nor do we hear calls for sacrifice from our leaders.
Our lawmakers are enablers, either joining us in the state of denial or
trying to anesthetize us. But if we can learn to face the future
realistically, everyone will benefit from a more robust, sustainable
economy.
The "Greatest
Generation" that lived through the Depression of the 1930s and World War II
confronted, overcame and paid for challenges more sobering than those we
face today. We can do it again. I refuse to believe that we have become so
selfish and self-absorbed that we don't care about our children's future and
America's leadership in the world.
How do we as a
country, and Americans as a people, learn to save more and spend less? How
do we educate the young about the crisis they will face if things aren't
changed, and then move them to do something about it? Or will it take a real
and very costly crisis to force us into action?
We need to go where
the young people are: new media, bloggers,
YouTube, Facebook, MySpace, MTV, and
networks and Web sites that have not even
been invented, and that is what my
foundation will try to do. We will sponsor
the production of films that educate people
about the perils America faces (I have been
impressed with what Al Gore accomplished
with "An Inconvenient Truth"). We will have
youth summits to get young leaders engaged
in the process. Maybe someone should develop
an AAYP, an
American Association of Young People,
to counteract the lobbying power of the
American Association of Retired Persons.
There are, of course, many other groups we
must reach. How best do we energize the
business community? Tom Friedman of The New
York Times called us MIAs, "missing in
action" on these daunting challenges. We
have a huge stake in tomorrow's economy. How
do we convince the media that the future is
worth covering?
These challenges
have hung over our economy for years. Others have tried to sound the alarm.
I know that the odds of success are daunting. Yet given what is at stake and
what I owe this remarkable country, I, and we, have no alternative but to
try. As we move forward, we need to remind ourselves of the words of
Dietrich Bonhoeffer, the German pastor who was instrumental in the
resistance movement against Nazism. "The ultimate test of a moral society is
the kind of world it leaves to its children," he said.
It is time we
become moral and worthy ancestors.
I.O.U.S.A.:
A Fact-Filled Documentary That Makes the Sicko's
Sicko Look
Sicko
"Another Inconvenient Truth," The Economist, August 16, 2008, pp 69-69
---
http://www.economist.com/finance/displaystory.cfm?story_id=11921663
AMERICA’S infamous debt clock, near New
York’s Times Square, was switched off in 2000 after the national burden
started to fall thanks to several years of Clinton-era budget restraint.
However, it was reactivated two years later as the politically motivated
urge to splurge once again took over. The debt has since swollen to $9.5
trillion, with the value of unfunded public promises (if you include
entitlements such as Social Security and Medicare) nudging $53 trillion—or
$175,000 for every American—and rising. On current trends, these will amount
to some 240% of GDP by 2040, up from a just-about-manageable 65% today.
David Walker, who until recently ran the
Government Accountability Office, has made it his mission to get the nation
to acknowledge and treat this “fiscal cancer”. His efforts form the core of
a new documentary, “I.O.U.S.A.”, out on August 21st. The message is simple
enough: America’s financial condition is a lot worse than advertised, and
dumping it on future generations would be not only economically reckless but
also immoral.
The biggest deficit of all, the film
contends, is in leadership: politicians continue to duck hard choices. It
hints at dark consequences. As America has become more reliant on foreign
lenders, it warns, so it has become more vulnerable to “financial warfare”,
of the sort America itself threatened to wage on Britain, a big debtor,
during the Suez crisis. Warren Buffett, America’s investor-in-chief, pops up
to warn of potential political instability.
The film is part of a broader effort to
popularise the issue. In 2005 Mr Walker set off on a “fiscal wake-up tour”
of town halls; sparsely attended at first, it now attracts hundreds to each
meeting (though some may be turned off by the giant pie chart strapped to
the side of his tour van). The young are being drawn in too, even forming
campaign groups; Concerned Youth of America’s activists “crusade against our
leveraged future” wearing prison suits. Mr Walker is talking to MTV, a music
broadcaster, about a tie-up. His profile has been lifted by a segment on
CBS’s “60 Minutes” and an appearance on “The Colbert Report”, a satirical TV
show, which dubbed him the “Taxes Ranger”.
Promisingly, the new film was well
received at the Sundance Film Festival. Some even wonder if it might do for
the economy what Al Gore’s “An Inconvenient Truth” did for the
environment—perhaps with this comparison in mind, Mr. Walker and his
supporters talk of a “red-ink tsunami” and bulging “fiscal levees”. But,
unlike the former vice-president, he is no heavy-hitter. And, even jazzed up
with fancy graphics, punchy one-liners and a splash of humour, courtesy of
Steve Martin, tales of fiscal folly are an acquired taste. Still,
“I.O.U.S.A” is a bold attempt to highlight a potentially huge problem. “The
Dark Knight” it may not be, but for those who care about economic reality as
much as cinematic fantasy, it might just be the scariest release of the
summer.
In the inspiring movie It's a Wonderful Life" played every year around
Christmas time, an angel visits bank manager Jimmy Stewart who is about to
commit suicide. The angel commends Jimmy for being an honest banker lending
responsibly to responsible borrowers. Then the angel shows Jimmy a hypothetical
scenario of a destroyed world that might be with if infectious greed is allowed
to pervade all institutions from borrowers to lenders and on up to corrupt Wall
Street executives and irresponsible government.
The hypothetical vision of disaster in the movie may well be the scenario
that becomes reality.
Ending of It’s
a Wonderful Life ---
http://hk.youtube.com/watch?v=ErrzjGCi3gY
Just for
fun, there’s a fine bit of jitterbug dancing in an earlier clip:
It's a Wonderful Life (Part 3 with Jimmy Stewart and Donna Reed dancing
the jitterbug) ---
http://hk.youtube.com/watch?v=DbKPLPhvmNU
Question
As of December 2008, what do Zimbabwe and the United States have in common?
Answer
Rather than taxing or borrowing to cover deficit spending, both governments are
simply printing more money?
What's wrong with that?
First look at what it did to Zimbabwe. Then read about Gresham's Law ---
http://en.wikipedia.org/wiki/Gresham%27s_Law
The instant the Federal Reserve announced this new funding policy in December,
the U.S. dollar plunged in value relative to foreign currencies. The reason is
obvious.
"Fed Cuts Key Rate to a Record Low," by Edmund L. Andrews and Jackie Calmes,
The New York Times, December 16, 2008 ---
http://www.nytimes.com/2008/12/17/business/economy/17fed.html?_r=1&scp=1&sq=printing
money&st=cse
In effect, the Fed is stepping in as a
substitute for banks and other lenders and acting more like a bank itself.
“The Federal Reserve will employ all available tools to promote the
resumption of sustainable economic growth,” it said. Those tools include
buying “large quantities” of mortgage-related bonds, longer-term Treasury
bonds, corporate debt and even consumer loans.
The move came as President-elect Barack
Obama summoned his economic team to a four-hour meeting in Chicago to map
out plans for an enormous economic stimulus measure that could cost anywhere
from $600 billion to $1 trillion over the next two years.
The two huge economic stimulus programs,
one from the Fed and one from the White House and Congress, set the stage
for a powerful but potentially risky partnership between Mr. Obama and the
Fed’s Republican chairman, Ben S. Bernanke.
“We are running out of the traditional
ammunition that’s used in a recession, which is to lower interest rates,”
Mr. Obama said at a news conference Tuesday. “It is critical that the other
branches of government step up, and that’s why the economic recovery plan is
so essential.”
Financial markets were electrified by the
Fed action. The Dow Jones industrial average jumped 4.2 percent, or 359.61
points, to close at 8,924.14.
Investors rushed to buy long-term Treasury
bonds. Yields on 10-year Treasuries, which have traditionally served as a
guide for mortgage rates, plunged immediately after the announcement to 2.26
percent, their lowest level in decades, from 2.51 percent earlier in the
day.
Yields on investment-grade corporate bonds
edged down to 7.215 percent on Tuesday, from 7.355 on Monday. Yields on
riskier high-yielding corporate bonds remained in the stratosphere at 22.493
percent, almost unchanged from 22.732 on Monday.
By contrast, the dollar dropped sharply
against the euro and other major currencies for the second consecutive day —
a sign that currency markets were nervous about a flood of newly printed
dollars.
Some analysts predict that the Treasury will have to sell $2 trillion worth
of new securities over the next year to finance its existing budget deficit,
a new stimulus program and to refinance about $600 billion worth of maturing
government debt.
For the moment, Mr. Obama and Mr. Bernanke
appear to be on the same page, though that could abruptly change if the
economy starts to revive. Fed officials have already assumed that Congress
will pass a major spending program to stimulate the economy, and they are
counting on it to contribute to economic growth next year.
In more normal times, the Fed might easily
start raising interest rates in reaction to a huge new spending program, out
of concern about rising inflation.
But data on Tuesday provided new evidence
that the biggest threat to prices right now was not inflation but deflation.
The federal government reported on Tuesday
that the Consumer Price Index fell 1.7 percent in November, the steepest
monthly drop since the government began tracking prices in 1947. The decline
was largely driven by the recent plunge in energy prices, but even the
so-called core inflation rate, which excludes the volatile food and energy
sectors, was essentially zero.
Mr. Obama’s goal is to have a package
ready when the new Congress convenes on Jan. 6. His hope is that the House
and Senate, with their bigger Democratic majorities, can agree quickly on a
plan for Mr. Obama to sign into law soon after he is sworn into office two
weeks later.
The Fed, in a statement accompanying its
rate decision, acknowledged that the recession was more severe than
officials had thought at their last meeting in October.
“Over all, the outlook for economic
activity has weakened further,” the central bank said.
“Labor market conditions have
deteriorated, and the available data indicate that consumer spending,
business investment and industrial production have declined.”
The central bank added: “The committee
anticipates that weak economic conditions are likely to warrant
exceptionally low levels of the federal funds rate for some time.”
With fewer than 10 days until Christmas,
retailers from Saks Fifth Avenue to Wal-Mart have been slashing prices to
draw in consumers, who have sharply reduced their spending over the last six
months. On Tuesday, Banana Republic offered customers $50 off on any
purchases that total $125. The clothing retailer DKNY offered customers $50
off any purchase totaling $250.
Ian Shepherdson, an analyst at High
Frequency Economics, said falling energy prices were likely to bring the
year-over-year rate of inflation to below zero in January.
The Fed has already announced or outlined
a range of unorthodox new tools that it can use to keep stimulating the
economy once the federal funds rate effectively reaches zero. On Tuesday,
Fed officials said they stood ready to expand them or create new ones to
relieve bottlenecks in the credit markets.
All of the tools involve borrowing by the
Fed, which amounts to printing money in vast new quantities, a process the
Fed has already started.
Since September, the Fed’s balance sheet has ballooned from about $900
billion to more than $2 trillion as it has created money and lent it out. As
soon as the Fed completes its plans to buy mortgage-backed debt and consumer
debt, the balance sheet will be up to about $3 trillion.
“At some point, and without knowing the
timing, the Fed is going to have to destroy all that money it is creating,”
said Alan Blinder, a professor of economics at Princeton and a former vice
chairman of the Federal Reserve.
“Right now, the crisis is created by the
huge demand by banks for hoarding cash. The Fed is providing cash, and the
banks want to hoard it. When things start returning to normal, the banks
will want to start lending it out. If that much money is left in the
monetary base, it would be extremely inflationary.”
This is the thing I’ve been afraid of ever since I
realized that Japan really was in the dreaded, possibly mythical liquidity trap.
You can read my 1998 Brookings Paper on the issue
here.
Incidentally, there were a bunch of us at Princeton
worrying about the Japan problem in the early years of this decade. I was one;
Lars Svensson, currently at Sweden’s Riksbank, was another; a third was a guy
named Ben Bernanke. I wonder whatever happened to him?
Paul Krugman, "ZIRP," The New York Times, December 16, 2008
---
http://krugman.blogs.nytimes.com/2008/12/16/zirp/?scp=8&sq=printing money&st=cse
As it has so often in recent months, the market
elation that greeted the Federal Reserve's epic monetary easing earlier this
week has turned to worry. Stocks fell off again yesterday, but the big news of
the week has been the slide in the dollar. The nearby chart shows the
greenback's story since September. From its dangerous summer lows, the buck
soared at the height of the credit panic as investors looked for safety in a
hurricane. But the dollar has fallen like Newton's apple in December, as
Chairman Ben Bernanke and his comrades signaled that they are willing to cut
interest rates to near-zero and print as much money as it takes to prevent a
deflation.
"A Dollar Referendum Currency markets reflect a lack of faith in Bernanke,"
The Wall Street Journal, December 19, 2008 ---
http://online.wsj.com/article/SB122965017184420567.html
Question
What will happen to all the future capital markets studies and
CAPM when the assumed
risk-free
interest rate is no longer "risk free?"
Is “Risk Free” an
oxymoron?
"Uncle Sam's Credit Line Running Out," by Randall Forsyth, Barron's,
November 11, 2008 ---
http://online.barrons.com/article/SB122633310980913759.html
Be that as it may, it's all
(new National Debt at now $6 billion per day)
adding up. If the late Sen. Everett Dirksen were around today, he might
comment that a trillion here, a trillion there and pretty soon you're
talking about real money.
Trillions are no hyperbole. The Treasury
is set to borrow $550 billion in the current quarter alone and $368 billion
in the first quarter of 2009. "Near-term pressures on Treasury finances are
much more intense than we had thought," Goldman Sachs economists commented
when the government announced its borrowing projections last week.
It may finally be catching up with Uncle
Sam. That's what the yield curve may be whispering. But some economists are
too deaf, or dumb, to get it.
The yield curve simply is the graph of
Treasury yields of increasing maturities, starting from one-month bills to
30-year bonds. The slope of the line typically is ascending -- positive in
math terms -- because investors would want more to tie up their money for
longer periods, all else being equal. Which it never is.
If they expect yields to rise in the
future, they'll want a bigger premium to commit to longer maturities.
Otherwise, they'd rather stay short and wait for more generous yields later
on. Conversely, if they think rates will fall, investors will want to lock
in today's yields for a longer period.
The Treasury yield curve -- from two to 10
years, which is how the bond market tracks it -- has rarely been steeper.
The spread is up to 250 basis points (2.5 percentage points, a level matched
only in the past quarter century in 2002 and 1992, at the trough of economic
cycles.
Based on a simplistic reading of that
history and the Cliff Notes version of theory, one economist whose main area
of expertise is to get quoted by reporters even less knowledgeable than he,
asserts such a steep yield curve typically reflects investors' anticipation
of economic recovery. Never mind that the yield curve has steepened as the
economy has worsened and prospects for recovery have diminished. Like the
Bourbons, the French royal family up to the Revolution, he learns nothing
and forgets nothing.
As with so much other things, something
else is happening this year.
The steepening of the Treasury yield curve
has been accompanied by an increase in the cost of insuring against default
by the U.S. Treasury. It may come as a shock, but there are credit-default
swaps on the U.S. government and they have become more expensive -- in
tandem with an increase in the spread between two- and 10-year notes.
This link has been brought to light by Tim
Backshall, the chief analyst of Credit Derivatives Research. The attraction
of investors to the short end of the Treasury market is "juxtaposed with the
massive oversupply and inflationary expectations of the longer end," he
writes.
Backshall is not alone in this dire
assessment. Scott Minerd, the chief investment officer for fixed income at
Guggenheim Partners, a Los Angeles money manager, estimates that total
Treasury borrowing for fiscal 2009 will total $1.5 trillion-$2 trillion.
That was based on $700 billion for TARP, a $500 billion-$750 billion
"cyclical deficit," an additional $500 billion stimulus program and some
uncertain amount for the Federal Deposit Insurance Corp.
Minerd doubts that private savings in the
U.S. and foreign purchases of Treasury debt will be sufficient to meet those
government cash requirements. That leaves the Fed to take up the slack; that
is, monetization of the debt.
However it comes about, Backshall's charts
of the yield curve and the spread on U.S. Treasury CDS paint a dramatic
picture. Both the yield spread and the cost of insuring debt moved up
sharply together starting in September.
Let's recall what happened that month: the
Fannie Mae-Freddie Mac bailouts, the AIG bailout and the Lehman Brothers
failure. The two lines continued their parallel ascent with the announcement
and ultimate passage of the TARP last month. And evidence mounted of an
accelerating slide in growth.
Cutting through the technical jargon, the
yield curve and the credit-default swaps market both indicate the markets
are exacting a greater cost to lend to Uncle Sam. And it's not because of
anticipated recovery, which would reduce, not increase, the cost of insuring
Treasury debt against default.
All of which suggests America's credit
line has its limits.
Continued in article
We Can't Tax Our Way Out of the
Entitlement Crisis," by R. Glenn Hubbard, The Wall Street Journal, August
21, 2008; Page A13 ---
http://online.wsj.com/article/SB121927694295558513.html
We can also secure a
firm financial footing for Social Security (and Medicare) without
choking off economic growth or curtailing our flexibility to pursue
other spending priorities. Three actions are essential: (1) reduce
entitlement spending growth through some form of means testing; (2)
eliminate all nonessential spending in the rest of the budget; and
(3) adopt policies that promote economic growth. This 180-degree
difference from Mr. Obama's fiscal plan forms the basis of Sen.
McCain's priorities for spending, taxes and health care.
The problem with Mr.
Obama's fiscal plans is not that that they lack vision. On the
contrary, the vision is plain enough: a larger welfare state paid
for by higher taxes. The problem is not even that they imply change.
The problem is that his plans are statist.
While the candidate
is sending a fiscal "Ich bin ein Berliner" message to Americans,
European critics of his call for greater spending on defense are the
canary in the coal mine for what lies ahead with his vision for the
United States.
Professor R. Glenn Hubbard is
Dean of the College of Business at Columbia University and a member
of the President's Council of Economic Advisors.
Bob Jensen's threads on the
"Entitlement Crisis" are at
http://faculty.trinity.edu/rjensen/entitlements.htm
Bob Jensen's threads on entitlements are at
http://faculty.trinity.edu/rjensen/entitlements.htm
Obama's Great Spending Message ---
http://www.mafo2008.com/
It's inspiring in every way except with a strategy on how to provide everything
without bursting America's National Debt bubble that ballooned under the
reckless unbalanced budgets of George W. Bush ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
At the moment the only way we can pay over a million dollars per minute interest
on this debt is to borrow more to cover the interest. We need an economic
strategy for the survival of this country, and that entails balanced budgets and
a reversal in the plunge of the value of the U.S. dollar.
Neither Obama or McCain ever promised such a strategy to
save America from itself.
"Crisis in Leadership," by J. Edward Ketz, SmartPros, October 2008 ---
http://lyris.smartpros.com/t/1725105/7762913/5995/0/
Because U.S. Government accounting is in such chaos (the GAO will not even
sign off on its annual audits of the Pentagon), nobody on earth really knows
what our total liabilities are. The former top accountant in the Federal
government estimates that the total is well in excess of $55+ trillion (present
value discounted) before the 2008 deficit is factored in. A huge proportion of
our National Debt is held by our friends in the Middle East and Asia. If you
plan to watch that 1981 movie entitled “Rollover,” bring along a crying towel
---
http://en.wikipedia.org/wiki/Rollover _(film) OPEC could probably put the
U.S. out of business in an hour if it was so inclined.
I.O.U.S.A.: A Fact-Filled Documentary That Makes the Sicko's
Sicko Look Sicko
"Another Inconvenient Truth," The Economist, August 16, 2008, pp 69-69
---
http://www.economist.com/finance/displaystory.cfm?story_id=11921663
AMERICA’S infamous debt clock, near New
York’s Times Square, was switched off in 2000 after the national burden
started to fall thanks to several years of Clinton-era budget restraint.
However, it was reactivated two years later as the politically motivated
urge to splurge once again took over. The debt has since swollen to $9.5
trillion, with the value of unfunded public promises (if you include
entitlements such as Social Security and Medicare) nudging $53 trillion—or
$175,000 for every American—and rising. On current trends, these will amount
to some 240% of GDP by 2040, up from a just-about-manageable 65% today.
David Walker, who until recently ran the
Government Accountability Office, has made it his mission to get the nation
to acknowledge and treat this “fiscal cancer”. His efforts form the core of
a new documentary, “I.O.U.S.A.”, out on August 21st. The message is simple
enough: America’s financial condition is a lot worse than advertised, and
dumping it on future generations would be not only economically reckless but
also immoral.
The biggest deficit of all, the film
contends, is in leadership: politicians continue to duck hard choices. It
hints at dark consequences. As America has become more reliant on foreign
lenders, it warns, so it has become more vulnerable to “financial warfare”,
of the sort America itself threatened to wage on Britain, a big debtor,
during the Suez crisis. Warren Buffett, America’s investor-in-chief, pops up
to warn of potential political instability.
The film is part of a broader effort to
popularise the issue. In 2005 Mr Walker set off on a “fiscal wake-up tour”
of town halls; sparsely attended at first, it now attracts hundreds to each
meeting (though some may be turned off by the giant pie chart strapped to
the side of his tour van). The young are being drawn in too, even forming
campaign groups; Concerned Youth of America’s activists “crusade against our
leveraged future” wearing prison suits. Mr Walker is talking to MTV, a music
broadcaster, about a tie-up. His profile has been lifted by a segment on
CBS’s “60 Minutes” and an appearance on “The Colbert Report”, a satirical TV
show, which dubbed him the “Taxes Ranger”.
Promisingly, the new film was well
received at the Sundance Film Festival. Some even wonder if it might do for
the economy what Al Gore’s “An Inconvenient Truth” did for the
environment—perhaps with this comparison in mind, Mr. Walker and his
supporters talk of a “red-ink tsunami” and bulging “fiscal levees”. But,
unlike the former vice-president, he is no heavy-hitter. And, even jazzed up
with fancy graphics, punchy one-liners and a splash of humour, courtesy of
Steve Martin, tales of fiscal folly are an acquired taste. Still,
“I.O.U.S.A” is a bold attempt to highlight a potentially huge problem. “The
Dark Knight” it may not be, but for those who care about economic reality as
much as cinematic fantasy, it might just be the scariest release of the
summer.
Say What?
Editorial in the ... no ... can't be ... well maybe ... yes ... YES!
... The New York Times, September 8, 2008 ---
http://www.nytimes.com/2008/09/09/opinion/09tue1.html?_r=1&oref=slogin
The
Bailout’s Big Lessons
As an act of
crisis management, the government takeover of Fannie Mae and
Freddie Mac, the mortgage-finance giants, was a reasonable and
reassuring move. It ensures the flow of mortgage credit and is
likely to reduce mortgage rates, which are important steps
toward the eventual recovery of the ailing United States housing
market.
And it does so
while putting taxpayers first for future dividends or money that
may be earned when the firms are reprivatized, holding out hope
that the bailout costs may someday be recouped. Beyond the
immediate crisis, however, the takeover raises disturbing issues
that may get lost in the tumult of the moment.
¶ The need for
an explicit bailout underlines the economic vulnerabilities of
the United States. In July, Congress gave Treasury Secretary
Henry Paulson unlimited authority to pay the debts of Fannie and
Freddie and to shore up their capital, if need be. Yet investors
the world over continued to doubt the companies’ viability,
shunning their securities or demanding unusually high interest
rates on loans. In effect, investors deemed the government’s
commitment to Fannie and Freddie as either insufficient or not
credible — an extraordinary vote of no confidence that, in the
end, led to the bailout.
¶ There is no
single reason for the lack of confidence. But investors have
good cause to be concerned about the deep indebtedness of the
United States, about the nation’s apparent political
unwillingness to restore its fiscal health and about the ability
of the government to responsibly make good on its commitments. A
pledge of the full faith and credit of the United States still
means something. That’s why the markets responded favorably to
the takeover. But investors’ refusal to accept a promise to act
is another sign of the need to reverse the fiscal mismanagement
of the Bush years.
¶ The United
States must acknowledge that its deep indebtedness is especially
dangerous in times of economic crisis. The level and stability
of American interest rates and of the dollar are now dependent
on the willingness of foreign central banks and other overseas
investors to continue lending to the United States. The bailout
became inevitable when central banks in Asia and Russia began to
curtail their purchases of the companies’ debt, pushing up
mortgage rates and deepening the economic downturn.
¶ The bailout is
new evidence of the need for better regulation of the American
financial system. As the housing bubble inflated, the Bush
administration often claimed that America’s unfettered markets
were the envy of the world. But, in fact, they have sowed
mistrust.
¶ The cost of
the bailout needs to be carefully monitored. Fannie and Freddie
own or back nearly $800 billion of generally junky mortgages,
and some of those will inevitably go bad. So it is reasonable to
assume that the cost could easily near $100 billion. There may
be ways to make back some of that money later, but for a long
time, the bailout will divert resources from other needs.
Senators John
McCain and Barack Obama have both voiced support for the
bailout, which shows good judgment. But what the next president
will need to worry about, and both candidates need to talk
about, is the depth of the country’s economic problems. It will
take discipline and sacrifice to address them.
Jensen Comment
The national debt is the reason for a weakening dollar, higher oil
prices, inflation, and our diminishing stature in the world. George
Bush was a spendthrift who plunged us deeper into debt by failing to
veto spending bills of a run-away Congress. Barack Obama's
unfundable populist programs will only bury us deeper in debt. John
McCain is probably maverick enough to veto some spending cuts. Our
real economic hope may lie in the ultimate veto pen of . . . gasp .
. . Sarah Palin.
For once (actually the second time
in 2008) The New York Times had an editorial that makes
economic sense:
Longer
term, the challenge is perhaps even more daunting. Saving more
is ultimately the only way to dig out of the budget hole that
the nation is in. That will be painful, because higher
government savings, done properly, means higher taxes and
restrained spending. Candidates for president do not like to be
pessimistic, or even candid, really, about the economy. But a
leader who wants to steer the nation through tough times should
not spend the campaign telling Americans they can have it all.
"There He Goes Again," The New York Times, July 12, 2008
---
http://www.nytimes.com/2008/07/12/opinion/12sat1.html?_r=1&oref=slogin
Jensen Comment
But true to form, the NYT only criticizes John McCain's balanced
budget goals in this context. No mention is made of the NYT's
favorite candidate who certainly, albeit truthfully, is not
promising anything within light years of a balanced budget. The
question is which candidate, if elected, will heavily veto the
outrageous spending bills that most certainly emerge from
Congress over the next four or eight years. Sadly, George Bush,
unlike Reagan, rarely inked a spending veto in his eight years.
This country does not know what a life-threatening debt crisis
is and will have a rude awakening after November when the U.S.
dollar skids to all time lows never imagined. The real problem
is that Congress is leaning to more of entitlement time bombs.
"We Can't Tax Our Way Out of the
Entitlement Crisis," by R. Glenn Hubbard, The Wall Street
Journal,August 21, 2008; Page A13 ---
http://online.wsj.com/article/SB121927694295558513.html
We can also
secure a firm financial footing for Social Security (and
Medicare) without choking off economic growth or curtailing our
flexibility to pursue other spending priorities. Three actions
are essential: (1) reduce entitlement spending growth through
some form of means testing; (2) eliminate all nonessential
spending in the rest of the budget; and (3) adopt policies that
promote economic growth. This 180-degree difference from Mr.
Obama's fiscal plan forms the basis of Sen. McCain's priorities
for spending, taxes and health care.
The problem with
Mr. Obama's fiscal plans is not that that they lack vision. On
the contrary, the vision is plain enough: a larger welfare state
paid for by higher taxes. The problem is not even that they
imply change. The problem is that his plans are statist.
While the
candidate is sending a fiscal "Ich bin ein Berliner" message to
Americans, European critics of his call for greater spending on
defense are the canary in the coal mine for what lies ahead with
his vision for the United States.
Professor R. Glenn Hubbard is
Dean of the College of Business at Columbia University and a
member of the President's Council of Economic Advisors.
Bob Jensen's threads on the
"Entitlement Crisis" are at
http://faculty.trinity.edu/rjensen/entitlements.htm
|
From The Wall
Street Journal Accounting Weekly Review on February 20, 2009
A Short History
of the National Debt
by John Steele
Gordon
The Wall Street Journal
Feb 17, 2009
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB123491373049303821.html?mod=djem_jiewr_AC
TOPICS: Governmental
Accounting
SUMMARY: "Mr.
Gordon is the author of 'Hamilton's Blessing: The Extraordinary Life and
times of Our National Debt' (Walker, 1997)." He discusses the budget deficit
and national debt before and after passage of the stimulus package.
CLASSROOM APPLICATION: The
article may be used in governmental accounting courses to understand the
importance of governmental accounting information to the legislative process
and the running of our country. The topics focus on understanding budget
deficit versus the level of debt.
QUESTIONS:
1. (Introductory)
What is the historical status of our government in relation to debt?
2. (Advanced)
What is a budget deficit? How much is our government's budget deficit
projected to be in fiscal 2009?
3. (Advanced)
What is the difference between the level of national debt and a budget
deficit in the current year?
4. (Advanced)
The author notes that "in fiscal 2008, the national debt increased from $9
trillion to slightly over $10 trillion. Yet the budget deficit in the last
fiscal year was $455 billion." What is wrong with this relationship?
5. (Advanced)
Explain the following statement in terms of governmental accounting,
including explaining where the information is located in the financial
statements: "Just call the money borrowed from the Social Security trust
fund an 'intragovernmental transfer: and exclude it from the calculation of
the deficit."
6. (Introductory)
Overall, how does this opinion-page piece characterize the need for unbiased
financial information about governmental entities?
Reviewed By: Judy Beckman, University of Rhode Island
"A Short History of the National Debt Deficits are nothing new. It's the
trend that should worry us," by John Steele Gordon, The Wall Street Journal,
February 17, 2009 ---
http://online.wsj.com/article/SB123491373049303821.html?mod=djem_jiewr_AC
When President Barack Obama signed the American
Recovery and Reinvestment Act of 2009 into law yesterday, he was adding to
what is already almost guaranteed to be the largest deficit in American
history. In January, the Congressional Budget Office projected that the
deficit this year would be $1.2 trillion before the stimulus package. That's
more than twice the deficit in fiscal 2008, more than the entire GDP of all
but a handful of countries, and more, in nominal dollars, than the entire
United States national debt in 1982.
But while the sum is huge, it is not in and of
itself threatening to the solvency of the Republic. At 8.3% of GDP, this
year's deficit is by far the largest since World War II. But the total debt
is, as of now, still under 75% of GDP. It was almost 130% following World
War II. (Japan's national debt right now is not far from 180% of that
nation's GDP.)
Still, it's the trend that is worrisome, to put it
mildly. There have always been two reasons for adding to the national debt.
One is to fight wars. The second is to counteract recessions. But while the
national debt in 1982 was 35% of GDP, after a quarter century of nearly
uninterrupted economic growth and the end of the Cold War the debt-to-GDP
ratio has more than doubled.
It is hard to escape the idea that this happened
only because Democrats and Republicans alike never said no to any
significant interest group. Despite a genuine economic emergency, the
stimulus bill is more about dispensing goodies to Democratic interest groups
than stimulating the economy. Even Sen. Charles Schumer (D., N.Y.) -- no
deficit hawk when his party is in the majority -- called it "porky."
It was not ever thus. Before the Great Depression,
balancing the budget and paying down the debt were considered second only to
the defense of the country as an obligation of the federal government.
Before 1930, the government ran surpluses in two years out of three. In
1865, the vast debt run up in the Civil War amounted to about 30% of GDP; by
1916 it was less than a tenth of that.
There even was a time when the U.S. made it a
deliberate policy to pay off the national debt entirely -- and succeeded in
doing so. It remains to this day the only time in history a major country
has been debt free. Ironically, the president who achieved this was the
founder of the modern Democratic Party, Andrew Jackson.
Jackson was a Jeffersonian through and through. The
smaller the federal government, the more he liked it. And, like Jefferson,
he hated banks, speculation and the "money interest." Unlike Jefferson,
however, he was born poor and made his own fortune. An early personal
encounter with debt had taught him to fear it. When the notes of someone who
had bought land from him proved worthless, he became liable for the debts he
had secured with those notes, and it took him years to pay them off.
When he ran for president the first time, in 1824,
Jackson called the debt a "national curse." He vowed to "pay the national
debt, to prevent a monied aristocracy from growing up around our
administration that must bend to its views, and ultimately destroy the
liberty of our country."
"How gratifying," he wrote in 1829 as he began his
presidency, "the effect of presenting to the world the sublime spectacle of
a Republic of more than 12 million happy people, in the 54th year of her
existence . . . free from debt and with all . . . [her] immense resources
unfettered!"
When Jackson entered the White House, the national
debt, which had reached $125 million at the end of the War of 1812, had
already been reduced to $48 million. To get it to zero he was perfectly
willing to forego what were then called "internal improvements" and are now
known as infrastructure projects. One Kentucky congressman, after a trip to
the White House to beg Jackson to sign one such bill, reported to his allies
that "nothing less than a voice from Heaven would prevent the old man from
vetoing the Bill, and [I doubt] whether that would!"
At the end of 1834, Jackson reported in the State
of the Union message that the country would be debt free as of Jan. 1, 1835,
with a Treasury balance of $440,000. Government revenues that year would be
twice expenses.
It didn't last long, to be sure. The great
prosperity of the early 1830s broke in the summer of 1836 when a bubble in
land speculation, fueled by easy credit, abruptly ended. The bubble burst,
ironically enough, thanks to Andrew Jackson's issuance of the "specie
circular," which required that all land bought from the government, except
that actually settled on, be paid for in gold or silver.
By the next spring, just as Jackson left the White
House, the longest contraction in American history -- six years -- had
begun. As one Wall Streeter put it, "The fortunes we have heard so much
about in the days of speculation, have melted like the snows before an April
sun." Federal revenues fell by half that year and the national debt was
back, this time for good.
While today there is no hope of balancing the
budget -- or wisdom in trying to -- until the economy substantially
improves, we could make a sort of down payment on reforming Washington's
porky ways by simply starting to tell the truth.
It has been widely noted that 2009 will have the
first "trillion-dollar deficit" in American history. Actually it's the
second. In fiscal 2008, the national debt increased from $9 trillion to
slightly over $10 trillion. Yet the budget deficit in the last fiscal year
was officially reported as being $455 billion. How could the national debt
have increased by considerably more than twice the "deficit"? Simple. Just
call the money borrowed from the Social Security trust fund an "intragovernmental
transfer" and exclude it from the calculation of the deficit.
Corporate managers have gone to jail for less book
cooking than that.
Mr. Gordon is the author of "Hamilton's Blessing: The Extraordinary
Life and Times of Our National Debt" (Walker, 1997).
Appendix B on LTCM
The first major model of systematic risk and
diversification theory was the 1959 Princeton thesis of Harry Markowitz. But the
model was totally impractical since we could not and still cannot
invert matrices with 500 or more rows and columns. Along came Bill Sharpe
and others who tried to approximate the Markowitz model with the much more
practical CAPM. With simplification a model almost always sacrifices accuracy
and robustness. The CAPM has had some good applications and some disastrous
applications such as the Trillion Dollar Bet disaster of Long Term Capital
Management ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#LTCM
Whenever I get news about increased interest in
mathematical models (especially economics and finance) professors on Wall
Street, I think back to "The Trillion Dollar Bet" in 1993 (Nova
on PBS Video) a bond trader, two Nobel Laureates, and their doctoral
students who very nearly brought down all of Wall Street and the U.S. banking
system in the crash of a hedge fund known as
Long Term Capital Management where the biggest and most prestigious firms
lost an unimaginable amount of money ---
http://en.wikipedia.org/wiki/LTCM
The blame for bad decisions that use models must fall on
the analysts who apply the model and not on the people that merely derive the
seminal model as long as the model builders point out all know limitations of
their models. There are some instances of research that should perhaps be banned
such as research that could put cheap and effective biological weapons of mass
destruction in the hands of any teenager in the world who has a basement
laboratory or effective date rape drugs that can be generated quickly, cheaply,
and easily from bananas and tomatoes.
There is also a question of enforcement of a ban on
research and model building. For example, if we’d had a ban on development of
nuclear fission in the U.S., what would’ve prevented Russia, Germany, and Japan
from development of nuclear fission in 1940? If David Li was not allowed to
invent the credit risk diversification model, who’s to say that China could not
invent such a model?
I think the limitations of Li’s model were well known to
the bankers who used the disastrous model. In reality it is like the Black Swan
theory that a model has a known miniscule (epsilon) chance of disaster but the
rewards of using the model seemed to greatly outweigh the risks ---
http://en.wikipedia.org/wiki/Black_Swan_Theory
The CDO bond risks
became compounded when so many investment banks commenced to crumble mortgage
contracts into diversified CDO bonds dictated by David Li’s model. CDO bond
sellers and holders commenced to use this model that essentially leaves out the
covariance terms for interactive defaults on investments. The chances that
everything would blow up seemed negligible at the time. Probably the best
summary of what happens appears in “In Plato’s Cave.”
Also see
"In Plato's Cave: Mathematical models are
a powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Absolutely a "must see" video on the demise of Long Term Capital
Management and its failed "Trillion Dollar Bet" that was previously featured in
one of the best PBS Nova television shows ever produced. Eric Rosenfeld was an
inside LTCM player.
Eric Rosenfeld's 90-minute presentation on 2/19/09 ---
http://techtv.mit.edu/collections/15437/videos/2450-eric-rosenfeld-15437-presentation-21909
Recall that LTCM single handedly would've brought down Wall Street if the major
Wall Street firms had not sacrificed the billions needed to save themselves
(albeit not save LTCM that folded soon afterwards).
LTCM was started by two famous
Nobel economists, some of their doctoral students, and a noted Wall Street bond
trader.
You can read about The Trillion Dollar Bet
at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
Message from finance professor Jim Mahar who
also has a video playback window for this module
Finance Professor Blog, April 23, 2009 ---
http://financeprofessorblog.blogspot.com/
Wow! Great presentation! It is Eric Rosenfeld (one
of the players of LTCM) speaking to Zvi Bodie's class on Long Term Capital
Management Ten Years Later.
This is a DEFINITE must see. I just sat transfixed
(must confess it totally changed what I had planned on doing all morning)
for over an hour. I have read the books and case studies, watched a
Trillion Dollar Bet, and have thought about it for
hundreds of hours in classes over the years. That said, I still learned
things from it. You will too.
Bob Jensen's threads on LTCM are at at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The first major model of systematic risk and
diversification theory was the 1959 Princeton thesis of Harry Markowitz. But the
model was totally impractical since we could not and still cannot
invert matrices with 500 or more rows and columns. Along came Bill Sharpe
and others who tried to approximate the Markowitz model with the much more
practical CAPM. With simplification a model almost always sacrifices accuracy
and robustness. The CAPM has had some good applications and some disastrous
applications such as the Trillion Dollar Bet disaster of Long Term Capital
Management ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#LTCM
Whenever I get news about increased interest in
mathematical models (especially economics and finance) professors on Wall
Street, I think back to "The Trillion Dollar Bet" in 1993 (Nova
on PBS Video) a bond trader, two Nobel Laureates, and their doctoral
students who very nearly brought down all of Wall Street and the U.S. banking
system in the crash of a hedge fund known as
Long Term Capital Management where the biggest and most prestigious firms
lost an unimaginable amount of money ---
http://en.wikipedia.org/wiki/LTCM
The blame for bad decisions that use models must fall on
the analysts who apply the model and not on the people that merely derive the
seminal model as long as the model builders point out all know limitations of
their models. There are some instances of research that should perhaps be banned
such as research that could put cheap and effective biological weapons of mass
destruction in the hands of any teenager in the world who has a basement
laboratory or effective date rape drugs that can be generated quickly, cheaply,
and easily from bananas and tomatoes.
There is also a question of enforcement of a ban on
research and model building. For example, if we’d had a ban on development of
nuclear fission in the U.S., what would’ve prevented Russia, Germany, and Japan
from development of nuclear fission in 1940? If David Li was not allowed to
invent the credit risk diversification model, who’s to say that China could not
invent such a model?
I think the limitations of Li’s model were well known to
the bankers who used the disastrous model. In reality it is like the Black Swan
theory that a model has a known miniscule (epsilon) chance of disaster but the
rewards of using the model seemed to greatly outweigh the risks ---
http://en.wikipedia.org/wiki/Black_Swan_Theory
The CDO bond risks
became compounded when so many investment banks commenced to crumble mortgage
contracts into diversified CDO bonds dictated by David Li’s model. CDO bond
sellers and holders commenced to use this model that essentially leaves out the
covariance terms for interactive defaults on investments. The chances that
everything would blow up seemed negligible at the time. Probably the best
summary of what happens appears in “In Plato’s Cave.”
Also see
"In Plato's Cave: Mathematical models are
a powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Every now and then the so-called "quants" in economics and finance make
enormous mistakes. Probably the best known mistake, before the trillion-dollar
CDO mistakes that came to light the collapse of the real estate market in 2007,
was the 1993 "Trillion Dollar Bet" made by two Nobel Prize winning quants and
their partners in Long-Term Capital Management (LTCM) that came within a hair of
destroying most big banks and investment firms on Wall Street ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
Whenever I get news of increased power of quants
on Wall Street, I think back to "The Trillion Dollar Bet" (Nova
on PBS Video) a bond trader, two Nobel Laureates, and their doctoral
students who very nearly brought down all of Wall Street and the U.S. banking
system in the crash of a hedge fund known as
Long Term Capital
Management where the biggest and most prestigious firms lost an unimaginable
amount of money ---
http://en.wikipedia.org/wiki/LTCM
The Trillion Dollar Bet transcripts are free ---
http://www.pbs.org/wgbh/nova/transcripts/2704stockmarket.html
However, you really have to watch the graphics in the video to appreciate this
educational video ---
http://www.pbs.org/wgbh/nova/stockmarket/
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
Warnings from a Theoretical Physicist With an Interest in Economics and
Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models,"
by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html
. . .
In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the
way millions of people and companies interact in a handful of pretty
equations.
The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the
probabilities of all possible futures and responding in an optimal way
to unexpected shocks.
Surreal Models
Surreal as such models might seem, they have
played a significant role in informing policy at the world’s largest
central banks. Unfortunately, they don’t work very well, and they proved
spectacularly incapable of accommodating the way markets and the economy
acted before, during and after the recent crisis.
Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.
Take, for example, a 2012 (and still somewhat
preliminary)
study by a group
of economists, social scientists, mathematicians and physicists
examining the causes of the housing boom and subsequent collapse from
2000 to 2006. Starting with data for the Washington D.C. area, the
study’s authors built up a computational model mimicking the behavior of
more than two million potential homeowners over more than a decade. The
model included detail on each individual at the level of race, income,
wealth, age and marital status, and on how these characteristics
correlate with home buying behavior.
Led by further empirical data, the model makes
some simple, yet plausible, assumptions about the way people behave. For
example, homebuyers try to spend about a third of their annual income on
housing, and treat any expected house-price appreciation as income.
Within those constraints, they borrow as much money as lenders’ credit
standards allow, and bid on the highest-value houses they can. Sellers
put their houses on the market at about 10 percent above fair market
value, and reduce the price gradually until they find a buyer.
The model captures things that dynamic
stochastic general equilibrium models do not, such as how rising prices
and the possibility of refinancing entice some people to speculate,
buying more-expensive houses than they otherwise would. The model
accurately fits data on the housing market over the period from 1997 to
2010 (not surprisingly, as it was designed to do so). More interesting,
it can be used to probe the deeper causes of what happened.
Consider, for example, the assertion of some
prominent economists, such as
Stanford University’s
John Taylor, that
the low-interest-rate policies of the
Federal Reserve
were to blame for the housing bubble. Some dynamic stochastic general
equilibrium models can be used to support this view. The agent- based
model, however, suggests that
interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom
and bust do become smaller, but only marginally.
Leverage Boom
A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were
able to borrow as much as 100 percent of the value of a house -- a form
of easy credit that had a big effect on housing demand. In the model,
freezing leverage at historically normal levels completely eliminates
both the housing boom and the subsequent bust.
Does this mean leverage was the culprit behind
the subprime debacle and the related global financial crisis? Not
necessarily. The model is only a start and might turn out to be wrong in
important ways. That said, it makes the most convincing case to date
(see my
blog for more
detail), and it seems likely that any stronger case will have to be
based on an even deeper plunge into the messy details of how people
behaved. It will entail more data, more agents, more computation and
less elegance.
If economists jettisoned elegance and got to
work developing more realistic models, we might gain a better
understanding of how crises happen, and learn how to anticipate
similarly unstable episodes in the future. The theories won’t be pretty,
and probably won’t show off any clever mathematics. But we ought to
prefer ugly realism to beautiful fantasy.
(Mark Buchanan, a theoretical physicist and the author of “The
Social Atom: Why the Rich Get Richer, Cheaters Get Caught and Your
Neighbor Usually Looks Like You,” is a Bloomberg View columnist. The
opinions expressed are his own.)
Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned
mortgages ---
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Learning From Mistakes
"School for quants: Inside UCL’s Financial Computing Centre, the planet’s
brightest quantitative analysts are now calculating our future," by Sam
Knight, Financial Times Magazine, March 2, 2012 ---
http://www.ft.com/intl/cms/s/2/0664cd92-6277-11e1-872e-00144feabdc0.html#axzz1oEeYcqi8
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On a recent winter’s afternoon, nine computer
science students were sitting around a conference table in the engineering
faculty at University College London. The room was strip-lit, unadorned, and
windowless. On the wall, a formerly white whiteboard was a dirty cloud,
tormented by the weight of technical scribblings and rubbings-out upon it. A
poster in the corner described the importance of having a heterogenous
experimental network, or Hen.
Every now and again, though, the discussion became
comprehensible. The students discussed annoyances – so much data about
animals! – and possibilities. One of the PhD students, Ilya Zheludev, talked
about “Wikipedia deltas” – records of deleted sections from the online
encyclopaedia. Immediately, the students hit on the idea of tracking the
Wikipedia entries of large companies and seeing what was deleted, and when.
The mood of the meeting was casual and exacting at
the same time. Galas, who is from Gdansk and once had ambitions to be a
hacker, is something of a giant at the Financial Computing Centre. One of
the first students to enrol in 2009, he has a gift for writing extremely
large computer programs. In order to carry out his own research, Galas has
built an electronic trading platform that he estimates would satisfy the
needs of a small bank. As a result, what he says goes. Galas closed the
meeting by giving the undergraduates a hard time about the overall messiness
of their programming. “I like beauty!” he declared, staring around the room.
The Financial Computing Centre at UCL, a
collaboration with the London School of Economics, the London Business
School and 20 leading financial institutions, claims to be the only
institute of its kind in Europe. Each year since its establishment in late
2008, between 600 and 800 students have applied for its 12 fully funded PhD
places, which each cost the taxpayer £30,000 per year. Dozens more
applicants come from the financial industry, where employers are willing to
subsidise up to five years of research at the tantalising intersection of
computers, data and money.
As of this winter, the centre had about 60 PhD
students, of whom 80 per cent were men. Virtually all hailed from such
forbiddingly numerate subjects as electrical engineering, computational
statistics, pure mathematics and artificial intelligence. These realms of
knowledge contain concepts such as data mining, non-linear dynamics and
chaos theory that make many of us nervous just to see written down. Philip
Treleaven, the centre’s director, is delighted by this. “Bright buggers,” he
calls his students. “They want to do great things.”
In one sense, the centre is the logical culmination
of a relationship between the financial industry and the natural sciences
that has been deepening for the past 40 years. The first postgraduate
scientists began to crop up on trading floors in the early 1970s, when
rising interest rates transformed the previously staid calculations of bond
trading into a field of complex mathematics. The most successful financial
equation of all time – the Black-Scholes model of options pricing – was
published in 1973 (the authors were awarded a Nobel prize in 1997).
Continued in article
Bob Jensen's threads on The Greatest Swindle in the History of the World
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
There will be a time “beyond crisis,” asserts Robert C.
Merton, who delves into the dense science of derivatives — a field he has
fundamentally shaped — to explain how the vast global economic collapse has come
about, and how financial innovations at the heart of the collapse could also be
tools for reconstruction. \Merton uses deceptively simple graphs to show how
risk propagated rapidly across financial networks, bringing down financial
institutions. While he admits the crisis “is very big and complicated,” Merton
boils a piece of it down to the use of put options, a derivative contract that’s
been around since the 17th century. This asset-value insurance contract, a
guarantee of debt, is the basis for the credit default swaps widely adopted by
financial giants in the last few years — now widely regarded as a primary cause
of the meltdown. It turns out, says Merton, that the put “makes risky debt very
complicated, and treacherous…” In these puts, if the value of assets goes down,
the guarantee value goes up, so the value of the written insurance is worth
more. The value of this guarantee is very sensitive to the movement of the
underlying asset. When dealing with puts on the local level, this movement can
be tracked and managed more easily. But when financial institutions manipulate
bundles of assets (for instance, mortgage-backed securities), the increase in
risk proves non-linear. Add some volatility, like the jolts posed by widespread
drops in housing prices, and the difference between the decline in asset value
and the value of the guarantee becomes enormous — leading to mountains of debt
and felling behemoths like AIG (insurer to lenders).
"Video Robert C. Merton: Observations on the Science of Finance in the Practice
of Finance," Simoleon Sense, April 6, 2009 ---
Click Here
Snipped Link ---
http://snipurl.com/mertenputs [www_simoleonsense_com]
Jensen Comment
Nobel Economist Robert Merton knows very well about the dense science and
practice of derivatives. He was a principle loser in Long Term Capital's 1993
"Trillion Dollar Bet" that nearly brought down Wall Street ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
There will be a time “beyond crisis,” asserts Robert
C. Merton, who delves into the dense science of derivatives — a field he has
fundamentally shaped — to explain how the vast global economic collapse has come
about, and how financial innovations at the heart of the collapse could also be
tools for reconstruction. \Merton uses deceptively simple graphs to show how
risk propagated rapidly across financial networks, bringing down financial
institutions. While he admits the crisis “is very big and complicated,” Merton
boils a piece of it down to the use of put options, a derivative contract that’s
been around since the 17th century. This asset-value insurance contract, a
guarantee of debt, is the basis for the credit default swaps widely adopted by
financial giants in the last few years — now widely regarded as a primary cause
of the meltdown. It turns out, says Merton, that the put “makes risky debt very
complicated, and treacherous…” In these puts, if the value of assets goes down,
the guarantee value goes up, so the value of the written insurance is worth
more. The value of this guarantee is very sensitive to the movement of the
underlying asset. When dealing with puts on the local level, this movement can
be tracked and managed more easily. But when financial institutions manipulate
bundles of assets (for instance, mortgage-backed securities), the increase in
risk proves non-linear. Add some volatility, like the jolts posed by widespread
drops in housing prices, and the difference between the decline in asset value
and the value of the guarantee becomes enormous — leading to mountains of debt
and felling behemoths like AIG (insurer to lenders).
"Video Robert C. Merton: Observations on the Science of Finance in the Practice
of Finance," Simoleon Sense, April 6, 2009 ---
Click Here
Snipped Link ---
http://snipurl.com/mertenputs [www_simoleonsense_com]
Jensen Comment
Nobel Economist Robert Merton knows very well about the dense science and
practice of derivatives. He was a principle loser in Long Term Capital's 1993
"Trillion Dollar Bet" that nearly brought down Wall Street ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
"Fatal Risk: The Must-Read Story Of AIG's Downfall," by John Hemton,
Business Insider, April 18, 2011 ---
http://www.businessinsider.com/fatal-risk-the-must-read-story-of-aigs-downfall-2011-4
There are dozens of books on the financial crisis: I
have read many of them and the Kindle samples for just about all of them.
There are only two I would recommend: those are Bethany McLean and Joe
Nocera’s excellent
All the Devils are Here and the much more
specifically detailed
Fatal Risk from
Roddy Boyd. Roddy's book is solely concerned with the failure of AIG.
Both books start without any strong ideological preconceptions and let the
facts woven into a good story do the talking - and both wind up ambivalent
about many of the major players - with many players having human weaknesses
(gullibility, delusion, arrogance etc) but committing nothing that looks
like a strong case for criminal prosecution. Reading these you can see why
there are so few criminal prosecutions from the crisis. And you will also
see just how extreme the human failings that caused the crisis are.
Continued in article
Bob Jensen's threads on the credit derivative disaster are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#IgnobleAgendas
Bob Jensen's Primer on Derivatives ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Primer
Warnings from a Theoretical Physicist With an Interest in Economics and
Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models,"
by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html
. . .
In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the way
millions of people and companies interact in a handful of pretty equations.
The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the probabilities of
all possible futures and responding in an optimal way to unexpected shocks.
Surreal Models
Surreal as such models might seem, they have played
a significant role in informing policy at the world’s largest central banks.
Unfortunately, they don’t work very well, and they proved spectacularly
incapable of accommodating the way markets and the economy acted before,
during and after the recent crisis.
Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.
Take, for example, a 2012 (and still somewhat
preliminary)
study by a group of
economists, social scientists, mathematicians and physicists examining the
causes of the housing boom and subsequent collapse from 2000 to 2006.
Starting with data for the Washington D.C. area, the study’s authors built
up a computational model mimicking the behavior of more than two million
potential homeowners over more than a decade. The model included detail on
each individual at the level of race, income, wealth, age and marital
status, and on how these characteristics correlate with home buying
behavior.
Led by further empirical data, the model makes some
simple, yet plausible, assumptions about the way people behave. For example,
homebuyers try to spend about a third of their annual income on housing, and
treat any expected house-price appreciation as income. Within those
constraints, they borrow as much money as lenders’ credit standards allow,
and bid on the highest-value houses they can. Sellers put their houses on
the market at about 10 percent above fair market value, and reduce the price
gradually until they find a buyer.
The model captures things that dynamic stochastic
general equilibrium models do not, such as how rising prices and the
possibility of refinancing entice some people to speculate, buying
more-expensive houses than they otherwise would. The model accurately fits
data on the housing market over the period from 1997 to 2010 (not
surprisingly, as it was designed to do so). More interesting, it can be used
to probe the deeper causes of what happened.
Consider, for example, the assertion of some
prominent economists, such as
Stanford University’s
John Taylor, that the
low-interest-rate policies of the
Federal Reserve were
to blame for the housing bubble. Some dynamic stochastic general equilibrium
models can be used to support this view. The agent- based model, however,
suggests that
interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom and
bust do become smaller, but only marginally.
Leverage Boom
A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were able
to borrow as much as 100 percent of the value of a house -- a form of easy
credit that had a big effect on housing demand. In the model, freezing
leverage at historically normal levels completely eliminates both the
housing boom and the subsequent bust.
Does this mean leverage was the culprit behind the
subprime debacle and the related global financial crisis? Not necessarily.
The model is only a start and might turn out to be wrong in important ways.
That said, it makes the most convincing case to date (see my
blog for more
detail), and it seems likely that any stronger case will have to be based on
an even deeper plunge into the messy details of how people behaved. It will
entail more data, more agents, more computation and less elegance.
If economists jettisoned elegance and got to work
developing more realistic models, we might gain a better understanding of
how crises happen, and learn how to anticipate similarly unstable episodes
in the future. The theories won’t be pretty, and probably won’t show off any
clever mathematics. But we ought to prefer ugly realism to beautiful
fantasy.
(Mark Buchanan, a theoretical physicist and the author of “The Social
Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually
Looks Like You,” is a Bloomberg View columnist. The opinions expressed are
his own.)
Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned mortgages
---
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The
rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Wall Street was also
brought to its knees in the Long Term Capital Management (LTCM)
"Trillion Dollar Bet" in 1993
The only difference was that at that time, the investment bankers on
Wall Street scrounged up enough desperation liquidity to save
themselves
To his credit, the Federal Reserve Chairman, Greenspan, refused to
bail Wall Street out with taxpayer dollars
(although he promoted deregulation that got us into the present
bigger 2008 Wall Street crisis)
The importance of LTCM history was overlooked
by unregulated investment bankers on a 21st Century "infectious
greed" feeding frenzy
Bob Jensen's threads on LTCM are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
Whenever I
get news about increased interest in business
(especially economics and finance) professors on Wall
Street, I think back to "The Trillion Dollar Bet" (Nova
on PBS Video) a bond trader, two Nobel
Laureates, and their doctoral students who very nearly
brought down all of Wall Street and the U.S. banking
system in the crash of a hedge fund known as
Long Term Capital Management where the biggest and
most prestigious firms lost an unimaginable amount of
money ---
http://en.wikipedia.org/wiki/LTCM
The Nova video is
probably available in your campus library.
In my viewpoint this is one
of the best Nova shows ever produced by PBS. I played
this video in every one of my accounting theory courses
beginning one week after "The Trillion Dollar Bet" was
first aired on Nova.
The Trillion Dollar Bet
transcripts are free ---
http://www.pbs.org/wgbh/nova/transcripts/2704stockmarket.html
However, you really have to watch the graphics in the
video to appreciate this educational video ---
http://www.pbs.org/wgbh/nova/stockmarket/
|
"A Tax Shelter, Deconstructed,: by
David Cay Johnston, The New York Times, July 13, 2003 ---
http://www.globalpolicy.org/nations/launder/regions/2003/0714scholes.htm
As a hedge fund,
Long-Term Capital, which was officially organized in the Cayman
Islands, was an unregulated investment pool that by law was open
only to the very wealthy. John W. Meriwether, the Wall Street
bond trader, created it in 1993 with a few of his investment
friends, including Dr. Scholes and Robert C. Merton, the Harvard
economist with whom Dr. Scholes shared the Nobel in 1997. Dr.
Scholes, whom colleagues have described as the consummate
analyst, brought much intellectual firepower to Long-Term
Capital. "This is a guy who will look at a problem and tries to
devise some sort of intellectual structure that explains it,"
said Burton G. Malkiel, a Princeton economist who worked closely
with him in the late 1980's to analyze the financial markets'
crash of 1987. "If you talk to him about a problem, he
immediately says, `How can we model this?' " Dr. Scholes traces
his fascination with market dynamics to his childhood in the
gold-mining territory of northern Canada. What was it, he says
he wondered back then, that makes prices fluctuate? "From an
early age, I was very, very fascinated by uncertainty," he once
said on the public television program "Nova." The big idea that
he had to offer to Long-Term Capital was to make money in the
securities markets by applying a technique for valuing stock
market options that he had helped invent. Known as the Black-Scholes
method, it was described in a paper that he and Dr. Merton wrote
in 1973 with Fischer Black of the University of Chicago. The
method would become the standard for options traders; it is now
widely used to value executive stock options, as well. The paper
ultimately won the Nobel for Dr. Scholes and Dr. Merton.
Dr. Scholes has
told friends that most of his wealth has been wiped out in the
collapse of Long-Term Capital. If the court rules in the
government's favor, he stands to owe millions of dollars to the
I.R.S.
Continued in
article
Jensen Comment
The LTCM tax shelter fraud was only incidental to LTCM's
Trillion Dollar Bet that almost brought down Wall Street.
Bob Jensen's threads on LTCM are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
Brooksley
Born, chair of the Commodity Futures Trading Commission ---
suggested that government should at least study whether some
regulation might make sense, a stampede of lobbyists, members of
Congress, and other regulators --- including Alan Greenspan and
Robert Rubin --- ran her over, admonishing her to keep quiet.
Derivatives tightened the connections among various markets,
creating enormous financial benefits and making global transacting
less costly --- no one denied that.
But they also raised the prospect of
a system-wide breakdown. With each crisis, a few more dominos fell,
and regulators and market participants increasingly expressed
concerns about systematic risk --- a term that described a
financial-market epidemic. After Long-Term Capital collapsed, even
Alan Greenspan admitted that the financial markets had been close to
the brink.
Frank Partnoy,
Infectious Greed (Henry Holt and Company, 2004, Page 229)
Appendix C
Don't Blame Fair Value Accounting Standards
(Except in Terms of Executive Bonus Payments)
Dumb, Dumb, and Dumber
Bill Isaac Blamed the Economic Meltdown of over 1.000 banks on fair value
accounting
"Former FDIC Chief: Fair Value Caused the Crisis " by David M. Katz, CFO
Journal, October 29, 2014 ---
http://ww2.cfo.com/accounting-tax/2008/10/former-fdic-chief-fair-value-caused-the-crisis/
Things were fine before the accounting
standards-setters barged in and "destroyed hundreds of billions of dollars
of capital," he contends.
In perhaps the most sweeping indictment of
fair-value accounting to date, the chairman of the Federal Deposit Insurance
Corporation during the 1980s savings-and-loan debacle told the Securities
and Exchange Commission today that mark-to-market accounting rules caused
the current financial meltdown.
Speaking at an SEC panel on mark-to-market
accounting and the recent period of market turmoil, William Isaac, FDIC
chairman from 1978 to 1985 and now the chairman of a consulting firm that
advises banks, said that before FAS 157, the controversial accounting
standard issued in 2006 that spells out how companies should measure assets
and liabilities that have been marked to market, took hold, subprime losses
were “a little biddy problem.”
Isaac rhetorically asked the participants how the
financial system could have come upon such hard times in under two years. “I
gotta tell you that I can’t come up with any other answer than that the
accounting system is destroying too much capital, and therefore diminishing
bank lending capacity by some $5 trillion,” he asserted. “It’s due to the
accounting system, and I can’t come up with any other explanation.”
As of late 2006, Isaac, now chairman of The Secura
Group, a financial institutions consulting firm, argued, “inflation was
under control, economic growth was good, unemployment was low, and there
were no major credit problems in the banking system.” There were $1.2
trillion worth of U.S. subprime mortgages, with about $300 billion provided
by FDIC-insured banks and the rest held by investors world-wide.
Since subprime losses were estimated to be about 20
percent in 2006, federally insured U.S. banks had lost about $60 billion in
that market, according to Isaac. But those banks had recorded about $150
billion in after-tax earnings and had $1.4 trillion of capital.
The devastation that followed stemmed largely from
the tendency of accounting standards-setters and regulators to force banks,
by means of their litigation-shy auditors, to mark their illiquid assets
down to “unrealistic fire-sale prices,” the former FDIC chief asserted. The
fair-value rules “have destroyed hundreds of billions of dollars of capital
in our financial system, causing lending capacity to be diminished by ten
times that amount,” he said in his prepared remarks.
Noting that 157 was issued in 2006, Isaac noted
that he wasn’t “asking that we change the whole system of accounting that
has been developed for centuries.” Instead, he said, “I’m asking for a very
bad rule to be suspended until we can think about this more and stop
destroying so much capital in our financial system. I think that’s a basic
step that needs to be taken immediately.”
Isaac added that it’s his “fervent hope that the
SEC will recommend in its report to Congress that we abandon mark-to-market
accounting altogether.” The panel was held as part of the commission’s
effort to comply with a requirement in the Emergency Economic Stabilization
Act signed earlier this month that the SEC complete a study of
mark-to-market’s role in the current crisis by Jan. 2, 2009.
Continued in article
Update in 2014: Researchers find fair value accounting was not to
blame for financial crisis
"Fair Value Accounting’s Role in Financial Crisis Scrutinized," by Michael Cohn,
Accounting Today, June 30, 2014 ---
http://www.accountingtoday.com/news/accounting_news/fair-value-accountings-role-in-financial-crisis-scrutinized-71129-1.html
A new academic study finds that fair value
accounting was unfairly blamed for precipitating the 2008-2009 financial
crisis, but acknowledges that some investors reacted positively to news that
the rules would be relaxed in response to the crisis.
In the wake of the crisis, Congress convened
hearings to examine the impact of mark-to-market accounting and fair value
measurement on the shares of investment banks such as Bear Stearns, Lehman
Brothers and Merrill Lynch that had difficulty valuing mortgage-based
securities in illiquid markets, pressuring the Financial Accounting
Standards Board to relax the requirements for writing down the value of such
securities. One of the provisions of the economic stimulus legislation, the
Emergency Economic Stabilization Act of 2008, was to require the Securities
and Exchange Commission to release a report in December 2008 to examine the
role of mark-to-market accounting. The SEC study largely defended the role
of mark-to-market and fair value accounting, but also provided some
recommendations for revising the standards, which FASB and the International
Accounting Standards Board quickly began to do.
Now a new academic study by researchers at Columbia
Business School also examines the role of fair value accounting in the
financial crisis. The study, published in the Journal of Accounting and
Public Policy, examines FVA’s role in the financial crisis and considers the
advantages it offers relative to other methods of accounting.
“Fair value accounting has been blamed for the near
collapse of the U.S. banking system,” said Urooj Khan, assistant professor
of accounting at Columbia Business School and co-author of the research. “On
one hand, FVA can provide timely and relevant information during crisis, but
it can feel like ripping off a Band-Aid causing immediate pain as it
accelerates the process of price adjustment and resource reallocation in
times of financial turmoil. On the other hand, it can increase contagion
among banks by potentially fueling fire sales. Our research demonstrates
that investors’ concerns about FVA’s detrimental affect overshadowed the
beneficial role it plays in promoting timely market information.”
The study, titled “Market reactions to policy
deliberations on fair value accounting and impairment rules during the
financial crisis of 2008-2009,” was co-authored by Professor Urooj Khan of
Columbia Business School and Professor Robert M. Bowen of the University of
San Diego’s School of Business Administration and the University of
Washington’s Foster School of Business. The researchers explored stock
market investors' and creditors' reactions to events such as policy
deliberations, recommendations and decisions related to the relaxation of
FVA rules during a period of extreme financial turmoil from September 2008
to April 2009.
The research found that while news about relaxing
FVA rules generally led to positive stock market reactions, the results
varied depending on a variety of bank characteristics. The research also
revealed additional points that call into question FVA’s role in the recent
financial crisis.
Investors acted as if FVA rules harmed banks and
accelerated their decline, resulting in a favorable reaction to discussions
about relaxing FVA rules, the study noted. The researchers found some
evidence that banks that were more susceptible to contagion are the ones
that benefited the most from the change in FVA rules. For banks without
analyst coverage, investor reactions to relaxed FVA rules were less
positive, suggesting that, in the absence of other information sources,
investors perceive FVA data as providing timely and informative disclosures
about banks’ financial soundness. Banks with a higher proportion of illiquid
assets saw a more positive stock price reaction to potential relaxation of
FVA rules.
For the study, Khan and Bowen examined investor and
creditor reactions to 10 events—including policymaker deliberations,
recommendations, and decisions—related to the relaxation of FVA and
impairment rules in the banking industry.
To complement the event analysis, the study also
investigated cross-sectional stock price reactions to bank-specific factors
that potentially contributed to the financial crisis’ spread. Factors
analyzed included whether banks were well capitalized, their proportion of
fair value assets, and the availability of information sources other than
FVA data.
Continued in article
Jensen Comment
At the time in 2008 I wrote that Bill Isaac was an ignorant advocate of horrible and
dangerous bank accounting ---
"Don't Blame Fair Value Accounting Standards (except in terms of executive
bonus payments): This includes a bull crap case based on an article by the
former head of the FDIC," Bob Jensen, 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#FairValue
Isaac blamed the subprime collapse of thousands of banks on the FASB
requirements for fair value accounting (totally dumb) ---
http://faculty.trinity.edu/rjensen/2008bailout.htm#FairValue
Isaac wanted the FASB to continued to grossly under estimate loan loss
reserves (now that the FASB is finally trying to fix the problem)
“AccountingWEB Exclusive: Former FDIC Chief says FASB proposal is
'irresponsible'," AccountingWeb, June 3, 2010 ---
http://www.accountingweb.com/topic/accounting-auditing/aw-exclusive-former-fdic-chief-says-fasb-proposal-irresponsible
Through the Banking Glass Darkly
"FASB to Propose More Flexible Accounting Rules for Banks," by
Floyd Norris, The New York Times, December 7, 2009 ---
http://www.nytimes.com/2009/12/08/business/08account.html?_r=2&ref=business
Facing political pressure to abandon “fair value”
accounting for banks, the chairman of the board that sets American
accounting standards will call Tuesday for the “decoupling” of bank capital
rules from normal accounting standards.
His proposal would encourage bank regulators to
make adjustments as they determine whether banks have adequate capital while
still allowing investors to see the current fair value — often the market
value — of bank loans and other assets.
In the prepared text of a speech planned for a
conference in Washington, Robert H. Herz, the chairman of the
Financial Accounting Standards Board, called on
bank regulators to use their own judgment in allowing banks to move away
from Generally Accepted Accounting Principles, or GAAP, which his board
sets.
“Handcuffing regulators to GAAP or distorting GAAP
to always fit the needs of regulators is inconsistent with the different
purposes of financial reporting and prudential regulation,” Mr. Herz said in
the prepared text.
“Regulators should have the authority and
appropriate flexibility they need to effectively regulate the banking
system,” he added. “And, conversely, in instances in which the needs of
regulators deviate from the informational requirements of investors, the
reporting to investors should not be subordinated to the needs of
regulators. To do so could degrade the financial information available to
investors and reduce public trust and confidence in the capital markets.”
Mr. Herz said that Congress, after the
savings and loan crisis, had required bank
regulators in 1991 to use GAAP as the basis for capital rules, but said the
regulators could depart from such rules.
Banks have argued that accounting rules should be
changed, saying that current rules are “pro-cyclical” — making banks seem
richer when times are good, and poorer when times are bad and bank loans may
be most needed in the economy.
Mr. Herz conceded the accounting rules can be
pro-cyclical, but questioned how far critics would go. Consumer spending, he
said, depends in part on how wealthy people feel. Should
mutual fund statements be phased in, he asked, so
investors would not feel poor — and cut back on spending — after markets
fell?
The House Financial Services Committee has approved
a proposal that would direct bank regulators to comment to the S.E.C. on
accounting rules, something they already can do. But it stopped short of
adopting a proposal to allow the banking regulators to overrule the S.E.C.,
which supervises the accounting board, on accounting rules.
“I support the goal of financial stability and do
not believe that accounting standards and financial reporting should be
purposefully designed to create instability or pro-cyclical effects,” Mr.
Herz said.
He paraphrased
Barney Frank, the chairman of the House committee,
as saying that “accounting principles should not be viewed to be so
immutable that their impact on policy should not be considered. I agree with
that, and I think the chairman would also agree that accounting standards
should not be so malleable that they fail to meet their objective of helping
to properly inform investors and markets or that they should be purposefully
designed to try to dampen business, market, and economic cycles. That’s not
their role.”
Banks have argued that accounting rules made the
financial crisis worse by forcing them to acknowledge losses based on market
values that may never be realized, if market values recover.
Mr. Herz said the accounting board had sought
middle ground by requiring some unrealized losses to be recognized on bank
balance sheets but not to be reflected on income statements.
Banking regulators already have capital rules that
differ from accounting rules, but have not been eager to expand those
differences. One area where a difference may soon be made is in the
treatment of off-balance sheet items that the accounting board is forcing
banks to bring back onto their balance sheets. The banks have asked
regulators to phase in that change over several years, to slow the impact on
their capital needs.
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Please don't blame the accountants for the banking meltdown ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#FairValue
Bob Jensen's threads on banking frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Proposed Accounting Standards Update
Financial Instruments—Credit Losses (Subtopic 825-15)
Exposure Draft Issued on December 20, 2012
---
Click Here
http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176160587228
Jensen Comment
This proposal lacking bright lines can best be described as a principles-based
standard allowing either discounted cash flow or anticipated cash flows or fair
value of the contract depending upon which is deemed most appropriate by the
client and its auditors. The former probability threshold would no longer apply.
Nearly all debt contracts receivable would receive and "Allowance for Credit
Impairment" based on the present value of contractual cash flows that the client
does not expect to collect.
This proposal abandons the infamous three-bucket model proposed by the FASB
and the IASB jointly.
Proposed Accounting Standards Update
Financial Instruments—Credit Losses (Subtopic 825-15)
Exposure Draft Issued on December 20, 2012
---
Click Here
http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176160587228
Why Is the FASB Issuing This Proposed Accounting Standards Update
(Update)?
Before the global economic crisis that began in
2008, both the Financial Accounting Standards Board (FASB) and the
International Accounting Standards Board (IASB) began a joint project to
revise and improve their respective standards of accounting for financial
instruments. In the aftermath of the global economic crisis, the
overstatement of assets caused by a delayed recognition of credit losses
associated with loans (and other financial instruments) was identified as a
weakness in the application of existing accounting standards. Specifically,
because the existing ―incurred loss‖ model delays recognition until a credit
loss is probable (or has been incurred), the Financial Crisis Advisory
Group1 recommended exploring alternatives to the incurred loss model that
would use more forward-looking information. The inherent complexity of
having multiple credit impairment models was identified as an additional
weakness of existing accounting standards.
1The Financial Crisis Advisory Group (FCAG) was
created in October 2008 by the FASB and the IASB, as part of a joint
approach to dealing with the reporting issues arising from the global
financial crisis. The FCAG was asked to consider how improvements in
financial reporting could help enhance investors’ confidence in financial
markets.
The main objective in developing this proposal is
to provide financial statement users with more decision-useful information
about the expected credit losses on financial assets and other commitments
to extend credit held by a reporting entity at each reporting date. This
objective would be achieved by replacing the current impairment model, which
reflects incurred credit events, with a model that recognizes expected
credit risks and by requiring consideration of a broader range of reasonable
and supportable information to inform credit loss estimates. These proposed
amendments also would reduce complexity by replacing the numerous existing
impairment models in current U.S. GAAP with a consistent measurement
approach.
Who Would Be Affected by the Amendments in This Proposed Update?
All entities that hold financial assets that are
not accounted for at fair value through net income and are exposed to
potential credit risk would be affected by the proposed amendments. Loans,
debt securities, trade receivables, lease receivables, loan commitments,
reinsurance receivables, and any other
receivables that represent the contractual right to
receive cash would generally be affected by the proposed amendments.
What Are the Main Provisions?
The proposed amendments would require an entity to
impair its existing financial assets on the basis of the current estimate of
contractual cash flows not expected to be collected on financial assets held
at the reporting date. This impairment would be reflected as an allowance
for expected credit losses. The proposed amendments would remove the
existing ―probable‖ threshold in U.S. generally accepted accounting
principles (GAAP) for recognizing credit losses and broaden the range of
information that must be considered in measuring the allowance for expected
credit losses. More specifically, the estimate of expected credit losses
would be based on relevant information about past events, including
historical loss experience with similar assets, current conditions, and
reasonable and supportable forecasts that affect the expected collectibility
of the assets’ remaining contractual cash flows. An estimate of expected
credit losses would always reflect both the possibility that a credit loss
results and the possibility that no credit loss results. Accordingly, the
proposed amendments would prohibit an entity from estimating expected credit
losses solely on the basis of the most likely outcome (that is, the
statistical mode).
As a result of the proposed amendments, financial
assets carried at amortized cost less an allowance would reflect the current
estimate of the cash flows expected to be collected at the reporting date,
and the income statement would reflect credit deterioration (or improvement)
that has taken place during the period. For financial assets measured at
fair value with changes in fair value recognized through other comprehensive
income, the balance sheet would reflect the fair value, but the income
statement would reflect credit deterioration (or improvement) that has taken
place during the period. An entity, however, may choose to not recognize
expected credit losses on financial assets measured at fair value, with
changes in fair value recognized through other comprehensive income, if both
(1) the fair value of the financial asset is greater than (or equal to) the
amortized cost basis and (2) expected credit losses on the financial asset
are insignificant.
The Board expects that different types of entities
can leverage their current risk monitoring systems in implementing the
proposed approach (for example, by a bank using regulatory risk categories
or an industrial company using an aging analysis). However, the inputs used
to estimate the allowance for credit losses may need to change to implement
the expected credit
How Would the Main Provisions Differ from Current U.S. GAAP and Why Would
They Be an Improvement?
Current U.S. GAAP includes five different incurred
loss credit impairment models for instruments within the scope of the
proposed amendments. The existing models generally delay recognition of
credit loss until the loss is considered ―probable.‖ This initial
recognition threshold is perceived to have interfered with the timely
recognition of credit losses and overstated assets during the recent global
economic crisis. The credit loss recognition guidance in the proposed
amendments would eliminate the existing ―probable‖ initial recognition
threshold in U.S. GAAP and instead reflect the entity’s current estimate of
expected credit losses.
Furthermore, when credit losses are measured under
current U.S. GAAP, an entity generally only considers past events and
current conditions in measuring the incurred loss. The proposed amendments
would broaden the information that an entity is required to consider in
developing its credit loss estimate. Specifically, the proposed amendments
would require that an entity’s estimate be based on relevant information
about past events, including historical loss experience with similar assets,
current conditions, and reasonable and supportable forecasts that affect the
expected collectibility of the financial assets’ remaining contractual cash
flows. As a result, an entity would consider quantitative and qualitative
factors specific to the borrower, including the entity’s current evaluation
of the borrower’s creditworthiness. An entity also would consider general
economic conditions and an evaluation of both the current point in, and the
forecasted direction of, the economic cycle (for example, as evidenced by
changes in issuer or industry-wide underwriting standards).
How Would the Main Provisions Differ from the FASB’s Previously Proposed
Accounting Standards Update?
In May 2010, the FASB issued a proposed Accounting
Standards Update,
Accounting for Financial Instruments
and Revisions to the Accounting for Derivative Instruments and Hedging
Activities. For purposes of measuring credit impairment, the May 2010
proposed Update would have required that an entity assume that the economic
conditions existing at the reporting date would remain unchanged for the
remaining life of the financial assets. In contrast, the proposed amendments
in this 2012 proposed Update would broaden rather than limit the information
set that an entity is required to consider in developing its credit loss
estimate. Specifically, the proposed amendments would require that an
entity’s estimate be based on relevant information about past events,
including historical loss experience with similar assets, current
conditions, and reasonable and supportable forecasts that affect the
expected collectibility of the financial assets’ remaining contractual cash
flows. Also, the credit loss allowance objective in the credit loss
approach, as explained in the examples.
May 2010 proposed Update differed on the basis of
whether the asset was originated or purchased. The proposed amendments have
a single measurement objective, one in which expected credit losses should
reflect management’s estimate of the contractual cash flows not expected to
be collected from a recognized financial asset (or group of financial
assets). Furthermore, the May 2010 proposed Update proposed to dramatically
change the interest income recognition approach by measuring interest income
on the basis of the effective interest rate multiplied by the net carrying
amount (that is, amortized cost minus the associated allowance). Unlike the
May 2010 proposed Update, the proposed amendments would maintain the
approach in current U.S. GAAP that measures interest income and credit
losses separately.
. . .
825-15-55-3
Paragraph 825-15-25-4
requires that an estimate of expected credit losses reflect the time value
of money either explicitly or implicitly. A
discounted cash flow model is an example of a method that explicitly
reflects the time value of money by forecasting future cash flows (or cash
shortfalls) and discounting these amounts to a present value using the
effective interest rate. Other methods
implicitly reflect the time value of money by developing loss statistics on
the basis of the ratio of the amortized cost amount written off because of
credit loss and the amortized cost basis of the asset and by applying the
loss statistic (after updating it for current conditions and reasonable and
supportable forecasts of the future) to the amortized cost balance as of the
reporting date to estimate the portion of the recorded amortized cost basis
that is not expected to be recovered because of credit loss. Such methods
may include loss-rate methods, roll-rate methods, probability-of-default
methods, and a provision matrix method using loss factors. The requirement
in paragraph 825-15-25-4 is met when the method used to estimate expected
credit losses either explicitly or implicitly reflects the time value of
money.
825-15-55-4
For collateral-dependent
financial assets, an entity may use, as a practical expedient, methods
that compare the amortized cost basis with the fair value of
collateral. Such an approach is considered a practical expedient because
there is an inherent inconsistency in how the time value of money is
reflected in an amortized cost amount (wherein the discount rate implicit in
the present value is a historical rate) and a fair value amount for
collateral (wherein the discount rate implicit in the present value is a
current rate). If an entity uses the fair value of the collateral to measure
expected credit losses on a collateral-dependent financial asset and
repayment or satisfaction of the asset depends on the sale of the
collateral, the fair value of the collateral should be adjusted to consider
estimated costs to sell (on a discounted basis). However, if repayment or
satisfaction of the financial asset depends only on the operation, rather
than the sale of the collateral, the estimate of expected credit losses
should not incorporate estimated costs to sell the collateral.
> > Estimation of Expected Credit Losses—Multiple
Possible Outcomes
825-15-55-5
Paragraph 825-15-25-5 requires
that an estimate of expected credit losses, always reflect both the
possibility that a credit loss results and the possibility that no credit
loss results. However, in making this estimate, a variety of credit loss
scenarios are not required to be identified and probability weighted to
estimate expected credit losses, when a range of at least two outcomes is
implicit in the method.
825-15-55-6
Some measurement methods (such
as a loss-rate method, a roll-rate method, a probability-of-default method,
and a provision matrix method using loss factors) rely on an extensive
population of actual historical loss data as an input when estimating credit
losses. Therefore, they implicitly satisfy the requirement in paragraph
825-15-25-5 as long as the population of actual loss data reflects items
within that population that ultimately resulted in a loss and those items
within that population that resulted in no loss. Similarly, as a practical
expedient, an entity may use the fair value of collateral (less estimated
costs to sell, as applicable) in estimating credit losses for
collateral-dependent financial assets. Such an approach is considered a
practical expedient because the fair value of collateral reflects several
potential outcomes on a market-weighted basis and may result in expected
credit losses of zero when the fair value of collateral exceeds the
amortized cost basis of the asset.
> > Estimation of Expected Credit Losses—Lease
Receivables
825-15-55-7
This Subtopic requires that an
entity recognize an allowance for all expected credit losses on lease
receivables recognized by a lessor in accordance with Topic 840. When
measuring expected credit losses on lease receivables using a discounted
cash flow method, the cash flows and discount rate used in measuring the
lease receivable under Topic 840 would be used in place of the contractual
cash flows and effective interest rate discussed in Section
825-15-25.
> > Estimation of Expected Credit Losses—Loan
Commitments
825-15-55-8
This Subtopic requires that an
entity recognize all expected credit losses on loan commitments that are not
measured at fair value with qualifying changes in fair value recognized in
net income. In estimating expected credit losses for such loan commitments,
an entity would estimate credit losses over the full contractual period over
which the entity is exposed to credit risk via a present legal obligation to
extend credit, unless unconditionally cancellable by the issuer. For that
period of exposure, the estimate of expected credit losses should consider
both the likelihood that funding will occur (which may be affected by, for
example, a material adverse change clause) and an estimate of expected
credit losses on commitments expected to be funded.
Continued in article
Jensen Comment
This proposal lacking bright lines can best be described as a principles-based
standard allowing either discounted cash flow or anticipated cash flows or fair
value of the contract depending upon which is deemed most appropriate by the
client and its auditors. The former probability threshold would no longer apply.
Nearly all debt contracts receivable would receive and "Allowance for Credit
Impairment" based on the present value of contractual cash flows that the client
does not expect to collect.
This proposal abandons the infamous three-bucket model proposed by the FASB
and the IASB jointly.
I think this exposure draft is the answer to a long awaited charge of the SEC
to issue a new standard on credit impairment accounting.
"SEC ISSUES DETAILED STUDY ON MARK-TO-MARKET ACCOUNTING,"
by Gia Chevis, Accounting Education.com, February 19, 2009 ---
http://accountingeducation.com/index.cfm?page=newsdetails&id=148980
The report was issued on December 31, 2008
At the direction of the U.S.
Congress, the SEC prepared and released on 30 December 2008 a study on
mark-to-market accounting and its role in the recent financial crises.
Though it concluded that mark-to-market accounting was not responsible
for the crisis, it did make eight recommendations.
The 259-page document, a result of the Emergency Economic Stabilization
Act of 2008, details an in-depth study of six issues identified by the
Act: effects of fair value accounting standards on financial
institutions' balance sheets; impact of fair value accounting on bank
failures in 2008; impact of fair value accounting on the quality of
financial information available to investors; process used by the FASB
in developing accounting standards; alternatives to fair value
accounting standards; and advisability and feasibility of modifications
to fair value accounting standards. Its eight recommendations are:
1) SFAS No. 157 should be improved, but not suspended.
2) Existing fair value and mark-to-market requirements should not be
suspended.
3) While the Staff does not recommend a suspension of existing fair
value standards, additional measures should be taken to improve the
application and practice related to existing fair value requirements
(particularly as they relate to both Level 2 and Level 3 estimates).
4) The accounting for financial asset impairments should be readdressed.
5) Implement further guidance to foster the use of sound judgment.
6) Accounting standards should continue to be established to meet the
needs of investors.
7) Additional formal measures to address the operation of existing
accounting standards in practice should be established.
8) Address the need to simplify the accounting for investments in
financial assets.
On February 18, the FASB
announced the addition of two short-timetable projects to its agenda
concerning fair value measurement and disclosure. The first project aims
to improve application guidance for measurement of fair value, with
issuance projected for the second quarter. The second will address
issues related to input sensitivity analysis and changes in levels; the
FASB anticipates completing that project in time for calendar-year-end
filing deadlines. Both projects were undertaken in response to the SEC's
recent study on mark-to-market accounting and input from the FASB's
Valuation Resource Group.
The full report can be freely downloaded at
http://www.sec.gov/news/studies/2008/marktomarket123008.pdf. (pdf)
SFAS No. 157’s fair value hierarchy prioritizes the inputs
to valuation techniques used to measure fair value into three broad levels. The
fair value hierarchy gives the highest priority to unadjusted quoted prices in
active markets (Level 1) and the lowest priority to unobservable inputs (Level
3). With respect to IFRS, the report states the following on Page 33:
Currently, under IFRS,
“guidance on measuring fair value is dispersed throughout [IFRS] and is
not always consistent.”52 However, as discussed in Section VII.B, the
IASB is developing an exposure draft on fair value measurement guidance.
IFRS generally defines fair
value as “the amount for which an asset could be exchanged, or a
liability settled, between knowledgeable, willing parties in an arm’s
length transaction” (with some slight
variations in wording in different standards).53
While
this definition is generallyconsistent with SFAS No. 157, it is not
fully converged in the following respects:
•
The definition in
SFAS No. 157 is explicitly an exit price, whereas the definition in IFRS
is neither explicitly an exit price nor an entry price.
•
SFAS No. 157
explicitly refers to market participants, which is defined by the
standard, whereas IFRS simply refers to knowledgeable, willing parties
in an arm’s length transaction.
•
For liabilities, the
definition of fair value in SFAS No. 157 rests on the notion that the
liability is transferred (the liability to the counterparty continues),
whereas the definition in IFRS refers to the amount at which a liability
could be settled.
Through the Banking Glass Darkly
"FASB to Propose More Flexible Accounting Rules for Banks," by
Floyd Norris, The New York Times, December 7, 2009 ---
http://www.nytimes.com/2009/12/08/business/08account.html?_r=2&ref=business
Facing political pressure to abandon “fair value”
accounting for banks, the chairman of the board that sets American
accounting standards will call Tuesday for the “decoupling” of bank capital
rules from normal accounting standards.
His proposal would encourage bank regulators to
make adjustments as they determine whether banks have adequate capital while
still allowing investors to see the current fair value — often the market
value — of bank loans and other assets.
In the prepared text of a speech planned for a
conference in Washington, Robert H. Herz, the chairman of the
Financial Accounting Standards Board, called on
bank regulators to use their own judgment in allowing banks to move away
from Generally Accepted Accounting Principles, or GAAP, which his board
sets.
“Handcuffing regulators to GAAP or distorting GAAP
to always fit the needs of regulators is inconsistent with the different
purposes of financial reporting and prudential regulation,” Mr. Herz said in
the prepared text.
“Regulators should have the authority and
appropriate flexibility they need to effectively regulate the banking
system,” he added. “And, conversely, in instances in which the needs of
regulators deviate from the informational requirements of investors, the
reporting to investors should not be subordinated to the needs of
regulators. To do so could degrade the financial information available to
investors and reduce public trust and confidence in the capital markets.”
Mr. Herz said that Congress, after the
savings and loan crisis, had required bank
regulators in 1991 to use GAAP as the basis for capital rules, but said the
regulators could depart from such rules.
Banks have argued that accounting rules should be
changed, saying that current rules are “pro-cyclical” — making banks seem
richer when times are good, and poorer when times are bad and bank loans may
be most needed in the economy.
Mr. Herz conceded the accounting rules can be
pro-cyclical, but questioned how far critics would go. Consumer spending, he
said, depends in part on how wealthy people feel. Should
mutual fund statements be phased in, he asked, so
investors would not feel poor — and cut back on spending — after markets
fell?
The House Financial Services Committee has approved
a proposal that would direct bank regulators to comment to the S.E.C. on
accounting rules, something they already can do. But it stopped short of
adopting a proposal to allow the banking regulators to overrule the S.E.C.,
which supervises the accounting board, on accounting rules.
“I support the goal of financial stability and do
not believe that accounting standards and financial reporting should be
purposefully designed to create instability or pro-cyclical effects,” Mr.
Herz said.
He paraphrased
Barney Frank, the chairman of the House committee,
as saying that “accounting principles should not be viewed to be so
immutable that their impact on policy should not be considered. I agree with
that, and I think the chairman would also agree that accounting standards
should not be so malleable that they fail to meet their objective of helping
to properly inform investors and markets or that they should be purposefully
designed to try to dampen business, market, and economic cycles. That’s not
their role.”
Banks have argued that accounting rules made the
financial crisis worse by forcing them to acknowledge losses based on market
values that may never be realized, if market values recover.
Mr. Herz said the accounting board had sought
middle ground by requiring some unrealized losses to be recognized on bank
balance sheets but not to be reflected on income statements.
Banking regulators already have capital rules that
differ from accounting rules, but have not been eager to expand those
differences. One area where a difference may soon be made is in the
treatment of off-balance sheet items that the accounting board is forcing
banks to bring back onto their balance sheets. The banks have asked
regulators to phase in that change over several years, to slow the impact on
their capital needs.
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Please don't blame the accountants for the banking meltdown ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#FairValue
Bob Jensen's threads on banking frauds ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Questions
Did the FASB's amended fair value guidelines give the players (banks), umpires
(regulators), and fans (notably shareholders like Steve Forbes and Warren
Buffett seeking a new stock market bubble) the overvalued wine they were
seeking? Will the new guidelines mostly increase client pressures on auditors to
sign off on fantasy financial statements?
Although the new FASB Guidelines for estimating fair value under FAS 157 and FAS
115 in "broken markets" expands client/auditor discretion for some types of
assets having long-term value such as real estate, it's asking a lot to have
auditors agree once again to rosy valuation of sorry-looking toxic investments
such as the value of a mortgage that's about to wither on the vine. You can't
squeeze sweet grape juice from shriveled homeowners, let alone fine wine. It
may, however, be that higher value on foreclosed properties in bank inventories
will lead to some partying over banks' financial statements.
The wonderful December 30, 2008 research report of the SEC shows that fair value
accounting is neither the cause nor the cure for the banking crisis. The
liquidity problem of the holders of the toxic investments is caused by trillions
of dollars invested in underperforming (often zero performing) of bad
investments mortgages or mortgaged-backed bonds that have to be written down
unless auditors agree to simply lie about values. That is not likely to happen,
but client pressures on auditors to value on the high side for many properties
will be heavy handed.
The wonderful full SEC report that bankers and
regulators do not want to read can be freely downloaded at
http://www.sec.gov/news/studies/2008/marktomarket123008.pdf
The FASB probably did its best to maintain integrity in the face of massive
political pressures. I hope the IASB is able to resist the same pressures in the
international arena. To me the new FASB Guidelines are mostly old wine in new
bottles since FAS 157 previously gave considerable discretion in valuing items
in broken markets.
Looking
for blue sky above polluted bank accounting hot air
Bank Profits Appear Out of Thin Air in 2009
Question
What direction did the price of shares of Bank of America move when BofA
announced higher than expected earnings for the first quarter of 2009?
Answer
Down, because investors suspect that such earnings were not sustainable while
BofA holds billions of dollars of Countrywide and Merrill Lynch toxic paper that
will drive down future earnings due to non-performance of home owners and
business owners who will not fully perform on loans.
The magic
accounting tricks in 2009 are hurting rather than helping to restore faith in
accounting and auditing after the 2008 banking crash.
Sydney Finkelstein, the Steven Roth professor of management at the Tuck School
of Business at Dartmouth College, also pointed out that Bank of America booked a
$2.2 billion gain by increasing the value of Merrill Lynch’s assets it acquired
last quarter to prices that were higher than Merrill kept them. “Although
perfectly legal, this move is also perfectly delusional, because some day soon
these assets will be written down to their fair value, and it won’t be pretty,”
he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross Sorkin, The New
York Times, April 20, 2009 ---
http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk
This is starting to feel like amateur hour for aspiring magicians.
Another day, another attempt by a Wall Street bank to pull a bunny out of
the hat, showing off an earnings report that it hopes will elicit oohs and
aahs from the market. Goldman Sachs, JPMorgan Chase, Citigroup and, on
Monday, Bank of America all tried to wow their audiences with what appeared
to be — presto! — better-than-expected numbers.
But in each case, investors spotted the attempts at sleight of hand, and
didn’t buy it for a second.
With Goldman Sachs, the disappearing month of December didn’t quite
disappear (it changed its reporting calendar, effectively erasing the impact
of a $1.5 billion loss that month); JPMorgan Chase reported a dazzling
profit partly because the price of its bonds dropped (theoretically, they
could retire them and buy them back at a cheaper price; that’s sort of like
saying you’re richer because the value of your home has dropped); Citigroup
pulled the same trick.
Bank of America sold its shares in China Construction Bank to book a big
one-time profit, but Ken Lewis heralded the results as “a testament to the
value and breadth of the franchise.”
Sydney Finkelstein, the Steven Roth professor of management at the Tuck
School of Business at Dartmouth College, also pointed out that Bank of
America booked a $2.2 billion gain by increasing the value of Merrill
Lynch’s assets it acquired last quarter to prices that were higher than
Merrill kept them.
“Although perfectly legal, this move is also perfectly delusional, because
some day soon these assets will be written down to their fair value, and it
won’t be pretty,” he said.
Investors reacted by throwing tomatoes. Bank of America’s stock plunged 24
percent, as did other bank stocks. They’ve had enough.
Why can’t anybody read the room here? After all the financial wizardry that
got the country — actually, the world — into trouble, why don’t these
bankers give their audience what it seems to crave? Perhaps a bit of simple
math that could fit on the back of an envelope, with no asterisks and no
fine print, might win cheers instead of jeers from the market.
What’s particularly puzzling is why the banks don’t just try to make some
money the old-fashioned way. After all, earning it, if you could call it
that, has never been easier with a business model sponsored by the federal
government. That’s the one in which Uncle Sam and we taxpayers are offering
the banks dirt-cheap money, which they can turn around and lend at much
higher rates.
“If the federal government let me borrow money at zero percent interest, and
then lend it out at 4 to 12 percent interest, even I could make a profit,”
said Professor Finkelstein of the Tuck School. “And if a college professor
can make money in banking in 2009, what should we expect from the highly
paid C.E.O.’s that populate corner offices?”
But maybe now the banks are simply following the lead of Washington, which
keeps trotting out the latest idea for shoring up the financial system.
The latest big idea is the so-called stress test that is being applied to
the banks, with results expected at the end of this month.
This is playing to a tough crowd that long ago decided to stop suspending
disbelief. If the stress test is done honestly, it is impossible to believe
that some banks won’t fail. If no bank fails, then what’s the value of the
stress test? To tell us everything is fine, when people know it’s not?
“I can’t think of a single, positive thing to say about the stress test
concept — the process by which it will be carried out, or outcome it will
produce, no matter what the outcome is,” Thomas K. Brown, an analyst at
Bankstocks.com, wrote. “Nothing good can come of this and, under certain,
non-far-fetched scenarios, it might end up making the banking system’s
problems worse.”
The results of the stress test could lead to calls for capital for some of
the banks. Citi is mentioned most often as a candidate for more help, but
there could be others.
The expectation, before Monday at least, was that the government would pump
new money into the banks that needed it most.
But that was before the government reached into its bag of tricks again. Now
Treasury, instead of putting up new money, is considering swapping its
preferred shares in these banks for common shares.
The benefit to the bank is that it will have more capital to meet its ratio
requirements, and therefore won’t have to pay a 5 percent dividend to the
government. In the case of Citi, that would save the bank hundreds of
millions of dollars a year.
And — ta da! — it will miraculously stretch taxpayer dollars without
spending a penny more.
This is a pretty good article on how players (banks), umpires (regulators),
and fans (like billionnaires Stever Forbes and Warren Buffet) have
inappropriately blamed the scorekeepers (accounts) for the demise of the big
banks. In fact the December 30, 2008 research report calls this attribution of
blame just plain wrong (and self-serving).
The wonderful December 30, 2008 research report of the SEC shows that fair value
accounting is neither the cause nor the cure for the banking crisis. The
liquidity problem of the holders of the toxic investments is caused by trillions
of dollars invested in underperforming (often zero performing) of bad
investments mortgages or mortgaged-backed bonds that have to be written down
unless auditors agree to simply lie about values. That is not likely to happen,
but client pressures on auditors to value on the high side for many properties
will be heavy handed.
The wonderful full SEC report that bankers and
regulators do not want to read can be freely downloaded at
http://www.sec.gov/news/studies/2008/marktomarket123008.pdf
"We Need Honest Accounting: Relax regulatory capital rules if need
be, but don't let banks hide the truth," by James A. Chanos, The Wall
Street Journal, March 24, 2009 ---
http://online.wsj.com/article/SB123785319919419659.html?mod=djemEditorialPage
Mark-to-market (MTM) accounting is under
fierce attack by bank CEOs and others who are pressing Congress to suspend,
if not repeal, the rules they blame for the current financial crisis. Yet
their pleas to bubble-wrap financial statements run counter to increased
calls for greater financial-market transparency and ongoing efforts to
restore investor trust.
We have a sorry history of the banking
industry driving statutory and regulatory changes. Now banks want accounting
fixes to mask their recklessness. Meanwhile, there has been no
acknowledgment of culpability in what top management in these financial
institutions did -- despite warnings -- to help bring about the crisis.
Theirs is a record of lax risk management, flawed models, reckless lending,
and excessively leveraged investment strategies. In the worst instances,
they acted with moral indifference, knowing that what they were doing was
flawed, but still willing to pocket the fees and accompanying bonuses.
MTM accounting isn't perfect, but it does
provide a compass for investors to figure out what an asset would be worth
in today's market if it were sold in an orderly fashion to a willing buyer.
Before MTM took effect, the Financial Accounting Standards Board (FASB)
produced much evidence to show that valuing financial instruments and other
difficult-to-price assets by "historical" costs, or "mark to management,"
was folly.
The rules now under attack are neither as
significant nor as inflexible as critics charge. MTM is generally limited to
investments held for trading purposes, and to certain derivatives. For many
financial institutions, these investments represent a minority of their
total investment portfolio. A recent study by Bloomberg columnist David
Reilly of the 12 largest banks in the KBW Bank Index shows that only 29% of
the $8.46 trillion in assets are at MTM prices. In General Electric's case,
the portion is just 2%.
Why is that so? Most bank assets are in
loans, which are held at their original cost using amortization rules, minus
a reserve that banks must set aside as a safety cushion for potential future
losses.
MTM rules also give banks a choice. MTM
accounting is not required for securities held to maturity, but you need to
demonstrate a "positive intent and ability" that you will do so. Further, an
SEC 2008 report found that "over 90% of investments marked-to-market are
valued based on observable inputs."
Financial institutions had no problem in
using MTM to benefit from the drop in prices of their own notes and bonds,
since the rule also applies to liabilities. And when the value of the
securitized loans they held was soaring, they eagerly embraced MTM. Once
committed to that accounting discipline, though, they were obligated to
continue doing so for the duration of their holding of securities they've
marked to market. And one wonders if they are as equally willing to forego
MTM for valuing the same illiquid securities in client accounts for margin
loans as they are for their proprietary trading accounts?
But these facts haven't stopped the charge
forward on Capitol Hill. At a recent hearing, bankers said that MTM forced
them to price securities well below their real valuation, making it
difficult to purge toxic assets from their books at anything but fire-sale
prices. They also justified their attack with claims that loans, mortgages
and other securities are now safe or close to safe, ignoring mounting
evidence that losses are growing across a greater swath of credit. This
makes the timing of the anti-MTM lobbying appear even more suspect. And not
all financial firms are calling for loosening MTM standards; Goldman Sachs
and others who are standing firm on this issue should be applauded.
According to J.P. Morgan, approximately
$450 billion of collateralized debt obligations (CDOs) of asset-backed
securities were issued from late 2005 to mid-2007. Of that amount, roughly
$305 billion is now in a formal state of default and $102 billion of this
amount has already been liquidated. The latest monthly mortgage reports from
investment banks are equally sobering. It is no surprise, then, that the
largest underwriters of mortgages and CDOs have been decimated.
Commercial banking regulations generally
do not require banks to sell assets to meet capital requirements just
because market values decline. But if "impairment" charges under MTM do push
banks below regulatory capital requirements and limit their ability to lend
when they can't raise more capital, then the solution is to grant temporary
regulatory capital "relief," which is itself an arbitrary number.
There is a connection between efforts over
the past 12 years to reduce regulatory oversight, weaken capital
requirements, and silence the financial detectives who uncovered such
scandals as Lehman and Enron. The assault against MTM is just the latest
chapter.
Instead of acknowledging mistakes, we are
told this is a "once in 100 years" anomaly with the market not functioning
correctly. It isn't lost on investors that the MTM criticisms come, too, as
private equity firms must now report the value of their investments. The
truth is the market is functioning correctly. It's just that MTM critics
don't like the prices that investors are willing to pay.
The FASB and Securities and Exchange
Commission (SEC) must stand firm in their respective efforts to ensure that
investors get a true sense of the losses facing banks and investment firms.
To be sure, we should work to make MTM accounting more precise, following,
for example, the counsel of the President's Working Group on Financial
Markets and the SEC's December 2008 recommendations for achieving greater
clarity in valuation approaches.
Unfortunately, the FASB proposal on March
16 represents capitulation. It calls for "significant judgment" by banks in
determining if a market or an asset is "inactive" and if a transaction is
"distressed." This would give banks more discretion to throw out "quotes"
and use valuation alternatives, including cash-flow estimates, to determine
value in illiquid markets. In other words, it allows banks to substitute
their own wishful-thinking judgments of value for market prices.
The FASB is also changing the criteria
used to determine impairment, giving companies more flexibility to not
recognize impairments if they don't have "the intent to sell." Banks will
only need to state that they are more likely than not to be able to hold
onto an underwater asset until its price "recovers." CFOs will also have a
choice to divide impairments into "credit losses" and "other losses," which
means fewer of these charges will be counted against income. If approved,
companies could start this quarter to report net income that ignores sharp
declines in securities they own. The FASB is taking comments until April 1,
but its vote is a fait accompli.
Obfuscating sound accounting rules by
gutting MTM rules will only further reduce investors' trust in the financial
statements of all companies, causing private capital -- desperately needed
in securities markets -- to become even scarcer. Worse, obfuscation will
further erode confidence in the American economy, with dire consequences for
the very financial institutions who are calling for MTM changes. If need be,
temporarily relax the arbitrary levels of regulatory capital, rather than
compromise the integrity of all financial statements.
The idea that massive changes have been made is a
huge overstatement. FASB is basically reiterating what it has said all along. A
number of comments from both bank insiders and analysts indicate that no
material changes have been made, . . . Estimates vary but it seems MTM
changes won’t have as big an impact as some would like to believe. Remember, as
Jim Chanos pointed out, the vast majority of bank assets such as ordinary loans,
are NOT marked to market and that the delinquencies on almost all classes of
loans continue to rise. Thus relaxing mark to market will not help stop the
rising delinquencies across a wide swathe of bank assets.
The idea that giving bank executives more leeway in how
they price their assets when a large part of the current problems is a lack of
transparency is laughable.
"Latest on Mark to Market Scapegoat," The Fundamental Analyst,
on April 2, 2009 ---
http://www.thefundamentalanalyst.com/?p=1145
Jensen Comment
Although I tend to agree that the FASB's April 2, 2009 change was not that much
of a change at all since Level 3 value estimates could come from subjective
estimates of future streams of cash flows. However, the problem will be that the
banks themselves use this re-enforce banks to depart from market on bad debt
reserves. Banks will accordingly understate bad debt reserves and overstate
earnings.
Even though the neutrality-believing FASB is in a state
of denial about the impact of FSP 115-4 on decision making in the real world,
financial analysts and the Director of Corporate Governance at the Harvard Law
School are in no such state of denial,
"The Fall of the Toxic-Assets Plan," The Wall Street Journal, July 9,
2009 ---
http://blogs.wsj.com/economics/2009/07/09/guest-contribution-the-fall-of-the-toxic-assets-plan/
The government
announced plans to move forward with its
Public-Private Investment Program yesterday. Lucian Bebchuk,
professor of law, economics, and finance and director of the corporate
governance program at Harvard Law School, says that the
program, which has been curtailed significantly, hasn’t made the problem go
away.
The plan for buying troubled assets — which was
earlier announced as the central element of the administration’s financial
stability plan — has been recently curtailed drastically. The Treasury and
the FDIC have attributed this development to banks’ new ability to raise
capital through stock sales without having to sell toxic assets.
But the program’s inability to take off is in large
part due to decisions by banking regulators and accounting officials to
allow banks to pretend that toxic assets haven’t declined in value as long
as they avoid selling them.
The toxic assets clogging banks’ balance sheets
have long been viewed — by both the Bush and the Obama administrations — as
being at the heart of the financial crisis. Secretary Geithner put forward
in March a “public-private investment program” (PPIP) to provide up to $1
trillion to investment funds run by private managers and dedicated to
purchasing troubled assets. The plan aimed at “cleansing” banks’ books of
toxic assets and producing prices that would enable valuing toxic assets
still remaining on these books.
The program naturally attracted much attention, and
the Treasury and the FDIC have begun implementing it. Recently, however, one
half of the program, focused on buying toxic loans from banks, was shelved.
The other half, focused on buying toxic securities from both banks and other
financial institutions, is expected to begin operating shortly but on a much
more modest scale than initially planned.
What happened? Banks’ balance sheets do remain
clogged with toxic assets, which are still difficult to value. But the
willingness of banks to sell toxic assets to investment funds has been
killed by decisions of accounting authorities and banking regulators.
Earlier in the crisis, banks’ reluctance to sell
toxic assets could have been attributed to inability to get prices
reflecting fair value due to the drying up of liquidity. If the PIPP program
began operating on a large scale, however, that would no longer been the
case.
Armed with ample government funding, the private
managers running funds set under the program would be expected to offer fair
value for banks’ assets. Indeed, because the government’s funding would come
in the form of non-recourse financing, many have expressed worries that such
fund managers would have incentives to pay even more than fair value for
banks’ assets. The problem, however, is that banks now have strong
incentives to avoid selling toxic assets at any price below face value even
when the price fully reflects fair value.
A month after the PPIP program was announced, under
pressure from banks and Congress, the U.S. Financial Accounting Standards
Board watered down accounting rules and made it easier for banks not to mark
down the value of toxic assets. For many toxic assets whose fundamental
value fell below face value, banks may avoid recognizing the loss as long as
they don’t sell the assets.
Even if banks can avoid recognizing economic losses
on many toxic assets, it remained possible that bank regulators will take
such losses into account (as they should) in assessing whether banks are
adequately capitalized. In another blow to banks’ potential willingness to
sell toxic assets, however, bank supervisors conducting stress tests decided
to avoid assessing banks’ economic losses on toxic assets that mature after
2010.
The stress tests focused on whether, by the end of
2010, the accounting losses that a bank will have to recognize will leave it
with sufficient capital on its financial statements. The bank supervisors
explicitly didn’t take into account the decline in the economic value of
toxic loans and securities that mature after 2010 and that the banks won’t
have to recognize in financial statements until then.
Together, the policies adopted by accounting and
banking authorities strongly discourage banks from selling any toxic assets
maturing after 2010 at prices that fairly reflect their lowered value. As
long as banks don’t sell, the policies enable them to pretend, and operate
as if, their toxic assets maturing after 2010 haven’t fallen in value at
all.
By contrast, selling would require recognizing
losses and might result in the regulators’ requiring the bank to raise
additional capital; such raising of additional capital would provide
depositors (and the government as their guarantor) with an extra cushion but
would dilute the value of shareholders’ and executives’ equity. Thus, as
long as the above policies are in place, we can expect banks having any
choice in the matter to hold on to toxic assets that mature after 2010 and
avoid selling them at any price, however fair, that falls below face value.
While the market for banks’ toxic assets will
remain largely shut down, we are going to get a sense of their value when
the FDIC auctions off later this summer the toxic assets held by failed
banks taken over by the FDIC. If these auctions produce substantial
discounts to face value, they should ring the alarm bells. In such a case,
authorities should reconsider the policies that allow banks to pretend that
toxic assets haven’t fallen in value. In the meantime, it must be recognized
that the curtailing of the PIPP program doesn’t imply that the toxic assets
problem has largely gone away; it has been merely swept under the carpet.
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
"Expedited fair value guidance may ease pressure on banks,"
AccountingWeb, March 17, 2009 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=107232
Following a hearing at a
House Financial Services subcommittee last week, the Financial Accounting
Standards Board (FASB) agreed to expedite release of their proposed guidance
for the application of FAS 157 "Fair Value Measurement." The proposed
guidance was published for public comment on March 17th and will be voted on
by the Board on April 2. If approved, the FASB recommends that the guidance
be effective for interim and annual periods ending after March 15, 2009.
According to CFO.com, FASB chairman, Robert H. Herz, chairman of the
Financial Accounting Standards Board (FASB), told legislators, "We can have
the guidance in three weeks, but whether that will fix everything is another
[issue]."
SB's proposal give more detailed guidance for
valuing assets that would be classified as Level 3 under FAS 157, where
values are assigned in the absence of an active market or where a sale has
occurred in distressed circumstances when prices are temporarily weighed
down. The new guidance allows companies to use their own models and
estimates and exercise "significant judgment" to determine whether a market
exists or whether the input is from a distressed sale. Under FAS 157,
financial instruments' fair values cannot be based on distressed sales.
FASB had planned to issue the proposed guidance by
the end of the second quarter. A study on mark-to-market accounting
standards conducted by the Securities and Exchange Commission (SEC), which
was mandated by the Emergency Economic Stabilization Act of 2008, concluded
that more application guidance to determine fair values was needed in
current market conditions. On February 18, Herz announced that FASB agreed
with the SEC study and would develop additional guidance.
Thomas Linsmeier, FASB board member, said that they
hoped that the new guidance could lead to more accurate and possibly higher
values, CFO.com reports. "What we are voting on will hopefully elevate fair
values to a more reasonable price so investors are more comfortable
investing in the banking system," he said.
Edward Yingling, president of the American Bankers
Association, said in a statement he welcomed the proposal but expressed
caution about the ways it might be used by auditors, MarketWatch says.
"While we welcome today's news, it will be important to look at the details
of the written proposal to see how fully it improves the guidance. It will
also be imperative to examine the practical effect the proposal will have
based on the various ways it is interpreted."
The FASB proposal recommends that companies take
two steps to determine whether there an active market exists and whether a
recent sale is distressed before applying their own models and judgment:
Step 1: Determine whether there are factors
present that indicate that the market for the asset is not active at the
measurement date. Factors include:
- Few recent transactions (based on volume and
level of activity in the market). Thus, there is not sufficient
frequency and volume to provide pricing information on an ongoing basis.
- Price quotations are not based on current
information.
- Price quotations vary substantially either
over time or among market makers (for example, some brokered markets).
- Indices that previously were highly correlated
with the fair values of the asset are demonstrably uncorrelated with
recent fair values.
- Abnormal (or significant increases in)
liquidity risk premiums or implied yields for quoted prices when
compared to reasonable estimates of credit and other nonperformance risk
for the asset class.
- Significant widening of the bid-ask spread.
- Little information is released publicly (for
example, a principal-to-principal market).
If after evaluating all the factors the sum of the
evidence indicates that the market is not active, the reporting entity shall
apply step 2.
Step 2: Evaluate the quoted price (that is,
a recent transaction or broker price quotation) to determine whether the
quoted price is not associated with a distressed transaction. The reporting
entity shall presume that the quoted price is associated with a distressed
transaction unless the reporting entity has evidence that indicates that
both of the following factors are present for a given quoted price:
- There was a period prior to the measurement
date to allow for marketing activities that are usual and customary for
transactions involving such assets or liabilities (for example, there
was not a regulatory requirement to sell).
- There were multiple bidders for the asset.
The proposed guidance also provides examples of
measurement approaches in the event that the observable input is from a
distressed sale.
At Monday's meeting, Herz deflated any beliefs that
FASB's new guidance will be a panacea for the many ills of the U.S. economy.
"There's not much accounting can do other than help people get the facts and
use their best judgment," he said.
The International Accounting Standards Board, which
sets accounting rules followed by more than 100 countries, plans to publish
a draft rule to replace and simplify fair-value accounting rules. Critics
say the rules have exacerbated the credit crunch by forcing write-downs. "We
plan to replace it, the whole thing. We want to stop patching up the
standard and we want to write a new one. We are aware that the current model
is too complex. We need to simplify.... We will move to exposure draft
hopefully within the next six months," said Philippe Danjou, a member of the
IASB board.
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
Professor Schiller at Yale asserts housing prices are still overvalued
and need to come down to reality
The median value of a U.S. home in 2000 was
$119,600. It peaked at $221,900 in 2006. Historically, home prices have
risen annually in line with CPI. If they had followed the long-term trend,
they would have increased by 17% to $140,000. Instead, they skyrocketed by
86% due to Alan Greenspan’s irrational lowering of interest rates to 1%, the
criminal pushing of loans by lowlife mortgage brokers, the greed and hubris
of investment bankers and the foolishness and stupidity of home buyers. It
is now 2009 and the median value should be $150,000 based on historical
precedent. The median value at the end of 2008 was $180,100. Therefore, home
prices are still 20% overvalued. Long-term averages are created by periods
of overvaluation followed by periods of undervaluation. Prices need to fall
20% and could fall 30%.....
Watch the video on Yahoo Finance ---
Click Here
See the chart at
http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
Also see Jim Mahar's blog at
http://financeprofessorblog.blogspot.com/2009/02/shiller-house-prices-still-way-too-high.html
Jensen Comment
In the worldwide move toward fair value accounting that replaces cost
allocation accounting, the above analysis by Professor Schiller is sobering.
It suggests how much policy and widespread fraud can generate misleading
"fair values" in deep markets with many buyers and sellers, although the
housing market is a bit more like the used car market than the stock market.
Each house and each used car are unique, non-fungible items that are many
times more difficult to update with fair value accounting relative to
fungible market securities and new car markets.
Last weekend, Harvard University sponsored a
conference called (I am not making this up) "The Free Market Mindset: History,
Psychology, and Consequences." Its purpose was to try to figure out why, since
everyone knows the current crisis amounts to a failure of the market economy,
the stupid rubes continue to believe in it. The promotional literature for the
conference opened with That Quotation from Alan Greenspan — the one in which he
suggested that there was, after all, a "flaw" in the free market he hadn't
noticed before.
Thomas E. Wood, Jr., "Supporters of Capitalism Are Crazy, Says Harvard," Ludwig
von Mises, Institute, March 17, 2009 ---
http://mises.org/story/3379
Jensen Comment
Conservatism's hero Bill Buckley once commented, after the implosion of the
Soviet Union and the tearing down of the Iron Curtain, that the only communists
left in the world worked along the banks of the Charles River (read that
Cambridge, Mass.). Communists can take heart that the person virtually in charge
of the U.S. economy, Lawrence Summers, is a Harvard Professor.
Aides say that Obama was drawn to Summers in part
because the former Harvard president shares the president-elect’s passion for a
more equitable distribution of economic benefits. Obama was impressed during
campaign policy discussions that Summers would often pull the conversation away
from general talk about economic growth to a concern with the living standards
of families with average incomes.” There’s an irony here . . . As Dem-oriented
economists go, Summers used to be known as among the more laissez-faire
oriented. As Dan Froomkin recently wrote at the Washington Post, citing the
Nation’s Christopher Hayes, “It’s hard to imagine the Larry Summers of 1993
saying that income inequality is the ‘defining issue of our time,’ as he
recently did.” But a couple years ago, perhaps sensing the changing political
sands, Summers became a born-again redistributionist. And that made him
attractive to Barack Obama.
Mark Finkelstein, "Obama Dug Summers’ Redistributionist
Rap," Finkel Blog, March 19, 2009 ---
http://finkelblog.com/index.php/2009/03/19/obama-dug-summers-redistributionist-rap/
Mark got the quote from E.J. Dionne’s Washington Post column ---
http://www.washingtonpost.com/wp-dyn/content/article/2008/11/24/AR2008112402116_pf.html
"Now Is No Time to Give Up on Markets (or fair value accounting)," by
Anastasia O'Grady, The Wall Street Journal, March 21, 2009 ---
http://online.wsj.com/article/SB123759849467801485.html?mod=djemEditorialPage
Gary Becker, the winner of the 1992 Nobel Prize in
Economic Sciences, is in New York to speak to a special meeting of the Mont
Pelerin Society on the global meltdown. He has agreed to sit down to chat
with me on the subject of his lecture.
Slumped in a soft chair in a noisy hotel coffee
lounge, the 78-year-old University of Chicago professor is relaxed and
remarkably humble for a guy who has achieved so much. As I pepper him with
the economic and financial riddles of our time, I am impressed by how many
times his answers, delivered in a pronounced Brooklyn accent, include an "I
think" and sometimes even an "I don't know the answer to that." It is a
reminder of why he is so highly valued. In contrast to a number of other
big-name practitioners of the dismal science, he is a solid empiricist
genuinely in search of answers -- not the job as the next chairman of the
Federal Reserve. What he sees is what you get.
. . .
Mr. Becker sees the finger prints of big government
all over today's economic woes. When I ask him about the sources of the
mania in housing prices, the first culprit he names is the Fed. Low interest
rates, he says, were "partly, maybe mainly, due to the Fed's policy of
keeping [its] interest rates very low during 2002-2004." A second reason
rates were low was the "high savings rates primarily from Asia and also from
the rest of the world."
"People debate the relative importance of the two
and I don't think we know exactly," Mr. Becker admits. But what is clear is
that "when you have low interest rates, any long-lived assets tend to go up
in price because they are based upon returns accruing over many years. When
interest rates are low you don't discount these returns very much and you
get high asset prices."
On top of that, Mr. Becker says, there were
government policies aimed at "extending the scope of homeownership in the
United States to low-credit, low-income families." This was done through
"the Community Reinvestment Act in the '70s and then Fannie Mae and Freddie
Mac later on" and it put many unqualified borrowers into the mix.
. . .
How about getting rid of the mark-to-market
pricing of bank assets [that is, pricing assets at the current market price]
that some say has destroyed bank capital?
Mr. Becker says he prefers mark-to-market over "pricing by cost because
costs are often completely out of whack with what the real prices are." Then
he adds this qualifier: "But when you have a very thin market, you have to
be very careful about what it means to mark-to-market. . . . It's a big
problem if you literally take mark-to-market in terms of prices continuously
based on transactions when there are very few transactions in that market. I
am a mark-to-market person but I think you have to do it in a sensible way."
However that issue is resolved in the short run,
there will remain the problem of institutions growing so big that a collapse
risks taking down the whole system. To deal with the "too big to fail"
problem in the long run, Mr. Becker suggests increasing capital requirements
for financial institutions, as the size of the institution increases, "so
they can't have [so] much leverage." This, he says, "will discourage banks
from getting so big" and "that's fine. That's what we want to do."
Mr. Becker is underwhelmed by the stimulus package:
"Much of it doesn't have any short-term stimulus. If you raise research and
development, I don't see how it's going to short-run stimulate the economy.
You don't have excess unemployed labor in the scientific community, in the
research community, or in the wind power creation community, or in the
health sector. So I don't see that this will stimulate the economy, but it
will raise the debt and lead to inefficient spending and a lot of problems."
There is also the more fundamental question of
whether one dollar of government spending can produce one and a half dollars
of economic output, as the administration claims. Mr. Becker is more than
skeptical. "Keynesianism was out of fashion for so long that we stopped
investigating variables the Keynesians would look at such as the multiplier,
and there is almost no evidence on what the multiplier would be." He thinks
that the paper by Christina Romer, chairman of the Council of Economic
Advisors, "saying that the multiplier is about one and a half [is] based on
very weak, even nonexistent evidence." His guess? "I think it is a lot less
than one. It gets higher in recessions and depressions so it's above zero
now but significantly below one. I don't have a number, I haven't estimated
it, but I think it would be well below one, let me put it that way."
As the interview winds down, I'm thinking more
about how people can make pretty crazy decisions with the right incentives
from government. Does this explain what seems to be a decreasing amount of
personal responsibility in our culture? "When you get a larger government,
when you have the government taking over Social Security, government taking
over health care and with further proposals now for the government to take
over more activities, more entitlements, the rational response is to have
less responsibility. You don't have to worry about things and plan on your
own as much."
That suggests that there is a risk to the U.S.
system with more people relying on entitlements. "Well, they become an
interest group," Mr. Becker says. "The more you have dependence on the
government, the stronger the interest group of people who want to maintain
it. That's one reason why it is so hard to get any major reform in reducing
government spending in Scandinavia and it is increasingly so in the United
States. The government is spending -- at the federal, state and local level
-- a third of GDP, and that share will go up now. The higher it is the more
people who are directly or indirectly dependent on the government. I am
worried about that. The basic theory of interest-group politics says that
they will have more influence and their influence will be to try to maintain
this, and it will be hard to go back."
Still, there remain many good reasons to continue
the struggle against the current trend, Mr. Becker says. "When the market
economy is compared to alternatives, nothing is better at raising
productivity, reducing poverty, improving health and integrating the people
of the world."
The
biggest joke is that banks want to blame the scorekeepers for the goofs they
made themselves while playing the game. It’s bad enough to blame the
umpire/referee, but to blame the scorekeeper is absurd. The players are bankers
and the umpire/referees are the regulators. These players and umpire/referees
are now trying to place the banking crisis blame on the lowly bean counters. I
think I can make a cartoon out of that metaphor.
November 25,
2008 message from Zane Swanson
Accounting could have a role
in addressing crisis situations but the current historical character of the
financial statements precludes explicit warnings about market failures. For
the most part (balance sheet fair value accounting notwithstanding),
statements present after-the-fact information. Only the auditors’
identification of a going concern problem gives an accounting advance
warning. But, how many of the 2008 failed financial institutions had going
concern opinions? None that I heard of this year … wait till next year. The
MD&A is the communication that management is supposed to use to discuss
trends. Once again, these reports come out once a year with the financial
statements. Even so, how many financial institution 2007 MD&As identified
the value at risk commensurate with the consequent 2008 disasters? Answer
that one yourself.
With the switch from US GAAP to the European style
IFRS, perhaps firms will also be coerced into preparing European style
sustainability reports. Sustainability reports may not be perfect (what is?)
as currently constituted, but they could be an avenue to more accurately
focus attention on future events / trends about impending crises.
Zane Swanson
November 25, 2008 reply from Bob Jensen
Hi Zane,
There are almost always warnings under most any accounting system. The
Paton and Littleton 1940 model required estimation of bad debts. Certainly
if bad debts had been properly estimated, we would’ve had ample warning with
virtually no fair value accounting other than bad debt estimation. It cannot
be argued that historical cost accounting as implemented in the 1940s and
1950s would’ve failed us if bad debts were properly estimated and auditors
were truly independent of their largest Wall Street clients. If bad debts
had been properly estimated for banks over the past two decades there
would’ve never been a crisis of this magnitude. Auditors simply caved in to
bullying clients who pressured for enormous underestimation of bad debts.
Under later GAAP with FAS 105, 115, and 133 in place there were even more
accounting warnings that a bubble was building and would one day burst. The
problem with accounting information is that it combines with other signals
in the economy that add noise and make it very difficult to predict just
when the bubble will burst. If investors and lawmakers paid close attention,
there were ample warnings.
Warren Buffett has been studying financial statements for the past two
decades and has been loudly warning about the dangers of a gigantic
derivatives bubble, and in many ways the present crisis is merely a
fulfillment of his prophecy.
Frank Partnoy (in Infectious Greed) and many other analysts and
academicians warned over and over again about the dangers of not regulating
the derivative markets, especially the credit default derivatives market ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds A
lot of the blame falls at the feet of Alan Greenspan who, after the big
bang, finally admits he made a “terrible mistake” by not requiring greater
regulation ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The problem is that people in power just did not want to heed the
warnings. Rep. Barney Frank kept pressuring Fannie Mae and the other
mortgage lenders to make loans to poor people who really had no chance of
making their mortgage payments. The investment bankers and traditional
bankers were making such high commissions and bonuses that they were more
than willing to keep blowing up the bubble even when it became obvious that
their shareholders were going to take a beating. All along the line hogs
feeding on the trough from Wall Street to Main Street knew what they were
doing was wrong, but succumbed to their own greed. Accounting should not be
blamed completely, although the actions of the auditors, credit rating
agencies, and banks estimating bad debts were complicit in creating this
mess ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen
"SEC ISSUES DETAILED STUDY ON MARK-TO-MARKET ACCOUNTING,"
by Gia Chevis, Accounting Education.com, February 19, 2009 ---
http://accountingeducation.com/index.cfm?page=newsdetails&id=148980
The report was issued on December 31, 2008
At the direction of the U.S.
Congress, the SEC prepared and released on 30 December 2008 a study on
mark-to-market accounting and its role in the recent financial crises.
Though it concluded that mark-to-market accounting was not responsible
for the crisis, it did make eight recommendations.
The 259-page document, a result of the Emergency Economic Stabilization
Act of 2008, details an in-depth study of six issues identified by the
Act: effects of fair value accounting standards on financial
institutions' balance sheets; impact of fair value accounting on bank
failures in 2008; impact of fair value accounting on the quality of
financial information available to investors; process used by the FASB
in developing accounting standards; alternatives to fair value
accounting standards; and advisability and feasibility of modifications
to fair value accounting standards. Its eight recommendations are:
1) SFAS No. 157 should be improved, but not suspended.
2) Existing fair value and mark-to-market requirements should not be
suspended.
3) While the Staff does not recommend a suspension of existing fair
value standards, additional measures should be taken to improve the
application and practice related to existing fair value requirements
(particularly as they relate to both Level 2 and Level 3 estimates).
4) The accounting for financial asset impairments should be readdressed.
5) Implement further guidance to foster the use of sound judgment.
6) Accounting standards should continue to be established to meet the
needs of investors.
7) Additional formal measures to address the operation of existing
accounting standards in practice should be established.
8) Address the need to simplify the accounting for investments in
financial assets.
On February 18, the FASB
announced the addition of two short-timetable projects to its agenda
concerning fair value measurement and disclosure. The first project aims
to improve application guidance for measurement of fair value, with
issuance projected for the second quarter. The second will address
issues related to input sensitivity analysis and changes in levels; the
FASB anticipates completing that project in time for calendar-year-end
filing deadlines. Both projects were undertaken in response to the SEC's
recent study on mark-to-market accounting and input from the FASB's
Valuation Resource Group.
The full report can be freely downloaded at
http://www.sec.gov/news/studies/2008/marktomarket123008.pdf. (pdf)
SFAS No. 157’s fair value hierarchy prioritizes the inputs
to valuation techniques used to measure fair value into three broad levels. The
fair value hierarchy gives the highest priority to unadjusted quoted prices in
active markets (Level 1) and the lowest priority to unobservable inputs (Level
3). With respect to IFRS, the report states the following on Page 33:
Currently, under IFRS,
“guidance on measuring fair value is dispersed throughout [IFRS] and is
not always consistent.”52 However, as discussed in Section VII.B, the
IASB is developing an exposure draft on fair value measurement guidance.
IFRS generally defines fair
value as “the amount for which an asset could be exchanged, or a
liability settled, between knowledgeable, willing parties in an arm’s
length transaction” (with some slight
variations in wording in different standards).53
While
this definition is generallyconsistent with SFAS No. 157, it is not
fully converged in the following respects:
•
The definition in
SFAS No. 157 is explicitly an exit price, whereas the definition in IFRS
is neither explicitly an exit price nor an entry price.
•
SFAS No. 157
explicitly refers to market participants, which is defined by the
standard, whereas IFRS simply refers to knowledgeable, willing parties
in an arm’s length transaction.
•
For liabilities, the
definition of fair value in SFAS No. 157 rests on the notion that the
liability is transferred (the liability to the counterparty continues),
whereas the definition in IFRS refers to the amount at which a liability
could be settled.
"SEC Advises No Break in 'Mark' (Fair Value
Accounting) Rules," by Michael R. Crittenden, The Wall Street Journal,
December 31, 2008 ---
http://online.wsj.com/article_email/SB123067591247143735-lMyQjAxMDI4MzMwMDYzNzA1Wj.html
The Securities and Exchange Commission recommended
against suspending fair-value accounting rules, instead suggesting
improvements to deal with illiquid markets and reducing the number of models
used to measure impaired assets.
In a 211-page report to U.S. lawmakers, as
expected, the agency's staff Tuesday definitely recommended that fair-value
and mark-to-market not be eliminated or suspended. "The abrupt elimination
of fair value and market-to-market requirements would erode investor
confidence," the report said.
The banking lobby has argued that financial
institutions have been forced to write off as losses still-valuable assets
because the market for them had dried up, creating a spiral of write-downs
and asset sales.
The report said that staff found no evidence to
suggest that the accounting rules had played a significant role in the
collapse of U.S. financial institutions. "While the application of fair
value varies among these banks...in each case studied it does not appear
that the application of fair value can be considered to have been a
proximate cause of the failure," the report said.
Additionally, the SEC suggests that the Financial
Accounting Standards Board narrow the number of accounting models firms can
use to assess the impairment for financial instruments.
IASB = International Accounting Standards Board
"IASB's Responses to the Global Financial Crisis," IAS Plus,
February 25, 2009 ---
http://www.iasplus.com/index.htm
The SAC discussed the current global financial
crisis and the IASB's responses to it. The IASB Chairman and the IASB's
Director of Capital Markets outlined the activities of the IASB and the
staff since the Financial Stability Forum's action plan was issued in April
2008. Among others, the following matters were raised or discussed:
- Regulatory responses tended to mingle
(unhelpfully) issues related to financial stability (prudential
regulation) and 'dynamic provisioning'. These were separate issues that
needed to be addressed separately and not necessarily by accounting
standard-setters.
- The recent activities of the US Financial
Accounting Standards Board with respect to proposed FAS 133
Implementation Issue C22, Exception Related to Embedded Credit
Derivatives, were acknowledged as still under deliberation by the
FASB. The IASB staff and SAC members noted that, if issued in the same
form as it was exposed, C22 would narrow but not eliminate an IFRS/US
GAAP difference. In particular, the March 2009 joint meeting of the IASB
and FASB would examine issues related to impairment.
- The FASB/ IASB Financial Crisis Advisory Group
was of the view that 'financial stability' was the responsibility of
regulators, while the interests of investors (who do not have the
statutory access to information usually available to regulators) are
best served by transparent financial reporting that reflected the
economics of the entity.
- SAC members supported this conclusion, but
noted that transparent financial reporting was necessary for regulators
to achieve financial stability. While SAC members noted that accounting
has an important role to play in market regulation, it should not be
driven by the prudential needs of regulators. As one SAC member put it:
'Financial stability is important, but not at the price of playing with
the numbers'.
- It was suggested that the IASB had been 'slow
out of the blocks' at the beginning of the crisis, with poor
communications. Communications had improved but needed to acknowledge
that, while accounting did not cause the crisis, it was inextricably
involved with it.
- While the use of fair value still has lots of
support in principle, there needs to be greater discipline in how it is
applied in practice. One SAC member, representing a financial regulator,
said that it would be helpful, for example, if all banks applied the
same measurement principles to the same instruments.
- While focusing on fair value for all financial
instruments as a long term goal, the IASB (and the FASB) might be more
successful if they adopted an 'evolutionary' rather than 'revolutionary'
approach and allow the financial markets to regain credibility before
adopting radical changes to the accounting for financial instruments.
- The Experts Advisory Panel's guidance on
applying fair value in illiquid and inactive markets was seen as very
useful guidance and was commended.
- Sharing the results of a study of the use of
the Reclassification Amendment to IAS 39 approved in October 2008, the
SAC was told that about €7.5 billion worth of assets had been
reclassified, resulting in about €5.5 billion positive effect on profit
and loss. The reclassifications had been done primarily for regulatory
capital reasons. The survey had demonstrated a fundamental conflict
between investor and supervisory interests.
The IASB Chairman suggested that the IASB had three
real alternative approaches to accounting for financial instruments
generally:
- (A) Fair value for all financial instruments
- (B) All financial instruments that are
'traded' to be measured at fair value; all others would be measured at
amoritsed cost. ('Traded' was not defined but, in context, appeared to
mean fair value reliably measurable based on price quotations or
transactions in an active market.)
- (C) All financial instruments with contractual
terms and conditions that permit the determination of a basis of
amortisation would be measured at amortised cost; all others would be
measured at fair value.
(It was assumed that certain financial instruments,
such as all derivative financial instruments, would be measured at fair
value.)
Bob Jensen's threads on the global financial crisis are
at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
ull Crap About Fair Value Accounting
Congress is
also be readying legislation to suspend doctors' cancer diagnoses for the next
two years to "help" with the health care crisis.
Ed Scribner
(paraphrased)
Here are three bull
crap teaching cases on this matter. At least two prominent billionaires (Warren
Buffet and Steve Forbes) are totally ignoring the wonderful December 30, 2008
SEC research report that concludes that suspension of fair value accounting for
banks will hurt rather than help solve the banking crisis. But nobody seems to
be listening to anything from the SEC these days. The outstanding SEC research
report is
at
http://www.sec.gov/news/studies/2008/marktomarket123008.pdf
Especially note the review of 22 bank failures beginning around Page 100.
It appears that
Warren Buffett and Steve Forbes are still holding billions of shares of equity
stock that tanked. They will stoop to almost any bull crap accounting rules that
will help lure investors back into the stock market. For example, Warren Buffet
lost $25 billion in share value. He wants you and millions of others to help
create a new stock market bubble. Coloring book fantasy accounting might help
them regain their lost billions.
Bull Crap Teaching Case 3
From The Wall Street Journal Accounting Weekly Review on March 13, 2009
Buffett's Unmentionable Bank Solution
by Holman
W. Jenkins Jr.
Mar 11, 2009
Click here to view the full article on WSJ.com
TOPICS: Disclosure
Requirements, Fair Value Accounting, Mark-to-Market,
Mark-to-Market Accounting, Banking, Disclosure
SUMMARY: In
a CNBC program on Monday, Warren Buffet called for suspension of
mark-to-market accounting for regulatory capital purposes. This
article emphasize that "market-to-market accounting is fine for
disclosure purposes". It also notes that "CNBC, sadly, has been
playing a loop of Mr. Buffet that...leaves out his most
important point. Nobody cares about the merits of mark-to-market
in the abstract, but how it impacts our current banking crisis."
CLASSROOM
APPLICATION: Understanding mark-to-market accounting, bank
regulatory processes, and the purposes of financial reporting
can be covered extremely well using this opinion page editorial.
QUESTIONS:
1. (Introductory) What is mark-to-market accounting?
2. (Advanced) How can banks' capital ratios be
insufficient and banks be reported as insolvent under
mark-to-market accounting, even if "their assets continue to
perform"? In your answer, define insolvency and compare the
notions of impairment of an asset versus the market value of an
asset.
3. (Introductory) What is the difference between using
financial reports for regulatory purposes and using them for
disclosure purposes? In your answer, comment on the definition
of "general purpose financial statements".
4. (Advanced) Why does regulatory reporting "require
actions that might make no sense in the circumstances"? In your
answer, comment on how regulatory reporting results in
requirements to raise capital.
5. (Advanced) Refer again to your answer to question 3
above. Explain the implications of raising capital for current
shareholders.
6. (Advanced) Define the concept of moral hazard.
According to these Opinion page editors, how must regulators
change their approach to handling our current banking crisis to
avoid the problem of moral hazard? How does that differ from
using a system of regulatory capital requirements for banks?
Reviewed By: Judy Beckman, University of Rhode Island
|
We had no need to eviscerate the U.S. financial
services industry in the past year. Mark to market -- applied to regulatory
capital --- was one of many contributors to
this debacle.
Robert D. Arnott, The Wall Street
Journal, March 26, 2009 ---
http://online.wsj.com/article/SB123811401157753457.html#mod=todays_us_opinion
Jensen Comment
Barf --- See below!
Bull Crap Teaching Case 2
Forbes serves up barf --- No it's worse than barf!
It's clear that Forbes never read the excellent December 2008 SEC research
report on this topic.
"Obama Repeats Bush's Worst Market Mistakes: Bad accounting rules are the
cause of the banking crisis," by Steve Forbes, The Wall Street Journal, March 6,
2009 ---
http://online.wsj.com/article/SB123630304198047321.html?mod=djemEditorialPage
What is most astounding about President Barack
Obama's radical economic recovery program isn't its breadth, but its
continuation of the most destructive policies of the Bush administration.
These Bush policies were in themselves repudiations of Franklin Delano
Roosevelt, Mr. Obama's hero.
The most disastrous Bush policy that Mr. Obama is
perpetuating is mark-to-market or "fair value" accounting for banks,
insurance companies and other financial institutions. The idea seems
harmless: Financial institutions should adjust their balance sheets and
their capital accounts when the market value of the financial assets they
hold goes up or down.
That works when you have very liquid securities,
such as Treasurys, or the common stock of IBM or GE. But when the credit
crisis hit in 2007, there was no market for subprime securities and other
suspect assets. Yet regulators and auditors kept pressing banks and other
financial firms to knock down the book value of this paper, even in cases
where these obligations were being fully serviced in the payment of
principal and interest. Thus, under mark-to-market, even non-suspect assets
are being artificially knocked down in value for regulatory capital (the
amount of capital required by regulators for industries like banks and life
insurance).
Banks and life insurance companies that have
positive cash flows now find themselves in a death spiral. Of the more than
$700 billion that financial institutions have written off, almost all of it
has been book write-downs, not actual cash losses. When banks or insurers
write down the value of their assets they have to get new capital. And the
need for new capital is a signal to ratings agencies that these outfits
might deserve a credit-rating reduction.
So although banks have twice the amount of cash on
hand that they did a year ago, they lend only under duress, or apply onerous
conditions that would warm Tony Soprano's heart. This is because they know
that every time they make a loan or an investment there is a risk of a book
write-down, even if the loan is unimpaired.
If this rigid mark-to-market accounting had been in
effect during the banking trouble in the early 1990s, almost every major
commercial bank in the U.S. would have collapsed because of shaky Latin
American and commercial real estate loans. We would have had a second Great
Depression.
But put aside for a moment the absurdity of trying
to price assets in a disrupted or non-existent market, of not distinguishing
between distress prices and "normal" prices. Regulatory capital by its
definition should take the long view when it comes to valuation; day-to-day
fluctuations shouldn't matter. Assets should be kept on the books at the
price they were obtained, as long as the assets haven't actually been
impaired.
Continued in article
Jensen Comment
By now investors know which large banks are stuck with trillions of dollars in
non-performing loans. Wrapping them gold ribbons by reporting them way above
market value is hardly going to induce investors to go out an buy enormous
amounts of common shares of CitiBank, Bank of America, Wells Fargo, and JP
Morgan. This artificial gilding of capital ratios does nothing to solve the
problem of detoxifying the poison of non-performing loans and poisonous
collateralized bonds.
This type of naive and dangerous reasoning was started on September 19, 2008
by former FDIC director Bill Isaac ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#FairValueAccounting
It's certain that FAS 157 needs some amending for broken markets, but what
Isaac and Forbes are proposing serve as no basis for improvements on FAS 157.
After Isaac proposed elimination of fair value accounting for troubled banks,
Congress ordered, in no uncertain terms, the SEC to do a research study on what
was causing so many bank failures like the huge failures of WaMu and Indy Mac.
Although the SEC has been disgraced for a lot of reasons as of late, the
particular study that emerged in a very short period of time (December 2008) is
an excellent study of why banks were failing.
But political pressures mounted in spite of the
SEC research findings. On April 2, 2009 in a 3-2 vote the FASB reached a highly
controversial decision to ease fair value accounting in such a way that banks
will be able to report higher earnings due to changes in accounting rules.
"Expedited fair value guidance may ease pressure on banks,"
AccountingWeb, March 17, 2009 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=107232
Following a hearing
at a House Financial Services subcommittee last week, the Financial
Accounting Standards Board (FASB) agreed to expedite release of their
proposed guidance for the application of FAS 157 "Fair Value
Measurement." The proposed guidance was published for public comment on
March 17th and will be voted on by the Board on April 2. If approved,
the FASB recommends that the guidance be effective for interim and
annual periods ending after March 15, 2009. According to CFO.com, FASB
chairman, Robert H. Herz, chairman of the Financial Accounting Standards
Board (FASB), told legislators, "We can have the guidance in three
weeks, but whether that will fix everything is another [issue]."
SB's proposal give more detailed guidance for
valuing assets that would be classified as Level 3 under FAS 157, where
values are assigned in the absence of an active market or where a sale
has occurred in distressed circumstances when prices are temporarily
weighed down. The new guidance allows companies to use their own models
and estimates and exercise "significant judgment" to determine whether a
market exists or whether the input is from a distressed sale. Under FAS
157, financial instruments' fair values cannot be based on distressed
sales.
FASB had planned to issue the proposed guidance
by the end of the second quarter. A study on mark-to-market accounting
standards conducted by the Securities and Exchange Commission (SEC),
which was mandated by the Emergency Economic Stabilization Act of 2008,
concluded that more application guidance to determine fair values was
needed in current market conditions. On February 18, Herz announced that
FASB agreed with the SEC study and would develop additional guidance.
Thomas Linsmeier, FASB board member, said that
they hoped that the new guidance could lead to more accurate and
possibly higher values, CFO.com reports. "What we are voting on will
hopefully elevate fair values to a more reasonable price so investors
are more comfortable investing in the banking system," he said.
Edward Yingling, president of the American
Bankers Association, said in a statement he welcomed the proposal but
expressed caution about the ways it might be used by auditors,
MarketWatch says. "While we welcome today's news, it will be important
to look at the details of the written proposal to see how fully it
improves the guidance. It will also be imperative to examine the
practical effect the proposal will have based on the various ways it is
interpreted."
The FASB proposal recommends that companies
take two steps to determine whether there an active market exists and
whether a recent sale is distressed before applying their own models and
judgment:
Step 1: Determine whether there are
factors present that indicate that the market for the asset is not
active at the measurement date. Factors include:
- Few recent transactions (based on volume
and level of activity in the market). Thus, there is not sufficient
frequency and volume to provide pricing information on an ongoing
basis.
- Price quotations are not based on current
information.
- Price quotations vary substantially either
over time or among market makers (for example, some brokered
markets).
- Indices that previously were highly
correlated with the fair values of the asset are demonstrably
uncorrelated with recent fair values.
- Abnormal (or significant increases in)
liquidity risk premiums or implied yields for quoted prices when
compared to reasonable estimates of credit and other nonperformance
risk for the asset class.
- Significant widening of the bid-ask
spread.
- Little information is released publicly
(for example, a principal-to-principal market).
If after evaluating all the factors the sum of
the evidence indicates that the market is not active, the reporting
entity shall apply step 2.
Step 2: Evaluate the quoted price (that
is, a recent transaction or broker price quotation) to determine whether
the quoted price is not associated with a distressed transaction. The
reporting entity shall presume that the quoted price is associated with
a distressed transaction unless the reporting entity has evidence that
indicates that both of the following factors are present for a given
quoted price:
- There was a period prior to the
measurement date to allow for marketing activities that are usual
and customary for transactions involving such assets or liabilities
(for example, there was not a regulatory requirement to sell).
- There were multiple bidders for the asset.
The proposed guidance also provides examples of
measurement approaches in the event that the observable input is from a
distressed sale.
At Monday's meeting, Herz deflated any beliefs
that FASB's new guidance will be a panacea for the many ills of the U.S.
economy. "There's not much accounting can do other than help people get
the facts and use their best judgment," he said.
The International Accounting Standards Board,
which sets accounting rules followed by more than 100 countries, plans
to publish a draft rule to replace and simplify fair-value accounting
rules. Critics say the rules have exacerbated the credit crunch by
forcing write-downs. "We plan to replace it, the whole thing. We want to
stop patching up the standard and we want to write a new one. We are
aware that the current model is too complex. We need to simplify.... We
will move to exposure draft hopefully within the next six months," said
Philippe Danjou, a member of the IASB board.
In my opinion, Bill Isaac is an ignorant advocate of horrible and
dangerous bank accounting
First of all he blamed the subprime collapse of thousands of banks on the FASB
requirements for fair value accounting (totally dumb) ---
http://faculty.trinity.edu/rjensen/2008bailout.htm#FairValue
Now he wants the FASB to continued to grossly under estimate loan loss
reserves (now that the FASB is finally trying to fix the problem)
“AccountingWEB Exclusive: Former FDIC Chief says FASB proposal is
'irresponsible'," AccountingWeb, June 3, 2010 ---
http://www.accountingweb.com/topic/accounting-auditing/aw-exclusive-former-fdic-chief-says-fasb-proposal-irresponsible
Banks are notorious for underestimating loan loss reserves and auditors
are notorious for letting them get away with it ---
http://faculty.trinity.edu/rjensen/2008bailout.htm#AuditFirms
On May 26, 2010 the FASB issued an exposure draft that would make it more
difficult to enormously underestimate load losses. International standards are
expected to be changed accordingly.
On May 26, 2010, the FASB issued a proposed Accounting Standards Update,
Accounting for Financial Instruments and Revisions to the Accounting for
Derivative Instruments and Hedging Activities, setting out its proposed
comprehensive approach to financial instrument classification and measurement,
and impairment, and revisions to hedge accounting. Also, extensive new
presentation and disclosure requirements are proposed.
Here’s a “brief” from PwC on
the new May 26 ED from the FASB ---
Click Here
http://cfodirect.pwc.com/CFODirectWeb/Controller.jpf?ContentCode=THUG-85UVWW&SecNavCode=MSRA-84YH44&ContentType=Content
PwC points out some of the
major differences between these proposed FASB revisions versus the IASB
provisions.
Click Here to download the ED http://snipurl.com/fasb5-26-2010
FASB's FSP Decisions: Bigger than Basketball?"
Seeking Alpha, April 2, 2009 ---
http://seekingalpha.com/article/129189-fasb-s-fsp-decisions-bigger-than-basketball
Finally, the FASB held its long-anticipated meeting
on the two FSPs that would have gutted fair value
reporting as it exists. There's been more hoopla
(and hope-la) about these two amendments than in all
of March Madness.
Briefly, here's what transpired, as best as I could
tell from the webcast of the meeting:
1. FSP 157-e, the
proposal which would have provided a direct route to
Level 3 modeling of fair values whenever there was a
problem with quoted prices, will be quite different
from the original plan. There will be indicators of
inactive markets in the final FSP, but they'll only
be indicators for a preparer to consider - and more
importantly, their presence WILL NOT create a
presumption of a distressed price for securities in
question. That part of the proposal would have
greased the skids for Level 3 modeling. Not now.
There will be added required
disclosures, which were not in the exposure draft.
One that I caught: quarterly "aging" disclosures of
the securities that are in a continuous loss
position for more than 12 months and less than 12
months. As discussed in last week's report on the
proposals, these now-annual disclosures are useful
for assessing riskiness of assets that could become
a firm's next other-than-temporary impairment
charge.
Bottom line:
investors didn't lose here.
2. FSP FAS 115-a,
124-a, and EITF 99-20-b, the proposal that
softens the blow of recognizing other-than-temporary
impairments, was essentially unchanged from the
original proposal. It remains a chancre on the body
of accounting literature. The credit portion of an
other-than-impairment loss will be recognized in
earnings, with all other attributed loss being
recorded in "other comprehensive income," to be
amortized into earnings over the life of the
associated security. That's assuming the
other-than-temporary impairment is recognized at
all, because the determination will still be largely
driven by the intent of the reporting entity and
whether it's more likely than not that it will have
to sell the security before recovery. This is a huge
mulligan for banks with junky securities.
If OTT charges are taken, the
full amount of the impairment will be disclosed on
the income statement with the amount being shunted
into other comprehensive income shown as a reduction
of the loss, leaving only the credit portion to be
recognized in current period earnings.
Bottom line:
Investors lost on this vote, and they will have to
pay more attention to OCI in the future, as it
becomes a more frequently-used receptacle for
unwanted debits. When investors note these "detoured
charges" in earnings, they should skip the detour
and factor the full charge into their evaluation of
earnings. A small victory for investors: the
original proposal would have included
other-than-temporary impairments on equity
securities. The final decision will affect only debt
securities.
There was a third, much less-heralded FSP voted upon
at the meeting:
3. FSP FAS 107-a and APB
28-a, which
will make the now-annual fair value disclosures for
all financial instruments required on a quarterly
basis. This will be required beginning in the second
quarter, with early implementation allowed in the
first quarter.
All three FSPs will become
effective in the second quarter, with early
implementation allowed in the first quarter. Note:
any firm electing early adoption of the impairment
FSP cannot wait until later to adopt the FSP 157-e
fair value amendment. If they change the way they
recognize impairments, they also have to change how
they consider the calculation of fair values.
Some board members expressed hope that this
was the last of the "emergency amendments"
to take place at the end of a reporting
period. It seems too much to hope for; there
could more ahead, depending on how
meddlesome the G-20 would like to be.
Remember when IFRS in the United States was
a hot topic? To a very large degree, that
sprouted from a trans-Atlantic summit
meeting between the EU and the White House.
The same thing could happen again if the
G-20 gang decides they know accounting
better than the standard-setters.
Two of the world's biggest accounting firms are
reigniting the dispute over the way that banks account for losses - raising
doubts over the long-awaited convergence of global reporting standards.
"Deloitte chief reignites debate over accounting for banks' losses,"
by Rachel Sanderson and Patrick Jenkins, Financial Times, February 15, 2010
---
http://www.ft.com/cms/s/0/a9cef3fa-19d0-11df-af3e-00144feab49a.html?nclick_check=1
Two of the world's biggest accounting firms are
reigniting the dispute over the way that banks account for losses -
raising doubts over the long-awaited convergence of global reporting
standards.
Jim Quigley, global head of "Big Four"
accounting firm Deloitte Touche Tohmatsu has proposed that banks account
for losses in two radically different ways, to meet the opposing demands
of politicians and accountants.
He has told the Financial Times that he is an
"advocate" of banks making loan loss provisions for "incurred losses"
separately from "expected losses" - and reporting them in two different
lines in their accounts.
However, PwC, the world's largest accounting
firm, has previously criticised a similar proposal, saying it would
"muddy the waters".
Mr Quigley's proposal comes as accountants are
grappling with politicians and regulators over how banks make provision
for their losses, in the wake of the financial crisis. The lack of
consensus threatens agreement on a global set of accounting standards by
mid 2011 - an aim of the group of 20 nations - and follows disputes over
the use of fair value or mark-to-market accounting, experts say.
Politicians and regulators have blamed the
current system of "incurred losses" - whereby companies may make
provision for loan losses only as they occur - for exacerbating the
crisis, by encouraging a cyclical approach to risk management.
But that view is questioned by many accountants
and bankers who say that "incurred losses" give investors clarity.
Accountants and bankers are also are sceptical about the "expected loss"
model, as they fear it raises the risk of "cookie jar" accounting,
whereby executives put funds aside during good years only to release
them later to cover up bad performance.
Mr Quigley said he believed that "one way we
can bridge some of the current conflicts in financial reporting is with
transparency". "The two-line idea accomplishes that transparency
objective," he told the FT. However, PwC, has said it is opposed to
putting two lines in the income statement.
The debate over the use of "expected losses"
centres on whether banks should judge their provisioning over a matter
of months, or over the life cycle of the loan - and whether the
provisions should be taken through profit and loss.
Where were the auditors ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Bob Jensen's threads on fair value accounting ---
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Bob Jensen's threads on accounting standard setting controversies are
at
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
"FASB Approves New Mark-to-Market Guidance," by Matthew G.
Lamoreaux, Journal of Accountancy, April 2, 2009 ---
http://www.journalofaccountancy.com/Web/20091601.htm
Exactly three weeks after FASB Chairman Robert
Herz’s March 12 testimony before a rancorous House Financial Services
subcommittee, the independent standard-setting board voted Thursday to
release three new pieces of guidance to address concerns over the
application of fair value accounting standards in current market
conditions.
All three new pronouncements will be published
in the form of FASB Staff Positions (FSPs). FASB Technical Director
Russell Golden said in a press conference following the meeting that the
final FSPs would not be available until next week.
FASB Staff Position no. FAS 157-e, Determining
Whether a Market Is Not Active and a Transaction Is Not Distressed,
establishes a process to determine whether a market is not active and a
transaction is not distressed. The FSP says companies should look at
several factors and use judgment to ascertain if a formerly active
market has become inactive. Once a market is determined to be inactive,
more work will be required. The company must see if observed prices or
broker quotes obtained represent “distressed transactions.” Other
techniques such as a discounted cash flow analysis might also be
appropriate in that circumstance, as long as it meets the objective of
estimating the orderly selling price of the asset in the current market.
The AICPA’s Accounting Standards Executive
Committee (AcSEC) submitted a comment letter to FASB recommending
against adoption of FSP FAS 157-e based on concerns that it could be
interpreted in a way that would contradict the exit price model of FASB
Statement no. 157, Fair Value Measurements.
But following the meeting, AcSEC Chairman Jay
Hanson said he was pleased that FASB clarified during its deliberations
on Thursday that the FSP is not intended to change the measurement
objective of Statement no. 157.
The second FASB document—FSP FAS 115-a, FAS
124-a, and EITF 99-20-b, Recognition and Presentation of
Other-Than-Temporary Impairments—deals with other-than-temporary
impairment (OTTI). This FSP was passed by a 3-2 vote. Under the new
rules, once an OTTI is determined for a debt security, the portion of an
asset write down attributed to credit losses may flow through earnings
and the remaining portion may flow through other comprehensive income,
depending on the situation and facts involved. There will be several new
required disclosures about how the charges are split.
Initial reaction from financial institutions
regarding the new OTTI rules was positive. “I am pleased to see the
changes being made and believe they will provide more accurate financial
information,” said Security Financial Bank CFO Mark C. Oldenberg, CPA.
“I expect there will be substantial discussion on how to determine
‘credit losses’ versus ‘market losses’ and whether to allow recovery of
OTTI losses.”
But at least some investors did not appear to
be quite so enthusiastic. “The new guidance seems to be a result of
government pressure,” said Jason S. Inman, CPA, of McDonnell Investment
Management LLC. “The fair value concept before the change allowed for
greater transparency in the market and for an investor to make a
decision as to whether or not the company had the ability to hold those
assets until recovery.”
“Investors lost on this vote,” wrote former
FASB Emerging Issues Task Force member Jack Ciesielski, CPA, on the AAO
Weblog regarding the new OTTI rules. “And they will have to pay more
attention to other comprehensive income in the future, as it becomes a
more frequently-used receptacle for unwanted debits. When investors note
these ‘detoured charges’ in earnings, they should skip the detour and
factor the full charge into their evaluation of earnings.”
The third piece of guidance—FSP FAS 107-B and
APB 28-A, Interim Disclosures About Fair Value of Financial
Instruments—will increase the frequency from annually to quarterly of
disclosures providing qualitative and quantitative information about
fair value estimates for all those financial instruments not measured on
the balance sheet at fair value.
All three FSPs will be effective for periods
ending after June 15, 2009. Early adoption is permitted for periods
ending after March 15, 2009. However, if a company wants to adopt the
FSP FAS 115-a, FAS 124-a, and EITF 99-20-b in the first quarter, it must
also adopt the FSP FAS 157-e at the same time.
April 3 message from Bob Jensen
Hi David,
I think I can correctly surmise what IASB Board
members who eventually dissent on easing fair value accounting rules, and I
think I it will be for the same reasons why two of five FASB Board members
voted against the FASB fair value changes announced at
http://www.fasb.org/action/sbd040209.shtml
Yes Robert Herz
Yes Leslie Seidman
Yes Lawrence Smith
No Thomas
Linsmeier
No Marc
Siegel
Reasons for the No votes have not been announced,
but they probably will be published soon by the FASB.
The same 3-2 voting outcome happened on FSP EITF
99-20-1
"FSP EITF 99-20-1: Dissenting Board Members Hit the
Nail on the Head," by Tom Selling, The Accounting Onion, January 14,
2009 ---
http://accountingonion.typepad.com/theaccountingonion/2009/01/fsp-eitf-99-20.html
Is there a pattern here in FASB voting on Fair Value
Accounting? Maybe not if we accept the rationale give to us by Denny
Beresford. My own opinion is that this is not really a fundamental change in
FAS 157 since Level 3 always allowed valuation based on models. What has
changed is that clients and auditors will no longer be so hesitant to move
down to Level 3 after this official re-affirmation of Level 3 taken by the
FASB on April 2 ---
http://seekingalpha.com/article/129189-fasb-s-fsp-decisions-bigger-than-basketball
There are three United States IASB Board Members
Mary Barth, John Smith, and Jim Leisenring. My guess is that two of the
three (maybe all three) will strongly dissent if the IASB follows the April
2 lead on easing fair value accounting rules set by the FASB on April 2.
Mary Barth and John Smith strongly dissented when
the IASB voted to allow entities a free choice between the partial and full
fair value alternatives to goodwill and NCI measurement. Jim Leisingring
went along with the majority of the IASB on that issue, but I think he has
stronger feelings about easing fair value accounting rules. I don’t
anticipate strong objections from the majority of the IASB voting members.
If I’m correct the
dissent is a straw man if you buy into the Level 3 of the original FAS 157.
However, it is a real tiger now that banks will once again be
underestimating bad debt reserves and overstating income with less worry
about investor class action lawsuits. This so-called change in accounting
rules certainly is consistent with “principled-based” accounting standards
and will lead to inconsistencies on how virtually identical financial
instruments are accounted for in practice.
Bob Jensen
April 2, 2009—
Audio
of Today's Press Conference with Robert Herz, Teresa Polley, and Russell Golden
on Fair Value and OTTI Actions
(Posted: 04/02/09)
April 3, 2009 reply from Dennis
Beresford
[dberesfo@TERRY.UGA.EDU]
One of the IASB board members is
on my campus today and he fully expects the IASB to follow the FASB's lead,
which he strongly disagrees with. For the record, I think the FASB's action
was much needed clarification of the intent of SFAS 157 and I applaud its
efforts. This was not at all a situation of "bowing to pressure" but rather
one of realizing that earlier guidance hadn't been applied in the intended
manner. The FASB clearly accelerated its work in response to Congressional
concerns but moving too slowly has been a fault of the FASB from the
beginning, including the 10 1/2 years I was there.
Bob Jensen
"Herz Should Resign," by: J. Edward Ketz, SmartPros, April 2009
---
http://accounting.smartpros.com/x66142.xml
April 2, 2009 is a day of
accounting infamy. It is a day in which the Financial Accounting Standards
Board (FASB) bowed to the pressures of the banking community and Congress to
allow distortions, massagings, and manipulations of the U.S. financial
reports. Because of these cowardly acts, I think it time for Robert Herz to
resign from the FASB.
Robert Herz is the chairman of the FASB, appointed
on July 1, 2002 and reappointed on July 1, 2007. Before this he was a senior
partner with PricewaterhouseCoopers. I have read many of his papers and I
have heard some of his speeches. I have found Mr. Herz quite intelligent,
filled with much knowledge about accounting and finance, well-mannered,
articulate, and an avid defender of the accounting profession.
Unfortunately, I also find Herz lacking in courage
and moral fortitude. Whenever some bully comes on the scene and challenges
him and the FASB to a fight, he runs away. When accounting truth is at
stake, he compromises and enables corporate managers to use methods and
vehicles by which they can cook the books. Shame!
The first thing the FASB did at its April 2 meeting
concerns whether a market is not active and a transaction is not distressed.
In this FSP FAS 157-e, the board allows business enterprises to weigh the
evidence whether the a transaction involved an orderly market; in reality it
will permit managers to ignore distressed conditions, some of which they
themselves created, and to pretend some “value” based on normalcy. Clearly,
this will buoy asset prices on the balance sheet and reduce losses or create
gains on the income statement. Too bad this is fiction.
In the second matter the FASB addressed
other-than-temporary impairments. In this FSP the FASB permits managers to
overlook other-than-temporary impairments if management believes that it
does not have the intent to sell the security and it is more likely than not
it will not have to sell the security before recovery of its cost basis. Of
course, that will be just about everybody so this is a vacuous recognition
condition.
The FSP goes on to state that gains or losses due
to credit risk will go into the income statement, while noncredit gains and
losses will bypass the income statement and go directly into comprehensive
income. This distinction appears academic as in practice it is hard to
distinguish credit losses from noncredit losses. Clearly, this decision will
give managers ample room to manipulate the income statement.
The FASB got pushed into this decision and Robert
Herz caved in. This isn’t the first time either. Herz became chairman after
Enron’s special purpose entities exploded on Wall Street and has yet to do
anything about them. These special purpose entities have also played a part
in the current banking crisis. Herz also presided over the new rules on
business combinations. While I applaud the elimination of the pooling
option, which enabled many corporate frauds, I remain skeptical of the
treatment of goodwill, which is another loophole. And Robert Herz keeps
preaching against complexity and for simplicity and principles-based
accounting, which are keywords to allow corporate executives the power to do
as they wish with the recognition and measurement of revenues and other
elements. (Bob, if these FSPs are based on any legitimate principles, pray
tell us which ones.)
Writing about these items when originally proposed,
Jonathan Weil referred to the FASB as the
Fraudulent Accounting Standards Board. I am
sympathetic with his f-word, but I think it may be too harsh. After all, the
board is “merely” allowing managers to commit fraud without facing any
disincentives. But I think there are other f-words that we could employ,
such as fearful, feckless, and futile.
Mr. Herz, please resign. You are making the board
ineffective as a standard bearer for accounting truth. While I think you
have a sense of right and wrong, you are not willing to hold bankers
accountable for their mistakes and you are not willing to stand up against
politicians who favor lies.
This essay reflects the opinion of the author and not necessarily the
opinion of The Pennsylvania State University.
Jensen Comment
Jonathon Weil was a prominent WSJ reporter during the Enron scandal
"GLASS LEWIS NAMED JONATHAN WEIL MANAGING DIRECTOR AND EDITOR OF FINANCIAL
RESEARCH in 2006 ---
http://www.glasslewis.com/downloads/354-38.pdf
The idea that massive changes have been made is a
huge overstatement. FASB is basically reiterating what it has said all along. A
number of comments from both bank insiders and analysts indicate that no
material changes have been made, . . . Estimates vary but it seems MTM
changes won’t have as big an impact as some would like to believe. Remember, as
Jim Chanos pointed out, the vast majority of bank assets such as ordinary loans,
are NOT marked to market and that the delinquencies on almost all classes of
loans continue to rise. Thus relaxing mark to market will not help stop the
rising delinquencies across a wide swathe of bank assets.
The idea that giving bank executives more leeway in how
they price their assets when a large part of the current problems is a lack of
transparency is laughable.
"Latest on Mark to Market Scapegoat," The Fundamental Analyst,
on April 2, 2009 ---
http://www.thefundamentalanalyst.com/?p=1145
Jensen Comment
Although I tend to agree that the FASB's April 2, 2009 change was not that much
of a change at all since Level 3 value estimates could come from subjective
estimates of future streams of cash flows. However, the problem will be that the
banks themselves use this re-enforce banks to depart from market on bad debt
reserves. Banks will accordingly understate bad debt reserves and overstate
earnings.
Bob
Jensen’s threads on fair value accounting ---
Bob Jensen’s threads
on accounting valuation are at
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
In particular, beginning on Page 100 of the study the SEC reports on why 22
large-size, medium-size, and small-size banks failed. It turns out that most
assets and liabilities of banks are not marked to market in the first place.
Secondly, fair value adjustments downward has not been the problem of recent
bank failures. The problem is non-performing loans, dangerous management of
financial risk, fraud in property valuations (which was especially bad at WaMu),
and performance-based reward systems that induced bank employees to screw their
companies and their shareholders.
If you want to blame accountants, blame the auditors for not raising going
concern questions about the failed banks ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Blame them for badly understating bad debt reserves.
But don't blame them or the FASB/IASB standard setters for fair value
accounting.
And this is from an old accounting professor who favors fair value accounting
for financial and derivative financial instruments but fights against fair value
accountign for non-financial investments ---
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
I'll bet you 99-1 odds that Steve Forbes never read this excellent SEC study:
"Report and Recommendations Pursuant to Section 133 of the Emergency Economic
Stabilization Act of 2008: Study on Mark-To-Market Accounting"
The full report can be freely downloaded at
http://www.sec.gov/news/studies/2008/marktomarket123008.pdf. (pdf)
March 6, 2009 reply from Dennis Beresford
[dberesfo@TERRY.UGA.EDU]
Bob,
Congress is holding a hearing on market value
accounting next week -
http://www.house.gov/apps/list/hearing/financialsvcs_dem/hr031209.shtml
I understand that one Congressman is readying
legislation to suspend market value accounting for two years in order to
"help" with the economic crisis.
On a somewhat related point, see the recent speech
by the Comptroller of the Currency who would like to use the allowance for
loan losses of banks to squirrel away amounts in good times that can then be
drawn on in bad times like these -
http://www.occ.treas.gov/ftp/release/2009-16a.pdf
Along with GM's going concern qualification,
accounting is truly front page news again - after fading into the background
a little a couple of years after SOX. We are indeed living in interesting
times although with the value of my portfolio being what it is "living" may
be putting too positive a spin on it!
Denny
March 6, 2009 reply from Ed Scribner
[escribne@NMSU.EDU]
Denny,
That same Congressman may also
be readying legislation to suspend doctors' cancer diagnoses for the next
two years to "help" with the health care crisis.
Ed
March 6, 2009 reply from Richard C. Sansing
[Richard.C.Sansing@TUCK.DARTMOUTH.EDU]
Thanks for a Friday afternoon chuckle. I see many
potential applications of the same idea. Can we help address global warming
by suspending the use of thermometers?
Richard Sansing
Bull Crap Teaching Case 1
From The Wall Street Journal Accounting Weekly Review on
Bank Capital Gets Stress Test
by Deborah
Solomon and Jon Hilsenrath
Feb 26, 2009
Click here to view the full article on WSJ.com
http://online.wsj.com/article/SB123557705225772665.html?mod=djem_jiewr_AC
TOPICS: Bad
Debts, Banking, Financial Analysis, Financial Statement Analysis
SUMMARY: The
Obama administration is proposing new bank capital requirement tests that
will be designed to assess whether "...banks can survive even if the
unemployment rate rises above 10% and home prices fall by another
25%....worse than most economists and the Federal Reserve currently expect."
If banks fail to demonstrate sufficient capital to weather those
circumstances, they may either raise additional funds privately or accept
further investment from the U.S. government. "The government's investment
would come in the form of convertible preferred shares, which institutions
could choose to convert into common equity at any time....Officials said
they expect banks would convert the shares to common equity as needed to
help protect against losses."
CLASSROOM APPLICATION: Questions
help students to understand the meaning of capital beyond the balance sheet
definition of assets - liabilities = equity and to understand the
relationship between economic forecasting and bank capital requirements. The
article also discusses the use of preferred shares versus common stock and
the use of convertible preferred shares.
QUESTIONS:
1. (Introductory)
Define bank capital in terms of the balance sheet equation.
2. (Advanced)
What tests are used to assess a bank's health based on the level of its
capital or equity? (Hint: for background information and an international
perspective, you may investigate the Basel and Basel II Accords of the Basel
Committee on Banking Supervision of the Group of Ten nations. See the
related articles.)
3. (Introductory)
How can economic and financial advisors relate the potential unemployment
rate and mortgage default rate in the U.S. economy to banks' capital needs?
4. (Advanced)
If financial institutions fail capital requirement tests based on new
thresholds as outlined by the Obama administration, the U.S. government may
invest in "...convertible preferred shares, which institutions could choose
to convert into common equity at any time." Define and describe the
differences between preferred and common shares. Also define convertibility
features.
5. (Introductory)
Why might financial institutions not want to issue common shares of stock
but be allowed to do so by converting preferred shares whenever they so
choose?
6. (Introductory)
What is the difference between financial institutions issuing stock to the
U.S. government in the ways described in this article and nationalizing our
financial institutions?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Rules on Capital Roil U.S. Bankers
by Damian Paletta
Nov 01, 2006
Page: C3
http://online.wsj.com/article/SB116234873761209749.html
by Damian Paletta and Alistair MacDonald
Mar 04, 2008
Page: 03/04
"Bank Capital Gets Stress Test," by Deborah Solomon and Jon Hilsenrath, The
Wall Street Journal, Feb 26, 2009
http://online.wsj.com/article/SB123557705225772665.html?mod=djem_jiewr_AC
The Obama administration, in unveiling details of
its financial-rescue plan, laid out a dark economic scenario it expects
banks to be able to withstand, the starting point for what could become a
significant new infusion of government cash into the banking system.
To ensure banks can survive even if the
unemployment rate rises above 10% and home prices fall by another 25%, the
administration will require some institutions to either raise private money
or accept a bigger investment from the U.S. government. U.S. officials don't
expect the economy to deteriorate that sharply, but they want to be sure
banks are prepared nonetheless.
The first step in the latest effort to shore up the
banking sector will be a series of "stress tests" to assess whether the
largest U.S. banks can survive a protracted slump. The tests aren't expected
to be finished until April. Banks will then have up to six months to address
any shortfall.
Unlike the Bush administration's effort to pump
$250 billion into banks, the Obama team didn't commit a set amount of money
to the effort and President Barack Obama said Tuesday it is likely that
banks will need additional funds beyond the $700 billion rescue package
approved by Congress last fall.
The government's investment would come in the form
of convertible preferred shares, which institutions could choose to convert
into common equity at any time. Regulators and investors have become more
concerned about the amount of common stock banks hold, since that is a
bank's first line of defense against losses.
To ensure their balance sheets are strong, the
biggest banks will be required to undergo a tough assessment, including
whether they have the right type of capital. Officials said they expect
banks would convert the shares to common equity as needed to help protect
against losses.
A bank's capital is its cushion against losses, a
buffer that ensures its depositors and other lenders will get paid even if
the bank runs into trouble.
Economists said most of the nation's largest banks
will likely have to raise capital under the economic assumptions that
regulators plan to use. The stress test assumes an unemployment rate
averaging 8.9% in 2009 and 10.3% in 2010. Because that is an average for a
whole year, the test envisions the jobless rate reaching higher than those
levels on a monthly basis during these stretches. It was 7.6% in January
Under some circumstances, the government might end
up owning majority stakes in banks.
"I think you'll find most firms need more capital
and that Bank of America and Citigroup are going to need a boatful of new
capital," said Douglas Elliott, a fellow at the Brookings Institution.
Discuss Would nationalizing banks improve or worsen
the crisis? Share your thoughts at Journal Community.Banks that get a
government investment will have to comply with strict executive-compensation
restrictions, including curtailed bonuses for top executives and earners.
The securities will pay a 9% dividend -- higher than the 5% banks are
required to pay under the Bush-era program -- and banks would be restricted
in paying dividends and from buying back their own stock. The securities
would automatically convert to common stock after seven years.
Banks that have already sold preferred shares to
the government as part of the $250 billion program would also be able to
swap the preferred shares for convertible securities that can convert to
common shares.
Administration officials said the effort is an
attempt to avoid nationalizing banks and to make sure institutions can lend
money. While officials said most banks are considered well capitalized,
uncertainty about economic conditions is hindering their ability to lend
money or attract private capital.
Treasury Secretary Timothy Geithner sought to knock
down speculation that the government may nationalize banks, saying such a
move is "the wrong strategy for the country and I don't think it's the
necessary strategy." Mr. Geithner, speaking on The NewsHour with Jim Lehrer,
said there may be situations where the government provides "exceptional
support" but that the best outcome is if the banks "are managed and remain
in private hands."
U.S. officials will demand that financial
institutions test the resilience of their portfolios and capital against a
grim, though not catastrophic, economic landscape. The test assumes a 3.3%
contraction in gross domestic product in 2009, which would be the worst
performance since 1946. And it assumes home-price declines of another 22% in
2009 and 7% in 2010.
That would be worse than most economists and the
Federal Reserve currently expect. Private economists on average forecast a
2% contraction in economic output this year and a 2% rebound next year, with
the jobless rate remaining below 10%.
Some private forecasters said they can imagine
worse.
"I don't have any problem believing the
unemployment rate is going to move to 12% or that vicinity," said Laurence
Meyer, vice chairman of Macroeconomic Advisers LLC, a forecasting firm whose
models are widely used in Washington and New York.
Mr. Meyer said regulators had to strike a delicate
balance in designing their test. If they painted a truly grim scenario --
the economy contracted by 9% in 1930, 6% in 1931 and 13% in 1932 -- it could
force banks to raise more capital than they are capable of raising, driving
them further into the government's arms.
"You don't want to know the answer to some of the
questions you might ask," Mr. Meyer said.
Bob Jensen's threads on accounting theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
Bob Jensen's threads on the bailout mess ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
We should not blame fair value accounting for the 2008 bank failures when,
in point of fact, there were conflicts of interest among rating agencies that
would've led to investment failures under any accounting system that did not
disclose the conflicts of interest in the rating agencies themselves.
From the Financial Clippings Blog on October 22, 2008 ---
http://financeclippings.blogspot.com/
I
wrote earlier
that credit rating agencies seem to be run like protection rackets..
from
CNBC
In a hearing today before the House Oversight
Committee, the credit rating agencies are being portrayed as
profit-hungry institutions that would give any deal their blessing for
the right price.
Case in point: this instant message exchange between two unidentified
Standard & Poor's officials about a mortgage-backed security deal on
4/5/2007:
Official #1: Btw (by the way) that deal is ridiculous.
Official #2: I know right...model def (definitely) does not capture half
the risk.
Official #1: We should not be rating it.
Official #2: We rate every deal. It could be structured by cows and we
would rate it.
A former executive of Moody's says
conflicts of interest got in the way of rating agencies properly valuing
mortgage backed securities.
Former Managing Director Jerome Fons, who worked at Moody's until August
of 2007, says Moody's was focused on "maxmizing revenues," leading it to
make the firm more "issuer friendly."
November 6 reply fromn Paul Polinski
[paulp_is@YAHOO.COM]
Hi Bob.
I'm not sure if this has been brought to the listserv yet, but the SEC's web
cast for its roundtable on FAS no. 157 (accessible at
http://www.connectlive.com/events/secroundtable102908/ )
makes for interesting listening, as the different
stakeholder groups, including banks, investors, accountants, and one
academic (Ray Ball; o.k., two, if you count Tom Linsmeier as an FASB
observer) discuss the role of mark-to-market on the financial markets.
Paul
Bob Jensen's threads on the history of
corruption among rating agencies can be found at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
From IASPlus on November 1, 2008 ---
http://www.iasplus.com/index.htm
1
November 2008: IASB publishes fair value guidance
The IASB has published educational guidance on the
application of fair value measurement when markets become
inactive. The guidance consists of a summary document
prepared by IASB staff and the final report of the expert
advisory panel established to consider the issue:
- The summary document
sets out the context of the expert advisory
panel report and highlights important issues
associated with measuring the fair value of
financial instruments when markets become
inactive. It takes into consideration and is
consistent with recent documents issued by the
US FASB and the US SEC.
- The report of the
expert advisory panel identifies practices that
experts use for measuring the fair value of
financial instruments when markets become
inactive and practices for fair value
disclosures in such situations. The report
provides useful information and educational
guidance about the processes used and judgements
made when measuring and disclosing fair value.
|
Here are links to:
|
|
Bob Jensen's threads on the history of
corruption among rating agencies can be found at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
Question
Can we put the following quotations to a test in a logic course in the
philosophy department?
"Some Lessons of the Financial Crisis," by Stephen Schwarzman, The Wall
Street Journal, November 4, 2008 ---
http://online.wsj.com/article/SB122576100620095567.html?mod=djemEditorialPage
Third, you need full transparency for financial
statements. Nothing should be
eliminated. Off-balance-sheet vehicles that
suddenly return to the balance sheet to wreak havoc make a mockery of
principles of disclosure.
Fourth, you need full
disclosure of all financial instruments to the
regulator. No regulator can do its job of assessing risk and systemic
soundness if large parts of the financial markets are invisible to it. A
regulator must be able to monitor all derivatives, including, for example,
$60 trillion in credit default swaps.
Sixth, we need to
abolish mark-to-market accounting for hard-to-value assets.
There is now emerging a broad realization that mark-to-market accounting has
exacerbated the current crisis. We are not talking about publicly traded
equities with a readily ascertainable value. The problem involves securities
held for investment purposes, and those instruments during certain times of
the cycle for which there is no readily observable market. These securities
and instruments would be fully disclosed to the regulator. However, a
financial institution would not be forced to suddenly take huge write downs
at artificial, fire-sale prices and thus contribute to financial
instability.
Bob Jensen's threads on earnings management are at
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Question
Will fair value accounting reduce or exacerbate the problem of economic and
stock market bubbles?
September 2008 reply from Bob Jensen
One time I posed a question to the,
then, Editor of The Wall Street Journal Editorial Page (my former
fraternity brother Bob Bartley) about why the WSJ on that very day was
attacking Mike Milken as a felonious thief on Page 1 and praising Milken
as a creative capitalist on the Editorial Page. Bob Bartley's truthful
response was that the WSJ, more than any other newspaper, is really two
newspapers bundled into one copy. The Editorial
Page is an unabashed advocate of free-reining capital markets (Damn the
Torpedoes). The rest of the newspaper reports the facts (and I
think the WSJ reporters are among the best in the world, especially when
they commenced to prickle Ken Lay and Jeff Skilling about hidden related
party transactions at Enron). See Question 22 at
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm
It's interesting that WSJ reporters discovered related party
transactions when Enron's auditors pleaded ignorance about such
fraudulent dealings. But then Andersen was becoming notorious at that
time for bad audits.
Although
I’m not the world’s biggest fan of fair value accounting, I thought
Isaac's article was misleading. It glossed over the fundamental problem
with the recent investment bank failures (personal infectious greed,
disregard for shareholder risk, an ever-fraudulent real estate appraisal
profession, and questionable auditor independence) in an attempt to put
the blame on the fair value accounting standards. If the auditors had
really insisted on adjusting bad debt allowances to what fair values
should’ve been, we might have avoided some of this Wall Street meltdown.
The auditors are partly to blame, although they most likely were
deceived as well by greedy Wall Street analysts and brokers.
Isaac's
opinion piece fits right into the WSJ's repeated and undeserving
hammering of SOX and efforts by standard setters to bring about greater
accounting transparency. The WSJ editors (certainly not all of their
great reporters) have the opinion that accounting stifles growth and
creative capitalism on Wall Street.
It is
interesting to compare the Isaac’s attack (a biased, self-serving attack
in my viewpoint) with Paul Miller’s hopes (Journal of Accountancy,
May 2008) for fair value accounting (that naively relies on the ability
and integrity of the fair value estimation and attestation system):
"The Capital
Markets’ Needs Will Be Served: Fair value accounting limits bubbles
rather than creates them," by Paul B.W. Miller
With regard to the relationship between financial accounting and the
subprime-lending crisis, I observe that the capital markets’ needs will
be served, one way or another.
Grasping this imperative leads to new outlooks and behaviors for the
better of all. In contrast to conventional dogma, capital markets cannot
be managed through accounting policy choices and political pressure on
standard setters. Yes, events show that markets can be duped, but not
for long and not very well, and with inevitable disastrous consequences.
With regard to the crisis, attempts to place blame on accounting
standards are not valid. Rather, other factors created it, primarily
actors in the complex intermediation chain, including:
Borrowers who sought credit beyond their reach.
Borrowers who sought credit beyond their reach.
Investment bankers who earned fees for bundling and selling vaporous
bonds without adequately disclosing risk.
Institutional investors who sought high returns without understanding
the risk and real value.
In addition, housing markets collapsed, eliminating the backstop
provided by collateral. Thus, claims that accounting standards fomented
or worsened this crisis lack credibility.
The following paragraphs explain why fair value accounting promotes
capital market efficiency.
THE GOAL OF FINANCIAL REPORTING The goal of financial reporting, and all
who act within it, is to facilitate convergence of securities’ market
prices on their intrinsic values. When that happens, securities prices
and capital costs appropriately reflect real risks and returns. This
efficiency mutually benefits everyone: society, investors, managers and
accountants.
Any other goals, such as inexpensive reporting, projecting positive
images, and reducing auditors’ risk of recrimination, are misdirected.
Because the markets’ demand for useful information will be satisfied,
one way or another, it makes sense to reorient management strategy and
accounting policy to provide that satisfaction.
THE PERSCRIPTION The key to converging market and intrinsic values is
understanding that more information, not less, is better. It does no
good, and indeed does harm, to leave markets guessing. Reports must be
informative and truthful, even if they’re not flattering.
To this end, all must grasp that financial information is favorable if
it unveils truth more completely and faithfully instead of presenting an
illusory better appearance. Covering up bad news isn’t possible,
especially over the long run, and discovered duplicity brings
catastrophe.
SUPPLY AND DEMAND To reap full benefits, management and accountants must
meet the markets’ needs. Instead, past attention was paid primarily to
the needs of managers and accountants and what they wanted to supply
with little regard to the markets’ demands. But progress always follows
when demand is addressed. Toward this end, managers must look beyond
preparation costs and consider the higher capital costs created when
reports aren’t informative.
Above all, they must forgo misbegotten efforts to coax capital markets
to overprice securities, especially by withholding truth from them.
Instead, it’s time to build bridges to these markets, just as managers
have accomplished with customers, employees and suppliers.
THE CONTENT In this paradigm, the preferable information concerns fair
values of assets and liabilities. Historical numbers are of no interest
because they lack reliability for assessing future cash flows. That is,
information’s reliability doesn’t come as much from its verifiability
(evidenced by checks and invoices) as from its dependability for
rational decision making. Although a cost is verifiable, it is
unreliable because it is a sample of one that at best reflects past
conditions. Useful information reveals what is now true, not what used
to be.
It’s not just me: Sophisticated users have said this, over and over
again. For example, on March 17, Georgene Palacky of the CFA Institute
issued a press release, saying, “Fair value is the most transparent
method of measuring financial instruments, such as derivatives, and is
widely favored by investors.” This expressed demand should help managers
understand that failing to provide value-based information forces
markets to manufacture their own estimates. In turn, the markets
defensively guess low for assets and high for liabilities. Rather than
stable and higher securities prices, disregarding demand for truthful
and useful information produces more volatile and lower prices that
don’t converge on intrinsic values.
However it arises, a vacuum of useful public information is always
filled by speculative private information, with an overall increase in
uncertainty, cost, risk, volatility and capital costs. These outcomes
are good for no one.
THE STRATEGY Managers bring two things to capital markets: (1)
prospective cash flows and (2) information. Their work isn’t done if
they don’t produce quality in both. It does no good to present rosy
pictures of inferior cash flow potential because the truth will
eventually be known. And it does no good to have great potential if the
financial reports obscure it.
Thus, managers need to unveil the truth about their situation, which is
far different from designing reports to prop up false images. Even if
well-intentioned, such efforts always fail, usually sooner rather than
later.
It’s especially fruitless to mold standards to generate this propaganda
because readers don’t believe the results. Capital markets choose
whether to rely on GAAP financial statements, so it makes no sense to
report anything that lacks usefulness. For the present situation, then,
not reporting best estimates of fair value frustrates capital markets,
creates more risk, diminishes demand for a company’s securities and
drives prices even lower.
THE ROLE FOR ACCOUNTING REPORTING Because this crisis wasn’t created by
poor accounting, it won’t be relieved by worse accounting. Rather, the
blame lies with inattention to CDOs’ risks and returns. It was bad
management that led to losses, not bad standards.
In fact, value-based reporting did exactly what it was supposed to by
unveiling risk and its consequences. It is pointless to condemn FASB for
forcing these messages to be sent. Rather, we should all shut up, pay
attention, and take steps to prevent other disasters.
That involves telling the truth, cleanly and clearly. It needs to be
delivered quickly and completely, withholding nothing. Further, managers
should not wait for a bureaucratic standard-setting process to tell them
what truth to reveal, any more than carmakers should build their
products to minimum compliance with government safety, mileage and
pollution standards.
I cannot see how defenders of the status quo can rebut this point from
Palacky’s press release: “…only when fair value is widely practiced will
investors be able to accurately evaluate and price risk.”
THE FUTURE Nothing can prevent speculative bubbles. However, the
sunshine of truth, freely offered by management with timeliness, will
certainly diminish their frequency and impact.
Any argument that restricting the flow of useful public information will
solve the problem is totally dysfunctional. The markets’ demand for
value-based information will be served, whether through public or
private sources. It might as well be public.
--------------------------------------------------------------------------------
Paul B.W. Miller, CPA, Ph.D., a professor of accounting at the
University of Colorado, served on both FASB’s staff and the staff of the
SEC’s Office of the Chief Accountant. He is also a member of the JofA’s
Editorial Advisory Board. His e-mail address is pmiller@uccs.edu.
A Challenge
to Your Students
Was Paul Miller
correct or out in left field in terms of theory vs. implementation vs.
both?
An interesting accounting theory exercise for students would be to
compare how fantasyland (fair value) accounting can in theory can be
used to prevent fantasyland bubbles and then have those students
consider the implementation realities (non-additive fair values due to
covariance terms in going concerns, mixing of realized and unrealized
changes in value, huge fair value measurement error bounds,
less-than-independent auditors engaged by clients suffering from
infectious greet,
etc.).
"Don't Blame Mark-to-Market for Banks' Problems," by Jonathan Weil,
Bloomberg ---
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_weil&sid=aJFrPa3rqhHw
If only we didn't know how badly off the banks are,
then maybe we could save the financial system as we used to know it.
That is the growing mantra from financial
executives and their water carriers in Washington. The major problem isn't
that banks made poor decisions and lost credibility with investors, in their
view. The problem is that mark-to-market accounting is dragging down
financial institutions and the U.S. economy, as House Financial Services
Committee Chairman Barney Frank said last week.
They couldn't be more wrong. And there's so much
misinformation floating around the markets on this subject that it's time,
once again, to debunk the myths.
Myth No. 1: The rules known as Financial Accounting
Standard No. 157 are to blame.
The latest iteration on this tired saw comes from
Christopher Whalen, a managing director at Institutional Risk Analytics, who
gave an interview on the subject Friday. Among his recommendations:
``Rescind FAS 157 so if you have a real quoted
price for an asset, fine, use it. Otherwise you allow companies to use
historic cost. You had a transaction, you know what you paid for it, it's a
fact. All this other stuff is speculation. We are literally creating the
impression of losses.''
The Awful Truth
The truth: FAS 157 doesn't expand the use of
fair-value accounting. Rather, it requires companies to divulge more
information about the reliability of their reported fair values.
Most companies won't even adopt FAS 157 until this
quarter. All the standard does is require companies to disclose how much of
their assets and liabilities are valued using quoted market prices, how much
are measured using valuation models, and how much come from models using
inputs that aren't observable in the market. That's it.
Myth No. 2: Mark-to-market accounting is new.
Companies have been ``marking to model'' for
decades, and few people complained when banks and others were recording
large gains as a result. The difference now, thanks to FAS 157, is that
outsiders can see the extent to which companies' fair-value results are
based on estimates, at least at companies that adopted the rules early.
Financial statements always have been piles of
estimates heaped upon a bunch of guesswork. Look through the footnotes to
any company's financial statements, and you'll see that estimates are used
for everything from loan-loss reserves, to income-tax and stock-option
costs, even revenue.
Solves Nothing
Moving everything to historical-cost accounting
wouldn't solve anything. For assets that aren't marked-to-market each
quarter, such as goodwill and inventory, they still must be written down to
fair value whenever their values have declined sharply and show no sign of
bouncing back. The accountants call this an ``other-than-temporary
impairment.''
So even if we had historical-cost accounting today
for all the mortgage-related holdings that have plummeted in value and for
which there is no liquid market, companies still would have to estimate the
assets' fair values and write them down accordingly. That's because the
values probably won't come back anytime soon, if ever.
Myth No. 3: Companies aren't allowed to explain
their mark- to-market values.
This is a fairly new one. Last week, the Securities
and Exchange Commission said it is drafting a letter to let companies tell
investors when they think the market values of their plunging assets don't
reflect the holdings' actual worth. Companies also would be allowed to
disclose ranges showing what their models say the assets might fetch in the
marketplace.
Guess what? Companies are allowed to do these
things already in the discussion-and-analysis sections of their SEC reports
each quarter. They also can make such disclosures in their
financial-statement footnotes. What they can't do is print ranges on their
balance sheets or income statements, any more than taxpayers can put down
ranges on their Internal Revenue Service returns.
Myth No. 4: Eliminating mark-to-market accounting
will prevent margin calls.
If you're a banker for, say, Thornburg Mortgage
Inc. or Carlyle Capital Corp., do you think for a minute that you would
hesitate to call in one of these companies' loans just because they started
using historical cost to account for hard-to-value financial instruments? No
way. The moment lenders decide the collateral isn't worth enough to support
the loans, they'll demand more collateral or pull the plug, no matter what
the financial statements say.
Myth No. 5: The public would be better off without
mark-to- market accounting.
Investors are fully capable of understanding that
unrealized losses on hard-to-value assets are estimates. They're also smart
enough to know that values change over time. And in the case of things such
as credit-default swaps that eventually might reach some settlement date,
the fair-value changes include vital forward-looking information about what
the future economic costs of these derivatives may be.
What most investors can't tolerate is being kept in
the dark, when companies in their portfolios are sliding toward insolvency
and whistling along the way that all is well.
We've got a meltdown, folks. Deal with it.
Absurd claims are being made that the 2008 U.S. economic meltdown might
have been avoided without fair value accounting
But then maybe it's not so clear cut for fair value accounting in the real
world: Fair Value Theory vs. Fair Value Fraud
In the current environment, I am an ardent supporter
of those who would resist calls to suspend fair value accounting rules. But,
when I was at the SEC, I had a front-row seat on what was perhaps one of the
most brazen abuses of fair value accounting in history. I was reminded of it by
Joseph Stiglitz's recent commentary on CNN.com, in which he
characterized the mortgage securitization craze as
just another pyramid scheme. Keep that in mind as I tell you the story of
Stephen Hoffenberg's $400 million fraud.
Tom Selling, "The Anti-Fair Value
Lobby Has a Point (Even if They Don't Know It)" The Accounting Onion,
September 22, 2008 ---
http://accountingonion.typepad.com/
But, how could fair value accounting be the device
by which one scheme was kept alive, yet could have prevented another? Like
the Hoffenberg case, there is no question that the two main ingredients of
the current fraud were lack of transparency into what was going on, and
accounting tricks to give the illusion that all was well. The difference is
that in the case of our present extreme unction, it was the ability to hide
actual losses (as opposed to create fictitious gains) by not using fair
value accounting for junk assets. The answer for the apparent paradox lies
in a significant flaw in 'fair value' accounting.
...
And another big difference between Towers and the
current crisis is that Hoffenberg got 20 years. Today's CEOs are smart
enough to take their money and run.
"Wall St. Points to Disclosure As Issue Accounting Rule Cited in Turmoil," by
Carrie Johnson, The Washington Post, September 22, 2008 ---
Click Here
Wall Street executives and lobbyists say they know
what helped push the nation's largest financial institutions over the edge
in recent months. The culprit, they say, is accounting.
The banks are making their case now in the hopes
they can persuade securities regulators and lawmakers to temporarily suspend
or roll back an accounting measure that took effect late last year as the
credit crisis bloomed.
At issue is a provision that requires companies to
disclose more information about the value of their assets, including how
much they could fetch on the open market. The accounting standard, known as
fair value or mark to market, has been cited as a contributing factor in the
collapses of American International Group, Freddie Mac and Lehman Brothers.
There's only one problem, according to regulators
and accounting analysts: The provision does not impose new duties on
companies but merely exposes bum mortgage bets, making it a convenient
scapegoat during market unrest.
"It's easy to blame accounting because it doesn't
fight back," said Jack Ciesielski, author of the Analyst's Accounting
Observer, a financial newsletter. "Now that there's somebody out there
putting some light on the financials, it's shoot the messenger."
. . .
"The accounting rules and their implementation have
made this crisis much, much worse than it needed to be," said Ed Yingling,
president of the bankers' association. "Instead of measuring the flame,
they're pouring fuel on the fire."
The odds of a wholesale regulatory reversal in the
near term, however, are slim, according to two sources briefed on the
process, because a shift away from fair-value accounting would only
intensify trouble with pricing complex assets in an unruly market. The
sources spoke on condition of anonymity because they were not authorized to
speak publicly about the matter.
"It is extremely unlikely they are going to back
off of market-value accounting in the midst of a crisis," said a financial
services policy expert with long government experience. "When things
stabilize, I guarantee you that you're going to see a revised procedure."
J. Edward Ketz, an accounting professor at
Pennsylvania State University, says he "doesn't buy" the argument that
fair-value accounting is a root cause of the problems. Executives never
complained about mark-to-market accounting standards when they helped banks
post huge gains on derivative investments during the economic boom, or when
fair-value accounting for stock options produced tax benefits, Ketz said.
"If anything, I think that market-value accounting
has helped to bring the problems to a head earlier and with less damage,
than if market-value accounting hadn't been applied," said Charles W.
Mulford, an accounting expert at the Georgia Institute of Technology.
Continued in article
"Accountants Asked For
Financial and Valuation Data," by Robert W. Owens, The Wall Street Journal,
October 15, 2008 ---
http://online.wsj.com/article/SB122403125701034771.html?mod=djem_jiewr_AC
L. Gordon Crovitz ("Seeking
Rational Exuberance," Information Age, Oct. 6)
justifiably criticizes
accounting for failing in its basic mission of being
informative, while also suggesting that federal
regulators cannot trust the numbers that accountants
provide when establishing capital requirements for
banks.
Mr.
Crovitz's first concern, informative accounting, can
be addressed but requires a major paradigm shift.
The problem here is that over the years the
accounting profession has commingled its primary
role of providing meaningful financial information
with a secondary role of providing "valuation-type"
information, however described. The first of these
roles lies unquestionably with financial
accountants. The second role lies largely outside
the accounting profession and with valuation experts
who take information provided by accountants and
integrate it into their decision process. Some of
the information provided by accountants may be
valuation in nature, such as information on the
current value of short-term receivables or the
current value of loans outstanding, but this should
be considered extracurricular accounting activity.
The
prototype for what financial accountants should be
doing can be found in the fund accounting process
used by municipalities. In the governmental funds,
where most municipal accounting occurs, daily
accounting activity is in the areas of revenue,
expenditures, cash, cash receipts, cash
disbursements, short-term payables, and short-term
receivables. All other types of financial
information (such as plant and equipment records,
long-term debt records, and pension records) are
kept in supplementary records outside the
governmental fund accounting records and can be
provided in a variety of user-friendly formats.
The
second of Mr. Crovitz's concerns can be readily
addressed by not basing capital requirements on
subjective accounting figures. For example, capital
requirements can be set at a flat dollar amount
(say, based on an average of deposits over the
preceding five years) plus some (hopefully, safe)
percentage of end-of-period deposits. Financial
information on deposits is part of the accounting
records but is not subjective in the sense that it
can be unduly influenced through one person's
interpretation of the various rules and regulations
that underpin current financial accounting.
Robert W. Owens, Ph.D.
Professor of Finance
Missouri State University
Springfield, Mo.
October 19, 2008 reply
from Roger Debreceny [roger@DEBRECENY.COM]
As discussed in Double Entries 14(33), the recent
bank rescue legislation (Emergency Economic Stabilization Act of 2008)
requires the SEC to study mark-to-market accounting
http://www.sec.gov/news/press/2008/2008-242.htm
Under the terms of the EESA, the study will focus
on:
1. The effects of such accounting standards on
a financial institution's balance sheet
2. The impacts of such accounting on bank
failures in 2008
3. The impact of such standards on the quality
of financial information available to investors
4. The process used by the Financial Accounting
Standards Board in developing accounting standards
5. The advisability and feasibility of
modifications to such standards
6. Alternative accounting standards to those
provided in [Financial Accounting Standards Board] Statement Number 157
SEC Chairman Christopher Cox announced that James
Kroeker, Deputy Chief Accountant for Accounting at the SEC, will serve as
staff director for the study.”
Roger Debreceny
"Blaming the Bean-Counters Accounting rules did not cause the financial
crisis; changing them won't end it," The Washington Post, October 21,
2008, Page A16
INEVITABLY, PERHAPS, the deepening financial crisis
has spawned a search for scapegoats and quick fixes. According to many
Republican members of Congress, banking industry lobbyists and financial
pundits, the Wall Street meltdown would not be nearly as bad as it is but
for the baleful impact of "mark-to-market" accounting rules. These are
national standards, adopted in the wake of the savings and loan debacle of
the 1980s, that require banks to carry certain financial assets on their
books at the current market price. The idea is to give investors the latest
and most objective estimate of a company's true financial condition -- as
opposed to a company's inevitably self-serving calculation based on original
costs.
Now that the markets for mortgage-backed securities
and derivatives have seized up, however, their market price is either
distressingly close to zero or impossible to determine. Critics argue that
marking-to-market when there is no market artificially and irrationally
depresses banks' balance sheets, since the assets would fetch near
face-value under normal circumstances. Ergo, they contend, the way to shore
up bank capital is to relax or eliminate mark-to-market -- and it wouldn't
cost taxpayers a dime.
The critics have a point. Undoubtedly the markets,
out of irrational fear, are shunning some relatively solid assets as well as
actual turkeys. Mark-to-market therefore does force banks to write their
books in the panicky language of today's meltdown. Perhaps, once the crisis
is over, it would be wise for the Securities and Exchange Commission and the
accounting authorities to revisit this "pro-cyclical" aspect of the rule.
The recent bailout legislation included a provision requiring the SEC to
study mark-to-market's impact. We see no harm in that.
But the critics' arguments against mark-to-market
may prove too much. If the rule requires banks to accentuate the negative
during bust times, then presumably it is also to blame for all those
wonderful financial statements the banks were issuing during the boom. We
don't recall anyone demanding its suspension then. Actually, complaints
about the rule probably overstate its impact, since financial institutions
only have to use it for securities they intend to trade. Loans and
securities held to maturity are not covered by mark-to-market; at big banks
such as SunTrust, Wells Fargo and Bank of America, such long-term assets
represent half or more of all assets.
Markets not only need transparent financial
reporting, they need consistent financial reporting. To suspend or abandon
mark-to-market now, in the middle of a panic, would simply deepen the
confusion and suspicion that are already crippling the financial system. No,
today's financial meltdown is not some accidental byproduct of misguided
technical rules. It happened because too many firms made too many bad
financial bets with borrowed money. Pretending otherwise won't solve
anything.
August 2018 Update
Wells Fargo & Co. agreed to pay $2.09 billion to settle with the U.S. Justice
Department over the sale of toxic mortgage-backed securities in the lead-up to
the financial crisis.---
https://www.wsj.com/articles/wells-fargo-agrees-to-2-09-billion-settlement-for-crisis-era-mortgage-loans-1533147302?mod=searchresults&page=1&pos=1&mod=djemCFO_h
This is on top of all the subsequent fines paid by Wells Fargo & Co. for
unrelated subsequent crimes. What a lousy company.
IFRS (or maybe just the EU) Accounting Rule
Flexibility in Action
"Accounting Changes Help Deutsche Bank Avoid Loss,"
Reuters, The New York Times, October 30, 2008 ---
Click Here
New accounting rules
allowed Deutsche Bank to dodge a loss in the third quarter, the company said
Thursday as it also announced heavy losses in proprietary trading.
Josef Ackermann, the chairman of Deutsche, which is
Germany’s flagship bank and once was seen as having escaped the worst of the
market turmoil, declared a year ago that the financial crisis for his bank
was over.
On Thursday, however, Mr. Ackermann departed from
the optimism that had led him to declare seeing the light at the end of the
tunnel several times over.
“Conditions in equity and credit markets remain
extremely difficult,” he said, warning that the bank could cut its dividend
to shore up capital in a “highly uncertain environment.”
Also Thursday, Germany’s finance minister, Peer
Steinbrück, said that a number of German banks were expected to turn to
Berlin for help. Mr. Steinbrück appeared to make a veiled reference to
Deutsche Bank when he told a newspaper that those seeking help could include
banks that had publicly opposed taking it in the past. Mr. Ackermann
recently was quoted as saying he would be “ashamed” to take taxpayer money.
Deutsche Bank made a pretax profit of 93 million
euros ($118.5 million) in the third quarter, a result possible only because
of changed accounting rules. These allowed it to cut write-downs by more
than 800 million euros, to 1.2 billion euros, during the period.
The new rules, sanctioned by Brussels lawmakers,
soften the old system that demanded all assets reflect market prices.
Deutsche Bank, for example, has more than 22
billion euros of leveraged loans — commitments often made to private equity
investors to lend money to buy companies.
Farming out these loans had become difficult as
worried investors retreated to safe havens and their value had fallen. The
new accounting rules allow Deutsche to hold some of these loans on their
books at a fixed price.
Like all other banks, Deutsche is grappling with a
freeze in interbank lending. Banks around the world have largely stopped
lending to one another after the Wall Street investment bank Lehman Brothers
collapsed in mid-September.
The crisis prompted the German government to start
a rescue fund of 500 billion euros, under which it can give guarantees for
banks seeking financing on this market or by issuing bonds, for example.
Bob Jensen's threads on earnings management are
at
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Claims of IFRS Accounting Rule Flexibility ---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
Agency Theory Question
Why do corporate executives like fair value accounting better than shareholders
like fair value accounting?
Answer
Cash bonuses on the upside are not returned after the downturn that wipes out
the previous unrealized paper profits.
Phantom (Unrealized) Profits on Paper, but
Real Cash Outflows for Employee Bonuses and Other Compensation
Rarely, if ever, are they forced to pay back their "earnings" even in instances
of earnings management accounting fraud
"On Wall Street, Bonuses, Not Profits, Were
Real," by Louise Story, The New York Times, December 17, 2008 ---
http://www.nytimes.com/2008/12/18/business/18pay.html?partner=permalink&exprod=permalink
"Merrill’s record earnings in 2006 — $7.5 billion —
turned out to be a mirage. The company has since lost three times that
amount, largely because the mortgage investments that supposedly had powered
some of those profits plunged in value.
“As a result of the extraordinary growth at Merrill
during my tenure as C.E.O., the board saw fit to increase my compensation
each year.”
— E. Stanley O’Neal, the former chief executive of
Merrill Lynch, March 2008
For Dow Kim, 2006 was a very good year. While his
salary at Merrill Lynch was $350,000, his total compensation was 100 times
that — $35 million.
The difference between the two amounts was his
bonus, a rich reward for the robust earnings made by the traders he oversaw
in Merrill’s mortgage business.
Mr. Kim’s colleagues, not only at his level, but
far down the ranks, also pocketed large paychecks. In all, Merrill handed
out $5 billion to $6 billion in bonuses that year. A 20-something analyst
with a base salary of $130,000 collected a bonus of $250,000. And a
30-something trader with a $180,000 salary got $5 million.
But Merrill’s record earnings in 2006 — $7.5
billion — turned out to be a mirage. The company has since lost three times
that amount, largely because the mortgage investments that supposedly had
powered some of those profits plunged in value.
Unlike the earnings, however, the bonuses have not
been reversed.
As regulators and shareholders sift through the
rubble of the financial crisis, questions are being asked about what role
lavish bonuses played in the debacle. Scrutiny over pay is intensifying as
banks like Merrill prepare to dole out bonuses even after they have had to
be propped up with billions of dollars of taxpayers’ money. While bonuses
are expected to be half of what they were a year ago, some bankers could
still collect millions of dollars.
Critics say bonuses never should have been so big
in the first place, because they were based on ephemeral earnings. These
people contend that Wall Street’s pay structure, in which bonuses are based
on short-term profits, encouraged employees to act like gamblers at a casino
— and let them collect their winnings while the roulette wheel was still
spinning.
“Compensation was flawed top to bottom,” said
Lucian A. Bebchuk, a professor at Harvard Law School and an expert on
compensation. “The whole organization was responding to distorted
incentives.”
Even Wall Streeters concede they were dazzled by
the money. To earn bigger bonuses, many traders ignored or played down the
risks they took until their bonuses were paid. Their bosses often turned a
blind eye because it was in their interest as well.
“That’s a call that senior management or risk
management should question, but of course their pay was tied to it too,”
said Brian Lin, a former mortgage trader at Merrill Lynch.
The highest-ranking executives at four firms have
agreed under pressure to go without their bonuses, including John A. Thain,
who initially wanted a bonus this year since he joined Merrill Lynch as
chief executive after its ill-fated mortgage bets were made. And four former
executives at one hard-hit bank, UBS of Switzerland, recently volunteered to
return some of the bonuses they were paid before the financial crisis. But
few think others on Wall Street will follow that lead.
For now, most banks are looking forward rather than
backward. Morgan Stanley and UBS are attaching new strings to bonuses,
allowing them to pull back part of workers’ payouts if they turn out to have
been based on illusory profits. Those policies, had they been in place in
recent years, might have clawed back hundreds of millions of dollars of
compensation paid out in 2006 to employees at all levels, including senior
executives who are still at those banks.
A Bonus Bonanza
For Wall Street, much of this decade represented a
new Gilded Age. Salaries were merely play money — a pittance compared to
bonuses. Bonus season became an annual celebration of the riches to be had
in the markets. That was especially so in the New York area, where nearly $1
out of every $4 that companies paid employees last year went to someone in
the financial industry. Bankers celebrated with five-figure dinners, vied to
outspend each other at charity auctions and spent their newfound fortunes on
new homes, cars and art.
The bonanza redefined success for an entire
generation. Graduates of top universities sought their fortunes in banking,
rather than in careers like medicine, engineering or teaching. Wall Street
worked its rookies hard, but it held out the promise of rich rewards. In
college dorms, tales of 30-year-olds pulling down $5 million a year were
legion.
While top executives received the biggest bonuses,
what is striking is how many employees throughout the ranks took home large
paychecks. On Wall Street, the first goal was to make “a buck” — a million
dollars. More than 100 people in Merrill’s bond unit alone broke the
million-dollar mark in 2006. Goldman Sachs paid more than $20 million apiece
to more than 50 people that year, according to a person familiar with the
matter. Goldman declined to comment.
Pay was tied to profit, and profit to the easy,
borrowed money that could be invested in markets like mortgage securities.
As the financial industry’s role in the economy grew, workers’ pay
ballooned, leaping sixfold since 1975, nearly twice as much as the increase
in pay for the average American worker.
“The financial services industry was in a bubble,"
said Mark Zandi, chief economist at Moody’s Economy.com. “The industry got a
bigger share of the economic pie.”
A Money Machine
Dow Kim stepped into this milieu in the mid-1980s,
fresh from the Wharton School at the University of Pennsylvania. Born in
Seoul and raised there and in Singapore, Mr. Kim moved to the United States
at 16 to attend Phillips Academy in Andover, Mass. A quiet workaholic in an
industry of workaholics, he seemed to rise through the ranks by sheer will.
After a stint trading bonds in Tokyo, he moved to New York to oversee
Merrill’s fixed-income business in 2001. Two years later, he became
co-president.
Skip to next paragraph
Bloomberg News Dow Kim received $35 million in 2006
from Merrill Lynch.
The Reckoning Cashing In Articles in this series
are exploring the causes of the financial crisis.
Previous Articles in the Series » Multimedia
Graphic It Was Good to Be a Mortgage-Related Professional . . . Related
Times Topics: Credit Crisis — The Essentials
Patrick Andrade for The New York Times Brian Lin is
a former mortgage trader at Merrill Lynch who lost his job at Merrill and
now works at RRMS Advisors. Readers' Comments Share your thoughts. Post a
Comment »Read All Comments (363) »
Even as tremors began to reverberate through the
housing market and his own company, Mr. Kim exuded optimism.
After several of his key deputies left the firm in
the summer of 2006, he appointed a former colleague from Asia, Osman Semerci,
as his deputy, and beneath Mr. Semerci he installed Dale M. Lattanzio and
Douglas J. Mallach. Mr. Lattanzio promptly purchased a $5 million home, as
well as oceanfront property in Mantoloking, a wealthy enclave in New Jersey,
according to county records.
Merrill and the executives in this article declined
to comment or say whether they would return past bonuses. Mr. Mallach did
not return telephone calls.
Mr. Semerci, Mr. Lattanzio and Mr. Mallach joined
Mr. Kim as Merrill entered a new phase in its mortgage buildup. That
September, the bank spent $1.3 billion to buy the First Franklin Financial
Corporation, a mortgage lender in California, in part so it could bundle its
mortgages into lucrative bonds.
Continued in article
Bob Jensen's threads on fair value accounting are a
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
Bob Jensen's "Rotten to the Core" document ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Appendix D
The End of Capitalism, Economics, and
Investment Banking as We Know It
Capitalism from From Adam Smith to Hayek to Von Mises (Austrian School) to Keynes to Michael Moore
Capitalism ---
http://en.wikipedia.org/wiki/Capitalism
Adam Smith ---
http://en.wikipedia.org/wiki/Adam_Smith
Fredrich Hayek ---
http://en.wikipedia.org/wiki/Friedrich_Hayek
Austrian School ---
http://en.wikipedia.org/wiki/Austrian_School
Video: Canadian Banks are Insolvent and Broke ---
http://www.youtube.com/watch?v=U8woOuDjqas&feature=player_embedded
Keynesianism and neoliberalism ---
http://en.wikipedia.org/wiki/Capitalism#Keynesianism_and_neoliberalism
Keynes: The Rise, Fall, and Return of the 20th Century's Most
Influential Economist by Peter Clarke (Bloomsbury; 2009, 211
pages; $20). Examines the life and legacy of the British economist
(1883-1946).
College Dropout Michael Moore's "Capitalism is Evil" ---
http://en.wikipedia.org/wiki/Michael_Moore
Let me
conclude with a political note. The main reason for reform is to serve the
nation. If we don’t get major financial reform now, we’re laying the foundations
for the next crisis. But there are also political reasons to act. For there’s a
populist rage building in this country, and President Obama’s kid-gloves
treatment of the bankers has put Democrats on the wrong side of this rage. If
Congressional Democrats don’t take a tough line with the banks in the months
ahead, they will pay a big price in November.
Paul Krugman, Bubbles and
the Banks," The New York Times, January 7, 2010 ---
http://www.nytimes.com/2010/01/08/opinion/08krugman.html?hpw
"Why Are Some Sectors (Ahem, Finance) So Scandal-Plagued?" by Ben W.
Heineman, Jr., Harvard Business Review Blog, January 10, 2013 ---
Click Here
http://blogs.hbr.org/cs/2013/01/scandals_plague_sectors_not_ju.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
The trouble with crony capitalism isn't capitalism. It's the cronies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#CronyCapitalism
Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit
rating agencies) ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of
Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Here's A Quick Guide To The Startling New Scandal Involving Goldman And
The New York Fed," by Elena Holodny, Business Insider, September 26, 2014
---
http://www.businessinsider.com/propublica-fed-goldman-sachs-recordings-2014-9
. . .
The report is driven by secret recordings that
suggest that the NY Fed regulators were too soft on Goldman and therefore
possibly other banks as well.
The recordings come from former New York Fed bank
examiner Carmen Segarra, who was fired after just seven months on the job.
The article is nearly 6,000 words long, and the
podcast runs for over an hour.
Continued in article
"Why the Fed Is So Wimpy," by Justin Fox, Harvard Business
Review Blog, September 26, 2014 ---
http://blogs.hbr.org/2014/09/why-the-fed-is-so-wimpy/?utm_source=Socialflow&utm_medium=Tweet&utm_campaign=Socialflow
Regulatory capture — when regulators come to act
mainly in the interest of the industries they regulate — is a phenomenon
that economists, political scientists, and legal scholars have been
writing about for decades.
Bank regulators in particular have been
depicted as
captives for years,
and have even taken to
describing themselves as such.
Actually witnessing capture in the wild is
different, though, and
the new This American Life episode with
secret recordings of bank examiners at the Federal Reserve Bank of New York
going about their jobs is going to focus a lot more attention on the
phenomenon. It’s really well done, and you should
listen to it, read
the transcript, and/or
read the story by ProPublica reporter Jake
Bernstein.
Still, there is some context that’s inevitably
missing, and as a former banking-regulation reporter for the
American Banker, I feel called to fill some
of it in. Much of it has to do with the structure of bank regulation in the
U.S., which actually seems designed to encourage capture. But to start,
there are a couple of revelations about Goldman Sachs in the story that are
treated as smoking guns. One seems to have fired a blank, while the other
may be even more explosive than it’s made out to be.
In the first, Carmen Segarra, the former Fed bank
examiner who made the tapes, tells of a Goldman Sachs executive saying in a
meeting that “once clients were wealthy enough, certain consumer laws didn’t
apply to them.” Far from being a shocking admission, this is actually a
pretty fair summary of American securities law. According to the Securities
and Exchange Commission’s “accredited
investor” guidelines, an individual with a net
worth of more than $1 million or an income of more than $200,000 is exempt
from many of the investor-protection rules that apply to people with less
money. That’s why rich people can invest in hedge funds while, for the most
part, regular folks can’t. Maybe there were some incriminating details
behind the Goldman executive’s statement that alarmed Segarra and were left
out of the story, but on the face of it there’s nothing to see here.
The other smoking gun is that Segarra pushed for a
tough Fed line on Goldman’s lack of a substantive conflict of interest
policy, and was rebuffed by her boss. This is a big deal, and for
much more than the legal/compliance reasons discussed in the piece. That’s
because, for the past two decades or so, not having a substantive conflict
of interest policy has been Goldman’s business model. Representing both
sides in mergers, betting alongside and against clients, and exploiting its
informational edge wherever possible
is simply how the firm makes its money. Forcing it
to sharply reduce these conflicts would be potentially devastating.
Maybe, as a matter of policy, the United States
government should ban such behavior. But asking bank examiners at
the New York Fed to take an action on their own that might torpedo a leading
bank’s profits is an awfully tall order. The regulators at the Fed and their
counterparts at the Office of the Comptroller of the Currency and the
Federal Deposit Insurance Corporation correctly see their main job as
ensuring the safety and soundness of the banking system. Over the decades,
consumer protections and other rules have been added to their purview, but
safety and soundness have remained paramount. Profitable banks are generally
safer and sounder than unprofitable ones. So bank regulators are
understandably wary of doing anything that might cut into profits.
The point here is that if bank regulators are
captives who identify with the interests of the banks they regulate, it is
partly by design. This is especially true of the Federal Reserve System,
which was created by Congress in 1913 more as a friend to and creature of
the banks than as a watchdog. Two-thirds of
the board that governs the New York Fed is chosen
by local bankers. And while
amendments to the Federal Reserve Act in 1933
shifted the balance of power in the Federal Reserve System from the regional
Federal Reserve Banks (and the New York Fed in particular) to the political
appointees on the Board of Governors in Washington, bank regulation
continues to reside at the regional banks. Which means that the bank
regulators’ bosses report to a board chosen by … the banks.
Then there’s the fact that Goldman Sachs is a
relative newcomer to Federal Reserve supervision — it and rival Morgan
Stanley only agreed
to become bank holding companies, giving them
access to New York Fed loans, at the height of the financial crisis in 2008.
While it’s a little hard to imagine Goldman choosing now to rejoin the ranks
of mere securities firms, and even harder to see how it could leap to a
different banking regulator, it is possible that some Fed examiners
are afraid of scaring it away.
All this is meant not to excuse the extreme
timidity apparent in the Fed tapes, but to explain why it’s been so hard for
the New York Fed to adopt the more aggressive, questioning approach urged by
Columbia Business School Professor David Beim in a
formerly confidential internal Fed report that
This American Life and ProPublica give a lot of play to. Bank
regulation springs from much different roots than, say, environmental
regulation.
So what is to be done? A lot of the
classic regulatory capture literature tends toward
the conclusion that we should just give up — shut down the regulators and
allow competitive forces to work their magic. That means letting businesses
fail. But with banks more than other businesses, failures tend to be
contagious. It was to counteract this risk of systemic failure that Congress
created the Fed and other bank regulators in the first place, and even if
you think that was a big mistake, they’re really not going away.
Continued in article
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Understanding the Great Recession," by Lawrence J. Christiano, Martin
Eichenbaum, and Mathias Trabandt, SSRN, April 2, 2014 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2474797
Abstract:
We argue that the vast bulk of movements in
aggregate real economic activity during the Great Recession were due to
financial frictions interacting with the zero lower bound. We reach this
conclusion looking through the lens of a New Keynesian model in which
firms face moderate degrees of price rigidities and no nominal
rigidities in the wage setting process. Our model does a good job of
accounting for the joint
behavior of labor and goods markets, as well as inflation, during the
Great Recession. According to the model the observed fall in total
factor productivity and the rise in the cost of working capital played
critical roles in accounting
for the small size of the drop in inflation that occurred during the
Great Recession.
From the CFO Journal's Morning Ledger on March 12, 2014
Moves to revamp the U.S. $10 trillion mortgage market are finally getting
underway, after senators and the White House agreed on a framework to
dismantle the giant lenders
Fannie Mae and
Freddie Mac, nearly
six years after the government took control and rescued them from financial
oblivion.
The
plan, by Senate Banking Committee leaders Tim Johnson (D., S.D.) and Mike
Crapo (R., Idaho), would see Fannie and Freddie replaced by a system of
federally insured mortgage securities in which private insurers would be
required to take initial losses before any government guarantee would be
triggered.
As
the
Wall Street Journal’s Nick Timiraos reports,
the proposal comes just as the companies start to
generate huge profits for the Treasury. But the deal will leave a number of
investors, who were counting on Fannie and Freddie being restructured,
somewhat confused about their next move. Fannie shares consequently fell 31%
to $4.03 and Freddie stock slid 27% to $4.04. But some of the firms’
preferred stock held by big investors saw only slight dips, remaining close
to their highest levels since the firms were taken over in 2008. The
agreement, which faces a few hurdles before approval, represents the most
concrete step so far to resolve the last major piece of unfinished business
from the 2008 financial collapse.
"New Michael Lewis Book on Financial World Will Be Published in March,"
by Julie Bosmanian, New York Times, January 14, 2014 ---
http://www.nytimes.com/2014/01/15/business/media/new-michael-lewis-book-on-financial-world-will-be-published-in-march.html?partner=socialflow&smid=tw-nytimesbusiness&_r=0
Michael Lewis, whose colorful reporting on
money and excess on Wall Street has made him one of the country’s most
popular business journalists, has written a new book on the financial world,
his publisher said on Tuesday.
The book, titled “Flash Boys,” will be released by
W.W. Norton & Company on March 31. A spokeswoman for Norton said the new
book “is squarely in the realm of Wall Street.”
Starling Lawrence, Mr. Lewis’s editor, said in a
statement: “Michael is brilliant at finding the perfect narrative line for
any subject. That’s what makes his books, no matter the topic, so indelibly
memorable.”
Mr. Lewis is the author of “Moneyball,” “Liar’s
Poker” and “The Big Short.”
Jensen Comment
His books are both humorous and well-researched.
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.
"The End," by Michael Lewis December 2008 Issue The era that
defined Wall Street is finally, officially over. Michael Lewis, who chronicled
its excess in Liar’s Poker, returns to his old haunt to figure out what went
wrong.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#TheEnd
Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek
Explanation of the Meltdown on Wall Street!
Now I asked
Gutfreund about his biggest decision. “Yes,” he said. “They—the
heads of the other Wall Street firms—all said what an awful thing it was
to go public (beg for a government
bailout) and how could you do such a
thing. But when the temptation arose, they all gave in to it.” He agreed
that the main effect of turning a partnership into a corporation was to
transfer the financial risk to the shareholders. “When things go wrong,
it’s their problem,” he said—and obviously not theirs alone. When a Wall
Street investment bank screwed up badly enough, its risks became the
problem of the U.S. government. “It’s laissez-faire until you get in
deep shit,” he said, with a half chuckle. He was out of the game.
This is a must read to understand what went wrong on Wall Street ---
especially the punch line!
"The End," by Michael Lewis December 2008 Issue The era that defined Wall
Street is finally, officially over. Michael Lewis, who chronicled its excess
in Liar’s Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
To this day, the willingness of a Wall Street
investment bank to pay me hundreds of thousands of dollars to dispense
investment advice to grownups remains a mystery to me. I was 24 years
old, with no experience of, or particular interest in, guessing which
stocks and bonds would rise and which would fall. The essential function
of Wall Street is to allocate capital—to decide who should get it and
who should not. Believe me when I tell you that I hadn’t the first clue.
I’d never taken an accounting course, never run
a business, never even had savings of my own to manage. I stumbled into
a job at Salomon Brothers in 1985 and stumbled out much richer three
years later, and even though I wrote a book about the experience, the
whole thing still strikes me as preposterous—which is one of the reasons
the money was so easy to walk away from. I figured the situation was
unsustainable. Sooner rather than later, someone was going to identify
me, along with a lot of people more or less like me, as a fraud. Sooner
rather than later, there would come a Great Reckoning when Wall Street
would wake up and hundreds if not thousands of young people like me, who
had no business making huge bets with other people’s money, would be
expelled from finance.
When I sat down to write my account of the
experience in 1989—Liar’s Poker, it was called—it was in the spirit of a
young man who thought he was getting out while the getting was good. I
was merely scribbling down a message on my way out and stuffing it into
a bottle for those who would pass through these parts in the far distant
future.
Unless some insider got all of this down on
paper, I figured, no future human would believe that it happened.
I thought I was writing a period piece about
the 1980s in America. Not for a moment did I suspect that the financial
1980s would last two full decades longer or that the difference in
degree between Wall Street and ordinary life would swell into a
difference in kind. I expected readers of the future to be outraged that
back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid
$3.1 million; I expected them to gape in horror when I reported that one
of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost
$250 million; I assumed they’d be shocked to learn that a Wall Street
C.E.O. had only the vaguest idea of the risks his traders were running.
What I didn’t expect was that any future reader would look on my
experience and say, “How quaint.”
I had no great agenda, apart from telling what
I took to be a remarkable tale, but if you got a few drinks in me and
then asked what effect I thought my book would have on the world, I
might have said something like, “I hope that college students trying to
figure out what to do with their lives will read it and decide that it’s
silly to phony it up and abandon their passions to become financiers.” I
hoped that some bright kid at, say, Ohio State University who really
wanted to be an oceanographer would read my book, spurn the offer from
Morgan Stanley, and set out to sea.
Somehow that message failed to come across. Six
months after Liar’s Poker was published, I was knee-deep in letters from
students at Ohio State who wanted to know if I had any other secrets to
share about Wall Street. They’d read my book as a how-to manual.
In the two decades since then, I had been
waiting for the end of Wall Street. The outrageous bonuses, the slender
returns to shareholders, the never-ending scandals, the bursting of the
internet bubble, the crisis following the collapse of Long-Term Capital
Management: Over and over again, the big Wall Street investment banks
would be, in some narrow way, discredited. Yet they just kept on
growing, along with the sums of money that they doled out to
26-year-olds to perform tasks of no obvious social utility. The
rebellion by American youth against the money culture never happened.
Why bother to overturn your parents’ world when you can buy it, slice it
up into tranches, and sell off the pieces?
At some point, I gave up waiting for the end.
There was no scandal or reversal, I assumed, that could sink the system.
The New Order The crash did more than wipe out
money. It also reordered the power on Wall Street. What a Swell Party A
pictorial timeline of some Wall Street highs and lows from 1985 to 2007.
Worst of Times Most economists predict a recovery late next year. Don’t
bet on it. Then came Meredith Whitney with news. Whitney was an obscure
analyst of financial firms for Oppenheimer Securities who, on October
31, 2007, ceased to be obscure. On that day, she predicted that
Citigroup had so mismanaged its affairs that it would need to slash its
dividend or go bust. It’s never entirely clear on any given day what
causes what in the stock market, but it was pretty obvious that on
October 31, Meredith Whitney caused the market in financial stocks to
crash. By the end of the trading day, a woman whom basically no one had
ever heard of had shaved $369 billion off the value of financial firms
in the market. Four days later, Citigroup’s C.E.O., Chuck Prince,
resigned. In January, Citigroup slashed its dividend.
From that moment, Whitney became E.F. Hutton:
When she spoke, people listened. Her message was clear. If you want to
know what these Wall Street firms are really worth, take a hard look at
the crappy assets they bought with huge sums of borrowed money, and
imagine what they’d fetch in a fire sale. The vast assemblages of highly
paid people inside the firms were essentially worth nothing. For better
than a year now, Whitney has responded to the claims by bankers and
brokers that they had put their problems behind them with this
write-down or that capital raise with a claim of her own: You’re wrong.
You’re still not facing up to how badly you have mismanaged your
business.
Rivals accused Whitney of being overrated;
bloggers accused her of being lucky. What she was, mainly, was right.
But it’s true that she was, in part, guessing. There was no way she
could have known what was going to happen to these Wall Street firms.
The C.E.O.’s themselves didn’t know.
Now, obviously, Meredith Whitney didn’t sink
Wall Street. She just expressed most clearly and loudly a view that was,
in retrospect, far more seditious to the financial order than, say,
Eliot Spitzer’s campaign against Wall Street corruption. If mere scandal
could have destroyed the big Wall Street investment banks, they’d have
vanished long ago. This woman wasn’t saying that Wall Street bankers
were corrupt. She was saying they were stupid. These people whose job it
was to allocate capital apparently didn’t even know how to manage their
own.
At some point, I could no longer contain
myself: I called Whitney. This was back in March, when Wall Street’s
fate still hung in the balance. I thought, If she’s right, then this
really could be the end of Wall Street as we’ve known it. I was curious
to see if she made sense but also to know where this young woman who was
crashing the stock market with her every utterance had come from.
It turned out that she made a great deal of
sense and that she’d arrived on Wall Street in 1993, from the Brown
University history department. “I got to New York, and I didn’t even
know research existed,” she says. She’d wound up at Oppenheimer and had
the most incredible piece of luck: to be trained by a man who helped her
establish not merely a career but a worldview. His name, she says, was
Steve Eisman.
Eisman had moved on, but they kept in touch.
“After I made the Citi call,” she says, “one of the best things that
happened was when Steve called and told me how proud he was of me.”
Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called Whitney again and
asked her, as I was asking others, whom she knew who had anticipated the
cataclysm and set themselves up to make a fortune from it. There’s a
long list of people who now say they saw it coming all along but a far
shorter one of people who actually did. Of those, even fewer had the
nerve to bet on their vision. It’s not easy to stand apart from mass
hysteria—to believe that most of what’s in the financial news is wrong
or distorted, to believe that most important financial people are either
lying or deluded—without actually being insane. A handful of people had
been inside the black box, understood how it worked, and bet on it
blowing up. Whitney rattled off a list with a half-dozen names on it. At
the top was Steve Eisman.
Steve Eisman entered finance about the time I
exited it. He’d grown up in New York City and gone to a Jewish day
school, the University of Pennsylvania, and Harvard Law School. In 1991,
he was a 30-year-old corporate lawyer. “I hated it,” he says. “I hated
being a lawyer. My parents worked as brokers at Oppenheimer. They
managed to finagle me a job. It’s not pretty, but that’s what happened.”
He was hired as a junior equity analyst, a
helpmate who didn’t actually offer his opinions. That changed in
December 1991, less than a year into his new job, when a subprime
mortgage lender called Ames Financial went public and no one at
Oppenheimer particularly cared to express an opinion about it. One of
Oppenheimer’s investment bankers stomped around the research department
looking for anyone who knew anything about the mortgage business.
Recalls Eisman: “I’m a junior analyst and just trying to figure out
which end is up, but I told him that as a lawyer I’d worked on a deal
for the Money Store.” He was promptly appointed the lead analyst for
Ames Financial. “What I didn’t tell him was that my job had been to
proofread the documents and that I hadn’t understood a word of the
fucking things.”
Ames Financial belonged to a category of firms
known as nonbank financial institutions. The category didn’t include
J.P. Morgan, but it did encompass many little-known companies that one
way or another were involved in the early-1990s boom in subprime
mortgage lending—the lower class of American finance.
The second company for which Eisman was given
sole responsibility was Lomas Financial, which had just emerged from
bankruptcy. “I put a sell rating on the thing because it was a piece of
shit,” Eisman says. “I didn’t know that you weren’t supposed to put a
sell rating on companies. I thought there were three boxes—buy, hold,
sell—and you could pick the one you thought you should.” He was
pressured generally to be a bit more upbeat, but upbeat wasn’t Steve
Eisman’s style. Upbeat and Eisman didn’t occupy the same planet. A hedge
fund manager who counts Eisman as a friend set out to explain him to me
but quit a minute into it. After describing how Eisman exposed various
important people as either liars or idiots, the hedge fund manager
started to laugh. “He’s sort of a prick in a way, but he’s smart and
honest and fearless.”
“A lot of people don’t get Steve,” Whitney
says. “But the people who get him love him.” Eisman stuck to his sell
rating on Lomas Financial, even after the company announced that
investors needn’t worry about its financial condition, as it had hedged
its market risk. “The single greatest line I ever wrote as an analyst,”
says Eisman, “was after Lomas said they were hedged.” He recited the
line from memory: “ ‘The Lomas Financial Corp. is a perfectly hedged
financial institution: It loses money in every conceivable interest-rate
environment.’ I enjoyed writing that sentence more than any sentence I
ever wrote.” A few months after he’d delivered that line in his report,
Lomas Financial returned to bankruptcy.
Continued in article
Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999,
ISBN 0340767006)
Lewis writes in Partnoy’s earlier whistleblower
style with somewhat more intense and comic portrayals of the major
players in describing the double dealing and break down of integrity on
the trading floor of Salomon Brothers.
Reply from Tom Hood
Thanks Bob for the Michael Lewis article, “The End” – great explanation of
the mess we a re in and how we got here. Just found this one that does a
great job of summarizing the mess – visually
http://flowingdata.com/2008/11/25/visual-guide-to-the-financial-crisis/
Tom Hood, CPA.CITP, CEO & Executive Director, Maryland Association of CPAs
443-632-2301,
http://www.macpa.org
Check out our blogs for CPAs
http://www.cpasuvvess.com
http://www.newcpas.com
http://www.cpaisland.com
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30,
2009 ---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this
video (a little over 5 Mbs) using a free updated version of RealMedia ---
Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP
Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"J.P. Morgan's Mortgage Troubles Ran Deep: Deals With Subprime
Lenders at Heart of $5.1 Billion Settlement," by Al Yoon, The Wall Street
Journal, October 27, 2013 ---
http://online.wsj.com/news/articles/SB10001424052702304470504579161532779973534?mod=djemCFO_h
A 1,625-square-foot bungalow at 51 Perthshire Lane
in Palm Coast, Fla., is among the thousands of homes at the heart of J.P.
Morgan Chase JPM +0.55% & Co.'s $5.1 billion settlement with a federal
housing regulator on Friday.
In 2006, J.P. Morgan bought one of two mortgage
loans on the home made by subprime lender New Century Financial Corp. J.P.
Morgan then bundled the loan with 4,208 others from New Century into a
mortgage-backed security it sold to investors including housing-finance
giant Freddie Mac. FMCC +11.89%
By the end of 2007, the borrower had stopped paying
back the loan, setting off yearslong delinquency and foreclosure proceedings
that halted income to the investors, according to BlackBox Logic LLC, a
mortgage-data company. Current Account
Settlement Puts U.S. in Tight Spot
The Palm Coast loan wasn't the only troubled one in
the New Century deal: Within a year, 15% of the borrowers were
delinquent—more than 60 days late on a payment, in some stage of foreclosure
or in bankruptcy—according to BlackBox. By 2010, that number exceeded 50%.
"That's much worse than anyone's expectations when
the deal was put together," said Cory Lambert, an analyst at BlackBox and
former mortgage-bond trader. "It's all pretty bad."
J.P. Morgan sidestepped many of the
subprime-mortgage problems that bedeviled rivals during the financial
crisis, and avoided much of the postcrisis scrutiny that dragged down others
on Wall Street. But now its own behavior during the housing boom is coming
under close examination as investigators work through a backlog of cases.
The bank dealt with some of the biggest subprime
lenders of the time, including Countrywide Financial Corp., Fremont
Investment & Loan and WMC Mortgage Corp., a former unit of General Electric,
according to the Federal Housing Finance Agency complaint.
J.P. Morgan's relationship with New Century, a
subprime lender that went bankrupt in 2007 and later faced a Securities and
Exchange Commission investigation and shareholder suits, shows that the New
York bank was part of the frenzied push to package mortgages for investors
at the end of the housing boom.
The New Century deal, J.P. Morgan Mortgage
Acquisition Trust 2006-NC1, was one of 103 cited in the lawsuit against J.P.
Morgan brought by the FHFA, which oversees Freddie Mac and home-loan giant
Fannie Mae. FNMA +13.40%
The $5.1 billion settlement is part of a larger
tentative deal with the Justice Department and other agencies that would
have J.P. Morgan pay a total of $13 billion. That deal is expected to be
completed this week.
"While these settlements seem huge, given the
nature of the offenses, they are trivially small," said William Frey, chief
executive of Greenwich Financial Services LLC, a broker-dealer that has
participated in investor lawsuits against banks that packaged mortgages.
J.P. Morgan declined to comment on the settlement or any loans in the bonds
it bought.
The FHFA has gotten aggressive in recouping losses
from mortgages and securities sold to Fannie and Freddie. In 2011 it sued 18
lenders, and J.P. Morgan was only the fourth to settle.
To be sure, the New Century deal was among J.P.
Morgan's worst performers, and other mortgage-backed securities it issued at
the time have held up better. An improving economy and housing market have
lifted many mortgage bonds sold in 2006 and 2007.
But that is of little consolation to Freddie Mac,
which bought more than a third of the $910 million New Century bond deal in
2006 and still is sitting on losses.
The group of loans backing Freddie's chunk of the
deal had more high-risk loans than the rest of the pool. Nearly 44% of
Freddie's piece had loan-to-value ratios between 80% and 100%, compared with
31% for the rest, according to the deal prospectus.
What's more, nearly half the loans backing the New
Century deal were from California and Florida, two states hit hard by the
housing bust. Of the 4,209 loans in the bond, more than half have some
experienced distress, according to BlackBox data.
Three debt-rating firms gave the top slice of the
deal AAA ratings. But as the housing market soured, a series of downgrades
starting in 2007 took them all into "junk" territory by July 2011. As of
last month, nearly a quarter of the principal of the underlying loans in the
deal had been wiped out, with a third of the remaining balance delinquent or
in some stage of foreclosure, according to BlackBox.
Continued in article
From the CFO Journal's Morning Ledger on October 28, 2013
J.P. Morgan settlement puts government in tight spot
Will the U.S. government have to refund
J.P. Morgan part
of the bank’s expected $13 billion payment over soured mortgage securities?
The question is the biggest stumbling block to completing the record
settlement between the bank and the Justice Department,
writes the WSJ’s Francesco Guerrera.
The crux of the issue is whether the government can go
after J.P. Morgan for (alleged) sins committed by others. And investors,
bankers and lawyers are watching the process closely, worried that it could
set a bad precedent for the relationship between buyers, regulators and
creditors in future deals for troubled banks.
"JPMorgan's $13 Billion Settlement: Jamie Dimon Is a Colossus No More,"
by Nick Summers, Bloomberg Businessweek, October 24, 2013 ---
http://www.businessweek.com/articles/2013-10-24/jpmorgans-13-billion-settlement-jamie-dimon-is-a-colossus-no-more
Thirteen billion dollars
requires some perspective. The record amount that
JPMorgan Chase (JPM)
has tentatively agreed to pay the
U.S. Department of Justice, to settle civil investigations into
mortgage-backed securities it sold in the runup to the 2008 financial
crisis, is equal to the gross domestic product of Namibia. It’s more
than the combined salaries of every athlete in every major U.S.
professional sport, with enough left over to buy every American a
stadium hotdog. More significantly to JPMorgan’s executives and
shareholders, $13 billion is equivalent to 61 percent of the bank’s
profits in all of 2012. Anticipating the settlement in early October,
the bank recorded its first quarterly loss under the leadership of Chief
Executive Officer Jamie Dimon.
That makes it real money, even for the
country’s biggest bank by assets. Despite this walloping, there’s reason
for the company to exhale. The most valuable thing Dimon, 57, gets out
of the deal with U.S. Attorney General Eric Holder is clarity. The
discussed agreement folds in settlements with a variety of federal and
state regulators, including the Federal Deposit Insurance Corp. and the
attorneys general of California and New York. JPMorgan negotiated a
similar tack in September, trading the gut punch of a huge headline
number—nearly $1 billion in penalties related to the 2012 London Whale
trading fiasco—for the chance to resolve four investigations in two
countries in one stroke. In both cases, the bank’s stock barely budged;
its shares have returned 25 percent this year, exactly in line with the
performance of Standard & Poor’s 500-stock index.
That JPMorgan is able to withstand
penalties and regulatory pressure that would cripple many of its
competitors attests both to the bank’s vast resources and the influence
of the man who leads it. The sight of Dimon arriving at the Justice
Department on Sept. 26 for a meeting with the attorney general
underscored Dimon’s extraordinary access to Washington
decision-makers—although the Wall Street chieftain did have to humble
himself by presenting his New York State driver license to a guard on
the street. As news of the settlement with Justice trickled out, the
admirers on Dimon’s gilded list rushed to his defense, arguing that he
struck the best deal he could. “If you’re a financial institution and
you’re threatened with criminal prosecution, you have no ability to
negotiate,”
Berkshire Hathaway (BRK/A)
Chairman Warren Buffett told
Bloomberg TV. “Basically, you’ve got to be like a wolf that bares its
throat, you know, when it gets to the end. You cannot win.”
The challenges facing Dimon and his
company are far from over. With the $13 billion payout, JPMorgan is
still the subject of a criminal probe into its mortgage-bond sales,
which could end in charges against the bank or its executives. And other
federal investigations—into suspected bribery in China, the bank’s role
in the Bernie Madoff Ponzi scheme, and more—are ongoing.
The ceaseless scrutiny has tarnished
Dimon’s public image, perhaps irreparably. Once seen as the white knight
of the financial crisis, he’s now the executive stuck paying the bill
for Wall Street’s misdeeds. And as the bank’s legal fights drag on, it’s
worth asking just how many more blows the famously pugnacious Dimon can
take.
Although the $13 billion settlement
would amount to the largest of its kind in the history of regulated
capitalism, it looks quite different broken into its component pieces.
While the relative amounts could shift, JPMorgan is expected to pay
fines of only $2 billion to $3 billion for misrepresenting the quality
of mortgage securities it sold during the subprime housing boom.
Overburdened homeowners would get $4 billion; another $4 billion would
go to the Federal Housing Finance Agency, which regulates
Freddie Mac (FMCC)
and
Fannie Mae (FNMA);
and about $3 billion would go to investors who lost money on the
securities, Bloomberg News reported.
JPMorgan will only pay fines (as
distinct from compensation to investors or homeowner relief) related to
its own actions—and not those of Bear Stearns or Washington Mutual, the
two troubled institutions the bank bought at discount-rack prices during
the crisis. Aside from shaving some unknown amount off the final
settlement, this proviso enhances Dimon’s reputation as the shrewdest
banker of that era. In 2008, with the backing of the U.S. Department of
the Treasury and the Federal Reserve, who saw JPMorgan as a port in a
storm, Dimon got the two properties for just $3.4 billion. Extending
JPMorgan’s retail reach overnight into Florida and California, Bear and
WaMu helped the bank become the largest in the U.S. by 2011. The
portions of the settlement attributable to their liabilities are almost
certainly outweighed by the profits they’ve brought and will continue to
bring.
Darrell Duffie: Big Risks Remain In the Financial System
A Stanford theoretician of financial risk looks at how to fix the "pipes and
valves" of modern finance
Stanford Graduate School of Business, May 2013
Click Here
http://www.gsb.stanford.edu/news/headlines/darrell-duffie-big-risks-remain-financial-system?utm_source=Stanford+Business+Re%3AThink&utm_campaign=edfd4f11fb-Stanford_Business_Re_Think_Issue_Thirteen5_17_2013&utm_medium=email&utm_term=0_0b5214e34b-edfd4f11fb-70265733&ct=t%28Stanford_Business_Re_Think_Issue_Thirteen5_17_2013%29
. . .
In March, Duffie and the Squam Lake Group proposed
a dramatic new restriction on executive pay at “systemically important”
financial institutions. Duffie argues that top bank executives still have
lopsided incentives to take excessive risks. The proposal: Force them to
defer 20 percent of their pay for five years, and to forfeit that money
entirely if the bank’s capital sinks to unspecified but worrisome levels
before the five years is up.
“On most issues,” Duffie said, “the banks would be
glad to see me go away.”
Jensen Comment
Squam Lake and its 30 islands is in the Lakes Region of New Hampshire ---
http://en.wikipedia.org/wiki/Squam_Lake
It is better known as "Golden Pond" after Jane Fonda, her father (Henry) and
Katherine Hepburn appeared in the Academy Award winning movie called "On
Golden Pond" that was filmed on Squam Lake. Professor Duffie now has some
"golden ideas" for finance reforms.
"Jenkins: The IPO From Hell? The Facebook fiasco was a blessing for the
mom and pop investors who were shut out of the deal," by Holman W. Jenkins
Jr., The Wall Street Journal, May 22, 2012 ---
http://online.wsj.com/article/SB10001424052702304019404577420383358865326.html?mod=djemEditorialPage_t
Anti-capitalist progressives are dancing in the street
But The Economist Magazine is really, really worried
"The endangered public company: The rise and fall of a great
invention, and why it matters," The Economist, May 19, 2012 ---
http://www.economist.com/node/21555562
AS THIS newspaper went to press, Facebook was about
to become a public company. It will be one of the biggest stockmarket
flotations ever: the social-networking giant expects investors to value it
at $100 billion or so. The news raises several questions, from “Is it worth
that much?” to “What will it do next?” But the most intriguing question is
what Facebook’s flotation tells us about the state of the public company
itself.
At first glance, all is well. The public company
was invented in the mid-19th century to provide the giants of the industrial
age with capital. That Facebook is joining Microsoft and Google on the
stockmarket suggests that public listings are performing the same miracle
for the internet age. Not every 19th-century invention has weathered so
well.
But look closer and the picture changes (see
article). Mark Zuckerberg, Facebook’s young founder, resisted going public
for as long as he could, not least because so many heads of listed companies
advised him to. He is taking the plunge only because American law requires
any firm with more than a certain number of shareholders to publish
quarterly accounts just as if it were listed. Like Google before it,
Facebook has structured itself more like a private firm than a public one:
Mr Zuckerberg will keep most of the voting rights, for example.
The number of public companies has fallen
dramatically over the past decade—by 38% in America since 1997 and 48% in
Britain. The number of initial public offerings (IPOs) in America has
declined from an average of 311 a year in 1980-2000 to 99 a year in 2001-11.
Small companies, those with annual sales of less than $50m before their
IPOs—have been hardest hit. In 1980-2000 an average of 165 small companies
undertook IPOs in America each year. In 2001-09 that number fell to 30.
Facebook will probably give the IPO market a temporary boost—several other
companies are queuing up to follow its lead—but they will do little to
offset the long-term decline.
Companies are like jets; the elite go private
Mr Zuckerberg will be joining a troubled club. The
burden of regulation has grown heavier for public companies since the
collapse of Enron in 2001. Corporate chiefs complain that the combination of
fussy regulators and demanding money managers makes it impossible to focus
on long-term growth. Shareholders are also angry. Their interests seldom
seem to be properly aligned at public companies with those of the managers,
who often waste squillions on empire-building and sumptuous perks.
Shareholders are typically too dispersed to monitor the men on the spot.
Attempts to solve the problem by giving managers shares have largely failed.
At the same time, alternative corporate forms are
flourishing. Once “going public” was every CEO’s dream; now it is perfectly
respectable to “go private”, like Burger King, Boots and countless other
famous names. State-run enterprises have recovered from the wreck of
communism and now include the world’s biggest mobile-phone company (China
Mobile), its most successful port operator (Dubai World), its
fastest-growing big airline (Emirates) and its 13 biggest oil companies.
No doubt the sluggish public equity markets have
played a role in this. But these alternative corporate forms have addressed
some of the structural weaknesses that once held them back. Access to
capital? Private-equity firms, helped by tax breaks, and venture capitalists
both have cash to spare, and there are private markets such as SecondMarket
(where $1 billion-worth of shares has changed hands since 2008). Limited
liability? Partners need no longer be fully liable, and firms can have as
many partners as they want. Professional managers? Family firms employ them
by the HBS-load and state-owned ones are no longer just sinecures for the
well-connected.
Make capitalism popular again
Does all this matter? The increase in the number of
corporate forms is a good thing: a varied ecosystem is more robust. But
there are reasons to worry about the decline of an organisation that has
spread prosperity for 150 years.
First, public companies have been central to
innovation and job creation. One reason why entrepreneurs work so hard, and
why venture capitalists place so many risky bets, is because they hope to
make a fortune by going public. IPOs provide young firms with cash to hire
new hands and disrupt established markets. The alternative is to sell
themselves to established firms—hardly a recipe for creative destruction.
Imagine if the fledgling Apple and Google had been bought by IBM.
Second, public companies let in daylight. They have
to publish quarterly reports, hold shareholder meetings (which have grown
acrimonious of late), deal with analysts and generally conduct themselves in
an open manner. By contrast, private companies and family firms operate in a
fog of secrecy.
Third, public companies give ordinary people a
chance to invest directly in capitalism’s most important wealth-creating
machines. The 20th century saw shareholding broadened, as state firms were
privatised and mutual funds proliferated. But today popular capitalism is in
retreat. Fewer IPOs mean fewer chances for ordinary people to put their
money into a future Google. The rise of private equity and the spread of
private markets are returning power to a club of privileged investors.
All this argues for a change in thinking—especially
among the politicians who have heaped regulations onto Western public
companies, blithely assuming that businessfolk have no choice but to go
public in the long run. Many firms now go (or stay) private to avoid red
tape. The result is that ever more business is conducted in the dark, with
rich insiders playing a more powerful role.
Public companies built the railroads of the 19th
century. They filled the world with cars and televisions and computers. They
brought transparency to business life and opportunities to small investors.
Because public companies sell shares to the unsophisticated, policymakers
are right to regulate them more tightly than other forms of corporate
organisation. But not so tightly that entrepreneurs start to dread the
prospect of a public listing. The public company has long been the
locomotive of capitalism. Governments should not derail it.
"Crony Capitalism for Intellectuals," by Luigi Zingales, Chronicle
of Higher Education, May 20, 2012 ---
http://chronicle.com/article/Crony-Capitalism-for/131894/?sid=cr&utm_source=cr&utm_medium=en
Jensen Comment
If economists were truly better forecasters they would all be at the top of the
1%. They would have invested in billions in short sales contracts and naked put
options in 2007, because even the poor can leverage themselves into the 1% with
short sales and naked put options if they know "when" the economy will melt
down.
Forecasting has twin brothers named If and When. The guy named If is a pretty
uncomplicated scholar who builds models on assumptions. But the secret of
success is not If but When, and When is a very mysterious guy who resorts to to
a crystal ball. What we know is that If just can't cut it no matter how hard he
wants to be in the 1%, and When's crystal ball turns out to be no better than
chance itself.
How we all live on welfare in the United States
"One Nation on Welfare: Living Your Life on the Dole," by Michael
Grunwald, Time Magazine, September 17, pp. 32-37 ---
http://www.time.com/time/magazine/article/0,9171,2123809,00.html
The sun is shining on Miami Beach, and I wake up in
subsidized housing. I throw on a T-shirt made of subsidized cotton, brush my
teeth with subsidized water and eat cereal made of subsidized grain. Soon
the chaos begins, two hours of pillow forts, dance parties and other
craziness with two hyper kids and two hyper Boston terriers, until our
subsidized nanny arrives to watch our 2-year-old. My wife Cristina then
drives to her subsidized job while listening to the subsidized news on
public radio. I bike our 4-year-old to school on public roads, play tennis
on a public court...
It's just another manic Monday, brought to us by
the deep pockets of Big Government. The sunshine is a natural perk, and
while our kids are tax-deductible, the fun we have with them is not. The
dogs are on our dime too. Otherwise, taxpayers help support just about every
aspect of our lives.
Of course, we're taxpayers too, and we don't
exactly fit the stereotype of entitled welfare queens. Cristina is an
attorney and until recently was a small-business owner. I'm a journalist, an
economic red flag these days, but I work for the company behind the Harry
Potter and Batman movies, so at press time I was still getting paid. My
family's subsidies are not the handouts to the poor that help fuel America's
political culture wars but the kind of government goodies that make the
comfortable even more comfortable. Our federally subsidized housing, for
example, is a two-story Art Deco home in the overpriced heart of South
Beach. But our mortgage interest is a personal deduction, my home office is
a business deduction, and federal subsidies keep our flood insurance cheap.
Even our property taxes are deductible. So thanks for your help.
The 2012 election is shaping up as a debate over
Big Government, but it is only loosely tethered to the reality of Big
Government. The vast majority of federal spending goes to defense, health
care and Social Security plus interest payments on the debt we've run up
paying for defense, health care and Social Security. Nondefense
discretionary spending--Washingtonese for "everything else," from the FBI to
the TSA to the center for grape genetics--amounts to only 12% of the budget.
Still, it's a big government. The U.S. did not
spend even $1 billion in 1912; it will spend $3.8 trillion in 2012 on
everything from Missing Alzheimer's Disease Patient Assistance ($593,842) to
Snow Survey and Water Supply Forecasting ($9,409,400), from mortgage
insurance for manufactured homes ($64,724,187) to ironworker training on
Indian reservations. There will be an additional $1.3 trillion in tax
expenditures, federal benefits (like the deductions for my 401(k) and my
nanny's salary) that are basically identical to those normal spending
programs except that they happen to be provided through the tax code.
The rise of the Tea Party and the weakness of the
Obama economy have fueled a Republican narrative about Big Government as a
threat to liberty, redistributing wealth from honorable Americans to
undeserving moochers, from taxpaying "makers" to freeloading "takers." In
fact, most Americans are makers and takers--proud of our making, blind to
our taking. Republicans often point out that only half the country pays
income taxes, but just about all Americans pay taxes: payroll taxes, state
and local taxes, gas taxes and much more. The problem is that we pay in $2.5
trillion and pay out $3.8 trillion. And those trillions of dollars don't all
go to undeserving moochers, except insofar as we're all undeserving
moochers.
7 a.m.: Subsidized food, water, electricity and
clothing
The right routinely portrays government as a giant
mess of Solyndra failures, lavish agency conferences in Vegas and pork for
society's leeches. But my taxpayer-supported morning didn't feel like
mooching at the time.
For example, my family pays for that water I use to
brush my teeth, about $100 a month. But that's a small fraction of the true
cost of delivering clean water to our home and treating the sewage that
leaves our home. And it certainly doesn't reflect the $15 billion federal
project to protect and restore the ravaged Everglades, which sit on top of
the aquifers that provide our drinking water. Most Americans think of the
water that comes out of our faucets as an entitlement, not a handout, but
it's a government service, and it's often subsidized.
Similarly, my family pays more than $200 a month
for the electricity that powers our toaster at breakfast. But that number
would be much higher if the feds didn't subsidize the construction,
liability insurance and just about every other cost associated with my
utility's nuclear power plants while also providing generous tax advantages
("depletion allowances," "intangible drilling costs" and so forth) for
natural gas and other fossil fuels. The $487 we're paying this year for
federal flood insurance is also outrageously low, considering that our
low-lying street floods all the time, that a major hurricane could wipe out
Miami Beach and that the Property Casualty Insurers Association of America
estimates that premiums in high-risk areas would be three times as high
without government aid.
Some federal largesse--tax breaks for NASCAR
racetracks ($40 million) and subsidies for rum distilleries ($172 million)
and rural airports ($200 million)--is just silly. There's no reason my poker
buddies should be able to deduct the gambling losses I inflict on them once
a month. (Just kidding, guys!)
The silliest handouts that brighten my morning are
the boondoggles that funnel billions to America's cotton and grain farmers
and maybe knock a few cents off the price of my T-shirts and my kids'
breakfast waffles. Uncle Sam sends at least $15 billion every year to
farmers and agribusinesses in the form of grants, loans, crop insurance and
other goodies. The farm lobby is so omnipotent in Washington that when the
World Trade Organization ruled that U.S. handouts give our cotton farmers an
unfair advantage over Brazil, the U.S. cut a deal to shovel $147 million a
year to Brazilian cotton farmers rather than kick our own farmers off the
dole. Our food and clothing may seem cheap, but, oh, we pay for them.
Reasonable people can disagree about most
government aid. I enjoy NPR, even though I don't really see why it needs
about $3 million a year of our tax dollars to produce good journalism;
public-radio stations receive only about 15% of their revenue from the
government anyway. On the other hand, I think my $500 Florida tax rebate for
the energy-efficient water heater that warms my shower made great sense,
promoting economic, environmental and national security by reducing
fossil-fuel use.
Unless you're a hardcore libertarian, it probably
doesn't bother you that the city of Miami Beach spends $500 million a year
building roads, fixing potholes, picking up trash, putting out fires and
creating bike lanes that make my cycling somewhat less life-threatening. The
city also owns my local tennis courts, which are receiving a somewhat
controversial $5 million upgrade, as well as the playground my 2-year-old
visits frequently and the track where Cristina and I work out much less
frequently. My mayor, Matti Herrera Bower, told me tennis players are the
city's most aggressive and obnoxious special interest. We're the farmers of
Miami Beach.
When I spoke to Bower, a former dental assistant
and PTA mom who got into politics after years of community activism, the FBI
had just busted a bunch of city code inspectors for shaking down a nightclub
owner, and the city manager had just quit. MIAMI BEACH SINKING IN A VAST
SWAMP OF DISHONESTY, a Miami Herald column declared. Citizens notice the bad
news, Bower said with a sigh, but they don't appreciate that government
keeps them safe and cleans their streets. They're not too interested in
learning more, either; Bower holds regular Mayor on the Move forums to bring
City Hall to Miami Beach's neighborhoods, but only two residents showed up
to the last one. "There's this perception that government is all dirty, and
perception is 99% of what matters," Bower says. "People are busy living
their lives. They don't understand where their taxes go and what they get."
One thing my family gets from government is
Cristina's paycheck from an advocacy group called Americans for Immigrant
Justice, which is nearly 30% funded by the feds. Cristina is paid less than
she would make at a private law firm, though more than most Americans, to
represent undocumented minors in detention centers--in other words, kids in
jail, some as young as 6, many victims of gang rape, gang terror or horrific
family abuse. Cristina helps save the time of judges and immigration
officials by advising these kids about their rights, and she probably saves
taxpayers money overall by advising her clients when they have no legal case
for staying. That said, it's unlikely that her job would exist without Uncle
Sam's help.
Continued in article
Question
If the job market does not improve, how long will it take for the Fed to own all
the real estate mortgages in the United States?
"Fed to Purchase $40 Billion Per Month in Bonds Until Job Market Improves,"
Time Magazine, September 12, 2012 ---
http://business.time.com/2012/09/13/fed-to-purchase-40-billion-per-month-in-bonds-until-job-market-improves/
The Federal Reserve says it will spend $40 billion
a month to buy mortgage-backed securities for long as necessary to stimulate
the still-weak economy and reduce high unemployment.
It also extended a plan to keep short-term interest
rates at record lows through mid-2015. And it said it’s ready to take other
steps to boost the economy even after it strengthens.
The Fed announced the series of bold steps after
its two-day policy meeting ended Thursday. Its actions pointed to how
sluggish the economy remains more than three years after the Great Recession
ended. “We’re not sure what the economic effects of this program will be –
it should help growth and employment on the margin,” Dan Greenhaus, chief
global strategist at BTIG LLC, said in a research note.
(VIDEO:
How the Federal Reserve Works)
Stocks rose after the announcement. The Dow Jones
industrial average was up 15 points for the day just before 12:30 p.m. It
surged by 105 points within minutes of the announcement, then gave up some
gains to be just 35 points higher.
The dollar dropped against major currencies, and
the price of gold shot up about $16 an ounce, roughly 1 percent, to $1,750.
“If the outlook for the labor market does not improve substantially, the
committee will continue its purchases of agency mortgage-backed securities,
undertake additional asset purchases and employ its other policy tools as
appropriate until such improvement is achieved in a context of price
stability,” the Fed said in a statement released after the meeting.
The statement was approved on an 11-1 vote. The
lone dissenter was Richmond Fed President Jeffrey Lacker, who worries about
igniting inflation.
The bond purchases are intended to lower long-term
interest rates to spur borrowing and spending. The Fed has previously bought
$2 trillion in Treasury bonds and mortgage-backed securities since the 2008
financial crisis.
(MORE:
U.S. Federal Reserve Earned $77 Billion Profit in 2011)
Skeptics caution that further bond buying might
provide little benefit. Rates are already near record lows. Critics also
warn that more bond purchases raise the risk of higher inflation later.
With less than eight weeks left until Election Day,
the economy remains the top issue on most voters’ minds. Many Republicans
have been critical of the Fed’s continued efforts to drive interest rates
lower, saying they fear it could ignite inflation.
The Fed is under pressure to act because the U.S.
economy is still growing too slowly to reduce high unemployment. The
unemployment rate has topped 8 percent every month since the Great Recession
officially ended more than three years ago.
Continued in article
"Bernanke Unbounded: The Fed enters a brave new world of unlimited
monetary easing," The Wall Street Journal, September 13, 2012 ---
http://professional.wsj.com/article/SB10000872396390444709004577649831698298106.html?mg=reno64-wsj#mod=djemEditorialPage_t
So much for fears that the Federal Reserve might
disappoint Wall Street. Chairman Ben Bernanke and his music men at the Fed's
Open Market Committee put on their party hats Thursday and unleashed an
unlimited program of monetary easing. The move exceeded even Wall Street's
expectations, but whether it will help the real economy in the long term is
doubtful.
This is the Fed's third round of quantitative
easing (QE3) since the 2008 panic, and the difference this time is that Ben
is unbounded. The Fed said it will keep interest rates at near-zero "at
least through mid-2015," which is six months longer than its previous vow.
The bigger news is that the Fed announced another round of asset
purchases—only this time as far as the eye can see.
The Fed will start buying $40 billion of additional
mortgage assets a month, with a goal of further reducing long-term interest
rates. But if "the labor market does not improve substantially," as the
central bankers put it, the Fed will plunge ahead and buy more assets. And
if that doesn't work, it will buy still more. And if . . .
The Fed statement paid lip service to pursuing its
"dual mandate" of controlling inflation and reducing unemployment, but no
one should be fooled. The Fed has declared that it is going all-in to cut
the jobless rate, no matter what it takes.
"We have to do more, and we'll do enough to make
sure the economy gets on the right track," Mr. Bernanke declared at his
Thursday press conference. That bravado contradicts the Chairman's by now
routine caveat that monetary policy "is no panacea" and can't save the
economy by itself, but no matter. He's going to try.
Will it work? Mr. Bernanke recently offered a
scholarly defense of his extraordinary policy actions since 2008, and
there's no doubt that QE1 was necessary in the heat of the panic. We
supported it at the time. The returns on QE2 in 2010-2011 and the Fed's
other actions look far sketchier, even counterproductive.
QE2 succeeded in lifting stocks for a time, but it
also lifted other asset prices, notably commodities and oil. The Fed's QE2
goal was to conjure what economists call "wealth effects," or a greater
propensity to spend and invest as consumers and businesses see the value of
their stock holdings rise. But the simultaneous increase in commodity prices
lifted food and energy prices, which raised costs for businesses and made
consumers feel poorer.
These "income effects" countered Mr. Bernanke's
wealth effects, and the proof is that growth in the real economy decelerated
in 2011. It decelerated again this year amid Operation Twist. When does the
Fed take some responsibility for policies that fail in their self-professed
goal of spurring growth, rather than blaming everyone else while claiming to
be the only policy hero?
Then there are the real and potential costs of
endless easing, three of which Mr. Bernanke addressed at his Thursday press
conference. He said Americans shouldn't complain about getting a pittance of
interest on their savings because they'll benefit in the long term from a
better economy spurred by low rates. Retirees might retort that they know
what Lord Keynes said about the long term.
Mr. Bernanke was also as slippery as a politician
in claiming that his policies don't promote deficit spending because the Fed
earns interest on the bonds it buys and hands that as revenue to the
Treasury. Yes, but its near-zero policy also disguises the real
interest-payment burden of running serial $1.2 trillion deficits, while
creating a debt-repayment cliff when interest rates inevitably rise. Does he
really think Congress would spend as much if he weren't making the cost of
government borrowing essentially free?
The third cost is the risk of future inflation,
which Mr. Bernanke accurately said hasn't strayed too far above the Fed's 2%
"core inflation" target. That conveniently ignores the run-up in food and
energy prices, which consumers pay even if the Fed discounts them in its own
"core" calculations.
The deeper into exotic monetary easing the Fed
goes, the harder it will also be to unwind in a timely fashion. Mr. Bernanke
says not to worry, he has the tools and the will to pull the trigger before
inflation builds.
That's what central bankers always say. But good
luck picking the right moment, which may be before prices are seen to be
rising but also before the expansion has begun to lift middle-class incomes.
That's one more Bernanke Cliff the economy will eventually face—maybe after
Ben has left the Eccles Building. ***
Given the proximity to the Presidential election,
the Fed move can't be divorced from its political implications. Mr. Bernanke
forswore any partisan motives on Thursday, and we'll give him the benefit of
the personal doubt. But by goosing stock prices, and thus lifting the
short-term economic mood, the Fed has surely provided President Obama an
in-kind re-election contribution.
The irony is that, with this historic and
open-ended easing, Mr. Bernanke is also tacitly admitting how lousy the
Obama-Bernanke economy really is. For all the back-slapping by the Fed and
the White House about how they've saved us from a Great Depression, four
years later the Fed is acknowledging that the recovery is rotten, that job
creation stinks, and that their policies haven't helped the middle class.
But, hey, it's great for Wall Street.
Jensen Comment
What is really sad that in it's effort to deceive the public, our deceptive
government removed increases in food and fuel prices from the definition of
"inflation."
"Longer-term inflation expectations spike in reaction to the Fed"
Sober Look, September 13, 2012 ---
http://soberlook.com/2012/09/longer-term-inflation-expectations.html
The sad, sad state of governmental accounting that's all done with smoke
and mirrors ---
http://faculty.trinity.edu/rjensen/Theory02.htm#GovernmentalAccounting
Regardless of who wins the election, the yawning
federal budget deficit cries out for tough medicine. The questions are what
kinds and who will bear the burden.
Professor Alan Blinder, close Princeton University colleague of Paul Krugman
"A Republican Ticket From Far Right Field With Romney and Ryan, it's out
with FDR and in with Ayn Rand," by Alan S. Blinder, The Wall Street
Journal, September 5, 2012 ---
http://professional.wsj.com/article/SB10000872396390444273704577633211572264238.html?mg=reno64-wsj#mod=djemEditorialPage_t
It is by now a commonplace that this looks like a
watershed election. By choosing Paul Ryan as his running mate, instead of
shaking the Etch A Sketch toward the center, Mitt Romney embraced an
economic vision that differs radically from the rough politico-economic
consensus in the United States since Franklin Roosevelt. Barack Obama
accepts that broad consensus and, like many other presidents, has sought to
deepen it.
The Rooseveltian consensus embodied three main
elements: a modest social safety net to protect vulnerable Americans from
some of the downsides of unfettered markets, Keynesian-style policies to
shorten recessions, and a progressive tax-transfer system to mitigate income
inequality (albeit only slightly).
The two political parties certainly had their
differences between the 1930s and the 2000s, but the broad consensus often
had bipartisan support. Thus Eisenhower built public infrastructure; Nixon
declared himself a Keynesian and established the Environmental Protection
Agency; both Reagan and Bush II acted like Keynesians; Bush I promised a
"kinder, gentler nation" and Bush II expanded Medicare—unfortunately,
without a way to pay for it.
But with Messrs. Romney and Ryan, it's out with
Franklin Roosevelt and in with Ayn Rand. As many observers have noticed,
even Ronald Reagan would be considered a bit too lefty for the current
Republican Party. After all, he signed several tax increases to shrink the
budget deficit and barked at but never seriously bit the safety net.
A government's budget is more than a mass of
numbers; it reveals a nation's priorities and aspirations. The Obama and
Romney budget proposals offer two starkly different visions of America's
future, making this election the sharpest contrast between competing
economic philosophies since Lyndon Johnson routed Barry Goldwater in 1964.
The Romney-Ryan budget would shred the safety net;
President Obama thickened it with near-universal health insurance. Mr. Obama
wants a more progressive tax code; Mr. Romney would pile on yet more income
tax cuts for the most prosperous Americans. Leading Republicans claim,
against both evidence and logic, that the 2009 fiscal stimulus failed to
create any jobs. They even oppose the Federal Reserve's efforts to boost
economic growth.
Regardless of who wins the election, the yawning
federal budget deficit cries out for tough medicine. The questions are what
kinds and who will bear the burden.
Mr. Obama's 10-year deficit-reduction plan offers a
balanced approach that shares the castor oil widely—it is similar (but not
identical) to that of the Simpson-Bowles fiscal commission. His budget would
end the Bush tax cuts for upper-income taxpayers, raise additional revenue
by limiting various deductions and exemptions, shrink nondefense
discretionary spending to the lowest share of GDP in 50 years, trim the
defense budget, and make selective cuts in entitlement programs including
Medicare and Medicaid. While doing so, it seeks higher spending on
education, infrastructure and basic research.
The nonpartisan Congressional Budget Office
estimates that the president's proposals would reduce the federal budget
deficit to about 3% of GDP by 2015. That's a sensible interim target which
would roughly stabilize the ratio of debt to GDP. But, as I have argued on
this page, more will have to be done about health-care costs in the long
run.
Continued in article
Jensen Comment
The problem for 2013-2016 may not so much be the presidency as it is with a
politically paralyzed House and Senate. I anticipate that President Obama will
be elected, but the victory will be bitter sweet with a Congress that blocks his
bigger-government progressive initiatives and a President who blocks
smaller-government initiatives conceived in Congress. It will not be pretty
surviving four years of stalemate with no checkmate.
There's no end of trillion dollar annual deficits and greenback printing
machines in sight.
And who will bail out California and Illinois unfunded pension fund
blockbusters?
http://faculty.trinity.edu/rjensen/Theory02.htm#Pensions
These were supposedly "too big to fail."
Where are they now?
Salomon Brothers
Drexel Burnham Lambert
E.F. Hutton
Paine Webber
Dean Witter Reynolds
Shearson
Smith Barney
Prudential-Bache
Kidder Peabody
Bear Stearns
Lehman Brothers
Merrill Lynch
"Seven Problems a Recovery Won't Fix." by Umair Haque, The Harvard
Business Reveiw Blog, June 8, 2011 ---
Click Here
http://blogs.hbr.org/haque/2011/06/seven_problems_a_recovery_wont.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
"Three Traps Facing New Global Leaders,"
by Saj-nicole Jon, BusinessSchools, November 7, 2011 ---
http://paper.li/businessschools?utm_source=subscription&utm_medium=email&utm_campaign=paper_sub
The Proust index: Advanced economies have gone backwards by a decade as a
result of the crisis
Harvard economist John Kenneth Galbraith said something like "Ireland is a
land of poets and has never produced one economist." This is not an exact
quotation but it captures the essence of what this famous Harvard professor
thought about Ireland's economic acumen.
Professor Galbraith did not live to see his diagnosis turn into proof.
Michael Lewis is one of my favorite authors and analysts. He's also a
humorist who finds little funny about the current economic crisis in Ireland.
"Michael Lewis: The Economic Crisis -When Irish Eyes Are Crying,"
Vanity Fair via Simoleon Sense, February 2, 2011 ---
http://www.simoleonsense.com/michael-lewis-the-economic-crisis-when-irish-eyes-are-crying/
Even in an era when capitalists went out of their
way to destroy capitalism, the Irish bankers set some kind of record for
destruction. Theo Phanos, a London hedge-fund manager with interests in
Ireland, says that “Anglo Irish was probably the world’s worst bank. Even
worse than the Icelandic banks.”
…
Ireland’s financial disaster shared some things
with Iceland’s. It was created by the sort of men who ignore their wives’
suggestions that maybe they should stop and ask for directions, for
instance. But while Icelandic males used foreign money to conquer foreign
places—trophy companies in Britain, chunks of Scandinavia—the Irish male
used foreign money to conquer Ireland. Left alone in a dark room with a pile
of money, the Irish decided what they really wanted to do with it was to buy
Ireland. From one another. An Irish economist named Morgan Kelly,
whose estimates of Irish bank losses have been the most prescient, made a
back-of-the-envelope calculation that puts the losses of all Irish banks at
roughly 106 billion euros. (Think $10 trillion.) At the rate money currently
flows into the Irish treasury, Irish bank losses alone would absorb every
penny of Irish taxes for at least the next three years.
….
In recognition of the spectacular losses, the
entire Irish economy has almost dutifully collapsed. When you fly into
Dublin you are traveling, for the first time in 15 years, against the
traffic. The Irish are once again leaving Ireland, along with hordes of
migrant workers. In late 2006, the unemployment rate stood at a bit more
than 4 percent; now it’s 14 percent and climbing toward rates not
experienced since the mid-1980s. Just a few years ago, Ireland was able to
borrow money more cheaply than Germany; now, if it can borrow at all, it
will be charged interest rates nearly 6 percent higher than Germany, another
echo of a distant past. The Irish budget deficit—which three years ago was a
surplus—is now 32 percent of its G.D.P., the highest by far in the history
of the Eurozone. One credit-analysis firm has judged Ireland the
third-most-likely country to default. Not quite as risky for the global
investor as Venezuela, but riskier than Iraq. Distinctly Third World, in any
case.
Continued in article
"New Michael Lewis Book on Financial World Will Be Published in March,"
by Julie Bosmanian, New York Times, January 14, 2014 ---
http://www.nytimes.com/2014/01/15/business/media/new-michael-lewis-book-on-financial-world-will-be-published-in-march.html?partner=socialflow&smid=tw-nytimesbusiness&_r=0
Michael Lewis, whose colorful reporting on
money and excess on Wall Street has made him one of the country’s most
popular business journalists, has written a new book on the financial world,
his publisher said on Tuesday.
The book, titled “Flash Boys,” will be released by
W.W. Norton & Company on March 31. A spokeswoman for Norton said the new
book “is squarely in the realm of Wall Street.”
Starling Lawrence, Mr. Lewis’s editor, said in a
statement: “Michael is brilliant at finding the perfect narrative line for
any subject. That’s what makes his books, no matter the topic, so indelibly
memorable.”
Mr. Lewis is the author of “Moneyball,” “Liar’s
Poker” and “The Big Short.”
Jensen Comment
His books are both humorous and well-researched.
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.
"The End," by Michael Lewis December 2008 Issue The era that
defined Wall Street is finally, officially over. Michael Lewis, who chronicled
its excess in Liar’s Poker, returns to his old haunt to figure out what went
wrong.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#TheEnd
Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek
Explanation of the Meltdown on Wall Street!
Now I asked
Gutfreund about his biggest decision. “Yes,” he said. “They—the
heads of the other Wall Street firms—all said what an awful thing it was
to go public (beg for a government
bailout) and how could you do such a
thing. But when the temptation arose, they all gave in to it.” He agreed
that the main effect of turning a partnership into a corporation was to
transfer the financial risk to the shareholders. “When things go wrong,
it’s their problem,” he said—and obviously not theirs alone. When a Wall
Street investment bank screwed up badly enough, its risks became the
problem of the U.S. government. “It’s laissez-faire until you get in
deep shit,” he said, with a half chuckle. He was out of the game.
This is a must read to understand what went wrong on Wall Street ---
especially the punch line!
"The End," by Michael Lewis December 2008 Issue The era that defined Wall
Street is finally, officially over. Michael Lewis, who chronicled its excess
in Liar’s Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
To this day, the willingness of a Wall Street
investment bank to pay me hundreds of thousands of dollars to dispense
investment advice to grownups remains a mystery to me. I was 24 years
old, with no experience of, or particular interest in, guessing which
stocks and bonds would rise and which would fall. The essential function
of Wall Street is to allocate capital—to decide who should get it and
who should not. Believe me when I tell you that I hadn’t the first clue.
I’d never taken an accounting course, never run
a business, never even had savings of my own to manage. I stumbled into
a job at Salomon Brothers in 1985 and stumbled out much richer three
years later, and even though I wrote a book about the experience, the
whole thing still strikes me as preposterous—which is one of the reasons
the money was so easy to walk away from. I figured the situation was
unsustainable. Sooner rather than later, someone was going to identify
me, along with a lot of people more or less like me, as a fraud. Sooner
rather than later, there would come a Great Reckoning when Wall Street
would wake up and hundreds if not thousands of young people like me, who
had no business making huge bets with other people’s money, would be
expelled from finance.
When I sat down to write my account of the
experience in 1989—Liar’s Poker, it was called—it was in the spirit of a
young man who thought he was getting out while the getting was good. I
was merely scribbling down a message on my way out and stuffing it into
a bottle for those who would pass through these parts in the far distant
future.
Unless some insider got all of this down on
paper, I figured, no future human would believe that it happened.
I thought I was writing a period piece about
the 1980s in America. Not for a moment did I suspect that the financial
1980s would last two full decades longer or that the difference in
degree between Wall Street and ordinary life would swell into a
difference in kind. I expected readers of the future to be outraged that
back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid
$3.1 million; I expected them to gape in horror when I reported that one
of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost
$250 million; I assumed they’d be shocked to learn that a Wall Street
C.E.O. had only the vaguest idea of the risks his traders were running.
What I didn’t expect was that any future reader would look on my
experience and say, “How quaint.”
I had no great agenda, apart from telling what
I took to be a remarkable tale, but if you got a few drinks in me and
then asked what effect I thought my book would have on the world, I
might have said something like, “I hope that college students trying to
figure out what to do with their lives will read it and decide that it’s
silly to phony it up and abandon their passions to become financiers.” I
hoped that some bright kid at, say, Ohio State University who really
wanted to be an oceanographer would read my book, spurn the offer from
Morgan Stanley, and set out to sea.
Somehow that message failed to come across. Six
months after Liar’s Poker was published, I was knee-deep in letters from
students at Ohio State who wanted to know if I had any other secrets to
share about Wall Street. They’d read my book as a how-to manual.
In the two decades since then, I had been
waiting for the end of Wall Street. The outrageous bonuses, the slender
returns to shareholders, the never-ending scandals, the bursting of the
internet bubble, the crisis following the collapse of Long-Term Capital
Management: Over and over again, the big Wall Street investment banks
would be, in some narrow way, discredited. Yet they just kept on
growing, along with the sums of money that they doled out to
26-year-olds to perform tasks of no obvious social utility. The
rebellion by American youth against the money culture never happened.
Why bother to overturn your parents’ world when you can buy it, slice it
up into tranches, and sell off the pieces?
At some point, I gave up waiting for the end.
There was no scandal or reversal, I assumed, that could sink the system.
The New Order The crash did more than wipe out
money. It also reordered the power on Wall Street. What a Swell Party A
pictorial timeline of some Wall Street highs and lows from 1985 to 2007.
Worst of Times Most economists predict a recovery late next year. Don’t
bet on it. Then came Meredith Whitney with news. Whitney was an obscure
analyst of financial firms for Oppenheimer Securities who, on October
31, 2007, ceased to be obscure. On that day, she predicted that
Citigroup had so mismanaged its affairs that it would need to slash its
dividend or go bust. It’s never entirely clear on any given day what
causes what in the stock market, but it was pretty obvious that on
October 31, Meredith Whitney caused the market in financial stocks to
crash. By the end of the trading day, a woman whom basically no one had
ever heard of had shaved $369 billion off the value of financial firms
in the market. Four days later, Citigroup’s C.E.O., Chuck Prince,
resigned. In January, Citigroup slashed its dividend.
From that moment, Whitney became E.F. Hutton:
When she spoke, people listened. Her message was clear. If you want to
know what these Wall Street firms are really worth, take a hard look at
the crappy assets they bought with huge sums of borrowed money, and
imagine what they’d fetch in a fire sale. The vast assemblages of highly
paid people inside the firms were essentially worth nothing. For better
than a year now, Whitney has responded to the claims by bankers and
brokers that they had put their problems behind them with this
write-down or that capital raise with a claim of her own: You’re wrong.
You’re still not facing up to how badly you have mismanaged your
business.
Rivals accused Whitney of being overrated;
bloggers accused her of being lucky. What she was, mainly, was right.
But it’s true that she was, in part, guessing. There was no way she
could have known what was going to happen to these Wall Street firms.
The C.E.O.’s themselves didn’t know.
Now, obviously, Meredith Whitney didn’t sink
Wall Street. She just expressed most clearly and loudly a view that was,
in retrospect, far more seditious to the financial order than, say,
Eliot Spitzer’s campaign against Wall Street corruption. If mere scandal
could have destroyed the big Wall Street investment banks, they’d have
vanished long ago. This woman wasn’t saying that Wall Street bankers
were corrupt. She was saying they were stupid. These people whose job it
was to allocate capital apparently didn’t even know how to manage their
own.
At some point, I could no longer contain
myself: I called Whitney. This was back in March, when Wall Street’s
fate still hung in the balance. I thought, If she’s right, then this
really could be the end of Wall Street as we’ve known it. I was curious
to see if she made sense but also to know where this young woman who was
crashing the stock market with her every utterance had come from.
It turned out that she made a great deal of
sense and that she’d arrived on Wall Street in 1993, from the Brown
University history department. “I got to New York, and I didn’t even
know research existed,” she says. She’d wound up at Oppenheimer and had
the most incredible piece of luck: to be trained by a man who helped her
establish not merely a career but a worldview. His name, she says, was
Steve Eisman.
Eisman had moved on, but they kept in touch.
“After I made the Citi call,” she says, “one of the best things that
happened was when Steve called and told me how proud he was of me.”
Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called Whitney again and
asked her, as I was asking others, whom she knew who had anticipated the
cataclysm and set themselves up to make a fortune from it. There’s a
long list of people who now say they saw it coming all along but a far
shorter one of people who actually did. Of those, even fewer had the
nerve to bet on their vision. It’s not easy to stand apart from mass
hysteria—to believe that most of what’s in the financial news is wrong
or distorted, to believe that most important financial people are either
lying or deluded—without actually being insane. A handful of people had
been inside the black box, understood how it worked, and bet on it
blowing up. Whitney rattled off a list with a half-dozen names on it. At
the top was Steve Eisman.
Steve Eisman entered finance about the time I
exited it. He’d grown up in New York City and gone to a Jewish day
school, the University of Pennsylvania, and Harvard Law School. In 1991,
he was a 30-year-old corporate lawyer. “I hated it,” he says. “I hated
being a lawyer. My parents worked as brokers at Oppenheimer. They
managed to finagle me a job. It’s not pretty, but that’s what happened.”
He was hired as a junior equity analyst, a
helpmate who didn’t actually offer his opinions. That changed in
December 1991, less than a year into his new job, when a subprime
mortgage lender called Ames Financial went public and no one at
Oppenheimer particularly cared to express an opinion about it. One of
Oppenheimer’s investment bankers stomped around the research department
looking for anyone who knew anything about the mortgage business.
Recalls Eisman: “I’m a junior analyst and just trying to figure out
which end is up, but I told him that as a lawyer I’d worked on a deal
for the Money Store.” He was promptly appointed the lead analyst for
Ames Financial. “What I didn’t tell him was that my job had been to
proofread the documents and that I hadn’t understood a word of the
fucking things.”
Ames Financial belonged to a category of firms
known as nonbank financial institutions. The category didn’t include
J.P. Morgan, but it did encompass many little-known companies that one
way or another were involved in the early-1990s boom in subprime
mortgage lending—the lower class of American finance.
The second company for which Eisman was given
sole responsibility was Lomas Financial, which had just emerged from
bankruptcy. “I put a sell rating on the thing because it was a piece of
shit,” Eisman says. “I didn’t know that you weren’t supposed to put a
sell rating on companies. I thought there were three boxes—buy, hold,
sell—and you could pick the one you thought you should.” He was
pressured generally to be a bit more upbeat, but upbeat wasn’t Steve
Eisman’s style. Upbeat and Eisman didn’t occupy the same planet. A hedge
fund manager who counts Eisman as a friend set out to explain him to me
but quit a minute into it. After describing how Eisman exposed various
important people as either liars or idiots, the hedge fund manager
started to laugh. “He’s sort of a prick in a way, but he’s smart and
honest and fearless.”
“A lot of people don’t get Steve,” Whitney
says. “But the people who get him love him.” Eisman stuck to his sell
rating on Lomas Financial, even after the company announced that
investors needn’t worry about its financial condition, as it had hedged
its market risk. “The single greatest line I ever wrote as an analyst,”
says Eisman, “was after Lomas said they were hedged.” He recited the
line from memory: “ ‘The Lomas Financial Corp. is a perfectly hedged
financial institution: It loses money in every conceivable interest-rate
environment.’ I enjoyed writing that sentence more than any sentence I
ever wrote.” A few months after he’d delivered that line in his report,
Lomas Financial returned to bankruptcy.
Continued in article
Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999,
ISBN 0340767006)
Lewis writes in Partnoy’s earlier whistleblower
style with somewhat more intense and comic portrayals of the major
players in describing the double dealing and break down of integrity on
the trading floor of Salomon Brothers.
Reply from Tom Hood
Thanks Bob for the Michael Lewis article, “The End” – great explanation of
the mess we a re in and how we got here. Just found this one that does a
great job of summarizing the mess – visually
http://flowingdata.com/2008/11/25/visual-guide-to-the-financial-crisis/
Tom Hood, CPA.CITP, CEO & Executive Director, Maryland Association of CPAs
443-632-2301,
http://www.macpa.org
Check out our blogs for CPAs
http://www.cpasuvvess.com
http://www.newcpas.com
http://www.cpaisland.com
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30,
2009 ---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this
video (a little over 5 Mbs) using a free updated version of RealMedia ---
Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP
Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Their Own Private Europe," by Paul Krugman, The New York Times,
January 27, 2011 ---
http://www.nytimes.com/2011/01/28/opinion/28krugman.html?_r=1&hp
Bob Jensen's threads on bankers that are rotten to the core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Bob Jensen's threads on the bailout mess ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Since Alan Failed, the Job Must Be
Impossible," by Floyd Norris, The New York Times, March 30, 2011 ---
http://norris.blogs.nytimes.com/
Alan Greenspan is back,
lecturing the regulators that they can’t possibly hope to do the jobs
the Dodd-Frank law assigned to them.
In an op-ed
piece in Wednesday’s Financial Times, Mr.
Greenspan writes:
In pressing forward,
the regulators are being entrusted with forecasting, and presumably
preventing, all undesirable repercussions that might happen to a
market when its regulatory conditions are importantly altered. No
one has such skills. Regulators were caught “flat-footed” by a
breakdown we had erroneously thought was more than adequately
reserved against.
In other words, the fact
that he completely failed to do his job — and in the process brought on
a financial crisis whose effects are still felt — is ample evidence that
it is futile to try to do the job at all.
He goes on:
The problem is
that regulators, and for that matter everyone else, can never get
more than a glimpse at the internal workings of the simplest of
modern financial systems. Today’s competitive markets, whether we
seek to recognise it or not, are driven by an international version
of Adam Smith’s “invisible hand” that is unredeemably opaque. With
notably rare exceptions (2008, for example), the global “invisible
hand” has created relatively stable exchange rates, interest rates,
prices and wage rates.
I really like that part
about “notably rare exceptions.” It reminds me of a defense lawyer
arguing that while his client may have committed a few murders on one
particular day, his conduct on all the other days of his life had been
exemplary.
Ayn Rand ---
http://en.wikipedia.org/wiki/Ayn_Rand
Once again the Chronicle of Higher Education panders to its
snobbishly liberal readership
Right-wing think tanks can have Rand (even if she had
little use for them). In the academy, she is a nonperson. Her theories
are works of fiction. Her works of fiction are theories, and bad ones at that.
Should the Republicans actually win in 2012, we might need to study her in the
academic world. It would be for the same reason we sometimes need to study
creationism.
See below
"The Ridiculous Rise of Ayn Rand," by Alan Wolfe, The Chronicle of
Higher Education, August 19, 2012 ---
http://chronicle.com/blogs/conversation/2012/08/19/the-ridiculous-rise-of-ayn-rand/
When the literary editor of The New Republic
(note that William Buckley hated Ayn Rand such that this invitation to
Alan Wolff was likely biased from get go)
asked me to review two new books on Ayn Rand three years ago, I readily
agreed. Rand, the Russian-born writer known for her take-no-prisoners
defense of capitalism, was beginning to come back into vogue among
conservatives, and I recalled hearing that there was a congressman from
Wisconsin who was singing her praises and assigning her writings to his
staff. I had had my own flirtation with Rand, when I was 18, and although it
lasted less than a year, I could never forget a college classmate who kept
extensive index cards ready so that he could quote her whenever he deemed
the situation appropriate.
The two books were interesting, indeed fascinating.
One, Goddess of the Market: Ayn Rand and the American Right, was written by
Jennifer Burns, a historian at Stanford University. The other, Ayn Rand and
the World She Made, came from the journalist Anne C. Heller. As good as the
books were, however, I felt that to do justice to the essay, I would have to
reread Rand’s own novels. That proved to be too much. One of the best things
I have done for American politics in recent years was to turn down the
review assignment. It went instead to Jonathan Chait, now at New York
magazine, and I consider his masterly essay to be one of the outstanding
pieces of political journalism of the past decade.
With Paul Ryan’s selection as vice-presidential
candidate on the 2012 Republican ticket, Rand is back in the news. Chait
continues to write about her. Burns came out with two essays about her
contemporary relevance, one in The New York Times, the other in The New
Republic. We now know that Ryan tempered his enthusiasm for Rand when he
realized that her atheism might prove problematic for members of his party.
It has become clear that Rand was pro-choice and, like any hater of
government properly ought to be, a civil libertarian. She would be disgusted
by the Republican Party’s spending on defense (let alone Ryan’s support,
during the George W. Bush years, for the Medicare Part D prescription
benefit and TARP).
Yet as much as I like it when intellectuals receive
attention, I still find myself uninterested in Ayn Rand. I do not care what
she would have thought of the current scene. That those who invoke her name
treat her selectively is of almost no significance to me. I have the sense,
moreover, that I am not alone, at least among those in the academic world.
Despite a flutter of interest, she has been mostly ignored.
Rand wrote novels that are highly unlikely to be
read and taught in departments of English. Her subject was the market, but
no academic economists take her seriously, unless, of course, wealthy
libertarians offer funds for that purpose. She considered herself an
Aristotelian, but it is impossible to imagine departments of philosophy and
political science adding her to the canon.
For those under Rand’s spell, all this is just more
evidence of academe’s irrelevance. For me it demonstrates that, for all the
attacks directed against it, American academic life still has standards. I
will be teaching a course next semester called “Liberalism and
Conservatism.” John Stuart Mill and Edmund Burke will be on the reading
list. So will libertarians such as Friedrich von Hayek and the founder of
the National Review, William F. Buckley Jr. Contemporary liberals such as
E.J. Dionne will be there. But not Rand. My reasons for excluding her may be
the same reasons that other academics ignore her.
Rand’s “thought,” such as it is, boils down to two
propositions. One is that selfishness is the highest of moral virtues. The
other is that the masses, above all resentful of success, are parasites
living off the hard work of capitalists far superior to them in every way.
Self-interest is a useful concept, while
selfishness is not. That, I believe, helps explain why Adam Smith is a
first-rate thinker and Ayn Rand is an amateur.
Self-interest makes altruism possible: I can decide
to help others, even if in doing so I may be set back financially, because
other gains to my self-esteem are important to me. Self-interest requires a
nuanced psychology, which is why economists now find themselves
investigating all kinds of human behavior and are increasingly interested in
how the mind works. Selfishness, by contrast, is not psychologically
interesting; Rand’s understanding of human behavior has no room for the
complex, the unexpected, or the paradoxical. It is one thing to say, as she
frequently did, that altruism is evil; that is a normative position with
which one might agree or, I hope, disagree. But to claim that altruism is
impossible, an empirical question, is another matter entirely. Any social
science, including economics, must be based on a realistic psychology. Rand
does not offer one.
As for the masses, serious thinkers have shared
Rand’s concern about their impact on society: de Tocqueville spoke of the
tyranny of the majority and Ortega y Gasset of their “revolt.” There was a
time when the concept of mass society was taken seriously in academic
sociology: Daniel Bell wrote an essay about it, C. Wright Mills a chapter,
and William Kornhauser a book. But while we continue to discuss mass media
and mass culture, we have also learned, as Mills tried to teach us, that
elites have flaws of their own. A theory of society that attributes virtues
to one group and vices to another cannot pass the realism test: Rand’s
“inverted” Marxism, as Chait calls it, is as myopic as its opposite.
Continued in article
Jensen Comment
Alan Wolff only hopes that Ayn Rand is a nonperson in the Academy, and if he's
correct he's preaching from an ivory tower detached from the world of real
people. If he's simply gone to Wikipedia, he would have found that she's not
exactly a nonperson in the Academy. Thumbs down to Alan Wolff's new scholarship.
Ayn Rand ---
http://en.wikipedia.org/wiki/Ayn_Rand
In his history of the
libertarian movement, journalist
Brian Doherty described her as "the most influential libertarian of the
twentieth century to the public at large",and biographer Jennifer Burns
referred to her as "the ultimate gateway drug to life on the right"
She faced intense opposition from
William F. Buckley, Jr. and other contributors for the
National Review magazine. They published numerous attacks in the
1950s and 1960s by
Whittaker Chambers,
Garry Wills, and
M. Stanton Evans. Nevertheless, her influence among conservatives forced
Buckley and other National Review contributors to reconsider how
traditional notions of virtue and Christianity could be integrated with
support for capitalism.
. . .
Academic reaction
During Rand's lifetime her work received little attention from academic
scholars.[4]
When the first academic book about Rand's philosophy appeared in 1971, its
author declared writing about Rand "a treacherous undertaking" that could
lead to "guilt by association" for taking her seriously.[175]
A few articles about Rand's ideas appeared in academic journals before her
death in 1982, many of them in
The Personalist.[176]
One of these was "On the Randian Argument" by libertarian philosopher
Robert Nozick, who argued that her
meta-ethical argument is unsound and fails to solve the
is–ought problem posed by
David
Hume.[177]
Some responses to Nozick by other academic philosophers were also published
in The Personalist arguing that Nozick misstated Rand's case.[176]
Academic consideration of Rand as a literary figure during her life was even
more limited. Gladstein was unable to find any scholarly articles about
Rand's novels when she began researching her in 1973, and only three such
articles appeared during the rest of the 1970s.[178]
Since Rand's death, interest in her work has gradually increased.[179]
Historian Jennifer Burns has identified "three overlapping waves" of
scholarly interest in Rand, the most recent of which is "an explosion of
scholarship" since the year 2000.[180]
However, few universities currently include Rand or Objectivism as a
philosophical specialty or research area, with many literature and
philosophy departments dismissing her as a pop culture phenomenon rather
than a subject for serious study.[181]
Academics Mimi Gladstein, Chris Sciabarra,
Allan Gotthelf,
Edwin A. Locke and
Tara Smith have taught her work in academic institutions. Sciabarra
co-edits the
Journal of Ayn Rand Studies, a nonpartisan peer-reviewed journal
dedicated to the study of Rand's philosophical and literary work.[182]
In 1987 Gotthelf helped found the Ayn Rand Society, and has been active in
sponsoring seminars about Rand and her ideas.[183]
Smith has written several academic books and papers on Rand's ideas,
including Ayn Rand's Normative Ethics: The Virtuous Egoist, a volume
on Rand's ethical theory published by
Cambridge University Press. Rand's ideas have also been made subjects of
study at
Clemson and
Duke universities.[184]
Scholars of English and American literature have largely ignored her work,[185]
although attention to her literary work has increased since the 1990s.[186]
Some academic philosophers have criticized Rand for what they consider
her lack of rigor and limited understanding of philosophical subject matter.[4][99]
The Philosophical Lexicon, a satirical web site maintained by
philosophers
Daniel Dennett and Asbjørn Steglich-Petersen, defines a 'rand' as: "An
angry tirade occasioned by mistaking philosophical disagreement for a
personal attack and/or evidence of unspeakable moral corruption."[187]
Chris Matthew Sciabarra has called into question the motives of some of
Rand's critics because of the unusual hostility of their criticisms.[188]
Sciabarra writes, "The left was infuriated by her anti-communist,
pro-capitalist politics, whereas the right was disgusted with her atheism
and civil libertarianism."[4]
Rand scholars Douglas Den Uyl and
Douglas B. Rasmussen, while stressing the importance and originality of
her thought, describe her style as "literary, hyperbolic and emotional".[189]
Philosopher Jack Wheeler says that despite "the incessant bombast and
continuous venting of Randian rage", Rand's ethics are "a most immense
achievement, the study of which is vastly more fruitful than any other in
contemporary thought."[190]
In the
Literary Encyclopedia entry for Rand written in 2001, John Lewis
declared that "Rand wrote the most intellectually challenging fiction of her
generation".[191]
In a 1999 interview in the
Chronicle of Higher Education, Rand scholar
Chris Matthew Sciabarra commented, "I know they laugh at Rand", while
forecasting a growth of interest in her work in the academic community.[192]
Philosopher
Michael Huemer has argued that very few people find Rand's ideas
convincing, especially her ethics,[193]
which he believes is difficult to interpret and may lack logical coherence.[194]
He attributes the attention she receives to her being a "compelling writer",
especially as a novelist. Thus, Atlas Shrugged outsells not only the
works of other philosophers of
classical liberalism as Ludwig von Mises,
Friedrich Hayek, or
Frederic Bastiat, but also Rand's own non-fiction works.[193]
Philosopher Robert H. Bass has argued that her central ethical ideas are
inconsistent and contradictory to her central political ideas
"Is Economics Ready for a New Model?" by Justin Fox, Harvard
Business Review Blog, December 2, 2010 ---
Click Here
http://blogs.hbr.org/fox/2010/12/economics-ready-for-new-model.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Economic theories based on rational behavior have
been called into doubt by recent events. A few maverick scholars "are
stepping up the hunt for new models that could more accurately describe the
real world." Some look to psychology for answers; others are interested in
importing approaches from the physical sciences.
Sound like something you might have read in
Tuesday's Wall Street Journal? It does in fact accurately describe
Mark Whitehouse's article, headlined, "Economists'
Grail: A Post-Crash Model." But it also describes
(and the quote is taken from)
a 1988 article in Fortune by Gary Hector.
If you want to learn about the subject, in fact,
Hector's article is probably better — it's clearer in its descriptions of
the relevant theories. But it's 22 years old. Have we learned
nothing in the intervening two decades?
In the sense that financial markets and the economy
in general are far more fragile than most mainstream economists contemplated
before 2008, there was a bit of unlearning done in the 1990s and
early 2000s. The 1987 stock market crash was a scare. So were the currency
and debt crises of 1997 and 1998, and the stock market collapse of
2000-2002. None of them brought economic devastation in the U.S. and Europe,
though (and Japan's long struggles were seen as the product of peculiarly
Japanese economic traits). The conviction spread that, thanks in part to
financial innovation, the world's developed economies had become more
resilient even as financial markets became more volatile. Alan Greenspan
was the most prominent cheerleader for this idea,
but he sure wasn't alone. I know
I believed it.
I don't really buy that anymore, and I don't think
all that many economists do, either. But does that mean their theories and
their way of going about their work are about to undergo wholesale change?
To get an idea, it's helpful to go back to that
1988 Fortune article. It focused on three young economists who were
arguing that emotion and error played a big role in financial market
fluctuations than was countenanced in then-standard theories of the market.
Their names:
Robert Shiller,
Lawrence Summers, and
Richard Thaler. Thaler and Shiller are now among
the most prominent economists on earth, best-selling authors, and regular
betting favorites for (albeit not yet actual winners of) the economics
Nobel. Summers, meanwhile, is the second most powerful economic official in
the U.S. —
at least for another couple of weeks.
Did these three men turn economics upside down? No.
But they — mainly Shiller and Thaler, as Summers didn't spend a whole lot of
time on the practice of academic economics over the past two decades — have
definitely helped open the discipline to new ideas about market volatility
and the strange quirks of human behavior. You can find lots of scholars at
top economics departments who study why bubbles and crashes happen, and how
psychology and genetics shape individual decisionmaking. What you won't find
is many who think the entire infrastructure of rationality-based economics
needs to be tossed out.
The other big idea in the 1988 article was chaos
theory. The hope, expressed in the piece mainly by
William "Buz" Brock of the University of
Wisconsin, was that economists would soon be able to use tools developed by
physicists, biologists and other hard scientists to predict market behavior.
Chaos — and the broader catch-all, complexity — became an enormously
fashionable economic topic for a few years.The physicist-founded Santa Fe
Institute in New Mexico was the center of this work. Most of the economists
involved, though, eventually concluded that chaos and complexity theory held
few answers for them and physicists were on the whole too ignorant of and
arrogant about economics to be much help. So they moved on (Brock's Santa Fe
affiliation ended in 2002).
In recent years
J. Doyne Farmer, a
Los-Alamos-National-Laboratory-scientist-turned-hedge-fund-manager-turned-Santa-Fe-Institute-professor,
has bent over backwards not to be ignorant and arrogant about
economics. He's co-authored papers with economists from Yale, MIT, and other
perfectly respectable places, and learned a remarkable amount about the
nitty-gritty of financial market functioning. Have economists begun to move
in his direction? Farmer, as quoted in the Wall Street Journal
article — and in a
panel
discussion I did
with him over the summer — is a bit frustrated
with how economists remain stuck on old, static ways of modeling reality.
And economists
are dubious of his
proposals for massive agent-based computer models of the economy.
So if you're looking for a revolution in economics,
you'll probably have to wait a long, long while. But evolution,
sure, there's some of that. And lots of cycling back and forth between the
belief that, in a market-based economy, everything will always work out for
the best, and the concern that markets — especially financial markets —
might have a natural tendency to self-destruct from time to time.
Bob Jensen's threads on theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
"What the Demise of Fannie Mae and Freddie Mac Means for the Future of
Homeownership," Knowledge@Wharton, March 16, 2011 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2737
By most accounts, the federally sponsored mortgage
giants Fannie Mae and Freddie Mac did not cause the housing and mortgage
crisis. But they were a big part of the problem, prompting a taxpayer
bailout costing more than $130 billion.
Now, seeking to protect taxpayers from future
meltdowns, the Obama administration wants to phase out the two firms over an
unspecified period and leave the lion's share of the mortgage market to
private lenders. It would be a dramatic change, given that the private
market has shriveled in recent years, leaving Fannie, Freddie and the
Federal Housing Administration to back about 90% of all new home loans. The
administration also proposes a reduced role for the FHA, one that would
focus on providing mortgages for the needy.
How would a phase-out of Fannie and Freddie affect
the availability of mortgages, loan rates and home prices? In the end, would
such a dramatic change be good for homeowners or not?
Opinions vary, and no one can know for sure. The
mortgage and housing markets are complex, and a controlled experiment that
removes Fannie and Freddie but leaves everything else the same is obviously
not possible, says Wharton real estate professor
Todd Sinai. "There's a debate over whether Fannie
and Freddie successfully reduced mortgage rates paid by borrowers, or
increased the mortgage availability for borrowers, or whether they just took
their implicit [government] subsidy and generated higher returns for
shareholders," Sinai says. "If Fannie and Freddie were successful in making
mortgage credit cheaper and more available, then eliminating [them] would
have a negative impact on house prices."
It is not clear that the private market can or
would absorb the volume of business done by Fannie and Freddie, which cover
trillions of dollars worth of loans, according to Wharton real estate
professor
Susan M. Wachter. "That's a good question," she
says, noting that even if the private market were to take over, borrowers
would probably not get the attractive deals they can today.
"The 30-year [mortgage] would become more
expensive," she states, adding that some experts predict a three percentage
point rate rise. With the 30-year, fixed-rate loan now averaging around 5%,
that would take it to 8%, raising the monthly payment for every $100,000
borrowed from $537 to $733. This would make the 30-year fixed loan
"noncompetitive" with adjustable-rate loans, Wachter says. ARMs can offer
lower rates because lenders face less risk, given that they can raise rates
as market conditions change
Jack M. Guttentag, an emeritus professor of
finance at Wharton who runs a website called
The Mortgage
Professor, thinks fixed rates might go up only
three quarters of a percentage point rather than three points. But with the
two firms' loan guarantees removed from the market, lenders would probably
demand larger down payments than they have in the past, and be less willing
to provide loans to those with less-than-stellar credit. Indeed, today's
tight lending standards, a reaction to the recent crisis, could become
permanent.
"Things like qualification standards have become
extremely strict," Guttentag says, noting that it is now all but impossible
for a self-employed applicant to get a mortgage. "The biggest part of it
would be the increase in the down payment; 20% would probably become the
minimum throughout the marketplace."
Larger down payments reduce the lender's risk
because borrowers are reluctant to default if they have equity in the home,
and because a smaller loan relative to the home's value makes it easier for
the lender to recover in a foreclosure. Currently, most lenders require 20%
down payments; a few years ago, however, it was possible to get a loan with
nothing down. The Obama administration wants underwriting standards to
require at least 10%, though the FHA would continue to offer low-down
payment loans to certain less-affluent borrowers.
Planning a Phase-out
Fannie, the Federal National Mortgage Association,
was formed as a government agency in 1938 and was converted to a publicly
traded company in 1968. Freddie, the Federal Home Loan Mortgage Corp., is a
publicly traded company created by the government in 1970 to provide
competition for Fannie. Their primary role is to buy and insure mortgages
issued by private lenders. Some loans stay on Fannie and Freddie's books,
but most are bundled into mortgage securities sold to investors like other
types of government and corporate bonds. Fannie and Freddie provide
investors certain guarantees that interest and principal payments will be
made even if homeowners default.
Continued in article
Bob Jensen's threads on Fannie and Freddie are at the following links:
http://faculty.trinity.edu/rjensen/2008Bailout.htm
http://faculty.trinity.edu/rjensen/Theory02.htm#Manipulation
"How Did Economists Get It So Wrong?" by Paul Krugman (liberal
Keynesian and Nobel Prize winner), The New York Times, September 2, 2009
---
http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?ref=business
It’s hard to believe now, but not long ago
economists were congratulating themselves over the success of their field.
Those successes — or so they believed — were both theoretical and practical,
leading to a golden era for the profession. On the theoretical side, they
thought that they had resolved their internal disputes. Thus, in a 2008
paper titled “The State of Macro” (that is, macroeconomics, the study of
big-picture issues like recessions), Olivier Blanchard of M.I.T., now the
chief economist at the International Monetary Fund, declared that “the state
of macro is good.” The battles of yesteryear, he said, were over, and there
had been a “broad convergence of vision.” And in the real world, economists
believed they had things under control: the “central problem of
depression-prevention has been solved,” declared Robert Lucas of the
University of Chicago in his 2003 presidential address to the American
Economic Association. In 2004, Ben Bernanke, a former Princeton professor
who is now the chairman of the Federal Reserve Board, celebrated the Great
Moderation in economic performance over the previous two decades, which he
attributed in part to improved economic policy making.
Last year, everything came apart.
Few economists saw our current crisis
coming, but this predictive failure was the least of the field’s problems.
More important was the profession’s blindness to the very possibility of
catastrophic failures in a market economy. During the golden years,
financial economists came to believe that markets were inherently stable —
indeed, that stocks and other assets were always priced just right. There
was nothing in the prevailing models suggesting the possibility of the kind
of collapse that happened last year. Meanwhile, macroeconomists were divided
in their views. But the main division was between those who insisted that
free-market economies never go astray and those who believed that economies
may stray now and then but that any major deviations from the path of
prosperity could and would be corrected by the all-powerful Fed. Neither
side was prepared to cope with an economy that went off the rails despite
the Fed’s best efforts.
And in the wake of the crisis, the fault
lines in the economics profession have yawned wider than ever. Lucas says
the Obama administration’s stimulus plans are “schlock economics,” and his
Chicago colleague John Cochrane says they’re based on discredited “fairy
tales.” In response, Brad DeLong of the University of California, Berkeley,
writes of the “intellectual collapse” of the Chicago School, and I myself
have written that comments from Chicago economists are the product of a Dark
Age of macroeconomics in which hard-won knowledge has been forgotten.
What happened to the economics profession?
And where does it go from here?
As I see it, the economics profession went
astray because economists, as a group, mistook beauty, clad in
impressive-looking mathematics, for truth. Until the Great Depression, most
economists clung to a vision of capitalism as a perfect or nearly perfect
system. That vision wasn’t sustainable in the face of mass unemployment, but
as memories of the Depression faded, economists fell back in love with the
old, idealized vision of an economy in which rational individuals interact
in perfect markets, this time gussied up with fancy equations. The renewed
romance with the idealized market was, to be sure, partly a response to
shifting political winds, partly a response to financial incentives. But
while sabbaticals at the Hoover Institution and job opportunities on Wall
Street are nothing to sneeze at, the central cause of the profession’s
failure was the desire for an all-encompassing, intellectually elegant
approach that also gave economists a chance to show off their mathematical
prowess.
Unfortunately, this romanticized and
sanitized vision of the economy led most economists to ignore all the things
that can go wrong. They turned a blind eye to the limitations of human
rationality that often lead to bubbles and busts; to the problems of
institutions that run amok; to the imperfections of markets — especially
financial markets — that can cause the economy’s operating system to undergo
sudden, unpredictable crashes; and to the dangers created when regulators
don’t believe in regulation.
It’s much harder to say where the
economics profession goes from here. But what’s almost certain is that
economists will have to learn to live with messiness. That is, they will
have to acknowledge the importance of irrational and often unpredictable
behavior, face up to the often idiosyncratic imperfections of markets and
accept that an elegant economic “theory of everything” is a long way off. In
practical terms, this will translate into more cautious policy advice — and
a reduced willingness to dismantle economic safeguards in the faith that
markets will solve all problems.
II. FROM SMITH TO KEYNES AND BACK
The birth of economics as a discipline is
usually credited to Adam Smith, who published “The Wealth of Nations” in
1776. Over the next 160 years an extensive body of economic theory was
developed, whose central message was: Trust the market. Yes, economists
admitted that there were cases in which markets might fail, of which the
most important was the case of “externalities” — costs that people impose on
others without paying the price, like traffic congestion or pollution. But
the basic presumption of “neoclassical” economics (named after the
late-19th-century theorists who elaborated on the concepts of their
“classical” predecessors) was that we should have faith in the market
system.
This faith was, however, shattered by the
Great Depression. Actually, even in the face of total collapse some
economists insisted that whatever happens in a market economy must be right:
“Depressions are not simply evils,” declared Joseph Schumpeter in 1934 —
1934! They are, he added, “forms of something which has to be done.” But
many, and eventually most, economists turned to the insights of John Maynard
Keynes for both an explanation of what had happened and a solution to future
depressions.
Keynes did not, despite what you may have
heard, want the government to run the economy. He described his analysis in
his 1936 masterwork, “The General Theory of Employment, Interest and Money,”
as “moderately conservative in its implications.” He wanted to fix
capitalism, not replace it. But he did challenge the notion that free-market
economies can function without a minder, expressing particular contempt for
financial markets, which he viewed as being dominated by short-term
speculation with little regard for fundamentals. And he called for active
government intervention — printing more money and, if necessary, spending
heavily on public works — to fight unemployment during slumps.
It’s important to understand that Keynes
did much more than make bold assertions. “The General Theory” is a work of
profound, deep analysis — analysis that persuaded the best young economists
of the day. Yet the story of economics over the past half century is, to a
large degree, the story of a retreat from Keynesianism and a return to
neoclassicism. The neoclassical revival was initially led by Milton Friedman
of the University of Chicago, who asserted as early as 1953 that
neoclassical economics works well enough as a description of the way the
economy actually functions to be “both extremely fruitful and deserving of
much confidence.” But what about depressions?
Friedman’s counterattack against Keynes
began with the doctrine known as monetarism. Monetarists didn’t disagree in
principle with the idea that a market economy needs deliberate
stabilization. “We are all Keynesians now,” Friedman once said, although he
later claimed he was quoted out of context. Monetarists asserted, however,
that a very limited, circumscribed form of government intervention — namely,
instructing central banks to keep the nation’s money supply, the sum of cash
in circulation and bank deposits, growing on a steady path — is all that’s
required to prevent depressions. Famously, Friedman and his collaborator,
Anna Schwartz, argued that if the Federal Reserve had done its job properly,
the Great Depression would not have happened. Later, Friedman made a
compelling case against any deliberate effort by government to push
unemployment below its “natural” level (currently thought to be about 4.8
percent in the United States): excessively expansionary policies, he
predicted, would lead to a combination of inflation and high unemployment —
a prediction that was borne out by the stagflation of the 1970s, which
greatly advanced the credibility of the anti-Keynesian movement.
Eventually, however, the anti-Keynesian
counterrevolution went far beyond Friedman’s position, which came to seem
relatively moderate compared with what his successors were saying. Among
financial economists, Keynes’s disparaging vision of financial markets as a
“casino” was replaced by “efficient market” theory, which asserted that
financial markets always get asset prices right given the available
information. Meanwhile, many macroeconomists completely rejected Keynes’s
framework for understanding economic slumps. Some returned to the view of
Schumpeter and other apologists for the Great Depression, viewing recessions
as a good thing, part of the economy’s adjustment to change. And even those
not willing to go that far argued that any attempt to fight an economic
slump would do more harm than good.
Not all macroeconomists were willing to go
down this road: many became self-described New Keynesians, who continued to
believe in an active role for the government. Yet even they mostly accepted
the notion that investors and consumers are rational and that markets
generally get it right.
Of course, there were exceptions to these
trends: a few economists challenged the assumption of rational behavior,
questioned the belief that financial markets can be trusted and pointed to
the long history of financial crises that had devastating economic
consequences. But they were swimming against the tide, unable to make much
headway against a pervasive and, in retrospect, foolish complacency.
III. PANGLOSSIAN FINANCE
In the 1930s, financial markets, for
obvious reasons, didn’t get much respect. Keynes compared them to “those
newspaper competitions in which the competitors have to pick out the six
prettiest faces from a hundred photographs, the prize being awarded to the
competitor whose choice most nearly corresponds to the average preferences
of the competitors as a whole; so that each competitor has to pick, not
those faces which he himself finds prettiest, but those that he thinks
likeliest to catch the fancy of the other competitors.”
And Keynes considered it a very bad idea
to let such markets, in which speculators spent their time chasing one
another’s tails, dictate important business decisions: “When the capital
development of a country becomes a by-product of the activities of a casino,
the job is likely to be ill-done.”
By 1970 or so, however, the study of
financial markets seemed to have been taken over by Voltaire’s Dr. Pangloss,
who insisted that we live in the best of all possible worlds. Discussion of
investor irrationality, of bubbles, of destructive speculation had virtually
disappeared from academic discourse. The field was dominated by the
“efficient-market hypothesis,” promulgated by Eugene Fama of the University
of Chicago, which claims that financial markets price assets precisely at
their intrinsic worth given all publicly available information. (The price
of a company’s stock, for example, always accurately reflects the company’s
value given the information available on the company’s earnings, its
business prospects and so on.) And by the 1980s, finance economists, notably
Michael Jensen of the Harvard Business School, were arguing that because
financial markets always get prices right, the best thing corporate
chieftains can do, not just for themselves but for the sake of the economy,
is to maximize their stock prices. In other words, finance economists
believed that we should put the capital development of the nation in the
hands of what Keynes had called a “casino.”
Continued in article
Here is Paul Krugman from his blog trying to deny that he was a persistent
advocate for the housing bubble and below that are quotes from him just prior to
the bubble taking off.
Mark Thornton, "Krugman
Did Cause the Housing Bubble," Von Mises Blog, June 17, 2009 ---
http://blog.mises.org/archives/010153.asp
Jensen Comment
My worry about Krugman is that he advocates more and more spending without much
concern about deficits, interest buildup of the National Debt, and long-term
entitlements that, in my viewpoint, will bring down the United States under any
economic system. He mostly advocates spend, spend, spend!
Keynes: The Rise, Fall, and Return of the 20th Century's Most
Influential Economist by Peter Clarke (Bloomsbury; 2009, 211
pages; $20). Examines the life and legacy of the British economist (1883-1946).
Video: Charles Furgeson has produced a powerful documentary, “Inside
Job,” about the deep capture of financial (de)regulation ---
http://thesituationist.wordpress.com/2010/11/14/the-situation-of-the-2008-economic-crisis/
"Economics has met the enemy, and it is economics," by Ira Basen,
Globe and Mail, October 15, 2011 ---
http://www.theglobeandmail.com/news/politics/economics-has-met-the-enemy-and-it-is-economics/article2202027/page1/
Thank you Jerry Trites for the heads up.
After Thomas Sargent learned on Monday morning that
he and colleague Christopher Sims had been awarded the Nobel Prize in
Economics for 2011, the 68-year-old New York University professor struck an
aw-shucks tone with an interviewer from the official Nobel website: “We're
just bookish types that look at numbers and try to figure out what's going
on.”
But no one who'd followed Prof. Sargent's long,
distinguished career would have been fooled by his attempt at modesty. He'd
won for his part in developing one of economists' main models of cause and
effect: How can we expect people to respond to changes in prices, for
example, or interest rates? According to the laureates' theories, they'll do
whatever's most beneficial to them, and they'll do it every time. They don't
need governments to instruct them; they figure it out for themselves.
Economists call this the “rational expectations” model. And it's not just an
abstraction: Bankers and policy-makers apply these formulae in the real
world, so bad models lead to bad policy.
Which is perhaps why, by the end of that interview
on Monday, Prof. Sargent was adopting a more realistic tone: “We experiment
with our models,” he explained, “before we wreck the world.”
Rational-expectations theory and its corollary, the
efficient-market hypothesis, have been central to mainstream economics for
more than 40 years. And while they may not have “wrecked the world,” some
critics argue these models have blinded economists to reality: Certain the
universe was unfolding as it should, they failed both to anticipate the
financial crisis of 2008 and to chart an effective path to recovery.
The economic crisis has produced a crisis in the
study of economics – a growing realization that if the field is going to
offer meaningful solutions, greater attention must be paid to what is
happening in university lecture halls and seminar rooms.
While the protesters occupying Wall Street are not
carrying signs denouncing rational-expectations and efficient-market
modelling, perhaps they should be.
They wouldn't be the first young dissenters to call
economics to account. In June of 2000, a small group of elite graduate
students at some of France's most prestigious universities declared war on
the economic establishment. This was an unlikely group of student radicals,
whose degrees could be expected to lead them to lucrative careers in
finance, business or government if they didn't rock the boat. Instead, they
protested – not about tuition or workloads, but that too much of what they
studied bore no relation to what was happening outside the classroom walls.
They launched an online petition demanding greater
realism in economics teaching, less reliance on mathematics “as an end in
itself” and more space for approaches beyond the dominant neoclassical
model, including input from other disciplines, such as psychology, history
and sociology. Their conclusion was that economics had become an “autistic
science,” lost in “imaginary worlds.” They called their movement
Autisme-economie.
The students' timing is notable: It was the spring
of 2000, when the world was still basking in the glow of “the Great
Moderation,” when for most of a decade Western economies had been enjoying a
prolonged period of moderate but fairly steady growth.
Some economists were daring to think the
unthinkable – that their understanding of how advanced capitalist economies
worked had become so sophisticated that they might finally have succeeded in
smoothing out the destructive gyrations of capitalism's boom-and-bust cycle.
(“The central problem of depression prevention has been solved,” declared
another Nobel laureate, Robert Lucas of the University of Chicago, in 2003 –
five years before the greatest economic collapse in more than half a
century.)
The students' petition sparked a lively debate. The
French minister of education established a committee on economic education.
Economics students across Europe and North America began meeting and
circulating petitions of their own, even as defenders of the status quo
denounced the movement as a Trotskyite conspiracy. By September, the first
issue of the Post-Autistic Economic Newsletter was published in Britain.
As The Independent summarized the students'
message: “If there is a daily prayer for the global economy, it should be,
‘Deliver us from abstraction.'”
It seems that entreaty went unheard through most of
the discipline before the economic crisis, not to mention in the offices of
hedge funds and the Stockholm Nobel selection committee. But is it ringing
louder now? And how did economics become so abstract in the first place?
The great classical economists of the late 18th and
early 19th centuries had no problem connecting to the real world – the
Industrial Revolution had unleashed profound social and economic changes,
and they were trying to make sense of what they were seeing. Yet Adam Smith,
who is considered the founding father of modern economics, would have had
trouble understanding the meaning of the word “economist.”
What is today known as economics arose out of two
larger intellectual traditions that have since been largely abandoned. One
is political economy, which is based on the simple idea that economic
outcomes are often determined largely by political factors (as well as vice
versa). But when political-economy courses first started appearing in
Canadian universities in the 1870s, it was still viewed as a small offshoot
of a far more important topic: moral philosophy.
In The Wealth of Nations (1776), Adam Smith
famously argued that the pursuit of enlightened self-interest by individuals
and companies could benefit society as a whole. His notion of the market's
“invisible hand” laid the groundwork for much of modern neoclassical and
neo-liberal, laissez-faire economics. But unlike today's free marketers,
Smith didn't believe that the morality of the market was appropriate for
society at large. Honesty, discipline, thrift and co-operation, not
consumption and unbridled self-interest, were the keys to happiness and
social cohesion. Smith's vision was a capitalist economy in a society
governed by non-capitalist morality.
But by the end of the 19th century, the new field
of economics no longer concerned itself with moral philosophy, and less and
less with political economy. What was coming to dominate was a conviction
that markets could be trusted to produce the most efficient allocation of
scarce resources, that individuals would always seek to maximize their
utility in an economically rational way, and that all of this would
ultimately lead to some kind of overall equilibrium of prices, wages, supply
and demand.
Political economy was less vital because government
intervention disrupted the path to equilibrium and should therefore be
avoided except in exceptional circumstances. And as for morality, economics
would concern itself with the behaviour of rational, self-interested,
utility-maximizing Homo economicus. What he did outside the confines of the
marketplace would be someone else's field of study.
As those notions took hold, a new idea emerged that
would have surprised and probably horrified Adam Smith – that economics,
divorced from the study of morality and politics, could be considered a
science. By the beginning of the 20th century, economists were looking for
theorems and models that could help to explain the universe. One historian
described them as suffering from “physics envy.” Although they were dealing
with the behaviour of humans, not atoms and particles, they came to believe
they could accurately predict the trajectory of human decision-making in the
marketplace.
In their desire to have their field be recognized
as a science, economists increasingly decided to speak the language of
science. From Smith's innovations through John Maynard Keynes's work in the
1930s, economics was argued in words. Now, it would go by the numbers.
Continued in a long article
Mathematical Analytics in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm#Analytics
Video Lecure by Nobel Laureate Robert Merton
The Future of Finance
MIT World
http://mitworld.mit.edu/video/881
In his keynote address, Robert Merton chooses not
to focus on the financial crisis. It is clear to him there were “fools and
knaves,” as well as “many structural elements that would have happened even
if people were well behaved and well informed” -- risks are simply “embedded
in our systems.” Instead, Merton explores how financial engineering is
essential in preparing for the inevitable next crisis, and in solving
critical challenges. “The world has changed; we can’t go back. Let’s talk
about what we should do going forward.”
To illustrate society’s need for financial
innovation, Merton uses “a live case study:” the vast problem of retirement
funding. In the past decade, stock market declines and falling interest
rates have hit mainstream employer pension plans hard. Municipal pension
plans may be underfunded to the tune of three trillion dollars. (“It makes
the S&L crisis look like nothing.”) But people seek, and are due, “the
standard of living during retirement they enjoyed in the latter part of
their work life.”
Generally, determining this standard of living
means adding up likely medical, housing and general consumption costs, and
Merton describes how to target such retirement income. The main ways to
achieve the desired goal are by saving more, working longer or taking more
risk. Merton would like to design a software-based tool for ordinary people,
simple on the user end, complex on the provider end, which would serve as a
“next generation pension solution,” offering a way to manipulate the key
variables in retirement income and demonstrate potential financial outcomes.
This tool would help users continuously optimize risk to help them reach
their retirement funding goals.
There are regulatory obstacles now to the
implementation of such a method on a widespread basis, and a gap between how
managers, advisers and financial institutions think about pension assets,
and what Merton has in mind. Nevertheless, he says, “What we need to do for
most of the people who don’t have extra money and must do the most with
their assets is deliver a simple, easy to use, and if they don’t use it
still gets them there, solution.” Merton acknowledges those who think the
giant problem of pension funding can be solved by what’s already available
-- bond and equity markets, bank loans – and who hanker “to get rid of all
the complexity, go back to 1930, ’50 or ’80.” From his perspective, this
means “throwing away a lot of what you could do, because the market-proven
strategies people have developed and used…can do a much better job for
people.”
Jensen Comment
Contributing to the pension crisis has been a willingness of the accounting and
auditing profession to allow both the public and private sectors to deceive
taxpayers and investors about the extend to which contracted pension obligations
are off the balance sheet and not even disclosed properly.
The sad state of governmental accounting ---
http://faculty.trinity.edu/rjensen/Theory02.htm#GovernmentalAccounting
Off Balance Sheet Financing (OBSF) ---
http://faculty.trinity.edu/rjensen/Theory02.htm#OBSF2
This is one of the few times I've seen a Harvard accounting faculty member
contribute to the daily Harvard Business Review Blog that has a steady
flow of contributions form management, marketing, and finance faculty that
sustain this blog.
"Dodd-Frank Financial Commentary from HBS Faculty," Harvard
Business Review Blog, July 20, 2010 ---
http://blogs.hbr.org/hbsfaculty/2010/07/dodd-frank-commentary-from-hbs.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE
"Five Major Defects of the Financial Reform Bill," by Nobel Laureate
Gary Becker, Becker-Posner Blog, July 11, 2010 ---
http://www.becker-posner-blog.com/2010/07/five-major-defects-of-the-financial-reform-bill-becker.html
A 2300 page bill is usually an indication of many
political compromises. The Dodd-Frank financial reform bill is no exception,
for it is a complex, disorderly, politically motivated, and not well thought
out reaction to the financial crisis that erupted beginning with the panic
of the fall of 2008. Not everything about the bill is bad-e.g., the
requirement that various derivatives trade through exchanges may be a good
suggestion- but the disturbing parts of the bill are far more important. I
will concentrate on five major defects, including omissions.
1. The bill adds regulations and rules about many
activities that had little or nothing to do with the crisis. For example, it
creates a consumer financial protection bureau to be housed at the Fed that
is supposed to protect consumers from fraud and other abusive financial
practices. Yet it is not apparent that many consumers were victimized during
the financial boom years, or that consumer behavior had anything of
importance to do with the crisis. For example, consumers who took out
subprime mortgages that required almost no down payments and had low
interest rates were not victimized since these conditions enabled them to
cheaply own houses, at least for a while. The “victims” were the banks, and
especially Fannie Mae and Freddie Mac, that were foolishly willing to hold
such risky mortgages.
The bill gives the Fed authority to limit
interchange or “swipe” fees that merchants pay for each debit-card
transaction, although these fees had not the slightest connection to the
financial crisis. Such price controls are in general undesirable, and hardly
seem to require the attention of the Federal Reserve. The bill also gives
the SEC authority to empower stockholders to run their own candidates for
corporate boards of directors. Corporate boards often receive some blame for
the crisis-mainly unjustified in my opinion- but stockholder election of
some members will not improve corporate governance, and will probably make
that worse.
2. The Dodd-Frank bill gives several government
agencies considerable additional discretion to try to forestall another
crisis, even though they already had the authority to take many actions. The
Fed could have tightened the monetary base and interest rates as the crisis
was developing, but chose not to do so. The SEC and various Federal Reserve
banks-especially the New York Fed- had the authority to stop questionable
lending practices and increase liquidity requirements. These and other
government bodies did not use their authority to try to head off the crisis
partly because they got caught up in the same bubble hysteria as did banks
and consumers. In addition, regulators are often “captured” by the firms
they are regulating, not necessarily because the regulators are corrupt, but
because they are mainly exposed to arguments made by the banks and other
groups they are regulating.
Despite the fact that regulators failed to use the
powers they already had, the bill mainly adds not clear rules of behavior
for banks, but additional governmental discretionary power. For example, the
bill creates the Financial Stability Oversight Council, a nine-member panel
drawn from the Fed, SEC, and other government agencies, that is supposed to
monitor Wall Street’s largest companies and other market participants to
spot and respond to any emerging growth in systemic risk in the economy.
With a two-thirds vote this Council could impose higher capital requirements
on lenders and place hedge funds and dealers under the Fed’s authority.
Given the regulators reluctance to use the power they already had to
forestall the crisis, it seems highly unlikely that this Council will act
decisively prior to the emergence of a crisis, especially when a two thirds
majority is required.
3. Insufficient capital relative to bank assets was
an important cause of the financial crisis. The bill does reduce the ability
of banks to count as bank capital certain risky assets, such as trust
preferred securities, and gives the Fed authority to impose additional
capital and liquidity requirements on banks and non-bank financial
companies, including insurers. I would have preferred a simple rule that
raised capital requirements of banks relative to their assets, especially
capital of larger and more interconnected banks. As suggested by Raghu Rajan
and the Squam Lake group of economists, the bill probably should have
required larger banks to issue “contingent” capital, such as debt that
automatically converts to equity when the banks are experiencing large
losses, or when a bank’s capital to asset ratio falls below a certain level.
4. One of the most serious omissions is that the
bill essentially says nothing about Freddie Mac or Fannie Mae. In 2008 these
organizations were placed into conservatorship of the Federal Housing
Finance Agency. During the run up to the crisis, Barney Frank and others in
Congress encouraged Freddie and Fannie to absorb most of the subprime
mortgages. In 2008 they held over half of all mortgages, and almost all the
subprimes. They have absorbed even a larger fraction of the relatively few
mortgages written after 2008. Freddie and Fannie deserve a considerable
share of the blame for the crisis, but they continue to have strong
political support. I would like to see both of them eventually dissolved,
but that is unlikely to happen. Instead we are promised that they will be
dealt with in future legislation, but I am skeptical that anything will be
done to terminate either organization, or even improve their functioning.
5. Many proposals in the bill will have highly
uncertain impacts on the economy. These include, among many other
provisions, the requirement that originators of mortgages and other assets
retain at least 5% of the assets they originate, that many derivatives go on
organized exchanges (may be an improvement but far from certain), that hedge
funds become more closely regulated, and that consumer be “protected” from
their financial decisions.
Most of these and other changes in the bill are not
based on a serious analysis of what contributed to the financial crisis, but
rather are the result of political and emotional reactions to the crisis.
Usually, such reactions do more harm than good. That is likely to be the
fate of the great majority of the provisions of the Dodd-Frank bill.
"13 Bankers Versus One Professor: The author of a new book on
financial reform makes a case for breaking up the nation's largest banks,"
by Scott Leibs, CFO.com, April 2, 2010 ---
http://www.cfo.com/article.cfm/14488823/c_14489620?f=home_todayinfinance
"This is about power and control and who decides
your future," Simon Johnson warned for at least the second time on Friday.
He had just returned to the campus of MIT's Sloan School of Management in
Cambridge, Massachusetts, having been in New York hours earlier to deliver a
similar message on The Today Show. Both appearances were part of an
intensive launch of his latest book, 13 Bankers: The Wall Street Takeover
and the Next Financial Meltdown, co-authored with former McKinsey
consultant James Kwak.
The "13 bankers" of the book's title refers to the
financial-industry luminaries who were summoned to the White House on March
27, 2009, in a mostly futile effort to enlist their help in solving the very
economic crisis they had been so instrumental, in Johnson's view, in
creating.
"We're all in this together," President Obama told
the assembled bankers. The statement was more apt than Obama intended,
Johnson contends. Wall Street bankers have become so entrenched in
Washington in the past three decades that the solution proposed by Johnson
and Kwak — break up "too big to fail" banks into smaller entities for which
failure is, in fact, an option — faces a very long uphill climb.
If Johnson's solution isn't adopted, it won't be
for lack of effort on his part. Speaking to an audience of 150 at MIT, where
he is the Ronald A. Kurtz Professor of Entrepreneurship, Johnson argued
forcefully that the astounding rise of the nation's largest banks mandates
immediate corrective action. In 1995, he pointed out, the assets of the six
largest banks equaled 17% of GDP; by last year that figure had risen to more
than 60%. Profits (and compensation) have followed similarly stunning
trajectories, as has the clout wielded by bankers on both sides of the
political aisle.
When bankers came looking for a bailout, Johnson
said, they not only got one, they got it on terms that were "completely at
odds with conventional practices" in similar financial catastrophes. The
result was a rescue operation that amounts to "nontransparent corporate
welfare that must be stopped."
Johnson disagrees with Treasury Secretary Timothy
Geithner's claim that the Great Recession represents a 30- or 40-year flood
that few people will see again in their working lifetimes. A more apt
comparison, he said, is to weakened levees, and the key question is whether
the structural changes that have taken place in the financial industry will
cause those levees to be breached again in the near future. "Do we want to
experience this crisis again," he asked, "just because six banks can't be
made smaller?"
Johnson has no illusions that enacting stronger
regulations than those currently put forward will be easy. "It will take
time to change people's attitudes," he admitted, but he said there is
historical precedent for picking a fight that few people grasp, let alone
support. "When Teddy Roosevelt took on J.P. Morgan," he said, "no one
understood why, and of those who did, no one thought he would win." Yet
Roosevelt triumphed over not only Morgan but also monopolies such as
Standard Oil, which was broken into almost three dozen smaller companies.
Asked by an audience member whether banks have
learned valuable lessons from the meltdown and thus won't need tighter
regulation, Johnson responded, "The recent executive bonuses handed out
suggest not much has been learned." Indeed, Wells Fargo and several others
have recently announced lavish compensation awards to some of the very
executives Johnson believes should have been ousted as one condition of the
bailouts.
But he remains hopeful, citing several chief
executives who support his argument, sometimes publicly, sometimes
privately. Asked about potential support from CFOs, who rarely, if ever,
champion any form of financial regulation, Johnson quipped, "I don't expect
CFOs to be in the vanguard, but I do believe many will support the concept
of breaking up too-big-to-fail banks once they take a close look at the
issues."
The following tidbit is politically controversial and perhaps should not be
sent out to the AECM. However, I do so in the interest of noting some history of
famous robber barons that many of us were not aware of, particularly the
reference to the following book:
Burton W. Folsom called "The Myth of the Robber Barons: A New Look at
the Rise of Big Business in America" (Young America's Foundation). Prof.
Folsom's core insight is to divide the men of that age into market
entrepreneurs and political entrepreneurs.
What might be of interest to accounting researchers is to investigate
accounting history of the robber barrons' enterprises and the study of how
accounting might ideally differ for market entrepreneurs versus political
entrepreneurs.
Daniel Henninger is one of my favorite columnists for the WST. He often
writes about modern-day accounting scandals.
"Bring Back the Robber Barons: There's a big difference between
entrepreneurs who make a fortune in the market, and those who do so by gaming
the government," by Daniel Henninger, The Wall Street Journal, March
4, 2010 ---
http://online.wsj.com/article/SB10001424052748703862704575099572105775414.html?mod=djemEditorialPage_t
Faced with high, painful unemployment as far as the
eye can see, the government naturally is here to help.
The Senate passed a $15 billion "jobs bill." Its
proudest piece is a tax credit for employers who hire a person out of work
at least 60 days. The employer won't have to pay the 6.2% Social Security
payroll tax for what remains of this year. If the worker stays on the job at
least a year, the government will give the employer $1,000.
As to the earlier $787 billion stimulus bill, Vice
President Joe Biden praised it in Orlando this week as an engine of job
creation, while he stood before a pile of broken concrete and asphalt. The
subject was highways.
Finally, Barack Obama's government now may force
companies to raise wages and benefits by squeezing their federal contracts
if they don't.
Maybe there's a better way.
*** Let's bring back the robber barons.
"Robber baron" became a term of derision to
generations of American students after many earnest teachers made them read
Matthew Josephson's long tome of the same name about the men whose
enterprise drove the American industrial age from 1861 to 1901.
Josephson's cast of pillaging villains was
comprehensive: Rockefeller, Carnegie, Vanderbilt, Morgan, Astor, Jay Gould,
James J. Hill. His table of contents alone shaped impressions of those
times: "Carnegie as 'business pirate'.'' "Henry Frick, baron of coke."
"Terrorism in Oil." "The sack of California."
I say, bring 'em back, and the sooner the better.
What we need, a lot more than a $1,000 tax credit, are industries no one has
thought of before. We need vision, vitality and commercial moxie. This
government is draining it away.
The antidote to Josephson's book is a small classic
by Hillsdale College historian Burton W. Folsom called "The Myth of the
Robber Barons: A New Look at the Rise of Big Business in America" (Young
America's Foundation). Prof. Folsom's core insight is to divide the men of
that age into market entrepreneurs and political entrepreneurs.
Market entrepreneurs like Rockefeller, Vanderbilt
and Hill built businesses on product and price. Hill was the railroad
magnate who finished his transcontinental line without a public land grant.
Rockefeller took on and beat the world's dominant oil power at the time,
Russia. Rockefeller innovated his way to energy primacy for the U.S.
Political entrepreneurs, by contrast, made money
back then by gaming the political system. Steamship builder Robert Fulton
acquired a 30-year monopoly on Hudson River steamship traffic from, no
surprise, the New York legislature. Cornelius Vanderbilt, with the slogan
"New Jersey must be free," broke Fulton's government-granted monopoly.
If the Obama model takes hold, we will enter the
Golden Age of the Political Entrepreneur. The green jobs industry that sits
at the center of the Obama master plan for the American future depends on
public subsidies for wind and solar technologies plus taxes on carbon to
suppress it as a competitor. Politically connected entrepreneurs will spend
their energies running a mad labyrinth of bureaucracies, congressional
committees and Beltway door openers. Our best market entrepreneurs, instead
of exhausting themselves on their new ideas, will run to ground gaming
Barack Obama's ideas.
If the goal is job growth, we need to admit one
fact: Political entrepreneurs create fewer jobs than do market
entrepreneurs. We need new mass markets, really big markets of the sort
Ford, Rockefeller and Carnegie created. Great employment markets are
discoverable only by people who create opportunities or see them in the
cracks of what already exists—a Federal Express or Wal-Mart. Either you
believe that the philosopher kings of the Obama administration can figure
out this sort of thing, or you don't. I don't.
FDIC chief Sheila Bair whacked bank bonuses
Tuesday. People on the East Coast spend too much time around the finance and
insurance industries. If the price of rediscovering the American job machine
is some people across the land getting really rich, it's a small price.
One of the richest now is Larry Ellison, the 1977
founder of Oracle Corp. (49,000 employees), whose tastes run to huge boats,
bigger houses and paying Elton John to play for his friends at the Cow
Palace. Someone in our politics has to find the courage to say, So what? If
the next Ellison and Oracle ripples into American life as many new jobs and
family incomes, I'm happy to be grossed out by parties and boats. The
alternative is a nation of Pecksniffs, choking on virtue.
We live in a world of rising competitors—foreign
robber barons—who don't much care about our endless quest for health-care
justice. The U.S. on its current path to a stage-managed economy floating in
a lake of taxes will keep down the greatest population of intellectual and
managerial firepower the world has seen. The rest of the world admits that,
with the recent exception of the Chinese, who think we're ready to be taken.
We have young people impatient for the chance to do what Carnegie,
Rockefeller and Hill did. Let them.
Continued in article
"Five Ways to Heal American Capitalism," by Roger Marti,
Harvard Business Review Blog, March 3, 2010 ---
http://blogs.hbr.org/cs/2010/03/healing_american_capitalism_to.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE
Three things have to happen in concert to heal the
ailing American democratic capitalist system:
- Senior executives have to be
helped out of a conflicted state in which they know they are living
inauthentic business lives but are both too
scared of the capital markets and too addicted to stock-based
compensation to change by themselves.
- Boards of directors who have
drunk the Kool-Aid of stock-based compensation need to be saved from
their own delusions about its effectiveness.
- The hedge funds who have
become so emboldened that they now hunt in predatory packs, destroying
companies in order to reap arbitrage profits, need a serious smack-down.
These changes will require government intervention,
not my favorite approach, but sometimes the only way.
Let's start with senior executives. As things
stand, they're expected to predict the future, which they can't do, and are
punished by the capital markets when they are wrong. This causes most of
them to manipulate earnings to make themselves right, which is hardly
conducive to psychological health as I've argued before.
Hence
Prescription #1: Repeal the
'Safe Harbor' provision of the Private Securities Litigation Reform Act of
1995. There should be no safe harbor
whatsoever for "anticipating," "projecting," "expecting," "estimating" or
any of the other "forward-looking" weasel-words used by senior executives
when "predicting" earnings. This will encourage senior executives to break
the habit of giving guidance and, by extension, of manipulating numbers to
hit their guidance numbers. They can get back to the psychologically
rewarding business of actually creating value.
Now boards. They think that stock-based
compensation aligns the interests of executives and shareholders. It
doesn't. It aligns the interests of senior executives with their own bank
accounts for reasons
I have detailed elsewhere.
Boards aren't going to challenge their own dogma,
especially when they are being egged on by the compensation consultants. And
like the executives with respect to guidance, boards are too scared to break
rank and shift from creating incentives to boost expectations to creating
incentives to boost real performance. Hence Prescription #2: Tax at
a rate of 80% gains from stock-based compensation that are based on stock
performance less than five years from the time of the awarding of the
stock-based compensation.
Stock-based compensation is a crummy idea. But it
gets less crummy as the period lengthens over which the performance needs to
occur. Doing the work necessary to have a chance of the stock price being
high five years from award at least gives long-term thinking a fighting
chance. Pushing realization of stock-based compensation to beyond time of
retirement is even better because retired executives can't manipulate
prices. It encourages strong succession planning because your pay-off is
dependent on your successor doing a good job. Hence Prescription #3:
Tax at a rate of 20% gains from stock-based compensation that are based on
stock performance five years or greater from the time of departure from the
company in question.
Let's turn to hedge funds and other market
operators who earn their returns by arbitraging short-term market swings.
They engage in manipulation too; if there aren't enough short-term market
swings to generate the returns they're used to, they will do whatever is
necessary, regardless of legal strictures, to manufacture short-term swings.
Here, we need to attack on two fronts.
First we have to neutralize their profit equation.
Hence Prescription #4: On stock holdings of less than one year,
increase the capital gains tax to 80% and reduce the portion of losses
allowable for tax purposes to 20%. And because these guys are as
sneaky as foxes, declare trading strategies that attempt to circumvent this
tax to be criminal tax evasion — otherwise hedge funds will swap with
non-taxable investors (like charitable foundations) to produce synthetic
holding periods of over one year. To neuter criticism that this will hurt
small investors, create a life-time $1 million exemption for short-term
capital gains and losses for individuals. Individual investors don't screw
up companies; hedge funds do.
Second, we need to dramatically reduce the source
of funds to hedge fund managers by dealing with their biggest supplier of
capital: pension funds. Pension fund managers accept the ridiculous
'2 & 20' fee structure that hedge funds charge
(2% annually of assets under management, plus 20%
of the upside) because pension fund managers love the treats that hedge fund
managers provide: junkets and "conferences" in exotic locales, and even the
payoffs from agents working for the hedge funds, as allegedly happened in
the
Quadrangle Group affair.
Pension funds are the soft underbelly of democratic
capitalism.
Peter Drucker predicted decades ago that
American workers would eventually own the means of production not through a
communist-style revolution but when their pension funds came to own the
biggest piece of American companies.
But the vast majority of US pension fund dollars
are not invested under anything approximating capitalist conditions. As a
worker in a given organization, you are typically forced to have your
pension managed by a single designated fund. And the rule with all
monopolists is that in due course they begin to serve themselves. Hence
Prescription #5: Every worker must have a choice of at least two
pension fund managers. That will give the worker choice and power
—and will discipline the behavior of pension fund managers.
If these five prescriptions were implemented —
which could be relatively straight-forward — we would give companies and
their senior executives the chance and the incentive to focus on building
great companies over the long term rather than subjugating themselves and
their companies to the traders. This would restore authenticity to the lives
of our corporate leaders.
There is a sixth prescription. It is trickier to
implement but it would build very productively on the five above. I will
leave that one for the next post...
Roger Martin
is the Dean of the Rotman School of Management at the University of
Toronto in Canada and the author of
The Design of Business: Why Design Thinking is the Next Competitive
Advantage (Harvard Business Press, 2009). His website is
rogerlmartin.com
Bob Jensen's threads on accounting history are at
http://faculty.trinity.edu/rjensen/theory01.htm#AccountingHistory
My Hero Lawyer, Professor, and Wall Street Financial Expert Weighs In
Question
In the bankruptcy court examiner's report on Lehman's downfall, is Volume 3 more
or less important than Volume 2?
Answer
For Ernst & Young it is probably Volume 3, but my true hero exposing Wall Street
scandals opts for Volume 2.
My favorite Wall Street books exposing the inside greed and fraud on Wall
Street are those written by Frank Partnoy. My timeline of his exposes can be
found at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds .
Professor Partnoy's Senate Testimony was among the first solid explanations
of how derivative financial instruments frauds took place at Enron. His entire
testimony can be found at
http://faculty.trinity.edu/rjensen/FraudEnron.htm#FrankPartnoyTestimony
See his explanation of the infamous Footnote 16 of the Year 2000 Enron Annual
report ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm#Senator
His books are among the funniest and best books I've ever read in my life,
even better than the books of Michael Lewis.
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
They are the most dog-eared and scruffed up books in my entire library.
"Lehman Examiner Punted on Valuation,"
by Frank Partnoy, Professor of Law and Finance University of San Diego School of
Law and author of Fiasco, Infectious Greed, and
The Match King
Naked Capitalism, March 14, 2010 ---
http://www.nakedcapitalism.com/2010/03/frank-partnoy-lehman-examiner-punted-on-valuation.html
The buzz on the Lehman bankruptcy examiner’s report
has focused on Repo 105, for good reason. That scheme is one powerful
example of how the balance sheets of major Wall Street banks are fiction. It
also shows why Congress must include real accounting reform in its financial
legislation, or risk another collapse. (If you have 8 minutes to kill, here
is my
recent talk on the off-balance sheet problem, from
the Roosevelt Institute financial conference.)
But an even more
troubling section of the Lehman report is not Volume 3 on Repo 105. It is
Volume 2, on Valuation. The Valuation
section is 500 pages of utterly terrifying reading. It shows that, even
eighteen months after Lehman’s collapse, no one – not the bankruptcy
examiner, not Lehman’s internal valuation experts, not Ernst and Young, and
certainly not the regulators – could figure out what many of Lehman’s assets
and liabilities were worth. It shows Lehman was too complex to
do anything but fail.
The report cites extensive evidence of valuation
problems. Check out page 577, where the report concludes that Lehman’s high
credit default swap valuations were reasonable because Citigroup’s marks
were ONLY 8% lower than Lehman’s. 8%? And since when are Citigroup’s
valuations the objective benchmark?
Or page 547, where the report describes how
Lehman’s so-called “Product Control Group” acted like Keystone Kops: the
group used third-party prices for only 10% of Lehman’s CDO positions, and
deferred to the traders’ models, saying “We’re not quants.” Here are two
money quotes:
While the function of the Product Control Group
was to serve as a check on the
desk marks set by Lehman’s traders, the CDO product controllers were
hampered in
two respects. First, the Product Control Group did not appear to have
sufficient
resources to price test Lehman’s CDO positions comprehensively. Second,
while the
CDO product controllers were able to effectively verify the prices of
many positions
using trade data and third‐party prices, they did not have the same
level of quantitative sophistication as many of the desk personnel who
developed models to price CDOs. (page 547)
Or this one:
However, approximately a quarter of Lehman’s
CDO positions were not affirmatively priced by the Product Control
Group, but simply noted as ‘OK’ because the desk had already written
down the position significantly. (page 548)
My favorite section describes the valuation of
Ceago, Lehman’s largest CDO position. My corporate finance students at the
University of San Diego School of Law understand that you should use higher
discount rates for riskier projects. But the Valuation section of the report
found that with respect to Ceago, Lehman used LOWER discount rates for the
riskier tranches than for the safer ones:
The discount rates used by Lehman’s Product
Controllers were significantly understated. As stated, swap rates were
used for the discount rate on the Ceago subordinate tranches. However,
the resulting rates (approximately 3% to 4%) were significantly lower
than the approximately 9% discount rate used to value the more senior S
tranche. It is inappropriate to use a discount rate on a subordinate
tranche that is lower than the rate used on a senior tranche. (page 556)
It’s one thing to have product controllers who
aren’t “quants”; it’s quite another to have people in crucial risk
management roles who don’t understand present value.
When the examiner compared Lehman’s marks on these
lower tranches to more reliable valuation estimates, it found that “the
prices estimated for the C and D tranches of Ceago securities are
approximately one‐thirtieth of the price reported by Lehman. (pages 560-61)
One thirtieth? These valuations weren’t even close.
Ultimately, the examiner concluded that these
problems related to only a small portion of Lehman’s overall portfolio. But
that conclusion was due in part to the fact that the examiner did not have
the time or resources to examine many of Lehman’s positions in detail
(Lehman had 900,000 derivative positions in 2008, and the examiner did not
even try to value Lehman’s numerous corporate debt and equity holdings).
The bankruptcy examiner didn’t see enough to bring
lawsuits. But the valuation section of the report raises some hot-button
issues for private parties and prosecutors. As the report put it, there are
issues that “may warrant further review by parties in interest.”
For example, parties in interest might want to look
at the report’s section on Archstone, a publicly traded REIT Lehman acquired
in October 2007. Much ink has been spilled criticizing the valuation of
Archstone. Here is the Report’s finding (at page 361):
… there is sufficient evidence to support a
finding that Lehman’s valuations for its Archstone equity positions were
unreasonable beginning as of the end of the first quarter of 2008, and
continuing through the end of the third quarter of 2008.
And Archstone is just one of many examples.
The Repo 105 section of the Lehman report shows
that Lehman’s balance sheet was fiction. That was bad. The Valuation section
shows that Lehman’s approach to valuing assets and liabilities was seriously
flawed. That is worse. For a levered trading firm, to not understand your
economic position is to sign your own death warrant.
|
Selected works of FRANK PARTNOY
Bob Jensen at Trinity University
1. Who is Frank
Partnoy?
Cheryl Dunn
requested that I do a review of my favorites among the
“books that have influenced [my] work.” Immediately
the succession of FIASCO books by Frank Partnoy
came to mind. These particular books are not the best
among related books by Wall Street whistle blowers such
as Liar's Poker: Playing the Money Markets by
Michael Lewis in 1999 and Monkey Business: Swinging
Through the Wall Street Jungle by John Rolfe and
Peter Troob in 2002. But in1997. Frank Partnoy was the
first writer to open my eyes to the enormous gap between
our assumed efficient and fair capital markets versus
the “infectious greed” (Alan Greenspan’s term) that had
overtaken these markets.
Partnoy’s succession
of FIASCO books, like those of Lewis and Rolfe/Troob
are reality books written from the perspective of inside
whistle blowers. They are somewhat repetitive and
anecdotal mainly from the perspective of what each
author saw and interpreted.
My favorite among
the capital market fraud books is Frank Partnoy’s latest
book Infectious Greed: How Deceit and Risk Corrupted
the Financial Markets (Henry Holt & Company,
Incorporated, 2003, ISBN: 080507510-0- 477 pages). This
is the most scholarly of the books available on business
and gatekeeper degeneracy. Rather than relying mostly
upon his own experiences, this book drawn from Partnoy’s
interviews of over 150 capital markets insiders of one
type or another. It is more scholarly because it
demonstrates Partnoy’s evolution of learning about
extremely complex structured financing packages that
were the instruments of crime by banks, investment
banks, brokers, and securities dealers in the most
venerable firms in the U.S. and other parts of the
world. The book is brilliant and has a detailed and
helpful index.
What did I learn
most from Partnoy?
I learned about the
failures and complicity of what he terms “gatekeepers”
whose fiduciary responsibility was to inoculate against
“infectious greed.” These gatekeepers instead
manipulated their professions and their governments to
aid and abet the criminals. On Page 173 of
Infectious Greed, he writes the following:
Page #173
When
Republicans captured the House of Representatives in
November 1994--for the first time since the Eisenhower
era--securities-litigation reform was assured. In a
January 1995 speech, Levitt outlined the limits on
securities regulation that Congress later would support:
limiting the statute-of-limitations period for filing
lawsuits, restricting legal fees paid to lead
plaintiffs, eliminating punitive-damages provisions from
securities lawsuits, requiring plaintiffs to allege more
clearly that a defendant acted with reckless intent, and
exempting "forward
looking
statements"--essentially, projections about a company's
future--from legal liability.
The Private
Securities Litigation Reform Act of 1995 passed easily,
and Congress even overrode the veto of President
Clinton, who either had a fleeting change of heart about
financial markets or decided that trial lawyers were an
even more
important
constituency than Wall Street. In any event, Clinton
and Levitt disagreed about the issue, although it wasn't
fatal to Levitt, who would remain SEC chair for another
five years.
He later introduces
Chapter 7 of Infectious Greed as follows:
Pages
187-188
The
regulatory changes of 1994-95 sent three messages to
corporate CEOs. First, you are not likely to be
punished for "massaging" your firm's accounting
numbers. Prosecutors rarely go after financial fraud
and, even when they do, the typical punishment is a
small fine; almost no one goes to prison. Moreover,
even a fraudulent scheme could be recast as mere
earnings management--the practice of smoothing a
company's earnings--which most executives did, and
regarded as perfectly legal.
Second,
you should use new financial instruments--including
options, swaps, and other derivatives--to increase your
own pay and to avoid costly regulation. If complex
derivatives are too much for you to handle--as they were
for many CEOs during the years immediately following the
1994 losses--you should at least pay yourself in stock
options, which don't need to be disclosed as an expense
and have a greater upside than cash bonuses or stock.
Third, you
don't need to worry about whether accountants or
securities analysts will tell investors about any hidden
losses or excessive options pay. Now that Congress and
the Supreme Court have insulated accounting firms and
investment banks from liability--with the Central Bank
decision and the Private Securities Litigation Reform
Act--they will be much more willing to look the other
way. If you pay them enough in fees, they might even be
willing to help.
Of course,
not every corporate executive heeded these messages.
For example, Warren Buffett argued that managers should
ensure that their companies' share prices were accurate,
not try to inflate prices artificially, and he
criticized the use of stock options as compensation.
Having been a major shareholder of Salomon Brothers,
Buffett also criticized accounting and securities firms
for conflicts of interest.
But for
every Warren Buffett, there were many less scrupulous
CEOs. This chapter considers four of them: Walter
Forbes of CUC International, Dean Buntrock of Waste
Management, Al Dunlap of Sunbeam, and Martin Grass of
Rite Aid. They are not all well-known among investors,
but their stories capture the changes in CEO behavior
during the mid-1990s. Unlike the "rocket scientists" at
Bankers Trust, First Boston, and Salomon Brothers, these
four had undistinguished backgrounds and little training
in mathematics or finance. Instead, they were
hardworking, hard-driving men who ran companies that met
basic consumer needs: they sold clothes, barbecue
grills, and prescription medicine, and cleaned up
garbage. They certainly didn't buy swaps linked to
LIBOR-squared.
The book
Infectious Greed has chapters on other capital
markets and corporate scandals. It is the best account
that I’ve ever read about Bankers Trust the Bankers
Trust scandals, including how one trader named Andy
Krieger almost destroyed the entire money supply of New
Zealand. Chapter 10 is devoted to Enron and follows up
on Frank Partnoy’s invited testimony before the United
States Senate Committee on Governmental Affairs, January
24, 2002 ---
http://www.senate.gov/~gov_affairs/012402partnoy.htm
The controversial
writings of Frank Partnoy have had an enormous impact on
my teaching and my research. Although subsequent
writers wrote somewhat more entertaining exposes, he was
the one who first opened my eyes to what goes on behind
the scenes in capital markets and investment banking.
Through his early writings, I discovered that there is
an enormous gap between the efficient financial world
that we assume in agency theory worshipped in academe
versus the dark side of modern reality where you find
the cleverest crooks out to steal money from widows and
orphans in sophisticated ways where it is virtually
impossible to get caught. Because I read his 1997 book
early on, the ensuing succession of enormous scandals in
finance, accounting, and corporate governance weren’t
really much of a surprise to me.
From his insider
perspective he reveals a world where our most respected
firms in banking, market exchanges, and related
financial institutions no longer care anything about
fiduciary responsibility and professionalism in
disgusting contrast to the honorable founders of those
same firms motivated to serve rather than steal.
Young men and women
from top universities of the world abandoned almost all
ethical principles while working in investment banks and
other financial institutions in order to become not only
rich but filthy rich at the expense of countless pension
holders and small investors. Partnoy opened my eyes to
how easy it is to get around auditors and corporate
boards by creating structured financial contracts that
are incomprehensible and serve virtually no purpose
other than to steal billions upon billions of dollars.
Most importantly,
Frank Partnoy opened my eyes to the psychology of
greed. Greed is rooted in opportunity and cultural
relativism. He graduated from college with a high sense
of right and wrong. But his standards and values sank
to the criminal level of those when he entered the
criminal world of investment banking. The only
difference between him and the crooks he worked with is
that he could not quell his conscience while stealing
from widows and orphans.
Frank Partnoy has a
rare combination of scholarship and experience in law,
investment banking, and accounting. He is sometimes
criticized for not really understanding the complexities
of some of the deals he described, but he rather freely
admits that he was new to the game of complex deceptions
in international structured financing crime.
2. What really
happened at Enron? ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm#FrankPartnoyTestimony
3. What are some
of Frank Partnoy’s best-known works?
Frank Partnoy,
FIASCO: Blood in the Water on Wall Street (W. W.
Norton & Company, 1997, ISBN 0393046222, 252 pages).
This is the first of a somewhat
repetitive succession of Partnoy’s “FIASCO” books that
influenced my life. The most important revelation from
his insider’s perspective is that the most trusted firms
on Wall Street and financial centers in other major
cities in the U.S., that were once highly professional
and trustworthy, excoriated the guts of integrity
leaving a façade behind which crooks less violent than
the Mafia but far more greedy took control in the
roaring 1990s.
After selling a succession of phony
derivatives deals while at Morgan Stanley, Partnoy blew
the whistle in this book about a number of his
employer’s shady and outright fraudulent deals sold in
rigged markets using bait and switch tactics.
Customers, many of them pension fund investors for
schools and municipal employees, were duped into complex
and enormously risky deals that were billed as safe as
the U.S. Treasury.
His books have received mixed reviews,
but I question some of the integrity of the reviewers
from the investment banking industry who in some
instances tried to whitewash some of the deals described
by Partnoy. His books have received a bit less praise
than the book Liars Poker by Michael Lewis, but
critics of Partnoy fail to give credit that Partnoy’s
exposes preceded those of Lewis.
Frank Partnoy,
FIASCO: Guns, Booze and Bloodlust: the Truth About High
Finance (Profile Books, 1998, 305 Pages)
Like his earlier books, some investment
bankers and literary dilettantes who reviewed this book
were critical of Partnoy and claimed that he
misrepresented some legitimate structured financings.
However, my reading of the reviewers is that they were
trying to lend credence to highly questionable offshore
deals documented by Partnoy. Be that as it may, it
would have helped if Partnoy had been a bit more
explicit in some of his illustrations.
Frank Partnoy,
FIASCO: The Inside Story of a Wall Street Trader
(Penguin, 1999, ISBN 0140278796, 283 pages).
This is a
blistering indictment of the unregulated OTC market
for derivative financial instruments and the million
and billion dollar deals conceived in investment
banking. Among other things, Partnoy describes
Morgan Stanley’s annual drunken skeet-shooting
competition organized by a “gun-toting strip-joint
connoisseur” former combat officer (fanatic) who
loved the motto: “When derivatives are outlawed
only outlaws will have derivatives.” At that event,
derivatives salesmen were forced to shoot entrapped
bunnies between the eyes on the pretense that the
bunnies were just like “defenseless animals” that
were Morgan Stanley’s customers to be shot down even
if they might eventually “lose a billion dollars on
derivatives.”
This book has one of the best accounts of the
“fiasco” caused almost entirely by the duping of
Orange
County ’s Treasurer (Robert Citron)
by the unscrupulous Merrill Lynch derivatives
salesman named Michael
Stamenson. Orange
County eventually lost over a billion
dollars and was forced into bankruptcy. Much of
this was later recovered in court from Merrill
Lynch. Partnoy calls
Citron and Stamenson
“The Odd Couple,” which is also the title of Chapter
8 in the book.Frank Partnoy, Infectious Greed:
How Deceit and Risk Corrupted the Financial Markets
(Henry Holt & Company, Incorporated, 2003, ISBN:
080507510-0, 477 pages)Frank Partnoy, Infectious
Greed: How Deceit and Risk Corrupted the Financial
Markets (Henry Holt & Company, Incorporated,
2003, ISBN: 080507510-0, 477 pages)
Partnoy shows how corporations gradually
increased financial risk and lost control over overly
complex structured financing deals that obscured the
losses and disguised frauds pushed corporate officers
and their boards into successive and ingenious
deceptions." Major corporations such as Enron, Global
Crossing, and WorldCom entered into enormous illegal
corporate finance and accounting. Partnoy documents the
spread of this epidemic stage and provides some
suggestions for restraining the disease.
"The Siskel and
Ebert of Financial Matters: Two Thumbs Down for the
Credit Reporting Agencies" by Frank Partnoy,
Washington University Law Quarterly, Volume 77, No. 3,
1999 ---
http://ls.wustl.edu/WULQ/
4. What are
examples of related books that are somewhat more
entertaining than Partnoy’s early books?
Michael Lewis,
Liar's Poker: Playing the Money Markets (Coronet,
1999, ISBN 0340767006)
Lewis writes in Partnoy’s earlier
whistleblower style with somewhat more intense and comic
portrayals of the major players in describing the double
dealing and break down of integrity on the trading floor
of Salomon Brothers.
John Rolfe and Peter
Troob, Monkey Business: Swinging Through the Wall
Street Jungle (Warner Books, Incorporated, 2002,
ISBN: 0446676950, 288 Pages)
This is
a hilarious tongue-in-cheek account by Wharton and
Harvard MBAs who thought they were starting out as
stock brokers for $200,000 a year until they
realized that they were on the phones in a bucket
shop selling sleazy IPOs to unsuspecting
institutional investors who in turn passed them
along to widows and orphans. They write. "It took
us another six months after that to realize
that we were, in fact, selling crappy public
offerings to investors."
There are other books along a similar
vein that may be more revealing and entertaining
than the early books of Frank Partnoy, but he was
one of the first, if not the first, in the roaring
1990s to reveal the high crime taking place behind
the concrete and glass of Wall Street. He was the
first to anticipate many of the scandals that soon
followed. And his testimony before the U.S. Senate
is the best concise account of the crime that
transpired at Enron. He lays the blame clearly at
the feet of government officials (read that Wendy
Gramm) who sold the farm when they deregulated the
energy markets and opened the doors to unregulated
OTC derivatives trading in energy. That is when
Enron really began bilking the public.
Some of the many, many
lawsuits settled by auditing firms can be found at
http://faculty.trinity.edu/rjensen/Fraud001.htm
|
|
The End of Wall Street?
Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek Explanation
of the Meltdown on Wall Street!
Now I asked
Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of
the other Wall Street firms—all said what an awful thing it was to go public
(beg for a government bailout)
and how could you do such a thing. But when the
temptation arose, they all gave in to it.” He agreed that the main effect of
turning a partnership into a corporation was to transfer the financial risk
to the shareholders. “When things go wrong, it’s their problem,” he said—and
obviously not theirs alone. When a Wall Street investment bank screwed up
badly enough, its risks became the problem of the U.S. government. “It’s
laissez-faire until you get in deep shit,” he said, with a half chuckle. He
was out of the game.
This is a must read to understand what went wrong on Wall Street ---
especially the punch line!
"The End," by Michael Lewis December 2008 Issue The era that defined Wall Street
is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s
Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
To this day, the willingness of a Wall Street
investment bank to pay me hundreds of thousands of dollars to dispense
investment advice to grownups remains a mystery to me. I was 24 years old,
with no experience of, or particular interest in, guessing which stocks and
bonds would rise and which would fall. The essential function of Wall Street
is to allocate capital—to decide who should get it and who should not.
Believe me when I tell you that I hadn’t the first clue.
I’d never taken an accounting course, never run a
business, never even had savings of my own to manage. I stumbled into a job
at Salomon Brothers in 1985 and stumbled out much richer three years later,
and even though I wrote a book about the experience, the whole thing still
strikes me as preposterous—which is one of the reasons the money was so easy
to walk away from. I figured the situation was unsustainable. Sooner rather
than later, someone was going to identify me, along with a lot of people
more or less like me, as a fraud. Sooner rather than later, there would come
a Great Reckoning when Wall Street would wake up and hundreds if not
thousands of young people like me, who had no business making huge bets with
other people’s money, would be expelled from finance.
When I sat down to write my account of the
experience in 1989—Liar’s Poker, it was called—it was in the spirit of a
young man who thought he was getting out while the getting was good. I was
merely scribbling down a message on my way out and stuffing it into a bottle
for those who would pass through these parts in the far distant future.
Unless some insider got all of this down on paper,
I figured, no future human would believe that it happened.
I thought I was writing a period piece about the
1980s in America. Not for a moment did I suspect that the financial 1980s
would last two full decades longer or that the difference in degree between
Wall Street and ordinary life would swell into a difference in kind. I
expected readers of the future to be outraged that back in 1986, the C.E.O.
of Salomon Brothers, John Gutfreund, was paid $3.1 million; I expected them
to gape in horror when I reported that one of our traders, Howie Rubin, had
moved to Merrill Lynch, where he lost $250 million; I assumed they’d be
shocked to learn that a Wall Street C.E.O. had only the vaguest idea of the
risks his traders were running. What I didn’t expect was that any future
reader would look on my experience and say, “How quaint.”
I had no great agenda, apart from telling what I
took to be a remarkable tale, but if you got a few drinks in me and then
asked what effect I thought my book would have on the world, I might have
said something like, “I hope that college students trying to figure out what
to do with their lives will read it and decide that it’s silly to phony it
up and abandon their passions to become financiers.” I hoped that some
bright kid at, say, Ohio State University who really wanted to be an
oceanographer would read my book, spurn the offer from Morgan Stanley, and
set out to sea.
Somehow that message failed to come across. Six
months after Liar’s Poker was published, I was knee-deep in letters from
students at Ohio State who wanted to know if I had any other secrets to
share about Wall Street. They’d read my book as a how-to manual.
In the two decades since then, I had been waiting
for the end of Wall Street. The outrageous bonuses, the slender returns to
shareholders, the never-ending scandals, the bursting of the internet
bubble, the crisis following the collapse of Long-Term Capital Management:
Over and over again, the big Wall Street investment banks would be, in some
narrow way, discredited. Yet they just kept on growing, along with the sums
of money that they doled out to 26-year-olds to perform tasks of no obvious
social utility. The rebellion by American youth against the money culture
never happened. Why bother to overturn your parents’ world when you can buy
it, slice it up into tranches, and sell off the pieces?
At some point, I gave up waiting for the end. There
was no scandal or reversal, I assumed, that could sink the system.
The New Order The crash did more than wipe out
money. It also reordered the power on Wall Street. What a Swell Party A
pictorial timeline of some Wall Street highs and lows from 1985 to 2007.
Worst of Times Most economists predict a recovery late next year. Don’t bet
on it. Then came Meredith Whitney with news. Whitney was an obscure analyst
of financial firms for Oppenheimer Securities who, on October 31, 2007,
ceased to be obscure. On that day, she predicted that Citigroup had so
mismanaged its affairs that it would need to slash its dividend or go bust.
It’s never entirely clear on any given day what causes what in the stock
market, but it was pretty obvious that on October 31, Meredith Whitney
caused the market in financial stocks to crash. By the end of the trading
day, a woman whom basically no one had ever heard of had shaved $369 billion
off the value of financial firms in the market. Four days later, Citigroup’s
C.E.O., Chuck Prince, resigned. In January, Citigroup slashed its dividend.
From that moment, Whitney became E.F. Hutton: When
she spoke, people listened. Her message was clear. If you want to know what
these Wall Street firms are really worth, take a hard look at the crappy
assets they bought with huge sums of borrowed money, and imagine what
they’d fetch in a fire sale. The vast assemblages of highly paid people
inside the firms were essentially worth nothing. For better than a year now,
Whitney has responded to the claims by bankers and brokers that they had put
their problems behind them with this write-down or that capital raise with a
claim of her own: You’re wrong. You’re still not facing up to how badly you
have mismanaged your business.
Rivals accused Whitney of being overrated; bloggers
accused her of being lucky. What she was, mainly, was right. But it’s true
that she was, in part, guessing. There was no way she could have known what
was going to happen to these Wall Street firms. The C.E.O.’s themselves
didn’t know.
Now, obviously, Meredith Whitney didn’t sink Wall
Street. She just expressed most clearly and loudly a view that was, in
retrospect, far more seditious to the financial order than, say, Eliot
Spitzer’s campaign against Wall Street corruption. If mere scandal could
have destroyed the big Wall Street investment banks, they’d have vanished
long ago. This woman wasn’t saying that Wall Street bankers were corrupt.
She was saying they were stupid. These people whose job it was to allocate
capital apparently didn’t even know how to manage their own.
At some point, I could no longer contain myself: I
called Whitney. This was back in March, when Wall Street’s fate still hung
in the balance. I thought, If she’s right, then this really could be the end
of Wall Street as we’ve known it. I was curious to see if she made sense but
also to know where this young woman who was crashing the stock market with
her every utterance had come from.
It turned out that she made a great deal of sense
and that she’d arrived on Wall Street in 1993, from the Brown University
history department. “I got to New York, and I didn’t even know research
existed,” she says. She’d wound up at Oppenheimer and had the most
incredible piece of luck: to be trained by a man who helped her establish
not merely a career but a worldview. His name, she says, was Steve Eisman.
Eisman had moved on, but they kept in touch. “After
I made the Citi call,” she says, “one of the best things that happened was
when Steve called and told me how proud he was of me.”
Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called Whitney again and asked
her, as I was asking others, whom she knew who had anticipated the cataclysm
and set themselves up to make a fortune from it. There’s a long list of
people who now say they saw it coming all along but a far shorter one of
people who actually did. Of those, even fewer had the nerve to bet on their
vision. It’s not easy to stand apart from mass hysteria—to believe that most
of what’s in the financial news is wrong or distorted, to believe that most
important financial people are either lying or deluded—without actually
being insane. A handful of people had been inside the black box, understood
how it worked, and bet on it blowing up. Whitney rattled off a list with a
half-dozen names on it. At the top was Steve Eisman.
Steve Eisman entered finance about the time I
exited it. He’d grown up in New York City and gone to a Jewish day school,
the University of Pennsylvania, and Harvard Law School. In 1991, he was a
30-year-old corporate lawyer. “I hated it,” he says. “I hated being a
lawyer. My parents worked as brokers at Oppenheimer. They managed to finagle
me a job. It’s not pretty, but that’s what happened.”
He was hired as a junior equity analyst, a helpmate
who didn’t actually offer his opinions. That changed in December 1991, less
than a year into his new job, when a subprime mortgage lender called Ames
Financial went public and no one at Oppenheimer particularly cared to
express an opinion about it. One of Oppenheimer’s investment bankers stomped
around the research department looking for anyone who knew anything about
the mortgage business. Recalls Eisman: “I’m a junior analyst and just trying
to figure out which end is up, but I told him that as a lawyer I’d worked on
a deal for the Money Store.” He was promptly appointed the lead analyst for
Ames Financial. “What I didn’t tell him was that my job had been to
proofread the documents and that I hadn’t understood a word of the fucking
things.”
Ames Financial belonged to a category of firms
known as nonbank financial institutions. The category didn’t include J.P.
Morgan, but it did encompass many little-known companies that one way or
another were involved in the early-1990s boom in subprime mortgage
lending—the lower class of American finance.
The second company for which Eisman was given sole
responsibility was Lomas Financial, which had just emerged from bankruptcy.
“I put a sell rating on the thing because it was a piece of shit,” Eisman
says. “I didn’t know that you weren’t supposed to put a sell rating on
companies. I thought there were three boxes—buy, hold, sell—and you could
pick the one you thought you should.” He was pressured generally to be a bit
more upbeat, but upbeat wasn’t Steve Eisman’s style. Upbeat and Eisman
didn’t occupy the same planet. A hedge fund manager who counts Eisman as a
friend set out to explain him to me but quit a minute into it. After
describing how Eisman exposed various important people as either liars or
idiots, the hedge fund manager started to laugh. “He’s sort of a prick in a
way, but he’s smart and honest and fearless.”
“A lot of people don’t get Steve,” Whitney says.
“But the people who get him love him.” Eisman stuck to his sell rating on
Lomas Financial, even after the company announced that investors needn’t
worry about its financial condition, as it had hedged its market risk. “The
single greatest line I ever wrote as an analyst,” says Eisman, “was after
Lomas said they were hedged.” He recited the line from memory: “ ‘The Lomas
Financial Corp. is a perfectly hedged financial institution: It loses money
in every conceivable interest-rate environment.’ I enjoyed writing that
sentence more than any sentence I ever wrote.” A few months after he’d
delivered that line in his report, Lomas Financial returned to bankruptcy.
Continued in article
Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999, ISBN
0340767006)
Lewis writes in Partnoy’s earlier whistleblower
style with somewhat more intense and comic portrayals of the major players
in describing the double dealing and break down of integrity on the trading
floor of Salomon Brothers.
Continued at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on the Lehman Examiner's Report ---
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
Do Investors Overvalue Firms With Bloated Balance Sheets?
David A. Hirshleifer University of California, Irvine - Paul Merage School of
Business
Kewei Hou Ohio State University - Department of Finance
Siew Hong Teoh University of California - Paul Merage School of Business
Yinglei Zhang Chinese University of Hong Kong (CUHK) - School of Accountancy
SSRN, February 2004
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=404120
Abstract:
If investors have limited attention, then accounting outcomes that saliently
highlight positive aspects of a firm's performance will promote high market
valuations. When cumulative accounting value added (net operating income)
over time outstrips cumulative cash value added (free cash flow), it becomes
hard for the firm to sustain further earnings growth. When the balance sheet
is 'bloated' in this fashion, we argue that investors with limited attention
will overvalue the firm, because naïve earnings-based valuation disregards
the firm's relative lack of success in generating cash flows in excess of
investment needs. The level of net operating assets, the difference between
cumulative earnings and cumulative free cash flow over time, is therefore a
measure of the extent to which operating/reporting outcomes provoke
excessive investor optimism. Therefore, if investor attention is limited,
net operating assets will negatively predict subsequent stock returns. In
our 1964-2002 sample, net operating assets scaled by beginning total assets
is a strong negative predictor of long-run stock returns. Predictability is
robust with respect to an extensive set of controls and testing methods.
Bob Jensen's threads on valuation are at
http://faculty.trinity.edu/rjensen/roi.htm
Derivative Financial Instruments and Hedging in Action
Gradient Analytics Forensic Accounting Firm ---
http://www.gradientanalytics.com/
Gradient Analytics, Inc., founded in 1996 by Don Vickrey and Carr Bettis as
Camelback Research Alliance, Inc. in Scottsdale, Arizona. Gradient Analytics is
an independent equity research company ---
http://investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId=11517448
"There is no question these transactions should be a
red flag for investors," says Carr Bettis, the co-founder of forensic accounting
firm Gradient Analytics and co-author of a recent study on hedging. "The
evidence is pretty compelling that hedges tend to be used before bad news hits
the market." Bettis' research found that in the year after executives and
directors had engaged in hedging, their company's stock often dropped markedly.
He also found evidence of an increase in financial restatements and shareholder
lawsuits during the same period. Executives at MCI, Enron, ImClone (IMCL),
Krispy Kreme—companies that suffered some of the great stock melt-downs of the
last decade—hedged their shares.
"Some CEOs Are Selling Their Companies Short," by Jane Saseen,
Business Week, February 25, 2010 ---
http://www.businessweek.com/magazine/content/10_10/b4169044647894.htm?campaign_id=magazine_related
Thanks to Jim Mahar for the heads up.
For investors in Switch & Data Facilities (SDXC), a
telecom services startup, 2008 was a wild year. From a low of 8.60 in
mid-March, shares more than doubled, to 18.17 three months later. Further
gains seemed likely in late July when CEO Keith Olsen boosted the guidance
he had given Wall Street analysts. But with revenue growth slowing even as
debt payments and other costs jumped, Switch & Data was in the red by
yearend. By November 2008, the shares had fallen to 4.21.
One shareholder avoided much of that drop: the CEO.
On June 19, the day the stock peaked, Olsen contracted with an investment
bank to hedge 150,000 shares—a quarter of his stock in the company—against
losses if the price fell below 18. As part of the complex maneuver, he
agreed to sell his shares to the bank one year later and got an advance of
$2.2 million. Olsen, who disclosed his hedging in public filings, declined
to comment for this story.
Hedges are ways to contain losses if a stock
declines, while still keeping some upside potential if the price keeps
rising (see table for a full explanation). It's a strategy anyone in the
market can employ. But the way hedging is done by CEOs, directors, and other
senior executives may deprive investors of clues about impending problems at
companies. Many grant executives stock as compensation largely because they
want them to have a stake in the company's success or failure. Investors
routinely follow insiders' sales and purchases of company stock as a gauge
of a corporation's prospects. Hedging, though, reduces an executive's
exposure to stock price drops in a way that investors have a hard time
detecting. The complex transactions are structured so that executives still
technically own the shares. And though some really big hedges get noticed at
the time they are made, disclosures of hedging are often vague or buried
deep in the footnotes of obscure public filings.
"There is no question these transactions should be
a red flag for investors," says Carr Bettis, the co-founder of forensic
accounting firm Gradient Analytics and co-author of a recent study on
hedging. "The evidence is pretty compelling that hedges tend to be used
before bad news hits the market." Bettis' research found that in the year
after executives and directors had engaged in hedging, their company's stock
often dropped markedly. He also found evidence of an increase in financial
restatements and shareholder lawsuits during the same period. Executives at
MCI, Enron, ImClone (IMCL), Krispy Kreme—companies that suffered some of the
great stock melt-downs of the last decade—hedged their shares.
Some 107 instances of executive hedging were
reported to the Securities & Exchange Commission in 2009, up from a decade
low of 48 in 2007, according to Bettis, and regulators are beginning to
scrutinize the transactions. Kenneth Feinberg, the U.S. Treasury pay czar,
has banned executives from hedging at the banks and automakers that received
government bailouts. "We wanted to make sure they couldn't undercut the
links we created between compensation and long-term performance," says
Feinberg. If executives at the companies could hedge their stock, he adds,
"they wouldn't have to worry about how [the stock] does."
In 2000 and 2001, billionaire Philip Anschutz
hedged shares of two companies in which he held major stakes, Union Pacific
(UNP) and Anadarko Petroleum (APC). Shorting stock is typically done as part
of a hedging strategy. In Anschutz's case, the bank that arranged the deal,
Donaldson, Lufkin & Jenrette (now part of Credit Suisse Group), shorted
Anschutz's own shares rather than borrowing shares in the market to short.
That was a common technique until tax authorities cracked down on it in
2006. In a case pending before U.S. Tax Court in Washington, the IRS is
arguing that Anschutz's deals were effectively stock sales rather than
hedges, and is seeking $143.6 million in capital gains taxes. Tax lawyers
are watching the case because they say many other executives who early in
the decade allowed their own shares to be shorted the way Anschutz did are
now being audited. If the IRS wins its case, these hedgers could face big
tax bills earlier than expected. Anschutz disputes the IRS's argument and
would not comment for this story.
There are plenty of reasons a senior executive
would hedge if he thought his company's stock was going to slide. In one
type of hedge, called a prepaid variable forward contract, he can get a cash
advance of up to 85% for shares he agrees to sell eventually to an
investment bank. Because he still technically owns the shares, the IRS
doesn't consider a hedge a sale so long as the bank doesn't short the
executive's own shares. So the executive need not pay capital gains taxes
until the hedge expires. Meanwhile, he can still vote the shares and collect
dividends.
U.S. executive hedging first took off in Silicon
Valley during the dot-com era, when transactions averaged around 290 a year.
Investment banks—Morgan Stanley (MS), Goldman Sachs (GS), JPMorgan Chase (JPM),
and Citigroup (C)—rushed to provide hedge services. "I don't know of a bank
that doesn't have a department doing this," says Mark Leeds, a tax lawyer
with Greenberg Traurig. By mid-decade, he adds, transactions worth several
billion had likely been sold. The hedge business helps the banks cement ties
with top executives, which comes in handy when a bank is pitching other
services. And the banks reap rich fees.
SUSPECT CORRELATIONS
Bettis and his co-authors examined 2,010 hedging transactions reported in
filings by 1,181 executives at 911 firms between 1996 and 2006. In the year
preceding executives' hedges, their companies' shares outpaced the market
anywhere from 17% to 31% on average, depending on the type of hedge used,
according to Bettis' analysis, which was completed last year. After the
executives hedged, it's a different story. Shares in companies where the
CEOs, directors, and other top executives had hedged using a variable
forward sale lagged the market by 16.2%, on average. Those where a collar,
another popular hedging transaction, had been used fell behind by 25%.
Roughly 11% of the companies where an executive
used a collar had to restate financials within two years of the hedge
transaction; comparable companies where no hedging occurred had half as many
restatements, Bettis says. Some 11% of the firms that let their executives
buy a variable forward contract faced securities-related suits within a
year, double the number at companies that didn't hedge. "The poor
performance following hedging suggests a number of these trades are
potentially based on privileged information," argues Bettis. The trades
"appear to be tied to events that were known or could reasonably have been
anticipated by the executives," he adds.
SEC officials say executives who hedge fall under
the same rules as those who sell their stock. If an executive were to use a
hedge to protect himself against losses at a time when he possessed specific
material information that the company's performance had stumbled or was
about to, that could potentially bring an insider trading charge. But SEC
spokesman John Heine says the agency has never pursued an insider trading
case against an executive following a hedge.
Missed earnings in the wake of a hedge appear
common, Bettis' research shows. Chattem Chairman and CEO Alexander Guerry
placed a hedge on 60,000 shares of the Chattanooga (Tenn.)-based maker of
Gold Bond foot powder,
Continued in article
Jensen Comment
Note that FAS 133 does not scope in accounting for short sales.
Bob Jensen's tutorials on accounting for derivative financial instruments
and hedge accounting ---
http://faculty.trinity.edu/rjensen/caseans/000index.htm
"A Non-Delirious New York Recovery
should not mean a return to the excess that betrayed so many," by Mark
Halprin, The Wall Street Journal, January 21, 2010 ---
http://online.wsj.com/article/SB10001424052748703699204575017040112575022.html#mod=djemEditorialPage
Midway between the first intoxications of borrowed
money that does not exist, and the red-hot bearings of presses that roll to
correct such inconsistencies, lies a wonderland in which human nature can
become a subsidiary of the making and spending of money. Not steadily and
honorably in furtherance of well being, charity, and art, but at the speed
of summer lightning and for its own sake.
When pay-out exceeds pay-in, balance is maintained
only by the weight of illusion—as in real-estate bubbles, or welfare states
in which benefits vastly exceed contributions. Within such failing systems
one finds nevertheless highly visible concentrations of wealth, like lumps
in tapioca, that persist in setting a tone that has long gone flat.
Take Manhattan, but first take the Hamptons, where
symptoms are readily apprehended, just as the pulse at the wrist is a
telltale of the heart. Mere multimillionaires cannot afford anymore to go
where within living memory actual people made a living from the farms, clam
beds, and sword-fishing grounds. Now the potato fields are covered with
houses that look like the headquarters of Martian expeditionary forces,
ice-cream factories, vacuum cleaners on stilts, the Seagram building on its
side, or shingled New England cottages monstrously swollen into something
you might see after eating a magic mushroom. In simple and quiet towns that
once deferred to the majesty of the ocean, the streets are now clogged with
a kabuki theater of Range Rovers and $35,000 handbags.
In Manhattan the knock-the-wind-out-of-you rich
used to be a relatively silent freak of nature who could easily be ignored,
but of late they are so electrically omnipresent, jumping out of every flat
screen and magazine, that they indelibly color the life of the city. Having
multiplied like Gucci-clad yeast, they have become objects of impossible
envy.
You cannot ignore them as you sit in your $2,000 a
month 7 x 10 "efficiency," eating your $5 street pretzel. Or when private
schools—where scholarships are reserved for peasants who subsist on $300,000
or less, and where if you haven't been admitted by the time you're an embryo
you're toast—have become like the class redoubts of Czarist Russia.
Or when Mayor Michael Bloomberg spends a hundred
million of his own money, $175 per vote, to crown himself like Napoleon,
perhaps forgoing the purchase of the presidency because at that rate he
would have to fork over $22 billion. What if he had spent comparably to his
predecessors—Fiorello La Guardia, or even Jimmy Walker, whose corruption
when compared to Mr. Bloomberg's well-established honesty seems nonetheless
like the innocence of a fawn? (It is possible that he would not have won on
his own merits.)
Ostentation has always been a hallmark of mankind,
and part of the price of freedom and power in ascendant nations. But the day
the baubles shine most brilliantly is the day when the civilization,
distracted from what made it, begins to go down the drain. This is not an
argument for restricting economic liberties, but rather a lamentation of
circumstance and a condemnation of taste. The right may envy by competition
and the left by expropriation, but the objects of such envy are not worthy
of its ruinous influences, and the city is at its best when the fury of
acquisitiveness is least.
Now that New York may be exiting yet another of
many eras of irrational exuberance, it presents an opportunity in the midst
of defeat, for when it is quiet it is far more lovely and profound than when
it is delirious. For a long, clear moment, September 11 blew the dross away
and the real city appeared. When such things arrive, as they always have and
always will—whether in the form of conquest, riots, depression, epidemics,
or war—they and their aftermath should be the cause of reflection.
Whenever New York has endured a blow, its real
strengths have emerged. If it is now on the verge of a long-term diminution
of wealth, or at least a roughly attained sobriety, all the suffering should
not be for nothing. Recovery should mean not just a return to the
fascination with excess that betrayed so many. For one, excess is too
limited a thing to be genuinely satisfying. Grab the first billionaire you
see (it should be easy) and he will tell you that stuff simply doesn't do
the trick.
This is why New York has for too long been a city
in which even the rich are poor. To the contrary, it should be a place in
which even the poor are rich. How to accomplish this is a riddle to which
public policy often proves inadequate and is anyway just a distant follower
of forces of history that assert themselves as far beyond its control as the
weather. As the waves of history sweep through the present what they leave
will depend in large part upon how they are perceived and how each
individual acts upon his perceptions, which law and regulation follow more
than they shape.
How things will turn out is anyone's guess, but it
would be nice if, as in the quiet during and after a snow storm, Manhattan
would reappear to be appreciated in tranquility; if cops, firemen, nurses,
and teachers did not have to live in New Jersey; if students,
waitress-actresses, waiter-painters, and dish-washer-writers did not have to
board nine to a room or like beagles in their parents' condominia; if the
traffic on Park Avenue (as I can personally attest it was in the late 1940s)
were sufficiently sparse that you could hear insects in the flower beds; if
to balance the frenetic getting and spending, the qualities of reserve and
equanimity would retake their once honored places; if celebrity were to be
ignored, media switched off, and the stories of ordinary men and women
assume their deserved precedence; and if for everyone, like health returning
after a long illness, a life of one's own would emerge from an era
tragically addicted to quantity and speed.
Mr. Helprin, a senior fellow at the Claremont Institute, is the author
of, among other works, "Winter's Tale" (Harcourt), "A Soldier of the Great
War" (Harcourt) and, most recently, "Digital Barbarism" (HarperCollins).
Great PBS Video on the Crash of 1929 ---
http://www.pbs.org/wgbh/americanexperience/crash/
Yale School of Management Cosponsors NYC Roundtable Discussion on the
Financial Crisis (Full Video Now Available)
http://mba.yale.edu/news_events/CMS/Articles/6608.shtml
A Grant Thornton LLP Study: A Wake-up Call for America
"Steep decline in U.S. listings attributed to existing market structure,"
Grant Thornton, November 2009 ---
www.GrantThornton.com/WakeupCall
Call for reform to stimulate the
economy and spur job creation
NEW YORK, November 9, 2009 - A study released today
by Grant Thornton LLP, A Wake-Up Call for America, demonstrates that
market structure changes implemented beginning in the late 1990s are leading
to a dramatic long-term decline in the number of publicly listed companies
in the United States. According to the study, SEC actions over recent
decades have encouraged the development of markets that favor the most
technologically sophisticated traders. The rise of high-frequency trading
is the natural consequence of regulations designed to increase efficiency,
but those same regulations have tended to undermine market support for
small, innovative companies.
"Our 'one-size-fits-all' market structure has added
liquidity to large cap stocks, but has created a black hole for small cap
listed companies," said David Weild, Capital Markets Advisor at Grant
Thornton LLP and former vice chairman of NASDAQ. "Wall Street's very nature
has been substantially transformed."
"This important study demonstrates convincingly
further cause for concern about rules that encourage high-frequency trading
to thrive, but perhaps have undermined one of Wall Street's most important
purposes: to provide the infrastructure for smaller, growing companies in
the United States to gain access to the public markets to facilitate further
growth and innovation," said Senator Ted Kaufman (D-Del.). "The Grant
Thornton study is a call to action. U.S. innovation policy must include an
intelligent review of our U.S. equity markets, so that Wall Street once
again helps innovative small companies to succeed."
Known in the 1990s as the "Four Horsemen," the
investment banks that once catered to emerging-growth companies are gone.
Today the market is dominated by firms that buy and sell in milliseconds,
using automated algorithms that have no interest in the fundamental
valuations underlying stocks. They include proprietary trading, statistical
arbitrage hedge funds, and automated market makers.
The result? Investors, issuers and the economy have
all been harmed. Wall Street is now fixated on trading profits and has
abandoned investments in quality sell-side analysis, underwriting and sales
support - the infrastructure necessary to support and create value in small
cap stocks. Policymakers must recognize that the structure and regulatory
framework guiding U.S. equity markets has become not only an important issue
for investors due to fairness concerns, but also a critical component of
U.S. economic policy that is affecting our economy's ability to innovate,
create jobs and grow.
The decline in the number of new listings began
before the technology bubble burst a decade ago - before the enactment of
Sarbanes-Oxley in 2002 - and has continued through bull and bear markets.
The number of U.S. listed companies has fallen by more than 22 percent since
1991, or 53 percent when calculating in inflation-adjusted GDP growth. In
contrast, exchanges in Asia are adding new listings faster than GDP growth
rates.
According to the study, 360 new listings per year -
a number not approached since 2000 - are required by the United States
simply to replace the number of listed companies that are lost every year.
Moreover, 520 new listings per year are needed to grow the U.S. listed
markets roughly in line with GDP growth. In reality, the U.S. has averaged
fewer than 166 IPOs per year since 2001, with only 54 in 2008.
Believed to be the first of its kind, the study was
conducted by David Weild and Edward Kim, Capital Markets Advisors at Grant
Thornton LLP, using data from a number of sources, including the World
Federation of Exchanges, and from direct interaction with major stock
exchanges.
"This study confirms that America's slipping global
competitiveness in the capital markets is rooted in long-term structural
problems, with devastating consequences for growth capital formation in the
U.S.," said Pascal Levensohn, Founder and Managing Partner of Levensohn
Venture Partners, Board Member of the National Venture Capital Association (NVCA),
and member of the Council on Foreign Relations. "The inability for emerging
growth companies to access U.S. public equity capital by completing IPOs
below $50 million inhibits job creation and hurts American entrepreneurs
more than any other group. If we can't repair the bridge into public
markets, the next generation of innovative private enterprises - starved for
long-term risk capital in the U.S. - will continue to move to non-U.S.
emerging innovation hotspots, where startups are nurtured through attractive
capital incentives."
Barry Silbert, Founder and CEO of SecondMarket, the
industry leader in private company stock transactions, said "The growth and
development of a robust private market is critical to creating a better
alternative and viable bridge to the public market. The time from company
formation to IPO is now so long - nearly 10 years - that it undermines the
development of small businesses, entrepreneurship and American global
competitiveness."
"Today, our stock markets are increasingly
structured to favor computer-driven trading interests at the expense of
long-term investors and the U.S. taxpayer," said Grant Thornton's Kim. "We
need a regulatory framework that guides Wall Street to help small companies
with their capital formation needs, not just build faster and more powerful
trading algorithms."
|
Number of listings |
Percent change
1991-2008 |
Number of listings |
Percent change
Peak Year - 2008 |
|
1991 |
2008 |
Actual GDP |
Adjusted |
Year |
Peak |
Actual GDP |
Adjusted |
NASDAQ |
4,094 |
2,952 |
(27.9)% |
(56.2)% |
1996 |
5,556 |
(46.9)% |
(62.2)% |
NYSE |
1,989 |
1,963 |
(1.3)% |
(40.1)% |
1998 |
2,592 |
(24.3)% |
(43.0)% |
AMEX |
860 |
486 |
(43.5)% |
(65.7)% |
1993 |
889 |
(45.3)% |
(64.8)% |
ALL |
6,943 |
5,401 |
(22.2)% |
(52.8)% |
1997 |
8,823 |
(38.8)% |
(54.5)% |
Source: Capital Markets Advisory Partners, World Federation of
Exchanges, individual stock exchanges, USDA Economic Research
Service (GDP in 2005 US$). Excluding funds. |
Recommended Changes
The Grant Thornton study calls for immediate action and includes
recommendations on how to improve both public and private stock markets in
ways that provide investors and issuers with more choice. It argues that
the opportunity cost of poor primary capital formation is so extreme that
the U.S. needs significant improvements to both the public and private
markets to restore U.S. competitiveness. Recommendations include:
- Alternative Public Market Segment: A
public market solution that provides an economic model that supports the
"value components" (research, sales and capital commitment) in the
marketplace. It would establish a new, parallel market segment that
benefits from a fixed spread and commission structure.
- Enhancements to the Private Market: A
private market solution that enables the creation of a qualified
investor marketplace - consisting of both institutional investors and
large accredited investors - that allows issuers to defer many of the
costs of accessing private capital as a precursor to becoming a public
company. This market would serve as an important bridge to an IPO,
notably in improving the market for 144A PIPO (pre-IPO) transactions
that require an issuer to list publicly in the future.
Grant Thornton urges Congress and the SEC to hold
immediate hearings to understand why the U.S. markets have failed to keep up
with foreign markets and to craft solutions quickly - solutions that,
together with thoughtful oversight, will advance the U.S. economy, create
high-quality jobs, improve U.S. competitiveness, increase the tax base and
decrease the U.S. budget deficit, all without major expenditures by the U.S.
government.
View the full study at:
www.GrantThornton.com/WakeupCall and urge Congress
to act. Sign up for future updates and
studies at
www.GrantThornton.com/subscribe and select the
Capital Markets Series.
For a chart showing the number of listed companies from global exchanges,
indexed to 1997, go to
www.GrantThornton.com/WakeupCall.
About Grant Thornton LLP
Grant Thornton LLP is the U.S. member firm of Grant Thornton International
Ltd, one of the six leading global accounting, tax and business advisory
organizations. Through member firms in more than 80 countries, including 50
offices in the United States, the partners and employees of Grant Thornton
member firms provide personalized attention and the highest quality service
to public and private clients around the globe. Visit Grant Thornton LLP at
www.GrantThornton.com.
Bob Jensen's threads on the recovery are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"On the road to socialism. "Bureaucracy", von Mises,1944," by Lee Carey, June
18, 2009 ---
http://www.sodahead.com/blog/95367/on-the-road-to-socialism-bureaucracy-von-mises1944/
Today, in their writings, we can today
find an articulate defense of capitalism and a rapier attack on socialism
and collectivism in general. Both economists offer an alternative to
Galbraith, and to a current leading proponent of Keynesian economics, New
York Times columnist Paul Krugman.
Here are several quotes from Mises’s
"Bureaucracy", first published in 1944, but holding relevance for today.
“The characteristic feature of present-day
policies is the trend toward a substitution of government control for free
enterprise. Powerful political parties and pressure groups are fervently
asking for public control of all economic activities, for thorough
government planning, and for the nationalization of business. They aim at
full government control of education and at the socialization of the medical
profession. There is no sphere of human activity that they would not be
prepared to subordinate to regimentation by the authorities. In their eyes,
state control is the panacea for all ills.” (p. 4)
“America is faced with a phenomenon that
the framers of the Constitution did not foresee and could not foresee: the
voluntary abandonment of congressional rights. Congress has in many
instances surrendered the function of legislation to government agencies and
commissions, and it has relaxed its budgetary control through the allocation
of large appropriations for expenditures, which the Administration has to
determine in detail.” (p. 5)
“Today the fashionable philosophy of
Statolatry has obfuscated the issue [of tyrants versus popular government].
The political conflicts are no longer seen as struggles between groups of
men. They are considered a war between two principles, the good and the bad.
The good is embodies in the great god State, the materialization of the
eternal idea of morality, and the bad is the ‘rugged individualism’ of
selfish men. In this antagonism the State is always right and the individual
always wrong. The State is the representative of the commonweal, of justice,
civilization, and superior wisdom. The individual is a poor wretch, a
vicious fool.” (p. 76)
“The fading of the critical sense is a
serious menace to the preservation of our civilization. It makes it easy for
quacks to fool people. It is remarkable that the educated strata are more
gullible than the less educated. The most enthusiastic supporters of
Marxism, Nazism, and Fascism are the intellectuals, not the boors. (p. 108)
“The main propaganda trick of the
supporters of the allegedly ‘progressive’ policy of government control is to
blame capitalism for all that is unsatisfactory in present day conditions
and to extol the blessings which socialism has in store for mankind. They
have never attempted to prove their fallacious dogmas or still less to
refute the objections raised by the economists. All they did was to call
their adversaries names and to cast suspicion upon their motives. And,
unfortunately, the average citizen cannot see through these stratagems.” (p.
111)
[The Middle Way] “The most detrimental
outcome of the average citizen’s repugnance to a serious concern with
economic problems is his readiness to back a program of compromise. He looks
upon the conflict between capitalism and socialism as if it were a quarrel
between two groups – labor and capital – each of which claims for itself the
whole of the matter at issue. As he himself is not prepared to appraise the
merits of the arguments advanced by each of the parties, he thinks it would
be a fair solution to end the dispute by an amicable arrangement: each
claimant should have a part of his claim. Thus the program of government
interference with business acquired its prestige. There should be neither
full capitalism nor full socialism, but something in between, a middle way.”
(pp.117-118)
And, as Hayek explains elsewhere, the
middle way is only a byway on the highway to more socialism.
"Michael Moore takes on capitalism," by Richard Coriss, Fortune,
September 7, 2009 ---
http://money.cnn.com/2009/09/04/magazines/fortune/michael_moore_capitalism_review.fortune/
If anyone has profited from the
free-enterprise system in the past 20 years, it's Michael Moore. Since 1989,
when his "Roger & Me" pioneered the docu-comedy form of nonfiction film,
Moore's movies, TV shows and best-selling books have given him an
eight-figure net worth.
And in all of these, he is the improbable
star: a heavyset fellow with a doofus grin, alternately laughing and
badgering but always at the center of his own attention. Why, there he is,
at the end of his new movie, "Capitalism: A Love Story," wrapping the New
York Stock Exchange building in yellow tape that reads: CRIME SCENE.
The writer-director-propagandist has
earned every penny and Euro of his boodle. Moore's last three filmed
diatribes -- "Bowling for Columbine," "Fahrenheit 9/11" and "Sicko" --h ave
amassed more than $300 million in theaters worldwide, and loads more on DVD;
and "Fahrenheit" is, by a long stretch, the top-grossing documentary of all
time.
Now, there's no reason a popular
entertainer, even one whose subjects are the gun lobby, the march to war in
Iraq and the health-care industry, should live like a monk. It's just a
little ironic that the man who made his career attacking corporate America
should be a pretty big business himself.
Moore is doing well abroad; his last three
films have made nearly half their total income in foreign countries. So it's
fitting "Capitalism: A Love Story" had its world premiere Sunday at the
Venice Film Festival. This follows the Cannes debuts, with headline-making,
mostly rapturous receptions, of "Columbine," "Fahrenheit" and "Sicko."
Why does has working-class guy from Flint,
Mich., won the hearts of Europeans? Perhaps because his movies indulge the
continental view of America: that we're gun-crazy, we invade countries that
haven't attacked us and we think medical coverage is a profit-making scam,
not a citizen's basic right. Europe is a peaceful civilization that knows
its place and cares for its people. We're armed, dangerous and stupid.
That's not quite Moore's view. He has a
dewy respect for the underclass; each of his films has testimony from
working men and women who burst into tears or soar into rage describing
injustices done them. To Moore, it's the bureaucratic-industrial complex --
the combined might of the West Wing, Wall street and Wal-Mart -- that's
evil.
That view was never clearer than in his
broadly entertaining, ceaselessly provocative, wildly ambitious new film.
Not satisfied with outlining and condemning the housing and banking crises
of the past year, it expands the story of the financial collapse into an
epic of malfeasance: capital crimes on a national scale.
Home are foreclosed on people who could
meet their old mortgage payments but not the new, ballooned ones. (One
family does get $1,000 for cleaning out the house they've just been evicted
from.) Corporations take out policies on their workers, then pocket tax-free
"dead peasants" insurance by the carload while the victims' families get
nothing. Two judges in Pennsylvania close down a state detention center,
then sentence children to long terms in a private facility that kicks back
millions to the judges.
By now, a Michael Moore film is its own
genre: a vigorous vaudeville of working-class sob stories, snippets of
right-wing power players saying ugly things, longer interviews with experts
on the Left, funny old film clips and, at the climax, Moore engaging in some
form of populist grandstanding.
This time, he goes to the headquarters of
the former AIG, a multibillion-dollar recipient of government largesse, and
attempts to make a citizen's arrest of its chief executives. He also asks
Wall Streeters for advice on healing the nation. One man's quick reply:
"Don't make any more movies."
"Capitalism" has lots of statistics, like
the Rasmussen poll that showed only a slight majority of young adults prefer
capitalism to socialism. But this is a lecture from a charismatic comedian
of a professor; he makes his points with gag movie references and quick
visual puns.
In "Capitalism," when the narrator of a
1950s instructional film about ancient Rome's use of gladiatorial games "to
keep the idle citizens entertained," he tosses in a shot from American Idol.
(Idle, Idol.) Running a clip from the 1977 "Jesus of Nazareth," Moore puts
new words in the Messiah's mouth so that Jesus now tells a supplicant, "I am
sorry, I cannot heal your preexisting condition."
Look, if you want fair and balanced, go to
Fox News. But Moore does give a little time to those on the other side. As a
carpenter hammers pasteboard over the facade of a foreclosed home, he
observes, "If people pay their bills, they don't get thrown out." Wall
Street Journal editorial board member Stephen Moore gets about a minute to
explain why capitalism is great and democracy isn't.
Sometimes Moore lavishes attention on
adversaries just because they're so much fun. Peter Zalewski, founder of
Condo Vultures, which buys up defaulted homes on the quick and cheap, tells
the filmmaker, "What's the difference between me and a real vulture? I say
that's simple: I don't vomit on myself."
Toward the end, Moore shows the jubilation
in Chicago's Grant Park the night Barack Obama was voted President. Two days
before that election, Moore said of Obama, "The Republicans aren't kidding
when they say he's the 'most liberal' member of the Senate. ... He is our
best possible chance to step back from the edge of the cliff."
Since Jan. 20, a part of the right may be
calling Obama a Communist, but not many liberals are calling him liberal.
The movie seems to be setting up the disappointment many on the Left have
felt over the awarding of more billions to giant banks and corporations,
among other things, since Jan. 20. And Moore does note that Goldman Sachs
gave more than $1 million to Obama's campaign.
But he doesn't go after this Democratic
President as he surely would have if John McCain had been elected. Instead,
he argues for participatory democracy: do-it-yourself do-gooding, through
community activism and union organizing. That's an optimistic and evasive
answer to the financial problem.
Surely what spun out of control because of
government indulgence and indolence needs to be repaired by government
regulation and ingenuity. Squatting in your repossessed home won't get the
trillions back. In "Capitalism: A Love Story," Moore has cogently and
passionately diagnosed the disease. But for a cure, instead of emergency
surgery, he prescribes Happy Meals.
"Efficient Market Theory and the Crisis: Neither the rating agencies'
mistakes nor the overleveraging by financial firms was the fault of an academic
hypothesis," by Jeremy J. Siegel, The Wall Street Journal, October
27, 2009 ---
http://online.wsj.com/article/SB10001424052748703573604574491261905165886.html?mod=djemEditorialPage
Financial journalist and best-selling author Roger
Lowenstein didn't mince words in a piece for the Washington Post this
summer: "The upside of the current Great Recession is that it could drive a
stake through the heart of the academic nostrum known as the
efficient-market hypothesis." In a similar vein, the highly respected money
manager and financial analyst Jeremy Grantham wrote in his quarterly letter
last January: "The incredibly inaccurate efficient market theory [caused] a
lethally dangerous combination of asset bubbles, lax controls, pernicious
incentives and wickedly complicated instruments [that] led to our current
plight."
But is the Efficient Market Hypothesis (EMH) really
responsible for the current crisis? The answer is no. The EMH, originally
put forth by Eugene Fama of the University of Chicago in the 1960s, states
that the prices of securities reflect all known information that impacts
their value. The hypothesis does not claim that the market price is always
right. On the contrary, it implies that the prices in the market are mostly
wrong, but at any given moment it is not at all easy to say whether they are
too high or too low. The fact that the best and brightest on Wall Street
made so many mistakes shows how hard it is to beat the market.
This does not mean the EMH can be used as an excuse
by the CEOs of the failed financial firms or by the regulators who did not
see the risks that subprime mortgage-backed securities posed to the
financial stability of the economy. Regulators wrongly believed that
financial firms were offsetting their credit risks, while the banks and
credit rating agencies were fooled by faulty models that underestimated the
risk in real estate.
After the 1982 recession, the U.S. and world
economies entered into a long period where the fluctuations in variables
such as gross domestic product, industrial production, and employment were
significantly lower than they had been since World War II. Economists called
this period the "Great Moderation" and attributed the increased stability to
better monetary policy, a larger service sector and better inventory
control, among other factors.
The economic response to the Great Moderation was
predictable: risk premiums shrank and individuals and firms took on more
leverage. Housing prices were boosted by historically low nominal and real
interest rates and the development of the securitized subprime lending
market.
According to data collected by Prof. Robert Shiller
of Yale University, in the 61 years from 1945 through 2006 the maximum
cumulative decline in the average price of homes was 2.84% in 1991. If this
low volatility of home prices persisted into the future, a mortgage security
composed of a nationally diversified portfolio of loans comprising the first
80% of a home's value would have never come close to defaulting. The credit
quality of home buyers was secondary because it was thought that underlying
collateral—the home—could always cover the principal in the event the
homeowner defaulted. These models led credit agencies to rate these subprime
mortgages as "investment grade."
But this assessment was faulty. From 2000 through
2006, national home prices rose by 88.7%, far more than the 17.5% gain in
the consumer price index or the paltry 1% rise in median household income.
Never before have home prices jumped that far ahead of prices and incomes.
This should have sent up red flags and cast doubts
on using models that looked only at historical declines to judge future
risk. But these flags were ignored as Wall Street was reaping large profits
bundling and selling the securities while Congress was happy that more
Americans could enjoy the "American Dream" of home ownership. Indeed,
through government-sponsored enterprises such as Fannie Mae and Freddie Mac,
Washington helped fuel the subprime boom.
Neither the rating agencies' mistakes nor the
overleveraging by the financial firms in the subprime securities is the
fault of the Efficient Market Hypothesis. The fact that the yields on these
mortgages were high despite their investment-grade rating indicated that the
market was rightly suspicious of the quality of the securities, and this
should have served as a warning to prospective buyers.
With few exceptions (Goldman Sachs being one),
financial firms ignored these warnings. CEOs failed to exercise their
authority to monitor overall risk of the firm and instead put their faith in
technicians whose narrow models could not capture the big picture. One can
only wonder if the large investment banks would have taken on such risks
when they were all partnerships and the lead partner had all his wealth in
the firm, as they were just a few decades ago.
The misreading of these economic trends did not
just reside within the private sector. Former Fed Chairman Alan Greenspan
stated before congressional committees last December that he was "shocked"
that the top executives of the financial firms exposed their stockholders to
such risk. But had he looked at their balance sheets, he would have realized
that not only did they put their own shareholders at risk, but their
leveraged positions threatened the viability of the entire financial system.
As home prices continued to climb and subprime
mortgages proliferated, Mr. Greenspan and current Fed Chairman Ben Bernanke
were perhaps the only ones influential enough to sound an alarm and soften
the oncoming crisis. But they did not. For all the deserved kudos that the
central bank received for their management of the crisis after the Lehman
bankruptcy, the failure to see these problems building will stand as a
permanent blot on the Fed's record.
Our crisis wasn't due to blind faith in the
Efficient Market Hypothesis. The fact that risk premiums were low does not
mean they were nonexistent and that market prices were right. Despite the
recent recession, the Great Moderation is real and our economy is inherently
more stable.
But this does not mean that risks have disappeared.
To use an analogy, the fact that automobiles today are safer than they were
years ago does not mean that you can drive at 120 mph. A small bump on the
road, perhaps insignificant at lower speeds, will easily flip the
best-engineered car. Our financial firms drove too fast, our central bank
failed to stop them, and the housing deflation crashed the banks and the
economy.
Dr. Siegel, a professor of finance at the University of Pennsylvania's
Wharton School, is the author of "Stocks for the Long Run," now in its 4th
edition from McGraw-Hill.
Eugene Fama Lecture: Masters of Finance, Oct 2, 2009
Videos Fama Lecture: Masters of Finance From the American Finance Association's
"Masters in Finance" video series, Eugene F. Fama presents a brief history of
the efficient market theory. The lecture was recorded at the University of
Chicago in October 2008 with an introduction by John Cochrane.
http://www.dimensional.com/famafrench/2009/10/fama-lecture-masters-of-finance.html#more
Fama Video on Market Efficiency in a Volatile Market
Widely cited as the father of the efficient market hypothesis and one of its
strongest advocates, Professor Eugene Fama examines his groundbreaking idea in
the context of the 2008 and 2009 markets. He outlines the benefits and
limitations of efficient markets for everyday investors and is interviewed by
the Chairman of Dimensional Fund Advisors in Europe, David Salisbury.
http://www.dimensional.com/famafrench/2009/08/fama-on-market-efficiency-in-a-volatile-market.html#more
Other Fama and French Videos ---
http://www.dimensional.com/famafrench/videos/
Jensen Comment
This does not mean the EMH and its wildly popular stepchild CAPM are not in deep
keeshee (theory and practice) ---
http://faculty.trinity.edu/rjensen/theory01.htm#EMH
Warren
Buffett did a lot of almost fatal damage to the EMH
If you really want to understand the problem you’re apparently wanting to study,
read about how Warren Buffett changed the whole outlook of a great
econometrics/mathematics researcher (Janet Tavkoli). I’ve mentioned this
fantastic book before --- Dear Mr.
Buffett. What opened her eyes is how Warren Buffet built his vast, vast
fortune exploiting the errors of the sophisticated mathematical model builders
when valuing derivatives (especially options) where he became the writer of
enormous option contracts (hundreds of millions of dollars per contract). Warren
Buffet dared to go where mathematical models could not or would not venture when
the real world became too complicated to model. Warren reads financial
statements better than most anybody else in the world and has a fantastic
ability to retain and process what he’s studied. It’s impossible to model his
mind.
I finally grasped what Warren was saying. Warren has such a wide body of
knowledge that he does not need to rely on “systems.” . . . Warren’s vast
knowledge of corporations and their finances helps him identify derivatives
opportunities, too. He only participates in derivatives markets when Wall
Street gets it wrong and prices derivatives (with mathematical models)
incorrectly. Warren tells everyone that he only does certain derivatives
transactions when they are mispriced.
Wall Street derivatives traders construct trading models with no clear idea
of what they are doing. I know investment bank modelers with advanced math
and science degrees who have never read the financial statements of the
corporate credits they model. This is true of some credit derivatives
traders, too.
Janet Tavakoli, Dear Mr. Buffett, Page 19
"'A Race to the Bottom': Assigning Responsibility for the Financial Crisis,"
Knowledge@wharton, December 9, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2397
The global financial meltdown has been marked by
shortages -- of oversight, due diligence, moral fortitude and common sense.
Today, approximately two years after the housing bubble burst and world
stock markets collapsed, possibly the only surplus left from the crisis is
that of finger pointing and blame.
"The question of blame has been one that's been on
a lot of people's minds," said Wharton Dean
Thomas S.
Robertson, introducing a panel discussion this
week titled, "Responsibility and the Financial Crisis of 2008." Attempts to
pinpoint who or what caused the global financial crisis usually results in a
long list of suspects: The Federal Reserve, government regulators, credit
rating agencies, the Securities and Exchange Commission, subprime lenders
and borrowers, and even business schools have found themselves at the end of
an accusing finger. "Whether they bear some responsibility or not,"
Robertson said, "We have an obligation to immerse ourselves in the question,
'Where do we go from here?'"
The panel of professors from Wharton and the
University of Pennsylvania spread the responsibility around. The possible
culprits they identified ranged from global capital imbalances to outdated
regulatory structures. Some found fault with the private sector and greed on
Wall Street, while others argued that the government had not been held fully
accountable for its failures. Perhaps the only common ground was a belief
that there are no simple solutions. Oversimplification of complex problems
is dangerous, some warned, and in itself might have contributed to the
crisis.
According to Wharton finance professor
Franklin Allen, there hasn't been enough focus on
the real causes of the financial crisis, which he traces to loose monetary
policy and global capital imbalances. "The public sector has done a very
successful job of pushing blame to the private sector," he said. "So for
example, there's a lot of debate about consumer protection, but not the
Federal Reserve.... There is little talk of reform of the global financial
system.",
The immediate cause of the crisis was clearly the
housing bubble, Allen said. From 1890 to 1996, real housing prices rose 27%,
whereas between 1996 and 2006, they rose 92%. "That's more than three times
as much. And that's the problem." The more important question is what caused
the bubble. In Allen's view, subprime mortgages were not to blame, because
other countries without subprime mortgages also suffered housing bubbles.
Rather, the problem was that the Fed kept interest rates too low for too
long, and imbalances in global capital flows allowed people to borrow large
amounts at low rates. "It became a very attractive arbitrage to borrow and
buy houses," Allen said.
He traces the global imbalances back to the Bretton
Woods Agreement of 1944 and the Asian financial crisis of 1997. Since
Bretton Woods smoothed financial conflict after World War II, the world's
financial system has been dominated by the United States and Europe. As a
result, Asia had little representation at the International Monetary Fund
when its financial crisis unfolded in 1997. Unable to get the loans they
needed during the crisis, Asian countries subsequently piled up safety
stashes of $4 trillion in foreign reserves, money that ended up being
invested in U.S. debt and contributing to the housing disaster.
Continued in article
The True Causes of the Economic Meltdown of 2008
"The 'Global Imbalances' Myth: Different countries have always played
different roles in the world economy," by Zachary Karabell, The Wall Street
Journal, December 21, 2009 ---
http://online.wsj.com/article/SB10001424052748703499404574563760018636586.html
As the economic crisis has eased in recent months,
a questionable international consensus has emerged: The global economy needs
to be rebalanced. "We cannot follow the same policies that led to such
imbalanced growth," President Barack Obama said during his Asia trip last
month. European Central Bank head Jean-Claude Trichet declared in September
that "imbalances have been at the roots of the present difficulties. If we
don't correct them, we'll have the recipe for the next major crisis."
These global "imbalances" supposedly include
excessive American consumption, too much trade flowing from Asia to the West
and not enough from the U.S. to Asia, and too much saving combined with
insufficient spending by Chinese consumers. But what if the whole notion of
global imbalances is a myth, and that policies to reverse them only make
things worse?
The blunt fact is that at no point in the past
century has there been anything resembling a global economic equilibrium.
Consider the heyday of the "American century" after
World War II, when Western European nations were ravaged by war, and the
Soviet Union and its new satellites slowly rebuilding. In 1945, the U.S.
accounted for more than 40% of global GDP and the preponderance of global
manufacturing. The country was so dominant it was able to spend the
equivalent of hundreds of billions of dollars to regenerate the economies of
Western Europe via the Marshall Plan, and also of Japan during a seven year
military occupation. By the late 1950s, 43 of the world's 50 largest
companies were American.
The 1970s were hardly balanced—not with the end of
the gold standard, the oil shocks and the 1973 Arab oil embargo, inflation
and stagflation, which spread from the U.S. through Latin America and into
Europe.
The 1990s were equally unbalanced. The U.S.
consumed and absorbed much of the available global capital in its red-hot
equity market. And with the collapse of the Soviet Union and the economic
doldrums of Germany and Japan, the American consumer assumed an ever-more
central position in the world. The innovations of the New Economy also gave
rise to a stock-market mania and overshadowed the debt crises of South
America and the currency implosion of South Asia—all of which were
aggravated by the concentration of capital in the U.S. and the paucity of it
in the developing world. When the tech bubble burst in 2000, it had little
to do with these global dynamics and everything to do with a glut of
telecommunication equipment in the U.S., and stock-market exuberance gone
wild.
When officials and economists today speak of
correcting global imbalances, it is unclear what benchmark they have in
mind.
So-called excessive American consumption, East-West
trade flows, Chinese savings and the like were not responsible for the
recent crisis. That was instead triggered by massive misplaced bets on the
U.S. housing market and trillions of dollars of derivatives built upon that
flimsy foundation.
Yes, many have woven a compelling narrative of how
the relationship between China and the U.S.—distorted by China's fixed and
nonconvertible currency on the one hand and America's debt-fueled appetites
on the other—led to massive flows of capital out of the U.S. But that money
flowed right back into the U.S. in the form of Chinese purchases of Treasury
bonds, mortgage-backed securities and other dollar-denominated assets, which
then flowed into our banking system, which then made its way back to U.S.
business and to the Treasury, some of which then circulated back into China.
What some see as imbalances can also be described
as a system of capital and goods in constant motion. Chinese reserves and
U.S. government debt didn't trigger the meltdown, nor did U.S. consumers
cause the meltdown. It wasn't even U.S. consumer debt—after all, more than
90% of Americans have remained current on their credit cards and their
mortgages. The real (and much messier) cause of the meltdown was a potent
brew of financial innovation, electronic and instantaneous flow of capital,
greed on the part of banks and investors world-wide, against a backdrop of
an economic fusion between China and the U.S. that kept interest rates low
and inflation lower.
Today's consensus sounds very much like the
orthodoxy of yesteryear—let each nation be its own system in equilibrium,
interacting with other systems to create one mega-balanced system. Yet such
balance has only existed in theory and only ever will.
Indeed, if the crisis of the past year teaches us
anything it should be that forcing reality to conform to abstract theory is
a sure recipe for disaster. Forced to act with expediency in the moment, the
central banks and governments of the world did a surprisingly good job of
triage during the economic emergency that swept the globe. The eclectic
demands of a crisis outweighed models and theories, and that was a good
thing.
Now that the crisis has eased, the greatest danger
is that our collective belief in how the world should work drowns out the
creative nimbleness of policy that adapts to the world as it is actually
working. Policies that might stem from the global imbalances consensus
include American government incentives to increase domestic savings. This
sounds good, but not if it leads to underinvestment in innovation, education
and infrastructure.
It could also lead Chinese officials to attempt to
shift away from exports and state spending. Over the long term this might be
beneficial, but it could wreak havoc on domestic Chinese growth and global
supply chains if it is done under the erroneous belief that urgent action is
required. For its part, the European Union rightly claims that it has not
been a primary cause of the perceived imbalances. But its leaders have been
central to pushing that thesis and urging China and the U.S. to redress
them.
Thankfully, there is less risk of the Chinese
government upsetting their apple cart than there is of the American
government acting precipitously.
Mr. Karabell is president of River Twice Research and the author, most
recently, of "Superfusion: How China and America Became One Economy" (Simon
& Schuster, 2009).
Replies, The Wall Street Journal, January 2, 2010 ---
http://online.wsj.com/article/SB20001424052748704680804574620431817158244.html#mod=todays_us_opinion
Zachary Karabell rightly decries the development of
a false thesis concerning the need for a "rebalancing" of global economic
activity ("The
'Global Imbalances' Myth," op-ed, Dec. 21). With respect to the origins
of the current downturn, however, he has joined the Obama administration in
buying into the false conventional wisdom that our recent crisis was
"triggered by massive misplaced bets on the U.S. housing market and
trillions of dollars of [innovative] derivatives" based on such
malinvestment; as well as "electronic and instantaneous" capital flows;
"greed on the part of banks and investors world-wide"; and an "economic
fusion between China and the U.S. that kept interest rates low and inflation
lower."
Not once does Mr. Karabell mention the core root of
all of these recent phenomena: the Federal Reserve's extreme monetary ease
for most of this decade. Loose money for a long period falsified the term
structure of interest rates, leading to distorted patterns of capital
investment and resource allocation. Further, asset values became distorted
across the globe, as other nations acted in concert with the Fed,
multiplying global investment and trade errors and imbalances.
This continued monetary pumping also led to the
development of complex hedging instruments in the form of derivative
securities, as investors sought to protect themselves from asset values
changing primarily due to volatility in monetary relations. Increasing
amounts of credit in the banking system always generate higher leverage on
corporate balance sheets, thus intensifying the eventual correction.
The inability of Mr. Karabell and President Obama
to apprehend the origins of the "Great Recession" of 2008 in turn leads to
convoluted policy recommendations. Mr. Karabell states, for example, that
increased savings in the U.S., an unambiguously good thing, might
nonetheless lead to "underinvestment in innovation, education and
infrastructure." Since when did increased saving lead to underinvestment?
But Mr. Obama agrees, saying we will "spend our way
out of this recession." Mr. Karabell further states that China should
continue its state spending binge so as not to disrupt domestic growth in
China or global supply chains; one can only wonder what he thought of the
inverse relationship between state spending and economic growth in, say,
Japan, post-1990.
Mark S. Wilser
Irvine, Calif.
Mr. Karabell misses an opportunity to explain the
true cause of our most recent crisis: The real reason for our crisis is that
the world lacks a true anchor of value. A system designed around an anchor
of value features natural self-correcting mechanisms. This currently does
not exist.
Mr. Karabell says, "The blunt fact is that at no
point in the past century has there been anything resembling a global
economic equilibrium." In fact, the U.S. current account balance spent
decades hovering around zero (i.e., balanced) prior to turning sharply
negative in the early 1980s.
Earlier in the century, while on the gold standard,
a large current account deficit would be met with a large outflow of gold,
which would act as a tightening on the banking system and would have kept
unrestrained growth in credit and consumer spending in check. It would not
have been possible to run the current account deficit the U.S. ran in the
past 20 years if there were an anchor of value. Without the unrestrained
credit growth that the U.S. experienced, the crisis would not have happened.
The values of the stock market, corporate and
government debt markets, commodities and currencies fluctuate with the
sentiment of market participants whose history with regards to stability is
bipolar at best. The resulting high volatility in oil price, its impact on
our current account, the dollar and credit markets all emanate from this
unanchored system. This volatility can serve as a trigger to financial
instability when the underlying imbalances get precarious enough.
To be clear, a system with a global anchor does not
mean that there will not be high volatility. When we were on the gold
standard we experienced many booms and busts but arguably they were kept in
check since the underlying imbalances were never allowed to get so large as
to threaten the whole system.
Kenneth Bauso, C.F.A.
Bob Jensen's threads on the causes of the economic meltdown are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Jensen Comment
If I had to choose the major culprit, I would blame lousy internal controls on
granting loans knowingly to borrowers who had almost no chance of repaying them.
Ostensibly this was based on the trend line that real estate values on average
never declined. But more importantly was the moral hazard of people willing to
screw their own companies (banks and other mortgage brokering companies), their
professional ethics (real estate appraisers), and Wall Street, their mandates
(credit rating agencies and auditors) in order to collect their fees and dump
the poison loans on third parties like Fannie Mae and Freddie Mack who had, in
many instances, pressures from Congress to buy up loans of poor people unlikely
to repay those loans.
The above article finds blame in the other cracks in the system that
exacerbated the basic problem of moral hazard in Main Street mortgage lending.
It was a moral hazard system of fees that blew up the biggest bubble in
history before bursting. This was followed by the Greatest Swindle in the
History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
"Moral Machines? New Approach To Decision Making Based On Computational
Logic," Science Daily, August 26, 2009 ---
http://www.sciencedaily.com/releases/2009/08/090825103229.htm
Researchers from Portugal and Indonesia describe an
approach to decision making based on computational logic in the current
issue of the International Journal of Reasoning-based Intelligent Systems,
which might one day give machines a sense of morality.
Science fiction authors often use the concept of
"evil" machines that attempt to take control of their world and to dominate
humanity. Skynet in the "Terminator" stories and Arthur C Clarke's Hal from
"2001: A Space Odyssey" are two of the most often cited examples. However,
for malicious intent to emerge in artificial intelligence systems requires
that such systems have an understanding of how people make moral decisions.
Luís Moniz Pereira of the Universidade Nova de
Lisboa, in Portugal and Ari Saptawijaya of the Universitas Indonesia, in
Depok, are both interested in artificial intelligence and the application of
computational logic.
"Morality no longer belongs only to the realm of
philosophers. Recently, there has been a growing interest in understanding
morality from the scientific point of view," the researchers say.
They have turned to a system known as prospective
logic to help them begin the process of programming morality into a
computer. Put simply, prospective logic can model a moral dilemma and then
determine the logical outcomes of the possible decisions. The approach could
herald the emergence of machine ethics.
The development of machine ethics will allow us to
develop fully autonomous machines that can be programmed to make judgements
based on a human moral foundation. "Equipping agents with the capability to
compute moral decisions is an indispensable requirement," the researchers
say, "This is particularly true when the agents are operating in domains
where moral dilemmas occur, e.g., in healthcare or medical fields."
The researchers also point out that machine ethics
could also help psychologists and cognitive scientists find a new way to
understand moral reasoning in people and perhaps extract fundamental moral
principles from complex situations that help people decide what is right and
what is wrong. Such understanding might then help in the development of
intelligent tutoring systems for teaching children morality.
The team has developed their program to help solve
the so-called "trolley problem". This is an ethical thought experiment first
introduced by British philosopher Philippa Foot in the 1960s. The problem
involves a trolley running out of control down a track. Five people are tied
to the track in its path. Fortunately, you can flip a switch, which will
send the trolley down a different track to safety. But, there is a single
person tied to that track. Should you flip the switch?
The prospective logic program can consider each
possible outcome based on different versions of the trolley problem and
demonstrate logically, what the consequences of the decisions made in each
might be. The next step would be to endow each outcome with a moral weight,
so that the prototype might be further developed to make the best judgement
as to whether to flip the switch.
--------------------------------------------------------------------------------
Journal reference:
Luís Moniz Pereira, Ari Saptawijaya. Modelling Morality with Prospective
Logic. Progress in Artificial Intelligence, 2007;
487499 DOI: 10.1007/978-3-540-77002-2_9
Adapted from materials provided by
Inderscience, via
AlphaGalileo..
50 Most Common Mistakes Made by Traders and Investors ---
http://www.ratiotrading.com/2009/09/50-common-mistakes-most-traders-make/
Alpha Return on Investment ---
http://en.wikipedia.org/wiki/Alpha_(investment)
The Small-Cap Alpha Myth - http://www.cpanet.com/up/s0210.asp?ID=0609
What the professional investors don't tell you ---
I downloaded this video ---
http://www.cs.trinity.edu/~rjensen/temp/FinancialRounds.flv
From the Financial Rounds Blog on September 4, 2009 ---
http://financialrounds.blogspot.com/
When I teach investments, there's always a section
on market efficiency. A key point I try to make is that any test of market
efficiency suffers from the "joint hypothesis" problem - that the test is
not tests market efficiency, but also assumes that you have the correct
model for measuring the benchmark risk-adjusted return.
In other words, you can't say that you have "alpha" (an abnormal return)
without correcting for risk.
Falkenblog makes exactly this point:
In my book
Finding Alpha I describe these strategies, as
they are built on the fact that alpha is a residual return, a
risk-adjusted return, and as 'risk' is not definable, this gives people
a lot of degrees of freedom. Further, it has long been the case that
successful people are good at doing one thing while saying they are
doing another.
Even better, he's got a pretty good video on the topic
(it also touches on other topics). Enjoy.
You can watch the video under September 4, 2009 at
http://financialrounds.blogspot.com/
I downloaded this video ---
http://www.cs.trinity.edu/~rjensen/temp/FinancialRounds.flv
Bob Jensen's threads on Return on Investment (ROI) are at
http://faculty.trinity.edu/rjensen/roi.htm
Bob Jensen's threads on market efficiency (EMH) are at
http://faculty.trinity.edu/rjensen/theory01.htm#EMH
Bob Jensen's investment helpers are at
http://faculty.trinity.edu/rjensen/Bookbob1.htm#InvestmentHelpers
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Two Videos Damning Capitalism: One Stupid, One Smart
Michael Moore cheered the bankruptcy of General Motors and absolutely
despises the comeback of General Motors
He has a relatively long list (some lucrative to him) leftist documentaries ---
http://en.wikipedia.org/wiki/Michael_Moore
His documentary Sicko got it wrong --- Cuba is not the dream country of
equity and quality in health care for the masses
Now he has a new documentary entitled: Capitalism: A Love Story
The Stupid Video
"Michael Moore Gets It Wrong," by John Stossel, ABC News, July 11,
2009 ---
http://blogs.abcnews.com/johnstossel/2009/07/michael-moore-gets-it-wrong.html
Michael Moore has been
working on
another documentary. This time, he’s taking on
capitalism:
"The wealthy, at some
point, decided they didn't have enough wealth. They wanted more -- a lot more.
So they systematically set about to fleece the American people out of their
hard-earned money."
How ridiculous is that?
The wealthy, and everyone else, almost always decide that they don’t have enough
wealth. People ask their bosses for raises. We invest in stocks hoping for
bigger returns than Treasury Bonds bring. “Greed” is a constant. The beauty of
free markets, when government doesn’t meddle in them, is that they turn this
greed into a phenomenal force for good. The way to win big money is to serve
your customers well. Profit-seeking entrepreneurs have given us better
products, shorter work days, extended lives, and more opportunities to write the
script of our own life.
On Thursday, Moore
announced the title of the movie:
Capitalism: A Love Story.
It’s a title I might have
picked to make a point opposite of what I assume Moore has in mind.
Moore also fails to
understand is that it was not “capitalism” run amok that caused today’s
financial problems. In reality, it was a combination of
ill-conceived
government policies and an
overzealous Federal Reserve artificially lowering
interest rates to fuel a bubble in the housing market. Then it was government
that took money from taxpayers and
forced banks to accept it.
Moore ought to understand
that, because he makes a good point when he says his movie will be about "the
biggest robbery in the history of this country - the massive transfer of U.S.
taxpayer money to private financial institutions."
That is indeed robbery.
It sure doesn’t sound like capitalism.
The Smart Video
Better Video Damning "Managerial Capitalism" and It's Free Online ---
Click Here
http://snipurl.com/managerialcapitalism [fora_tv]
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Being Honest About Being Dishonest
Democrats openly admit that most of the stimulus money is going to counties that
voted for Obama
A new study released by USA Today also finds that
counties that voted for Obama received about twice as much stimulus money per
capita as those that voted for McCain. "The stimulus bill is designed to help
those who have been hurt by the economic downturn.... Do you see disparity out
there in where the money is going? Certainly," a Democratic congressional
staffer knowledgeable about the process told FOXNews.com.
John Lott, "ANALYSIS: States Hit
Hardest by Recession Get Least Stimulus Money," Fox News, July 19,
2009---
http://www.foxnews.com/story/0,2933,533841,00.html
I’d been working for the bank for about five weeks
when I woke up on the balcony of a ski resort in the Swiss Alps. It was midnight
and I was drunk. One of my fellow management trainees was urinating onto the
skylight of the lobby below us; another was hurling wine glasses into the
courtyard. Behind us, someone had stolen the hotel’s shoe-polishing machine and
carried it into the room; there were a line of drunken bankers waiting to use
it. Half of them were dripping wet, having gone swimming in all their clothes
and been too drunk to remember to take them off. It took several more weeks of
this before the bank considered us properly trained. . . . By the time I arrived
on Wall Street in 1999, the link between derivatives and the real world had
broken down. Instead of being used to reduce risk, 95 per cent of their use was
speculation - a polite term for gambling. And leveraging - which means taking a
large amount of risk for a small amount of money. So while derivatives, and the
financial industry more broadly, had started out serving industry, by the late
1990s the situation had reversed. The Market had become a near-religious force
in our culture; industry, society, and politicians all bowed down to it. It was
pretty clear what The Market didn’t like. It didn’t like being closely watched.
It didn’t like rules that governed its behaviour. It didn’t like goods produced
in First-World countries or workers who made high wages, with the notable
exception of financial sector employees. This last point bothered me especially.
Philipp Meyer,
American Rust (Simon & Schuster, 2009) ---
http://search.barnesandnoble.com/American-Rust/Philipp-Meyer/e/9780385527514/?itm=1
American excess: A Wall Street trader tells all - Americas, World - The
Independent
http://www.independent.co.uk/news/world/americas/american-excess--a-wall-street-trader-tells-all-1674614.html
Jensen Comment
This book reads pretty much like an update on the derivatives scandals featured
by Frank Partnoy covering the Roaring 1990s before the dot.com scandals broke.
There were of course other insiders writing about these scandals as well ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
It would seem that bankers and investment bankers do not learn from their own
mistake. The main cause of the scandals is always pay for performance schemes
run amuck.
It's so sad that Wall Street shot itself in the head rather than the
foot!
With Finance Disgraced, Which Career Will Be King?
"With Finance Disgraced, Which Career Will Be King?" by Steve Lohr, The
New York Times, April 11, 2009 ---
http://www.nytimes.com/2009/04/12/weekinreview/12lohr.html?pagewanted=1&hpw
In the Depression, smart college students flocked
into civil engineering to design the highway, bridge and dam-building
projects of those days. In the Sputnik era, students poured into the
sciences as America bet on technology to combat the cold war Communist
challenge. Yes, the jobs beckoned and the pay was good. But those careers,
in their day, had other perks: respect and self-esteem.
Big shifts in the flow of talent can ripple through
the nation and the economy for decades with lasting effect. The engineers of
the Depression built everything from inter-city roads to the Hoover Dam,
while the Sputnik-inspired scientists would go on, often with research
funding from the Pentagon, to create the building-block innovations behind
modern computing and the Internet.
Today, the financial crisis and the economic
downturn are likely to alter drastically the career paths of future years.
The contours of the shift are still in flux, in part because there is so
much uncertainty about the shape of the economic landscape and the job
market ahead.
But choosing a career is a guess about the future
in which economics is only part of the calculation. Prestige, peer
expectations and the climate of public opinion also matter. And early
indications suggest new career directions that are tethered less to the
dream of an immediate six-figure paycheck on Wall Street than to the demands
of a new public agenda to solve the nation’s problems.
The deep recession has clearly battered industries
— and professions — whose economics were at risk before the downturn. Law
firms are laying off lawyers as never before and questioning the industry’s
traditional unit of payment, the billable hour. Journalism is reeling from
the falloff in advertising and the inability of newspapers and magazines to
make a living on the Web.
Still, the industry whose troubles are having the
greatest impact on the rethinking of careers, especially at the nation’s
elite universities, is the one at the center of the country’s economic
downturn — finance. For years, the hefty paychecks and social status on Wall
Street proved irresistible to many of America’s brightest young people, but
the jobs, money and social respect there are much diminished today.
“In choosing careers, young people look for signals
from society, and Wall Street will no longer pull the talent that it did for
so many years,” said Richard Freeman, director of the labor studies program
at the National Bureau of Economic Research. “We have a great experiment
before us.”
What will the new map of talent flow look like?
It’s early, but based on graduate school applications this spring,
enrollment in undergraduate courses, preliminary job-placement results at
schools, and the anecdotal accounts of students and professors, a new
pattern of occupational choice seems to be emerging. Public service,
government, the sciences and even teaching look to be winners, while fewer
shiny, young minds are embarking on careers in finance and business
consulting.
For the highest-paid business fields, the outlook
is for a tempering correction instead of an all-out exodus. At Harvard, for
example, about 40 percent of undergraduates in recent years went into the
most lucrative corporate arenas like finance and consulting, based on
surveys at the school year’s end. “That certainly won’t be the case this
year,” observed Lawrence Katz, a professor and labor economist who has
studied undergraduate career choices at Harvard going back to the 1960s.
“We’re seeing students who would have been part of the Ivy League pipeline
to Wall Street in the past considering very different career paths.”
Kedamai Fisseha, a 21-year-old senior, is one of
them. An economics major, Mr. Fisseha says he always assumed he would go
into finance, and his summer internship last year was at the investment bank
Morgan Stanley. Yet after Wall Street’s meltdown, job prospects there have
withered. Instead, he is interviewing with Teach for America, a nonprofit
group that recruits college graduates to teach in hard-to-staff schools for
two-year stints. (After that, only one-third stay in the classrooms, though
two-thirds remain in education.)
Mr. Fisseha regards the turn of events as an
opportunity to broaden his horizons. “It’s been liberating, and lucky for
me,” he said. “But your situation does dictate your preferences.”
Graduate schools of government and public policy
are seeing a surge of applications. In a survey of its members released last
week, the National Association of Schools of Public Affairs and
Administration found that 82 percent reported an increase in applications
this year, and many saw the largest percentage jumps in several years, or
ever. The most-cited reason was the expectation by students that government
will be hiring.
Continued in article
Jensen Comment
In spite of continued strong career opportunities, with some of the best
opportunities for women, the above article ignores accountancy careers. I think
much of this is due to Lohr's focus on high ranked MBA programs. These MBA
Programs have not been major sources of public accountants in the past three
decades. One reason is that to take the CPA examination most states requires
more pre-requisite accounting course coverage than top MBA programs make
available in the curriculum. This makes it more difficult for graduates of top
MBA programs to sit for the CPA examination unless they were undergraduate
accounting majors. Top ranked MBA programs like Harvard, Wharton, Stanford, and
Darden generally prefer to admit students who were not undergraduate business
and/or accounting majors.
Following the conflicts of interest charges and/or the Sarbanes-Oxley
legislation, most CPA firms sold off their consulting divisions like Andersen
Consulting, Cap Gemini, PwC Consulting, and KPMG Consulting. Those divisions
were more apt to hire MBA graduates who had no intention of ever taking the CPA
examination. Also consulting firms have cut way back on their entry-level hiring
in favor of hiring persons with technical expertise and experience.
Although faculty in state-supported universities are somewhat different from
what we view as workers in the federal, state, and local bureaucracies, there
will be increased hiring opportunities for faculty careers as the government
pours upwards of a trillion dollars, over several years, into education
opportunities for lower-income students. But with declining career opportunities
as the private sector cuts back, the outlook is not particularly strong for
academic careers in schools of business and accounting. It's even bleaker for
undergraduate finance programs. The outlook is much better for science and
medical/nursing/pharmacy faculty openings.
What I find somewhat sad in Lohr's article is the prediction that government
careers are the long-term wave of the future. I've never been a fan of big
public sector relative to the private sector. It's so sad that Wall Street shot
itself in the head rather than the foot!
Bob Jensen's threads on careers are at
http://faculty.trinity.edu/rjensen/Bookbob1.htm#careers
"Financial Restoration for the United States December 2008," by
James C. VanHorne, A. P. Giannini Professor of Banking and Finance at
Stanford University, December 2008 ---
http://www.gsb.stanford.edu/news/research/financial-restoration.html/?tr=kb0812
The Antecedents to 2008 During the past 200 years,
there have been 16 credit crises in the United States, all marked by
speculative excesses in the years immediately preceding. Following the 1907
and early 1930s crises, the Congress undertook substantial reform of the
financial services industry. Again it is time for substantial
regulatory/supervisory change. Recall that beginning in the late 1970s,
there began a period of deregulation of financial services in the United
States. Much good came in lowering costs and inconvenience, but it came with
greater risk taking and less disciplined behavior. No longer did a lender
need to carry a loan on its own books, but could securitize it and capture
fat front-end fees and not have to worry if the borrower paid.
Self-regulation and market discipline, frequently quixotic, cannot stem the
type of systemic risk we have recently experienced.
The Reform Needed As the ultimate safeguard to stem
a financial panic, the government should have in place the apparatus that
will allow it to curtail speculative excesses in advance of their triggering
a financial panic. “An ounce of prevention is worth a pound of cure,” if you
will. A number of things are in order. Regulatory authorities dealing with
the financial services industry broadly defined should be consolidated.
There are too many of them, often with conflicting objectives, and
competition among them—relics of the past. More specifically, I would have
the Securities and Exchange Commission responsible only for disclosure of
information to investors on new and existing securities, together with
oversight of mutual funds. No regulation of investment banks and others, for
which it has proven to be inept. The FDIC should continue its present role,
as should the Fed under its now expanded mandate.
I would consolidate all other regulatory agencies
into a new agency with broad powers to regulate investment banks, insurance
companies, mortgage companies, hedge funds, finance companies, thrifts,
credit unions, commodity firms, brokerage firms, prime brokers, derivative
and futures markets dealers, and banks not regulated by the Fed and FDIC.
Any U.S. or foreign financial institution that operates in U.S. financial
markets would fall under the agency’s purview. For other than depository
institutions, however, I would establish size thresholds for inclusion in
regulatory oversight; say, above $10 billion in assets and/or $40 billion in
derivative positions (notional amount) for a single institution or
collective institutions under interlocking ownership. Supervisory and
regulatory oversight would embrace asset quality, leverage, and counterparty
risk, as well as overall risk with full power of the agency to curtail
overly risky activities. The governing board should be independent and
appointed by the Congress and the president for, say, 10-year terms on a
staggered basis.
As part of the change, a new department should be
established to facilitate workouts for mortgages and other loans. Presently
many loans have been securitized with legal impediments to workouts.
Efficiently managed workouts benefit both the borrower, in reducing payment
outlays, and the lender, in not having to charge off as much of the loan.
While many other worthwhile changes are possible, I will mention only three.
1) Restore the uptick rule, where short sales can be consummated only upon a
rise in security price. This is a better remedy than periodically freezing
short sales. 2) Require loan originators to retain a small portion, say 5 to
7 percent, of loans that are securitized. This creates a discipline that
otherwise does not occur. 3) Have credit-rating agencies paid by the
government from fees collected by the government from security issuers. This
move will result in more objectivity and align the incentives of the rating
agencies with investors.
Social Allocation of Capital Finally, the method by
which the capital is socially allocated is a matter of concern. Fannie Mae
and Freddie Mac were actively pressured by the Congress and the Department
of Housing and Urban Development to promote housing ownership through low/no
down payment and deferred interest types of mortgages. Seemingly there is no
cost, as long as the government’s implicit guarantee of these agencies does
not occur. When it did in 2008, the cost is huge. A more efficient method
for socially allocating capital is for the government to pay an
interest-rate and/or principal subsidy to the lender or to the borrower for
certain types of socially desirable loans. In this manner, the lender
receives the market clearing rate of interest while the borrower pays this
rate minus the subsidy. The cost of socially allocating capital is
recognized up front and the allocation of capital in society is more
efficient.
A Closing Thought While not a complete or
comprehensive set of reforms, I believe the proposals outlined above would
do much to reduce systemic risk in the financial services industry and save
taxpayers much in the process.
James VanHorne
Note: Below are listed the credit crises in the United States during the
past 200 years by year in which they (approximately) began and/or peaked.
There is no beginning/peak in the 1930s, as there were several. During the
War of 1812 there was a credit crisis of sorts. However, it was not
occasioned by speculative excesses in the years preceding but rather by the
British occupying Washington and I have chosen not to include it. The
classifications are partially subjective on my part – particularly with
respect to the exact year in which a crisis occurred.
The credit crises by year are: 1819; 1837; 1857; 1873; 1893; 1907; 1919;
1930s; 1949; 1958; 1970; 1974; 1981; 1991; 2002; 2008.
"The 'Market' Isn't So Wise After All:
This year saw the end of an illusion," by Thomas Frank, The Wall Street
Journal, December 31, 2008 ---
http://online.wsj.com/article/SB123069094735544743.html?mod=djemEditorialPage
As I read the last
tranche of disastrous news stories from this catastrophic year, I found
myself thinking back to the old days when it all seemed to work, when
everyone agreed what made an economy go and the stock market raced and the
commentators and economists and politicians of the world stood as one under
the boldly soaring banner of laissez-faire.
In particular, I
remembered that quintessential work of market triumphalism, "The Lexus and
the Olive Tree," by New York Times columnist Thomas Friedman. It was
published in the glorious year 1999, and in those days, it seemed, every
cliché was made of gold: the brokerage advertisements were pithy, the small
investors were mighty, and the deregulated way was irresistibly becoming the
global way.
In one anecdote,
Mr. Friedman described a visit to India by a team from Moody's Investor
Service, a company that carried the awesome task of determining "who is
pursuing sound economics and who is not." This was shortly after India had
tested its nuclear weapons, and the idea was that such a traditional bid for
power counted for little in this globalized age; what mattered was making
political choices of which the market approved, with organizations like
Moody's sifting out the hearts of nations before its judgment seat. In the
end, Moody's "downgraded India's economy," according to Mr. Friedman,
because it disapproved of India's politics. The Opinion Journal Widget
Download Opinion
Journal's widget and link to the most important editorials and op-eds of the
day from your blog or Web page.
And who makes sure
that Moody's and its competitors downgrade what deserves to be downgraded?
In 1999 the obvious answer would have been: the market, with its fantastic
self-regulating powers.
But something went
wrong on the road to privatopia. If everything is for sale, why shouldn't
the guardians put themselves on the block as well? Now we find that the
profit motive, unleashed to work its magic within the credit-rating
agencies, apparently exposed them to pressure from debt issuers and led them
to give high ratings to the mortgage-backed securities that eventually blew
the economy to pieces.
And so it has gone
with many other shibboleths of the free-market consensus in this tragic
year.
For example, it was
only a short while ago that simply everyone knew deregulation to be the path
to prosperity as well as the distilled essence of human freedom. Today,
though, it seems this folly permitted a 100-year flood of fraud. Consider
the Office of Thrift Supervision (OTS), the subject of a withering
examination in the Washington Post last month. As part of what the Post
called the "aggressively deregulatory stance" the OTS adopted toward the
savings and loan industry in the years of George W. Bush, it slashed staff,
rolled back enforcement, and came to regard the industry it was supposed to
oversee as its "customers." Maybe it's only a coincidence that some of the
biggest banks -- Washington Mutual and IndyMac -- ever to fail were
regulated by that agency, but I doubt it.
Or consider the
theory, once possible to proffer with a straight face, that lavishing
princely bonuses and stock options on top management was a good idea since
they drew executives' interests into happy alignment with those of the
shareholders. Instead, CEOs were only too happy to gorge themselves and turn
shareholders into bag holders. In the subprime mortgage industry, bankers
handed out iffy loans like candy at a parade because such loans meant
revenue and, hence, bonuses for executives in the here-and-now. The
consequences would be borne down the line by the suckers who bought
mortgage-backed securities. And, of course, by the shareholders.
At Washington
Mutual, the bank that became most famous for open-handed lending, incentives
lined the road to hell. According to the New York Times, realtors received
fees from the bank for bringing in clients, mortgage brokers got "handsome
commissions for selling the riskiest loans," and the CEO raked in $88
million from 2001 to 2007, before the outrageous risks of the scheme
cratered the entire enterprise.
Today we stand at
the end of a long historical stretch in which laissez-faire was glorified as
gospel and the business community got almost its entire wish list granted by
the state. To show its gratitude, the finance industry then stampeded us all
over a cliff.
To be sure, some of
the preachers of the old-time religion now admit the error of their ways.
Especially remarkable is Alan Greenspan's confession of "shocked disbelief"
on discovering how reality differed from holy writ.
But by and large
the free-market medicine men seem determined to learn nothing from this
awful year. Instead they repeat their incantations and retreat deeper into
their dogma, generating endless schemes in which government is to blame, all
sin originates with the Community Reinvestment Act, and the bailouts for
which their own flock is desperately bleating can do nothing but harm.
And they wait for
things to return to normal, without realizing that things already have.
January 5, 2008 eply from Paul Williams after I asserted this is what he's
believed his entire adult life
Bob,
Not all of my life. As a "youngster" I was a true believer. But people
mature, both physically, ethically, and intellectually. The self-correcting
market is a myth based on Smith's analogizing to what was the 17th century
view of the natural world -- notably Newton's clockwork model and
naturalists belief in self-regulating natural forces (e.g., conditions
favorable for rabbit reproduction creates favorable conditions for fox
reproduction which automatically corrects for the overpopulation of
rabbits). All of this consistent with Biblical notions of the great
clockmaker in the sky -- "neither do they sow or reap, yet your Heavenly
Father takes care of them." Contemporary free-market ideologues have merely
substituted markets for gods that guide our affairs always in a favorable
direction (ala Dr. Pangloss).
Darwin, Freud and Einstein pretty much upset that
comfortable belief about the world. Unfortunately for the economics espoused
by the accountics, it is still stuck with a 17th century model. If it can
still be found, a very instructive collection of essays that were created
for a conference at the Yale School of Forestry in 1970 is titled, "Man and
his Environment: The Ecological Limits to Optimism." One essay, in
particular, by William R. Burch, Jr. is titled "Fishes and Loaves: Some
Sociological Observations on the Environmental Crisis."
Throughout your life there are those moments when
something you read or someone says that lead to epiphanies. This essay
connecting the inherent optimism of belief in the omniscience and justness
of markets to Biblical belief in miracles was one of those moments. In spite
of all of our contention that we are convinced only by the empirical
evidence, we persist in believing in things that the empirical evidence long
ago indicated was nonsense.
Paul
Ten Times More Complex Than Enron
"The Creditors of Lehman Can Do Little but Wait," by Julia Werdigier,
The New York Times, November 14, 2008 ---
http://www.nytimes.com/2008/11/15/business/worldbusiness/15lehman.html?_r=2&oref=slogin&oref=slogin
Creditors of Lehman Brothers’ international
business, arriving at London’s gigantic O2 concert hall on Friday, had no
illusions about getting their money back any time soon.
In a three-hour meeting in a hall usually reserved
for rock bands like the Who, Lehman’s administrators explained to about
1,000 creditors that dismantling the bank’s European business would take
“many years.”
This is at least “ten times more complex than
Enron,” the administrators from PricewaterhouseCoopers said, adding that
they had no idea what the company’s total liabilities may be.
“It’s frustrating that after nine weeks, we still
haven’t come to any clarity,” especially on how much counterparties hold
with Lehman’s European business, said Tony Lomas, the PricewaterhouseCoopers
partner leading the administration. “The prospect is that the creditors will
lose money.”
PricewaterhouseCoopers identified 11,500 creditors
and counterparties of Lehman’s European business, ranging from the coffee
machine maker Nespresso and taxi companies in Milan and Zurich to Bulgari
hotels and resorts and the financial news company Bloomberg.
From Lehman’s glass and steel offices in London’s
Canary Wharf, the administrators are working through the bank’s $1 trillion
of assets and said they cannot pay creditors until they have a “reasonable
grip” on liabilities.
Continued in article
From Jim Mahar's Blog on September 23, 2008
Do you remember the old REM song "It's
the end of the world as we know it"? Well they
could have been singing about this past week in finance (except the feeling
fine part maybe...). The latest manifestation is the news of yesterday that
Morgan Stanley and Goldman Sachs begun the process to convert to a bank
holding company. The move will bring them under the protection, but also the
regulation, of the Fed.
Some of the coverage of this monumental switch:
Big payoffs off table for Morgan Stanley, Goldman:
"The move to convert to a commercial bank
structure will help the two companies avoid the fates of Bear Stearns,
Lehman Brothers and Merrill Lynch by giving them broader access to
borrow federal money and the ability to build a stable base of deposits.
But it also likely means an end to the sky high profits that were topped
by few other companies. The strict rules set by the Federal Reserve will
limit opportunities for big payoffs from bets on the price of oil and
other investments usually funded with borrowed money.
'The Fed is a much more intrusive regulator...experts expect smaller
companies _ including private equity firms and hedge funds _ to take
their place.
But even in the area of private equity this switch to
a bank holding company may have large implications. For instance, investment
bankers have been large players in Private Equity a practice that will
likely end.
From the
WSJ:
"Goldman has been a big investor in its own
private-equity funds, and Morgan Stanley intended to be. Close to half
of the capital in Goldman’s most recent, $20 billion buyout fund, for
instance, came from the parent company and its employees. Morgan Stanley
is expected to contribute about one-third of the capital to its new
fund. But changing into bank holding companies may limit how much
capital these banks are able to commit to their PE funds...."
From the
NY Times:
"The move alters one of the models of modern Wall
Street, the independent investment bank, soon after the federal
government unveiled the biggest market intervention since the New Deal.
It heralds new regulations and supervision of previously lightly
regulated investment banks, as well as an end to the outsize paychecks
that helped shape the image of the chest-thumping Wall Street banker."
The new classification will also affect the amount
of leverage the firms can use.
Again from the
NY Times:
"The regulation by the Federal Reserve also
brings a host of accounting rule changes that should benefit the two
banks in the current environment. [ugh, I cringe when accounting rule
changes are ever given as a reason for anything]
In return , they will submit themselves to
greater regulation, including limits on the amount of debt they can take
on. When it collapsed, Lehman had about a 30:1 debt-to-equity ratio,
meaning it had borrowed $30 for every dollar in capital it held. Morgan
Stanley currently has a debt-to-equity ratio of 30:1, while Goldman
Sachs has one of about 22:1.
Bank of America, on the other hand, currently
has about an 11:1 leverage ratio, while JPMorgan has about 13:1 and
Citigroup about 15:1."
Appendix E
Your Money at Work, Fixing Others’ Mistakes
That some bankers have ended up in
prison is not a matter of scandal, but what is outrageous is the fact that all
the others are free.
Honoré de Balzac
Bankers bet with their bank's capital, not their own. If the bet goes right,
they get a huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by
Avital Louria Hahn, "Missing: How Poor Risk-Management Techniques Contributed
to the Subprime Mess," CFO Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to
bail out these crooks with taxpayer funds makes it all the worse.
Wall Street
Remains Congress to the Core
The boom in corporate mergers
is creating concern that illicit trading ahead of deal announcements is becoming
a systemic problem. It is against the law to trade on inside information about
an imminent merger, of course. But an analysis of the nation’s biggest mergers
over the last 12 months indicates that the securities of 41 percent of the
companies receiving buyout bids exhibited abnormal and suspicious trading in the
days and weeks before those deals became public. For those who bought shares
during these periods of unusual trading, quick gains of as much as 40 percent
were possible.
Gretchen Morgenson, "Whispers of Mergers Set Off Suspicious Trading," The New
York Times, August 27, 2006 ---
Click Here
"Why Are Some Sectors (Ahem, Finance) So Scandal-Plagued?" by Ben W.
Heineman, Jr., Harvard Business Review Blog, January 10, 2013 ---
Click Here
http://blogs.hbr.org/cs/2013/01/scandals_plague_sectors_not_ju.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
The trouble with crony capitalism isn't capitalism. It's the cronies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#CronyCapitalism
Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit
rating agencies) ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of
Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Banks, Bailouts & Irish Literature ---
http://ocw.nd.edu/irish-studies/banks-bailouts-and-irish-literature
The Mystery is Why Bank of America Does not Appeal It's New $17 Billion Fine
All the Way to the Supreme Court
Why isn't former Treasury Secretary Hank Paulson being punished?
These Countrywide Financial mortgage lending crimes were committed before
Paulson foreced BofA to buy out Countrywide Financial.
After the subprime collapse then BofA CEO, Ken Lewis, most certainly did not
want to use BofA money to stop the free fall of Merrill Lynch and Countrywide
Financial. However, U.S. Treasury Secretary Hank Paulson resorted to personal
blackmail according to Ken Lewis.
"Bank Chief Tells of U.S. Pressure to Buy Merrill Lynch," by Louise Story and Jo
Becker, The New York Times, June 11. 2009 ---
http://www.nytimes.com/2009/06/12/business/12bank.html
"No Good Rescue Goes Unpunished: Bank of America keeps paying for doing
the feds two bailout favors," The Wall Street Journal, August 1, 2014 ---
http://online.wsj.com/articles/no-good-rescue-goes-unpunished-1407454672?tesla=y&mod=djemMER_h&mg=reno64-wsj
If you thought the last financial crisis was
expensive, wait until taxpayers see how much it costs to rescue banks when
they have to do it all on their own. The U.S. Department of Justice aims to
extract as much as $17 billion from Bank of America BAC +0.26% for the crime
of taking problems off Washington's hands in 2008.
Regulators were high-fiving when the bank bought
Countrywide Financial and then Merrill Lynch during the crisis. But now
Washington seems intent on making bank shareholders pay again for the
problems that caused these firms to need a rescue in the first place. Come
the next crisis, CEOs will know to run in the other direction when the
government offers a deal on a failing firm. And when private capital flees,
guess whose money will be used to prop up the banking system.
In some earlier post-crisis settlements, the feds
at least pretended that the cases were about making mortgage investors or
borrowers whole. But the pending Bank of America settlement appears to
consist largely of a penalty for alleged mortgage sins committed by the two
failing companies the feds wanted the bank to buy, and in one case pressured
it to buy.
The new game at Justice seems to be to come up with
a big dollar figure to be paid by bank shareholders—big enough to persuade
progressives that the department is being tough on Wall Street—and then fill
in the blanks on the alleged legal violations. So we can't say for sure what
the final deal will claim the bank did. But BofA must be taking the fall for
Countrywide and Merrill Lynch because the bank itself originated only 4% of
the bad mortgage paper for which it is now responsible.
The bank has already shovelled out roughly $60
billion in mortgage settlements to various public and private parties, far
more than any other bank. Now the feds are coming back to further punish
Bank of America for its foolish acquisitions. But at the time the bank made
these deals, the regulators were celebrating.
In 2008 Federal Reserve officials were concerned
about their exposure to Countrywide. As BofA prepared for an early July
closing on its purchase of Countrywide, New York Fed banking supervisor
Arthur Angulo told the Federal Open Market Committee that Countrywide's use
of one Fed lending facility "should come to a close next week, knock on
wood."
In his recent memoir, former New York Fed President
and Treasury Secretary Timothy Geithner, who thought Countrywide was a
systemic threat, wrote that Bank of America's investment "eased fears of a
collapse."
When the bank agreed to buy Merrill a few months
later, regulators were once again gratified. St. Louis Fed President James
Bullard said at a September 16 meeting of the Federal Open Market Committee
that the Merrill deal had removed one of the "large uncertainties looming
over the economy." Regulators were so pleased that when BofA CEO Ken Lewis
later expressed a desire to back out of the deal, then-Treasury Secretary
Hank Paulson threatened to fire him and gave the bank another $20 billion in
TARP rescue money to absorb Merrill.
Bank of America finished repaying its $45 billion
in TARP loans in 2009. But we wonder if its shareholders will ever stop
paying Washington for the deals Washington wanted—and even demanded—during
the crisis.
"FHA to draw $1.7b from Treasury to Cover Losses," SmartPros, September 27,
2013 ---
http://accounting.smartpros.com/x75403.xml
Bob Jensen's threads on the bottomless bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
"Understanding the Great Recession," by Lawrence J. Christiano, Martin
Eichenbaum, and Mathias Trabandt, SSRN, April 2, 2014 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2474797
Abstract:
We argue that the vast bulk of movements in
aggregate real economic activity during the Great Recession were due to
financial frictions interacting with the zero lower bound. We reach this
conclusion looking through the lens of a New Keynesian model in which
firms face moderate degrees of price rigidities and no nominal
rigidities in the wage setting process. Our model does a good job of
accounting for the joint
behavior of labor and goods markets, as well as inflation, during the
Great Recession. According to the model the observed fall in total
factor productivity and the rise in the cost of working capital played
critical roles in accounting
for the small size of the drop in inflation that occurred during the
Great Recession.
From the CFO Journal's Morning Ledger on March 12, 2014
Moves to revamp the U.S. $10 trillion mortgage market are finally getting
underway, after senators and the White House agreed on a framework to
dismantle the giant lenders
Fannie Mae and
Freddie Mac, nearly
six years after the government took control and rescued them from financial
oblivion.
The
plan, by Senate Banking Committee leaders Tim Johnson (D., S.D.) and Mike
Crapo (R., Idaho), would see Fannie and Freddie replaced by a system of
federally insured mortgage securities in which private insurers would be
required to take initial losses before any government guarantee would be
triggered.
As
the
Wall Street Journal’s Nick Timiraos reports,
the proposal comes just as the companies start to
generate huge profits for the Treasury. But the deal will leave a number of
investors, who were counting on Fannie and Freddie being restructured,
somewhat confused about their next move. Fannie shares consequently fell 31%
to $4.03 and Freddie stock slid 27% to $4.04. But some of the firms’
preferred stock held by big investors saw only slight dips, remaining close
to their highest levels since the firms were taken over in 2008. The
agreement, which faces a few hurdles before approval, represents the most
concrete step so far to resolve the last major piece of unfinished business
from the 2008 financial collapse.
"Here's A Quick Guide To The Startling New Scandal Involving Goldman And The
New York Fed," by Elena Holodny, Business Insider, September 26, 2014 ---
http://www.businessinsider.com/propublica-fed-goldman-sachs-recordings-2014-9
. . .
The report is driven by secret recordings that
suggest that the NY Fed regulators were too soft on Goldman and therefore
possibly other banks as well.
The recordings come from former New York Fed bank
examiner Carmen Segarra, who was fired after just seven months on the job.
The article is nearly 6,000 words long, and the
podcast runs for over an hour.
Continued in article
"Why the Fed Is So Wimpy," by Justin Fox, Harvard Business Review Blog,
September 26, 2014 ---
http://blogs.hbr.org/2014/09/why-the-fed-is-so-wimpy/?utm_source=Socialflow&utm_medium=Tweet&utm_campaign=Socialflow
Regulatory capture — when regulators come to act
mainly in the interest of the industries they regulate — is a phenomenon
that economists, political scientists, and legal scholars have been
writing about for decades.
Bank regulators in particular have been
depicted as
captives for years,
and have even taken to
describing themselves as such.
Actually witnessing capture in the wild is
different, though, and
the new This American Life episode with
secret recordings of bank examiners at the Federal Reserve Bank of New York
going about their jobs is going to focus a lot more attention on the
phenomenon. It’s really well done, and you should
listen to it, read
the transcript, and/or
read the story by ProPublica reporter Jake
Bernstein.
Still, there is some context that’s inevitably
missing, and as a former banking-regulation reporter for the
American Banker, I feel called to fill some
of it in. Much of it has to do with the structure of bank regulation in the
U.S., which actually seems designed to encourage capture. But to start,
there are a couple of revelations about Goldman Sachs in the story that are
treated as smoking guns. One seems to have fired a blank, while the other
may be even more explosive than it’s made out to be.
In the first, Carmen Segarra, the former Fed bank
examiner who made the tapes, tells of a Goldman Sachs executive saying in a
meeting that “once clients were wealthy enough, certain consumer laws didn’t
apply to them.” Far from being a shocking admission, this is actually a
pretty fair summary of American securities law. According to the Securities
and Exchange Commission’s “accredited
investor” guidelines, an individual with a net
worth of more than $1 million or an income of more than $200,000 is exempt
from many of the investor-protection rules that apply to people with less
money. That’s why rich people can invest in hedge funds while, for the most
part, regular folks can’t. Maybe there were some incriminating details
behind the Goldman executive’s statement that alarmed Segarra and were left
out of the story, but on the face of it there’s nothing to see here.
The other smoking gun is that Segarra pushed for a
tough Fed line on Goldman’s lack of a substantive conflict of interest
policy, and was rebuffed by her boss. This is a big deal, and for
much more than the legal/compliance reasons discussed in the piece. That’s
because, for the past two decades or so, not having a substantive conflict
of interest policy has been Goldman’s business model. Representing both
sides in mergers, betting alongside and against clients, and exploiting its
informational edge wherever possible
is simply how the firm makes its money. Forcing it
to sharply reduce these conflicts would be potentially devastating.
Maybe, as a matter of policy, the United States
government should ban such behavior. But asking bank examiners at
the New York Fed to take an action on their own that might torpedo a leading
bank’s profits is an awfully tall order. The regulators at the Fed and their
counterparts at the Office of the Comptroller of the Currency and the
Federal Deposit Insurance Corporation correctly see their main job as
ensuring the safety and soundness of the banking system. Over the decades,
consumer protections and other rules have been added to their purview, but
safety and soundness have remained paramount. Profitable banks are generally
safer and sounder than unprofitable ones. So bank regulators are
understandably wary of doing anything that might cut into profits.
The point here is that if bank regulators are
captives who identify with the interests of the banks they regulate, it is
partly by design. This is especially true of the Federal Reserve System,
which was created by Congress in 1913 more as a friend to and creature of
the banks than as a watchdog. Two-thirds of
the board that governs the New York Fed is chosen
by local bankers. And while
amendments to the Federal Reserve Act in 1933
shifted the balance of power in the Federal Reserve System from the regional
Federal Reserve Banks (and the New York Fed in particular) to the political
appointees on the Board of Governors in Washington, bank regulation
continues to reside at the regional banks. Which means that the bank
regulators’ bosses report to a board chosen by … the banks.
Then there’s the fact that Goldman Sachs is a
relative newcomer to Federal Reserve supervision — it and rival Morgan
Stanley only agreed
to become bank holding companies, giving them
access to New York Fed loans, at the height of the financial crisis in 2008.
While it’s a little hard to imagine Goldman choosing now to rejoin the ranks
of mere securities firms, and even harder to see how it could leap to a
different banking regulator, it is possible that some Fed examiners
are afraid of scaring it away.
All this is meant not to excuse the extreme
timidity apparent in the Fed tapes, but to explain why it’s been so hard for
the New York Fed to adopt the more aggressive, questioning approach urged by
Columbia Business School Professor David Beim in a
formerly confidential internal Fed report that
This American Life and ProPublica give a lot of play to. Bank
regulation springs from much different roots than, say, environmental
regulation.
So what is to be done? A lot of the
classic regulatory capture literature tends toward
the conclusion that we should just give up — shut down the regulators and
allow competitive forces to work their magic. That means letting businesses
fail. But with banks more than other businesses, failures tend to be
contagious. It was to counteract this risk of systemic failure that Congress
created the Fed and other bank regulators in the first place, and even if
you think that was a big mistake, they’re really not going away.
Continued in article
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
PwC's Appeal to Upgrade the Shameful Valuation Profession Smitten With
Non-independence and Unreliability
Jensen Comment
Tom Selling repeatedly assumes there is a valuation profession of men and women
in white robes and gold halos who can be called upon to reliably and
independently valuate such things as troubled loan investments having no deep
markets. Bob Jensen argues that the valuation profession is one of the
least-independent and least-reliable professions in the world, especially in the
USA as evidenced in part by the shameful valuations of mortgage collateral on
tens of millions of properties, thereby enabling subprime mortgages that never
should have been granted in the first place. Furthermore credit rating agencies
that value securities participated wildly in overvaluing poisoned CDO bonds that
brought down some of the big investment banks of Wall Street like Bear Sterns,
Merrill Lynch, and Lehman Bros.
In the article below, PwC calls the valuation profession shameful and calls
for major upgrades that, while falling short of issuing white robes with gold
halos, would go a long way toward improving a rotten profession.
"PwC Calls for New Approach to Valuations," by Tammy Whitehouse,
Compliance Week, November 26, 2013 ---
http://www.complianceweek.com/pwc-calls-for-new-approach-to-valuations/article/322671/
The largely unregulated valuation profession could
use a shake-up, in the view of some who rely on valuations to achieve
regulatory compliance.
PwC recently published two white papers calling on
the valuation profession to up their game in terms of unifying themselves
under a single professional framework and improving their standards. The
financial reporting world needs greater quality and consistency, the Big 4
firms says, as financial reporting grows increasingly reliant on valuations
to help prepare and audit financial statements steeped in fair value
measurements. One paper focuses on the need for the valuation profession to
unify itself under a single professional infrastructure, while the other
addresses the need for better valuation standards.
The message is consistent with one delivered
earlier by Paul Beswick, now chief accountant at the Securities and Exchange
Commission. “The fragmented nature of the profession creates an environment
where expectation gaps can exist between valuators, management, and
auditors, as well as standard setters and regulators,” he said at a 2011
accounting conference. The SEC and the Public Company Accounting Oversight
Board both have called on preparers and auditors to pay closer attention to
the valuations they are relying on and not simply accept them at face value.
“Historically, the valuation profession hasn't been
front and center in capital markets,” says John Glynn, U.S. valuation
services leader for PwC. “The accounting model didn't have as many pieces
measured at fair value as we have today. Some of the questions about the
professional infrastructure that didn't matter previously have become more
apparent.”
The valuation profession is governed by a number of
different professional organizations, PwC says, each with different
credentialing and membership requirements and none of them specific to the
needs of capital markets. “To maintain its professional standing in an
increasingly rigorous environment and promote greater confidence in its
work, the valuation profession needs to address questions about the quality,
consistency, and reliability of its valuations, particularly those performed
for financial reporting purposes,” PwC writes. “A key element to
successfully addressing such questions is having a leading global standard
setter that issues technical valuation standards governing the performance
of valuations for financial reporting purposes.”
The answer is not necessarily a new regulatory
channel, says Glynn. “We need to give the valuation profession a way to
build a self-regulatory mechanism,” he says. “One or or more of the
professional organizations need to agree to build something that is focused
on building a high-quality infrastructure to support the valuation
professionals that are working in public capital markets, particularly
around financial reporting.” That should include education requirements,
accreditations, certifications, as well as professional standards and
performance standards developed under a robust system of due process, he
says. The International Valuations Standards Council is showing potential to
become a leader in driving the profession to a unified, global valuation
approach, Glynn says.
PBS Frontline: Why don't some of biggest fraudsters in history go to
prison?
"The Untouchables," Frontline, January 22, 2013 ---
http://www.pbs.org/wgbh/pages/frontline/untouchables/?elq=923e1cf54bd4465092ea4b303aac1291&elqCampaignId=511
Thank you Dennis Huber for the heads up.
Bob Jensen's threads on Why White Collar Crime Pays Even If You Know You're
Going to Get Caught ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
Bob Jensen's threads on Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Jensen Comment
I highly respect this video, although it tends to not blame the major source of
the fraud on Main Street --- that blame that falls on government for pressuring
Fannie Mae and Freddy Mack to buy up millions of mortgages generated on Main
Street without having any recourse to the banks and mortgages companies who
knowingly granted mortgages without to borrowers who could never repay those
loans. This was compounded by granting loas way in excess of collateral value
such as when Fannie Mae had to buy a fraudulent loan of $103,000 on a shack that
Marvene (a woman on welfare and food stamps) purchased for $3,000.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Barney's Rubble ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
"We’re All Still Hostages to the Big Banks," by Anat R. Admati, The
New York Times, August 25, 2013 ---
Click Here
http://www.nytimes.com/2013/08/26/opinion/were-all-still-hostages-to-the-big-banks.html?utm_source=Stanford+Business+Re%3AThink&utm_campaign=6076b3a7fe-Re_Think_Twenty_Two9_9_2013&utm_medium=email&utm_term=0_0b5214e34b-6076b3a7fe-70265733&ct=t%28Re_Think_Twenty_Two9_9_2013%29&_r=0
NEARLY five years after the bankruptcy of Lehman
Brothers touched off a global financial crisis, we are no safer. Huge,
complex and opaque banks continue to take enormous risks that endanger the
economy. From Washington to Berlin, banking lobbyists have blocked essential
reforms at every turn. Their efforts at obfuscation and influence-buying are
no surprise. What’s shameful is how easily our leaders have caved in, and
how quickly the lessons of the crisis have been forgotten.
We will never have a safe and healthy global
financial system until banks are forced to rely much more on money from
their owners and shareholders to finance their loans and investments. Forget
all the jargon, and just focus on this simple rule.
Mindful, perhaps, of the coming five-year
anniversary, regulators have recently taken some actions along these lines.
In June, a committee of global banking regulators based in Basel,
Switzerland, proposed changes to how banks calculate their leverage ratios,
a measure of how much borrowed money they can use to conduct their business.
Last month, federal regulators proposed going
somewhat beyond the internationally agreed minimum known as Basel III, which
is being phased in. Last Monday, President Obama scolded regulators for
dragging their feet on implementing Dodd-Frank, the gargantuan 2010 law that
was supposed to prevent another crisis but in fact punted on most of the
tough decisions.
Don’t let the flurry of activity confuse you. The
regulations being proposed offer little to celebrate.
From Wall Street to the City of London comes the
same wailing: requiring banks to rely less on borrowing will hurt their
ability to lend to companies and individuals. These bankers falsely imply
that capital (unborrowed money) is idle cash set aside in a vault. In fact,
they want to keep placing new bets at the poker table — while putting
taxpayers at risk.
When we deposit money in a bank, we are making a
loan. JPMorgan Chase, America’s largest bank, had $2.4 trillion in assets as
of June 30, and debts of $2.2 trillion: $1.2 trillion in deposits and $1
trillion in other debt (owed to money market funds, other banks, bondholders
and the like). It was notable for surviving the crisis, but no bank that is
so heavily indebted can be considered truly safe.
The six largest American banks — the others are
Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley —
collectively owe about $8.7 trillion. Only a fraction of this is used to
make loans. JPMorgan Chase used some excess deposits to trade complex
derivatives in London — losing more than $6 billion last year in a
notoriously bad bet.
Risk, taken properly, is essential for innovation
and growth. But outside of banking, healthy corporations rarely carry debts
totaling more than 70 percent of their assets. Many thriving corporations
borrow very little.
Banks, by contrast, routinely have liabilities in
excess of 90 percent of their assets. JPMorgan Chase’s $2.2 trillion in debt
represented some 91 percent of its $2.4 trillion in assets. (Under
accounting conventions used in Europe, the figure would be around 94
percent.)
Basel III would permit banks to borrow up to 97
percent of their assets. The proposed regulations in the United States —
which Wall Street is fighting — would still allow even the largest bank
holding companies to borrow up to 95 percent (though how to measure bank
assets is often a matter of debate).
If equity (the bank’s own money) is only 5 percent
of assets, even a tiny loss of 2 percent of its assets could prompt, in
essence, a run on the bank. Creditors may refuse to renew their loans,
causing the bank to stop lending or to sell assets in a hurry. If too many
banks are distressed at once, a systemic crisis results.
Prudent banks would not lend to borrowers like
themselves unless the risks were borne by someone else. But insured
depositors, and creditors who expect to be paid by authorities if not by the
bank, agree to lend to banks at attractive terms, allowing them to enjoy the
upside of risks while others — you, the taxpayer — share the downside.
Implicit guarantees of government support
perversely encouraged banks to borrow, take risk and become “too big to
fail.” Recent scandals — JPMorgan’s $6 billion London trading loss, an HSBC
money laundering scandal that resulted in a $1.9 billion settlement, and
inappropriate sales of credit-card protection insurance that resulted, on
Thursday, in a $2 billion settlement by British banks — suggest that the
largest banks are also too big to manage, control and regulate.
NOTHING suggests that banks couldn’t do what they
do if they financed, for example, 30 percent of their assets with equity (unborrowed
funds) — a level considered perfectly normal, or even low, for healthy
corporations. Yet this simple idea is considered radical, even heretical, in
the hermetic bubble of banking.
Bankers and regulators want us to believe that the
banks’ high levels of borrowing are acceptable because banks are good at
managing their risks and regulators know how to measure them. The failures
of both were manifest in 2008, and yet regulators have ignored the lessons.
If banks could absorb much more of their losses,
regulators would need to worry less about risk measurements, because banks
would have better incentives to manage their risks and make appropriate
investment decisions. That’s why raising equity requirements substantially
is the single best step for making banking safer and healthier.
The transition to a better system could be managed
quickly. Companies commonly rely on their profits to grow and invest,
without needing to borrow. Banks should do the same.
Banks can also sell more shares to become stronger.
If a bank cannot persuade investors to buy its shares at any price because
its assets are too opaque, unsteady or overvalued, it fails a basic “stress
test,” suggesting it may be too weak without subsidies.
Ben S. Bernanke, chairman of the Federal Reserve,
has acknowledged that the “too big to fail” problem has not been solved, but
the Fed counterproductively allows most large banks to make payouts to their
shareholders, repeating some of the Fed’s most obvious mistakes in the
run-up to the crisis. Its stress tests fail to consider the collateral
damage of banks’ distress. They are a charade.
Dodd-Frank was supposed to spell the end to all
bailouts. It gave the Federal Deposit Insurance Corporation “resolution
authority” to seize and “wind down” banks, a kind of orderly liquidation —
no more panics. Don’t count on it. The F.D.I.C. does not have authority in
the scores of nations where global banks operate, and even the mere
possibility that banks would go into this untested “resolution authority”
would be disruptive to the markets.
The state of financial reform is grim in most other
nations.
Continued in article
August 2018 Update
Wells Fargo & Co. agreed to pay $2.09 billion to settle with the U.S. Justice
Department over the sale of toxic mortgage-backed securities in the lead-up to
the financial crisis.---
https://www.wsj.com/articles/wells-fargo-agrees-to-2-09-billion-settlement-for-crisis-era-mortgage-loans-1533147302?mod=searchresults&page=1&pos=1&mod=djemCFO_h
This is on top of all the subsequent fines paid by Wells Fargo & Co. for
unrelated subsequent crimes. What a lousy company.
Bob Jensen's threads on the "Financial Crisis" and its bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank
Partnoy, New York Review of Books, November 10, 2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
More than three years have passed since the
old-line investment bank Lehman Brothers stunned the financial markets by
filing for bankruptcy. Several federal government programs have since tried
to rescue the financial system: the $700 billion Troubled Asset Relief
Program, the Federal Reserve’s aggressive expansion of credit, and President
Obama’s additional $800 billion stimulus in 2009. But it is now apparent
that these programs were not sufficient to create the conditions for a full
economic recovery. Today, the unemployment rate remains above 9 percent, and
the annual rate of economic growth has slipped to roughly 1 percent during
the last six months. New crises afflict world markets while the American
economy may again slide into recession after only a tepid recovery from the
worst recession since the Great Depression.
n our article in the last issue,1 we showed that,
contrary to the claims of some analysts, the federally regulated mortgage
agencies, Fannie Mae and Freddie Mac, were not central causes of the crisis.
Rather, private financial firms on Wall Street and around the country
unambiguously and overwhelmingly created the conditions that led to
catastrophe. The risk of losses from the loans and mortgages these firms
routinely bought and sold, particularly the subprime mortgages sold to
low-income borrowers with poor credit, was significantly greater than
regulators realized and was often hidden from investors. Wall Street bankers
made personal fortunes all the while, in substantial part based on profits
from selling the same subprime mortgages in repackaged securities to
investors throughout the world.
Yet thus far, federal agencies have launched few
serious lawsuits against the major financial firms that participated in the
collapse, and not a single criminal charge has been filed against anyone at
a major bank. The federal government has been far more active in rescuing
bankers than prosecuting them.
In September 2011, the Securities and Exchange
Commission asserted that overall it had charged seventy-three persons and
entities with misconduct that led to or arose from the financial crisis,
including misleading investors and concealing risks. But even the SEC’s
highest- profile cases have let the defendants off lightly, and did not lead
to criminal prosecutions. In 2010, Angelo Mozilo, the head of Countrywide
Financial, the nation’s largest subprime mortgage underwriter, settled SEC
charges that he misled mortgage buyers by paying a $22.5 million penalty and
giving up $45 million of his gains. But Mozilo had made $129 million the
year before the crisis began, and nearly another $300 million in the years
before that. He did not have to admit to any guilt.
The biggest SEC settlement thus far, alleging that
Goldman Sachs misled investors about a complex mortgage product—telling
investors to buy what had been conceived by some as a losing proposition—was
for $550 million, a record of which the SEC boasted. But Goldman Sachs
earned nearly $8.5 billion in 2010, the year of the settlement. No
high-level executives at Goldman were sued or fined, and only one junior
banker at Goldman was charged with fraud, in a civil case. A similar suit
against JPMorgan resulted in a $153.6 million fine, but no criminal charges.
Although both the SEC and the Financial Crisis
Inquiry Commission, which investigated the financial crisis, have referred
their own investigations to the Department of Justice, federal prosecutors
have yet to bring a single case based on the private decisions that were at
the core of the financial crisis. In fact, the Justice Department recently
dropped the one broad criminal investigation it was undertaking against the
executives who ran Washington Mutual, one of the nation’s largest and most
aggressive mortgage originators. After hundreds of interviews, the US
attorney concluded that the evidence “does not meet the exacting standards
for criminal charges.” These standards require that evidence of guilt is
“beyond a reasonable doubt.”
This August, at last, a federal regulator launched
sweeping lawsuits alleging fraud by major participants in the mortgage
crisis. The Federal Housing Finance Agency sued seventeen institutions,
including major Wall Street and European banks, over nearly $200 billion of
allegedly deceitful sales of mortgage securities to Fannie Mae and Freddie
Mac, which it oversees. The banks will argue that Fannie and Freddie were
sophisticated investors who could hardly be fooled, and it is unclear at
this early stage how successful these suits will be.
Meanwhile, several state attorneys general are
demanding a settlement for abuses by the businesses that administer
mortgages and collect and distribute mortgage payments. Negotiations are
under way for what may turn out to be moderate settlements, which would
enable the defendants to avoid admitting guilt. But others, particularly
Eric Schneiderman, the New York State attorney general, are more
aggressively pursuing cases against Wall Street, including Goldman Sachs and
Morgan Stanley, and they may yet bring criminal charges.
Successful prosecutions of individuals as well as
their firms would surely have a deterrent effect on Wall Street’s deceptive
activities; they often carry jail terms as well as financial penalties.
Perhaps as important, the failure to bring strong criminal cases also makes
it difficult for most Americans to understand how these crises occurred. Are
they simply to conclude that Wall Street made well- meaning if very big
errors of judgment, as bankers claim, that were rarely if ever illegal or
even knowingly deceptive?
What is stopping prosecution? Apparently not public
opinion. A Pew Research Opinion survey back in 2010 found that three
quarters of Americans said that government policies helped banks and
financial institutions while two thirds said the middle class and poor
received little help. In mid-2011, half of those surveyed by Pew said that
Wall Street hurts the economy more than it helps it.
Many argue that the reluctance of prosecutors
derives from the power and importance of bankers, who remain significant
political contributors and have built substantial lobbying operations. Only
5 percent of congressional bills designed to tighten financial regulations
between 2000 and 2006 passed, while 16 percent of those that loosened such
regulations were approved, according to a study by the International
Monetary Fund.2 The IMF economists found that a major reason was lobbying
efforts. In 2009 and early 2010, financial firms spent $1.3 billion to lobby
Congress during the passage of the Dodd-Frank Act. The financial
reregulation legislation was weakened in such areas as derivatives trading
and shareholder rights, and is being further watered down.
Others claim federal officials fear that punishing
the banks too much will undermine the fragile economic recovery. As one
former Fannie official, now a private financial consultant, recently told
The New York Times, “I am afraid that we risk pushing these guys off of a
cliff and we’re going to have to bail out the banks again.”
The responsibility for reluctance, however, also
lies with the prosecutors and the law itself. A central problem is that
proving financial fraud is much more difficult than proving most other
crimes, and prosecutors are often unwilling to try it. Congress could fix
this by amending federal fraud statutes to require, for example, that
prosecutors merely prove that bankers should have known rather than actually
did know they were deceiving their clients.
But even if Congress does not, it is not too late
for bold federal prosecutors to try to bring a few successful cases. A
handful of wins could create new precedents and common law that would set a
higher and clearer standard for Wall Street, encourage more ethical
practices, deter fraud—and arguably prevent future crises.
Continued in article
August 2018 Update
Wells Fargo & Co. agreed to pay $2.09 billion to settle with the U.S. Justice
Department over the sale of toxic mortgage-backed securities in the lead-up to
the financial crisis.---
https://www.wsj.com/articles/wells-fargo-agrees-to-2-09-billion-settlement-for-crisis-era-mortgage-loans-1533147302?mod=searchresults&page=1&pos=1&mod=djemCFO_h
This is on top of all the subsequent fines paid by Wells Fargo & Co. for
unrelated subsequent crimes. What a lousy company.
Bob Jensen's threads on how the banking system is rotten to the core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"Into the Bailout Buzz Saw," by Gretchen Morgenson, The New York
Times, July 21, 2012 ---
http://www.nytimes.com/2012/07/22/business/neil-barofskys-journey-into-a-bailout-buzz-saw-fair-game.html?_r=1&partner=rss&emc=rss
. . .
A few months after the modification plan was
announced, his office began a preliminary audit of its rollout. “We soon
verified what we had suspected,” Mr. Barofsky writes. “Treasury had failed
to ensure that the servicers had the necessary infrastructure to support a
massive mortgage modification program.” It barely got off the ground, and
few homeowners have received the help they hoped for.
This was just one of many examples from Mr.
Barofsky’s 16-month tenure, during which, he says, Washington abandoned Main
Street while rescuing Wall Street. “There has to be wide-scale
acknowledgment that regulatory capture exists, dominates our system and
needs to be eradicated,” Mr. Barofsky said in the interview. “It was my job
to bring as much transparency to taxpayers so they knew what was going on.
Writing the book, I tried to bring the same level of transparency so people
understand how captured their government has become to the financial
interests.”
I asked Mr. Barofsky, now a senior fellow at the
N.Y.U. School of Law, what could be done to get regulators to man up, as it
were.
“We need to re-educate our regulators that it’s
O.K. to be adversarial, that it’s not going to hurt your career advancement
to be more skeptical and more challenging,” he said. “It’s implicit in so
much of the regulatory structure that if you don’t make too many waves there
will be a job for you elsewhere. So we have to limit those job opportunities
and develop a more professional path for regulators as a career. That way,
they won’t always have that siren call of Wall Street.”
Mr. Barofsky’s assessment of his former regulatory
brethren is crucial for taxpayers to understand, because Congress’s
financial reform act — the Dodd-Frank legislation — left so much of the
heavy lifting to the weak-kneed.
“So much of what’s wrong with Dodd-Frank is it
trusts the regulators to be completely immune to the corrupting influences
of the banks,” he said in the interview. “That’s so unrealistic. Congress
has to take a meat cleaver to these banks and not trust regulators to do the
job with a scalpel.”
Finally, Mr. Barofsky joins the ranks of those who
believe that another crisis is likely because of the failed response to this
one. “Incentives are baked into the system to take advantage of it for
short-term profit,” he said. “The incentives are to cheat, and cheating is
profitable because there are no consequences.”
Despite all of this, Mr. Barofsky ends on something
of a positive note. Meaningful changes to our broken system may finally come
about, he writes, if enough people get angry. His conclusion is this: “Only
with this appropriate and justified rage can we sow the seeds for the types
of reform that will one day break our system free from the corrupting grasp
of the megabanks.”
That’s not much of a silver lining. But I guess
it’s better than none.
Bob Jensen's threads on the Bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Investment Banking, Banking, Brokerage, Banking, and Security Analysis
Scandals
(Investors are still losing the war in spite of all the promises made.)
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Alan Blinder ---
http://en.wikipedia.org/wiki/Alan_Blinder
Disclaimer
I've never been a fan of the progressive scholarship of Alan Blinder. He's been
a promoter of low (virtually zero) interest rates for megabanks that I think are
turning into a disaster in this economic recovery. Ben Bernanke can do no wrong
in the eyes of Professor Blinder. In my opinion, the real Bernanke-Blinder
disaster is their support of restraining the government budget deficit with
Zimbabwe economics that entails printing more greenbacks (over $2 trillion to
date) rather than taxing or borrowing what is needed to fight the deficit.
Actually the government does not add to the money supply by literally printing
greenbacks. But having the Fed buy up over 60% of the new government debt is
tantamount to printing greenbacks.
Taxing and borrowing to support government spending are going out of
style.
The main problem with Zimbabwe economics is that it does little to restrain the
excesses of government spending --- which we are now witnessing in the economic
mess in Greece. Greece, of course, cannot simply print Euros to continue to feed
government spending excesses. Greece has to get out of the Euro Zone to engage
in the Zimbabwe economics of Benanke and Blinder. Of course all of Europe might
soon engage in Zimbabwe economics to pay its debts. Taxing and borrowing to
support government spending are going out of style.
The budget should be balanced, the Treasury
should be refilled, public debt should be reduced, the arrogance of officialdom
should be tempered and controlled, and the assistance to foreign lands should be
curtailed lest Rome become bankrupt. People must again learn to work, instead of
living on public assistance.
Taylor Caldwell, A Pillar of Iron
(wrongly attributed to Cicero in 55 B.C.)
But under my philosophy of sharing all sides of arguments, I forward the
following case.
Teaching Case from The Wall Street Journal Accounting Weekly Review on
May 25, 2012
The Long and Short of Fiscal Policy
by:
Alan S. Blinder
May 22, 2012
Click here to view the full article on WSJ.com
TOPICS: Governmental Accounting, Income Tax, Tax Laws, Tax Policy,
Taxation
SUMMARY: Alan S. Blinder "...is a former vice chairman of the
Federal Reserve [and is now] a professor of economics and public affairs at
Princeton University." This opinion page piece provides a clear explanation
of macroeconomic effects of budget deficits, tax cuts, and spending cuts,
emphasizing the "macroeconomic effects of budget deficits in the short and
long runs."
CLASSROOM APPLICATION: The article is useful in either a tax course
or a governmental accounting class. The related article presents letters to
the editor with more Republican viewpoints than Mr. Blinder's.
QUESTIONS:
1. (Advanced) What are budget deficits?
2. (Introductory) Why can budget deficit spending be beneficial for
the U.S. economy in the short run?
3. (Introductory) Why are budget deficits bad for the U.S. economy
in the long run?
4. (Advanced) What tax law changes are imminent in January 2013?
How do they relate to the comic graphic associated with this opinion piece?
In your answer, comment on the size of these changes relative to the total
economy.
5. (Introductory) How might specific choices in spending be more
helpful than other possible choices? In your answer, explain the use of
return on investment in these decisions, defining that finance concept as
well.
6. (Introductory) What is the biggest cost component that could
most readily reduce the long term budget deficit problem we face in the
U.S.?
7. (Introductory) What does Mr. Blinder recommend as a plan for our
national fiscal policy?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Perhaps the 2013 Fiscal Cliff Presents an Opportunity
by Letters to the Editor: Carroll Hoke, Frank Peel, and Keith Colonna
Mar 23, 2012
Page: A14
"The Long and Short of Fiscal Policy," by: Alan S. Blinder, The Wall Street
Journal, May 22, 2012 ---
http://online.wsj.com/article/SB10001424052702303360504577408490648029470.html?mod=djem_jiewr_AC_domainid
Can we talk about the federal budget deficit?
Better yet, can we think about it? For there has been a lot more talking
than thinking. One persistent point of confusion arises from the radically
different macroeconomic effects of larger budget deficits in the short and
long runs.
In the short run—let's say within a year or so—a
larger deficit, whether achieved by spending more or taxing less, boosts
economic growth by increasing aggregate demand. It's pretty simple. If the
government spends more money without raising anyone's taxes to pay the
bills, that adds to total demand directly.
That's true, by the way, whether you like the
specific expenditures or hate them. Similarly, cutting somebody's taxes
without also cutting spending raises spending indirectly—again, whether you
like the tax cut or not.
A second layer of subtlety recognizes that some
types of spending and some types of tax cuts have larger effects on spending
than others, and similarly, that some types are more sharply targeted on job
creation than others. Such details matter in designing a cost-effective
stimulus package. But for present purposes, let's keep it simple: Higher
spending or lower taxes speed up growth by adding to demand.
So, as long as the government can borrow on
reasonable terms, the crucial short-run question is: Does the economy need
more or less demand? For the last several years, the answer has been clear:
more. Bolstering demand was the rationale for fiscal stimulus under
President Bush in 2008 and under President Obama in 2009. It remains a
persuasive rationale for further stimulus today.
But that's not going to happen. Instead, the
operational budget objective for the coming months is to ensure that we
don't shoot ourselves in the collective foot with fiscal austerity while the
economy is still weak. Sounds foolish, but we could make that grievous error
either by letting ourselves fall off the so-called fiscal cliff that awaits
us in January (tax increases and spending cuts amounting to 3.5%-4% of GDP),
or by crashing headlong into the national debt ceiling, as we almost did
last summer.
But don't we need to reduce the deficit—and by
large amounts? Yes, we do, but that's in the long run, where the effects of
larger deficits are mostly harmful to economic growth. In the jargon, more
government borrowing tends to "crowd out" private borrowers by pushing
interest rates up. Those crowded-out borrowers include both consumers who
want to buy cars and businesses that want to buy equipment. In the latter
case, higher government budget deficits take a toll on growth by slowing
down capital formation.
There is an important exception, however, which is
highly germane to today's situation. Suppose government borrowing is used to
finance productive investments in public capital—such as highways, bridges,
and tunnels. Right now, the U.S. government can borrow for 10 years at under
2% per annum. At these super-low interest rates, you don't have to be a
genius to find many public infrastructure projects with strongly positive
net present values. Borrowing to make such investments will enhance long-run
growth, not retard it. And I can't, for the life of me, understand why we
are not doing more of it.
But other types of spending, and any tax cut that
does not boost capital formation enough, will slow down growth. And that's
the fundamental indictment of large deficits.
To think clearly about how to shrink the long-run
deficit, we must understand its origins. Looking ahead, the lion's share of
projected future deficits comes from rising health-care expenditures.
Some of this cost escalation stems from heavier
usage—consuming more health services per capita. But most of it comes from
ever-rising relative prices; health care just keeps getting more expensive
relative to almost everything else. The good news is that, if we could
somehow limit health-care inflation to the overall inflation rate, much of
the long-run budget problem would virtually vanish. The bad news is that
nobody knows how to do that.
Given this ignorance, President Obama's health-care
reform law, which Republicans want to repeal and the Supreme Court may
vacate, takes a sensible approach to cost control. It includes—either on an
experimental, small-scale, or pilot basis—virtually every cost-containment
idea that has been suggested. The pragmatic attitude is: Let's try
everything and go with what works.
But what about the middle, between the short run
and the long run? When should the federal
government get serious about paring its deficit? There is no formulaic
answer, but U.S. Treasury borrowing rates will provide a clue. When they
start rising on a sustained basis, it will be time to push deficits down.
Another important clue will be the health of the economy.
The government should stop supporting aggregate demand when the
economy is strong enough to stand on its own two feet.
Continued in article
Jensen Comment
What Blinder does not admit to is that government borrowing rates are not
allowed to go up as long as the Fed buys over 60% of the new debt issues in its
Zimbabwe economic policy. I think I'm going to throw up!
Alan Blinder is all smoke and mirrors in an election year.
Bob Jensen's threads on The Greatest Swindle in the History of the World
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Collateralized Debt Obligation ---
http://en.wikipedia.org/wiki/Collateralized_debt_obligation
"CDOs Are Back: Will They Lead to Another Financial Crisis?"
Knowledge@wharton, April 10, 2013 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=3230
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Wall Street’s Math Wizards Forgot a Few Variables
What wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/
Who says bipartisanship is dead in Washington?
House
Republicans played the dastardly trick of putting President Obama's budget
proposal to a floor vote on Wednesday, and the verdict was a unanimous
defeat—414-0. Fifteen Democrats did the White House the favor of not voting on
the measure that would raise taxes by $1.9 trillion.
"Calling the Budget Roll House votes reveal who's serious about fiscal reform,"
The Wall Street Journal, March 29, 2012 ---
http://online.wsj.com/article/SB10001424052702303404704577311950398592584.html#mod=djemEditorialPage_t
While the bipartisan U.S. Congress voted down President Obama's proposed
budget Canada seems to be finding its way to recovery
"Canada Beats America: And we don't mean in hockey. Try taxes, spending
and energy," The Wall Street Journal, April 3, 2012 ---
.
http://online.wsj.com/article/SB10001424052702303816504577319743650637600.html#mod=djemEditorialPage_t
Not too many years ago, Americans could get away
with cracking jokes about spendthrift Canada, its weak dollar and the long
wait for MRIs. These days, the joke is on Americans, as Canada's government
has cleaned up its fiscal mess and focused on private economic growth.
The governing Conservative Party took another step
forward last week with a pledge to balance the budget by 2015 without
raising taxes. That's a year later than Prime Minister Stephen Harper
pledged on the stump in 2011, but it sure beats America's four consecutive
years of deficits of $1.3 trillion. Canada's federal debt as a share of GDP
is forecast to fall to 28.5% in 2016–17 from 33.8%. Add in state debt and
that number is closer to 66%, but the trend is in the right direction, while
America's is heading toward 70% and rising.
Canada's progress isn't a political accident. Our
northern neighbor has been liberalizing since the mid-1990s, under
politicians of the right and left, and through better policies it dodged the
government-supercharged housing boom and bust that sent the U.S. into
recession.
Provincial governments led the intellectual way.
Alberta's Ralph Klein in the 1990s cut taxes, slimmed government and created
a stable investment climate. Saskatchewan's socialists, British Columbia and
Ontario reformed too. The Harper government took power in 2006 and started
to cut taxes, trim government employment and clinch free-trade deals.
Canada's corporate tax rate is now 15%, compared with America's 35%.
Finance Minister Jim Flaherty explained that
policies to "raise taxes, increase government spending, and shun new trading
opportunities" would "kill jobs, impose crushing deficits, and cripple our
economy." He will not be President Obama's next Treasury secretary.
Overall federal spending will continue to rise, but
at a slower pace. Most notably, the budget proposes to raise the eligibility
age to 67 from 65 for Old Age Security, starting in 2023, and it will also
allow retirees to voluntarily defer benefits if they want to receive a
higher payout later. A later retirement age, phased in over time, is
precisely the kind of reform that the U.S. needs for Social Security and
Medicare.
The budget also treats Canada's energy resources as
national assets to be exploited—with as few delays as possible. Thus the
budget proposes to eliminate overlapping federal and provincial
environmental reviews for major projects. It proposes firm review timelines,
including for projects that are already underway, such as the Northern
Gateway pipeline from northern Alberta to the Pacific coast. Mr. Flaherty's
catch phrase is "one project, one review." Contrast this with the multiple
reviews that have stymied the Keystone XL pipeline from Canada and North
Dakota's Bakken Shale to the Gulf Coast.
As America's recent performance proves, the wealth
of a nation isn't guaranteed. Canada shows how mistakes can be reversed with
sound policies.
Jensen Comment
But there's a bright side to the U.S. deficit problem. Rather than borrow so
much from the Middle East and China, the Fed is now buying up 61% of the
Treasury bonds --- which is tantamount to printing over $2 trillion greenbacks
in a Zimbabwe solution to lowering the deficit. I'll bet Canada never thought of
that solution to not having to reduce spending so much.
If we would just print a few trillion more greenbacks we might yet achieve a
balanced budget in the United States.
"Washington's Knack for Picking Losers," by Michael J. Boskin, The
Wall Street Journal, February 15, 2012 ---
http://online.wsj.com/article/SB10001424052970204883304577221630318169656.html?mod=djemEditorialPage_t
Like the mythical monster Hydra—who grew two heads
every time Hercules cut one off—President Obama, in both his State of the
Union address and his new budget, has defiantly doubled down on his brand of
industrial policy, the usually ill-advised attempt by governments to promote
particular industries, companies and technologies at the expense of broad,
evenhanded competition.
Despite his record of picking losers—witness the
failed "clean energy" projects Solyndra, Ener1 and Beacon Power—Mr. Obama
appears determined to continue pushing his brew of federal spending,
regulations, mandates, special waivers, loan guarantees, subsidies and tax
breaks for companies he deems worthy.
Favoring key constituencies with taxpayer money
appeals to politicians, who can claim to be helping the overall economy, but
it usually does far more harm than good. It crowds out valuable competing
investment efforts financed by private investors, and it warps decisions by
bureaucratic diktats susceptible to political cronyism. Former Obama adviser
Larry Summers echoed most economists' view when he warned the administration
against federal loan guarantees to Solyndra, writing in a 2009 email that
"the government is a crappy venture capitalist."
Markets function well when the returns are received
and the risks borne by private owners. There are, of course, exceptions:
Governments have a responsibility to fund defense R&D and other forms of
pre-competitive, generic R&D—e.g., basic science and technology from
nanoscience to batteries—but only when they pass rigorous cost-benefit tests
and maintain a level playing field among alternative commercial
applications.
For example, the computer-linking technology that
created the Internet was funded by the Defense Department for defense
purposes. But, like numerous defense technologies, it wound up with
commercially valuable civilian applications. Yet it would be foolish for the
government to subsidize a particular search engine or social-networking
platform.
The previous peak for U.S. industrial policy was in
the 1970s and 1980s, when many Democrats wanted to emulate the then-growing
Japanese economy by managing trade and directing specific technology and
investment outcomes. Japanese subsidies mostly went to old industries like
agriculture, mining and heavy manufacturing. We now know that this
misallocation of capital was one of the main reasons for Japan's stagnation
over the past two decades.
Industrial-policy fever waned after the 1980s but
never died. President George W. Bush expanded ethanol mandates and pushed
hydrogen cars. Hydrogen's use for transportation must still overcome
combustibility concerns, or we'll be driving mini-Hindenburgs. The Bush and
Obama administrations bet big on ethanol and other biofuels, providing
subsidies that distorted the global market for corn. The federal government
was forced to drop its cellulosic ethanol quota by 97% last year because of
a lack of viable biorefineries—and the quota still wasn't met.
Even under optimistic projections, heavily
subsidized wind and solar would each amount to a tiny fraction of global
energy by 2030 and thus cannot be the main answer to energy-security or
environmental problems. The short-run focus of most Department of Energy
funding misses the main strategic imperative: We need alternatives that can
scale to significance long-term without subsidies, and we need a lot more
North American oil and gas in the meantime.
Mr. Obama is spending immense sums for subsidies to
particular industries and technologies, almost $40 billion for clean-energy
programs alone (some, appropriately, for pre-competitive generic
technology.) Yet a large number of prominent venture-capital funds are
devoted to alternative-energy providers. They should be competing with each
other and with the technologies they seek to replace—not for government
handouts.
Meanwhile, the administration blocks shovel-ready
private investment such as the Keystone XL pipeline from Canada to the Gulf
Coast, which would create thousands of American jobs, increase energy
security, and even improve the environment. The alternative is shipping the
Canadian oil to China; we can refine it more cleanly than the Chinese, and
pipelines are safer than shipping.
America certainly has energy-security and possible
environmental concerns that merit diversifying energy sources. More domestic
oil and natural gas production will clearly play a large role. The shale gas
hydraulic fracturing revolution—credit due to Halliburton and Mitchell
Energy; the government's role was minor—is rapidly providing a piece of the
intermediate-term solution.
The arguments to promote industrial
policy—incubating industries, benefits of clustering and learning, more
jobs, etc.—don't stand up to scrutiny. Echoing 1980s Japan-fear and envy,
some claim we must enact industrial policies because China does. We should
remember that Presidents Lyndon Johnson and Richard Nixon wanted the U.S. to
build a supersonic transport (SST) plane because the British and French were
doing so. The troubled Concorde was famously shut down after a
quarter-century of subsidized travel for wealthy tourists and Wall Street
types.
Instead of an industrial policy that fails
miserably to pick winners, a better response to foreign competition should
be:
• Remove our own major competitive
obstacles. We can do this with more competitive corporate tax
rates, more sensible regulation, improved K-12 education, and better job
training for skills that the market demands such as the computer
literacy necessary even to operate today's machinery. (Mr. Obama's green
jobs training program spent hundreds of millions but only 3% of
enrollees had the targeted jobs six months later.)
• Base trade and industrial policies on
sound economics, not 'in-sourcing' protectionism. If another
country has a comparative cost advantage, we gain from exchanging such
products for those we produce relatively more efficiently. If we tried
to produce everything in America, our standard of living would plummet.
• Pursue rapid redress for illegal
subsidization and protectionism by our competitors. The appropriate
venue for trade complaints is the World Trade Organization, not the
campaign trail. We need to strengthen the WTO, not threaten its
legitimacy with protectionist rhetoric that could spark a trade war.
Continued in article
"The Fed Votes No Confidence The prolonged—'emergency'—near-zero interest
rate policy is harming the economy," by Charles Schwab, The Wall Street
Journal, February 6, 2012 ---
http://online.wsj.com/article/SB10001424052970204740904577197374292182402.html?mod=djemEditorialPage_t
We're now in the 37th month of central government
manipulation of the free-market system through the Federal Reserve's
near-zero interest rate policy. Is it working?
Business and consumer loan demand remains modest in
part because there's no hurry to borrow at today's super-low rates when the
Fed says rates will stay low for years to come. Why take the risk of
borrowing today when low-cost money will be there tomorrow?
Federal Reserve Chairman Ben Bernanke told
lawmakers last week that fiscal policy should first "do no harm." The same
can be said of monetary policy. The Fed's prolonged, "emergency" near-zero
interest rate policy is now harming our economy.
The Fed policy has resulted in a huge infusion of
capital into the system, creating a massive rise in liquidity but negligible
movement of that money. It is sitting there, in banks all across America,
unused. The multiplier effect that normally comes with a boost in liquidity
remains at rock bottom. Sufficient capital is in the system to spur
growth—it simply isn't being put to work fast enough.
Average American savers and investors in or near
retirement are being forced by the Fed's zero-rate policy to take greater
investment risks. To get even modest interest or earnings on their savings,
they move out of safer assets such as money markets, short-term bonds or CDs
and into riskier assets such as stocks. Either that or they tie up their
assets in longer-term bonds that will backfire on them if inflation returns.
They're also dramatically scaling back their consumer spending and living
more modestly, thus taking money out of the economy that would otherwise
support growth.
We've also seen a destructive run of capital out of
Europe and into safe U.S. assets such as Treasury bonds, reflecting a
world-wide aversion to risk. New business formation is at record lows,
according to Census Bureau data. There is still insufficient confidence
among business people and consumers to spark an investment and growth boom.
We're now in the 37th month of central government
manipulation of the free-market system through the Federal Reserve's
near-zero interest rate policy. Is it working?
Business and consumer loan demand remains modest in
part because there's no hurry to borrow at today's super-low rates when the
Fed says rates will stay low for years to come. Why take the risk of
borrowing today when low-cost money will be there tomorrow?
Federal Reserve Chairman Ben Bernanke told
lawmakers last week that fiscal policy should first "do no harm." The same
can be said of monetary policy. The Fed's prolonged, "emergency" near-zero
interest rate policy is now harming our economy.
The Fed policy has resulted in a huge infusion of
capital into the system, creating a massive rise in liquidity but negligible
movement of that money. It is sitting there, in banks all across America,
unused. The multiplier effect that normally comes with a boost in liquidity
remains at rock bottom. Sufficient capital is in the system to spur
growth—it simply isn't being put to work fast enough.
Average American savers and investors in or near
retirement are being forced by the Fed's zero-rate policy to take greater
investment risks. To get even modest interest or earnings on their savings,
they move out of safer assets such as money markets, short-term bonds or CDs
and into riskier assets such as stocks. Either that or they tie up their
assets in longer-term bonds that will backfire on them if inflation returns.
They're also dramatically scaling back their consumer spending and living
more modestly, thus taking money out of the economy that would otherwise
support growth.
We've also seen a destructive run of capital out of
Europe and into safe U.S. assets such as Treasury bonds, reflecting a
world-wide aversion to risk. New business formation is at record lows,
according to Census Bureau data. There is still insufficient confidence
among business people and consumers to spark an investment and growth boom.
Jensen Comment
Bob Jensen's threads on the bailout mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on The Greatest Swindle in the History of the World
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
"The Hidden Dangers of Low Interest Rates," by David Cay Johnston, Reuters,
January 10, 2012 ---:
http://blogs.reuters.com/david-cay-johnston/2012/01/10/the-hidden-dangers-of-low-interest-rates/
The Fed’s campaign to hold short-term interest
rates near zero is a loser for taxpayers. A rise in rates would also burden
taxpayers, but it would come with a benefit for those who save.
Low rates keep alive the banks that the government
considers too big to fail and reduce the cost of servicing the burgeoning
federal debt. Low rates also come at a cost, cutting income to older
Americans and to pension funds. This forces retirees to eat into principal,
may put more pressure on welfare programs for the elderly, and will probably
require the government to spend money to fulfill pension guarantees.
Raising interest rates shifts the costs and
benefits, increasing the risks that mismanaged banks will collapse and
diverting more taxpayers’ money to service federal debt. On the other hand,
higher interest rates mean that savers, both individual and in pension
funds, enjoy the fruits of their prudence.
No matter which way interest rates go, taxpayers
face dangers. The question is where we want to take our losses. For my
money, saving the mismanaged mega-banks should be the last priority and
savers the first. Of course breaking up the big banks or letting them fail
also imposes costs and low interest rates benefit many Americans, though
mostly those with top credit scores, but policy involves choices and
rescuing banks from their own mistakes and subtly siphoning wealth from the
prudent is corrosive to the ethical and social fabric.
ON THE RISE?
The federal government paid $454 billion in
interest on its debt in 2011. That is the equivalent of all the individual
income taxes paid last year through the first three weeks of June
If rates return to, say, 6.64 percent, the level
they were in 2000, one year’s interest costs would equal the individual
income taxes for all of 2011 plus the first few weeks of 2012.
Last week , rates took a step in that direction.
The yield on the 10-year bond, a benchmark for other interest rates, jumped
to 3.3 percent, from 2.57 percent in early November, raising the
government’s cost of borrowing in that sale by one fourth.
The average maturity of federal bills, notes and
bonds is just five years, with just 7 percent of debt financed for more than
10 years, the equivalent of an adjustable rate mortgage with no upside
limit.
PRUDENT PEOPLE
The low interest rates since the financial crisis
already have imposed a cost on the prudent people who saved for the future,
both those who saved as individuals and those who put their money in pension
funds.
Banks are paying less than one percent interest on
savings, which means rates are negative in real terms, forcing retirees to
dig into their nest eggs or cut spending.
Across the country, some fundraisers have told me
of benefactors who called to say that expected bequests would not be
forthcoming because they had been forced to dig into their savings.
Tax returns, too, show a disturbing, if logical,
trend toward less saving. The share of income from taxable interest fell
from 3 percent in 1999 to 2.2 percent in 2009, the latest year for which tax
return data are available.
More troubling is that the number of taxpayers grew
by more than 13 million over those years, while those reporting any taxable
interest fell from 67.2 million to 57.8 million. The share of taxpayers
earning interest plummeted from 52.9 percent to 44.1 percent.
RAVAGED PENSION FUNDS
At the same time, low interest rates, on top of
weak stock prices, have ravaged pension funds.
Overall, state and local public employee plans lost
22.7 percent of their value in 2009, the Census Bureau reported in October.
Their assets fell to $2.5 trillion from more than $3.2 trillion, while
annual payments to retirees and survivors rose 6.7 percent to $187 billion.
Continued in article
"SEC Brings Crisis-Era Suits Fannie, Freddie Ex-Executives Face Cases
Stemming From Subprime Disclosures," by Nick Timiraos and Chad Bray, The
Wall Street Journal, December 17, 2011 ---
http://online.wsj.com/article/SB10001424052970203733304577102310955780788.html
U.S. securities regulators accused six former
executives at mortgage firms Fannie Mae and Freddie Mac of playing down the
risks to investors of the firms' foray into subprime loans.
The civil lawsuits, filed Friday by the Securities
and Exchange Commission in Manhattan federal court, rank among the
highest-profile crisis-related cases the government has brought. They are
also the first cases against the top executives at Fannie and Freddie before
their 2008 government takeover, which has cost taxpayers $151 billion.
The complaints name as defendants former Freddie
Mac Chief Executive Richard Syron and former Fannie Mae CEO Daniel Mudd, who
is currently chief executive of Fortress Investment Group LLC. The agency
also accused four other high-ranking former executives at Freddie Mac and
Fannie Mae.
The executives and their lawyers said they would
vigorously contest the charges.
At the heart of the lawsuits is the government's
contention that Fannie and Freddie executives knowingly misled investors
about the volumes of risky mortgages that the companies were purchasing as
the housing boom turned to bust. Documents
Complaints: SEC v. Fannie Mae | SEC v. Freddie Mac
Nonprosecution Agreements: Fannie Mae | Freddie Mac
"Fannie Mae and Freddie Mac executives told the
world that their subprime exposure was substantially smaller than it really
was," said Robert Khuzami, director of the SEC's Enforcement Division.
The lawsuits come as the SEC and other
law-enforcement agencies face rising political pressure to take more
aggressive action against financial companies over the 2008 crisis. Federal
authorities have a mixed record in cases tied to the subprime-mortgage bust,
with no major cases having been brought in some of the highest-profile
blowups, such as the September 2008 bankruptcy of Lehman Brothers Holdings
Inc.
Continued in article
Jensen Comment
So why is the Department of Justice and the SEC backing off of bigger criminals
like the banksters of Countrywide, Washington Mutual, Citigroup, JP Morgan,
Merrill Lynch, Lehman Brothers, Bear Sterns, etc.?
The Justice Department can put criminals in jail, but the SEC can only go for
fines. The problem is that when dealing with banksters the SEC has a track
record of pittance, chicken feed fines. Steal a dollar and the SEC will go
after less than a dime from a bankster.
Another CBS Sixty Minutes Blockbuster (December 4, 2011)
"Prosecuting Wall Street"
Free download for a short while
http://www.cbsnews.com/8301-18560_162-57336042/prosecuting-wall-street/?tag=pop;stories
Note that this episode features my hero Frank Partnoy
Key provisions of Sarbox with respect to the Sixty Minutes revelations:
The act also covers issues such as
auditor independence,
corporate governance,
internal control assessment, and enhanced financial disclosure.
Sarbanes–Oxley Section 404: Assessment of internal control ---
http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Sarbanes.E2.80.93Oxley_Section_404:_Assessment_of_internal_control
Both the corporate CEO and the external auditing firm are to
explicitly sign off on the following and are subject (turns out to be a
ha, ha joke) to huge fines and jail time for egregious failure to
do so:
- Assess both the design and operating
effectiveness of selected internal controls related to significant
accounts and relevant assertions, in the context of material
misstatement risks;
- Understand the flow of transactions,
including IT aspects, in sufficient detail to identify points at
which a misstatement could arise;
- Evaluate company-level (entity-level)
controls, which correspond to the components of the
COSO framework;
- Perform a fraud risk assessment;
- Evaluate controls designed to
prevent or detect fraud, including management override of
controls;
- Evaluate controls over the period-end
financial
reporting process;
- Scale the assessment based on the size and
complexity of the company;
- Rely on management's work based on factors
such as competency, objectivity, and risk;
- Conclude on the adequacy of internal
control over financial reporting.
Most importantly as far as the CPA auditing firms are concerned is
that Sarbox gave those firms both a responsibility to verify that
internal controls were effective and the authority to charge more
(possibly twice as much) for each audit. Whereas in the 1990s auditing
was becoming less and less profitable, Sarbox made the auditing industry
quite prosperous after 2002.
There's a great gap between the theory of Sarbox and its enforcement
In theory, the U.S. Justice Department (including the FBI) is to enforce
the provisions of Section 404 and subject top corporate executives and audit
firm partners to huge fines (personal fines beyond corporate fines) and jail
time for signing off on Section 404 provisions that they know to be false.
But to date, there has not been one indictment in enormous frauds where the
Justice Department knows that executives signed off on Section 404 with
intentional lies.
In theory the SEC is to also enforce Section 404, but the SEC in Frank
Partnoy's words is toothless. The SEC cannot send anybody to jail. And the
SEC has established what seems to be a policy of fining white collar
criminals less than 20% of the haul, thereby making white collar crime
profitable even if you get caught. Thus, white collar criminals willingly
pay their SEC fines and ride off into the sunset with a life of luxury
awaiting.
And thus we come to the December 4 Sixty Minutes module that features
two of the most egregious failures to enforce Section 404:
The astonishing case of CitiBank
The astonishing case of Countrywide (now part of Bank of America)
The Astonishing Case of CitiBank
What makes the Sixty Minutes show most interesting are the whistle
blowing revelations by a former Citi Vice President in Charge of Fraud
Investigations
- What has to make the CitiBank revelations the most embarrassing
revelations on the Sixty Minutes blockbuster emphasis that top
CItiBank executives were not only informed by a Vice President in Charge of
Fraud Investigation of huge internal control inadequacies, the outside U.S.
government top accountant, the U.S. Comptroller General, sent an official
letter to CitiBank executives notifying them of their Section 404 internal
control failures.
- Eight days after receiving the official warning from the government, the
CEO of CitiBank flipped his middle finger at the U.S. Comptroller General
and signed off on Section 404 provisions that he'd also been informed by his
Vice President of Fraud and his Internal Auditing Department were being
violated.
http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html
- What the Sixty Minutes show failed to mention is that the
external auditing firm of KPMG also flipped a bird at the U.S. Comptroller
General and signed off on the adequacy of its client's internal controls.
- A few months thereafter CitiBank begged for and got hundreds of billions
in bailout money from the U.S. Government to say afloat.
- The implication is that CitiBank and the other Wall Street corporations
are just to0 big to prosecute by the Justice Department. The Justice
Department official interviewed on the Sixty Minutes show sounded
like hollow brass wimpy taking hands off orders from higher authorities in
the Justice Department.
- The SEC worked out a settlement with CitiBank, but the fine is such a
joke that the judge in the case has to date refused to accept the
settlement. This is so typical of SEC hand slapping settlements --- and the
hand slaps are with a feather.
The astonishing case of Countrywide (now part of Bank of America)
- Countrywide Financial before 2007 was the largest issuer of mortgages on
Main Streets throughout the nation and by estimates of one of its own
whistle blowing executives in charge of internal fraud investigations over
60% of those mortgages were fraudulent.
- After Bank of America purchased the bankrupt Countrywide, BofA top
executives tried to buy off the Countrywide executive in charge of fraud
investigations to keep him from testifying. When he refused BofA fired him.
- Whereas the Justice Department has not even attempted to indict
Countrywide executives and the Countrywide auditing firm of Grant Thornton
(later replaced by KPMG) to bring indictments for Section 404 violations,
the FTC did work out an absurdly low settlement of $108 million for 450,000
borrowers paying "excessive fees" and the attorneys for those borrowers ---
http://www.nytimes.com/2011/07/21/business/countrywide-to-pay-borrowers-108-million-in-settlement.html
This had nothing to do with the massive mortgage frauds committed by
Countrywide.
- Former Countrywide CEO Angelo Mozilo settled the SEC’s Largest-Ever
Financial Penalty ($22.5 million) Against a Public Company's Senior
Executive
http://sec.gov/news/press/2010/2010-197.htm
The CBS Sixty Minutes show estimated that this is less than 20% of what he
stole and leaves us with the impression that Mozilo deserves jail time but
will probably never be charged by the Justice Department.
I was disappointed in the CBS Sixty Minutes show in that it completely
ignored the complicity of the auditing firms to sign off on the Section 404
violations of the big Wall Street banks and other huge banks that failed.
Washington Mutual was the largest bank in the world to ever go bankrupt. Its
auditor, Deloitte, settled with the SEC for Washington Mutual for
$18.5 million. This isn't even a hand slap relative to the billions lost by
WaMu's investors and creditors.
No jail time is expected for any partners of the negligent auditing
firms. .KPMG settled for peanuts with Countrywide for
$24 million of negligence and New Century for
$45 million of negligence costing investors billions.
"Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank
Partnoy, New York Review of Books, November 10, 2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
Thank you Robert Walker for the heads up!
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on how white collar crime pays even if you get caught
---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
"Investment strategist: 'Big banks make their money from optimism',"
by Joris Luyenduc, The Guardian, January 3, 2012 ---
http://www.guardian.co.uk/commentisfree/joris-luyendijk-banking-blog/2012/jan/03/investment-strategist-emerging-markets
. . .
"If you take an honest look at the financial sector
today, you see banks can borrow money almost for free on what is called the
short-term market, then lend that money to governments for 2% or 3%. Now why
would they lend to small businesses if they can make money so easily? This
is what 'zero interest rates' are doing to our economy, as well as taxing
savers with inflation at over 5%. You take on new debt to pay off your old
debt. It's like drinking your hangover away with ever more drinks. You are
destroying your liver. That's what's currently happening."
Continued in article
The Commission's Final Report ---
http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_full.pdf
Video: Charles Furgeson has produced a powerful documentary, “Inside
Job,” about the deep capture of financial (de)regulation ---
http://thesituationist.wordpress.com/2010/11/14/the-situation-of-the-2008-economic-crisis/
"How Wall Street Fleeced the World: The Searing New doc Inside
Job Indicts the Bankers and Their Washington Pals," by Mary Corliss
and Richard Corliss, Time Magazine, October 18, 2010 ---
http://www.time.com/time/magazine/article/0,9171,2024228,00.html
Like some malefactor being grilled by Mike Wallace
in his 60 Minutes prime, Glenn Hubbard, dean of Columbia Business School,
gets hot under the third-degree light of Charles Ferguson's questioning in
Inside Job. Hubbard, who helped design George W. Bush's tax cuts on
investment gains and stock dividends, finally snaps, "You have three more
minutes. Give it your best shot." But he has already shot himself in the
foot.
Frederic Mishkin, a former Federal Reserve Board
governor and for now an economics professor at Columbia, begins stammering
when Ferguson quizzes him about when the Fed first became aware of the
danger of subprime loans. "I don't know the details... I'm not sure
exactly... We had a whole group of people looking at this." "Excuse me,"
Ferguson interrupts, "you can't be serious. If you would have looked, you
would have found things." (See the demise of Bernie Madoff.)
Ferguson—whose Oscar-nominated No End in Sight
analyzed the Bush Administration's slipshod planning of the Iraq
occupation—did look at the Fed, the Wall Street solons and the decisions
made by White House administrations over the past 30 years, and he found
plenty. Of the docufilms that have addressed the worldwide financial
collapse (Michael Moore's Capitalism: A Love Story, Leslie and Andrew
Cockburn's American Casino), this cogent, devastating synopsis is the
definitive indictment of the titans who swindled America and of their pals
in the federal government who enabled them.
With a Ph.D. in political science from MIT,
Ferguson is no knee-jerk anticapitalist. In the '90s, he and a partner
created a software company and sold it to Microsoft for $133 million. He is
at ease talking with his moneyed peers and brings a calm tone to the film
(narrated by Matt Damon). Yet you detect a growing anger as Ferguson digs
beneath the rubble, and his fury is infectious. If you're not enraged by the
end of this movie, you haven't been paying attention. (See "Protesting the
Bailout.")
The seeds of the collapse took decades to flower.
By 2008, the financial landscape had become so deregulated that homeowners
and small investors had few laws to help them. Inflating the banking bubble
was a group effort—by billionaire CEOs with their private jets, by agencies
like Moody's and Standard & Poor's that kept giving impeccable ratings to
lousy financial products, by a Congress that overturned consumer-protection
laws and by Wall Street's fans in academe, who can earn hundreds of
thousands of dollars by writing papers favorable to Big Business or sitting
on the boards of firms like Goldman Sachs.
Who's Screwing Whom? In the spasm of moral
recrimination that followed the collapse, some blamed the bright kids who
passed up careers in science or medicine to make millions on Wall Street and
charged millions more on their expense accounts for cocaine and prostitutes.
After the savings-and-loan scandals of the late-'80s, according to Inside
Job, thousands of executives went to jail. This time, with the economy
bulking up on the steroids of derivatives and credit-default swaps, the only
person who has done any time is Kristin Davis, the madam of a bordello
patronized by Wall Streeters. Davis appears in the film, as does disgraced
ex--New York governor Eliot Spitzer; both seem almost virtuous when compared
with the big-money men. (See "The Case Against Goldman Sachs.")
The larger message of both No End in Sight and
Inside Job is that American optimism, the engine for the nation's expansion,
can have tragic results. The conquest of Iraq? A slam dunk. Gambling
billions on risky mortgages? No worry—the housing market always goes up.
Ignoring darker, more prescient scenarios, the geniuses in charge
constructed faith-based policies that enriched their pals; they stumbled
toward a precipice, and the rest of us fell off.
The shell game continues. Inside Job also details
how, in Obama's White House, finance-industry veterans devised a "recovery"
that further enriched their cronies without doing much for the average Joe.
Want proof? Look at the financial industry's fat profits of the past year
and then at your bank account, your pension plan, your own bottom line.
Video: Watch Columbia's Business School Economist and Dean Hubbard rap
his wrath for Ben Bernanke
The video is a anti-Bernanke musical performance by the Dean of Columbia
Business School ---
http://www.youtube.com/watch?v=3u2qRXb4xCU
Ben Bernanke (Chairman of the Federal Reserve and a great friend of big banks)
---
http://en.wikipedia.org/wiki/Ben_Bernanke
R. Glenn Hubbard (Dean of the Columbia Business School) ---
http://en.wikipedia.org/wiki/Glenn_Hubbard_(economics)
Bob Jensen's threads on the Greatest Swindle in History ---
Read Below
"Cheat Sheet: What’s Happened to the Big Players in the Financial Crisis?"
by Braden Goyette, Publica, October 26, 2011 ---
http://www.propublica.org/article/cheat-sheet-whats-happened-to-the-big-players-in-the-financial-crisis
Widespread demonstrations in support of Occupy Wall Street have put the
financial crisis back into the national spotlight lately.
So here’s a
quick refresher on what’s happened to some of the main players, whose
behavior, whether merely reckless or downright deliberate, helped cause
or worsen the meltdown. This list isn’t exhaustive -- feel welcome to
add to it.
Mortgage originators
Mortgage lenders contributed to the financial crisis by issuing or
underwriting loans to people who
would have a difficult time paying them back, inflating a housing
bubble that was bound to pop.
Lax regulation allowed banks to stretch their mortgage lending
standards and use aggressive tactics to rope borrowers into complex
mortgages that were more expensive than they first appeared. Evidence
has also surfaced that
lenders were filing fraudulent documents to push some of these mortgages
through, and, in some cases, had been doing so as early as the
1990s. A 2005 Los Angeles Times
investigation of Ameriquest – then the nation’s largest
subprime lender
– found that “they forged documents, hyped
customers' creditworthiness and ‘juiced’ mortgages with hidden rates and
fees.” This behavior was reportedly typical for the subprime mortgage
industry. A similar culture existed at
Washington Mutual, which went under in 2008 in the
biggest bank collapse in U.S. history.
Countrywide, once the nation’s largest mortgage lender, also
pushed customers to sign on for
complex and costly mortgages that boosted the company’s profits.
Countrywide CEO Angelo Mozilo was
accused of misleading investors about the company’s mortgage lending
practices, a charge he denies. Merrill
Lynch and
Deutsche Bank both purchased subprime mortgage lending
outfits in 2006 to get in on the lucrative business. Deutsche Bank has
also been accused of
failing to adequately check on borrowers’ financial status before
issuing loans backed by government insurance. A lawsuit filed by U.S.
Attorney Preet Bharara claimed that, when employees at Deutsche Bank’s
mortgage received audits on the quality of their mortgages from an
outside firm, they
stuffed them in a closet without reading them. A Deutsche Bank
spokeswoman said the claims being made against the company are
“unreasonable and unfair,” and that most of the problems occurred before
the mortgage unit was bought by Deutsche Bank.
Where they are now: Few prosecutions have been brought against
subprime mortgage lenders. Ameriquest
went out of business in 2007, and Citigroup bought its mortgage
lending unit. Washington Mutual was bought by JP Morgan in 2008. A
Department of Justice investigation into alleged fraud at WaMu
closed with no charges this summer. WaMu also recently
settled a class action lawsuit brought by shareholders for $208.5
million. In an ongoing lawsuit, the FDIC is accusing former
Washington Mutual executives Kerry Killinger, Stephen Rotella and David
Schneider of going on a "lending
spree, knowing that the real-estate market was in a 'bubble.'" They
deny the allegations.
Bank of America purchased Countrywide in January of 2008, as
delinquencies on the company’s mortgages soared and investors began
pulling out. Mozilo left the company after the sale. Mozilo
settled an SEC lawsuit for $67.5 million with no admission of
wrongdoing, though he is now banned from serving as a top executive at a
public company. A criminal investigation into his activities fizzled out
earlier this year. Bank of America invited several senior Countrywide
executives to stay on and run its mortgage unit. Bank of America Home
Loans does not make subprime mortgage loans. Deutsche Bank is still
under investigation by the Justice Department.
Mortgage securitizers
In the years before the crash, banks took subprime mortgages, bundled
them together with prime mortgages and turned them into collateral for
bonds or securities, helping to seed the bad mortgages throughout the
financial system. Washington Mutual, Bank of America,
Morgan Stanley and others were securitizing mortgages as well as
originating them. Other companies, such as Bear Stearns, Lehman
Brothers, and Goldman Sachs,
bought mortgages straight from subprime lenders, bundled them into
securities and sold them to investors including pension funds and
insurance companies.
Where they are now: This spring, New York’s Attorney General
launched a
probe into mortgage securitization at Bank of America, JP Morgan,
UBS, Deutsche Bank, Goldman Sachs and Morgan Stanley during the housing
boom. Morgan Stanley
settled with Nevada’s Attorney General last month following an
investigation into problems with the securitization process.
As part of a proposed settlement with the 50 state attorneys general
over foreclosure abuses, several big banks were
offered immunity from charges related to improper mortgage
origination and securitization. California and New York have
withdrawn from those talks.
The people who created and dealt CDOs
Once mortgages had been bundled into mortgage-backed securities,
other bankers took groups of them and bundled them together into new
financial products called Collateralized Debt Obligations. CDOs are
composed of tiers with different levels of risk. As we’ve reported,
a hedge fund named Magnetar worked with banks to fill CDOs
with the riskiest possible materials, then used credit default swaps to
bet that they would fail. Magnetar says that the majority of its short
positions were against CDOs it didn’t own. Magnetar also says it didn’t
choose what went its own CDOs, though people involved in the deals who
spoke to ProPublica
contradict this account.
American International Group’s London-based financial products
unit was among the entities that
provided credit default swaps on CDOs. Though the business of
insuring the risky securities made AIG large short-term profits, it
eventually brought the company to the brink of collapse, prompting an
$85 billion government bailout.
Merrill Lynch, Citigroup, UBS, Deutsche Bank, Lehman
Brothers and JPMorgan all made CDO deals with Magnetar. The
hedge fund invested in 30 CDOs from the spring of 2006 to the summer of
2007. The bankers who worked on these deals almost always reaped hefty
bonuses. From
our story:
Even today, bankers and managers speak with awe at the elegance
of the Magnetar Trade. Others have become famous for betting big
against the housing market. But they had taken enormous risks.
Meanwhile, Magnetar had created a largely self-funding bet against
the market.
When banks found CDOs hard to sell, some of them, notably Merrill
Lynch and Citibank,
bought each other’s CDOs, creating the illusion of true investors
when there were almost none. That was one way they kept the market for
CDOs going longer than it otherwise would have. Eventually CDOs began
purchasing risky parts of other CDOs created by the same bank. Take a
look at our
comic strip explaining self-dealing, and our chart detailing
which banks bought their own CDOs.
Goldman Sachs and
Morgan Stanley also made similar deals in which they created,
then bet against, risky CDOs. The hedge fund
Paulson & Co helped decide which assets to put inside Goldman’s
CDOs.
Where they are now: Overall, the banks and individuals
involved in CDO deals haven’t been convicted on criminal charges. The
civil suits against them have produced fines that aren’t very big
compared to the profits they made in the leadup to the financial crisis.
JP Morgan paid $153.6 million to settle an SEC suit alleging they
hadn’t disclosed to investors that Magnetar was betting against Morgan’s
CDO.
Citigroup just agreed to pay a $285 million fine to the SEC for
betting against one of its mortgage-related CDOs. The lawsuit
doesn’t mention dozens of similar deals made by Citi.
Magnetar is still thriving (the deals they made weren’t illegal
according to the rules at the time). In 2007, Magnetar’s
founder took home $280 million, and the fund had $7.6 billion under
management. The SEC is considering banning hedge funds and banks from
betting against securities of their own creation. As of May 2010,
federal prosecutors were investigating
Morgan Stanley over their CDO deals, and
Goldman Sachs paid $550 million last year to settle a lawsuit
related to one of theirs. Only
one Goldman employee, Fabrice Tourre, has been charged criminally in
connection to the deals.
Though recorded phone calls suggest that former AIG CEO Joseph
Cassano misled investors about the credit default swaps that contributed
to his company’s troubles, the evidence wasn’t airtight, and federal
probes against him fell apart in 2010. Cassano’s lawyers deny any
wrongdoing.
The ratings agencies
Standard and Poor’s, Moody’s and Fitch gave
their highest rating to investments based on risky mortgages in the
years leading up to the financial crisis.
A Senate investigations panel found that S&P and Moody’s continued
doing so even as the housing market was collapsing. An SEC report also
found failures at 10 credit rating agencies.
Where they are now: The SEC is
considering suing Standard and Poor’s over one particular CDO deal
linked to the hedge fund Magnetar. The agency had previously
considered suing Moody’s, but instead issued a report
criticizing all of the rating agencies generally. Dodd-Frank created
a regulatory body to oversee the credit rating agencies, but its
development has been
stalled by budgetary constraints.
The regulators
The
Financial Crisis Inquiry Commission [PDF] concluded that the
Securities and Exchange Commission failed to crack down on risky
lending practices at banks and make them keep more substantial capital
reserves as a buffer against losses. They also found that the Federal
Reserve failed to stop the housing bubble by setting prudent
mortgage lending standards, though it was the one regulator that had the
power to do so.
An internal SEC audit
faulted the agency for missing warning signs about the poor
financial health of some of the banks it monitored,
particularly Bear Stearns. [PDF] Overall, SEC enforcement actions
went down under the leadership of Christopher Cox, and a 2009 GAO
report found that he
increased barriers to launching probes and levying fines.
Cox wasn’t the only regulator who resisted using his power to rein in
the financial industry. The former head of the Federal Reserve, Alan
Greenspan, reportedly
refused to heighten scrutiny of the subprime mortgage market.
Greenspan later said before Congress that
it was a mistake to presume that financial firms’ own rational
self-interest would serve as an adequate regulator. He has also said he
doubts the financial crisis could have been prevented.
The Office of Thrift Supervision, which was tasked with
overseeing savings and loan banks, also helped to scale back their own
regulatory powers in the years before the financial crisis. In 2003
James Gilleran and John Reich, then heads of the OTS and
Federal Deposit Insurance Corporation respectively,
brought a chainsaw to a press conference as an indication of how
they planned to cut back on regulation. The OTS was known for being so
friendly with the banks -- which it referred to as its “clients” -- that
Countrywide
reorganized its operations so it could be regulated by OTS. As we’ve
reported, the regulator failed to recognize serious
signs of trouble at AIG, and
didn’t disclose key information about IndyMac’s finances in the
years before the crisis. The Office of the Comptroller of the
Currency, which oversaw the biggest commercial banks, also
went easy on the banks.
Where they are now: Christopher Cox
stepped down in 2009 under
public pressure. The OTS was dissolved this summer and its duties
assumed by the OCC. As we’ve noted, the
head of the OCC has been advocating to weaken rules set out by the
Dodd Frank financial reform law. The Dodd Frank law
gives the SEC new regulatory powers, including the ability to bring
lawsuits in administrative courts, where the rules are more favorable to
them.
The politicians
Two bills supported by Phil Gramm and signed into law by
Bill Clinton created many of the conditions for the financial crisis
to take place. The Gramm-Leach-Bliley Act of 1999 repealed all the
remaining parts of Glass-Steagall, allowing firms to participate in
traditional banking, investment banking, and insurance at the same time.
The Commodity Futures Modernization Act, passed the year after,
deregulated
over-the-counter
derivatives – securities like CDOs and credit default swaps, that
derive their value from underlying assets and are traded directly
between two parties rather than through a stock exchange. Greenspan and
Robert Rubin, Treasury Secretary from 1995 to 1999, had both
opposed regulating derivatives. Lawrence Summers, who went
on to succeed Rubin as Treasury Secretary, also
testified before the Senate that derivatives shouldn’t be regulated.
Continued in article
Jensen Comment
This is a well-researched summary article of what happened between 2008 and 2011
to the "Major Players" in the enormous economic crisis, subprime mortgage, CDO,
and other scandals.
My criticism is that the article seems to let CPA auditors off the hook in
terms of being "Big Players" which, in my viewpoint is an enormouse oversight.
For example, it mentions the huge WaMu settlement without mentioning the lawsuit
against Deloitte. It mentions the Lehman Bros. scandal without mentioning Ernst
& Young. Nor does it mention the other dereliction of duty of all the
large international audit firms and the small audit firms who never warned the
public about pending failures of thousands of small banks and mortgage companies
on Main Street as well as Wall Strett. The large and small CPA audit firms fell
flat on their faces as important watchdogs over the Bigger Players and Smaller
Players ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Here are the only tidbits about audits and auditors in the above article:
U.S. Attorney Preet Bharara claimed that, when
employees at Deutsche Bank’s mortgage received audits on the quality of
their mortgages from an outside firm, they
stuffed them in a closet without reading them. A
Deutsche Bank spokeswoman said the claims being made against the company are
“unreasonable and unfair,” and that most of the problems occurred before the
mortgage unit was bought by Deutsche Bank
. . .
An internal SEC audit
faulted the agency for missing warning signs about
the poor financial health of some of the banks it monitored,
particularly Bear Stearns.
[PDF] Overall, SEC enforcement actions went down under the leadership of
Christopher Cox, and a 2009 GAO report found that he
increased barriers to launching probes and levying fines.
.
So my conclusion is that Braden Goyette did a pretty good job summarizing
what happened to what he called the "Big Players" in the economic crisis. He
just did not include all of the Big Players ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The Fed Audit
Socialist Bernie Sanders is probably my least favorite senator alongside Barbara
(mam) Boxer. But he does make some important revelations in the posting below.
The first ever GAO audit of the Federal Reserve was conducted in early 2011
due to the Ron Paul, Alan Grayson Amendment to the Dodd-Frank bill, which passed
last year. Jim DeMint, a Republican Senator, and Bernie Sanders, an independent
Senator, led the charge for a Federal Reserve audit in the Senate, but watered
down the original language of the house bill (HR1207), so that a complete audit
would not be carried out. Ben Bernanke, Alan Greenspan, and various other
bankers vehemently opposed the audit and lied to Congress about the effects an
audit would have on markets. Nevertheless, the results of the first audit in the
Federal Reserve nearly 100 year history were posted on Senator Sanders webpage
in July.
The list of
institutions that received the most money from the Federal Reserve can be found
on page 131 of the GAO Audit and is as follows:
Citigroup: $2.5
trillion($2,500,000,000,000)
Morgan Stanley: $2.04 trillion ($2,040,000,000,000)
Merrill Lynch: $1.949 trillion ($1,949,000,000,000)
Bank of America : $1.344 trillion ($1,344,000,000,000)
Barclays PLC ( United Kingdom ): $868 billion* ($868,000,000,000)
Bear Sterns: $853 billion ($853,000,000,000)
Goldman Sachs: $814 billion ($814,000,000,000)
Royal Bank of Scotland (UK): $541 billion ($541,000,000,000)
JP Morgan Chase: $391 billion ($391,000,000,000)
Deutsche Bank ( Germany ): $354 billion ($354,000,000,000)
UBS ( Switzerland ): $287 billion ($287,000,000,000)
Credit Suisse ( Switzerland ): $262 billion ($262,000,000,000)
Lehman Brothers: $183 billion ($183,000,000,000)
Bank of Scotland ( United Kingdom ): $181 billion ($181,000,000,000)
BNP Paribas (France): $175 billion ($175,000,000,000)
"The Fed Audit," by Bernie Sanders, Independent Senator from Vermont, July
21, 2011 ---
http://sanders.senate.gov/newsroom/news/?id=9e2a4ea8-6e73-4be2-a753-62060dcbb3c3
The first top-to-bottom audit of the Federal
Reserve uncovered eye-popping new details about how the U.S. provided a
whopping $16 trillion in secret loans to bail out American and foreign banks
and businesses during the worst economic crisis since the Great Depression.
An amendment by Sen. Bernie Sanders to the Wall Street reform law passed one
year ago this week directed the Government
Accountability Office to conduct the study. "As a
result of this audit, we now know that the Federal Reserve provided more
than $16 trillion in total financial assistance to some of the largest
financial institutions and corporations in the United States and throughout
the world," said Sanders. "This is a clear case of socialism for the rich
and rugged, you're-on-your-own individualism for everyone else."
Among the investigation's key findings is that the
Fed unilaterally provided trillions of dollars in financial assistance to
foreign banks and corporations from South Korea to Scotland, according to
the GAO report. "No agency of the United States government should be allowed
to bailout a foreign bank or corporation without the direct approval of
Congress and the president," Sanders said.
The non-partisan, investigative arm of Congress
also determined that the Fed lacks a comprehensive system to deal with
conflicts of interest, despite the serious potential for abuse. In fact,
according to the report, the Fed provided conflict of interest waivers to
employees and private contractors so they could keep investments in the same
financial institutions and corporations that were given emergency loans.
For example, the CEO of JP Morgan Chase served on
the New York Fed's board of directors at the same time that his bank
received more than $390 billion in financial assistance from the Fed.
Moreover, JP Morgan Chase served as one of the clearing banks for the Fed's
emergency lending programs.
In another disturbing finding, the GAO said that on
Sept. 19, 2008, William Dudley, who is now the New York Fed president, was
granted a waiver to let him keep investments in AIG and General Electric at
the same time AIG and GE were given bailout funds. One reason the Fed did
not make Dudley sell his holdings, according to the audit, was that it might
have created the appearance of a conflict of interest.
To Sanders, the conclusion is simple. "No one who
works for a firm receiving direct financial assistance from the Fed should
be allowed to sit on the Fed's board of directors or be employed by the
Fed," he said.
The investigation also revealed that the Fed
outsourced most of its emergency lending programs to private contractors,
many of which also were recipients of extremely low-interest and then-secret
loans.
The Fed outsourced virtually all of the operations
of their emergency lending programs to private contractors like JP Morgan
Chase, Morgan Stanley, and Wells Fargo. The same firms also received
trillions of dollars in Fed loans at near-zero interest rates. Altogether
some two-thirds of the contracts that the Fed awarded to manage its
emergency lending programs were no-bid contracts. Morgan Stanley was given
the largest no-bid contract worth $108.4 million to help manage the Fed
bailout of AIG.
A more detailed GAO investigation into potential
conflicts of interest at the Fed is due on Oct. 18, but Sanders said one
thing already is abundantly clear. "The Federal Reserve must be reformed to
serve the needs of working families, not just CEOs on Wall Street."
To read the GAO report, click here
http://sanders.senate.gov/imo/media/doc/GAO Fed Investigation.pdf
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Video
Looking back at the events leading up to the 2008 crisis by Michael Burry
Vanderbilt University Chancellor's Lecture
April 5, 2011
Thank you Jim Mahar for the heads up
http://financeprofessorblog.blogspot.com/2011/04/video-looking-back-at-events-leading-up.html
Jensen Comment
Michael Burry is the physician who anticipated the subprime scandal and made a
fortune on short positions.
Bob Jensen's threads on the subprime scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
These two items say a lot (bad) about Mary Shapiro's SEC ---
http://en.wikipedia.org/wiki/Mary_Shapiro
"Clawbacks Without Claws," by Gretchen Morgenson, The New York
Times, September 10, 2011 ---
http://www.nytimes.com/2011/09/11/business/clawbacks-without-claws-in-a-sarbanes-oxley-tool.html?_r=2&emc=tnt&tntemail1=y
AFTER the grand frauds at Enron, WorldCom and
Adelphia, Congress set out to hold executives accountable if their companies
cook the books.
Fair Game Clawbacks Without Claws By GRETCHEN
MORGENSON Published: September 10, 2011
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AFTER the grand frauds at Enron, WorldCom and
Adelphia, Congress set out to hold executives accountable if their companies
cook the books. Add to Portfolio
Diebold Inc New Century Financial Corp NutraCea
Go to your Portfolio »
Under the Sarbanes-Oxley Act of 2002, the
Securities and Exchange Commission was encouraged to hit executives where it
hurts — in the wallet — if they certified financial results that turned out
to be, in a word, bogus.
SarbOx was supposed to keep managers honest. They
would have to hand back incentive pay like bonuses, even if they didn’t
fudge the accounts themselves.
That, anyway, was the idea. The record suggests a
bark decidedly worse than its bite. The S.E.C. brought its first case under
Section 304 of SarbOx in 2007. Since then, it has filed cases demanding that
only 31 executives at only 20 companies return some pay.
In 2007 and 2008, most of the cases involved
shenanigans with stock options and produced some big recoveries. In the wake
of the financial crisis, the dollars recouped have amounted to an asterisk.
Since the beginning of 2009, the S.E.C. has pursued 18 executives at 10
companies. So far, it has recovered a total of $12.2 million from nine
former executives at five. The other cases are pending.
“It seems like a dormant enforcement tool,” Jack T.
Ciesielski, president of R. G. Associates and editor of The Analyst’s
Accounting Observer, says of the SarbOx provision. “It was supposed to be a
deterrent, but it’s only really a deterrent if they use it.”
How assiduously the S.E.C. enforces this aspect of
Sarbanes-Oxley is important. Only the S.E.C. can bring cases under Section
304. Companies can’t. Nor, it appears, can shareholders. In 2009, the Court
of Appeals for the Ninth Circuit ruled that there was no private cause of
action for violations of Section 304.
Half the companies pursued by the S.E.C. during the
past three years have been small and relatively obscure.
For example, the commission sued executives at
SpongeTech Delivery Systems (2008 revenue: $5.6 million), contending that
the company had booked $4.6 million in phony sales that year. NutraCea, a
maker of dietary supplements with 2008 sales of $35 million, was sued along
with Bradley D. Edson, its former chief executive, over what the S.E.C.
called its recording of $2.6 million in false revenue. An executive at
Isilon Systems, a data storage company, was pursued because, the S.E.C.
maintained, the company had inflated sales by $4.8 million during 2007.
No money has been recovered in the SpongeTech or
Isilon matters, which are still pending. Mr. Edson, who could not be reached
for comment, returned his 2008 bonus of $350,000.
In all cases when executives have returned money,
they have neither admitted nor denied allegations.
The S.E.C. typically recovers more money from
executives at bigger companies. But top executives are rarely compelled to
return all their incentive pay.
In a case brought last year against Navistar, for
example, the S.E.C. contended that the company had overstated its income by
$137 million from 2001 through 2005. Daniel C. Ustian, who is Navistar’s
chief executive and who was not charged with wrongdoing, returned common
stock worth $1.32 million. He had received $2.2 million in incentive pay and
restricted stock during the time that the S.E.C. says Navistar inflated its
accounting. A company spokeswoman said Mr. Ustian would not comment.
Robert C. Lannert, Navistar’s former chief
financial officer, who also was not charged, gave back stock worth $1.05
million. His incentive pay consisted of only $828,555 during the years that
the S.E.C. said the company misstated its results. He didn’t return a phone
call seeking comment.
ANOTHER case brought by the S.E.C. last year
involved Diebold, a maker of automated teller machines. Contending that
Diebold had overstated its results by $127 million between 2002 and 2007,
the commission sued to recover money from three former executives. Walden W.
O’Dell, who is a former C.E.O. and who was not charged, repaid $470,000 in
cash, and 30,000 Diebold shares and 85,000 stock options. During the years
that the S.E.C. alleged that results were overstated, he received bonuses
totaling $1.9 million, in addition to restricted stock worth $261,000 and
295,000 stock options. Mr. O’Dell didn’t return a message seeking comment.
The cases against the other Diebold executives are pending. A company
spokesman said it had settled with regulators and declined to comment
further.
Continued in article
"Commissioner slams SEC settlement," SmartPros, July 13, 2011
---
http://accounting.smartpros.com/x72323.xml
One of the SEC's five
commissioners has taken the extraordinary step of publicly dissenting from
an enforcement action on the grounds that it was too weak.
Commissioner Luis A.
Aguilar said the Securities and Exchange Commission should have charged
a former Morgan Stanley trader with fraud in view of what he called "the
intentional nature of her conduct."
The dissent comes weeks
after the SEC took flak for negotiating a $153.6 million fine from J.P.
Morgan Chase in another enforcement case but taking no action against
any of the firm's employees or executives.
Under a settlement
announced Tuesday, the SEC alleged that former Morgan Stanley trader
Jennifer Kim and a colleague who previously settled with the agency had
executed at least 32 sham trades to mask the amount of risk they had
been incurring and to get around an internal restriction.
Their trading
contributed to millions of dollars of losses at the investment firm, the
SEC said.
Without admitting or
denying the SEC's findings, Kim agreed to pay a fine of $25,000.
Aguilar said the
settlement was "inadequate" and "fails to address what is in my view the
intentional nature of her conduct."
"The settlement should
have included charging Kim with violations of the antifraud provisions,"
Aguilar wrote.
Continued in article
Jensen Comment
Maybe Jennifer also did porn. SEC enforcers like porn (daily).---
http://abcnews.go.com/GMA/sec-pornography-employees-spent-hours-surfing-porn-sites/story?id=10452544
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Weekly Book List, June 13, 2011," Chronicle of Higher Education,
June 12, 2011 ---
http://chronicle.com/article/Weekly-Book-List-June-13/127897/?sid=cr&utm_source=cr&utm_medium=en
Economics
Corporate Governance Failures: The Role of Institutional Investors
in the Global Financial Crisis edited by James P. Hawley, Shyam J.
Kamath, and Andrew T. Williams (University of Pennsylvania Press; 344 pages;
$69.95). Writings on such topics as the limits of corporate governance in
dealing with asset bubbles.
From Financial Crisis to Global Recovery by Padma Desai
(Columbia University Press; 254 pages; $27.50). Considers the origins of the
contemporary crisis and the prospects for recovery; includes comparative
discussion of the Great Depression.
Forged mortgage paperwork mess: the next housing shock and toxic mold
threats?
I have written tens of thousands of tidbits over the years. Aside from my
tidbits on wars, deficits/entitlements, and unemployment, I think my most
depressing tidbits are on the corrupted real estate deed registries of virtually
all counties in the 50 states if America. The major reason for this corruption
is that, after the subprime bubble burst in 2008, megabanks and Wall Street
brokerage houses lost track of mortgage paperwork on millions of real estate
parcels. These banks/brokerages then forged new copies of the mortgages, often
with fictitious names of bank officials where the loans originated. When these
properties were then foreclosed or otherwise resold to new buyers, the forged
mortgages became part of recorded deeds, thereby corrupting the deed registries
across the entire United States.
Watch the Video
"Mortgage paperwork mess: the next housing shock?" CBS Sixty Minutes,
April 3, 2011 ---
http://www.cbsnews.com/stories/2011/04/01/60minutes/main20049646.shtml
If there was a question about whether we're headed
for a second housing shock, that was settled last week with news that home
prices have fallen a sixth consecutive month. Values are nearly back to
levels of the Great Recession. One thing weighing on the economy is the huge
number of foreclosed houses.
Many are stuck on the market for a reason you
wouldn't expect: banks can't find the ownership documents.
Who really owns your mortgage?
Scott Pelley explains a bizarre aftershock of the U.S. financial
collapse: An epidemic of forged and missing mortgage documents.
It's bizarre but, it turns out, Wall Street cut
corners when it created those mortgage-backed investments that triggered the
financial collapse. Now that banks want to evict people, they're unwinding
these exotic investments to find, that often, the legal documents behind the
mortgages aren't there
Continued in article
Deed Registry ---
http://en.wikipedia.org/wiki/Registry_of_deeds
Mortgage ---
http://en.wikipedia.org/wiki/Mortgage_loan
Mortgage Backed Security ---
http://en.wikipedia.org/wiki/Mortgage-backed_security
Collateralized Debt Obligation (CDO) or Structured Asset Backed Security
(CABS) ---
http://en.wikipedia.org/wiki/Collateralized_debt_obligation
Registered deeds keep legal track over the years of all real estate in the
United States. Often the owners have taken out mortgages that give lenders
priority claims on the real estate ownership when owners default on mortgage
lending contracts. It's important to note that names of mortgage investors,
along with the property owners, are written into the recorded deeds. Before a
buyer purchases real estate the chronological records of recorded deeds on the
property are generally searched by legal experts who then certify and sometimes
insure that the buyer will have a clear title to the purchased property.
If mortgages referenced in recorded deeds are forged, the recorded deeds are
thereby corrupted. Present owners accordingly do not have clear titles to the
purchased real estate. This includes John and Jane Doe now living in their home
at 123 Main Street. It also includes Fannie Mae, Freddie Mack, Goldman Sachs,
Bank of America, JP Morgan, and most of the other megabanks inside and outside
the United States. All are waiting for former owners to file lawsuits claiming
damages because of forged documents (including lawsuits from owners who simply
abandoned their houses because they could not make the mortgage payments and
those that got forced out by foreclosure proceedings).
The FDIC claims that probably the only way out of this mess is for the large
banks and brokerages who in one way or another are responsible for the document
forgeries to pay tens of billions into a "clean up fund" to be administered by
the government to make claimants accept cash settlements and relinquish their
rights to sue over forged or missing documents. This may be the only way to
clear the titles to registered deeds, including the deeds on millions of empty
homes that now cannot be sold until the titles are cleared of the forged
recorded paperwork.
A Summary of How This Mess Came About
1.
The main cause of this mess roots back to a time when banks and mortgage
companies that initially approve mortgage contracts commenced selling all their
mortgage investments to downstream investors like Fannie Mae, Freddie Mac, Bear
Stearns, Lehman Brothers, Merrill Lynch, and virtually all the large
international banks and Wall Street brokerages. Some like Bank of America did
not directly buy many of these downstream mortgages but later inherited millions
of mortgages such as when Bank of America bought the troubled Countrywide and JP
Morgan bought the troubled Wachovia as part of the TARP deals engineered by the
U.S. Treasury Department. It took until 2011 for the government to finally
mandate that original lenders must retain "some skin" in the mortgages sold
downstream (currently at least 5% of the financial risk skin). That was not the
case when the subprime bubble burst in 2008.
2.
Another leading cause was the common 1990s practice of issuing subprime interest
rate mortgages where interest in the early years was below prime rates with a
clause that higher rates would eventually kick in several years down the road.
Even current owners were tempted to abandon their fixed rate mortgages and
refinance with subprime mortgages with the intent of flipping their homes before
the higher rates kicked in with payments they could not afford. The plan was to
sell their houses at huge gains and move up the hill to bigger houses and better
neighborhoods. All of this was predicated on the assumption that the price
bubble in real estate would never burst. But in 2008 it did burst and millions
of home owners could no longer make their mortgage payments when the subprime
rates gave way to double-digit rates. Low income people defaulted in droves, but
higher income people also defaulted. Some very high income people bought
mansions on the hill at subprime rates hoping to turn those mansions over for
enormous profits as long as housing prices in America kept going up and up. CBS
Sixty Minutes captured the essence of what happened when the bubble burst.
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards"
---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
3.
The eventual downstream owners of these risky subprime mortgages invented a way
of diversifying default risk by putting together and selling portfolios of
mortgages known as Collateralized Debt Obligation portfolios. Buyers included
many wealthy investors in the Middle East and Asia. Forest Gump describes a CDO
portfolio as a box of chocolates with mostly small pieces of good mortgages with
a few turds thrown in (small pieces of mortgages are likely to go into default
by owners who cannot afford their mortgage payments). Note that a CDO portfolio
does not 100% of any mortgage investment. Rather it contains like a 1% piece of
a mortgage spread over 100 CDO portfolios. This is important because this
slicing and dicing shredding of financial risk is where much of the original
paperwork got lost.
Mortgage Backed Securities are like boxes of
chocolates. Criminals (bankers and brokers)
on Wall Street and one particular U.S. Congressional Committee stole a few
chocolates from the boxes and replaced them with turds. Their criminal buddies
at Standard & Poors rated these boxes AAA Investment Grade chocolates. These
boxes were then sold all over the world to investors. Eventually somebody bites
into a turd and discovers the crime. Suddenly nobody trusts American chocolates
anymore worldwide. Hank Paulson now wants the American taxpayers to buy up and
hold all these boxes of turd-infested chocolates for $700 billion dollars until
the market for turds returns to normal. Meanwhile, Hank's buddies, the Wall
Street criminals who stole all the good chocolates are not being investigated,
arrested, or indicted. Momma always said: "Sniff the chocolates first Forrest."
Things generally don't pass the smell test if they came from Wall Street or from
Washington DC.
Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14, 2010. Both videos feature
one of my favorite authors of all time, Michael Lewis, who hhs been writing
(humorously with tongue in cheek) about Wall Street scandals since he was a bond
salesman on Wall Street in the 1980s. The other person featured on in these
videos is a one-eyed physician with Asperger Syndrome who made hundreds of
millions of dollars anticipating the collapse of the CDO markets while the
shareholders of companies like Merrill Lynch, AIG, Lehman Bros., and Bear
Stearns got left holding the empty bags.
4.
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30, 2009
---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this
video (a little over 5 Mbs) using a free updated version of RealMedia ---
Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP
Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
5.
So where does mortgage/deed forgeries enter into the picture.
It turns out that the Wall Street brokerage houses and megabanks that ended up
downstream with the mortgages and then sliced and diced them into new
securitization instruments called Mortgage Backed Obligation (MBO) portfolios
completely lost track of the millions original mortgage paper work that they
were shredding into millions of MBOs. Then when owners defaulted on their
original subprime mortgages the megabanks and brokerages, gasp, could not find
the original paperwork. Even worse, when responsible homeowners sold their homes
and wanted to pay off their mortgages the megabanks and brokerages also could
not find the original paperwork.
Horrors!
What's a megabank to do when new deeds have to be recorded and the current
recorded deeds/mortgages cannot be located. What the megabanks essentially
did was forge new paperwork. Not wanting to implicate their own employees in
this fraud they hired sleazy mortgage servicing companies who in turn hired high
school kids at minimum wage to forge up thousands of names per hour (including
forged notary public signatures). The megabanks now claim they did not know
these forgeries were taking place, but if you believe this I've got some ocean
front property in Arizona and the Brooklyn Bridge that I would like to sell to
those megabanks.
To see how all of this forgery really took place watch the following:
Mortgage paperwork mess: the next housing shock?" CBS Sixty Minutes,
April 3, 2011 ---
http://www.cbsnews.com/stories/2011/04/01/60minutes/main20049646.shtml
If there was a question about whether we're headed
for a second housing shock, that was settled last week with news that home
prices have fallen a sixth consecutive month. Values are nearly back to
levels of the Great Recession. One thing weighing on the economy is the huge
number of foreclosed houses.
Many are stuck on the market for a reason you
wouldn't expect: banks can't find the ownership documents.
Who really owns your mortgage?
Scott Pelley explains a bizarre aftershock of the U.S. financial
collapse: An epidemic of forged and missing mortgage documents.
It's bizarre but, it turns out, Wall Street cut
corners when it created those mortgage-backed investments that triggered the
financial collapse. Now that banks want to evict people, they're unwinding
these exotic investments to find, that often, the legal documents behind the
mortgages aren't there
Continued in article
6.
So where does this leave us now and why is this so serious?
This leaves us with millions of corrupted deed registries containing
references to forged documents. Current owners do not have clear titles to their
properties, including megabanks holding corrupted titles to vacant homes.
Currently 13% of all the houses in America are vacant, including millions of
double wides in mobile home parks and millions of mansions in every county of
the United States. Owners, including megabanks, of these vacant houses do not
have clear title do to forged documents. The houses cannot be sold with
corrupted titles such that they sit vacant year after year.
Mold takes hold in the walls and ceilings of vacant homes that are not
properly cooled and dehumidified in hot summer months and warmed in frigid
winter months. The mold spreads more and more until it reaches toxic levels
where real estate inspectors will not allow the homes to be sold. The bull
dozers have to push through those double wides and even those mansions on the
hill.
Now lawyers are hovering like vultures to commence the lawsuits on behalf of
former owners such as owners thrown out of foreclosed houses and new owners who
do not have clear titles to properties purchased in good faith ---
http://wgroup.ning.com/
The FDIC is proposing a forged document cleanup fund where the megabanks
responsible for using forged paperwork put up tens of billions of dollars into a
fund to pay off the damaged former owners so that titles can be cleared on
millions of homes now having corrupted deeds on file due to those forgeries.
It's a little like how the BP fund in being administered for oil spill damages
to employees and businesses along the Gulf Coast, only the forged mortgage fund
has to be much, much, much larger.
What a mess!
Charles Ferguson via
MIT World (H/T
Jesse's Cafe Americain).
"Video: The Financial Crisis, the Recession, and the American Political Economy:
A Systemic Perspective," by Nadine Sabai, Sleight of Hand, January 13, 2011 ---
http://sleightfraud.blogspot.com/2011/01/video-financial-crisis-recession-and.html
Ferguson finds galling both government apathy in
regulating and in prosecuting high-end white collar crime, but perceives the
reason: a financial services industry that “as it rapidly consolidated and
concentrated became the dominant source not only of corporate profits but
campaign contributions and political funding in the U.S.” Evidence for
unrestrained financial power lies in the fact that the government response
to the crisis has been engineered by Wall Street insiders intent on shoring
up firms too big to fail. Ferguson cites as well “corruption of the
economics discipline,” the rising role of money in politics, and the
increasing concentration of wealth in the hands of a few.
The dominance of a single industry constitutes a
deep change and danger for America, believes Ferguson. The nation “has
evolved a political duopoly where two political parties agree on things
related to finance and money.” Without a political structure immune to such
influence, Ferguson sees little likelihood of challenging the interests of
the financial giants.
Bob Jensen's Rotten to the Core threads for bankers are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"TARP Was No Win for the Taxpayers : Treasury's claim that the bank
bailouts will return a profit ignores the other, more costly programs enabling
the banks to repay their TARP funds," by Paul Atkins, Mark McWatters, and
Kenneth Troske, The Wall Street Journal, March 17, 2011 ---
http://online.wsj.com/article/SB10001424052748703899704576204383282043422.html?mod=djemEditorialPage_t
Today the Senate Banking Committee will explore the
Troubled Asset Relief Program (TARP). Almost 30 months after its birth, TARP
is far from dead. More than 550 banks, AIG, GM, Chrysler and others still
have approximately $160 billion of taxpayer money outstanding.
Even so, the administration would have us believe
that TARP has been a success because it supposedly alleviated the financial
crisis and is (so far) being paid back at an apparent profit for taxpayers.
Perhaps because he helped invent TARP before he joined the Obama
administration, Treasury Secretary Timothy Geithner has called TARP the
"most effective government program in recent memory."
Treasury's view is misleading. First, it hides the
full story of the government's financial crisis effort, of which TARP is but
a minor part. Moreover, Treasury has not been content using rhetoric alone
to try to put TARP in the best light. The Special Inspector General for TARP
criticized Treasury in October for inadequately disclosing a change in its
valuation methodology that reduced a $45 billion loss in AIG to $5 billion,
making TARP losses appear smaller than they really are. This data
manipulation is only part of a much larger problem with Treasury's
representations regarding the supposed success of the bank bailout payments
that lie at the heart of TARP.
The focus on repayment fails to consider the huge
taxpayer costs from non-TARP programs that directly and indirectly enabled
many of the large banks to repay their TARP funds. These intertwined
programs, operated by the Treasury and the Federal Reserve, dwarf the size
of TARP and lack its accountability.
The financial crisis was born in the housing bubble
caused by the policies of Fannie Mae and Freddie Mac, the two bankrupt
government-sponsored entities (GSEs) charged with buying and packaging
mortgages into mortgage-backed securities (MBS). TARP banks own billions of
dollars worth of MBS and have remained liquid in part because the Federal
Reserve has bought more than $1.1 trillion of these GSE-guaranteed MBS in
the securities markets—all outside TARP.
The Fed purchased the MBS at fair market value, but
this value reflects Treasury's bailout and continued support of the GSEs—also
done outside of TARP with taxpayer money. Had the GSEs failed, TARP
recipients probably would have been stuck with these MBS, writing them down
at significant loss. Their ability to pay back TARP funding would have been
hurt, and they might have had to obtain more TARP funds or go bust.
So the taxpayer-backed GSE guarantee enables the
Fed to prop up the market with taxpayer funds, in turn allowing the TARP
banks to "repay" their TARP funds. The bailout of the GSEs by Treasury thus
shifts potential losses from TARP to other programs that have less oversight
and public scrutiny. Any evaluation of TARP's success must take into account
the interaction among all government programs designed to prop-up the
financial system, and the shifting of costs among these programs.
The Congressional Budget Office estimates that
Treasury's bailout of the GSEs will cost the taxpayers approximately $380
billion through fiscal year 2021. If only one-fourth of CBO's estimate
ultimately benefits TARP recipients and other financial institutions,
taxpayers will have provided a subsidy to these institutions of
approximately $100 billion, which is not accounted for under TARP.
Also seldom mentioned are future costs resulting
from using TARP funds to rescue "systemically important" financial and other
firms. TARP exacerbates the "too big to fail" phenomenon by targeting much
of its funding toward large banks and automobile firms, solidifying the
market's belief in an implicit guarantee from the government for these
firms. As credit-rating agencies have recognized, these large firms can
borrow much more cheaply than their small-enough-to-fail competitors, which
will lead to less competition, a more concentrated financial sector, and
higher prices paid by consumers.
In addition, creating larger, more systemically
important financial firms increases the likelihood of future financial
crises because these firms have an incentive to invest in riskier projects
as a result of the implicit government guarantee. The additional costs borne
by consumers in the form of higher prices for financial services and the
additional costs that result from future financial crises need to be
included in any accounting of the costs of the TARP.
TARP was never where the real action was happening.
In fact, other Fed and FDIC programs added another $2 trillion of taxpayer
money at risk to the 19 stress-tested banks alone, on top of the $1.1
trillion of MBS purchased by the Fed. TARP is but one-eighth of that total.
The government's efforts inside and outside of TARP
have sown the seeds for the next crisis and, unfortunately, last year's
2,319-page Dodd-Frank Act does nothing to fix these problems. Treasury must
be more transparent regarding TARP. The real myth that the Treasury
secretary should dispel is that TARP is a big win for the taxpayer.
Mr. Atkins was a member of the Congressional Oversight Panel from
2009-2010. Messrs. McWatters and Troske are current members of the panel.
Bob Jensen's threads on the Bailout of Banksters and the Greatest Swindle
in the History of the World are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
"Which of These Banks Was 2010's Most Shameless Corporate Outlaw?" by
Richard Escow, Huffington Post, December 30, 2010 ---
http://www.huffingtonpost.com/rj-eskow/which-of-these-banks-was_b_802887.html
Their collective rap sheet includes fraud, sex
discrimination, collusion to bribe public officials... even laundering drug
money for Mexican drug cartels. One of them is accused of ripping off some
nuns! None of this criminal behavior has stopped them from sulking over a
presidential slight. Let's review the record for these corporate
malefactors, and then decide:
The Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
"The Feds Stage a Sideshow, While the Big Tent Sits Empty," by Jesse
Eisinger, The New York Times, December 8, 2010 ---
http://dealbook.nytimes.com/2010/12/08/where-are-the-financial-crisis-prosecutions/
Thank you Nadine Sabai for the heads up.
Jesse Eisinger is a reporter for ProPublica, an independent, nonprofit
newsroom that produces investigative journalism in the public interest.
You may have noticed that prosecutors are in
something of a white-collar slump lately.
The stock options backdating prosecutions have
largely been a bust, and not because it wasn’t a true scandal. The
Securities and Exchange Commission and the Justice Department investigated
more than 100 companies. Over 100 took accounting restatements. Yet only a
handful of executives went to prison, with some prominent cases fizzling
out. Prosecutors also stumbled in other high priority corporate fraud
prosecutions, like the KPMG tax shelter and the stock-exchange specialists
cases.
The most spectacular prosecutorial flameout was the
case against the Bear Stearns hedge fund managers, including Ralph Cioffi.
The consequences of that disaster are still reverberating. The United States
attorney’s office in Brooklyn rushed to haul low-level executives in front
of a jury based on a few seemingly incriminating e-mails. The defense was
easily able to convince jurors that these represented only out-of-context
glimpses of fear as markets swooned, not a conspiracy to mislead.
Now we have a supposedly new push: the insider
trading scandal.
The United States attorney in Manhattan, Preet
Bharara, and United States Attorney General Eric H. Holder Jr. are hyping
their efforts. “Illegal insider trading is rampant and may even be on the
rise,” Mr. Bharara pronounced in a speech in October. The feds are raiding
hedge funds and publicly celebrating their criminal investigations related
to insider trading.
The story line is that Wall Street now lives in
fear. Hedge fund managers’ phones may be tapped, any stray remark is suspect
and old trades are being exhumed so that the entrails can be examined.
In fact, plenty of people on Wall Street are happy
about the investigation. The ones with clean consciences like the idea that
the world of special access to favorable tips is being cleaned up.
But others are pleased for a different reason: They
realize the investigation is a sideshow.
All the hype carries an air of defensiveness.
Everyone is wondering: Where are the investigations related to the financial
crisis?
John Hueston, a former lead Enron prosecutor,
wonders, “Have they committed the resources in the right place? Do these
scandals warrant apparent national priority status?”
Nobody from Lehman, Merrill Lynch or Citigroup has
been charged criminally with anything. No top executives at Bear Stearns
have been indicted. All former American International Group executives are
running free. No big mortgage company executive has had to face the law.
How about someone other than Fabrice Tourre, known
as the Fabulous Fab, at Goldman Sachs? How could the Securities and Exchange
Commission merely settle with Countrywide’s Angelo Mozilo, and for a
fraction of what he made as chief executive?
The world was almost brought low by the American
banking system, and we are supposed to think that no one did anything wrong?
The most common explanation from lawyers for this
bizarre state of affairs is that it’s complicated to make criminal cases in
corporate fraud. Getting a case that shows the wrongdoer acted with intent —
and proving it to a jury — is difficult.
But, of course, Enron was complicated, too, and
prosecutors got the big boys. Ken Lay was found guilty (he died before he
served his time). Jeff Skilling is in prison, though the end result was
bittersweet for prosecutors when much of his conviction was overturned by
the Supreme Court. Bernie Ebbers of WorldCom and Dennis Kozlowski of Tyco
are wearing stripes.
Continued in article
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14, 2010. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.
The major lessons of videos 2 and 3 went over the head of my wife. I think
that viewers need to do a bit of homework in order to fully appreciate those
videos. Here's what I recommend before viewing Videos 2 and 3 if you've not been
following details of the 2008 Wall Street collapse closely:
This
is not necessary to Videos 2 and 3, but to really appreciate what suckered
the Wall Street Banks into spreading the poison, you should read about how
they all used the same risk diversification mathematical function --- David
Li's Gaussian Copula Function:
Can the
2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked
like an unambiguously positive breakthrough, a piece of financial technology
that allowed hugely complex risks to be modeled with more ease and accuracy
than ever before. With his brilliant spark of mathematical legerdemain, Li
made it possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond investors and Wall Street
banks to ratings agencies and regulators. And it became so deeply
entrenched—and was making people so much money—that warnings about its
limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors felt so safe with the
triple-A tranches was that they believed there was no way hundreds of
homeowners would all default on their loans at the same time. One person
might lose his job, another might fall ill. But those are individual
calamities that don't affect the mortgage pool much as a whole: Everybody
else is still making their payments on time.
But not all calamities are individual, and tranching still hadn't solved all
the problems of mortgage-pool risk. Some things, like falling house prices,
affect a large number of people at once. If home values in your neighborhood
decline and you lose some of your equity, there's a good chance your
neighbors will lose theirs as well. If, as a result, you default on your
mortgage, there's a higher probability they will default, too. That's called
correlation—the degree to which one variable moves in line with another—and
measuring it is an important part of determining how risky mortgage bonds
are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The “math error” might truly be have been an error or it might have simply
been a gamble with what was perceived as miniscule odds of total market
failure. Something similar happened in the case of the trillion-dollar
disastrous 1993 collapse of Long Term Capital Management formed by Nobel
Prize winning economists and their doctoral students who took similar
gambles that ignored the “miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question
is whether the failure is ignorance in model building or risk taking using
the model?
- You should understand how the Wall Street Banks used the big credit
rating agencies to give AAA ratings to sell CDO bonds that should've instead
been rated as junk bonds. Michael Lewis in Video 2 seems to think the credit
rating agencies were just naive and were manipulated by the Wall Street
bankers. I'm more inclined to think the CRAs were knowingly and greedily
part of the frauds ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
CRA ---
http://en.wikipedia.org/wiki/Credit_rating_agency
- You should also understand what a credit default swap (CDS) is and how
Video 2 above keeps calling it unregulated credit "insurance." Essentially,
this is how some banks, particularly Goldman Sachs was "insuring" against
the value collapse of the poisoned CDOs they were creating and selling. The
"insurance" company brokering the AIG credit default swaps was AIG.
CDS ---
http://en.wikipedia.org/wiki/Credit_default_swap
Here's how they worked ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
- Understand how some Wall Street Banks were better connected in the
Treasury Department and Federal Reserve than other banks. In particular,
Goldman Sachs alumni were practically in charge while
Hank
Paulson (former Goldman Sachs CEO) was U.S. Treasury Secretary. Why did
Paulson save Goldman Sachs and let others watch their shareholders get wiped
out like Lehman Bros., Bear Stearns, Merrill Lynch, etc.? Understand why
saving Goldman Sachs with TARP money entailed saving AIG since saving AIG
was crucial to paying off the CDS insurance.
- For the above three videos it is not necessary to understand the lack of
professionalism (at best) among the bank auditors that never provided any
warning that thousands of banks that failed had badly underestimated bad
debts and overvalued poisoned loan portfolios. The above videos do not get
into the failings of the CPA auditors in this regard, but you can read about
these failings at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
For more on the inside track of all of this I highly recommend Janet
Tavakili's great book entitled Dear Mr. Buffett (Wiley, 2009). Videos 1-3
will help you understand some of the technicalities in her fantastic and very
depressing book.
Here are some of the take-aways from the three CBS videos above:
- The root cause of the 2008 meltdown of Wall Street was really the
failings on Main Street where the poison was first added to mortgages by
Main Street brokers who were willing to broker mortgages (including
re-financings) that were bound to be defaulted. Note that the problem was
not just in brokering mortgages for poor people (Barney's Rubble). Poisoned
mortgages were also being written for higher income people who were
borrowing beyond their means for those four-car garage dream houses with
swimming pools and marble floors. In other words the root cause was the
ability to broker a poisoned mortgage and then sell it to Freddie Mack,
Fannie Mae, and the Wall Street Banks.
- The next cause of the 2008 meltdown was David Li's risk diversification
formula that all the Wall Street banks were using on the theory that default
risk of mortgage investments could be diversified by crumbling mortgage
cookies into crumbs that were reassembled into thousands of CDOs (each CDO
having only a small crumble of each mortgage's poison). With the blessings
of credit rating agencies, these CDO bonds were then sold as AAA-rated when
in fact they were worse than junk.
- Videos 2 and 3 above stress how the underlying cause of allowing a
one-eyed physician with Asperger Syndrome make hundreds of millions dollars
by detecting the collapse of the CDO values way in advance of the Wall
Street pros is that the Wall Street pros were paid not to look for the CDO
risks. And the bank CDO sellers who perhaps did understand the risks were
willing to screw their eimployers (such as Lehman, Bear Stearnes, etc.)
because it was so easy to steal hundreds of millions from these employers
who were even willing and still are willing to pay them bonuses in spite of
their thefts.
- After the government bailed them out, the Wall Street banks that
survived because of the government's bailout are still paying out billions
in bonuses. One of my favorite quotes in Video 2 goes something like:
"If Goldman does not pay its best people billions in bonuses they will quit
and go to JP Morgan, and if JP Morgan does not pay its best people billions
in bonuses they will quit and go to Goldman." Meanwhile the taxpayers got
screwed out of nearly a trillion dollars.
- Video 2 leaves us with the impression that Wall Street is no longer a
value-added part of U.S. economy. The TARP in reality is truly the
Greatest Swindle in the History of the World
--- (scroll down )
Meanwhile the surviving swindlers and their credit rating agencies and their
auditors are still thriving as if nothing has happened. Opps! I forgot that
the credit rating agencies and auditing firms still have some multi-billion
shareholder lawsuits pending that do threaten their survival. But a lot of
big swindlers still have their yachts thanks to Hank and Ben and Tim.
I highly recommend the outstanding and often humorous books of both
Michael Lewis and Frank Partnoy.
My timeline of these books and the scandals they write about can be found at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Related CBS Sixty Minutes videos are as follows:
I also recommend watching all the David Walker videos on YouTube.
Watch them and weep.
Ketz Me If You Can
"Triumph of Banking," by J. Edward Ketz, SmartPros, January 2011
---
http://accounting.smartpros.com/x71113.xml
My, how the year 2010 ended with a bang! First,
Attorney General Andrew Cuomo initiated a fraud suit against Ernst & Young,
and then the Financial Accounting Foundation named Leslie Seidman as the
chair of the FASB. These events culminate a return to power and prestige for
the investment banking industry, and we should salute the triumph of
banking.
Banks have not been so fortunate during the
previous five to ten years, when history was not so kind to them. But the
industry has fought back virulently both in direct and covert ways. They
employed the bully pulpit to argue the points they wished to advance, they
courted members of Congress and the White House, and they issued innuendo
after innuendo. And the battlefield shows their victory and the spoils they
have earned.
Recent troubles were in a sense triggered by the
CDO racketeering by the banking industry during the last five to ten years,
though I suppose I should be more genteel and call it the collapse of the
CDO business and the real estate market. More accurately, the mayhem goes
back at least to the days of Enron, when the bankers had to minimize the
damage caused by their enabling Lay and Skilling and their underlings to
commit accounting and securities frauds. Of course, it included many other
corporations, but part of the public relations battle was to focus the
dysfunctions exclusively on Enron, which allowed bankers and corporate
managers to claim it was just a few bad apples.
Even with Enron it was a battle, but the industry
mostly kept the casualties to a few fines and court settlements. It is a
minor miracle that the executives at Merrill Lynch avoided prison,
especially given the fraud involving the Nigerian barges.
More recently, when bankers were at the verge of
swallowing poison of their own making, they convinced members of Congress
and the White House that this was a societal problem, thus it would be just
and fair to rescue the banks from economic collapse because it would help
the common man. Amazingly the populace accepted such drivel and Washington
assisted them with massive bailouts. Such wealth transfers from the middle
class to the rich are unparalleled in history.
It is instructive that the banking industry was
able to convince many that the difficulties were actually systemic problems.
The beauty of this positioning is that it absolved the banks from most of
the blame for the catastrophe. Further, it is important to notice that the
bankers were able to push most of the flotsam and jetsam onto Lehman
Brothers alone, similar to their interpretation of the events of 2001-2002.
By focusing exclusively on Lehman Brothers, the spokesmen for the banks
could assert that the industry’s contribution to the 2008 downfall was
limited to a few bad apples at this one institution.
But, the bankers really showed their agility when
public opinion opposed the granting of colossal bonuses to top managers. The
industry first got cheap loans from the government as well as the ability to
unload so-called “toxic” assets as the idiots at the Fed paid top dollar for
the junk. Then the industry quickly paid off its debts to the federal
government, so the poor executives could enjoy the millions in bonuses.
Amid this posturing, some politicians wanted to
make sure the banks were solvent and devised stress tests to evaluate the
banks. The industry again displayed amazing dexterity by manipulating the
regulators so that they devised feeble stress tests that Lehman Brothers
could pass even after its bankruptcy. These felicitous results calmed the
public by relieving any fears that the banks were weak and illiquid. Even if
they were.
Bankers clamored against fair value accounting,
claiming that it was behind the 2008 collapse. That this is untrue is hardly
important. That the banks were gung ho in favor of fair value accounting
almost a decade ago when fair value gains added substantially to the banks’
income statement seems a curiosity lost on many observers. Bankers reversed
their position only when the gains turned into losses, and they have been
zealously against fair value accounting ever since. The work paid off when
the FASB on April 2, 2009 caved in to the demands of bankers and allowed
them favorable treatments to minimize any losses on their “toxic” assets.
And in this turmoil, it is remarkable that banks
have avoided any significant regulation of derivatives. The CDOs that got us
into this mess have been absolved by the priests within the bank industry
and their minions in Washington. Of course, it helps to have the Treasury
Secretary and the Fed Chairman in your back pockets.
Continued in article
Jensen Comment
I join my friend Frank Partnoy in singing a loud chorus for more regulation of
derivatives ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
The Pentagon and the IRS are Deemed Unauditable by the GAO. What About
the FED?
"Alan Grayson On The Passage Of The Partial "Audit The Fed" Amendment,"
by Alan Grayson, Zero Hedge, May 12, 2010 ---
http://www.zerohedge.com/article/alan-grayson-passage-partial-audit-fed-amendment
The Senate just voted, 96-0, to audit the Federal
Reserve. Soon, we will know what the Federal Reserve did with the trillions
of dollars that it handed out during the financial crisis.
A few months ago, such a vote would have been
unthinkable. One senior Treasury official claimed he would fight to stop an
audit 'at all costs'. Senator Chris Dodd predicted that an audit would spell
economic doom, while Senator Judd Gregg attacked accountability for the Fed
as "pandering populism".
Today, both the Treasury Department and Senator
Dodd support this amendment. As for Judd Gregg, he was just on the floor of
the Senate discussing -- of all people -- 19th century populist Presidential
candidate William Jennings Bryan.
What happened?
People Power is what happened. We built a coalition
of people on the right and the left, ordinary citizens and economists,
ex-regulators and politicians, all with one question for which we demanded
an answer: "What happened to our money?"
No longer can Ben Bernanke get away with saying, "I
don't know."
Now, we're going to know who got what, and why.
Releasing this information will show that the
Federal Reserve's arguments for secrecy are -- and have always been-- a
ruse, to cover up the handing out of hundreds of billions of dollars like
party favors to the Wall Street favorites who brought the American economy
to the brink of ruin.
But our work isn't quite done. The Senate audit
provision isn't as strong as what we passed in the House. The Senate
provision has only a one-time audit, whereas what we passed in the House
would allow audits going forward. There will be a conference committee that
will merge the provisions from the two bills.
The need for audits and oversight over Fed handouts
going forward is great. The financial crisis isn't over, and neither are the
Fed's secret bailouts. Earlier this week, the Federal Reserve announced it
was going underwrite the Greek bailout by lending dollars to the central
banks of Europe, England, and Japan. The loans may never be paid back, the
Fed accepts the risk that the dollar will strengthen in the meantime, and
the interest rate charged by the Fed is very likely at below-market rates.
So such loans are in effect just a subsidy, to bail out foreigners.
The Fed has not been chastened. It is bolder and
more of a rogue actor than ever. It's clear that without full audit
authority going forward, the Fed will continue to give out "foreign aid"
without Congressional or even Executive permission.
And it will do so in secret.
So we will be fighting on to get a full audit from
the conference committee.
But let's not lose sight of what we have
accomplished so far - real independent inquiry into the Fed, and its
incestuous relationships with Wall Street banks. For the first time ever.
Our calls, emails, lobbying, blogging, and support
really mattered. We made it happen.
Today, we beat the Fed.
Courage,
Alan Grayson
Jensen Comment
It's important to trace where the bailout funds eventually ended up after being
laundered. For example, billions went to AIG that in turn sent it on to Goldman
Sachs. Without the Bailout, Goldman Sachs would've been left holding the empty
bag.
"Goldman Sachs accused of fraud by US regulator SEC," BBC News,
April 16, 2010 ---
http://news.bbc.co.uk/2/hi/business/8625931.stm
Link forwarded by Roger Collins
Goldman Sachs, the Wall Street powerhouse, has been
accused of defrauding investors by America's financial regulator.
The Securities and Exchange Commission (SEC)
alleges that Goldman failed to disclose conflicts of interest.
The claims concern Goldman's marketing of sub-prime
mortgage investments just as the US housing market faltered.
Goldman rejected the SEC's allegations, saying that
it would "vigorously" defend its reputation.
News that the SEC was pressing civil fraud charges
against Goldman and one of its London-based vice presidents, Fabrice Tourre,
sent shares in the investment bank tumbling 12%.
The SEC says Goldman failed to disclose "vital
information" that one of its clients, Paulson & Co, helped choose which
securities were packaged into the mortgage portfolio.
These securities were sold to investors in 2007.
But Goldman did not disclose that Paulson, one of
the world's largest hedge funds, had bet that the value of the securities
would fall.
The SEC said: "Unbeknownst to investors, Paulson...
which was posed to benefit if the [securities] defaulted, played a
significant role in selecting which [securities] should make up the
portfolio."
"In sum, Goldman Sachs arranged a transaction at
Paulson's request in which Paulson heavily influenced the selection of the
portfolio to suit its economic interests," said the Commission.
Housing collapse
The whole building is about to collapse anytime
now... Only potential survivor, the fabulous Fabrice...
Email by Fabrice Tourre The SEC alleges that
investors in the mortgage securities, packaged into a vehicle called Abacus,
lost more than $1bn (£650m) in the US housing collapse.
Mr Tourre was principally behind the creation of
Abacus, which agreed its deal with Paulson in April 2007, the SEC said.
The Commission alleges that Mr Tourre knew the
market in mortgage-backed securities was about to be hit well before this
date.
The SEC's court document quotes an email from Mr
Tourre to a friend in January 2007. "More and more leverage in the system.
Only potential survivor, the fabulous Fab[rice Tourre]... standing in the
middle of all these complex, highly leveraged, exotic trades he created
without necessarily understanding all of the implications of those
monstrosities!!!"
Goldman denied any wrongdoing, saying in a brief
statement: "The SEC's charges are completely unfounded in law and fact and
we will vigorously contest them and defend the firm and its reputation."
The firm said that, rather than make money from the
deal, it lost $90m.
The two investors that lost the most money, German
bank IKB and ACA Capital Management, were two "sophisticated mortgage
investors" who knew the risk, Goldman said.
And nor was there any failure of disclosure,
because "market makers do not disclose the identities of a buyer to a seller
and vice versa."
Calls to Mr Tourre's office were referred to the
Goldman press office. Paulson has not been charged.
Asked why the SEC did not also pursue a case
against Paulson, Enforcement Director Robert Khuzami told reporters: "It was
Goldman that made the representations to investors. Paulson did not."
The firm's owner, John Paulson - no relation to
former US Treasury Secretary Henry Paulson - made billions of dollars
betting against sub-prime mortgage securities.
In a statement, Paulson & Co. said: "As the SEC
said at its press conference, Paulson is not the subject of this complaint,
made no misrepresentations and is not the subject of any charges."
'Regulation risk'
Goldman, arguably the world's most prestigious
investment bank, had escaped relatively unscathed from the global financial
meltdown.
This is the first time regulators have acted
against a Wall Street deal that allegedly helped investors take advantage of
the US housing market collapse.
The charges come as US lawmakers get tough on Wall
Street practices that helped cause the financial crisis. Among proposals
being considered by Congress is tougher rules for complex investments like
those involved in the alleged Goldman fraud.
Observers said the SEC's move dealt a blow to
Goldman's standing. "It undermines their brand," said Simon Johnson, a
professor at the Massachusetts Institute of Technology and a Goldman critic.
"It undermines their political clout."
Analyst Matt McCormick of Bahl & Gaynor said that
the allegation could "be a fulcrum to push for even tighter regulation".
"Goldman has a fight in front of it," he said.
"Goldman CDO case could be tip of iceberg,"
by Aaron Pressman and Joseph Giannone, Reuters, April 17, 2010 ---
http://in.reuters.com/article/businessNews/idINIndia-47771020100417
The case against Goldman Sachs Group Inc over a
2007 mortgage derivatives deal it set up for a hedge fund manager could be
just the start of Wall Street's legal troubles stemming from the subprime
meltdown.
The U.S. Securities and Exchange Commission charged
Goldman with fraud for failing to disclose to buyers of a collaterlized debt
obligation known as ABACUS that hedge fund manager John Paulson helped
select mortgage derivatives he was betting against for the deal. Goldman
denied any wrongdoing.
The practice of creating synthetic CDOs was not
uncommon in 2006 and 2007. At the tail end of the real estate bubble, some
savvy investors began to look for more ways to profit from the coming
calamity using derivatives.
Goldman shares plunged 13 percent on Friday and
shares of other financial firms that created CDOs also fell. Shares of
Deutsche Bank AG ended down 9 percent, Morgan Stanley 6 percent and Bank of
America, which owns Merrill Lynch, and Citigroup each declined 5 percent.
Merrill, Citigroup and Deutsche Bank were the top
three underwriters of CDO transactions in 2006 and 2007, according to data
from Thomson Reuters. But most of those deals included actual
mortgage-backed securities, not related derivatives like the ABACUS deal.
Hedge fund managers like Paulson typically wanted
to bet against so-called synthetic CDOs that used derivatives contracts in
place of actual securities. Those were less common.
The SEC's charges against Goldman are already
stirring up investors who lost big on the CDOs, according to well-known
plaintiffs lawyer Jake Zamansky.
"I've been contacted by Goldman customers to bring
lawsuits to recover their losses," Zamansky said. "It's going to go way
beyond ABACUS. Regulators and plaintiffs' lawyers are going to be looking at
other deals, to what kind of conflicts Goldman has."
An investigation by the online site ProPublica into
Chicago-based hedge fund Magnetar's 2007 bets against CDO-related debt also
turned up allegations of conflicts of interest against Deutsche Bank,
Merrill and JPMorgan Chase.
Magnetar has denied any wrongdoing. Deutsche Bank
declined to comment. Merrill and JPMorgan had no immediate comment.
The Magnetar deals have spawned at least one
lawsuit. Dutch bank Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., or
Rabobank for short, filed suit in June against Merrill Lynch over Magnetar's
involvement with a CDO called Norma.
"Merrill Lynch teamed up with one of its most
prized hedge fund clients -- an infamous short seller that had helped
Merrill Lynch create four other CDOs -- to create Norma as a tailor-made way
to bet against the mortgage-backed securities market," Rabobank said in its
complaint filed on June 12 in the Supreme Court of New York.
The two matters are unrelated and the claims today
are not only unfounded but were not included in the Rabobank lawsuit filed
nearly a year ago, said Merrill Lynch spokesman Bill Halldin.
Rabobank was a lender, not an investor, he added.
Regulators at the SEC and around the country said
they would be investigating other deals beyond ABACUS.
We are looking very closely at these products and
transactions," Robert Khuzami, head of the SEC's enforcement division, said.
"We are moving across the entire spectrum in determining whether there was
(fraud)."
Meanwhile, Connecticut Attorney General Richard
Blumenthal said in a statement his office had already begun a preliminary
review of the Goldman case.
"A key question is whether this case was an
isolated incident or part of a pattern of investment banks colluding with
hedge funds to purposely tank securities they created and sold to unwitting
investors," Connecticut Attorney General Richard Blumenthal said in a
statement.
"Accused of Deception, Citi Agrees to Pay $285 Million," by Edward
Wyatt, The New York Times, October 19, 2011 ---
http://www.nytimes.com/2011/10/20/business/citigroup-to-pay-285-million-to-settle-sec-charges.html?hp
Citigroup agreed to pay $285 million to settle
charges that it misled investors in a $1 billion derivatives deal tied to
the United States housing market, then bet against investors as the housing
market began to show signs of distress, the Securities and Exchange
Commission said Wednesday.
The S.E.C. also brought charges against a Citigroup
employee who was responsible for structuring the transaction, and brought
and settled charges against the asset management unit of Credit Suisse and a
Credit Suisse employee who also had responsibility for the derivative
security.
¶ The S.E.C. said that the $285 million would be
returned to investors in the deal, a collateralized debt obligation known as
Class V Funding III. The commission said that Citigroup exercised
significant influence over the selection of $500 million of assets in the
deal’s portfolio.
¶ Citigroup then took a short position against
those mortgage-related assets, an investment in which Citigroup would profit
if the assets declined in value. The company did not disclose to the
investors to whom it sold the collateralized debt obligation that it had
helped to select the assets or that it was betting against them.
¶ The S.E.C. also charged Brian Stoker, the
Citigroup employee who was primarily responsible for putting together the
deal, and Samir H. Bhatt, a Credit Suisse portfolio manager who was
primarily responsible for the transaction. Credit Suisse served as the
collateral manager for the C.D.O. transaction.
¶ “The securities laws demand that investors
receive more care and candor than Citigroup provided to these C.D.O.
investors,” said Robert Khuzami, director of the S.E.C.’s division of
enforcement. “Investors were not informed that Citigroup had decided to bet
against them and had helped choose the assets that would determine who won
or lost.”
¶ Citigroup received fees of $34 million for
structuring and marketing the transaction and realized net profits of at
least $126 million from its short position. The $285 million settlement
includes $160 million in disgorgement plus $30 million in prejudgment
interest and a $95 million penalty, all of which will be returned to
investors.
¶ The companies and individuals who settled the
charges neither admitted nor denied the charges.
Continued in article
Jensen Question
Does anybody see something in this deal that does not screw taxpayers for the
benefit of big bankers?
Or is this just a sweetheart deal for the FDIC and its billionaire friends?
Or am I missing something here?
Dr. Wolff sent me a link to this video.
Video ---
http://www.youtube.com/user/fiercefreeleancer
I really was not aware of how this thing really worked, so I found a link to
the following document:
"FDIC's Sale of IndyMac to One West Bank - Sweetheart deal or not?" by Dennis
Norman, Real Estate Investors Daily, February 15, 2010 ---
http://realestateinvestordaily.com/market-information-news/fdics-sale-of-indymac-to-one-west-bank-sweetheart-deal-or-not/
Last week a friend emailed me a link to a video
titled “The
Indymac Slap in Our Face” that was
created by
Think Big Work Small. I watched the video which
gave a recap of the failure of Indymac bank back resulting in it’s seizure
by the FDIC in July, 2008, and the ultimate sale by the FDIC of Indymac Bank
to One West Bank in March, 2009.
According to the video, One West Bank
received a cushy, “sweetheart deal” and implied it was related to
the fact that the owners of One West Bank include Goldman Sachs VP, Steven
Mnuchin, billionaires George Soros and John Paulsen, and that “it’s good to
have friends in high places.” Here is a recap of some of the “facts” of the
deal they gave on the video:
- One West Bank paid the FDIC 70 percent of the
principal balance of all current residential loans
- One West Bank paid the FDIC 58 percent of the
principal balance of all HELOC’s (Home Equity Lines of Credit)
- The FDIC agreed to cover 80 – 95 percent of
One West’s loss on an Indymac loan as a result of a short sale or
foreclosure.
- The kicker is, according to the video, is
that the “loss” is computed based upon the
original loan amount and not the
amount One West paid for the loan.
On the video the hosts give an example of an “actual
scenario” showing how the deal worked, below is a recap:
- One West Bank approved a short-sale of
$241,000 on one of the Indymac loans it purchased from the FDIC (the
total balance owed by the borrower at the time was $485,200).
- Based upon the terms of the loss sharing
agreement, One West “lost” $244,200 on this transaction, 80 percent of
which ($195,360) was paid to One West by the FDIC.
- So, One West received $241,000 from the short
sale and $195,360 from the FDIC for a total of $436,360 on a loan they
bought from the FDIC for $334,600, thereby resulting in a profit of
$101,760 on the loan to One West.
- One last kicker, the video claims, in addition
to making over $100,000 on the loan, since the house was sold for less
than what the borrower owed, One West also made the borrower sign a
promissory note for $75,000 of the short-fall.
Below is a link to the video if you want to watch
it for yourself.
ThinkBigWorkSmall.com Video ---
http://www.thinkbigworksmall.com/mypage/archive///
The video got me pretty fired up like I imagine it
did most people that saw it. Afterall, our federal government is running up
debt faster than ever before, the FDIC has had to take over a record number
of banks in the past year and now a sweetheart deal for people that are
“connected.” OK, I’ll admit it, I was a little jealous….a 30 percent
profit, guaranted by the FDIC? And all I have to do is discourage
borrowers from doing loan modifications and force short-sales and
foreclosures? Easier than taking candy from a baby, huh?
Hmm….wait a minute though, the skeptic in me
(especially when it comes to anything distributed via email) made me wonder
if the video was accurate or was it misunderstanding the facts, taking facts
out of context or simply just wrong? To the credit of
Think Big Work Small they did have links on their
site to the loss-sharing agreement they were referencing.
I went to the FDIC website and found what I believe
to be the original
Indymac sale agreement as well as the
loss sharing agreement with One West Bank as well
as a
supplemental information document on the sale the
FDIC published after the sale.
Following are some highlights from the
FDIC “Fact Sheet” on the sale of IndyMac:
- The FDIC entered into a letter of internt to
sell New IndyMac to IMB HoldCo, LLC, a thrift holding company controlled
by IMB Management Holdings, LOP for approximately $13.9 billion. IMB
holdCo is owned by a consortium of private equity investors led by
Steven T. Mnuchin of Dune Capital Management LP.
- The FDIC has agreed to share losses
on a portfolio of qualifying loans with New IndyMac assuming the
first 20 percent of losses, after which the FDIC will
share losses 80/20 for the next 10 percent and 95/5
thereafter.
- Under a participation structure on
approximately $2 billion portfolio of construction and other loans, the
FDIC will receive a majority of all cash flows generated.
- When the transaction is closed, IMB HoldCo
will put $1.3 billion in cash in New IndyMac to capitalize it.
- In an overview of the Consortium it does
identify “Paulson & Co” as a member as well as “SSP Offshore LLC”, which
is managed by Soros Fund Management.
Just about the time I finished researching
everything for this article I received a
press release from the FDIC in response to the
video which stated “It is unfortunate but necessary to respond to the
blatantly false claims in a web video that
is being circulated about the loss-sharing agreement
between the FDIC and One West Bank.” The press release goes on to give these
“facts” about the deal:
- One West has “not been paid one penny by the
FDIC” in loss-share claims.
- The loss-shre agreement is limited to 7
percent of the total assets that One West services.
- One West must first take more than $2.5
billion in losses before it can make a loss-share claim on owned assets.
- In order to be paid through loss share, One
West must have adhered to the Home Affordable Modification Plan
(HAMP).
The last paragraph starts with “this video
has no credibility.”
My Analysis
Before I get into this, I need to point out that
while I have reviewed the sale agreement between the FDIC and One West as
well as the loss-sharing agreement, watched the video above and read the
FDIC’s press release, this is complicated stuff and not easy to understand.
However, I think I have my arms around the deal somewhat so the following is
my best guess analysis of the IndyMac deal with regard to the loss-sharing
provision:
- The FDIC says the loss sharing agreement only
applies to 7 percent of the IndyMac Loans serviced by One West. It
appears there is $157.7 billion in loans serviced, 7 percent of that
amount is about $11 billion. So my guess is the loss-share
applies to about $11 billion worth of loans.
- One West agreed to a “First Loss Amount” of 20
percent of the shared-loss loans. The attachment for this was blank but
the FDIC’s press release indicates this amount is $2.5 Billion. If that
is the case then the total amount of loans the loss-share
provision applies to is $12.5 billion. Obviously there is a
$1.5 billion discrepancy between my calculation above and here (what’s
$1.5 billion among friends?) but I’m going to go with the $12.5 billion
because the amount of loans serviced I referenced may have been adusted
at closing.
- One West purchased the $12.5 billion
in loans covered by the loss-sharing agreement for less
than $8.75 billion. I say “less than” $8.75
billion as that is 70 percent of the loan amount which represents the
amount One-West paid for residential loans that were current. The amount
paid for current HELOC’s was only 58 percent and the price for
delinquent mortgages went as low as 55 percent and as low as 37.75
percent for delinquent HELOC’s. Therefore I would assume the actual
price paid by One-West was less than the $8.75 billion.
- Once One West has covered $2.5 billion in
losses, then the FDIC starts covering 80 percent of the
losses up to a threshold at which time the FDIC covers 95
percent of the losses. Figuring out the threshold was a little
trickier…I see a reference to 30 percent of the total loans covered by
the loss-share so I’m going to use that which works out to $3.75
billion.
Now let’s figure the profit One West stands
to make on the loans covered by the Loss-Share agreement;
- If all the borrowers would pay off their loans
in full, not less than $3.75 billion (not likely though
that all borrowers will pay off in full).
- Let’s be real pessimistic and look at the “worst-case”
scenario: Lets say 100 percent of the loans bought by One West (covered
by the loss-share) go bad and have to be short-sales or foreclosures at
a loss. For the sake of conversation lets say the losses equal 40
percent of the loan amount, or $5 billion ($12.5 billion times 40
percent).
- One West would have to cover the first
$2.5 billion at which time the 80/20 rule would kick in for the next
$1.25 billion in losses resulting in One West recovering $1.0
billion of those losses from the FDIC. Then for the next $1.25
billion ($3.75 to $5 billion) One West would recover 95 percent of
the loss fro the FDIC or $1.1875 billion.
- Recap: Of the $12.5 billion in loans,
under the scenario above, One West would have realized $7.5
billion from foreclosures or short sales (60 percent of the
debt) and would have recovered $2.1875 billion from the FDIC of
the $5 billion in losses, for a total to One West of
$9.6875 billion for loans they paid not more than $8.75
billion for a profit of a little less than $1 billion.
Keep in mind, my analysis above is based somewhat
on fact and some on speculation and my “profit” scenario is based purely on
speculation and pretty negative assumptions as to loan losses. This coupled
with the fact that, as I stated above, One West probably bought the loans
for less than I indicated, probably makes this a better deal with more than
the $1 billion profit at the end of the day.
So is is a sweetheart deal or not? You be the
judge…
One thing to keep in mind is the investors
only put $1.3 billion cash into the deal to buy IndyMac, and they
got a lot more than just the loans covered by the loss-sharing agreement.
I’m thinking it’s a pretty good deal and one I probably would have
jumped on…well, if I had $1.3 billion sitting around doing nothing…
Jensen Question
Does anybody see something in this deal that does not screw taxpayers for the
benefit of big bankers?
Or is this just a sweetheart deal for the FDIC and its billionaire friends?
Or am I missing something here?
Bob Jensen
Unrelated reference
"Fed to Banks: Quit Stalling on Short Sales" ---
http://www.housingwatch.com/2010/01/13/fed-to-banks-quit-stalling-on-short-sales/
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Abusive off-balance sheet accounting was a major
cause of the financial crisis. These abuses triggered a daisy chain of
dysfunctional decision-making by removing transparency from investors,
markets, and regulators. Off-balance sheet accounting facilitating the
spread of the bad loans, securitizations, and derivative transactions that
brought the financial system to the brink of collapse.
As in the 1920s, the balance sheets of major
corporations recently failed to provide a clear picture of the financial
health of those entities. Banks in particular have become predisposed to
narrow the size of their balance sheets, because investors and regulators
use the balance sheet as an anchor in their assessment of risk. Banks use
financial engineering to make it appear that they are better capitalized and
less risky than they really are. Most people and businesses include all of
their assets and liabilities on their balance sheets. But large financial
institutions do not.
Click here to read the full chapter.---
http://www.rooseveltinstitute.org/sites/all/files/Off-Balance Sheet
Transactions.pdf
Frank Partnoy is the George E.
Barnett Professor of Law and Finance and is the director of the Center on
Coporate and Securities Law at the University of San Diego. He worked as a
derivatives structurer at Morgan Stanley and CS First Boston during the
mid-1990s and wrote F.I.A.S.C.O.:
Blook in the Water on Wall Street, a
best-selling book about his experiences there. His other books include
Infectious Greed: How Deceit and Risk Corrupted the Financial Markets
and
The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall
Street Scandals.
Lynn Turner has the unique
perspective of having been the Chief Accountant of the Securities and
Exchange Commission, a member of boards of public companies, a trustee of a
mutual fund and a public pension fund, a professor of accounting, a partner
in one of the major international auditing firms, the managing director of a
research firm and a chief financial officers and an executive in industry.
In 2007, Treasury Secretary Paulson appointed him to the Treasury Committee
on the Auditing Profession. He currently serves as a senior advisor to LECG,
an international forensics and economic consulting firm.
The views expressed in this paper are those of the authors and do not
necessarily reflect the positions of the Roosevelt Institute, its officers,
or its directors.
Bob Jensen's threads on OBSF are at
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
For over 15 years Frank Partnoy has been appealing in vain for financial
reform. My timeline of history of the scandals, the new accounting standards,
and the new ploys at OBSF and earnings management is at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
After the Bailout the Banks are Still Hiding Debt and the Auditors
Acquiesce
"Major Banks Said to Cover Up Debt Levels," The New York Times via The
Wall Street Journal, April 9, 2010 ---
http://dealbook.blogs.nytimes.com/2010/04/09/major-banks-said-to-cover-debt-levels/?dlbk&emc=dlbk
Goldman Sachs,
Morgan Stanley, JPMorgan
Chase, Bank of America and
Citigroup are the big names among
18 banks revealed by data from the Federal Reserve
Bank of New York to be hiding their risk levels in
the past five quarters by lowering the amount of
leverage on the balance sheet before making it
available to the public, The Wall Street Journal
reported.
The Federal
Reserve’s data shows that, in the middle of
successive quarters, when debt levels are not in the
public domain, that banks would acknowledge debt
levels higher by an average of 42 percent, The
Journal says.
“You want your leverage to
look better at quarter-end than it actually was
during the quarter, to suggest that you’re taking
less risk,” William Tanona, a former Goldman analyst
and head of financial research in the United States
at Collins Stewart, told The
Journal.
The newspaper suggests this
practice is a symptom of the 2008 crisis in which
banks were harmed by their high levels of debt and
risk. The worry is that a bank displaying too much
risk might see its stocks and credit ratings suffer.
There is nothing illegal
about the practice, though it means that much of the
time investors can have little idea of the risks the
any bank is really taking.
Lehman/Ernst Teaching Case on the Largest Bankruptcy in History
From The Wall Street Journal Accounting Weekly Review on March 19, 2010
Examiner: Lehman Torpedoed Lehman
by: Mike
Spector, Susanne Craig, Peter Lattman
Mar 11, 2010
Click here to view the full article on WSJ.com
TOPICS: Advanced
Financial Accounting, Debt, Degree of Operating Leverage, Disclosure,
Revenue Recognition
SUMMARY: "A
federal judge released a scathing report on the collapse of Lehman Brothers
Holdings Inc. that singles out senior executives, auditor Ernst & Young and
other investment banks for serious lapses that led to the largest bankruptcy
in U.S. history...." The report focuses on the use of "repos" to improve the
appearance of Lehman's financial condition as it worsened with the market
declines beginning in 2007. "Mr Valukus, chairman of law firm Jenner &
Block, devotes more than 300 pages alone to balance sheet manipulation..."
through repo transactions. As explained more fully in the related articles,
repurchase agreements are transactions in which assets are sold under the
agreement that they will be repurchased within days. Yet, when Lehman
exchanged assets with a value greater than 105% of the cash received for
them, the company would report it as an outright sale of the asset, not a
loan, thus reducing the firms apparent leverage. These transactions were
based on a legal opinion of the propriety of this treatment made for their
European operations, but the company never received such an opinion letter
in the U.S., so Lehman transferred assets to Europe in order to execute the
trades. The second related article clarifies these issues. Of course, this
was but one significant problem; other forces helped to "tip Leham over the
brink" into bankruptcy including J.P. Morgan Chases' "demands for collateral
and modifications to agreements...that hurt Lehman's liquidity...."
CLASSROOM APPLICATION: The
questions ask students to understand repurchase agreements and cases in
which financing (borrowing) transactions might alternatively be treated as
sales. The role of the auditor, in this case Ernst & Young, also is
highlighted in the article and in the questions in this review.
QUESTIONS:
1. (Introductory)
What report was issued in March 2010 regarding Lehman Brothers? Summarize
some main points about the report.
2. (Advanced)
Based on the discussion in the main and first related articles, describe the
"repo market'. What is the business purpose of these transactions?
3. (Advanced)
How did Lehman Brothers use repo transactions to improve its balance sheet?
Note: be sure to refer to the related articles as some points in the main
article emphasize the impact of removing the assets that are subject to the
repo agreements from the balance sheet. The main point of your discussion
should focus on what else might have been credited in the entries to record
these transactions.
4. (Introductory)
Refer to the second related article. What was the role of Lehman's auditor
in assessing the repo transactions? What questions have been asked of this
firm and how has E&Y responded?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Lehman Maneuver Raises Accounting Question.
by David Reilly
Mar 13, 2010
Online Exclusive
"Examiner: Lehman Torpedoed Lehman," by: Mike Spector, Susanne Craig, Peter
Lattman, The Wall Street Journal, Mar 11, 2010 ---
http://online.wsj.com/article/SB10001424052748703625304575115963009594440.html?mod=djem_jiewr_AC_domainid
A scathing report by a U.S. bankruptcy-court
examiner investigating the collapse of Lehman Brothers Holdings Inc. blames
senior executives and auditor Ernst & Young for serious lapses that led to
the largest bankruptcy in U.S. history and the worst financial crisis since
the Great Depression.
In the works for more than a year, and costing more
than $30 million, the report by court-appointed examiner Anton Valukas
paints the most complete picture yet of the free-wheeling culture inside the
158 year-old firm, whose chief executive Richard S. Fuld Jr. prided himself
on his ability to manage market risk.
The document runs thousands of pages and contains
fresh allegations. In particular, it alleges that Lehman executives
manipulated its balance sheet, withheld information from the board, and
inflated the value of toxic real estate assets.
Lehman chose to "disregard or overrule the firm's
risk controls on a regular basis,'' even as the credit and real-estate
markets were showing signs of strain, the report said.
In one instance from May 2008, a Lehman senior vice
president alerted management to potential accounting irregularities, a
warning the report says was ignored by Lehman auditors Ernst & Young and
never raised with the firm's board.
The allegations of accounting manipulation and
risk-control abuses potentially could influence pending criminal and civil
investigations into Lehman and its executives. The Manhattan and Brooklyn
U.S. attorney's offices are investigating, among other things, whether
former Lehman executives misled investors about the firm's financial picture
before it filed for bankruptcy protection, and whether Lehman improperly
valued its real-estate assets, people familiar with the matter have said.
The examiner said in the report that throughout the
investigation it conducted regular weekly calls with the Securities and
Exchange Commission and Department of Justice. There have been no
prosecutions of Lehman executives to date.
Several factors helped to tip Lehman over the brink
in its final days, Mr. Valukas wrote. Investment banks, including J.P.
Morgan Chase & Co., made demands for collateral and modified agreements with
Lehman that hurt Lehman's liquidity and pushed it into bankruptcy.
Lehman's own global financial controller, Martin
Kelly, told the examiner that "the only purpose or motive for the
transactions was reduction in balance sheet" and "there was no substance to
the transactions." Mr. Kelly said he warned former Lehman finance chiefs
Erin Callan and Ian Lowitt about the maneuver, saying the transactions posed
"reputational risk" to Lehman if their use became publicly known.
In an interview with the examiner, senior Lehman
Chief Operating Officer Bart McDade said he had detailed discussions with
Mr. Fuld about the transactions and that Mr. Fuld knew about the accounting
treatment.
In an April 2008 email, Mr. McDade called such
accounting maneuvers "another drug we r on." Mr. McDade, then Lehman's
equities chief, says he sought to limit such maneuvers, according to the
report. Mr. McDade couldn't be reached to comment.
In a November 2009 interview with the examiner, Mr.
Fuld said he had no recollection of Lehman's use of Repo 105 transactions
but that if he had known about them he would have been concerned, according
to the report.
Mr. Valukas's report is among the largest
undertaking of its kind. Those singled out in the report won't face
immediate repercussions. Rather, the report provides a type of road map for
Lehman's bankruptcy estate, creditors and other authorities to pursue
possible actions against former Lehman executives, the bank's auditors and
others involved in the financial titan's collapse.
One party singled out in the report is Lehman's
audit firm, Ernst & Young, which allegedly didn't raise concerns with
Lehman's board about the frequent use of the repo transactions. E&Y met with
Lehman's Board Audit Committee on June 13, one day after Lehman senior vice
president Matthew Lee raised questions about the frequent use of the
transactions.
"Ernst & Young took no steps to question or
challenge the nondisclosure by Lehman of its use of $50 billion of
temporary, off-balance sheet transactions," Mr. Valukas wrote.
In a statement, Mr. Fuld's lawyer, Patricia Hynes,
said, "Mr. Fuld did not know what those transactions were—he didn't
structure or negotiate them, nor was he aware of their accounting
treatment."
An Ernst & Young statement Thursday said Lehman's
collapse was caused by "a series of unprecedented adverse events in the
financial markets." It said Lehman's leverage ratios "were the
responsibility of management, not the auditor."
Ms. Callan didn't respond to a request for comment.
An attorney for Mr. Lowitt said any suggestion he breached his duties was
"baseless." Mr. Kelly couldn't be reached Thursday evening.
As Lehman began to unravel in mid-2008, investors
began to focus their attention on the billions of dollars in commercial real
estate and private-equity loans on Lehman's books.
The report said that while Lehman was required to
report its inventory "at fair value," a price it would receive if the asset
were hypothetically sold, Lehman "progressively relied on its judgment to
determine the fair value of such assets."
Between December 2006 and December 2007, Lehman
tripled its firmwide risk appetite.
But its risk exposure was even larger, according to
the report, considering that Lehman omitted "some of its largest risks from
its risk usage calculations" including the $2.3 billion bridge equity loan
it provided for Tishman Speyer's $22.2 billion take over of apartment
company Archstone Smith Trust. The late 2007 deal, which occurred as the
commercial-property market was cresting, led to big losses for Lehman.
Lehman eventually added the Archstone loan to its
risk usage profile. But rather than reducing its balance sheet to compensate
for the additional risk, it simply raised its risk limit again, the report
said.
Where Were the Auditors? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Bob Jensen's threads on off-balance-sheet financing (OBSF) ---
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
"Even Without TARP, Banks Are Still Heavily Subsidized," by John
Carney, Business Insider, December 14, 2009 ---
http://www.businessinsider.com/even-without-tarp-banks-are-still-heavily-subsized-2009-12
Despite the massive
repayments of TARP money coming from our biggest banks, the financial system is
still very much dependent on the rescue operations of the government.
Perhaps the best
illustration of this is the massive balance sheet of the Federal Reserve, which
has inflated by purchases of $1.058 Trillion of mortgage backed securities.
The Atlanta Fed's most
recent financial highlights point out that in the last two months, the average
weekly amount of MBS purchased has averaged $17 billion. That's a significant
slowdown from a prior average of $23.4 billion per week. And last week the Fed
purchased only $16 billion.
Still, cumulative numbers
matter. Prior to this year, the Federal Reserve had never purchased mortgage
backed securities. Now the Fed owns more than 15 percent of the market in agency
backed mortgage securities, Fannie Mae and Freddie Mac combined own roughly 17
percent of the market, while commercial banks own around 20 percent.
We don't know exactly
what the Fed has been buying or the prices it has been paying, of course. We
have no idea who the sellers are, either. But it is fair to say that until this
program ends--if it ends on schedule, that will be in early 2010--the financial
sector is still heavily subsidized by the central bank.
But here's what we do
know. Banks are still being propped up on both ends by the Fed. They have access
to dirt cheap money and then they can sell the mortgage loans they make with
that money right back to the Fed.
The Greatest Swindle in the History of the World
Paulson and Geithner Lied Big Time:
The Greatest
Swindle in the History of the World
What was their real motive in the greatest fraud conspiracy in the history of
the world?
Bombshell: In 2008 and early 2009, Treasury Secretary leaders
Paulson
and
Geithner
told the media and Congress that
AIG needed a
global bailout due to not having cash reserves to meet credit default swap
(systematic risk) obligations and insurance policy payoffs. On November 19, 2009
in Congressional testimony Geithner now admits that all this was a pack of lies.
However, he refuses to resign as requested by some Senators.
Forwarded by a good friend on February 21, 2010
From:
http://www.rollingstone.com/politics/story/32255149/wall_streets_bailout_hustle/
Rolling Stone
Wall Street's Bailout Hustle
Goldman Sachs and other big banks aren't just pocketing the trillions we
gave them to rescue the economy - they're re-creating the conditions for
another crash
MATT TAIBBI
Posted Feb 17, 2010 5:57 AM
On January 21st, Lloyd Blankfein left a peculiar voicemail message
on the work phones of his employees at Goldman Sachs. Fast becoming
America's pre-eminent Marvel Comics supervillain, the CEO used the call to
deploy his secret weapon: a pair of giant, nuclear-powered testicles. In his
message, Blankfein addressed his plan to pay out gigantic year-end bonuses
amid widespread controversy over Goldman's role in precipitating the global
financial crisis.
The bank had already set aside a tidy $16.2 billion for salaries and bonuses
— meaning that Goldman employees were each set to take home an average of
$498,246, a number roughly commensurate with what they received during the
bubble years. Still, the troops were worried: There were rumors that Dr.
Ballsachs, bowing to political pressure, might be forced to scale the number
back. After all, the country was broke, 14.8 million Americans were stranded
on the unemployment line, and Barack Obama and the Democrats were trying to
recover the populist high ground after their bitch-whipping in Massachusetts
by calling for a "bailout tax" on banks. Maybe this wasn't the right time
for Goldman to be throwing its annual Roman bonus orgy.
Not to worry, Blankfein reassured employees. "In a year that proved to have
no shortage of story lines," he said, "I believe very strongly that
performance is the ultimate narrative."
Translation: We made a shitload of money last year because we're so amazing
at our jobs, so fuck all those people who want us to reduce our bonuses.
Goldman wasn't alone. The nation's six largest banks — all committed to this
balls-out,
I drink
your milkshake! strategy of flagrantly gorging themselves as
America goes hungry — set aside a whopping $140 billion for executive
compensation last year, a sum only slightly less than the $164 billion they
paid themselves in the pre-crash year of 2007. In a gesture of
self-sacrifice, Blankfein himself took a humiliatingly low bonus of $9
million, less than the 2009 pay of elephantine New York Knicks washout Eddy
Curry. But in reality, not much had changed. "What is the state of our moral
being when Lloyd Blankfein taking a $9 million bonus is viewed as this great
act of contrition, when every penny of it was a direct transfer from the
taxpayer?" asks Eliot Spitzer, who tried to hold Wall Street accountable
during his own ill-fated stint as governor of New York.
Beyond a few such bleats of outrage, however, the huge payout was met, by
and large, with a collective sigh of resignation. Because beneath America's
populist veneer, on a more subtle strata of the national psyche, there
remains a strong temptation to not really give a shit. The rich, after all,
have always made way too much money; what's the difference if some fat cat
in New York pockets $20 million instead of $10 million?
The only reason such apathy exists, however, is because there's
still a widespread misunderstanding of how exactly Wall Street "earns" its
money, with emphasis on the quotation marks around "earns." The question everyone
should be asking, as one bailout recipient after another posts massive
profits — Goldman reported $13.4 billion in profits last year, after paying
out that $16.2 billion in bonuses and compensation — is this: In an economy
as horrible as ours, with every factory town between New York and Los
Angeles looking like those hollowed-out ghost ships we see on History
Channel documentaries like
Shipwrecks of the Great Lakes, where in the hell did Wall
Street's eye-popping profits come from, exactly? Did Goldman go from bailout
city to $13.4 billion in the black because, as Blankfein suggests, its
"performance" was just that awesome? A year and a half after they were
minutes away from bankruptcy, how are these assholes not only back on their
feet again, but hauling in bonuses at the same rate they were during the
bubble?
The answer to that question is basically twofold: They raped the taxpayer,
and they raped their clients.
The bottom line is that banks like Goldman have learned absolutely nothing
from the global economic meltdown. In fact,
they're back conniving and playing speculative long shots in force — only
this time with the full financial support of the U.S. government. In the
process, they're rapidly re-creating the conditions for another crash, with
the same actors once again playing the same crazy games of financial chicken
with the same toxic assets as before.
That's why this bonus business isn't merely a matter of getting upset about
whether or not Lloyd Blankfein buys himself one tropical island or two on
his next birthday. The reality is that the post-bailout era in which Goldman
thrived has turned out to be a chaotic frenzy of high-stakes con-artistry,
with taxpayers and clients bilked out of billions using a dizzying array of
old-school hustles that, but for their ponderous complexity, would have fit
well in slick grifter movies like
The Sting
and
Matchstick Men. There's even a term in con-man lingo for what
some of the banks are doing right now, with all their cosmetic gestures of
scaling back bonuses and giving to charities. In the grifter world, calming
down a mark so he doesn't call the cops is known as the "Cool Off."
To appreciate how all of these (sometimes brilliant) schemes work is to
understand the difference between earning money and taking scores, and to
realize that the profits these banks are posting don't so much represent
national growth and recovery, but something closer to the losses one would
report after a theft or a car crash. Many Americans instinctively understand
this to be true — but, much like when your wife does it with your 300-pound
plumber in the kids' playroom, knowing it and actually watching the whole
scene from start to finish are two very different things. In that spirit, a
brief history of the best 18 months of grifting this country has ever seen:
CON #1
THE SWOOP AND SQUAT
By
now, most people who have followed the financial crisis know that the
bailout of AIG was actually a bailout of AIG's "counterparties" — the big
banks like Goldman to whom the insurance giant owed billions when it went
belly up.
What is less understood is that the bailout of AIG counter-parties like
Goldman and Société Générale, a French bank, actually began
before the collapse of
AIG, before the Federal Reserve paid them so much as a dollar. Nor is it
understood that these counterparties actually accelerated the wreck of AIG
in what was, ironically, something very like the old insurance scam known as
"Swoop and Squat," in which a target car is trapped between two perpetrator
vehicles and wrecked, with the mark in the game being the target's insurance
company — in this case, the government.
This may sound far-fetched, but the financial crisis of 2008 was very much
caused by a perverse series of legal incentives that often made failed
investments worth more than thriving ones. Our economy was like a town where
everyone has juicy insurance policies on their neighbors' cars and houses.
In such a town, the driving will be suspiciously bad, and there will be a
lot of fires.
AIG was the ultimate example of this dynamic. At the height of the housing
boom, Goldman was selling billions in bundled mortgage-backed securities —
often toxic crap of the no-money-down, no-identification-needed variety of
home loan — to various institutional suckers like pensions and insurance
companies, who frequently thought they were buying investment-grade
instruments. At the same time, in a glaring example of the perverse
incentives that existed and still exist, Goldman was also betting
against
those same sorts of securities — a practice that one government investigator
compared to "selling a car with faulty brakes and then buying an insurance
policy on the buyer of those cars."
Goldman often "insured" some of this garbage with AIG, using a virtually
unregulated form of pseudo-insurance called credit-default swaps. Thanks in
large part to deregulation pushed by Bob Rubin, former chairman of Goldman,
and Treasury secretary under Bill Clinton, AIG wasn't required to actually
have the capital to pay off the deals.
As a result,
banks like Goldman bought more than $440 billion worth of this bogus
insurance from AIG, a huge blind bet that the taxpayer ended up having to
eat.
Thus, when the housing bubble went crazy, Goldman made money coming and
going. They made money selling the crap mortgages, and they made money by
collecting on the bogus insurance from AIG when the crap mortgages flopped.
Still, the trick for Goldman was: how to
collect
the insurance money. As AIG headed into a tailspin that fateful summer of
2008, it looked like the beleaguered firm wasn't going to have the money to
pay off the bogus insurance. So Goldman and other banks began demanding that
AIG provide them with cash collateral.
In the 15
months leading up to the collapse of AIG, Goldman received $5.9 billion in
collateral. Société Générale, a bank holding lots of mortgage-backed crap
originally underwritten by Goldman, received $5.5 billion. These
collateral demands squeezing AIG from two sides were the "Swoop and Squat"
that ultimately crashed the firm. "It put the company into a liquidity
crisis," says Eric Dinallo, who was intimately involved in the AIG bailout
as head of the New York State Insurance Department.
It was a brilliant move. When a company like AIG is about to die,
it isn't supposed to hand over big hunks of assets to a single creditor like
Goldman; it's supposed to equitably distribute whatever assets it has left
among all its creditors. Had AIG gone bankrupt, Goldman would have likely
lost much of the $5.9 billion that it pocketed as collateral. "Any
bankruptcy court that saw those collateral payments would have declined that
transaction as a fraudulent conveyance," says Barry Ritholtz, the author of
Bailout Nation. Instead, Goldman and the other counterparties
got their money out in advance — putting a torch to what was left of AIG.
Fans of the movie
Goodfellas will recall
Henry Hill and Tommy DeVito taking the same approach to the Bamboo Lounge
nightclub they'd been gouging. Roll the Ray Liotta narration:
"Finally,
when there's nothing left, when you can't borrow another buck . . . you bust
the joint out. You light a match."
And why not? After all, according to the terms of the bailout deal struck
when AIG was taken over by the state in September 2008, Goldman was paid 100
cents on the dollar on an additional $12.9 billion it was owed by AIG —
again, money it almost certainly would not have seen a fraction of had AIG
proceeded to a normal bankruptcy. Along with the collateral it pocketed,
that's $19 billion in pure cash that Goldman would not have "earned" without
massive state intervention. How's that $13.4 billion in 2009 profits looking
now? And that doesn't even include the
direct
bailouts of Goldman Sachs and other big banks, which began in earnest after
the collapse of AIG.
CON #2
THE DOLLAR STORE
In
the usual "DollarStore" or "Big Store" scam — popularized in movies like
The Sting
— a huge cast of con artists is hired to create a whole fake environment
into which the unsuspecting mark walks and gets robbed over and over again.
A warehouse is converted into a makeshift casino or off-track betting
parlor, the fool walks in with money, leaves without it.
The two key elements to the Dollar Store scam are the whiz-bang theatrical
redecorating job and the fact that everyone is in on it except the mark. In
this case, a pair of investment banks were dressed up to look like
commercial banks overnight, and it was the taxpayer who walked in and lost
his shirt, confused by the appearance of what looked like real Federal
Reserve officials minding the store.
Less than a week after the AIG bailout, Goldman and another investment bank,
Morgan Stanley, applied for, and received, federal permission to become bank
holding companies — a move that would make them eligible for much greater
federal support. The stock prices of both firms were cratering, and there
was talk that either or both might go the way of Lehman Brothers, another
once-mighty investment bank that just a week earlier had disappeared from
the face of the earth under the weight of its toxic assets.
By law, a five-day waiting period was required for such a conversion — but
the two banks got them overnight, with final approval actually coming only
five days after the AIG bailout.
Why did they need those federal bank charters? This question is the key to
understanding the entire bailout era — because this Dollar Store scam was
the big one. Institutions that were, in reality, high-risk gambling houses
were allowed to masquerade as conservative commercial banks. As a result of
this new designation, they were given access to a virtually endless tap of
"free money" by unsuspecting taxpayers. The $10 billion that Goldman
received under the better-known TARP bailout was chump change in comparison
to the smorgasbord of direct and indirect aid it qualified for as a
commercial bank.
When Goldman Sachs and Morgan Stanley got their federal bank charters, they
joined Bank of America, Citigroup, J.P. Morgan Chase and the other banking
titans who could go to the Fed and borrow massive amounts of money at
interest rates that, thanks to the aggressive rate-cutting policies of Fed
chief Ben Bernanke during the crisis, soon sank to zero percent. The ability
to go to the Fed and borrow big at next to no interest was what saved
Goldman, Morgan Stanley and other banks from death in the fall of 2008.
"They had no other way to raise capital at that moment, meaning they were on
the brink of insolvency," says Nomi Prins, a former managing director at
Goldman Sachs. "The Fed was the only shot."
In fact, the Fed became not just a source of emergency borrowing
that enabled Goldman and Morgan Stanley to stave off disaster — it became a
source of long-term guaranteed income. Borrowing at zero percent interest,
banks like Goldman now had virtually infinite ways to make money. In one of
the most common maneuvers, they simply took the money they borrowed from the
government at zero percent and lent it back to the government by buying
Treasury bills that paid interest of three or four percent. It was basically
a license to print money — no different than attaching an ATM to the side of
the Federal Reserve.
"You're borrowing at zero, putting it out there at two or three percent,
with hundreds of billions of dollars — man, you can make a lot of money that
way," says the manager of one prominent hedge fund. "It's free money." Which
goes a long way to explaining Goldman's enormous profits last year. But all
that free money was amplified by another scam:
CON #3
THE PIG IN THE POKE
At
one point or another, pretty much everyone who takes drugs has been burned
by this one, also known as the "Rocks in the Box" scam or, in its more
elaborate variations, the "Jamaican Switch." Someone sells you what looks
like an eightball of coke in a baggie, you get home and, you dumbass, it's
baby powder.
The scam's name comes from the Middle Ages, when some fool would be sold a
bound and gagged pig that he would see being put into a bag; he'd miss the
switch, then get home and find a tied-up cat in there instead. Hence the
expression "Don't let the cat out of the bag."
The "Pig in the Poke" scam is another key to the entire bailout era. After
the crash of the housing bubble — the largest asset bubble in history — the
economy was suddenly flooded with securities backed by failing or
near-failing home loans. In the cleanup phase after that bubble burst, the
whole game was to get taxpayers, clients and shareholders to buy these
worthless cats, but at pig prices.
One of the first times we saw the scam appear was in September 2008, right
around the time that AIG was imploding. That was when the Fed changed some
of its collateral rules, meaning banks that could once borrow only against
sound collateral, like Treasury bills or AAA-rated corporate bonds, could
now borrow against pretty much anything — including some of the
mortgage-backed sewage that got us into this mess in the first place. In
other words, banks that once had to show a real pig to borrow from the Fed
could now show up with a cat and get pig money. "All of a sudden, banks were
allowed to post absolute shit to the Fed's balance sheet," says the manager
of the prominent hedge fund.
The Fed spelled it out on September 14th, 2008, when it changed the
collateral rules for one of its first bailout facilities — the Primary
Dealer Credit Facility, or PDCF. The Fed's own write-up described the
changes: "With the Fed's action, all the kinds of collateral then in use . .
.
including non-investment-grade securities and equities . . .
became eligible for pledge in the PDCF."
Translation: We now accept cats.
The Pig in the Poke also came into play in April of last year, when Congress
pushed a little-known agency called the Financial Accounting Standards
Board, or FASB, to change the so-called "mark-to-market" accounting rules.
Until this rule change, banks had to assign a real-market price to all of
their assets. If they had a balance sheet full of securities they had bought
at $3 that were now only worth $1, they had to figure their year-end
accounting using that $1 value. In other words, if you were the dope who
bought a cat instead of a pig, you couldn't invite your shareholders to a
slate of pork dinners come year-end accounting time.
But last April, FASB changed all that. From now on, it
announced, banks could avoid reporting losses on some of their crappy cat
investments simply by declaring that they would "more likely than not" hold
on to them until they recovered their pig value. In short, the banks didn't
even have to
actually
hold on to the toxic shit they owned — they just had to
sort of
promise to hold on to it.
That's why the "profit" numbers of a lot of these banks are
really a joke. In many
cases, we have absolutely no idea how many cats are in their proverbial bag.
What they call "profits" might really be profits, only
minus undeclared millions
or billions in losses.
"They're hiding all this stuff from their shareholders," says Ritholtz, who
was disgusted that the banks lobbied for the rule changes. "Now, suddenly
banks that were happy to mark to market on the way up don't have to mark to
market on the way down."
CON #4
THE RUMANIAN BOX
One
of the great innovations of Victor Lustig, the legendary Depression-era con
man who wrote the famous "Ten Commandments for Con Men," was a thing called
the "Rumanian Box." This was a little machine that a mark would put a blank
piece of paper into, only to see real currency come out the other side. The
brilliant Lustig sold this Rumanian Box over and over again for vast sums —
but he's been outdone by the modern barons of Wall Street, who managed to
get themselves a real Rumanian Box.
How they accomplished this is a story that by itself highlights the
challenge of placing this era in any kind of historical context of known
financial crime. What the banks did was something that was never — and never
could have been — thought of before. They took so much money from the
government, and then did so little with it, that the state was forced to
start printing new cash to throw at them. Even the great Lustig in his
wildest, horniest dreams could never have dreamed up
this
one.
The setup: By early 2009, the banks had already replenished
themselves with billions if not trillions in bailout money. It wasn't just
the $700 billion in TARP cash, the free money provided by the Fed, and the
untold losses obscured by accounting tricks.
Another
new rule
allowed banks to collect interest on the cash they were required by law to
keep in reserve accounts at the Fed — meaning the state was now compensating
the banks simply for guaranteeing their own solvency. And a
new federal operation called the Temporary Liquidity Guarantee Program let
insolvent and near-insolvent banks dispense with their deservedly ruined
credit profiles and borrow on a clean slate, with FDIC backing. Goldman
borrowed $29 billion on the government's good name, J.P. Morgan Chase $38
billion, and Bank of America $44 billion. "TLGP," says Prins, the former
Goldman manager, "was a big one."
Collectively, all this largesse was worth trillions. The idea behind the
flood of money, from the government's standpoint, was to spark a national
recovery: We refill the banks' balance sheets, and they, in turn, start to
lend money again, recharging the economy and producing jobs. "The banks were
fast approaching insolvency," says Rep. Paul Kanjorski, a vocal critic of
Wall Street who nevertheless defends the initial decision to bail out the
banks. "It was vitally important that we recapitalize these institutions."
But here's the thing. Despite all these trillions in government rescues,
despite the Fed slashing interest rates down to nothing and showering the
banks with mountains of guarantees, Goldman and its friends had still not
jump-started lending again by the first quarter of 2009. That's where those
nuclear-powered balls of Lloyd Blankfein came into play, as Goldman and
other banks basically threatened to pick up their bailout billions and go
home if the government didn't fork over more cash — a
lot
more. "Even if the Fed could make interest rates negative, that wouldn't
necessarily help," warned Goldman's chief domestic economist, Jan Hatzius.
"We're in a deep recession mainly because the private sector, for a variety
of reasons, has decided to save a lot more."
Translation: You can lower interest rates all you want, but we're still not
fucking lending the bailout money to anyone in this economy. Until the
government agreed to hand over even more goodies, the banks opted to join
the rest of the "private sector" and "save" the taxpayer aid they had
received — in the form of bonuses and compensation.
The ploy worked. In March of last year, the Fed sharply expanded a radical
new program called quantitative easing, which effectively operated as a
real-live Rumanian Box. The government put stacks of paper in one side, and
out came $1.2 trillion "real" dollars.
The government used some of that freshly printed money to prop itself up by
purchasing Treasury bonds — a desperation move, since Washington's demand
for cash was so great post-Clusterfuck '08 that even the Chinese couldn't
buy U.S. debt fast enough to keep America afloat. But the Fed used most of
the new cash to buy mortgage-backed securities in an effort to spur home
lending — instantly creating a massive market for major banks.
And what did the banks do with the proceeds? Among other things,
they bought Treasury bonds, essentially lending the money back to the
government, at interest. The money that came out of the magic Rumanian Box
went from the government back to the government, with Wall Street stepping
into the circle just long enough to get paid. And
once quantitative easing ends, as it is scheduled to do in March, the flow
of money for home loans will once again grind to a halt.
The
Mortgage Bankers Association expects the number of new residential mortgages
to plunge by 40 percent this year.
CON #5
THE BIG MITT
All
of that Rumanian box paper was made even more valuable by running it through
the next stage of the grift. Michael Masters, one of the country's leading
experts on commodities trading, compares this part of the scam to the poker
game in the Bill Murray comedy
Stripes.
"It's like that scene where John Candy leans over to the guy who's new at
poker and says, 'Let me see your cards,' then starts giving him advice,"
Masters says. "He looks at the hand, and the guy has bad cards, and he's
like, 'Bluff me, come on! If it were me, I'd bet everything!' That's what
it's like. It's like they're looking at your cards as they give you advice."
In more ways than one can count, the economy in the bailout era turned into
a "Big Mitt," the con man's name for a
rigged poker game. Everybody was indeed looking at everyone else's cards, in many
cases with state sanction. Only taxpayers and clients were left out of the
loop.
At the same time the Fed and the Treasury were making massive, earthshaking
moves like quantitative easing and TARP, they were also consulting regularly
with
private advisory boards that include every major player on Wall Street.
The Treasury Borrowing Advisory Committee has a
J.P. Morgan executive as its chairman and a
Goldman
executive as its vice chairman, while the board advising the Fed includes
bankers from
Capital One and
Bank of New
York Mellon.
That means that, in addition to getting great gobs of free money, the banks
were also getting clear signals about
when
they were getting that money, making it possible to position themselves to
make the appropriate investments.
One of the best examples of the banks blatantly gambling, and winning, on
government moves was the Public-Private Investment Program, or PPIP. In this
bizarre scheme cooked up by goofball-geek Treasury Secretary Tim Geithner,
the government loaned money to hedge funds and other private investors to
buy up the absolutely most toxic horseshit on the market — the same kind of
high-risk, high-yield mortgages that were most responsible for triggering
the financial chain reaction in the fall of 2008. These satanic deals were
the basic currency of the bubble: Jobless dope fiends bought houses with no
money down, and the big banks wrapped those mortgages into securities and
then sold them off to pensions and other suckers as investment-grade deals.
The whole point of the PPIP was to get private investors to relieve the
banks of these dangerous assets before they hurt any more innocent
bystanders.
But what did the banks do instead, once they got wind of the PPIP? They
started
buying
that worthless crap again, presumably to sell back to the government at
inflated prices! In the third quarter of last year, Goldman, Morgan Stanley,
Citigroup and Bank of America combined to add $3.36 billion of exactly this
horseshit to their balance sheets.
This brazen decision to gouge the taxpayer startled even hardened market
observers. According to Michael Schlachter of the investment firm Wilshire
Associates, it was "absolutely ridiculous" that the banks that were supposed
to be reducing their exposure to these volatile instruments were instead
loading up on them in order to make a quick buck.
"Some of
them created this mess," he said, "and they are making a killing undoing
it."
CON #6
THE WIRE
Here's
the thing about our current economy. When Goldman and Morgan Stanley
transformed overnight from investment banks into commercial banks, we were
told this would mean a new era of "significantly tighter regulations and
much closer supervision by bank examiners," as
The New
York Times put it the very next day. In reality, however, the
conversion of Goldman and Morgan Stanley simply completed the dangerous
concentration of power and wealth that began in 1999, when Congress repealed
the Glass-Steagall Act — the Depression-era law that had prevented the
merger of insurance firms, commercial banks and investment houses. Wall
Street and the government became one giant dope house, where a few major
players share valuable information between conflicted departments the way
junkies share needles.
One of the most common practices is a thing called
front-running,
which is really no different from the old "Wire" con, another scam
popularized in
The Sting.
But instead of intercepting a telegraph wire in order to bet on racetrack
results ahead of the crowd, what Wall Street does is make bets ahead of
valuable information they obtain in the course of everyday business.
Say you're working for the commodities desk of a big investment bank, and a
major client — a pension fund, perhaps — calls you up and asks you to buy a
billion dollars of oil futures for them. Once you place that huge order, the
price of those futures is almost guaranteed to go up. If the guy in charge
of asset management a few desks down from you somehow finds out about that,
he can make a fortune for the bank by betting ahead of that client of yours.
The deal would be instantaneous and undetectable, and it would offer huge
profits. Your own client would lose money, of course — he'd end up paying a
higher price for the oil futures he ordered, because you would have driven
up the price. But that doesn't keep banks from screwing their own customers
in this very way.
The scam is so blatant that Goldman Sachs actually warns its clients that
something along these lines might happen to them.
In the
disclosure section at the back of a research paper the bank issued on
January 15th, Goldman advises clients to buy some dubious high-yield bonds
while
admitting
that the
bank itself
may bet
against
those same shitty bonds. "Our salespeople, traders and other professionals may provide oral
or written market commentary or trading strategies to our clients and our
proprietary trading desks that reflect opinions that are contrary to the
opinions expressed in this research," the disclosure reads. "Our
asset-management area, our proprietary-trading desks and investing
businesses may make investment decisions that are inconsistent with the
recommendations or views expressed in this research."
Banks like Goldman admit this stuff openly, despite the fact that there are
securities laws that require banks to engage in "fair dealing with
customers" and prohibit analysts from issuing opinions that are at odds with
what they really think. And yet here they are, saying flat-out that they may
be issuing an opinion at odds with what they really think.
To help them screw their own clients, the major investment banks employ
high-speed computer programs that can glimpse orders from investors before
the deals are processed and then make trades on behalf of the banks at
speeds of fractions of a second. None of them will admit it, but everybody
knows what this computerized trading — known as "flash trading" — really is.
"Flash trading is nothing more than computerized front-running,"
says the prominent hedge-fund manager. The SEC voted to ban flash trading in
September, but five months later it has yet to issue a regulation to put a
stop to the practice.
Over the summer, Goldman suffered an embarrassment on that score when one of
its employees, a Russian named Sergey Aleynikov, allegedly stole the bank's
computerized trading code. In a court proceeding after Aleynikov's arrest,
Assistant U.S. Attorney Joseph Facciponti reported that
"the bank has raised the possibility that there is a danger that somebody
who knew how to use this program could use it to manipulate markets in
unfair ways."
Six months after a federal prosecutor admitted in open court that the
Goldman trading program could be used to unfairly manipulate markets, the
bank released its annual numbers. Among the notable details was the fact
that a staggering 76 percent of its revenue came from trading, both for its
clients and for its own account. "That is much, much higher than any other
bank," says Prins, the former Goldman managing director. "If I were a client
and I saw that they were making this much money from trading, I would
question how badly I was getting screwed."
Why big institutional investors like pension funds continually come to Wall
Street to get raped is the million-dollar question that many experienced
observers puzzle over. Goldman's own explanation for this phenomenon is
comedy of the highest order. In testimony before a government panel in
January, Blankfein was confronted about his firm's practice of betting
against the same sorts of investments it sells to clients. His response:
"These are the professional investors who want this exposure."
In other words, our clients are big boys, so screw 'em if they're dumb
enough to take the sucker bets I'm offering.
CON #7
THE RELOAD
Not
many con men are good enough or brazen enough to con the same victim twice
in a row, but the few who try have a name for this excellent sport:
reloading.
The usual way to reload on a repeat victim (called an "addict" in grifter
parlance) is to rope him into trying to get back the money he just lost.
This is exactly what started to happen late last year.
It's important to remember that the housing bubble itself was a classic
confidence game — the Ponzi scheme. The Ponzi scheme is any scam in which
old investors must be continually paid off with money from new investors to
keep up what appear to be high rates of investment return. Residential
housing was never as valuable as it seemed during the bubble; the soaring
home values were instead a reflection of a continual upward rush of new
investors in mortgage-backed securities, a rush that finally collapsed in
2008.
But by the end of 2009, the unimaginable was happening: The bubble was
re-inflating. A bailout policy that was designed to help us get out from
under the bursting of the largest asset bubble in history inadvertently
produced exactly the opposite result, as all that government-fueled capital
suddenly began flowing into the most dangerous and destructive investments
all over again. Wall Street was going for the reload.
A lot of this was the government's own fault, of course. By
slashing interest rates to zero and flooding the market with money, the Fed
was replicating the historic mistake that Alan Greenspan had made not once,
but twice, before the tech bubble in the early 1990s and before the housing
bubble in the early 2000s. By making sure that traditionally safe
investments like CDs and savings accounts earned basically nothing, thanks
to rock-bottom interest rates, investors were forced to go elsewhere to
search for moneymaking opportunities.
Now we're in the same situation all over again, only far worse. Wall Street
is flooded with government money, and interest rates that are not just low
but flat are pushing investors to seek out more "creative" opportunities.
(It's "Greenspan times 10," jokes one hedge-fund trader.) Some of that money
could be put to use on Main Street, of course, backing the efforts of
investment-worthy entrepreneurs. But that's not what our modern Wall Street
is built to do. "They don't seem to want to lend to small and medium-sized
business," says Rep. Brad Sherman, who serves on the House Financial
Services Committee. "What they want to invest in is marketable securities.
And the definition of small and medium-sized businesses, for the most part,
is that they don't
have
marketable securities. They have bank loans."
In other words, unless you're dealing with the stock of a major, publicly
traded company, or a giant pile of home mortgages, or the bonds of a large
corporation, or a foreign currency, or oil futures, or some country's debt,
or anything else that can be rapidly traded back and forth in huge numbers,
factory-style, by big banks, you're not really on Wall Street's radar.
So with small business out of the picture, and the safe stuff not worth
looking at thanks to the Fed's low interest rates, where did Wall Street go?
Right back into the shit that got us here.
One trader, who asked not to be identified, recounts a story of what
happened with his hedge fund this past fall. His firm wanted to short — that
is, bet against — all the crap toxic bonds that were suddenly in vogue
again. The fund's analysts had examined the fundamentals of these
instruments and concluded that they were absolutely not good investments.
So they took a short position. One month passed, and they lost money.
Another month passed — same thing. Finally, the trader just shrugged and
decided to change course and buy.
"I said, 'Fuck it, let's make some money,'" he recalls. "I absolutely did
not believe in the fundamentals of any of this stuff. However, I can get on
the bandwagon, just so long as I know when to jump out of the car before it
goes off the damn cliff!"
This is the very definition of bubble economics — betting on crowd behavior
instead of on fundamentals. It's old investors betting on the arrival of new
ones, with the value of the underlying thing itself being irrelevant. And
this behavior is being driven, no surprise, by the biggest firms on Wall
Street.
The research report published by Goldman Sachs on January 15th underlines
this sort of thinking. Goldman issued a strong recommendation to buy exactly
the sort of high-yield toxic crap our hedge-fund guy was, by then, driving
rapidly toward the cliff.
"Summarizing our views," the bank wrote, "we expect robust flows .
. . to dominate fundamentals." In other words: This stuff is crap, but
everyone's buying it in an awfully robust way, so you should too. Just like
tech stocks in 1999, and mortgage-backed securities in 2006.
To sum up, this is what Lloyd Blankfein meant by "performance": Take massive
sums of money from the government, sit on it until the government starts
printing trillions of dollars in a desperate attempt to restart the economy,
buy even more toxic assets to sell back to the government at inflated prices
— and then, when all else fails, start driving us all toward the cliff again
with a frank and open endorsement of bubble economics. I mean, shit — who
wouldn't deserve billions in bonuses for doing all that?
Con
artists have a word for the inability of their victims to accept that
they've been scammed. They call it the
"True
Believer Syndrome."
That's sort of where we are, in a state of nagging disbelief about
the real problem on Wall Street. It isn't so much that we have inadequate
rules or incompetent regulators, although both of these things are certainly
true. The real problem is that it doesn't matter what regulations are in
place if the people running the economy are rip-off artists. The system
assumes a certain minimum level of ethical behavior and civic instinct over
and above what is spelled out by the regulations. If those ethics are absent
— well, this thing isn't going to work, no matter what we do. Sure, mugging
old ladies is against the law, but it's also easy. To prevent it, we depend,
for the most part, not on cops but on people making the conscious decision
not to do it.
That's why the biggest gift the bankers got in the bailout was not fiscal
but psychological. "The most valuable part of the bailout," says Rep.
Sherman, "was the implicit guarantee that they're Too Big to Fail." Instead
of liquidating and prosecuting the insolvent institutions that took us all
down with them in a giant Ponzi scheme, we have showered them with money and
guarantees and all sorts of other enabling gestures. And what should really
freak everyone out is the fact that Wall Street immediately started skimming
off its own rescue money. If the bailouts validated anew the crooked
psychology of the bubble, the recent profit and bonus numbers show that the
same psychology is back, thriving, and looking for new disasters to create.
"It's evidence," says Rep. Kanjorski, "that they still don't get it."
More to the point, the fact that we haven't done much of anything
to change the rules and behavior of Wall Street shows that
we
still don't get it. Instituting a bailout policy that stressed
recapitalizing bad banks was like the addict coming back to the con man to
get his lost money back. Ask yourself how well that ever works out. And then
get ready for the reload.
[From Issue 1099 — March 4, 2010]
"AIG and Systemic Risk Geithner says credit-default swaps weren't the
problem, after all," Editors of The Wall Street Journal, November 20, 2009 ---
Click Here
TARP Inspector General Neil Barofsky keeps
committing flagrant acts of political transparency, which if nothing else
ought to inform the debate going forward over financial reform. In his
latest bombshell, the IG discloses that the New York Federal Reserve did not
believe that AIG's credit-default swap (CDS) counterparties posed a systemic
financial risk.
Hello?
For the last year, the entire Beltway theory of the
financial panic has been based on the claim that the "opaque," unregulated
CDS market had forced the Fed to take over AIG and pay off its
counterparties, lest the system collapse. Yet we now learn from Mr. Barofsky
that saving the counterparties was not the reason for the bailout.
In the fall of 2008 the New York Fed drove a
baby-soft bargain with AIG's credit-default-swap counterparties. The Fed's
taxpayer-funded vehicle, Maiden Lane III, bought out the counterparties'
mortgage-backed securities at 100 cents on the dollar, effectively canceling
out the CDS contracts. This was miles above what those assets could have
fetched in the market at that time, if they could have been sold at all.
The New York Fed president at the time was none
other than Timothy Geithner, the current Treasury Secretary, and Mr.
Geithner now tells Mr. Barofsky that in deciding to make the counterparties
whole, "the financial condition of the counterparties was not a relevant
factor."
This is startling. In April we noted in these
columns that Goldman Sachs, a major AIG counterparty, would certainly have
suffered from an AIG failure. And in his latest report, Mr. Barofsky comes
to the same conclusion. But if Mr. Geithner now says the AIG bailout wasn't
driven by a need to rescue CDS counterparties, then what was the point? Why
pay Goldman and even foreign banks like Societe Generale billions of tax
dollars to make them whole?
Both Treasury and the Fed say they think it would
have been inappropriate for the government to muscle counterparties to
accept haircuts, though the New York Fed tried to persuade them to accept
less than par. Regulators say that having taxpayers buy out the
counterparties improved AIG's liquidity position, but why was it important
to keep AIG liquid if not to protect some class of creditors?
Yesterday, Mr. Geithner introduced a new
explanation, which is that AIG might not have been able to pay claims to its
insurance policy holders: "AIG was providing a range of insurance products
to households across the country. And if AIG had defaulted, you would have
seen a downgrade leading to the liquidation and failure of a set of
insurance contracts that touched Americans across this country and, of
course, savers around the world."
Yet, if there is one thing that all observers
seemed to agree on last year, it was that AIG's money to pay policyholders
was segregated and safe inside the regulated insurance subsidiaries. If the
real systemic danger was the condition of these highly regulated
subsidiaries—where there was no CDS trading—then the Beltway narrative
implodes.
Interestingly, in Treasury's official response to
the Barofsky report, Assistant Secretary Herbert Allison explains why the
department acted to prevent an AIG bankruptcy. He mentions the "global scope
of AIG, its importance to the American retirement system, and its presence
in the commercial paper and other financial markets." He does not mention
CDS.
All of this would seem to be relevant to the
financial reform that Treasury wants to plow through Congress. For example,
if AIG's CDS contracts were not the systemic risk, then what is the argument
for restructuring the derivatives market? After Lehman's failure, CDS
contracts were quickly settled according to the industry protocol. Despite
fears of systemic risk, none of the large banks, either acting as a
counterparty to Lehman or as a buyer of CDS on Lehman itself, turned out to
have major exposure.
More broadly, lawmakers now have an opportunity to
dig deeper into the nature of moral hazard and the restoration of a healthy
financial system. Barney Frank and Chris Dodd are pushing to give regulators
"resolution authority" for struggling firms. Under both of their bills, this
would mean unlimited ability to spend unlimited taxpayer sums to prevent an
unlimited universe of firms from failing.
Americans know that's not the answer, but what is
the best solution to the too-big-to-fail problem? And how exactly does one
measure systemic risk? To answer these questions, it's essential that we
first learn the lessons of 2008. This is where reports like Mr. Barofsky's
are valuable, telling us things that the government doesn't want us to know.
In remarks Tuesday that were interpreted as a
veiled response to Mr. Barofsky's report, Mr. Geithner said, "It's a great
strength of our country, that you're going to have the chance for a range of
people to look back at every decision made in every stage in this crisis,
and look at the quality of judgments made and evaluate them with the benefit
of hindsight." He added, "Now, you're going to see a lot of conviction in
this, a lot of strong views—a lot of it untainted by experience."
Mr. Geithner has a point about Monday-morning
quarterbacking. He and others had to make difficult choices in the autumn of
2008 with incomplete information and often with little time to think, much
less to reflect. But that was last year. The task now is to learn the
lessons of that crisis and minimize the moral hazard so we can reduce the
chances that the panic and bailout happen again.
This means a more complete explanation from Mr.
Geithner of what really drove his decisions last year, how he now defines
systemic risk, and why he wants unlimited power to bail out creditors—before
Congress grants the executive branch unlimited resolution authority that
could lead to bailouts ad infinitum.
Jensen Comment
One of the first teller of lies was the highly respected Gretchen Morgenson of
The New York Times who was repeating the lies told to her and Congress by
the Treasury and the Fed. This was when I first believed that the problem at AIG
was failing to have capital reserves to meet CDS obligations. I really believed
Morgenson's lies in 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
Here's what I wrote in 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes bad
due to having turds mixed in with the chocolates, the "counterparty" who
purchased the CDO will recover the value fraudulently invested in turds. On
September 30, 2008 Gretchen Morgenson of The New York Times aptly
explained that the huge CDO underwriter of CDOs was the insurance firm called
AIG. She also explained that the first $85 billion given in bailout money by
Hank Paulson to AIG was to pay the counterparties to CDS swaps. She also
explained that, unlike its casualty insurance operations, AIG had no capital
reserves for paying the counterparties for the the turds they purchased from
Wall Street investment banks.
"Your Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson, The
New York Times, September 20, 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
Also see "A.I.G., Where Taxpayers’ Dollars Go to Die," The New York Times,
March 7, 2009 ---
http://www.nytimes.com/2009/03/08/business/08gret.html
What Ms. Morgenson failed to explain, when Paulson eventually gave over $100
billion for AIG's obligations to counterparties in CDS contracts, was who were
the counterparties who received those bailout funds. It turns out that most of
them were wealthy Arabs and some Asians who we were getting bailed out while
Paulson was telling shareholders of WaMu, Lehman Brothers, and Merrill Lynch to
eat their turds.
You tube had a lot of videos about a CDS. Go to YouTube and read in the
phrase "credit default swap" ---
http://www.youtube.com/results?search_query=Credit+Default+Swaps&search_type=&aq=f
In particular note this video by Paddy Hirsch ---
http://www.youtube.com/watch?v=kaui9e_4vXU
Paddy has some other YouTube videos about the financial crisis.
Bob Jensen’s
threads on accounting for credit default swaps are under the C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
The
Greatest Swindle in the History of the World
"The
Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print
The legislation's guidelines for crafting the rescue plan were clear: the TARP
should protect home values and consumer savings, help citizens keep their homes
and create jobs. Above all, with the government poised to invest hundreds of
billions of taxpayer dollars in various financial institutions, the legislation
urged the bailout's architects to maximize returns to the American people.
That $700 billion bailout has since
grown into a
more than $12 trillion commitment by the US government and the Federal Reserve.
About
$1.1 trillion
of that is taxpayer money--the TARP money and an additional $400 billion rescue
of mortgage companies Fannie Mae and Freddie Mac. The TARP now includes twelve
separate programs, and recipients range from megabanks like Citigroup and
JPMorgan Chase to automakers Chrysler and General Motors.
Seven months in, the bailout's impact is unclear. The Treasury Department has
used the
recent "stress test" results
it applied to nineteen of the nation's largest banks
to suggest that the worst might be over; yet the
International Monetary Fund,
as well as economists like New York University
professor and economist Nouriel Roubini and New York Times columnist Paul
Krugman
predict greater losses in US markets,
rising unemployment and generally tougher economic
times ahead.
What cannot be disputed, however, is the financial bailout's biggest loser: the
American taxpayer. The US government, led by the Treasury Department, has done
little, if anything, to maximize returns on its trillion-dollar, taxpayer-funded
investment. So far, the bailout has favored rescued financial institutions by
subsidizing their losses to the tune of $356 billion,
shying away from much-needed management changes and--with the exception of the
automakers--letting companies take taxpayer money without a coherent plan for
how they might return to viability.
The bailout's perks have been no less favorable for private investors who are
now picking over the economy's still-smoking rubble at the taxpayers' expense.
The newer bailout programs rolled out by Treasury Secretary Timothy Geithner
give private equity firms, hedge funds and other private investors significant
leverage to buy "toxic" or distressed assets, while leaving taxpayers stuck with
the lion's share of the risk and potential losses.
Given the lack of transparency and accountability, don't expect taxpayers to be
able to object too much. After all, remarkably little is known about how TARP
recipients have used the government aid received. Nonetheless, recent government
reports,
Congressional testimony and commentaries offer those patient enough to pore over
hundreds of pages of material glimpses of just how Wall Street friendly the
bailout actually is. Here, then, based on the most definitive data and analyses
available, are six of the most blatant and alarming ways taxpayers have been
scammed by the government's $1.1-trillion, publicly funded bailout.
1. By overpaying for its TARP investments, the Treasury Department provided
bailout recipients with generous subsidies at the taxpayer's expense.
When the Treasury Department ditched its initial plan to buy up "toxic" assets
and instead invest directly in financial institutions, then-Treasury Secretary
Henry Paulson Jr. assured Americans that they'd get a fair deal. "This is an
investment, not an expenditure, and there is no reason to expect this program
will cost taxpayers anything," he
said in
October 2008.
Yet the Congressional Oversight Panel (COP), a five-person group tasked with
ensuring that the Treasury Department acts in the public's best interest,
concluded in its
monthly report for February
that the department had significantly overpaid by
tens of billions of dollars for its investments. For the ten largest TARP
investments made in 2008, totaling $184.2 billion, Treasury received on average
only $66 worth of assets for every $100 invested. Based on that shortfall, the
panel calculated that Treasury had received only $176 billion in assets for its
$254 billion investment, leaving a $78 billion hole in taxpayer pockets.
Not all investors subsidized the struggling banks so heavily while investing in
them. The COP report notes that private investors received much closer to fair
market value in investments made at the time of the early TARP transactions.
When, for instance,
Berkshire Hathaway invested $5 billion in Goldman
Sachs in September, the Omaha-based
company received securities worth $110 for each $100 invested. And when
Mitsubishi invested in Morgan Stanley
that same month, it received securities worth $91 for
every $100 invested.
As of May 15, according to the
Ethisphere TARP Index,
which tracks the government's bailout investments, its various
investments had depreciated in value by almost $147.7 billion. In other words,
TARP's losses come out to almost $1,300 per American taxpaying household.
2. As the government has no real oversight over bailout funds, taxpayers remain
in the dark about how their money has been used and if it has made any
difference.
While the Treasury Department can make TARP recipients report on just how they
spend their government bailout funds, it has chosen not to do so. As a result,
it's unclear whether institutions receiving such funds are using that money to
increase lending--which would, in turn, boost the economy--or merely to fill in
holes in their balance sheets.
Neil M. Barofsky, the special inspector general for TARP, summed the situation
up this way in his office's April quarterly report to Congress: "The American
people have a right to know how their tax dollars are being used, particularly
as billions of dollars are going to institutions for which banking is certainly
not part of the institution's core business and may be little more than a way to
gain access to the low-cost capital provided under TARP."
This lack of transparency makes the bailout process highly susceptible to fraud
and corruption.
Barofsky's report stated
that twenty separate criminal investigations were
already underway involving corporate fraud, insider trading and public
corruption. He also
told the
Financial Times that his office was investigating whether banks manipulated
their books to secure bailout funds. "I hope we don't find a single bank that's
cooked its books to try to get money, but I don't think that's going to be the
case."
Economist Dean Baker, co-director of the Center for Economic and Policy Research
in Washington, suggested to TomDispatch in an interview that the opaque and
complicated nature of the bailout may not be entirely unintentional, given the
difficulties it raises for anyone wanting to follow the trail of taxpayer
dollars from the government to the banks. "[Government officials] see this all
as a Three Card Monte, moving everything around really quickly so the public
won't understand that this really is an elaborate way to subsidize the banks,"
Baker says, adding that the public "won't realize we gave money away to some of
the richest people."
3. The bailout's newer programs heavily favor the private sector, giving
investors an opportunity to earn lucrative profits and leaving taxpayers with
most of the risk.
Under Treasury Secretary Geithner, the Treasury Department has greatly expanded
the financial bailout to troubling new programs like the Public-Private
Investment Program (PPIP) and the Term Asset-Backed-Securities Loan Facility
(TALF). The PPIP, for example, encourages private investors to buy "toxic" or
risky assets on the books of struggling banks. Doing so, we're told, will get
banks lending again because the burdensome assets won't weigh them down.
Unfortunately, the incentives the Treasury Department is offering to get private
investors to participate are so generous that the government--and, by extension,
American taxpayers--are left with all the downside.
Joseph Stiglitz, the Nobel-prize winning economist,
described the PPIP program
in a New York Times op-ed this way:
Consider an asset that has a 50-50 chance of being worth either zero or $200 in
a year's time. The average "value" of the asset is $100. Ignoring interest, this
is what the asset would sell for in a competitive market. It is what the asset
is 'worth.' Under the plan by Treasury Secretary Timothy Geithner, the
government would provide about 92 percent of the money to buy the asset but
would stand to receive only 50 percent of any gains, and would absorb almost all
of the losses. Some partnership!
Assume that one of the public-private partnerships the Treasury has promised to
create is willing to pay $150 for the asset. That's 50 percent more than its
true value, and the bank is more than happy to sell. So the private partner puts
up $12, and the government supplies the rest--$12 in "equity" plus $126 in the
form of a guaranteed loan.
If, in a year's time, it turns out that the true value of the asset is zero, the
private partner loses the $12, and the government loses $138. If the true value
is $200, the government and the private partner split the $74 that's left over
after paying back the $126 loan. In that rosy scenario, the private partner more
than triples his $12 investment. But the taxpayer, having risked $138, gains a
mere $37."
Worse still, the PPIP can be easily manipulated for private gain. As economist
Jeffrey Sachs has described it,
a bank with worthless toxic assets on its books could actually set up its own
public-private fund to bid on those assets. Since no true bidder would pay for a
worthless asset, the bank's public-private fund would win the bid, essentially
using government money for the purchase. All the public-private fund would then
have to do is quietly declare bankruptcy and disappear, leaving the bank to make
off with the government money it received. With the PPIP deals set to begin in
the coming months, time will tell whether private investors actually take
advantage of the program's flaws in this fashion.
The Treasury Department's TALF program offers equally enticing possibilities for
potential bailout profiteers, providing investors with a chance to double,
triple or even quadruple their investments. And like the PPIP, if the deal goes
bad, taxpayers absorb most of the losses. "It beats any financing that the
private sector could ever come up with," a
Wall Street trader commented
in a recent Fortune magazine story. "I almost want to say it is
irresponsible."
4. The government has no coherent plan for returning failing financial
institutions to profitability and maximizing returns on taxpayers' investments.
Compare the treatment of the auto industry and the financial sector, and a
troubling double standard emerges. As a condition for taking bailout aid, the
government required Chrysler and General Motors to present
detailed plans
on how the companies would return to profitability. Yet the Treasury Department
attached minimal conditions to the billions injected into the largest bailed-out
financial institutions. Moreover, neither Geithner nor Lawrence Summers, one of
President Barack Obama's top economic advisors, nor the president himself has
articulated any substantive plan or vision for how the bailout will help these
institutions recover and, hopefully, maximize taxpayers' investment returns.
The Congressional Oversight Panel highlighted the absence of such a
comprehensive plan in its
January report.
Three months into the bailout, the Treasury
Department "has not yet explained its strategy," the report stated. "Treasury
has identified its goals and announced its programs, but it has not yet
explained how the programs chosen constitute a coherent plan to achieve those
goals."
Today, the department's endgame for the bailout still remains vague. Thomas
Hoenig, president of the Federal Reserve Bank of Kansas City,
wrote in the
Financial Times in May that the government's response to the financial
meltdown has been "ad hoc, resulting in inequitable outcomes among firms,
creditors, and investors." Rather than perpetually prop up banks with endless
taxpayer funds, Hoenig suggests, the government should allow banks to fail. Only
then, he believes, can crippled financial institutions and systems be fixed.
"Because we still have far to go in this crisis, there remains time to define a
clear process for resolving large institutional failure. Without one, the
consequences will involve a series of short-term events and far more uncertainty
for the global economy in the long run."
The healthier and more profitable bailout recipients are once financial markets
rebound, the more taxpayers will earn on their investments. Without a plan,
however, banks may limp back to viability while taxpayers lose their investments
or even absorb further losses.
5. The bailout's focus on Wall Street mega-banks ignores smaller banks serving
millions of American taxpayers that face an equally uncertain future.
The government may not have a long-term strategy for its trillion-dollar
bailout, but its guiding principle, however misguided, is clear: what's good for
Wall Street will be best for the rest of the country.
On the day the mega-bank stress tests were officially released, another set of
stress-test results came out to much less fanfare. In its
quarterly report on the health of individual banks
and the banking industry as a whole,
Institutional Risk Analytics (IRA), a respected financial services organization,
found that the stress levels among more than 7,500 FDIC-reporting banks
nationwide had risen dramatically. For 1,575 of the banks, net incomes had
turned negative due to decreased lending and less risk-taking.
The conclusion IRA drew was telling: "Our overall observation is that US policy
makers may very well have been distracted by focusing on 19 large stress test
banks designed to save Wall Street and the world's central bank bondholders,
this while a trend is emerging of a going concern viability crash taking shape
under the radar." The report concluded with a question: "Has the time come to
shift the policy focus away from the things that we love, namely big zombie
banks, to tackle things that are truly hurting us?"
6. The bailout encourages the very behaviors that created the economic crisis in
the first place instead of overhauling our broken financial system and helping
the individuals most affected by the crisis.
As Joseph Stiglitz explained in the New York Times, one major cause of
the economic crisis was bank overleveraging. "Using relatively little capital of
their own," he wrote, banks "borrowed heavily to buy extremely risky real estate
assets. In the process, they used overly complex instruments like collateralized
debt obligations." Financial institutions engaged in overleveraging in pursuit
of the lucrative profits such deals promised--even if those profits came with
staggering levels of risk.
Sound familiar? It should, because in the PPIP and TALF bailout programs the
Treasury Department has essentially replicated the very over-leveraged, risky,
complex system that got us into this mess in the first place: in other words,
the government hopes to repair our financial system by using the flawed
practices that caused this crisis.
Then there are the institutions deemed "too big to fail." These financial
giants--among them AIG, Citigroup and Bank of America-- have been kept afloat by
billions of dollars in bottomless bailout aid. Yet reinforcing the notion that
any institution is "too big to fail" is dangerous to the economy. When a company
like AIG grows so large that it becomes "too big to fail," the risk it carries
is systemic, meaning failure could drag down the entire economy. The government
should force "too big to fail" institutions to slim down to a safer, more modest
size; instead, the Treasury Department continues to subsidize these financial
giants, reinforcing their place in our economy.
Of even greater concern is the message the bailout sends to banks and
lenders--namely, that the risky investments that crippled the economy are fair
game in the future. After all, if banks fail and teeter at the edge of collapse,
the government promises to be there with a taxpayer-funded, potentially
profitable safety net.
The handling of the bailout makes at least one thing clear, however. It's not
your health that the government is focused on, it's theirs-- the very banks and
lenders whose convoluted financial systems provided the underpinnings for
staggering salaries and bonuses, while bringing our economy to the brink of
another Great Depression.
Keynes:
The Rise, Fall, and Return of the 20th Century's Most Influential Economist
by Peter Clarke (Bloomsbury; 2009, 211 pages; $20). Examines the life and
legacy of the British economist (1883-1946).
"Lack of Candor and the AIG Bailout: If AIG wasn't too big to fail,
why did the government rescue it? And why do we need to turn the financial
system upside down?" by Peter J. Wallison, The Wall Street Journal,
November 27, 2009 ---
http://online.wsj.com/article/SB10001424052748704779704574551861399508826.html?mod=djemEditorialPage
Since last September, the government's case for
bailing out AIG has rested on the notion that the company was too big to
fail. If AIG hadn't been rescued, the argument goes, its credit default swap
(CDS) obligations would have caused huge losses to its counterparties—and
thus provoked a financial collapse.
Last week's news that this was not in fact the
motive for AIG's rescue has implications that go well beyond the Obama
administration's efforts to regulate CDSs and other derivatives. It's one
more example that the administration may be using the financial crisis as a
pretext to extend Washington's control of the financial sector.
The truth about the credit default swaps came out
last week in a report by TARP Special Inspector General Neil Barofsky. It
says that Treasury Secretary Tim Geithner, then president of the New York
Federal Reserve Bank, did not believe that the financial condition of AIG's
credit default swap counterparties was "a relevant factor" in the decision
to bail out the company. This contradicts the conventional assumption, never
denied by the Federal Reserve or the Treasury, that AIG's failure would have
had a devastating effect.
So why did the government rescue AIG? This has
never been clear.
The Obama administration has consistently argued
that the "interconnections" among financial companies made it necessary to
save AIG and Bear Stearns. Focusing on interconnections implies that the
failure of one large financial firm will cause debilitating losses at
others, and eventually a systemic breakdown. Apparently this was not true in
the case of AIG and its credit default swaps—which leaves open the question
of why the Fed, with the support of the Treasury, poured $180 billion into
AIG.
The broader question is whether the entire
regulatory regime proposed by the administration, and now being pushed
through Congress by Rep. Barney Frank and Sen. Chris Dodd, is based on a
faulty premise. The administration has consistently used the term "large,
complex and interconnected" to describe the nonbank financial institutions
it wants to regulate. The prospect that the failure of one of these firms
might pose a systemic risk is the foundation of the administration's
comprehensive regulatory regime for the financial industry.
Up to now, very few pundits or reporters have
questioned this logic. They have apparently been satisfied with the
explanation that the "interconnectedness" created by those mysterious credit
default swaps was the culprit.
But the New York Fed is the regulatory body most
familiar with the CDS market. If that agency did not believe AIG's failure
would have actually brought down its counterparties—and ultimately the
financial system itself—it raises serious questions about the
administration's credibility, and about the need for its regulatory
proposals. If "interconnections" among financial institutions are indeed the
source of the financial crisis, the administration should be far more
forthcoming than it has been about exactly what these interconnections are,
and how exactly a broad new system of regulation and resolution would
eliminate or reduce them.
The administration's unwillingness or inability to
clearly define the problem of interconnectedness is not the only weakness in
its rationale for imposing a whole new regulatory regime on the financial
system. Another example is the claim—made by Mr. Geithner and President
Obama himself—that predatory lending by mortgage brokers was one of the
causes of the financial crisis.
No doubt some deceptive practices occurred in
mortgage origination. But the facts suggest that the government's own
housing policies—and not weak regulation—were the source of these bad loans.
At the end of 2008, there were about 26 million
subprime and other nonprime mortgages in our financial system. Two-thirds of
these mortgages were on the balance sheets of the Federal Housing
Administration, Fannie Mae and Freddie Mac, and the four largest U.S. banks.
The banks were required to make these loans in order to gain approval from
the Fed and other regulators for mergers and expansions.
The fact that the government itself either bought
these bad loans or required them to be made shows that the most plausible
explanation for the large number of subprime loans in our economy is not a
lack of regulation at the mortgage origination level, but government-created
demand for these loans.
Finally, although there may be a good policy
argument for a new consumer protection agency for financial services and
products, the scope of what the administration has proposed goes far beyond
lending, or even deposit-taking. In the administration's proposed
legislation, the Consumer Financial Protection Agency would cover any
business that provides consumer credit of any kind, including the common
layaway plans and Christmas clubs that small retailers offer their
customers.
Under the guise of addressing the causes of a
global financial crisis, the Obama administration's bill would have
regulated credit counseling, educational courses on finance, financial-data
processing, money transmission and custodial services, and dozens more small
businesses that could not possibly cause a financial crisis. Even Chairmen
Frank and Dodd balked at this overreach. Their bills exempt retailers if
their financial activity is incidental to their other business. Still, many
vestiges of this excess remain in the legislation that is now being pushed
toward a vote.
The lack of candor about credit default swaps, the
effort to blame lack of regulation for the subprime crisis and the excessive
reach of the proposed consumer protection agency are all of a piece. The
administration seems to be using the specter of another financial crisis to
bring more and more of the economy under Washington's control.
With the help of large Democratic majorities in
Congress, this train has had considerable momentum. But perhaps—with the
disclosure about credit default swaps and the AIG crisis—the wheels are
finally coming off.
Bob Jensen's threads on the Greatest Swindle in the World are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob
Jensen's threads on why the infamous "Bailout" won't work ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity
"Democratic Payoffs, Er, Stimulus,"
by Mona Charen, Townhall, January 5, 2010 ---
http://townhall.com/columnists/MonaCharen/2010/01/05/democratic_payoffs,_er,_stimulus
When a non-American scholar I admired let slip a
casual reference to "American corruption" a few years ago, my chauvinistic
pride was wounded. This isn't Mexico, after all, or even Italy, where bribes
are the normal social lubricant. Still, an unsentimental examination of
government dollars at work seems to confirm my friend's observation.
A small example: The U.S. government has announced
plans to spend $340 million on an advertising campaign to promote the
Census, including $2.5 million for ads during the Super Bowl. Though the
nation has been collecting this data for 220 years, it seems we now need
commercial jingles to complete the forms. Or could there be another agenda?
The government, reports The Hill newspaper, will target $80 million of those
dollars to racial and ethnic minorities and non-English speakers -- groups
that vote disproportionately Democratic. Nor will Democrats permit efforts
to limit the count to those here legally. An effort by Sen. David Vitter,
R-La., to exclude illegal aliens from the count went nowhere.
Illegal aliens don't (usually) vote, of course. But
when they are counted in the Census, they do affect representation in the
Congress. So some of the money you pay in taxes will go toward increasing
the legislative clout of one party.
That same party has seen to its own perpetuation in
other ways, too. Consider the $787 billion stimulus bill. Veronique de Rugy
and Jerry Brito of George Mason University report that "a total of 56,399
contracts and grants totaling $157,028,362,536 were awarded in this first
quarter for which Recovery.gov reports are available. The number of jobs
claimed as created or saved is 638,826.54 -- an average of $245,807.51 per
job."
But it gets more interesting. "There are 177
districts represented by Republicans and 259 represented by Democrats," they
write. "On average, Democratic districts received 1.6 times more awards than
Republican ones. The average number of awards per Republican district is 94,
while the average number of awards per Democratic district is 152."
Democratic districts also received nearly twice the dollar value of funds as
Republican ones.
Continued in article
Video: Is Anyone Minding the Store at the Federal Reserve? ---
http://www.silverbearcafe.com/private/05.09/mindingthestore.html
The video is a anti-Bernanke musical performance by the Dean of Columbia
Business School ---
http://www.youtube.com/watch?v=3u2qRXb4xCU
Ben Bernanke (Chairman of the Federal Reserve and a great friend
of big banks) ---
http://en.wikipedia.org/wiki/Ben_Bernanke
R. Glenn Hubbard (Dean of the Columbia Business School) ---
http://en.wikipedia.org/wiki/Glenn_Hubbard_(economics)
Video: Is Anyone Minding the Store at the Federal Reserve? ---
http://www.silverbearcafe.com/private/05.09/mindingthestore.html
Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30,
2009 ---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
I downloaded the video (5,631 Kbs) to
http://www.cs.trinity.edu/~rjensen/temp/FinancialWMDs.rv
Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)
I was not aware how fraudulent the credit derivatives markets had become. I
always viewed credit derivatives as an unregulated insurance market for credit
protection. But in 2007 and 2008 this market turned into a betting operation
more like a rolling crap game on Wall Street.
Simoleon Sense
Reviews Janet Tavakoli’s Dear Mr. Buffett ---
http://www.simoleonsense.com/simoleon-sense-reviews-janet-tavakolis-dear-mr-buffett/
What’s The Book (Dear Mr. Buffett) About
Dear Mr. Buffett,
chronicles the agency problems, poor regulations, and participants which led to
the current financial crisis. Janet accomplishes this herculean task by
capitalizing on her experiences with derivatives, Wall St, and her relationship
with Warren Buffett. One wonders how she managed to pack so much material in
such few pages!
Unlike many books which only analyze past events, Dear Mr.
Buffett, offers proactive advice for improving financial markets. Janet is
clearly very concerned about protecting individual rights, promoting honesty,
and enhancing financial integrity. This is exactly the kind of character we
should require of our financial leaders.
Business week once called Janet the Cassandra of Credit
Derivatives. Without a doubt Janet should have been listened to. I’m confident
that from now on she will be.
Closing thoughts
Rather than a complicated book on financial esoterica, Janet has
created a simple guide to understanding the current crisis. This book is a must
read for all students of finance, economics, and business. If you haven’t read
this book, please do so.
Warning –This book is likely to infuriate you, and that’s a good
thing!
Janet provides indicting evidence and citizens may be tempted to
initiate vigilante like witch trials. Please
consult with your doctor before taking this financial medication.
Continued in article
Bob Jensen's Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Also see "Credit Derivatives" under the C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
Of all the corporate bailouts that have taken place
over the past year, none has proved more costly or contentious than the rescue
of American International Group (AIG). Its reckless bets on subprime mortgages
threatened to bring down Wall Street and the world economy last fall until the
U.S Treasury and the Federal Reserve stepped in to save it. So far, the huge
insurance and financial services conglomerate has been given or promised $180
billion in loans, investments, financial injections and guarantees - a sum
greater than the annual cost of the wars in Iraq and Afghanistan."
"Why AIG Stumbled, And Taxpayers Now Own It," CBS Sixty Minutes,
May 17, 2009 ---
http://www.cbsnews.com/stories/2009/05/15/60minutes/main5016760.shtml?source=RSSattr=HOME_5016760
Jensen Comment
To add pain to misery, AIG lied to the media about the extent of bonuses granted
after receiving TARP funds.
Bob Jensen's threads on AIG are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
AIG now says it paid out more than $454 million in
bonuses to its employees for work performed in 2008. That is nearly four times
more than the company revealed in late March when asked by POLITICO to detail
its total bonus payments. At that time, AIG spokesman Nick Ashooh said the firm
paid about $120 million in 2008 bonuses to a pool of more than 6,000 employees.
The figure Ashooh offered was, in turn, substantially higher than company CEO
Edward Liddy claimed days earlier in testimony before a House Financial Services
Subcommittee. Asked how much AIG had paid in 2008 bonuses, Liddy responded: “I
think it might have been in the range of $9 million.”
Emon Javers, "AIG bonuses four times
higher than reported," Politico, May 5, 2009 ---
http://www.politico.com/news/stories/0509/22134.html
Bank Meltdown
Collateralized Debt Obligations (CDOs) and Credit Derivatives (CDR) Got Too Much
of the Blame
As more U.S. banks get shut down by the Federal Deposit
Insurance Corp., it is becoming clear that most bank failures have nothing to do
with investments in complex financial products that bear risks that are
difficult for laymen to understand. Today, banks fail the old-fashioned way:
They make loans but do not ever get the money back. These loans are going bad at
a rate far beyond what banks and regulators imagined.
"Most Failing Banks Are Doing It the Old-School Way," by Floyd Norris, The
New York Times, August 20, 2009 ---
http://www.nytimes.com/2009/08/21/business/21norris.html?_r=1&ref=business
Banks are now losing money and going broke the
old-fashioned way: They made loans that will never be repaid.
As the number of banks closed by the Federal
Deposit Insurance Corporation has grown rapidly this year, it has become
clear that most of them had nothing to do with the strange financial
products that seemed to dominate the news when the big banks were nearing
collapse and being bailed out by the government.
There were no C.D.O’s, or S.I.V.’s or AAA-rated
“supersenior tranches” that turned out to have little value. Certainly there
were no “C.D.O.-squareds.”
Staying away from strange securities has not made
things better. Jim Wigand, the F.D.I.C.’s deputy director of resolutions and
receiverships, says banks that are failing now are in worse shape — in terms
of the amount of losses relative to the size of the banks — than the ones
that collapsed during the last big wave of failures, from the savings and
loan crisis.
The severity of the current string of bank failures
shows that many of the proposed remedies batted about since the financial
crisis erupted would have done nothing to stem this wave of closures. These
banks did not get in over their heads with derivatives or hide their bad
assets in off-balance sheet vehicles. Nor did their traders make bad bets;
they generally had no traders. They did not make loans that they expected to
sell quickly, so they had plenty of reason to care that the loans would be
repaid.
What they did do is see loans go bad, in some cases
with stunning rapidity, in volumes that they never thought possible.
The fact that so many loans are souring is a
testament to how bad the recession, and the collapse in property prices, has
been. But looking at some of the banks in detail shows that they were also
victims of their own apparent success. Year after year, these banks grew and
grew, and took more and more risks. Losses were minimal. Cautious bankers
appeared to be missing opportunities.
As the great economist Hyman P. Minsky pointed out,
stability eventually will be destabilizing. The absence of problems in the
middle of this decade was taken as proof that nothing very bad was likely to
happen. Any bank that did not lower its lending standards from 2005 through
mid-2007 would have stopped growing, simply because its competitors were
offering more and more generous terms.
Take the recent failure of Temecula Valley Bank, in
Riverside County, Calif. For most of this decade, it grew rapidly. Deposits
leapt by 50 percent a year, rising to $1.1 billion in 2007, from less than
$100 million in 2001.
That growth was powered by construction loans, on
which it suffered virtually no losses for many years. By 2005, loans to
builders amounted to more than half its total loans — and to 450 percent of
its capital.
Temecula appeared to be very well capitalized. But
virtually all that capital vanished when the boom stopped.
When the F.D.I.C. stepped in last month, the bank
had $1.5 billion in assets. The agency thinks it will lose about a quarter
of that amount.
Across the country, at Security Bank of Bibb
County, Ga., the story was remarkably similar. Its fast growth was powered
by construction loans, although in this case the loans mostly financed
commercial buildings, not houses. When those loans went bad, what had
appeared to be a well-capitalized bank went under. The F.D.I.C. estimates
its losses will be almost 30 percent of the bank’s $1.2 billion in assets.
In both of those cases, to get another bank to take
over the failed bank, the F.D.I.C. had to agree to share future losses on
most of the loans. That is one reason the agency’s estimates of its eventual
losses could turn out to be wrong. In the best of all worlds, the loss
estimates would be too high because the economy and property prices recover
rapidly. But if the recovery is slow, the losses could grow.
In either case, the F.D.I.C. may soon need to seek
more money to pay for failing banks. It could seek that cash from the
Treasury, where it has a line of credit, or it could seek to raise the fees
it charges banks.
So far this year, the F.D.I.C. has closed 77 banks,
and there almost certainly will be more on Friday, the agency’s preferred
day for bank closures. Last Friday there were five. Not since June 12 has
there been a Friday without a bank closing. By contrast, there were three
failures in 2007 and 25 in 2008.
Of the 77 failures in 2009, the F.D.I.C. could not
even find a bank to acquire eight of them. Of the other 69, the agency
signed loss-sharing agreements on 41.
By contrast, the agency found acquirers for all of
the 25 failed banks in 2008, and had to sign loss-sharing agreements for
just three of the banks.
“Loss-sharing” is something of a misnomer. In
practice, the vast majority of the losses are borne by the F.D.I.C.
Typically, it takes 80 percent of the losses up to a negotiated limit, and
95 percent of losses above that level.
Continued in article
"The Price for Fannie and Freddie Keeps Going Up: Barney Frank's
decision to 'roll the dice' on subsidized housing is becoming an epic disaster
for taxpayers," by Peter J. Wallison, The Wall Street Journal,
December 29, 2009 ---
http://online.wsj.com/article/SB10001424052748703278604574624681873427574.html?mod=djemEditorialPage
On Christmas Eve, when most Americans' minds were
on other things, the Treasury Department announced that it was removing the
$400 billion cap from what the administration believes will be necessary to
keep Fannie Mae and Freddie Mac solvent. This action confirms that the
decade-long congressional failure to more closely regulate these two
government-sponsored enterprises (GSEs) will rank for U.S. taxpayers as one
of the worst policy disasters in our history.
Fannie and Freddie's congressional sponsors—some of
whom are now leading the administration's effort to "reform" the financial
system—have a lot to answer for. Rep. Barney Frank (D., Mass.), chairman of
the House Financial Services Committee, sponsored legislation adopted in
2008 that established a new regulatory structure for the GSEs. But by then
it was far too late. The GSEs had begun buying risky loans in 1993 to meet
the "affordable housing" requirements established under congressional
direction by the Department of Housing and Urban Development (HUD).
Most of the damage was done from 2005 through 2007,
when Fannie and Freddie were binging on risky mortgages. Back then, Mr.
Frank was the bartender, denying that there was any cause for concern, and
claiming that he wanted to "roll the dice" on subsidized housing support.
In 2005, the Senate Banking Committee, then
controlled by Republicans, adopted tough regulatory legislation that would
have established more auditing and oversight of the two agencies. But it was
passed out of committee on a partisan vote, and with no Democratic support
it never came to a vote.
By the end of 2008, Fannie and Freddie held or
guaranteed approximately 10 million subprime and Alt-A mortgages and
mortgage-backed securities (MBS)—risky loans with a total principal balance
of $1.6 trillion. These are now defaulting at unprecedented rates,
accounting for both their 2008 insolvency and their growing losses today.
Since 2008, under government control, the two agencies have continued to buy
dicey mortgages in order to stabilize housing prices.
There is more to this ugly situation. New research
by Edward Pinto, a former chief credit officer for Fannie Mae and a housing
expert, has found that from the time Fannie and Freddie began buying risky
loans as early as 1993, they routinely misrepresented the mortgages they
were acquiring, reporting them as prime when they had characteristics that
made them clearly subprime or Alt-A.
In general, a subprime mortgage refers to the
credit of the borrower. A FICO score of less than 660 is the dividing line
between prime and subprime, but Fannie and Freddie were reporting these
mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a
third-quarter 10-Q report in 2008.
An Alt-A mortgage is one in which the quality of
the mortgage or the underwriting was deficient; it might lack adequate
documentation, have a low or no down payment, or in some other way be more
likely than a prime mortgage to default. Fannie and Freddie were also
reporting these mortgages as prime, according to Mr. Pinto.
It is easy to see how this misrepresentation was a
principal cause of the financial crisis.
Market observers, rating agencies and investors
were unaware of the number of subprime and Alt-A mortgages infecting the
financial system in late 2006 and early 2007. Of the 26 million subprime and
Alt-A loans outstanding in 2008, 10 million were held or guaranteed by
Fannie and Freddie, 5.2 million by other government agencies, and 1.4
million were on the books of the four largest U.S. banks.
In addition, about 7.7 million subprime and Alt-A
housing loans were in mortgage pools supporting MBS issued by Wall Street
banks—which had long before been driven out of the prime market by Fannie
and Freddie's government-backed, low-cost funding. The vast majority of
these MBS were rated AAA, because the rating agencies' models assumed that
the losses that are incurred by subprime and Alt-A loans would be within the
historical range for the number of high-risk loans known to be outstanding.
But because of Fannie and Freddie's mislabeling,
there were millions more high-risk loans outstanding. That meant default
rates as well as the actual losses after foreclosure were going to be
outside all prior experience. When these rates began to show up early in
2007, it was apparent something was seriously wrong with assumptions on
which AAA ratings had been based.
Losses, it was now certain, would invade the AAA
tranches of the mortgage-backed securities outstanding. Investors, having
lost confidence in the ratings, fled the MBS market and ultimately the
market for all asset-backed securities. They have not yet returned.
By the end of 2007, the MBS market collapsed
entirely. Assets once carried at par on financial institutions' balance
sheets could not be sold except at distress prices. This raised questions
about the stability and even the solvency of most of the world's largest
financial institutions.
The first major victim was Bear Stearns, the
smallest of the five major Wall Street investment banks but one invested
heavily in risky MBS. The government rescue of Bear Stearns in March 2008
signaled that the U.S. government, and perhaps others, would stand behind
other large financial institutions. The moral hazard this engendered was
deadly when Lehman Brothers' solvency came under challenge. Spreads in the
credit default swap market for Lehman, despite massive short-selling, showed
very little alarm by investors until just before the fateful weekend of
Sept. 13 and 14, when they blew out on fears that the firm might not be
rescued.
By that time it was too late for Lehman's
counterparties to take the protective action that might have cushioned the
shock. As it turned out, however, none of Lehman's largest counterparties
failed—so much for the idea that the financial market is
"interconnected"—but all market participants now realized they had to know
the true financial condition of their counterparties. The result was a
freeze-up in interbank lending.
For most people, that freeze-up is the beginning of
the financial crisis. But its roots go back to 1993, when Fannie and Freddie
began stocking up on subprime and other risky loans while reporting them as
prime.
Why Fannie and Freddie did this is still to be
determined. But the leading candidate is certainly HUD's affordable housing
regulations, which by 2007 required that 55% of all the loans the agencies
acquired had to be made to borrowers at or below the median income, with
almost half of these required to be low-income borrowers.
Another likely reason for Fannie and Freddie's
mislabeling of mortgages was their desire to retain congressional support by
"rolling the dice" while making believe they weren't betting. With the
Federal Housing Administration, Wall Street investment banks, and Fannie and
Freddie all competing for these loans, the bottom of the barrel had long
before been scraped and the financial system set up for a crisis.
However, the looting of the taxpayers, which was
initially $700 billion for Wall Street and has now ballooned to an estimated
$1.8 trillion and is not over yet, was not labeled as corruption by our media.
Instead, it was called a “rescue” and was demanded by many anchors and
reporters. We were told it would stabilize the markets and help ordinary people.
It didn’t. Kevin Howley, Associate Professor of Communication at DePauw
University, says this was deliberate propaganda on their part. He comments that
“…the phrase ‘bailout’―with its connotation that the government is letting Wall
Street off the hook for questionable business practices―has given way to a far
more agreeable term― ‘rescue plan.’ This phrasing appeals to the basic decency
of the American people and suggests that we’re all in this thing together.” In a
real-life corruption case, which was just as suspiciously timed as the financial
crisis itself, Alaska Senator Ted Stevens was indicted and then convicted in
this election year on all seven charges of making false statements on Senate
financial documents. One of the charges was that he had received a $1,000
Alaskan sled dog puppy that he valued at only $250 and claimed had come from a
charity. This is chicken feed compared to what the politicians and their
appointees have done by bringing the U.S. to the point of bankruptcy. But can we
ever expect the Department of Justice to turn on the politicians for these
financial crimes? Not likely.
Cliff Kincaid, "The Financial
“Rescue” that Bankrupted America," Accuracy in the Media, November 9,
2008 ---
http://www.aim.org/aim-column/the-financial-rescue-that-bankrupted-america/
Please meet George Orwell's
Big Brother!
The US
government is on a “burning platform” of unsustainable policies and practices
with fiscal deficits, chronic healthcare underfunding, immigration and overseas
military commitments threatening a crisis if action is not taken soon.
David M. Walker,
Former Chief Accountant of the United States ---
http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt
for entitlements (over five times the booked national debt and soaring with new
entitlements) ---
http://faculty.trinity.edu/rjensen/entitlements.htm
A democracy
cannot exist as a permanent form of government. It can only exist until the
voters discover that they can vote themselves largesse from the public treasury.
From that moment on, the majority always votes for the candidates promising the
most benefits from the public treasury, with the result that a democracy always
collapses over loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm
(where the debt clock in real time is a few months behind)
The
National Debt Amount This Instant (Refresh your browser for updates by the
second) ---
http://www.brillig.com/debt_clock/
America, what is happening to you?
“One thing seems probable to me,” said Peer
Steinbrück, the German finance minister, in September 2008....“the United States
will lose its status as the superpower of the global financial system.” You
don’t have to strain too hard to see the financial crisis as the death knell for
a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida,
"How the Crash Will Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
The inherent
vice of capitalism is the unequal sharing of the blessings. The inherent
blessing of socialism is the equal sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)
From the Abraham Lincoln School of Finance
The government should create, issue, and circulate all the currency and credits
needed to satisfy the spending power of the government and the buying power of
consumers. By adoption of these principles, the taxpayers will be saved immense
sums of interest. Money will cease to be master and become the servant of
humanity.
Abraham Lincoln
(I wonder why this just does not work in Zimbabwe where Robert Mugabe adopted
Lincoln's fiscal policy?)
For
the sake of future America, we’d better hope that Lincoln was correct. But
Lincoln’s fiscal policy sure did not work for Zimbabwe.
Zimbabwe's
central bank will introduce a 100 trillion Zimbabwe dollar banknote, worth about
$33 on the black market, to try to ease desperate cash shortages, state-run
media said on Friday.
KyivPost, January 16, 2009 ---
http://www.kyivpost.com/world/33522
Jensen Comment
This is a direct result of raising money by simply printing it, and the U.S.
should take note since this is how our Federal government has decided to pay for
anticipated trillion-dollar budget deficits ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
Professor Schiller at Yale asserts housing prices are still overvalued and
need to come down to reality
The median value of a U.S. home in 2000 was $119,600.
It peaked at $221,900 in 2006. Historically, home prices have risen annually in
line with CPI. If they had followed the long-term trend, they would have
increased by 17% to $140,000. Instead, they skyrocketed by 86% due to Alan
Greenspan’s irrational lowering of interest rates to 1%, the criminal pushing of
loans by lowlife mortgage brokers, the greed and hubris of investment bankers
and the foolishness and stupidity of home buyers. It is now 2009 and the median
value should be $150,000 based on historical precedent. The median value at the
end of 2008 was $180,100. Therefore, home prices are still 20% overvalued.
Long-term averages are created by periods of overvaluation followed by periods
of undervaluation. Prices need to fall 20% and could fall 30%.....
Watch the video on Yahoo Finance ---
Click Here
See the chart at
http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
Also see Jim Mahar's blog at
http://financeprofessorblog.blogspot.com/2009/02/shiller-house-prices-still-way-too-high.html
Jensen Comment
Some Republicans now propose that
mortgage rates be set at 4% or lower for 30-year mortgages, but this will simply
jumpstart the mortgage brokering racket (with overvalued appraisals) that got us
into this mess. Also banks are not going to make 30-year loans at such low fixed
rates. Fannie Mae and Freddie Mack, now owned by Congress, will have to buy up
those new loans. Currently Freddie and Fannie need trillions to recover from the
toxic paper they already own. If current homeowners can also refinance at such
low rates we're talking tens of trillions of cost in this stupid Republican plan
being pushed by real estate brokers and home builders and especially mortgage
brokers.
"A Republican Fannie Mae The worst mortgage idea since Barney Frank's last
one," The Wall Street Journal, February 6, 2009 ---
http://online.wsj.com/article/SB123388493959055161.html?mod=djemEditorialPage
February 23, 2009 reply from David Albrecht
[albrecht@PROFALBRECHT.COM]
Very
interesting, but much of what you say is dependent on how consistent was the
2000 value of $119,600.
Dave Albrecht
February 24, 2009 reply from Bob Jensen
Hi David,
Picking any earlier year as a benchmark for value is a lot like picking a
benchmark year for an inflation index such as the CPI-Urban. It doesn’t
matter so much which year is chosen as a benchmark year if all related
calculations are then relative to that benchmark. If there’s inflation in a
given benchmark year, the inflation-adjustment calculations in other years
are valid as long as the same benchmark is used for all years. I think the
same reasoning applies to a real estate value benchmark year.
The important outcome of Schiller’s conclusion lies in the graph at
http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
The cost of building houses went up, but not anything like home prices
soared like a rocket after Greenspan lowered interest rates and the mortgage
fraud processes commenced on Main Street and Wall Street.
The surge in housing prices was not the same among all 50 states. There
are four sunshine states that had the biggest surge and will now receive the
lion’s share of the mortgage bailout funding. Those states are California,
Florida, Arizona, and Nevada. Michigan is the fifth foreclosure problem
state, but the problem there is job loss rates rather than inflated housing
values and overbuilding of new homes. I hate to admit it, but I learned this
five-state foreclosure bailout unfairness last night from Glenn Beck.
Glenn Beck also had the world’s simplest explanation for the CDO problem.
He used a giant cookie to represent a single home mortgage of John Doe. John
Doe’s mortgage was sold to AGI (or virtually any investment bank). AGI in
turn crumbled the cookie into crumbs that were scattered into CDO
collateralized securitization instruments. A given CDO securitization
instrument was then comprised of cookie crumbles from hundreds of mortgage
contracts, including a crumb from John Doe’s contract.
The mathematical theory was that investing in John Doe’s single cookie
had a lot of unsystematic risk that John Doe might lose his job and default.
But in a CDO investment the loss would only be one small cookie crumb.
That
was the
Markowitz-based theory until the housing market crashed.
I
don't think that Glenn Beck has ever heard of Harry Markowitz, so he still
has a few academic lessons to learn. Sadly, academic lessons can sometimes
be toxic. Actually you did not have to crumble each cookie if you held over
a million whole cookies in your portfolio, which was the strategy of Marion
and Herb Sandler at World Savings. The Sandler's used more traditional
portfolio theory rather than CDO-based
Markowitz-based theory of cookie crumbles.
The problem of course, is that now too many crumbs are rotten and the CDO
investments themselves are toxic to the banks that hold them, including Bank
of American that bought a bunch of them when B of A bought Countrywide and
Merrill Lynch. If you know the CDO’s are toxic, why buy them? B of A’s CEO,
Lewis, should’ve been lynched after buying Lynch,.
Glenn Beck pointed out a great legal tactic that John Doe can use for
delaying foreclosure after missing a succession of mortgage payments. If
hauled into court, John Doe should insist on seeing his mortgage contract
--- the original big cookie. This will send all the bank lawyers to work at
enormous fees trying to aggregate all of John Doe’s cookie crumbs scattered
around the world after CDOs were bought, sold, bought, sold etc. in cookie
crumble piles. This just adds to the problems banks are having when
foreclosing on saavy guys like John Doe. In many instances it is just
cheaper to renegotiate a favorable mortgage with John Doe. But I presume,
the owners of every crumb of John Doe’s big cookie must agree to the
renegotiated mortgage.
Now you see why the banks that bought these toxic loans were so stupid.
JP Morgan made a stupid deal buying WaMu. Bank of America made a stupid deal
buying Countrywide Financial and Merrill Lynch. Wachovia made a stupid deal
when buying World Savings. Wells Fargo made a stupid deal when buying
Wachovia. And the list of stupid CEOs goes on and on.
What were they thinking?
They probably believed, as they were taught at Harvard, Chicago, and Wharton,
that Harry Markowitz was infallible.
Bob Jensen
August 2018 Update
Wells Fargo & Co. agreed to pay $2.09 billion to settle with the U.S. Justice
Department over the sale of toxic mortgage-backed securities in the lead-up to
the financial crisis.---
https://www.wsj.com/articles/wells-fargo-agrees-to-2-09-billion-settlement-for-crisis-era-mortgage-loans-1533147302?mod=searchresults&page=1&pos=1&mod=djemCFO_h
This is on top of all the subsequent fines paid by Wells Fargo & Co. for
unrelated subsequent crimes. What a lousy company.
"GE's $19 Billion (And Increasing) Toxic Asset Sink Hole," by Tyler
Durden, Zero Hedge, November 3, 2009 ---
http://www.zerohedge.com/article/ges-19-billion-and-increasing-toxic-asset-sink-hole
One, and maybe the only, of the recent benefits
of the FASB's meager attempts at providing balance sheet transparency
has been the requirement for banks and financial companies to disclose
the difference between the Fair Market Value and the Carrying (Book)
value of their assets, especially as pertains to loans held on the
balance sheet. And while even the FMV calculation leaves much to be
desired, it does demonstrate which companies take abnormal liberties
with their balance sheets, instead of performing needed asset
write-downs as more and more loans turn toxic. A good example of just
such optimism appears when one evaluates the disclosure by "banking"
company General Electric. On page 38 of the firm's just released 10-Q,
the firm indicates that the delta between its loan portfolio FMV and
Book Value continues increasing, and as of September 30, hit an all time
(disclosed) high of $18.8 billion. In other words, General Electric,
whose market cap is about $150 billion at last check, is likely impaired
by at least $19 billion if it were forced to access the market today and
sell off its loans. The $19 billion is 13% of its entire market cap. And
the real number is likely much, much worse.
The delta between the Carrying and Fair Market
Value of GECC's loans can be seen on the chart below:
A reminder of how GE calculates loan FMV is taken from the
company's 10-K:
Based on quoted market prices, recent
transactions and/or discounted future cash flows, using rates we
would charge to similar borrowers with similar maturities.
In other words FMV uses the traditional
Level III evaluation methodology. And even when using DCF (we assume
that was used as it will always give the firm the "best", most
palatable value reading), GE is still seeing a nearly $20 billion
balance sheet shortfall?
What is more troubling, is that even as
GECC has been collapsing its balance sheet, with book value of loans
dropping from $305 billion to $292 billion from FYE 2009 to Q3 2008,
the FMV-Book delta has increased from $12.6 to $18.8 billion. And
this is occurring in a time when the credit market is presumably
surging? Is there something wrong with this picture? As we pointed
out, the $18.8 billion is likely a gross underestimation of the real
valuation shortfall, if one were to really mark all of GE's myriads
of illiquid loans to market.
Yet if nothing else, this shortfall should
explain GE's urgent desire to sell NBCU and to use the ~$30 billion
in proceeds to plug what is becoming an ever growing hole.
More on the greatest swindles of the world
General Electric, the world's largest industrial company, has quietly become the
biggest beneficiary of one of the government's key rescue programs for banks. At
the same time, GE has avoided many of the restrictions facing other financial
giants getting help from the government. The company did not initially qualify
for the program, under which the government sought to unfreeze credit markets by
guaranteeing debt sold by banking firms. But regulators soon loosened the
eligibility requirements, in part because of behind-the-scenes appeals from GE.
As a result, GE has joined major banks collectively saving billions of dollars
by raising money for...
Jeff Gerth and Brady Dennis, "How a Loophole Benefits GE in Bank Rescue
Industrial Giant Becomes Top Recipient in Debt-Guarantee Program," The
Washington Post, June 29, 2009 ---
http://www.washingtonpost.com/wp-dyn/content/article/2009/06/28/AR2009062802955.html?hpid=topnews
Jensen Comment
GE thus becomes the biggest winner under both the TARP and the Cap-and-Trade
give away legislation. It is a major producer of wind turbines and other
machinery for generating electricity under alternative forms of energy. The
government will pay GE billions for this equipment. GE Capital is also "Top
Recipient in Debt-Guarantee Program." Sort of makes you wonder why GE's NBC
network never criticizes liberal spending in Congress.
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Jensen's threads on the bank rescue swindle are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm z
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Interestingly, the term "federal stimulus
spending" is an oxymoron.
....a paper written at the University of California Berkeley entitled The
Macroeconomic Effects of Tax Changes: Estimates Based on a new Measure of Fiscal
Shocks, by Christina D. and David H. Romer (March 2007). (Christina Romer now
chairs the president's Council of Economic Advisors). This study found that the
tax multiplier is 3, meaning that each dollar rise in taxes will reduce private
spending by $3.
Van R. Hoisington and Lacy H. Hunt, "Debt and Inflation,"
Investors Insight ---
http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2009/07/13/debt-and-deflation.aspx#
Bob Jensen's threads on the largest swindle in the history of the
world ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Two Videos Damning Capitalism: One Stupid, One Smart
Michael Moore cheered the bankruptcy of General Motors and absolutely
despises the comeback of General Motors
He has a relatively long list (some lucrative to him) leftist documentaries ---
http://en.wikipedia.org/wiki/Michael_Moore
His documentary Sicko got it wrong --- Cuba is not the dream country of
equity and quality in health care for the masses
Now he has a new documentary entitled: Capitalism: A Love Story
The Stupid Video
"Michael Moore Gets It Wrong," by John Stossel, ABC News, July
11, 2009 ---
http://blogs.abcnews.com/johnstossel/2009/07/michael-moore-gets-it-wrong.html
Michael Moore has been working on
another documentary. This time, he’s taking on
capitalism:
"The wealthy, at some point, decided they
didn't have enough wealth. They wanted more -- a lot more. So they
systematically set about to fleece the American people out of their
hard-earned money."
How ridiculous is that? The wealthy, and everyone
else, almost always decide that they don’t have enough wealth. People ask
their bosses for raises. We invest in stocks hoping for bigger returns than
Treasury Bonds bring. “Greed” is a constant. The beauty of free markets,
when government doesn’t meddle in them, is that they turn this greed into a
phenomenal force for good. The way to win big money is to serve your
customers well. Profit-seeking entrepreneurs have given us better products,
shorter work days, extended lives, and more opportunities to write the
script of our own life.
On Thursday, Moore
announced the title of the movie: Capitalism:
A Love Story.
It’s a title I might have picked to make a point
opposite of what I assume Moore has in mind.
Moore also fails to understand is that it was not
“capitalism” run amok that caused today’s financial problems. In reality,
it was a combination of
ill-conceived
government policies and an
overzealous Federal Reserve artificially lowering
interest rates to fuel a bubble in the housing market. Then it was
government that took money from taxpayers and
forced banks to accept it.
Moore ought to understand that, because he makes a
good point when he says his movie will be about "the biggest robbery in the
history of this country - the massive transfer of U.S. taxpayer money to
private financial institutions."
That is indeed robbery. It sure doesn’t sound like
capitalism.
The Smart Video
Better Video Damning "Managerial Capitalism" and It's Free Online ---
Click Here
http://snipurl.com/managerialcapitalism [fora_tv]
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
The legislation's guidelines for crafting the rescue
plan were clear: the TARP should protect home values and consumer savings,
help citizens keep their homes and create jobs. Above all, with the
government poised to invest hundreds of billions of taxpayer dollars in
various financial institutions, the legislation urged the bailout's
architects to maximize returns to the American people.
That $700 billion bailout has since
grown into a more than $12 trillion commitment by
the US government and the Federal Reserve. About
$1.1 trillion
of that is taxpayer money--the TARP money and an additional $400 billion
rescue of mortgage companies Fannie Mae and Freddie Mac. The TARP now
includes twelve separate programs, and recipients range from megabanks like
Citigroup and JPMorgan Chase to automakers Chrysler and General Motors.
Seven months in, the bailout's impact is unclear.
The Treasury Department has used the
recent "stress test" results it applied to
nineteen of the nation's largest banks to suggest that the worst might be
over; yet the
International Monetary Fund, as well as economists
like New York University professor and economist Nouriel Roubini and New
York Times columnist Paul Krugman
predict greater losses in US markets, rising unemployment and
generally tougher economic times ahead.
What cannot be disputed, however, is the financial
bailout's biggest loser: the American taxpayer. The US government, led by
the Treasury Department, has done little, if anything, to maximize returns
on its trillion-dollar, taxpayer-funded investment. So far, the bailout has
favored rescued financial institutions by
subsidizing their
losses to the tune of $356 billion, shying away
from much-needed management changes and--with the exception of the
automakers--letting companies take taxpayer money without a coherent plan
for how they might return to viability.
The bailout's perks have been no less favorable for
private investors who are now picking over the economy's still-smoking
rubble at the taxpayers' expense. The newer bailout programs rolled out by
Treasury Secretary Timothy Geithner give private equity firms, hedge funds
and other private investors significant leverage to buy "toxic" or
distressed assets, while leaving taxpayers stuck with the lion's share of
the risk and potential losses.
Given the lack of transparency and accountability,
don't expect taxpayers to be able to object too much. After all, remarkably
little is known about how TARP recipients have used the government aid
received. Nonetheless, recent government
reports,
Congressional testimony and commentaries offer those
patient enough to pore over hundreds of pages of material glimpses of just
how Wall Street friendly the bailout actually is. Here, then, based on the
most definitive data and analyses available, are six of the most blatant and
alarming ways taxpayers have been scammed by the government's $1.1-trillion,
publicly funded bailout.
1. By overpaying for
its TARP investments, the Treasury Department provided bailout recipients
with generous subsidies at the taxpayer's expense.
When the Treasury Department ditched its initial
plan to buy up "toxic" assets and instead invest directly in financial
institutions, then-Treasury Secretary Henry Paulson Jr. assured Americans
that they'd get a fair deal. "This is an investment, not an expenditure, and
there is no reason to expect this program will cost taxpayers anything," he
said in October 2008.
Yet the Congressional Oversight Panel (COP), a
five-person group tasked with ensuring that the Treasury Department acts in
the public's best interest, concluded in its
monthly report for February that the department
had significantly overpaid by tens of billions of dollars for its
investments. For the ten largest TARP investments made in 2008, totaling
$184.2 billion, Treasury received on average only $66 worth of assets for
every $100 invested. Based on that shortfall, the panel calculated that
Treasury had received only $176 billion in assets for its $254 billion
investment, leaving a $78 billion hole in taxpayer pockets.
Not all investors subsidized the struggling banks
so heavily while investing in them. The COP report notes that private
investors received much closer to fair market value in investments made at
the time of the early TARP transactions. When, for instance,
Berkshire Hathaway invested $5 billion in Goldman Sachs
in September, the Omaha-based company received
securities worth $110 for each $100 invested. And when
Mitsubishi invested in Morgan Stanley that same
month, it received securities worth $91 for every $100 invested.
As of May 15, according to the
Ethisphere TARP Index, which tracks the
government's bailout investments, its various investments had depreciated in
value by almost $147.7 billion. In other words, TARP's losses come out to
almost $1,300 per American taxpaying household.
2. As the government
has no real oversight over bailout funds, taxpayers remain in the dark about
how their money has been used and if it has made any difference.
While the Treasury Department can make TARP
recipients report on just how they spend their government bailout funds, it
has chosen not to do so. As a result, it's unclear whether institutions
receiving such funds are using that money to increase lending--which would,
in turn, boost the economy--or merely to fill in holes in their balance
sheets.
Neil M. Barofsky, the special inspector general for
TARP, summed the situation up this way in his office's April quarterly
report to Congress: "The American people have a right to know how their tax
dollars are being used, particularly as billions of dollars are going to
institutions for which banking is certainly not part of the institution's
core business and may be little more than a way to gain access to the
low-cost capital provided under TARP."
This lack of transparency makes the bailout process
highly susceptible to fraud and corruption.
Barofsky's report stated that twenty separate
criminal investigations were already underway involving corporate fraud,
insider trading and public corruption. He also
told the Financial Times that his office
was investigating whether banks manipulated their books to secure bailout
funds. "I hope we don't find a single bank that's cooked its books to try to
get money, but I don't think that's going to be the case."
Economist Dean Baker, co-director of the Center for
Economic and Policy Research in Washington, suggested to TomDispatch in an
interview that the opaque and complicated nature of the bailout may not be
entirely unintentional, given the difficulties it raises for anyone wanting
to follow the trail of taxpayer dollars from the government to the banks.
"[Government officials] see this all as a Three Card Monte, moving
everything around really quickly so the public won't understand that this
really is an elaborate way to subsidize the banks," Baker says, adding that
the public "won't realize we gave money away to some of the richest people."
3. The bailout's newer
programs heavily favor the private sector, giving investors an opportunity
to earn lucrative profits and leaving taxpayers with most of the risk.
Under Treasury Secretary Geithner, the Treasury
Department has greatly expanded the financial bailout to troubling new
programs like the Public-Private Investment Program (PPIP) and the Term
Asset-Backed-Securities Loan Facility (TALF). The PPIP, for example,
encourages private investors to buy "toxic" or risky assets on the books of
struggling banks. Doing so, we're told, will get banks lending again because
the burdensome assets won't weigh them down. Unfortunately, the incentives
the Treasury Department is offering to get private investors to participate
are so generous that the government--and, by extension, American
taxpayers--are left with all the downside.
Joseph Stiglitz, the Nobel-prize winning economist,
described the PPIP program in a New York Times
op-ed this way:
Consider an asset that has a
50-50 chance of being worth either zero or $200 in a year's time. The
average "value" of the asset is $100. Ignoring interest, this is what the
asset would sell for in a competitive market. It is what the asset is
'worth.' Under the plan by Treasury Secretary Timothy Geithner, the
government would provide about 92 percent of the money to buy the asset but
would stand to receive only 50 percent of any gains, and would absorb almost
all of the losses. Some partnership!
Assume that one of the
public-private partnerships the Treasury has promised to create is willing
to pay $150 for the asset. That's 50 percent more than its true value, and
the bank is more than happy to sell. So the private partner puts up $12, and
the government supplies the rest--$12 in "equity" plus $126 in the form of a
guaranteed loan.
If, in a year's time, it turns
out that the true value of the asset is zero, the private partner loses the
$12, and the government loses $138. If the true value is $200, the
government and the private partner split the $74 that's left over after
paying back the $126 loan. In that rosy scenario, the private partner more
than triples his $12 investment. But the taxpayer, having risked $138, gains
a mere $37."
Worse still, the PPIP can be easily manipulated for
private gain. As economist
Jeffrey Sachs has described it, a bank with
worthless toxic assets on its books could actually set up its own
public-private fund to bid on those assets. Since no true bidder would pay
for a worthless asset, the bank's public-private fund would win the bid,
essentially using government money for the purchase. All the public-private
fund would then have to do is quietly declare bankruptcy and disappear,
leaving the bank to make off with the government money it received. With the
PPIP deals set to begin in the coming months, time will tell whether private
investors actually take advantage of the program's flaws in this fashion.
The Treasury Department's TALF program offers
equally enticing possibilities for potential bailout profiteers, providing
investors with a chance to double, triple or even quadruple their
investments. And like the PPIP, if the deal goes bad, taxpayers absorb most
of the losses. "It beats any financing that the private sector could ever
come up with," a
Wall Street trader commented
in a recent Fortune magazine story. "I almost want to say it is
irresponsible."
4. The government has
no coherent plan for returning failing financial institutions to
profitability and maximizing returns on taxpayers' investments.
Compare the treatment of the auto industry and the
financial sector, and a troubling double standard emerges. As a condition
for taking bailout aid, the government required Chrysler and General Motors
to present
detailed plans on how the companies would return
to profitability. Yet the Treasury Department attached minimal conditions to
the billions injected into the largest bailed-out financial institutions.
Moreover, neither Geithner nor Lawrence Summers, one of President Barack
Obama's top economic advisors, nor the president himself has articulated any
substantive plan or vision for how the bailout will help these institutions
recover and, hopefully, maximize taxpayers' investment returns.
The Congressional Oversight Panel highlighted the
absence of such a comprehensive plan in its
January report. Three months into the bailout, the
Treasury Department "has not yet explained its strategy," the report stated.
"Treasury has identified its goals and announced its programs, but it has
not yet explained how the programs chosen constitute a coherent plan to
achieve those goals."
Today, the department's endgame for the bailout
still remains vague. Thomas Hoenig, president of the Federal Reserve Bank of
Kansas City,
wrote in the Financial Times in May that
the government's response to the financial meltdown has been "ad hoc,
resulting in inequitable outcomes among firms, creditors, and investors."
Rather than perpetually prop up banks with endless taxpayer funds, Hoenig
suggests, the government should allow banks to fail. Only then, he believes,
can crippled financial institutions and systems be fixed. "Because we still
have far to go in this crisis, there remains time to define a clear process
for resolving large institutional failure. Without one, the consequences
will involve a series of short-term events and far more uncertainty for the
global economy in the long run."
The healthier and more profitable bailout
recipients are once financial markets rebound, the more taxpayers will earn
on their investments. Without a plan, however, banks may limp back to
viability while taxpayers lose their investments or even absorb further
losses.
5. The bailout's focus
on Wall Street mega-banks ignores smaller banks serving millions of American
taxpayers that face an equally uncertain future.
The government may not have a long-term strategy
for its trillion-dollar bailout, but its guiding principle, however
misguided, is clear: what's good for Wall Street will be best for the rest
of the country.
On the day the mega-bank stress tests were
officially released, another set of stress-test results came out to much
less fanfare. In its
quarterly report on the health of individual banks and the banking industry
as a whole, Institutional Risk Analytics (IRA), a
respected financial services organization, found that the stress levels
among more than 7,500 FDIC-reporting banks nationwide had risen
dramatically. For 1,575 of the banks, net incomes had turned negative due to
decreased lending and less risk-taking.
The conclusion IRA drew was telling: "Our overall
observation is that US policy makers may very well have been distracted by
focusing on 19 large stress test banks designed to save Wall Street and the
world's central bank bondholders, this while a trend is emerging of a going
concern viability crash taking shape under the radar." The report concluded
with a question: "Has the time come to shift the policy focus away from the
things that we love, namely big zombie banks, to tackle things that are
truly hurting us?"
6. The bailout
encourages the very behaviors that created the economic crisis in the first
place instead of overhauling our broken financial system and helping the
individuals most affected by the crisis.
As Joseph Stiglitz explained in the New York
Times, one major cause of the economic crisis was bank overleveraging.
"Using relatively little capital of their own," he wrote, banks "borrowed
heavily to buy extremely risky real estate assets. In the process, they used
overly complex instruments like collateralized debt obligations." Financial
institutions engaged in overleveraging in pursuit of the lucrative profits
such deals promised--even if those profits came with staggering levels of
risk.
Sound familiar? It should, because in the PPIP and
TALF bailout programs the Treasury Department has essentially replicated the
very over-leveraged, risky, complex system that got us into this mess in the
first place: in other words, the government hopes to repair our financial
system by using the flawed practices that caused this crisis.
Then there are the institutions deemed "too big to
fail." These financial giants--among them AIG, Citigroup and Bank of
America-- have been kept afloat by billions of dollars in bottomless bailout
aid. Yet reinforcing the notion that any institution is "too big to fail" is
dangerous to the economy. When a company like AIG grows so large that it
becomes "too big to fail," the risk it carries is systemic, meaning failure
could drag down the entire economy. The government should force "too big to
fail" institutions to slim down to a safer, more modest size; instead, the
Treasury Department continues to subsidize these financial giants,
reinforcing their place in our economy.
Of even greater concern is the message the bailout
sends to banks and lenders--namely, that the risky investments that crippled
the economy are fair game in the future. After all, if banks fail and teeter
at the edge of collapse, the government promises to be there with a
taxpayer-funded, potentially profitable safety net.
The handling of the bailout makes at least one
thing clear, however. It's not your health that the government is focused
on, it's theirs-- the very banks and lenders whose convoluted financial
systems provided the underpinnings for staggering salaries and bonuses,
while bringing our economy to the brink of another Great Depression.
Bob Jensen's threads on why the infamous "Bailout" won't work ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity
From Jim Mahar's Blog on May 15, 2009 ---
http://financeprofessorblog.blogspot.com/
From NPR: Financial Time's Gillian Tett on JP Morgan
and Derivatives
I listened to this on the radio tonight. It was so good, that the very first
chance I had to blog it, I did. Good stuff!
Fresh Air from WHYY : NPR:
"Journalist Gillian Tett warned about the
problems in the financial industry long before many of her
colleagues. In her new book, Fool's Gold, Tett examines the role
J.P. Morgan played in creating and marketing risky and complex
financial products"
The author is from FT fame and
FT has two extracts from the book.
"The
first sign that there might be a structural problem with the
innovative bundles of credit derivatives that bankers at JP Morgan
had dreamed up emerged in the second half of 1998. In the preceding
months, Blythe Masters and Bill Demchak – key members of JP Morgan’s
credit derivatives team – had been pestering financial regulators.
They believed that by using the new credit derivative products they
had helped create, JP Morgan could better manage the risks in its
portfolio of loans to companies, and thereby reduce the amount of
capital it needed to put aside to cover possible defaults. The
question was by how much. (Though these bundles of credit
derivatives later went under other names, such as collateralised
debt obligations [CDOs], at that time these pioneering structures
were known as “Bistro” deals, short for Broad Index Secured Trust
Offering). Masters and Demchak had done the first couple of Bistro
deals on behalf of their own bank without knowing the answer to
their question for sure. But when they were doing these deals for
other banks, the question of reserve capital became more important –
the others were mainly interested in cutting their reserve
requirements."
Stanford
University Video (Stanford Business Professor Darrell Duffie) ---
http://www.youtube.com/watch?v=OSBgfYrL9fs
Message from Bob Jensen on March 3, 2009
Hi Robin,
Tom Selling is correct. I’m sorry I forwarded this banking crisis explanation
depicting the failing homeowners as alcoholics in Heidi's Bar. It’s very bitter
and equates the people behind on their mortgages to alcoholics intent on
screwing taxpayers. Most were merely sober hopefuls at the racetrack.
Certainly there were many borrowers who conspired with crooked brokers when
refinancing their houses for far more than the house would ever be worth. A
typical scam was Marvene’s scam in Arizona. Marvene’s been in a few bars and has
an income of about $3,000 a month from welfare programs, food stamps and
disability payments related to a back injury. Marvene got in with a crooked
lender called “Integrity” that loaded her up on credit of $75,500 knowing full
well that Marvene could never repay. Marvene got her big luxury truck, her new
electronics, and financed the drug habit of her son. Marvene knew she could
never repay Integrity from her monthly income.
Integrity’s CEO Barry Rybicki and his loan officer, however, had a plan from the
start. They never laid eyes on Marvene’s shack but brokered a $103,000 mortgage
on her shack that neighbors ultimately bought in foreclosure for $10,000 and
tore down because it was such an eyesore. The 107 mortgages that Integrity sold
for $47 million included Marvene’s adjustable rate mortgage. Fannie Mae and
Freddie Mack were forced by Rep. Barney Frank and Sen. Chris Dodd to buy up
mortgages of poor people like Marvene. Of course Integrity, Fannie, and Freddie
knew full well that mortgages like these would never be repaid --- but that was
the big game in town in the subprime era.
You can read about Marvene’s case and see pictures at
http://faculty.trinity.edu/rjensen/FraudMarvene.htm
At the time her shack was still for sale for $15,000 in foreclosure.
Marvene is not an innocent. She’s dumb like a fox in playing the games (read
that government) offered to her in life.
What was wrong about the credit crisis story below is that it equates the credit
crisis with the Marvenes of this world. Sure there were over a million of
Marvenes. But there were also millions of Nelson families (if
you’re old enough you remember little Rick Nelson and his mother Harriet on
television) of middle or upper class means that were conned by unscrupulous
mortgage brokers to get spendable cash by refinancing with subprime adjustable
rate mortgages on homes valued at $200,000 or more. Often it was the mortgage
brokers who lied about their incomes and home values in order to get them to
sign huge mortgages. The Nelsons were honest and law abiding citizens. They were
good family folks that we call yuppies who really believed that their incomes
would increase in time to pay the eventual kick-up in mortgage rates. If their
incomes were not sufficient increased to pay the eventual increase in mortgage
payments, they just assumed real estate values always went up such that they
could sell their home for well above their loan balance and still come out
ahead.
But the real estate market bubble burst!
Harriet Nelson and Marvene are not at all alike.
Harriet Nelson and her loving husband Ozzie defaulted on their subprime
mortgage just like millions of other Nelson-like church-going families defaulted
on their mortgages. These were not alcoholics sitting in bars drinking up
taxpayer money.
Now we move up the ladder of shame. I honestly believe that Rep. Barney Frank
and Sen. Chris Dodd never suspected the real estate bubble would burst. They
were not as street smart as they like to pretend and did not anticipate that
Main Street mortgage brokers would cheat so drastically when submitting lies
about borrower incomes and home values. More importantly, Frank and Dodd, like
the Nelson family, assumed that the odds were 100% that the real estate boom
would never burst.
And those investment banks on Wall Street and other banks made the same
assumption that real estate was better than gold since they had watched their
own homes go up as much as ten times what they paid for them only a few years
back. Sure they knew that there are always loan foreclosures and the odds of
foreclosure were higher with subprime mortgages. But they assumed that they
could diversify this foreclosure risk in
Markowitz-based mathematical models that diversified risk. They let Fannie
and Freddie get stuck with the hopeless Marvene-type mortgages. But they bought
up Nelson-type mortgage cookies and then crumbled the cookies into CDO bonds in
anticipation that a few spoiled crumbs in a CDO bond would not make the entire
bond toxic. And they would’ve been correct if the real estate bubble had not
burst!
The legal and moral issues here concern intention of fraud. Barry Rybicki at
Integrity is an outright crook! Marvene is a willing cheat when given a chance.
The Nelsons simply took what looked like a pretty good gamble. The Harvard and
Wharton graduates at Lehman Brothers and other Wall Street firms violated their
responsibilities to their companies and shareholders by creating trillions upon
trillions of CDO cookie crumble bonds that they probably knew were building up
into too much risk in one type of business. But they badly wanted their
commissions and bonuses and fees that they got for each new CDO bag of crumbles
they sold.
Hence, Robin, the only people sitting Heidi’s bar were Marvene, Barry Rybicki,
and some greedy Harvard and Wharton alumni willing to drink up shareholder
value. The millions of Nelson families, Barney Frank, Chris Dodd, and even some
bank CEOs made what they thought were good bets that were totally wiped out when
the real estate market imploded. They were not in Heidi’s bar at the time. They
were at the racetrack.
The Economic Crisis Created a Perfect Storm for Progressives in Congress
Speaking of race tracks, we at last come to the U.S. Congress after the 2008
election. Democrats have monopoly power and most of them are progressives with
good intentions. They reason that if the U.S. could afford to wage war in Iraq
it can afford free education, training, and health care for over 300 million
U.S. citizens and unknown millions of pretenders living in the United States.
The banking crisis along with the economic crash (I still don’t think it’s an
economic depression) afford the monopolist progressives an excuse to more than
double the booked National Debt of $10 trillion today to about $20 trillion by
2012. Worse the unbooked entitlements OBSF of about $60 trillion today will jump
to about $100 trillion by 2012.
What's great about the Recovery Act and the trillions that will be spent in
ensuing deficit budgets is that hundreds of millions of people in the U.S. will
eventually get free education, training, and health care. Housing will be a
whole lot cheaper and the government will pay out trillions of dollars to keep
homeowners from losing their homes. If it sounds too good to be true, it
probably is too good to be true.
The new healthy graduates with their free training and education will be like
dead atheists in open coffins. They’ll be all dressed up with no place to go.
Congress is creating public works job opportunities while destroying career
opportunities. The reason is that the progressives, with all their good
intentions, will have placed trillions of stimulus money into part-time laboring
jobs like road building that are physically demanding and not at all suited for
people with career aspirations. Only so many can work in the health care and
education fields, and careers there will become pretty low paying due to the
need to minimize the cost of free health and education services and rationing.
Prosperous businesses create career opportunity growth. Congress at present is
destroying business opportunity. It is only creating government work
opportunity. Paul Williams cringes at thinking of his university as a socialist
organization owned and operated by government. By whatever name it’s owned and
managed by the government and it’s principle service graduates students into the
working world. I would like this to be a business world with career
opportunities. Yes I know that he will counter this by saying that for the past
four decades business has depended upon government in one way or another for its
prosperity, often with subsidies in one form or another. But until George W.
Bush went to war and could not say no to Congress on progressive spending
programs like the Medicare Drug Plan, the National Debt was only $6 trillion and
entitlements were perhaps around $30 trillion. Virtually all college graduates
had career hopes and most of these were hopes for careers in some type of
business or profession.
Compare this with a National Debt load of $20 trillion and unbooked OBSF
entitlements of $100 trillion. There’s no hope of carrying such booked and
unbooked debt without resorting to the Abraham Lincoln School of Finance (see
Honest Abe’s quote below). Career aspirations in most disciplines are shrinking
to near nothing.
A democracy cannot exist as a
permanent form of government. It can only exist until the voters discover that
they can vote themselves largesse from the public treasury. From that moment on,
the majority always votes for the candidates promising the most benefits from
the public treasury, with the result that a democracy always collapses over
loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh
your browser for updates by the second) ---
http://www.brillig.com/debt_clock/
America, what is happening to you?
“One thing seems probable to me,” said Peer
Steinbrück, the German finance minister, in September 2008....“the United States
will lose its status as the superpower of the global financial system.” You
don’t have to strain too hard to see the financial crisis as the death knell for
a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida,
"How the Crash Will Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
The inherent vice of capitalism is the unequal
sharing of the blessings. The inherent blessing of socialism is the equal
sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)
From the Abraham Lincoln School of Finance
The government should create, issue, and circulate all the currency and credits
needed to satisfy the spending power of the government and the buying power of
consumers. By adoption of these principles, the taxpayers will be saved immense
sums of interest. Money will cease to be master and become the servant of
humanity.
Abraham Lincoln
(I wonder why this just does not work in Zimbabwe where Robert Mugabe adopted
Lincoln's fiscal policy?)
If you’re looking for me I will be at Heidi’s Bar spending my social security
check. Eventually I might enroll in free fly fishing and golf education courses
when President Obama gives me the green light.
Bob Jensen
From:
AECM, Accounting Education using Computers and Multimedia [mailto:AECM@LISTSERV.LOYOLA.EDU]
On Behalf Of Alexander Robin A
Sent: Monday, March 02, 2009 8:30 PM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: Re: Bank Crisis explained
Ok,
please elaborate.
Robin A
From:
Tom Selling
Sent: Sun 3/1/2009 6:19 PM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: Re: Bank Crisis explained
This is not
a “simple” explanation; it is dangerously simplistic, and obviously written
by someone with an ax to grind. I would feel sorry for the students who
were fed this CRAP.
Tom Selling
From:
AECM, Accounting Education using Computers and Multimedia [mailto:AECM@LISTSERV.LOYOLA.EDU]
On Behalf Of Jensen, Robert
Sent: Sunday, March 01, 2009 4:11 AM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: FW: Bank Crisis explained
Forwarded by a close friend.
They
keep trying to make it sound complicated but it's really very simple!
Even your students will understand now.
Bank Crisis in Terms Understood
Heidi
is the proprietor of a bar in Washington, DC. In order to increase sales and
comply with CRAP (Community Reinvestment Act Program reinforced by
Socialist Progressive Congressmen),
she decides to allow her loyal customers - most of whom are unemployed
alcoholics - to drink now but pay later. She keeps track of the drinks
consumed on a ledger (thereby granting the customers loans).
Word gets around and as a result increasing numbers of customers flood into
Heidi's bar.
Taking advantage of her customers' freedom from immediate payment
constraints, Heidi increases her prices for wine and beer, the most-consumed
beverages. Her sales volume increases massively.
A young and dynamic customer service consultant at the local bank recognizes
these customer debts as valuable future assets and increases Heidi's
borrowing limit.
He sees no reason for undue concern since he has the debts of the alcoholics
as collateral.
At the bank's corporate headquarters, expert bankers transform these
customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities
are then traded on markets worldwide. No one really understands what these
abbreviations mean and how the securities are guaranteed. Nevertheless, as
their prices continuously climb, the securities become top-selling items.
One day, although the prices are still climbing, a risk manager
(subsequently of course fired due his negativity) of the bank decides that
slowly the time has come to demand payment of the debts incurred by the
drinkers at Heidi's bar.
However they cannot pay back the debts.
Heidi cannot fulfill her loan obligations and claims bankruptcy.
DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better,
stabilizing in price after dropping by 90 %.
The suppliers of Heidi's bar, having granted her generous payment due dates
and having invested in the securities are faced with a new situation. Her
wine supplier claims bankruptcy, her beer supplier is taken over by a
competitor.
The bank is saved by the Government following dramatic round-the-clock
consultations by leaders from the governing political parties.
The funds required for this purpose are obtained by a tax levied on the
non-drinkers.
Finally an explanation I understand...
Bob
Jensen’s threads on the
bailout and stimulus mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Paul Krugman: The Prophet of Socialism A prophet who has been
consistently wrong," by Donald Luskin )Editor’s Note: This article is
excerpted from Donald Luskin’s new book, I Am John Galt,, National Review,
June 13, 2011 ---
http://www.nationalreview.com/articles/269428/paul-krugman-prophet-socialism-donald-luskin
Christiane Amanpour’s eyes darted back and forth in
fear, and her mouth twisted in disgust, because she could see where this was
going. A guest on her Sunday-morning political talk show, ABC’s This Week,
was getting dangerously overexcited, and something very regrettable was
about to happen.
She could see that he was winding himself up as he
talked about how a recent deficit-reduction panel hadn’t been “brave enough”
— because it failed to endorse the idea of expert panels that would
determine what medical services government-funded care wouldn’t pay for.
When Obamacare was still being debated in Congress, Sarah Palin had created
a media sensation by calling them “death panels,” causing most liberals who
supported Obamacare to quickly distance themselves from any idea of
rationing care as being tantamount to murder.
The guest said, “Some years down the pike, we’re
going to get the real solution, which is going to be a combination of death
panels and sales taxes.”
It was all the more horrifying because the guest
was not a conservative, not an opponent of Obamacare. This guest was an avid
liberal, a partisan Democrat, and an enthusiastic supporter of
government-run health care. He was endorsing death panels, not warning about
them. He was saying death panels are a good thing. And it was even more
horrifying because of who this guest was. This was no fringe lefty wearing a
tinfoil hat, churning out underground newspapers in his parents’ basement.
This was an economics professor at Princeton, one of the country’s most
prestigious universities. This was the winner of the Nobel Prize in
economics, the highest honor the profession can bestow. This was a columnist
for the New York Times, the most influential newspaper in the world. This
was Paul Krugman, live, on national television, endorsing government control
over life and death. And while we’re at it, let’s raise taxes on those who
are permitted to live.
Who exactly does Paul Krugman think he is? He’d
like to think he’s John Maynard Keynes, the venerated British economist who
created the intellectual framework for modern government intervention in the
economy. Keynes is something of a cult figure for modern liberal economists
like Krugman, who read his texts with exegetical fervor. But Krugman will
never live up to Keynes. However politicized his economic theories, Keynes’s
predictions were so astute that he made himself wealthy as a speculator.
Economics is called “the dismal science,” but as we’ll see, Krugman’s
predictions are so laughably bad his economics should be called the abysmal
pseudo-science.
Most critiques of Krugman as a public intellectual
begin with what is apparently an obligatory disclaimer, usually in the very
first sentence — something to the effect that Krugman is a very accomplished
and well-respected economist. Then comes the “But . . .” and the critique
proceeds in earnest, often scathingly.
But why concede this honor to Krugman? So what if
he won the Nobel Prize? The real test of Krugman’s mettle as an economist is
the accuracy of his economic forecasting. The fact is that, with about three
decades of evidence now in, Krugman’s track record, to use a technical term
favored by economists, sucks.
He’s not always candid about this. But once, under
the pressure of a televised debate with conservative talk-show host Bill
O’Reilly, Krugman blurted out an understated if truthful self-evaluation:
“Compare me . . . compare me, uh, with anyone else, and I think you’ll see
that my forecasting record is not great.”
The most egregious example of “not great” is
Krugman’s utterly incorrect 1982 prediction that inflation would soar. He
made this prediction from no less lofty a perch than the White House, as
staff member of the Council of Economic Advisers in the first Reagan
administration. In a memo titled “The Inflation Time Bomb” Krugman wrote
with co-author Lawrence Summers, “We believe that it is reasonable to expect
a significant reacceleration of inflation . . . at least 5 percentage points
to future increases in consumer prices. . . . This estimate is
conservative.”
It also turned out to be hilariously,
side-splittingly, knee-slappingly, rolling-on-the-floor wrong. Except for a
tiny uptick the very next month, inflation didn’t rise; it fell. Four years
later, it had fallen to 1.18 percent, a rate so low as to border on
deflation.
In late February 2000, two weeks before the peak of
the dot-com stock bubble at Nasdaq 5,000, Krugman wrote in his Times column
that the Dow Jones Industrial Average was overvalued, saying, “Let the blue
chips fall where they may.” As for the Nasdaq — which at that point had
almost doubled over the prior year, and more than tripled over the prior
three years — Krugman said soothingly, “I’m not sure that the current value
of the Nasdaq is justified, but I’m not sure that it isn’t.”
We all know what happened. As of this writing, the
Dow is about 20 percent higher than when Krugman wrote those words — and
that’s not including a decade of dividends. The Nasdaq is about 42 percent
lower. It hit bottom in October 2002, a 75.7 percent loss from where Krugman
said not to worry about it. After something of a recovery, stocks fell
again. They hit a real bottom — about a week after Krugman wrote a Times
column asking the rhetorical question, “Is there any relief in sight?” His
wrong answer: “No.”
Perfect bookends: He missed the top, and then three
years later, he missed the bottom. But then he outdid himself. In June 2003,
with the Nasdaq up 20 percent since Krugman’s “No,” did he recognize his
error and reverse course? Again, no. Krugman wrote that “the current surge
in stocks looks like another bubble.” From there the Nasdaq was to rally
another 75 percent.At around the same time,
afraid of what he called a “fiscal train wreck” that would
lead to disastrously high interest rates,
he announced in the lead paragraph of a March 2003 Times column:
“So last week I switched to a fixed-rate mortgage. It means higher monthly
payments, but I’m terrified about what will happen to interest rates once
financial markets wake up to the implications of skyrocketing budget
deficits.” In fact, rates didn’t rise, even when budget deficits skyrocketed
beyond anything he could have imagined then, driven by government “stimulus”
spending that he himself urged. Nowadays, on his New York Times
blog, he regularly chides deficit-wary Republicans by using today’s low
interest rates to prove that the U.S. faces no financial difficulties.
In 2003, I set out to expose Krugman’s various
distortions, and to force the New York Times to correct them. I
started first on my blog, and soon afterward in a series of columns for
National Review Online called “The Krugman
Truth Squad” (KTS). The inaugural KTS column appeared on March 20, 2003. The
series of columns was structured as what is now called “crowdsourcing”:
Within several hours of a Krugman column’s appearing on the Times
website, I and a network of fellow bloggers would put it under a microscope
and discover all the filthy microbes hiding in every crack. We’d fact-check
every claim, confirm every quotation, run down every source, and compare
every statement for consistency with statements made in the past. The KTS
called Krugman “America’s most dangerous liberal pundit,” and our promise to
readers was: “We’ll read Paul Krugman so you don’t have to.”
I won’t cite here very many of the dozens upon
dozens of prevarications that my Krugman Truth Squad exposed in 94 columns
over five years. If you are interested, look up my name in the NRO author archives,
where most of the KTS columns can still be seen. Or
you can download a PDF file with the entire collection of KTS columns
here.
Continued in article
Bob Jensen's threads on entitlements are at
http://faculty.trinity.edu/rjensen/Entitlements.htm
Question
When is $7 billion not a material bad debt exposure?
Answer
When the "bad debt" is from an "empty creditor"
Now do you understand?
"'Empty Creditors' and the Crisis How
Goldman's $7 billion was 'not material," by Henry T.C. Hu, The Wall Street
Journal, April 10, 2009 ---
http://online.wsj.com/article/SB123933166470307811.html
The defining moments of our financial crisis are
now familiar. Last September, Lehman collapsed and AIG was teetering.
Because an AIG collapse was viewed as posing unacceptable systemic risks,
the Federal Reserve provided the company with an emergency $85 billion loan
on Sept. 16.
But a curious incident that fateful day raises
significant public policy issues. Goldman Sachs reported that its exposure
to AIG was "not material." Yet on March 15 of this year, AIG disclosed that
it paid $7 billion of its government loan last fall to satisfy obligations
to Goldman. A "not material" statement and a $7 billion payout appear to be
at odds.
Why didn't Goldman bark that September day? One
explanation is that Goldman was, to use a term that I coined a few years
ago, largely an "empty creditor" of AIG. More generally, the empty-creditor
phenomenon helps explain otherwise-puzzling creditor behavior toward
troubled debtors. Addressing the phenomenon can help us cope with its impact
on individual debtors and the overall financial system.
What is an empty creditor? Consider that debt
ownership conveys a package of economic rights (to receive principal and
interest), contractual control rights (to enforce the terms of the
agreement), and other legal rights (to participate in bankruptcy
proceedings). Traditionally, law and business practice assume these
components are bundled together. Another foundational assumption: Creditors
generally want to keep solvent firms out of bankruptcy and to maximize their
value.
These assumptions can no longer be relied on.
Credit default swaps and other products now permit a creditor to avoid any
actual exposure to financial risk from a shaky debt -- while still
maintaining his formal contractual control rights to enforce the terms of
the debt agreement, and his legal rights under bankruptcy and other laws.
Thus the "empty creditor": someone (or institution)
who may have the contractual control but, by simultaneously holding credit
default swaps, little or no economic exposure if the debt goes bad. Indeed,
if a creditor holds enough credit default swaps, he may simultaneously have
control rights and incentives to cause the debtor firm's value to fall. And
if bankruptcy occurs, the empty creditor may undermine proper
reorganization, especially if his interests (or non-interests) are not fully
disclosed to the bankruptcy court.
Goldman Sachs was apparently an empty creditor of
AIG. On March 20, David Viniar, Goldman's chief financial officer, indicated
that the company had bought credit default swaps from "large financial
institutions" that would pay off if AIG defaulted on its debt. A Bloomberg
News story on that day quotes Mr. Viniar as saying that "[n]et-net I would
think we had a gain over time" with respect to the credit default swap
contracts.
Goldman asserted its contractual rights to require
AIG to provide collateral on transactions between the two, notwithstanding
the impact of such collateral calls on AIG. This behavior was
understandable: Goldman had responsibilities to its own shareholders and, in
Mr. Viniar's words, was "fully protected and didn't have to take a loss."
Nothing in the law prevents any creditor from
decoupling his actual economic exposure from his debt. And I do not suggest
any inappropriate behavior on the part of Goldman or any other party from
such "debt decoupling." But none of the existing regulatory efforts
involving credit derivatives are directed at the empty-creditor issue. Empty
creditors have weaker incentives to cooperate with troubled corporations to
avoid collapse and, if collapse occurs, can cause substantive and disclosure
complexities in bankruptcy.
An initial, incremental, and low-cost step lies in
the area of a real-time informational clearinghouse for credit default swaps
and other over-the-counter (OTC) derivatives transactions and other crucial
derivatives-related information. Creditors are not generally required to
disclose the "emptiness" of their status, or how they achieved it. More
generally, OTC derivatives contracts are individually negotiated and not
required to be disclosed to any regulator, much less to the public
generally. No one regulator, nor the capital markets generally, know on a
real-time basis the entity-specific exposures, the ultimate resting places
of the credit, market, and other risks associated with OTC derivatives.
With such a clearinghouse, the interconnectedness
of market participants' exposures would have been clearer, governmental
decisions about bailing out Lehman and AIG would have been better informed,
and the market's disciplining forces could have played larger roles. Most
important, a clearinghouse could have helped financial institutions to avoid
misunderstanding their own products, and modeling and risk assessment
systems -- misunderstandings that contributed to the global economic crisis.
Henry Hu is a professor at the University of Texas Law School.
Charles B. Reed, chancellor of the California State
University system, explains why he wants the federal government to provide
billions of dollars in direct aid to four-year colleges, based on the number of
students they enroll who are eligible for Pell Grants or who are from
underrepresented minority groups.
"To Reach Obama's Goal, Colleges Should Get Billions From U.S., Cal State Chief
(Video)," Chronicle of Higher Education, March 2009 ---
http://chronicle.com/media/audio/v55/i26/reed/?utm_source=at&utm_medium=en
Jensen Comment
The new graduates with their free training and education will be like dead
atheists in open coffins. They’ll be all dressed up with no place to go.
Congress is creating public works job opportunities while destroying career
opportunities. The reason is that the progressives, with all their good
intentions, will have placed trillions of stimulus money into part-time laboring
jobs like road building that are physically demanding and not at all suited for
people with career aspirations. Only so many can work in the health care and
education fields, and careers there will become pretty low paying due to the
need to minimize the cost of free health and education services and rationing.
"Graduation is
what President Obama is all about," says the U.S. Cal State Chief in the above
video
Jensen Comment
Prosperous businesses create career opportunity growth. Congress at present is
destroying business opportunity. It is only creating government work
opportunity. Paul Williams cringes at thinking of his university as a socialist
organization owned and operated by government. By whatever name it’s owned and
managed by the government and it’s principle service graduates students into the
working world. I would like this to be a business world with career
opportunities. Yes I know that he will counter this by saying that for the past
four decades business has depended upon government in one way or another for its
prosperity, often with subsidies in one form or another. But until George W.
Bush went to war and could not say no to Congress on progressive spending
programs like the Medicare Drug Plan, the National Debt was only $6 trillion and
entitlements were perhaps around $30 trillion. Virtually all college graduates
had career hopes and most of these were hopes for careers in some type of
business or profession.
Instead of reducing government spending, just a few
weeks ago he adopted the largest increase in government spending in world
history through his so-called economic stimulus bill, which will only stimulate
the increased welfare and Big Government that Obama believes in ideologically.
Obama's new budget proposes the largest increase in Federal spending since World
War II, an insane one-year increase of 33% over the prior budget, from $3
trillion in fiscal 2008 to $4 trillion for fiscal 2009. That whopping $4
trillion is the largest Federal spending total in U.S. history. Obama says in
his budget message that we have arrived at this present crisis "as a result of
an era of profound irresponsibility…." Does this wild spending increase to
record levels sound responsible to you?
Peter Ferara, "Obama's Fantasy
Budget," American Spectator, March 4, 2009 ---
http://spectator.org/archives/2009/03/04/obamas-fantasy-budget
"Obama’s last hope on housing," by Christopher Joye, Financial
Times, March 3, 2009 ---
http://blogs.ft.com/economistsforum/2009/03/obamas-last-hope-on-housing/
Make no mistake: President Obama’s $75bn
housing plan is a policy disaster. It merely treats the symptoms of the
calamity in an extremely costly manner via short-term interest rate relief
and remarkably does nothing to prevent the next generation of borrowers
experiencing the same problems.
The administration’s response also
exacerbates the underlying dysfunction that is the root cause of the US’s
housing market woes by, for example, offering defaulting borrowers scope to
wriggle out of their contracts through the judicial system.
This will only undermine the
enforceability of US mortgages and embed a new risk premium that will
inevitably lead to higher interest rates and likely funding uncertainty.
By reinvigorating Fannie Mae and Freddie
Mac without genuine reforms, the administration has demonstrated that it
does not understand the fundamental flaws inherent in the US financing
system, which precipitated this crisis in the first place.
There remains, however, hope that the more
thoughtful decision-makers will search for superior long-term reforms. In
this context, I was fortunate enough to be able to present a tractable
solution to the US’s housing market problems at a summit in New York for
Obama administration officials.
The plan I presented directly cauterises
the US’s housing market dysfunction, delivers far greater and more permanent
interest rate relief for distressed borrowers, allows banks to immediately
recapitalise their balance-sheets with a $77bn cash injection, and costs
taxpayers much less than the administration’s initiative. On all objective
counts I feel that it is an unambiguous improvement on the administration’s
alternative.
As I’ve noted previously, one of the most
critical lessons from the global financial crisis has been that many
households had far too much leverage, particularly in the US where the
average borrower’s mortgage is now worth an astonishing 95 per cent of their
home. The only genuine policy solution to the desire to deleverage is the
development of external markets in housing equity – or ‘shared equity’ –
which borrowers can use synergistically in combination with traditional debt
finance.
Here’s how a government ‘debt for equity
swap’ programme would allow distressed US borrowers to radically deleverage
their balance-sheets:
Assume that the average ‘distressed’
borrower’s loan-to-value ratio is, say, 115 per cent. Under the
debt-for-equity swap, the traditional lender would only write off 15 per
cent of the value of their loan to bring the LTV back to 100 per cent (as
opposed to writing off most of the loan). A similar write-down is
anticipated in the administration’s scheme.
Yet instead of making a gift to lenders to
temporarily cut borrowers’ repayments, the government would refinance 25 per
cent of the reset home loan by swapping it with a taxpayer-funded ‘shared
equity’ loan (this could be operationally achieved by having borrowers pay
down 25 per cent of the reset loan).
Importantly, the shared equity loan
carries no monthly repayments during its maximum 30-year life. In exchange,
taxpayers receive half of the property’s future capital growth in lieu of
interest when the home owner elects to repay the loan either on refinancing
or sale of the property. The lender also owns no legal interest in the home
since it is structured using a traditional mortgage contract; i.e. the owner
retains control over what they do with their property.
The traditional lender is now left with a
dramatically less risky 75 per cent LTV. They are also directly paid 25 per
cent of the face value of their reset loan by the government and thus get
the benefit of a significant cash injection – which is worth about $77bn –
onto their balance-sheets.
The borrower is now only paying a full
rate of interest on a home loan that is 65 per cent of its original value.
They therefore benefit from a permanent 35 per cent reduction in their
interest and principal repayments over the 30 year life of the package. In
contrast, the lower repayments realised by borrowers under the
administration’s proposal only last five years – after which rates are
ratcheted back up, thereby raising the risk of ‘redefault’.
Assuming that house prices increase at a
rate no greater than nominal gross domestic product during the next 30
years, which given the recent 25 per cent correction seems defendable,
taxpayers could expect to earn a 5-10 per cent annualised, ungeared rate of
return. This is patently superior to the 100 per cent losses that taxpayers
will realise on their $75bn ‘gift’ to distressed borrowers under the
existing plan.
How much would this cost? According to the
Mortgage Bankers’ Association, 6.6 per cent of the circa $11tn of US home
loans are in 60 days or more arrears. Assume that half of these borrowers go
into foreclosure and need to access the programme. That gives $363bn worth
of loans in distress. If the average LTV is 115 per cent, and the lender
wears a 15 per cent write-down, a 25 per cent debt for equity swap would
cost taxpayers roughly $77bn, which, coincidentally, is almost exactly the
same size as the administration’s package.
Importantly, once the shared equity loans
are repaid the government can recycle the capital to assist the next
generation of households in distress. The $77bn equity fund could therefore
be used to reduce the risk of families facing foreclosure in perpetuity. And
since traditional lenders are minimising their foreclosure risk, they could
ultimately contribute.
Successful private and publicly markets in
housing equity now exist in Australia, NZ, and the UK. Combined with the
fact that leading academics such as Ian Ayers and Barry Nalebuff, Luigi
Zingales, and Edward Glaeser have recently made similar calls for the US
government to help borrowers swap their debt for equity, it is hard not to
acknowledge that there is immense merit to this plan.
Nobody would begrudge the administration
the opportunity to refine their response to this calamity. I just hope they
have the humility and foresight to listen.
The Short and Simple Video About What Caused the Credit Crisis ---
http://vimeo.com/3261363
Also at
http://www.youtube.com/watch?v=Q0zEXdDO5JU
Ed Scribner forwarded the above video links
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the actual formula etc.
"In Plato's Cave: Mathematical models are a powerful way of
predicting financial markets. But they are fallible" The Economist, January 24, 2009, pp. 10-14 ---
http://www.economist.com/specialreports/displaystory.cfm?story_id=12957753
ROBERT RUBIN was Bill Clinton’s treasury
secretary. He has worked at the top of Goldman Sachs and Citigroup. But he
made arguably the single most influential decision of his long career in
1983, when as head of risk arbitrage at Goldman he went to the MIT Sloan
School of Management in Cambridge, Massachusetts, to hire an economist
called Fischer Black.
A decade earlier Myron Scholes, Robert
Merton and Black had explained how to use share prices to calculate the
value of derivatives. The Black-Scholes options-pricing model was more than
a piece of geeky mathematics. It was a manifesto, part of a revolution that
put an end to the anti-intellectualism of American finance and transformed
financial markets from bull rings into today’s quantitative powerhouses.
Yet, in a roundabout way, Black’s approach also led to some of the late
boom’s most disastrous lapses.
Derivatives markets are not new, nor are
they an exclusively Western phenomenon. Mr Merton has described how Osaka’s
Dojima rice market offered forward contracts in the 17th century and
organised futures trading by the 18th century. However, the growth of
derivatives in the 36 years since Black’s formula was published has taken
them from the periphery of financial services to the core.
In “The Partnership”, a history of Goldman
Sachs, Charles Ellis records how the derivatives markets took off. The
International Monetary Market opened in 1972; Congress allowed trade in
commodity options in 1976; S&P 500 futures launched in 1982, and options on
those futures a year later. The Chicago Board Options Exchange traded 911
contracts on April 26th 1973, its first day (and only one month before
Black-Scholes appeared in print). In 2007 the CBOE’s volume of contracts
reached almost 1 trillion.
Trading has exploded partly because
derivatives are useful. After America came off the gold standard in 1971,
businesses wanted a way of protecting themselves against the movements in
exchange rates, just as they sought protection against swings in interest
rates after Paul Volcker, Mr Greenspan’s predecessor as chairman of the Fed,
tackled inflation in the 1980s. Equity options enabled investors to lay off
general risk so that they could concentrate on the specific types of
corporate risk they wanted to trade.
The other force behind the explosion in
derivatives trading was the combination of mathematics and computing. Before
Black-Scholes, option prices had been little more than educated guesses. The
new model showed how to work out an option price from the known
price-behaviour of a share and a bond. It is as if you had a formula for
working out the price of a fruit salad from the prices of the apples and
oranges that went into it, explains Emanuel Derman, a physicist who later
took Black’s job at Goldman. Confidence in pricing gave buyers and sellers
the courage to pile into derivatives. The better that real prices correlate
with the unknown option price, the more confidently you can take on any
level of risk. “In a thirsty world filled with hydrogen and oxygen,” Mr
Derman has written, “someone had finally worked out how to synthesise H2O.”
Poetry in Brownian motion Black-Scholes is
just a model, not a complete description of the world. Every model makes
simplifications, but some of the simplifications in Black-Scholes looked as
if they would matter. For instance, the maths it uses to describe how share
prices move comes from the equations in physics that describe the diffusion
of heat. The idea is that share prices follow some gentle random walk away
from an equilibrium, rather like motes of dust jiggling around in Brownian
motion. In fact, share-price movements are more violent than that.
Over the years the “quants” have found
ways to cope with this—better ways to deal with, as it were, quirks in the
prices of fruit and fruit salad. For a start, you can concentrate on the
short-run volatility of prices, which in some ways tends to behave more like
the Brownian motion that Black imagined. The quants can introduce sudden
jumps or tweak their models to match actual share-price movements more
closely. Mr Derman, who is now a professor at New York’s Columbia University
and a partner at Prisma Capital Partners, a fund of hedge funds, did some of
his best-known work modelling what is called the “volatility smile”—an
anomaly in options markets that first appeared after the 1987 stockmarket
crash when investors would pay extra for protection against another imminent
fall in share prices.
The fixes can make models complex and
unwieldy, confusing traders or deterring them from taking up new ideas.
There is a constant danger that behaviour in the market changes, as it did
after the 1987 crash, or that liquidity suddenly dries up, as it has done in
this crisis. But the quants are usually pragmatic enough to cope. They are
not seeking truth or elegance, just a way of capturing the behaviour of a
market and of linking an unobservable or illiquid price to prices in traded
markets. The limit to the quants’ tinkering has been not mathematics but the
speed, power and cost of computers. Nobody has any use for a model which
takes so long to compute that the markets leave it behind.
The idea behind quantitative finance is to
manage risk. You make money by taking known risks and hedging the rest. And
in this crash foreign-exchange, interest-rate and equity derivatives models
have so far behaved roughly as they should.
A muddle of mortgages Yet the idea behind
modelling got garbled when pools of mortgages were bundled up into
collateralised-debt obligations (CDOs). The principle is simple enough.
Imagine a waterfall of mortgage payments: the AAA investors at the top catch
their share, the next in line take their share from what remains, and so on.
At the bottom are the “equity investors” who get nothing if people default
on their mortgage payments and the money runs out.
Despite the theory, CDOs were hopeless, at
least with hindsight (doesn’t that phrase come easily?). The cash flowing
from mortgage payments into a single CDO had to filter up through several
layers. Assets were bundled into a pool, securitised, stuffed into a CDO,
bits of that plugged into the next CDO and so on and on. Each source of a
CDO had interminable pages of its own documentation and conditions, and a
typical CDO might receive income from several hundred sources. It was a
lawyer’s paradise.
This baffling complexity could hardly be
more different from an equity or an interest rate. It made CDOs impossible
to model in anything but the most rudimentary way—all the more so because
each one contained a unique combination of underlying assets. Each CDO would
be sold on the basis of its own scenario, using central assumptions about
the future of interest rates and defaults to “demonstrate” the payouts over,
say, the next 30 years. This central scenario would then be “stress-tested”
to show that the CDO was robust—though oddly the tests did not include a 20%
fall in house prices.
This was modelling at its most feeble.
Derivatives model an unknown price from today’s known market prices. By
contrast, modelling from history is dangerous. There was no guarantee that
the future would be like the past, if only because the American housing
market had never before been buoyed up by a frenzy of CDOs. In any case,
there are not enough past housing data to form a rich statistical picture of
the market—especially if you decide not to include the 1930s nationwide fall
in house prices in your sample.
Neither could the models take account of
falling mortgage-underwriting standards. Mr Rajan of the University of
Chicago says academic research suggests mortgage originators, keen to
automate their procedures, stopped giving potential borrowers lengthy
interviews because they could not easily quantify the firmness of someone’s
handshake or the fixity of their gaze. Such things turned out to be better
predictors of default than credit scores or loan-to-value ratios, but the
investors at the end of a long chain of securities could not monitor lending
decisions.
The issuers of CDOs asked rating agencies
to assess their quality. Although the agencies insist that they did a
thorough job, a senior quant at a large bank says that the agencies’ models
were even less sophisticated than the issuers’. For instance, a BBB tranche
in a CDO might pay out in full if the defaults remained below 6%, and not at
all once they went above 6.5%. That is an all-or-nothing sort of return,
quite different from a BBB corporate bond, say. And yet, because both shared
the same BBB rating, they would be modelled in the same way.
Issuers like to have an edge over the
rating agencies. By paying one for rating the CDOs, some may have laid
themselves open to a conflict of interest. With help from companies like
Codefarm, an outfit from Brighton in Britain that knew the agencies’ models
for corporate CDOs, issuers could build securities with any risk profile
they chose, including those made up from lower-quality ingredients that
would nevertheless win AAA ratings. Codefarm has recently applied for
administration.
There is a saying on Wall Street that the
test of a product is whether clients will buy it. Would they have bought
into CDOs had it not been for the dazzling performance of the quants in
foreign-exchange, interest-rate and equity derivatives? There is every sign
that the issuing banks believed their own sales patter. The banks so liked
CDOs that they held on to a lot of their own issues, even when the idea
behind the business had been to sell them on. They also lent buyers much of
the money to bid for CDOs, certain that the securities were a sound
investment. With CDOs in deep trouble, the lenders are now suffering.
Modern finance is supposed to be all about
measuring risks, yet corporate and mortgage-backed CDOs were a leap in the
dark. According to Mr Derman, with Black-Scholes “you know what you are
assuming when you use the model, and you know exactly what has been swept
out of view, and hence you can think clearly about what you may have
overlooked.” By contrast, with CDOs “you don’t quite know what you are
ignoring, so you don’t know how to adjust for its inadequacies.”
Now that the world has moved far beyond
any of the scenarios that the CDO issuers modelled, investors’ quantitative
grasp of the payouts has fizzled into blank uncertainty. That makes it hard
to put any value on them, driving away possible buyers. The trillion-dollar
bet on mortgages has gone disastrously wrong. The hope is that the
trillion-dollar bet on companies does not end up that way too.
Continued in article
Denny Beresford forwarded the following link. I don't know how long it will
be a free download.
"The Crash: What Went Wrong? How did the most dynamic and sophisticated
financial markets in the world come to the brink of collapse? The Washington
Post examines how Wall Street innovation outpaced Washington regulation.,"
The Washington Post, January 2009 ---
http://www.washingtonpost.com/wp-srv/business/risk/index.html
Jensen Comment
The above site has three links to AIG and what went wrong with their credit
default swaps.
Part 1 "The Beautiful Machine" ---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/28/AR2008122801916.html
Part 2 "A Crack in the System"---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/29/AR2008122902670.html
Part 3 "Downgrades and Downfall"---
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/30/AR2008123003431.html
"Everything You Wanted to Know about Credit Default Swaps--but Were Never
Told," by Peter J. Wallison, RGE, January 25, 2009 ----
Click Here
Also see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Question
When does one fall guy (read that taxpayer) pay for the prosecution and and the
defense at the same time?
"Taxpayers May Pay Legal Fees for Mortgage Execs," Fox News, November
6, 2008 ---
http://www.foxnews.com/story/0,2933,447784,00.html
When the government took over mortgage giants
Fannie Mae and Freddie Mac, taxpayers inherited more than just bad debts.
They're also potentially on the hook for tens of millions of dollars in
legal fees for the executives at the center of the housing market's
collapse.
With the Justice Department investigating companies
involved in the mortgage and financial meltdown, executives around the
country are hiring defense lawyers. Like many large companies, Fannie and
Freddie had contracts promising to cover legal bills for their executives.
When the Treasury Department delivered a $200
billion bailout to Fannie and Freddie, that obligation passed to the
government, which may find itself paying for the lawyers defending the
executives against the government's own prosecutors.
"Who'd have thought we might be on the hook for
paying the defense costs when we're also paying the prosecution costs?" said
Doug Heller, executive director of Consumer Watchdog, a Santa Monica,
Calif.-based group that has been critical of the financial bailout packages.
"To defend the economy from the havoc that's been created, we're going to
defend the havoc creators?"
The Bush administration is working to avoid it. The
Federal Housing Finance Agency, which controls Fannie and Freddie, said in
regulatory filings it soon will try to prohibit the two companies from
paying legal fees to their executives. But such a prohibition almost
certainly would lead to a costly court fight over who's responsible for the
bills when the Justice Department comes knocking.
Continued in article
Jensen Comment
I see this as only fair since the government (read that Chris Dodd and Barney
Frank) forced the executives of Fannie and Freddie to buy up mortgages of
borrowers who never intended to make payments on those mortgages.
It was all in the
“nutty” (from Oak Trees) plan
Fannie Mae said Monday that it might need more than
the $100 billion that the Treasury said it was willing to invest in the giant
mortgage company to help it stay in business. “If we continue to experience
substantial losses in future periods or to the extent that we experience a
liquidity crisis that prevents us from accessing the unsecured debt markets,
this commitment may not be sufficient to keep us in solvent condition or from
being placed into receivership,” Fannie Mae said in a filing with the Securities
and Exchange Commission. Fannie Mae reported earlier Monday that it lost $29
billion in the third quarter. It said the number of loans in its portfolio that
were in foreclosure or delinquent by more than three months had jumped to 1.72
percent in September. The mortgage company said in its S.E.C. filing that it had
a limited ability to issue debt maturing past one year, citing market
conditions, the lack of an explicit federal guarantee and competition from
government-insured bank bonds.
"Fannie Mae May Need More Than $100 Billion From U.S.," The New York Times,
November 10, 2008 ---
http://dealbook.blogs.nytimes.com/2008/11/10/fannie-mae-may-need-more-than-100-billion-from-us/
Jensen Comment
Since Fannie Mae's debt is virtually guaranteed now by the U.S. Government, what
Fannie is really saying is that it wants a handout it will not have to pay back.
It's only fair since, Rep. Barney Frank and Sen. Chris Dodd forced Fannie Mae to
buy mortgages that hadn't the slightest hope of being repaid that the taxpayers
that elected Frank and Dodd. I just hate to see us reward Big Fannie after all
the accounting fraud committed by Fannie over the years ---
http://faculty.trinity.edu/rjensen/2008bailout.htm#FannieFraud
"Barney's Rubble," The Wall Street Journal, September 17, 2008 ---
http://online.wsj.com/article/SB122161010874845645.html?mod=todays_us_opinion
Barney Frank didn't like our recent editorial
taking him to task for his longtime defense of Fannie Mae and Freddie Mac,
and the Congressional baron defends himself in his signature style here.
We'd let him have his say without comment except that his "whole story" is,
well, far from the whole truth.
Mr. Frank contends that he favored "very strong
reform" of Fannie Mae and Freddie Mac, even before Democrats took over
Congress after the 2006 elections. To adapt a famous phrase, this depends on
what the meaning of "reform" is. Mr. Frank did support a bill that he and
others on Capitol Hill described as reform. But on the threshold reform
issue -- limiting the size of the portfolios of mortgage-backed securities (MBS)
that the two companies could hold -- Mr. Frank was a stalwart opponent.
In fact, Mr. Frank was publicly arguing for an
increase in the size of their combined $1.4 trillion portfolios right up to
the day they were bailed out. Even now, after he's been proven wrong about a
taxpayer guarantee, he opposes Treasury's planned reduction in the size of
the portfolios starting in 2010, according to a quote attributed to him in
this newspaper last week. "Good luck on that," he reportedly said. Mr.
Frank's spokeswoman hung up the phone when we sought confirmation Tuesday.
Fannie Mayhem: A History A compendium of The Wall
Street Journal's recent editorial coverage of Fannie and Freddie. The MBS
portfolios have long been both the chief source of the systemic risk posed
by the two mortgage giants and of the profits that so handsomely enriched
shareholders and officers alike for decades. Without the extreme leverage
inherent in those portfolios -- which the companies borrowed heavily, at
taxpayer-subsidized rates, to accumulate -- their federal takeover might
never have become necessary.
For years, Mr. Frank and other friends of Fan and
Fred opposed not only bills written to limit the size of their portfolios,
but any bill that in their view gave an independent regulator too much
discretion to order a reduction. This was true of the reform that his House
committee passed last year. Only when the White House caved to Mr. Frank and
dropped its earlier insistence that a reform bill rein in the portfolios did
Mr. Frank move his bill.
In his letter, Mr. Frank also repeats his familiar
claim that Fannie and Freddie are vital because they support "affordable
housing." This is political smoke. The awful irony of Fan and Fred is that
they have done very little to assist affordable housing. Most of the
taxpayer subsidy has gone to enrich shareholders and Fannie managers, as a
2003 study by the Federal Reserve shows.
Mr. Frank says he favored the disclosure of Fannie
and Freddie compensation -- which is nice, but beside the point. The source
of the rich pay packages was the Fannie business model that Mr. Frank fought
so hard to protect. Instead of helping the poor, Mr. Frank was enriching Jim
Johnson, Frank Raines, Angelo Mozilo and Wall Street.
If Mr. Frank thinks his "affordable housing"
goals are so popular, he can always ask Congress to appropriate money for
any housing subsidy he desires. But he knows those votes are hard to come
by. It's much easier to have Fannie and Freddie take inordinate risks, even
at taxpayer expense, so they can pay a political dividend called an
"affordable housing trust fund" (and
ACORN) that politicians will disperse. In
opposing genuine reform of Fan and Fred, Mr. Frank wasn't acting like a
principled liberal. He was protecting corporate giants while hiding their
risks from taxpayers until the middle class got stuck with the bill.
Some regulations proposed for credit default swaps do not solve the
problems such as the AIG default problems
"A Central Clearing House Doesn’t Reduce CDS Risk," by Bill Snyder, Stanford
GSB News, April 2009 ---
http://www.gsb.stanford.edu/news/research/duffie_clearinghouse.html?cmpid=kb0904
A plan by global financial regulators to fix the
mess created by the misuse of credit default swaps is flawed, says Darrell
Duffie, professor of finance at the Stanford Graduate School of Business.
In a preliminary research paper, Duffie, and GSB
doctoral student Haoxiang Zhu, conclude that the central clearing houses
founded to rationalize the $27 trillion market for credit default swaps will
not remove nearly as much risk as regulators might hope. What's more,
despite a mistaken belief by some commentators, the clearing houses are
unlikely to bring much needed transparency to trades of credit-default
swaps, or CDS, says Duffie.
Credit default swaps are essentially insurance
policies used to hedge risky bonds. Their misuse has been blamed for the
near-collapse of American International Group (AIG) and the subsequent
damage to the global financial system in an over-the-counter market, out of
view and off the public record.
Because there was, until recently, no central
clearing house for the CDS market, buyers and sellers have been
unnecessarily exposed to the risk of default. A clearing house stands
between buyers and sellers, ensuring that accounts are settled properly when
trades are made, and that margin requirements have been met. In effect, the
clearing house acts as a buyer to every seller and a seller to every buyer,
reducing the risk of default by either counterparty, as participants in such
trades are called.
Responding to pressure from regulators, dealers in
Europe and the United States, agreed to the establishment of CDS clearing
houses, and by early spring two had been opened and more are planned.
Duffie, a member of the Financial Advisory
Roundtable of the New York Federal Reserve Bank, supported the establishment
of a clearinghouse in testimony last year to the U.S. Senate Committee on
Banking, Housing, and Urban Affairs. He still supports that idea, but
maintains that the current implementation is flawed in several respects.
Although the worldwide market for credit default
swaps is huge at $27 trillion, it has shrunk by more than 50 percent in the
past year, and is too small—and the number of participating institutions is
too small—for a clearinghouse that deals only in CDS to efficiently reduce
counterparty risk, says Duffie. Instead, Duffie and Zhu suggest that the
clearinghouse should clear a much larger fraction of trades made in the $500
trillion market for over-the-counter (off-exchange) derivatives.
"Our results make it clear that regulators and
dealers should carefully consider the tradeoffs involved in carving out a
particular class of derivatives, such as credit default swaps, for
clearing," the research paper states. Here's why:
Banks reduce risk by trading across various classes
of options, derivatives, and other financial instruments. Ultimately,
positions between two counterparties tend to have offsetting exposures; some
are of positive market value to a given counterparty, and others are of
negative market value. These have a "netting effect," that is, only the net
amount of market value is at risk in a default by one of the counterparties
Duffie and his co-author built a theoretical model
to clarify an important tradeoff between two types of netting opportunities,
"namely bilateral netting between pairs of dealers across different
underlying assets, versus multilateral netting among many dealers across a
single class of underlying assets, such as credit default swaps." The latter
of these is the method by which the new clearinghouses will work.
Their model reveals that clearing only credit
default swaps can actually increase the risk to the counterparties because
the benefits of bilateral netting across asset classes is reduced in this
case.
For instance, if Dealer A is exposed to Dealer B by
$100 million on CDS, while at the same time Dealer B is exposed to Dealer A
by $150 million on interest-rate swaps, then the introduction of central
clearing for only credit default swaps increases the maximum loss between
these two dealers, before collateral and after netting, from $50 million to
$150 million. Additionally, CDS-only clearing would likely result in demands
for additional, expensive, collateral to protect the two parties.
A CDS-only clearinghouse would work if the market
were larger, say Duffie and Zhu. More precisely, their report finds that a
dedicated central clearing counterparty [a clearinghouse] improves netting
efficiency for these dealers if and only if the fraction of a typical
dealer's expected exposure attributable to CDS is the majority of the total
expected exposures of all remaining bilaterally netted classes of
derivatives. In fact, the credit-default swap market is now too small to
reach that threshold.
Making matters somewhat worse was the decision to
establish multiple clearing houses. Having more than one reduces the netting
effect even more, says Duffie, adding that each additional clearing house
exacerbates the problem.
Even though the clearinghouse plan is flawed with
respect to reducing counterparty risk, it has been suggested that
establishing these new entities would at least add much needed transparency
to the CDS market. Actually, the same level of information about CDS trades
that would be available to regulators in a clearing house is already
available through the Depository Trust and Clearing Corporation (DTCC). With
or without a clearing house, there is no plan to reveal trades to the
public. So, the stories of improved transparency are a red herring.
Public discussion, says Duffie, assumes that the
clearinghouses would act like exchanges, such as the New York Stock
Exchange, by systematically reporting all trades. "I’m sorry to disappoint,
but most of the information about default swaps remains confidential even
when cleared," he said during an interview.
Moreover, a clearinghouse can only clear standard
transactions. But most of the credit default swaps initiated by AIG, are not
standard, and would never have been cleared, even if a clearing house had
existed years ago.
Presented in mid-February of 2009, the preliminary
draft of the Duffie-Zhu paper is titled: "Does a Central Clearing
Counterparty Reduce Counterparty Risk?" The work is something of a departure
for Duffie, who says he rarely writes a paper to meet the immediate needs of
a policy debate, but felt compelled to weigh in because of the critical
nature of the discussion.
"During a research discussion over lunch, my
co-author and I had a hunch that there was an important concept missing from
the policy discussion. We could not confirm our intuition without building
and solving a model. Once we did, it was obvious that we should present our
results in a new research paper," he said in the interview.
Darrell Duffie is the Dean Witter Distinguished
Professor in Finance at the Stanford Graduate School of Business and Senior
Fellow, by courtesy, at the Stanford Institute for Economic Policy Research.
"The Financial Crisis, From A-Z," by Tunku Varadarajan, Forbes,
November 10, 2008 ---
http://www.forbes.com/opinions/2008/11/09/financial-crisis-tarp-oped-cx_tv_1110varadarajan.html
The Awesome Warren Buffet Interview on CNBC ---
http://clusterstock.alleyinsider.com/2008/8/that-awesome-warren-buffett-cnbc-interview
There's a reason Warren Buffett is so revered:
Because he deserves to be.
It's a tall order to get up at 5am and speak for
three hours and never say anything that isn't wise, charming, or funny.
Sure, it helps to have CNBC's lovely Becky Quick sitting right there, but
that's not the source of Warren's wisdom.
Full three-hour transcript here (with minor
deletions), courtesy of CNBC. If you don't have time to read it now, save it
for the weekend.
Here are a few of Buffett's quotations reported by Jim Mahar on November 14,
2008 ---
http://financeprofessorblog.blogspot.com/
Two short ones:
"...you
know, you only find out who's been swimming naked when the tide goes
out. Well, we found out that Wall Street has been kind of a nudist
beach"
"...the country will be doing far better five years from now than it is
now, but it won't be, in my judgment, it probably won't be doing better
five months from now."
and two longer ones:
On Fannie
Mae and Freddie Mac:
"...they also had an
added problem in that they had a dual mission. The government expected
them to promote housing and the stockholders expected them to raise the
earnings substantially every year. And as the years went by, they
emphasized the latter more and more. They started talking about "steady
Freddie," and Fannie Mae said,
`We're going to increase the earnings at 15 percent a year.' Any large
financial institution that tells you that sort of thing is giving you a
line of baloney. I mean, they may do itfor a while, but when they can't
do it with operations, they do it with accounting and they cheat."
and one
last one on regulation and management:
"...
managing complex financial
institutions where the management wants to deceive you can be very, very
difficult.
Or even when the management doesn't
know what's going on, and--just take Bear Stearns.
Bear Stearns had--I read it, anyway--750,000
derivative contracts. Now, you
know, I could clone Albert Einstein, you know, and--many, many times and
have him work 12-hour days for me and he would not be able to keep track
of what's going on in an institution like that. It's--the ones that are
too big to fail may be too big to manage"
A Summary of the Meltdown and Its Causes on NPR (Audio) ---
http://www.thisamericanlife.org/Radio_Episode.aspx?episode=365
I thank David Spener at Trinity University for pointing out this link to me.
"Your Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson, The
New York Times, September 20, 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
It looks as if we may get through this weekend
without another scramble to save a troubled financial firm with a
trillion-dollar balance sheet.
But that doesn’t mean taxpayers are out of danger.
No, sir. No, ma’am. Because lawmakers are at work on a bailout fund that
would buy the kind of distressed assets (defaulted mortgages, for example)
that have ignited this firestorm.
Treasury Secretary Henry M. Paulson Jr. has called
the fund the “troubled asset relief program.” I’ll just call it TARP for
short (you know, the kind of thing they spread over muddy fields so you
don’t soil your Guccis).
And depending on how TARP is operated, and how the
assets are valued before taxpayers are forced to buy them, it could bloat
our final bill for this mess while benefiting the very institutions that got
us into it.
Yes, we need a smart plan and a concerted effort to
get the frozen credit markets up and running. But we also have to be certain
that the types of conflicts of interest that riddle Wall Street aren’t
visited upon TARP.
Consider: A bank wants to sell the TARPistas (also
known as TAXPAYERS) a pile of stinky mortgage securities that it currently
values at 60 cents on the dollar. Let’s assume that the most recent actual
trade between market participants for similar assets was struck at 30 cents
on the dollar.
So what’s a fair price that we TARPistas should pay
for the assets?
If we bought at 60 cents, a price that the bank
would argue is appropriate, we would most likely face a loss. The bank,
however, would be much better off than if it had to dump at 30 cents.
Conversely, if the assets were sold at 30 cents,
taxpayers could wind up making a profit on the purchase if the assets
performed better than expected over time. But the bank would have to write
down the value of the assets as a result of the sale, possibly threatening
its financial standing yet again.
Do you think, perchance, that financial services
lobbyists might be working their Hill contacts right this very minute to
ensure that the TARP valuations are rigged in their favor?
You know the answer to that.
And you also know that we should steel ourselves
for heavy losses as the TARP gets pulled over our eyes. Never mind that it
was the banks, with their reckless lending and monumental leverage, that
drove us into this ditch.
Such is our lot today: They break it. We own it.
Taxpayers deserve better than this, of course. But
we have no lobbyists, so we get skinned.
IF federal regulators and political leaders want to
earn back some trust, they could do two things. First, they could provide us
with some transparency about whom precisely we are backing in the recent
bailouts.
Take, for example, the rescue on Tuesday of the
American International Group, once the world’s largest insurance company. It
was pretty breathtaking. Since when do insurance companies, whose business
models seem to consist of taking in premiums and stonewalling claims,
deserve rescues from beleaguered taxpayers?
Answer: Ever since the world became so intertwined
that the failure of one company can topple a host of others. And ever since
credit default swaps, those unregulated derivative contracts that allow
investors to bet on a debt issuer’s financial prospects, loomed so big on
balance sheets that they now drive every bailout decision.
The deal to save A.I.G. involves a two-year, $85
billion loan from taxpayers. In exchange, the new owners — us — get 80
percent of the company. If enough of A.I.G.’s assets are sold for good
prices, we may get our money back.
Credit default swaps, which operate like insurance
policies against the possibility that an issuer of debt will not pay on its
obligations, were the single biggest motivator behind the A.I.G. deal.
A.I.G. had written $441 billion in credit insurance
on mortgage-related securities whose values have declined; if A.I.G. were to
fail, all the institutions that bought the insurance would have been subject
to enormous losses. The ripple effect could have turned into a tsunami.
So, the $85 billion loan to A.I.G. was really a
bailout of the company’s counterparties or trading partners.
Now, inquiring minds want to know, whom did we
rescue? Which large, wealthy financial institutions — counterparties to
A.I.G.’s derivatives contracts — benefited from the taxpayers’ $85 billion
loan? Were their representatives involved in the talks that resulted in the
last-minute loan?
And did Lehman Brothers not get bailed out because
those favored institutions were not on the hook if it failed?
We’ll probably never know the answers to these
troubling questions. But by keeping taxpayers in the dark, regulators
continue to earn our mistrust. As long as we are not told whom we have
bailed out, we will be justified in suspecting that a favored few are making
gains on our dimes.
A.I.G.’s financial statements provided a clue to
the identities of some of its credit default swap counterparties. The
company said that almost three-quarters of the $441 billion it had written
on soured mortgage securities was bought by European banks. The banks bought
the insurance to reduce the amounts of capital they were required by
regulators to set aside to cover future losses.
Enjoy the absurdity: Billions in unregulated
derivatives that were about to take down the insurance company that sold
them were bought by banks to get around their regulatory capital
requirements intended to rein in risk.
Got that?
Which brings us to Item 2 for policy makers. Stop
pretending that the $62 trillion market for credit default swaps does not
need regulatory oversight. Warren E. Buffett was not engaging in hyperbole
when he called these things financial weapons of mass destruction.
“The last eight years have been about permitting
derivatives to explode, knowing they were unregulated,” said Eric R. Dinallo,
New York’s superintendent of insurance. “It’s about what the government
chose not to regulate, measured in dollars. And that is what shook the
world.”
And it will continue.
Also see "A.I.G., Where Taxpayers’ Dollars Go to Die," The New York
Times, March 7, 2009 ---
http://www.nytimes.com/2009/03/08/business/08gret.html
Who helped AIG fail?
Answer: Why the government's own industry-infested regulators
"The Real AIG Outrage," The Wall Street Journal, March 17, 2009 ---
http://online.wsj.com/article/SB123725551430050865.html?mod=djemEditorialPage
Since September 16, AIG has sent $120
billion in cash, collateral and other payouts to banks, municipal
governments and other derivative counterparties around the world. This
includes at least $20 billion to European banks. The list also includes
American charity cases like Goldman Sachs, which received at least $13
billion. This comes after months of claims by Goldman that all of its AIG
bets were adequately hedged and that it needed no "bailout." Why take $13
billion then? This needless cover-up is one reason Americans are getting
angrier as they wonder if Washington is lying to them about these bailouts.
Given that the government has never
defined "systemic risk," we're also starting to wonder exactly which system
American taxpayers are paying to protect. It's not capitalism, in which
risk-takers suffer the consequences of bad decisions. And in some cases it's
not even American. The U.S. government is now in the business of
distributing foreign aid to offshore financiers, laundered through a
once-great American company.
The politicians also prefer to talk about
AIG's latest bonus payments because they deflect attention from Washington's
failure to supervise AIG. The Beltway crowd has been selling the story that
AIG failed because it operated in a shadowy unregulated world and cleverly
exploited gaps among Washington overseers. Said President Obama yesterday,
"This is a corporation that finds itself in financial distress due to
recklessness and greed." That's true, but Washington doesn't want you to
know that various arms of government approved, enabled and encouraged AIG's
disastrous bet on the U.S. housing market.
Scott Polakoff, acting director of the
Office of Thrift Supervision, told the Senate Banking Committee this month
that, contrary to media myth, AIG's infamous Financial Products unit did not
slip through the regulatory cracks. Mr. Polakoff said that the whole of AIG,
including this unit, was regulated by his agency and by a "college" of
global bureaucrats.
But what about that supposedly rogue AIG
operation in London? Wasn't that outside the reach of federal regulators?
Mr. Polakoff called it "a false statement" to say that his agency couldn't
regulate the London office.
And his agency wasn't the only federal
regulator. AIG's Financial Products unit has been overseen for years by an
SEC-approved monitor. And AIG didn't just make disastrous bets on housing
using those infamous credit default swaps. AIG made the same stupid bets on
housing using money in its securities lending program, which was heavily
regulated at the state level. State, foreign and various U.S. federal
regulators were all looking over AIG's shoulder and approving the bad
housing bets. Americans always pay their mortgages, right? Mr. Polakoff said
his agency "should have taken an entirely different approach" in regulating
the contracts written by AIG's Financial Products unit.
Jensen Comment
When then Treasury Secretary
Hank
Paulsen gave the first $85 billion to AIG, we did
learn that
the money was mostly going to credit derivative counterparties. The
names of the counterparties, however, was a carefully guarded secret. Hank
was the former CEO of Goldman Sachs. Goldman Sachs received favorable
publicity by declaring it did not need any TARP bailout money. It now turns
out, however, that AIG was laundering TARP money for banks like Goldman
Sachs that received at least $13 billion while pretending it did not receive
any TARP bailout money. This certainly does not pass the smell test if
Paulsen was in fact trying to keep it secret that his former bank was
receiving the TARP money he was doling out as Treasury Secretary.
On March 15, 2009 belatedly disclosed the names of the
largest credit derivatives counterparties ---
http://www.scribd.com/doc/13294757/AIGs-Biggest-Counterparties
Bob Jensen's threads on the AIG mess ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
How is bank regulation going in the United Kingdom?
Answer: Like the U.S., the U.K. has let the regulated control the
regulators
"Distancing regulator from regulated: A public debate on effective
regulation is long overdue, and would put an end to the constant pandering to
private interests," by Prem Sikka, The Guardian, March 17, 2009 ---
http://www.guardian.co.uk/commentisfree/2009/mar/16/regulators
The 1995 collapse of Barings Bank drew
attention to organised gambling, but no regulator questioned it. The high
court ruled that accountancy firm Deloitte & Touche was negligent in its
audit of Barings. Rather than exerting pressures on auditors to improve
quality of their work, the Limited Liability Partnership Act 2000 and the
Companies Act 2006 gave auditing firms liability concessions and made it
harder for injured parties to get redress from negligent auditors.
In 1996, after an explained 11 year delay,
a report on the alleged insider dealings at Guinness was finally published.
It concluded that the City of London is rife with "cynical disregard of laws
and regulations ... cavalier misuse of company monies ... contempt for truth
and common honesty". Some 12 years later the FSA chairman admitted that the
City did not take insider trading seriously.
Accountants and lawyers indulged in money
laundering, but regulators preferred cover-up to clean-up. UK-based
companies plundered developing countries through numerous tax avoidance
schemes. Former Nigerian dictator General Sani Abacha transferred billions
of pounds of stolen money via UK banks. Successive governments have failed
to repatriate the funds and refused to name the banks that played a central
role.
With complete failure of social steering
mechanisms, banks continued to pick people's pockets through exorbitant bank
charges, overdraft fees, credit card rates and payment protection insurance
(PPI), eventually culminating in the biggest financial crisis of all time.
There have been plenty of warnings, but successive governments and
regulators have been too enthralled with markets and business interests.
At the very least, an effective system of
regulation requires that there should be distance between the regulators and
the regulated. The regulators should not promote the industry and should not
have a cosy relationship with those to be regulated. Their prime concern
should be to protect the interests of stakeholders, consumers, depositors,
borrowers and citizens generally, even if that goes against the interests of
the industry. No industry should ever have an in-built majority on any
regulatory body. Thus regulatory practices would need to be negotiated with
other stakeholders. The possibilities of "capture" should be further checked
by ensuring that all meetings of the regulators are held in the open and all
files are on the public record.
A public debate on creating effective
regulatory system is long overdue and should be embedded to principles of
democracy, openness and accountability rather than pandering to private
interests.
Question
How do you account for and bail out a company with over $1 trillion in assets
that has ownership contracting that the best experts cannot untangle?
Did you ever think Osama Bin Laden may be in for some of these bailout
billions from our taxpayers?
Corporate contracting is becoming incomprehensible!
Denny Beresford forwarded this link to me.
"The Professor’s Pop Quiz: Who Controls A.I.G.?" by Steven M. Davidoff,
Dealbook.com, November 18, 2018 ---
http://dealbook.blogs.nytimes.com/2008/11/18/the-professors-pop-quiz-who-controls-aig/?ei=5070&emc=eta1
The terms of the government’s investment in the
American International Group were released last week. After reading these
terms, I have a multiple-choice question.
Who controls A.I.G.? Is it:
1) The Federal Reserve
2) The Department of the Treasury
3) The current shareholders of A.I.G. (but not the government)
4) All of the above collectively
5) No one knows
The best answer I can discern right now is number
5. The deal has become much more complicated than it was before, but the
control rights over A.I.G. appear to be as follows:
1. In exchange for its $40 billion preferred share
injection under the Emergency Economic Stabilization Act, the government is
getting a 10 percent dividend on these shares (plus A.I.G.’s agreement to
restrictions on lobbying), the same limitations on executive compensation as
in other preferred equity injections, a further limitation on annual bonus
pools for senior partners not to exceed 2007 and 2006 levels, and compliance
with an expense policy. As for control rights — the $40 billion preferred is
nonvoting except on certain major issues affecting the preferred. If A.I.G.
misses dividend payments for four consecutive quarters, the Treasury has the
right under the terms of this preferred stock to elect two directors and a
number of directors (rounded upward) equal to 20 percent of the total number
of directors after giving effect to such election.
2. In exchange for the new $60 billion Federal
Credit Facility (down from $85 billion), the Federal Reserve obtains the
general rights of a creditor including senior security over A.I.G.’s
unregulated subsidiaries, but no real governance rights except for some
negative covenants limiting A.I.G.’s operations and expenditures.
3. Finally, the government is receiving 100,000
Series C preferred shares convertible into 77.9 percent of A.I.G.’s
outstanding common stock. This second preferred stock has a vote equal to
77.9 percent of A.I.G.’s share capital and is entitled to 77.9 percent of
any dividends paid by A.I.G. on its common stock.
Thus, whoever controls these Series C preferred
shares controls A.I.G. These Series C shares, the stock that will vote and
control A.I.G., will be owned by is a trust for the benefit of the Treasury
Department. The trust is called the A.I.G. Credit Facility Trust. And who
are the trustees of this trust and the controllers of A.I.G.? I have no idea
nor have I seen any public disclosure on the issue except for news reports
in October that these trustees would be appointed by the Fed and that there
would be three of them. Moreover, under Section 5.11 of the original credit
agreement, a provision that appears to be unamended in the new deal, A.I.G.
“shall use all reasonable efforts to cause the composition of the board of
directors of [A.I.G.] to be … satisfactory to the Trust in its sole
discretion.”
So, why this oddity? I must admit, I am puzzled.
Perhaps it is related to accounting or some other legal requirement? But I
also suspect it may be political — the government does not want to control
A.I.G. directly. Rather, it is preserving some separation of ownership and
control to bar future administrations from political meddling (read the
Obama administration). This is probably a worthy goal — allowing A.I.G. to
operate on an economic basis protected from political meddling.
However, there should be adequate oversight of the
trust and some mechanisms to prevent the trustees from obtaining their own
private benefits from controlling A.I.G. and its $1 trillion in assets. In
addition, the trustees themselves should be chosen for their acumen and
ability to right the sinking A.I.G. ship. Here, the government could begin
by disclosing the terms of this trust once they are drafted.
Jensen Comment
What's even more comical is that accounting standards for various purposes, such
as when implementing securitization accounting under FAS 140, are heavily
dependent upon the "degree of control" irrespective of actual number of equity
shares owned. How do such standards get implemented when top experts have no
idea who controls what and for how long? Real life just is not as simple as what we teach in
Accounting 101.
What do you want to bet that lucrative consulting contracts are being given
to Andy Fastow to draft these ownership and control contracts? Here's an example
of one that Andy cut his teeth on ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
"Morgan Stanley's Mack Seeks Protection From You," by Jonathan Weil,
Bloomberg, September 22, 2008 ---
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aHRwgi.Jd2L0
Here's the truth about why Treasury Secretary Hank
Paulson wants $700 billion of your money to bail out stupid financial
companies. It's not about protecting you, the unwitting American. It's about
protecting people like him.
Specifically, people like Morgan Stanley Chief
Executive Officer John Mack. With his company's shares in a freefall, Mack
sent a memo on Sept. 17 to all employees, telling them ``short sellers are
driving our stock down.''
Mack offered no facts to support this claim. He
also said ``there is no rational basis for the movements in our stock.''
Actually, there was: Investors don't believe Morgan Stanley's numbers.
No matter. Heeding pleas of people such as Mack,
U.S. and U.K. regulators raced to ban short sales of all financial
companies' shares. They also opened investigations into ``market
manipulation'' by shorts, investors who sell borrowed shares, hoping to buy
them back at a lower price for a profit.
Then on Sept. 19, Paulson, the former boss of
Goldman Sachs Group Inc., unleashed the ultimate market manipulation -- the
bailout, although this isn't really the right word. It's more like a
needle-exchange program.
Mission accomplished: Stocks soar. Morgan Stanley
and Goldman survive. Armageddon is averted. And, here's the important part:
People like you stop dreaming of lining people like John Mack up against a
wall and shooting them.
For now, at least. The problem with Paulson's plan,
on paper, is it shouldn't work, unless Paulson authorizes
government-sponsored looting of the Treasury, which seems likely. The only
way it will work is if (1) people like you, (2) think other people like you,
(3) think other people like you, (4) will think it will work.
Meaning of `Troubled'
Here's why. Since the financial crisis began last
year, banks worldwide have disclosed $519 billion of losses from writing
down assets. Consequently, many of them don't have enough capital left to
absorb more losses. And unless their stock prices go up a lot, they can't
raise any more.
Under Paulson's plan, the Treasury will get as much
as $700 billion to buy ``troubled assets'' from financial institutions. The
word ``troubled'' seems to mean whatever Paulson wants it to mean. As far as
I can tell, the only way this would help plug banks' capital holes is if the
Treasury pays them much more than the assets are worth.
Even if Treasury pays 100 percent of the assets'
balance- sheet value, banks still won't have enough capital. And as the
whole world seems to know, the asset values on banks' balance sheets are
grotesquely inflated. If Treasury pays only what they're worth, the banks
would have to take more writedowns and admit to bigger capital shortfalls.
You Gotta Believe
So, to boost the banks' capital, the Treasury
basically has to bribe U.S. banks into staying afloat. As it turns out,
Paulson's plan gives him unchecked authority to do just that.
It doesn't matter whether Paulson's plan will work,
though. What matters is getting enough people like you to believe it will.
If that happens, the banks' stock prices will go up. Then bankers can start
raising capital again from people like themselves who, while richer, are no
less gullible than people like you.
The government also said it will offer unlimited
insurance for money-market mutual funds. This would draw deposits away from
the commercial banks supposedly being rescued, where federal insurance is
capped at $100,000. It also will inspire money- market fund managers to turn
to the needle themselves, taking greater risks in search of higher returns,
more assets under management, bigger fees and, in time, bigger bailouts.
Slight Loophole
The supreme lunacy comes from the Securities and
Exchange Commission. It passed emergency rules last week to make investment
managers disclose their short positions. Now, you might think this would
mean someone like Jim Chanos, who runs the world's largest short-only hedge
fund, Kynikos Associates, would have to start disclosing his firm's bets.
Here's a scoop, though: He doesn't.
Instead, the rules only require short-sale
disclosures by funds that held ownership stakes in public companies'
securities as of June 30. Kynikos, which has $7 billion under management,
doesn't own any securities. It only shorts them. So, the rules don't cover
Kynikos.
``It does underscore our concerns about the
hastiness of these late-night regulations,'' Chanos told me, after I called
to make sure I wasn't imagining the loophole. He says Kynikos will disclose
its short positions anyway, to abide by the rules' spirit.
Prosecution Rests
This goes to show: If the government didn't care
enough to make sure its rules apply to Chanos, it probably doesn't really
care about short-sellers. It just wants to divert attention by creating an
enemy for public persecution. Don't take my word for it, though. Check out
what President George W. Bushsaid Sept. 19 on national television.
``The SEC is also requiring certain investors to
disclose their short selling, and has launched rigorous enforcement actions
to detect fraud and manipulation in the market,'' he said. ``Anyone engaging
in illegal financial transactions will be caught and persecuted (sic).''
Whatever it takes to save our financial system from
descending into oblivion, it will be tried, even if it all but guarantees
we'll have a bigger meltdown later. It's not about principle. It's about the
money. And it's about people like John Mack protecting themselves from
people like you, by whatever means necessary.
Heaven help us all if it doesn't work.
Do we have a 2008 Orange County-type fraud instigated by JP Morgan Chase
Bank?
Added Insights on How the CDO Scandals Worked
February 9, 2009 message from Phillip Chiu
[p_chill@hotmail.com]
Dear Professor Jensen,
I am writing on behalf of a group of investors
numbering several tens of thousands in Hong Kong who believe they have been
duped by Lehman Brothers in purchasing what is described as ‘credit-linked’
notes (a small portion is variously described as ‘equity-linked note’ and
the like).
The complexity of the products only gradually came
to light after the bankruptcy of Lehman Brothers last September, followed by
the rather irresponsible conduct manifested by the refusal of the
distributor banks and the regulators (the Securities and Futures Commission
and the Hong Kong Monetary Authority) to answer queries relating to the
approval and sales of such Notes.
The Notes were being sold indiscriminately to the
public without any regard to suitability of the particular investor. By a
rough estimate (profiles of the victimized investors have been withheld by
the government), about 40% of the entire body of investors are retirees,
elderly, uneducated or suffering from other handicaps.
We believe that the so-called credit-linked notes
actually conceal poor quality synthetic CDO described as ‘underlying
security’. Ostensibly the Notes are advertised as ‘credit-linked’ to a
handful of well-known companies, but this is no more than a façade in order
to obscure the all-important role played by the portfolios of credit
derivatives. I attach the issue prospectus and programme prospectus of one
of the many series for your ease of reference.
From your remarkable wealth of knowledge in white
collar fraud, I wonder if you would be interested in having a look of the
attachment and considering adding this scam in your website. Being mere
amateurs in finance, we have been struggling to unravel the fraud without
any assistance from the banks and the regulators. We would be most grateful
for any advice from you such as similar deceptive practice
(mischaracterizing highly risky derivatives as ‘security’ in order to
mislead the investors in this instance), or any other aspects that you may
consider we should pay attention to.
No details about the ‘underlying security’ was
given in the prospectuses and Lehman sought to excuse the non-disclosure by
asserting that final decision had not been made when the prospectus went to
print. The intervals between each series of the Notes could be as short as
one month which renders the assertion implausible. After all, some issuers
of similar notes have adopted the practice of revealing an ‘expected
portfolio’ and cognate details. We consider this a key aspect of intentional
withholding of information. Your opinion on this would be very much
appreciated.
May I thank you in advance for taking time to read
our request.
Yours faithfully
Philip Chiu
Attachment 1 ---
http://faculty.trinity.edu/rjensen/HongKongLehman01.pdf
Attachment 2 ---
http://faculty.trinity.edu/rjensen/HongKongLehman02.pdf
Bob Jensen’s Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Justice, SEC Investigate Morgan Stanley's Mortgage Transactions,"
SmartPros, May 13, 2010 ---
http://accounting.smartpros.com/x69456.xml
The Justice Department and the Securities and
Exchange Commission are investigating Morgan Stanley as part of a probe into
whether Wall Street firms misled investors in selling mortgage-related
securities, according to federal law enforcement officials and others
familiar with the matter.
Since summer, the SEC has been looking at how a
number of banks packaged and marketed those securities, according to sources
familiar with the matter. The criminal probe into Morgan Stanley, which came
to light early Wednesday, is focused on whether the bank accurately
represented to investors its role in mortgage-related deals it helped design
but sometimes bet against, the sources said.
The investigation into Morgan, which is at a
preliminary stage, is reminiscent of a federal criminal probe into mortgage
transactions at Goldman Sachs. The SEC sued Goldman on civil fraud last
month, alleging that the firm created and marketed an investment, known as a
synthetic collateralized debt obligation, that was secretly designed to
fail.
According to a source familiar with Morgan
Stanley's business, the bank bet against one CDO that it also marketed to
investors, a $160 million investment known as Baldwin. The sources all spoke
on the condition of anonymity because the inquiries are at an early stage.
The Wall Street Journal first reported the
investigation on its Web site Wednesday morning, saying that prosecutors
were scrutinizing two mortgage-related deals named after U.S. presidents
James Buchanan and Andrew Jackson.
Sources could not immediately confirm that those
transactions are part of the probe, and it is not clear what
misrepresentations Morgan Stanley might have made to clients. The firm made
bets that the Buchanan and Jackson investments would lose value but did not
create the investments or play any role in marketing them, according to a
source familiar with Morgan Stanley's business.
"We have not been contacted by the Justice
Department about the transactions being raised by the Wall Street Journal,
and we have no knowledge of a Justice Department investigation into these
transactions," Mark Lake, a Morgan Stanley spokesman, said Wednesday.
A source familiar with Morgan Stanley's business
said the firm has received some requests for information from the SEC but
not any broader subpoenas seeking documents or depositions.
Citigroup and UBS created the Buchanan and Jackson
CDOs. The review of the deals might be focusing on whether Citigroup and UBS
properly told its clients that Morgan Stanley would be betting against the
investment.
Citigroup and UBS declined to comment.
The SEC lawsuit against Goldman claims the firm and
an executive, Fabrice Tourre, committed fraud when they sold clients a CDO
linked to the value of home loans that was secretly designed to fail.
A hedge fund, Paulson & Co., had helped Goldman
create the CDO and planned to bet against it. But the SEC claims that
relationship was not disclosed to Goldman's clients, ACA Financial Guaranty
and the German bank IKB.
Continued in article
Bob Jensen's threads on the subprime sleaze are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on rotten to the core banks ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Were AIG losses hidden early on by creative
accounting?
PwC is the external auditor of AIG
"A Question for A.I.G.: Where Did the Cash
Go?" by Mary Williams Walsh, The New York Times, October 29, 2008 ---
http://www.nytimes.com/2008/10/30/business/30aig.html?dlbk
The American International Group is rapidly running
through $123 billion in emergency lending provided by the Federal Reserve,
raising questions about how a company claiming to be solvent in September
could have developed such a big hole by October. Some analysts say at least
part of the shortfall must have been there all along,
hidden by irregular accounting.
“You don’t just suddenly lose $120 billion
overnight,” said Donn Vickrey of Gradient Analytics, an independent
securities research firm in Scottsdale, Ariz.
Mr. Vickrey says he believes A.I.G. must have
already accumulated tens of billions of dollars worth of losses by
mid-September, when it came close to collapse and received an $85 billion
emergency line of credit by the Fed. That loan was later supplemented by a
$38 billion lending facility.
But losses on that scale do not show up in the
company’s financial filings. Instead, A.I.G. replenished its capital by
issuing $20 billion in stock and debt in May and reassured investors that it
had an ample cushion. It also said that it was making its accounting more
precise.
Mr. Vickrey and other analysts are examining the
company’s disclosures for clues that the cushion was threadbare and that
company officials knew they had major losses months before the bailout.
Tantalizing support for this argument comes from
what appears to have been a behind-the-scenes clash at the company over how
to value some of its derivatives contracts. An accountant brought in by the
company because of an earlier scandal was pushed to the sidelines on this
issue, and the company’s outside auditor, PricewaterhouseCoopers, warned of
a material weakness months before the government bailout.
The internal auditor resigned and is now in
seclusion, according to a former colleague. His account, from a prepared
text, was read by Representative Henry A. Waxman, Democrat of California and
chairman of the House Committee on Oversight and Government Reform, in a
hearing this month.
These accounting questions are of interest not only
because taxpayers are footing the bill at A.I.G. but also because the
post-mortems may point to a fundamental flaw in the Fed bailout: the money
is buoying an insurer — and its trading partners — whose cash needs could
easily exceed the existing government backstop if the housing sector
continues to deteriorate.
Edward M. Liddy, the insurance executive brought in
by the government to restructure A.I.G., has already said that although he
does not want to seek more money from the Fed, he may have to do so.
Continuing Risk
Fear that the losses are bigger and that more
surprises are in store is one of the factors beneath the turmoil in the
credit markets, market participants say.
“When investors don’t have full and honest
information, they tend to sell everything, both the good and bad assets,”
said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting
firm in Chicago. “It’s really bad for the markets. Things don’t heal until
you take care of that.”
A.I.G. has declined to provide a detailed account
of how it has used the Fed’s money. The company said it could not provide
more information ahead of its quarterly report, expected next week, the
first under new management. The Fed releases a weekly figure, most recently
showing that $90 billion of the $123 billion available has been drawn down.
A.I.G. has outlined only broad categories: some is
being used to shore up its securities-lending program, some to make good on
its guaranteed investment contracts, some to pay for day-to-day operations
and — of perhaps greatest interest to watchdogs — tens of billions of
dollars to post collateral with other financial institutions, as required by
A.I.G.’s many derivatives contracts.
No information has been supplied yet about who
these counterparties are, how much collateral they have received or what
additional tripwires may require even more collateral if the housing market
continues to slide.
Ms. Tavakoli said she thought that instead of
pouring in more and more money, the Fed should bring A.I.G. together with
all its derivatives counterparties and put a moratorium on the collateral
calls. “We did that with ACA,” she said, referring to ACA Capital Holdings,
a bond insurance company that was restructured in 2007.
Of the two big Fed loans, the smaller one, the $38
billion supplementary lending facility, was extended solely to prevent
further losses in the securities-lending business. So far, $18 billion has
been drawn down for that purpose.
Continued in Article
From Jim Mahar's blog on October 31, 2008 ---
http://financeprofessorblog.blogspot.com/
First and foremost it gets to a serious question.
Were the initial infusions (into AIG) by the government just a stop gap
measure and will even more be needed. (The idea of throwing good money after
bad comes to mind). Secondly in class yesterday we talked about information
asymmetries and how accounting can only partially lessen the problem and
that firms can have billions of dollars of losses that investors may not be
aware of even after reading the financial statements. And finally a student
in class is doing a paper on this and what the executives must have known
(or at least should have known) before hand.
Bob Jensen's threads on where the bailout
money paid to AIG went are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Hint: Think credit default derivatives not backed with capital reserves
If AIG executives knew about these problems
early on, what did the auditor not insist on disclosing?
Sounds like a massive class action lawsuit here for AIG shareholders who lost
their investments.
Bob Jensen's threads on PwC auditors are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Will the all Big Four auditing firms
survive the forthcoming class action lawsuits? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
Although PwC is the newly designated auditor
of the Bailout Program, appearances of conflict of interest just keep increasing
since a huge and controversial recipient of Bailout funds is not only a PwC
client, the recipient has now been convicted of accounting fraud dating back to
Year 2000.
Will government bailout money be used to pay
AIG's court settlements?
"A federal judge has ruled that shareholders of
American International Group Inc. lost more than $500 million as a result of a
scheme to manipulate the financial statements of the world's largest insurance
company," AccountingWeb, November 3, 2008 ---
http://accounting.smartpros.com/x63720.xml
A federal judge has ruled that shareholders of
American International Group Inc. lost more than $500 million as a result of
a scheme to manipulate the financial statements of the world's largest
insurance company.
The ruling Friday by Judge Christopher Droney means
five former insurance executives convicted of the scheme could face up to
life in prison under advisory sentencing guidelines.
Four former executives of General Re Corp. and a
former executive of AIG were convicted in February of conspiracy, securities
fraud, mail fraud and making false statements to the Securities and Exchange
Commission.
Prosecutors filed court papers citing a study by
its expert, concluding the fraud-related losses to AIG shareholders totaled
$1.2 billion to $1.4 billion.
They cited another methodology by the expert that
put the losses at $544 million to $597 million, but said either method is
reasonable.
Droney rejected the higher estimate, but said the
lower range was reasonable. That finding and a determination that the fraud
affected more than 250 victims will increase the advisory guideline sentence
range.
The guideline range and a sentencing date have not
been set yet.
The defendants challenged the estimate, saying
there was no loss to investors. The defendants are Christopher Garand,
Ronald Ferguson, Elizabeth Monrad, Robert Graham and Christian Milton.
Ferguson has said in court papers that he
anticipated the government will advocate a loss amount that leads to a
recommendation for life in prison. But prosecutors made no such
recommendation, simply concluding that the defendants should receive a
"substantial" prison sentence.
A report by the probation department recommended
sentences of 14 years to more than 17 years for each defendant.
Prosecutors said the defendants participated in a
scheme in which AIG paid Gen Re as part of a secret side agreement to take
out reinsurance policies with AIG in 2000 and 2001, propping up its stock
price and inflating reserves by $500 million.
Reinsurance policies are backups purchased by
insurance companies to completely or partly insure the risk they have
assumed for their customers.
General Re is part of Berkshire Hathaway Inc.,
which is led by billionaire investor Warren Buffett of Omaha, Neb.
Jensen Comment
Just for the record --- I’m
not the only one raising concerns about independence of the Bailout consultant
and auditor, I provide reference to the following published in CFO.com:
Carolina Selby wrote the following in CFO.com ---
http://www.cfo.com/article.cfm/l_comments/12454494?context_id=2984378#4270
PWC&EY contract for bailout
I am very troubled that
the government has chosen PwC as one of the firms to help with the internal
controls on the $700b bail out which included AIG. PWC just recently agreed to
one of the largest settlements in the public accounting history over a
class-action law suit because of their carelessness in auditing AIG. What
happened to the Sarbanes-Oxley requirements? Where were the auditors,
controllers and CFO?s of these companies requiring the bailout? Something is
fundamentally wrong. I fully agree with Lynn Turner, former CFO and former chief
accountant of the SEC on the recent quote:
When you look at the past and see where auditors didn't get the job done right,
there were indicators that they didn't pay attention to,". "Auditors are going
to need to take off the blinders."
I was a former PwC employee and always thought highly of the caliber of training
and values they taught me. In the last decade or so, however, public accounting
firms are more worried about the bottom line than the significant value the
profession can bring to troubled companies.
David
Newman wrote the following in CFO.com ---
http://www.cfo.com/article.cfm/l_comments/12454494?context_id=2984378#4270
Auditor Conflicts
I hope there are no
conflicts of interest, such as independence issues, of PwC, and Ernst and
Young auditing the USA Federal Treasury while also consulting on accounting
and internal control areas. The latter is indicated in the article. The
auditing is not.
Though some research indicates that the Government Accountability Office
(GA) audits the Federal Treasury. Now the million dollar question: who
audits the GAO?
It appears it is Internal Audit and KPMG.
http://www.gao.gov/press/peerreview_cleanopinion.pdf
Jensen
Comment
All of the comments published may be dysfunctional
at this point to our profession at this moment. I will not deliberately continue
my search for evidence that other people in the world are raising the same
concerns about independence of the Bailout auditor and consultant.
Auditing has a huge image
problem since all of the failed and failing banks (with Washington Mutual
perhaps being the worst-case illustration) had clean audit reports prior to
failing and wiping out shareholder equity. Even if the CPA Profession finds
reasons and excuses for those clean opinions, the image of independence and
value added by an audit is badly tarnished at this point. Paying those same
auditing firms giving those clean opinions for failed banks millions of dollars
in the government’s subsequent bailing out of PwC and E&Y banking clients
seemingly adds to the tarnish at this point in time.
Although AIG, that is now dependent upon billions in the
government's Bailout Program in order to survive, AIG will have to come up with
another $500 million from somewhere following the judge's October 31, 2008
ruling establishing the amount owing for its accounting fraud dating back to
Year 2000.
AIG admitted that it misled its PwC auditor.
For its part in the AIG scandal, however, PwC
settled some separately when it paid $97.5 million to settle a class-action
securities fraud lawsuit instigated by the Ohio State Attorney General's Office
---
http://gist.whistlehog.com/items/show/188970
This is considerably less that the initial $1.6 billion sought by AIG
shareholders ---
http://www.accountancyage.com/accountancyage/news/2200128/pwc-sued-shareholders
Under censure from the SEC for compromising its independence AIG
accounting fraud, Ernst & Young agreed to pay up
$1.5 million to clients of AIG in 2007.
From The Wall Street Journal Accounting Weekly Review
on March 30, 2007
Ernst Censure Over Independence, Agrees to
$1.5 Million Settlement
by Judith Burns
Mar 27, 2007
Page: C2
Click here to view the full article on
WSJ.com ---
http://online.wsj.com/article/SB117495897778849860.html?mod=djem_jiewr_ac
TOPICS: Accounting,
Advanced Financial Accounting, Auditing,
Auditing Services, Auditor Independence,
Financial Accounting, Sarbanes-Oxley Act,
Securities and Exchange Commission
SUMMARY: Ernst
& Young (E&Y) "was censured by the
Securities and Exchange Commission (SEC) and
will pay $1.5 million to settle charges that
it compromised its independence through work
it did in 2001 for clients American
International Group Inc. and PNC Financial
Services Group. "Regulators claimed AIG
hired E&Y to develop and promote an
accounting-driven financial product to help
public companies shift troubled or volatile
assets off their books using special-purpose
entities created by AIG." PNC accounted
incorrectly for its special purpose entities
according to the SEC, who also said that
"PNC's accounting errors weren't detected
because E&Y auditors didn't scrutinize
important corporate transactions, relying on
advice given by other E&Y partners.
QUESTIONS:
1.) What are "special purpose entities" or
"variable interest entities"? For what
business purposes may they be developed?
2.) What new interpretation addresses issues
in accounting for variable interest
entities?
3.) What issues led to the development of
the new accounting requirements in this
area? What business failure is associated
with improper accounting for and disclosures
about variable interest entities?
4.) For what invalid business purposes do
regulators claim that AIG used special
purpose entities (now called variable
interest entities)? Why would Ernst & Young
be asked to develop these entities?
5.) What audit services issue arose because
of the combination of consulting work and
auditing work done by one public accounting
firm (E&Y)? What laws are now in place to
prohibit the relationships giving rise to
this conflict of interest?
|
|
|
It appears that, when they were appointed by the 2008 Bailout Program as
consultants and auditors, both PwC and
E&W had already settled the AIG lawsuits.
This is not the case for AIG itself that must come up with more cash.
Jim Mahar writes as follows in his Finance Professor Blog on October 30, 2008
From
the NY Times Article
A Question for A.I.G. - Where Did the Cash Go? - NYTimes.com:
The American International Group is rapidly running
through $123 billion in emergency lending provided by the Federal Reserve,
raising questions about how a company claiming to be solvent in September could
have developed such a big hole by October.....Mr. Vickrey says he believes A.I.G.
must have already accumulated tens of billions of dollars worth of losses by
mid-September, when it came close to collapse and received an $85 billion
emergency line of credit by the Fed. That loan was later supplemented by a $38
billion lending facility.
But losses on that scale do not show up in the company’s financial filings.
Instead, A.I.G. replenished its capital by issuing $20 billion in stock and debt
in May and reassured investors that it had an ample cushion....Mr. Vickery and
other analysts are examining the company’s disclosures for clues that the
cushion was threadbare and that company officials knew they had major losses
months before....
Professor Mahar Comment
Several reasons for including this one. First and
foremost it gets to a serious question. Were the initial infusions by the
government just a stop gap measure and will even more be needed. (The idea of
throwing good money after bad comes to mind).
Secondly in class yesterday we talked about information asymmetries and how
accounting can only partially lessen the problem and that firms can have
billions of dollars of losses that investors may not be aware of even after
reading the financial statements. And
finally a student in class is doing a paper on this and what the executives must
have known (or at least should have known) before hand.
PwC'a auditors either ignored or missed the warning signs of accounting
fraud at AIG
For years, PricewaterhouseCoopers LLP gave a clean bill
of financial health to American International Group Inc., only to watch the
insurance giant disclose a long list of accounting problems this spring. But in
checking for trouble, PwC might have asked the audit committee of AIG's board of
directors, which is supposed to supervise the outside accountant's work. For two
years, the committee said that it couldn't vouch for AIG's accounting. In 2001
and 2002, the five-member directors committee, which included such figures as
former U.S. trade representative Carla A. Hills and, in 2002, former National
Association of Securities Dealers chairman and chief executive Frank G. Zarb,
reported in an annual corporate filing that the committee's oversight did "not
provide an independent basis to determine that management has maintained
appropriate accounting and financial reporting principles." Further, the
committee said, it couldn't assure that the audit had been carried out according
to normal standards or even that PwC was in fact "independent." While the
distancing statement by the audit committee is not unprecedented, the AIG
committee's statement is one of the strongest he has seen, said Itzhak Sharav,
an accounting professor at Columbia University. "Their statement, the phrasing,
all of it seems to be to get the reader to understand that they're going out of
their way to emphasize the possibility of problems that are undisclosed and
undiscovered, and they want no part of it." Language in audit committee reports
ran the gamut . . .
"Accountants Missed AIG Group's Red Flags," SmartPros, May 31, 2005 ---
http://accounting.smartpros.com/x48436.xml
Bob Jensen's threads on PwC auditors are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Will the all Big Four auditing firms survive
the forthcoming class action lawsuits? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
"The GM IPO: Are You Buying It?" by Francine McKenna, Forbes,
November 4, 2010 ---
http://blogs.forbes.com/francinemckenna/2010/11/04/the-gm-ipo-are-you-buying-it/
The Obama administration
says the bailout of General Motors (NYSE:GM) is a success. Their former car
czar, Steve Rattner, may have moved the ball out of the opposing team’s end
zone by avoiding a full scale, free-for-all bankruptcy like
Lehman’s, but that doesn’t mean we should be
celebrating any touchdowns just yet.
Mr. Rattner has a new book out about his experience
at GM. It’s Rattner’s view – or his publicist’s – that
Overhaul: An Insider’s Account of the Obama Administration’s Emergency
Rescue of the Auto Industry, “captures
a unique moment in American business that will have lasting influence on all
industries, as the archetypal American industry (which helped create our
nation’s wealth and status) is used to write the playbook for corporate
bailouts.”
God, I hope not.
The U.S. government plans to sell the GM garbage
barge back to investors after taxpayers poured $50 billion in to save it. GM
will report final third-quarter figures on November 10th, a week ahead of
its November 18th IPO. The company “projects” a third-quarter profit of
between $1.9 billion and $2.1 billion, according to
preliminary results the automaker released
yesterday. It’s supposedly the third consecutive quarterly profit for
post-bankruptcy GM but none of those numbers were audited and the
financial statements included in the prospectus
for the share offering are also unaudited.
I’m skeptical about any numbers GM issues, whether
blessed by their auditor Deloitte or not.
Tom Selling, blogging at
The Accounting Onion, extends an argument made by
Jonathan Weil in early September: “GM’s
shareholders’ equity at December 31, 2009 would have been a negative $6.2
billion if it were not able to book a whole bunch of goodwill. To say
that few companies would be able to pull off a successful IPO with a
negative number for shareholders’ equity on its balance sheet would be an
understatement. To say the same after applying fresh-start accounting would
be a statement of fact.”
General Motors included a litany of potential risks
in its IPO prospectus. One of them is the “current”
weakness of internal controls over its internal financial reporting. GM’s
internal controls over financial reporting were still not effective on June
30. The issue was previously disclosed in GM’s 2009 annual report.
And its 2008, 2007 and 2006 annual reports.
In March of 2007, GM reported, “ineffective
internal controls over financial reporting might make it difficult for the
company to execute on its business plan.” At that time, GM was
also under investigation by the SEC on several matters, including financial
reporting related to pension accounting, transactions with suppliers
including their former subsidiary Delphi (another bankrupt company) and
transactions in precious metals.
The only news here is that a lot of suckers will
invest in a company that hasn’t produced financial reports anyone should
trust in a long time. Amongst many other weaknesses, they never have enough
competent accounting professionals to book the complex transactions it takes
to create their balance sheet.
When companies go
bankrupt, their underfunded pensions are taken over by the Pension Benefit
Guaranty Corp. (PBGC), a government-run, industry-funded insurance agency,
which then pays retirees a fraction of what they were owed. But that didn’t
happen in the GM bankruptcy. The UAW resisted, according to the
Washington Post. GM’s defined-benefit plans for US
employees were underfunded by $16.7 billion as of June 30. GM’s prospectus
says federal law will require it to start pumping in “significant” amounts
by 2014 if not sooner.
When
I wrote about my preference for a real GM
bankruptcy, I thought it would also be great for GM’s employees to see how
the other half lives with regard to health insurance. Putting GM’s former
employees on the rolls of a single-payer, government-funded program (my hope
at the time) would provide additional economies of scale and volume buying
power for the government as well as get rid of this monkey on our back. No
longer would taxpayers, or car buyers, subsidize health benefit entitlements
that are way beyond what anyone else gets these days. Reset expectations
for this constituency and we can all move on.
Unfortunately, neither the outsize pension
liabilities nor the unrealistic healthcare benefits for these employees and
retirees were cut down to size by the US government’s approach.
In August of 2008,
General Motors and their auditor Deloitte settled
a class-action securities lawsuit against them alleging the automaker filed
misleading financial reports between 2002 and 2006. GM paid $277 million and
Deloitte kicked in $26 million.
GM was forced to reduce the amount paid to auditor
Deloitte after the Sarbanes-Oxley Act prohibited companies from using the
same firm as a consultant and an auditor. About $49 million was spent on
Deloitte for consulting services in 2001 and only $21 million was for audit
work. By 2008, GM’s bill for audit work was up to $31.5 million.
Deloitte has been GM’s auditor since 1918. That’s
ninety-two years of making sure GM survives to pay another invoice. Don’t
bet on independence, objectivity, or lawsuits ruining this beautiful
relationship anytime soon.
Bob Jensen's threads on Deloitte ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
To my knowledge
Rashad was the first Accounting Review editor to impose a requirement
that authors place an abstract in front of a paper that explains the paper and
its significance in non-technical terms --- perhaps to the teenage child of an
author. This has been somewhat successful subject to abstract length
restrictions. Probably the biggest drawback has been that abstracts often
suggest quite general findings that, when subjected to tests of model robustness
(often overlooked in the study itself) and limiting assumptions, the findings
are about as narrow as the sharp edge of a
Samurai sword.
For example,
log-linear models generally seek a parsimonious model that, when put to the
test, is not especially robust relative to other parsimonious models vis-a-vis
the saturated model ---
http://faculty.chass.ncsu.edu/garson/PA765/logit.htm
Another example of a model that is not robust is Ijiri’s cash flow recovery rate
model that’s great in theory but lacks robustness and is too sensitive to even
the slightest errors in parameter estimation. In theory it sounds like a
tremendous tool for financial analysts. But in practice the model is just not
robust. Have you ever seen robustness mentioned in the abstract of a paper? See
http://en.wikipedia.org/wiki/Robust
One thing
abstracts often reveal is the trivial nature of the findings when they are
explained in plain English rather than statistical significance ---
Click Here
Another problem with very large samples arises when researchers declare
statistical significance to differences that are substantively trivial. When is
that last time you saw such a conclusion in an abstract or even the accounting
research paper itself?
I will give you
an example of the residual-errors test that is seldom mentioned in an accountics
paper abstract or even the paper itself. The example is classic even though it’s
not an accounting research finding. This illustration is from a book entitled
Credit Derivatives & Synthetic Structures by Janet M. Tavakoli (Wiley, 2001,
pp. 2-3),
Many years ago, my
advanced statistics professor, one of the world’s most talented statisticians
and statistical modelers, laughingly admitted to model hubris early in his
career. He had been asked to participate in a study to model tree trunk wood
volumes. He diligently measured the trees and recorded the wood yield data
corresponding to the measured trees. He tabulated and graphed the data. He used
a computer program and regression analysis. He applied modeling theory and came
up with a formula that was closely correlated with tree wood yields. It was
magic. Statistics worked.
The formula looked
very much like that for the volume of a cylinder --- with a small fudge factor
thrown in. Fudge factors are common. They make up for the fact that the world
doesn’t always behave the way we think it should behave. This was in the days
before fractal theory. Euclidean geometry always leaves us with the need for
fudge factors; we’re used to it.
We know the world
isn’t made up of squares, triangles, circles, and cylinders. Nonetheless, the
model was a nice, neat, and intuitive little formula. It had a high correlation
coefficient. When you plugged in the trunk width and the height of the tree, the
wood volume was pretty much as predicted by the neat little formula. Statistics
showed that the formula described the data and predicted future events pretty
well. That --- among other things --- is what makes a statistician feel
satisfied
The formula was
perfect.
Well, almost
perfect.
Little things about
the formula kept bothering the budding professor. For instance, a plot of the
residuals didn’t look random. The residuals, the unexplained data, appeared to
have a pattern. Statisticians know that isn’t a good thing. That usually means
the neat little formula missed something. But it was so close. The minor error
seemed negligible.
The budding professor
was tempted to ignore these pesky residuals and declare the job done. But he
kept at it, laboring away, modifying the formula, trying to make the residuals
disappear. The cylinderlike formula seemed so right. The professor had a
problem. He couldn’t see the formula for the trees.
Trees do indeed look
very much like cylinders. But they look even more like cones.
One of the
foresters pointed this out one day to the budding professor. This is a moment
statisticians and mathematicians both love and hate.
They hate it
because they get the churning feeling in the pit of their stomachs, which lets
them know in their gut that they are wrong. They also love it because now
they’ve hit on a better answer.
In retrospect
between 2001 and the credit default swap derivatives fiasco of 2008 (where Wall Street had
millions of such contracts) is that Janet M. Tavakoli’s credit derivative models
in 2001 looked almost perfect but ignored the Black Swan of 2008 that some might
arguably helped to bring down the world of finance to the extent that so many
credit derivatives were used, in a failing effort, to insure against investment
failures. This, of course, was a much larger specification problem than the
Euclidean difference between cylinders and cones. I wonder how Ms. Tavokoli is
sleeping these days. See
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Who is Nassim Nicholas Taleb?
---
http://en.wikipedia.org/wiki/Taleb
Many finance professors make students watch some of Taleb's videos, especially
the Black Swan ---
http://video.google.com/videosearch?q=taleb+black+swan+&www_google_domain=www.google.com&emb=0&aq=f&aq=f#
Black Swan Financial Collapse Black Swan ---
http://www.dailymotion.com/video/x720r3_black-swan-paradigm-financial-colla_tech
(People underestimate the probability of rare events)
You tube has a lot of videos about a CDS. Go to YouTube and read in the
phrase "credit default swap" ---
http://www.youtube.com/results?search_query=Credit+Default+Swaps&search_type=&aq=f
In particular note this video by Paddy Hirsch ---
http://www.youtube.com/watch?v=kaui9e_4vXU
Paddy has some other YouTube videos about the financial crisis.
The second is the comment that Joan
Robinson made about American Keynsians: that their theories were so flimsy that
they had to put math into them. In accounting academia, the shortest path to
respectability seems to be to use math (and statistics), whether meaningful or
not.
Professor Jagdish Gangolly, SUNY
Albany
I don't think it's ready for IFRS prime time with the quants, but
improvements are being suggested for Black Swan fat tails.
The quants are more desperate at Senator Spector (now a lame duck) running
to save their jobs.
We might facetiously assert that its all for the birds.
Do we forecast? You bet. Do we have
confidence in our forecasts? Never! Confidence about a non-linear chaotic system
can only come in degrees, and even those degrees of confidence are guesses. Not
all hope is lost. There are times when it seems our ability to predict is better
than others. Thus we need to take advantage of it if we see it. Trading ranges,
pivot points, support and resistance, and the like can help, and do help the
trader.
Michael Covel, Trading Black Swans,
September 2009 ---
http://www.michaelcovel.com/pdfs/swan.pdf
"A Finer Formula for Assessing Risk," by Martin Hutchinson, The New
York Times, May 10, 2010 ---
http://www.nytimes.com/2010/05/11/business/11views.html?src=busln
The credit crisis would not have been as bad if
investment banks’ risk management systems worked well. But the systems rely
on sophisticated mathematical models that have a fundamental flaw: they
grossly underestimate a factor called “tail risk.” This problem can be
solved fairly easily.
In a way, this is a highly technical dispute about
the arcane details of the calculation of Value at Risk, the prime measure of
the riskiness of trading books.
To nonmathematicians, the possible answers sound
daunting: Gaussian, Cauchy and Pareto-Levy. But the underlying question is
straightforward: how often and how badly do markets blow up?
On a day to day basis, financial asset prices seem
to go up and down at random, or in response to news. But the rocket
scientists of finance analyze thousands of movements to identify patterns.
The answer is what is known as a stable “Paretian
distribution.” Picture a curve that looks like a cross-section of a hat,
with a brim that is wide and thin and a great big crown in the middle.
The crown represents the days that prices don’t
move very much. It is high because most days are like that. On those calm
days, holders cannot lose much money. The brim represents the days of big
losses or gains. The further from the center of the crown, the bigger the
loss or gain. The wider the brim, the more often the big moves occur.
The argument is about the shape of the hat brim.
The standard model employed by banks — named for the German mathematician
Carl Friedrich Gauss — is one in which really bad days happen rarely and
horrible days almost never.
How rarely? Well, in August 2007 David Viniar, the
chief financial officer of Goldman Sachs, said, “We were seeing things that
were 25 standard deviation moves, several days in a row.”
Standard deviations are a measure of the distance
from the center of the hat, or, to use the common image in the trade, the
length of the tail. If those days were really 25 standard deviations away,
they would not be expected to come around in the lifetime of a billion
universes.
But the 2007-style collapse had many precedents in
the last few centuries, well within the life of this one universe.
The Gaussian model is too optimistic about market
stability, because it uses an unrealistically high number for the key
variable, the exponential rate of decay, known to its friends as alpha (not
the alpha of performance measurement).
Gauss is at 2. If markets worked with an alpha of
zero — known as the Cauchy distribution for its founder, Augustin-Louis
Cauchy — the 2007 days would come around every 2.5 months. That is
unrealistic in the other direction.
In 1962, the mathematician Benoit Mandelbrot
demonstrated that an alpha of 1.7 provided the best fit with a 100-year
series of cotton prices.
More recent market history — the 1987 crash, the
Long Term Capital Management debacle and the 2007-8 crisis — suggest big bad
events occur about once a decade.
That goes better with an alpha of 0.5, the
Pareto-Levy distribution. This is the model used by the Options Clearing
Corporation to assess option trading counterparty risk for margin purposes.
The Clearing Corporation has no incentive to allow
counterparty risk to build up. But for investment banks, more conservative
measures of the chance of big market drops would reduce returns on capital,
because they would have to put aside more capital to protect against the
possibility.
The lure of maximizing trading positions, profits
and bonuses in noncrash years could well distort the experts’ judgment.
Indeed, one way to look at the exotic financial instruments that have
proliferated in recent years is as a sort of statistical arbitrage.
If alpha were calculated correctly, the tails for
portfolios of complex derivatives and the like would be fat and long — more
gains in the good times and bigger losses in the bad — and more capital
would be needed. But the measure that is actually used, the Gaussian alpha,
hides the actual risk.
Regulators should get a better handle on that risk,
but by using less Gauss and more Pareto-Levy. That would reduce the chance
that a pretty predictable market blowup wrecks the entire financial system.
Bob Jensen's threads on Black Swan fat tails are at
http://faculty.trinity.edu/rjensen/Theory01.htm#EMH
"Testimony
Concerning Credit Default Swaps," by Erik Sirri Director, Division of
Trading and Markets U.S. Securities and Exchange Commission, SEC, November 20,
2008 ---
http://www.sec.gov/news/testimony/2008/ts112008ers.htm
I am pleased to have the opportunity today to again
testify regarding the credit default swaps (CDS) market. My testimony today
summarizes the key points from my testimony before this committee five weeks
ago and updates it to reflect the Commission's activities since then.
CDS can serve important purposes. They can be
employed to closely calibrate risk exposure to a credit or a sector. CDS can
be especially useful for the business model of some financial institutions
that results in the institution making heavily directional bets, and others
— such as dealer banks — that take both long and short positions through
their market-making and proprietary trading activities. Through CDS, market
participants can shift credit risk from one party to another, and thus the
CDS market may be an important element to a particular firm's willingness to
participate in an issuer's securities offering.
The current CDS market operates solely on a
bilateral, over-the-counter basis and has grown to many times the size of
the market for the underlying credit instruments. In light of the problems
involving AIG, Lehman, Fannie, Freddie, and others, attention has focused on
the systemic risks posed by CDS. The ability of protection sellers (such as
AIG and Lehman) to meet their CDS obligations has raised questions about the
potentially destabilizing effects of the CDS market on other markets. Also,
the deterioration of credit markets generally has increased the likelihood
of CDS payouts, thus prompting protection buyers to seek additional margin
from protection sellers. These margin calls have strained protection
sellers' balance sheets and may be forcing asset sales that contribute to
downward pressure on the cash securities markets.
In addition to the risks that CDS pose systemically
to financial stability, CDS also present the risk of manipulation. Like all
financial instruments, there is the risk that CDS are used for manipulative
purposes, and there is a risk of fraud in the CDS market.
The SEC has a great interest in the CDS market
because of its impact on the securities markets and the Commission's
responsibility to maintain fair, orderly, and efficient securities markets.
These markets are directly affected by CDS due to the interrelationship
between the CDS market and the securities that compose the capital structure
of the underlying issuers on which the protection is written. In addition,
we have seen CDS spreads move in tandem with falling stock prices, a
correlation that suggests that activities in the OTC CDS market may in fact
be spilling over into the cash securities markets.
OTC market participants generally structure their
acivities in CDS to comply with the CFMA's swap exclusion from the
Securities Act and the Exchange Act. These CDS are "security-based swap
agreements" under the CFMA, which means that the SEC currently has limited
authority to enforce anti-fraud prohibitions under the federal securities
laws, including prohibitions against insider trading. If CDS were
standardized as a result of centralized clearing or exchange trading or
other changes in the market, and no longer subject to individual
negotiation, the "swap exclusion" from the securities laws under the CFMA
would be unavailable.
Progress on Establishing a Central Counterparty for
CDS
As announced on November 14th, a top priority for
The President's Working Group on Financial Markets, in which the SEC
Chairman is a member, is to oversee the implementation of central
counterparty services for CDS. A central counterparty ("CCP") for CDS could
be an important step in reducing the counterparty risks inherent in the CDS
market, and thereby help mitigate potential systemic impacts.
By clearing and settling CDS contracts submitted by
participants in the CCP, the CCP could substitute itself as the purchaser to
the CDS seller and the seller to the CDS buyer. This novation process by a
CCP would mean that the two counterparties to a CDS would no longer be
exposed to each others' credit risk. A single, well-managed, regulated CCP
could vastly simplify the containment of the failure of a major market
participant. In addition, the CCP could net positions in similar
instruments, thereby reducing the risk of collateral flows.
Moreover, a CCP could further reduce risk through
carefully regulated uniform margining and other robust risk controls over
its exposures to its participants, including specific controls on
market-wide concentrations that cannot be implemented effectively when
counterparty risk management is uncoordinated. A CCP also could aid in
preventing the failure of a single market participant from destabilizing
other market participants and, ultimately, the broader financial system.
A CCP also could help ensure that eligible trades
are cleared and settled in a timely manner, thereby reducing the operational
risks associated with significant volumes of unconfirmed and failed trades.
It may also help to reduce the negative effects of misinformation and rumors
that can occur during high volume periods, for example when one market
participant is rumored to "not be taking the name" or not trading with
another market participant because of concerns about its financial condition
and taking on incremental credit risk exposure to the counterparty. Finally,
a CCP could be a source of records regarding CDS transactions, including the
identity of each party that engaged in one or more CDS transactions. Of
course, to the extent that participation in a CCP is voluntary, its value as
a device to prevent and detect manipulation and other fraud and abuse in the
CDS market may be limited.
The Commission staff, together with Federal Reserve
and CFTC staff, has been evaluating proposals to establish CCPs for CDS. SEC
staff has participated in on-site assessments of these CCP proposals,
including review of their risk management systems. The SEC brings to this
exercise its experience over more than 30 years of regulating the clearance
and settlement of securities, including derivatives on securities. The
Commission will use this expertise, and its regulatory and supervisory
authorities over any CCPs for CDS that may be established, to strengthen the
market infrastructure and protect investors.
To facilitate the speedy establishment of one or
more CCPs for CDS and to encourage market participants to voluntarily submit
their CDS trades to the CCP, Commission staff are preparing conditional
exemptions from the requirements of the securities laws for Commission
consideration. SEC staff have been discussing the potential scope and
conditions of these draft exemptions with each prospective CCP and have been
coordinating with relevant U.S. and foreign regulators.
In addition, last Friday, Chairman Cox, on behalf
of the SEC, signed a Memorandum of Understanding (MOU) with the Federal
Reserve Board and the Commodity Futures Trading Commission. This MOU
establishes a framework for consultation and information sharing on issues
related to CCPs for CDS. Cooperation and coordination under the MOU will
enhance each agency's ability to effectively carry out its respective
regulatory responsibilities, minimize the burden on CCPs, and reduce
duplicative efforts.
Other Potential Improvements to OTC Derivatives
Market
As explained above, the SEC has limited authority
over the current OTC CDS market. The SEC, however, is statutorily prohibited
under current law from promulgating any rules regarding CDS trading in the
over-the-counter market. Thus, the tools necessary to oversee this market
effectively and efficiently do not exist. Chairman Cox has urged Congress to
repeal this swap exclusion, which specifically prohibits the SEC from
regulating the OTC swaps market.
Recordkeeping and Reporting to the SEC
The repeal of this swap exclusion would allow the
SEC to promulgate recordkeeping requirements and require reporting of CDS
trades to the SEC. As I discussed in my earlier testimony, a mandatory
system of recordkeeping and reporting of all CDS trades to the SEC, is
essential to guarding against misinformation and fraud. The information that
would result from such a system would not only reduce the potential for
abuse of the market, but would aid the SEC in detection of fraud in the
market quickly and efficiently.
Investigations of over-the-counter CDS transactions
have been far more difficult and time-consuming than those involving cash
equities and options. Because these markets lack a central clearing house
and are not exchange traded, audit trail data is not readily available and
must be reconstructed manually. The SEC has used its anti-fraud authority
over security-based swaps, including the CDS market, to expand its
investigation of possible market manipulation involving certain financial
institutions. The expanded investigation required hedge fund managers and
other persons with positions in CDS and other derivative instruments to
disclose those positions to the Commission and provide certain other
information under oath. This expanded investigation is ongoing and should
help to reveal the extent to which the risks I have identified played a role
in recent events. Depending on its results, this investigation may lead to
more specific policy recommendations.
However, because of the lack of uniform
recordkeeping and reporting to the SEC, the information on security-based
CDS transactions gathered from market participants has been incomplete and
inconsistent. Given the interdependency of financial institutions and
financial products, it is crucial for our enforcement efforts that we have a
mechanism for promptly obtaining CDS trading information — who traded, how
much and when — that is complete and accurate.
Recent private sector efforts may help to alleviate
some of these concerns. For example, Deriv/SERV, an unregulated subsidiary
of DTCC, provides automated matching and confirmation services for
over-the-counter derivatives trades, including CDS. Deriv/SERV's customers
include dealers and buy-side firms from more than 30 countries. According to
Deriv/SERV, more than 80% of credit derivatives traded globally are now
confirmed through Deriv/SERV, up from 15% in 2004. Its customer base
includes 25 global dealers and more than 1,100 buy-side firms in 31
countries. While programs like Deriv/SERV may aid the Commission's efforts,
from an enforcement perspective, such voluntary programs would not be
expected to take the place of mandatory recordkeeping and reporting
requirements to the SEC.
In the future, Deriv/SERV and similar services may
be a source of reliable information about most CDS transactions. However,
participation in Deriv/SERV is elective at present, and the platform does
not support some of the most complex credit derivatives products.
Consequently, not all persons that engage in CDS transactions are members of
Deriv/SERV or similar platforms. Greater information on CDS trades,
maintained in consistent form, would be useful to financial supervisors. In
addition to better recordkeeping by market participants, ready information
on trades and positions of dealers also would aid the SEC in its enforcement
of anti-fraud and anti-manipulation rules. Finally, because Deriv/SERV is
unregulated, the SEC has no authority to obtain the information stored in
this facility for supervision of risk associated with the OTC CDS market and
can only obtain it if given voluntarily or by subpoena.
Market Transparency
Market transparency is another improvement to the
CDS market that the Commission supports. The development of a CCP could
facilitate greater market transparency, including the reporting of prices
for CDS, trading volumes, and aggregate open interest. The availability of
pricing information can improve the fairness, efficiency, and
competitiveness of markets — all of which enhance investor protection and
facilitate capital formation. The degree of transparency, of course, depends
on participation in the CCP, which currently is not mandatory.
Exchange Trading
A CCP also could facilitate the exchange trading of
CDS because the CDS would be in standardized form. Exchange trading of
credit derivatives could add both pre- and post-trade transparency to the
market that would enhance efficient pricing of credit derivatives. Exchange
trading also could reduce liquidity risk by providing a centralized market
that allows participants to efficiently initiate and close out positions at
the best available prices.
Continued in article
Too-Fat Tails Lead to All Sorts of Troubles in Life
The Value at Risk (VaR) Model of Investment Risk ---
http://en.wikipedia.org/wiki/VaR
"In Plato's cave," The Economist, January 24, 2009, pp. 10-14 ---
http://www.economist.com/specialreports/displaystory.cfm?story_id=12957753
...
Almost as damaging is the hash that banks have made
of “value-at-risk” (VAR) calculations, a measure of the potential losses of
a portfolio. This is supposed to show whether banks and other financial
outfits are being safely run. Regulators use VAR calculations to work out
how much capital banks need to put aside for a rainy day. But the
calculations are flawed.
The mistake was to turn a blind eye to what is
known as “tail risk”. Think of the banks’ range of possible daily losses and
gains as a distribution. Most of the time you gain a little or lose a
little. Occasionally you gain or lose a lot. Very rarely you win or lose a
fortune. If you plot these daily movements on a graph, you get the familiar
bell-shaped curve of a normal distribution (see chart 4). Typically, a VAR
calculation cuts the line at, say, 98% or 99%, and takes that as its measure
of extreme losses.
Tail spin However, although the normal distribution
closely matches the real world in the middle of the curve, where most of the
gains or losses lie, it does not work well at the extreme edges, or “tails”.
In markets extreme events are surprisingly common—their tails are “fat”.
Benoît Mandelbrot, the mathematician who invented fractal theory, calculated
that if the Dow Jones Industrial Average followed a normal distribution, it
should have moved by more than 3.4% on 58 days between 1916 and 2003; in
fact it did so 1,001 times. It should have moved by more than 4.5% on six
days; it did so on 366. It should have moved by more than 7% only once in
every 300,000 years; in the 20th century it did so 48 times.
In Mr Mandelbrot’s terms the market should have
been “mildly” unstable. Instead it was “wildly” unstable. Financial markets
are plagued not by “black swans”—seemingly inconceivable events that come up
very occasionally—but by vicious snow-white swans that come along a lot more
often than expected.
This puts VAR in a quandary. On the one hand, you
cannot observe the tails of the VAR curve by studying extreme events,
because extreme events are rare by definition. On the other you cannot
deduce very much about the frequency of rare extreme events from the shape
of the curve in the middle. Mathematically, the two are almost decoupled.
The drawback of failing to measure the tail beyond
99% is that it could leave out some reasonably common but devastating
losses. VAR, in other words, is good at predicting small day-to-day losses
in the heart of the distribution, but hopeless at predicting severe losses
that are much rarer—arguably those that should worry you most.
When David Viniar, chief financial officer of
Goldman Sachs, told the Financial Times in 2007 that the bank had seen
“25-standard-deviation moves several days in a row”, he was saying that the
markets were at the extreme tail of their distribution. The centre of their
models did not begin to predict that the tails would move so violently. He
meant to show how unstable the markets were. But he also showed how wrong
the models were.
Modern finance may well be making the tails fatter,
says Daron Acemoglu, an economist at MIT. When you trade away all sorts of
specific risk, in foreign exchange, interest rates and so forth, you make
your portfolio seem safer. But you are in fact swapping everyday risk for
the exceptional risk that the worst will happen and your insurer will
fail—as AIG did. Even as the predictable centre of the distribution appears
less risky, the unobserved tail risk has grown. Your traders and managers
will look as if they are earning good returns on lower risk when part of the
true risk is hidden. They will want to be paid for their skill when in fact
their risk-weighted returns may have fallen.
Edmund Phelps, who won the Nobel prize for
economics in 2006, is highly critical of today’s financial services.
“Risk-assessment and risk-management models were never well founded,” he
says. “There was a mystique to the idea that market participants knew the
price to put on this or that risk. But it is impossible to imagine that such
a complex system could be understood in such detail and with such amazing
correctness…the requirements for information…have gone beyond our abilities
to gather it.”
Every trading strategy draws upon a model, even if
it is not expressed in mathematical symbols. But Mr Phelps believes that
mathematics can take you only so far. There is a big role for judgment and
intuition, things that managers are supposed to provide. Why have they
failed?
"In Defense Of Value At Risk (VaR) And Other Risk Management Methods,"
by Suna Reyent, Seeking Alpha, January 19, 2009 ---
http://seekingalpha.com/article/115339-defending-var-but-you-still-need-common-sense
In the beginning of the month, New York
Times Magazine published an article by Joe Nocera called “Risk
Mismanagement” that created quite a stir in the blogosphere and beyond.
Despite the watering-down of certain aspects related to risk management
tools, as well as the diversity with which these tools are applied practice,
the article was a success because of the buzz it created as well as the
ensuing debate.
The article portrays a debate over value
at risk methodology between well-known practitioners of VAR and the critics
of the methodology led by Nassim Taleb. It is hard not to get carried away
with Mr. Taleb’s tabloid-like descriptions of VAR as a “fraud” and its
practitioners as “intellectual charlatans.”
I love how the debate is construed. The
premise is that value at risk and other valuation models (such as Black-Scholes)
assume normal distribution of asset returns. Okay, they do that in their
most primitive forms, but let’s just accept the oversimplification as a fact
for a moment because the debate would hardly exist in this simplistic form
if we didn’t go along with the show here.
This is where our hero Mr. Taleb, an
experienced options trader no less, emerges to the public mainstream to
inform all of us ignorant folks that asset returns do not follow a normal
distribution! The horror! The painful realization that this stuff continues
to be taught in business schools! All that wasted class time learning
statistics!
It is fair to say that this assumption
will mislead naïve market participants about the nature of their risk
exposures as “Black Swan” events happen a lot more frequently than suggested
by Gaussian distributions. The problem is, almost anyone in finance already
knows that asset prices are not normally distributed, and many practitioners
build models or apply extensions to existing ones in order to take this into
consideration.
I decided to give a little background on
value at risk in order to get the points across that I feel strongly about.
Since I teach VAR in the classroom as part of a risk management curriculum,
I feel it is best to give some preliminary information.
A Primer On Value At Risk
Depending on the confidence interval
chosen, value at risk, in its simplest form, exists of applying a one-sided
test to figure out the loss that a portfolio may weather in a given time
period. For instance, a 95% daily VAR of ten million dollars indicates that
a portfolio is likely to lose at most that amount of money 95% of the time,
or once a month assuming 20 trading days in a given month. At the same time,
it displays the LEAST amount of money that the portfolio can lose 5% of the
time. I appreciated it when Mr. Nocera mentioned this in his article
prepared for general readership. As VAR is unable to tell us about what kind
of a loss we should expect in that tail of 5%, the limitation of this metric
if taken as gospel becomes apparent even to the untrained eye.
More on the tail risk later. But first, I
would like to talk about three established ways of calculating value at risk
for one asset and analyze the current risk management crisis within this
framework:
Analytical VAR – “Misunderestimating”
Risks
Otherwise known as variance-covariance
method of calculating the value at risk, this is the well-known method of
calculating VAR and the easiest one to apply. It assumes a normal
distribution of returns. All it takes to calculate VAR is a standard
deviation, which represents the “volatility” of the asset as well as a mean,
which is the expected return on the same asset.
This is the VAR that Mr. Taleb seems to
conveniently focus on, because it will indeed underestimate the risk at the
tails of a negatively skewed or a leptokurtic distribution.
Stock markets in general exhibit negative
skewness, which means that the distribution of returns will exhibit a long
tail (a few extreme losses) to the left side. They also exhibit
leptokurtosis, which means that both tails of the distribution are fatter
than implied by normal distribution.
So we could go nuts over how wrong the
normal distribution assumption is, and apparently people do. But we should
also be very concerned over how sensitive this measure is to the standard
deviation as well the mean, both of which are subject to change as markets
change especially in the light of the current crisis.
Historical VAR – Good As Long As Future
Resembles Past
This method does not need any assumptions
about the distribution of returns and is certainly superior to analytical
VAR because it is not parametric. The more data there is, the better the
measurement. Historical data will exhibit characteristics such as skewness
or kurtosis as long as the asset itself exhibits these qualities as well.
Assuming 250 trading days in a given year,
in order to measure the 95% daily VAR you need to rank the returns from
worst to best and pick the greatest return among those that correspond to
the bottom 5% of returns. So the worst 12th return (or you could interpolate
between the 12th and13th worst return, since 250 divided by 20 is 12.5, but
since VAR itself is an approximation, why bother?) will tell you the maximum
percentage loss 95% percent of the time, or the minimum percentage loss 5%
of the time. Multiply the loss by your portfolio value and you get the neat
VAR value in terms of dollars.
Moreover, the majority of investment
houses use historical VAR as the basis for measurement as it is a clear
improvement over the analytical VAR. You do not need return assumptions or
standard deviation values to come up with this value.
Historical VAR calculations replace
parametric assumptions with historical data. This means that if you had
positions in mortgage derivative securities and started the year 2007 with
models that were built around data of the previous two years encompassing
the “peaceful” periods of 2005 and 2006, you would soon be awakened to a
world where your VAR measures no longer reflected the reality of the
marketplace. Note that such limitations of VAR as an all-encompassing risk
measure were visible to any professional who understood risk management
models as well as the limitations of historical data that went into them.
As Mr. Nocera’s article conveys, this is
precisely what Goldman Sachs (GS) did. When it became obvious that the
mortgage markets had changed in fundamental ways and aggressive positions in
these securities started bringing in gigantic losses (as opposed to reaping
the usual gigantic profits on the back of the ever-rising housing market),
the team decided to limit its risk exposure by “getting closer to home.”
I don’t think the article conveys what
“getting closer to home” really means. Let me use day trading as an example
here. In day trading terms, this means that when your positions start
showing huge losses at the end of the day, you accept “defeat” and take your
losses as opposed to trying to ride them in the hope that the market will
come around. So instead of wishing for market to make a comeback to recoup
losses, you close out your open positions, take your losses and go home.
Then you go back to the drawing board to strategize for the next day given
the new reality of the marketplace.
Of course, looking retrospectively, the
decision to limit exposure and take losses as opposed to trying to ride them
in the expectation of a housing market turnaround has been the right
decision to make. However, as we have seen with many other bubbles, managers
do not have the incentive to make the sound trading decisions, nor do they
have the incentive to listen to their risk managers as long as they get a
huge piece of profits made during the ride and the taxpayer ends up holding
the bag when the market finally blows up.
We have seen this movie over and over
again. What surprises me is the heavy blame put on models for not reflecting
“reality,” whereas those in charge knew that the mortgage bubble was
collapsing, they had many opportunities to get rid of their huge exposures
to the derivatives securities, but they chose not to do it most likely
because of expectations of a market turn around. This is trading 101. If you
try to ride your losses, you may make comebacks, but you will eventually
blow up.
Now the next episode features critics who
tell us that the “models” have been faulty and wrong. Hence the conclusion
that value at risk is an erroneous and misleading measure, not to mention a
“fraud.”
Ladies and gentleman, we found the “fraud”
haunting the trading floor on the street, and it is not a human being: Shame
on you, VAR and other risk management tools! Of course, we can blame the car
manufacturers for the accident: the car’s faulty speedometer, or its lack of
an apparatus to show us the bumps on the road ahead. But why is the culture
that is reticent to blame the drunk driver who was clearly intoxicated with
the thrill of making green?
These “models” are as guilty as the
“accounting” that was used with a sleight of hand to conceal what was really
going on behind the curtains during the Enron debacle and others. Of course,
given the mathematical complexities of models, the quantitative brainpower
needed to understand some of them, and the assumptions required in creating
a map of your territory, there is more of an opportunity to either blame the
models or to pretend that you didn’t understand them when things turned
sour.
As I ventured with this essay, hoping to
make my points within the value at risk framework featured in textbooks, I
will move on to the third methodology used in calculating the measure.
Monte Carlo Simulation – Anything Goes,
But More Of An Art Than Science
Monte Carlo Simulation is especially
useful in calculating risk exposures of assets that have either little
historical data or whose historical data is rendered irrelevant due to
changing economic conditions that affect both the price of securities and
the way these securities interact with each other in a portfolio. Also,
historical returns of assets with asymmetric payoffs or returns of
derivative securities that interact with variables such as interest rates,
housing prices, and the like will not reflect the future when factors that
influence the return of the security change as the economic climate shifts.
Continued in article
Bob Jensen's threads on VaR are at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#VaR
Bob Jensen's threads on the banking crisis ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
You can read how CDS contracts are the main reason over
$100 billion is being given in the bailout to keep AIG alive ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's threads on accounting for credit default
swaps can be found under the C-terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
Appendix F
Christopher Cox Waits Until Now to Tell Us His
Horse Was Lame All Along
S.E.C. Concedes Oversight Flaws Fueled Collapse
And This is the Man Who Wants Accounting Standards to Have Fewer Rules
SEC = Suckers Endup Cheated
David Albrecht, Bowling Green University"
In 2007, The Harris Poll found that fully 71% of the
public who understood what the Securities and Exchange Commission (SEC) did
rated the job it was doing positively (i.e., excellent or pretty good). A new
Harris Poll finds that only 29% of all adults now give the SEC positive ratings,
a huge drop of 42 points. Almost three-quarters (71%) give the SEC negative
ratings.
"Positive Rating of SEC Plunges 42 Points," SmartPros, February 16, 2009
---
http://accounting.smartpros.com/x65448.xml
Much of this fall is the fault of the worst SEC Director in History --- Se Below
"SEC Discord Could Stymie Schapiro's Efforts," by Kara Scannell,
The Wall Street Journal, February 6, 2010 ---
http://online.wsj.com/article/SB20001424052748703894304575047623539208044.html#mod=todays_us_section_b
No one said it would be easy. But one big part of
Securities and Exchange Commission Chairman Mary Schapiro's job—winning the
support she needs from the agency's commissioners—is turning into a
headache.
Since taking over the embattled agency in January
2009, the 54-year-old Ms. Schapiro has brought in a new enforcement chief,
created a division to scout out market risks and laid out an ambitious
rule-making agenda to restore market confidence. The number of formal
investigations launched and temporary restraining orders sought more than
doubled last year from 2008. It takes about six months for the average SEC
rule to make it through the pipeline, down from 10 months.
Suddenly, though, Ms. Schapiro is hitting some
speed bumps inside the SEC. Usually, the five-person panel that must approve
new rules unanimously backs the agency's chairman. Under Ms. Schapiro, who
was sworn in a week after President Barack Obama, SEC commissioners have
splintered four times, with two Republicans suggesting that she is bending
to politics.
Last week, Commissioner Kathleen Casey, a
Republican appointed by President George W. Bush, accused the agency of
placing "the imprimatur of the commission on the agenda of the social and
environmental policy lobby" by issuing guidance encouraging companies to
disclose the effects of climate change on their businesses.
While the measure passed by a 3-2 vote, Ms.
Schapiro has been lambasted by Republican lawmakers. Rep. Spencer Bachus,
the House Financial Services Committee's top Republican, accused her of
pushing a "partisan political agenda."
The discord from within could complicate Ms.
Schapiro's efforts to push through more changes in the second year of her
cleanup. Friday, she said the agency will decide by the end of March on
proposed rules to put brakes on short selling, where investors borrow shares
and then sell them in hopes of making money from the stock's decline.
The ideas being reviewed include a circuit breaker
that would be triggered when a stock falls by a certain percentage. People
familiar with the matter say the agency is looking for steps that would be
the least intrusive to the market. Troy Paredes, a Republican who joined the
commission in 2008, voted for an earlier version of the short-selling
proposal but warned that the SEC needed "room" to "exercise [its] expert
judgment." Mr. Paredes didn't respond to requests for comment. Ms. Casey
also expressed skepticism.
In addition, the SEC is expected to take up soon
the long-controversial issue of whether to let shareholders nominate
director candidates using the ballots that companies mail to shareholders.
Shareholders now must fund their own proxy fights, which rarely happens.
Unions and some institutional investors support
giving shareholders more muscle, while some executives have warned that
frequent director battles could disrupt business and conflict with state
laws. The SEC voted 3-2 last year to issue the proposal for public comment,
with the two Republican commissioners dissenting.
Ms. Schapiro says more than 90% of enforcement
actions and more than 80% of open-meeting votes since she took over have
been approved unanimously. "We haven't shied away from difficult issues
because I think these are times that call for people to make hard choices,"
she said in an interview.
She denies accusations that she is bending over
backward to satisfy Democrats. "While we are interested in Congress's views,
it doesn't drive our agenda," Ms. Schapiro said.
The recent guidance on climate change, for example,
came after the SEC got petitions from investors who "had close to $1.4
trillion under management, and we didn't go anywhere near as far as they
asked us," she said.
Some outsiders say the split votes aren't a sign of
impending paralysis that would derail Ms. Schapiro's agenda as much as her
willingness to impose new regulations. Her predecessors also ran into
opposition from commissioners. But too much resistance could make it hard
for Ms. Schapiro to follow through on her strategy for revamping the SEC
following the financial crisis and Bernard Madoff fraud.
That includes persuading the sharply divided
Congress to give the SEC additional funding and wider authority.
"I would not like to see the commission devolve
into a steady stream of 3-2 votes," said Harvey Pitt, SEC chairman from 2001
to 2003. Ms. Schapiro has "really gotten off to a fabulous start" and is
"very tuned in to what needs to get done at the SEC," Mr. Pitt added.
Richard Roberts, an SEC commissioner from 1990 to
1995, said Ms. Schapiro might have miscalculated in her handling of the
climate-change vote. "When you wade into a polarized issue that's not
necessarily at the center of investor protection, there can be consequences
associated with that that are not always positive," he said.
James Cox, a securities-law professor at Duke
University, said critics of Ms. Schapiro are ignoring recent signs of her
political independence. For instance, she has said the Obama
administration's proposal to designate the Federal Reserve as the nation's
systemic-risk regulator needs to be tempered by a robust council of
regulators, compared with the administration's weaker council. "I give her
high marks of being independent of the administration's position," Mr. Cox
said.
Ms. Schapiro's split votes remind some securities
experts of William Donaldson, a Republican and longtime Wall Street
executive brought in as SEC chairman in 2003 to restore investor confidence
after the Enron and WorldCom scandals. He faced opposition from his own
party while pushing through a rule requiring hedge-fund advisers to register
with the agency. The rule was later tossed out by a federal appeals court.
Harvey Goldschmid, who often voted with Mr.
Donaldson as a Democratic commissioner, says commissioners who don't agree
with the chairman "should also be careful that they not jeopardize the
commission's reputation for independence and integrity by dissenting
unnecessarily."
The SEC in
2008: A Very Good Year? A terrific one, the commission says, tallying a
fiscal-year record in insider-trading cases, and the second-highest number of
enforcement cases overall. But what would John McCain say?" by Stephen Taub and
Roy Harris, CFO.com, October 22, 2008 ---
http://www.cfo.com/article.cfm/12465408/c_12469997
Sadly, Chris Cox will leave office with both U.S. capital markets and the
U.S. financial accounting/auditing systems in disarray. It's not so much that
he's a bad person. It's just that he was too trusting of the oligopolies when
allowing them free hand in policing themselves.
That did not work
all well as we're now writing into the histories of disasters.
As a departing (hopefully soon) Director of the SEC, the legacy of Chris Cox
will not be commendable in spite of a
record number of successful recent SEC court cases against financial fraud.
John McCain announced during his campaign that, if elected President of the
U.S., one of his first acts would be to fire Chris Cox. In spite of some great
leadership against specific targets of fraud, Chris Cox failed to see the
dangers in allowing oligopolies to control two industries. In the case of Wall
Street, Commissioner Cox decided not to exercise the SEC's power and
responsibility of oversight of investment banks. And Wall Street investment
bankers took advantage of lax SEC oversight to a point of self-destruction.
In the case of the accounting industry, Chris Cox decided to allow the
oligopoly of the largest international accounting firms to dictate, for all U.S.
accounting firms and U.S. industry, abandonment of our rich heritage of U.S.
accounting principles in favor of an incomplete set (compared
to U.S. GAAP standards) of international accounting standards (IFRS).
Although this might be a commendable goal in a couple of decades after the
International Accounting Standards Board has the resources and infrastructure
and standards in place to take on the giant U.S. economy, the large-firm
oligopoly seemingly moved too quickly to make this transition. Possibly the
large accounting firms rushed us into IFRS this year because they had Chris Cox
under their thumbs. Tom Selling on October 8, 2008 now reveals some of the
politics being played by the big firms in this regard and predicts that the new
SEC Director will not be so favorably inclined toward a rush to abandon U.S.
accounting standards.
"Speaking Out Against IFRS Adoption? Welcome to the "Loud Minority," by
Tom Selling, The Accounting Onion, October 8, 2008 ---
http://accountingonion.typepad.com/
As I mentioned in a previous post, PCAOB member
Charles Niemeier delivered a tour de force critique of U.S. efforts to adopt
IFRS, at a recent New York State Society of CPAs (NYSSCPA) educational
event. To its credit, the NYSSCPA's e-zine covered Niemeier's remarks a few
days later. On the other hand, the PCAOB sure took its sweet time (weeks) to
post the text of his speech on its website.
Perhaps one reason the PCAOB appears to have
dragged its feet is that Niemeier was equally critical, if not more so, of
two other "global initiatives" in the financial reporting arena: "reliance
on non-U.S. regimes for auditor oversight, and converging U.S. auditing
standards to those developed by the International Federation of
Accountants." These thoughts were completely overlooked in the NYSSCPA's
coverage, and given short shrift by almost everyone else it seems.
Evidently, few care whether the PCAOB willingly gores its own ox; but
opposing IFRS adoption is like standing between hungry pigs and their
troughs.
IASC to Niemeier: You're Loud and We're Right ('Cuz
We Said So)
With respect to IFRS adoption, NYSSCPAs' coverage
of Niemeier was fair, and gets kudos from me for reporting this key
reaction:
"'The impression I got and the reaction from the
audience was: it's about time somebody said something about this,' said
conference Chair George I. Victor, who is also immediate past chair of the
NYSSCPA's Accounting and Auditing Oversight Committee. 'It's David and
Goliath and David stood up to Goliath here. Just about everybody in the room
agreed with most if not all, of what he said.'" [emphasis supplied]
You can bet that a Goliath would want the last
word, and preferably with no David to contend with. So, the NYSSCPA
accommodated Goliath a week later in the person of Philip Laskawy,
vice-chairman of the International Accounting Standards Committee Foundation
(IASCF), new chairman of Fannie Mae, and former head of Ernst & Young (1994
– 2001). Not all of the questions posed to Laskawy were softballs; however,
there can be no denying that numerous disingenuous answers were allowed to
prevail with nary a token of protest.
If a straight-shooting David were present, maybe
the encounter would have gone something like this:
NYSSCPA: The 22 trustees of the IASCF are
responsible for the governance, oversight and funding of IASB and the
rigorous application of International Financial Reporting Standards (IFRS).
Philip A. Laskawy retired as the chairman and CEO of Ernst & Young in 2001,
a position he had held since 1994. In addition to his service as a trustee,
he currently serves on the boards of several U.S. and foreign-based
companies and non-profits.
David: Another pertinent fact, which may affect
your assessment of Mr. Laskawy's credibility, is that he presided over E&Y
during a time when, as evidenced by unprecedented sanctions, E&Y committed
some of the most blatant independence violations by an international firm
since the enactment of the federal securities laws:
[In 2004, an] SEC administrative law judge fined
E&Y $2.164 million (including $1.7 million disgorgement) and bars the firm
from accepting any new clients in the U.S. for six months, after finding
that the firm acted improperly by auditing PeopleSoft Inc. -- a company with
which it had a profitable business relationship. … According to The New York
Times, the administrative law judge said the firm "committed repeated
violations of its auditor independence standards by conduct that was
reckless, highly unreasonable and negligent." (Floyd Norris, "Big Auditing
Firm Gets 6-Month Ban on New Business," April 17, 2004) … The SEC alleged
that E&Y violated the auditor independence requirements in connection with
E&Y's audits of PeopleSoft Inc.'s financial statements from 1994 through
2000. … [Available at http://www.crocodyl.org/wiki/ernst_young; emphasis
supplied]
NYSSCPA: More than one study has reported that
companies show higher earnings under IFRS versus GAAP. Can anything be done
to smooth the contradictory data investors will be relying upon as IFRS is
phased in for more companies in the years ahead?
Goliath: I have no basis of knowing whether any of
those studies are right or wrong. Anyway, that gets adjusted in the market
place, but more importantly you'll be able to compare two companies from
different countries who are in the same business to see how they're doing.
David: It sounds like you're not even interested in
knowing the answer to these questions. Evidently, the numerous studies cited
by Niemeier, and by Professor Teri Yohn in her testimony to Congress amount
to an inconvenient truth you would prefer to ignore. Yes, I know you're
Goliath, so I'll humor you and pretend that the totality of research on this
topic is actually inconclusive. How can you say on the one hand that the
market adjusts for differences in accounting, rendering differences between
IFRS and GAAP inconsequential; and then say on the other hand that market
participants will benefit from enhanced comparability! You seem to be saying
that accounting doesn't matter now, but it will when everyone adopts IFRS.
NYSSCPA: Are you concerned that comparability
across companies will decrease if the U.S. conducts a phased-in transition
to IFRS?
Goliath: Nope. U.S. companies aren't comparable
anyway, because GAAP changes so darn much. And, I don't think there have
been any examples where it's been that impactful on stock prices. Even
today, investors are not using GAAP earnings necessarily as a way of
determining their recommendations on companies.
David: Once again, the evidence contradicts your
wishful thinking. Those same folks I just mentioned cite evidence that
investors do prefer GAAP, and GAAP is more closely associated with stock
prices – i.e., investors putting their money where their mouth is.
Besides, lack of comparability due to changes in
GAAP is way overstated; all significant changes to GAAP require retroactive
restatements to assure comparability over earlier periods. Also, are you
actually saying that once the U.S. takes the plunge on IFRS, there will be
the equivalent of world peace, and for the first time since the days of the
Old Testament, accounting standards won't change? Unless that's what you are
saying, then IFRS won't result in comparability either; you have just thrown
comparability, your biggest selling point for global accounting convergence,
under the bus.
NYSSCPA: If the transition goes as expected, the
U.S. will be basically giving up control of financial standards to an
international body by 2016. We're surprised more people haven't been talking
about it.
Goliath: You really would have to ask them.
David: "You really would have to ask them" is
exactly what the IASCF and SEC should be doing more often and more better –
if the goal of U.S. adoption of IFRS is to make a change that investors
actually want and can benefit from. Instead of blatantly shilling for IFRS,
Goliaths should be spending their time looking for real answers. For
example, figure out how to encourage broad-based investor feedback so that
rigorous studies by impartial investigators can provide reliable answers to
high-stakes questions.
NYSSCPA: We're also surprised that you haven't
gotten more comment letters on the constitution review from stakeholders who
would want to weigh in on the oversight of IASB. What's your opinion on
that? Do you think all the stakeholders are really paying attention at this
point, or maybe it's too far off?
Goliath: With most things in life there's a very
loud minority, and Charles Niemeier truly is part of that minority—very
small—who make a lot of noise, but the vast silent majority just goes about
and does its thing, and I think that's what's happening here. And by the
way, I don't think the presidential election is going to affect the
transition to IFRS.
David: I don't know which insult makes me want to
shoot you with my slingshot more: your arrogant disrespect of a man of
obvious intelligence and integrity; or channeling Richard Nixon and Spiro
Agnew with their infamous Vietnam-era "silent majority" ("vast," no less)
schtick. Either way, there can be no denying Niemeier is in the company of
some other very smart people: among them, Ed Trott, former FASB member is
now speaking out about the questionable political agendas motivating the
SEC's proposed roadmap and the EU's adoption of IFRS; Floyd Norris of the
New York Times doing pretty much the same; and Shyam Sunder of Yale, who
believes that U.S. adoption of IFRS would lead to a mandated monopoly,
thereby creating more chaos than order to accounting standards. And, don't
forget the reaction of Niemeier's audience at the NYSSCPA program: it sounds
like he is the one preaching to the majority choir.
As to "loud," that better describes the Big Four
et. al., and the AICPA with their unabashed promotion of their own
self-interest. Now that current events are forcing the SEC to refocus on
investor protection, the long-awaited document proposing a "roadmap" to IFRS
seems to have disappeared (along with my 401(k) account). That seems to have
had no effect on your rhetoric – or that of your former firm. I received an
invitation from E&Y to watch a webcast on IFRS 2 (share-based payment) with
the following come on:
"International Financial Reporting Standards (IFRS)
is becoming the dominant language of financial reporting worldwide. With the
pending release of the SEC's proposed IFRS Roadmap, IFRS adoption in the US
is almost official. The question now remains a matter of when will adoption
be required and how will companies make the transition. For many, the key
will be early preparation and these businesses are developing their
transition plans now." [bold and italics in original; underline is mine]
Given recent events, that sounds awfully loud to
me! Other work prevented me from watching the webcast, but I'm betting that
there was more of the same hyperbole: probably some useful tips designed to
lead to fees for assisting management should they desire to re-engineer
their own compensation schemes to get the most out of IFRS in their
financial statements. But wait. I forgot that, according to you, the "market
adjusts" for these things. I'm also betting that a lot of investors' money
will be headed out the window when management figures out how to manage its
compensation under IFRS.
As to the outcome of the elections, don't be
surprised if "loud minority" leader Niemeier becomes the next SEC chair!
Even though he is a Republican, and Barack Obama is the likely victor,
Niemeier has the integrity, experience and profile that the SEC desperately
needs at this critical juncture. With three Democrats and a Republican chair
who owes nothing to his party, IFRS adoption in the U.S. will be history.
The bottom line, Goliath, is that the footnotes to
Niemeier's speech by themselves were more compelling and interesting than
what essentially boils down to your blind eye, blind faith or vested
interest responses for the sole objective of selling IFRS. My father taught
me to watch out for people, like you and the SEC's John White, who weave
"truly" into pompous rhetoric like "loud minority" and "vast silent
majority." The reliability of such utterances are usually anything but.
And by the way, I'm sure you're going to do a truly
great job for me at Fannie Mae.
At least six accounting professors have been trying to actively derail the current
SEC Chairman's abusing of his power to rush the replacement of rule-laced U.S.
accounting standards with mushy "principles-based" international standards that
allow business firms much greater flexibility (read that "subjective judgment")
in accounting for earnings and risk. But our efforts to derail or at least
postpone the Cox-Herz IFRS Express Train are utterly futile ---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
As Chairman of the SEC, Christopher Cox should've instead been paying more
attention to preventing fraud and preventing the Men in Black (bankers) from
bullying their auditors into understating their bad debt reserves for faltering
mortgaged-backed securities (e.g., at Bear Stearns) and sinking credit default
swaps (e.g., at AIG). Mixing the metaphor here, we might say that Nero was
fiddling while Rome was burning.
"S.E.C. Concedes Oversight Flaws Fueled Collapse," by Stephen Labaton, The
New York Times, September 26, 2008 ---
http://www.nytimes.com/2008/09/27/business/27sec.html?_r=1&hp&oref=slogin
The chairman of the Securities and Exchange
Commission, a longtime proponent of deregulation, acknowledged on Friday
that failures in a voluntary supervision program for Wall Street’s largest
investment banks had contributed to the global financial crisis, and he
abruptly shut the program down.
The S.E.C.’s oversight responsibilities will
largely shift to the Federal Reserve, though the commission will continue to
oversee the brokerage units of investment banks.
Also Friday, the S.E.C.’s inspector general
released a report strongly criticizing the agency’s performance in
monitoring Bear Stearns before it collapsed in March. Christopher Cox, the
commission chairman, said he agreed that the oversight program was
“fundamentally flawed from the beginning.”
“The last six months have made it abundantly clear
that voluntary regulation does not work,” he said in a statement. The
program “was fundamentally flawed from the beginning, because investment
banks could opt in or out of supervision voluntarily. The fact that
investment bank holding companies could withdraw from this voluntary
supervision at their discretion diminished the perceived mandate” of the
program, and “weakened its effectiveness,” he added.
Mr. Cox and other regulators, including Ben S.
Bernanke, the Federal Reserve chairman, and Henry M. Paulson Jr., the
Treasury secretary, have acknowledged general regulatory failures over the
last year. Mr. Cox’s statement on Friday, however, went beyond that by
blaming a specific program for the financial crisis — and then ending it.
On one level, the commission’s decision to end the
regulatory program was somewhat academic, because the five biggest
independent Wall Street firms have all disappeared.
The Fed and Treasury Department forced Bear Stearns
into a merger with JPMorgan Chase in March. And in the last month, Lehman
Brothers went into bankruptcy, Merrill Lynch was acquired by Bank of
America, and Morgan Stanley and Goldman Sachs changed their corporate
structures to become bank holding companies, which the Federal Reserve
regulates.
But the retreat on investment bank supervision is a
heavy blow to a once-proud agency whose influence over Wall Street has
steadily eroded as the financial crisis has exploded over the last year.
Because it is a relatively small agency, the S.E.C.
tries to extend its reach over the vast financial services industry by
relying heavily on self-regulation by stock exchanges, mutual funds,
brokerage firms and publicly traded corporations.
The program Mr. Cox abolished was unanimously
approved in 2004 by the commission under his predecessor, William H.
Donaldson. Known by the clumsy title of “consolidated supervised entities,”
the program allowed the S.E.C. to monitor the parent companies of major Wall
Street firms, even though technically the agency had authority over only the
firms’ brokerage firm components.
The commission created the program after heavy
lobbying for the plan from all five big investment banks. At the time, Mr.
Paulson was the head of Goldman Sachs. He left two years later to become the
Treasury secretary and has been the architect of the administration’s
bailout plan.
The investment banks favored the S.E.C. as their
umbrella regulator because that let them avoid regulation of their
fast-growing European operations by the European Union.
Facing the worst financial crisis since the Great
Depression, Mr. Cox has begun in recent weeks to call for greater government
involvement in the markets. He has imposed restraints on short-sellers,
market speculators who borrow stock and then sell it in the hope that it
will decline. On Tuesday, he asked Congress for the first time to regulate
the market for credit-default swaps, financial instruments that insure the
holder against losses from declines in bonds and other types of securities.
The commission will continue to be the primary
regulator of the companies’ broker-dealer units, and it will work with the
Fed to supervise holding companies even though the Fed is expected to take
the lead role.
The Fed had already begun regulating Wall Street
firms that borrowed money under a new Fed lending program, and the S.E.C.
had entered into an agreement under which its examiners worked jointly with
Fed examiners, an arrangement that is expected to continue.
The S.E.C. will still have primary responsibility
for regulating securities brokers and dealers.
The announcement was the latest illustration of how
the market turmoil was rapidly changing the regulatory landscape. In the
coming months, Congress will consider overhauls to the regulatory structure,
but the markets and the regulators are already transforming it in response
to events.
Still, the inspector general’s report made a series
of recommendations for the commission and the Federal Reserve that could
ultimately reshape how the nation’s largest financial institutions are
regulated. The report recommended, for instance, that the commission and the
Fed consider tighter limits on borrowing by the companies to reduce their
heavy debt loads and risky investing practices.
The report found that the S.E.C. division that
oversees trading and markets had failed to update the rules of the program
and was “not fulfilling its obligations.” It said that nearly one-third of
the firms under supervision had failed to file the required documents. And
it found that the division had not adequately reviewed many of the filings
made by other firms.
The division’s “failure to carry out the purpose
and goals of the broker-dealer risk assessment program hinders the
commission’s ability to foresee or respond to weaknesses in the financial
markets,” the report said.
The S.E.C. approved the consolidated supervised
entities program in 2004 after several important developments in Congress
and in Europe.
In 1999, the lawmakers adopted the
Gramm-Leach-Bliley Act, which broke down the Depression-era restrictions
between investment banks and commercial banks. As part of a political
compromise, the law gave the commission the authority to regulate the
securities and brokerage operations of the investment banks, but not their
holding companies.
In 2002, the European Union threatened to impose
its own rules on the foreign subsidiaries of the American investment banks.
But there was a loophole: if the American companies were subject to the same
kind of oversight as their European counterparts, then they would not be
subject to the European rules. The loophole would require the commission to
figure out a way to supervise the holding companies of the investment banks.
In 2004, at the urging of the investment banks, the
commission adopted a voluntary program. In
exchange for the relaxation of capital requirements by the commission, the
banks agreed to submit to supervision of their holding companies by the
agency.
Jensen Comment
In other words the Men in Black did indeed submit themselves to supervision, but
they probably knew full well that their man in charge of the SEC was going to be
focusing more on matters other than the shenanigans of the Men in Black
(bankers). Belatedly Cox now admits he should have paid more attention to what
he was supposed to be supervising.
Cox is going to be fired by either John McCain or Barack Obama. But in the
few remaining days before he leaves office he's trying to force the replacement
of rule-laced U.S. accounting standards with mushy "principles-based"
international standards that allow business firms much greater flexibility (read
that "subjective judgment") in accounting for earnings and risk. Efforts to
derail or at least postpone the Cox-Herz IFRS Express Train are utterly futile
---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
I’m about to
give up on the FASB and the SEC. This is where you can find me, where the
air is clear and free of train smoke ---
http://hk.youtube.com/watch?v=C-F3vSrJIUQ
I
have three questions that I really want Christopher Cox to consider before
being fired:
1. Why the rush to commit
in 2008 (now) the United States to IFRS on an express train schedule? From a
strategy standpoint here in the U.S. it would seem better to wait and hold a
carrot in front of the IASB so that the IASB gets its infrastructure and
funding in place to handle the job of setting standards for the U.S. and all
the rest of the planet.
2. Why should our local Presby Construction Company that has audits to
maintain a line of credit at a local bank have to rush to change over to
IFRS global standards on such an express schedule by 2011? There just does
not seem to be enough time for this company to change over all its
accounting software (e.g., eliminate the LIFO inventory system), rewrite
leasing contracts, train employees, etc.
3. Why should so many accounting educators in the U.S., who cannot possibly
be up to speed to teach IFRS and FASB standards jointly by 2011, be forced
to do so without more time to prepare for this complete overhaul of the
courses, the curriculum, and the CPA Examination. NASBA has not yet
committed itself to an all-IFRS exam by 2011. Our accounting educators will
have the burden of teaching both FASB and IASB standards simultaneously when
preparing students for the CPA examination. I’m glad I’ve retired from
teaching!
Sadly, resistance is futile ---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
Our Main Regulating Agency: The Sad Sack SEC
One of the biggest regulation failures in history is the way the SEC failed to
seriously investigate Bernie Madoff's fund even after being warned by Wall
Street experts across six years before Bernie himself disclosed that he was
running a $65 billion Ponzi fund.
CBS Sixty Minutes on June 14, 2009 ran a rerun that is
devastatingly critical of the SEC. If you’ve not seen it, it may still be
available for free (for a short time only) at
http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
The title of the video is “The Man Who Would Be King.”
Between 2002 and 2008 Harry Markopolos repeatedly told
(with indisputable proof) the Securities and Exchange Commission that Bernie
Madoff's investment fund was a fraud. Markopolos was ignored and, as a result,
investors lost more and more billions of dollars. Steve Kroft reports.
Markoplos makes the SEC look truly incompetent or
outright conspiratorial in fraud.
I'm really surprised that the SEC survived after Chris
Cox messed it up so many things so badly.
As Far as Regulations Go
An annual report issued by
the Competitive Enterprise Institute (CEI) shows that the U.S. government
imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the
$1.2 trillion generated by individual income taxes, and amounts to $3,849 for
every American citizen. According the 2009 edition of Ten Thousand Commandments:
An Annual Snapshot of the Federal Regulatory State, the government issued 3,830
new rules last year, and The Federal Register, where such rules are listed,
ballooned to a record 79,435 pages. “The costs of federal regulations too often
exceed the benefits, yet these regulations receive little official scrutiny from
Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report.
“The U.S. economy lost value in 2008 for the first time since 1990,” Crews said.
“Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on
Americans beyond the $3 trillion officially budgeted” through the regulations.
Adam Brickley,
"Government Implemented Thousands of New Regulations Costing $1.17 Trillion in
2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487
Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the
regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur
Levitt to Chris Cox do absolutely nothing to change my belief ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
This is the Washington DC Idea of Separation of the Regulated from the
Regulator
"Our primary focus has been in facilitating capital raising and strategic
transactions," John White, director of the SEC's division of corporation
finance, said at a Practising Law Institute conference in New York. "We do not
want to be in the way of what companies need to do," he added. He said his unit
was looking at how it could be more responsive to issues companies are having
with SEC restrictions that could stand in the way of or slow down deals. White
said the SEC had reprioritized in this way over the summer as Lehman Brothers
Holdings Inc looked for capital and suitors to rescue the firm. "We had a Lehman
summer," White said. "We spent basically the whole summer jumping through hoops
trying to help them." Lehman ultimately filed for bankruptcy protection on Sept.
15 in the largest U.S. bankruptcy filing in history.
SmartPros, November 13, 2008 ---
http://accounting.smartpros.com/x63794.xml
Why Madoff's Hedge Fund Could Be Audited by Non-registered Auditors?
We all know that Bernie Madoff's brokerage firm was
audited by an obscure 3-person accounting firm that is not registered with the
Public Company Accounting Oversight Board. This was permitted because the SEC
exempted privately owned brokerage firms from the SOX requirement that firms are
audited by registered accountants. Floyd Norris reports, in today's NY Times,
that the SEC has now quietly rescinded that exemption. As a result, firms that
audit broker-dealers for fiscal years that end December 2008 or later will have
to be registered. However, under another SOX provision, PCAOB is allowed to
inspect only audits of publicly held companies. NYTimes,
Oversight for Auditor of Madoff.
"Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law
Professor Blog, January 9, 2008 ---
http://lawprofessors.typepad.com/securities/
Appendix G
Why the Trillion-Dollar Bankster Bailout Won't Work
Bailout Game Humor (actually an entertaining chronology of
events to date more than a game) ---
http://www.thebailoutgame.us/
The video is a anti-Bernanke musical performance by the Dean of Columbia
Business School ---
http://www.youtube.com/watch?v=3u2qRXb4xCU
Ben Bernanke (Chairman of the Federal Reserve and a great friend
of big banks) ---
http://en.wikipedia.org/wiki/Ben_Bernanke
R. Glenn Hubbard (Dean of the Columbia Business School) ---
http://en.wikipedia.org/wiki/Glenn_Hubbard_(economics)
Failed Banks List as of June 22, 2009 (including 2008 failures)
---
http://www.cnbc.com/id/31049457
Sagging sales rattle
Wal-Mart executives
From the CFO Morning Ledger newsletter on February 19, 2013
Sagging sales rattle Wal-Mart executives. After a disappointing
January, Wal-Mart
had the worst sales start to a month in seven years as the end of the
payroll-tax holiday hit demand. “In case you haven’t seen a sales report
these days, February MTD sales are a total disaster,” Jerry Murray,
Wal-Mart’s vice president of finance and logistics, said in a Feb. 12 email
to other executives, obtained
by
Bloomberg. “The worst start to a month I have
seen in my ~7 years with the company.” The grim numbers caught executives
off-guard. They’d been expecting a strong start to February because of the
Super Bowl, milder weather and paycheck cycles, Bloomberg says.
Labor Force Participation Rate ---
http://en.wikipedia.org/wiki/Labor_force_participation_rate
Declines in labor participation rates are more important than increases in
unemployment rates
"Civilian Labor Force Participation Rate (CIVPART)," Economic Research from the
Federal Reserve Bank in St. Louis, Februay 1, 2013 ---
http://research.stlouisfed.org/fred2/series/CIVPART/
"There Will Be No Economic Recovery. Prepare Yourself Accordingly," by
Stefan Molyneux ---
http://www.youtube.com/watch?v=bYkl3XlEneA
Thank you Jim Mahar for the heads up.
"J.P. Morgan's Mortgage Troubles Ran Deep: Deals With Subprime
Lenders at Heart of $5.1 Billion Settlement," by Al Yoon, The Wall Street
Journal, October 27, 2013 ---
http://online.wsj.com/news/articles/SB10001424052702304470504579161532779973534?mod=djemCFO_h
A 1,625-square-foot bungalow at 51 Perthshire Lane
in Palm Coast, Fla., is among the thousands of homes at the heart of J.P.
Morgan Chase JPM +0.55% & Co.'s $5.1 billion settlement with a federal
housing regulator on Friday.
In 2006, J.P. Morgan bought one of two mortgage
loans on the home made by subprime lender New Century Financial Corp. J.P.
Morgan then bundled the loan with 4,208 others from New Century into a
mortgage-backed security it sold to investors including housing-finance
giant Freddie Mac. FMCC +11.89%
By the end of 2007, the borrower had stopped paying
back the loan, setting off yearslong delinquency and foreclosure proceedings
that halted income to the investors, according to BlackBox Logic LLC, a
mortgage-data company. Current Account
Settlement Puts U.S. in Tight Spot
The Palm Coast loan wasn't the only troubled one in
the New Century deal: Within a year, 15% of the borrowers were
delinquent—more than 60 days late on a payment, in some stage of foreclosure
or in bankruptcy—according to BlackBox. By 2010, that number exceeded 50%.
"That's much worse than anyone's expectations when
the deal was put together," said Cory Lambert, an analyst at BlackBox and
former mortgage-bond trader. "It's all pretty bad."
J.P. Morgan sidestepped many of the
subprime-mortgage problems that bedeviled rivals during the financial
crisis, and avoided much of the postcrisis scrutiny that dragged down others
on Wall Street. But now its own behavior during the housing boom is coming
under close examination as investigators work through a backlog of cases.
The bank dealt with some of the biggest subprime
lenders of the time, including Countrywide Financial Corp., Fremont
Investment & Loan and WMC Mortgage Corp., a former unit of General Electric,
according to the Federal Housing Finance Agency complaint.
J.P. Morgan's relationship with New Century, a
subprime lender that went bankrupt in 2007 and later faced a Securities and
Exchange Commission investigation and shareholder suits, shows that the New
York bank was part of the frenzied push to package mortgages for investors
at the end of the housing boom.
The New Century deal, J.P. Morgan Mortgage
Acquisition Trust 2006-NC1, was one of 103 cited in the lawsuit against J.P.
Morgan brought by the FHFA, which oversees Freddie Mac and home-loan giant
Fannie Mae. FNMA +13.40%
The $5.1 billion settlement is part of a larger
tentative deal with the Justice Department and other agencies that would
have J.P. Morgan pay a total of $13 billion. That deal is expected to be
completed this week.
"While these settlements seem huge, given the
nature of the offenses, they are trivially small," said William Frey, chief
executive of Greenwich Financial Services LLC, a broker-dealer that has
participated in investor lawsuits against banks that packaged mortgages.
J.P. Morgan declined to comment on the settlement or any loans in the bonds
it bought.
The FHFA has gotten aggressive in recouping losses
from mortgages and securities sold to Fannie and Freddie. In 2011 it sued 18
lenders, and J.P. Morgan was only the fourth to settle.
To be sure, the New Century deal was among J.P.
Morgan's worst performers, and other mortgage-backed securities it issued at
the time have held up better. An improving economy and housing market have
lifted many mortgage bonds sold in 2006 and 2007.
But that is of little consolation to Freddie Mac,
which bought more than a third of the $910 million New Century bond deal in
2006 and still is sitting on losses.
The group of loans backing Freddie's chunk of the
deal had more high-risk loans than the rest of the pool. Nearly 44% of
Freddie's piece had loan-to-value ratios between 80% and 100%, compared with
31% for the rest, according to the deal prospectus.
What's more, nearly half the loans backing the New
Century deal were from California and Florida, two states hit hard by the
housing bust. Of the 4,209 loans in the bond, more than half have some
experienced distress, according to BlackBox data.
Three debt-rating firms gave the top slice of the
deal AAA ratings. But as the housing market soured, a series of downgrades
starting in 2007 took them all into "junk" territory by July 2011. As of
last month, nearly a quarter of the principal of the underlying loans in the
deal had been wiped out, with a third of the remaining balance delinquent or
in some stage of foreclosure, according to BlackBox.
Continued in article
From the CFO Journal's Morning Ledger on October 28, 2013
J.P. Morgan settlement puts government in tight spot
Will the U.S. government have to refund
J.P. Morgan part
of the bank’s expected $13 billion payment over soured mortgage securities?
The question is the biggest stumbling block to completing the record
settlement between the bank and the Justice Department,
writes the WSJ’s Francesco Guerrera.
The crux of the issue is whether the government can go
after J.P. Morgan for (alleged) sins committed by others. And investors,
bankers and lawyers are watching the process closely, worried that it could
set a bad precedent for the relationship between buyers, regulators and
creditors in future deals for troubled banks.
"JPMorgan's $13 Billion Settlement: Jamie Dimon Is a Colossus No More,"
by Nick Summers, Bloomberg Businessweek, October 24, 2013 ---
http://www.businessweek.com/articles/2013-10-24/jpmorgans-13-billion-settlement-jamie-dimon-is-a-colossus-no-more
Thirteen billion dollars
requires some perspective. The record amount that
JPMorgan Chase (JPM)
has tentatively agreed to pay the
U.S. Department of Justice, to settle civil investigations into
mortgage-backed securities it sold in the runup to the 2008 financial
crisis, is equal to the gross domestic product of Namibia. It’s more
than the combined salaries of every athlete in every major U.S.
professional sport, with enough left over to buy every American a
stadium hotdog. More significantly to JPMorgan’s executives and
shareholders, $13 billion is equivalent to 61 percent of the bank’s
profits in all of 2012. Anticipating the settlement in early October,
the bank recorded its first quarterly loss under the leadership of Chief
Executive Officer Jamie Dimon.
That makes it real money, even for the
country’s biggest bank by assets. Despite this walloping, there’s reason
for the company to exhale. The most valuable thing Dimon, 57, gets out
of the deal with U.S. Attorney General Eric Holder is clarity. The
discussed agreement folds in settlements with a variety of federal and
state regulators, including the Federal Deposit Insurance Corp. and the
attorneys general of California and New York. JPMorgan negotiated a
similar tack in September, trading the gut punch of a huge headline
number—nearly $1 billion in penalties related to the 2012 London Whale
trading fiasco—for the chance to resolve four investigations in two
countries in one stroke. In both cases, the bank’s stock barely budged;
its shares have returned 25 percent this year, exactly in line with the
performance of Standard & Poor’s 500-stock index.
That JPMorgan is able to withstand
penalties and regulatory pressure that would cripple many of its
competitors attests both to the bank’s vast resources and the influence
of the man who leads it. The sight of Dimon arriving at the Justice
Department on Sept. 26 for a meeting with the attorney general
underscored Dimon’s extraordinary access to Washington
decision-makers—although the Wall Street chieftain did have to humble
himself by presenting his New York State driver license to a guard on
the street. As news of the settlement with Justice trickled out, the
admirers on Dimon’s gilded list rushed to his defense, arguing that he
struck the best deal he could. “If you’re a financial institution and
you’re threatened with criminal prosecution, you have no ability to
negotiate,”
Berkshire Hathaway (BRK/A)
Chairman Warren Buffett told
Bloomberg TV. “Basically, you’ve got to be like a wolf that bares its
throat, you know, when it gets to the end. You cannot win.”
The challenges facing Dimon and his
company are far from over. With the $13 billion payout, JPMorgan is
still the subject of a criminal probe into its mortgage-bond sales,
which could end in charges against the bank or its executives. And other
federal investigations—into suspected bribery in China, the bank’s role
in the Bernie Madoff Ponzi scheme, and more—are ongoing.
The ceaseless scrutiny has tarnished
Dimon’s public image, perhaps irreparably. Once seen as the white knight
of the financial crisis, he’s now the executive stuck paying the bill
for Wall Street’s misdeeds. And as the bank’s legal fights drag on, it’s
worth asking just how many more blows the famously pugnacious Dimon can
take.
Although the $13 billion settlement
would amount to the largest of its kind in the history of regulated
capitalism, it looks quite different broken into its component pieces.
While the relative amounts could shift, JPMorgan is expected to pay
fines of only $2 billion to $3 billion for misrepresenting the quality
of mortgage securities it sold during the subprime housing boom.
Overburdened homeowners would get $4 billion; another $4 billion would
go to the Federal Housing Finance Agency, which regulates
Freddie Mac (FMCC)
and
Fannie Mae (FNMA);
and about $3 billion would go to investors who lost money on the
securities, Bloomberg News reported.
JPMorgan will only pay fines (as
distinct from compensation to investors or homeowner relief) related to
its own actions—and not those of Bear Stearns or Washington Mutual, the
two troubled institutions the bank bought at discount-rack prices during
the crisis. Aside from shaving some unknown amount off the final
settlement, this proviso enhances Dimon’s reputation as the shrewdest
banker of that era. In 2008, with the backing of the U.S. Department of
the Treasury and the Federal Reserve, who saw JPMorgan as a port in a
storm, Dimon got the two properties for just $3.4 billion. Extending
JPMorgan’s retail reach overnight into Florida and California, Bear and
WaMu helped the bank become the largest in the U.S. by 2011. The
portions of the settlement attributable to their liabilities are almost
certainly outweighed by the profits they’ve brought and will continue to
bring.
Elizabeth Warren, chairwoman of the TARP Congressional
Oversight Panel, saying that former Treasury Secretary Henry Paulson told the
panel that assets given to banks would be returned at equal value. The panel,
however, found that the banks were overpaid by $78 billion.
Time Magazine, February 6, 2009 ---
http://www.time.com/time/quotes
"Geithner's AIG Bailout," by Greg Kaughmann, The Nation, January
29, 2010 ---
http://www.thenation.com/doc/20100208/kaufmann
"Into the Bailout Buzz Saw," by Gretchen Morgenson, The New York
Times, July 21, 2012 ---
http://www.nytimes.com/2012/07/22/business/neil-barofskys-journey-into-a-bailout-buzz-saw-fair-game.html?_r=1&partner=rss&emc=rss
. . .
A few months after the modification plan was
announced, his office began a preliminary audit of its rollout. “We soon
verified what we had suspected,” Mr. Barofsky writes. “Treasury had failed
to ensure that the servicers had the necessary infrastructure to support a
massive mortgage modification program.” It barely got off the ground, and
few homeowners have received the help they hoped for.
This was just one of many examples from Mr.
Barofsky’s 16-month tenure, during which, he says, Washington abandoned Main
Street while rescuing Wall Street. “There has to be wide-scale
acknowledgment that regulatory capture exists, dominates our system and
needs to be eradicated,” Mr. Barofsky said in the interview. “It was my job
to bring as much transparency to taxpayers so they knew what was going on.
Writing the book, I tried to bring the same level of transparency so people
understand how captured their government has become to the financial
interests.”
I asked Mr. Barofsky, now a senior fellow at the
N.Y.U. School of Law, what could be done to get regulators to man up, as it
were.
“We need to re-educate our regulators that it’s
O.K. to be adversarial, that it’s not going to hurt your career advancement
to be more skeptical and more challenging,” he said. “It’s implicit in so
much of the regulatory structure that if you don’t make too many waves there
will be a job for you elsewhere. So we have to limit those job opportunities
and develop a more professional path for regulators as a career. That way,
they won’t always have that siren call of Wall Street.”
Mr. Barofsky’s assessment of his former regulatory
brethren is crucial for taxpayers to understand, because Congress’s
financial reform act — the Dodd-Frank legislation — left so much of the
heavy lifting to the weak-kneed.
“So much of what’s wrong with Dodd-Frank is it
trusts the regulators to be completely immune to the corrupting influences
of the banks,” he said in the interview. “That’s so unrealistic. Congress
has to take a meat cleaver to these banks and not trust regulators to do the
job with a scalpel.”
Finally, Mr. Barofsky joins the ranks of those who
believe that another crisis is likely because of the failed response to this
one. “Incentives are baked into the system to take advantage of it for
short-term profit,” he said. “The incentives are to cheat, and cheating is
profitable because there are no consequences.”
Despite all of this, Mr. Barofsky ends on something
of a positive note. Meaningful changes to our broken system may finally come
about, he writes, if enough people get angry. His conclusion is this: “Only
with this appropriate and justified rage can we sow the seeds for the types
of reform that will one day break our system free from the corrupting grasp
of the megabanks.”
That’s not much of a silver lining. But I guess
it’s better than none.
Bob Jensen's threads on the Bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Investment Banking, Banking, Brokerage, Banking, and Security Analysis
Scandals
(Investors are still losing the war in spite of all the promises made.)
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"How the Fed Is Holding Back Recovery: By promising to print more
money, it's giving Congress an excuse to avoid critical tax and spending cuts,"
by David Malpass, The Wall Street Journal, October 19, 2010 ---
http://online.wsj.com/article/SB10001424052702304410504575559972460199304.html?mod=djemEditorialPage_t
Congress will face a runaway train on taxes and
spending when it reconvenes after the elections. The solution is to restrain
both—especially to stop the $6 trillion tax increase scheduled to take place
on Jan. 1—in order to restore business confidence and help job growth.
Instead, Congress is more likely to do nothing and
count on the central bank to flood the economy with more money. In his
speech at the Boston Federal Reserve Bank on Friday, Fed Chairman Ben
Bernanke practically promised to oblige by resuming the large purchases of
Treasury notes carried out to help stop the 2008 financial crisis. It's a
sweeping manipulation of longer-term government interest rates and the
dollar that the Fed should consider only in the direst of national
emergencies or with specific congressional authorization.
Mr. Bernanke argued that most of today's high
unemployment is cyclical and therefore susceptible to monetary stimulus. "We
see little evidence that the reallocation of workers across industries and
regions is particularly pronounced relative to other periods of recession,"
he said, "suggesting that the pace of structural change is not greater than
normal." This ignores the tax, regulatory and federal spending crises
hammering workers and small businesses.
In reality, workers are being reallocated, and by
the millions. Due to the mortgage shambles, they are not moving around as
much as in past recessions. But the structural reallocation is clearly
pushing older workers into long-term unemployment.
Meanwhile, there's also been a powerful
rechanneling of credit away from small businesses. Corporate and government
jobs are faring better than small business jobs, another major structural
change that Fed purchases will exacerbate by channeling cheap credit to big
entities.
Jobs are moving to Asia as Washington's weak-dollar
policy causes trillions of dollars to move abroad to protect against the
risk of U.S. inflation and dollar debasement. Investors put their money into
foreign factories, mines and workers, creating a boom there. They avoid
long-term job-creating investments here, instead buying short-term IOUs from
our government.
Whether in Republican or Democratic
administrations, the Washington policy consensus for a decade has been
"print and spend." When that doesn't work, the Washington prescription is to
double the dose—more monetary easing and dollar devaluation, and always more
government spending. The Fed in particular has become accustomed to
subsidizing federal borrowing by holding interest rates too low, which
distorts capital flows and fosters asset bubbles.
By claiming that most of our unemployment is
cyclical and not structural—and by not once mentioning the crashing dollar
or small business profits—Mr. Bernanke has demonstrated that the central
bank has blinders on. In his speech Mr. Bernanke cited the decline in the
core PCE deflator (which uses the broad-based price index for personal
consumption expenditures and excludes the volatile food and energy
components) as evidence that inflation trends are subdued. This is the same
backward-looking indicator that former Fed Chairman Alan Greenspan used to
defend his disastrous low-interest, weak-dollar monetary policy from 2003
through 2006.
The reality is that core PCE inflation is regularly
revised upward as the government takes into proper account rising prices for
popular new items. Thus inflation gets underestimated and the Fed makes
mistakes based on this mismeasure. For example, core PCE inflation was
originally reported at 1.5% in most of 2004 with no real uptrend until
Katrina hit in the second half of 2005. However, the corrected data now
shows that core inflation was rising sharply in 2003 when the Fed hit the
gas pedal and weakened the dollar. By April 2004, core inflation was already
rising above the Fed's 2% ceiling and constantly exceeded it through 2008.
The Fed's public advocacy of bond purchases has
already weakened the dollar. And the nearly $100 billion per year in profit
the Fed is earning from its investments are at the expense of savers forced
to compete with the Fed for bonds.
President Obama and Mr. Bernanke tried
print-and-spend in trillion-dollar increments in 2009 and 2010, with no
discernible improvement in unemployment (which is still almost 27 million
counting underemployment) or small business investment plans, nearly the
weakest on record according to the September survey by the National
Federation of Independent Business.
The administration's centralized small business
loan plan, enacted in September, was the latest spending flop. As the
government controls more industries and allocates more of the nation's
capital, small businesses lower their hiring plans, as they did last month,
on the expectation that the federal government will tax them more to pay for
Washington's largess.
By electing a new Congress in November, voters may
be able to slow federal spending growth, but they probably can't stop the
Fed's latest expansion plan. The Fed is likely to buy more long-term
government-guaranteed bonds, using newly created money to add to the over $2
trillion in bonds it already owns.
The damage is substantial. Near-zero interest rates
are hammering savers, while transferring hundreds of billions of dollars
annually to bond issuers—mostly governments, banks and bigger corporations.
The weaker dollar is pushing risk capital away from this country and toward
Asia and emerging markets.
America's structural growth problems are clearly
focused in small business and stem from high taxes, regulatory threats and
the central control of credit. But the Fed's stimulus policy supports
government over the private sector and big business over small—meanwhile,
giving Congress an excuse to impose crippling increases in taxes and
spending.
"The Fed Votes No Confidence The prolonged—'emergency'—near-zero interest
rate policy is harming the economy," by Charles Schwab, The Wall Street
Journal, February 6, 2012 ---
http://online.wsj.com/article/SB10001424052970204740904577197374292182402.html?mod=djemEditorialPage_t
We're now in the 37th month of central government
manipulation of the free-market system through the Federal Reserve's
near-zero interest rate policy. Is it working?
Business and consumer loan demand remains modest in
part because there's no hurry to borrow at today's super-low rates when the
Fed says rates will stay low for years to come. Why take the risk of
borrowing today when low-cost money will be there tomorrow?
Federal Reserve Chairman Ben Bernanke told
lawmakers last week that fiscal policy should first "do no harm." The same
can be said of monetary policy. The Fed's prolonged, "emergency" near-zero
interest rate policy is now harming our economy.
The Fed policy has resulted in a huge infusion of
capital into the system, creating a massive rise in liquidity but negligible
movement of that money. It is sitting there, in banks all across America,
unused. The multiplier effect that normally comes with a boost in liquidity
remains at rock bottom. Sufficient capital is in the system to spur
growth—it simply isn't being put to work fast enough.
Average American savers and investors in or near
retirement are being forced by the Fed's zero-rate policy to take greater
investment risks. To get even modest interest or earnings on their savings,
they move out of safer assets such as money markets, short-term bonds or CDs
and into riskier assets such as stocks. Either that or they tie up their
assets in longer-term bonds that will backfire on them if inflation returns.
They're also dramatically scaling back their consumer spending and living
more modestly, thus taking money out of the economy that would otherwise
support growth.
We've also seen a destructive run of capital out of
Europe and into safe U.S. assets such as Treasury bonds, reflecting a
world-wide aversion to risk. New business formation is at record lows,
according to Census Bureau data. There is still insufficient confidence
among business people and consumers to spark an investment and growth boom.
We're now in the 37th month of central government
manipulation of the free-market system through the Federal Reserve's
near-zero interest rate policy. Is it working?
Business and consumer loan demand remains modest in
part because there's no hurry to borrow at today's super-low rates when the
Fed says rates will stay low for years to come. Why take the risk of
borrowing today when low-cost money will be there tomorrow?
Federal Reserve Chairman Ben Bernanke told
lawmakers last week that fiscal policy should first "do no harm." The same
can be said of monetary policy. The Fed's prolonged, "emergency" near-zero
interest rate policy is now harming our economy.
The Fed policy has resulted in a huge infusion of
capital into the system, creating a massive rise in liquidity but negligible
movement of that money. It is sitting there, in banks all across America,
unused. The multiplier effect that normally comes with a boost in liquidity
remains at rock bottom. Sufficient capital is in the system to spur
growth—it simply isn't being put to work fast enough.
Average American savers and investors in or near
retirement are being forced by the Fed's zero-rate policy to take greater
investment risks. To get even modest interest or earnings on their savings,
they move out of safer assets such as money markets, short-term bonds or CDs
and into riskier assets such as stocks. Either that or they tie up their
assets in longer-term bonds that will backfire on them if inflation returns.
They're also dramatically scaling back their consumer spending and living
more modestly, thus taking money out of the economy that would otherwise
support growth.
We've also seen a destructive run of capital out of
Europe and into safe U.S. assets such as Treasury bonds, reflecting a
world-wide aversion to risk. New business formation is at record lows,
according to Census Bureau data. There is still insufficient confidence
among business people and consumers to spark an investment and growth boom.
Jensen Comment
Bob Jensen's threads on the bailout mess are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on The Greatest Swindle in the History of the World
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
The Fed Audit
Socialist Bernie Sanders is probably my least favorite senator alongside Barbara
(mam) Boxer. But he does make some important revelations in the posting below.
The first ever GAO audit of the Federal Reserve was conducted in early 2011
due to the Ron Paul, Alan Grayson Amendment to the Dodd-Frank bill, which passed
last year. Jim DeMint, a Republican Senator, and Bernie Sanders, an independent
Senator, led the charge for a Federal Reserve audit in the Senate, but watered
down the original language of the house bill (HR1207), so that a complete audit
would not be carried out. Ben Bernanke, Alan Greenspan, and various other
bankers vehemently opposed the audit and lied to Congress about the effects an
audit would have on markets. Nevertheless, the results of the first audit in the
Federal Reserve nearly 100 year history were posted on Senator Sanders webpage
in July.
The list of
institutions that received the most money from the Federal Reserve can be found
on page 131 of the GAO Audit and is as follows:
Citigroup: $2.5
trillion($2,500,000,000,000)
Morgan Stanley: $2.04 trillion ($2,040,000,000,000)
Merrill Lynch: $1.949 trillion ($1,949,000,000,000)
Bank of America : $1.344 trillion ($1,344,000,000,000)
Barclays PLC ( United Kingdom ): $868 billion* ($868,000,000,000)
Bear Sterns: $853 billion ($853,000,000,000)
Goldman Sachs: $814 billion ($814,000,000,000)
Royal Bank of Scotland (UK): $541 billion ($541,000,000,000)
JP Morgan Chase: $391 billion ($391,000,000,000)
Deutsche Bank ( Germany ): $354 billion ($354,000,000,000)
UBS ( Switzerland ): $287 billion ($287,000,000,000)
Credit Suisse ( Switzerland ): $262 billion ($262,000,000,000)
Lehman Brothers: $183 billion ($183,000,000,000)
Bank of Scotland ( United Kingdom ): $181 billion ($181,000,000,000)
BNP Paribas (France): $175 billion ($175,000,000,000)
"The Fed Audit," by Bernie Sanders, Independent Senator from Vermont, July
21, 2011 ---
http://sanders.senate.gov/newsroom/news/?id=9e2a4ea8-6e73-4be2-a753-62060dcbb3c3
The first top-to-bottom audit of the Federal
Reserve uncovered eye-popping new details about how the U.S. provided a
whopping $16 trillion in secret loans to bail out American and foreign banks
and businesses during the worst economic crisis since the Great Depression.
An amendment by Sen. Bernie Sanders to the Wall Street reform law passed one
year ago this week directed the Government
Accountability Office to conduct the study. "As a
result of this audit, we now know that the Federal Reserve provided more
than $16 trillion in total financial assistance to some of the largest
financial institutions and corporations in the United States and throughout
the world," said Sanders. "This is a clear case of socialism for the rich
and rugged, you're-on-your-own individualism for everyone else."
Among the investigation's key findings is that the
Fed unilaterally provided trillions of dollars in financial assistance to
foreign banks and corporations from South Korea to Scotland, according to
the GAO report. "No agency of the United States government should be allowed
to bailout a foreign bank or corporation without the direct approval of
Congress and the president," Sanders said.
The non-partisan, investigative arm of Congress
also determined that the Fed lacks a comprehensive system to deal with
conflicts of interest, despite the serious potential for abuse. In fact,
according to the report, the Fed provided conflict of interest waivers to
employees and private contractors so they could keep investments in the same
financial institutions and corporations that were given emergency loans.
For example, the CEO of JP Morgan Chase served on
the New York Fed's board of directors at the same time that his bank
received more than $390 billion in financial assistance from the Fed.
Moreover, JP Morgan Chase served as one of the clearing banks for the Fed's
emergency lending programs.
In another disturbing finding, the GAO said that on
Sept. 19, 2008, William Dudley, who is now the New York Fed president, was
granted a waiver to let him keep investments in AIG and General Electric at
the same time AIG and GE were given bailout funds. One reason the Fed did
not make Dudley sell his holdings, according to the audit, was that it might
have created the appearance of a conflict of interest.
To Sanders, the conclusion is simple. "No one who
works for a firm receiving direct financial assistance from the Fed should
be allowed to sit on the Fed's board of directors or be employed by the
Fed," he said.
The investigation also revealed that the Fed
outsourced most of its emergency lending programs to private contractors,
many of which also were recipients of extremely low-interest and then-secret
loans.
The Fed outsourced virtually all of the operations
of their emergency lending programs to private contractors like JP Morgan
Chase, Morgan Stanley, and Wells Fargo. The same firms also received
trillions of dollars in Fed loans at near-zero interest rates. Altogether
some two-thirds of the contracts that the Fed awarded to manage its
emergency lending programs were no-bid contracts. Morgan Stanley was given
the largest no-bid contract worth $108.4 million to help manage the Fed
bailout of AIG.
A more detailed GAO investigation into potential
conflicts of interest at the Fed is due on Oct. 18, but Sanders said one
thing already is abundantly clear. "The Federal Reserve must be reformed to
serve the needs of working families, not just CEOs on Wall Street."
To read the GAO report, click here
http://sanders.senate.gov/imo/media/doc/GAO Fed Investigation.pdf
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"Washington's Knack for Picking Losers," by Michael J. Boskin, The
Wall Street Journal, February 15, 2012 ---
http://online.wsj.com/article/SB10001424052970204883304577221630318169656.html?mod=djemEditorialPage_t
Like the mythical monster Hydra—who grew two heads
every time Hercules cut one off—President Obama, in both his State of the
Union address and his new budget, has defiantly doubled down on his brand of
industrial policy, the usually ill-advised attempt by governments to promote
particular industries, companies and technologies at the expense of broad,
evenhanded competition.
Despite his record of picking losers—witness the
failed "clean energy" projects Solyndra, Ener1 and Beacon Power—Mr. Obama
appears determined to continue pushing his brew of federal spending,
regulations, mandates, special waivers, loan guarantees, subsidies and tax
breaks for companies he deems worthy.
Favoring key constituencies with taxpayer money
appeals to politicians, who can claim to be helping the overall economy, but
it usually does far more harm than good. It crowds out valuable competing
investment efforts financed by private investors, and it warps decisions by
bureaucratic diktats susceptible to political cronyism. Former Obama adviser
Larry Summers echoed most economists' view when he warned the administration
against federal loan guarantees to Solyndra, writing in a 2009 email that
"the government is a crappy venture capitalist."
Markets function well when the returns are received
and the risks borne by private owners. There are, of course, exceptions:
Governments have a responsibility to fund defense R&D and other forms of
pre-competitive, generic R&D—e.g., basic science and technology from
nanoscience to batteries—but only when they pass rigorous cost-benefit tests
and maintain a level playing field among alternative commercial
applications.
For example, the computer-linking technology that
created the Internet was funded by the Defense Department for defense
purposes. But, like numerous defense technologies, it wound up with
commercially valuable civilian applications. Yet it would be foolish for the
government to subsidize a particular search engine or social-networking
platform.
The previous peak for U.S. industrial policy was in
the 1970s and 1980s, when many Democrats wanted to emulate the then-growing
Japanese economy by managing trade and directing specific technology and
investment outcomes. Japanese subsidies mostly went to old industries like
agriculture, mining and heavy manufacturing. We now know that this
misallocation of capital was one of the main reasons for Japan's stagnation
over the past two decades.
Industrial-policy fever waned after the 1980s but
never died. President George W. Bush expanded ethanol mandates and pushed
hydrogen cars. Hydrogen's use for transportation must still overcome
combustibility concerns, or we'll be driving mini-Hindenburgs. The Bush and
Obama administrations bet big on ethanol and other biofuels, providing
subsidies that distorted the global market for corn. The federal government
was forced to drop its cellulosic ethanol quota by 97% last year because of
a lack of viable biorefineries—and the quota still wasn't met.
Even under optimistic projections, heavily
subsidized wind and solar would each amount to a tiny fraction of global
energy by 2030 and thus cannot be the main answer to energy-security or
environmental problems. The short-run focus of most Department of Energy
funding misses the main strategic imperative: We need alternatives that can
scale to significance long-term without subsidies, and we need a lot more
North American oil and gas in the meantime.
Mr. Obama is spending immense sums for subsidies to
particular industries and technologies, almost $40 billion for clean-energy
programs alone (some, appropriately, for pre-competitive generic
technology.) Yet a large number of prominent venture-capital funds are
devoted to alternative-energy providers. They should be competing with each
other and with the technologies they seek to replace—not for government
handouts.
Meanwhile, the administration blocks shovel-ready
private investment such as the Keystone XL pipeline from Canada to the Gulf
Coast, which would create thousands of American jobs, increase energy
security, and even improve the environment. The alternative is shipping the
Canadian oil to China; we can refine it more cleanly than the Chinese, and
pipelines are safer than shipping.
America certainly has energy-security and possible
environmental concerns that merit diversifying energy sources. More domestic
oil and natural gas production will clearly play a large role. The shale gas
hydraulic fracturing revolution—credit due to Halliburton and Mitchell
Energy; the government's role was minor—is rapidly providing a piece of the
intermediate-term solution.
The arguments to promote industrial
policy—incubating industries, benefits of clustering and learning, more
jobs, etc.—don't stand up to scrutiny. Echoing 1980s Japan-fear and envy,
some claim we must enact industrial policies because China does. We should
remember that Presidents Lyndon Johnson and Richard Nixon wanted the U.S. to
build a supersonic transport (SST) plane because the British and French were
doing so. The troubled Concorde was famously shut down after a
quarter-century of subsidized travel for wealthy tourists and Wall Street
types.
Instead of an industrial policy that fails
miserably to pick winners, a better response to foreign competition should
be:
• Remove our own major competitive
obstacles. We can do this with more competitive corporate tax
rates, more sensible regulation, improved K-12 education, and better job
training for skills that the market demands such as the computer
literacy necessary even to operate today's machinery. (Mr. Obama's green
jobs training program spent hundreds of millions but only 3% of
enrollees had the targeted jobs six months later.)
• Base trade and industrial policies on
sound economics, not 'in-sourcing' protectionism. If another
country has a comparative cost advantage, we gain from exchanging such
products for those we produce relatively more efficiently. If we tried
to produce everything in America, our standard of living would plummet.
• Pursue rapid redress for illegal
subsidization and protectionism by our competitors. The appropriate
venue for trade complaints is the World Trade Organization, not the
campaign trail. We need to strengthen the WTO, not threaten its
legitimacy with protectionist rhetoric that could spark a trade war.
Continued in article
Bob Jensen's threads on the biggest swindle in the history of the world
---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
"SEC Brings Crisis-Era Suits Fannie, Freddie Ex-Executives Face Cases
Stemming From Subprime Disclosures," by Nick Timiraos and Chad Bray, The
Wall Street Journal, December 17, 2011 ---
http://online.wsj.com/article/SB10001424052970203733304577102310955780788.html
U.S. securities regulators accused six former
executives at mortgage firms Fannie Mae and Freddie Mac of playing down the
risks to investors of the firms' foray into subprime loans.
The civil lawsuits, filed Friday by the Securities
and Exchange Commission in Manhattan federal court, rank among the
highest-profile crisis-related cases the government has brought. They are
also the first cases against the top executives at Fannie and Freddie before
their 2008 government takeover, which has cost taxpayers $151 billion.
The complaints name as defendants former Freddie
Mac Chief Executive Richard Syron and former Fannie Mae CEO Daniel Mudd, who
is currently chief executive of Fortress Investment Group LLC. The agency
also accused four other high-ranking former executives at Freddie Mac and
Fannie Mae.
The executives and their lawyers said they would
vigorously contest the charges.
At the heart of the lawsuits is the government's
contention that Fannie and Freddie executives knowingly misled investors
about the volumes of risky mortgages that the companies were purchasing as
the housing boom turned to bust. Documents
Complaints: SEC v. Fannie Mae | SEC v. Freddie Mac
Nonprosecution Agreements: Fannie Mae | Freddie Mac
"Fannie Mae and Freddie Mac executives told the
world that their subprime exposure was substantially smaller than it really
was," said Robert Khuzami, director of the SEC's Enforcement Division.
The lawsuits come as the SEC and other
law-enforcement agencies face rising political pressure to take more
aggressive action against financial companies over the 2008 crisis. Federal
authorities have a mixed record in cases tied to the subprime-mortgage bust,
with no major cases having been brought in some of the highest-profile
blowups, such as the September 2008 bankruptcy of Lehman Brothers Holdings
Inc.
Continued in article
Jensen Comment
So why is the Department of Justice and the SEC backing off of bigger criminals
like the banksters of Countrywide, Washington Mutual, Citigroup, JP Morgan,
Merrill Lynch, Lehman Brothers, Bear Sterns, etc.?
The Justice Department can put criminals in jail, but the SEC can only go for
fines. The problem is that when dealing with banksters the SEC has a track
record of pittance, chicken feed fines. Steal a dollar and the SEC will go
after less than a dime from a bankster.
Another CBS Sixty Minutes Blockbuster (December 4, 2011)
"Prosecuting Wall Street"
Free download for a short while
http://www.cbsnews.com/8301-18560_162-57336042/prosecuting-wall-street/?tag=pop;stories
Note that this episode features my hero Frank Partnoy
Key provisions of Sarbox with respect to the Sixty Minutes revelations:
The act also covers issues such as
auditor independence,
corporate governance,
internal control assessment, and enhanced financial disclosure.
Sarbanes–Oxley Section 404: Assessment of internal control ---
http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Sarbanes.E2.80.93Oxley_Section_404:_Assessment_of_internal_control
Both the corporate CEO and the external auditing firm are to
explicitly sign off on the following and are subject (turns out to be a
ha, ha joke) to huge fines and jail time for egregious failure to
do so:
- Assess both the design and operating
effectiveness of selected internal controls related to significant
accounts and relevant assertions, in the context of material
misstatement risks;
- Understand the flow of transactions,
including IT aspects, in sufficient detail to identify points at
which a misstatement could arise;
- Evaluate company-level (entity-level)
controls, which correspond to the components of the
COSO framework;
- Perform a fraud risk assessment;
- Evaluate controls designed to
prevent or detect fraud, including management override of
controls;
- Evaluate controls over the period-end
financial
reporting process;
- Scale the assessment based on the size and
complexity of the company;
- Rely on management's work based on factors
such as competency, objectivity, and risk;
- Conclude on the adequacy of internal
control over financial reporting.
Most importantly as far as the CPA auditing firms are concerned is
that Sarbox gave those firms both a responsibility to verify that
internal controls were effective and the authority to charge more
(possibly twice as much) for each audit. Whereas in the 1990s auditing
was becoming less and less profitable, Sarbox made the auditing industry
quite prosperous after 2002.
There's a great gap between the theory of Sarbox and its enforcement
In theory, the U.S. Justice Department (including the FBI) is to enforce
the provisions of Section 404 and subject top corporate executives and audit
firm partners to huge fines (personal fines beyond corporate fines) and jail
time for signing off on Section 404 provisions that they know to be false.
But to date, there has not been one indictment in enormous frauds where the
Justice Department knows that executives signed off on Section 404 with
intentional lies.
In theory the SEC is to also enforce Section 404, but the SEC in Frank
Partnoy's words is toothless. The SEC cannot send anybody to jail. And the
SEC has established what seems to be a policy of fining white collar
criminals less than 20% of the haul, thereby making white collar crime
profitable even if you get caught. Thus, white collar criminals willingly
pay their SEC fines and ride off into the sunset with a life of luxury
awaiting.
And thus we come to the December 4 Sixty Minutes module that features
two of the most egregious failures to enforce Section 404:
The astonishing case of CitiBank
The astonishing case of Countrywide (now part of Bank of America)
The Astonishing Case of CitiBank
What makes the Sixty Minutes show most interesting are the whistle
blowing revelations by a former Citi Vice President in Charge of Fraud
Investigations
- What has to make the CitiBank revelations the most embarrassing
revelations on the Sixty Minutes blockbuster emphasis that top
CItiBank executives were not only informed by a Vice President in Charge of
Fraud Investigation of huge internal control inadequacies, the outside U.S.
government top accountant, the U.S. Comptroller General, sent an official
letter to CitiBank executives notifying them of their Section 404 internal
control failures.
- Eight days after receiving the official warning from the government, the
CEO of CitiBank flipped his middle finger at the U.S. Comptroller General
and signed off on Section 404 provisions that he'd also been informed by his
Vice President of Fraud and his Internal Auditing Department were being
violated.
http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html
- What the Sixty Minutes show failed to mention is that the
external auditing firm of KPMG also flipped a bird at the U.S. Comptroller
General and signed off on the adequacy of its client's internal controls.
- A few months thereafter CitiBank begged for and got hundreds of billions
in bailout money from the U.S. Government to say afloat.
- The implication is that CitiBank and the other Wall Street corporations
are just to0 big to prosecute by the Justice Department. The Justice
Department official interviewed on the Sixty Minutes show sounded
like hollow brass wimpy taking hands off orders from higher authorities in
the Justice Department.
- The SEC worked out a settlement with CitiBank, but the fine is such a
joke that the judge in the case has to date refused to accept the
settlement. This is so typical of SEC hand slapping settlements --- and the
hand slaps are with a feather.
The astonishing case of Countrywide (now part of Bank of America)
- Countrywide Financial before 2007 was the largest issuer of mortgages on
Main Streets throughout the nation and by estimates of one of its own
whistle blowing executives in charge of internal fraud investigations over
60% of those mortgages were fraudulent.
- After Bank of America purchased the bankrupt Countrywide, BofA top
executives tried to buy off the Countrywide executive in charge of fraud
investigations to keep him from testifying. When he refused BofA fired him.
- Whereas the Justice Department has not even attempted to indict
Countrywide executives and the Countrywide auditing firm of Grant Thornton
(later replaced by KPMG) to bring indictments for Section 404 violations,
the FTC did work out an absurdly low settlement of $108 million for 450,000
borrowers paying "excessive fees" and the attorneys for those borrowers ---
http://www.nytimes.com/2011/07/21/business/countrywide-to-pay-borrowers-108-million-in-settlement.html
This had nothing to do with the massive mortgage frauds committed by
Countrywide.
- Former Countrywide CEO Angelo Mozilo settled the SEC’s Largest-Ever
Financial Penalty ($22.5 million) Against a Public Company's Senior
Executive
http://sec.gov/news/press/2010/2010-197.htm
The CBS Sixty Minutes show estimated that this is less than 20% of what he
stole and leaves us with the impression that Mozilo deserves jail time but
will probably never be charged by the Justice Department.
I was disappointed in the CBS Sixty Minutes show in that it completely
ignored the complicity of the auditing firms to sign off on the Section 404
violations of the big Wall Street banks and other huge banks that failed.
Washington Mutual was the largest bank in the world to ever go bankrupt. Its
auditor, Deloitte, settled with the SEC for Washington Mutual for
$18.5 million. This isn't even a hand slap relative to the billions lost by
WaMu's investors and creditors.
No jail time is expected for any partners of the negligent auditing
firms. .KPMG settled for peanuts with Countrywide for
$24 million of negligence and New Century for
$45 million of negligence costing investors billions.
"Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank
Partnoy, New York Review of Books, November 10, 2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
Thank you Robert Walker for the heads up!
Bob Jensen's Rotten to the Core threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's threads on how white collar crime pays even if you get caught
---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
"Investment strategist: 'Big banks make their money from optimism',"
by Joris Luyenduc, The Guardian, January 3, 2012 ---
http://www.guardian.co.uk/commentisfree/joris-luyendijk-banking-blog/2012/jan/03/investment-strategist-emerging-markets
. . .
"If you take an honest look at the financial sector
today, you see banks can borrow money almost for free on what is called the
short-term market, then lend that money to governments for 2% or 3%. Now why
would they lend to small businesses if they can make money so easily? This
is what 'zero interest rates' are doing to our economy, as well as taxing
savers with inflation at over 5%. You take on new debt to pay off your old
debt. It's like drinking your hangover away with ever more drinks. You are
destroying your liver. That's what's currently happening."
Continued in article
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
"TARP Was No Win for the Taxpayers : Treasury's claim that the bank
bailouts will return a profit ignores the other, more costly programs enabling
the banks to repay their TARP funds," by Paul Atkins, Mark McWatters, and
Kenneth Troske, The Wall Street Journal, March 17, 2011 ---
http://online.wsj.com/article/SB10001424052748703899704576204383282043422.html?mod=djemEditorialPage_t
Today the Senate Banking Committee will explore the
Troubled Asset Relief Program (TARP). Almost 30 months after its birth, TARP
is far from dead. More than 550 banks, AIG, GM, Chrysler and others still
have approximately $160 billion of taxpayer money outstanding.
Even so, the administration would have us believe
that TARP has been a success because it supposedly alleviated the financial
crisis and is (so far) being paid back at an apparent profit for taxpayers.
Perhaps because he helped invent TARP before he joined the Obama
administration, Treasury Secretary Timothy Geithner has called TARP the
"most effective government program in recent memory."
Treasury's view is misleading. First, it hides the
full story of the government's financial crisis effort, of which TARP is but
a minor part. Moreover, Treasury has not been content using rhetoric alone
to try to put TARP in the best light. The Special Inspector General for TARP
criticized Treasury in October for inadequately disclosing a change in its
valuation methodology that reduced a $45 billion loss in AIG to $5 billion,
making TARP losses appear smaller than they really are. This data
manipulation is only part of a much larger problem with Treasury's
representations regarding the supposed success of the bank bailout payments
that lie at the heart of TARP.
The focus on repayment fails to consider the huge
taxpayer costs from non-TARP programs that directly and indirectly enabled
many of the large banks to repay their TARP funds. These intertwined
programs, operated by the Treasury and the Federal Reserve, dwarf the size
of TARP and lack its accountability.
The financial crisis was born in the housing bubble
caused by the policies of Fannie Mae and Freddie Mac, the two bankrupt
government-sponsored entities (GSEs) charged with buying and packaging
mortgages into mortgage-backed securities (MBS). TARP banks own billions of
dollars worth of MBS and have remained liquid in part because the Federal
Reserve has bought more than $1.1 trillion of these GSE-guaranteed MBS in
the securities markets—all outside TARP.
The Fed purchased the MBS at fair market value, but
this value reflects Treasury's bailout and continued support of the GSEs—also
done outside of TARP with taxpayer money. Had the GSEs failed, TARP
recipients probably would have been stuck with these MBS, writing them down
at significant loss. Their ability to pay back TARP funding would have been
hurt, and they might have had to obtain more TARP funds or go bust.
So the taxpayer-backed GSE guarantee enables the
Fed to prop up the market with taxpayer funds, in turn allowing the TARP
banks to "repay" their TARP funds. The bailout of the GSEs by Treasury thus
shifts potential losses from TARP to other programs that have less oversight
and public scrutiny. Any evaluation of TARP's success must take into account
the interaction among all government programs designed to prop-up the
financial system, and the shifting of costs among these programs.
The Congressional Budget Office estimates that
Treasury's bailout of the GSEs will cost the taxpayers approximately $380
billion through fiscal year 2021. If only one-fourth of CBO's estimate
ultimately benefits TARP recipients and other financial institutions,
taxpayers will have provided a subsidy to these institutions of
approximately $100 billion, which is not accounted for under TARP.
Also seldom mentioned are future costs resulting
from using TARP funds to rescue "systemically important" financial and other
firms. TARP exacerbates the "too big to fail" phenomenon by targeting much
of its funding toward large banks and automobile firms, solidifying the
market's belief in an implicit guarantee from the government for these
firms. As credit-rating agencies have recognized, these large firms can
borrow much more cheaply than their small-enough-to-fail competitors, which
will lead to less competition, a more concentrated financial sector, and
higher prices paid by consumers.
In addition, creating larger, more systemically
important financial firms increases the likelihood of future financial
crises because these firms have an incentive to invest in riskier projects
as a result of the implicit government guarantee. The additional costs borne
by consumers in the form of higher prices for financial services and the
additional costs that result from future financial crises need to be
included in any accounting of the costs of the TARP.
TARP was never where the real action was happening.
In fact, other Fed and FDIC programs added another $2 trillion of taxpayer
money at risk to the 19 stress-tested banks alone, on top of the $1.1
trillion of MBS purchased by the Fed. TARP is but one-eighth of that total.
The government's efforts inside and outside of TARP
have sown the seeds for the next crisis and, unfortunately, last year's
2,319-page Dodd-Frank Act does nothing to fix these problems. Treasury must
be more transparent regarding TARP. The real myth that the Treasury
secretary should dispel is that TARP is a big win for the taxpayer.
Mr. Atkins was a member of the Congressional Oversight Panel from
2009-2010. Messrs. McWatters and Troske are current members of the panel.
Bob Jensen's threads on the Bailout of Banksters and the Greatest Swindle
in the History of the World are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Economic Risks of Zero Interest Rates and Zimbabwe Economics of the Fed
"Mega-Banks and the Next Financial Crisis: Hedge-fund manager Paul
Singer recognized the risks of subprime mortgages and bet against them. Now he
warns that monetary policy could cripple American banks again," by James
Freeman, The Wall Street Journal, March 19, 2011 ---
http://online.wsj.com/article/SB10001424052748703899704576204594093772576.html?mod=djemEditorialPage_t
At the height of the housing bubble, hedge-fund
manager Paul Singer was shorting subprime mortgages. By the spring of 2007,
he was warning regulators on both sides of the Atlantic that the world was
facing a major financial crisis.
They ignored him. Now the founder of Elliott
Management says the biggest banks are headed for another credit meltdown.
Among the likely triggers for the next crisis, Mr. Singer sees one leading
candidate: Monetary policy "is extremely risky," he says, "the risk being
massive inflation."
In some areas gas prices have reached $4 per
gallon, and now Americans must brace themselves for higher grocery bills.
This week the Labor Department reported that February wholesale food prices
posted their sharpest increase since 1974. News like that has driven Mr.
Singer to the history books: He treats visitors to his 5th Avenue office to
a copy of a 1931 treatise on German currency debasement, Constantino
Bresciani-Turroni's "The Economics of Inflation."
Mr. Singer—who launched Elliott in 1977 and has
delivered a 14.3% compound annual return (compared to the S&P 500's
10.9%)—is not comparing today's Federal Reserve to the Reichsbank of the
early 1920s. Rather, he's once again warning financial regulators. This time
the message is: Don't take for granted investor faith in a major currency.
While at Harvard Law School, Mr. Singer turned down
a research job with his intellectual hero, Daniel Patrick Moynihan, to
pursue a career in finance. Today, he's still looking for heroes among the
stewards of the major currencies. Central bankers, particularly at the Fed
but also in Europe, "seem to be acting as if they have unlimited flexibility
to ease monetary policy," he says.
He specifically targets the Fed's "unprecedented"
policy of sustaining near-zero interest rates and its exercise in
money-printing, "Quantitative Easing 2," that has it buying medium- and
longer-term securities from the Treasury. "In effect they're treating
confidence in fiat money—in paper money—as inexhaustible, that it's a tool
that's able to be used not just in the throes of crisis," but also as "a
virtually complete substitute for sound fiscal, regulatory and taxing
policy."
Fed officials, he adds, "really seem to think that
inflation is something they can deal with very easily and very quickly. I
don't believe they're right." He notes that, in the late 1970s, inflation
was only in the high single digits yet curing it required interest rates of
20% and a collapse of the bond market.
Mr. Singer further warns that investors shouldn't
misinterpret apparently bullish signals from a rising market. "Of course
printing money is going to support asset prices," but "it's very dangerous"
and is not a substitute for trade, tax and regulatory reforms that make
America an attractive place for job creation.
"What would a loss of confidence in the dollar
actually look like? Gold going absolutely nuts," adds Mr. Singer, who is
also a major donor to conservative intellectual causes and think tanks such
as the Manhattan Institute. He observes that prices for many commodities are
already near all-time highs, even with "kind of a soft recovery" in the U.S.
and Europe, and robust growth in Asia. "Imagine if hoarding, speculation,
investment positions in [hard assets] accumulate to cause commodities and
gold to go rocketing up. Wages, prices will follow," he says.
As destructive as raging inflation would be, why
would it hurt the big financial institutions? It could wreak havoc on the
ability of big banks' corporate customers to make good on their obligations,
Mr. Singer believes—and financial reform did little to reduce risks.
"Dodd-Frank has made the system more brittle and
has shaped the next crisis in a very negative way," he warns. "The opacity
of financial institution financial statements has not been addressed or
changed at all. . . . We have a very large analytical research effort here
and we have not found anybody that can parse" the sensitivity of big banks
to changes in interest rates, asset prices and the like. "You can't do it."
Continued in article
Bernanke Says Bailouts of Banks ‘Unconscionable’
Federal Reserve Chairman Ben S. Bernanke said
government bailouts of large financial firms are “unconscionable” and must be
ended as part of a regulatory overhaul following the worst financial crisis
since the 1930s. It is unconscionable that the fate of the world economy should
be so closely tied to the fortunes of a relatively small number of giant
financial firms,” Bernanke said today in a speech in Orlando, Florida. “If we
achieve nothing else in the wake of the crisis, we must ensure that we never
again face such a situation.”
Steve Matthews and Phil Mattingly, "Bernanke Says Bailouts of Banks
‘Unconscionable’ (Update2)," Business Week, March 20, 2010 ---
http://www.businessweek.com/news/2010-03-20/bernanke-says-bailouts-of-banks-unconscionable-update1-.html
Oh, and don't
forget Fannie Mae and Freddie Mac, those two government-sponsored mortgage
giants that engineered the 2008 subprime mortgage fiasco and are now on the
public dole. The Fed kept them afloat by buying over a trillion dollars of their
paper. Now, part of the Treasury's borrowing from the public covers their
continuing large losses.
George Melloan, "Hard Knocks
From Easy Money: The Federal Reserve is feeding big government and harming
middle-class savers," The Wall Street Journal, July 6, 2010 ---
http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t
"Elizabeth Warren: Why Credit Is Still Frozen The congressional TARP
watchdog says there's no evidence that the $700 billion bailout boosted lending
to small business," by John Tozzi, Business Week, June 24, 2010 ---
http://www.businessweek.com/smallbiz/content/jun2010/sb20100623_599348.htm?link_position=link8
You report that after Treasury infused
capital into banks, most recipients decreased their small business lending
rather than increasing it. Why?
Wall Street banks cut back small business lending
by 9 percent, more than double their 4 percent cutback in overall lending.
Small business lending is expensive. It falls between consumer lending,
which is driven almost entirely by numbers like credit scores or Zip Codes
and pays off in volume, and large business lending, which is very much about
relationships but pays off in very large fees per transaction. Small
business lending has proportionally more expense associated with each loan.
Treasury is proposing a measure to provide
smaller banks with $30 billion to get them to lend more to small companies.
Will this do more to increase credit than the Troubled Asset Relief Program
did?
What the Secretary of the Treasury now proposes is
not a TARP program. It would require new authorization from Congress. But it
continues to follow the same basic TARP pattern: Put money into banks, and
they will lend it. The legislation would add some incentives to make the
borrowed money cheaper if it's loaned to small businesses, but it's not
clear that those incentives will be strong enough.
Even if small banks do start lending more,
can they make up for the contraction by the largest banks?
Our economy increasingly must rely on small banks
to fund small businesses, but many of those same small banks are themselves
in trouble. Commercial real estate loans have left huge holes in the balance
sheets of many of these banks, and there's more trouble on the horizon.
Frankly, I'm worried.
Some banks argue that lending is
constricted because regulators are pressing them to reduce the risk on their
books. Do you agree?
Banks have to show that they're strong, and if
they're not strong, then the regulators are right to press them to reduce
risk. Banks complain about their regulators, but the banks are not going to
get structurally stronger from looser regulations. Right now there are no
data that suggest the regulators are too tough.
You say Treasury doesn't have good data on
small business lending.
The data were terrible even before the crisis—very
little information was collected. TARP presented an opportunity to require
much more granular reporting from the banks that took taxpayer money, but
Treasury didn't ask for it. We pointed this out early and often, but no
changes were made. Now, policymakers are flying blind because they failed to
collect data on many aspects of how lending shifted when the financial
crisis hit.
Bob Jensen's threads on the current financial crisis and its aftermath ---
http://faculty.trinity.edu/rjensen/2008bailout.htm
"MIT economist finds temporary jobs may
actually reduce workers' income and employment prospects," by Christine
Daniloff, PhysOrg, January 20, 2010 ---
http://www.physorg.com/news183385347.html
While the U.S. economy struggles, one
form of employment is on the rise: Temporary jobs. In December, the country
lost 85,000 jobs overall, but added 47,000 temp positions, according to the
Bureau of Labor Statistics. Increasingly America relies on these contingent
employees -- or “disposable workers,” as Business Week put it in a
recent cover story.
For many workers, these
jobs are stop-gap measures, but social scientists
have long floated another idea: That temp positions help low-skill workers
to acquire experience and eventually join the permanent workforce in better
long-term jobs. Now, a new working paper co-authored by MIT economist David
Autor throws cold water on that notion. Not only do many temp employees
struggle to find long-term or “direct-hire” work, the study says, but
holding a temp job generally lowers a worker’s employment and income
prospects over time.
“Temp jobs have some initial
positive impact,” says Autor. “But not only do they end quickly, they tend
to displace what a person would have done instead, either taking a
direct-hire job or engaging in the kind of search that could lead to a
direct-hire job.”
Autor and his co-author, Susan
Houseman of the W.E. Upjohn Institute for Employment Research in Kalamazoo,
Mich., came to this conclusion after examining a welfare-to-work program in
Detroit called Work First. The program offers some job-seeking training and
attempts to put people in either temporary or long-term positions. Using
Work First data for over 37,000 cases from 1999 to 2003, combined with state
employment information, Autor and Houseman examined how workers fared in the
two years before and after they participated in Work First.
Their findings showed that workers
placed into direct-hire jobs increased their earnings by about $2,000 per
year, compared to their earnings before trying the Work First program. By
contrast, workers initially placed into temp jobs saw their earnings lowered
by about $1,000 per year, compared to their previous average
income.
The study, “Do Temporary-Help Jobs
Improve Labor Market Outcomes for Low-Skilled Workers? Evidence from ‘Work
First,’” (PDF) which will be published in the American Economic Journal:
Applied Economics, has clear policy implications. “Work First as a model is
not a bad idea, but I think these programs should be more focused on getting
people into direct-hire positions,” says Autor. “In terms of what state
agencies should be spending their money on, it should not be temporary-help
placements, at least for this part of the population.”
Workplace
experiment
The study’s surprising results have
already gained notice among labor researchers, who have often assumed a
solid correlation between temp employment and better job prospects. “I would
have expected them to find a positive result, but they didn’t,” says Mary
Corcoran, a professor of political science, public policy, social work, and
women's studies at the University of Michigan, who is conducting her own
study of temporary employment in Michigan. Corcoran thinks the Autor-Houseman
paper is “one of the best pieces out there on the effects of using temp
agencies, because it’s more like an experiment than other studies.”
Indeed, the study uses a key
feature of Work First to create what economists call a “quasi-experiment” —
research that uses a random element found in data to duplicate the structure
of a laboratory trial. In general, it is hard to separate the employment
status of people from their skills and motivation; temp workers might have
temp jobs because they are less predisposed to have long-term jobs. But in
Detroit, Work First arbitrarily rotated job-seekers through different
job-placement contractors which themselves had varying tendencies in terms
of placing workers in temp positions or long-term jobs. Because each group
of job-hunters assigned to each job placement contractor was essentially
identical, Autor and Houseman could rule out differences in workers as the
primary explanation of differences in workers’
employment trajectories; in this case, even some
workers who were highly motivated to find full-time work started out in temp
jobs.
To be sure, a valid question is how
broadly these findings apply, given Michigan’s acute economic struggles.
However, as Autor notes, the study’s data starts when the state economy was
growing in the late 1990s, then continues through the slump of the early
2000s and the subsequent rebound; it ends before the current recession
began.
Moreover, Autor and Houseman
believe there is no regional bias in the study because the overall figures
for people finding both temporary and long-term jobs through Work First in
Detroit closely match the equivalent data for other regions, including North
Carolina and Missouri. The researchers also say temp workers fared no
differently in the production-line jobs associated with Michigan than in the
kinds of clerical jobs found everywhere.
“I don’t think it’s anything
specific about Detroit, or the type of work in which temps are placed,” says
Autor. “In terms of the external validity of the conclusions, my main
concern is how this relates to a more skilled population. There we don’t
have a clear answer yet.” It is possible that temp jobs for people with
college degrees do
lead to greater opportunities and earnings — something the researchers would
study if the right data set presents itself, Autor says. Given the way
America’s temporary workforce keeps growing, there may be plenty of those
numbers for Autor to scrutinize in the future.
Continued in article
Goodwill Impairment and Liabilities Contingent Upon Uncertain Politics of
the Future
Lehman bought back 100% of its Repo 105/108 poison with the auditor's
blessing that these were truly sales
http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst
Bank of America, however, is resisting buying back its dumping off of poisoned
securities
Wouldn't it be a kick if tens of thousands of local Main Street banks and
mortgage companies had to buy back their fraudulent mortgages sold down stream
to Fannie, Freddie, etc.?
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 22, 2010
BofA Resists Buying Back Bad Loans
by: Dan Fitzpatrick
Oct 20, 2010
Click here to view the full article on WSJ.com
TOPICS: Bad Debts, Banking, Flexible Spending Accounts, Loan Loss Allowance
SUMMARY: Bank of America Corp. "..vowed to fight government backed demand
that it repurchase loans that allegedly didn't meet underwriting guidelines
and other promises." Those demanding the repurchases include Freddie Mac and
Fannie Mae as well as other investors such as the Federal Reserve Bank of
New York, Neuberger Bergman Group, BlackRock Inc., Western Asset Management
Co. and Pacific Investment Management Co, or Pimco. These demands were the
first time that Fannie and Freddie have attempted to force banks to buy back
mortgage-backed securities that were issued by Wall Street, not by Freddie
and Fannie themselves. BofA made these statements as it reported a $4.3
billion loss, primarily stemming from a goodwill charge related to a decline
in value of its credit card business that the company says stems from
regulatory changes; otherwise, the company would have earned $3.1 billion.
CLASSROOM APPLICATION: The article covers loan losses and a goodwill
impairment charge, useful for covering these topics in a financial reporting
class.
QUESTIONS:
1. (Introductory) What are mortgage-backed securities? Why might Bank of
America be forced to repurchase these securities or their underlying loans?
2. (Introductory) What is BofA saying it will do in response to investor
requests to repurchase these loans?
3. (Introductory) Refer to the related article and describe the response to
BofA's announcement. In your answer, define the terms Freddie Mac, Fannie
Mae, and government sponsored entities (GSEs).
4. (Advanced) Describe in general the factors that lead to a goodwill
impairment charge. What accounting codification section addresses these
requirements?
5. (Advanced) Access the BofA filing on Form 8-K of the earnings press
release on October 19, 2010, available at http://www.sec.gov/Archives/edgar/data/70858/000119312510231353/0001193125-10-231353-index.htm
It is also available by clicking on the live link to Bank of America in the
online version of the article, then clicking on SEC filings on the left hand
side of the page, then clicking on Form 8-K filed on October 19, 2010.
Review the selected slides used to facilitate the earnings release
conference call with analysts. Describe the goodwill charge.
6. (Advanced) How does a goodwill impairment charge result from "diminished
future debit card profitability"?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Regulator for Fannie Set to Get Litigious
by Nick Timiraos
Oct 21, 2010
Online Exclusive
"BofA Resists Buying Back Bad Loans," by: Dan Fitzpatrick, The Wall Street
Journal, October 20, 2010 ---
http://online.wsj.com/article/SB10001424052702304510704575561763244413610.html?mod=djem_jiewr_AC_domainid
Bank of America Corp. and some of its largest
mortgage investors clashed on Tuesday as the bank vowed to fight
government-backed demands that it repurchase loans that allegedly didn't
meet underwriting guidelines and other promises.
The bank acknowledged receiving a Monday letter
from investors alleging that a Bank of America unit didn't properly service
115 bond deals. The investors include Freddie Mac, the government-owned
mortgage company. Freddie Mac and Fannie Mae, its larger sibling, have
boosted demands on lenders over the past year to buy back defaulted loans
that had been sold to and guaranteed by the mortgage titans.
Now Reporting Track the performances of 150
companies as they report and compare their results with analyst estimates.
Sort by reporting date and industry. .More Heard: BofA Is Bracing for a Long
War BofA Sues FDIC Over Mortgage Losses Custody Banks Rebound BofA: Not
Worried on Mortgages Buyback .But Tuesday's action marks the first step by
either company to force banks to buy back mortgage-backed securities that
were issued by Wall Street, not by government-backed mortgage giants.
Other investors, some of whom were acting on behalf
of their clients, include the Federal Reserve Bank of New York, Neuberger
Berman Group LLC, BlackRock Inc., Western Asset Management Co. and Allianz
SE's Pacific Investment Management Co., or Pimco, according to people
familiar with the matter.
The Charlotte, N.C., bank hoped the lifting of its
foreclosure sale moratorium would debunk fears that the mortgage process was
flawed. But investors grappled with new concerns Tuesday that the bank could
be overwhelmed with investor requests to repurchase flawed mortgages made
before the U.S. housing collapse. Its shares dropped 54 cents or 4.4% to
$11.80. The shares have declined more than 30% since the end of April amid
worries about regulatory reform, lackluster revenues and weak loan demand.
Experience WSJ professional Editors' Deep Dive:
Banks Face Changing LandscapeFINANCIAL NEWS Banks Must Rethink Their
Strategies .Fund Strategy IMF Warns Finance Is Vulnerable .Financial News
Could Basel III Rescue Banking?. Access thousands of business sources not
available on the free web. Learn More .Chief Executive Brian Moynihan
quickly vowed to push back on the repurchase requests.
"We will diligently fight this," Mr. Moynihan told
analysts Tuesday.
.A spokesman, responding to Monday's letter, added
that "We're not responsible for the poor performance of loans as a result of
a bad economy. We don't believe we've breached our obligations as servicer.
We will examine every avenue to vigorously defend ourselves."
The bank's defiant stance came as it reported a
$7.3 billion loss in the third quarter, or 77 cents per share. The loss was
largely the result of a $10.4 billion goodwill charge tied to a decline in
value of its credit card business. Without the charge, which the company
attributes to a regulatory crimp in its debit-card revenue, the bank would
have earned $3.1 billion.
No U.S. bank is more vulnerable to an array of
political and financial threats posed by home-lending woes. Bank of America
has more repurchase requests than any of its rivals and it services one out
of every five U.S. mortgages, many of them picked up from California lender
Countrywide Financial Corp. in 2008.
Worries about sloppy mortgage underwriting and
servicing practices clouded discussion of the bank's results Tuesday.
The bank on Oct. 1 said it would suspend
foreclosures cases in 23 states where court approval is required and on Oct.
8 said it would halt all foreclosures sales in 50 states. Starting Monday,
the bank will begin resubmitting court documents in the first 23 states
after the company said an internal review of 102,000 cases found no
underlying problems. It and other banks initiated reviews following
revelations that "robo signers" had approved hundreds of foreclosure
documents a day without examining them thoroughly.
Mr. Moynihan said it would take a few more weeks
for the bank to complete its assessment of all 50 states, but so far "we
don't see the issues that people were worried about."
Concerns about the underlying foreclosure documents
amount to "technical issues" that are not a "big deal" for the bank,
although he acknowledged it was a "big issue for people who live in the
homes."
Investors submitted $4 billion in new mortgage
repurchase claims during the third quarter, the bank said. Total claims
amounted to $12.8 billion at the end of the third quarter, up from $7.5
billion in the year-ago quarter. The bank has so far set aside $4.4 billion
in reserves for these putback attempts, including $872 billion in the third
quarter.
A majority of the claims are from Freddie Mac and
Fannie Mae. The bank said it sold $1.2 trillion in loans to the
government-controlled housing giants from 2004 to 2008 and has thus far
received $18 billion in repurchase claims on those loans. The bank has
resolved $11.4 billion of the $18 billion, recording a net loss of $2.5
billion on those putbacks, or 22%.
The bank also could face more losses on claims from
other investors, although Chief Financial Officer Chuck Noski said those
figures are harder to predict.
"This is an area where there is a lot of
speculation and commentary but not a lot of specific claims asserted," he
said in an interview. The bank said it had received $3.9 billion in private
repurchase claims through the end of the third quarter.
Mr. Moynihan said he isn't interested in a large
lump sum payment to make the repurchase issue go away. "We're not going to
put this behind us to make us feel good," he said. "We're going to make sure
that we'll pay when due but not just do a settlement to move the matter
behind us."
Sandler O'Neill + Partners analyst Jeff Harte
said in a note that "the actual level of future repurchase remains both a
key determinant and an unknown." Nomura Securities analyst Glenn Schorr said
in a note it is "tough to convince investors on putback risk."
Some analysts also noted several silver linings in
Bank of America's results Tuesday.
Excluding the $10.4 billion charge, which the bank
attributed entirely to an amendment in the Dodd-Frank financial-overhaul law
that limits debit-card income, the bank's third-quarter results exceeded
Wall Street estimates. Its $3.5 billion in fixed-income revenue also beat
rivals Citigroup Inc. and J.P. Morgan Chase & Co. and credit costs showed
improvement. The amount the bank set side for future loan losses was $5.4
billion, compared with $11.7 billion a year ago.
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 22, 2010
BofA is Bracing for a Long War
by: David Reilly
Oct 20, 2010
Click here to view the full article on WSJ.com
TOPICS: Banking, Loan Loss Allowance, Securitization
SUMMARY: David Reilly, the author of this article, analyzes the loan loss
reserves and potential loan write-offs facing Bank of America(BofA). These
assessments are based on information in the BoA earnings release and
presentation slides prepared for the related conference call with analysts.
The graphic associated with the article shows the large size of the reserve
balance at the end of the third quarter relative to past quarters.
CLASSROOM APPLICATION: The article is useful to discuss both the latest
developments in the mortgage and banking crisis and then to thoroughly
analyze loss reserves and bank warranties made on securitized loan
portfolios.
QUESTIONS:
1. (Introductory) By how much did BoA stock drop on announcement of the
investor push for the big bank to buy back mortgage loans sold off as
mortgage-backed securities? How much has it dropped since last spring?
2. (Introductory) What are the efforts of investors who bought loans or
mortgage-backed securities made by BofA? In your answer, describe your
understand of the process for selling mortgage-backed securities.
3. (Advanced) Access the BofA filing on Form 8-K of the earnings press
release on October 19, 2010, available at http://www.sec.gov/Archives/edgar/data/70858/000119312510231353/0001193125-10-231353-index.htm
It is also available by clicking on the live link to Bank of America in the
online version of the article, then clicking on SEC filings on the left hand
side of the page, then clicking on Form 8-K filed on October 19, 2010.
Review the selected slides used to facilitate the earnings release
conference call with analysts. What points in the discussion in this article
are taken from those slides?
4. (Advanced) Focus on the author's analysis of BoA sales to Fannie Mae and
Freddie Mac from 2004 to 2008. How does the author use that information to
estimate the impact of possible repurchases and subsequent write-offs of MBS
sold to private investors?
5. (Introductory) What does the author conclude in this article?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
BofA Resists Buying Back Bad Loans
by Dan Fitzpatrick
Oct 20, 2010
Page: C1
"BofA is Bracing for a Long War," by: David Reilly, The Wall Street
Journal, October 20, 2010 ---
http://online.wsj.com/article/SB10001424052702304510704575562611959168200.html?mod=djem_jiewr_AC_domainid
Brian Moynihan seemed to be channeling Winston
Churchill on Tuesday. Describing how Bank of America will deal with
mortgage-bond holders trying to force it to repurchase loans, he made clear
the bank shall fight, fight and fight in court.
"We have thousands of people willing to stand and
look at every one of these loans," the chief executive declared on the
bank's earnings call.
Judging by the 4.4% drop in BofA's stock, the tough
talk didn't convince investors. After all, mortgage-bond holders, including
the Federal Reserve Bank of New York, are ratcheting up efforts to return
more loans to the bank as "put-backs." And Mr. Moynihan's chances of winning
this war depend on knotty legal issues related to questions over loan
ownership or the terms on which mortgages were sold to investment pools.
News Hub: BofA Braces for Long Foreclosure War 3:10
David Reilly discusses Bank of America's continuing
foreclosure battle. .Even so, Mr. Moynihan's stance should be taken
seriously. Bank of America, like other big banks, has the resources and the
ability to drag the legal fight out for years. That should reassure the
bank's shareholders. Not only could a war of attrition wear out opponents,
who already face significant legal hurdles in attempts to bring actions, but
it means losses connected to repurchased loans may be stretched over many
years and may not ultimately be as severe as some investors fear.
Tuesday, Bank of America tried to address
shareholder angst by laying out its experience with repurchase claims. That
should help investors think through some scenarios for new claims.
From 2004 to 2008, Bank of America said it sold
$1.2 trillion in loans to Fannie Mae and Freddie Mac. It has received
repurchase requests for $18 billion and believes this represents two-thirds
of expected claims. That would put total expected claims at about $27
billion, or 2.25% of the total. Of loans repurchased, Bank of America
sustained losses of 22%.
Bank of America also sold $750 billion in loans to
private investors, which may become subject to new repurchase claims. It
said 40% have already paid off.
Say, for example, that repurchase requests on the
still-outstanding $450 billion in these loans run at 10 times the rate of
those sold to Fannie and Freddie. That would put repurchase requests at
about $100 billion. Assume, then, that half the requests were approved and
losses ran at 30%. The result would be a hit of about $15 billion.
While a blow, it should be manageable, especially
if spread over four or five years. What's more, Bank of America has already
lost about $15 billion in market value since announcing it would temporarily
halt foreclosures.
Granted, Bank of America and peers still face
plenty of unknown legal risks related to loan ownership and securitization.
But, for now, the market looks to have already priced in much of the risk
facing Bank of America.
Bob Jensen's threads on goodwill impairment are at
http://faculty.trinity.edu/rjensen/theory01.htm#Impairment
Bob Jensen's threads on intangibles and contingencies are at
http://faculty.trinity.edu/rjensen/theory01.htm#TheoryDisputes
"The Financial Reform Law: A 'Fig Leaf' It won't prevent bad bets by
banks, and hence won't prevent the next financial crisis, say the experts,"
by Christine Harper and Bradley Keoun, Business Week, July 1, 2010 ---
http://www.businessweek.com/magazine/content/10_28/b4186042369207.htm?link_position=link3
The financial reform bill will change the way banks
do business in everything from credit cards to credit default swaps. What it
won't do is fundamentally reshape Wall Street, and it doesn't seem likely to
prevent bad bets by bankers from causing another crisis. The legislation is
"largely a fig leaf," says Dean Baker, co-director of the Center for
Economic & Policy Research in Washington. "Given where we were when this got
started, I'd have to imagine the Wall Street firms are pretty happy."
The overhaul allows banks to remain in the
profitable derivatives business and won't shrink those deemed "too big to
fail," leaving largely intact a U.S. financial industry dominated by six
companies with a combined $9.4 trillion of assets. The changes also do
little to address the danger posed by banks relying on the fickle credit
markets for funding that can evaporate in a panic, like the one that spread
in late 2008.
A deal reached by members of a House and Senate
conference just after dawn on June 25 diluted provisions from the tougher
Senate bill, limiting rather than prohibiting the ability of banks to trade
derivatives and invest in hedge funds or private equity funds. Senator Scott
Brown (R-Mass.) made his support conditional on a loosening of restrictions
on hedge fund and private equity fund ownership by banks. Brown won another
concession when he demanded that the committee remove a $19 billion fee on
banks and hedge funds that had been tacked on at the last minute. The June
28 death of Senator Robert C. Byrd (D-W. Va.), who supported the bill, means
a final vote won't take place until mid-July.
Senator Blanche Lincoln (D-Ark.) had originally
advocated forbidding banks from trading swaps if they receive federal
support such as deposit insurance. That could have forced banks to spin off
those businesses. In the final legislation, bank holding companies such as
JPMorgan Chase (JPM) and Citigroup (C) will be required to move less than 10
percent of the derivatives in their deposit-taking banks to a broker-dealer
division over the next two years. Goldman Sachs (GS) and Morgan Stanley
(MS), the two biggest U.S. securities firms before they converted into banks
in 2008, have smaller deposit-taking units and already hold most of their
derivatives in their broker-dealer arms. The derivatives rules are "nowhere
near as bad as what the banks might have feared," William T. Winters, former
co-chief executive officer of JPMorgan's investment bank, told Bloomberg
Television on June 25.
Another portion of the legislation that was amended
in the final conference was the so-called Volcker rule, named for Paul A.
Volcker, the former Federal Reserve chairman who championed it. Originally
the rule would have prevented any systemically important bank holding
company from engaging in proprietary trading, or betting with its own money,
as well as investing its own capital in hedge funds or private equity funds.
In the final version, the banks will be allowed to
provide no more than 3 percent of a fund's equity and will be limited to
investing up to 3 percent of their Tier 1 capital—which includes common
stock, retained earnings, and some preferred stock—in hedge funds or private
equity funds. That represents a ceiling of about $3.9 billion for JPMorgan,
$3.6 billion for Citigroup, and $2.1 billion for Goldman Sachs, according to
the companies' latest quarterly reports.
Further diluting its impact, the Volcker rule
doesn't take effect for 15 to 24 months after the law is passed. Then the
banks have two years to comply, with the potential for three one-year
extensions after that. They could seek five more years to withdraw money
from funds that invest in "il- liquid" assets such as private equity and
real estate, says Lawrence D. Kaplan, an attorney at Paul, Hastings,
Janofsky & Walker in Washington. "I don't think it will have any impact at
all on most banks," Winters said of the amended Volcker rule.
Some provisions of the new law may require banks to
raise more capital as a buffer against setbacks. But they will still be able
to borrow heavily in the short-term credit markets to fund their operations,
rather than rely on deposits, which are more stable. Their dependence on
market-based funding made firms like Goldman Sachs and Morgan Stanley
vulnerable to the panic of 2008. "Something has to be put in place to cause
banks to have deposit-based liabilities and not market-based liabilities,"
says Benjamin B. Wallace, a securities analyst at money manager Grimes & Co.
The legislation will make the financial system
safer, says James Ellman, president of Seacliff Capital, a hedge fund that
specializes in financial industry stocks. Even so, he says, "It won't
satisfy anybody who wanted really strict additional regulation of banks."
The bottom line: The financial reform bill imposes
a raft of new rules, but critics say it does not go to the heart of the
problems that created the crisis.
Bob Jensen's threads on the current financial crisis and its aftermath ---
http://faculty.trinity.edu/rjensen/2008bailout.htm
A surprising editorial from the Editors of
The Wall Street Journal
"Obama v. Wall Street The President gets serious about moral hazard," The
Wall Street Journal, January 22, 2010 ---
http://online.wsj.com/article/SB10001424052748703699204575017341468635052.html#mod=djemEditorialPage
President Obama and Democrats have settled on
demonizing Wall Street as a campaign theme for November's elections. If
history is any guide, Mr. Obama and New York Senator Chuck Schumer will now
persuade Wall Street to underwrite this campaign. Ah, the politics of hope
and change. How refreshing.
Phony populism aside, yesterday Mr. Obama
introduced his first serious idea into the debate on reforming the financial
system. In calling for an end to proprietary trading at firms with a federal
safety net, the President showed that he now understands an important
principle: Risk-taking in the capital markets is incompatible with a
taxpayer guarantee.
Under the President's still-sketchy plan, firms
that hold government-insured deposits or are eligible to receive cheap loans
in an emergency from the Federal Reserve would not be able to trade for
their own accounts. The firms could facilitate customer orders as brokers
have always done and continue to underwrite new issues of stocks and bonds,
but they could not make bets with their own capital or own or invest in
hedge funds.
Yesterday's announcement is a critical departure
from the reform plan Mr. Obama introduced last year—largely incorporated in
the House and Senate bills written by Barney Frank and Chris Dodd. Those
plans all sought to expand the universe of too-big-to-fail companies
eligible for taxpayer rescue. Mr. Obama has at last joined the most
important policy discussion: How to eliminate the moral hazard now embedded
in the U.S. financial system. Political assaults on banker compensation have
done nothing to address this core problem that enables gargantuan bonuses.
The days ahead will demonstrate whether Mr. Obama
is serious, or if this is merely a political tactic to encourage Republicans
to defend big banks. If he's serious, he will add to his plan a taxpayer
exit strategy from the most expensive bailouts—at Fannie Mae and Freddie
Mac.
He'll also soon realize that while his plan raises
the right questions, its details will be crucial. Since there's a
counterparty on the other end of every trade made by Goldman Sachs, it won't
always be easy to discern trades made for customers versus those made for
Goldman.
More fundamentally, even if the logistics can be
mastered, the President's plan would not have prevented the credit chaos of
2008. Bear Stearns was not a bank, could not borrow from the Fed's discount
window and wasn't even all that big, yet the government still wouldn't let
it fail. Under Mr. Obama's new rules, Goldman might simply decide to sell
its bank—yet investors and its own traders would still assume it is too big
to fail. That problem still needs to be addressed.
Mr. Obama also keeps peddling the illusion that the
entire crisis was caused by the bankers. But the root cause was a credit
mania, courtesy of the Federal Reserve. The mania was concentrated in the
housing market, courtesy of Congress and several Presidential
Administrations.
If we are going to have a Fed and a political class
as reckless as we have, then we need a more comprehensive answer to
financial risk. Bankruptcy for risk-takers who bet wrong is the best option.
Barring that, strict limits on margin and leverage, especially for holders
of insured deposits, can be helpful. Mr. Obama's suggestion yesterday of
limits on the size of financial firms—with the limits still to be
determined—deserves a hearing but would seem more problematic.
Still, we're encouraged by yesterday's
announcement. The Democrats appear to finally realize that too-big-to-fail
is a problem to be solved, not the foundation of a modern banking system.
Jensen Comment
Now let's hope our President sends out the same moral hazard message about
Fannie and Freddie! ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
"The Great Recession Continues:
Americans haven't been fooled by the Dow's rise.
What they see ahead are more taxes,"
by Mortimer Zuckerman, The Wall Street Journal, January 21, 2010 ---
http://online.wsj.com/article/SB10001424052748703837004575013592466508822.html?mod=djemEditorialPage
The December jobs report has doused the hope that
we were at the beginning of a sustained economic recovery.
The unemployment rate managed to hold at 10% in
December only because of an extraordinary shrinkage in the labor force: Some
661,000 gave up looking for a job.
Bureau of Labor Statistics' (BLS) nonfarm payroll
data indicate that December job losses totaled 85,000. But the bureau's
household survey, a better and more comprehensive measure of both the
unemployed and underemployed, indicated a loss of 589,000 jobs. Since the
Great Recession began in 2007, some 8.6 million jobs have been lost,
according to the bureau; and small businesses, the normal source for new
jobs, are still shedding workers. Fewer than 10% added employees, while more
than 20% cut back—and the cuts averaged nearly twice as many per firm as the
hires at the expanding companies.
Unemployment, in short, has graduated from being a
difficulty, a worry. It is now a catastrophe, with some 15.3 million
Americans out of work, according to the BLS.
What about the future? The problem in the job
market going forward is not so much layoffs in the private sector, which are
abating, but a lack of hiring. The federal stimulus program is offset by a
2010 budget shortfall for state, city, county and school districts, which
the Center on Budget and Policy Priorities recently estimated will be in the
range of an astonishing $200 billion nationally. Since virtually all states
and cities have to run balanced budgets, the result will be reduced
services, layoffs and tax hikes.
The consequence is that the U.S. economy—for
decades the greatest job creation machine in the world—is taking longer and
longer to replace the jobs already lost. In the 1970s and 1980s, Jane
Sasseen noted in a recent report in BusinessWeek, it took as little as one
year from the end of a recession to add back the lost jobs. After the
eight-month downturn ending in March of 1991, for example, jobs came back in
23 months. After the downturn from the dot-com bust in 2001, it took 31
months. This time it could take as many as five years or even more to
recover all of the eight-plus million jobs lost since March 2007. That's
because we would have to create an additional 1.7 million jobs annually
beyond those for the 1.3 million new people who enter the work force every
year.
Economists may see the recession as being over, but
the man on the street does not. Roughly 60% of the public believes the
recession still has a way to go, a NBC/Wall Street Journal poll reported
last October. Even those who have not suffered know someone—a friend, a
neighbor, a family member—who is being hurt. Two in three say the rally in
the stock market has not changed their views.
There are sound reasons for this gloom. Consumers
have learned a bitter lesson. They understand that increased
consumption—private and public—will have to come from income and not
borrowing, and income will have to come from employment.
Today, mainstream Americans are going on a
financial diet amid deteriorating family finances. They know now that they
cannot spend what they don't have, as the painful consequences of spending
levels that were artificially pumped up by too much debt have hit home. The
top 20% of the nation's households account for 40% of all spending,
according to government data reported by Ylan Q. Mui in the Washington Post
last September. But these households no longer trust their home equity or
rising stock portfolios (up by almost $5 trillion this past year) as a basis
for spending in lieu of saving. All they see ahead are taxes, taxes, taxes.
So the dollars have not yet started to flow. This is the new normal.
What this means is that larger-than-typical head
winds face two of the three normal engines of recovery: consumption and
residential investment. Rather than pumping more cash into a fragile economy
to make up this difference, the government will have to focus on its next
big task: drawing up credible plans for bringing bloated budget deficits
under control without triggering another downturn.
The prospect, therefore, is sluggish GDP growth;
employment gains that are too slow to prevent further increases in the
unemployment rate; and firms still very reluctant to hire vigorously.
How can we accelerate a substantial recovery in job
growth that will generate additional labor income? There is no snap answer.
But this is no argument for inertia.
We must have programs that create some degree of
confidence that America can be rebuilt, and jobs can be created, especially
since consumer spending will likely decline as a part of GDP for many years.
The unemployed have to be supported. But it would be better if the financial
support employed labor in rational, long-term, major infrastructure
projects, processed by a newly created National Infrastructure Bank.
These wouldn't be entitlement programs, but
regeneration programs. Government spending on infrastructure
projects—broadband Internet access across the nation, restoring decaying
bridges and canals, building high-speed railways, modern airports, sewage
plants, ports—has a high multiplier effect for adding jobs to the economy.
And we will be fulfilling a desperate national need.
A second avenue for increasing employment would be
to enhance technology, the area of our greatest strength. We are depriving
ourselves of productive talent by a fearful attitude toward immigration. We
make it hard for bright people to come and we make it hard for them to stay,
so once they have graduated from our universities they go home to work for
our competitors. This is not the way to run a railroad.
Foreign students are a significant proportion of
those with graduate degrees in the hard sciences in American universities.
We should restore the quotas for H-1B visas to 195,000 annually (where it
was in the early 2000s) from 65,000, where it is now.
This increase has been blocked by shortsighted
special-interest groups that fear jobs will be taken from Americans. On the
contrary. The kind of people we should be striving to keep are those whose
work in technology and engineering provides more than their share of new
jobs.
Technology and innovation have long given us our
greatest job growth. Just think: In 1800, about three-quarters of the U.S.
labor force was devoted to agriculture. Today, it is less than 3%.
Manufacturing employed one-third of the work force at the end of World War
II. Today, it is down to about one-tenth. Americans are accustomed to
economic transformation.
We must follow rational economic policies in the
interest of the nation and not in the interest of narrow parochial groups
who lobby legislators. Otherwise, as illustrated by the sorry journey of
health-care legislation, we will see more of the politics of corruption.
Mr. Zuckerman is chairman and editor in chief of U.S. News & World
Report.
"A Non-Delirious New York Recovery
should not mean a return to the excess that betrayed so many," by Mark
Halprin, The Wall Street Journal, January 21, 2010 ---
http://online.wsj.com/article/SB10001424052748703699204575017040112575022.html#mod=djemEditorialPage
Midway between the first intoxications of borrowed
money that does not exist, and the red-hot bearings of presses that roll to
correct such inconsistencies, lies a wonderland in which human nature can
become a subsidiary of the making and spending of money. Not steadily and
honorably in furtherance of well being, charity, and art, but at the speed
of summer lightning and for its own sake.
When pay-out exceeds pay-in, balance is maintained
only by the weight of illusion—as in real-estate bubbles, or welfare states
in which benefits vastly exceed contributions. Within such failing systems
one finds nevertheless highly visible concentrations of wealth, like lumps
in tapioca, that persist in setting a tone that has long gone flat.
Take Manhattan, but first take the Hamptons, where
symptoms are readily apprehended, just as the pulse at the wrist is a
telltale of the heart. Mere multimillionaires cannot afford anymore to go
where within living memory actual people made a living from the farms, clam
beds, and sword-fishing grounds. Now the potato fields are covered with
houses that look like the headquarters of Martian expeditionary forces,
ice-cream factories, vacuum cleaners on stilts, the Seagram building on its
side, or shingled New England cottages monstrously swollen into something
you might see after eating a magic mushroom. In simple and quiet towns that
once deferred to the majesty of the ocean, the streets are now clogged with
a kabuki theater of Range Rovers and $35,000 handbags.
In Manhattan the knock-the-wind-out-of-you rich
used to be a relatively silent freak of nature who could easily be ignored,
but of late they are so electrically omnipresent, jumping out of every flat
screen and magazine, that they indelibly color the life of the city. Having
multiplied like Gucci-clad yeast, they have become objects of impossible
envy.
You cannot ignore them as you sit in your $2,000 a
month 7 x 10 "efficiency," eating your $5 street pretzel. Or when private
schools—where scholarships are reserved for peasants who subsist on $300,000
or less, and where if you haven't been admitted by the time you're an embryo
you're toast—have become like the class redoubts of Czarist Russia.
Or when Mayor Michael Bloomberg spends a hundred
million of his own money, $175 per vote, to crown himself like Napoleon,
perhaps forgoing the purchase of the presidency because at that rate he
would have to fork over $22 billion. What if he had spent comparably to his
predecessors—Fiorello La Guardia, or even Jimmy Walker, whose corruption
when compared to Mr. Bloomberg's well-established honesty seems nonetheless
like the innocence of a fawn? (It is possible that he would not have won on
his own merits.)
Ostentation has always been a hallmark of mankind,
and part of the price of freedom and power in ascendant nations. But the day
the baubles shine most brilliantly is the day when the civilization,
distracted from what made it, begins to go down the drain. This is not an
argument for restricting economic liberties, but rather a lamentation of
circumstance and a condemnation of taste. The right may envy by competition
and the left by expropriation, but the objects of such envy are not worthy
of its ruinous influences, and the city is at its best when the fury of
acquisitiveness is least.
Now that New York may be exiting yet another of
many eras of irrational exuberance, it presents an opportunity in the midst
of defeat, for when it is quiet it is far more lovely and profound than when
it is delirious. For a long, clear moment, September 11 blew the dross away
and the real city appeared. When such things arrive, as they always have and
always will—whether in the form of conquest, riots, depression, epidemics,
or war—they and their aftermath should be the cause of reflection.
Whenever New York has endured a blow, its real
strengths have emerged. If it is now on the verge of a long-term diminution
of wealth, or at least a roughly attained sobriety, all the suffering should
not be for nothing. Recovery should mean not just a return to the
fascination with excess that betrayed so many. For one, excess is too
limited a thing to be genuinely satisfying. Grab the first billionaire you
see (it should be easy) and he will tell you that stuff simply doesn't do
the trick.
This is why New York has for too long been a city
in which even the rich are poor. To the contrary, it should be a place in
which even the poor are rich. How to accomplish this is a riddle to which
public policy often proves inadequate and is anyway just a distant follower
of forces of history that assert themselves as far beyond its control as the
weather. As the waves of history sweep through the present what they leave
will depend in large part upon how they are perceived and how each
individual acts upon his perceptions, which law and regulation follow more
than they shape.
How things will turn out is anyone's guess, but it
would be nice if, as in the quiet during and after a snow storm, Manhattan
would reappear to be appreciated in tranquility; if cops, firemen, nurses,
and teachers did not have to live in New Jersey; if students,
waitress-actresses, waiter-painters, and dish-washer-writers did not have to
board nine to a room or like beagles in their parents' condominia; if the
traffic on Park Avenue (as I can personally attest it was in the late 1940s)
were sufficiently sparse that you could hear insects in the flower beds; if
to balance the frenetic getting and spending, the qualities of reserve and
equanimity would retake their once honored places; if celebrity were to be
ignored, media switched off, and the stories of ordinary men and women
assume their deserved precedence; and if for everyone, like health returning
after a long illness, a life of one's own would emerge from an era
tragically addicted to quantity and speed.
Mr. Helprin, a senior fellow at the Claremont Institute, is the author
of, among other works, "Winter's Tale" (Harcourt), "A Soldier of the Great
War" (Harcourt) and, most recently, "Digital Barbarism" (HarperCollins).
Bank regulators report more than half of modified mortgages back in
default six months after modification
U.S. Department of the Treasury, Third Quarter 2009
Mortgage Metrics ---
http://www.occ.treas.gov/ftp/release/2009-163a.pdf
"Obama vs. the Banks: Why make risky loans when you can
exploit the Fed-Treasury interest rate spread?" by Gerald P. O'Driscoll,
Jr., The Wall Street Journal, December 16, 2009 ---
http://online.wsj.com/article/SB10001424052748704398304574597910616856696.html#mod=djemEditorialPage
Over the weekend, President Barack Obama went on
the offensive against Wall Street for not lending more to Main Street. On
CBS's "60 Minutes," the president declared, "I did not run for office to be
helping out a bunch of fat cat bankers on Wall Street." He was joined on the
Sunday morning circuit by his chief economic adviser, Lawrence Summers, who
echoed the message of intimidation.
Wall Street fat cats are always a convenient
political target, but bankers are responding to the incentives generated by
the economic policies of the Treasury and the Federal Reserve. First and
foremost is the Fed's policy of near-zero interest rates.
What this means is that banks can raise short-term
money at very low interest rates and buy safe, 10-year Treasury bonds at
around 3.5%. The Bernanke Fed has promised to maintain its policy for "an
extended period." That translates into an extended opportunity for banks to
engage in this interest-rate arbitrage.
Why would a banker take on traditional loans, which
even in good times come with some risk of loss? In today's troubled times,
only the best credits will be bankable. Meanwhile, financial institutions
are happy to service their new, best customer: the U.S. Treasury. That play
on the yield curve is open to banks of all sizes.
The Fed's policy makes sense if the goal is
restoring bank profitability by generating cash flow. It is a terrible
policy if the goal is fueling small business, the engine of economic growth
and job creation. Large, nonfinancial corporations have access to banks.
They can also tap the public credit markets and have access to internally
generated funds. Not so for small business, which depends heavily on banks
for credit.
Since the financial crisis began, the Fed has
worked in tandem with the Bush/Paulson Treasury and now with the Obama/Geithner
Treasury. One must assume its policies have the administration's approval.
That puts the administration's policies at war with its stated goals. Larry
Summers is a first-rate economist and must understand the economic
incentives those policies have created. In short, the weekend interviews,
along with the president's meeting with bankers on Monday, was political
theater.
While the public is upset with $10 million to $20
million banker bonuses, public policy should focus on what is generating
them. The largest banks have had their risk appetites whetted. They are not
looking to traditional lending, but to proprietary trading and a renewed
commitment to innovative financial products. But as Obama adviser and former
Fed Chairman Paul Volcker noted, financial products such as credit default
swaps and collateralized debt obligations brought the economy to the brink
of disaster. It is excessive risk-taking by Wall Street that is generating
the profits from which the bonuses are being paid. Curb the former and you
curb the latter without government planning of banker pay.
Has recent experience taught the leaders of large
financial institutions the need to curb their risk appetite? Not really. The
lesson they have learned is that presidents of both parties, the Fed and
Congress will come to their rescue when they get in trouble. Under a vague
set of ideas, scarcely a theory, some banks are viewed as too big to fail.
They will be propped up, bailed out and generally protected from the
consequences of their own bad decisions. That generates incentives to engage
in excessively risky activities.
A few bankers lost their jobs or quit in the
aftermath of the financial crisis, but that small risk is evidently one most
of Wall Street's fat cats will accept. Mr. Obama may not have run for
president in order to reward them, but that is the effect of his policies.
Sending scarce resources to major banks in the form
of funds from the Troubled Asset Relief Program (TARP), ultra-low interest
rates, and the Fed's targeted credit schemes has diverted needed capital
from real, productive activity. Now the politicians feel the public's anger
and are complaining about the lack of lending and the size of executive
compensation. If Congress wanted banks to lend and to limit pay packages, it
should have put those in as conditions in the TARP legislation.
The TARP was hastily arranged, poorly designed and
badly executed. Nonetheless, Congress acted in haste and now gets to repent
at leisure. Meanwhile, the totality of the policies to aid the major
financial institutions is delaying the recovery of the broader U.S. economy
and the hiring of its unemployed workers.
Mr. O'Driscoll, a senior fellow at the Cato
Institute, was formerly a vice president at the Dallas Federal Reserve Bank
and a vice president at Citigroup.
"Obama Administration Steers Lucrative No-Bid Contract for Afghan Work to
Dem Donor," Free Republic, January 25, 2010 ---
http://www.freerepublic.com/focus/f-news/2436733/posts
Despite President Obama's long history of
criticizing the Bush administration for "sweetheart deals" with favored
contractors, the Obama administration this month awarded a $25 million
federal contract for work in Afghanistan to a company owned by a Democratic
campaign contributor without entertaining competitive bids, Fox News has
learned. The contract, awarded on Jan. 4 to Checchi & Company Consulting,
Inc., a Washington-based firm owned by economist and Democratic donor
Vincent V. Checchi, will pay the firm $24,673,427 to provide "rule of law
stabilization services" in war-torn Afghanistan.
"Big government's business cronies," by John Stossel, WorldNetDaily,
February 3, 2010 ---
http://www.wnd.com/index.php?fa=PAGE.view&pageId=123960
Many window-making companies struggle because of
the recession's effect on home building. But one little window company,
Serious Materials, is "booming,"
says Fortune. "On a roll," according to Inc.
magazine, which put Serious' CEO on its cover, with a story titled:
"How to Build a Great Company."
The
Minnesota Freedom Foundation tells me that this
same little window company also gets serious attention from the most visible
people in America.
Vice President Joe Biden appeared at the opening of
one of its plants. CEO Kevin Surace thanked him for his "unwavering
support." "Without you and the recovery ("stimulus") act, this would not
have been possible," Surace said.
Biden returned the compliment: "You are not just
churning out windows; you are making some of the most energy-efficient
windows in the world. I would argue the most energy-efficient windows in the
world."
Gee, other window-makers say their windows are just
as
energy
efficient, but the vice president
didn't visit them.
Biden laid it on pretty thick for Serious
Materials: "This is a story of how a new economy predicated on innovation
and efficiency is not only helping us today but inspiring a better
tomorrow."
Serious doesn't just have the vice president in his
corner. It's got President Obama himself.
Milton Friedman's classic "Capitalism and Freedom" explains how individual
liberty can only thrive when accompanied by economic liberty
Company board member Paul Holland had the rare of
honor of introducing Obama at a "green energy" event. Obama then said:
"Serious Materials just reopened ... a manufacturing plant outside of
Pittsburgh. These workers will now have a new mission: producing some of the
most energy-efficient windows in the world."
How many companies get endorsed by the president of
the United States?
When the CEO said that opening his factory wouldn't
have been possible without the Obama administration, he may have known
something we didn't. Last month, Obama announced a new set of tax credits
for so-called green companies. One window company was on the list: Serious
Materials. This must be one very special company.
But wait, it gets even more interesting.
On my Fox
Business
Network show on
"crony capitalism," I displayed a picture of
administration officials and so-called "energy leaders" taken at the U.S.
Department of Energy. Standing front and center was Cathy Zoi, who oversees
$16.8 billion in stimulus
funds, much of it for weatherization
programs that benefit Serious.
The interesting twist is that Zoi happens to be the
wife of Robin Roy, who happens to be vice president of "policy" at Serious
Windows.
Of all the window companies in America, maybe it's
a coincidence that the one that gets presidential and vice presidential
attention and a special tax credit is one whose company executives give
thousands of dollars to the Obama campaign and where the policy officer
spends nights at home with the Energy Department's weatherization boss.
Or maybe not.
There may be nothing illegal about this. Zoi did
disclose her marriage and said she would recuse herself from any matter that
had a predictable effect on her financial interests.
But it sure looks funny to me, and it's odd that
the liberal media have so much interest in this one company. Rachel Maddow
of MSNBC, usually not a big promoter of corporate growth, gushed about how
Serious Materials is an example of how the "stimulus" is working.
When we asked the company about all this, a
spokeswoman said, "We don't comment on the personal lives of our employees."
Later she called to say that my story is "full of lies."
But she wouldn't say what those lies are.
On its website, Serious Materials says it did not
get a taxpayer subsidy. But that's just playing with terms. What it got was
a tax credit, an opportunity that its competitors did not get: to keep money
it would have paid in taxes. Let's not be misled. Government is as
manipulative with selective tax credits as it is with cash subsidies. It
would be more efficient to cut taxes across the board. Why should there be
favoritism?
Because politicians like it. Big, complicated
government gives them opportunities to do favors for their friends.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/fraudUpdates.htm
Peter Schiff (another Jensen Hero): "The U.S. economy is not recovering.
All we're doing is spending stimulus money"
"The Future of Gold, the Dollar, and More," by Jennifer Schonberger Motley
Fool, December 11, 2009 ---
http://www.fool.com/investing/general/2009/12/11/the-future-of-gold-the-dollar-and-more.aspx
The dollar has had a huge effect on the
stock market's moves this year. As the dollar has depreciated, many stocks
have climbed higher; the logic is that a weaker dollar will boost the bottom
lines of companies such as McDonald's (NYSE: MCD), Aflac (NYSE: AFL), and
Coca-Cola (NYSE: KO), all of which derive a substantial portion of their
revenues from abroad. The depreciating dollar has also boosted commodity
prices and associated commodity stocks such as Freeport-McMoRan (NYSE: FCX)
or Newmont Mining (NYSE: NEM), serving to lift the market.
As we approach 2010, what is the future of
the dollar, and what are the implications for the asset prices that move
inversely to it? What does it all mean when it comes to rebalancing the
global economy and our economic relationship with China?
For some insight on all this, I spoke with
the man who had the foresight to call the financial meltdown in 2006: Peter
Schiff, president and chief global strategist of Euro Pacific Capital and
author of the newly updated book Crash Proof 2.0.
Schiff believes the dollar is on a
long-term downward trajectory, and that it could collapse if the government
continues its current policies. That has implications for the stock market
and gold, which he thinks could go to $5,000 an ounce.
Here's an edited transcript of our
conversation:
Jennifer Schonberger: You've been bearish
on the dollar for some time. Do you still stand by your bearish call for the
greenback?
Peter Schiff: Yes. I think the dollar is
going to fall for years. It's not going to fall every day, or every week.
There are going to be periods of time where the dollar rallies -- that's how
markets work. Like a bull market climbs a wall of worry, a bear market
follows a slope of hope. And there's always going to be hope that the dollar
is going to recover, based on "maybe the Fed will raise interest rates,"
"maybe the U.S. economy will improve." But none of that is going to help the
dollar. I think the dollar's fate has been sealed by the policies being
pursued by the government and the Federal Reserve, and unfortunately it's a
grim fate.
Schonberger: If the dollar does remain
weak, as you expect, what are the implications in terms of rebalancing the
global economy?
Schiff: Part of rebalancing the global
economy is going to necessitate a lower dollar. The reason the global
economy is so out of balance is because the dollar is artificially strong.
It's been propped up by foreign central banks, and this enables Americans to
import products they really can't afford. So if we want the global
imbalances to be solved, it's going to require a lower dollar -- and that's
what's going to happen. The longer foreign central banks artificially prop
up the dollar, enabling Americans to keep spending borrowed money, the worse
the global imbalances are going to get.
Schonberger: You recently wrote, "While
[China's] peg [to the U.S. dollar] certainly is responsible for much of the
world's problems, its abandonment would cause severe hardship in the United
States." Why?
Schiff: It would cause hardship in the
U.S., but it's something that we have to deal with sooner rather than later.
By propping up the U.S. dollar and by carrying U.S.-dollar-denominated debt
-- U.S. Treasuries, mortgage-backed securities -- the Chinese have kept
interest rates and consumer prices artificially low. Americans have been
able to benefit from that in the short run because their mortgages, car
payments, and credit card payments are lower. They can go to stores like
Wal-Mart (NYSE: WMT) and get those everyday low prices. But those prices
aren't because of Wal-Mart, they're because of China.
When the Chinese government removes all
those subsidies, there's going to be an immediate benefit to the Chinese
people, because they're suddenly going to see lower prices and more access
to capital. In America, we're going to have the rug pulled out from under us
...
Schonberger: The dollar is central to the
relationships of other assets' prices. There is an inverse relationship
between the dollar and equities. Do you expect that linkage (between the
dollar and equities) to continue into next year?
Schiff: Remember, there's an inverse
relationship between the dollar and the price of everything, because as the
dollar loses value, you need more dollars to buy anything. That's true for
an ounce of gold, a barrel of oil, a bushel of wheat, or shares of stock. So
you're always going to see prices rising as the dollar is falling. That's
what's happening now.
Now at some point, inflation could be so
problematic that it drives interest rates up substantially, and as inflation
gets bigger and bigger, the prices that tend to react more quickly will be
things like food and energy. So if U.S. corporations suddenly see the cost
of their long-term debt or short-term debt jump up and their customers don't
have any money to buy their products because they're spending all their
money on food, then ultimately you could see falling stock prices as the
dollar is falling.
Schonberger: Speaking of relationships,
you expect gold to go to $5,000 an ounce, correct?
Schiff: Yeah. It could go higher than
that, but I think $5,000 is a reasonable expectation of where gold is headed
over the course of the next several years, based on monetary and fiscal
policy that is in place. Now if the government were to reverse course -- if
they suddenly brought the budget into surplus, and if the Fed aggressively
raised interest rates back up to a reasonable level, say 5%, 6%, or 7%, not
just a quarter-point every few months -- then gold would probably not get to
$5,000.
But I don't think they're going to do
that. Based on what the Fed is saying and doing, they're going to keep
interest rates at practically nothing for as far as the eye can see. The
U.S. economy is not recovering. All we're doing is spending stimulus money.
The minute you take away the stimulus, all the GDP growth, all the jobs that
are associated with that stimulus spending, will vanish. So they can't take
the stimulus away without destroying the phony recovery. So if interest
rates are going to stay low and they're going to keep printing money, the
only thing that's going to happen is the dollar is going to fall until it
all of a sudden collapses ...
Schonberger: So then you're actually
calling for a collapse in the dollar relatively soon?
Schiff: Relatively soon, yes. Maybe not
tomorrow, but I think it will happen soon. I think it will happen before
Barack Obama leaves office even if he's only a one-termer. The first initial
collapse in the dollar will be about a 50%, 60%, or 70% decline in dollar
value. That collapse will usher in the new leg -- the much more severe leg
of our economic downturn. Not only will we have a financial crisis, but
we'll also have a currency and economic crisis.
Hopefully that will be the tough medicine,
the shock that finally causes Congress and the Fed to abandon its current
policy and start doing the right thing. If it doesn't -- if they respond to
that big drop in the dollar by creating more inflation, and if they fail to
raise interest rates aggressively and withdraw liquidity -- then they will
turn the dollar into confetti. Then we will have hyperinflation. If we go
down that road, gold prices aren't just going to $5,000, they'll go to
$50,000, or $500,000. I hope that cooler heads will prevail before we go
down that road, but from this point that's still a possibility if we don't
change policies.
Bernanke is insanely printing hundreds of millions of dollars that do not
arise from taxes or borrowing
We remember that 2003 debate because it turns out
we played a part in it. The Fed recently released the transcripts of its 2003
FOMC meetings, and what a surprise to find a
Journal
editorial the subject of an insider rebuttal from
none other than Ben Bernanke, then a Fed Governor and now Chairman. We had run
an editorial on monetary policy on the same day as the Dec. 9, 2003 FOMC
meeting, and Mr. Bernanke clearly didn't take well to our warning about "Speed
Demons at the Fed."We reprint nearby both Mr.
Bernanke's comments and
our
editorial from that day. Readers can judge who got
the better of the argument, but far more important is what Mr. Bernanke's
reasoning tells us about the Fed today. Our guess is that it won't reassure
holders of dollar assets
"Bernanke at the Creation: What the Fed Chairman said at the
onset of the credit bubble, and the lesson for today," The Wall Street
Journal, June 23, 2009 ---
http://online.wsj.com/article/SB124572415681540109.html
Failed Banks List as of June 22, 2009 (including 2008 failures) ---
http://www.cnbc.com/id/31049457
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
The legislation's guidelines for crafting the rescue
plan were clear: the TARP should protect home values and consumer savings,
help citizens keep their homes and create jobs. Above all, with the
government poised to invest hundreds of billions of taxpayer dollars in
various financial institutions, the legislation urged the bailout's
architects to maximize returns to the American people.
That $700 billion bailout has since
grown into a more than $12 trillion commitment by
the US government and the Federal Reserve. About
$1.1 trillion
of that is taxpayer money--the TARP money and an additional $400 billion
rescue of mortgage companies Fannie Mae and Freddie Mac. The TARP now
includes twelve separate programs, and recipients range from megabanks like
Citigroup and JPMorgan Chase to automakers Chrysler and General Motors.
Seven months in, the bailout's impact is unclear.
The Treasury Department has used the
recent "stress test" results it applied to
nineteen of the nation's largest banks to suggest that the worst might be
over; yet the
International Monetary Fund, as well as economists
like New York University professor and economist Nouriel Roubini and New
York Times columnist Paul Krugman
predict greater losses in US markets, rising unemployment and
generally tougher economic times ahead.
What cannot be disputed, however, is the financial
bailout's biggest loser: the American taxpayer. The US government, led by
the Treasury Department, has done little, if anything, to maximize returns
on its trillion-dollar, taxpayer-funded investment. So far, the bailout has
favored rescued financial institutions by
subsidizing their
losses to the tune of $356 billion, shying away
from much-needed management changes and--with the exception of the
automakers--letting companies take taxpayer money without a coherent plan
for how they might return to viability.
The bailout's perks have been no less favorable for
private investors who are now picking over the economy's still-smoking
rubble at the taxpayers' expense. The newer bailout programs rolled out by
Treasury Secretary Timothy Geithner give private equity firms, hedge funds
and other private investors significant leverage to buy "toxic" or
distressed assets, while leaving taxpayers stuck with the lion's share of
the risk and potential losses.
Given the lack of transparency and accountability,
don't expect taxpayers to be able to object too much. After all, remarkably
little is known about how TARP recipients have used the government aid
received. Nonetheless, recent government
reports,
Congressional testimony and commentaries offer those
patient enough to pore over hundreds of pages of material glimpses of just
how Wall Street friendly the bailout actually is. Here, then, based on the
most definitive data and analyses available, are six of the most blatant and
alarming ways taxpayers have been scammed by the government's $1.1-trillion,
publicly funded bailout.
1. By overpaying for
its TARP investments, the Treasury Department provided bailout recipients
with generous subsidies at the taxpayer's expense.
When the Treasury Department ditched its initial
plan to buy up "toxic" assets and instead invest directly in financial
institutions, then-Treasury Secretary Henry Paulson Jr. assured Americans
that they'd get a fair deal. "This is an investment, not an expenditure, and
there is no reason to expect this program will cost taxpayers anything," he
said in October 2008.
Yet the Congressional Oversight Panel (COP), a
five-person group tasked with ensuring that the Treasury Department acts in
the public's best interest, concluded in its
monthly report for February that the department
had significantly overpaid by tens of billions of dollars for its
investments. For the ten largest TARP investments made in 2008, totaling
$184.2 billion, Treasury received on average only $66 worth of assets for
every $100 invested. Based on that shortfall, the panel calculated that
Treasury had received only $176 billion in assets for its $254 billion
investment, leaving a $78 billion hole in taxpayer pockets.
Not all investors subsidized the struggling banks
so heavily while investing in them. The COP report notes that private
investors received much closer to fair market value in investments made at
the time of the early TARP transactions. When, for instance,
Berkshire Hathaway invested $5 billion in Goldman Sachs
in September, the Omaha-based company received
securities worth $110 for each $100 invested. And when
Mitsubishi invested in Morgan Stanley that same
month, it received securities worth $91 for every $100 invested.
As of May 15, according to the
Ethisphere TARP Index, which tracks the
government's bailout investments, its various investments had depreciated in
value by almost $147.7 billion. In other words, TARP's losses come out to
almost $1,300 per American taxpaying household.
2. As the government
has no real oversight over bailout funds, taxpayers remain in the dark about
how their money has been used and if it has made any difference.
While the Treasury Department can make TARP
recipients report on just how they spend their government bailout funds, it
has chosen not to do so. As a result, it's unclear whether institutions
receiving such funds are using that money to increase lending--which would,
in turn, boost the economy--or merely to fill in holes in their balance
sheets.
Neil M. Barofsky, the special inspector general for
TARP, summed the situation up this way in his office's April quarterly
report to Congress: "The American people have a right to know how their tax
dollars are being used, particularly as billions of dollars are going to
institutions for which banking is certainly not part of the institution's
core business and may be little more than a way to gain access to the
low-cost capital provided under TARP."
This lack of transparency makes the bailout process
highly susceptible to fraud and corruption.
Barofsky's report stated that twenty separate
criminal investigations were already underway involving corporate fraud,
insider trading and public corruption. He also
told the Financial Times that his office
was investigating whether banks manipulated their books to secure bailout
funds. "I hope we don't find a single bank that's cooked its books to try to
get money, but I don't think that's going to be the case."
Economist Dean Baker, co-director of the Center for
Economic and Policy Research in Washington, suggested to TomDispatch in an
interview that the opaque and complicated nature of the bailout may not be
entirely unintentional, given the difficulties it raises for anyone wanting
to follow the trail of taxpayer dollars from the government to the banks.
"[Government officials] see this all as a Three Card Monte, moving
everything around really quickly so the public won't understand that this
really is an elaborate way to subsidize the banks," Baker says, adding that
the public "won't realize we gave money away to some of the richest people."
3. The bailout's newer
programs heavily favor the private sector, giving investors an opportunity
to earn lucrative profits and leaving taxpayers with most of the risk.
Under Treasury Secretary Geithner, the Treasury
Department has greatly expanded the financial bailout to troubling new
programs like the Public-Private Investment Program (PPIP) and the Term
Asset-Backed-Securities Loan Facility (TALF). The PPIP, for example,
encourages private investors to buy "toxic" or risky assets on the books of
struggling banks. Doing so, we're told, will get banks lending again because
the burdensome assets won't weigh them down. Unfortunately, the incentives
the Treasury Department is offering to get private investors to participate
are so generous that the government--and, by extension, American
taxpayers--are left with all the downside.
Joseph Stiglitz, the Nobel-prize winning economist,
described the PPIP program in a New York Times
op-ed this way:
Consider an asset that has a
50-50 chance of being worth either zero or $200 in a year's time. The
average "value" of the asset is $100. Ignoring interest, this is what the
asset would sell for in a competitive market. It is what the asset is
'worth.' Under the plan by Treasury Secretary Timothy Geithner, the
government would provide about 92 percent of the money to buy the asset but
would stand to receive only 50 percent of any gains, and would absorb almost
all of the losses. Some partnership!
Assume that one of the
public-private partnerships the Treasury has promised to create is willing
to pay $150 for the asset. That's 50 percent more than its true value, and
the bank is more than happy to sell. So the private partner puts up $12, and
the government supplies the rest--$12 in "equity" plus $126 in the form of a
guaranteed loan.
If, in a year's time, it turns
out that the true value of the asset is zero, the private partner loses the
$12, and the government loses $138. If the true value is $200, the
government and the private partner split the $74 that's left over after
paying back the $126 loan. In that rosy scenario, the private partner more
than triples his $12 investment. But the taxpayer, having risked $138, gains
a mere $37."
Worse still, the PPIP can be easily manipulated for
private gain. As economist
Jeffrey Sachs has described it, a bank with
worthless toxic assets on its books could actually set up its own
public-private fund to bid on those assets. Since no true bidder would pay
for a worthless asset, the bank's public-private fund would win the bid,
essentially using government money for the purchase. All the public-private
fund would then have to do is quietly declare bankruptcy and disappear,
leaving the bank to make off with the government money it received. With the
PPIP deals set to begin in the coming months, time will tell whether private
investors actually take advantage of the program's flaws in this fashion.
The Treasury Department's TALF program offers
equally enticing possibilities for potential bailout profiteers, providing
investors with a chance to double, triple or even quadruple their
investments. And like the PPIP, if the deal goes bad, taxpayers absorb most
of the losses. "It beats any financing that the private sector could ever
come up with," a
Wall Street trader commented
in a recent Fortune magazine story. "I almost want to say it is
irresponsible."
4. The government has
no coherent plan for returning failing financial institutions to
profitability and maximizing returns on taxpayers' investments.
Compare the treatment of the auto industry and the
financial sector, and a troubling double standard emerges. As a condition
for taking bailout aid, the government required Chrysler and General Motors
to present
detailed plans on how the companies would return
to profitability. Yet the Treasury Department attached minimal conditions to
the billions injected into the largest bailed-out financial institutions.
Moreover, neither Geithner nor Lawrence Summers, one of President Barack
Obama's top economic advisors, nor the president himself has articulated any
substantive plan or vision for how the bailout will help these institutions
recover and, hopefully, maximize taxpayers' investment returns.
The Congressional Oversight Panel highlighted the
absence of such a comprehensive plan in its
January report. Three months into the bailout, the
Treasury Department "has not yet explained its strategy," the report stated.
"Treasury has identified its goals and announced its programs, but it has
not yet explained how the programs chosen constitute a coherent plan to
achieve those goals."
Today, the department's endgame for the bailout
still remains vague. Thomas Hoenig, president of the Federal Reserve Bank of
Kansas City,
wrote in the Financial Times in May that
the government's response to the financial meltdown has been "ad hoc,
resulting in inequitable outcomes among firms, creditors, and investors."
Rather than perpetually prop up banks with endless taxpayer funds, Hoenig
suggests, the government should allow banks to fail. Only then, he believes,
can crippled financial institutions and systems be fixed. "Because we still
have far to go in this crisis, there remains time to define a clear process
for resolving large institutional failure. Without one, the consequences
will involve a series of short-term events and far more uncertainty for the
global economy in the long run."
The healthier and more profitable bailout
recipients are once financial markets rebound, the more taxpayers will earn
on their investments. Without a plan, however, banks may limp back to
viability while taxpayers lose their investments or even absorb further
losses.
5. The bailout's focus
on Wall Street mega-banks ignores smaller banks serving millions of American
taxpayers that face an equally uncertain future.
The government may not have a long-term strategy
for its trillion-dollar bailout, but its guiding principle, however
misguided, is clear: what's good for Wall Street will be best for the rest
of the country.
On the day the mega-bank stress tests were
officially released, another set of stress-test results came out to much
less fanfare. In its
quarterly report on the health of individual banks and the banking industry
as a whole, Institutional Risk Analytics (IRA), a
respected financial services organization, found that the stress levels
among more than 7,500 FDIC-reporting banks nationwide had risen
dramatically. For 1,575 of the banks, net incomes had turned negative due to
decreased lending and less risk-taking.
The conclusion IRA drew was telling: "Our overall
observation is that US policy makers may very well have been distracted by
focusing on 19 large stress test banks designed to save Wall Street and the
world's central bank bondholders, this while a trend is emerging of a going
concern viability crash taking shape under the radar." The report concluded
with a question: "Has the time come to shift the policy focus away from the
things that we love, namely big zombie banks, to tackle things that are
truly hurting us?"
6. The bailout
encourages the very behaviors that created the economic crisis in the first
place instead of overhauling our broken financial system and helping the
individuals most affected by the crisis.
As Joseph Stiglitz explained in the New York
Times, one major cause of the economic crisis was bank overleveraging.
"Using relatively little capital of their own," he wrote, banks "borrowed
heavily to buy extremely risky real estate assets. In the process, they used
overly complex instruments like collateralized debt obligations." Financial
institutions engaged in overleveraging in pursuit of the lucrative profits
such deals promised--even if those profits came with staggering levels of
risk.
Sound familiar? It should, because in the PPIP and
TALF bailout programs the Treasury Department has essentially replicated the
very over-leveraged, risky, complex system that got us into this mess in the
first place: in other words, the government hopes to repair our financial
system by using the flawed practices that caused this crisis.
Then there are the institutions deemed "too big to
fail." These financial giants--among them AIG, Citigroup and Bank of
America-- have been kept afloat by billions of dollars in bottomless bailout
aid. Yet reinforcing the notion that any institution is "too big to fail" is
dangerous to the economy. When a company like AIG grows so large that it
becomes "too big to fail," the risk it carries is systemic, meaning failure
could drag down the entire economy. The government should force "too big to
fail" institutions to slim down to a safer, more modest size; instead, the
Treasury Department continues to subsidize these financial giants,
reinforcing their place in our economy.
Of even greater concern is the message the bailout
sends to banks and lenders--namely, that the risky investments that crippled
the economy are fair game in the future. After all, if banks fail and teeter
at the edge of collapse, the government promises to be there with a
taxpayer-funded, potentially profitable safety net.
The handling of the bailout makes at least one
thing clear, however. It's not your health that the government is focused
on, it's theirs-- the very banks and lenders whose convoluted financial
systems provided the underpinnings for staggering salaries and bonuses,
while bringing our economy to the brink of another Great Depression.
Bob Jensen's threads how your money was put to word (fraudulently) to pay
for the mistakes of the so-called professionals of finance ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Bob Jensen's "Rotten to the Core" threads ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Interestingly, the term "federal stimulus
spending" is an oxymoron.
....a paper written at the University of California Berkeley entitled The
Macroeconomic Effects of Tax Changes: Estimates Based on a new Measure of Fiscal
Shocks, by Christina D. and David H. Romer (March 2007). (Christina Romer now
chairs the president's Council of Economic Advisors). This study found that the
tax multiplier is 3, meaning that each dollar rise in taxes will reduce private
spending by $3.
Van R. Hoisington and Lacy H. Hunt, "Debt and Inflation,"
Investors Insight ---
http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2009/07/13/debt-and-deflation.aspx#
Bank of America pays $33M SEC fine over Merrill bonuses
Bank of America Corp. has agreed to pay a $33 million
penalty to settle government charges that it misled investors about Merrill
Lynch's plans to pay bonuses to its executives, regulators said Monday. In
seeking approval to buy Merrill, Bank of America told investors that Merrill
would not pay year-end bonuses without Bank of America's consent. But the
Securities and Exchange Commission said Bank of America had authorized New
York-based Merrill to pay up to $5.8 billion in bonuses. That rendered a
statement Bank of America mailed to 283,000 shareholders of both companies about
the Merrill deal "materially false and misleading," the SEC said in a statement.
Yahoo News, August 3, 2009 ---
http://news.yahoo.com/s/ap/20090803/ap_on_bi_ge/us_bank_of_america_sec
"Stop Insuring Mortgages: The folly of government intervention in
the housing market," by John Stossel, Reason Magazine, December 3, 2009 ---
http://reason.com/archives/2009/12/03/stop-insuring-mortgages
The Federal Housing Administration
announced this week that it wants tougher rules on mortgage lenders. It's
about time.
Maybe FHA got spooked by the recent New
York Times story titled "Easy Loans to Wealthier Areas," which said: "In its
efforts to prop up a shattered housing market, the government is greatly
extending its traditional support of real estate, including guaranteeing the
mortgages of middle-class and even upper-class buyers against default."
The Times explained that San Francisco,
one of the priciest real estate markets in the country, had no
government-insured mortgages two years ago, but now "the government is
guaranteeing an average of six mortgages a week here. ... The Federal
Housing Administration is underwriting loans at quadruple the rate of three
years ago even as its reserves to cover defaults are dwindling."
And some of those loans are surely
questionable.
The Times explains that 27-year-old Mike
Rowland and his friends were able to buy a two-unit apartment building for
almost a million dollars. "They had only a little cash to bring to the table
but, with the federal government insuring the transaction, a large down
payment was not necessary."
"It was kind of crazy we could get this
big a loan," Rowland said.
Yes, it was crazy. Such policies do not
end well. Young Rowland gets that. Even the Times does: "With government
finances already under great strain, the policy expansions are creating new
risks for American taxpayers."
But our leaders plunge ahead, with your
money. Has the administration forgotten that today's financial mess was
precipitated in part by government's moves to encourage mortgage lending to
unqualified or at best unproven borrowers? In the 1990s, the Federal Reserve
Bank of Boston, concerned that blacks and Hispanics were "underserved,"
issued guidelines to banks stating: "Policies regarding applicants with no
credit history or problem credit history should be reviewed. Lack of credit
history should not be seen as a negative factor...."
Soon, the lower standards spilled into the
prime-mortgage market. The risk to lenders seemed small because
government-sponsored Fannie Mae and Freddie Mac happily bought the dubious
loans. An entire financial edifice was built on these securitized mortgages
and derivatives based on them.
Then the good times ended. Interest rates
rose. Home prices flattened and then declined. Then those AAA
mortgage-backed securities became "toxic."
After all that, it's crazy that government
still subsidizes housing rather than letting the market work. The economy
will recover from recession only when it is allowed to discover the real
value of assets like houses. But the government refuses to allow this to
happen. FHA has been blowing air into another bubble, while other agencies
do everything they can to boost prices.
This includes leaning on and bribing banks
to ease mortgage terms for people in default. The Obama administration
announced that it would increase that pressure because "the banks are not
doing a good enough job," said Michael S. Barr, assistant treasury secretary
for financial institutions. Some Democrats want to go further. They demand
that the government compel mediation over defaulted mortgages or empower
judges to change the terms.
This sounds humane, but it is typical
political shortsightedness. When government helps delinquent borrowers to
get easier loan terms, it simultaneously makes it harder for marginal
borrowers to get loans in the first place. That's because lenders must now
factor in the likelihood of a judge changing the terms.
The know-it-alls in Washington "help"
Americans by hurting them.
Why won't the government let housing
prices seek their own level? After a Washington-inflated bubble, that would
seem to be the wise thing to do. Sure, some people get hurt when prices
fall, but others—prospective home-buyers—are helped. By artificially raising
prices, the Realtor-Construction-Banking-Big Government Complex cheats
honest low-income people who would otherwise have been able to afford a
first home without begging the government for help.
"This Time is Different: A Panoramic View of Eight Centuries
of Financial Crises," by Carmen M. Reinhart, University of Maryland and NBER
and Kenneth S. Rogoff, Harvard University and NBER, April 16, 2008 ---
http://www.economics.harvard.edu/files/faculty/51_This_Time_Is_Different.pdf
This link was forwarded on December 3, 2009 by Scott Bonacker
[lister@BONACKERS.COM]
Recently I received a copy of the new book "This
Time is Different" by Reinhart and Rogoff as a gift. The paper of the same
name that preceded it can be found here:
http://www.economics.harvard.edu/files/faculty/51_This_Time_Is_Different.pdf
Is anyone else here reading that?
As I work my way through it, I am reminded of a
commentator on national news reporting that "there is growing concern that
employment won't pick up as soon as hoped." According to the book, it takes
an average of 4.8 years for employment to return to previous levels.
It's curious that there isn't more reporting on
what people should really expect, as opposed to either feeding expectations
that things will improve right away or scaring them into hoarding food and
buying guns.
Scott Bonacker CPA
Springfield, MO
Bob Jensen's threads on the financial crisis are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
From Simoleon Sense on July 29, 2009 ---
http://www.simoleonsense.com/the-science-of-economic-bubbles-and-busts/
The Science of Economic Bubbles and Busts
Brilliant introduction to economic bubbles- article
covers psychology, economics, neurology, and finance.
Click Here To Read About The Science Of Economic Bubbles & Busts
http://www.scientificamerican.com/article.cfm?id=the-science-of-economic-bubbles
Introduction (Via Scientific American)
The worst economic crisis since the Great
Depression has prompted a reassessment of how financial markets work and how
people make decisions about money
Key Concepts (Via Scientific American)
1. The worldwide financial meltdown has caused a
new examination of why markets sometimes become overheated and then come
crashing down.
2. The dot-com blowup and the subsequent housing and credit crises highlight
how psychological quirks sometimes trump rationality in investment decision
making. Understanding these behaviors elucidates the genesis of booms and
busts.
3. New models of market dynamics try to protect against financial blowups by
mirroring more accurately how markets work. Meanwhile more intelligent
regulation may gently steer the home buyer or the retirement saver away from
bad decisions.
Click Here To Read About The Science Of Economic Bubbles & Busts
http://www.scientificamerican.com/article.cfm?id=the-science-of-economic-bubbles
Bob Jensen's threads on the economic crisis ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Question
Would you like to see (AIG) Special Purpose Vehicles pull away from the loading
($25 billion) dock?
"AIG
Sells Shares to Fed: Papa's Little Dividend? The New York Fed has agreed to get
involved in the life insurance business by investing $25 billion in two
special-purpose vehicles," by David M. Katz, CFO.com, June 25, 2009 ---
http://www.cfo.com/article.cfm/13932672/c_2984368/?f=archives
In a move aimed at cutting American International
Group's $40 billion debt to the Federal Reserve Bank of New York by $25
billion and setting up two AIG life insurance giants as initial public
offerings, the N.Y. Fed has agreed to a debt-for-equity swap done via
special-purpose vehicles.
Under the agreement announced today, AIG will place
the equity of American International Assurance Company and American Life
Insurance Company in separate SPVs in exchange for preferred and common
shares of the vehicles. The New York Fed will get all the preferred shares
in the two SPVs, amounting to $16 billion in the AIA unit and $9 billion in
the ALICO vehicle.
The New York Fed will be paid a 5 percent dividend
on its shares, which it will get at a fairly hefty discount, until September
2013. For shares that aren't redeemed by that date, the SPVs would start
paying a 9 percent dividend.
The face value of the preferred shares represents a
percentage of the estimated fair-market value of AIA and ALICO. With the
IPOs looming, the parties aren't saying what that value is. But the New York
Fed, which will hold all the preferred shares, will get a majority stake in
the economic value of the companies.
For its part, AIG will hold all the common equity
in the two SPVs and "will benefit from the fair market value of AIA and
ALICO in excess of the value of the preferred interests as the SPVs monetize
their stakes in these companies in the future," AIG said in a release issued
today.
The dates of the closing of the deal and the IPOs
aren't tied to each other. The AIG-New York Fed transaction is expected to
close late in the third quarter of this year. AIA, which has already
launched its IPO process, is expected to start the offering in 2010. While
ALICO hasn't started the process of its offering just yet, it has announced
its attention to do so.
As for the SPVs, they will structured as
limited-liability companies in Delaware. Until they're spun off, AIA and
ALICO will remain wholly owned subsidiaries of AIG, consolidated in the
company's reported financial statements.
"Placing AIA and ALICO into SPVs represents a major
step toward repaying taxpayers and preserving the value of AIA and ALICO,
two terrific life insurance businesses with great futures," said Edward
Liddy, AIG's chairman and chief executive officer said in the release.
"Operating AIA's and ALICO's successful business models in the SPV format
will enhance the value of these franchises as we move forward with our
global restructuring."
Asked why the company chose to structure the
arrangement by means of the much stigmatized method of setting up SPVs, AIG
spokesperson Christina Pretto told CFO that since the vehicles were
on-balance-sheet entities they wouldn't be the target of disapproval.
AIA has one of the biggest books of life insurance
in Asia, and ALICO has a large presence in Japan. While both are profitable,
AIG has found it impossible to achieve its goal of selling the companies-at
least partly because they are so large.
Continued in article
Bob Jensen's threads on
Off-Balance-Sheet Financing (OBSF) are at
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
What's Right and What's Wrong With
SPEs, SPVs, and VIEs ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
How CDO's led to the collapse of Wall Street in 2008 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Government Efficiency and Sound Management in Action
"After Losing $20 Million in Equipment, Federal Health-Care Agency Won $500
Million Earmark in Stimulus; Agency’s HQ Had 10 Pieces of IT Equipment Per
Worker," by Monica Gabriel, CNS News, June 19, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49591
The $787 billion stimulus bill that President Obama
signed in February awarded the Indian Health Service with an earmark for
$500 million in new funding, including $85 million specifically set aside
for “health information technology activities,” even though a Government
Accountability Office audit released the previous June concluded that
mismanagement of the IHS had allowed $15.8 million worth of equipment to be
lost or stolen between 2004 and 2007.
The GAO report released in June 2008 also concluded
that wasteful spending by the Indian Health Service had resulted in the
service’s headquarters possessing 10 pieces of IT equipment for every
employee who worked there.
The report was entitled: "IHS Mismanagment Led to
Millions of Dollars in Lost or Stolen Property."
This June, a year after publication of the original
GAO report, and four months after the stimulus bill earmarked $500 million
in new funding for the Indian Health Service, a new GAO report revealed that
the IHS was continuing to lose government property.
The new report was entitled: "Indian Health
Service--Millions of Dollars in Property and Equipment Continue to be Lost
or Stolen."
“We found that property continues to be lost or
stolen at IHS at an alarming rate,” the GAO reported this month. “From
October 2007 through January 2009, IHS identified about 1,400 items with an
acquisition value of about $3.5 million that were lost or stolen agencywide.
These property losses are in addition to what we identified in our June 2008
report.
“Our full headquarters inventory testing and our
random sample testing of six field offices estimated that over a million
dollars worth of IT equipment was lost, stolen, or unaccounted for,
confirming that property management weaknesses continue at IHS,” said the
new report.
Continued in article
Instead of adding more regulating agencies, I think
we should simply make the FBI tougher on crime and the IRS tougher on cheats
Our Main Financial Regulating Agency: The SEC Screw
Everybody Commission
One of the biggest regulation failures in history is the way the SEC failed to
seriously investigate Bernie Madoff's fund even after being warned by Wall
Street experts across six years before Bernie himself disclosed that he was
running a $65 billion Ponzi fund.
CBS Sixty Minutes on June 14, 2009 ran a rerun that is
devastatingly critical of the SEC. If you’ve not seen it, it may still be
available for free (for a short time only) at
http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
The title of the video is “The Man Who Would Be King.”
Between 2002 and 2008 Harry Markopolos repeatedly told
(with indisputable proof) the Securities and Exchange Commission that Bernie
Madoff's investment fund was a fraud. Markopolos was ignored and, as a result,
investors lost more and more billions of dollars. Steve Kroft reports.
Markoplos makes the SEC look truly incompetent or
outright conspiratorial in fraud.
I'm really surprised that the SEC survived after Chris
Cox messed it up so many things so badly.
As Far as Regulations Go
An annual report issued by
the Competitive Enterprise Institute (CEI) shows that the U.S. government
imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the
$1.2 trillion generated by individual income taxes, and amounts to $3,849 for
every American citizen. According the 2009 edition of Ten Thousand Commandments:
An Annual Snapshot of the Federal Regulatory State, the government issued 3,830
new rules last year, and The Federal Register, where such rules are listed,
ballooned to a record 79,435 pages. “The costs of federal regulations too often
exceed the benefits, yet these regulations receive little official scrutiny from
Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report.
“The U.S. economy lost value in 2008 for the first time since 1990,” Crews said.
“Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on
Americans beyond the $3 trillion officially budgeted” through the regulations.
Adam Brickley,
"Government Implemented Thousands of New Regulations Costing $1.17 Trillion in
2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487
Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the
regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur
Levitt to Chris Cox do absolutely nothing to change my belief ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
How do industries leverage the regulatory agencies?
The primary control mechanism is to have high paying jobs waiting in industry
for regulators who play ball while they are still employed by the government. It
happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so
many people work for the FBI and IRS, it's a little harder for industry to
manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of
the worst offenders whereas other agencies often deal with top management of the
largest companies in America.
Wasted Taxpayer Money: Purchase
Accounting Rule Will Enable Banks to Report Billions in TARP Profits
"Banks Stand to Reap Billions From Purchased Bad Loans," by Julie Crawshaw,
NewsMax, May 27, 2009 ---
http://moneynews.newsmax.com/financenews/purchase_accounting_rule/2009/05/27/218542.html
An accounting rule that governs how banks book
acquired loans is making it possible for banks that purchased bad loans to
reap billions.
Applying this regulation — known as the purchase
accounting rule — to mortgages and commercial loans that lost value during
the credit crisis gives acquiring banks an incentive to mark down loans they
acquire as aggressively as possible, says RBC Capital Markets analyst Gerard
Cassidy.
"One of the beauties of purchase accounting is
after you mark down your assets, you accrete them back in," Cassidy told
Bloomberg. "Those transactions should be favorable over the long run."
Here’s how it works: When JPMorgan bought WaMu out
of receivership last September, it used the purchase accounting rule to
record impaired loans at fair value, marking down $118.2 billion of assets
by 25 percent.
Now, JPMorgan says that first-quarter gains from
the WaMu loans resulted in $1.26 billion in interest income and left the
bank with an accretable-yield balance that could result in additional income
of $29.1 billion.
So JPMorgan, Wells Fargo, Bank of America, and PNC
Financial Services all stand to make big bucks on bad loans they bought from
Washington Mutual, Wachovia, Countrywide and National City.
Their combined deals provide a $56 billion in
accretable yields, which is the difference between the value of the loans on
the banks’ balance sheets and the cash flow they’re expected to produce.
However, it’s tough to tell how much the yield will
increase the acquiring banks’ total revenues because banks don’t disclose
all their expenses and book the additional revenues over the lives of the
loans.
May 28, 2009 reply from Tom Selling
[tom.selling@GROVESITE.COM]
Thanks for providing fodder for what I hope will be
a "fun" blog post. Under APB 16, you had to evaluate the adequacy of the
allowance for bad debts in an acquisition. With the objective of curbing
this particular abuse, the SEC issued a Staff Accounting Bulletin (SAB
Codification Topic 2.B.5) that constrained the acquiror from changing the
allowance for bad debts, unless the plans for collection was fundamentally
different.
The new problem arises, because when the loans were
held by the acquiree, they were measured at contractual amount less the
allowance for bad debts. Upon acquisition, they now have to be measured at
fair value. If the acquirer wants to maximize future profits, it will
maximize the difference between the old and new carrying value, subject to
the following considerations: (1) auditor and/or SEC push back; (2) future
goodwill impairment charges, and (3) capital adequacy regulations.
As to Denny's comment about ultimate collectibility,
current managers may not care if the loans go further south some years from
now. This generation will be compensated based on accounting profits over
the next 2-3 years -- and will be long gone before the proverbial stuff hits
the fan.
The more things change, the more they remain the
same. I think that the biggest lesson here, Bob, and something I expect you
will react to, is that multi-attribute accounting standards don't work.
Best,
Tom
May 29, 2009 reply from Bob Jensen
Hi Tom,
When I first learned about how
business firms were exploiting derivative financial instruments contracts in
large measure to avoid accounting rules, and before FAS 119/133 issuance, I
attended a workshop in Orlando back in the 1980s conducted by Deloitte's
derivatives accounting expert John Smith (who later did a lot of IAS 39 work
for the IASB).
John told us about a Deloitte client
in L.A. that was behaving so strangely that the auditor in charge brought it
to John's attention (John was the top research partner in Deloitte at the
time). Bank X was repeatedly taking reversing positions on an interest rate
swap in a manner such that each time a reversing position was taken there
was an ultimate cash flow loss. It seemed that Bank X was making a terrible
mistake. John Smith posed this problem as a case to us derivatives
accounting neophyte professors in the audience in Orlando.
I recall that the first professor to
shout out the answer from the audience was Hugo Nurnberg. Hugo was the first
among us neophytes to recognize that, prior to FAS 133 rules, Bank X was
making harmful economic decisions just to "frontload income" as Hugo put it.
By frontloading income, the CEO got bigger bonuses in what was a bit like
Ponzi damage to shareholders. Each year frontloaded income in similar
contracting grows by enough to cover tailing cash flow losses. Bonuses and
share prices accordingly grow and grow until, dah, frontloaded income is no
longer sufficient to cover the tailing cash flow losses. I wonder if a
California relative of Bernie Madoff was running Bank X. By the time
the Ponzi exploded the Bank X CEO was probably living in luxury in Hawaii.
This was one of the first times I
became aware of how executives are willing to maximize personal gains at the
ultimate expense of the shareholders for whom they are acting as agents.
Since the roaring derivatives fraud days of the 1990s such behavior became
the rule rather than the exception, which is why we're in such a dire
economic crisis today. Alan Greenspan and Chris Cox belatedly admitted that
they "made mistakes" by assuming bankers would put shareholder interests
above their own personal greed ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#SEC
I wonder if this current TARP poison
plan is a bit of a Ponzi scheme to inflate banking share prices in what will
once again be a royal screwing of investors?
My timeline on the massive derivative
financial instruments frauds is at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Bob Jensen
June 1, 2009 rely from The Accounting Onion
[tom.selling@grovesite.com]
From a MoneyNews.com story published this Wednesday headlined
"Banks
Stand to Reap Billions from Purchased Bad Loans,"
came an account of a jaw-dropping transaction. It was spawned by FAS 141(R),
the latest and greatest standard on accounting for business combinations:
"When JPMorgan bought WaMu out of receivership last September, it used the
purchase accounting rule [FAS 141(R)] to record impaired loans at fair
value, marking down 118.2 billion of assets by 25 percent.
Now, JPMorgan says its first-quarter gains from the WaMu loans resulted in
$1.26 billion in interest income and left the bank within an accretable-yield
balance that could result in additional income of $29.1 billion."
Business combination accounting has forever been fertile ground for earnings
and balance sheet management for one simple reason: the opportunity to tweak
the amounts reported for the assets acquired and liabilities assumed, with
the ultimate objective of brightening post-acquisition earnings reports.
But, as tiresome as that old game might be, the kind of maneuver that
JPMorgan's management has engineered is a novel twist on an old loophole
that had once been closed pretty tightly by the SEC.
The Closed Loophole that Would Be Re-Opened by the FASB
Once the "pooling of interests" method of business combination accounting of
APB 16 was abolished with the advent of FAS 141 (not to be confused with
FAS 141(R)),
the most basic surviving principle of business combination accounting became
thus: the acquisition of a business should always be reflected on the
financial statements of the acquiror by assigning a new carrying amount to
each of the acquired company's assets and liabilities. This new carrying
amount would be updated, based on current assumptions and estimates
regarding the future role of the acquired assets and liabilities in the
combined entity. The implementation of this principle had long been known as
the "purchase accounting" method for business combinations.
With certain important exceptions, SFAS 141 mandated that new carrying
amounts for assets acquired in a business combinations would be based on
their fair values. The exception that is germane to the JPMorgan story
pertains to loans (i.e., trade receivables, interest-bearing loans and
marketable debt securities classified as held-to-maturity). The measurement
bases for these items were carried forward from APB 16's version of the
purchase accounting method: a gross amount reduced by an appropriate
allowance for uncollectible accounts. This exception to loan measurement was
important, because it also meant that a 1986 SEC staff position would still
be applicable to purchase accounting.
At that time, the SEC saw fit to put a stop to unwarranted increases in the
allowance for loan losses as part of the business combination transaction.
Increases to loan loss allowances would mathematically transfer future loan
losses to goodwill, where they would be deferred indefinitely, with the
effect of reporting inflated earnings in future periods as the loans were
eventually settled for more than their understated carrying amounts. Staff
Accounting Bulletin 61 (Topic 2-A(5)) states that the SEC would not permit
any adjustments of the
acquiree's
estimate of loan loss reserves, unless the acquiror's plans for
ultimate recovery of the loans were demonstrably different from the plans
that had served as the basis for the acquiree's estimates of the loss
reserves.
FASB Amnesia?
FAS 141(R) did away with the "purchase method" and established the
"acquisition method" of accounting for business combinations. It apparently
did so out of a belief that measurements of assets and liabilities that are
based on the most current information available are usually, if not always,
preferable to valuations based on less-current information. The JPMorgan
case glaringly points to a significant flaw in that belief:
inconsistent
application of fair value could be more harmful than
consistent
application of a less desirable attribute. As to the case at hand:
§
WaMu, as is quite common, accounted for its loans based on a
held-to-maturity model. That is, except for recognizing declines in
creditworthiness, the loan carrying amount is based on the original
contractual terms; interest is accrued by multiplying the net carrying
amount by the yield to maturity as of the date the loan was
originated/acquired.
§
Even though the market value of these loans had declined significantly as
they turned toxic, WaMu apparently was not required to record losses to
bring the loans down to their fair values.
§
JPMorgan, when acquiring WaMu, was required by FAS 141(R) to mark the loans
to market.
Subsequent
accounting by JPMorgan will continue the WaMu the held-to-maturity model.
It would be a pretty safe bet that JPMorgan was very 'conservative' in their
estimates of fair value for the loans; that's because the lower the fair
value, the higher the yield to maturity, and the higher the amount of
reported future earnings. Of course, there are some limits to JPMorgan's
estimate of fair value: auditor pushback, SEC review, increased risk of
goodwill impairment charges, and capital adequacy regulations. But, at least
in this case, it is possible to become rich without being greedy.
Where is the SEC!?
Maybe there has been more coverage of this issue, but I haven't seen it;
kudos to its author, Julie Crawshaw of Newsmax. If we are concerned that
bank executives are being overcompensated, especially on the taxpayers'
dime, here is a prime example of where insufficient oversight has spawned a
new source of moral hazard.
For starters, the SEC should put a stop to this obvious and blatant abuse,
immediately. They should issue another SAB, carving out the
offending provision of FAS 141(R) and restoring the long-established and
functioning status quo. Every company that benefitted from the ill-conceived
accounting rule should be forced to retroactively restate their earnings –
especially any financial institution on the government dole.
Perhaps the lack of permanent leadership in the Commission's Office of the
Chief Accountant is contributing to a lack of attention to this obvious
problem, but it is in no way an excuse. Also, this is a problem created by
the FASB. Let's be charitable and call it an unintended consequence, but
whatever the cause, the FASB should move to fix it forthwith. I'm suggesting
that the SEC should act first, solely because they have the demonstrated
capability of being able to move the fastest. That's because a SAB doesn't
have to be exposed for comment before it can be issued.
But, lacking any actions by either the FASB or SEC to put the cat back in
the bag, auditors (perhaps via the PCAOB), and boards should be put on
notice of a new potential scheme to inflate executive compensation in the
absence of actual value creation for stakeholders. If a single dime of
executive compensation comes out of accreted excess earnings from these
business combination games, I hope that private securities lawyers will
round up the proxies and the lawsuits, settling for nothing less than "a
pound of flesh."
A larger lesson is important to briefly discuss in order to understand how
this kind of loophole can occur: in accounting for financial assets, the
only workable system is comprehensive mark-to-market, all of the time. The
current situation is a consequence (intended or otherwise) of the piecemeal
approach pursued by the FASB (and IASB) towards fair value accounting.
Bob Jensen's threads on accounting
theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
"Why Mark-to-Paulson Accounting Won't (and
eventually did not) Save Banks," by Jonathan Weil ,
Bloomberg, September 25, 2008 ---
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aK6vnh_5ZknM
There's one glaring weakness in Treasury Secretary
Hank Paulson's plan to save the U.S. financial system: We know what the plan
is. Any other problems with it are mere details.
Much like the credo of Brad Pitt's character in the
1999 movie ``Fight Club,'' the first rule of market manipulation is you
don't talk about market manipulation.
Give Paulson a $700 billion check without asking
any questions, and the former Goldman Sachs boss might have a shot at
kick-starting the credit markets using some mysterious, black- box, trading
sorcery. Because the money isn't his, though, he has to give us at least a
vague outline of what he's up to. Now, even if Congress approves some form
of his proposal, it's far less likely to work because we're all in on the
deal.
The plan goes like this: Treasury will pay
financial institutions above-market prices for garbage assets nobody else
wants. Then, through the magic of mark-to-Paulson accounting, everybody else
that owns similar stuff will use those same prices, or marks, to value the
trash on their own balance sheets.
Shazam! Banks and insurance companies write up the
asset values on their books. They post big profits. Their capital goes up.
Everyone gets fooled. And nobody knows the difference.
Except, we do. And that's why the plan
probably won't work.
Still, give Paulson and Federal Reserve Chairman
Ben Bernanke credit for ingenuity. At the same time banks are begging
regulators to suspend mark-to-market accounting rules so they can avoid
disclosing more losses, Paulson and Bernanke instead devise a way to abuse
the same rules for the same banks' benefit.
Put It in Reverse
Under Paulson's plan, Treasury would hold so-called
reverse auctions for financial institutions' troubled assets. Whoever
submits the lowest bid gets to sell its junky assets to Treasury for cash.
While that might look like a competitive,
free-market mechanism, it's not. Once the first bid in the first auction is
submitted, it may not go much lower, and it probably will be much higher
than the true market value.
That's because the real incentive for the banks
isn't to sell their rubbish to Treasury and get cash. It's to watch the
Treasury pay grossly inflated prices to others. That way, they can use those
transactions for accounting purposes to mark their books to the Treasury's
farcical market prices.
This presents another problem. The transaction
prices coming out of these auctions may not meet the accepted definition of
fair value. Under the Financial Accounting Standards Board's definition,
fair value is the price ``in an orderly transaction between market
participants.''
Stretched Rules
A know-nothing buyer that sets up a rigged market
to overpay for dreck wouldn't seem to count as a ``market participant,''
under the FASB's definition of the term. To qualify, a buyer must be
``knowledgeable, having a reasonable understanding about the asset or
liability and the transaction based on all available information.''
It would be a stretch to say the Treasury knows or
understands anything about the swill it would be buying. Even if regulators
waived the accounting rules to permit this, investors would see it as
government-sponsored fraud and lose any confidence they still had about
banks' balance sheets.
So, the main hope for Paulson's plan is that
Treasury makes enough outrageously expensive purchases to spur real market
participants to start buying the toxic waste from each other again, even if
only in hopes of flipping it for more money to the spendthrift Treasury.
Pain Avoidance
In that case, the prices paid outside the auction
process probably would qualify as ``fair value.'' Then, over time, maybe the
prices in Treasury's auctions would come down as competition increased.
If the prices drop too much, though, banks will
wind up taking huge losses and failing anyway, which is what Paulson and
Bernanke are supposedly trying to avoid. All the while, the Treasury would
be spending as much as $700 billion getting us right back where we started.
And a lot of Wall Street charlatans who should lose their shirts would
expand their fortunes, which is politically and morally untenable.
Whatever the government proposes probably won't
work as intended. It also could make things worse. This seems to have dawned
on a lot of people in Congress this week while they watched Bernanke and
Paulson testify. Even if Congress fails to act, that wouldn't mean Paulson's
plan was a disaster. In one respect, the details of his plan don't matter.
By making it known on the afternoon of Sept. 18
that he had a bailout proposal, at precisely the moment when the financial
system seemed to be tipping over the edge, Paulson bought the markets the
most valuable commodity of all -- time.
Years from now, when we look back on the past
week's events, we may conclude this was his real goal all along.
Whatever hits the fan will not be distributed
equally.
Anonymous
Jensen Comment
The $20 billion handed secretly to Ken Lewis was not nearly equal to the losses
incurred in the deal. I think Lewis accepted the bribe with his eyes closed and
his ears open to promises of more bribes that failed to materialize.
"Welcome to the new capitalism," by Star Parker, Townhall, May 4, 2009
---
http://townhall.com/columnists/StarParker/2009/05/04/welcome_to_the_new_capitalism
Frank recently praised Bank of America chairman
(now ex-chairman) Ken Lewis for acting in "the public interest" for caving
in to bribes and threats from former Treasury Secretary Hank Paulson and
Federal Reserve chairman Ben Bernanke regarding B of A's takeover of Merrill
Lynch.
Lewis wanted to back out the deal last year when he
discovered the massive scope of Merrill's losses. But Paulson and Bernanke
decided that Merrill shouldn't fail, so they bribed Lewis with $20 billion
of taxpayer funds, instructed him to conceal the agreement from his
shareholders, and told him his job would be on the line if he didn't play
ball -- which he did.
These sordid details have come to light in an
investigation being conducted by New York State Attorney General Andrew
Cuomo.
So if such behavior is what Barney Frank calls
economic patriotism, what might constitute subversive behavior?
When Congress moved last year to politically
engineer changes in terms of existing mortgages in the name of bailing out
distressed homeowners, Bill Frey, who manages a fund that holds
mortgage-backed securities, protested.
Frey told the New York Times, "Any investor in
mortgage-backed securities has a right to insist that their contract be
enforced."
Contracts? Private property? That's the old
capitalism.
Frank fired off a letter to Frey saying he was
"outraged...that you are actively opposing our efforts to achieve diminution
in foreclosures by voluntary efforts." Frank then clarified his idea of
"voluntary" by summoning Frey to testify in Washington, noting that "if this
cannot be arranged on a voluntary basis, then we will pursue further steps."
The House has passed legislation, which is now in
the Senate, containing Frank's idea of "diminution in foreclosures by
voluntary efforts." It amounts to -- what a surprise -- taxpayer funded
bribes to abrogate existing mortgage contracts and provisions for legal
protection for doing so.
Frey and others managing funds for investors
holding billions in mortgage-backed securities are fighting back. We're not
talking Bernie Madoff here. We're talking about funds that have invested in
these securities on behalf of pension funds and 401Ks.
Financial institutions -- banks like B of A and
Wells Fargo -- originate mortgages and then sell them off to be sliced and
diced up into bonds that individual investors can purchase. This financial
innovation has been a boon for providing capital and liquidity to our
mortgage markets.
The originating bank, however, stays in the picture
to service the loan, collecting and processing the payments. Contractual
agreements exist between the bank and the bondholders that this will be done
in good faith, according to the terms of the original mortgage.
For a host of reasons, mostly massive government
meddling and social engineering, the mortgage market exploded and thus,
we've got homeowners who can't make payments.
The House passed bill proposes to bail these folks
out by paying banks servicing the mortgages $1000 for each one they
re-finance, cutting interest rates and payments. Those who actually own the
loans -- the bondholders -- are left out to pasture. And, the bill protects
servicing banks from lawsuits to which they would normally be exposed for
breaking their contracts.
So taxpayers will subsidize banks to refinance the
bad loans they originated but no longer own, homeowners who borrowed beyond
their means get bailed out, and investors -- the bondholders -- are left to
bear the costs. On top of this, many of these same banks originated second
mortgages on these same homes. The second mortgages, which the banks still
own, bear even higher interest rates because they are allegedly more risky.
Yet, they will be left secure and undisturbed.
Aside from the costs that our society will bear as
law and contracts no longer have meaning, Frey rightly points out that it
all will just make future mortgage borrowing more expensive. Who will take
risks to lend when politicians can change contracts at the drop of a hat?
Welcome to the new capitalism. Where politicians
rule, irresponsible behavior is rewarded, and theft is legal.
"Busting Bank of America: A case study in how to spread systemic
financial risk," The Wall Street Journal, April 27, 2009 ---
http://online.wsj.com/article/SB124078909572557575.html
The cavalier use of brute government force has
become routine, but the emerging story of how Hank Paulson and Ben Bernanke
forced CEO Ken Lewis to blow up Bank of America is still shocking. It's a
case study in the ways that panicky regulators have so often botched the
bailout and made the financial crisis worse.
In the name of containing "systemic risk," our
regulators spread it. In order to keep Mr. Lewis quiet, they all but ordered
him to deceive his own shareholders. And in the name of restoring financial
confidence, they have so mistreated Bank of America that bank executives
everywhere have concluded that neither Treasury nor the Federal Reserve can
be trusted.
Mr. Lewis has told investigators for New York
Attorney General Andrew Cuomo that in December Mr. Paulson threatened him
not to cancel a deal to buy Merrill Lynch. BofA had discovered billions of
dollars in undisclosed Merrill losses, and Mr. Lewis was considering
invoking his rights under a material adverse condition clause to kill the
merger. But Washington decided that America's financial system couldn't
withstand a Merrill failure, and that BofA had to risk its own solvency to
save it. So then-Treasury Secretary Paulson, who says he was acting at the
direction of Federal Reserve Chairman Bernanke, told Mr. Lewis that the feds
would fire him and his board if they didn't complete the deal.
Mr. Paulson told Mr. Lewis that the government
would provide cash from the Troubled Asset Relief Program (TARP) to help
BofA swallow Merrill. But since the government didn't want to reveal this
new federal investment until after the merger closed, Messrs. Paulson and
Bernanke rejected Mr. Lewis's request to get their commitment in writing.
"We do not want a disclosable event," Mr. Lewis
says Mr. Paulson told him. "We do not want a public disclosure." Imagine
what would happen to a CEO who said that.
After getting the approval of his board, Mr. Lewis
executed the Paulson-Bernanke order without informing his shareholders of
the material events taking place at Merrill. The merger closed on January 1.
But investors and taxpayers had to wait weeks to learn that the government
had invested another $20 billion plus loan portfolio insurance in BofA, and
that Merrill had lost a staggering $15 billion in the last three months of
2008.
This was the second time in three months that
Washington had forced Bank of America to take federal money. In his
testimony to the New York AG's office, Mr. Lewis noted that an earlier TARP
investment in his bank had a "dilutive effect" on existing shareholders and
was not requested by BofA. "We had not sought any funds. We were taking 15
[billion dollars] at the request of Hank [Paulson] and others," Mr. Lewis
testified.
But it is the Merrill deal that raises the most
troubling questions. Evaluating the policy of Messrs. Bernanke and Paulson
on their own terms, this transaction fundamentally increased systemic risk.
In order to save a Wall Street brokerage, the feds spread the risk to one of
the country's largest deposit-taking banks. If they were convinced that
Merrill had to be saved, then they should have made the public case for it.
And the first obligation of due diligence is to make sure that their Merrill
"rescuer" of choice -- BofA -- had the capacity to bear the losses. Instead
they transplanted the Merrill risk to BofA shareholders, the bank's
depositors and the taxpayers who ensure those deposits. And then they had to
bail out BofA too.
Messrs. Bernanke and Paulson also undermined the
transparency that is a vital source of investor confidence. Disclosure is
not a luxury to be enjoyed only when markets are rising. It is the
foundation of the American regulatory system and a reason investors have
long sought to keep their money within U.S. borders. Could either man have
believed that their actions wouldn't eventually come to light, with all of
the repercussions for their bank rescue plans?
Mr. Paulson told Mr. Cuomo's investigators that he
also kept former SEC Chairman Christopher Cox out of the loop while forcing
BofA to rescue Merrill. Mr. Cox wasn't the only one. Mr. Paulson and Mr.
Bernanke both sit on the Financial Stability Oversight Board, comprised of
federal regulators who oversee TARP. Two days after Mr. Lewis told the
dynamic duo that Merrill's losses were exploding and that he was looking for
a way out, Mr. Bernanke chaired and Mr. Paulson attended a meeting of this
board. Minutes of the meeting show no mention of BofA or Merrill.
At the next meeting on January 8, a week after the
merger had closed, the minutes again make no mention of either regulator
telling their colleagues that they had committed tens of billions of
dollars. Yet the minutes helpfully note that among the topics discussed were
"coordination, transparency and oversight."
Meeting minutes suggest Messrs. Bernanke and
Paulson finally informed fellow board members at 4:30 p.m. on January 15,
after news outlets had already reported a pending new taxpayer investment in
BofA. What exactly did Mr. Bernanke and Mr. Paulson tell their colleagues
about their plans for TARP prior to January 15?
Let's hope they treated their government colleagues
better than they've treated Ken Lewis, whom they hung out to dry. After
making him an offer he could hardly refuse, they've let him endure a public
flogging from shareholders and the press, lengthy discussions with
prosecutors, plus new hiring and compensation rules that limit his bank's
ability to compete.
No wonder no banker in his right mind trusts the
Fed or Treasury, and no wonder nobody but Pimco and other Treasury favorites
is eager to invest in the TALF, the PPIP, or any of the other programs that
require trusting the government as a business partner.
The political class has spent the last few months
blaming bankers for everything that has gone wrong in the financial system,
and no doubt many banks have earned public scorn. But Washington has been
complicit every step of the way, from the Fed's easy money to the nurturing
of Fannie Mae and Freddie Mac, and since last autumn with regulatory and
Congressional panic that is making financial repair that much harder. The
men who nearly ruined Bank of America have some explaining to do.
Jensen Comment
It is interesting to compare the song Ken Lewis was singing before the
purchase of Merrill Lynch versus the song he's now singing about "his" burdening
BofA with the billions of Merrill Lynch's toxic investments. You can watch and
hear him literally brag that BofA was in stronger shape than all the other large
U.S. banks because it sold most of its sub-prime mortgages to other buyers (like
Fannie, Freddie, and Merrill Lynch) rather than to retain BofA ownership of such
poison. Note his bragging in an interview on CBS Sixty Minutes on October
19, 2009.
I watched the show on October 19, 2008, in a CBS Sixty
Minutes TV module, when Leslie Stahl interviewed the CEO of Bank of America,
Ken Lewis. Mr. Lewis was charming and forceful when he bragged heavily that BofA
was much stronger than the other failing banks and was only accepting some
Bailout money as a “patriotic duty.” He said BofA really had no need for Bailout
cash since his truly giant international bank was in such strong shape even
after the subprime scandal first made the news.
Belatedly, Ken Lewis is claiming that the U.S. Treasury Department and
Federal Reserve teamed up against him and forced him to take on the billions of
Merrill Lynch's poison. If this was indeed the case, it would've been a great
opportunity for Mr. Lewis to make a public stand against the near-ruination of
BofA. Think of what a hero he would've become in the eyes of BofA shareholders
and if he would've drawn a line and dared Paulson to fire him for refusing to
BofA shareholders to gulp down Merrill Lynch poison.
My guess is that Paulson would've instead sweetened the deal by having the
government dilute Merrill Lynch poison such as by making BofA liable for 15% of
Merrill Lynch's subprime and CDO losses.
After the purchasing Merrill Lynch, the sour grapes cry baby Ken Lewis does
not come across as having CEO quality and guts!
“Bridge Loan to Nowhere,” by Thomas Ferguson & Robert Johnson, The
Nation, September 22, 2008 ---
http://www.thenation.com/doc/20081006/ferguson_johnson
Posner's Solution Makes Even Better Sense
A more palatable approach would be for the government to drive a Warren Buffett
style hard bargain, in which, rather than buying anything from banks, the
government would invest in them in a form, such as purchase of newly issued
preferred stock, or bonds with a long maturity, that would augment the banks'
capital and thus enable banks to make more loans. That would avoid conferring a
windfall on the banks by overpaying them for their bad securities; no one thinks
Buffett is conferring a windfall on Goldman Sachs. After the industry was back
on its feet, the government could sell the bank stocks or bonds that it had
acquired.
Richard Posner, "The $700+ Billion Bailout," The Becker-Posner Blog,
September 28, 2008 ---
http://www.becker-posner-blog.com/
Finally, the "too big to fail"
approach to banks and other companies should be abandoned as new long-term
financial policies are developed. Such an approach is inconsistent with a free
market economy. It also has caused dubious company bailouts in the past, such as
the large government loan years ago to Chrysler, a company that remained weak
and should have been allowed to go into bankruptcy. All the American auto
companies are now asking for handouts too since they cannot compete against
Japanese, Korean, and German carmakers. They will probably get these subsidies,
even though these American companies have been badly managed. A "too many to
fail" principle, as in the present financial crisis, may still be necessary on
hopefully rare occasions, but failure of badly run big financial and other
companies is healthy and indeed necessary for the survival of a robust free
enterprise competitive system.
Nobel Laureate Gary Becker, "The $700+ Billion Bailout," The
Becker-Posner Blog, September 28, 2008 ---
http://www.becker-posner-blog.com/
November 12, 2008 Update: Paulson finally came to
his senses and opted for direct investment in banks via loans and equity rather
than buying up all the junk mortgages owned by troubled banks.
Appendix H
The Aftermath Leaves Auditing Firms in a
Precarious State
When the mortgage bubble burst, Americans were
"shocked" at how many Wall Street buccaneers had been gambling in a vast
pyramid scheme with someone else's money. Paper fortunes were made buying
and selling questionable sub-prime mortgages on the silly assumption that
such gargantuan inside profiting would always expand -- even as the number
of homebuyers able to buy overpriced properties was shrinking.
Now after the recent crash in sub-prime mortgages
and the stock of several investment firms, a trillion dollars in "assets"
could be nearly worthless. An already indebted American government must
restore some sort of trust to banks and markets by either printing money or
borrowing hundreds of billions of dollars from foreign creditors to
guarantee loans.
All that remains of this Ponzi scheme is the
election-year blame game. Republicans charge that important financial
firewalls were dismantled by the Clinton administration while insider
liberal senators got shady campaign donations in exchange for aiding Wall
Street. Democrats counter that the laissez-faire capitalism espoused by
Republicans for two decades encouraged financial piracy while tax policy
favored the rich speculator over the middle-class wage earner.
But no one dares to ask what really drove the
wheeler-dealer portfolio managers. Who re-elected these shady politicians of
both parties? Who fostered the cash-in culture in which both Wall Street
profit mongering and Washington lobbying are nourished and thrive? We
citizens did -- red-state conservatives and blue-state liberals, Republicans
and Democrats, alike. We may be victims of Wall Street greed -- but not
quite innocent victims.
Let me explain. The profiteering was not just the
result of a few thousand scoundrels on Wall Street or in Washington, as
greedy and as bonus-hungry as many of them no doubt were. Look at the
housing market as a sort of musical chairs in which everyone profited as
long he grabbed a seat when the music stopped. Then those left standing --
with high-priced loans and negative equity when the crash came -- defaulted
and stuck taxpayers with debt in the billions of dollars. But until then,
most owners who had sold homes cashed out beyond their wildest dreams.
Thousands of dollars in past profits are still in
sellers' bank accounts or were spent on their own consumption. If the shaky
buyer at the bottom of the pyramid should not have borrowed to buy an
overpriced house, then the luckier seller higher up hardly worried that the
cash-strapped fool was paying him way too much with unsecured borrowed
money.
We created the cultural climate for this shared
madness. Television shows advised how to "flip" a house after putting in
cosmetic improvements. Real-estate seminars and popular videos convinced us
that homes were not places to live in and raise a family but rather no
different from piles of chips on a Vegas table.
We created the phony populist creed that everyone
deserved to own a house. So lawmakers got the message to relax lending
standards in service to "fairness." But Americans forgot that historically
nearly four in 10 of us aren't ever ready, or able, to sacrifice for a down
payment, monthly mortgage bills, home maintenance and yearly taxes -- and so
should stick to renting.
The problem went way beyond real-estate fantasies.
Five-percent interest as a return on our money was once considered pretty
good -- especially inasmuch as a factory or farm on the other side of the
banking equation could not really stay in business paying 10 percent in
interest to banks for its necessary borrowing.
But soon retirement-account holders and
institutional investors began to expect as a given 7, 10 -- and even 20 --
percent "return" on their portfolios. Wage earners and professionals alike
compared the glossy brochures that appeared in the mail, and then jumped to
this 401(k) investment or that mutual fund to "maximize" retirement
portfolio earnings.
How Wall Street managers, eager for more
multimillion-dollar bonuses, planned to deliver on their promised sky-high
returns no one asked. But it often proved to be more by hook-and-crook shell
games than by financing new productive businesses or by extending credit for
the production of real goods in vital plants.
In a larger sense, this zeal for quick profits and
easy money reflected an oblivious too-good-to-be-true culture in which we
drove larger cars but demanded more oil drilling from everyone except
ourselves. We expected both expanded government entitlements and lower
taxes.
Our government borrowed ever more money from
foreign creditors, because it was a collective reflection of our own
profligate financial habits. Of course, we should reform Wall Street and
Washington -- and punish severely the crooks in both places. But Americans
should remember that Frankenstein was not the name of the monster but of its
creator.
Victor Davis Hanson is a classicist and historian at the Hoover
Institution, Stanford University, and author, most recently, of "A War Like
No Other: How the Athenians and Spartans Fought the Peloponnesian War." You
can reach him by e-mailing
author@victorhanson.com
“Going
Concern Audit Opinions: Why So Few Warning Flares?" by Francine McKenna,
re: The Auditors, September 18, 2009 ---
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Lehman Brothers. Bear Stearns. Washington Mutual. AIG. Countrywide. New Century.
American Home Mortgage. Citigroup. Merrill Lynch. GE Capital. Fannie Mae.
Freddie Mac. Fortis. Royal Bank of Scotland. Lloyds TSB. HBOS. Northern Rock.
When each of the notorious “financial crisis” institutions collapsed, were
bailed out/nationalized by their governments or were acquired/rescued by
“healthier” institutions, they were all carrying in their wallets non-qualified,
clean opinions on their financial statements from their auditors. In none of the
cases had the auditors warned shareholders and the markets that there was “ a
substantial doubt about the company’s ability to continue as a going concern for
a reasonable period of time, not to exceed one year beyond the date of the
financial statements being audited.”
Continued
in a very good article by Francine (she talks with some major players)
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
November 25, 2009 reply from Gerald Trites
[gtrites@ZORBA.CA]
I just have to weigh in here, as we have spoken about this issue before. You
have stated the theory very well, but the fact of the matter is that it just
can't work that way. Auditors do not have enough information to be able to do an
independent assessment of loan loss allowances. They need to rely on management
and staff knowledge and expertise in order to assess the reasonableness of the
allowances. If that knowledge and expertise is based on deception or is flawed,
they cannot necessarily discover that.
Lets take the allowance for doubtful accounts as an example. The auditors do not
know the accounts well enough to determine if they are collectible or not. They
can review the agings, compare them to other years, review subsequent payments,
confirm the accounts, etc. If the agings identify particular accounts, they will
go to the accounts receivable managers and discuss those accounts with them. As
part off thosse discussions they will likely review supporting evidence as to
the condition of the debtors. These discussions form an important part of their
audit of that allowance. The other procedures only provide corroborative
evidence. Lets also remember that many companies are very large, so we are
looking at accounts that could number in the hundreds of thousands and exist in
numerous countries of the world. So the audit firm needs to send in people - on
a test basis - to review accounts in those other countries. Since they are doing
branch audits, those auditors know even less about the client than the home
office auditors do. I understand that knowledge of the business is an important
standard, but this can not substitute for the knowledge of the management and
staff of the client. So there is always an imbalance.
In the case of the recent financial mess, we are looking at it with the benefit
of hindsight - always a nice position to be in. Before the events, very people
predicted the kind of mess that would evolve. Those who did were often laughed
at.
If the audit firms did not follow the standards of the profession, then they
could be in the wrong. However if they did, and simply failed to predict the
serious downturn in the economy that generated the losses that occured, then
they clearly are not in the wrong.
Francine is right - the auditors cannot be expected to second guess management;
and they cannot be expected to predict the future.
Jerry
November
25, 2009 reply from Zane Swanson
[ZSwanson@UCO.EDU]
Timeliness of information could be a major factor in the poor decision-making.
Major financial institutions are heavily engaged in micro-economic day trading
in contrast to prior (decade+) banking business. Accounting statements should be
reflective of the economics of the firm. If auditors do not have the information
to decide, why not require financial institutions to publish their statements on
the next day on the internet?. Given that management is responsible for the
their statements, they should welcome rational investor decisions based on
timely data instead of run-on-the-bank problems based on old information or
grave-vine stuff that the average investor does not possess.
Bye, Zane
November
27, 2009 reply from Glen Gray
A side note to this discussion:
The auditor cannot use as a defense that there was too much data, the supporting
materials were inadequate, or the big one--the company was so complex no body
could fully understand their process/procedures/business model etc. because by
making any of those admissions would mean that the auditor was violating GAAS to
do the audit. Because GAAS requires that the auditor be competent in GAAP, GAAS,
and the client's business. Otherwise, the auditor must withdraw from the audit.
Dan Guy, who has a long history with the AICPA and now functions as an expert
witness, made this point at the audit workshop at the 2009 AAA audit mid-year
meeting. He said they know they have won the case (against the audit firm) as
soon as the audit partner says--The client's business was so complex that no one
could understand it.
Glen L. Gray, PhD, CPA
Dept. of Accounting & Information Systems
College of Business & Economics
California State University,
Northridge 18111 Nordhoff ST Northridge, CA 91330-8372
818.677.3948
http://www.csun.edu/~vcact00f
November
26, 2009 reply from Bob Jensen
Hi Jerry and Zane,
The current shareholder lawsuits pending against virtually all the big firms
that audit bands will investigate whether auditors should have been more
diligent in detail testing of tainted mortgage bank portfolios and poisoned
tranches. I anticipate that some of the lawsuits will bring out some bad
auditing of bank loan portfolios and poor investigations of internal controls as
required under SOX.
Do you have any empirical references that show that the loan loss reserves of
banks have not been systematically earnings managed across the past four
decades. My searches show the opposite to be the case such that auditors must be
aware of the problem on bank audits.
Recall that Freddie and Fannie were audited by KPMG until KPMG was
fired and Deloitte took over as auditor
From The Wall Street Journal Accounting Weekly Review on
September 12, 2008 ---
http://online.wsj.com/article/SB122083722708908863.html?mod=djem_jiewr_AC
No End Yet to the Capital Punishment
by Peter Eavis
The Wall Street Journal
Sep 08, 2008
Page: C10
Click here to view the full article on
WSJ.com ---
http://online.wsj.com/article/SB122083722708908863.html?mod=djem_jiewr_AC
TOPICS: Accounting,
Allowance For Doubtful Accounts, Bad Debts, Banking, Financial
Analysis, Financial Statement Analysis, Loan Loss Allowance,
Reserves
SUMMARY: "The
chief problem at Fannie and Freddie -- an inadequate capital cushion
against losses -- also bedevils large banks in the U.S. and Europe
more than 12 months into the credit crunch. The broader strains now
facing the markets are not as easily relieved by central banks or
governments as the company specific crises at Fannie and Freddie or
Bear Stearns earlier this year. Of course, central banks could cut
interest rates in the face of this threat. The trouble is banks are
being extra cautious, justifiably, about lending as the economy
slows. And while banks are reluctant to lend, many are having
problems borrowing to fund themselves. That is because the market's
assessment of their creditworthiness is darkening."
CLASSROOM APPLICATION: Couching
the continued problems in credit markets in terms of adequacy of
loan loss reserves can help students in accounting classes better
understand the credit market issues--and put a real world example to
the academic learning about the importance of the accrual for bad
debts. The article therefore is useful in any financial or MBA
accounting course covering bad debts and the impact of the
accounting for loan losses on capital accounts. Questions also
discuss a related article on the topic of Fannie Mae, Freddie Mac,
and banks' preferred stock.
QUESTIONS:
1. (Introductory) Describe the recent events undertaken by
the U.S. government in relation to the Federal National Mortgage
Association (nickname Fannie Mae) and Federal Home Loan Mortgage
Corporation (Freddie Mac). You may use the related articles to do
so. In your answer, describe the roles of these entities in
facilitating mortgage lending and home ownership across the U.S.
2. (Introductory) The article states "the chief problem at
Fannie and Freddie is an inadequate capital cushion against losses."
Whether they are business accounts receivable for a company or
mortgage loan receivables on a bank or mortgage entity's balance
sheet, how do we establish an allowance for losses on receivables?
How does this procedure help to properly present a receivable
balance on the balance sheet and an uncollectable accounts expense
on the income statement?
3. (Introductory) What is the impact of recording an
allowance for doubtful accounts on an entity's capital or
stockholders' equity?
4. (Advanced) What is the purpose of requirements for banks,
Fannie Mae and Freddie Mac to maintain a "cushion" of capital? How
is that "cushion" eroded when loan losses prove greater than
previously anticipated?
5. (Advanced)
How is it possible that Fannie Mae and Freddie Mac have inadequate
allowances for doubtful mortgage loans?
6. (Advanced) Why is it likely that inadequate allowances for
losses on loan and accounts receivable are established in times of
significant change in the product market generating the receivables?
Did such a change occur in mortgage loan markets?
7. (Introductory) One of the related articles discusses the
implications of the government takeover and its suspension of
dividends on the value of Fannie Mae and Freddie Mac preferred
stock. How does preferred stock differ from common stock? How are
these types of ownership interests similar in cases of failure of
the entity issuing them?
8. (Advanced) Why do debtholders fare better than common and
preferred shareholders in this case of government takeover or any
case of corporate failure?
9. (Advanced) Why might investors "view preferred stock as
debt by another name"?
Reviewed By: Judy Beckman, University of Rhode Island |
I hope you are correct, but a four-decade history of mismanaged or purposefully
managedloan losses in banking suggests something is wrong in the auditing of
banks. It would seem that there’s a long history of actual losses exceeding loan
loss reserves. Do you have empirical evidence to the contrary of the following
citations illustrative of hundreds of banking studies?
I will cite some older studies to show how bank loan loss reserves have been
poorly estimated for many years. Auditors cannot possibly be ignorant of this
problem.
"Loan Loss
Reserves," by John R. Walter, Economic Review, July/August 1991, Page 28
Nevertheless, the desire to smooth reported profits, to lower taxes, and to
limit the expenses of estimating future loan losses continues to provide an
incentive for banks to hold reserves at levels that differ from their best
estimates of the losses inherent in their loan portfolios.
From The William and Mary Law Review, Summer of 1970
Bad debt reserves manipulation is one of the key ways bank managers manage
earnings according to Mark W. Nelson , John A. Elliott , Robin L. Tarpley,
Accounting Horizons Supplement, Vol. 17, 2003.
"The
harder they fall: Will the Big Four survive the credit crunch?" by Rob Lewis,
AccountingWeb, October 2008 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=106124
A U.S. Justice Department report has already concluded that KPMG either helped
perpetrate the fraud at the mortgager or deliberately ignored it. Class-action
lawsuits are already pending. Only weeks before the report was published the
U.S. Supreme Court's Stone Ridge ruling immunized third party advisers like
accountants and bankers from the disgruntled shareholders of other entities, but
that may be not much of a shield. Of course, New Century might not be KPMG's
biggest problem. That's probably the Federal National Mortgage Association, or
Fannie Mae.
The following is not a bank audit, but it provides an excellent reason why we
had SOX legislation.
AccountingWeb ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=87261&d=815&h=817&f=816&dateformat=%B%20%e,%20%Y
(Requires Subscription)
KPMG Gets Probation For Bungling Orange County
Audit
|
AccountingWEB US - July 29, 2002 -
International accounting firm KPMG has been
slapped with a $1.8 million fine and a year of
probation after being found guilty of gross
negligence and unprofessional conduct for its
handling of the 1992 and 1993 audit and
financial statements of Orange County,
California. The California Board of Accountancy
also ordered three years of probation and 100
hours community service for KPMG partner
Margaret Jean McBride and two years of probation
each for former KPMG accountants Joseph Horton
Parker and Bradley J. Timon. All were found
guilty of gross negligence and unprofessional
conduct.
The county declared bankruptcy in late 1994
after it lost $1.7 billion in its investment
pool. County treasurer Robert L. Citron oversaw
the investment pool. Mr. Citron was convicted of
faking interest earnings and falsifying
accounts. The Board claims that KPMG, attempting
to save money on what turned out to be an
underbid audit, cut corners by allowing junior
staff members to conduct certain areas of the
audit and by not helping the county solve its
problem of a lack of internal controls with
regard to the investment pool. KPMG auditors did
not speak with the county treasurer regarding
the investment pool, nor did they determine the
true market value of the highly leveraged and
speculative investments. KPMG paid a settlement
of $75 million to Orange County in 1998.
KPMG refutes the claims and
says the
accountancy board wasted millions of dollars
with the goal of making KPMG a scapegoat. "The
claims by the board incorrectly challenge how
KPMG reached its conclusions rather than claim
our conclusions were wrong," said KPMG spokesman
George Ledwith.
Continued at the AccountingWeb link shown above. |
|
|
November
26, reply from Gerald Trites
[gtrites@ZORBA.CA]
My dear Bob,
Of course, auditors have taken a stand in many situations. That's what I have
been trying to say. When they reach the conclusion that they cannot live with
the concerns they have, then they take a stand. That happens all the time.
The financial industry is a special case. The scope of judgement is so wide and
what passes for assets so complex and muddy that traditional audits do not do
the job. The mortgage debacle is a case of financiers gone wild. We need to ask
those questions you're talking about, not just of the auditors, but of everyone
else involved right from the property holders who thought it was sensible to
take 100% mortgages, through to the top Wall Street bankers who think it is
reasonable to declare multi-million bonuses for themselves. The auditors are a
bit player in a widespread systemic failure. We need to get to the root of the
matter and then make the necessary changes. Suing the auditors will not resolve
the problem.
I think one of the areas of change needed is in the financial reporting methods
used for financial institutions. Reporting of complex financial instruments
cannot be achieved through conventional financial statements. Using fair values
is a sham, because nobody knows what the fair values are until the instruments
have gone through their life cycle. Until then, its all guesswork.
Financial and business reporting is moving through a stage where we are placing
less reliance on financial statements and more on reporting of other data items.
Whereas financial statements used to be the major part of the reports to
stakeholders, now they are only a small part. A study released by the CICA last
year identified over 50 types of information reported to stakeholders of which
the financial statements are only one. More data is becoming available through
such vehicles as XBRL and this data can be analyzed electronically. Just as the
SEC did not have enough staff to review the filings coming their way, and called
for the filings to be in XBRL so they could automate the reviews, we may well
find that for financial institutions more raw data needs to be made available in
a form that can be analyzed electronically. If this had been done with the
complex instruments that led to the financial debacle we have been going
through, there is reason to believe that some of the issues that came to light
through defaults would have been identified earlier. I have some references on
this point, but haven't taken the time to dig them out, but can if you wish.
Roger or Glen might have them readily available.
Data reporting through systems like XBRL is a better response than trying to fix
an outmoded financial reporting system that worked well in a simpler world but
is no longer adequate to express the complexities of the modern financial world.
Instead of branding the auditors as incompetent and sleazy, lets address the
real problems.
Your good and faithful colleague,
Jerry
November
27, 2009 reply from Bob Jensen
Hi Jerry,
I agree somewhat if you begin to delve into
Black Swan Theory and the
Gaussian Copula Function,
but the real problem for current
shareholders lawsuits against banks and mortgage companies boils down to a
much more basic Auditing 101 negligence question about things that auditors
were required to handle under SOX. Gaussian Copula Functions would've worked
just fine on Wall Street if mortgage contracts had not be poisoned on Maine
Street.
Where did the poison in loan portfolios come
from in the first place before this poison later caused problems in CDOs,
credit derivatives, and millions of foreclosures? This is an Auditing 101
problem, and auditors blew it in spite of the hopes of Zane. The question
is whether lending approvals conformed to the rules of approving loans.
SOX requires that internal control systems be
evaluated and test checked by CPA auditors, including internal controls for
banks and mortgage companies for following the rules of approving loans.
Simple test checks of the loan approval internal control process should’ve
uncovered illegal approving of enormous mortgage loans to borrowers with
very negative credit history in violation of mortgage lending laws and
policies (including rules laid down to mortgage lenders by Fannie and
Freddie). Exhibit A in Phoenix is unemployed Marvene living on welfare who
was deep, hopelessly deep in $75,000 debt, when she managed to pay off her
debts and buy an enormous new truck by getting a 2007 $119,000 mortgage on a
shack she purchased for $3,200. Lenders never visited her shack to approve
the 2007 loan. They did not even check the tax records. Neighbors in 2009
bought her property in foreclosure almost nothing and tore her shack down.
It doesn’t take a rocket science auditor to
know how to test check some of the loans and compare the value of the
collateral with the amount loaned. Even a simple auditor comparison of tax
record valuations should have disclosed that many new mortgage amounts were
in excess of ten or even 100 times the tax record valuations.
There were all sorts of possible red flags to
be checked while auditing under SOX requirements. At a minimum, credit
ratings of borrowers could’ve been examined along with employment status.
Each time I applied for a mortgage (on four different homes), I was required
to send copies of my IRS Form 1040 to the bank along with copies of my
recent credit card billings before my loan was approved. These telling forms
were available to CPA auditors of my banks when auditors test checked the
lending control process.
It seems to me that you are excusing auditors
for lack of sophistication in David Lee’s Copula Function when in fact there
would’ve been no problem with the Copula Function in the least if auditors
had detected the poison in the bank loans on main street due to the fact
that lenders were not following mortgage approval laws, rules, and policies.
This is an Auditing 101 failure under SOX that requires zero rocket science.
Viewers who never graduated from high school
can understand every word of the CBS video of how the poison was added to
the loan portfolios. Why couldn’t auditors understand at least at that
level?
CBS Sixty Minutes featured how bad things became when poison was added to
loan portfolios. The Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
It was Auditing 101 failure that let the poison
get into the loan portfolios.
November 27, 2009 replies from Bob Jensen and Jerry Trites
Nice reply below Jerry,
It’s still confusing to me how loan approval
laws and rules were violated millions of times, because CPA testing for loan
approval internal controls seems to me to be one of the easiest SOX
conformance audit procedures since so much customer documentation should be
in the files to meet mortgage lending laws, rules, and policies
When I got my mortgage in 2004 for my present
house up here in the mountains I had to provide the bank with copies of my
prior IRS 1040 forms (for the last five years), recent credit card billing
statements for all credit cards, a copy of the payoff receipt on the
mortgage that I had in Texas, etc. I had to provide certified copies of my
TIAA-CREF balances and statements of my lifetime annuities and other mutual
fund account records. And I know for certain that the bank delved into my
entire credit history. All of these supporting documents were on file for
CPA auditors of the bank. The bank insisted on all this backup material even
though I think it almost immediately sold my mortgage to Fannie.
Perhaps because my property is so rural in the
boonies, I also had to pay over 50% down in cash
When I refinanced to get a lower rate fixed
rate in 2006 I had to provide updates on all the above information even
though I refinanced through the same regional bank.
Similarly in New Hampshire and in most other
states property tax valuation records are available to the public in general
such that CPA auditors could certainly verify the most recent tax assessor’s
valuation of the property that I was purchasing.
What I’m saying is that, if the bank or
mortgage company, conformed to mortgage laws, rules, and policies, about the
easiest audit procedure under SOX rules should be to test check whether the
bank had adequate internal controls for adhering to laws, rules, and
policies. Auditors that did not test check this conformance had to, in my
judgment, negligent under SOX rulings.
The bank also has a statement from my casualty
insurance company with respect to the maximum it will insure my house for,
and this is somewhat of a valuation check since the insurance company made
such a detailed onsite visit of the property before my mortgage was
approved.
None of these things apparently took place when
Marvene got her fraudulent mortgage in Phoenix ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Whenever I watch the following wonderful CBS
Sixty Minutes video I have to ask myself:
Where were the CPA auditors investigating internal controls over the loan
approval process?
Viewers who never graduated from high school
can understand every word of the CBS video of how the poison was added to
the loan portfolios. Why couldn’t auditors understand at least at that
level?
CBS
Sixty Minutes featured how bad things became when poison was added to loan
portfolios. The Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
It was Auditing 101 failure that let the poison
get into the loan portfolios.
Robert E. (Bob) Jensen
Trinity University Accounting Professor
(Emeritus)
190 Sunset Hill Road
Sugar Hill, NH 03586
Tel. 603-823-8482
www.trinity.edu/rjensen
From:
AECM, Accounting Education using Computers and Multimedia [mailto:AECM@LISTSERV.LOYOLA.EDU]
On Behalf Of Gerald Trites
Sent: Saturday, November 28, 2009 11:08 AM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: Re: Going Concern Audit Opinions: Why So Few Warning
Flares?"
Hi Bob
I don't want to belabour this, but I have a couple of points to add. I agree
with your assessment of the audit procedures that one would expect, assuming
that a decision was made to test the controls. If I were still a partner in
a big firm, and in charge of one of those audits, I think I would have:
1. Identified SOX compliance as a priority at the planning stage.
2. Read the SOX rules carefully and considered the impact on my client.
3. Brought in one of the firm's SOX specialists to help with the audit.
4. Discussed the issues with the staff in planning meetings.
5. Discussed SOX compliance with management, and determined what procedures
they have put in place to ensure compliance.
6. Ensured the audit programs included procedures to determine that the
procedures put in place were actually implemented and are working properly.
7. Reviewed the procedures carried out by the staff and their conclusions.
8. Discussed the results with management.
9. Reported on any SOX compliance issues to the Audit Committee.
If we decided that the controls put in place were critical and needed to be
tested, then I would have had procedures such as you have outlined carried
out, and perhaps others. To be honest, I don't know if I would have made
that decision or not, without actually going through the process and doing
the risk analysis. Certainly in retrospect I would, but hindsight is
wonderful.
Also, the second partner review would likely have had experience with
similar clients and would identify SOX compliance as an issue and reviewed
what had been done.
I can't believe that these things were universally not done. If they were
done, why didn't they identify the valuation problems? I don't know. I can't
leap to the conclusion that the auditors failed in their duties. I need to
know what they did and what the results were. I'll be really interested to
see what comes out of the legal actions. Hopefully we don't punish a lot of
innocent people like we did with AA.
Jerry
November
26, 2009 reply from Francine McKenna
[retheauditors@GMAIL.COM]
Thanks Bob.
This is very helpful. I'm working on a post about where were the auditors during
the weekend last September when Merrill Lynch was sold suddenly to BofA and Leh
was allowed to fail.
I often talk about the most important risk assessment step in an audit - Tone at
the Top, but many pooh-pooh my expectation that auditors should be evaluating
the integrity and veracity of senior management and then making adjustments of
audit programs form there.
http://retheauditors.com/2009/10/03/auditing-standard-5-how-now-brown-cow/
There seems to be a huge amount of slack cut for audits who can't possibly know
their clients business better than the executives and are An accounting firm
that conducts an annual audit of a multitude of unrelated firms in a multitude
of different industries cannot be expected to be expert in the firms’ business
environments…” in Judge Posner's words.
What are they then?
So Much
Auditor Litigation Makes For Strange Bedfellows
Francine McKenna's Great Blog, October 12, 2009 ---
Click Here
Includes a clip from the old risqué movie Bob,Carol, Ted, and Alice
Every one of the Big 4 (and the next tier) has a
handful of lawsuits on their desk
related to their audits of the banks and other
financial institutions that failed, were taken over in the dead of night, or
bailed out by their respective central banks. That’s in addition to the
various fraud and Madoff related suits. It may or may not have been better
for them to have
warned us with “going concern” opinions earlier. We’ll
let the judges and juries decide, if any of the cases are actually tried.
Most often they settle and the audit firm pays, but
not as much as you would think.
Deloitte has been party to settlements, left and right, lately, but they’re
no more prone to settlements. After all, per Adam Savett of Risk Metrics
(by
way of
Kevin La Croix of D&O Diary),
“jury trials in securities class action lawsuits are extremely rare” :
“As reported on the Securities Litigation Watch blog
(here),
only 21 cases (prior to Vivendi) have gone
trial since the 1995 enactment of the PSLRA.
Only seven of the 21 cases (including the
Household International case) that have gone to a verdict involved
conduct that occurred after the PSLRA was enacted.”
Jury trials in accounting malpractice cases are even rarer. It’s just that
Deloitte has more than the average share of
subprime-related litigation and as a
result is suffering from the double whammy of both losing clients due to the
crisis and having those former clients sue them.
What’s interesting about the current flood of lawsuits is the heightened
probability Deloitte - and the rest of the Big 4 - will end up on both sides
of lawsuits with their former and current audit clients.
Take the
Merrill Lynch litigation.
Please.
Deloitte is a co-defendant with Bank of America (in place of Merrill Lynch)
on lawsuits stemming from Bank of America’s
“Deal From Hell”
to buy Merrill Lynch for $50 billion, arranged in
48 hours, and agreed to on September 15 of last year. In January of this
year, Merrill Lynch announced settlement of a
suit filed in October 2007
related to the earlier period where Merrill Lynch
experienced significant losses due to write downs of CDOs and other subprime
related assets. Deloitte was a
defendant and may also have to contribute
to that $475 million settlement. Kevin La Croix described it as,
”…unquestionably
the largest subprime subprime securities lawsuit settlements so far, and
[ ] certainly suggest[s] the enormous stakes that may be involved in the
mass of subprime and credit crisis-related litigation cases that remain
pending.”
Continued in article
Bob
Jensen's threads on large firm litigation ---
http://retheauditors.com/2009/10/12/so-much-auditor-litigation-makes-for-strange-bedfellows/
Francine
maintains an outstanding auditing blog at
http://retheauditors.com/
The current shareholder lawsuits pending against virtually all the big firms
that audit bands will investigate whether auditors should have been more
diligent in detail testing of tainted mortgage bank portfolios and poisoned
tranches.
Keep in mind that auditors since SOX have taken on the added responsibility of
testing the internal control system for weaknesses in the lending.
November
26, 2009 reply from Francine McKenna
[retheauditors@GMAIL.COM]
Dear Gerald,
So many concerns I have with your comments... They are thoughtful and obviously
come from significant experience, but...
"They cannot predict the future. " - For a going concern assessment, according
to AU341, "The auditor has a responsibility to evaluate whether there is
substantial doubt about the entity's ability to continue as a going concern for
a reasonable period of time, not to exceed one year beyond the date of the
financial statements being audited (hereinafter referred to as a reasonable
period of time)." That's a requirement to look into the future, like it or not,
for the benefit of the shareholders not in service to management.
"Instead management instructs their accountants to, for example, see if we can
make $10 million in earnings. Please be clear. I'm not talking about the kind of
earnings management that includes contrived earnings that are vastly different
from what they should have been and mis-represent the results for the company.
In this case, management may have felt that earnings could fall between 9.5
million and 10.5 million and they feel that 10 million is a benchmark they would
like to achieve. To achieve management's earnings objectives, the staff in
making judgements, gives the company the benefit of the doubt where they can. "
Sounds like GE,
http://www.forbes.com/2009/08/04/ge-immelt-sec-earnings-business-beltway-ge.html
...an approach that was put up with for a very long time, where KPMG allowed
themselves to be pushed and shoved into going along with what managment wanted
in order to meet analyst expectations of smooth earnings. It was always wrong.
Why? Because the approach and your assumption speak loudly of management's
desires, management's goals and, in the end as we have seen with the banks,
management's desires to hit targets that will pay out their incentive comp. When
are we going to stop making excuses for this behavior? http://retheauditors.com/2008/04/21/ge-will-somebody-please-look-really-hard-under-their-hood/
"Just that audit opinions cannot be relied upon to guarantee that the accounts
are "right". But they can be relied upon to provide some incremental assurance
that the accounts are reasonable, that they were arrived at using reasonable
processes. There are all kinds of things that can go wrong that the auditors
could not reasonably have picked up, but in the normal course of events, the
auditors play a valuable role in the process of reporting to stakeholders. Thats
why they are worth paying." How much to pay for "incremental" assurance that
accounts are "reasonable"? I say not much. http://blogs.reuters.com/reuters-dealzone/2009/07/01/aig-investor-questions-pwc-fees/
AIG paid PwC a total of $131 million in audit and other fees in 2008 and $119.5
million in 2007. “I want to know what these fees were paid for,” shareholder
Kenneth Steiner of Great Neck, New York said. “Why didn’t anybody know what was
going on? What were the accountants doing? Were they sleeping?” The fees look
large but are not unheard of. GE, for instance, paid KPMG $133 million in 2008
and $122.5 million in 2007.
November
25. 2009 reply from Saeed Roohani
[sroohani@COX.NET]
Are you saying current going concern standard is adequate?
Let’s try something better than current going concern standard: SOX Section 409:
‘‘(l) REAL TIME ISSUER DISCLOSURES.—Each issuer reporting under section 13(a) or
15(d) shall disclose to the public on a rapid and current basis such additional
information concerning material changes in the financial condition or operations
of the issuer, in plain English, which may include trend and qualitative
information and graphic presentations, as the Commission determines, by rule, is
necessary or useful for the protection of investors and in the public
interest.’’.
It is obvious many people behind doors making deals last year knew about how bad
things were, it looks like all these companies violated SOX Section 409 as well,
and nobody cares either.
Bob
Jensen's threads on "Where Were the Auditors?" ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Some
auditing firms are now being hauled into court in bank shareholder and pension
fund lawsuits ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
1999 Quote from The New York Times
''If they fail, the government will have to step up and
bail them out the way it stepped up and bailed out the thrift industry.''
Self explanatory. I received this from a friend. The highlights below are
his.
FYI
David Coy
Adrian College
**********************
September 30, 1999
Fannie Mae Eases
Credit To Aid Mortgage
Lending
By STEVEN A. HOLMES
In a move that could help increase home
ownership rates among minorities and low-income consumers, the Fannie
Mae Corporation is easing the credit requirements on loans that
it will purchase from banks and other lenders.
The action, which will begin as a pilot
program involving 24 banks in 15 markets -- including the New York
metropolitan region -- will encourage those banks to extend home
mortgages to individuals whose credit
is generally not good enough to qualify for conventional loans. Fannie
Mae officials say they hope to make it a nationwide program by next
spring.
Fannie Mae, the nation's biggest underwriter
of home mortgages, has been under
increasing pressure from the Clinton
Administration to
expand mortgage loans among low and moderate income people and felt
pressure from stock holders to maintain its phenomenal growth in
profits.
In addition, banks, thrift institutions and
mortgage companies have been pressing Fannie Mae to help them make more
loans to so-called subprime borrowers. These borrowers whose incomes,
credit ratings and savings are not good enough to qualify for
conventional loans, can only get loans from finance companies that
charge much higher interest rates -- anywhere from three to four
percentage points higher than conventional loans.
''Fannie Mae has expanded home ownership for
millions of families in the 1990's by reducing down payment
requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief
executive officer. ''Yet there remain too many borrowers whose credit is
just a notch below what our underwriting has required who have been
relegated to paying significantly higher mortgage rates in the so-called
subprime market.''
Demographic information on these borrowers is sketchy. But at least one
study indicates that 18 percent of the loans in the subprime market went
to black borrowers, compared to 5 per cent of loans in the conventional
loan market.
In moving, even tentatively, into this new
area of lending, Fannie Mae is taking on significantly more risk, which
may not pose any difficulties during flush economic times. But the
government-subsidized corporation may run into trouble in an economic
downturn, prompting a government rescue similar to that of the savings
and loan industry in the 1980's.
''From the perspective of many people, including me, this is another
thrift industry growing up around us,'' said Peter Wallison a resident
fellow at the Americ an Enterprise Institute. ''If
they fail, the government will have to step up and bail them out the way
it stepped up and bailed out the thrift industry.''
Under Fannie Mae's pilot program, consumers
who qualify can secure a mortgage with an interest rate one percentage
point above that of a conventional, 30-year fixed rate mortgage of less
than $240,000 -- a rate that currently averages about 7.76 per cent. If
the borrower makes his or her monthly payments on time for two years,
the one percentage point premium is dropped.
Fannie Mae, the nation's biggest underwriter
of home mortgages, does not lend money directly to consumers. Instead,
it purchases loans that banks make on what is called the secondary mark
et. By expanding the type of loans that it will buy, Fannie
Mae is hoping to spur banks to make more loans to people with
less-than-stellar credit ratings.
The Fate of the Large Auditing Firms After the
2008 Banking Meltdown
Hi Tom,
I really do appreciate that you are trying to be constructive. However,
even the pejorative title of your blog post, like that of Francine's
post, seems to suggest that auditors are getting away with something
they should not get away with in the courts.
Your title is: "Why
Nothing Sticks to Auditors when Loans Go Bad"
Her title is:
"Big Four Auditors and Jury Trials: Not In The U.S.
In your blog posting you then goes on to state:
If the auditors don't settle, then (follow
me on this one) the SEC will have to convince the ALJ that the
auditors acted "unreasonably" by not concluding that
the numbers fed to them by management were themselves
"unreasonable."
I tried to point out that both auditors and management relied upon
"unreasonable" mortgage value estimates thousands of thousands of
mortgage valuation experts at the time of the KPMG audit in question.
Over 99.999% of those valuation experts were greatly overvaluing
those poisoned mortgages in Countrywide Financial, IndyMac Bank,
Ameriquest, Wells Fargo, Washington Mutual, etc. The exception was Peter
Schiff, but nobody was listening to him.
Sleazy real estate appraisers were greatly overvaluing properties
serving as collateral.
Security valuation experts were greatly overvaluing the mortgages.
and CDO portfolios comprised of those mortgage investments. Many relied
upon the flawed
Gaussian copula function.
Your proposals for improved auditing almost always entail suggesting
that auditors rely on "independent valuation experts."
My point is that in these particular instance of auditors at
Countrywide, IndyMac, Washington Mutual, and the others virtually all
"independent valuation experts" were going to agree to unreliable
valuations by experts for reasons given in Professor Galbaith's Senate
Testimony:
"Why the ‘Experts’ Failed to See How Financial Fraud Collapsed the
Economy," by "James K. Galbraith, Big Picture, June 2, 2010
---
http://www.ritholtz.com/blog/2010/06/james-k-galbraith-why-the-experts-failed-to-see-how-financial-fraud-collapsed-the-economy/
My point is that fair value accounting and KPMG's auditing relying on
"independent valuation experts" of the mortgages in Countrywide would
not have helped to predict that Countrywide was no longer a going
concern. The valuation experts across the U.S.A. did not foresee the
collapse of the mortgage lending companies and Wall Street investment
banks until after the bubble burst.
Where did the auditors fail?
The CPA auditors like KPMG and the other Big Four firms failed because
they did not go granular on a sampling of mortgages held by Countrywide
Financial, IndyMac Bank, Ameriquest, Wells Fargo, Washington Mutual,
Bear Stearns, Lehman Bros., Merrill Lynch, and over 1,000 other failed
banks. The failing was to rely upon valuation experts rather than to
themselves sample the mortgage investments during audits to investigate
the likelihood of mortgages failing.
The auditors should have detected that there was not a snow ball
chance in Hell that Mervene on welfare and food stamps was going to pay
off a $103,000 mortgage on her shack.
For a picture of Mervene's shack in Phoenix go to
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
After foreclosure on this shack, her neighbors bought it for less than
$10,000 and tore the eyesore down.
Diligent auditors should've detected themselves that something was
wrong if a woman on welfare could get a $103,000 mortgage on that cheap
shack.
My contention is that the CPA audit firms failed because they relied
upon fair value estimates from "valuation experts" as being
"reasonable." They should've instead done a deeper granular
investigation of the mortgage investments themselves. There is precedent
for this in auditing. In the early days of FAS 133, audit firms were
aware that they were outsourcing too much to banks for the valuation of
derivative financial instruments. Very quickly the audit firms purchased
their own Bloomberg or Reuters Terminals and began to themselves value
samplings of each client's investments in derivative financial
instruments.
Conclusion
Hence, I would contend that instead of relying upon "independent
valuation experts" for loan investments, CPA auditors should instead go
granular on samplings of those loans to investigate the likelihood of
paybacks on those loans.
It did not even take an accounting degree to realize that Marvene was
never going to pay back this loan once the mortgage lending firm sold it
to Fannie Mae --- which was tantamount to sticking government with the
Mervene's loan loss.
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Respectfully,
Bob Jensen
"UPDATE 2-UK proposes tougher accounting test on banks' health," by
Huw Jones, Reuters, January 30, 2013 ---
http://www.reuters.com/article/2013/01/30/britain-accounting-idUSL5N0AZCS420130130
Accountants will have to determine more thoroughly
if a bank can stand on its own two feet for well over a year without
taxpayer help under draft changes from Britain's audit regulator.
The Financial Reporting Council (FRC) said auditors
such as KPMG, PwC, Deloitte and Ernst & Young would have to examine threats
to a company's
business model and capital adequacy through
the economic cycle for the sector a company is in.
The planned reform stems from anger among UK
policymakers that auditors gave
banks a clean bill of health just before
taxpayers had to shore them up in the 2007-09 financial crisis.
Currently auditors only attest to a company as a
"going concern" for the following 12 months, but an inquiry by Lord Sharman
recommended a longer period and wider criteria.
KPMG said the proposals represented a high hurdle
as the duration of an economic cycle was long and may be open to debate. "My
concern is that it will be difficult for many companies to meet what appears
to be such a tough test," said Tony Cates, KPMG's head of audit.
The FRC said on Wednesday auditors would also have
to be sure a company's solvency and liquidity can be managed for at least a
year, disclose any significant risks posed by this, and demonstrate there
has been a "robust going-concern assessment".
Currently audits of
banks look at solvency and liquidity but in other sectors
typically only liquidity is looked at in any depth. There is no requirement
at present to show there has been any in-depth examination of going concern
issues in an audit.
GOING CONCERN
The reform is part of efforts to end the perception
in
markets that banks would not be allowed to
fail and taxpayers would always ultimately step in to rescue them.
Saying a bank is a going concern based on this
assumption won't be acceptable any longer.
"We make it clear it's not possible or appropriate
to rely on banks not being allowed to fail. They would have ensure they have
appropriate facilities for as long as they needed," said Marek Grabowski,
head of audit policy at the FRC.
The changes would apply to all listed companies who
must be audited, not just banks.
The FRC's draft changes have been put out to public
consultation until April and follow an inquiry chaired by Lord Sharman who
said on Wednesday the reforms will be radical for many companies.
Question
Before thousands of banks failed after 2007, where were the auditors?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
What is the world is going to happen to private sector versus
public sector auditing?
The big difference between private sector auditors versus
government auditors is that we can sue the private sector auditors over and over
and over until they make serious efforts to get it right. Virtually nothing is
being done to make the government’s auditors get it right.
What
my inside contacts in the large firms are telling me is that more than ever
efforts are now being made to make their auditors independent to a point where
they will stand up to their largest and most lucrative clients and demand that
there be better GAAP and GAAS conformance ---
Advancing Quality through Transparency Deloitte LLP Inaugural
Report ---
http://www.cs.trinity.edu/~rjensen/temp/DeloitteTransparency
Report.pdf
I think the PCAOB audit reviews have contributed in a small but
marked way to improve audits. But there’s a long way, miles and miles, to go
before we sleep ---
http://faculty.trinity.edu/rjensen/fraud001.htm
It’s
Market Versus the Government!
The question is what’s the alternative? Those that want a
Government’s Central Planning Board to allocate resources in the economy (in
place of markets) are aiming the world economy for disaster, confusion, and
disruption. And who keeps the government honest? At the moment the GAO declares
that it’s impossible to audit our largest government agencies like the Pentagon,
the IRS, etc. Government accountability, accounting, and auditing are in much
worse shape than our far less-than-perfect private sector accountability,
accounting, and auditing.
The Sad State of Government Accounting ---
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
The Sad State of Private Sector Accounting ---
http://faculty.trinity.edu/rjensen/fraud001.htm
No
Resource Allocation System Can Exist Without Accountability, Accounting, and
Auditing
Accountability, accounting, and auditing are necessary under any type of
resource stewardship and resource allocation system. At one extreme we have
markets, investors, and creditors who rely upon audits and stewardship
accounting of the private sector market participants. The FASB and the IASB do
indeed, in my viewpoint, focus on the information needs of those investors and
creditors. The auditing firms, however, are faced with what Tom Selling calls a
“broken model” where those being audited choose their auditors and negotiate the
audit fees. This is certainly problematic if not completely broken.
The Government’s resource allocation system brought us the Jack
Murtha Airport with its full security system, air controller system, six flights
a day to only one destination, and less than 50 passengers a day. It’s a
taxpayer cash flow black hole.
At the other extreme we have the government auditors who cannot
get any type of handle on how to audit the enormous agencies to a point with
the auditors have just given up on total system audits. Nobody audits the
Pentagon after the GAO declared it “unauditable.”
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
The world is not perfect, and certainly financial and commodities
markets were manipulated by Enron, Lehman, Merrill, etc. Andersen’s audits were
among the worst in the history of the world, and Andersen got its just dessert
for not enforcing quality control of its audits. Government is the land of
corrupt resource allocation that usually leads to even less efficient resource
allocations than the market-based resource allocations.
I think auditing of banks has been a sham by virtually all the
auditing firms, and these firms will soon pay a heavy price in court for
certifying fiction of bank accounting for the thousands of banks that recently
went “bank”rupt. Unless the large auditing firms overcome their sham audits of
banks, they too will bite the dust.
The
question is whether the professionalism/independence recovery efforts of all the
large auditing firms can save them is still open to question. After all these
years since Andersen imploded, I think the Wall Street bank audits indicate that
the big auditing firms, in Art Wyatt’s wording, “still didn’t get it.” Art Wyatt
was the lead executive research partner for Andersen. After Andersen imploded,
Art observed the lack of professionalism in the surviving auditing firms and
concluded that “They Still Don’t Get It” ---
http://aaahq.org/AM2003/WyattSpeech.pdf
But the real problem in my viewpoint is not the mixing of consulting and
auditing nearly as much as it is the "too big to lose" clients (read that as
auditing firms being unwilling to quit the audit after spending so much time and
money gearing up for the big-client audit).
Can
you hear us now?
The question is whether the auditing firms, in the wake of the banking collapse
and bailout, are more seriously listening and, more importantly, finally doing
the right thing. Investors are amazingly tolerant of the cycles of scandal and
promised reforms in the capital markets. The Dow remained amazingly high
during all the recent Wall Street scandals and bailouts. And investors and
creditors will have their day in court when they bring the bankers and their
auditors to the dock ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
But nobody is bringing the broken government accounting and
auditing system to the dock. You can’t usually sue the government. Many of the
recent frauds could’ve been prevented or mitigated by the SEC, but the SEC is
not being held accountable for its huge failures, especially under an
incompetent political hack named Chris Cox.
Question
What’s
the big difference between Soviet Union Accounting in 1960 and accounting in the
U.K. and the U.S. in 2010?
Answer
In the Soviet Union the public could not haul the sham auditors into court.
Accounting in the Soviet Union really was fiction writing at all levels of
enterprise. In the Soviet Union there could never be a Prem Sikka, an Abe
Briloff, a Frank Partnoy, a Mark Lewis, a Lynn Turner, or a CBS Sixty Minutes.
Why does Prem Sikka now want to destroy our market system and model us after the
Soviet Union? Perhaps I’m being unfair to Prem. He tears at the foundations of
markets without ever suggesting what he thinks should take their place for an
economy’s resource allocation system. Others like Partnoy, Lewis, and Turner
want to “make markets be markets” with better accountability and auditing”
"Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Why
aren’t we hauling the GAO and the SEC and government watchdogs in general into
court and demanding that they make at least as much effort at reform as the
private sector accountants and auditors?
The
big difference between private sector auditors versus government auditors is
that we can sue the private sector auditors over and over and over until they
make serious efforts to get it right. Virtually nothing is being done to make
the government’s auditors get it right.
http://faculty.trinity.edu/rjensen/fraud001.htm
More Woes for PwC
"New York Attorney General Sues JP Morgan And Raises Question Of What The
"Auditor" Knew," by Francine McKenna, Forbes, October 2, 2012 ---
http://www.forbes.com/sites/francinemckenna/2012/10/02/new-york-attorney-general-sues-jp-morgan-and-raises-questions-of-what-the-auditor-knew/
Eric Schneiderman,the New York Attorney General,
filed suit yesterday against JPMorgan Chase for the sins of Bear Stearns
committed prior to the distressed purchase of Bear Stearns by the bank in
2008. Schneiderman plays a dual role here, as New York AG and co-head of the
Obama administration Residential Mortgage Backed Securities Working Group.
That task force was peeved, according to Alison Frankel for Thomson Reuters’
On The Case blog, that Schneiderman filed the suit Monday, jumping the gun
on a joint federal-state press conference scheduled for Tuesday.
The NYAG complaint rests heavily on work done by
others, in particular law firm Patterson Belknap Webb & Tyler, journalist
Teri Buhl - who has been following this story since 2010 – and documentary
filmmaker Nick Verbitsky. Patterson Belknap represents monoline mortgage
insurers Ambac, Syncora and Assured Guaranty in their pursuit of Bear
Stearns and now JPM.
Unfortunately, the NYAG complaint rests a bit too
heavily on Patterson Belknap’s Ambac complaints (first and second amended
versions) when discussing the role and responsibilities of global
professional services firm PricewaterhouseCoopers.
From the
Ambac Second Amended Complaint:
In
August 2006, Bear Stearns’ external auditor, PriceWaterhouseCoopers
(“PWC”), advised Bear Stearns that its failure to promptly review the
loans identified as defaulting or defective was a breach of its
obligations to the securitizations.232 PWC advised Bear Stearns to begin
the “[i]mmediate processing of the buy-out if there is a clear breach in
the PSA agreement to match common industry practices, the expectation of
investors and to comply with the provisions in the PSA agreement.”
The New York Attorney General’s complaint repeats
an error made by Patterson Belknap in the Ambac complaints and that was
proliferated in many media reports when the Ambac suit was filed: PwC
is not Bear Stearns external auditor. The error in the
paragraph above and another that says “audit firm” PwC advised Bear Stearns
in August of 2006 that “its failure to promptly evaluate whether the
defaulting loans breached
EMC’s
representations and warranties to the securitization
participants was contrary to “common industry practices, the expectation of
investors and . . . the provisions in the [deal documents],”” misrepresents
PwC’s role and the importance of its report, misleading the reader. The
error wasn’t caught by the New York Attorney General’s office, potentially
affecting its litigation strategy and the public’s perception of PwC.
The PwC report prepared for Bear Stearns is
entitled, “UPB Break Repurchase Project – August 31, 2006.”
Alison Frankel obtained a copy of the first few
pages but that’s enough to see that PwC acted as a consultant to Bear
Stearns, not its external auditor. This was not an audit report. It is the
summary of recommendations to a client by a consultant who was
paid for advice that likely wasn’t followed.
Continued in article
Bob Jensen's threads on the woes of PwC ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
In case you missed it, note how cheaply some Big Four auditing firms wiggled
out of some major bank failure litigation. What could have been billions were
settled for pennies on the dollar.
"The Big Four Accounting Firms' Financial Tipping Point -- Time for a
Fresh Look," by Jim Peterson, re:TheBalance, November 30, 2011 ---
Click Here
http://www.jamesrpeterson.com/home/2011/11/the-big-four-accounting-firms-financial-tipping-point-time-for-a-fresh-look-.html
. . .
Latest available figures for the Big Four indicate
total annual global revenues of some $ 102 billion.
Applied to those figures, the model indicates that
the break-up threshold for any one of the Big Four firm’s litigation
“worst-cases” would be in the range from a maximum of $ 6 billion down to $
2.2 billion, if viewed at the global level.
That is a considerable increase from the earlier
numbers, owing to the great leap in total big-firm revenues in the
intervening years.
But cautions remain. Most importantly, cohesion of
the international networks under the strain of death-threat litigation, or
the extended availability of collegial cross-border financial support,
cannot be assumed. Arthur Andersen’s rapid disintegration in 2002 with the
flight of its non-US member firms is illustrative.
So it is necessary to look at the bust-up range
based on figures alone from the Americas, the most hazardous region. If left
to their local resources, as was Andersen’s US firm, the disintegration
range shrinks, from a maximum of less than $ 3 billion down to a truly
frightening $ 675 million.
Amounts at that level compare ominously with the
litigation settlements recently extracted from the larger debacles of the
last decade – examples led by Bank of America’s post-Countrywide
mortgage-securities settlement of $8.5 billion (here)
and including such investor settlements as Enron ($7.2
billion), WorldCom ($6.2 billion) and Tyco ($3.2 billion) (here).
But those amounts were only available because
inflicted on the investor-funded balance sheets of the corporations
contributing to the settlements – resources not available to the private
accounting partnerships. And they are even more darkly comparable with the
exposures looming in the pending claims inventory.
True, in recent months the large accounting
firms have enjoyed remarkable success in disposing of large litigations for
modest sums – examples include KPMG resolving Countrywide for $ 24 million
(here)
and New Century for $ 45 million (here),
and Deloitte settling Washington Mutual for $ 18.5
million (here).
However, hope for the indefinite continuation of
such forbearance on the part of the plaintiffs is not a strategy, but only a
wish.
As the catastrophic impact of “black swan” events
makes clear, it only takes one. And at that tipping point, all the marginal
fiddling by Barnier, Doty and their ilk becomes academic.
The auditors were giving out going concern opinions and hugely
underestimating loan loss reserves when thousands of banks faiiled ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"They’re Everywhere! Big Four Auditors Mixed Up In Mortgage Fraud," by
Francine McKenna, Forbes Blog, June 30, 2011 ---
http://blogs.forbes.com/francinemckenna/2011/06/30/theyre-everywhere-big-four-auditors-mixed-up-in-mortgage-fraud/
When I’m not wondering, “Where is my coffee?”, I’m
usually curled up in a ball in the corner of my little living room filled
with Latin American art moaning, “Where were the auditors?”
Me insufficiently caffeinated. Not a pretty
picture.
Ugly also are the blank stares from contorted faces
glaring back at me when I talk about auditors and their
“good crisis.”
The largest global audit firms are everywhere – in
every public company and working for the government agencies that regulate
them. They’re about as welcome as a hard rain and, yet, officially
necessary.
Can anyone deny that there are four firms – KPMG,
Deloitte, PricewaterhouseCoopers (PwC), and
Ernst & Young (auditor to Lehman) –
who knew all along what was going on and never told a
soul, including the SEC?
The story
Bloomberg’s Tom Schoenberg tells today of
Fannie Mae’s complicity in the Taylor, Bean &
Whitaker (TBW) $3 billion mortgage fraud scares the bejeezus out of me.
That’s because, like the little boy in “The Sixth Sense” who sees dead
people, I see complicit or, at the very least incompetent, auditors
everywhere. What’s even more frightening is that there are only four firms
of sufficient size to audit the largest public companies and they’re getting
bigger and even more powerful.
PwC, one of the four largest global audit firms,
audited TBW. TBW Chairman
Lee Farkas, who was just
sentenced to 30 years for his crimes, testified,
“he was only trying to help keep his company stay afloat and that he did not
believe that what he was doing was wrong. What he was doing was essentially
bundling and selling the same mortgages that his firm had originated twice.”
PwC was also the auditor of Colonial Bank, which
Farkas and TBW wrapped into the the fraud that eventually led to the
Colonial’s failure.
Continued in article
"Deloitte Touche sued for $7.6bn in mortgage fraud case," BBC,
September 26, 2011 ---
http://www.bbc.co.uk/news/business-15069976
Thank you Hossein Nouri for the heads up.
Giant accounting and consulting firm Deloitte
Touche Tohmatsu has been accused of failing to detect fraud during audits of
a mortgage firm which failed during the US housing crash.
A trust overseeing now-defunct Taylor, Bean &
Whitaker (TBW), and one of the company's subsidiaries, have filed complaints
in a Florida court.
They are claiming a combined $7.6bn (£4.9bn) in
losses.
TBW shut down after federal agents raided its
headquarters in August 2009.
Deloitte spokesman Jonathan Gandal said the firm
rejected the court claims, and that they were "utterly without merit". 'Red
flags'
The fraud at Ocala-based TBW began in 2002 and
continued until its collapse two years ago.
Seven TBW executives were convicted of federal
criminal charges, with former chairman Lee B Farkas sentenced to 30 years in
jail.
The lawsuits claim Deloitte's certifications of the
TBW books were essential in giving it the appearance of a legitimate
mortgage business.
However the lawsuits say TBW was selling false or
highly overvalued mortgages, mis-stating its liabilities and hiding
overdrawn bank accounts.
"They [Deloitte Touche Tohmatsu] certainly did not
do their job," said attorney Steven Thomas, who represents those suing
Deloitte.
"This is one of those cases where the red flags are
staring you in the face, and you've got to do a lot, and they did not."
Bob Jensen's threads on Deloitte are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Bob Jensen's threads on "Where Were the Auditors?" ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Francine Alleges that the Largest Audit Firms Were All "Mixed Up in
the Mortgage Fraud"
"Lehman, Bank of America Settlement Wins Court Approval," by Linda
Sandler, Bloomberg, May 18, 2011 ---
http://www.bloomberg.com/news/2011-05-18/lehman-bank-of-america-settlement-wins-court-approval-1-.html
A bankruptcy judge approved a settlement between
Lehman Brothers Holdings Inc. (LEHMQ) and Bank of America Corp. (BAC) today.
Bank of America, previously ordered by U.S. Bankruptcy Judge James Peck to
pay Lehman $500 million plus interest, said it would settle a remaining
dispute by paying bankrupt Lehman $1.5 million, according to a court filing
today.
"Bank of America Says $500 Million Lehman Order Was 'Error'." SF
Gate, June 30, 2011 ---
http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/06/30/bloomberg1376-LNNZ9D6JTSEE01-6AKHB4QI433DHSII5JCVQ4FK5U.DTL
"Judge Clears $861 Million J.P. Morgan-Lehman Settlement," The Wall
Street Journal, June 23, 2011 ---
http://blogs.wsj.com/deals/2011/06/23/judge-clears-861-million-j-p-morgan-lehman-settlement/
A judge on Thursday approved a settlement that
calls for J.P. Morgan Chase to pay $861 million in cash and securities to
customers of the defunct broker-deal business of Lehman Brothers Holdings.
The settlement is the largest to date reached by
the trustee winding down’s Lehman’s former U.S. brokerage business.
“I’m satisfied that this is indeed an excellent
result,” Judge James Peck of U.S. Bankruptcy Court in Manhattan said. He
added, “This is obviously a very substantial step forward of the LBI
liquidation.” LBI is the brokerage subsidiary, Lehman Brothers Inc.
Hughes Hubbard & Reed LLP’s Jeffrey Coleman, a
lawyer for the trustee, said the avoidance of long litigation and the fact
that most of the money will be paid in cash made it a great deal.
“The court’s approval of the J.P. Morgan agreement
marks a milestone in the administration of the LBI Estate to recover assets
to pay customer claims,” Giddens, also a Hughes Hubbard & Reed partner, said
in a statement.
Former Lehman customers will receive all of the
$861 million, $755 million of which is in cash. No parties objected to the
settlement.
The deal largely settles the outstanding claims the
trustee has against J.P. Morgan but doesn’t affect disputes between J.P.
Morgan and Lehman Brothers Holdings. The holding company and J.P. Morgan are
embroiled in two pending multibillion-dollar lawsuits.
Continued in article
"They’re Everywhere! Big Four Auditors Mixed Up In Mortgage Fraud," by
Francine McKenna, Forbes Blog, June 30, 2011 ---
http://blogs.forbes.com/francinemckenna/2011/06/30/theyre-everywhere-big-four-auditors-mixed-up-in-mortgage-fraud/
When I’m not wondering, “Where is my coffee?”, I’m
usually curled up in a ball in the corner of my little living room filled
with Latin American art moaning, “Where were the auditors?”
Me insufficiently caffeinated. Not a pretty
picture.
Ugly also are the blank stares from contorted faces
glaring back at me when I talk about auditors and their
“good crisis.”
The largest global audit firms are everywhere – in
every public company and working for the government agencies that regulate
them. They’re about as welcome as a hard rain and, yet, officially
necessary.
Can anyone deny that there are four firms – KPMG,
Deloitte, PricewaterhouseCoopers (PwC), and
Ernst & Young (auditor to Lehman) –
who knew all along what was going on and never told a
soul, including the SEC?
The story
Bloomberg’s Tom Schoenberg tells today of
Fannie Mae’s complicity in the Taylor, Bean &
Whitaker (TBW) $3 billion mortgage fraud scares the bejeezus out of me.
That’s because, like the little boy in “The Sixth Sense” who sees dead
people, I see complicit or, at the very least incompetent, auditors
everywhere. What’s even more frightening is that there are only four firms
of sufficient size to audit the largest public companies and they’re getting
bigger and even more powerful.
PwC, one of the four largest global audit firms,
audited TBW. TBW Chairman
Lee Farkas, who was just
sentenced to 30 years for his crimes, testified,
“he was only trying to help keep his company stay afloat and that he did not
believe that what he was doing was wrong. What he was doing was essentially
bundling and selling the same mortgages that his firm had originated twice.”
PwC was also the auditor of Colonial Bank, which
Farkas and TBW wrapped into the the fraud that eventually led to the
Colonial’s failure.
Continued in article
July 1, 2011 reply from Robert Bruce Walker
I find what Francine writes to be both terrifying
and depressing. What the hell has happened?
I think a partial explanation can be found in a
book by the recently deceased historian Tony Judt. His last book is entitled
Ill Fares the Land. The title comes from poem written by Oliver Goldsmith
called The Deserted Village (1770).
It says:
Ill fares the land, to hastening ills a prey,
Where wealth accumulates, and men decay.
Apparently the poem is about the destruction of a
village to make way for the county estate of a newly enriched aristocrat.
The book explains how our psychological and
philosophical attitudes play out in our political and economic lives. It is
the origin of individualism that surprises. It is an amalgam of left and
right and, once pointed out, is obvious. It finds expression in ‘tune in
etc.’ attitudes from the sixties. It finds expression in the Ayn Randism
that grew popular in the eighties and which lasts to this day. I have
believed both of those two things at different times in my life. Essentially
they are fused in a deeply held belief in individualism.
July 2, 2011 reply from Bob Jensen
Hi Robert,
I'm less philosophical about the behavior of greed and exploitation. In
terms of the subprime mortgage scandals I attribute bad behavior to
opportunity and lemming behavior. When opportunity arose, bad behavior
followed the crowd like lemmings in terms of "our competitors are doing it"
and "our supervisors are doing it" and the "guys in the surrounding
cubicles" are doing it.
The primary source of the opportunity for subprime mortgage fraud commenced
in the Bill Clinton era when originators of mortgages on Main Street could
sell those low-down payment mortgages downstream, without bearing any
residual bad debt risk, to buyers in Washington DC (Fannie and Freddie) and
Wall Street (Bear Stearns, Lehman, Merrill Lynch, etc.). This was
exacerbated by a real estate price bubble that nearly everybody thought
would never burst in times of general price inflation.
Jane Bryant Quinn once said something to the effect that, when corporate
executives and bankers see billions of loose dollars swirling above there
heads, it's just too tempting to hold up both hands and pocket some loose
bill floating about. I told my students that it's possible to buy an "A"
grade in my courses but none of them can possibly afford it. The point is
that, being human, most of us are vulnerable to some temptations in a weak
moment. Fortunately, none of you reading this have oak barrels of
highly-aged whiskey in your cellars, the world's most beautiful women/men
lined up outside your bedroom door, and billions of loose dollars swirling
about like autumn leaves in a tornado. Most corporate criminals that
regret their actions later confess that the temptations went beyond what
they could resist. What amazes me in this era, however, is how they
want to steal more and more after they already have $100 million stashed.
Why do they want more than they could possibly need?
The question that remains in my mind about the auditors is whether the
mortgage audit scandals that are surfacing are the the tip of the
Unprofessionalism Iceberg or whether they are only small chunks of the
Professionalism Iceberg that broke off due to intense heat of client
pressures in unique circumstances of finding themselves in a sea of
poisonous mortgages and CDO bonds laced with slivers of poison..
Is this an outlier problem or does the melting extend to the very core of
the auditing iceberg? I still tend to personally feel that this was and
still is an outlier problem that the audit profession, standard setters,
courts, and educators must deal with as if it is an outlier problem.
Francine and I both tend to write about unprofessional outliers in auditing
---
http://www.trinity.edu/rjensen/Fraud001.htm
We don't write much about the everyday auditing successes where audit teams
acted with commendable professionalism.
If this is a complete meltdown then there's not much hope for my beloved
profession. I do think there's a high probability that one or more of the
Big Four will not survive the pending court settlements of class action
lawsuits. Perhaps government will have to take over the auditing industry. I
don't have much hope for such a government takeover since it's so easy for
the bad guys to corrupt government.
See Bob Jensen's "Rotten to the Core" document at
http://www.trinity.edu/rjensen/FraudRotten.htm
The exact quotation from Jane Bryant Quinn at
http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
Where Were the Auditors?
I personally believe the auditors were among the hoards that believed that
real estate values would just keep going up and up and up. And when the
bubble did burst audit firms succumbed to banking client and brokerage firm
client pressures to underestimate bad debt reserves.
I'm glad I'm not young anymore!
Respectfully,
Bob Jensen
Statement of Lynn E. Turner Before the Senate Subcommittee on Securities,
Insurance and Investment;
OnThe Role of the Accounting Profession in Preventing Another Financial Crisis
Dirksen Senate Office Building
April 6, 2011
http://goingconcern.com/2011/04/lynn-turner-doesnt-let-accountants-sec-fasb-off-the-hook-for-their-part-in-financial-crisis/#more-28171
PCAOB advisory group
head calls for investigations into audit firms
Auditor rotation, annual reports recommended (Adds PCAOB comment)
"UPDATE 1-US urged to probe auditors' role in credit crisis," by Dena Aubin,
Reuters, March 16, 2011 ---
http://www.reuters.com/article/2011/03/16/pcaob-auditors-idUSN1611473820110316
Audit firms that failed to flag risks ahead of the
financial crisis have not been held to account and an in-depth investigation
is needed, an advisory group to the U.S. auditor watchdog agency said on
Wednesday.
Regulators in Europe and the United Kingdom are
probing the role of auditors in the 2008 crisis, but the United States has
lagged and needs to do more, said Barbara Roper, head of a working group for
the Public Company Accounting Oversight Board.
"Auditors failed to perform their basic watchdog
function in the financial crisis," Roper said at a PCAOB advisory group
meeting in Washington. "There's a need to figure out why they failed to
perform that function and what can be done to fix that problem."
The PCAOB was created after the Enron and WorldCom
accounting scandals to police audit firms. It oversees the work of the Big
Four auditors -- Deloitte, KPMG, Ernst & Young and PricewaterhouseCoopers --
and other auditors of public companies.
While auditors did not cause the financial crisis,
they gave stamps of approval to many companies' financial statements just
months before they failed, said Roper, director of investor protection for
the Consumer Federation of America.
She said the PCAOB should look at examples of
companies that failed or had to be bailed out and find out what went wrong
with the audits and why.
Lehman Brothers (LEHMQ.PK), American International
Group (AIG.N), Citigroup (C.N), Fannie Mae (FNMA.OB), and Freddie Mac (FMCC.OB),
among others, received unqualified audit opinions on their financial
statements months before their collapse or bailouts, Roper said.
"If the auditors were performing as they should and
this is the result we get, then there's a problem with the system," she
said.
AUDITOR ROTATION RECOMMENDED
Audit firms also lack the basic independent
governance that most public companies around the globe have, Lynn Turner,
head of a PCAOB working group on audit firm governance, said at the meeting
in Washington.
He said these firms need more transparency. They
should have to file annual financial statements with the PCAOB, including
information about how they control quality globally, Turner said.
PCAOB members said they will consider all the
recommendations and report back on what they decide.
Asked for his response to the recommendations,
PCAOB chair James Doty told Reuters that the PCAOB had identified areas
where audits performed during the credit crisis needed to be stronger in a
report released in September. Some of the problem audits are being
investigated and disciplinary actions may result, he said.
"All of these activities, including what we heard
from the investor advisory group today, will give us insights into the root
causes of problems we identify and will inform our initiatives to strengthen
investor protection," he said.
Because the Big Four audit firms are private, they
are not required to file public financial statements, though they do report
their revenues annually.
Without seeing their financial statements, however,
it will be difficult for the PCAOB to properly regulate them, said Turner, a
former chief accountant for the Securities and Exchange Commission.
The PCAOB also should require companies to rotate
auditors periodically to break up cozy relationships between some companies
and their auditors, he said.
Audit partners, but not audit firms, have to be
rotated every five years currently.
Continued in article
Bob Jensen's threads on audit firm professionalism are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism
Where were the auditors?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"Spitzer Calls Accountants 'Facilitators' for Corporate Abuse," by
Michael Cohn, Accounting Today, February 8, 2011 ---
Click Here
http://www.accountingtoday.com/debits_credits/Spitzer-Calls-Accountants-Enablers-Corporate-Abuse-57235-1.html?ET=webcpa:e1282:133851a:&st=email&utm_source=editorial&utm_medium=email&utm_campaign=WebCPA_Daily_020811
Former New York Governor and Attorney General Eliot
Spitzer took aim at corporate influence in politics and blamed accountants,
as well as lawyers and bankers, for allowing companies and their CEOs to get
away with dodgy valuations and overblown compensation.
During a speech Tuesday at the New York University
School of Law, sponsored by the American Constitution Society for Law and
Policy, Spitzer derided the Obama administration’s increasing acquiescence
to corporate America, including the recent extension of the Bush-era tax
cuts.
“We have created a class in our society of what I
call facilitators,” said Spitzer. “Facilitators — and we’re all part of it —
lawyers, investment bankers and accountants. Our purpose is to be hired to
justify the actions that are being taken by CEOs and others to run their
businesses, and over time what has happened is that we have lost our
backbone. We have lost our willingness to stand up and say, ‘Stop.’ There
are a bunch of reasons for this. I’ve been in private practice and I know
how those pressures are. We don’t like to look at our clients and say, ‘No,
you can’t do that. I’m not writing an opinion letter that justifies that
valuation.’ We don’t like to write a letter to the CEO saying, ‘No, you
don’t deserve a 50 percent bonus.’ Those things don’t happen very often
because we succumb to the pressures of our clients.”
Continued in article
Jensen Comment
Aside from his adulterous use of a prostitution ring, Spitzer has had some
integrity lapses himself such as lying about campaign contributions, using
campaign donations to pay for prostitutes, and the hiding of bribes ---
http://en.wikipedia.org/wiki/Eliot_Spitzer#Scandal_and_resignation .
As Attorney General and Governor of New York, he did take some unusual measures
to combat corruption in state government, including orders to state police to
conduct surveillances of some top legislators.
Be that as it may, Spitzer is a top Harvard Law School graduate and in
total seems to be dedicated, as a liberal Democrat, to fighting corruption in
the private as well as the public sectors. Since the Kennedy era it seems more
difficult for the public to forget sex scandals --- in part because of the
changed practice of the media in no longer hiding those scandals from the
public. Many of the affairs of John and Bobby Kennedy were suppressed by the
press until after they were dead. Spitzer will probably never rise again to high
office, but he will continue to be a force using his media jobs to hammer at
corruption. It would, however, be better if he accompanied his future articles
with more examples and facts.
Spitzer earned his reputation as a crime fighter by taking on the Gambino mob
in the NYC area. Now he wants to take on the Big Four mob and the Wall Street
mob. He's got guts.
Bob Jensen's threads on accounting and auditing scandals are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
"A Few People Are Not Satisfied with the $624 Million Countrywide
Settlement," by Caleb Newquist, Going Concern, February 25, 2011 ---
http://goingconcern.com/2011/02/a-few-people-are-not-satisfied-with-the-624-million-countrywide-settlement/#more-26016
And, unfortunately for
Bank of America and KPMG,
that could mean
digging through the couch cushions.
Several large institutional investors have
rejected a court settlement where Countrywide Financial Corp. had
agreed to pay $600 million to a number of national pension funds.
Those pulling out of the agreement include BlackRock Inc.; the
California Public Employees Retirement System, or Calpers; T. Rowe
Price Group Inc.; Nuveen Investments Inc.; and the Maryland State
Retirement and Pension System, according to a document from the suit
filed in U.S. District Court in Los Angeles. The investors decided
the settlement, initially agreed to last May, wasn’t enough and will
seek their own terms with the mortgage originator and its current
owner Bank of America Corp., as well as Countrywide’s auditor KPMG
LLP. KPMG had committed another $24 million to the settlement.
In typical HofK fashion, the firm didn’t bother
commenting for the Journal’s story however BofA managed to
express their disappointment, “It is unfortunate that some investors
chose to opt out of what we believe is a fair and equitable agreement to
settle these issues.” Right. Because the likes of BlackRock and Calpers
should be tickled pink with the pleasure of splitting $624 million with
dozens of other investors.
Big Investors Refuse Countrywide Settlement [WSJ]
"Big Investors Refuse Countrywide Settlement," by David Benoit, The
Wall Street Journal, February 25, 2011 ---
http://online.wsj.com/article/SB10001424052748704150604576166382331877062.html
Several large institutional investors have rejected
a court settlement where Countrywide Financial Corp. had agreed to pay $600
million to a number of national pension funds.
Those pulling out of the agreement include
BlackRock Inc.; the California Public Employees Retirement System, or
Calpers; T. Rowe Price Group Inc.; Nuveen Investments Inc.; and the Maryland
State Retirement and Pension System, according to a document from the suit
filed in U.S. District Court in Los Angeles.
The investors decided the settlement, initially
agreed to last May, wasn't enough and will seek their own terms with the
mortgage originator and its current owner Bank of America Corp., as well as
Countrywide's auditor KPMG LLP. KPMG had committed another $24 million to
the settlement.
A spokesman for New York State Comptroller Thomas
P. DiNapoli, who represented the massive New York State Common Retirement
Fund in the litigation, said the fund intends to remain part of the "very
reasonable settlement." Ola Fadahunsi, the spokesman, noted the
comptroller's office is "very happy" with the work of its counsel on the
case.
Shirley Norton, a Bank of America spokeswoman,
said, "It is unfortunate that some investors chose to opt out of what we
believe is a fair and equitable agreement to settle these issues."
KPMG declined to comment.
The settlement agreement, which is facing a final
approval hearing before a federal judge in Los Angeles Friday, was amended
last month as a result of the investors leaving. The new agreement, which
remains at a total of $624 million, now includes a provision that allows
Countrywide and KPMG to take up to $22.5 million of that amount to pay the
investors who rejected the agreement. The amount must be used within two
years.
Blair A Nicholas, a lawyer representing some of the
largest institutional investors to pull out of the agreement, including
BlackRock, Calpers and T. Rowe, said his clients "exercised their legal
right to opt out in order to maximize the recovery" of their damages.
"If our clients are unable to resolve their claims
to recovery, they are fully committed to pursuing their claims at trial to
hold Countrywide's former executives fully accountable for the pervasive
fraud at Countrywide," Mr. Nicholas said.
The L.A. Times had reported earlier that investors
were leaving the settlement.
The lawsuit alleged Countrywide made false
statements and omissions about its policies and procedures for underwriting
loans, exposing investors to excessive undisclosed risk.
According to the court document, 33 investors,
including names of some individuals, were withdrawing. Some of these
investors include Montana Board of Investments, Teacher Retirement System of
Texas, Oregon Public Employees Retirement Fund, and the Michigan State
Treasurer, on behalf of several public pension funds in the state.
Bob Jensen's threads on Countrywide sleaze are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on KPMG are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
A computer that lacks common sense, unfortunately,
isn't an oddity. Maybe it should be.
Henry Lieberman,
MIT
"Watson on Jeopardy, Part 2: The IBM machine's mistakes offered insights
about how it works," by Henry Lieberman, MIT's Technology Review,
February 16, 2011 ---
http://www.technologyreview.com/blog/guest/26396/?nlid=4141
What Watson failed to realize was that the word
"leg," by itself, wasn't actually an answer to the question. This is common
sense for people, because "leg" is an anatomical part, not an anatomical
oddity, though Watson did realize that legs were involved somehow. What
happened here might have been something more profound than a simple bug.
David Ferrucci, Watson's project leader, attributed the failure to the
difficulty of the word "oddity" in the question. To understand what might be
odd, you have to compare it to what isn't odd—that is to say, what's common
sense. A problem with Watson's approach is that if some sentence appears in
its database, it can't tell whether someone put it there just because it's
true, or because someone felt it was so unusual that it needed to be said.
A computer that lacks common sense, unfortunately,
isn't an oddity. Maybe it should be.
Henry Lieberman is a
research
scientist who works on artificial intelligence at the Media Laboratory
at MIT.
An audit firm that lacks common sense, unfortunately, isn't an oddity.
Maybe it should be.
In the context of Repo 105/108 auditing of Lehman and C12 Capital Management
auditing at Barclays where common sense should've prevailed but did not prevail
in order to facilitate accounting deception. What happened to the common sense
auditors? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"Spitzer Calls Accountants 'Facilitators' for Corporate Abuse," by
Michael Cohn, Accounting Today, February 8, 2011 ---
Click Here
http://www.accountingtoday.com/debits_credits/Spitzer-Calls-Accountants-Enablers-Corporate-Abuse-57235-1.html?ET=webcpa:e1282:133851a:&st=email&utm_source=editorial&utm_medium=email&utm_campaign=WebCPA_Daily_020811
Teaching Case on Auditor Firm's Denial of a Going Concern Opinion
From The Wall Street Journal Accounting Weekly Review on March 11, 2011
Dynegy Auditor Issues Warning (not available online)
by: John Kell
Mar 09, 2011
TOPICS: Audit
Report, Auditing
SUMMARY: Dynegy's
auditors, Ernst & Young, have issued a going concern opinion on the
company's 2010 financial statements. The going concern issue has arisen
because Dynegy expects it likely will not meet a debt covering related to
the level of EBITDA over consolidated interest expense.
CLASSROOM APPLICATION: The
article is useful to cover types of audit opinions in an auditing class.
Questions further allow discussion of the meaning behind the going concern
assumption versus an assessment of the company's financial health. The
questions also refer to the Form10-K filing and management's discussion and
analysis that specifically identifies the debt covenant failure that is
expected to occur; the article therefore can be used in covering long term
debt. While there is no on line article link, the related article covers a
lot of the issues and questions direct the student to the Dynegy 10-K filing
and the associated auditor's report.
QUESTIONS:
1. (Advanced) What are the types of audit opinions that may be
issued? What type was issued by Ernst & Young on Dynegy's financial
statements?
2. (Introductory) What problem led to the auditor's conclusion that
Ernst & Young (E&Y) should issue a "going concern opinion" on the Dynegy
financial statements? Was it the result of E&Y's assessment of the financial
health of Dynegy? Explain.
3. (Introductory) What is a debt covenant? Based on your
understanding of the statements in the article, is Dynegy currently in
violation of its debt covenants? Explain.
4. (Advanced) Access the Dynegy annual report for 2010 filed on
Form 10-K with the SEC available at
http://sec.gov/Archives/edgar/data/1105055/000114036111015138/form_10-k.htm#a009v1
Scroll down to the Table of Contents, then click on Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Read through the first three paragraphs under "Overview." What specific
financial ratio is Dynegy expecting to be unable to meet? What does this
ratio measure? What are the potential results of this failure?
5. (Introductory) What corporate actions have kept Dynegy from
undertaking transactions that might save it from bankruptcy proceedings?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Dynegy Warns of Chapter 11
by Rebecca Smith
Mar 09, 2011
Online Exclusive
Question
Why weren't there similar denials of going concern opinions on thousands of
failed banks shortly after 2009?
Where were the auditors?
See below.
"No Audit At All: Deloitte and Bear Stearns," by Francine McKenna,
Forbes, January 25, 2011 ---
http://blogs.forbes.com/francinemckenna/2011/01/25/no-audit-at-all-deloitte-and-bear-stearns/
Deloitte’s audits “were so deficient that the
audit amounted to no audit at all,” the [Bear Stearns investors]
plaintiffs argued in court papers.
That’s
Reuters describing the rationale behind the
decision of US District Judge Robert Sweet on January 23, 2011 to allow a
case against fallen investment bank Bear Stearns and its outside auditor,
Deloitte, to go forward.
The decision for a group of plaintiffs, including
the State of Michigan Retirement system, and their attorneys is indeed
sweet. Subprime suits have been hampered by the argument they are trying to
punish the case of “classic fraud by hindsight”. Bankers did a great job
during and after the crisis of describing the events that occurred as “black
swan” events,
forces of nature that could not have been
identified in advance.
That rhetoric is
slowly being disproved.
This decision is even more significant because it
provides a successful template for including claims against the auditors for
financial crisis failures when warranted. In
Ernst & Ernst v. Hochfelder, the Supreme
Court held that actions under Section 10(b) of the Exchange Act and Rule
10b-5 require an allegation of “`scienter’—intent to deceive, manipulate, or
defraud.” The “scienter” requirement, necessary to sustain allegations
against the auditors in a securities claim under Section 10(b), is
notoriously difficult to meet.
If there’s anything of substance in a claim against
auditors the case usually settles before the facts are made public. New
Century Trustee v. KPMG is an early crisis mortgage originator case,
cited several times in this decision. However, those facts will never be
heard in open court. In spite of – or perhaps because of – very particular
examples of reckless behavior by the auditor documented by the bankruptcy
examiner,
the case was settled.
The Ernst & Ernst v. Hochfelder decision
left open the question of “whether, in some circumstances, reckless behavior
is sufficient for civil liability under § 10(b) and Rule 10b-5.” However,
since Ernst, most courts have concluded that recklessness can
satisfy the requirement of “scienter” in a securities fraud action against
an accountant.
“Recklessness” in a securities fraud action against
an accountant is defined as, “highly unreasonable [conduct], involving
not merely simple, or even inexcusable negligence, but an extreme departure
from the standards of ordinary care, and which presents a danger of
misleading buyers or sellers that is either known to the defendant or is so
obvious that the actor must have been aware of it.”
Continued in article
Bob Jensen's threads on Deloitte are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Questions
Did auditing firms not warn that banks were failing "going concern" auditing
rules based upon ill-advised speculation that governments would bail out failing
banks?
Did auditors not object to greatly underestimated loan loss reserves
based upon speculation that governments would bail out failing banks?
Since well over a thousand banks failed in the U.S. immediately following the
subprime scandal., this was not a very good alleged speculation on the part of
CPA firm auditors..
"Big 4 Bombshell: “We Didn’t Fail Banks Because They Were Getting A
Bailout,” by Francine McKenna, re:TheAuditors, November 28, 2010 ---
http://retheauditors.com/2010/11/28/big-4-bombshell-we-didnt-fail-banks-because-they-were-getting-a-bailout/
Leaders of the four largest global accounting firms
–
Ian Powell, chairman of PwC UK,
John Connolly, Senior Partner and Chief Executive
of Deloitte’s UK firm and Global MD of its international firm, John
Griffith-Jones, Chairman of KPMG’s Europe, Middle
East and Africa region and Chairman of KPMG UK, and
Scott Halliday, UK &
Ireland Managing Partner for Ernst & Young – appeared before the UK’s House
of Lords Economic Affairs Committee yesterday to discuss competition and
their role in the financial crisis.
The discussion moved past the topic of competition
when the
same old recommendations were raised and the same old
excuses for the status quo were given.
Reuters, November 23, 2010: The House of Lords
committee was taking evidence on concentration in the auditing market
and the role of auditors.
Nearly all the world’s blue chip companies are
audited by the Big Four, creating
concerns among policymakers of growing systemic risks,
particularly if one of them fails.
“I don’t see that is on the horizon at all,”
Connolly said.
The European Union’s executive European
Commission has also opened a public consultation into ways to boost
competition in the sector, such as by having smaller firms working
jointly with one of the Big Four so there is a “substitute on the
bench.”
“Having a single auditor results in the best
communication with the board and with management and results in the
highest quality audit,” said Scott Halliday, an E&Y managing partner.
The Lord’s Committee was more interested in
questioning the auditors about the issue of
“going concern” opinions
and, in particular, why there were none for the banks that failed, were
bailed out, or were nationalized.
The answer the Lord’s received was, in one word,
“Astonishing!”
Accountancy Age, November 23, 2010: Debate
focused on the use of “going concern” guidance, issued by auditors if
they believe a company will survive the next year. Auditors
said they did not change their going concern guidance because they were
told the government would bail out the banks.
“Going concern [means] that a business can pay
its debts as they fall due. You meant something thing quite different,
you meant that the government would dip into its pockets and give the
company money and then it can pay it debts and you gave an unqualified
report on that basis,” Lipsey said.
Lord Lawson said there was
a “threat to solvency” for UK banks which was
not reflected in the auditors’ reports.
“I find that absolutely astonishing, absolutely
astonishing. It seems to me that you are saying that
you noticed they were on very thin ice but you were completely relaxed
about it because you knew there would be support, in other words, the
taxpayer would support them,” he said.
The leadership of the Big 4 audit firms in the UK
has admitted that they did not
issue “going concern” opinions because they were told by government
officials, confidentially, that the banks would be bailed out.
The Herald of Scotland, November 24, 2010:
John Connolly, chief executive of Deloitte auditor to Royal Bank of
Scotland, said the UK’s big four accountancy firms initiated “detailed
discussions” with then City minister Lord Paul Myners in late 2008 soon
after the collapse of Lehman Brothers prompted money markets to gum up.
Ian Powell, chairman of PricewaterhouseCoopers,
said there had been talks the previous year.
Debate centred on whether the banks’ accounts
could be signed off as “going concerns”. All banks got a clean bill of
health even though they ended up needing vast amounts of taxpayer
support.
Mr. Connolly said: “In the circumstances we
were in, it was recognised that the banks would only be ‘going concerns’
if there was support forthcoming.”
“The
consequences of reaching the conclusion that a bank was actually going
to go belly up were huge.” John Connolly, Deloitte
He said that the firms held meetings in December
2008 and January 2009 with Lord Myners, a former director of NatWest who was
appointed Financial Services Secretary to the Treasury in October 2008.
I’ve asked the question many times why there were
no “going concern” opinions for the banks and other institutions that were
bailed out, failed or essentially nationalized
here in the US. I’ve never received a good answer until now. In fact, I
had the impression
the auditors were not there.
There has been no mention of their presence or their role in any accounts
of the crisis. There has been no similar admission that meetings in took
place between the auditors and the Federal Reserve or the Treasury leading
to Lehman’s failure and afterwards. No one has asked them.
How could I been so naive?
If it happened in the UK, why not in the US?
Does
Andrew Ross Sorkin have any notes about this that
didn’t make it to his book?
Will
Ted Kaufman call the auditors to account now that
he is Chairman of the Congressional Oversight Panel?
Is there still time to call the four US leaders to
testify in front of the
Financial Crisis Inquiry Commission?
What is the recourse for shareholders and other
stakeholders who lost everything if the government was the one who prevented
them from hearing any warning?
Continued in article
Auditors Work for Banking Clients, Not Investors: Resistance to
Disclosing Subprime Poison Repurchase Risk
"Auditors Aren’t Forcing Full Repurchase Risk Exposure Disclosure," by Francine
McKenna, re:TheAuditors, September 27, 2010 ---
http://retheauditors.com/2010/09/27/auditors-arent-forcing-full-repurchase-risk-exposure-disclosure/
My reply to Francine on October 26, 2010
Up, Up, and Away in Our 1990s Baloon
1
---------- Forwarded message ----------
From: Jensen, Bob <rjensen@trinity.edu>
Date: Tue, Oct 26, 2010 at 10:02 AM
Subject: Re: New blog in Forbes
To: retheauditors@gmail.com
It is truly amazing how auditing firms are ignoring
why Sarbox became the law of the land and are returning to their
pre-Enron bad behavior. First we have PwC and the rest of the Big
Four "auditing" firms roaring back into controversial financial
consulting.
.
Now we have auditors agreeing with huge loan loss reserve reductions
of banks in the face of possible the biggest loan losses in the
history of the world.
It's going to be harder and harder to feel sorry for
the Big Four if one or all crash and burn.
Francine wrote the following in her first Forbes
blog:
Citigroup (NYSE:C), audited
by KPMG for the last forty-one years, posted a profit for its
third consecutive quarter after cutting its loan loss reserves. But
the bank is potentially under reserved in the event Fannie Mae (
NYSE:FNM), Freddie Mac (NYSE:FRE), and the Federal Home Loan Banks
prevail in forcing significant mortgage loan repurchases. Citigroup
was heavily criticized prior to the earnings release by an analyst
for, in his opinion, higher than justified balances for deferred tax
assets – a “cookie jar” of sorts used to offset taxes on future
profits. I’m guessing Citigroup is the unnamed “Issuer B”
in the most
recent inspection report for KPMG issued by the PCAOB, since one
of the failures the regulator found was related to lack of scrutiny
of the client’s deferred tax assets.
"The GM IPO: Are You Buying It?" by Francine McKenna, Forbes,
November 4, 2010 ---
http://blogs.forbes.com/francinemckenna/2010/11/04/the-gm-ipo-are-you-buying-it/
The Obama administration
says the bailout of General Motors (NYSE:GM) is a success. Their former car
czar, Steve Rattner, may have moved the ball out of the opposing team’s end
zone by avoiding a full scale, free-for-all bankruptcy like
Lehman’s, but that doesn’t mean we should be
celebrating any touchdowns just yet.
Mr. Rattner has a new book out about his experience
at GM. It’s Rattner’s view – or his publicist’s – that
Overhaul: An Insider’s Account of the Obama Administration’s Emergency
Rescue of the Auto Industry, “captures
a unique moment in American business that will have lasting influence on all
industries, as the archetypal American industry (which helped create our
nation’s wealth and status) is used to write the playbook for corporate
bailouts.”
God, I hope not.
The U.S. government plans to sell the GM garbage
barge back to investors after taxpayers poured $50 billion in to save it. GM
will report final third-quarter figures on November 10th, a week ahead of
its November 18th IPO. The company “projects” a third-quarter profit of
between $1.9 billion and $2.1 billion, according to
preliminary results the automaker released
yesterday. It’s supposedly the third consecutive quarterly profit for
post-bankruptcy GM but none of those numbers were audited and the
financial statements included in the prospectus
for the share offering are also unaudited.
I’m skeptical about any numbers GM issues, whether
blessed by their auditor Deloitte or not.
Tom Selling, blogging at
The Accounting Onion, extends an argument made by
Jonathan Weil in early September: “GM’s
shareholders’ equity at December 31, 2009 would have been a negative $6.2
billion if it were not able to book a whole bunch of goodwill. To say
that few companies would be able to pull off a successful IPO with a
negative number for shareholders’ equity on its balance sheet would be an
understatement. To say the same after applying fresh-start accounting would
be a statement of fact.”
General Motors included a litany of potential risks
in its IPO prospectus. One of them is the “current”
weakness of internal controls over its internal financial reporting. GM’s
internal controls over financial reporting were still not effective on June
30. The issue was previously disclosed in GM’s 2009 annual report.
And its 2008, 2007 and 2006 annual reports.
In March of 2007, GM reported, “ineffective
internal controls over financial reporting might make it difficult for the
company to execute on its business plan.” At that time, GM was
also under investigation by the SEC on several matters, including financial
reporting related to pension accounting, transactions with suppliers
including their former subsidiary Delphi (another bankrupt company) and
transactions in precious metals.
The only news here is that a lot of suckers will
invest in a company that hasn’t produced financial reports anyone should
trust in a long time. Amongst many other weaknesses, they never have enough
competent accounting professionals to book the complex transactions it takes
to create their balance sheet.
When companies go
bankrupt, their underfunded pensions are taken over by the Pension Benefit
Guaranty Corp. (PBGC), a government-run, industry-funded insurance agency,
which then pays retirees a fraction of what they were owed. But that didn’t
happen in the GM bankruptcy. The UAW resisted, according to the
Washington Post. GM’s defined-benefit plans for US
employees were underfunded by $16.7 billion as of June 30. GM’s prospectus
says federal law will require it to start pumping in “significant” amounts
by 2014 if not sooner.
When
I wrote about my preference for a real GM
bankruptcy, I thought it would also be great for GM’s employees to see how
the other half lives with regard to health insurance. Putting GM’s former
employees on the rolls of a single-payer, government-funded program (my hope
at the time) would provide additional economies of scale and volume buying
power for the government as well as get rid of this monkey on our back. No
longer would taxpayers, or car buyers, subsidize health benefit entitlements
that are way beyond what anyone else gets these days. Reset expectations
for this constituency and we can all move on.
Unfortunately, neither the outsize pension
liabilities nor the unrealistic healthcare benefits for these employees and
retirees were cut down to size by the US government’s approach.
In August of 2008,
General Motors and their auditor Deloitte settled
a class-action securities lawsuit against them alleging the automaker filed
misleading financial reports between 2002 and 2006. GM paid $277 million and
Deloitte kicked in $26 million.
GM was forced to reduce the amount paid to auditor
Deloitte after the Sarbanes-Oxley Act prohibited companies from using the
same firm as a consultant and an auditor. About $49 million was spent on
Deloitte for consulting services in 2001 and only $21 million was for audit
work. By 2008, GM’s bill for audit work was up to $31.5 million.
Deloitte has been GM’s auditor since 1918. That’s
ninety-two years of making sure GM survives to pay another invoice. Don’t
bet on independence, objectivity, or lawsuits ruining this beautiful
relationship anytime soon.
Bob Jensen's threads on the bailout are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on Deloitte ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
"Michel Barnier: The Big 4 Audit Model Is a Failure," by Caleb
Newquist, Going Concern, October 13, 2010 ---
http://goingconcern.com/2010/10/michel-barnier-the-big-4-audit-model-is-a-failure/
Jensen Comment
Something that sticks in my mind is Tom Selling's comment that the CPA "audit
model is broken" I think Tom was mostly referring to the way clients themselves
cherry pick their firms' CPA auditors and frequently pressure audit firms to
veer from audit professionalism.
There's nothing new in the way audits are being funded by clients. But since
SarbBox audits are much much more costly and, contrary to the intent of SarBox,
clients are pressuring auditors to cut corners, overlook internal control
weaknesses, under estimate loan loss reserves, over value security portfolios,
etc.
In my opinion, however, the alternative of having government audits of
private corporations is not the answer.
Interestingly, the most serious pressure on clients for better accounting is
the threat lawsuits from creditors and investors. Reley (William Bendix) of my
generations would have said
"What a revoltin' development that is." ---
http://en.wikipedia.org/wiki/The_Life_of_Riley
"EC proposes mandatory rotation of auditors," by Mario Christodoulou,
Accountancy Age, October 13, 2010 ---
http://www.accountancyage.com/accountancyage/news/2271438/audit-green-paper-proposes
Bob Jensen's threads on auditor professionalism ---
http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism
Francine says "The report nailed the KPMG auditors"
"Settling For Silence: KPMG Closes The Books On New Century And
Countrywide," by Francine McKenna, re:TheAuditors, August 18, 2010
---
http://retheauditors.com/2010/08/18/settling-for-silence-kpmg-closes-the-books-on-new-century-and-countrywide/
And in the naked light I saw
Ten thousand people maybe more
People talking without speaking
People hearing without listening
People writing songs that voices never shared
No one dared
Disturb the sound of silence
It’s no coincidence that settlements were announced
less than a week apart for both New Century and Countrywide. As two of the
earliest subprime failures, all parties were probably anxious to clear some
clutter and make room for other matters.
Fortune, August 3, 2010: A federal judge
signed off Monday on a settlement under which
former shareholders of the troubled mortgage [originator] will get $624
million, the Los Angeles Times reported. The plaintiff lawyers
called the sum the largest shareholder settlement since the mortgage
meltdown started in 2007.
Bank of America (BAC),
which acquired the mortgage lender two years ago
and has since stopped using the Countrywide name, will pay $600 million
and accounting firm KPMG will pay $24 million.
The Countrywide settlement comes just days
after officers and directors in another big
subprime class action agreed to pay $90
million to settle claims in that case. New Century co-founder Brad
Morrice
said then that he
hoped the settlement “would make up for some of the losses suffered and
provide closure to me and the shareholders.”
Closure isn’t coming any time soon for
Countrywide. Bank of America’s
annual report provides a list of legal cases
tied to Countrywide that covers parts of three pages.
Nor is [Angelo] Mozilo [Countrywide former CEO]
out of the woods. He and two other former Countrywide execs still face a
Securities and Exchange Commission
fraud suit that centers on familiar
allegations, that the company duped shareholders by failing to disclose
the growing risk of its subprime lending business.
Countrywide was not, strictly speaking, a failure.
Bank of America agreed to buy them in January of 2008, before the bigger
“failures” of Lehman, AIG, and Bear Stearns changed the language describing
our economic challenges from subprime crisis to full-blown,
“is-it-a-second-coming-of-the-depression-well-at-least-it’s-a-serious-recession”
financial crisis.
Reuters, January 11, 2008: “Regulators and
politicians in Washington are very keen to see troubled lenders find
solutions to their problems, experts said. Egan said the Federal Deposit
Insurance Corp did not want to deal with the potential failure of
Countrywide. And Bove said: “The people in Washington must be having
fits about what would happen if a bank or a thrift with $55 billion in
assets went under, so I think they pushed Countrywide hard in this
direction.”
I started writing about the subprime crisis in
early 2007. Countrywide was already
spinning out of control.
“Countrywide, the nation’s biggest mortgage
lender in terms of loan volume, said it faces “unprecedented
disruptions” in debt and mortgage-finance markets that could hurt
earnings and the company’s financial condition. In its quarterly filing
with the SEC, the bank said “the situation is rapidly evolving and the
impact on the company is unknown.”
KPMG is their auditor and gave them a
squeaky clean opinion in 2006.
By mid-2007, New Century was
giving KPMG a migraine and Deloitte had its hands
full with
American Home. By November, Deloitte was also
worried about
Bear Stearns and Merrill Lynch.
Countrywide became a black hole for Bank of
America. The bank was still gushing red ink in March, while due diligence
continued, before the deal closed.
This was unexpected, they said.
Countrywide’s Mortgage Woes Deepen
Countrywide Financial Corp.’s mortgage
portfolio continues to deteriorate rapidly as defaults increase and home
prices fall, a securities filing shows…The lender also said it took a
big loss in the fourth quarter on home-equity lines of credit.
Further
losses may lie ahead…Countrywide was blindsided during the quarter by
obligations on home-equity lines of credit that it had sold to investors
in the form of securities…Countrywide said the likelihood of
such a situation was “deemed remote” until late 2007. It blamed
a “sudden deterioration” in the housing market. As a result, it recorded
a $704 million loss to cover the estimated costs of its obligations on
the lines of credit…A
Countrywide computer model used to gauge risks
on these securities didn’t take into account the possible effects of
exceeding the loss levels that cut off reimbursements…
Much has been written about Countrywide and its
failings. There was enough evidence, I suppose,
in re Countrywide Financial Corp. Securities Litigation, 07-05295
that “former
Countrywide Chief Executive Officer
Angelo Mozilo and other executives
hid the fact that the company was fueling its growth by letting underwriting
standards deteriorate” to scare the
defendants away from a trial. Mozilo is still subject to SEC civil suits
and potential criminal indictments for fraud. But Countrywide, its
executives and its auditors, KPMG, were not subjected to a bankruptcy filing
and a bankruptcy examiner’s report like New Century was.
The judge in the Countrywide case has agreed to
accept KPMG’s acknowledgment of $24 million of the $624 million liability or
about 4% culpability. Without a bankruptcy examiner’s report such as the New
Century report or a trial, we will never know the full extent, if any, of
KPMG’s knowledge, negligence,
aiding or abetting of the alleged Countrywide
fraud.
Michael Missal’s New Century bankruptcy examiner
report was a tour de force, the complete anatomy of a pre-financial crisis
fraud, including several smoking guns pointed at auditors KPMG. Let me
remind you that pros like
Mr. Missal, who cut his teeth on the World Com
bankruptcy and Arthur Andersen, drew the map used by Anton Valukas and the
Lehman bankruptcy examiner’s report. Missal set the standard for Valukas’ colorable
claims against Ernst and Young for
professional impotence and complacency when faced with Lehman’s Repo 105
activities.
Paul Barrett of Business Week reminded us, too, of
the important role of the virtuoso bankruptcy examination when setting up
Trustees’ litigation and criminal indictments:
“The unavoidable question is whether the SEC
will hold someone responsible for what happened at Lehman,” says Michael
J. Missal, a partner in Washington with the law firm K&L Gates. Missal,
who makes a living defending companies faced with government
investigations, is another of those attorneys capable, when asked by a
court, of transforming himself into a public-spirited, if generously
compensated, pit bull. He published an impressive bankruptcy examiner’s
report of his own in 2008 in the case of New Century Financial, one of
the subprime mortgage giants that, with Wall Street’s assistance,
recklessly inflated the housing bubble.
I spoke to Michael Missal recently. He told me
that to have a successful bankruptcy examiner’s engagement, the examiner
must be:
1) Thorough
2) Accurate
3) Fair
4) Objective
5) Timely
I think his New Century report, clocking in at 551
pages plus appendices, did a great job of explaining, for the first time,
difficult issues we would see so many times in later subprime and financial
crisis litigation.
The report also
really nailed the auditors, KPMG.
Bloomberg, April 2, 2009: KPMG’s audits of New
Century violated both professional standards promoted by its
international body and regulatory requirements, according to the
complaint. Dissenters within the auditing firm were silenced by senior
partners to protect the firm’s business relationship with New Century
and KPMG LLP’s fees from the company.
One KPMG specialist who complained about an
incorrect accounting practice on the eve of the company’s 2005 annual
report filing was told by a lead KPMG audit partner “as far as I am
concerned we are done. The client thinks we are done. All we are going
to do is piss everybody off,” the complaint said.
KPMG’s regulator,
the PCAOB, has told us over and over that
KPMG will fudge on behalf of their clients when it
comes to auditing estimates of
loan loss reserves. That claim was the
smoking gun in the
New Century litigation.
Attorney for the New Century Trustee, Steven
Thomas, thought so much of this smoking gun he put a
$1 billion price tag
on the litigation by the Trustee against KPMG
Continued in article
Late in the afternoon I'm tired of reporting bad news --- read it for
yourself and weep!
"Westpoint Now Embroils KPMG, Deloitte And Australian Securities and
Investments Commission," Big Four Blog, August 19, 2010 ---
http://bigfouralumni.blogspot.com/2010/08/westpoint-now-embroils-kpmg-deloitte.html
KPMG's litigation woes ---
http://faculty.trinity.edu/rjensen/fraud001.htm
Question
Why do auditors continue to allow earnings management with loan loss reserves?
July 19, 2010 message from Francine McKenna
[retheauditors@GMAIL.COM]
Bob,
Sound familiar? The banks are making what they can
based on technical accounting manipulation including playing with loan loss
reserves. There's still a lot of bad debt on their books.
http://www.nytimes.com/2010/07/17/business/17bank.html?_r=1&scp=3&sq=citigroup&st=Search
"Citigroup’s net income declined 37 percent, to $2.7
billion, and Bank of America’s net income fell 3 percent, to $3.1 billion,
from a year earlier. Both banks padded those results with a big release of
funds that had been set aside to cover future loan losses, with executives
citing improvements in the economy."
http://www.businessweek.com/news/2010-07-16/bank-of-america-citigroup-fall-as-loan-books-interest-shrink.html
"
Citigroup also got $599 million of mark-ups on loans
and securities in a “special asset pool” of trading positions left over from
before the credit crisis. Citigroup booked a $447 million gain from writing
down the value of its own debt, under an accounting rule that allows
companies to profit when their creditworthiness declines. The rules reflect
the possibility that a company could buy back its own liabilities at a
discount, which under traditional accounting methods would result in a
profit.
About $1.2 billion of Bank of America’s revenue
came from writing down the value of obligations assumed from its purchase of
Merrill Lynch & Co., according to the bank’s CFO, Charles Noski."
Francine
Francine
July 19, 2010 reply from Bob Jensen
Hi Francine,
Bank behaviors with auditor blessings are so sad.
Thanks for the tidbit.
Sydney
Finkelstein, the Steven Roth professor of management at the Tuck School of
Business at Dartmouth College, also pointed out that Bank of America booked
a $2.2 billion gain by increasing the value of Merrill Lynch’s assets it
acquired last quarter to prices that were higher than Merrill kept them.
“Although perfectly legal, this move is also perfectly delusional, because
some day soon these assets will be written down to their fair value, and it
won’t be pretty,” he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross Sorkin, The
New York Times, April 20, 2009 ---
http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk
This is starting to feel like amateur
hour for aspiring magicians.
Another day, another attempt by a Wall
Street bank to pull a bunny out of the hat, showing off an earnings report
that it hopes will elicit oohs and aahs from the market. Goldman Sachs,
JPMorgan Chase, Citigroup and, on Monday, Bank of America all tried to wow
their audiences with what appeared to be — presto! — better-than-expected
numbers.
But in each case, investors spotted
the attempts at sleight of hand, and didn’t buy it for a second.
With Goldman Sachs, the disappearing
month of December didn’t quite disappear (it changed its reporting calendar,
effectively erasing the impact of a $1.5 billion loss that month); JPMorgan
Chase reported a dazzling profit partly because the price of its bonds
dropped (theoretically, they could retire them and buy them back at a
cheaper price; that’s sort of like saying you’re richer because the value of
your home has dropped); Citigroup pulled the same trick.
Bank of America sold its shares in
China Construction Bank to book a big one-time profit, but Ken Lewis
heralded the results as “a testament to the value and breadth of the
franchise.”
Sydney Finkelstein, the Steven Roth
professor of management at the Tuck School of Business at Dartmouth College,
also pointed out that Bank of America booked a $2.2 billion gain by
increasing the value of Merrill Lynch’s assets it acquired last quarter to
prices that were higher than Merrill kept them.
“Although perfectly legal, this move is
also perfectly delusional, because some day soon these assets will be
written down to their fair value, and it won’t be pretty,” he said.
Investors reacted by throwing
tomatoes. Bank of America’s stock plunged 24 percent, as did other bank
stocks. They’ve had enough.
Why can’t anybody read the room here?
After all the financial wizardry that got the country — actually, the world
— into trouble, why don’t these bankers give their audience what it seems to
crave? Perhaps a bit of simple math that could fit on the back of an
envelope, with no asterisks and no fine print, might win cheers instead of
jeers from the market.
What’s particularly puzzling is why
the banks don’t just try to make some money the old-fashioned way. After
all, earning it, if you could call it that, has never been easier with a
business model sponsored by the federal government. That’s the one in which
Uncle Sam and we taxpayers are offering the banks dirt-cheap money, which
they can turn around and lend at much higher rates.
“If the federal government let me
borrow money at zero percent interest, and then lend it out at 4 to 12
percent interest, even I could make a profit,” said Professor Finkelstein of
the Tuck School. “And if a college professor can make money in banking in
2009, what should we expect from the highly paid C.E.O.’s that populate
corner offices?”
But maybe now the banks are simply
following the lead of Washington, which keeps trotting out the latest idea
for shoring up the financial system.
The latest big idea is the so-called
stress test that is being applied to the banks, with results expected at the
end of this month.
This is playing to a tough crowd that
long ago decided to stop suspending disbelief. If the stress test is done
honestly, it is impossible to believe that some banks won’t fail. If no bank
fails, then what’s the value of the stress test? To tell us everything is
fine, when people know it’s not?
“I can’t think of a single, positive
thing to say about the stress test concept — the process by which it will be
carried out, or outcome it will produce, no matter what the outcome is,”
Thomas K. Brown, an analyst at Bankstocks.com, wrote. “Nothing good can come
of this and, under certain, non-far-fetched scenarios, it might end up
making the banking system’s problems worse.”
The results of the stress test could
lead to calls for capital for some of the banks. Citi is mentioned most
often as a candidate for more help, but there could be others.
The expectation, before Monday at
least, was that the government would pump new money into the banks that
needed it most.
But that was before the government
reached into its bag of tricks again. Now Treasury, instead of putting up
new money, is considering swapping its preferred shares in these banks for
common shares.
The benefit to the bank is that it
will have more capital to meet its ratio requirements, and therefore won’t
have to pay a 5 percent dividend to the government. In the case of Citi,
that would save the bank hundreds of millions of dollars a year.
And — ta da! — it will miraculously
stretch taxpayer dollars without spending a penny more.
"Watch Banks Pull Rabbits Out of Hats, Ably Assisted by Their Auditors," by
Francine McKenna, re:TheAuditors, July 19, 2010 ---
http://retheauditors.com/2010/07/19/watch-banks-pull-rabbits-out-of-hats-ably-assisted-by-their-auditors/
Do you own stock in a large money center bank?
Work for one? Count on one to lend you money for a small business? Expect
them to stimulate the economy via commercial loans and lending again for
residential or commercial real estate?
You’ve been deluded by the illusion of their
self-serving public relations – rah-rah intended to help you forget
financial reform that barely is and no safety net for anyone but the elite.
The global money center banks are masters at
managing financial reporting. Regulators repeatedly feign surprise at
balance sheet sleight of hand, prestidigitation at the expert level intended
to buy time until the banks can grow out of the black hole that bubble
lending put them in. They announce their quarterly results, with all the
details – they don’t even try to hide them anymore – and they’re ignored or
the con is traded on for short term profits.
The New York Times, July 16, 2010
“Citigroup’s net income declined 37 percent, to
$2.7 billion, and Bank of America’s net income fell 3 percent, to $3.1
billion, from a year earlier. Both banks padded those results with a big
release of funds that had been set aside to cover future loan losses,
with executives citing improvements in the economy.”
Business Week reports that Citigroup flip flopped
on the value of assets acquired with Merrill Lynch and magic happened:
“Citigroup also got $599 million of mark-ups on
loans and securities in a “special asset pool” of trading positions left
over from before the credit crisis. Citigroup booked a $447 million gain
from writing down the value of its own debt, under an accounting
rule that allows companies to profit when their
creditworthiness declines. The rules reflect the possibility that a
company could buy back its own liabilities at a discount, which under
traditional accounting methods would result in a profit.
About $1.2 billion of Bank of America’s revenue
came from writing down the value of obligations assumed from its
purchase of Merrill Lynch & Co., according to the bank’s CFO,
Charles Noski.”
Interestingly enough,
the opposite move also netted them a gain last
year. How exactly did this years write down equal a gain too?
Sydney Finkelstein, the Steven Roth
professor of management at the Tuck School of Business at
Dartmouth College, also pointed out that Bank of America
booked a $2.2 billion gain by increasing the value
of Merrill Lynch’s assets it acquired last quarter to prices
that were higher than Merrill kept them.
“Although perfectly legal, this move
is also perfectly delusional, because some day soon these
assets will be written down to their fair value, and it
won’t be pretty,” he said.
John Talbott, meanwhile,
explains today why Treasury Secretary Tim Geithner
doesn’t want watchdog Elizabeth Warren as the head of the new post-reform
consumer protection agency – she’ll prevent banks from making money off the
little guy while lending and trading remain unreliable profit drivers.
“Hank Paulson, the Treasury Secretary at the
time, had announced that the $700 billion TARP funds would be used to
buy toxic assets like bad mortgage loans from the commercial banks. But
this never happened and now the amount of bad bank loans has increased
in the trillions. Immediately after receiving authorization of the
funding for TARP from Congress, Paulson reversed direction and decided
to make direct equity investments in the banks rather than using the
TARP funds to acquire their bad loans.
So where are the trillions of dollars of bad
loans that the banks had on their books? They are still there. The
Federal Reserve took possession temporarily of some of them as
collateral for lending to the banks in an attempt to clean up the banks
for their supposed” stress tests”. But as of now, the trillions of
dollars of underwater mortgages, CDO’s and worthless credit default
swaps are still on the banks books. Geithner is going to the familiar
“bank in crisis” playbook and hoping that the banks can earn their way
out of their solvency problems over time so the banks are continuing to
slowly write off their problem loans but at a rate that will take years,
if not decades, to clean up the problem.”
Paul Krugman predicted this roller coaster ride
with bank earnings back in October, in particular with regard to Bank of
America and Citigroup. What he missed is that when trading profits are down
too, the banks – with the assistance of their auditors advice – must be
ever more creative to avoid having to write off those bad assets all at once
or without cover.
…while the wheeler-dealer side of the financial
industry, a k a trading operations, is highly profitable again, the part
of banking that really matters — lending, which fuels investment and job
creation — is not. Key banks remain financially weak, and their weakness
is hurting the economy as a whole.
You may recall that earlier this year there was
a big debate about how to get the banks lending again. Some analysts,
myself included, argued that at least some major banks needed a large
injection of capital from taxpayers, and that the only way to do this
was to temporarily nationalize the most troubled banks. The debate faded
out, however, after Citigroup and Bank of America, the banking system’s
weakest links, announced surprise profits. All was well, we were told,
now that the banks were profitable again.
But a funny thing happened on the way back to a
sound banking system: last week both Citi and BofA announced losses in
the third quarter. What happened?
Part of the answer is that those earlier
profits were in part a figment of the accountants’ imaginations.”
I’ve told you more than once that Citigroup is
still a mess. Anyone who isn’t a senior insider is nuts to buy their stock
or count on them for a job or business. Listen to me talk about AIG, Bank of
America and Citigroup, “an accident waiting to happen,” at the 8:15 mark on
this video for Stocktwits TV recorded June 3, 2010.
. . .
Both AIG and Goldman Sachs executives have been
questioned recently by the Financial Crisis Inquiry Commission.. The
Commission seeks to “examine the causes, domestic and global, of the current
financial and economic crisis in the United States.” We’ve also seen Lehman
executives called to account by Congressional inquisitors.
But we’ve yet to see the auditors – Pricewaterhouse
Coopers (auditor of AIG, Goldman Sachs, and Freddie Mac), Ernst & Young
(auditor of Lehman) or KPMG (auditor of Citigroup, previously of
Countrywide, Wells Fargo and Wachovia and earlier of Fannie Mae) – called to
testify to explain their role in blessing fraudulent bank balance sheet
accounting.
Isn’t it about time?
July 19, 2010 reply from Bob Jensen
Hi Francine,
Here’s an important citation on this topic --- my favorite!
My all-time heroes Frank Partnoy and Lynn Turner contend that Wall Street
bank accounting is an exercise in writing fiction: Watch the video! (a bit
slow loading) Lynn Turner is Partnoy's co-author of the white paper "Make
Markets Be Markets" "Bring Transparency to Off-Balance Sheet Accounting," by
Frank Partnoy, Roosevelt Institute, March 2010 ---
http://makemarketsbemarkets.org/modals/report_off.php
Watch the above video!
Bob Jensen
July 19, 2010 message from Steven Kachelmeier, University of Texas at Austin
[kach@MAIL.UTEXAS.EDU]
An article by Kanagaretnam,
Krishnan, and Lobo that is forthcoming in the November 2010 issue of The
Accounting Review is the most recent effort on this topic of which I am
aware. You can find it on the SSRN network at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1590506 .
The title is "An Empirical
Analysis of Auditor Independence in the Banking Insustry," but don't be
fooled by the title -- it's about manipulation of banks' loan loss reserves,
with an emphasis on how auditors bear upon that phenomenon. Kanagaretnam et
al. (2010) also cite most of the earlier studies on earnings management
involving bank loan loss reserves. Kiridan Kanagaretnam is at McMaster
University, Gopal Krishnan is at Lehigh University, and Gerald Lobo is at
the University of Houston.
Best.
Steve
July 19, 2010 reply from Jagdish Gangolly
[gangolly@CSC.ALBANY.EDU]
I have briefly gone through this paper. Its main
thesis is that there is lack of an association between banks fiddling with
earnings via LLLP (loan loss provisions) and "unexpected" audit fees for
large banks, while for the small banks that association is strongly
negative. The authors consider this evidence of a relationship between audit
independence and earnings management at least in the case of smaller banks.
They provide a blizzard of regressions and other data.
The paper is interesting from a policy perspective,
and would be a great paper in a policy oriented economics journal. I am glad
for the authors that it got accepted. However, does it have a bearing on
accounting' practice beyond setting the regulators on a chase of auditors of
small banks? Does it give us a better way of computing LLP? Does it give us
a way of finding out the reliability of the LLP number? Does it even tell us
if the LLP numbers are more (or less) reliable for the larger banks? Does
the age distribution of the loan portfolio vary between the two types of
banks? What is the distribution of auditors between the two types of banks?
There are a host of questions that should be triggered by this thread. Of
course, the authors pick the hypothesis they want to study, but an
accounting or auditing orientation (as opposed to "about" accounting
orientation in Sterling's language) would make a lot more sense for is
accountants.
The other issue, endemic to most of these types of
papers is the oblique way of introducing causality (a definite no-no for a
positivist) to obfuscate discussions. Figure 1 in the paper is what is
usually called a path graph giving the trace of causality (the direction of
the arrows indicating causality), but the statistical analysis is entirely
associational. Statistical techniques have existed for causal analysis for
almost half a century, but accounticians have uniformly pretended they do
not exist. Stating the models in causal terms but testing them
associationally is certainly less than truthful advertising. Unless, of
course, I am misstating the model, which I doubt. I have been in this game
for too long.
Nothing I have said above should be construed as
indicating my doubt on the questions raised by the authors; they should be
of great interest to a policy oriented audience. It is just that when it
comes to accounting practice, they are trying to sell kryptonite or worse.
Jagdish Gangolly (gangolly@albany.edu)
Department of Informatics College of Computing &
Information
State University of New York at Albany
7A, Harriman Campus Road, Suite 220 Albany, NY 12206 Phone: (518) 956-8251,
Fax: (518) 956-8247
Bob Jensen's threads on creative accounting and earnings management
http://faculty.trinity.edu/rjensen/Theory01.htm#ManagementAccounting
"Will Auditors Ever Answer To Investors For Aiding And Abetting?," by
Francine McKenna, re: TheAuditors, June 16, 2010 ---
http://retheauditors.com/2010/06/16/will-auditors-ever-answer-to-investors-for-aiding-and-abetting/
The House – Senate Wall Street Reform and
Consumer Protection Act Conference reconvened on Tuesday, June 15
and
Compliance Week says a version of the Specter Bill
– to repeal the Supreme Court’s Stoneridge decision – will not be included
in whatever comes out of the process.
Bruce Carton in Compliance Week:
As this process gets underway, auditors, lawyers, bankers and other
advisers to public companies are quietly breathing a sigh of relief that
one of the items no longer on the table is an amendment proposed by Sen.
Arlen Specter that would have overturned the U.S. Supreme Court’s 2008
ruling in Stoneridge Investment Partners, LLC v. Scientific-Atlanta,
Inc., thereby permitting “aiding and abetting” liability for a
company’s auditors and others. The final version of the financial reform
bill that passed the Senate did not include the Specter amendment.
However,
a coalition of state regulators, public pension
funds, professors, consumers and investors and the attorneys who advise
them, are still working to put something back in the bill as an amendment to
restore the right of investors to defend themselves and hold white collar
criminals accountable.
Their email to me states:
The
amendment brought by Senators Arlen Specter
(D-PA), Jack Reed (D-RI), Dick Durbin (D-IL) and many other senior
Democrats would have enacted one simple change in current anti-investor
law – law that was “legislated” by a conservative Supreme Court rather
than the U.S. Congress. The reform would have restored the right of
pension funds and other investors to hold accountable in courts those
who knowingly aid and abet securities fraud.
This legal right of investors, which for fifty
years helped white collar crime victims recover their losses while also
deterring future fraud enablers, was stripped from shareholders and
bondholders by the radical Stoneridge Supreme Court decision of
2008, which expanded upon an earlier misguided Court decision in order
to throw out thousands of remaining meritorious fraud claims brought by
retirement funds and individual investors against investment banks and
others who helped design the Enron fraud – the largest financial crime
in U.S. history.
Earlier this Spring, a Federal appeals court
cited the “Supremes” and threw out the legitimate claims of ripped-off
shareholders and bondholders in the billion dollar Refco, Inc.
derivatives fraud. In Refco, a now criminally convicted corporate
lawyer had worked with Refco’s senior execs to execute fake transactions
as a paper trail leading to falsified financial statements that were
issued to investors and the public.
Both Congressman Barney Frank and Senator Ted Kaufman responded to
questions about the Specter amendment during my visit to Washington DC for
Compliance Week’s Annual Conference. House
Financial Services Committee Chairman Frank said at the conference that
he was in favor of bringing the amendment back in the bill. Senator
Kaufman, although a
co-sponsor of the original amendment, is
in favor but does not think it’s likely.
I’ve written quite a bit about the impact of third party liability on the
auditors in fraud claims and the
Stoneridge decision.
In February of 2008 , I wrote about Treasury’s attempt to address the
nagging issues of
viability and sustainability of the accounting profession.
They punted.
I have consistently disagreed with the Big 4’s
claim that auditor liability caps are necessary to
avoid losing one of the remaning firms to catastrophic litigation.
I have lamented the fact that the auditors don’t
get sued often enough for my tastes and, when they do, they often
settle. I’ve also said that they don’t deserve our pity, as they are
less than transparent regarding their true financial capacity to address
ongoing litigation…
“The Treasury Department established the
Advisory Committee on the Auditing Profession to examine the
sustainability of a strong and vibrant auditing profession.”
John P.
Coffey, the Co-Managing Partner of Bernstein
Litowitz Berger & Grossmann LLP… agrees with what I have been saying on
this blog all last year.
It is with this
perspective that I address one of the questions the Committee
is considering, namely, whether there ought to be a cap on auditor
liability. I respectfully submit that the case for such a cap has not
been made…
…the fact that, in
today’s environment, auditors are rarely named as defendants in these
actions. In a three-year period immediately before the PSLRA was enacted
– April 1992 through April 1995 – auditors were named as defendants in
81 of 446 private securities class actions filed, for an average of 27
suits per year, or 18% of all private securities class actions. As the
reforms of the PSLRA and the concomitant jurisprudence took hold, that
number dropped precipitously. Auditors were named as defendants in only
five suits in 2005, and only two cases in each of 2006 and 2007.
The number for 2007
is especially telling because approximately one out of every eleven
companies with U.S.-listed securities – almost 1200 companies in all –
filed financial restatements in 2007 to correct material accounting
errors. Further, an analysis of securities actions filed in 2006 and
2007 demonstrates a significant decline in the number of cases alleging
GAAP violations, appearing to suggest “a movement away from the focus in
recent years on the validity of financial results and accounting
treatment.”
Well, that’s changed post-financial crisis. In
addition to the big frauds like
Satyam, Glitnir, the
Madoff feeder funds and
garden variety accounting malpractice claims, the
auditors are named in high profile subprime cases where fraud is alleged
such as
New Century and
Lehman.
It’s still not a deluge, since the
PSLRA makes it damn difficult to draw the auditors
in without a smoking gun or, actually, a rogue mechanical pencil. Even with
a top
notch bankruptcy examiner’s report – I’m talking
Refco here – it’s not easy.
July 11, 2007, Bloomberg
Refco
Inc.’s tax accountant, Ernst & Young, and a
company law firm may have helped the defunct futures trader defraud
investors, according to an examiner’s report unsealed today.
Ernst & Young, the second-biggest U.S.
accounting firm, and Mayer Brown Rowe & Maw, a Chicago-based law firm,
might face claims by Refco for aiding and abetting the fraud, examiner Joshua
Hochberg said in a report filed in U.S.
Bankruptcy Court in New York. Grant Thornton, the sixth biggest U.S.
accounting firm, might face claims of professional negligence for work
it did before Refco’s bankruptcy, Hochberg said.
Contrast that seemingly slam-dunk assessment with
this report on August 22, 2009:
Two accounting firms and a law firm won
dismissal of a lawsuit on behalf of former Refco Inc currency trading
customers who lost more than $500 million when the defunct futures and
commodities broker went bankrupt.
U.S. District Judge Gerard Lynch on Tuesday
said Marc Kirschner, a trustee representing the customers, failed to
show that Ernst & Young LLP [ERNY.UL], Grant Thornton LLP and the law
firm Mayer Brown LLP knew of or substantially assisted in the fraudulent
diversion of assets that led to Refco’s demise.
The Manhattan federal judge, however, gave
permission for Kirschner to file a new complaint. Citing the trustee’s
access to a “substantial trove” of Refco documents, Lynch said: “It is
far from clear that repleading would be futile.”
In his 35-page opinion, Lynch said Grant
Thornton’s work gave it “a complete picture of how Refco and the Refco
fraud, functioned.”
He also said Mayer Brown “actively participated
in carrying out Refco’s fraudulent misstatement of its financial
position,” while Ernst performed to work for Refco “despite apprehending
the scope of the fraud.”
Judges, even while granting motions to dismiss,
have more than once bemoaned the fact that the law does not allow them to
act differently. In case after case,
the judges are forced to let culpable third-party actors in these frauds off
the hook.
Continued in article
Bob Jensen's threads on auditing firm litigation woes ---
http://faculty.trinity.edu/rjensen/fraud001.htm
Bob Jensen's threads on professionalism and independence in auditing --- a
http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism
“What A Tangled Web We Weave: AIG’s Cassano Says He Told PwC Everything,”
by Francine McKenna, re:TheAuditors, June 30, 2010 ---
http://retheauditors.com/2010/06/30/going-concern-what-a-tangled-web-we-weave-aigs-cassano-says-he-told-pwc-everything/
My
new column is up @Going Concern:
Joseph Cassano, the former head of AIG’s
Financial Products Group, testifies today for the Financial Crisis
Inquiry Commission, a bipartisan commission with a critical non-partisan
mission — to examine the causes of the financial crisis.
[...]
The Department of Justice cleared Mr. Cassano
in May. No criminal charges will be filed. U.K.’s Serious Fraud Office
dropped probes last month, and the U.S. Securities and Exchange
Commission also closed their investigations too…the investigations went
south
when, “prosecutors found evidence Mr. Cassano
did make key disclosures. They obtained notes written by a PwC auditor
suggesting Mr. Cassano informed the auditor and senior AIG executives
about the adjustment…[and] told AIG shareholders in November 2007 that
AIG would have “more mark downs,” meaning it would lower the value of
its swaps.”
So who’s telling the truth? Was PwC duped by
AIG? Who is looking out for AIG shareholders and the US taxpayer in this
mess?
Based on
my reading of the Audit Committee minutes, I
believe that PwC was aware of weaknesses in internal controls over the
AIGFP super senior credit default portfolio throughout 2007 and prior.
Why were they pussy-footing around still on January 15, 2008 as to
whether these control weaknesses were a significant deficiency (which
would not have to have been disclosed) or a material weakness (which
eventually was)?
Read the rest
here.
http://goingconcern.com/2010/06/what-a-tangled-web-we-weave-aig’s-cassano-says-he-told-pwc-everything/
Bob Jensen's threads on PwC are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Where Were the Auditors?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Bob Jensen's Rotten to the Core threads on banks and brokerages ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
"The Auditors And Financial Regulatory Reform: That Dog Don’t Hunt,"
by Francine McKenna, re: The Auditors, May 31, 2010 ---
http://retheauditors.com/2010/05/31/the-auditors-and-financial-regulatory-reform-that-dog-dont-hunt/
It’s not every day that a regular girl from Chicago
has a chance to talk with a sitting US Senator about the subject most
important to her.
No… I’m not talking about Rosie, my Rottweiler.
I’m talking about the auditors’ role in the
financial crisis and their place in the regulatory reform bills now being
considered. Through a series of wonderful and kind acts, namely the efforts
of one
particular journalist, I was invited to talk with
Delaware Senator Ted Kaufman (D) and his staff about accounting industry
reform.
The conversation was wide ranging and opinions
expressed off-the-record. The meeting happened on the same day as Representative
Barney Frank’s speech to the Compliance Week conference
and we talked about his remarks. I expressed my
disappointment with several things especially Rep. Frank’s capitulation on a
Sarbanes-Oxley exception for smaller companies and his rambling response to
the question about a Department of Justice implied “too few to fail” policy.
The Kaufman team is led with mucho gusto by the
Senator. It was great to have a chance to meet them, but I realize it’s
probably too late to get anything that addresses audit industry reform in
this bill. There’s a lot of compromise
going on with what’s already there.
Health care reform took some of the fight out of
more than a few on both sides of the aisle and in both legislative bodies.
Rep. Frank mentioned it a few times during his speech. He described
advantages and disadvantages from a legislative perspective of the pure
focus on financial regulatory reform now that health care is “a done deal.”
It makes it both easier for media to spotlight an individual politician’s
positions without the clutter of other major legislation and harder for that
politician to hide behind multiple major initiatives when it comes to
supporting or voting for controversial or dramatic change.
I came to the meeting with a few points to make. I
think I did that but, as usual, a discussion of the issues facing the audit
industry can get a little depressing, even for me.
However, this meeting, as well as the ones at the
PCAOB, made me realize the time has come to make proposals and suggestions
for industry change instead of just pointing out the issues, problems and
need for change.
Most regulators and legislators avoid talking about
wholesale change to the structure of the accounting/audit industry. It
seems too big a task and untenable. The refrain I hear most often both when
attending conferences and events and on this site is, “We can’t get rid of
the audit opinion. It’s required.” I’ve also written about the strong and
steady political contributions the accounting industry makes,
party-agnostic, dictated primarily by the politician’s position and
influence over the audit firms’ interests.
Lack of vision and loads of cash. These are the
fundamental obstacles to serving investors and other stakeholders with
financial reporting that can be trusted.
But it’s also true that Big Oil has spent years
deluding itself and others into thinking that this kind of spill was
impossible and that preparing for one wasn’t necessary. Indeed, BP once
called a blowout disaster “inconceivable.”
Certainly, if you can’t conceive of a disaster, you’ll become more and
more lax, more and more reckless, until one happens. You’ll cut corners
on backup systems and testing. And you certainly won’t pre-build and
pre-position any relevant equipment for staunching the flow. Since a
disaster can’t happen, you and your allies in Congress will block all
serious safeguards and demagogue all efforts to oversee the industry as
“Big Government interference in the marketplace that will raise the
price of gasoline for average Americans.”
This quote comes from Salon
and refers to the oil spill disaster. But it could
have just as easily been said about the litigation threats against the
largest global accounting firms and doubts about their
viability and credibility post-financial crisis.
If legislators and regulators can’t imagine a world without the audit firms
and the audit report in their current form, then they can’t work towards
something better for investors and the capitalist system.
The firms are broken and their basic product is
worthless. The auditors were completely impotent to warn investors of
over-leverage and risky business models, to prevent erroneous and
potentially fraudulent financial reporting and to mitigate the impact on
everyone of these errors, misstatements, obfuscations and subterfuge by
executives of the failed, bailed out and nationalized financial
institutions.
It wasn’t such an intellectual leap for media,
regulators and legislators to see the inherent conflicts in the ratings
agencies’ business model post-crisis and to essentially, with the stroke of
a pen, destroy that business model.
New York Times, The Caucus Blog,
May 13, 2010: One amendment, sponsored by Senators George LeMieux,
Republican of Florida and Maria Cantwell, Democrat of Washington, would
remove references to the credit agencies in major financial
services laws, including the Securities Exchange Act of 1934,
the Investment Company Act of 1940 and the Federal Deposit Insurance
Act. It was approved by a vote of 61 to 38.
Additional reform legislation sponsored by
Senator Al Franken – I kid you not – puts the
government in the middle between ratings agencies and the securities
issuers. The ideas is to take the “pleaser” part out of how the credit
raters make their living.
The Atlantic,
May 13, 2010: “The new legislation calls for every new ABS bond issue to
have a rating by one agency assigned by a new board, instead of being
chosen by the investment bank creating the security. The board will
consist of mostly investors along with a few other industry
participants. Although the underwriter can solicit additional ratings,
it cannot escape the verdict of the assigned agency, so it cannot shop
around for whichever agency has the most favorable view.”
Wouldn’t it be funny if the audit
firms took advantage of the credit ratings agencies’ weakness
and swooped in to do that business? After all, the
auditors have the trust
and integrity thing down pat. But there’s
no way the audit firms would have the nerve to even float that idea post-EY/Lehman…
Nobody disagrees when I remind them that audit
firms have the same inherent conflict of interest as ratings agencies. The
audit firms have a business relationship with Audit Committees who are
selected by the corporations’ executives. Audit partners are “pleasers.”
The
audit fees for the
largest financial institutions are in the $100,000,000 annually range but
it’s been a challenge to grow that business in the current economic
environment. The Sarbanes-Oxley gravy train has pretty much derailed.
Is it such a stretch to think about taking the
control over appointment and renewal of auditors away from the corporations
– the corporate executives are the true corrupting influence on the poor,
innocent auditors – and give it to the SEC or PCAOB? Corporations could be
required to pay the auditor regardless of the audit opinion or how many
exceptions are found or hard the auditor has to push back on aggressive
accounting. All this can happen under the watchful eye of their regulator
who can put the firms on a “good list” and can effect limited or general
“debarment” type actions if an audit firm or audit partner rolls over and
plays dead too often.
Continued in article
One of my heroes in life is Frank Partnoy
I quote him scores of times at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
"Living Like It's 1931: Law professor Frank Partnoy questions
whether the regulatory reform bill under debate in Congress will be enough to
move the economy toward prosperity," by Sarah Johnson, CFO.com, June
17, 2010 ---
http://www.cfo.com/article.cfm/14505447/c_14505581?f=home_todayinfinance
The calendar says 2010, but Frank Partnoy believes
that in certain respects, we're living like it's 1931. That was a
transitional year between the 1929 stock market crash and the passing of two
transformative securities laws, in 1933 and 1934, that established a
regulatory body for public companies, mandated widespread financial
reporting, and created antifraud remedies.
Seven decades later, optimists would like to
believe that the regulatory reform bill in Congress will mark the beginning
of better days for the U.S. economy. But Partnoy, a University of San Diego
law and finance professor and longtime follower of regulatory reforms,
thinks 2010 will likewise be considered a transitional time. "We're still in
the middle of the ball game in terms of regulatory response," he told CFO in
a recent interview.
In Partnoy's view, the regulatory response to the
financial crisis thus far has been "muddled." Congress is plodding through
more than 1,500 pages of reforms that will affect various areas of the U.S.
financial system. The reforms include a new government authority to prevent
financial institutions from becoming too big to fail, a consumer protection
agency, regulations for the derivatives market, and even some measures that
could be deemed antiregulation (such as a provision that would exempt the
smallest U.S. publicly traded companies from getting an audit opinion on
their internal controls).
The bill is expected to be finalized at the end of
this month. Around the same time, Partnoy will speak about the new
regulatory reforms and their resemblance to past reforms at the upcoming CFO
Core Concerns Conference, to be held June 27-29 in Baltimore. An edited
version of CFO's recent interview with Partnoy follows.
How can we assess whether the new legislation will
be successful? The only way we'll know is to wait and hope. If we could go
back in time a few years with these proposed rules, would the crisis have
been prevented? The answer is no. Congress is considering more than 1,500
pages of reform, but most of that is not directed at problems that would
have prevented the crisis.
What piece of the legislation do you most hope will
survive the process? The most crucial part is the removal of regulatory
references to credit ratings. I have my fingers crossed that it will pass.
Participants in the financial markets need to stop relying on Moody's and
S&P.
Why isn't a similar proposal by the Securities and
Exchange Commission to end the practice good enough? The SEC doesn't have
the power to change a statute; Congress does. And many of these references
extend beyond the securities area, outside the purview of the SEC. In
addition, it's important for Congress to fire a shot across the bow of all
regulators to let them know that it's not appropriate to rely on ratings.
It's the kind of reform that needs to come from the top, and that means
Congress.
In a joint paper with former SEC chief accountant
Lynn Turner, you called on Congress to "clarify that financial statements
have primacy over footnotes, not the other way around." Why do you think our
financial-reporting system has evolved to become, in your view, not as
transparent as it should be? It's been a slow evolution that has been driven
by lobbying, in particular by major financial institutions. This started in
the 1980s, when accounting standard-setters were trying to figure out
whether swaps should be accounted for on the balance sheet. Once that
argument was lost — once we went down the road of saying that swaps were
different — it was a very slippery slope. There's a focused group of market
participants who benefit from off-balance-sheet treatment but only a few who
represent investor interests. Analysts are in an interesting position
because on the one hand, they would be able to do a better job if they had
more information about exposures and liabilities. But if everything is
off-balance-sheet, they have a comparative advantage in finding out what's
buried on page 246 of Form 10-K.
Do you see any signs that this issue will be
addressed in the legislation? Congress, Wall Street, and large institutional
investors all seem to have united against putting these financial
instruments on the balance sheet. It seems unlikely that there will be any
kind of substantive change.
What's your view on proposed reforms for
derivatives? What I regard as the most important reform has met with mixed
reactions. That would be simply for banks to more accurately report their
exposure to derivatives and give better information about worst-case
scenarios. Those initiatives have taken a back seat to the push for
requiring that derivatives be traded on exchanges, and then for trying to
move derivatives outside of the banking sector. Keep in mind, the
transactions that generated the crisis were not transactions that would ever
find a home on an exchange. They're private, custom-tailored deals that fall
outside of the legislation. Paradoxically, we might end up with a law that
will hurt useful markets in plain-vanilla derivatives, yet will not resolve
problems.
Another one of my heroes is former Coopers partner and SEC Chief Accountant
Lynn Turner. My two heroes, Turner and Partnoy, write about how bank financial
statements should be classified under "Fiction."
Frank
Partnoy and Lynn Turner contend that bank accounting is an exercise in writing
fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper "Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the great video!
Great Speeches About the State of Accountancy
"20th Century Myths," by Lynn Turner when he was still Chief Accountant at the
SEC in 1999 ---
http://www.sec.gov/news/speech/speecharchive/1999/spch323.htm
Bob Jensen's threads on accounting theory are at
http://faculty.trinity.edu/rjensen/Theory01.htm
Bob Jensen's timeline of derivative financial instruments frauds can be
found at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Why must we worry about the hiring-away pipeline?
Credit Rating Agencies ----
http://en.wikipedia.org/wiki/Credit_rating_agency
A credit rating agency (CRA) is a
company that assigns
credit ratings for
issuers of certain types of
debt obligations as well as the debt instruments
themselves. In some cases, the servicers of the underlying
debt are also given ratings. In most cases, the
issuers of
securities are companies,
special purpose entities, state and local
governments,
non-profit organizations, or national governments
issuing debt-like securities (i.e.,
bonds) that can be traded on a
secondary market. A credit rating for an issuer
takes into consideration the issuer's
credit worthiness (i.e., its ability to pay back a
loan), and affects the
interest rate applied to the particular security
being issued. (In contrast to CRAs, a company that issues
credit scores for individual credit-worthiness is
generally called a
credit bureau or
consumer credit reporting agency.) The value of
such ratings has been widely questioned after the 2008 financial crisis. In
2003 the
Securities and Exchange Commission submitted a
report to Congress detailing plans to launch an investigation into the
anti-competitive practices of credit rating agencies and issues including
conflicts of interest.
Agencies that assign credit ratings for
corporations include:
How to Get AAA Ratings on Junk Bonds
- Pay cash under the table to credit rating agencies
- Promise a particular credit rating agency future multi-million
contracts for rating future issues of bonds
- Hire away top-level credit rating agency
employees with insider information and great networks inside the credit
rating agencies
By now it is widely known that the big credit rating agencies (like Moody's,
Standard & Poor's, and Fitch) that rate bonds as AAA to BBB to Junk were
unethically selling AAA ratings to CDO mortgage-sliced bonds that should've been
rated Junk. Up to now I thought the credit rating agencies were merely selling
out for cash or to maintain "goodwill" with their best customers to giant Wall
Street banks and investment banks like Lehman Bros., AIG., Merrill Lynch, Bear
Stearns, Goldman Sachs, etc. ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
But it turns out that the credit rating agencies were also in that "hiring-away"
pipeline.
Wall
Street banks and nvestment banks were employing a questionable tactic used by
large clients of auditing firms. It is common for large clients to hire away the
lead auditors of their CPA auditing firms. This is a questionable practice,
although the intent in most instances (we hope) is to obtain accounting experts
rather than to influence the rigor of the audits themselves. The tactic is much
more common and much more sinister when corporations hire away top-level
government employees of regulating agencies like the FDA, FAA, FPC, EPA, etc.
This is a tactic used by industry to gain more control and influence over its
regulating agency. Current regulating government employees
who get too tough on industry will, thereby, be cutting off their chances of
getting future high compensation offers from the companies they now regulate.
The
investigations of credit rating agencies by the New York Attorney General and
current Senate hearings, however, are revealing that the hiring-away tactic was
employed by Wall Street Banks for more sinister purposes in order to get AAA
ratings on junk bonds. Top-level employees of the credit rating agencies were
lured away with enormous salary offers if they could use their insider networks
in the credit rating agencies so that higher credit ratings could be stamped on
junk bonds.
"Rating Agency Data Aided Wall Street in
Deals," The New York Times, April 24, 2010 ---
http://dealbook.blogs.nytimes.com/2010/04/24/rating-agency-data-aided-wall-street-in-deals/#more-214847
One of the mysteries of the financial crisis is how
mortgage investments that turned out to be so bad earned credit ratings that
made them look so good, The New York Times’s Gretchen Morgenson and Louise
Story
report. One answer is that Wall Street was given
access to the formulas behind those magic ratings —
and hired away some of the very people who had devised
them.
In essence, banks started with the answers and
worked backward, reverse-engineering top-flight ratings for investments that
were, in some cases, riskier than ratings suggested, according to former
agency employees.
Read More »
"Credit rating agencies
should not be dupes," Reuters, May 13, 2010 ---
http://www.reuters.com/article/idUSTRE64C4W320100513
THE PROFIT INCENTIVE
In fact, rating agencies sometimes discouraged
analysts from asking too many questions, critics have said.
In testimony last month before a Senate
subcommittee, Eric Kolchinsky, a former Moody's ratings analyst, claimed
that he was fired by the rating agency for being too harsh on a series of
deals and costing the company market share.
Rating agencies spent too much time looking for
profit and market share, instead of monitoring credit quality, said David
Reiss, a professor at Brooklyn Law School who has done extensive work on
subprime mortgage lending.
"It was incestuous -- banks and rating agencies had
a mutual profit motive, and if the agency didn't go along with a bank, it
would be punished."
The Senate amendment passed on Thursday aims to
prevent that dynamic in the future, by having a government clearinghouse
that assigns issuers to rating agencies instead of allowing issuers to
choose which agencies to work with.
For investigators to portray rating agencies as
victims is "far fetched," and what needs to be fixed runs deeper than banks
fooling ratings analysts, said Daniel Alpert, a banker at Westwood Capital.
"It's a structural problem," Alpert said.
Continued in article
Also see
http://blogs.reuters.com/reuters-dealzone/
Jensen Comment
CPA auditing firms have much to worry about these investigations and pending new
regulations of credit rating agencies.
Firstly, auditing firms are at the higher end
of the tort lawyer food chain. If credit rating agencies lose class action
lawsuits by investors, the credit rating agencies themselves will sue the bank
auditors who certified highly misleading financial statements that greatly
underestimated load losses. In fact, top level analysts are now claiming that
certified Wall Street Bank financial statement were pure fiction:
"Calpers
Sues Over Ratings of Securities," by Leslie Wayne, The New York Times,
July 14, 2009 ---
http://www.nytimes.com/2009/07/15/business/15calpers.html
Secondly, the CPA profession must begin to question the ethics of allowing
lead CPA auditors to become high-level executives of clients such as when a lead
Ernst & Young audit partner jumped ship to become the CFO of Lehman Bros. and as
CFO devised the questionable Repo 105 contracts that were then audited/reviewed
by Ernst & Yound auditors. Above you read that: "In
fact, rating agencies sometimes discouraged analysts from asking too many
questions, critics have said." We must also
worry that former auditors sometimes discourage current auditors from asking too
many questions.
http://retheauditors.com/2010/03/15/liberte-egalite-fraternite-lehman-brothers-troubles-for-ernst-young-threaten-the-big-4-fraternity/
Credit rating of CDO mortgage-sliced bonds
turned into fiction writing by hired away raters!
Frank Partnoy and Lynn Turner contend that Wall Street bank accounting is an
exercise in writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
"Rating Agencies Face Crackdown," by Ben Protess, The New York
Times, May 18, 2011 ---
http://dealbook.nytimes.com/2011/05/18/rating-agencies-face-crackdown/
Securities regulators are out to tame the credit
rating agencies, crucial Wall Street players at the center of the financial
crisis.
The Securities and Exchange Commission proposed
sweeping new rules on Wednesday to overhaul the rating business —
regulations that would force tougher internal controls, potentially curb
conflicts of interest and even mandate that the agencies periodically test
the competence of their employees.
“These rules are intended to help investors and
other users of credit ratings better understand and assess the ratings,”
Mary L. Schapiro, chairwoman of the S.E.C., said at a public meeting on
Wednesday. “It is a massive proposal,” she said of the plan, which spans
more than 500 pages.
The S.E.C.’s five commissioners unanimously agreed
to advance the proposals, which are now open for public comment for 60 days.
The agency’s Republican commissioners indicated,
however, that they would push for some changes. The proposals “could be life
threatening” to small rating agencies,” Kathleen L. Casey, a Republican
commissioner, said at the public meeting.
A rating agency, for instance, would have to take
on the costs of periodically administering performance exams that would
“test its credit analysts on the credit rating procedures and methodologies
it uses,” according to a summary of the proposal.
The proposals stem from the Dodd-Frank Act, the
financial overhaul law enacted last year. The S.E.C. has already proposed
new policies under Dodd-Frank that would strip references to credit ratings
from rules that govern securities offerings.
The rating agencies in recent years became a target
in Washington, as regulators and lawmakers blamed them for feeding the
mortgage bubble by awarding top grades to bonds backed by subprime
mortgages. The investments later soured, driving the economy to the brink.
A Congressional panel that chronicled the crisis
called the largest rating agencies — Standard & Poor’s, Moody’s Investors
Service and Fitch Ratings — “essential cogs in the wheel of financial
destruction.”
The problems, critics say, stem from an inherent
conflict of interest plaguing the rating agencies’ business model.
Banks and corporations that issue debt must pay the
rating agencies to assign their bonds a letter grade. In the lead-up to the
crisis, the rating agencies had a heavy hand in the mortgage bond business,
as they advised big banks how to earn a top triple-A grade. In a quest for
profits, the critics say, the agencies compromised the integrity of their
ratings.
The S.E.C.’s proposal intends to mitigate some of
those conflicts, which have long hurt the industry’s reputation.
The plan would prohibit analysts from issuing a
rating if they also marketed their rating agency’s products or services.
Small rating agencies can apply for an exemption from this rule.
The proposal also takes aim at the revolving door
between the rating agencies and Wall Street firms that seek the grades.
Under the plan, the rating agencies would have to
examine whether their former analysts awarded overly rosy ratings to a firm
that later hired that person. In such cases, the rating agencies would have
to “promptly determine whether the credit rating must be revised.”
Ms. Casey said that this proposal “threatened to
cross the line” into dictating the substance of credit ratings. “I am
concerned.
Continued in article
"Viking Drama: Glitnir Bank Sues PwC for Malpractice and Negligence,"
The Big Four Blog, May 12, 2010 ---
http://bigfouralumni.blogspot.com/2010/05/viking-drama-glitnir-bank-sues-pwc-for.html
It’s not just volcanic ash that comes out of
Iceland.
We see today a large $2 billion lawsuit filed by
one of Iceland’s largest banks, now defunct, naming PricewaterhouseCoopers
as one of the defendants.
Glitnir Bank (we see in Wikipedia that Glitnir is
the hall of Forseti, the Norse god of law and justice, and the seat of
justice amongst gods and men), filed today a legal claim against Jon Asgeir
Johannesson and also PwC for malpractice and negligence in the Supreme Court
of the State of New York.
The suit against Jon Asgeir Johannesson, formerly
its principal 39% shareholder, Larus Welding, previously Glitnir's Chief
Executive, Thorsteinn Jonsson, its former Chairman, and other former
directors, shareholders and third parties associated with Johannesson,
alleges that these defendants fraudulently and unlawfully drained more than
$2 billion out of the Bank.
Former auditors PricewaterhouseCoopers are also
sued for “facilitating and helping to conceal the fraudulent transactions
engineered by Johannesson and his associates, which ultimately led to the
Bank's collapse in October 2008.”
The suits shows how a cabal of businessmen led by
Johannesson conspired to systematically loot Glitnir Bank in order to prop
up their own failing companies; how they seized control of Glitnir, removing
or sidelining experienced Bank employees; and then facilitated and concealed
their diversions from the Bank by overriding Glitner's financial risk
controls, and finally how the transactions cost Glitnir more than $2billion
and contributed significantly to the Bank's collapse.
There is in particular a sale of $1billion of Bonds
to investors located in New York and elsewhere in the United States in
September 2007, which is sure to get the attention of the very-aggressive US
regulators.
According to Steinunn Guobjartsdottir, chair of the
Glitnir Winding-Up Board, which conducted the investigation and is making
the legal claim, "There is evidence supporting the allegation that Glitnir
Bank was robbed from the inside."
In terms of PwC, the suit alleges, “Johannesson and
the other individual Defendants could not have succeeded in their schemes
without the complicity of PwC. PwC knew about Glitnir's irregular related
party exposures, reviewed and signed off on Glitnir financial statements
which grossly misrepresented these exposures, and facilitated Glitnir's
fraudulent fundraising in New York.”
According to Reuters, “Neither PwC nor Mr
Jóhannesson immediately responded to requests for comment.”
This is serious stuff, in that the bank’s own
senior management is being accused of fraudulent intent to bankrupt the
bank. Iceland’s banking system with its extraordinary regime of easy credit
has negatively impacted thousands of investors and depositers all over
Europe, but there are now government and non-governmental organizations
investigating what happened and pursuing financial claims.
This Nordic Drama is just getting started, and
likely other lawsuits will follow both in Europe and in the US. Auditors of
Icelandic banks are sure to get named in these suits as defendants and
parties to any misconduct.
"Worlds Apart But Two Of A Kind: Glitnir, Satyam And Their Auditor PwC,"
by Francine McKenna, re: The Auditors, May 17, 2010 ---
http://retheauditors.com/2010/05/17/worlds-apart-but-two-of-a-kind-glitnir-satyam-and-their-auditor-pwc/
Taking care of family and close friends first is
universal. Whether Irish, Italian, Kenyan, Mexican, or Tunisian… Legal,
regulatory, ethical and moral lines are often crossed in service to family
and those who are “like a brother to me…”
re: Satyam in the
New York Times January 9, 2009: “What started
as a marginal gap between actual operating profit and the one reflected
in the books of accounts continued to grow over the years. It has
attained unmanageable proportions as the size of company operations
grew,” he wrote. “It was like riding a tiger, not knowing how to get off
without being eaten.”
Mr. Raju said he had tried and failed to bridge
the gap, including an effort in December to buy two construction firms
in which the company’s founders held stakes.
The
Times of India, January 8, 2009: The country’s
fourth largest IT company—after TCS,Infosys and Wipro—was for several
years cooking its books by inflating revenues and profits,thus boosting
its cash and bank balances; showing interest income where none existed;
understating liability; and overstating debtors position (money due to
it)….[On December 16, 2008] Raju announced his ill-fated plan to
shell out $1.6 billion to acquire his sons’ companies, Maytas Properties
and Maytas Infra. It created such a furore that Raju was forced to
backtrack. It now transpires that what was seen as a move by Raju to
bail out his sons was actually a last-ditch effort to covering his
tracks through fictitious cash transfers and wriggle out of a tight
corner...There’s intense speculation as to what finally
triggered Raju’s confession of wrongdoing. It’s clearly more than
coincidence that it came hot on the heels of investment banker DSP
Merrill Lynch’s letter to the company on Tuesday evening terminating its
days-old agreement with Satyam to advise it on strategic options because
of “material accounting irregularities’’. But the beginning of the end
came when furious investors forced Raju to reverse his Maytas moves.
Contrast this scenario of cronyism run amok with
the news out of Iceland re: Glitnir:
From Kevin LaCroix’s
D&O Diary: In October 2008, in the midst of
the global financial crisis, Iceland’s Financial Services Authority took
control of Glitner. Glitner ultimately
filed a petition for bankruptcy in the U.S. under Chapter
15 of the Bankruptcy Code. According to the
May 11 complaint, creditors have filed claims exceeding $26 billion…The
May 11 complaint alleges that Jon
Asgeir Johannesson and his wife,
Ingibjorg Stefania Palmadottir , and businesses they owned or
controlled, used improper means to “wrest control” of Glitnir and to
“fraudulently drain over $2 billion out of the Bank to fill their
pockets and prop up their own failing companies.”
According to the complaint, beginning
in 2006, Johannesson “engaged in a scheme” using his “web of companies”
to take control of Glitnir in violation of Icelandic law. By April 2007,
Johannesson and his companies owned about 39% of Glitnir’s stock. As a
result, Johanneson was able to “stack” Glitnir’s board “with individuals
who had connections with companies he controlled,” and he also “had his
inexperienced hand-selected candidate” replace the existing CEO.
Having taken control of the Bank, its
board and its management, Johannesson and the other individual
defendants “used their control over the Bank and funds raised in U.S.
financial markets to issue massive ‘loans’ to, and a series of equity
transactions with, companies Johannesson controlled, in an effort to
stave off their eventual collapse,” which “placed the Bank in
extreme financial peril.
There are obvious similarities between
Satyam and Glitnir…
- Companies using loans and investments to
related entities to hide distress at main firm and funnel cash abroad.
- Glitnir sold U.S. investors $1 billion in
medium-term notes to finance their schemes. Satyam’s ADR’s were listed
on the NYSE.
- Glitnir’s CEO stacked the bank’s board of
directors with “willing accomplices” in “a sweeping conspiracy” to wrest
control of the bank.
- Satyam’s Board filled with Indian elite
industry and academic leaders who didn’t get involved in details.
- The involvement of the board,
Chaudhuri adds, was at the “strategic
level; in companies like Satyam, it is the owner/promoter/founder
who runs the show. It has to do with the ownership structure.”
- Satyam’s balance sheet included nearly $1.5
billion in non-existent cash and bank balances, accrued interest and
misstatements. It had also inflated its 2008 second quarter revenues
by$122 million, and actual operating margins were less than a tenth of
the stated $135 million.
- Per
Times of London October 25, 2009: Each of the
three big banks — Kaupthing, Landsbanki and Glitnir — loaned large sums
to their biggest shareholders on favourable terms.It has emerged that at
the time of Glitnir’s collapse, the 15 biggest creditors were all
connected to FL Group, its largest shareholder, which was controlled by
Jon Asgeir Johannesson, the boss of collapsed Icelandic retail group
Baugur.
And then there is the most telling similarity
between the two companies:
Both Satyam and Glitnir were audited by
PwC.
PwC is now named in lawsuits in New York by
shareholders and creditors of both entities.
Continued in article
"How Dangerous is the Two-Billion Dollar Suit Against PwC Over Iceland's
Glitnir Bank? The Answer is Blowin' in the Wind," by James Peterson, re:
Balance, May 12, 2010 ---
Click Here
Bob Jensen's threads on large auditing firm litigations and settlements
---
http://faculty.trinity.edu/rjensen/Fraud001.htm
After the Bailout the Banks are Still Hiding Debt and the Auditors
Acquiesce
"Major Banks Said to Cover Up Debt Levels," The New York Times via The
Wall Street Journal, April 9, 2010 ---
http://dealbook.blogs.nytimes.com/2010/04/09/major-banks-said-to-cover-debt-levels/?dlbk&emc=dlbk
Goldman Sachs,
Morgan Stanley, JPMorgan
Chase, Bank of America and
Citigroup are the big names among
18 banks revealed by data from the Federal Reserve
Bank of New York to be hiding their risk levels in
the past five quarters by lowering the amount of
leverage on the balance sheet before making it
available to the public, The Wall Street Journal
reported.
The Federal
Reserve’s data shows that, in the middle of
successive quarters, when debt levels are not in the
public domain, that banks would acknowledge debt
levels higher by an average of 42 percent, The
Journal says.
“You want your leverage to
look better at quarter-end than it actually was
during the quarter, to suggest that you’re taking
less risk,” William Tanona, a former Goldman analyst
and head of financial research in the United States
at Collins Stewart, told The
Journal.
The newspaper suggests this
practice is a symptom of the 2008 crisis in which
banks were harmed by their high levels of debt and
risk. The worry is that a bank displaying too much
risk might see its stocks and credit ratings suffer.
There is nothing illegal
about the practice, though it means that much of the
time investors can have little idea of the risks the
any bank is really taking.
Lehman/Ernst Teaching Case on the Largest Bankruptcy in History
From The Wall Street Journal Accounting Weekly Review on March 19, 2010
Examiner: Lehman Torpedoed Lehman
by: Mike
Spector, Susanne Craig, Peter Lattman
Mar 11, 2010
Click here to view the full article on WSJ.com
TOPICS: Advanced
Financial Accounting, Debt, Degree of Operating Leverage, Disclosure,
Revenue Recognition
SUMMARY: "A
federal judge released a scathing report on the collapse of Lehman Brothers
Holdings Inc. that singles out senior executives, auditor Ernst & Young and
other investment banks for serious lapses that led to the largest bankruptcy
in U.S. history...." The report focuses on the use of "repos" to improve the
appearance of Lehman's financial condition as it worsened with the market
declines beginning in 2007. "Mr Valukus, chairman of law firm Jenner &
Block, devotes more than 300 pages alone to balance sheet manipulation..."
through repo transactions. As explained more fully in the related articles,
repurchase agreements are transactions in which assets are sold under the
agreement that they will be repurchased within days. Yet, when Lehman
exchanged assets with a value greater than 105% of the cash received for
them, the company would report it as an outright sale of the asset, not a
loan, thus reducing the firms apparent leverage. These transactions were
based on a legal opinion of the propriety of this treatment made for their
European operations, but the company never received such an opinion letter
in the U.S., so Lehman transferred assets to Europe in order to execute the
trades. The second related article clarifies these issues. Of course, this
was but one significant problem; other forces helped to "tip Leham over the
brink" into bankruptcy including J.P. Morgan Chases' "demands for collateral
and modifications to agreements...that hurt Lehman's liquidity...."
CLASSROOM APPLICATION: The
questions ask students to understand repurchase agreements and cases in
which financing (borrowing) transactions might alternatively be treated as
sales. The role of the auditor, in this case Ernst & Young, also is
highlighted in the article and in the questions in this review.
QUESTIONS:
1. (Introductory)
What report was issued in March 2010 regarding Lehman Brothers? Summarize
some main points about the report.
2. (Advanced)
Based on the discussion in the main and first related articles, describe the
"repo market'. What is the business purpose of these transactions?
3. (Advanced)
How did Lehman Brothers use repo transactions to improve its balance sheet?
Note: be sure to refer to the related articles as some points in the main
article emphasize the impact of removing the assets that are subject to the
repo agreements from the balance sheet. The main point of your discussion
should focus on what else might have been credited in the entries to record
these transactions.
4. (Introductory)
Refer to the second related article. What was the role of Lehman's auditor
in assessing the repo transactions? What questions have been asked of this
firm and how has E&Y responded?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Lehman Maneuver Raises Accounting Question.
by David Reilly
Mar 13, 2010
Online Exclusive
"Examiner: Lehman Torpedoed Lehman," by: Mike Spector, Susanne Craig, Peter
Lattman, The Wall Street Journal, Mar 11, 2010 ---
http://online.wsj.com/article/SB10001424052748703625304575115963009594440.html?mod=djem_jiewr_AC_domainid
A scathing report by a U.S. bankruptcy-court
examiner investigating the collapse of Lehman Brothers Holdings Inc. blames
senior executives and auditor Ernst & Young for serious lapses that led to
the largest bankruptcy in U.S. history and the worst financial crisis since
the Great Depression.
In the works for more than a year, and costing more
than $30 million, the report by court-appointed examiner Anton Valukas
paints the most complete picture yet of the free-wheeling culture inside the
158 year-old firm, whose chief executive Richard S. Fuld Jr. prided himself
on his ability to manage market risk.
The document runs thousands of pages and contains
fresh allegations. In particular, it alleges that Lehman executives
manipulated its balance sheet, withheld information from the board, and
inflated the value of toxic real estate assets.
Lehman chose to "disregard or overrule the firm's
risk controls on a regular basis,'' even as the credit and real-estate
markets were showing signs of strain, the report said.
In one instance from May 2008, a Lehman senior vice
president alerted management to potential accounting irregularities, a
warning the report says was ignored by Lehman auditors Ernst & Young and
never raised with the firm's board.
The allegations of accounting manipulation and
risk-control abuses potentially could influence pending criminal and civil
investigations into Lehman and its executives. The Manhattan and Brooklyn
U.S. attorney's offices are investigating, among other things, whether
former Lehman executives misled investors about the firm's financial picture
before it filed for bankruptcy protection, and whether Lehman improperly
valued its real-estate assets, people familiar with the matter have said.
The examiner said in the report that throughout the
investigation it conducted regular weekly calls with the Securities and
Exchange Commission and Department of Justice. There have been no
prosecutions of Lehman executives to date.
Several factors helped to tip Lehman over the brink
in its final days, Mr. Valukas wrote. Investment banks, including J.P.
Morgan Chase & Co., made demands for collateral and modified agreements with
Lehman that hurt Lehman's liquidity and pushed it into bankruptcy.
Lehman's own global financial controller, Martin
Kelly, told the examiner that "the only purpose or motive for the
transactions was reduction in balance sheet" and "there was no substance to
the transactions." Mr. Kelly said he warned former Lehman finance chiefs
Erin Callan and Ian Lowitt about the maneuver, saying the transactions posed
"reputational risk" to Lehman if their use became publicly known.
In an interview with the examiner, senior Lehman
Chief Operating Officer Bart McDade said he had detailed discussions with
Mr. Fuld about the transactions and that Mr. Fuld knew about the accounting
treatment.
In an April 2008 email, Mr. McDade called such
accounting maneuvers "another drug we r on." Mr. McDade, then Lehman's
equities chief, says he sought to limit such maneuvers, according to the
report. Mr. McDade couldn't be reached to comment.
In a November 2009 interview with the examiner, Mr.
Fuld said he had no recollection of Lehman's use of Repo 105 transactions
but that if he had known about them he would have been concerned, according
to the report.
Mr. Valukas's report is among the largest
undertaking of its kind. Those singled out in the report won't face
immediate repercussions. Rather, the report provides a type of road map for
Lehman's bankruptcy estate, creditors and other authorities to pursue
possible actions against former Lehman executives, the bank's auditors and
others involved in the financial titan's collapse.
One party singled out in the report is Lehman's
audit firm, Ernst & Young, which allegedly didn't raise concerns with
Lehman's board about the frequent use of the repo transactions. E&Y met with
Lehman's Board Audit Committee on June 13, one day after Lehman senior vice
president Matthew Lee raised questions about the frequent use of the
transactions.
"Ernst & Young took no steps to question or
challenge the nondisclosure by Lehman of its use of $50 billion of
temporary, off-balance sheet transactions," Mr. Valukas wrote.
In a statement, Mr. Fuld's lawyer, Patricia Hynes,
said, "Mr. Fuld did not know what those transactions were—he didn't
structure or negotiate them, nor was he aware of their accounting
treatment."
An Ernst & Young statement Thursday said Lehman's
collapse was caused by "a series of unprecedented adverse events in the
financial markets." It said Lehman's leverage ratios "were the
responsibility of management, not the auditor."
Ms. Callan didn't respond to a request for comment.
An attorney for Mr. Lowitt said any suggestion he breached his duties was
"baseless." Mr. Kelly couldn't be reached Thursday evening.
As Lehman began to unravel in mid-2008, investors
began to focus their attention on the billions of dollars in commercial real
estate and private-equity loans on Lehman's books.
The report said that while Lehman was required to
report its inventory "at fair value," a price it would receive if the asset
were hypothetically sold, Lehman "progressively relied on its judgment to
determine the fair value of such assets."
Between December 2006 and December 2007, Lehman
tripled its firmwide risk appetite.
But its risk exposure was even larger, according to
the report, considering that Lehman omitted "some of its largest risks from
its risk usage calculations" including the $2.3 billion bridge equity loan
it provided for Tishman Speyer's $22.2 billion take over of apartment
company Archstone Smith Trust. The late 2007 deal, which occurred as the
commercial-property market was cresting, led to big losses for Lehman.
Lehman eventually added the Archstone loan to its
risk usage profile. But rather than reducing its balance sheet to compensate
for the additional risk, it simply raised its risk limit again, the report
said.
Where Were the Auditors? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"PwC's
Administration of Lehman Translates to $24,000 Per Hour!" Big Four Blog,
April 16, 2010 ---
http://www.bigfouralumni.blogspot.com/
Bob
Jensen's threads on the Lehman-Ernst Controversies ---
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
Bob Jensen's threads on off-balance-sheet financing (OBSF) ---
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
Auditing the Lepricons That Learned from Lehman ---
http://wiki.answers.com/Q/What_do_lepricons_have_to_do_with_Ireland
"Not To Be Twistin’ Hay… Auditors Mucking It Up In Ireland," by
Francine McKenna, re: theAuditors, May 4, 2010 ---
http://retheauditors.com/2010/05/04/not-to-be-twistin-hay-auditors-mucking-it-up-in-ireland/
Round trip loans. Director-approved balance sheet
manipulation. Window-dressing of accounts at period-end.
“The regulator said auditing firms needed
to pay “particular attention” to guidance that it had previously issued
on monitoring transactions taking place around year-end, as well as the
procedures expected to be followed by auditors…These standards and
guidance notes require auditors to scrutinize “material” short-term
deposits that are re-lent on broadly similar terms, and loan repayments
that are received shortly before year-end and then subsequently
re-advanced within a short timeframe.
The guidance notes emphasized that the
auditors needed experience and judgment to identify the implications of
such transactions, and assess whether they constituted attempts to
engage in the so-called “window-dressing” of accounts.”
The Sunday Business Post, March 1, 2009
If that sounds like
Lehman Brothers, it’s because the kinds of tricks
and techniques used in that case, such as Repo 105, are neither new nor
unique.
The
PCAOB, the US regulator of public accounting
firms, tried to remind the firms at the end of December 2008 of their
responsibilities in the “current economic environment.”
In an audit of internal control over
financial reporting, the auditor also should evaluate whether the
company’s controls sufficiently address the identified risks of material
misstatement due to fraud and controls intended to address the risk of
management override of controls. Controls that might address these risks
include:
- Controls over significant, unusual
transactions, particularly those that result in late or unusual
journal entries;
- Controls over journal entries and
adjustments made in the period-end financial reporting process;
- Controls over related party
transactions;
- Controls related to significant
management estimates; and
- Controls that mitigate incentives for,
and pressures on, management to falsify or inappropriately manage
financial results.
Repurchase
agreements recorded as loans are legal “round trip” financing tools, often
used to both improve liquidity as well as shuffle assets and liabilities at
period end to suit management’s objectives.
When disguised as “sales” without proper disclosure
and splashed like mud over and over in the face of a
skeptical attorney like
Anton Valukas,
Repo 105 transactions they gain high-class
call-girl-type notoriety that’s undeserved given their common whore
characteristics.
A round-trip loan was used by
Refco executives to hide uncollectible
receivables. Three of their executives, as well as an outside counsel, went
to jail for that fraud.
In 2005, Time-Warner paid a $300 million penalty,
agreed to an anti-fraud injunction and an order to comply with prior
cease-and-desist order and agreed to restate its financial results and
engage independent examiner. Their CFO, Controller and Deputy Controller
also consented to a cease-and-desist order.
From the
SEC
press release:
“Beginning in mid-2000, stock prices of
Internet-related businesses declined precipitously as, among other
things, sales of online advertising declined and the rate of growth of
new online subscriptions started to flatten. Beginning at this time, and
extending through 2002, the company employed fraudulent
round-trip transactions that boosted its online advertising revenue to
mask the fact that it also experienced a business slow-down. The
round-trip transactions ranged in complexity and sophistication, but in
each instance the company effectively funded its own online advertising
revenue by giving the counterparties the means to pay for advertising
that they would not otherwise have purchased. To
conceal the true nature of the transactions, the company typically
structured and documented round-trips as if they were two or more
separate, bona fide transactions, conducted at arm’s length and
reflecting each party’s independent business purpose…”
Time Warner Inc. and its auditor reached a $2.5 billion settlement
of the resulting securities fraud litigation. Time
Warner paid $2.4 billion, while its auditor, Ernst & Young, paid
$100 million.
Continued in article
Bob Jensen's threads on the Lehman-Ernst controversies area at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst
Where were the auditors before the banks failed?
http://faculty.trinity.edu/rjensen/2008bailout.htm#AuditFirms
"Demystify the Lehman Shell Game," by Floyd Norris, The New York
Times, April 1, 2010 ---
http://www.nytimes.com/2010/04/02/business/02norris.html
Making unattractive assets disappear from corporate balance sheets was one
of the great magical tricks performed by accountants over the last few
decades.
Whoosh went assets into off-balance-sheet vehicles that seemed to be owned
by no one. Zip went assets into securitizations that turned mortgage loans
for poor credit risks into complicated pieces of paper that somehow earned
AAA ratings.
As impressive as those accomplishments were, they did not make the assets
vanish altogether. If you dug deep enough, you could find the structured
investment vehicle or the underlying assets of that strange securitization.
Now there is another possibility in the world of accounting magic. Did
accountants find a way to make some assets disappear altogether? Was it
possible for everybody with an interest in them to disclaim ownership?
Until recently, it never would have occurred to me
that companies would want to do that — particularly if the assets in
question were perfectly respectable ones. But now that we have learned Lehman
Brothers did
it, the question arises of how far the practice went.
Lehman’s reasons for doing it were simple: to mislead investors into
thinking the company was not overleveraged. Were other firms doing that? Are
they still? Lehman thought not, but no one really knows.
Now the Securities
and Exchange Commission is
demanding that other firms disclose whether they did the same. If it finds
they did, the commission ought to go further and examine whether there were
conspiracies to make the assets vanish, thus making Wall Street appear to be
less leveraged than it was.
Lehman’s practices, outlined in a bankruptcy
examiner’s report released
last month, showed the creative use of accounting for repos.
Don’t let your eyes glaze over. I’ll try to keep it simple.
A repo is simply a “sale” of a financial asset to
someone else, with an agreement to repurchase it at a fixed price and date.
That amounts to borrowing secured by the asset, often a Treasury bond,
with the added security that the lender has the bond, and so can sell it
quickly if need be.
Normally, such transactions are accounted for as loans, as they should be.
They are often the cheapest way for a brokerage firm to borrow money.
I had taken for granted that repos were always
accounted for as loans, but it turns out there was a loophole. The Financial
Accounting Standards Board had
accepted that under some conditions a repo could be treated as a sale. One
condition: if the securities securing the transaction were worth
significantly more than the loan, that could be a sale.
In the examples the board provided, it concluded that securing the loan with
assets worth 102 percent of the amount borrowed did not produce a sale, but
that 110 percent would push the deal over the line. In between was a gray
area.
Lehman appears to have concluded that 105 percent was enough if the assets
being borrowed against were bonds. If they were equities, it set the bar at
108 percent.
By doing such sales repos at the end of each quarter, and reversing them a
few days later, the firm could seem to have less debt than it really did.
It started the practice in 2001 but really accelerated it in 2007 and early
2008, when investors belatedly discovered there were risks to high leverage
ratios. At the end of 2007, the bankruptcy examiner concluded, Lehman’s real
leverage ratio was 17.8 — meaning it had $17.80 in assets for every dollar
of equity. It reported a ratio of 16.1.
By the end of June 2008 — Lehman’s last public balance sheet — it was hiding
$50 billion of debt that way, enabling it to appear to be reducing its
leverage far more than it was. When investors asked how it was doing that,
Lehman officials chose not to explain what was actually happening.
Lehman’s collapse is history, but after it was allowed to collapse other
firms were rescued. We don’t know whether those firms used the same tricks,
although we do know that Lehman thought they were not doing so.
The questions sent
to financial companies by the S.E.C. this week should provide answers to
that question. Companies that classified repos as sales are going to have to
provide specifics and explain exactly why the accounting was justified. The
reports will go back three years, so we can see history as well as current
practices.
It would be nice if the commission found that other firms did not choose to
hide borrowing this way.
But if that is not what is found, then the commission should dig deeper into
actual transactions. It should find out how the firm on the other side of
each repo accounted for it.
There are at least two abuses that might have happened.
The first would stem from differing reporting periods. One firm could hide
debt with another when its quarter ended. Then, when the other firm’s
quarter ended, that firm could hide debt with the first firm.
The second method would reflect the fact that two companies involved in a
transaction do not have to use the same accounting. Lehman could treat the
repo as a sale, but the other firm could call it a financing. Presto: Nobody
reports owning the assets in question.
That could even be legal. The second firm could conclude that an
asset-to-loan ratio of 105 percent was not high enough to qualify for sales
treatment, while the first firm thought 105 percent was high enough.
But legal or not, it would be misleading.
Wall Street leverage remains an important issue. The S.E.C. should discover
if it was, or is, being concealed, and then get to the bottom of how that
was done.
Floyd Norris comments on finance and economics in his blog at
nytimes.com/norris.
The Financial Accounting Standards Board moved last
year to close the loophole that Lehman is accused of using, Bushee says. A new
rule, FAS 166, replaces the 98%-102% test with one designed to get at the intent
behind a repurchase agreement. The new rule, just taking effect now, looks at
whether a transaction truly involves a transfer of risk and reward. If it does
not, the agreement is deemed a loan and the assets stay on the borrower's
balance sheet.
"Lehman's Demise and Repo 105: No Accounting for Deception,"
Knowledge@Wharton, March 31, 2010 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2464
Bob Jensen's threads on the Lehman-Ernst controversies are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
"Lehman Channeled Risks Through ‘Alter Ego’ Firm," by Louise Story and
Eric Dash, The New York Times, April 12, 2010 ---
http://www.nytimes.com/2010/04/13/business/13lehman.html?th&emc=th
It was like a hidden passage on Wall Street, a
secret channel that enabled billions of dollars to flow through Lehman
Brothers.
In the years before its collapse, Lehman used a
small company — its “alter ego,” in the words of a former Lehman trader — to
shift investments off its books.
The firm, called Hudson Castle, played a crucial,
behind-the-scenes role at Lehman, according to an internal Lehman document
and interviews with former employees. The relationship raises new questions
about the extent to which Lehman obscured its financial condition before it
plunged into bankruptcy.
While Hudson Castle appeared to be an independent
business, it was deeply entwined with Lehman. For years, its board was
controlled by Lehman, which owned a quarter of the firm. It was also stocked
with former Lehman employees.
None of this was disclosed by Lehman, however.
Entities like Hudson Castle are part of a vast
financial system that operates in the shadows of Wall Street, largely beyond
the reach of banking regulators. These entities enable banks to exchange
investments for cash to finance their operations and, at times, make their
finances look stronger than they are.
Critics say that such deals helped Lehman and other
banks temporarily transfer their exposure to the risky investments tied to
subprime mortgages and commercial real estate. Even now, a year and a half
after Lehman’s collapse, major banks still undertake such transactions with
businesses whose names, like Hudson Castle’s, are rarely mentioned outside
of footnotes in financial statements, if at all.
The Securities and Exchange Commission is examining
various creative borrowing tactics used by some 20 financial companies. A
Congressional panel investigating the financial crisis also plans to examine
such deals at a hearing in May to focus on Lehman and Bear Stearns,
according to two people knowledgeable about the panel’s plans.
Most of these deals are legal. But certain Lehman
transactions crossed the line, according to the account of the bank’s demise
prepared by an examiner of the bank. Hudson Castle was not mentioned in that
report, released last month, which concluded that some of Lehman’s
bookkeeping was “materially misleading.” The report did not say that Hudson
was involved in the misleading accounting.
At several points, Lehman did transactions greater
than $1 billion with Hudson vehicles, but it is unclear how much money was
involved since 2001.
Still, accounting experts say the shadow financial
system needs some sunlight.
“How can anyone — regulators, investors or anyone —
understand what’s in these financial statements if they have to dig 15
layers deep to find these kinds of interlocking relationships and these
kinds of transactions?” said Francine McKenna, an accounting consultant who
has examined the financial crisis on her blog, re: The Auditors.
“Everybody’s talking about preventing the next crisis, but they can’t
prevent the next crisis if they don’t understand all these incestuous
relationships.”
The story of Lehman and Hudson Castle begins in
2001, when the housing bubble was just starting to inflate. That year,
Lehman spent $7 million to buy into a small financial company, IBEX Capital
Markets, which later became Hudson Castle.
From the start, Hudson Castle lived in Lehman’s
shadow. According to a 2001 memorandum given to The New York Times, as well
as interviews with seven former employees at Lehman and Hudson Castle,
Lehman exerted an unusual level of control over the firm. Lehman, the
memorandum said, would serve “as the internal and external ‘gatekeeper’ for
all business activities conducted by the firm.”
The deal was proposed by Kyle Miller, who worked at
Lehman. In the memorandum, Mr. Miller wrote that Lehman’s investment in
Hudson Castle would give the bank and its clients access to financing while
preventing “headline risk” if any of its deals went south. It would also
reduce Lehman’s “moral obligation” to support its off-balance sheet
vehicles, he wrote. The arrangement would maximize Lehman’s control over
Hudson Castle “without jeopardizing the off-balance sheet accounting
treatment.”
Mr. Miller became president of Hudson Castle and
brought several Lehman employees with him. Through a Hudson Castle
spokesman, Mr. Miller declined a request for an interview.
The spokesman did not dispute the 2001 memorandum
but said the relationship with Lehman had evolved. After 2004, “all funding
decisions at Hudson Castle were solely made by the management team and
neither the board of directors nor Lehman Brothers participated in or
influenced those decisions in any way,” he said, adding that Lehman was only
a tenth of Hudson’s revenue.
Still, Lehman never told its shareholders about the
arrangement. Nor did Moody’s choose to mention it in its credit ratings
reports on Hudson Castle’s vehicles. Former Lehman workers, who spoke on the
condition that they not be named because of confidentiality agreements with
the bank, offered conflicting accounts of the bank’s relationship with
Hudson Castle.
One said Lehman bought into Hudson Castle to
compete with the big commercial banks like Citigroup, which had a greater
ability to lend to corporate clients. “There were no bad intentions around
any of this stuff,” this person said.
But another former employee said he was leery of
the arrangement from the start. “Lehman wanted to have a company it
controlled, but to the outside world be able to act like it was arm’s
length,” this person said.
Typically, companies are required to disclose only
material investments or purchases of public companies. Hudson Castle was
neither.
Nonetheless, Hudson Castle was central to some
Lehman deals up until the bank collapsed.
“This should have been disclosed, given how
critical this relationship was,” said Elizabeth Nowicki, a professor at
Boston University and a former lawyer at the S.E.C. “Part of the problems
with all these bank failures is there were a lot of secondary actors — there
were lawyers, accountants, and here you have a secondary company that was
helping conceal the true state of Lehman.”
Continued in article
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on the Lehman-Ernst scandal are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
"Accounting firms facing rise in negligence claims amid credit crunch
fallout," by Alex Spence, London Times, March 29, 2010 ---
http://business.timesonline.co.uk/tol/business/law/article7079418.ece
Leading accounting firms are facing more
professional negligence claims as they are targeted by investors who lost
money in the credit crunch.
There were 13 negligence cases against accountants
in the High Court last year, according to research by Reynolds Porter
Chamberlain, the City law firm, compared with four claims in the previous
five years.
Although the number of claims last year was far
lower than the 61 that reached the High Court in the wake of the dot-com
collapse — when auditors were criticised for their their role in corporate
scandals such as those involving Enron and WorldCom — lawyers predict that
this is the beginning of a wave of cases that will emerge from the financial
crisis.
“The sudden jump in professional negligence claims
suggests that cases relating to the credit crunch have started to reach the
courts,” Jane Howard, a partner of Reynolds Porter Chamberlain, said.
The big accounting firms are often regarded by
investors as their best hope of recovering losses in the aftermath of a
company failure, because they are perceived as having deep pockets and
remain standing while other parties may have disappeared or been declared
insolvent.
In 2005 Ernst & Young was sued for £700 million by
Equitable Life, its former audit client, after the insurance company almost
collapsed. The claim was dropped but could have bankrupted the accountant’s
UK division if it had succeeded.
Further cases relating to the financial crisis have
been filed against the big accounting firms in other countries. KPMG was
sued for $1 billion by creditors of New Century, a failed American sub-prime
lender, and PricewaterhouseCoopers has faced questions over its audit of
Satyam, the Indian outsourcing company that was hit by an accounting fraud.
Several firms are facing lawsuits relating to their auditing of the feeder
funds that channelled investors into Bernard Madoff’s Ponzi scheme.
Ms Howard said that claims in the British courts
would be likely to centre on allegations that accountants had failed to spot
a fraud while auditing a company’s accounts or that they had overvalued a
company’s assets.
The accountants’ tax practices may also face
accusations of negligently mis-selling schemes intended to mitigate or defer
income or capital gains tax, or of giving bad advice to clients about the
risk of a successful challenge by the taxman.
The role of auditors in the financial crisis had
received relatively little scrutiny until this month when Ernst & Young, one
of the “big four”, was cast into the spotlight for its auditing of Lehman
Brothers, the collapsed investment bank.
A strongly critical 2,200-page report by Anton
Valukas, an examiner appointed by a federal bankruptcy court in New York,
criticised Ernst & Young’s advice to Lehman as failing to measure up to
professional standards. The firm, which has defended its work, could now
face legal action by the bank’s creditors, although lawyers said that this
was likely to take place in the United States rather than in the UK.
It is more difficult for investors to sue
accountants successfully for negligence in Britain than in the United
States, lawyers said, because the legal threshold for proving liability is
higher.
“We’ve seen a lot of threats of credit
crunch-related claims against accountants that are highly speculative and
often fall by the wayside at the pre-action stage when firmly rebutted,” Ms
Howard said.
Last year, in the most recent big negligence case
against a City accountant, Britain’s law lords threw out a
multimillion-pound claim against Moore Stephens, which had been accused of
failing to uncover a £58 million fraud at Stone & Rolls, a commodity trader
that it had audited from 1997 to 2001.
The case centred on whether Moore Stephens should
have known that Stone & Rolls was allegedly being used by its managing
director as a vehicle for defrauding banks through a letter-of-credit scam.
The law lords dismissed the claim on the ground
that the company’s liquidators could not pursue the auditors for losses
suffered as a result of the company’s own behaviour. However, the judges’
split decision provided less clarity about auditors’ liability for fraud
than the industry had hoped for.
Although negligence cases can be difficult to win,
accounting firms are worried about the threat of legal action. They can be
held liable for the full amount of losses in the event that a business that
they audit collapses, even if they were only partly to blame.
The accountants fear that a big lawsuit, such as
that faced by Ernst & Young over Equitable Life, could put one of them out
of business.
Led by the big four, the profession has lobbied the
Government to encourage companies to cap their auditors’ liability. So far
their efforts have failed.
The Financial Accounting Standards Board moved last
year to close the loophole that Lehman is accused of using, Bushee says. A new
rule, FAS 166, replaces the 98%-102% test with one designed to get at the intent
behind a repurchase agreement. The new rule, just taking effect now, looks at
whether a transaction truly involves a transfer of risk and reward. If it does
not, the agreement is deemed a loan and the assets stay on the borrower's
balance sheet.
Best Explanation to Date:
"Lehman's Demise and Repo 105: No Accounting for Deception,"
Knowledge@Wharton, March 31, 2010 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2464
The collapse of Lehman Brothers in September 2008
is widely seen as the trigger for the financial crisis, spreading panic that
brought lending to a halt. Now a 2,200-page report says that prior to the
collapse -- the largest bankruptcy in U.S. history -- the investment bank's
executives went to extraordinary lengths to conceal the risks they had
taken. A new term describing how Lehman converted securities and other
assets into cash has entered the financial vocabulary: "Repo 105."
While Lehman's huge indebtedness and other mistakes
have been well documented, the $30 million study by Anton Valukas, assigned
by the bankruptcy court, contains a number of surprises and new insights,
several Wharton faculty members say.
Among the report's most disturbing revelations,
according to Wharton finance professor
Richard J. Herring, is the picture of Lehman's
accountants at Ernst & Young. "Their main role was to help the firm
misrepresent its actual position to the public," Herring says, noting that
reforms after the Enron collapse of 2001 have apparently failed to make
accountants the watchdogs they should be.
"It was clearly a dodge.... to circumvent the
rules, to try to move things off the balance sheet," says Wharton accounting
professor professor
Brian J. Bushee,
referring to Lehman's Repo 105 transactions. "Usually, in these kinds of
situations I try to find some silver lining for the company, to say that
there are some legitimate reasons to do this.... But it clearly was to get
assets off the balance sheet."
The use of outside entities to remove risks from a
company's books is common and can be perfectly legal. And, as Wharton
finance professor
Jeremy J. Siegel points out, "window dressing" to
make the books look better for a quarterly or annual report is a widespread
practice that also can be perfectly legal. Companies, for example, often
rush to lay off workers or get rid of poor-performing units or investments,
so they won't mar the next financial report. "That's been going on for 50
years," Siegel says. Bushee notes, however, that Lehman's maneuvers were
more extreme than any he has seen since the Enron collapse.
Wharton finance professor professor
Franklin Allen suggests that the other firms
participating in Lehman's Repo 105 transactions must have known the whole
purpose was to deceive. "I thought Repo 105 was absolutely remarkable – that
Ernst & Young signed off on that. All of this was simply an artifice, to
deceive people." According to Siegel, the report confirms earlier evidence
that Lehman's chief problem was excessive borrowing, or over-leverage. He
argues that it strengthens the case for tougher restrictions on borrowing.
A Twist on a Standard Financing Method
In his report, Valukas, chairman of the law firm
Jenner & Block, says that Lehman disregarded its own risk controls "on a
regular basis," even as troubles in the real estate and credit markets put
the firm in an increasingly perilous situation. The report slams Ernst &
Young for failing to alert the board of directors, despite a warning of
accounting irregularities from a Lehman vice president. The auditing firm
has denied doing anything wrong, blaming Lehman's problems on market
conditions.
Much of Lehman's problem involved huge holdings of
securities based on subprime mortgages and other risky debt. As the market
for these securities deteriorated in 2008, Lehman began to suffer huge
losses and a plunging stock price. Ratings firms downgraded many of its
holdings, and other firms like JPMorgan Chase and Citigroup demanded more
collateral on loans, making it harder for Lehman to borrow. The firm filed
for bankruptcy on September 15, 2008.
Prior to the bankruptcy, Lehman worked hard to make
its financial condition look better than it was, the Valukas report says. A
key step was to move $50 billion of assets off its books to conceal its
heavy borrowing, or leverage. The Repo 105 maneuver used to accomplish that
was a twist on a standard financing method known as a repurchase agreement.
Lehman first used Repo 105 in 2001 and became dependent on it in the months
before the bankruptcy.
Repos, as they are called, are used to convert
securities and other assets into cash needed for a firm's various
activities, such as trading. "There are a number of different kinds, but the
basic idea is you sell the security to somebody and they give you cash, and
then you agree to repurchase it the next day at a fixed price," Allen says.
In a standard repo transaction, a firm like Lehman
sells assets to another firm, agreeing to buy them back at a slightly higher
price after a short period, sometimes just overnight. Essentially, this is a
short-term loan using the assets as collateral. Because the term is so
brief, there is little risk the collateral will lose value. The lender – the
firm purchasing the assets – therefore demands a very low interest rate.
With a sequence of repo transactions, a firm can borrow more cheaply than it
could with one long-term agreement that would put the lender at greater
risk.
Under standard accounting rules, ordinary repo
transactions are considered loans, and the assets remain on the firm's
books, Bushee says. But Lehman found a way around the negotiations so it
could count the transaction as a sale that removed the assets from its
books, often just before the end of the quarterly financial reporting
period, according to the Valukas report. The move temporarily made the
firm's debt levels appear lower than they really were. About $39 billion was
removed from the balance sheet at the end of the fourth quarter of 2007, $49
billion at the end of the first quarter of 2008 and $50 billion at the end
of the next quarter, according to the report.
Bushee says Repo 105 has its roots in a rule called
FAS 140, approved by the Financial Accounting Standards Board in 2000. It
modified earlier rules that allow companies to "securitize" debts such as
mortgages, bundling them into packages and selling bond-like shares to
investors. "This is the rule that basically created the securitization
industry," he notes.
FAS 140 allowed the pooled securities to be moved
off the issuing firm's balance sheet, protecting investors who bought the
securities in case the issuer ran into trouble later. The issuer's
creditors, for example, cannot go after these securities if the issuer goes
bankrupt, he says.
Because repurchase agreements were really loans,
not sales, they did not fit the rule's intent, Bushee states. So the rule
contained a provision saying the assets involved would remain on the firm's
books so long as the firm agreed to buy them back for a price between 98%
and 102% of what it had received for them. If the repurchase price fell
outside that narrow band, the transaction would be counted as a sale, not a
loan, and the securities would not be reported on the firm's balance sheet
until they were bought back.
This provided the opening for Lehman. By agreeing
to buy the assets back for 105% of their sales price, the firm could book
them as a sale and remove them from the books. But the move was misleading,
as Lehman also entered into a forward contract giving it the right to buy
the assets back, Bushee says. The forward contract would be on Lehman's
books, but at a value near zero. "It's very similar to what Enron did with
their transactions. It's called 'round-tripping.'" Enron, the huge Houston
energy company, went bankrupt in 2001 in one of the best-known examples of
accounting deception.
Lehman's use of Repo 105 was clearly intended to
deceive, the Vakulas report concludes. One executive email cited in the
report described the program as just "window dressing." But the company,
which had international operations, managed to get a legal opinion from a
British law firm saying the technique was legal.
Bamboozled
The Financial Accounting Standards Board moved last
year to close the loophole that Lehman is accused of using, Bushee says. A
new rule, FAS 166, replaces the 98%-102% test with one designed to get at
the intent behind a repurchase agreement. The new rule, just taking effect
now, looks at whether a transaction truly involves a transfer of risk and
reward. If it does not, the agreement is deemed a loan and the assets stay
on the borrower's balance sheet.
The Vakulas report has led some experts to renew
calls for reforms in accounting firms, a topic that has not been
front-and-center in recent debates over financial regulation. Herring argues
that as long as accounting firms are paid by the companies they audit, there
will be an incentive to dress up the client's appearance. "There is really a
structural problem in the attitude of accountants." He says it may be
worthwhile to consider a solution, proposed by some of the industry's
critics, to tax firms to pay for auditing and have the Securities and
Exchange Commission assign the work and pay for it.
The Valukas report also shows the need for better
risk-management assessments by firm's boards of directors, Herring says.
"Every time they reached a line, there should have been a risk-management
committee on the board that at least knew about it." Lehman's ability to get
a favorable legal opinion in England when it could not in the U.S.
underscores the need for a "consistent set" of international accounting
rules, he adds.
Siegel argues that the report also confirms that
credit-rating agencies like Moody's and Standard & Poor's must bear a large
share of the blame for troubles at Lehman and other firms. By granting
triple-A ratings to risky securities backed by mortgages and other assets,
the ratings agencies made it easy for the firms to satisfy government
capital requirements, he says. In effect, the raters enabled the excessive
leverage that proved a disaster when those securities' prices fell to
pennies on the dollar. Regulators "were being bamboozled, counting as safe
capital investments that were nowhere near safe."
Some financial industry critics argue that big
firms like Lehman be broken up to eliminate the problem of companies being
deemed "too big to fail." But Siegel believes stricter capital requirements
are a better solution, because capping the size of U.S. firms would cripple
their ability to compete with mega-firms overseas.
While the report sheds light on Lehman's inner
workings as the crisis brewed, it has not settled the debate over whether
the government was right to let Lehman go under. Many experts believe
bankruptcy is the appropriate outcome for firms that take on too much risk.
But in this case, many feel Lehman was so big that its collapse threw
markets into turmoil, making the crisis worse than it would have been if the
government had propped Lehman up, as it did with a number of other firms.
Allen says regulators made the right call in
letting Lehman fail, given what they knew at the time. But with hindsight
he's not so sure it was the best decision. "I don't think anybody
anticipated that it would cause this tremendous stress in the financial
system, which then caused this tremendous recession in the world economy."
Allen, Siegel and Herring say regulators need a
better system for an orderly dismantling of big financial firms that run
into trouble, much as the Federal Deposit Insurance Corp. does with ordinary
banks. The financial reform bill introduced in the Senate by Democrat
Christopher J. Dodd provides for that. "I think the Dodd bill has a
resolution mechanism that would allow the firm to go bust without causing
the kind of disruption that we had," Allen says. "So, hopefully, next time
it can be done better. But whether anyone will have the courage to do that,
I'm not sure."
Bob Jensen's theads on the Lehman/Ernst controversies are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
Far from going unnoticed, Lehman's Repo 105
transactions are destined to take a prominent place in the annals of accounting
scandals — somewhere between Enron's infamous special-purpose entities and AIG's
booby-trapped credit default swaps.
"SEC to CFOs: More Repo Disclosure: In its latest "Dear CFO" letter,
the SEC is seeking more information on why some repurchase agreements are being
booked as sales" by Marie Leone, CFO.com, March 31, 2010 ---
http://www.cfo.com/article.cfm/14487561/c_14487542?f=home_todayinfinance
The Securities and Exchange Commission is asking
public-company CFOs for additional information about repurchase agreements,
or repos, the transactions that Lehman Brothers used to make its balance
sheet look healthier before the investment bank collapsed into bankruptcy.
The SEC wants companies to help the regulator
"better understand" the accounting treatment used to record repos, and to
provide details about how management determines whether to record repos as a
sale or a collateralized financing. The commission would like to know, for
example, how many repos qualified for sales accounting treatment each
quarter for the past three years, whether those sales were concentrated with
certain counterparties or countries, the business reason for structuring
such transactions as sales, and whether a company has changed its original
accounting treatment for any of the repos.
Issued in March in the form of a "Dear CFO" letter,
the SEC's request for additional information seems "granular and broad at
the same time," says Wallace Enman, a vice president and senior accounting
analyst with Moody's Investor Services. He says that if companies were to
use the letter as a guide, they would create "relatively robust" disclosures
about repos. A sample letter was posted on the SEC's Website on Monday.
While SEC comment letters are usually directed at a
single company, Dear CFO letters cover issues that affect a large swath of
companies. But the repo letter "is not a typical Dear CFO letter where we
provide companies with our views on accounting and disclosure matters they
should consider," says SEC spokesman John Nester. "In this case, we are
seeking very specific information from companies about repurchase agreements
and similar transactions."
Nester says that based on company responses, the
SEC could ask issuers to amend their filings or modify disclosures in future
filings. But so far the commission has not concluded that any company has
failed to comply with generally accepted accounting principles, violated any
SEC rules, or failed to provide appropriate disclosures.
This isn't the first time the SEC has questioned
companies about the way they apply asset-transfer accounting rules. Since
2004, the SEC has exchanged 171 comment letters with 93 different companies
about whether agreements to transfer financial assets are treated as a sale
or a temporary transaction under U.S. GAAP, according to research firm Audit
Analytics.
For his part, Enman says the questions are the
SEC's way of making sure that Lehman's so-called Repo 105 technique doesn't
go unnoticed. Indeed, in an interview with CNBC this week, SEC Chairman Mary
Schapiro said the commission is looking at all the issues surrounding Repo
105, both at Lehman and other financial institutions. "We want to make sure
their accounting and disclosures are accurate when it comes to
characterizing repurchases," said Schapiro.
One for the Books
Far from going unnoticed, Lehman's Repo 105
transactions are destined to take a prominent place in the annals of
accounting scandals — somewhere between Enron's infamous special-purpose
entities and AIG's booby-trapped credit default swaps.
Earlier this month, Anton Valukas, the
court-appointed examiner in the Lehman bankruptcy case, released a
2,200-page report on the collapse of the investment bank, devoting more than
300 pages to Repo 105. While the report did not find that Lehman violated
asset-transfer accounting rules, it said that the investment bank was not as
forthcoming as it should have been in its financial-statement disclosures.
Valukas faulted Lehman for not revealing enough to
investors about the purpose of Repo 105 transactions and how they affected
the bank's leverage ratios. However, internal Lehman e-mail messages made
public in the report quoted Lehman executives as describing the repos as
balance-sheet "window dressing" and an "accounting gimmick."
In general, repos are used to buy and sell groups
of securities, usually Treasury securities, in short-term transactions,
typically overnight. The securities are put up as collateral by a borrower
and in exchange, the borrower receives cash from counterparties that charge
interest. Since the securities are treated as collateral and the agreement
stipulates that the borrower has an obligation to pay back the cash in short
order, the transaction is considered a financing for accounting purposes,
and the transaction remains on the balance sheet.
In the case of Repo 105, however, Lehman
overcollateralized the transactions by pledging $105 million for $100
million in cash. As a result, the investment bank — with the blessing of a
legal opinion from UK law firm Linklaters — categorized Repo 105 as a sale
for accounting purposes. The sales accounting treatment enabled Lehman to
remove the securities from its balance sheet and use the cash from the
"sale" to pay down other debt and improve its overall leverage ratios.
Lehman repeated the transaction again and again,
including at the end of the last three quarters the bank was solvent.
According to the Valukas report, "Lehman employed off-balance sheet devices
. . . to temporarily remove securities inventory from its balance sheet,
usually for a period of seven to ten days, and to create a materially
misleading picture of the firm's financial condition in late 2007 and 2008."
Then, a few days into the new quarter, Lehman would borrow funds to repay
the repo borrowing plus interest, repurchase the securities, and restore the
assets to its balance sheet.
Bob Jensen's threads on the Lehman/Ernst controversies ---
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
"My Commentary Part 1: Ernst & Young’s Letter To Audit Committee Members,"
by Francine McKenna, re: The Auditors, March 31, 2010 ---
http://retheauditors.com/2010/03/31/my-commentary-part-1-ernst-youngs-letter-to-audit-committee-members/
"My Commentary Part 2: Ernst & Young’s Letter To Audit Committee Members,"
by Francine McKenna, re: The Auditors, April 4, 2010 ---
http://retheauditors.com/2010/04/04/my-commentary-part-2-ernst-young%e2%80%99s-letter-to-audit-committee-members/
Jensen Comment
Francine is not so impressed with the Ernst & Young defense to date.
A Lehman/Ernst Teaching Case
First of all I might note that an article in The Economist supports
what I've been saying all along ---
that Lehman's Repo 105 contracts supported by their auditors had only one
purpose --- to deceive the public
"Beancounters in a bind Banks’ professional advisers come under scrutiny,"
The Economist, March 20, 2010, Page 81 ---
http://www.economist.com/business-finance/displaystory.cfm?story_id=15721559
Some of its counterparty banks get a slap on the
wrist for changing the terms of their collateral demands, for instance. But
the strongest criticism of those who interacted with the flailing firm is
reserved for Lehman’s auditor, Ernst & Young (E&Y), for failing to “question
and challenge improper or inadequate disclosures”. The main “accounting
gimmick” hidden from investors, but apparently known to the auditor, was
called Repo 105. This technique helped the firm flatter its numbers by
temporarily moving assets off its balance-sheet at the end of each quarter.
Lawyers are also in the spotlight: unable to find an American law firm to
approve the transaction as a “true sale” of assets, Lehman got the nod from
Linklaters in London. Both E&Y and Linklaters deny any wrongdoing.
Although Repo 105 appears to have been in line
with American accounting standards, its effect was to deceive.
The technique allowed Lehman to reduce its reported leverage substantially
and thus avoid ruinous ratings downgrades as it fought for survival.
Investors would like to think that auditors consider not just the letter of
the rules but their spirit, too. The examiner concluded that there was
enough evidence to support a case for malpractice against E&Y.
Continued in article"
From The Wall Street Journal Accounting Weekly Review on March 26,
2010
Note that Ernst & Young is disputing some portions of the Examiner's Report with
regard to the whitleblower
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
Lehman Insider's Letter Warned About Violating Code of Ethics
by: Michael
Corkery
Mar 20, 2010
Click here to view the full article on WSJ.com
TOPICS: Bankruptcy,
Business Ethics, Code of Ethics, Ethics, Financial Statement Fraud, Fraud,
Internal Controls, Management Fraud, whistleblower
SUMMARY: Matthew
Lee, a Lehman Brothers Holdings Inc. senior vice president, warned in a May
2008 letter that he believed "senior management" may have violated Lehman's
internal code of ethics by misleading investors and regulators about the
true value of the firm's assets. Mr. Lee's complaints echo those of many
investors and analysts at the time, who questioned whether Lehman was
delaying write-downs to avoid potentially crippling losses. Mr. Lee, a
14-year veteran who headed the firm's global balance-sheet and legal-entity
accounting, said Lehman had "tens of billions of dollars of unsubstantiated
balances, which may or may not be 'bad,' or non-performing assets." "I
believe the manner in which the Firm is reporting [certain] assets is
potentially misleading to the public and various governmental agencies," Mr.
Lee wrote.
CLASSROOM APPLICATION: The
Lehman bankruptcy court's report offers us a current-events case study in
financial statement fraud, as well as whistleblowing law and companies'
codes of ethics. This article also connects our course material with law and
ethics, showing students that the things they are learning in various
classes in the business school are connected. Educated business students
need to see the connections and overlap that occurs.
QUESTIONS:
1. (Introductory)
What warnings did Mr. Lee include in his letter to Lehman officers? What
were his concerns? What evidence did he offer?
2. (Advanced)
What happened to Mr. Lee after he verbally complained? After he submitted
his letter? What has happened to Lehman Brothers since then? Were Mr. Lee's
concerns accurate or were they incorrect accusations?
3. (Introductory)
What was "Repo 105"? Why did Lehman implement this plan? What are the
problems with this plan? Point to specific rules in GAAP that Lehman
violated with this plan. How should those transaction have been booked
according to GAAP?
4. (Advanced)
What is a whistleblower? What is the value of whistleblowing to the
accounting profession and to society? What are the risks involved for
employees who decide to whistleblow? What do you think whistleblowing laws
should include? Why?
5. (Introductory)
What was the ultimate resolution between Mr. Lee and Lehman Brothers? Which
terms of the agreement are known? Why do you think Lehman made this
decision? How would this settlement be booked?
6. (Advanced)
How could this situation have been prevented? What could Lehman management
have done when they heard Mr. Lee's complaints? Could the situation have
been remedied at that point? Why or why not? Who was ultimately responsible
for Lehman's problems and the treatment of Mr. Lee?
Reviewed By: Linda Christiansen, Indiana University Southeast
RELATED ARTICLES:
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by Michael Corkery
Mar 19, 2010
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"Lehman Insider's Letter Warned About Violating Code of Ethics: Top
Executives Told Firm Misled Investors on Assets; Problems in Mumbai," by by:
Michael Corkery, The Wall Street Journal, March 20, 2010 ---
http://online.wsj.com/article/SB10001424052748704534904575132120222684184.html?mod=djem_jiewr_AC_domainid
Matthew Lee, a Lehman Brothers Holdings Inc. senior
vice president, warned in a May 2008 letter that he believed "senior
management" may have violated Lehman's internal code of ethics by misleading
investors and regulators about the true value of the firm's assets.
View Full Image
Photo by Catherine Lee Matthew Lee's complaints
echo those of investors and analysts at the time, who questioned whether
Lehman was delaying write-downs to avoid potentially crippling losses.
Mr. Lee addressed his letter to then-Chief
Financial Officer Erin Callan and Chief Risk Officer Chris O'Meara, among
others, only days before he was ousted from the firm. Portions of the letter
were excerpted in the U.S. Bankruptcy Court examiner's report on Lehman
released last week. A full version of the letter was reviewed Friday by The
Wall Street Journal. Ms. Callan didn't return a phone call seeking comment.
Mr. Lee's complaints echo those of many investors
and analysts at the time, who questioned whether Lehman was delaying
write-downs to avoid potentially crippling losses. Mr. Lee, a 14-year
veteran who headed the firm's global balance-sheet and legal-entity
accounting, said Lehman had "tens of billions of dollars of unsubstantiated
balances, which may or may not be 'bad,' or non-performing assets."
"I believe the manner in which the Firm is
reporting [certain] assets is potentially misleading to the public and
various governmental agencies," Mr. Lee wrote.
On Friday, Senate Banking Committee Chairman
Christopher Dodd (D., Conn.) asked the Justice Department to investigate
alleged accounting manipulations that took place at Lehman and that were
detailed in the 2,200-page examiner's report.
More
What Central Figures at Lehman Knew The Lehman
Whistleblower's Letter In the May 18, 2008, letter, Mr. Lee specifically
criticized the accounting controls in Lehman's Mumbai office. "There is a
very real possibility of a potential misstatement of material facts being
efficiently distributed by that office," Mr. Lee wrote.
At the time, one India investment was drawing
scrutiny from Lehman critics, including David Einhorn of hedge fund
Greenlight Capital Inc. Mr. Einhorn questioned why the Wall Street firm had
written up the value of a power plant there, known as KSK Energy Ventures,
during the first quarter of 2008. In a speech to investors on May 21, Mr.
Einhorn, who was betting that Lehman's stock would decline, said the firm
had booked a $400 million to $600 million gain in the first quarter by
writing up the value of KSK Energy.
Lehman said in the spring of 2008 that it booked
the gains because an investor had invested in the venture at a higher
valuation than Lehman's investment. In his May 21 speech, Mr. Einhorn said
Lehman later said that it valued KSK based on its "expected" pre-IPO
financing, as well as other factors.
Mr. Lee's lawyer, Erwin Shustak, of San Diego, said
his client had complained orally for several months to his boss, Martin
Kelly, Lehman's former global financial controller, about many of the same
issues he raised "formally" in his letter. Mr. Kelly declined to comment,
through a Barclays PLC spokesman, where he now works. According to the
examiner's report, Mr. Kelly had raised concerns to top executives about the
firm's accounting tactic, known as "Repo 105," which temporarily moved
billions of dollars off its balance sheet, according to the examiner's
report. The Lehman bankruptcy estate declined to comment.
Mr. Shustak said his client was demoted about two
months before he wrote the letter, which was drafted with help from the
attorney. Mr. Lee was terminated a few days after he wrote the letter.
Lehman's auditors, Ernst & Young LLP, referred to
the document as a "whistleblower letter" that was "pretty ugly," according
to the examiner's report. In a statement, Ernst & Young said Lehman
management determined that Mr. Lee's "allegations were unfounded."
"Mr. Lee believes he has been the victim of
retaliation for bringing what he believed, in good faith, to have been
ethical and securities law violations by Lehman to Lehman's managements'
attention," Mr. Shustak wrote in a letter to Jack Johnson, a former member
of the general counsel's staff, that was reviewed by The Wall Street
Journal.
After being terminated in May, Mr. Lee was asked to
return to Lehman on June 12 to be interviewed by Ernst & Young auditors
about his complaints, his lawyer said. That is when Mr. Lee brought up his
concerns about Lehman's use of Repo 105.
Mr. Shustak also wrote that Mr. Lee, who is now 56
years old, was considering filing a discrimination complaint because he was
the "victim of age discrimination in what appears to be a company wide
decision to replace more senior, higher paid employees, such as Mr. Lee, all
over the age of forty years of age, with younger, less experienced and less
expensive employees."
The letter added: "At time same time, Mr. Lee would
prefer to resolve his dispute with Lehman amicably."
Mr. Lee and Lehman ultimately negotiated a
severance agreement, which his lawyer said precluded him from filing a
lawsuit or a whistle-blower complaint under the Sarbanes-Oxley Act.
Bob Jensen's threads on the Lehman/Ernst scandal are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
Question
Will the big auditing firms survive the explosion in lawsuits stemming from
questionable audits of failed firms in the wake of the 2008 economic collapse?
Where Were the Auditors? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Will the Largest International Auditing Firms Survive? --- See Below
"For The Auditors Nothing’s Over Until It’s Over: Or Is It?" by
Francine McKenna, re: The Auditors, March 23, 2010 ---
http://retheauditors.com/2010/03/23/for-the-auditors-nothings-over-until-its-over-or-is-it/
The leadership of the Big 4 audit firms – Deloitte,
Ernst & Young, KPMG and PricewaterhouseCoopers – are scared witless. The
auditors prefer to be Switzerland. That is, they prefer to remain neutral.
They don’t like the kind of attention that Ernst & Young is getting. They
like the soft, managed,
scripted kind of attention for
Davos,
diversity,
charitable endeavors and support of
higher education.
Until the
Lehman Bankruptcy Examiner’ Report was issued on
March 11th, the auditors had experienced a “good crisis.” No
serious scrutiny of their behavior, no testimony before the various
investigative committees of the US Congress and only a few lawsuits that had
not yet come to trial.
October 2008, Gavin Hinks in
Accountancy Age:
“Speaking at a meeting of accountants from
across the world at the Mansion House yesterday,
Paul Boyle said:
‘So far at least, auditing has had a good crisis.’
Detractors, Boyle added, had been vague in
their complaints and had misunderstood the role of auditor, on the one
hand, and corporate governance and financial services supervision, on
the other. These statements are notable because Boyle is clearly
sticking up for the profession. If he had thought the opposite he would
presumably not addressed the subject during the speech. This is active
backing for auditors.”
So much for that.
The Lehman Bankruptcy Examiner threw the word
“fraud” into the financial crisis conversation.
The words “auditor malpractice’” followed.
It’s quite likely EY will be called before the US House
Oversight Committee to testify about the Lehman
bankruptcy. David Einhorn, a member of the much maligned
“short club,” will probably be called to testify,
too.
I criticized Ernst & Young in mid-2008 for not
questioning
Lehman’s CFO revolving door. Lehman had chosen
another non-CPA CFO, the second one in less than three years. I was
following the lead of another
Cassandra, David
Einhorn. Einhorn is now being heralded because he questioned Lehman’s
accounting, in spite of being ridiculed and damned for it at the time. He’s
getting almost as much applause as the “whistleblower” du jour,
Matthew Lee.
Einhorn has also recently been vindicated in
another case where he called foul and faced harsh
criticism.
The SEC’s watchdog found that the agency
failed to properly pursue serious allegations made against Allied
Capital, a public company that invests in small to midsize businesses.
But after heavy lobbying by Allied Capital, the agency aggressively
pursued the hedge fund manager who had challenged the value of Allied’s
investments…The case…began in 2002, when a hedge fund manager named
David Einhorn explained in a speech that he bet against Allied Capital’s
stock by short-selling it because he thought Allied overvalued its
holdings.
Other investors proceeded to short Allied’s
stock, which declined sharply in value.
About the same time, Einhorn began
contacting the SEC by phone and letter to explain his skepticism about
Allied Capital’s accounting techniques. Allied also worked behind the
scenes to urge the SEC to investigate whether Einhorn was engaging in
illegal behavior to undermine the company’s shares, according to the
inspector general’s report.
Without any specific evidence of
wrongdoing, Allied met with SEC investigators in June 2002 to urge them
to investigate Einhorn. Shortly thereafter, the SEC opened a probe,
questioning Einhorn about his trading activities, subpoenaing documents,
and seeking his telephone records and a list of clients. Soon after
investigators started looking at Einhorn, they concluded that he had
done nothing wrong.
Sources tell me that the SEC Inspector General’s
report on the Allied Capital investigation paints an even worse picture of
the SEC than those involved ever expected. For example, it was the SEC
lawyer who grilled Einhorn that later became a lobbyist for Allied and was
the one who hired private investigators to steal Greenlight Capital’s phone
records. Allied Capital’s auditor is
KPMG. They are
not yet accused of any wrongdoing, but
the report also discusses the
mis-valuations that Allied was originally accused
of by Greenlight.
Maybe it’s time to start listening to the “shorts”
and the contrarians.
Many ask me if Ernst & Young will fail because of
Lehman. I
have answered that in previous posts.
In short, not immediately.
Maybe E&Y won’t be the first of the remaining Big 4
to fail. The leadership of the Big 4 are terrified because any one of them
could be thrust into the harsh spotlight the way Ernst & Young has been. At
any time.
Because they’re all on the brink.
Take KPMG. When the
New Century Trustee v. KPMG US and KPMG International
lawsuit comes to trial, you can bet the media will suddenly remember there’s
an auditor smoking gun there, too. Mr. Missal, the New Century bankruptcy
examiner, found emails that uncovered the same kind of disregard for KPMG’s
experts and their risk and quality gurus that we saw in Arthur Andersen’s
handling of Enron. New Century is more like Enron for that reason than EY/Lehman
is. So far. That we know of.
Depending on how well
Steven Thomas tries it, the media will be all over
the “KPMG will fail” scenario. Losing the case carries a $1 billion dollar
price tag for KPMG. There’s also significant implications for the global
network business model in addition to the enormous costs of KPMG defending
themselves in the meantime.
Arthur Andersen’s partner ignored his own expert’s
advice in
Enron. KPMG is accused of doing the same in New
Century. All for the sake of keeping a lucrative client. EY may have done
the same to hold onto Lehman. Certainly the
long, lucrative relationship between EY and Lehman
paints a similar picture of mercenary motivation.
When EY’s Lehman audit team ran into the growing
use of Repo 105 transactions, or the declining market value of the CDOs, or
the Archstone REIT or any of the other problematic accounting issues
mentioned in the Examiner’s report, one of four scenarios took place:
- The audit team didn’t ask for advice from
their technical GAAP and SEC reporting/disclosure specialists at EY
headquarters. The team went along and did what had always been done in
the past: They acquiesced to Lehman CFOs. After all it was the Lehman
CFO Goldfarb, an EY alumni who designed the transactions and approved
the accounting treatments. When Sarbanes-Oxley outlawed the revolving
door of audit partners moving into high level positions at clients, Dick
Fuld chose non-accountants who didn’t know better, would not question
and weren’t interested in accounting.
- Or…The audit team asked for advice from their
technical GAAP and SEC reporting/disclosure specialists at EY
headquarters. The headquarters specialists blessed the existing
treatment. After all it was Lehman CFOs who were EY alumni who had
designed the transactions and approved the accounting treatments.
- Or…The audit team asked for advice from their
technical GAAP and SEC reporting/disclosure specialists at EY
headquarters. The audit team received advice that the problematic issues
represented unacceptable treatments according to current standards.
And/or the experts suggested disclosures to clarify Lehman’s position.
When this answer was brought to the audit partners they dismissed it and
acquiesced to the Lehman executives. That’s similar the KPMG/New Century
scenario.
- Or…The audit team asked for advice from their
technical GAAP and SEC reporting/disclosure specialists at EY
headquarters. The audit team received advice that the problematic issues
represented unacceptable accounting treatments according to standards.
When this answer was brought to the audit partners they raised the
issue with Lehman executives, encouraged them to stop manipulating the
balance sheet without disclosures using Repo 105 or to write down assets
such as Archstone or the CDOs and were rebuffed. Lehman executives
threatened to fire them and replace them with another firm like KPMG and
EY backed down. We may never know if this happened unless or until EY
partners are forced to settle charges and flip on the Lehman
executives.
Or take the massive Satyam fraud-related litigation
facing PricewaterhouseCoopers. When the courts in the Southern District of
New York decide that
PwC’s motions to dismiss are denied,
PricewaterhouseCoopers will face a flood of lawsuits that will dwarf New
Century v. KPMG. The publicity over EY/Lehman should make it difficult for
the court to accept any lame excuses from PwC. PwC’s argument is that the
case should be tried in India but they are
fighting in India to have the case dismissed.
New York courts will now hear age discrimination
litigation that names PwC as a defendant because the courts agreed that
decisions about PwC partnership are made in New York. That
same theory can certainly be applied when it comes to PwC global leadership
(elected to represent the interests of the owners of its largest member
firms) and their control over a global client like Satyam. Satyam is a PwC
client that was listed on the New York Stock Exchange. The global leadership
exerted control over member firm India because it has significant strategic
importance to the global leadership.
The global leadership exerted that control
using the PwC International Limited legal construct.
The
Satyam saga is far from over. The PCAOB
recently sanctioned two fairly low-level PW India staff.
(They are actually employees of local Indian member
firm
Lovelock and Lewes.)
These employees are now “barred from being an associated person of a [PCAOB]
registered public accounting firm” because they would not cooperate in the
Satyam investigation.
I asked PCAOB spokesperson Colleen Brennan if there
was more to come. What about the Price Waterhouse India partners that were
jailed?
The order says formal investigation
started Jan 8, 2009. It is now 14 months later and the outcome is that
they wouldn’t talk to you. What took so long?
Generally speaking the
investigative process requires getting relevant audit work papers and
other documents and scheduling the testimony of witnesses.
Particularly in cases where witnesses are located abroad, which is the
case here, the staff works with the witnesses and their counsel
regarding an appropriate location for the testimony. Depending on the
location, different planning goes into scheduling the testimony. Under
the Board’s rules, witnesses are allowed to have counsel present during
their testimony. In this instance, the auditors obtained new counsel
during the investigative process which led to a postponement of the
original testimony.
Is this it on your Satyam
activities? What else is PCAOB doing to address the Satyam matter?
The order mentions that the Board
issued an order of formal investigation relating to the audits of
Satyam. We cannot comment further.
What are next steps for PCAOB on
Satyam? The disciplinary
proceedings as to these respondents are complete. The Board does not
comment one way or another about the specifics of its investigative
inventory. (We cannot confirm that we have an ongoing investigation
because Section 105(b)(5)(A) of the Act. This is the first case where we
barred someone only for non-cooperation with Enforcement.)
Has the Board charged any other
Lovelock & Lewes personnel, or Lovelock & Lewes, the firm, in connection
with the Satyam audit? We
cannot comment on whether others have been or will be charged. These
orders only address the conduct of Messrs. Ravindernath and Prasad.
Are the Board’s investigation and
disciplinary proceedings in connection with this matter completed?
These disciplinary proceedings are
completed as to Messrs. Ravindernath and Prasad. The Board does not
comment one way or another about the specifics of its nonpublic
investigative inventory, or about any proceedings that may be in
litigation before the Board, which are non-public as required by the
Sarbanes-Oxley Act.
What prompted the Board to
investigate the audits and reviews of Satyam’s financial statements?
The orders disclose that
Satyam filed a Form 6-K with the SEC on January 7, 2009, that its
chairman had revealed that he had inflated key financial results,
and the Board issued an order of formal investigation on January 8,
2009.
Is the SEC also investigating this
matter? Do you expect the SEC also to take enforcement action against
Satyam management, or the auditors in this matter?
As a matter of policy, the Board
does not comment on SEC investigations.
Don’t forget Deloitte has its own subprime/crisis
litigation already on the docket. They are named in lawsuits related to the
acquisition of
Merrill Lynch by Bank of America and the failure of Bear Stearns,
as well as the bankruptcy of Washington
Mutual.
Finally…
PwC, EY and KPMG are named in significant
Madoff feeder fund litigation and it looks like
those cases are
starting to move through the courts. There are
billions of dollars in damages that will probably be paid.
Each of the largest global audit firms could take a
hit of $1 billion if forced to. They would find a way to come up with the
cash. But they don’t want to. A $1 billion dollar settlement would make a
significant impact on any of the firms. A settlement or judgment,
especially of that size, would make it very difficult to stay in business
even if the firm remained technically viable.
But there are several $1 billion claims out there.
All four of the largest firms are suffocating under the weight of the
potential claims and the cost to defend them as well as the distraction from
normal business activities and the impact on morale.
The Big 4 feels the pain on a rotating basis, only
for a short for a while, and only whenever a painful exposé such as the
Lehman bankruptcy report surfaces or a case gets closer to trial. Then the
media moves on. Very few cases against the auditors went to trial in the
past. There are many reasons for this. But the sheer volume of cases filed
given number of scandals, frauds and failures, is giving plaintiff’s lawyers
and regulatory enforcement more practice than ever before. The plaintiff’s
lawyers, in particular are talking to each other, sharing information and
getting better at their arguments with each filing.
The tide’s gone out and left the audit firms high
and dry.
Which case will be the showcase trial of the new
millennium? Which billion dollar case will
make it to the jury first? Which case will force
legislators and regulators to admit the business model for public accounting
is irreparably broken?
Bob Jensen's threads on accounting firm litigation are at
http://faculty.trinity.edu/rjensen/fraud001.htm
"Heads Up Play With David Einhorn," by Bess Levin, DealBreaker,
December 21, 2010 ---
Click Here
http://dealbreaker.com/2010/12/heads-up-play-with-david-einhorn-a-qa/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+dealbreaker+%28Dealbreaker%29
If you’re going to commit financial fraud, you
probably don’t want to find yourself sitting at a table across from David
Einhorn, who will know what you’re up to and share it with the world.
Similarly, if you’ve never played poker and have only ever had a 15 minute
tutorial on the game, you probably should avoid playing with the Greenlight
Capital founder, whose vastly superior skills will demonstrate just how much
you suck. As I like to live on the edge, yesterday in an undisclosed
location, I choose not to heed the wisdom of the latter. Over several hands,
Einhorn and I discussed the new edition of his 2008 book, “Fooling Some Of
The People, All Of The Time.”
The latest version includes an epilogue, and
concludes the story of Allied and Einhorn’s years of trying to get other
people to listen when he said something was up.
As we now know, Allied’s shares collapsed, Greenlight
collected $35 million, and the hedge fund made another big (and correct)
call on a bank called Lehman Brothers, whose failure was, according to
Einhorn, “the Allied story all over again,” just on a bigger scale, with
more resounding consequences. Even after
the last crisis, which should have been a wake-up call, Einhorn doesn’t
think we’ve changed much and if anything, the reforms passed only “encourage
poor behavior and will likely foster an even bigger crisis.” He and I
chatted about that exciting event, Quantitative Easing, Steve Eisman’s
illicit pleasure of choice and more, plus poker tips for people who really,
really need them.
Continued in article
An older tidbit from
http://faculty.trinity.edu/rjensen/Fraud001.htm
Selling New Equity to Pay Dividends: Reminds Me About the South Sea Bubble
of 1720 ---
http://en.wikipedia.org/wiki/South_Sea_bubble
"Fooling Some People All the Time"
"Melting
into Air: Before the financial system went bust, it went postmodern,"
by John Lanchester, The New Yorker, November 10, 2008 ---
http://www.newyorker.com/arts/critics/atlarge/2008/11/10/081110crat_atlarge_lanchester
This is also why the financial masters of the universe tend not to write
books. If you have been proved—proved—right, why bother? If you need to
tell it, you can’t truly know it. The story of David Einhorn and Allied
Capital is an example of a moneyman who believed, with absolute
certainty, that he was in the right, who said so, and who then watched
the world fail to react to his irrefutable demonstration of his own
rightness. This drove him so crazy that he did what was, for a
hedge-fund manager, a bizarre thing: he wrote a book about it.
The story began on May 15, 2002, when Einhorn, who runs a hedge fund
called Greenlight Capital, made a speech for a children’s-cancer charity
in Hackensack, New Jersey. The charity holds an annual fund-raiser at
which investment luminaries give advice on specific shares. Einhorn was
one of eleven speakers that day, but his speech had a twist: he
recommended shorting—betting against—a firm called Allied Capital.
Allied is a “business development company,” which invests in companies
in their early stages. Einhorn found things not to like in Allied’s
accounting practices—in particular, its way of assessing the value of
its investments. The
mark-to-market accounting
that Einhorn favored is based on the price an asset would fetch if it
were sold today, but many of Allied’s investments were in small startups
that had, in effect, no market to which they could be marked. In
Einhorn’s view, Allied’s way of pricing its holdings amounted to “the
you-have-got-to-be-kidding-me method of accounting.” At the same time,
Allied was issuing new equity,
and, according to Einhorn, the revenue from
this could be used to fund the dividend payments that were keeping
Allied’s investors happy. To Einhorn,
this looked like a potential Ponzi scheme.
The next day, Allied’s stock dipped more than twenty per cent, and a
storm of controversy and counter-accusations began to rage. “Those
engaging in the current misinformation campaign against Allied Capital
are cynically trying to take advantage of the current post-Enron
environment by tarring a great and honest company like Allied Capital
with the broad brush of a Big Lie,” Allied’s C.E.O. said. Einhorn would
be the first to admit that he wanted Allied’s stock to drop, which might
make his motives seem impure to the general reader, but not to him. The
function of hedge funds is, by his account, to expose faulty companies
and make money in the process. Joseph Schumpeter described capitalism as
“creative destruction”: hedge funds are destructive agents, predators
targeting the weak and infirm. As Einhorn might see it, people like him
are especially necessary because so many others have been asleep at the
wheel. His book about his five-year battle with Allied, “Fooling Some
of the People All of the Time” (Wiley; $29.95), depicts analysts,
financial journalists, and the S.E.C. as being culpably complacent. The
S.E.C. spent three years investigating Allied. It found that Allied
violated accounting guidelines, but noted that the company had since
made improvements. There were no penalties. Einhorn calls the S.E.C.
judgment “the lightest of taps on the wrist with the softest of
feathers.” He deeply minds this, not least because the complacency of
the watchdogs prevents him from being proved right on a reasonable
schedule: if they had seen things his way, Allied’s stock price would
have promptly collapsed and his short selling would be hugely
profitable. As it was, Greenlight shorted Allied at $26.25, only to
spend the next years watching the stock drift sideways and upward;
eventually, in January of 2007, it hit thirty-three dollars.
All this has a great deal of resonance now, because, on May 21st of this
year, at the same charity event, Einhorn announced that Greenlight had
shorted another stock, on the ground of the company’s exposure to
financial derivatives based on dangerous subprime loans. The company was
Lehman Brothers. There was little delay in Einhorn’s being proved right
about that one: the toppling company shook the entire financial system.
A global cascade of bank implosions
ensued—Wachovia, Washington Mutual, and the Icelandic banking system
being merely some of the highlights to date—and a global bailout of the
entire system had to be put in train.
The short sellers were proved right, and also came to be seen as
culprits; so was mark-to-market accounting, since it caused sudden,
cataclysmic drops in the book value of companies whose holdings had
become illiquid. It is therefore the perfect moment for a short-selling
advocate of marking to market to publish his account. One can only
speculate whether Einhorn would have written his book if he had known
what was going to happen next. (One of the things that have happened is
that, on September 30th, Ciena Capital, an Allied portfolio company to
whose fraudulent lending Einhorn dedicates many pages, went into
bankruptcy; this coincided with a collapse in the value of Allied
stock—finally!—to a price of around six dollars a share.) Given the
esteem with which Einhorn’s profession is regarded these days, it’s a
little as if the assassin of Archduke Franz Ferdinand had taken the
outbreak of the First World War as the timely moment to publish a book
advocating bomb-throwing—and the book had turned out to be unexpectedly
persuasive.
Heavy
Insider Trading ---
http://investing.businessweek.com/research/stocks/ownership/ownership.asp?symbol=ALD
Allied's independent auditor is KPMG
KPMG
has a lot of problems with litigation ---
http://faculty.trinity.edu/rjensen/fraud001.htm
Bob
Jensen's threads on the collapse of the Banking System are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob
Jensen's threads on fraud are at
http://faculty.trinity.edu/rjensen/Fraud.htm
Also see Fraud Rotten at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob
Jensen's threads on accounting theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
Also see the theory of fair value accounting at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
History of Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Abusive off-balance sheet accounting was a major
cause of the financial crisis. These abuses triggered a daisy chain of
dysfunctional decision-making by removing transparency from investors,
markets, and regulators. Off-balance sheet accounting facilitating the
spread of the bad loans, securitizations, and derivative transactions that
brought the financial system to the brink of collapse.
As in the 1920s, the balance sheets of major
corporations recently failed to provide a clear picture of the financial
health of those entities. Banks in particular have become predisposed to
narrow the size of their balance sheets, because investors and regulators
use the balance sheet as an anchor in their assessment of risk. Banks use
financial engineering to make it appear that they are better capitalized and
less risky than they really are. Most people and businesses include all of
their assets and liabilities on their balance sheets. But large financial
institutions do not.
Click here to read the full chapter.---
http://www.rooseveltinstitute.org/sites/all/files/Off-Balance Sheet
Transactions.pdf
Frank Partnoy is the George E.
Barnett Professor of Law and Finance and is the director of the Center on
Coporate and Securities Law at the University of San Diego. He worked as a
derivatives structurer at Morgan Stanley and CS First Boston during the
mid-1990s and wrote F.I.A.S.C.O.:
Blook in the Water on Wall Street, a
best-selling book about his experiences there. His other books include
Infectious Greed: How Deceit and Risk Corrupted the Financial Markets
and
The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall
Street Scandals.
Lynn Turner has the unique
perspective of having been the Chief Accountant of the Securities and
Exchange Commission, a member of boards of public companies, a trustee of a
mutual fund and a public pension fund, a professor of accounting, a partner
in one of the major international auditing firms, the managing director of a
research firm and a chief financial officers and an executive in industry.
In 2007, Treasury Secretary Paulson appointed him to the Treasury Committee
on the Auditing Profession. He currently serves as a senior advisor to LECG,
an international forensics and economic consulting firm.
The views expressed in this paper are those of the authors and do not
necessarily reflect the positions of the Roosevelt Institute, its officers,
or its directors.
Bob Jensen's threads on OBSF are at
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
For over 15 years Frank Partnoy has been appealing in vain for financial
reform. My timeline of history of the scandals, the new accounting standards,
and the new ploys at OBSF and earnings management is at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Former employees of Big Four firms (alumni) have a blog that is generally
upbeat and tends not to be critical of their former employers
However, with respect to the impact of the Lehman Bankruptcy Examiners Report,
this Big Four Blog is unusually critical of Ernst and Young and predicts a very
tough time for E&Y in the aftermath.
The next few days will reveal how the regulators,
erstwhile shareholders of Lehman and other stakeholders will move against E&Y.
Valukas’ statement that there is sufficient evidence to show that E&Y was
negligent is enough to spur a whole host of law suits. E&Y is in a very tough
spot now, and while it may escape an imploding collapse like Andersen, the long
tail of Lehman is sure to create a strong whiplash with painful monetary,
reputational and punitive
"Ernst and Young Found Negligent in Lehman Report, Tough
Consequences," The Big Four Blog, March 17, 2010 ---
http://bigfouralumni.blogspot.com/2010/03/ernst-and-young-found-negligent-in.html
There’s been so much press on the recently released
report on the spectacular failure of Lehman Brothers by Anton Valukas, so
we’ll just focus on the key elements which involve Lehman’s auditor Ernst &
Young.
Valukas is highly critical of E&Y’s work, claiming
that they did not perform the due diligence needed by audit firms, the
ultimate watchdog of investors’ interests. He believes there is a case of
negligence and professional malpractice against the firm. Though in a very
limited sense Lehman perhaps followed standard accounting principles, and
this is the basis on which E&Y signed off on their annual and quarterly
filings, they wrongly categorized a repo as a sale to knowingly report a
lower leverage ratio, they exceeded internal limits on the infamous Repo
105, and they found a loophole in the British system to execute these
transactions, and keep them off the public eye.
Lehman was clearly at fault and grossly fraudulent
in hiding this from investors, and then obfuscating answers to clear
questions from analysts. Is Ernst and Young equally culpable?
E&Y should have been more rigorous in pursuing this
issue, knowing that it was material, being misrepresented and highly abused.
With full knowledge of its usage, and then signing off on SEC documents is
definitely negligent.
E&Y is now being investigated by the FRC in the UK
and very likely in due course by the SEC. The Saudi government has already
cancelled E&Y’s security license in the kingdom. The law suits are yet to
hit the wires, but they are coming. The key is whether a criminal indictment
of the firm is likely, recall that this is what brought down Andersen.
Dealing with civil suits is only a matter of money, but a criminal charge is
going to send clients away in droves. The critical question is whether the
industry can withstand the loss of a $20 billion accounting giant, the
consequences of a Big Three are quite hard to imagine.
E&Y was recently hit with a $8.5 million fine by
the SEC for its involvement with Bally Fitness, and in that settlement E&Y
agreed to tighten internal procedures and refrain from audit abuse. So the
SEC is unlikely to look favorably on this.
The next few days will reveal how the regulators,
erstwhile shareholders of Lehman and other stakeholders will move against
E&Y. Valukas’ statement that there is sufficient evidence to show that E&Y
was negligent is enough to spur a whole host of law suits.
E&Y is in a very tough spot now, and while it may
escape an imploding collapse like Andersen, the long tail of Lehman is sure
to create a strong whiplash with painful monetary, reputational and punitive
consequences.
Bob Jensen's threads on the Examiner's Report aftermath can be found at
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
Lehman/Ernst Teaching Case on the Largest Bankruptcy in History
March 18, 2010 reply from Bob Jensen
Dear Jim,
The Repo 105 issue was more like having a poisoned CDO bond worth $1 that
you sell for $1,000 with a guaranteed buyback in a week for $1,005. That way
you report a sale for $1,000, an asset of $0 in the balance sheet for a
“sold investment,” and $0 for the liability to buy it back. Sounds like a
bad economic deal and a great OBSF ploy. Of course it’s not necessarily
boosting earnings if you paid more than $1,000 for the CDO cookie crumbles
in the first place in the first place.
But it sure beats writing investments down from $1,000 to a $1.
Ernst and Young claims using these contracts to keep billions of dollars
of poison investments and unbooked debt out of the financial statements
result fairly present the financial status of sales and liabilities in the
financial statements.
Do our Accounting 101 and Auditing 101 students concur?
God help this profession if our students side with Ernst & Young!
Frank Partnoy and Lynn Turner contend that Wall Street bank accounting is
an exercise in writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Bob Jensen
Lehman/Ernst Teaching Case on the Largest Bankruptcy in History
March 18, 2010 reply from Bob Jensen
Dear Jim,
The Repo 105 issue was more like having a poisoned CDO bond worth $1 that
you sell for $1,000 with a guaranteed buyback in a week for $1,005. That way
you report a sale for $1,000, an asset of $0 in the balance sheet for a
“sold investment,” and $0 for the liability to buy it back. Sounds like a
bad economic deal and a great OBSF ploy. Of course it’s not necessarily
boosting earnings if you paid more than $1,000 for the CDO cookie crumbles
in the first place in the first place.
But it sure beats writing investments down from $1,000 to a $1.
Ernst and Young claims using these contracts to keep billions of dollars
of poison investments and unbooked debt out of the financial statements
result fairly present the financial status of sales and liabilities in the
financial statements.
Do our Accounting 101 and Auditing 101 students concur?
God help this profession if our students side with Ernst & Young!
Frank Partnoy and Lynn Turner contend that Wall Street bank accounting is
an exercise in writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Bob Jensen
Lehman/Ernst Teaching Case on the Largest Bankruptcy in History
From The Wall Street Journal Accounting Weekly Review on March 19, 2010
Examiner: Lehman Torpedoed Lehman
by: Mike
Spector, Susanne Craig, Peter Lattman
Mar 11, 2010
Click here to view the full article on WSJ.com
TOPICS: Advanced
Financial Accounting, Debt, Degree of Operating Leverage, Disclosure,
Revenue Recognition
SUMMARY: "A
federal judge released a scathing report on the collapse of Lehman Brothers
Holdings Inc. that singles out senior executives, auditor Ernst & Young and
other investment banks for serious lapses that led to the largest bankruptcy
in U.S. history...." The report focuses on the use of "repos" to improve the
appearance of Lehman's financial condition as it worsened with the market
declines beginning in 2007. "Mr Valukus, chairman of law firm Jenner &
Block, devotes more than 300 pages alone to balance sheet manipulation..."
through repo transactions. As explained more fully in the related articles,
repurchase agreements are transactions in which assets are sold under the
agreement that they will be repurchased within days. Yet, when Lehman
exchanged assets with a value greater than 105% of the cash received for
them, the company would report it as an outright sale of the asset, not a
loan, thus reducing the firms apparent leverage. These transactions were
based on a legal opinion of the propriety of this treatment made for their
European operations, but the company never received such an opinion letter
in the U.S., so Lehman transferred assets to Europe in order to execute the
trades. The second related article clarifies these issues. Of course, this
was but one significant problem; other forces helped to "tip Leham over the
brink" into bankruptcy including J.P. Morgan Chases' "demands for collateral
and modifications to agreements...that hurt Lehman's liquidity...."
CLASSROOM APPLICATION: The
questions ask students to understand repurchase agreements and cases in
which financing (borrowing) transactions might alternatively be treated as
sales. The role of the auditor, in this case Ernst & Young, also is
highlighted in the article and in the questions in this review.
QUESTIONS:
1. (Introductory)
What report was issued in March 2010 regarding Lehman Brothers? Summarize
some main points about the report.
2. (Advanced)
Based on the discussion in the main and first related articles, describe the
"repo market'. What is the business purpose of these transactions?
3. (Advanced)
How did Lehman Brothers use repo transactions to improve its balance sheet?
Note: be sure to refer to the related articles as some points in the main
article emphasize the impact of removing the assets that are subject to the
repo agreements from the balance sheet. The main point of your discussion
should focus on what else might have been credited in the entries to record
these transactions.
4. (Introductory)
Refer to the second related article. What was the role of Lehman's auditor
in assessing the repo transactions? What questions have been asked of this
firm and how has E&Y responded?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Lehman Maneuver Raises Accounting Question.
by David Reilly
Mar 13, 2010
Online Exclusive
"Examiner: Lehman Torpedoed Lehman," by: Mike Spector, Susanne Craig, Peter
Lattman, The Wall Street Journal, Mar 11, 2010 ---
http://online.wsj.com/article/SB10001424052748703625304575115963009594440.html?mod=djem_jiewr_AC_domainid
A scathing report by a U.S. bankruptcy-court
examiner investigating the collapse of Lehman Brothers Holdings Inc. blames
senior executives and auditor Ernst & Young for serious lapses that led to
the largest bankruptcy in U.S. history and the worst financial crisis since
the Great Depression.
In the works for more than a year, and costing more
than $30 million, the report by court-appointed examiner Anton Valukas
paints the most complete picture yet of the free-wheeling culture inside the
158 year-old firm, whose chief executive Richard S. Fuld Jr. prided himself
on his ability to manage market risk.
The document runs thousands of pages and contains
fresh allegations. In particular, it alleges that Lehman executives
manipulated its balance sheet, withheld information from the board, and
inflated the value of toxic real estate assets.
Lehman chose to "disregard or overrule the firm's
risk controls on a regular basis,'' even as the credit and real-estate
markets were showing signs of strain, the report said.
In one instance from May 2008, a Lehman senior vice
president alerted management to potential accounting irregularities, a
warning the report says was ignored by Lehman auditors Ernst & Young and
never raised with the firm's board.
The allegations of accounting manipulation and
risk-control abuses potentially could influence pending criminal and civil
investigations into Lehman and its executives. The Manhattan and Brooklyn
U.S. attorney's offices are investigating, among other things, whether
former Lehman executives misled investors about the firm's financial picture
before it filed for bankruptcy protection, and whether Lehman improperly
valued its real-estate assets, people familiar with the matter have said.
The examiner said in the report that throughout the
investigation it conducted regular weekly calls with the Securities and
Exchange Commission and Department of Justice. There have been no
prosecutions of Lehman executives to date.
Several factors helped to tip Lehman over the brink
in its final days, Mr. Valukas wrote. Investment banks, including J.P.
Morgan Chase & Co., made demands for collateral and modified agreements with
Lehman that hurt Lehman's liquidity and pushed it into bankruptcy.
Lehman's own global financial controller, Martin
Kelly, told the examiner that "the only purpose or motive for the
transactions was reduction in balance sheet" and "there was no substance to
the transactions." Mr. Kelly said he warned former Lehman finance chiefs
Erin Callan and Ian Lowitt about the maneuver, saying the transactions posed
"reputational risk" to Lehman if their use became publicly known.
In an interview with the examiner, senior Lehman
Chief Operating Officer Bart McDade said he had detailed discussions with
Mr. Fuld about the transactions and that Mr. Fuld knew about the accounting
treatment.
In an April 2008 email, Mr. McDade called such
accounting maneuvers "another drug we r on." Mr. McDade, then Lehman's
equities chief, says he sought to limit such maneuvers, according to the
report. Mr. McDade couldn't be reached to comment.
In a November 2009 interview with the examiner, Mr.
Fuld said he had no recollection of Lehman's use of Repo 105 transactions
but that if he had known about them he would have been concerned, according
to the report.
Mr. Valukas's report is among the largest
undertaking of its kind. Those singled out in the report won't face
immediate repercussions. Rather, the report provides a type of road map for
Lehman's bankruptcy estate, creditors and other authorities to pursue
possible actions against former Lehman executives, the bank's auditors and
others involved in the financial titan's collapse.
One party singled out in the report is Lehman's
audit firm, Ernst & Young, which allegedly didn't raise concerns with
Lehman's board about the frequent use of the repo transactions. E&Y met with
Lehman's Board Audit Committee on June 13, one day after Lehman senior vice
president Matthew Lee raised questions about the frequent use of the
transactions.
"Ernst & Young took no steps to question or
challenge the nondisclosure by Lehman of its use of $50 billion of
temporary, off-balance sheet transactions," Mr. Valukas wrote.
In a statement, Mr. Fuld's lawyer, Patricia Hynes,
said, "Mr. Fuld did not know what those transactions were—he didn't
structure or negotiate them, nor was he aware of their accounting
treatment."
An Ernst & Young statement Thursday said Lehman's
collapse was caused by "a series of unprecedented adverse events in the
financial markets." It said Lehman's leverage ratios "were the
responsibility of management, not the auditor."
Ms. Callan didn't respond to a request for comment.
An attorney for Mr. Lowitt said any suggestion he breached his duties was
"baseless." Mr. Kelly couldn't be reached Thursday evening.
As Lehman began to unravel in mid-2008, investors
began to focus their attention on the billions of dollars in commercial real
estate and private-equity loans on Lehman's books.
The report said that while Lehman was required to
report its inventory "at fair value," a price it would receive if the asset
were hypothetically sold, Lehman "progressively relied on its judgment to
determine the fair value of such assets."
Between December 2006 and December 2007, Lehman
tripled its firmwide risk appetite.
But its risk exposure was even larger, according to
the report, considering that Lehman omitted "some of its largest risks from
its risk usage calculations" including the $2.3 billion bridge equity loan
it provided for Tishman Speyer's $22.2 billion take over of apartment
company Archstone Smith Trust. The late 2007 deal, which occurred as the
commercial-property market was cresting, led to big losses for Lehman.
Lehman eventually added the Archstone loan to its
risk usage profile. But rather than reducing its balance sheet to compensate
for the additional risk, it simply raised its risk limit again, the report
said.
Bob Jensen's threads on the Lehman financial and accounting fraud are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
Where Were the Auditors?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Repo105 ---
http://en.wikipedia.org/wiki/Repo_105
Thanks XXXXX for the heads up!
Dear Bob,
Please don't forward this email with my name, but I thought
you may find the info below of interest, you may (or may not) want to
cut/paste info below to share with others; if you do share it, please
don't attribute the comments to me, it can just be someone
who prefers to be anonymous). Thank you!
www.repo105.com strikes me as possibly being a spam site, maybe even
authored by someone overseas, due to some misspellings on their site
including "Bernie Maddof" and "Dick Chaney."
Moreover, it looks like the site may have been set up to get attention of
people looking for info on "Repo 105" but drives them to their own business
which apparently is selling FX or gold trading, e.g. this para. on their
website:
"Financial markets may well roil in the throws of
this latest revelation, especially if the practice is shown to be widespread
From
XXXXX
Jensen Comment
An evolving site that might one day be quite good for Repo 105 information
might be
http://en.wikipedia.org/wiki/Repo_105
Currently I think my links below will be more useful on this accounting
controversy.
Bob Jensen’s threads on
the Lehman/Ernst Repo 105 mess will soon be available at
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
Also see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Hi David,
“Accounting Pornography” (http://profalbrecht.wordpress.com/2010/03/16/what-is-accounting-pornography-revised/
)
breaks down in to three categories --- solos, couples, and groupies.
At the end of her blog post Francine suggests that Repos 105 OBSF ploys should
perhaps fall under the Groupie Category (her word is Fraternité).
“Liberté, Egalité,
Fraternité: Big Lehman Brothers Troubles For Ernst & Young,” By Francine
McKenna, re; The Auditors, March 15, 2010 ---
http://retheauditors.com/2010/03/15/liberte-egalite-fraternite-lehman-brothers-troubles-for-ernst-young-threaten-the-big-4-fraternity/
Begin Quote (about how top financial executives at
Lehman were former E=&Y auditors of Lehman)
That kind of comfort and
confidence in your client and their technical competence comes from a long,
lucrative relationship. But it must have been more than that. It could not have
possibly come from confidence in the CFO suite, given its revolving door and the
lack of accounting interest and aptitude in later years.
No.
Ernst and Young’s confidence in Lehman’s CFO leadership was rooted in
fraternity. Both Christopher O’Meara and
David Goldfarb,
his predecessor who was CFO from 2000 to 2004, are Ernst and Young alumni.
Prior to joining Lehman Brothers in 1994, Mr. O’Meara worked as a senior
manager in Ernst & Young’s Financial Services practice. Prior to joining Lehman
Brothers in 1993, Mr. Goldfarb served as the Senior Partner of the Ernst &
Young’s Financial Services practice, where he worked from 1979 to 1993.
Mr. Goldfarb, the former EY
Senior Partner, was the Lehman CFO who created the Repo 105 transactions.
End Quote
Jensen Comment
But the Lehman-E&Y Fraternity was merely a local chapter of the larger National
Fraternity. The National Fraternity appears to have been among the FASB, the
Credit Rating Agencies (read that Moody’s) and Big Four alumni working in all
the troubled Wall Street Banks. When drowning in the poison of AAA-rated CDO
Bond Investments that should’ve been rated as junk, the Repo 105 wash sale ploys
were invented to keep the poisoned bond investments off the balance sheet at
fair values along with the wash sale debt obligation to buy them back about a
week after a Wall Street bank’s books closed for the year.
Frank
Partnoy and Lynn Turner proclaim these fiction transactions are all part of the
“fiction” balance sheets of Wall Street banks ---
http://www.rooseveltinstitute.org/sites/all/files/Off-Balance Sheet
Transactions.pdf
The video is at
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Fraternity brothers at the FASB apparently joined in this groupie by making FAS
140 mushy enough to make Repo 105 deceptive sales appear to be legitimate.
Lehman could sell a poisoned CDO bond the day before the books closed as long as
the Repo 105 sales contract had an iron-clad clause to buy the poisoned CDO bond
back at a higher price in about a week. This was a costly Hail Mary effort to
hide the poisoned CDO bonds from the balance sheet and “pretend” with an
orgiastic gasp that the poisoned bonds were sold at a phony price immensely
greater than true fair value of junk.
And yet the FASB continues to stand before the congregation and preach the
virtues of “Fair Value Accounting.”
The FASB makes a huge deal in FAS 133 and FAS 157 about booking financial
contracts at fair value, but in FAS 140 allows its fraternity brothers on Wall
Street (and their Big Four auditors) not to even have to disclose billions in
Repo 105 buy-back obligations. Even an Accounting 101 student can tell the FASB
that this wasn’t really a sale, and even if it was a sale the obligation to buy
it back should’ve been booked as debt.
Francine had the right idea about this being a groupie. But she only hints at a
local chapter of the groupie. I take that back. She does provide the slightest
hint of a National Chapter of that fraternity.
“Liberté, Egalité,
Fraternité: Big Lehman Brothers Troubles For Ernst & Young,” By Francine
McKenna, re; The Auditors, March 15, 2010 ---
http://retheauditors.com/2010/03/15/liberte-egalite-fraternite-lehman-brothers-troubles-for-ernst-young-threaten-the-big-4-fraternity/
Begin Quote (actually Francine’s quoting the
Examiner’s Report)
Lehman initiated its Repo 105 program sometime
in 2001, soon after SFAS 140 took effect in September 2000 Lehman’s outside
auditors and lawyers participated in the firm’s review of SFAS 140. Indeed,
Lehman vetted the concept of a SFAS 140 repo transaction with its outside
auditor, before the firm formalized a Repo 105 accounting policy and
approved Repo 105 transactions for use by firm personnel.
(Bankruptcy Examiner’s Report
V3, page 765)
End Quote
What’s ironic is that Lehman could not even find a shyster law firm in the U.S.
to bless its Repo 105 transactions. If you can’t get a U.S. law firm to lie for
you it must really be a rotten lie. Lehman and E&Y had to go all the way to
England to find a shyster law firm.
"Repos Played a Key Role in Lehman's Demise: Report Exposes Lack of
Information And Confusing Pacts With Lenders," by Suzanne Craig and Mike Spector,
The Wall Street Journal, March 13, 2010 ---
http://online.wsj.com/article/SB20001424052748703447104575118150651790066.html#mod=todays_us_money_and_investing
The rare look into the
repo market embedded in the report comes 18 months after Lehman Brothers
collapsed in the U.S.'s largest bankruptcy filing. While top Lehman executives
were quick to blame the real-estate market for their woes, the exhaustive report
singles out senior executives and auditor Ernst & Young for serious lapses.
The report exposed for
the first time what appears to be an accounting slight of hand known as a Repo
105 transaction, where Lehman was able to book what looked like an ordinary
asset for cash as an out-and-out sale, drastically reducing its leverage and
making its financial picture look better than it really was. The transactions
often were done in flurries in a financial quarter's waning days, before Lehman
reported earnings.
Four days prior to the
close of the 2007 fiscal year, Jerry Rizzieri, a member of Lehman's fixed-income
division, was searching for a way to meet his balance-sheet target, according to
the report. He wrote in an email: "Can you imagine what this would be like
without 105?"
A day before the close of
Lehman's first quarter in 2008, other employees scrambled to make balance-sheet
reductions, the report said. Kaushik Amin, then-head of Liquid Markets, wrote to
a colleague: "We have a desperate situation, and I need another 2 billion from
you, either through Repo 105 or outright sales. Cost is irrelevant, we need to
do it."
Marie Stewart, the former
global head of Lehman's accounting policy group, told the examiner the
transactions were "a lazy way of managing the balance sheet as opposed to
legitimately meeting balance-sheet targets at quarter end."
Lehman's use of this
accounting technique goes back to the start of the decade when Lehman business
units from New York and London met to discuss how the firm could manage its
balance sheet using accounting rules that had taken effect in September 2000.
Lehman soon created the "Repo 105" maneuver: Because assets the firm moved
amounted to 105% or more of the cash it received in return, Lehman could treat
the transactions as sales and remove securities inventory that otherwise would
have to be kept on its balance sheet.
Because no U.S. law firm
would bless the transaction, Lehman got an opinion letter from London-based law
firm Linklaters. That letter essentially blessed using the maneuver for Lehman's
European broker-dealer under English law. If one of Lehman's U.S. entities
needed to engage in a Repo 105 transaction, the firm moved the securities to its
European arm to conduct the deal on the U.S. entity's behalf, the report found.
That is likely why the counterparties on the repo transactions were largely a
group of seven non-U.S. banks. These included Germany's Deutsche Bank AG,
Barclays PLC of the U.K. and Japan's Mitsubishi UFJ Financial Group.
In a statement, a
Linklaters spokeswoman said the report "does not criticize" the legal opinions
it gave Lehman "or suggest or say they were wrong or improper." The law firm
said it was never contacted during the investigation.
Jensen Comment
Although Lehman could not find a shady U.S. law firm to "bless the transaction,"
Ken Lay at Enron managed to find a shady U.S. law firm to bless the Raptors'
transactions after Sherron Watkins (an Enron executive) sent her infamous
whistle blowing memo to both Ken Lay and to Andersen executives in Chicago.---
http://faculty.trinity.edu/rjensen/FraudEnron.htm
Yogi Berra says Lehman bankruptcy
following Enron bankruptcy is auditing “Déjà vu all over again.”
Question
Were the Ernst & Young's auditors negligent or cleverly deceived or complicit in
the deception by the Lehman Brothers?
More from the examiner’s report:
Lehman never publicly disclosed its use of Repo 105
transactions, its accounting treatment for these transactions, the
considerable escalation of its total Repo 105 usage in late 2007 and into
2008, or the material impact these transactions had on the firm’s publicly
reported net leverage ratio. According to former Global Financial Controller
Martin Kelly, a careful review of Lehman’s Forms 10‐K and 10‐Q would not
reveal Lehman’s use of Repo 105 transactions. Lehman failed to disclose its
Repo 105 practice even though Kelly believed “that the only purpose or
motive for the transactions was reduction in balance sheet”; felt that
“there was no substance to the transactions”; and expressed concerns with
Lehman’s Repo 105 program to two consecutive Lehman Chief Financial Officers
– Erin Callan and Ian Lowitt – advising them that the lack of economic
substance to Repo 105 transactions meant “reputational risk” to Lehman if
the firm’s use of the transactions became known to the public. In addition
to its material omissions, Lehman affirmatively misrepresented in its
financial statements that the firm treated all repo transactions as
financing transactions – i.e., not sales – for financial reporting purposes.
"Report
Details How Lehman Hid Its Woes as It Collapsed," by Michael de la Merced and
Andrew Ross Sorkin, The New York Times, March 11, 2010 ---
http://www.nytimes.com/2010/03/12/business/12lehman.html?src=me
It is the Wall Street
equivalent of a coroner’s report — a
2,200-page document
that lays out, in new
and startling detail, how
Lehman Brothers
used accounting sleight of hand to conceal
the bad investments that led to its undoing.
The report, compiled by an examiner for the bank,
now bankrupt, hit Wall Street with a thud late Thursday. The 158-year-old
company, it concluded, died from multiple causes. Among them were bad
mortgage holdings and, less directly, demands by rivals like JPMorgan Chase
and Citigroup, that the foundering bank post collateral against loans it
desperately needed.
But the examiner, Anton R. Valukas, also for the
first time, laid out what the report characterized as “materially
misleading” accounting gimmicks that Lehman used to mask the perilous state
of its finances. The bank’s bankruptcy, the largest in American history,
shook the financial world. Fears that other banks might topple in a cascade
of failures eventually led Washington to arrange a sweeping rescue for the
nation’s financial system.
According to the report, Lehman used what amounted
to financial engineering to temporarily shuffle $50 billion of troubled
assets off its books in the months before its collapse in September 2008 to
conceal its dependence on leverage, or borrowed money. Senior Lehman
executives, as well as the bank’s accountants at Ernst & Young, were aware
of the moves, according to Mr. Valukas, the chairman of the law firm Jenner
& Block and a former federal prosecutor, who filed the report in connection
with Lehman’s bankruptcy case.
Richard S. Fuld Jr., Lehman’s former chief
executive, certified the misleading accounts, the report said.
“Unbeknownst to the investing public, rating
agencies, government regulators, and Lehman’s board of directors, Lehman
reverse engineered the firm’s net leverage ratio for public consumption,”
Mr. Valukas wrote.
Mr. Fuld was “at least grossly negligent,” the
report states, adding that Henry M. Paulson Jr., who was then the Treasury
secretary, warned Mr. Fuld that Lehman might fail unless it stabilized its
finances or found a buyer.
Lehman executives engaged in what the report
characterized as “actionable balance sheet manipulation,” and “nonculpable
errors of business judgment.”
The report draws no conclusions as to whether
Lehman executives violated securities laws. But it does suggest that enough
evidence exists for potential civil claims. Lehman executives are already
defendants in civil suits, but have not been charged with any criminal
wrongdoing.
A large portion of the nine-volume report centers
on the accounting maneuvers, known inside Lehman as “Repo 105.”
First used in 2001, long before the crisis struck,
Repo 105 involved transactions that secretly moved billions of dollars off
Lehman’s books at a time when the bank was under heavy scrutiny.
According to Mr. Valukas, Mr. Fuld ordered Lehman
executives to reduce the bank’s debt levels, and senior officials sought
repeatedly to apply Repo 105 to dress up the firm’s results. Other
executives named in the examiner’s report in connection with the use of the
accounting tool include three former Lehman chief financial officers:
Christopher O’Meara, Erin Callan and Ian Lowitt.
Patricia Hynes, a lawyer for Mr. Fuld, said in an
e-mailed statement that Mr. Fuld “did not know what those transactions were
— he didn’t structure or negotiate them, nor was he aware of their
accounting treatment.”
Charles Perkins, a spokesman for Ernst & Young,
said in an e-mailed statement: “Our last audit of the company was for the
fiscal year ending Nov. 30, 2007. Our opinion indicated that Lehman’s
financial statements for that year were fairly presented in accordance with
Generally Accepted Accounting Principles (GAAP), and we remain of that
view.”
Bryan Marsal, Lehman’s current chief executive, who
is unwinding the firm, said in a statement that he was evaluating the report
to assess how it might help in efforts to advance creditor interests.
Repos, short for repurchase agreements, are a
standard practice on Wall Street, representing short-term loans that provide
sometimes crucial financing. In them, firms essentially lend assets to other
firms in exchange for money for short periods of time, sometimes overnight.
But Lehman used aggressive accounting in its Repo
105 transactions: it appears to have structured transactions such that they
sold securities at the end of the quarter, but planned to buy them back
again days later. These assets were mostly illiquid real estate holdings,
meaning that they were hard to sell in normal transactions.
Continued in article
Jensen Comment
The link to Volume 1 of the Examiner's Report ---
http://dealbook.blogs.nytimes.com/2010/03/11/lehman-directors-did-not-breach-duties-examiner-finds/#reports
"Calif
County Accuses Lehman Executives, Auditor Of Fraud In Suit," CNN, November
13, 2008 ---
Click Here
http://money.cnn.com/news/newsfeeds/articles/djf500/200811131743DOWJONESDJONLINE000915_FORTUNE5.htm
The San Mateo County (Calif.) Investment Pool sued
executives of bankrupt Lehman Brothers Holdings Inc. (LEHMQ)
and their accountants, accusing them of fraud, deceit
and misleading accounting practices that led to the loss
of more than $150 million in county funds.
The suit, filed in San Francisco Superior Court, said
executives of the former Wall Street investment bank
made repeated public statements about its financial
strength while privately scrambling to save it from
collapse.
The suit names former Lehman Chief Executive Richard S.
Fuld Jr., former Chief Financial Officers Christopher M.
O'Meara and Erin Callan, former President Joseph M.
Gregory, certain directors and Ernst & Young, Lehman's
auditor.
It accused Lehman of hiding its exposure to
mortgage-related losses while reporting record profits
for fiscal year 2007 and giving bonuses to its
executives.
"The defendants focused their efforts on trying to save
their company and their jobs with little or no regard to
how their egregious actions harmed those who in good
faith invested in Lehman Brothers," said San Mateo
County Counsel Michael Murphy. "In our view, their
actions were blatantly illegal."
The San Mateo County Investment Pool consists of the
county, school districts, special districts and other
public agencies in the county.
San Mateo County Supervisors Richard Gordon and Rose
Jacobs Gibson called for a federal investigation of the
allegations in the suit, and Supervisor Jerry Hill,
newly elected to the state Assembly, will request
hearings on how many California public entities face
similar losses.
Representatives of Lehman and of Ernst & Young were not
immediately available to comment.
This is but one of many lawsuits and criminal
investigations to be faced Ernst & Young and the other
large auditing firms. Survival of the Big Four will be
precarious ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
|
|
Watch the Video
Its conclusions – that there is credible evidence
against Mr Fuld and others for breach of their fiduciary duties and against
E&Y for professional malpractice – are also a further blow to the battered
credibility of the entire banking industry
Francesco Guerrera, "Lehman file rocks Wall Street," Financial Times, March 12,
2010
Watch the Video ---
http://www.ft.com/cms/s/0/2e412d50-2d6e-11df-a262-00144feabdc0.html?ftcamp=rss
“A Lehman senior vice
president raised questions about the propriety of these transactions as early as
May 2008, but the report said that the accountants at Ernst & Young “took no
steps to question or challenge the non-disclosure of its use of $50bn of
temporary, off balance sheet transactions” ---
http://www.ft.com/cms/s/0/1be0aca2-2d79-11df-a262-00144feabdc0.html?nclick_check=1
Regarding FIN 41
Here’s a somewhat disturbing action by the FASB (caving in to Wall Street banks)
--
http://edmontonobservers.net/fasb-eases-up-on-repo-funding-source/
March 11, 2010 reply from
LynnETurne@aol.com
I’m forwarding this message from Lynn Turner without comment,
because I’m in a bit over my head on this without having studied the
nine-volume set of the Examiner’s report (2,200 pages). In fairness, I will
probably still be in over my head after reading the 2,200 pages.
Lynn Turner is a former Coopers partner who became SEC Chief
Accountant ---
http://www.s-ox.com/dsp_getSpotlightDetails.cfm?CID=2611
He’s one of my professional heroes, and I’ve enjoyed on occasion
sharing a speaking platform with him.
Robert E. (Bob) Jensen
Trinity University Accounting Professor (Emeritus)
190 Sunset Hill Road
Sugar Hill, NH 03586
Tel. 603-823-8482
www.trinity.edu/rjensen
From:
LynnETurne@aol.com [mailto:LynnETurne@aol.com]
Sent: Friday, March 12, 2010 2:07 PM
To: Jensen, Robert
Subject: Fwd: The Lehman Examiners Report on Auditorfs
From: eorenstein@financialexecutives.org
To: lynneturne@aol.com
Sent: 3/12/2010 11:56:58 A.M. Mountain Standard Time
Subj: RE: The Lehman Examiners Report on Auditorfs
Lynn, are you on Prof. Bob Jensen’s listserve (technically, it’s an
accounting listserve out of Loyola University, but Bob Jensen is the most
frequent poster/unofficial chairman of that listserve, so to speak). There
have been numerous posts on their listserve today on that topic (the AECM
listserve, and the CPAs-L listserve), they would probably be interested in
the info you have provided here, including your attachment, you may want to
forward this material to Bob at
rjensen@trinity.edu if you’d like him to share it. Thank you. Regards,
Edith
From:
LynnETurne@aol.com [mailto:LynnETurne@aol.com]
Sent: Friday, March 12, 2010 1:44 PM
To: lynneturne@aol.com
Subject: The Lehman Examiners Report on Auditorfs
Below is the discussion regarding the independent auditors from the
Examiner's report on Lehman. It provides and excellent case study for
students as it properly highlights how the courts and SEC have consistently
said auditors cannot merely hide behind "GAAP." This concept is also
engrained in the language of Sarbanes Oxley which requires executives to
sign off on the fair presentation of financial statements without mentioning
GAAP.
The report also states the auditor did not inform the audit committee of the
transactions in question. There have been other enforcement cases in which
it was found the auditor did not inform the audit committee of questionable
accounting practices. The PCAOB has done work in past years on the standard
for communications between the auditor and audit committee but has never
updated that standard.
From the Lehman Examiner Report - Volume 3, beginning page 945:
"(3) Lehman’s Board of Directors
Without exception, former Lehman directors were unaware of Lehman’s
Repo
105 program and transactions.3642
As discussed in greater detail below, Lehman’s own Corporate Audit group led
by Beth Rudofker, together with Ernst & Young, investigated allegations
about balance
sheet substantiation problems made in a May 16, 2008
“whistleblower” letter sent to
senior management by Matthew Lee.3643 On June 12, 2008, during the
investigation, Lee
informed Ernst & Young about Lehman’s use of $50 billion of Repo 105
transactions in
the second quarter of 2008.3644 At a June 13, 2008 meeting,
Ernst & Young failed to
disclose that allegation to the Board’s Audit Committee.3645
Former Lehman director Cruikshank recalled that he made very clear he wanted
a full and thorough investigation into each allegation made by Lee, whether
the allegation was contained in Lee’s May 16, 2008 letter or raised by Lee
in the course of
the investigation.3646 Another former Lehman director, Berlind, similarly
stated that the
Audit Committee explicitly instructed Lehman’s Corporate Audit Group and
Ernst &
Young to keep the Audit Committee informed of all of Lee’s allegations.3647
Berlind also
said that he would have wanted to know about Lehman’s Repo 105 program and
that if
he had known about Lehman’s Repo 105 transactions, he would have asked
Lehman’s
auditors to test the transactions to ensure they were appropriate.3648 Upon
learning from
the Examiner the volume of Repo 105 transactions at quarter‐end
in late 2007 and 2008,
Sir Christopher Gent said that he believed the volume mandated disclosure to
the Audit
Committee and further investigation.3649
Dr. Kaufman, on the other hand, stated that he would have wanted to know
about Repo 105 transactions only if they were “huge” and fraudulent, by
which he
meant in violation of specific accounting rules or in violation of the
law.3650 Dr.
Kaufman did not believe that $50 billion in Repo 105 transactions was
significant even if
that volume changed Lehman’s net leverage ratio by approximately two
points.3651 Dr.Kaufman considered a four or five point change in the net
leverage ratio to be
significant.3652
In late 2007 and 2008, management made numerous presentations to the Board
regarding balance sheet reduction and deleveraging; in no case was the use
of Repo 105
transactions disclosed in those presentations.3653
i) Ernst & Young’s Knowledge of Lehman’s Repo 105 Program
During several Rule 30(b)(6)‐type3654
interview sessions, the Examiner
interviewed members of Ernst & Young’s Lehman audit team regarding Ernst &
Young’s knowledge of and involvement in Lehman’s Repo 105 program.
(1) Ernst & Young’s Comfort with Lehman’s Repo 105 Accounting
Policy
The Examiner interviewed Ernst & Young’s lead partner on the Lehman audit
team, William Schlich, regarding Lehman’s Repo 105 program. According to
Schlich,
Ernst & Young had been aware of Lehman’s Repo 105 policy and
transactions for many
years.3655
Consistent with the statements of Lehman’s John Feraca (Secured Funding
Desk), Schlich stated that Lehman introduced its Repo 105 Accounting Policy
on the
heels of the FASB’s promulgation of SFAS 140.3656
During that time, Ernst & Young
“discussed” the Repo 105 Accounting Policy (including Lehman’s structure for
Repo
105 transactions) and Ernst & Young’s team had a number of additional
conversations
with Lehman about Repo 105 over the years.3657 However, according to Schlich,
Ernst &Young had no role in the drafting or preparation of Lehman’s Repo 105
Accounting
Policy.3658
Schlich stated definitively that Ernst & Young had no advisory role with
respect
to Lehman’s use of Repo 105 transactions and that Ernst & Young did not
“approve”
the Accounting Policy.3659 Rather, according to Schlich, Ernst & Young
“bec[a]me
comfortable with the Policy for purposes of auditing financial
statements.”3660
Following “consultation and dialogue” about the proper interpretation and
application of SFAS 140, Ernst & Young “clearly. . .concurred with Lehman’s approach”
to SFAS 140 and subsequent literature by FASB on the issue of “control” of
assets
involved in a repo transactions.3661 Ernst &
Young’s view, however, was not based upon
an analysis of whether actual Repo 105 transactions complied with SFAS
140.3662 Rather,
Ernst & Young’s review of Lehman’s Repo 105 Accounting Policy was purely
“theoretical.”3663 In other words, Ernst & Young solely assessed Lehman’s
understanding of the requirements of SFAS 140 in the abstract and as
reflected in its
Accounting Policy; Ernst & Young did not opine on the propriety of the
transactions as a balance sheet management tool.3664 Ernst & Young did not
review the Linklaters letter,
referenced in the Accounting Policy Manual.3665
According to Martin Kelly, it was not unusual for him to discuss various
issues,
including Repo 105, with Ernst & Young.3666 Indeed, Kelly recalled
specifically speaking
with Schlich about Repo 105 transactions soon after becoming Financial
Controller on
December 1, 2007, in an effort to learn more about the program and “to
understand
[Ernst & Young’s] approach before talking to Callan.”3667
Kelly “wanted to ensure that Ernst & Young analyzed the program in the same
way that [Marie] Stewart [Global Head of Accounting Policy] had analyzed
it.”3668
Kelly’s conversations with Ernst & Young focused on the accounting treatment
of Repo
105 transactions.3669 According to Kelly,
Ernst & Young “was comfortable with the
treatment under GAAP for the same reasons that Lehman was comfortable.”3670
Kelly also discussed with Ernst & Young Lehman’s inability to get a true
sale opinion under United States law for Repo 105 transactions.3671 Kelly
could not recall whether he
discussed with Ernst & Young his discomfort with Lehman’s Repo 105
program.3672
(2) The “Netting Grid”
Throughout 2007, Lehman maintained a document entitled “Accounting Policy
Review Balance Sheet Netting and Other Adjustments,” known colloquially
among
Lehman’s Accounting Policy and Balance Sheet Groups, as well at Ernst &
Young, as
the “Netting Grid.” The Netting Grid identified and described various
balance sheet
netting mechanisms employed by Lehman: one such balance sheet mechanisms was
Lehman’s use of Repo 105 transactions.3673
Lehman provided the Netting Grid to Ernst & Young at least in August 2007
(the
close of Lehman’s third quarter 2007) and in November 2007 (the close of
Lehman’s
fiscal year 2007).3674 Notably, the Netting Grid provided by Lehman to Ernst
& Young in
August 2007 and November 2007 only contained Repo 105 volumes from November
30, 2006 and February 28, 2007.3675 Schlich was unaware whether Ernst &
Young asked
Lehman to provide its second quarter 2007 and third quarter 2007 Repo 105
usage
figures or a forecast of Lehman’s fourth quarter 2007 Repo 105 numbers.3676
Ernst & Young reviewed the Netting Grid, analyzed the various balance sheet
netting mechanisms identified in the Netting Grid, and used the document in
connection with its 2007 year‐end audit of
Lehman.3677 According to Schlich,
Ernst &
Young, as part of its review of Lehman’s Netting Grid, approved of Lehman’s
internal Repo 105 Accounting Policy only, and did not pass upon the actual
practice.3678
The Netting Grid described the transactions and United States GAAP reference
as follows: “Under certain conditions that meet the criteria described in
paragraphs 9
and 218 of SFAS 140,
Lehman policy permits reverse repo and repo agreements to be
recharacterized as purchases and sales of inventory.”3679
With respect to Lehman’s use
of Repo 105 transactions to reduce its net balance sheet, the Netting Grid
sets forth the conclusion that Lehman’s “current practice [for Repo 105] is
correct.”3680 Schlich noted
that this conclusion about the Repo 105 practice was Lehman’s, not Ernst &
Young’s.3681
To test Lehman’s conclusion, however, Ernst & Young “reviewed how Lehman
applied
the control provisions of the accounting rules.”3682
Ernst & Young’s review, however, applied only to the accounting basis for
these
transactions, not to their volume or purpose. Specifically, Ernst & Young’s
review and
analysis of Lehman’s Repo 105 program did not account for the volumes of
Repo 105
transactions Lehman undertook at quarter‐end.3683
Indeed, Schlich was unable to
confirm or deny the volumes of Repo 105 transactions Lehman undertook at
Lehman’s
fiscal year‐end 2007, or in the first two quarter‐ends
of 2008.3684 Nor was Schlich able to
confirm or deny that Lehman’s use of Repo 105 transactions was increasing in
late 2007
and into mid 2008.3685
(a) Quarterly Review and Audit
Through Schlich, Ernst & Young maintained that its duties as Lehman’s
auditor
required it to ensure that transactions were accounted for correctly (i.e.,
that they
complied with accounting rules) and that Lehman’s financial disclosures were
not materially misstated.3686 According to Schlich, Ernst & Young’s audit
did not require
Ernst & Young to consider or review the volume or timing of Repo 105
transactions.3687
Accordingly, as part of its year‐end
2007 audit, Ernst & Young did not ask Lehman
about any directional trends, such as whether its Repo 105 activity was
increasing
during fiscal year 2007.3688 Notably, as part of its quarterly review
process, Ernst &
Young did not audit any of Lehman’s Repo 105 transactions.3689
(3) Ernst & Young Would Not Opine on the Materiality of
Lehman’s Repo 105 Usage
Ernst & Young, through Schlich,
was unwilling to
comment to the Examiner on
the materiality of the volume of Lehman’s quarter‐end
Repo 105 transactions.3690 Asked
whether, as part of its responsibility to ensure Lehman’s financial
statements were not
materially misstated,
Ernst & Young should
have considered the possibility that strict technical adherence to SFAS 140
or any other specific accounting rule could nonetheless lead to a material
misstatement in Lehman’s publicly‐reported
financial statements,
Schlich refrained from comment.3691
When pressed further, Schlich stated that the volume of any particular
transaction impacts neither the question of whether accounting rules are
applied correctly, nor the question of whether a financial statement is
materially misleading.3692
However, Schlich eventually acknowledged that “when you look at a balance
sheet
issue, volume is a factor.”3693
Notably,
the definition of “materiality” contained in a “walk‐through”
document
related to Ernst & Young’s 2007 fiscal year‐end
audit of Lehman was: “any transaction
that would move Lehman’s firm‐wide
net leverage by 0.1 or more.”3694 This
definition
reflected “Lehman’s determination of a materiality threshold” in connection
with
Lehman’s own criteria for when to consider reopening and adjusting its
balance
sheet.3695
When Schlich was asked what level of impact to Lehman’s firm‐wide
net assets
Ernst & Young would have considered “material,” Schlich replied that Ernst &
Young
did not have a hard and fast rule defining materiality in the balance sheet
context, and
that, with respect to balance sheet issues, “materiality” depends upon the
facts and
circumstances.3696 Schlich agreed that Lehman made no specific disclosures
about Repo 105 transactions in its Forms 10‐K and
Form 10‐Q,
including the MD&A section.3697
Schlich believed, however, that Lehman’s public filings would have included
general
language regarding secured borrowings and compliance with SFAS 140.3698
Schlich was
not aware whether Ernst & Young ever discussed Lehman’s disclosures vel non
of Repo
105 activity with senior Lehman management.3699
(4) Matthew Lee’s Statements Regarding Repo 105 to Ernst &
Young
On May 16, 2008,
Matthew Lee, then‐Senior
Vice President in the Finance
Division responsible for Lehman’s Global Balance Sheet and Legal Entity
Accounting,
sent a letter to certain members of Lehman’s senior management
identifying possible violations of Lehman’s Ethics Code related to
accounting/balance sheet issues.3700 Lehman involved Ernst & Young in its
investigation of the concerns raised in Lee’s May
16, 2008 letter.3701
Subsequently, less than a month later, on June 12, 2008, Ernst & Young –
Schlich
and Hillary Hansen – interviewed Lee.3702 Hansen’s notes of the interview
reveal that
Lee made certain statements to Ernst & Young about Lehman’s Repo
105 practice,
including, most notably, the volume of Repo 105 activity that Lehman engaged
in at
quarter‐end
(May 31, 2008).3703 Hansen’s notes specifically recount Lee’s allegation that
Lehman moved $50 billion of inventory off its balance sheet at quarter‐end
through
Repo 105 transactions and that
these assets returned to the balance sheet approximately
a
week later.3704
When interviewed by the Examiner, Schlich did not recall Lee saying anything
about Repo 105 transactions during that interview, although he did not
dispute the
authenticity of Hansen’s notes from the Lee interview.3705 In spite of
Hansen’s notes,
Schlich maintained that Ernst & Young did not know that Lehman engaged in
the
following Repo 105 activity during the listed time periods: $49.1 billion at
first quarter
2008 (Feb. 29, 2008); and $50.38 billion at second quarter 2008 (May 31,
2008).3706
During the Examiner’s interview of Hansen, Hansen recalled that while Ernst
&
Young questioned Lee about his May 16, 2008 letter, Lee “rattled off” a list
of additional
issues and concerns he held, one of which was Lehman’s use of Repo 105
transactions.3707 Ernst & Young had no further conversations with Lee about
Repo 105
transactions.3708 Prior to her interview of Lee in June 2008, Hansen had
heard the term
Repo 105 “thrown around” but she did not know its meaning; according to
Hansen,
Schlich described Repo 105 transactions to her shortly after they met with
Lee.3709
Following Ernst & Young’s June 12, 2008 interview of Lee, Schlich and Hansen
met with Lehman’s Gerard Reilly to discuss Lee’s assertions regarding
improper valuations.3710 During that meeting, Hansen informed Reilly of the
$50 billion Repo 105
figure Lee provided during Ernst & Young’s interview of Lee.3711 According
to Schlich,
Reilly (now deceased) told the auditors that he had no knowledge that Lehman
used
Repo 105 transactions to move $50 billion in assets off its balance
sheet.3712 “Hillary
[Hansen] took away from the meeting with Reilly that he did not know and it
was not
$50 billion.”3713
On June 13, 2008 – the day after Lee informed Ernst & Young of the $50
billion in
Repo 105 transactions that Lehman undertook at the end of the second quarter
2008 –
Ernst & Young spoke to Lehman’s Audit Committee
but did not inform the committee
of Lee’s
allegation, even though the Chairman of the Audit Committee had clearly
stated that he wanted every allegation made by Lee – whether in Lee’s May 16
letter or during the course of the investigation – to be investigated.3714
Ernst & Young met with
the Audit Committee on July 8, 2008, to review the second quarter financial
statements and again did not mention Lee’s allegations regarding Repo
105.3715 On July 22, 2008,
Ernst & Young was also present when Beth Rudofker, Head of Corporate Audit,
gave a
presentation to the Audit Committee on the results of the investigation into
Lee’s
allegations.3716
Ernst & Young did not disclose to the Audit Committee – either during the
meetings or in private executive sessions after – that Lee made an
allegation related to
Repo 105 transactions being used to move assets off Lehman’s balance sheet
at quarterend.
3717 Cruikshank told the Examiner that he would have expected to be told
about
Lee’s Repo 105 allegations.3718 Similarly, Sir Gent told the Examiner that
the alleged volume of Lehman’s Repo 105 transactions mandated disclosure to
the Audit
Committee as well as further investigation.3719
Ernst & Young did not follow‐up on
either Lee’s allegations regarding Lehman’s
Repo 105 activity or Reilly’s claim that he had no knowledge of Lehman’s
alleged $50
billion Repo 105 usage figure.3720 Ernst & Young signed a Report of
Independent
Registered Public Accounting Firm for Lehman’s second quarter 2008 Form 10‐Q
on
July 10, 2008, less than four weeks after Schlich and Hansen interviewed
Lee.3721
(5) Accounting‐Motivated
Transactions
Ernst & Young did not evaluate the possibility that Repo 105
transactions were accounting‐motivated
transactions that lacked a business purpose.3722
Schlich
characterized the off‐balance sheet treatment of Lehman’s assets in Repo 105
transactions as a consequence of the accounting rules, rather than a motive
for the
transactions.3723
j) The Examiner’s Conclusions
There is sufficient evidence to support a determination by a trier of fact
that
Lehman’s failure to disclose that it relied upon Repo 105 transactions to
temporarily
reduce the firm’s net balance sheet and net leverage ratio was materially
misleading. In
addition, a trier of fact could find that Lehman affirmatively
misrepresented its
accounting treatment for repos by stating that Lehman treated repo
transactions as
financing transactions rather than sales for financial reporting purposes,
despite the fact
that Lehman treated tens of billions of dollars in repo transactions –
namely, Repo 105
transactions – as true sale transactions.
The Examiner thus concludes that sufficient evidence exists from which a
trier of fact could find the existence of a colorable claim that certain
Lehman officers breached
their fiduciary duties to Lehman and its shareholders by causing the company
to file deficient and materially misleading financial statements, thereby
exposing the company
to potential liability.
Certain officers of Lehman not only failed to inform the public of
its reliance on Repo 105 transactions to reduce its balance sheet, they also
failed to
advise Lehman’s Board of Directors of the firm’s Repo 105 practice. Thus,
the Examiner
concludes that a trier of fact could find that certain Lehman officers
breached their
fiduciary duties to Lehman’s Board of Directors by failing to inform them
of: (1) the
firm’s reliance upon Repo 105 to reduce the balance sheet at quarter‐end,
(2) the rampup
in Repo 105 usage in mid‐to‐late 2007 and 2008, (3) the impact of these transactions
on Lehman’s publicly reported net leverage ratio, or (4) the fact that
Lehman did not
disclose its Repo 105 practice in its publicly reported financials
statements and MD&A.
(1) Materiality
The materiality of information is evaluated from the perspective of a
reasonable
investor.3724 Information is deemed material if there is “a substantial
likelihood that the
disclosure of the omitted fact would have been viewed by the reasonable
investor as having significantly altered the ‘total mix’ of information made
available.”3725
Materiality does not require, however, that the information be of a type
that would
cause an investor to change his investment decision.3726
(a) Whether Lehman’s Repo 105 Transactions Technically
Complied with SFAS 140 Does Not Impact Whether a
Colorable Claim Exists
This Report does not reach the question of whether Lehman’s Repo 105
transactions technically complied with the relevant financial accounting
standard, SFAS
140, because the answer to that question does not impact whether a colorable
claim
exists regarding Lehman’s failure to disclose its Repo 105 practice and
whether that
failure rendered the firm’s financial statements materially misleading.
Even if Lehman’s use of Repo 105 transactions technically
complied with SFAS 140, financial statements may be materially misleading
even when they do not violate GAAP.3727 The Second Circuit has explained
that “GAAP itself recognizes that technical compliance with particular GAAP
rules may lead to misleading financial statements, and
imposes an overall requirement that the statements as a whole accurately
reflect the financial status of the company.”3728
Similarly, as noted in In re Global Crossing Ltd. Securities Litigation,
even if a
defendant established that its accounting practices
“were in technical compliance with
certain individual GAAP provisions . . . this would not necessarily insulate
it from liability. This is because, unlike other regulatory systems, GAAP’s
ultimate goals of fairness and accuracy in reporting require more than mere
technical compliance.”3729
The court
explained that “when viewed as a whole,” GAAP has no “loopholes” because its
purpose, shared by the securities laws, is “to increase investor confidence
by ensuring
transparency and accuracy in financial reporting.”3730
Technical compliance with
specific accounting rules does not automatically lead to fairly presented
financial statements. “Fair presentation is the touchstone for determining
the adequacy of disclosure in financial statements. While adherence to
generally accepted accounting principles is a tool to help achieve that end,
it is not necessarily a guarantee of fairness.”3731 Moreover,
registrants are “required to provide whatever additional information would
be necessary to make the statements in their financial reports fair and
accurate, and not
misleading.”3732
This view is echoed in an SEC enforcement order, concluding that GAAP
compliance does not excuse a misleading or less than full disclosure
regarding a
transaction, especially if the transaction’s purpose is “the attainment of a
particular
financial reporting result.”3733 “[E]ven if the transactions comply with
GAAP, the issuer
is required to evaluate the material accuracy and completeness of the
presentation
made by its financial statements.”3734 Issuers must “ensure that the way
they publicly
portray themselves discloses, as required, the material elements of [their]
economic and
business realities and risks.”3735
3732 Id.
(citing 17 C.F.R. § 240.10b‐5(b)
and 17 C.F.R. § 230.408 (requiring that “in addition to the information
expressly required to be included in a registration statement, there shall
be added such further material information, if any, as may be necessary to
make the required statements, in the light of the circumstances under which
they are made, not misleading”) (emphasis added); see also SEC
v. Seghers, 298 Fed. App’x 319, 331 (5th Cir. 2008)
(“The Commission’s proof of
Segher’s misrepresentations and omissions does not depend on compliance with
GAAP, but instead depends on evidence that Segher’s statements and omissions
were false or misleading to investors.”); United
States v. Olis, Civil Action No. H‐07‐3295, Criminal No. H‐03‐217‐01,
2008 WL 5046342, at *20 (S.D. Tex. Nov. 21, 2008) (“The scheme to defraud
alleged and proved in this case did not turn on whether the treatment
accorded to Project Alpha in Dynegy’s financial statements technically
complied with GAAP or whether Olis and his coconspirators intended to
violate GAAP but, instead, on whether the defendants’ disclosures about
Project Alpha intentionally omitted material facts that caused Dynegy’s
financial statements to be materially false and misleading.”) (citing United
States v. Rigas, 490 F.3d 208, 221 (2d Cir. 2007), and United States v.
Ebbers, 458 F.3d 110, 125‐26
(2d Cir. 2006)).
Repo105 ---
http://en.wikipedia.org/wiki/Repo_105
Repo105.com ---
http://www.repo105.com/
"Colorable claims exist that Ernst & Young did not
meet professional standards, both in investigating Lee's allegations and in
connection with its audit and review of Lehman's financial statements."
For those of you who don't have time to read the entire 2,200-page
Examiners Report
that's so unkind to Ernst & Young and Lehman Executives
"Excerpts from the Lehman Report," The Wall Street Journal,
March 13, 2010 ---
http://online.wsj.com/article/SB10001424052748704131404575117682843690948.html?mod=todays-us-money-and-investing
Thursday, a U.S. bankruptcy-court examiner
investigating the collapse of Lehman Brothers Holdings Inc. released a
scathing 2,200-page report. Here are some highlights.
* * *
Criminal Case? -- "Colorable Claims"
The allegations lodged by a bankruptcy-court
examiner have raised questions about whether prosecutors could build a case
against former Lehman executives.
"Colorable claims exist against the senior officers
who were responsible for balance sheet management and financial disclosure,
who signed and certified Lehman's financial statements and who failed to
disclose Lehman's use and extent of Repo 105 transactions to manage its
balance sheet."
--From
the report, volume 1, executive summary,
page 20
"Colorable claims exist that Ernst & Young did
not meet professional standards, both in investigating Lee's allegations and
in connection with its audit and review of Lehman's financial statements."
--From
the report, executive summary, page 21
"The Examiner finds colorable claims against
JPMorgan Chase ("Chase") and CitiBank in connection with modifications of
guaranty agreements and demands for collateral in the final days of Lehman's
existence. The demands for collateral by Lehman's Lenders had direct impact
on Lehman's liquidity pool; Lehman's available liquidity is central to the
question of why Lehman failed."
--From
the report, executive summary, page 24
* * *
Whistleblower Letter -- "On Its Face Pretty Ugly"
Lehman employee Matthew Lee will gain fame as
one of whistleblowers who tried to prevent the company's demise. The report
says Lehman's auditors refer to Matthew Lee's letter to senior management as
a "whistleblower letter" and an "ugly" one at that. No wonder Lehman's
senior management and outside auditors, Ernst & Young, said they were
"stressed."
"[W]e are also dealing with a whistleblower
letter, that is on its face pretty ugly and will take us a significant
amount of time to get through. I am confident from what I have seen it
shouldn't result in any significant issues around financial reporting, but
again there is a lot of work to do yet. This combined with some very
difficult accounting issues around off balance sheet items is adding stress
to everyone." (From a June 8, 2008, email from William Schlich, a former
lead partner on Ernst & Young's Lehman team)
--From
the report: Volume 3, page 961
Repo 105 -- "Another drug we r on"
The examiner criticized Lehman for the "materially
misleading" approach it took to represent its financial condition. He
focused on the so-called "repo" market, in which firms sell assets in
exchange for cash to fund operations, often just overnight or for a few
days.
The examiner said that Lehman -- anxious to
maintain favorable credit ratings -- engaged in an accounting device known
within the firm as "Repo 105" to essentially park about $50 billion of
assets away from Lehman's balance sheet. The move helped Lehman look like it
had less debt on its books.
"In this way, unbeknownst to the investing public,
rating agencies, Government regulators, and Lehman's Board of Directors,
Lehman reverse engineered the firm's net leverage ratio for public
consumption."
--From
the report, volume 3, page 739
* * *
The Repo 105 strategy sparked debate inside Lehman,
according to the report. In an April 2008 email, Bart McDade called such
accounting maneuvers "another drug we r on." Mr. McDade, then Lehman's
equities chief, says he sought to limit such maneuvers, according to the
report (page 763..
Numerous internal Lehman e-mails referred to Repo
105 transactions in pejorative terms, such as "balance sheet
window-dressing."
An illustrative example is found in the following
July 2008 e-mail exchange:
"Vallecillo: "So what's up with repo 105? Why are
we doing less next quarter end?"
McGarvey: "It's basically window-dressing. We are
calling repos true sales based on legal technicalities. The exec committee
wanted the number cut in half."
Vallecillo: "I see . . . so it's legally do-able
but doesn't look good when we actually do it? Does the rest of the street do
it? Also is that why we have so much BS [balance sheet] to Rates Europe?
McGarvey: "Yes, No and yes. :)"
--From
the report, volume 3, pages 860-866:
* * *
Senior management exerted pressure, particularly at
or near quarter-end, to utilize the Repo 105 mechanism to meet the
firm-imposed balance sheet targets:
Four days before the close of Lehman's fiscal year
in November 2007, Mitch King wrote to Marc Silverberg: "Let me know if we
have room for any more repo 105. I have some more I can put in over month
end." Jerry Rizzieri, who reported directly to Kaushik Amin, replied to
King: "Can you imagine what this would be like without 105?"
--From
the report, volume 3, pages 860-866:
* * *
J.P. Morgan's Collateral Demands -- "Part Art,
Part Science, and Part Catch Up"
Several factors helped to tip Lehman over the brink
in its final days. Investment banks, including J.P. Morgan Chase & Co., made
demands for collateral and modified agreements with Lehman that hurt
Lehman's liquidity and pushed it into bankruptcy.
On September 11, J.P. Morgan executives met to
discuss significant valuation problems with securities that Lehman had
posted as collateral over the summer. J.P. Morgan concluded that the
collateral was not worth nearly what Lehman had claimed it was worth, and
decided to request an additional $5 billion in cash collateral from Lehman
that day. Discussions between Lehman and J.P. Morgan executives were tense.
According to J.P. Morgan witnesses, Steven Black, a senior J.P. Morgan
executive, communicated the $5 billion collateral request to Richard Fuld by
telephone on September 9. Black stated that he explained that the collateral
was intended to cover J.P. Morgan's exposure to Lehman in its entirety.
Lehman posted $5 billion in cash to JPMorgan by the afternoon of Friday,
Sept. 12.
Mr. Black described J.P. Morgan's formulation of
the $5 billion amount to the examiner as "part art, part science, and part
catch up."
"Black stated that he relayed to Fuld that JPMorgan
was not trying to solve JPMorgan's problem by creating new problems for
Lehman. He asserted that he told Fuld that, if Lehman was "near the edge,"
Fuld should say so. According to Black, Fuld asked whether JPMorgan was
interested in making a capital infusion, but JPMorgan was not. Black stated
that he advised Fuld that if Lehman were skating close to the edge, Lehman
should call the Federal Reserve so that the Federal Reserve could "herd the
cats" needed to assist Lehman. According to Black, Fuld said Lehman was not
anywhere close to the point of needing such assistance."
From the report, Volume 4, page 95
* * *
More on J.P. Morgan's Role -- Good Faith and Fair
Dealing?
"Notwithstanding J.P. Morgan's concerns with the
quantity and quality of collateral posted by Lehman, Lehman believed that
J.P. Morgan was overcollateralized. There is no evidence, however, that
Lehman requested in writing the return of the billions of dollars of
collateral it had posted in September. Lehman did informally request the
return of at least some of its collateral, and J.P. Morgan returned some
securities to Lehman on September 12. J.P. Morgan did not, however, release
any of the cash collateral that Lehman had posted in response to the
September 9 and September 11 requests.
"Finally, the examiner concludes that the evidence
may support the existence of a colorable claim – but not a strong claim –
that J.P. Morgan breached the implied covenant of good faith and fair
dealing by making excessive collateral requests to Lehman in September 2008.
A trier of fact would have to consider evidence that the collateral requests
were reasonable and that Lehman waived any claims by complying with the
requests."
--
From the report, volume 4, page 1071
* * *
'Hail Mary' to Warren Buffett:
New details in the report contain insights on why
Buffett passed on Lehman. They open a window on his methods for assessing
management and some of the red flags that waved him off.
"Fuld and Buffett spoke on Friday, March 28, 2008.
They discussed Buffett investing at least $2 billion in Lehman.2439 Two
items immediately concerned Buffet during his conversation with Fuld.2440
First, Buffett wanted Lehman executives to buy under the same terms as
Buffett.2441 Fuld explained to the Examiner that he was reluctant to require
a significant buy‐in from Lehman executives, because they already received
much of their compensation in stock.2442 However, Buffett took it as a
negative that Fuld suggested that Lehman executives were not willing to
participate in a significant way.2443 Second, Buffett did not like that Fuld
complained about short sellers.2444 Buffett thought that blaming short
sellers was indicative of a failure to admit one's own problems."
--From
the report, Volume 2, page 480
* * *
How Liquid was Lehman's Liquidity Pool?
"[T]he importance of liquidity to investment bank
holding companies cannot be overstated. Broker-dealers are dependent on
short-term financing to fund their daily operations, and a robust liquidity
pool is critical to a broker-dealer's access to such financing."
--From
the report, volume 4, page 1066
"By the second week of September 2008, Lehman found
itself in a liquidity crisis; it no longer had sufficient liquidity to fund
its survival. Thus, an understanding of Lehman's collateral transfers, and
Lehman's attendant loss of readily available liquidity, is essential to a
complete understanding of why Lehman ultimately failed."
--
From the report, volume 4, page 1084
"Lehman represented in regulatory filings and in
public disclosures that it maintained a liquidity pool that was intended to
cover expected cash outflows for 12 months in a stressed liquidity
environment and was available to mitigate the loss of secured funding
capacity. After the Bear Stearns crisis in March 2008, it became acutely
apparent to Lehman that any disruption in liquidity could be catastrophic;
Lehman thus paid careful attention to its liquidity pool and how it was
described to the market. Lehman reported the size of its liquidity pool as
$34 billion at the end of first quarter 2008, $45 billion at the end of
second quarter, and $42 billion at the end of the third quarter. Lehman
represented that its liquidity pool was unencumbered – that it was composed
of assets that could be "monetized at short notice in all market
environments."
"The Examiner's investigation of Lehman's transfer
of collateral to its lenders in the summer of 2008 revealed a critical
connection between the billions of dollars in cash and assets provided as
collateral and Lehman's reported liquidity. At first, Lehman carefully
structured certain of its collateral pledges so that the assets would
continue to appear to be readily available (i.e., the Overnight Account at
JPMorgan, the $2 billion comfort deposit to Citi, and the three-day notice
provision with BofA). Witness interviews and documents confirm that Lehman's
clearing banks required this collateral and without it would have ceased
providing clearing and settlement services to Lehman or, at the very least,
would have required Lehman to prefund its trades. The market impact of
either of those outcomes could have been catastrophic for Lehman. Lehman
also included formally encumbered collateral in its liquidity pool. Lehman
included the almost $1 billion posted to HSBC and secured by the U.K. Cash
Deeds in its liquidity pool; Lehman included the $500 million in collateral
formally pledged to BofA; Lehman included an additional $8 billion in
collateral posted to JPMorgan and secured by the September Agreements; and
Lehman continued to include the $2 billion at Citi, even after the Guaranty
and DCSA amendments."
--
From the report, volume 4, page 1082-1083
* * *
"This Section of the Report examines the
circumstances surrounding Lehman's provision of approximately $15 to $21
billion in collateral (both in cash and securities) to its clearing banks,
and Lehman's simultaneous inclusion of those funds in its reported liquidity
pool."
"Critically, the collateral posted by Lehman with
its various clearing banks was initially structured in a manner that enabled
Lehman to claim the collateral as nominally lien-free (at least overnight),
and continue to count it in its reported liquidity pool. However, by
September 2008, much of Lehman's reported liquidity was locked up with its
clearing banks, and yet this fact remained undisclosed to the market prior
to Lehman's bankruptcy."
--
From the report, volume 4, page 1067
\
Also see
http://documents.nytimes.com/lehman-brothers-repo-105-valukas-report#p=1
From the Lehman Examiner Report - Volume 3, beginning page 945
as Forwarded (with highlights) to Bob Jensen by Lynn Turner
"(3) Lehman’s Board of Directors
Without exception, former Lehman directors were unaware of Lehman’s
Repo
105
program and transactions.3642
As discussed in greater detail below, Lehman’s own Corporate Audit group led
by Beth Rudofker, together with Ernst & Young, investigated allegations about
balance
sheet substantiation problems made in a May 16, 2008
“whistleblower” letter sent to
senior management by Matthew Lee.3643 On June 12, 2008, during the
investigation, Lee
informed Ernst & Young about Lehman’s use of $50 billion of Repo 105
transactions in
the second quarter of 2008.3644 At a June 13, 2008 meeting,
Ernst & Young failed to
disclose that allegation to the Board’s Audit Committee.3645
Former Lehman director Cruikshank recalled that he made very clear he wanted
a full and thorough investigation into each allegation made by Lee, whether the
allegation was contained in Lee’s May 16, 2008 letter or raised by Lee in the
course of
the investigation.3646 Another former Lehman director, Berlind, similarly stated
that the
Audit Committee explicitly instructed Lehman’s Corporate Audit Group and Ernst &
Young to keep the Audit Committee informed of all of Lee’s allegations.3647
Berlind also
said that he would have wanted to know about Lehman’s Repo 105 program and that
if
he had known about Lehman’s Repo 105 transactions, he would have asked Lehman’s
auditors to test the transactions to ensure they were appropriate.3648 Upon
learning from
the Examiner the volume of Repo 105 transactions at quarter‐end
in late 2007 and 2008,
Sir Christopher Gent said that he believed the volume mandated disclosure to the
Audit
Committee and further investigation.3649
Dr. Kaufman, on the other hand, stated that he would have wanted to know
about Repo 105 transactions only if they were “huge” and fraudulent, by which he
meant in violation of specific accounting rules or in violation of the law.3650
Dr.
Kaufman did not believe that $50 billion in Repo 105 transactions was
significant even if
that volume changed Lehman’s net leverage ratio by approximately two points.3651
Dr.Kaufman considered a four or five point change in the net leverage ratio to
be
significant.3652
In late 2007 and 2008, management made numerous presentations to the Board
regarding balance sheet reduction and deleveraging; in no case was the use of
Repo 105
transactions disclosed in those presentations.3653
i) Ernst & Young’s Knowledge of Lehman’s Repo 105 Program
During several Rule 30(b)(6)‐type3654
interview sessions, the Examiner
interviewed members of Ernst & Young’s Lehman audit team regarding Ernst &
Young’s knowledge of and involvement in Lehman’s Repo 105 program.
(1) Ernst & Young’s Comfort with Lehman’s Repo 105 Accounting
Policy
The Examiner interviewed Ernst & Young’s lead partner on the Lehman audit
team, William Schlich, regarding Lehman’s Repo 105 program. According to Schlich,
Ernst & Young had been aware of Lehman’s Repo 105 policy and
transactions for many
years.3655
Consistent with the statements of Lehman’s John Feraca (Secured Funding
Desk), Schlich stated that Lehman introduced its Repo 105 Accounting Policy
on the
heels
of the FASB’s promulgation of SFAS 140.3656
During that time, Ernst & Young
“discussed” the Repo 105 Accounting Policy (including Lehman’s structure for
Repo
105 transactions) and Ernst & Young’s team had a number of additional
conversations
with Lehman about Repo 105 over the years.3657 However, according to Schlich,
Ernst &Young had no role in the drafting or preparation of Lehman’s Repo 105
Accounting
Policy.3658
Schlich stated definitively that Ernst & Young had no advisory role with respect
to Lehman’s use of Repo 105 transactions and that Ernst & Young did not
“approve”
the Accounting Policy.3659 Rather, according to Schlich, Ernst & Young “bec[a]me
comfortable with the Policy for purposes of auditing financial statements.”3660
Following “consultation and dialogue” about the proper interpretation and
application of SFAS 140, Ernst & Young “clearly. . .concurred with Lehman’s approach”
to
SFAS 140 and subsequent literature by FASB on the issue of “control” of assets
involved in a repo transactions.3661 Ernst &
Young’s view, however, was not based upon
an analysis of whether actual Repo 105 transactions complied with SFAS 140.3662
Rather,
Ernst & Young’s review of Lehman’s Repo 105 Accounting Policy was purely
“theoretical.”3663 In other words, Ernst & Young solely assessed Lehman’s
understanding of the requirements of SFAS 140 in the abstract and as reflected
in its
Accounting Policy; Ernst & Young did not opine on the propriety of the
transactions as a balance sheet management tool.3664 Ernst & Young did not
review the Linklaters letter,
referenced in the Accounting Policy Manual.3665
According to Martin Kelly, it was not unusual for him to discuss various issues,
including Repo 105, with Ernst & Young.3666 Indeed, Kelly recalled specifically
speaking
with Schlich about Repo 105 transactions soon after becoming Financial
Controller on
December 1, 2007, in an effort to learn more about the program and “to
understand
[Ernst & Young’s] approach before talking to Callan.”3667
Kelly “wanted to ensure that Ernst & Young analyzed the program in the same
way that [Marie] Stewart [Global Head of Accounting Policy] had analyzed
it.”3668
Kelly’s conversations with Ernst & Young focused on the accounting treatment of
Repo
105 transactions.3669 According to Kelly,
Ernst & Young “was comfortable with the
treatment under GAAP for the same reasons that Lehman was comfortable.”3670
Kelly also discussed with Ernst & Young Lehman’s inability to get a true sale
opinion under United States law for Repo 105 transactions.3671 Kelly could not
recall whether he
discussed with Ernst & Young his discomfort with Lehman’s Repo 105 program.3672
(2) The “Netting Grid”
Throughout 2007, Lehman maintained a document entitled “Accounting Policy
Review Balance Sheet Netting and Other Adjustments,” known colloquially among
Lehman’s Accounting Policy and Balance Sheet Groups, as well at Ernst & Young,
as
the “Netting Grid.” The Netting Grid identified and described various balance
sheet
netting mechanisms employed by Lehman: one such balance sheet mechanisms was
Lehman’s use of Repo 105 transactions.3673
Lehman provided the Netting Grid to Ernst & Young at least in August 2007 (the
close of Lehman’s third quarter 2007) and in November 2007 (the close of
Lehman’s
fiscal year 2007).3674 Notably, the Netting Grid provided by Lehman to Ernst &
Young in
August 2007 and November 2007 only contained Repo 105 volumes from November 30,
2006 and February 28, 2007.3675 Schlich was unaware whether Ernst & Young asked
Lehman to provide its second quarter 2007 and third quarter 2007 Repo 105 usage
figures or a forecast of Lehman’s fourth quarter 2007 Repo 105 numbers.3676
Ernst & Young reviewed the Netting Grid, analyzed the various balance sheet
netting mechanisms identified in the Netting Grid, and used the document in
connection with its 2007 year‐end audit of
Lehman.3677 According to Schlich,
Ernst &
Young, as part of its review of Lehman’s Netting Grid, approved of Lehman’s
internal Repo 105 Accounting Policy only, and did not pass upon the actual
practice.3678
The Netting Grid described the transactions and United States GAAP reference
as follows: “Under certain conditions that meet the criteria described in
paragraphs 9
and
218 of SFAS 140,
Lehman policy permits reverse repo and repo agreements to be
recharacterized as purchases and sales of inventory.”3679
With respect to Lehman’s use
of Repo 105 transactions to reduce its net balance sheet, the Netting Grid sets
forth the conclusion that Lehman’s “current practice [for Repo 105] is
correct.”3680 Schlich noted
that this conclusion about the Repo 105 practice was Lehman’s, not Ernst &
Young’s.3681
To test Lehman’s conclusion, however, Ernst & Young “reviewed how Lehman applied
the control provisions of the accounting rules.”3682
Ernst & Young’s review, however, applied only to the accounting basis for these
transactions, not to their volume or purpose. Specifically, Ernst & Young’s
review and
analysis of Lehman’s Repo 105 program did not account for the volumes of Repo
105
transactions Lehman undertook at quarter‐end.3683
Indeed, Schlich was unable to
confirm or deny the volumes of Repo 105 transactions Lehman undertook at
Lehman’s
fiscal year‐end 2007, or in the first two quarter‐ends
of 2008.3684 Nor was Schlich able to
confirm or deny that Lehman’s use of Repo 105 transactions was increasing in
late 2007
and into mid 2008.3685
(a)
Quarterly Review and Audit
Through Schlich, Ernst & Young maintained that its duties as Lehman’s auditor
required it to ensure that transactions were accounted for correctly (i.e., that
they
complied with accounting rules) and that Lehman’s financial disclosures were not
materially misstated.3686 According to Schlich, Ernst & Young’s audit did not
require
Ernst & Young to consider or review the volume or timing of Repo 105
transactions.3687
Accordingly, as part of its year‐end
2007 audit, Ernst & Young did not ask Lehman
about any directional trends, such as whether its Repo 105 activity was
increasing
during fiscal year 2007.3688 Notably, as part of its quarterly review process,
Ernst &
Young did not audit any of Lehman’s Repo 105 transactions.3689
(3)
Ernst & Young Would Not Opine on the Materiality of
Lehman’s Repo 105 Usage
Ernst & Young, through Schlich,
was unwilling to
comment to the Examiner on
the materiality of the volume of Lehman’s quarter‐end
Repo 105 transactions.3690 Asked
whether, as part of its responsibility to ensure Lehman’s financial statements
were not
materially misstated,
Ernst & Young should
have considered the possibility that strict technical adherence to SFAS 140 or
any other specific accounting rule could nonetheless lead to a material
misstatement in Lehman’s publicly‐reported
financial statements,
Schlich refrained from comment.3691
When pressed further, Schlich stated that the volume of any particular
transaction impacts neither the question of whether accounting rules are applied
correctly, nor the question of whether a financial statement is materially
misleading.3692
However, Schlich eventually acknowledged that “when you look at a balance sheet
issue, volume is a factor.”3693
Notably,
the definition of “materiality” contained in a “walk‐through”
document
related to Ernst & Young’s 2007 fiscal year‐end
audit of Lehman was: “any transaction
that
would move Lehman’s firm‐wide
net leverage by 0.1 or more.”3694 This
definition
reflected “Lehman’s determination of a materiality threshold” in connection with
Lehman’s own criteria for when to consider reopening and adjusting its balance
sheet.3695
When Schlich was asked what level of impact to Lehman’s firm‐wide
net assets
Ernst & Young would have considered “material,” Schlich replied that Ernst &
Young
did not have a hard and fast rule defining materiality in the balance sheet
context, and
that, with respect to balance sheet issues, “materiality” depends upon the facts
and
circumstances.3696 Schlich agreed that Lehman made no specific disclosures about
Repo 105 transactions in its Forms 10‐K and
Form 10‐Q,
including the MD&A section.3697
Schlich believed, however, that Lehman’s public filings would have included
general
language regarding secured borrowings and compliance with SFAS 140.3698 Schlich
was
not aware whether Ernst & Young ever discussed Lehman’s disclosures vel non of
Repo
105 activity with senior Lehman management.3699
(4)
Matthew Lee’s Statements Regarding Repo 105 to Ernst &
Young
On May 16, 2008,
Matthew Lee, then‐Senior
Vice President in the Finance
Division responsible for Lehman’s Global Balance Sheet and Legal Entity
Accounting,
sent a letter to certain members of Lehman’s senior management
identifying possible violations of Lehman’s Ethics Code related to
accounting/balance sheet issues.3700 Lehman involved Ernst & Young in its
investigation of the concerns raised in Lee’s May
16, 2008 letter.3701
Subsequently, less than a month later, on June 12, 2008, Ernst & Young – Schlich
and Hillary Hansen – interviewed Lee.3702 Hansen’s notes of the interview reveal
that
Lee made certain statements to Ernst & Young about Lehman’s Repo
105 practice,
including, most notably, the volume of Repo 105 activity that Lehman engaged in
at
quarter‐end
(May 31, 2008).3703 Hansen’s notes specifically recount Lee’s allegation that
Lehman moved $50 billion of inventory off its balance sheet at quarter‐end
through
Repo 105 transactions and that
these assets returned to the balance sheet approximately
a
week later.3704
When interviewed by the Examiner, Schlich did not recall Lee saying anything
about Repo 105 transactions during that interview, although he did not dispute
the
authenticity of Hansen’s notes from the Lee interview.3705 In spite of Hansen’s
notes,
Schlich maintained that Ernst & Young did not know that Lehman engaged in the
following Repo 105 activity during the listed time periods: $49.1 billion at
first quarter
2008 (Feb. 29, 2008); and $50.38 billion at second quarter 2008 (May 31,
2008).3706
During the Examiner’s interview of Hansen, Hansen recalled that while Ernst &
Young questioned Lee about his May 16, 2008 letter, Lee “rattled off” a list of
additional
issues and concerns he held, one of which was Lehman’s use of Repo 105
transactions.3707 Ernst & Young had no further conversations with Lee about Repo
105
transactions.3708 Prior to her interview of Lee in June 2008, Hansen had heard
the term
Repo 105 “thrown around” but she did not know its meaning; according to Hansen,
Schlich described Repo 105 transactions to her shortly after they met with
Lee.3709
Following Ernst & Young’s June 12, 2008 interview of Lee, Schlich and Hansen
met with Lehman’s Gerard Reilly to discuss Lee’s assertions regarding improper
valuations.3710 During that meeting, Hansen informed Reilly of the $50 billion
Repo 105
figure Lee provided during Ernst & Young’s interview of Lee.3711 According to
Schlich,
Reilly (now deceased) told the auditors that he had no knowledge that Lehman
used
Repo 105 transactions to move $50 billion in assets off its balance sheet.3712
“Hillary
[Hansen] took away from the meeting with Reilly that he did not know and it was
not
$50 billion.”3713
On June 13, 2008 – the day after Lee informed Ernst & Young of the $50 billion
in
Repo 105 transactions that Lehman undertook at the end of the second quarter
2008 –
Ernst & Young spoke to Lehman’s Audit Committee
but did not inform the committee
of Lee’s
allegation, even though the Chairman of the Audit Committee had clearly stated
that he wanted every allegation made by Lee – whether in Lee’s May 16 letter or
during the course of the investigation – to be investigated.3714
Ernst & Young met with
the Audit Committee on July 8, 2008, to review the second quarter financial
statements and again did not mention Lee’s allegations regarding Repo 105.3715
On July 22, 2008,
Ernst & Young was also present when Beth Rudofker, Head of Corporate Audit, gave
a
presentation to the Audit Committee on the results of the investigation into
Lee’s
allegations.3716
Ernst & Young did not disclose to the Audit Committee – either during the
meetings or in private executive sessions after – that Lee made an allegation
related to
Repo 105 transactions being used to move assets off Lehman’s balance sheet at
quarterend.
3717 Cruikshank told the Examiner that he would have expected to be told about
Lee’s Repo 105 allegations.3718 Similarly, Sir Gent told the Examiner that the
alleged volume of Lehman’s Repo 105 transactions mandated disclosure to the
Audit
Committee as well as further investigation.3719
Ernst & Young did not follow‐up on
either Lee’s allegations regarding Lehman’s
Repo 105 activity or Reilly’s claim that he had no knowledge of Lehman’s alleged
$50
billion Repo 105 usage figure.3720 Ernst & Young signed a Report of Independent
Registered Public Accounting Firm for Lehman’s second quarter 2008 Form 10‐Q
on
July 10, 2008, less than four weeks after Schlich and Hansen interviewed
Lee.3721
(5) Accounting‐Motivated
Transactions
Ernst & Young did not evaluate the possibility that Repo 105
transactions were accounting‐motivated
transactions that lacked a business purpose.3722
Schlich
characterized the off‐balance sheet treatment of Lehman’s assets in Repo 105
transactions as a consequence of the accounting rules, rather than a motive for
the
transactions.3723
j)
The Examiner’s Conclusions
There is sufficient evidence to support a determination by a trier of fact that
Lehman’s failure to disclose that it relied upon Repo 105 transactions to
temporarily
reduce the firm’s net balance sheet and net leverage ratio was materially
misleading. In
addition, a trier of fact could find that Lehman affirmatively misrepresented
its
accounting treatment for repos by stating that Lehman treated repo transactions
as
financing transactions rather than sales for financial reporting purposes,
despite the fact
that Lehman treated tens of billions of dollars in repo transactions – namely,
Repo 105
transactions – as true sale transactions.
The Examiner thus concludes that sufficient evidence exists from which a trier
of fact could find the existence of a colorable claim that certain Lehman
officers breached
their
fiduciary duties to Lehman and its shareholders by causing the company to file
deficient and materially misleading financial statements, thereby exposing the
company
to
potential liability.
Certain officers of Lehman not only failed to inform the public of
its reliance on Repo 105 transactions to reduce its balance sheet, they also
failed to
advise Lehman’s Board of Directors of the firm’s Repo 105 practice. Thus, the
Examiner
concludes that a trier of fact could find that certain Lehman officers breached
their
fiduciary duties to Lehman’s Board of Directors by failing to inform them of:
(1) the
firm’s reliance upon Repo 105 to reduce the balance sheet at quarter‐end,
(2) the rampup
in Repo 105 usage in mid‐to‐late 2007 and 2008, (3) the impact of these transactions
on Lehman’s publicly reported net leverage ratio, or (4) the fact that Lehman
did not
disclose its Repo 105 practice in its publicly reported financials statements
and MD&A.
(1)
Materiality
The materiality of information is evaluated from the perspective of a reasonable
investor.3724 Information is deemed material if there is “a substantial
likelihood that the
disclosure of the omitted fact would have been viewed by the reasonable investor
as having significantly altered the ‘total mix’ of information made
available.”3725
Materiality does not require, however, that the information be of a type that
would
cause an investor to change his investment decision.3726
(a)
Whether Lehman’s Repo 105 Transactions Technically
Complied with SFAS 140 Does Not Impact Whether a
Colorable Claim Exists
This Report does not reach the question of whether Lehman’s Repo 105
transactions technically complied with the relevant financial accounting
standard, SFAS
140, because the answer to that question does not impact whether a colorable
claim
exists regarding Lehman’s failure to disclose its Repo 105 practice and whether
that
failure rendered the firm’s financial statements materially misleading.
Even if Lehman’s use of Repo 105 transactions technically
complied with SFAS 140, financial statements may be materially misleading even
when they do not violate GAAP.3727 The Second Circuit has explained that “GAAP
itself recognizes that technical compliance with particular GAAP rules may lead
to misleading financial statements, and
imposes an overall requirement that the statements as a whole accurately reflect
the financial status of the company.”3728
Similarly, as noted in In re Global Crossing Ltd. Securities Litigation, even if
a
defendant established that its accounting practices
“were in technical compliance with
certain individual GAAP provisions . . . this would not necessarily insulate it
from liability. This is because, unlike other regulatory systems, GAAP’s
ultimate goals of fairness and accuracy in reporting require more than mere
technical compliance.”3729
The court
explained that “when viewed as a whole,” GAAP has no “loopholes” because its
purpose, shared by the securities laws, is “to increase investor confidence by
ensuring
transparency and accuracy in financial reporting.”3730
Technical compliance with
specific accounting rules does not automatically lead to fairly presented
financial statements. “Fair presentation is the touchstone for determining the
adequacy of disclosure in financial statements. While adherence to generally
accepted accounting principles is a tool to help achieve that end, it is not
necessarily a guarantee of fairness.”3731 Moreover,
registrants are “required to provide whatever additional information would be
necessary to make the statements in their financial reports fair and accurate,
and not
misleading.”3732
This view is echoed in an SEC enforcement order, concluding that GAAP
compliance does not excuse a misleading or less than full disclosure regarding a
transaction, especially if the transaction’s purpose is “the attainment of a
particular
financial reporting result.”3733 “[E]ven if the transactions comply with GAAP,
the issuer
is required to evaluate the material accuracy and completeness of the
presentation
made by its financial statements.”3734 Issuers must “ensure that the way they
publicly
portray themselves discloses, as required, the material elements of [their]
economic and
business realities and risks.”3735
3732 Id.
(citing 17 C.F.R. § 240.10b‐5(b)
and 17 C.F.R. § 230.408 (requiring that “in addition to the information
expressly required to be included in a registration statement, there shall be
added such further material information, if any, as may be necessary to make the
required statements, in the light of the circumstances under which they are
made, not misleading”) (emphasis added); see also SEC v. Seghers,
298 Fed. App’x 319, 331 (5th Cir. 2008)
(“The Commission’s proof of Segher’s misrepresentations and omissions
does not depend on compliance with GAAP, but instead depends on evidence that
Segher’s statements and omissions were false or misleading to investors.”); United States v. Olis, Civil Action No. H‐07‐3295,
Criminal No. H‐03‐217‐01, 2008 WL 5046342, at *20 (S.D. Tex. Nov. 21, 2008) (“The scheme
to defraud alleged and proved in this case did not turn on whether the treatment
accorded to Project Alpha in Dynegy’s financial statements technically complied
with GAAP or whether Olis and his coconspirators intended to violate GAAP but,
instead, on whether the defendants’ disclosures about Project Alpha
intentionally omitted material facts that caused Dynegy’s financial statements
to be materially false and misleading.”) (citing United States v. Rigas, 490
F.3d 208, 221 (2d Cir. 2007), and United States v. Ebbers, 458 F.3d 110, 125‐26 (2d Cir. 2006)).
Bob Jensen's threads on Ernst & Young ---
http://faculty.trinity.edu/rjensen/fraud001.htm
Ernst & Young Explains Its Side of the Lehman Bankruptcy Examiner's Report
Controversy
March 19, 2010 message from Dennis Beresford
[dberesfo@TERRY.UGA.EDU]
In light of the extensive
discussion of the Lehman Bros. and E&Y matter on this listserv over the past
couple of weeks, I thought readers might be interested in the message I've
copied below. This was sent to me in my capacity as an audit committee
chairman.
I hope this might balance the
discussion somewhat. I would observe that to date the postings have been
based mainly on newspaper accounts of the bankruptcy examiner's lengthy
report that was completed for the purpose of determining whether the
bankruptcy estate might have claims against various parties. In effect,
basing one's conclusions about a situation on this source material is
roughly equivalent to a judge or jury reaching a decision after hearing only
the prosecution's side of the case. While the message below is necessarily
very brief, I think it illustrates that there are other facts and arguments
that should be fairly evaluated before anyone is found guilty in the court
of public opinion or otherwise.
Denny Beresford
I hope this note finds you
well and enjoying the early days of Spring.
In light of your role in our
Audit Committee Leadership Network, I am sending you this note to brief you
on a matter given there have been extensive media reports about the release
of the Bankruptcy Examiner’s Report relating to the September 2008
bankruptcy of Lehman Brothers. As you may have read, Ernst & Young was
Lehman Brothers’ independent auditors.
The concept of an examiner’s
report is a feature of US bankruptcy law.
It does not represent the
views of a court or a regulatory body, nor is the Report the result of a
legal process. Instead, an examiner’s report is intended to identify
potential claims that, if pursued, may result in a recovery for the bankrupt
company or its creditors. EY is confident we will prevail should any of the
potential claims identified against us be pursued.
We wanted to provide you with
EY’s perspective on some of the potential claims in the Examiner’s Report.
We also wanted to address certain media coverage and commentary on the
Examiner’s Report that has at times been inaccurate, if not misleading.
A few key points are set out
below.
*_General Comments_*
· EY’s last audit was for the
year ended November 30, 2007. Our opinion stated that Lehman’s financial
statements for 2007 were fairly presented in accordance with US GAAP, and we
remain of that view. We reviewed but did not audit the interim periods for
Lehman’s first and second quarters of fiscal 2008.
· Lehman’s bankruptcy was the
result of a series of unprecedented adverse events in the financial markets.
The months leading up to Lehman’s bankruptcy were among the most turbulent
periods in our economic history. Lehman's bankruptcy was caused by a
collapse in its liquidity, which was in turn caused by declining asset
values and loss of market confidence in Lehman. It was not caused by
accounting issues or disclosure issues.
· The Examiner identified _no_
potential claims that the assets and liabilities reported on Lehman’s
financial statements (approximately
$691 billion and $669 billion
respectively, at November 30, 2007) were improperly valued or accounted for
incorrectly.
*_Accounting and Disclosure
Issues Relating to Repo 105 Transactions_* · There has been significant
media attention about potential claims identified by the Examiner related to
what Lehman referred to as “Repo 105” transactions. What has not been
reported in the media is that the Examiner _did not_ challenge Lehman’s
accounting for its Repo 105 transactions.
·As recognized by the
Examiner, all investment banks used repo transactions extensively to fund
their operations on a daily basis; these banks all operated in a high-risk,
high-leverage business model.
Most repo transactions are
accounted for as financings; some (the Repo
105 transactions) are
accounted for as sales if they meet the requirements of SFAS 140.
· The Repo 105 transactions
involved the sale by Lehman of high quality liquid assets (generally
government-backed securities), in return for which Lehman received cash. The
media reports that these were “sham transactions” designed to off-load
Lehman’s “bad assets” are inaccurate.
· Because effective control of
the securities was surrendered to the counterparty in the Repo 105
arrangements, the accounting literature (SFAS 140) /required /Lehman to
account for Repo 105 transactions as sales rather than financings.
· The potential claims against
EY arise solely from the Examiner’s conclusion that these transactions
($38.6 billion at November 30, 2007) should have been specifically disclosed
in the footnotes to Lehman’s financial statements, and that Lehman should
have disclosed in its MD&A the impact these transactions would have had on
its leverage ratios if they had been recorded as financing transactions.
· While no specific
disclosures around Repo 105 transactions were reflected in Lehman’s
financial statement footnotes, the 2007 audited financial statements were
presented in accordance with US GAAP, and clearly portrayed Lehman as a
leveraged entity operating in a risky and volatile industry. Lehman’s 2007
audited financial statements included footnote disclosure of off balance
sheet commitments of almost $1 trillion.
· Lehman’s leverage ratios are
not a GAAP financial measure; they were included in Lehman’s MD&A, not its
audited financial statements. Lehman concluded no further MD&A disclosures
were required; EY did not take exception to that judgment.
· If the Repo 105 transactions
were treated as if they were on the balance sheet for leverage ratio
purposes, as the Examiner suggests, Lehman’s reported gross leverage would
have been 32.4 instead of 30.7 at November 30, 2007. Also, contrary to media
reports, the decline in Lehman’s reported leverage from its first to second
quarters of 2008 was not a result of an increased use of Repo 105
transactions*. *Lehman’s Repo 105 transaction volumes were comparable at the
end of its first and second quarters.
*_Handling of the
Whistleblower’s Issues_*
· The media has inaccurately
reported that EY concealed a May 2008 whistleblower letter from Lehman’s
Audit Committee. The whistleblower letter, which raised various significant
potential concerns about Lehman’s financial controls and reporting /but did
not mention Repo 105/, was directed to Lehman’s management. When we learned
of the letter, our lead partner promptly called the Audit Committee Chair;
we also insisted that Lehman’s management inform the Securities & Exchange
Commission and the Federal Reserve Bank of the letter. EY’s lead partner
discussed the whistleblower letter with the Lehman Audit Committee on at
least three occasions during June and July 2008.
· In the investigations that
ensued, the writer of the letter did briefly reference Repo 105 transactions
in an interview with EY partners. He also confirmed to EY that he was
unaware of any material financial reporting errors. Lehman’s senior
executives did not advise us of any reservations they had about the
company’s Repo 105 transactions.
· Lehman’s September 2008
bankruptcy prevented EY from completing its assessment of the
whistleblower’s allegations. The allegations would have been the subject of
significant attention had EY completed its third quarter review and 2008
year-end audit.
Should any of the potential
claims be pursued, we are confident we will prevail.
March 20, 2010 reply from Bob Jensen
Hi Denny,
Thank you for this. I was worried that Ernst & Young
would refrain from commenting on this hot topic that will probably end up in
pending litigation.
The E&Y response is terribly discouraging to me
because the audit firm tries to hide behind the letter of the rules of GAAP
rather than the spirit of GAAP. Yesterday I pointed out that USC's Jerry
Arnold (who is truly an expert on the rules of GAAP) tried to earn his
million dollars defending Enron's founder, Ken Lay, by arguing in court that
Enron abided by the letter of GAAP (except where Andy Fastow was lying about
SPEs and really embezzling money from Enron itself). In Ken Lay's case
Arnold's testimony did not prevent his client's being found guilty on ten
counts of fraud and conspiracy to mislead investors in Enron's audited
financial statements. In court, the verdicts often focus on the spirit of
the law instead of the letter of the law.
I am particularly distressed by the following claim
(in the message below) by Ernst & Young:
Begin Quotation
Because effective control of the securities was
surrendered to the
counterparty in the Repo 105 arrangements, the
accounting literature
(SFAS 140) /required /Lehman to account for
Repo 105 transactions as
sales rather than financings.
End Quotation
If Lehman is obligated in a matter of days to buy
back the poisoned Repo 105 securities at prices greater than the “selling
prices” I have a hard time with the auditor’s assertion that these were
legitimate sales where the seller gave up control. The buyer is not like to
keep those securities or sell them to anybody other than Lehman since the
selling prices were phony inflated prices way above fair market value.
This is a Jerry Arnold déjà vu where auditors are
trying to hide behind the letter of accounting rules but not the spirit of
accounting rules. It makes a mockery out of the “present fairly” concept. If
this was anything but a ploy from having to show impaired-value assets on
the balance sheet I will eat my hat.
I will never, ever accept the E&Y argument that the
2007 audited report of Lehman fairly presented the poison CDO investments of
Lehman. The poison in those CDOs existed before the end of 2007, and surely
the auditors must've known the bad debt reserves were underestimated by
hundreds of billions of dollars. Where were the asset impairment tests
required for auditors?
Where were the auditors?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Bob Jensen
It seems to me that there’s a whole lot more
professionalism issues involved in the Lehman audits and reviews just like
there should’ve been a whole lot more involved in the Enron audits and
reviews.
In any event, Andersen does not appear to
have applied the GAAP requirement to recognize asset impairment (FAS 121).
From our reading of the Powers Report, the put-options written by the SPEs
that, presumably, offset Enron's losses on its merchant investment, were not
collectible, because the SPEs did not have sufficient net assets.
"ENRON: what happened and what we can learn from it," by George J. Benston
and Al L. Hartgraves, Journal of Accounting and Public Policy, 2002,
pp. 125-137:
3.3 Independent public accountants (CPAs)
The highly respected firm of Arthur Andersen
audited and unqualifiedly signed Enron's financial statements since 1985.
According to the Powers Report, Andersen was consulted on and participated
with Fastow in setting up the SPEs described above. Together, they crafted
the SPEs to conform to the letter of the GAAP requirement that the ownership
of outside, presumably independent, investors must be at least 3% of the SPE
assets. At this time, it is very difficult to understand why they
determined that Fastow was an independent investor. Kopper's independence
also is questionable, because he worked for Fastow. In any event, Andersen
appears, at best, to have accepted as sufficient Enron's conformance with
the minimum specified requirements of codified GAAP. They do not appear to
have realized or been concerned that the substance of GAAP was violated,
particularly with respect to the independence of the SPEs that permitted
their activities to be excluded from Enron's financial statements and the
recording of mark-to-market-based gains on assets and sales that could not
be supported with trustworthy numbers (because these did not exist). They
either did not examine or were not concerned that the put obligations from
the SPEs that presumably offset declines in Enron's investments (e.g.,
Rhythms) were of no or little economic value. Nor did they require Enron to
record as a liability or reveal as a contingent liability its guarantees
made by or though SPEs. Andersen also violated the letter of GAAP and GAAS
by allowing Enron to record issuance of its stock for other than cash as an
increase in equity. Andersen also did not have Enron adequately report, as
required, related-party dealings with Fastow, an executive officer of Enron,
and the consequences to stockholders of his conflict of interest.
4.1 GAAP
We believe that two important shortcomings
have been revealed. First, the US model of specifying rules that must be
followed appears to have allowed or required Andersen to accept procedures
that accord with the letter of the rules, even though they violate the basic
objectives of GAAP accounting. Whereas most of the SPEs in question
appeared to have the minimum-required 3% of assets of independent ownership,
the evidence outlined above indicates that Enron in fact bore most of the
risk. In several important situations, Enron very quickly transferred funds
in the form of fees that permitted the 3% independent owners to retrieve
their investments, and Enron guaranteed the SPEs liabilities. Second, the
fair-value requirement for financial instruments adopted by the FASB
permitted Enron to increase its reported assets and net income and thereby,
to hide losses. Andersen appears to have accepted these valuations (which,
rather quickly, proved to be substantially incorrect), because Enron was
following the specific GAAP rules.
Andersen, though, appears to have violated
some important GAAP and GAAS requirements. There is no doubt that Andersen
knew that the SPEs were managed by a senior officer of Enron, Fastow, and
that he profited from his management and partial ownership of the SPEs he
structured. On that basis alone, it seems that Andersen should have
required Enron to consolidate the Fastow SPEs with its financial statements
and eliminate the financial transactions between those entities and Enron.
Furthermore, it seems that the SPEs established by Fastow were unlikely to
be able to fulfill the role of closing put options written to offset losses
in Enron's merchant investments. If this were the purpose, the options
should and would have been purchased from an existing institution that could
meet its obligations.
Andersen also seems to have allowed Enron to
violate the requirement specified in FASB Statement 5 that guarantees of
indebtedness and other loss contingencies that in substance have the same
characteristics, should be disclosed even if the possibility of loss is
remote. The disclosure shall include the nature and the amount of the
guarantee. Even if Andersen were correct in following the letter, if not
the spirit of GAAP in allowing Enron to not consolidate those SPEs in which
independent parties held equity equal to at least 3% of assets, Enron's
contingent liabilities resulting from its loan guarantees should have been
disclosed and described.
In any event, Andersen does not appear to have
applied the GAAP requirement to recognize asset impairment (FAS 121). From
our reading of the Powers Report, the put-options written by the SPEs that,
presumably, offset Enron's losses on its merchant investment, were not
collectible, because the SPEs did not have sufficient net assets.
(Details on the SPEs' financial situations should have been available to
Andersen.) GAAP (FAS 5) also requires a liability to be recorded when it is
probable that an obligation has been incurred and the amount of the related
loss can reasonable be estimated. The information presently available
indicates that Enron's guarantees on the SPEs and Kopper's debt had become
liabilities to Enron. It does not appear that they were reported as such.
GAAP (FAS 57) specifies that relationships
with related parties "cannot be presumed to be carried out on an
arm's-length basis, as the requisite conditions be competitive, free-market
dealings may not exist". As Executive Vice President and CFO, Fastow
clearly was a "related party". SEC Regulation S-K (Reg. §229.404. Item 404)
requires disclosure of details of transactions with management, including
the amount and remuneration of the managers from the transactions. Andersen
does not appear to have required Enron to meet this obligation. Perhaps
more importantly, Andersen did not reveal the extent to which Fastow
profited at the expense of Enron's shareholders, who could only have
obtained this information if Andersen had insisted on its inclusion in
Enron's financial statements.
4.2 GAAS
SAS 85 warns auditors not to rely on
management representations about onset values, liabilities, and
related-party transactions, among other important items. Appendix B to SAS
85 illustrates the information that should be obtained by the auditor to
review how management determined the fair values of significant assets that
do not have readily determined market values. We do not have access to
Andersen's working papers to examine whether or not they followed this GAAS
requirement. In the light of the Wall Street Journal report presented above
of Enron's recording a fair value for the Braveheart project with
Blockbuster Inc., though, we find it difficult to believe that Andersen
followed the spirit and possibly not even the letter of this GAAS
requirement.
SAS 45 and AICPA, Professional Standards, vol.
1, AU sec. 334 specify audit requirements and disclosures for transactions
with related parties. As indicated above, this requirement does not appear
to have been followed.
An additional lesson that should be derived
from the Enron debacle is that auditors should be aware of the ability of
opportunistic managers to use financial engineering methods, to get around
the requirements of GAAP. For example, derivatives used as hedges can be
structured to have gains on one side recorded at market or fair values while
offsetting losses are not recorded, because they do not qualify for
restatement to fair-value. Another example is a loan disguised as a sale of
a corporation's stock with guaranteed repurchase from the buyer at a higher
price. If this subterfuge were not discovered, liabilities and interest
expense would be understated. Thus, as auditors have learned to become
familiar with computer systems, they must become aware of the means by which
modern finance techniques can be used to subvert GAAP.
The above findings from the Powers Report appear to be inconsistent with
the testimony of four years later.
"Accountants: Enron Financials Correct ," by Michael Graczyk (Associated
Press Writer), SmartPros, May 4, 2006 ---
http://accounting.smartpros.com/x52873.xml
May 4, 2006 (Associated Press) — Last-minute
changes to quarterly earnings reports prosecutors contend were ordered by
Enron Corp. Chief Executive Jeffrey Skilling to improve the company's
reputation on Wall Street were accurate, and not the result of improper
tapping of company reserves, a defense expert testified Wednesday.
"The whole process of financial reporting, in
a company as large as Enron, to get financial statements out ... is an
enormous undertaking," said Walter Rush, an accounting expert hired by
Skilling. "And people are scrambling, trying to get these estimates put
together.
"There are changes going on up to the very
last second. It is universal. Every company goes through this."
Rush was the second consecutive accounting
expert to take the stand, following University of Southern California
professor Jerry Arnold, who testified for Enron founder and former CEO
Kenneth Lay.
They are among the last defense witnesses, as
lawyers for the two top chiefs at Enron expect to conclude their case early
next week, the 15th week of their federal fraud trial.
Mark Koenig, former head of investor relations
at Enron, testified early in the trial that he believed top Enron executives
were so bent on meeting or beating earnings expectations to keep analysts
bullish on the company's stock that they made or knew of overnight changes
to estimates. Paula Rieker, Koenig's former top lieutenant, said Koenig told
her Skilling ordered abrupt last-minute changes to two quarterly earnings
reports to please analysts and investors.
"They could have just had a bad number," Rush
said, referring to Koenig's and Rieker's testimony about a late-night change
in a fourth-quarter 1999 report that boosted earnings per share from 30
cents to 31 cents.
Arthur Andersen, Enron's outside accounting
firm, already had the 31-cent number days earlier, Rush said.
"They could have been a couple steps behind
the way the process was evolving," he said of Koenig and Rieker.
In addition, Rush said the intention to "beat
the street," a phrase attributed to Skilling, was typical in business.
"Companies set goals and forecasts for
themselves all the time," Rush said.
Prosecutors also contend Enron achieved its
rosy earnings by drawing improperly from reserves. But Rush, responding
specifically to second-quarter earnings in 2000, said a transfer from one
reserve was not material since Enron had another, underreported reserve.
"That number had the effect of understating
Enron's profits," he said.
He also disputed government contentions Enron
executives improperly moved parts of the company's retail operation into its
highly profitable wholesale business unit to hide financial problems under
the guise of an accounting process called "resegmentation."
"I do believe it was properly disclosed and
properly accounted for," Rush said, adding that he believed Enron went
beyond the rules in disclosing particulars about the resegmentation.
"The rules only require we tell we have made a
resegmentation. You just merely need to alert the reader there has been a
change."
Earlier Wednesday, Arnold repeated his
sentiment that Lay did not mislead investors about the company's financial
health in the weeks before it filed for bankruptcy protection in December
2001.
Arnold said third-quarter 2001 financial
statements cited by Lay in discussions with investors complied with
Securities and Exchange Commission rules.
"That is my view," he said, answering repeated
questions about the quarter when Enron reported $638 million in losses and a
$1.2 billion reduction in shareholder equity.
The government contends Lay knew many Enron
assets were overvalued and that losses were coming and misrepresented this
to the public.
Several former high-ranking Enron executives
have testified Lay misled investors when he said the losses were one-time
events.
"I disagree with their interpretation," Arnold
said, who noted his company had been paid $1 million for his work on the
Enron defense.
Only 10 minutes into his testimony Wednesday,
U.S. District Judge Sim Lake grew impatient when Arnold and prosecutor
Andrew Stolter repeatedly went round and round on the same question.
"I'm not going to have sparring over minor,
uncontroverted issues," a clearly irritated Lake barked.
Skilling, who testified earlier, and Lay, who
wrapped up six days on the witness stand Tuesday, are accused of repeatedly
lying to investors and employees about Enron when prosecutors say they knew
the company's success stemmed from accounting tricks.
Skilling faces 28 counts of fraud, conspiracy,
insider trading and lying to auditors, while Lay faces six counts of fraud
and conspiracy.
The two men counter no fraud occurred at Enron
other than that committed by a few executives, like Fastow, who stole money
through secret side deals. They attribute Enron's descent into bankruptcy
proceedings to a combination of bad publicity and lost market confidence.
March 20, 2010 reply from Dennis Beresford
[dberesfo@TERRY.UGA.EDU]
Bob,
This will be my one and only response to your
comment.
As "the guy who wrote GAAP" for 10 plus years, it's
pretty hard for me to criticize anyone who followed the letter of the rules.
However, much more important is to understand the context of SFAS 140. While
I was gone from the Board when it was developed, I was there for its
predecessor, SFAS 125. That standard involved a very long, laborious process
of determining extremely precise rules for when liabilities should and
shouldn't be "derecognized" from the balance sheet. I can't tell you how
many meetings we had with lawyers involved with securitization transactions
and the like. In the end the document attempted to walk a fine line like
Goldilocks of getting it "just right"- trying to derecognizing those
liabilities where responsibility for obligations had truly been passed to
third parties while leaving those on the balance sheet the ones for which
the substance of an obligation was retained. In the typical fashion of
standards setting, that necessitated very precise rules including legal
opinions in some cases.
Not too long after SFAS 125 was issued, it became
clear that it wasn't working very well and it wasn't accomplishing the "just
right" objective. So the Board began another project that took several more
years and resulted in SFAS 140. Still more (or, rather, different) rules
were developed in an effort to accomplish the same objective of keeping true
obligations on the balance sheet and derecognizing those for which risks and
rewards of ownership had passed to third parties.
SFAS 140 has been seen as not fully satisfactory by
many parties, most notably because of the "QSPE" exception that allowed
Fannie Mae and many other large financial institutions to keep huge amounts
of securitization trusts and similar amounts off the balance sheet when the
trusts were considered set up on "auto pilot." The FASB changed this last
year through SFAS 166 and 167 and Fannie Mae will consolidate $2.5 trillion
of trust assets and liabilities that it doesn't own or owe in its first
quarter 2010 financial statements.
The bottom line is that this has been a highly
contentious aspect of accounting for many years. GAAP has been evolving and
it may evolve further. Would we have been better off with a "principle
based" approach? I personally doubt it although a New York Times article on
Friday suggested exactly that. The rules based approach to this general area
is far from perfect but I think it at least has resulted in more consistency
from company to company. I shudder to think how individual companies would
have applied a judgmental approach in an area like this.
Denny Beresford
March 20, 2010 reply from Bob Jensen
Hi Denny,
I will not prolong the agony, but I surely would
like to have someone explain to me how the Repo 105 accounting in the
particular context used by Lehman served any economic purpose other than to
deceive investors and creditors in the financial statements.
How in the world can the auditors conclude that
Lehman severed "all controls" over poisoned investments that they were 100%
certain would come back to Lehman in a few days. There was zero chance that
the market values of these poisoned CDOs would bounce back.
What could Lehman possibly gain other than balance
sheet trickery?
Would Lehman have even entered into these Repo 105
transactions if Lehman had to book the buy-back obligations as debt having
higher values than the sales prices at inflated and phony values?
I'm not sure auditors should follow any rules-based
standards for transactions only intended to deceive. Egads! Will Patricia
Walters love to hear me say that. Darn! She'll hang this one over my head
for as long as I live.
I think I'm interpreting principles-based a little
differently than you.
You are taking a micro view from the specific rules in FAS 140. I'm taking a
macro view that auditors have both a right and a duty to look at any
transactions that have only one purpose --- to deceive investors and/or
possibly members of the board. Accordingly auditors have a right and a duty
to disclose more to the persons being deceived, whether they are members of
the board of directors or individual investors.
Also the seeking out an opinion from an
England-based law firm has shades of Enron painted all over it in the eyes
of many of us in the academy. This is especially the case for those of us
that remember how Ken Lay hired a shyster law firm to whitewash the whistle
blowing of Sherron Watkins ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm
You know the story. If it walks like a duck, quacks
like a duck, and looks like a duck then it probably is a duck.
I really think that all Big Four auditors have for
years been helping Wall Street banks write fiction in their financial
statements.
Frank Partnoy and Lynn Turner contend that Wall
Street bank accounting is an exercise in writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper "Make Markets Be
Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Thanks Denny,
Bob Jensen
Bob Jensen's threads on the Lehman Examiner's Report ---
http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst
"Ernst & Young Prevails in $140 Million Case Brought by Frontier Creditors
Trust Andrew Longstreth," The American Lawyer, December 14, 2009 ---
http://www.law.com/jsp/article.jsp?id=1202436290441&rss=newswire&utm_source=twitterfeed&utm_medium=twitter
When the creditors of bankrupt companies draw up
lists of litigation targets, auditing firms are often right there at the
top. So it was for the creditors trust of the bankrupt insurer, Frontier
Insurance Group. The trust, represented by John McKetta III of Graves
Dougherty Hearon & Moody, alleged that Ernst & Young underestimated the
reserves Frontier needed to hold, making the company look healthy when it
was actually insolvent. It claimed $140 million in damages, plus interest.
But E&Y decided to make a stand. It refused to chip
up, and instead headed for a jury trial before White Plains, N.Y., federal
district court Judge Cathy Seibel. On Wednesday, after 12 days of trial,
jurors needed only two hours to exonerate the auditor.
"This case shows that E&Y is willing to go to trial
in a case it believes has no merit, even where the threatened damages are
substantial," said Ernst & Young's outside counsel, Dennis Orr of Morrison &
Foerster. Orr told us that Ernst & Young hopes other potential litigants get
the message.
Trust counsel McKetta said no decision had been
made about the trust's next move in the case. But he was gracious in defeat,
complimenting Seibel, the jury, and even the team at Morrison & Foerster.
"They did a terrific job," McKetta said.
Question
It appears that Lehman is was trying to whitewash it's creative accounting with
a ruling from a shady law firm.
Because no U.S. law firm would bless the
transaction, Lehman got an opinion letter from London-based law firm
Linklaters. That letter essentially blessed using the maneuver for Lehman's
European broker-dealer under English law. If one of Lehman's U.S. entities
needed to engage in a Repo 105 transaction, the firm moved the securities to
its European arm to conduct the deal on the U.S. entity's behalf, the report
found. That is likely why the counterparties on the repo transactions were
largely a group of seven non-U.S. banks. These included Germany's Deutsche
Bank AG, Barclays PLC of the U.K. and Japan's Mitsubishi UFJ Financial
Group.
What other loser corporation and its auditing firm sought to hide behind a
shady law firm's blessing on deceptive accounting?
Hint: The law firm was contacted after a whistle blower notified both the
client's CEO and the its auditing firm.
Answer
If you don't recall the answer, scroll down past the following tidbit.
"Repos Played a Key Role in Lehman's Demise: Report Exposes Lack of
Information And Confusing Pacts With Lenders," by Suzanne Craig and Mike Spector,
The Wall Street Journal, March 13, 2010 ---
http://online.wsj.com/article/SB20001424052748703447104575118150651790066.html#mod=todays_us_money_and_investing
The rare look into the repo market embedded in the
report comes 18 months after Lehman Brothers collapsed in the U.S.'s largest
bankruptcy filing. While top Lehman executives were quick to blame the
real-estate market for their woes, the exhaustive report singles out senior
executives and auditor Ernst & Young for serious lapses.
The report exposed for the first time what appears
to be an accounting slight of hand known as a Repo 105 transaction, where
Lehman was able to book what looked like an ordinary asset for cash as an
out-and-out sale, drastically reducing its leverage and making its financial
picture look better than it really was. The transactions often were done in
flurries in a financial quarter's waning days, before Lehman reported
earnings.
Four days prior to the close of the 2007 fiscal
year, Jerry Rizzieri, a member of Lehman's fixed-income division, was
searching for a way to meet his balance-sheet target, according to the
report. He wrote in an email: "Can you imagine what this would be like
without 105?"
A day before the close of Lehman's first quarter in
2008, other employees scrambled to make balance-sheet reductions, the report
said. Kaushik Amin, then-head of Liquid Markets, wrote to a colleague: "We
have a desperate situation, and I need another 2 billion from you, either
through Repo 105 or outright sales. Cost is irrelevant, we need to do it."
Marie Stewart, the former global head of Lehman's
accounting policy group, told the examiner the transactions were "a lazy way
of managing the balance sheet as opposed to legitimately meeting
balance-sheet targets at quarter end."
Lehman's use of this accounting technique goes back
to the start of the decade when Lehman business units from New York and
London met to discuss how the firm could manage its balance sheet using
accounting rules that had taken effect in September 2000. Lehman soon
created the "Repo 105" maneuver: Because assets the firm moved amounted to
105% or more of the cash it received in return, Lehman could treat the
transactions as sales and remove securities inventory that otherwise would
have to be kept on its balance sheet.
Because no U.S. law firm would bless the
transaction, Lehman got an opinion letter from London-based law firm
Linklaters. That letter essentially blessed using the maneuver for Lehman's
European broker-dealer under English law. If one of Lehman's U.S. entities
needed to engage in a Repo 105 transaction, the firm moved the securities to
its European arm to conduct the deal on the U.S. entity's behalf, the report
found. That is likely why the counterparties on the repo transactions were
largely a group of seven non-U.S. banks. These included Germany's Deutsche
Bank AG, Barclays PLC of the U.K. and Japan's Mitsubishi UFJ Financial
Group.
In a statement, a Linklaters spokeswoman said the
report "does not criticize" the legal opinions it gave Lehman "or suggest or
say they were wrong or improper." The law firm said it was never contacted
during the investigation.
Jensen Comment
Although Lehman could not find a shady U.S. law firm to "bless the transaction,"
Ken Lay at Enron managed to find a shady law firm to bless the Raptors'
transactions after Sherron Watkins (an Enron executive) sent her infamous
whistle blowing memo to both Ken Lay and to Andersen executives in Chicago.
"Warning on Enron Recounted," by Alexei Barrionuevo, The New York
Times, March 16, 2006 ---
http://www.nytimes.com/2006/03/16/business/businessspecial3/16enron.html?_r=1&oref=slogin
Ms. Watkins, 46,
attracted national attention after testifying before Congress in February 2002
about Enron's collapse two months earlier. She was named one of Time magazine's
people of the year in 2002 for raising red flags about the company's accounting
while still working there. She has since written a book with a Houston
journalist about Enron's fall, and formed a consulting practice that advises
companies on governance issues.
Defense lawyers, during
combative cross-examination, tried to paint Ms. Watkins as an opinionated
fame-seeker who had profited from the Enron scandal on the lecture circuit. The
defense lawyers also suggested that Ms. Watkins was never charged with insider
trading for selling Enron shares because she was wrong in believing that the
Raptors were fraudulent.
Prosecutors contend that
the partnerships and hedges Ms. Watkins testified about were part of a broad
effort by Mr. Skilling and Mr. Lay to manipulate earnings and hide debt. The
former chief executives are accused of overseeing a conspiracy to deceive
investors about Enron's finances so they could profit by selling Enron shares at
inflated prices.
Defense lawyers contend
that prosecutors are seeking to criminalize normal business practices and that
the Enron executives were the victims of thieving subordinates like Andrew S.
Fastow, the former chief financial officer.
Ms. Watkins's appearance
on the stand came as the government neared the end of its case. Judge Simeon T.
Lake III said Wednesday that he estimated that the case could be wrapped up by
the end of April.
Ben F. Glisan Jr., a
former Enron treasurer, is scheduled to take the stand next week. Mr. Glisan
pleaded guilty to conspiracy and is currently serving a five-year prison term.
In often-colorful
testimony, Ms. Watkins recounted how she became concerned around June 2001 that
about a dozen Enron assets were being hedged, or guaranteed against loss, by the
Raptors vehicles, which she soon learned contained only Enron stock. The Raptors
were intertwined with partnerships run by Mr. Fastow, who became Ms. Watkins's
boss that summer. The value of the assets, she said, "had tanked," dragged down
by Enron's plummeting share price.
After doing some
investigation, she wrote an anonymous letter about her concerns, then on Aug.
22, 2001, she met with Mr. Lay to discuss them. The meeting came about a week
after Mr. Lay had stepped back into the role of chief executive after the
resignation of Mr. Skilling.
At the meeting, they
discussed a letter of hers in which she had said that she was "incredibly
nervous that Enron would implode in a wave of accounting scandals." She also
noted to Mr. Lay that employees were talking about a "handshake deal" that Mr.
Fastow had with Mr. Skilling that ensured that Mr. Fastow would not lose money
on transactions done with the LJM partnership, which Mr. Fastow was running.
Mr. Lay seemed to take
her seriously, Ms. Watkins testified.
Days after the meeting, she
learned that Vinson & Elkins, the law firm that had originally approved the
Raptors, was doing the internal investigation into the partnerships. The firm,
after consulting with Arthur Andersen, Enron's auditor, issued a report saying
that while the "optics" or appearances were bad, the accounting was appropriate.
Ms. Watkins said she
remained adamant that Andersen, which had received several high-profile
setbacks, should not be trusted.
"I thought this was
bogus," she said of the investigation.
Concerned that Enron was
manipulating its financial statements, Ms. Watkins stepped up efforts to leave
the company, which she had begun shortly after she concluded the Raptors could
be fraudulent. She did not leave until after the bankruptcy.
Ultimately, Mr. Lay
decided to unwind the Raptors and take a write-off in a single quarter rather
than restate the accounting of Enron's financial statements. Ms. Watkins, under
questioning from Chip B. Lewis, a lawyer for Mr. Lay, conceded that while that
was not her preference, "continuing the fraud would have been worse."
Defense lawyers sparred
with Ms. Watkins from the outset. Mr. Lewis placed a copy of Ms. Watkins's book,
"Power Failure," in front of her, calling it a "housewarming present."
Ms. Watkins acknowledged
that she could not explain why prosecutors did not charge her with insider
trading for selling Enron shares.
Continued in article
"Enron Employee Told Lay Last Summer Of Concerns About Accounting
Practices," by Michael Schroeder and John Emshwiller, The Wall Street
Journal, January 15, 2002 ---
http://interactive.wsj.com/articles/SB1011043581125393520.htm
A House committee asked
Enron Corp. for information related to a newly discovered letter written by an
Enron employee last summer warning the company's chairman about its accounting
practices, which prompted an internal investigation.
That inquiry,
conducted by Enron's outside law firm, Vinson & Elkins, "has the appearance of a
whitewash," said House Energy and Commerce Committee spokesman Ken Johnson.
A committee investigator
combing through 40 boxes of documents supplied by Enron found the letter over
the weekend. The author, Sherron Watkins, an Enron Global Finance executive who
wasn't identified further, questioned the propriety of accounting methods,
writing: "I am incredibly nervous that we will implode in a wave of accounting
scandals."
Enron, suffering from a
crisis of confidence by investors, filed for Chapter 11 bankruptcy-court
protection on Dec. 2, shielding it from creditors as it seeks to reorganize.
In concluding its review
of the matters raised in the letter, Vinson & Elkins told Enron that "further
widespread investigation by independent counsel and auditors" was unwarranted.
But the firm warned that "bad cosmetics" involving the transactions and the
decline of Enron's stock posed the "serious risk of adverse publicity and
litigation."
The internal review was
dated Oct. 15, 2001 -- one day before Enron announced its big third-quarter loss
and a $1.2 billion reduction in shareholder equity because of losses later
associated with various partnerships involving Enron officials.
Ms. Watkins's letter and
the lawyers' conclusion were quoted Monday in a request for additional documents
from the House committee to Enron Chairman Kenneth Lay; the firm's outside
auditor, Arthur Andersen LLP; and Vinson & Elkins. The panel is seeking
additional information about the letter and Enron's response to it.
Joe Householder, a
spokesman for Vinson & Elkins, said the firm had received the committee's
request for information, but that "we're not prepared to respond yet to the
specific questions in the letter."
An Enron spokesman didn't
return a call seeking comment. Ms. Watkins, who no longer works for Enron
Global, couldn't be reached for comment.
Her letter to Mr. Lay
questioned special-purpose entities that Enron used to help keep its debt off
its books, the adequacy of public disclosure and the financial impact of the
decline of Enron's stock.
The committee said the
existence of the internal investigation suggests that "senior officials at Enron
and Andersen were aware of the controversial financial transactions and
accounting practices that would ultimately contribute significantly to Enron's
demise."
Mr. Johnson said Vinson &
Elkins "had one hand tied behind its back" by Enron officials as it began its
review of Ms. Watkins's warnings. "As part of Vinson & Elkins's mandate for
investigating the letter, they were told [by Enron officials] not to second
guess Arthur Andersen and not to analyze specific transactions," he said.
Ms. Watkins wasn't the
first Enron insider to raise concerns about partnerships related to Chief
Financial Officer Andrew Fastow. Sometime before the end of 2000, then-Enron
Treasurer Jeffrey McMahon went to company President Jeffrey Skilling and
complained about potential conflicts of interest posed by partnerships operated
by Mr. Fastow, which began in 1999 and early 2000. Mr. Fastow quit the
partnerships last July.
Mr. Skilling didn't share
Mr. McMahon's concerns, say people familiar with the matter. Mr. McMahon
requested and received reassignment to another post. In October, Mr. McMahon was
named as successor to Mr. Fastow as Enron's chief financial officer in the face
of rising controversy over the partnerships.
Ms. Watkins's August 2001
letter came when what now appears to be the first major crack in Enron's facade
appeared. Mr. Skilling, who had been given the chief-executive post earlier in
the year, unexpectedly resigned on Aug. 14. He initially cited unspecified
personal reasons.
But in an interview the
next day, he said that his frustration over Enron's falling stock price played a
major role in his decision to quit after only six months as chief executive.
That remark has since raised questions about whether Mr. Skilling saw problems
ahead for Enron because some of its partnership arrangements relied heavily on
the use of Enron stock and their stability could be threatened by a falling
price.
Separately, Andersen
issued a statement providing more details about an e-mail sent by an in-house
attorney that resulted in the destruction by Andersen employees of numerous
Enron-related audit documents.
Mr. Odom forwarded the
e-mail to David Duncan, the partner in charge of the Enron audit as a reminder
of the firm's existing policy, Andersen said. The firm added that the e-mails
"are not a representation that there were no inappropriate actions" and said it
is continuing to investigate the matter.
Andersen's
records-retention policy goes into great detail about what documents should be
kept for what periods of time and when they should be disposed of. But the
policy does note, "In cases of threatened litigation, no related information
will be destroyed." At the time the e-mail was sent, no subpoenas had been
issued, but Enron's problems were mounting and drawing the attention of
attorneys representing shareholders.
Bob Jensen's threads on the Enron/Andersen scandals are
at
http://faculty.trinity.edu/rjensen/FraudEnron.htm
Bob Jensen's threads on all large international auditing firms ---
http://faculty.trinity.edu/rjensen/fraud001.htm
Dear Jerry,
I’ve probably beat this thread to death, but we (Jerry, Zane, Francine, and Bob)
seemed to leave the thread hanging by saying that any evidence of
audit negligence and weak testing of internal controls in loan loss reserve
auditing and securities valuation is pretty much up to the courts to resolve in
the many pending lawsuits against auditors ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
I just want to point out that there is some existing evidence of bad
auditing while the CDOs and underlying poisoned mortgages were being overvalued.
Here’s one example from a former Tidbit ---
http://faculty.trinity.edu/rjensen/fraud001.htm#KPMG
KPMG Should Be Tougher on Testing, PCAOB Finds The Big
Four audit firm was cited for not ramping up its tests of some clients'
assumptions and internal controls.
KPMG did not show enough skepticism toward
clients last year, according to the Public Company Accounting Oversight Board,
which cited the Big Four accounting firm for deficiencies related to audits it
performed on nine companies. The deficiencies were detailed in an inspection
report released this week by the PCAOB that covered KPMG's 2008 audit season.
The shortcomings focused mostly on a lack of proper evidence provided by KPMG to
support its audit opinions on pension plans and
securities valuations.
But in some instances, the firm was cited for
weak testing of internal controls
over financial reporting and the application of generally accepted accounting
principles.
Marie Leone, CFO.com, June 19, 2009 ---
http://www.cfo.com/article.cfm/13888653/c_2984368/?f=archives
In
one instance, the audit lacked evidence about whether the pension plans
contained subprime assets. In another case, the PCAOB noted, the audit firm
didn't collect enough supporting material to gain an understanding of how the
trustee gauged the fair values of the assets when no quoted market prices were
available.
The
PCAOB, which inspects the largest public accounting firms on an annual basis,
also found that three other KPMG audits were shy an appropriate amount of
internal controls testing related to loan-loss allowances, securities
valuations, and financing receivables.
In
one audit, KPMG accepted its client's data on non-performing loans without
determining whether the information was "supportable and appropriate." In
another case, KPMG "failed to perform sufficient audit procedures" with regard
to the valuation of hard-to-price financial instruments.
In
still another case, the PCAOB found that KPMG "failed to identify" that a
client's revised accounting of an outsourcing deal was not in compliance with
GAAP because some of the deferred costs failed to meet the definition of an
asset - and the costs did not represent a probably future economic benefit for
the client.
As loans were being poisoned on Main Street and divided
up on to CDO tranches on Wall Street, where were the auditors investigating loan
approval internal controls on Main Street and poisoned security valuations on
Wall Street?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
The largest bank failure in history!
How could Deloitte give a thumbs up audit report on these scams known by the
bank's executives?
"Eyes Open, WaMu Still Failed," by Floyd Norris, The New York Times,
March 24, 2011 ---
http://www.nytimes.com/2011/03/25/business/25norris.html?_r=1
At that same bank, executives checking for
fraudulent mortgage applications found that at one bank office 42 percent of
loans reviewed showed signs of fraud, “virtually all of it attributable to
some sort of employee malfeasance or failure to execute company policy.” A
report recommended “firm action” against the employees involved.
In addition to such internal foresight and
vigilance, that bank had regulators who spotted problems with procedures and
policies. “The regulators on the ground understood the issues and raised
them repeatedly,” recalled a retired bank official this week.
This is not, however, a column about a bank that
got things right. It is about Washington Mutual, which in 2008 became the
largest bank failure in American history.
What went wrong? The chief executive, Kerry K.
Killinger, talked about a bubble but was also convinced that Wall Street
would reward the bank for taking on more risk. He kept on doing so, amassing
what proved to be an almost unbelievably bad book of mortgage loans. Nothing
was done about the office where fraud seemed rampant.
The regulators “on the ground” saw problems, as
James G. Vanasek, the bank’s former chief risk officer, told me, but the
ones in Washington saw their job as protecting a “client” and took no
effective action. The bank promised change, but did not deliver. It
installed programs to spot fraud, and then failed to use them. The board
told management to fix problems but never followed up.
WaMu, as the bank was known, is back in the news
because the Federal Deposit Insurance Corporation sued Mr. Killinger and two
other former top officials of the bank last week, seeking to “hold these
three highly paid senior executives, who were chiefly responsible for WaMu’s
higher-risk home-lending program, accountable for the resulting losses.”
Mr. Killinger responded by going on the attack. His
lawyers called the suit “baseless and unworthy of the government.” Mr.
Killinger, they said, deserved praise for his excellent management.
I’ll let the courts sort out whether Mr. Killinger
will become the rare banker to be penalized for making disastrously bad
loans. But I am fascinated by how his bank came to make those loans despite
his foresight.
Answers are available, or at least suggested, in
the mass of documents collected and released by the Senate Permanent
Subcommittee on Investigations, which held hearings on WaMu last year. Mr.
Killinger wanted both the loan book and profits to rise rapidly, and saw
risky loans as a means to those ends.
Moreover, this was a market in which a bank that
did not reduce lending standards would lose a lot of business. A decision to
publicly decry the spread of high-risk lending and walk away from it —
something Mr. Vanasek proposed before he retired at the end of 2005 — might
have saved the bank in the long run. In the short run, it would have
devastated profits.
Ronald J. Cathcart, who became the chief risk
officer in 2006, told a Senate hearing he pushed for more controls but ran
into resistance. The bank’s directors, he said, were interested in hearing
about problems that regulators identified over and over again. “But,” he
added, “there was little consequence to these problems not being fixed.”
There were consequences for him. He was fired in
2008 after he took his concerns about weak controls and rising losses to
both the board and to regulators from the Office of Thrift Supervision.
By early 2007, the subprime mortgage market was
collapsing, and the bank was trying to rush out securitizations before that
market vanished. The Federal Deposit Insurance Corporation, a secondary
regulator, was pushing to impose tighter regulation, but the primary
regulator, the Office of Thrift Supervision, was successfully resisting
allowing the F.D.I.C. to even look at the bank’s loan files.
Continued in article
More Headaches for Deloitte After Auditing the Biggest Bank to Ever Fail
"Investigation finds fraud in WaMu lending: Senate report: Failed bank’s
own action couldn’t stop deceptive practices," by Marcy Gordon, MSNBC, April 12,
2010 ---
http://www.msnbc.msn.com/id/36440421/ns/business-mortgage_mess/?ocid=twitter
The mortgage lending operations of Washington
Mutual Inc., the biggest U.S. bank ever to fail, were threaded through with
fraud, Senate investigators have found.
And the bank's own probes failed to stem the
deceptive practices, the investigators said in a report on the 2008 failure
of WaMu.
The panel said the bank's pay system rewarded loan
officers for the volume and speed of the subprime mortgage loans they
closed. Extra bonuses even went to loan officers who overcharged borrowers
on their loans or levied stiff penalties for prepayment, according to the
report being released Tuesday by the investigative panel of the Senate
Homeland Security and Governmental Affairs Committee.
Sen. Carl Levin, D-Mich., the chairman, said Monday
the panel won't decide until after hearings this week whether to make a
formal referral to the Justice Department for possible criminal prosecution.
Justice, the FBI and the Securities and Exchange Commission opened
investigations into Washington Mutual soon after its collapse in September
2008.
The report said the top WaMu producers, loan
officers and sales executives who made high-risk loans or packaged them into
securities for sale to Wall Street, were eligible for the bank's President's
Club, with trips to swank resorts, such as to Maui in 2005.
Fueled by the housing boom, Seattle-based
Washington Mutual's sales to investors of packaged subprime mortgage
securities leapt from $2.5 billion in 2000 to $29 billion in 2006. The
119-year-old thrift, with $307 billion in assets, collapsed in September
2008. It was sold for $1.9 billion to JPMorgan Chase & Co. in a deal
brokered by the Federal Deposit Insurance Corp.
Jennifer Zuccarelli, a spokeswoman for JPMorgan
Chase, declined to comment on the subcommittee report.
WaMu was one of the biggest makers of so-called
"option ARM" mortgages. These mortgages allowed borrowers to make payments
so low that loan debt actually increased every month.
The Senate subcommittee investigated the Washington
Mutual failure for a year and a half. It focused on the thrift as a case
study for the financial crisis that brought the recession and the loss of
jobs or homes for millions of Americans.
The panel is holding hearings Tuesday and Friday to
take testimony from former senior executives of Washington Mutual, including
ex-CEO Kerry Killinger, and former and current federal regulators.
Washington Mutual "was one of the worst," Levin
told reporters Monday. "This was a Main Street bank that got taken in by
these Wall Street profits that were offered to it."
The investors who bought the mortgage securities
from Washington Mutual weren't informed of the fraudulent practices, the
Senate investigators found. WaMu "dumped the polluted water" of toxic
mortgage securities into the stream of the U.S. financial system, Levin
said.
In some cases, sales associates in WaMu offices in
California fabricated loan documents, cutting and pasting false names on
borrowers' bank statements. The company's own probe in 2005, three years
before the bank collapsed, found that two top producing offices — in Downey
and Montebello, Calif. — had levels of fraud exceeding 58 percent and 83
percent of the loans. Employees violated the bank's policies on verifying
borrowers' qualifications and reviewing loans.
Washington Mutual was repeatedly criticized over
the years by its internal auditors and federal regulators for sloppy lending
that resulted in high default rates by borrowers, according to the report.
Violations were so serious that in 2007, Washington Mutual closed its big
affiliate Long Beach Mortgage Co. as a separate entity and took over its
subprime lending operations.
Senior executives of the bank were aware of the
prevalence of fraud, the Senate investigators found.
In late 2006, Washington Mutual's primary
regulator, the U.S. Office of Thrift Supervision, allowed the bank an
additional year to comply with new, stricter guidelines for issuing subprime
loans.
According to an internal bank e-mail cited in the
report, Washington Mutual would have lost about a third of the volume of its
subprime loans if it applied the stricter requirements.
Deloitte is Included in the Shareholder Lawsuit Against Washington Mutual
"Feds Investigating WaMu Collapse," SmartPros, October 16, 2008 ---
http://accounting.smartpros.com/x63521.xml
Oct. 16, 2008 (The
Seattle Times) — U.S. Attorney Jeffrey Sullivan's office [Wednesday] announced
that it is conducting an investigation of Washington Mutual and the events
leading up to its takeover by the FDIC and sale to JP Morgan Chase.
Said Sullivan in a
statement: "Due to the intense public interest in the failure of Washington
Mutual, I want to assure our community that federal law enforcement is examining
activities at the bank to determine if any federal laws were violated."
Sullivan's task force
includes investigators from the FBI, Federal Deposit Insurance Corp.'s Office of
Inspector General, Securities and Exchange Commission and the Internal Revenue
Service Criminal Investigations division.
Sullivan's office asks
that anyone with information for the task force call 1-866-915-8299; or e-mail
fbise@leo.gov.
"For more than 100
years Washington Mutual was a highly regarded financial institution
headquartered in Seattle," Sullivan said. "Given the significant losses to
investors, employees, and our community, it is fully appropriate that we
scrutinize the activities of the bank, its leaders, and others to determine if
any federal laws were violated."
WaMu was seized by the
FDIC on Sept. 25, and its banking operations were sold to JPMorgan Chase,
prompting a Chapter 11 bankruptcy filing by Washington Mutual Inc., the bank's
holding company. The takeover was preceded by an effort to sell the entire
company, but no firm bids emerged.
The Associated Press
reported Sept. 23 that the FBI is investigating four other major U.S. financial
institutions whose collapse helped trigger the $700 billion bailout plan by the
Bush administration.
The AP report cited two
unnamed law-enforcement officials who said that the FBI is looking at potential
fraud by mortgage-finance giants Fannie Mae and Freddie Mac, and insurer
American International Group (AIG). Additionally, a senior law-enforcement
official said Lehman Brothers Holdings is under investigation. The inquiries
will focus on the financial institutions and the individuals who ran them, the
senior law-enforcement official said.
FBI Director Robert
Mueller said in September that about two dozen large financial firms were under
investigation. He did not name any of the companies but said the FBI also was
looking at whether any of them have misrepresented their assets.
KPMG Should Be Tougher on
Testing, PCAOB Finds The Big Four audit firm was cited for not ramping
up its tests of some clients' assumptions and internal controls.
KPMG did not show enough skepticism toward
clients last year, according to the Public Company Accounting Oversight
Board, which cited the Big Four accounting firm for deficiencies related
to audits it performed on nine companies. The deficiencies were detailed
in an inspection report released this week by the PCAOB that covered
KPMG's 2008 audit season. The shortcomings focused mostly on a lack of
proper evidence provided by KPMG to support its audit opinions on
pension plans and securities valuations.
But in some instances, the firm was cited for weak testing of internal
controls over financial reporting and the application of generally
accepted accounting principles.
Marie Leone, CFO.com, June 19, 2009 ---
http://www.cfo.com/article.cfm/13888653/c_2984368/?f=archives
In one
instance, the audit lacked evidence about whether the pension plans
contained subprime assets. In another case, the PCAOB noted, the
audit firm didn't collect enough supporting material to gain an
understanding of how the trustee gauged the fair values of the
assets when no quoted market prices were available.
The PCAOB,
which inspects the largest public accounting firms on an annual
basis, also found that three other KPMG audits were shy an
appropriate amount of internal controls testing related to loan-loss
allowances, securities valuations, and financing receivables.
In one
audit, KPMG accepted its client's data on non-performing loans
without determining whether the information was "supportable and
appropriate." In another case, KPMG "failed to perform sufficient
audit procedures" with regard to the valuation of hard-to-price
financial instruments.
In still
another case, the PCAOB found that KPMG "failed to identify" that a
client's revised accounting of an outsourcing deal was not in
compliance with GAAP because some of the deferred costs failed to
meet the definition of an asset - and the costs did not represent a
probably future economic benefit for the client.
Have the auditors resumed handing out rose colored glasses to accompany
banking's bad debt reserves?
Last week, Wells Fargo (WFC) said it will report
record Q1 earnings. It caused the stock to shoot up, but it also raised a few
eyebrows as analysts wondered how realistic the company is being with respect to
loan losses . . . The bottom line is that if bank earnings are across-the-board
too strong, then it looks like the game is just totally rigged. The economy is
still going to crap, defaults are still increasing rapidly, and commercial real
estate is finally set to teeter -- how does it make sense for banks to be
reporting anything near record earnings? It doesn't. Unless Wells Fargo and
Goldman Sachs can explain exactly how they had such amazing quarters against the
current backdrop, the only conclusion will be that the banks are still
fundamentally black holes that can't be trusted or valued by investors and
counterparties. And when you factor in the stress test results -- which however
ridiculous they may be could result in forced capital raises -- the bloom could
come off this rose pretty fast.
Joe Weisenthall,
"Banks Risk Reporting Too-Good Earnings," Business Insider, April 13,
2009 ---
http://www.businessinsider.com/banks-risk-reporting-too-good-earnings-2009-4
From The Wall Street Journal Accounting Weekly Review on June 12, 2009
Wells Fargo, BofA Pay to Settle Claims
by
Jennifer Levitz
The Wall Street Journal
Jun 09, 2009
Click here to view the full article on WSJ.com
http://online.wsj.com/article/SB124447741263994585.html?mod=djem_jiewr_AC
TOPICS: Advanced
Financial Accounting, Auditing, Fair-Value Accounting Rules, Internal Controls,
Investments
SUMMARY: "One
of the nation's largest mutual-fund companies allegedly overvalued its holdings
of mortgage securities during the housing bust, making its fund appear to be one
of the top performers, and then was forced to take big write-downs, leaving some
investors in the supposedly conservative offering with losses approaching
25%....Evergreen began repricing the securities after its valuation committee
learned on June 10 that the portfolio managers had known since March about
problems with a certain mortgage-backed security but had failed to disclose it
to the committee", the SEC said.
CLASSROOM APPLICATION: The
implication of properly establishing fair values in a trading portfolio is the
major topic covered in this article. Also touched on are the internal control
procedures and related audit steps over this valuation process.
QUESTIONS:
1. (Introductory)
What was the implication of not properly valuing certain fund investment for the
reported performance of the Evergreen Ultra Fund?
2. (Introductory)
What also was the apparent problem with the type of investment made by portfolio
managers of this Evergreen fund? In your answer, comment on the purpose of the
fund and the risk of mortgage-backed securities in which it invested.
3. (Introductory)
How should an entity such as the Evergreen Ultra Fund account for its
investments? Describe the balance and income implications and state what
accounting standard requires this treatment.
4. (Advanced)
What evidence should the Evergreen fund's portfolio managers have taken into
account in valuing investments? How did the fund managers allegedly avoid using
that evidence?
5. (Advanced)
What internal control procedures were apparently in place at Evergreen to ensure
that fund assets were properly valued by portfolio managers? What was the
apparent breakdown in internal control?
6. (Advanced)
Based on the description in the article of internal control processes at
Evergreen, design audit procedures to assess whether the internal control over
investment valuations is functioning properly. What evidence might arise to
indicate a failure in internal control?
Reviewed By: Judy Beckman, University of Rhode Island
"CPAs MIA," by Ralph Nader , Independent Political Report, April 12,
2009 ---
http://www.independentpoliticalreport.com/2009/04/ralph-nader-cpas-mia/
Where were the giant
accounting firms, the CPAs, and the rest of the accounting profession while the
Wall Street towers of fraud, deception and cover-ups were fracturing our
economy, looting and draining trillions of dollars of other peoples’ money?
This is the licensed
profession that is paid to exercise independent judgment with independent
standards to give investors, pension funds, mutual funds, and the rest of the
financial world accurate descriptions of corporate financial realities.
It is now obvious that
the accountants collapsed their own skill, integrity and self-respect faster and
earlier than the collapse of Wall Street and the corporate barons. The
accountants—both external and internal—could have blown the whistle on what
Teddy Roosevelt called the “malefactors of great wealth.”
The Big Four auditors
knew what was going on with these complex, abstractly structured finance
instruments, these collateralized debt obligations (CDOs) and other financial
products too abstruse to label. They were on high alert after early warning
scandals involving Long Term Capital Management, Enron, and others a decade or
so ago. These corporate casino capitalists used the latest tricks to cook the
books with many of the on-balance sheet or off-balance sheet structured
investment vehicles that metastasized big time in the first decade of this new
century. These big firms can’t excuse themselves for relying on conflicted
rating companies, like Moody’s or Standard & Poor, that gave triple-A ratings to
CDO tranches in return for big fees. Imagine the conflict. After all,
“prestigious” outside auditors were supposed to be on the inside incisively
examining the books and their footnotes, on which the rating firms excessively
relied.
Let’s be specific with
names. Carl Olson, chairman of the Fund for Stockowners Rights wrote in the
letters column of The New York Times Magazine (January 28, 2009) that
“PricewaterhouseCoopers O.K.’d AIG and FreddieMac. Deloitte & Touche certified
Merrill Lynch and Bear Stearns. Ernst & Young vouched for Lehman Brothers and
IndyMac Bank. KPMG assured over Countrywide and Wachovia. These ‘Big Four’
C.P.A. firms apparently felt they could act with impunity.” “Undoubtedly they
knew that the state boards of accountancy,” continued Mr. Olson, “which granted
them their licenses to audit, would not consider these transgressions seriously.
And they were right…Not one of them has taken up any serious investigation of
the misbehaving auditors of the recent debacle companies.”
“Misbehaving” is too
kind a word. The “Big Four” destroyed their very reason for being by their
involvement in these and other boondoggles that have made headlines and
dragooned our federal government into bailing them out with disbursements, loans
and guarantees totaling trillions of dollars. “Criminally negligent” is a better
phrase for what these big accounting firms got rich doing—which is to look the
other way.
Holding accounting
firms like these accountable is very difficult. It got more difficult in 1995
when Congress passed a bill shielding them from investor lawsuits charging that
they “aided and abetted” fraudulent or deceptive schemes by their corporate
clients. Clinton vetoed the legislation, but Senator Chris Dodd (D-CT) led the
fight to over-ride the veto.
Moreover, the
under-funded and understaffed state boards of accountancy are dominated by
accountants and are beyond inaction. What can you expect?
As for the Securities
and Exchange Commission (SEC), “asleep at the switch for years” would be a
charitable description of that now embarrassed agency whose mission is to
supposedly protect savers and shareholders. This agency even missed the massive
Madoff Ponzi scheme.
The question of
accounting probity will not go away. In the past couple of weeks, the non-profit
Financial Accounting Standards Board (FASB)—assigned to be the professional
conscience of accountancy—buckled under overt pressure from Congress and the
banks. It loosened the mark-to-market requirement to value assets at fair market
value or what buyers are willing to pay.
This decision by the
FASB is enforceable by the SEC and immediately “cheered Wall Street” and pushed
big bank stocks upward. Robert Willens, an accounting analyst, estimated this
change could boost earnings at some banks by up to twenty percent. Voilà, just
like that. Magic!
Overpricing depressed
assets may make bank bosses happy, but not investors or a former SEC Chairman,
Arthur Levitt, who was “very disappointed” and called the FASB decision “a step
toward the kind of opaqueness that created the economic problems that we’re
enduring today.”
To show the
deterioration in standards, banks tried to get the FASB and the SEC in the 1980s
to water down fair-value accounting during the savings and loan failures.
Then-SEC Chairman Richard Breeden refused outright. Not today.
Former SEC chief
accountant, Lynn Turner, presently a reformer of his own profession, supports
mark-to-market or fair value accounting as part of bringing all assets and
liabilities, including credit derivatives, back on the balance sheets of the
financial firms. He wants regulation of the credit rating agencies, mortgage
originators and the perverse incentives that lead to making bad loans. He even
wants the SEC to review these new financial products before they come to market,
eliminating “hidden financing.”
Now comes the life
insurance industry, buying up some small banks to qualify for their own large
federal bailouts for making bad, risky speculations.
The brilliant Joseph M.
Belth, writing in his astute newsletter, the Insurance Forum (May 2009), noted
that life insurers are lobbying state insurance departments to weaken statutory
accounting rules so as to “increase assets and/or decrease liabilities.” Some
states have already caved. Again, voilà, suddenly there is an increase in
capital. Magic. Here we go again.
Who among the brainy,
head up accountants, in practice or in academia, will join with Lynn Turner and
rescue this demeaned, chronically rubber-stamping “profession,” especially the
“Big Four,” from its pathetic pretension for which tens of millions of people
are paying dearly?
"In Pari Delicto: Are Auditors Equally At Fault In The Big Fraud Cases?"
by Francine McKenna, Re: The Auditors, March 9, 2010 ---
http://retheauditors.com/2010/03/09/in-pari-delicto-are-auditors-equally-at-fault-in-the-big-fraud-cases/
The phrase in pari delicto
sounds like something dirty to me. Maybe I’m still preoccupied with the
accusation
that I’m producing accounting pornography.
“…the etymology of the term [pornography] is:
“Etymology: Greek pornographos, adjective, writing about prostitutes, from porn
prostitute + graphein to write; akin to Greek pernanai to sell, porosjourney “
That implies accounting porn is writing about
accounting prostitutes. That being the case, then Francine McKenna, Sam Antar,
Tracy Coenen and Bob Jensen all engage in accounting porn. They write about the
corporate executives and audit firm partners that prostitute their accounting
reports in the search for fictitious profits and all too real unearned bonuses.
In other words, accounting fraud is accounting prostitution…”
In pari delicto, for those of you not lawyers or legal argument
junkies like me, is “Latin for “in equal fault”. It’s a legal term used to
indicate that two persons or entities are equally at fault, whether we’re
talking about a
crime or
tort. The phrase is most commonly used by
courts when relief is being denied to both
parties in a
civil action because of wrongdoing by both
parties. The phrase means, in essence, that since both parties are equally at
fault, the court will not involve itself in resolving one side’s claim over the
other, and whoever possesses whatever is in dispute may continue to do so in the
absence of a superior claim.”
There are two active cases where this doctrine and
defense is being employed by auditors trying to avoid liability for fraud.
In Teachers’ Retirement System of Louisiana
v. PricewaterhouseCoopers LLP, No. 454, 2009 (Del. March 4, 2010), one of
many AIG suits that PwC is involved in directly or indirectly, the Delaware
Supreme Court used a procedure provided for under the New York Rules of
Court to
certify a question of law to New York’s highest court, the New York Court of
Appeals.This matter involves an appeal from the
Delaware Court of Chancery regarding the oft-cited AIG case which
denied a motion to dismiss claims against the top officials of AIG for breach of
fiduciary duty based on Delaware law. However, the claims against the auditor,
PwC, were dismissed based on New York law. The Plaintiff’s are appealing the
Chancery Court’ decision regarding PwC. (Summary borrowed for accuracy from
Francis Pileggi at
Delaware Litigation.com who alerted me to this most
unusual move by the Chancery Court.)
The Court of Chancery held that the claims
against PwC were governed by New York law, and that based on the allegations of
the Complaint, AIG’s senior officers did not “totally abandon[]”
AIG’s interests—as would be required under New York law to establish
the “adverse interest” exception to imputation. Accordingly, the Court
of Chancery held that the wrongdoing of AIG’s senior officers is imputed
to AIG.3 The Court of Chancery concluded that, once the wrongdoing was imputed
to AIG, AIG’s claims against PwC were barred by New York’s in pari delicto
doctrine and by the related Wagoner line of standing cases in
the United States Court of Appeals for the Second Circuit.
This Court hereby certifies the following
question to the New York Court of Appeals:
Would the doctrine of in pari delicto bar a
derivative claim under New York law where a corporation sues its outside auditor
for professional malpractice or negligence based on the auditor’s failure to
detect fraud committed by the corporation; and, the outside
auditor did not knowingly participate in the corporation’s fraud, but instead,
failed to satisfy professional
standards in its audits of the
corporation’s financial statements?
The other case where the in
pari delicto defense has tied the litigation into knots and
caused some stops and starts is in
Kirschner
v. KPMG LLP et al., case number 09-2020, in the U.S. Court of
Appeals for the Second Circuit which is about the
Refco fraud. The
Second Circuit certified the questions about an
exception to the
in pari
delicto defense. Now they have two high profile cases
against auditors to consider. From
Law360.com:
Not one to go down easy, the bankruptcy trustee
for
Refco Inc. brought his suit implicating
Mayer Brown LLP,
KPMG LLP and other corporate giants in the massive Refco fraud to a federal
appeals court…The U.S. Court of Appeals for the Second Circuit found Monday that
trustee Marc S. Kirschner’s fight to revive his claims against the clutch of
corporate insiders raised critical unresolved questions concerning the
bankruptcy trustee’s standing under New York law to sue third parties for
Refco’s fraud.
The trustee alleges outside counsel Mayer Brown,
auditors
Ernst & Young LLP, [Grant Thornton]
PricewaterhouseCoopersLLP, Banc of America Securities LLC and several other
insiders are liable for defrauding Refco’s creditors, namely by helping the
defunct brokerage conceal hundreds of millions of dollars in uncollectible debt.
Steve Jakubowski, a local
Chicago lawyer who writes the
Bankruptcy Litigation Blog, sponsored a guest
post in January by Catherine Vance, one of the
fiercest critics of the “expansive” use of the
in pari delicto
defense. He introduces her post this way:
Whatever you may think about the fact that Refco’s outside corporate
counsel, Joe Collins, was convicted on 5 criminal counts and
sentenced today to 7 years in prison, one has to wonder how the system got
so turned upside down on the civil side that while the law firm’s lead lawyer is
torched in criminal court, his firm is summarily dismissed from a civil case for
precisely the same conduct on a simple motion to dismiss (based on a theory that
the Refco trustee lacked standing to bring suit to recover for damages arising
from a fraudulent scheme devised and carried out by Refco’s own senior
management). One could argue that this result is unique to the Second
Circuit (and
the Seventh) because of the Wagoner decision and its progeny (which
are not followed in the First, Third, Fifth, Eighth, or Eleventh Circuits).
Even in those circuits, however, management’s wrongful conduct has been imputed
to the corporation under the in pari delicto doctrine to just as effectively
knock the props out from civil actions involving some of the most spectacular
commercial frauds of the century.
Ms. Vance wrote an article entitled, In
Pari Delicto, Reconsidered, in which she
posited–as none had before–that the in pari delicto
doctrine is being inappropriately used by federal courts to supplant traditional
tort law defenses that derive from state, not federal, law.
The way I see it, the in pari delicto
doctrine is being used like a pair of needle nosed pliers by audit
firm defense lawyers to diffuse a bomb – huge liability for some of the biggest
frauds in history. The in pari delicto doctrine attempts
to pull the auditors’ tails from the fire by excusing any of their guilty acts
due to the approval of those acts by potentially equally guilty executives. The
law allows these executives to continue to “stand in the shoes” of the
shareholder plaintiffs even after their guilt has been determined. The theory is
that the executives perpetrated the fraud for the benefit of the corporation and
never “totally abandoned” it, as would be required for the “adverse interest”
exception.
Auditors who should otherwise be tested on their
fulfillment of their public duty are instead getting reprieves because courts
have been unwilling to impose the
“adverse interest” exception as expansively as
they have the in pari delicto defense itself. How can
executives who are successfully sued, been subject to regulatory sanctions or,
in the case of the Refco executives, plead guilty to criminal activities, still
be considered representatives of the corporation’s interests? They should
forfeit the right to stand in the shoes of the corporation’s shareholders in
derivative suits and therefore to shield other potentially guilty or negligent
parties.
The situation gets complicated in a bankruptcy
case such as Refco since, traditionally according to
Section 541 of a decision called
In re PSA, Inc, “property of the bankruptcy
estate consists of all legal or equitable interests of the debtor, including
causes of action, as of the commencement of the bankruptcy case. A bankruptcy
estate’s causes of action, therefore, as well as the attendant defenses thereto,
transfer to the bankruptcy trustee frozen and fixed as they existed at
the commencement of the bankruptcy case. As a result, an “innocent” bankruptcy
trustee “stands in the shoes” of the pre-petition debtor and may be unable to
prevail on estate causes of action where the pre-bankruptcy debtor participated
or was complicit in the wrongful acts upon which the estate attempts to sue.”
A trustee in bankruptcy must have
standing to sue anyone on behalf of the
creditors and other injured parties. Unfortunately, this habit of allowing
guilty parties to continue to drive the bankruptcy bus by having the
actions of the guilty officers “imputed” to the corporation
and, therefore, in bankruptcy to the trustee
potentially threatens the trustee’s ability to sue “co-conspirators.”
It’s just nuts.
Akin Gump summarizes critics of this line of
reasoning this way:
The purpose of the in pari delicto defense,
they argue, is to prevent a party who is complicit in wrongdoing from prevailing
against their joint actors. In their view, the intercession of an innocent
trustee whose duty it is to maximize the value of the estate for the debtor’s
creditors purges the taint of the debtor’s wrongdoing, and that to
hold otherwise would simply elevate the legal fiction of section 541 over the
purpose of the in pari delicto defense.
Ms. Vance reminds us in her
treatise that in pari delicto was
ushered into modern bankruptcy jurisprudence as a part of the
deepening insolvency
discussion. I’ve written about deepening insolvency many times as it relates to
the auditors who, by continuing to provide false and negligent clean audit
opinions, allow a company to go deeper and deeper into debt and ruin, thereby
significantly diminishing any remaining value for stakeholders once the gig is
up.
The deepening insolvency
arguments have been
shot down by no less than
Judge Posner whose pernicious pragmatism forces
him to engage in the self-delusion that helping companies remain “viable” via
fraud doesn’t hurt anyone. This fantasy presupposes the company to be a person
and not the embodiment of the goals and objectives, hopes and dreams, faith and
trust of the shareholders, employees, creditors, and community that count on it
to continue legally and honorably instead. I suppose a
Supreme Court that allows corporations to donate money to political campaigns
in an exercise of their inalienable constitutional
rights would not find this idea so strange.
Continued in article
Bob Jensen's threads on auditor fraud and negligence are at
http://faculty.trinity.edu/rjensen/fraud001.htm
"Audit firms left unprotected against claims of negligence," by Alex
Spence, London Times, September 28, 2009 ---
http://business.timesonline.co.uk/tol/business/industry_sectors/support_services/article6851623.ece
Britain’s big four
auditing firms have been left exposed to a surge in negligence claims after the
Government refused to limit further the damages they could face.
Deloitte, Ernst &
Young, KPMG and PricewaterhouseCoopers (PwC) lobbied hard for a cap on payouts.
Senior figures involved in the discussions said that Lord Mandelson, the
Business Secretary, appeared receptive to their concerns but stopped short of
changing the law.
The decision is a huge
blow to the firms — some face lawsuits relating to Bernard Madoff’s $65 billion
fraud — which believe there may not be another chance for a change in the law
for at least two years. They fear that they will be targeted by investors and
liquidators seeking to recover losses from Madoff-style frauds and big company
failures.
At present, auditors
can be held liable for the full amount of losses in the event of a collapse,
even if they are found to be only partly to blame.
In April,
representatives of the companies met Lord Mandelson to plead for new measures to
cap their liability. They warned that British business could be plunged into
chaos if one of them were bankrupted by a blockbuster lawsuit.
However, an official of
the Department for Business, Innovation and Skills said: “The 2006 Companies Act
already allows auditor liability limitation where companies and their auditors
want to take this course.”
Under present company
law, directors can agree to restrict their auditors’ liability if shareholders
approve; however, to date, no blue-chip company has done so. Directors have seen
little advantage in limiting their auditors’ liability, and objections by the US
Securities and Exchange Commission (SEC) have also been a significant obstacle.
The SEC opposes caps on
the ground that their introduction could lead to secret deals whereby directors
agree to restrict liability in return for auditors compromising on their
oversight of a company’s accounts. The SEC could attempt to block caps put in
place by British companies that have operations in the United States.
The big four auditors
had hoped to persuade Lord Mandelson to amend the legislation to address the
SEC’s concerns and to encourage companies to limit their auditors’ liability.
Peter Wyman, a senior
PwC partner, who was involved in the discussions, said that the Government’s
lack of action was disappointing. He said: “The Government, having legislated to
allow proportionate liability for auditors, is apparently content to have its
policy frustrated by a foreign regulator.”
Auditors are often hit
with negligence claims in the aftermath of a company failure because they are
perceived as having deep pockets and remain standing while other parties may
have disappeared or been declared insolvent.
In 2005 Ernst & Young
was sued for £700 million by Equitable Life, its former audit client, after the
insurance company almost collapsed. The claim was dropped but could have
bankrupted the firm’s UK arm if it had succeeded.
This year KPMG was sued
for $1 billion by creditors of New Century, a failed sub-prime lender, and PwC
has faced questions over its audit of Satyam, the Indian outsourcing company
that was hit by a long- running accounting fraud.
Three of the big four
are also facing numerous lawsuits relating to their auditing of the feeder funds
that channelled investors into Madoff’s Ponzi scheme.
Investors and
accounting regulators worry that the big four’s dominance of the audit market is
so great that British business would be thrown into disarray if one of the four
were put out of business by a huge court action. All but two FTSE 100 companies
are audited by the four.
Mr Wyman said: “The
failure of a large audit firm would be very damaging to the capital markets at a
time when they are already fragile.”
Arthur Andersen,
formerly one of the world’s five biggest accounting firms, collapsed in 2002 as
a result of its role in the Enron scandal.
Suits you
KPMG
A defendant in a class-action lawsuit in the Southern District of New York
against Tremont, a Bernard Madoff feeder fund
Ernst & Young
Sued by investors in a Luxembourg court with UBS for oversight of a European
Madoff feeder fund
PwC
Included in several lawsuits in Canada claiming damages of up to $2 billion
against Fairfield Sentry, a big Madoff feeder fund
KPMG
Sued in the US for at least $1 billion by creditors of New Century Financial, a
failed sub-prime mortgage lender, which claimed that KPMG’s auditing was
“recklessly and grossly negligent”
Deloitte
Sued by the liquidators of two Bear Stearns-related hedge funds that collapsed
at the start of the credit crunch
And the beat goes on and on and on ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
My threads on lawsuits and settlements of large CPA firms are a t
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"Going Concern Audit Opinions: Why So Few Warning Flares?" by Francine
McKenna, re: The Auditors, September 18, 2009 ---
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Lehman Brothers. Bear Stearns. Washington Mutual.
AIG. Countrywide. New Century. American Home Mortgage. Citigroup. Merrill
Lynch. GE Capital. Fannie Mae. Freddie Mac. Fortis. Royal Bank of Scotland.
Lloyds TSB. HBOS. Northern Rock.
When each of the notorious “financial crisis”
institutions collapsed, were bailed out/nationalized by their governments or
were acquired/rescued by “healthier” institutions, they were all carrying in
their wallets non-qualified, clean opinions on their financial statements
from their auditors. In none of the cases had the auditors warned
shareholders and the markets that there was “ a substantial doubt about the
company’s ability to continue as a going concern for a reasonable period of
time, not to exceed one year beyond the date of the financial statements
being audited.”
Continued in a very good article by Francine (she talks with some major
players)
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Francine maintains an outstanding auditing blog at
http://retheauditors.com/
Some auditing firms are now being hauled into court in bank shareholder
and pension fund lawsuits ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
"Audit firms left unprotected against claims of negligence," by Alex
Spence, London Times, September 28, 2009 ---
http://business.timesonline.co.uk/tol/business/industry_sectors/support_services/article6851623.ece
Britain’s big four auditing firms have been left
exposed to a surge in negligence claims after the Government refused to
limit further the damages they could face.
Deloitte, Ernst & Young, KPMG and
PricewaterhouseCoopers (PwC) lobbied hard for a cap on payouts. Senior
figures involved in the discussions said that Lord Mandelson, the Business
Secretary, appeared receptive to their concerns but stopped short of
changing the law.
The decision is a huge blow to the firms — some
face lawsuits relating to Bernard Madoff’s $65 billion fraud — which believe
there may not be another chance for a change in the law for at least two
years. They fear that they will be targeted by investors and liquidators
seeking to recover losses from Madoff-style frauds and big company failures.
At present, auditors can be held liable for the
full amount of losses in the event of a collapse, even if they are found to
be only partly to blame.
In April, representatives of the companies met Lord
Mandelson to plead for new measures to cap their liability. They warned that
British business could be plunged into chaos if one of them were bankrupted
by a blockbuster lawsuit.
However, an official of the Department for
Business, Innovation and Skills said: “The 2006 Companies Act already allows
auditor liability limitation where companies and their auditors want to take
this course.”
Under present company law, directors can agree to
restrict their auditors’ liability if shareholders approve; however, to
date, no blue-chip company has done so. Directors have seen little advantage
in limiting their auditors’ liability, and objections by the US Securities
and Exchange Commission (SEC) have also been a significant obstacle.
The SEC opposes caps on the ground that their
introduction could lead to secret deals whereby directors agree to restrict
liability in return for auditors compromising on their oversight of a
company’s accounts. The SEC could attempt to block caps put in place by
British companies that have operations in the United States.
The big four auditors had hoped to persuade Lord
Mandelson to amend the legislation to address the SEC’s concerns and to
encourage companies to limit their auditors’ liability.
Peter Wyman, a senior PwC partner, who was involved
in the discussions, said that the Government’s lack of action was
disappointing. He said: “The Government, having legislated to allow
proportionate liability for auditors, is apparently content to have its
policy frustrated by a foreign regulator.”
Auditors are often hit with negligence claims in
the aftermath of a company failure because they are perceived as having deep
pockets and remain standing while other parties may have disappeared or been
declared insolvent.
In 2005 Ernst & Young was sued for £700 million by
Equitable Life, its former audit client, after the insurance company almost
collapsed. The claim was dropped but could have bankrupted the firm’s UK arm
if it had succeeded.
This year KPMG was sued for $1 billion by creditors
of New Century, a failed sub-prime lender, and PwC has faced questions over
its audit of Satyam, the Indian outsourcing company that was hit by a long-
running accounting fraud.
Three of the big four are also facing numerous
lawsuits relating to their auditing of the feeder funds that channelled
investors into Madoff’s Ponzi scheme.
Investors and accounting regulators worry that the
big four’s dominance of the audit market is so great that British business
would be thrown into disarray if one of the four were put out of business by
a huge court action. All but two FTSE 100 companies are audited by the four.
Mr Wyman said: “The failure of a large audit firm
would be very damaging to the capital markets at a time when they are
already fragile.”
Arthur Andersen, formerly one of the world’s five
biggest accounting firms, collapsed in 2002 as a result of its role in the
Enron scandal.
Suits you
KPMG A defendant in a class-action lawsuit
in the Southern District of New York against Tremont, a Bernard Madoff
feeder fund
Ernst & Young Sued by investors in a
Luxembourg court with UBS for oversight of a European Madoff feeder fund
PwC Included in several lawsuits in Canada
claiming damages of up to $2 billion against Fairfield Sentry, a big Madoff
feeder fund
KPMG Sued in the US for at least $1 billion
by creditors of New Century Financial, a failed sub-prime mortgage lender,
which claimed that KPMG’s auditing was “recklessly and grossly negligent”
Deloitte Sued by the liquidators of two Bear
Stearns-related hedge funds that collapsed at the start of the credit crunch
Bob Jensen's threads on CPA firm litigation losses are at
http://faculty.trinity.edu/rjensen/fraud001.htm
Will the large international auditing firms survive?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
Banks using Deloitte and Ernst & Young show sharper declines in the fair
value of their loans than those using other accounting firms, a Wall Street
Journal analysis shows.
"Accounting for Banks' Value Gaps," by Michael Rapoport, The Wall Street
Journal, December 29, 2009 ---
http://online.wsj.com/article/SB20001424052748703278604574624463134498976.html#mod=todays_us_money_and_investing
Can investors count on consistency when it comes to
bank accounting? As many banks struggle with piles of bad loans, some
auditors appear stricter than others when assessing their true value.
Banks using Deloitte and Ernst & Young show sharper
declines in the fair value of their loans than those using other accounting
firms, a Wall Street Journal analysis shows.
Of course, it is quite possible Ernst and Deloitte
simply have a less-healthy group of bank clients. But if it instead reflects
different audit policies when it comes to assessing loans, it could have
consequences on the strength of banks' regulatory capital.
Banks carry most loans on balance sheet at their
original cost. But they must also disclose the loans' fair value, or current
market value, in footnotes. At most banks, despite the carnage of recent
years, fair value is only slightly below cost. Some banks, however, show
much steeper declines.
At Regions Financial, fair value was 19.3% lower
than cost as of Sept. 30. The difference was 13.4% at Huntington Bancshares,
12% at KeyCorp, 9% at SunTrust Banks and 8.6% at Marshall & Ilsley. Regions,
Key and SunTrust are audit clients of Ernst; Huntington and M&I are Deloitte
clients.
Among the top-25 U.S. commercial banks, those five
Ernst and Deloitte clients accounted for five of the six biggest gaps
between fair value and cost as of Sept. 30. The average gap among Ernst and
Deloitte clients in the 25-bank group was about 6%; among clients of
PricewaterhouseCoopers and KPMG it was about 2%.
Those differences can affect how investors view a
bank's loan portfolio, and could have an effect on regulatory capital in the
future.
The Financial Accounting Standards Board is
considering changes in banks' accounting for loans and may require them to
carry loans on the balance sheet at fair value instead of cost. If that
happened, the fair-value declines could reduce shareholder equity and
regulatory capital—in some cases, to levels regulators would find
troublesome. At Regions, for example, the $16.9 billion gap between its
loans' fair value and carrying value would wipe out its $13 billion in Tier
1 capital using a fair-value balance-sheet standard.
A move by the FASB to require banks to use fair
value as the balance-sheet standard doesn't have to hurt the banks'
regulatory capital. Bank regulators could adjust the capital measures they
use.
But big hits to the fair value of loans still
matter to investors. Who audits a bank's books may have importance beyond
whose name goes on the letter blessing the financial statements once a year.
Where were the auditors? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Questions about survival of the world's largest auditing firms in the wake of
the subprime scandals ---
Auditors failed to warn shareholders of virtually all recent bank failures due
to toxic investments. Let the class action lawsuits commence.
Question
What caused the credit crisis and why can't credit be unlocked after throwing
over $1 trillion at the big banks?
Great answers on Video --- this is a must-see video for you, your family, and
your students who want to understand these banking failures
The Short and Simple Video About What Caused the Credit Crisis ---
http://vimeo.com/3261363
Also at
http://www.youtube.com/watch?v=Q0zEXdDO5JU
Ed Scribner forwarded the above links
Question
Who more than anybody else is at fault for wiping out shareholders in AIG, Bear
Stearns, Merrill Lynch, CitiBank, Bank of America, Washington Mutual, Fannie
Mae, Freddie Mack, etc.
Answers
I primarily blame the CPA auditors, internal auditors, and credit rating
agencies that failed to disclose the off-balance-sheet risks that fee-loving
bankers had created. The auditors and credit rating agencies have a fiduciary
and professional responsibility to disclose to investors the extent of looming
uncollectable investments. For many years auditors have been knowingly
understating banks' bad debt risks and failing to warn investors about such
banking risks. I also think auditors, along with credit rating agencies, knew
full well about the financial risks of their huge clients but were afraid to
jeopardize their fees by blowing whistles.
Question
What more than anything else saved United Airlines and who is primarily at fault
for wiping out the shareholders of United Airlines in 2002?
Answer
In December 2002 United Airlines filed Chapter 11 Bankruptcy. In order to get
United's airplanes back in the air, the single most important saving device was
to have Uncle Sam's taxpayers take over the lifetime retirement obligations to
be paid to United's retired pilots, flight attendants, mechanics, passenger
agents, and ground crews. This saved United Airlines with the help of some major
wage concessions of existing employees who decided that keeping their jobs was
the most important thing to them.
Once again the auditors are primarily at fault for not warning investors soon
enough that United Airlines was not a viable going concern and would not be able
to meet its unbooked liabilities called Off-Balance-Sheet-Financing (OBSF) by
accountants. If investors had been warned years earlier, the stock market
would've forced United Airlines to become more serious about pricing and funding
of retirement obligations. But since investors were not forewarned by the
auditors and credit rating agencies, the equity holders (many of them United
Airlines employees) got wiped out by the 2002 declaration of bankruptcy.
Question
What more than anything else will save General Motors in 2009 and who is
primarily at fault for wiping out the shareholders of General Motors?
In 2009 or 2010 filed General Motors will most likely declare Chapter 11
Bankruptcy. It will be Deja Vu United Airlines. In order to get GM's vehicles
back on the road, the single most important saving device was to have Uncle
Sam's taxpayers take over the retirement obligations (pensions and health care
obligations) to be paid to GM's retired management and factory workers and GMAC
retired employees as well. This will save GM with the help of some major wage
concessions of existing employees who eventually decide that keeping their jobs
was the most important thing to them.
Once again the auditors are primarily at fault for not warning investors soon
enough that United Airlines was not a viable going concern and would note be
able to meet its unbooked liabilities called Off-Balance-Sheet-Financing (OBSF).
If investors had been warned years earlier, the stock market would've forced
General Motors to become more serious about pricing and funding of retirement
obligations. But since investors were not forewarned by the auditors and credit
rating agencies, the equity holders (many of them being huge investment funds)
got wiped out by the forthcoming 2009 declaration of bankruptcy.
In fairness, the accountants did give more warning about OBSF unfunded
retirement obligations in GM's case relative the United Airlines. Accountants
did disclose some years ago that about $1,500 of each new vehicle sold went
toward current funding of for retirement and health care of GM's retired
workers. It's been widely known for some time that GM's retirement obligations
were badly underfunded. What made it especially difficult for GM is that it's
major foreign competitors were making longer-lasting vehicles that beat GM
prices. The reason Toyota, Subaru, Nissan, etc. could undercut GM prices is that
these foreign automakers did not have the serious unbooked OBSF obligations that
GM carried on its back.
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Taibbi vs. Goldman Sachs: Whose side are you on?
Place a barf bag in your lap before watching
these videos!
But are they accurate?
In June and July Goldman Sachs put up a pretty good defense.
Now I'm not so sure.
Questions
Why is the SEC still hiding the names of these tremendously lucky naked short
sellers in Bear Sterns and Lehman Bros.?
Was it because these lucky speculators were such good friends of Hank Paulson
and Timothy Geithner?
Or is Matt Taibbi himself a fraud as suggested last summer by Wall Street media
such as
Business Insider?
Jensen Comment
Evidence suggests that the SEC may be protecting these Wall Street thieves!
Or was all of this stealing perfectly legal? If so why the continued secrecy on
the part of the SEC?
Suspicion: The stealing may have taken place in top investors needed by
the government for bailout (Goldman Sachs?)
"Wall Street's Naked Swindle" by Matt
Taibbi
Watch the Video at one of the following sites:
You Tube ---
http://www.youtube.com/watch?v=OqZUbe9KIMs
Google video ---
Click Here
Read the complete article ---
Click Here
Video Updates for Matt Taibbi
GRITtv: Matt Taibbi & Michael Lux: Goldman's Coup
---
http://www.youtube.com/watch?v=nFWjXQLDkXg
"Matt Taibbi's Goldman Sachs Story Is A Joke,"
Joe Weisenthal, Business Insider, July 13, 2009 ---
http://www.businessinsider.com/matt-taibbis-goldman-sachs-story-is-a-joke-2009-7
"Goldman Sachs responds to Taibbi Post," by:
Felix Salmon, Rueters, June 26, 2009 ---
Calls Taibbi "Hysterical" ---
http://blogs.reuters.com/felix-salmon/2009/06/26/goldman-sachs-responds-to-taibbi/
Others Now Argue it Is Not a Joke
"Taibbi's Naked-Shorting Rage: Goldman's Lobbying, SEC's Fail,"l by bobswern.
Daily Kohs, September 30, 2009 ---
http://www.dailykos.com/story/2009/9/30/787963/-Taibbis-Naked-Shorting-Rage:-Goldmans-Lobbying,-SECs-Fail
Now, off we go to Goldman Sachs' notorious lobbying
hubris, the historically-annotated, umpteenth oversight failure of the
Securities Exchange Commission ("SEC"), and what I'm quickly realizing may
well turnout to be the story with regard to it becoming the poster
child for regulatory capture and supervisory breakdown as far as our Wall
Street-based corporatocracy/oligarchy is concerned. Here's the link to
Taibbi's preview blog post: "An
Inside Look at How Goldman Sachs Lobbies the Senate."
Yesterday, as described in this lead-in piece from
the Wall Street Journal, the SEC held a public roundtable discussion
on "New Rules for Lending of Securities." (See link here: "SEC
Weighs New Rules for Lending of Securities.")
SEC Weighs New Rules for Lending of Securities
BY KARA SCANNELL AND CRAIG KARMIN
Wall Street Journal
Saturday, September 26th, 2009
Securities regulators are exploring new
regulations for the multitrillion-dollar securities-lending market, the
first major step regulators have taken in the area in decades.
Securities and Exchange Commission Chairman
Mary Schapiro said she wants to shine a light on the "opaque market."
After many large investors lost millions in last year's credit crunch,
she said, "we need to consider ways to enhance investor-oriented
oversight."
The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants...
Enter Taibbi: "An
Inside Look at How Goldman Sachs Lobbies the Senate."
An Inside Look at How Goldman Sachs Lobbies the
Senate
Matt Taibbi
TruSlant.com
(very early) Tuesday, September 29th, 2009
The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants contend.
Securities lending is central to the practice of short selling, in which
investors borrow shares and sell them in a bet that the price will
decline. Short sellers later hope to buy back the shares at a lower
price and return them to the securities lender, booking a profit.
Lending and borrowing also help market makers keep stock trading
functioning smoothly.
--SNIP--
Later on this week I have a story coming out in
Rolling Stone that looks at the history of the Bear Stearns and Lehman
Brothers collapses. The story ends up being more about naked
short-selling and the role it played in those incidents than I had
originally planned -- when I first started looking at the story months
ago, I had some other issues in mind, but it turns out that there's no
way to talk about Bear and Lehman without going into the weeds of naked
short-selling, and to do that takes up a lot of magazine inches. So
among other things, this issue takes up a lot of space in the upcoming
story.
Naked short-selling is a kind of counterfeiting
scheme in which short-sellers sell shares of stock they either don't
have or won't deliver to the buyer. The piece gets into all of this, so
I won't repeat the full description in this space now. But as this week
goes on I'm going to be putting up on this site information I had to
leave out of the magazine article, as well as some more timely material
that I'm only just getting now.
Included in that last category is some of the
fallout from this week's SEC "round table" on the naked short-selling
issue.
The real significance of the naked
short-selling issue isn't so much the actual volume of the behavior,
i.e. the concrete effect it has on the market and on individual
companies -- and that has been significant, don't get me wrong -- but
the fact that the practice is absurdly widespread and takes place right
under the noses of the regulators, and really nothing is ever done about
it.
It's the conspicuousness of the crime that is
the issue here, and the degree to which the SEC and the other financial
regulators have proven themselves completely incapable of addressing the
issue seriously, constantly giving in to the demands of the major banks
to pare back (or shelf altogether) planned regulatory actions. There
probably isn't a better example of "regulatory capture," i.e. the
phenomenon of regulators being captives of the industry they ostensibly
regulate, than this issue.
Taibbi continues on to inform us that none of the
invited speakers to this government-sponsored event represented stockholders
or companies that could, or have, become targets/victims of naked
short-selling. Also "...no activists of any kind in favor of tougher rules
against the practice. Instead, all of the invitees are (were) either banks,
financial firms, or companies that sell stuff to the first two groups."
Taibbi then informs us that there is only one
panelist invited that's in favor of what may be, perhaps, the most basic
level of regulatory control with regard to this industry practice: a "simple
reform" called "pre-borrowing." Pre-borrowing requires short-sellers to
actually possess the stock shares before they're sold.
It's been proven to work, as last summer the SEC,
concerned about predatory naked short-selling of big companies in the
wake of the Bear Stearns wipeout, instituted a temporary pre-borrow
requirement for the shares of 19 fat cat companies (no other companies
were worth protecting, apparently). Naked shorting of those firms
dropped off almost completely during that time.
The lack of pre-borrow voices invited to this
panel is analogous to the Max Baucus health care round table last
spring, when no single-payer advocates were invited. So who will get to
speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a
hedge fund that has done the occasional short sale, to put it gently),
Credit Suisse, NYSE Euronext, and so on.
Taibbi then tells us of increased efforts by
industry players, specifically noting Goldman Sachs being at the forefront
of this effort, and having "their presence felt."
Taibbi mentioned that he'd received two completely
separate calls from two congressional staffers from different offices--folks
whom Taibbi never met before--who felt compelled to inform him of Goldman's
actions.
We learn that these folks both commented on how
these Goldman folks were lobbying against restrictions on naked
short-selling. One of the aides told Taibbi that they had passed out a "fact
sheet about the issue that was so ridiculous that one of the other staffers
immediately thought to send it to me. "
I would later hear that Senate aides between
themselves had discussed Goldman's lobbying efforts and concluded that
it was one of the most shameless performances they'd ever seen from any
group of lobbyists, and that the "fact sheet" the company had had the
balls to hand to sitting U.S. Senators was, to quote one person familiar
with the situation, "disgraceful" and "hilarious."
Checkout the whole story on his blog. Apparently,
in the upcoming Rolling Stone piece, he gets into the nitty gritty with
regard to how naked short-selling brought down both Bear Stearns and Lehman,
last year.
Should be pretty powerful stuff.
Meanwhile, getting back to the SEC roundtable,
noted above, strike up the fifth item that I've now documented in the past
48 hours where it's becoming self-evident that our elected representatives
and our government agencies aren't even bothering to author the new
regulations and legislation that's so needed to prevent a recurrence of
events such as those we witnessed through the economic/market catastrophes
of the past 24 months; these legislators and high-ranking government
officials are actually having the lobbyists navigate the discussion and
write the damn stuff, too!
How much worse can it get? I really don't want
to know the answer to that rhetorical question. But, with the inmates
running the asylum, we may just find out sooner than we think!
Bob Jensen's threads on noble and ignoble
agendas of the bailout machine ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#IgnobleAgendas
"Going Concern Audit Opinions: Why So Few Warning Flares?" by Francine
McKenna, re: The Auditors, September 18, 2009 ---
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Lehman Brothers. Bear Stearns. Washington Mutual.
AIG. Countrywide. New Century. American Home Mortgage. Citigroup. Merrill
Lynch. GE Capital. Fannie Mae. Freddie Mac. Fortis. Royal Bank of Scotland.
Lloyds TSB. HBOS. Northern Rock.
When each of the notorious “financial crisis”
institutions collapsed, were bailed out/nationalized by their governments or
were acquired/rescued by “healthier” institutions, they were all carrying in
their wallets non-qualified, clean opinions on their financial statements
from their auditors. In none of the cases had the auditors warned
shareholders and the markets that there was “ a substantial doubt about the
company’s ability to continue as a going concern for a reasonable period of
time, not to exceed one year beyond the date of the financial statements
being audited.”
Continued in a very good article by Francine (she talks with some major
players)
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Francine maintains an outstanding auditing blog at
http://retheauditors.com/
Bob Jensen's threads on "Where Were the Auditors?" ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Question
What are the two secret numbers that you will never hear mentioned by Uncle
Sam's current leaders like President Obama, House Speaker Pelosi, and Senate
Leader Reid?
Answer
They will never mention the extent of Uncle Sam's unbooked OBSF liabilities.
Accountants have no accurate estimates of these liabilities, but the former
Chief Accountant of the United States, David Walker, estimates that these are
about $60 trillion at the moment. They may well be $100 trillion in four years
if Congress is successful in legislating tens of trillions of dollars in new
entitlements for education, energy, welfare, and health care.
Uncle Sam's leaders are now focusing our attention on problems with the annual
spending deficit (which may well approach $ trillion at the end of 2009) and the
booked National Debt (which may well approach $12 trillion by the end of 2009).
But these booked items will not break the back of Uncle Sam. What will break the
back of Uncle Sam is what broke the back of United Airlines and General Motors.
It's the unbooked OBSF debt which the companies, auditors, and credit rating
agencies tried to keep secret.
Uncle Sam saved United Airlines by taking over United's OBSF retirement debt.
Uncle Sam will probably do the same for GM, Ford, and Chrysler unfunded OBSF
debt. But who will save Uncle Sam from its $60-$100 trillion of unfunded and
unbooked OBSF debt?
Only the Zimbabwe School of Finance will save Uncle Sam.
You, your family, and your students may learn a great deal from the links to
David Walker's warning videos and the most worrisome CBS Sixty Minutes module
ever produced ---
http://faculty.trinity.edu/rjensen/entitlements.htm
When will auditors learn about complexities of financial risk?
"Did Wells Fargo's Auditors Miss Repurchase Risk?" by
Francine McKenna, ClusterStock, September 20,
2009 ---
http://www.businessinsider.com/john-carney-did-wells-fargos-auditors-miss-repurchase-risk-2009-9
On Friday,
the Business Insider worried that Wells Fargo may be making the same fatal
mistake AIG did – underestimating, or worse,
naively ignoring Collateral Call Risk.
The concern was focused on
potential exposure from the credit default swaps portfolio they inherited
from Wachovia. In WFC's annual report the Buiness Insider saw limited
discussion of this risk and no details of the reserves for it.
There are two possible ways
to account for the lack of discussion of Collateral Call Risk. Either
Wachovia wrote its derivative contracts in ways that don’t permit buyers to
demand more collateral or Wells Fargo is not disclosing this risk. (A third
possibility—that they don't even seem aware that they have this risk — seems
remote after AIG.)
When I read that, I saw eerie parallels with New
Century, all the more so because of the auditor connection – both Wells
Fargo and Wachovia and New Century (now in Chapter 11) are audited by KPMG.
New Century was not too transparent either and, as a result, many people,
including
some very sophisticated investors
were caught with their pants down. KPMG is accused in a $1 billion dollar
lawsuit of not just being incompetent, but of aiding, abetting, and covering
up New Century’s fraudulent loan loss reserve calculations just so they
could keep their lucrative client happy and viable.
From
the lawsuit:
KPMG’s audit and review failures concerning New Century’s reserves
highlights KPMG’s gross negligence, and its calamitous effect — including
the bankruptcy of New Century. New Century engaged in admittedly high risk
lending. Its public filings contained pages of risk factors…New Century’s
calculations for required reserves were wrong and violated GAAP. For
example, if New Century sold a mortgage loan that did not meet certain
conditions, New Century was required to repurchase that loan. New Century’s
loan repurchase reserve calculation assumed that all such repurchases occur
within 90 days of when New Century sold the loan, when in fact that
assumption was false.
In 2005 New Century informed KPMG that the total outstanding loan repurchase
requests were $188 million. If KPMG only considered the loans sold within
the prior 90 days, the potential liability shrank to $70 million. Despite
the fact that KPMG knew the 90 day look-back period excluded over $100
million in repurchase requests, KPMG nonetheless still accepted the flawed
$70 million measure used by New Century to calculate the repurchase
reserve. The obvious result was that New Century significantly under
reserved for its risks.
How does the New Century situation and KPMG’s role in
it remind me of Wells Fargo now? Well, in both cases, there’s no disclosure
of the quantity and quality of the repurchase risk to the organization. Back
in
March of 2007, I wrote about the lack of
disclosure of this repurchase risk in New Century’s 2005 annual report:
There are 17 pages of discussion of general and REIT specific risk
associated with this company, but no mention of the specific risk of the
potential for their banks to accelerate the repurchase of mortgage loans
financed under their significant number of lending arrangements….it does not
seem that reserves or capital/liquidity requirements were sufficient to
cover the possibility that one of or more lenders could for some reason
decide to call the loans. Did the lenders have the right to call the loans
unilaterally? It does say that if one called the loans it is likely that all
would. Didn’t someone think that this would be a very big number (US 8.4
billion) if that happened.
Some have been writing since 2005 about the elephant in the room that is
mortgage loan repurchase risk:
Even if a lender sells most of the loans it originates, and, theoretically,
passes the risk of default on to the buyer of the loan, there remains an
elephant lurking in the room: the risk posed to mortgage bankers from the
representations and warranties made by them when they sell loans in the
secondary market… in bad times, the holders of the loans have been known to
require a second "scrubbing" of the loan files, looking for breaches of
representations and warranties that will justify requiring the originator to
repurchase the loan. …A "pure" mortgage banker, who holds and services few
loans, may think he's passed on the risk (absent outright fraud).
Sophisticated originators know better…When the cycle turns (as it always
does) and defaults rise, those originating lenders who sacrificed sound
underwriting in return for fee income will find the grim reaper knocking at
their door once again, whether or not they own the loan.
Clusterstock quoted Wells Fargo from page 127 of their
2008 Annual Report (emphasis added):
In certain loan sales or
securitizations, we provide recourse to the buyer whereby we are
required to repurchase loans at par value plus accrued interest on the
occurrence of certain credit-related events within a certain period of time.
The maximum risk of loss…In 2008 and in 2007, we did not repurchase a
significant amount of loans associated with these agreements.
But earlier, on page 114,
there is a footnote to a chart representing loans in their balance sheet
that have been securitized--including residential mortgages and
securitzations sold to FNMA and FHLMC--where servicing is their only form of
continuing involvement.
However, the delinquencies
and charge off figures do not include sold loans. Wells Fargo tells us these
numbers do not represent their potential obligations for repurchase if FNMA
and FHLMC decide their underwriting standards were not up to par.
Delinquent loans and net charge-offs exclude loans sold to FNMA and FHLMC.
We continue to service the loans and would only experience a loss if
required to repurchasea delinquent loan due to a breach in original
representations and warranties associated with our underwriting standards.
So where are those numbers?
Where is the number that correlates to the $8.4 billion dollar exposure that
brought down New Century? Wells Fargo saw an almost 300% increase from 2007
to 2008 in delinquencies and 200% increase in charge offs from commercial
loans and a 300% increase in delinquencies and 350% increase in charge offs
on residential loans they still hold. Can anyone say with certainty that we
won’t see FNMA and FHLMC come back and force some repurchases on Wells Fargo
for lax underwriting standards?
This is all we get from
Wells Fargo in the 2008 Annual Report:
During 2008, noninterest income was
affected by changes in interest rates, widening credit spreads, and other
credit and housing market conditions, including…
The lack of disclosure of this issue here mirrors the
lack of disclosure in New Century and perhaps in other KPMG clients such at
Citigroup, Countrywide ( now inside Bank of America) and others. How do I
know there could be a pattern? Because
the inspections of KPMG by the PCAOB, their
regulator, tell us they have been called on auditing deficiencies just like
this. Do we have to wait for a post-failure lawsuit to bring some sense,
and some sunshine, to the system?
Francine McKenna is Editor of Re: The Auditors.
Will auditors survive the huge lawsuits concerning their negligence in
estimating loan losses in the subprime mortgage and CDO crisis ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
Bob Jensen's threads on auditing firm lawsuits ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
"It’s Mine, Mine All Mine: Can Anyone Catch Lehman Stealing?" by
Francine McKenna, re: The Auditors, February 22, 2010 ---
http://retheauditors.com/2010/02/22/its-mine-mine-all-mine-can-anyone-catch-lehman-stealing/
Most of what’s been written about the financial
crisis and the firms that were forcibly acquired, failed, or bailed out
tends to focus on “fair value” as the feckless culprit.
Satyajit Das
wrote for the site,
Naked Capitalism:
“MtM [mark-to-market] accounting itself is
flawed… There are difficulties in establishing real values of many
instruments. It creates volatility in earnings attributable to
inefficiencies in markets rather than real changes in financial
position…Valuation for all but the simplest instruments today requires a
higher degree in a quantitative discipline, a super computer and a vivid
imagination. For complex structured securities and exotic derivatives,
the only available price is from the bank that originally sold the
security to the investor. Prices available from the purveyor of the
instrument (a concept known as mark-to-myself) strain reasonable
concepts of independence and objectivity…In the global financial crisis,
with the capital markets virtually frozen, the extent of losses on bank
inventories of hard-to-value products and commitments (structured debt
and leveraged loans) was difficult to establish.”
We know that the banks’ “independent” external
auditors had a hard time establishing both fair values and the “extent of
losses on bank inventories of hard-to-value products and commitments.” We
know this because their clients did not tell us about the extent of the
losses until it was too late. There were no
“going concern” warnings for any of the financial
institutions that went bankrupt, were taken over, or were nationalized via
bailout.
We also know that the auditors did a poor and
inconsistent job of
establishing fair values and forcing disclosure of the “extent of losses” on
banks’ investments because
their regulator, the PCAOB, told us so.
Inspection teams also observed instances
where firms’ procedures to test the fair values of financial
instruments, including derivative instruments, loans, and securities,
were inadequate. In these instances, deficiencies included (a) the
failure to gain an understanding of the methods and assumptions used to
develop the fair value measurements of financial instruments that were
illiquid or difficult to price, (b) the reliance on issuer-supplied
pricing information without obtaining corroboration of that information,
and (c) the reliance on confirmation responses from third parties or
counterparties that included disclaimers as to their accuracy and
appropriateness for use in the preparation of financial statements.
How do the auditors, one step removed and ten steps
behind, determine fair values of complex instruments especially in illiquid
markets if even the super-bankers couldn’t get it right? This question
supposes that it’s the auditors’ obligation to determine the values and that
the bankers didn’t get it right.
Neither is true.
What are the auditors’ obligations with regard to
clients’ fair value measurements and disclosures? Auditors do not establish
fair values. Instead, their role is to, “test management’s fair value
measurements and disclosures.” But that obligation is broader than just
taking the word of the
“masters of the universe.”
The auditor should consider using the work
of a specialist if the auditor does not have the necessary skill and
knowledge to plan and perform audit procedures related to fair value.[1]
Observable market prices may exist to assist in testing fair values.
Where they do not and other valuation methods are used, the auditor’s
substantive tests of fair value may involve (a) testing the significant
assumptions, the valuation model, and the underlying data, (b)
developing an independent estimate of fair value for corroborative
purposes or, where applicable, (c) reviewing events or transactions
occurring after the period covered by the financial statements and
before the date of the auditor’s report.
I say it’s outrageous to see
ongoing material “disputes” regarding the fair
value of complex derivatives between counterparties, especially if they are
clients of the same auditor. Critics have suggested that I condone breaches
of client confidentiality. Without betraying client confidentiality, they
ask, how can distinct audit teams compare the values assigned to either side
of same transaction?
One of my
commenters explained it:
Just how many PhD’s with CDS valuation
expertise do you think PwC has lying around in New York? The valuation
of these instruments and the testing of the assumptions would have been
sent to a centralized derivative valuation group to review and test.
Such a team would have had a fairly standard set of guidelines and
testing approach regardless of the team sending it. After validating the
inputs, they would have likely put it through their own sausage machine
/ valuation tool and compared the results. I think there would be a high
probability that the same analysts would have been reviewing the same
instrument for both GS and AIG. And when they notice that GS is using
market derived inputs for the referenced MBS while AIG is using the
historical average default rates and ignoring the market you would have
hoped they might speak up. And when the partner (finally) heard the
rumblings of a problem, even after it has been filtered through the
manager / senior manager “make-it-go-away” screen, he would have asked
“who else deals with this cr_p in the firm? GS… ah, [insert name of old
white guy here] is an old buddy of mine, I’ll just give him a call and
ask him what they do…”
When one excuses the auditors for not getting fair
value right, there’s a follow-on argument that claims no one got it right.
No one could possibly get it right. That’s why the crisis
occurred. That’s what the scoundrels that benefited most from the crisis
would like you to believe.
Reality is the opposite.
Much has been written about how well Goldman Sachs made out as a result
of the crisis. But there are others. Some are getting prosecuted like
Bank of America’s Ken Lewis for hiding losses to
further their interest in millions of bonus dollars. That’s why some are
starting to use the word “fraud” when speaking of Lehman’s collapse.
On February 11th,
Bloomberg’s Jonathan Weil asked why no one is prosecuting Lehman
Brothers executives for fraud:
It is so widely accepted that Lehman Brothers Holdings Inc.’s
balance sheet was bogus that even former Treasury Secretary Hank Paulson
can say it in his new memoir. And still, the government hasn’t found
anyone who did anything wrong at the failed investment bank…In his new
book, “On the Brink,” Paulson doesn’t
point fingers at specific Lehman executives for violating any rules. He
displays amazing candor, though, in describing how Lehman’s asset values
were a gross distortion of the truth. It doesn’t take much imagination
to figure out they didn’t get that way all by themselves.”
A reader, I’ll call him David the CFE,
repeats a story to me to illustrate this point:
“Casey Stengel probably said it best when
he said after the Mets 40-120 season, ‘Gentlemen, not one of you could
have done this on your own. This was a team effort.’ “
Losing $156 billion requires a team effort.
When former Lehman Managing Director
Arthur Doyle reviewed Larry McDonald’s book on Lehman,
he asked the same questions about fraud and Lehman
executives:
“The most important questions of all are
not even asked in “A Colossal Failure of Common Sense,” or in any other
account I have so far seen of the Lehman failure. Simply put, how did
Lehman’s published financial statements, as recently as its final 10-Q
published in July of 2008, show a positive net worth of $26 billion,
when the bankruptcy liquidators are saying that they are looking at a
negative net worth of $130 billion? Doesn’t any or all this constitute
securities fraud? And shouldn’t there be criminal liability for the
executives who signed the firm’s 10-K and 10-Q’s, who under
Sarbanes-Oxley are responsible for material misstatements made in those
documents?”
Bloomberg’s Weil has a theory about why these
crimes are not being prosecuted:
“There’s been much talk the past two years
about moral hazard, which is the risk that companies and their investors
will behave more recklessly when they believe the government will bail
them out. Less has been made of a similar hazard: The danger that
powerful companies won’t follow the law when their executives believe
the government won’t hold them to it…The latter risk threatens not only
our economy, but our democracy. There’s every reason to believe both
kinds are growing.”
David the CFE and I have
another theory:
Collusion.
The crimes are too numerous to prosecute without
indicting the whole system and most of the major players. And because they
were part of the problem before they were theoretically part of the
solution, culpability also attaches to Paulson and Tim Geithner.
David the CFE’s theory is
premised on some of the oldest tricks in the book for manipulating
revenue recognition and, therefore, reported
profits and incentive compensation payouts including stock options -
roundtrips, parking, and channel stuffing. In
another variation on the theme, global trading company Refco used
a round trip loan to
repeatedly hide a related-party transaction incurred to delay disclosure of
significant uncollectible accounts. It’s not like these techniques haven’t
been used before (by AIG, for example) to offload risk and smooth earnings
at quarter- and year-end.
“This
case shows that the Commission will
pursue insurance companies and other financial institutions that market
or sell so-called financial products that are, in reality, just vehicles
to commit financial fraud,” said Stephen M. Cutler, director of the
SEC’s Division of Enforcement.
With regard to
the financial crisis, these revenue recognition fraud techniques may have
been most useful in establishing
“observability” of market prices for otherwise
illiquid assets. Establishing “market prices” via fraudulent, sham
transactions amongst the market participants before quarter-end and year-end
reporting periods would have allowed assets to remain on the books longer at
inflated values and, therefore, to inflate profits and bonuses. “Market
prices” that appeared to support existing valuations sustained the myth. The
investments were not written down until long after the market for subprime
real estate securities started to wilt.
David the CFE explains
this theory in the case of Lehman Brothers:
Nassim Taleb
says about banks: “Banks hire dull people and
train them to be even duller. If they look conservative, it’s only
because their loans go bust on rare, very rare occasions. But bankers
are not conservative at all. They are just phenomenally skilled at
self-deception by burying the possibility of a large, devastating loss
under the rug.
Taleb further states: “Executives will
game the system by showing good performance so they can get their yearly
bonus.”
Lehman paid out $5.2 billion in bonuses in 2006
and $5.7 billion in bonuses in 2007. Did this result from the
executives at the bank gaming the system to increase their bonuses? An
example of burying a large loss under the rug can be found in this
excerpt from Lehman Brothers in its
2006 10-K:
We held
approximately $2.0 billion and $0.7 billion of non-investment grade
retained interests at November 30, 2006 and 2005, respectively. Because
these interests primarily represent the junior interests in
securitizations for which there are not active trading markets,
estimates generally are required in determining fair value. We value
these instruments using prudent estimates of expected cash flows and
consider the valuation of similar transactions in the market.
Junior interests in securitizations.
Lehman and other firms purchased
mortgages that would effectively be resold by them as collateralized
debt obligations. Each of Lehman’s securitizations was broken into
tranches in which senior interests received greater preference with
respect to collections of interest and principal than junior interests
that were entitled to greater profits, if such profits were realized. A
junior interest in a securitization is the lowest level of the tranches
for collateralized debt obligations. Generally, only the
bottom 3% of a
securitization was labeled as equity.
During 2006, housing prices dropped nationally
by at least 5% from the spring of 2006 to Lehman’s Nov. 30, 2006 and the
default rate was increasing as well. With prices of houses dropping and
the default rate increasing, there was a risk of large losses when the
buyer defaults. Thus, the junior interests in securitizations that
Lehman was purportedly investing in were probably already worthless at
the time that Lehman invested in them or at November 30, 2006.
An auditor would have to suspect a material
loss is being hidden and that collusion between several departments at
Lehman Brothers and management’s participation in the deception was
possible.
Ernst and Young, Lehman’s auditors, were
probably unwilling to consider such a possibility because auditors
accept as dogma that collusion between many employees and multiple
departments is unlikely no matter what the motive, i.e., $5.2 billion in
bonuses. Auditing standards also do not consider collusion likely.
Apparently, auditors did not consider the possibility that two different
groups at Lehman Brothers such as the underwriters who sold the
securitization IPOs and the trading departments would collude to hide a
$1.3 billion loss in a junior equity position that could not be sold.
Hiding losses on CDOs
and mortgages purchased for securitization. A reasonable
question to ask was: If Lehman Brothers started the fiscal year ending
Nov. 2007 with $57 billion of CDOs and held them for the year, what
would their estimated loss be? Also: What would the additional loss be
with $32 billion in CDOs and/or mortgages purchased?
Presumably, the losses would be in the range of
$10 billion to $30 billion. By Nov. 2007, everyone knew of the problems
with CDOs. Bear Stearns had already closed two hedge funds investing in
CDOs. Merrill Lynch had made huge write downs and forced out its CEO. My
guess is that Lehman Brothers engaged in schemes to fool the auditor in
order to avoid disclosing losses from their securitizations and
investments in CDOs.
Lehman probably pulled a variation of the old
“telecom swap.” In the “telecom swap” cases,
one telecom company would sell telecom capacity to another telecom and
then purchase the same amount of telecom capacity from the other party.
The firm selling the capacity would book the amount received as revenue
and the firm purchasing the capacity would book the amount received as a
fixed asset. It worked very well in creating fictitious profits for
those firms.
That same trick could be used by financial
institutions in the case of CDOs/CDSs. Let’s say Financial Institution A
sells collateralized debt obligations with a true fair market value of
90 million to Financial Institution B for 100 million dollars in cash.
Financial Institution B purchases collateralized debt obligations with a
true fair market value of 90 million dollars from Financial Institution
A for 100 million dollars in cash.
And then those phony trades are shown as the
“observable” similar transactions in the market.
Did the auditors check for this item? Probably
not. Why not? Because it’s an example of collusion between Lehman and
other companies. Auditors don’t check for collusion no matter how many
times they get fooled by it!
Continued in article
Lloyds to reveal £13bn of bad debts
The write-downs continue to stem from the riskier
property exposure in HBOS's corporate lending book, after the bank's new owner
took a more conservative view of its debts. However, the bank will also suffer
higher defaults in its mortgage lending book this year as unemployment rises and
more households are unable to make repayments. Lloyds is still in talks with the
government about placing £260bn in toxic debt – mostly from HBOS – into a
taxpayer-backed insurance scheme to strengthen its balance sheet.
Erikka Askeland, The Scotsman, July 13, 2009 ---
http://business.scotsman.com/bankinginsurance/Lloyds-to-reveal-13bn-of.5452046.jp
Jensen Comment
Both Lloyds and Ernst & Young failed to warn investors of the magnitude of
pending bad debt write-offs.
"Time to count the cost of failure:
Accounting firms are trying to shield themselves
from the consequences of the financial crisis despite being partly to blame." by
Prem Sikka, The Guardian, May 21, 2009 ---
http://www.guardian.co.uk/commentisfree/2009/may/21/accounting-financial-crisis
The FASB and IASB Won't Care For This Case
The Moral Hazard of Fair Value Accounting
From The Wall Street Journal Accounting
Weekly Review on June 12, 2009
Wells Fargo, BofA Pay to Settle Claims
by Jennifer
Levitz
The Wall Street Journal
Jun 09, 2009
Click here to view the full article on WSJ.com
http://online.wsj.com/article/SB124447741263994585.html?mod=djem_jiewr_AC
TOPICS: Advanced
Financial Accounting, Auditing, Fair-Value Accounting Rules, Internal
Controls, Investments
SUMMARY: "One
of the nation's largest mutual-fund companies allegedly overvalued its
holdings of mortgage securities during the housing bust, making its fund
appear to be one of the top performers, and then was forced to take big
write-downs, leaving some investors in the supposedly conservative offering
with losses approaching 25%....Evergreen began repricing the securities
after its valuation committee learned on June 10 that the portfolio managers
had known since March about problems with a certain mortgage-backed security
but had failed to disclose it to the committee", the SEC said.
CLASSROOM APPLICATION: The
implication of properly establishing fair values in a trading portfolio is
the major topic covered in this article. Also touched on are the internal
control procedures and related audit steps over this valuation process.
QUESTIONS:
1. (Introductory)
What was the implication of not properly valuing certain fund investment for
the reported performance of the Evergreen Ultra Fund?
2. (Introductory)
What also was the apparent problem with the type of investment made by
portfolio managers of this Evergreen fund? In your answer, comment on the
purpose of the fund and the risk of mortgage-backed securities in which it
invested.
3. (Introductory)
How should an entity such as the Evergreen Ultra Fund account for its
investments? Describe the balance and income implications and state what
accounting standard requires this treatment.
4. (Advanced)
What evidence should the Evergreen fund's portfolio managers have taken into
account in valuing investments? How did the fund managers allegedly avoid
using that evidence?
5. (Advanced)
What internal control procedures were apparently in place at Evergreen to
ensure that fund assets were properly valued by portfolio managers? What was
the apparent breakdown in internal control?
6. (Advanced)
Based on the description in the article of internal control processes at
Evergreen, design audit procedures to assess whether the internal control
over investment valuations is functioning properly. What evidence might
arise to indicate a failure in internal control?
Reviewed By: Judy Beckman, University of Rhode Island
"Wells Fargo, BofA Pay to Settle Claims," by Jennifer Levitz, The Wall
Street Journal, June 10, 2009 ---
http://online.wsj.com/article/SB124447741263994585.html?mod=djem_jiewr_AC
Wells Fargo & Co. and Bank of America Corp. agreed
Monday to settle claims that employees misled investors about the value and
safety of certain securities during the financial crisis.
Wells's Boston-based mutual fund Evergreen
Investment Management Co. agreed along with its brokerage unit to pay $40
million to end civil state and federal securities-fraud allegations that it
overvalued the holdings of its Evergreen Ultra Short Opportunities Fund and
then, when it was going to lower the value of the securities, informed only
select investors -- many of them customers of an Evergeen affiliate --
allowing them to cash out of the fund and lessen their losses.
Separately, Bank of America agreed to "facilitate"
the return of more than $3 billion to California clients who purchased
auction rate securities, an investment that went sour last year amid a
liquidity freeze. The bank reached the agreement with the California
Department of Corporations.
"We are pleased that the outcome of these
negotiations will result in the return of money to many investors who
suffered by the freezing of their assets when the auctions failed," said
California Department of Corporations Deputy Commissioner Alan Weinger. A
bank spokeswoman couldn't be reached for comment.
The Wells case highlights the valuing of securities
as a key issue during the financial crisis as banks, hedge funds and now
mutual funds have failed to take losses on their holdings even though there
was evidence in the market these securities were trading at lower prices.
In one case Evergreen, which had $164 billion in
assets at the end of the first quarter, was holding a security at nearly
full value when another fund at the firm purchased a similar security for 10
cents on the dollar.
Evergreen didn't admit or deny wrongdoing in a
settlement with the Securities and Exchange Commission and the Massachusetts
Securities Division. "We are committed to acting in the best interest of
shareholders, and continue to move forward with our primary goal of
safeguarding your investments," Evergreen stated in a letter to clients on
its Web site announcing the settlement.
Evergreen was a unit of Wachovia Corp. at the time
of the alleged overvaluations. Lisa Brown Premo and Robert Rowe, then
co-managers of the Ultra fund, have left Evergreen, as have two unidentified
senior vice presidents, said Evergreen spokeswoman Laura Fay. Wachovia was
acquired last year by Wells Fargo.
The Evergreen case is similar to an SEC fraud case
against Van Wagoner Funds in San Francisco. In 2004, Van Wagoner agreed to
pay $800,000 to settle civil charges by the SEC that it mispriced some
technology-company securities in its stock funds.
Regulators allege that Evergreen inflated the value
of mortgage-related securities in the Ultra fund -- which the company touted
as conservative -- by as much as 17% between February 2007 and June 2008,
when it closed and liquidated the fund. The overstatement caused the fund to
rank as one of the top five or 10 funds among between 40 and 50 similar
funds in 2007 and part of 2008. An accurate valuation would have placed the
fund at the bottom of its category, regulators said.
Regulators said that when Evergreen began to
reprice certain inflated holdings in the three weeks before the fund was
liquidated on June 18, the company only disclosed the adjustments -- and the
reason why -- to select customers, many of them customers of Evergreen
affiliate Wachovia Securities LLC. Those customers also were told more
pricing adjustments were likely.
At liquidation, the fund had $403 million in
assets, down from $739 million at the end of 2007, regulators said.
David Bergers, director of the SEC in Boston, said
that by law mutual funds must treat all shareholders equally, and that "it's
particularly troubling in these difficult times that that did not happen."
He said the SEC's "investigation is continuing relating to this matter."
Ms. Fay declined to comment on Mr. Bergers's
statement. Of Monday's settlement, she said it is in "Evergreen's and our
clients' best interest to resolve the matter and move forward."
Regulators say that in pricing Ultra fund
securities, Evergreen's portfolio managers didn't factor in readily
available information about the decline in mortgage-backed securities. By
law, mutual funds are supposed to take all available information into
account when valuing securities, and "that's especially true when the market
is shifting," Mr. Bergers said.
Massachusetts regulators cite one case in May 2008
in which the Ultra fund priced a subprime mortgage-backed security for
$98.93, even though another Evergreen fund purchased the same security for
$9.50.
After learning of the transaction, state regulators
allege, the Ultra fund's portfolio management team contacted the broker who
had sold the security to determine whether the sale was distressed and thus
could be disregarded for purposes of determining the fair value of the
security. The dealer responded that the security wasn't coming from a
distressed seller. Nonetheless, the Ultra fund team told Evergreen's
valuation committee they believed the sale was distressed and failed to
lower the price of the security for several days.
Evergreen began repricing the securities after its
valuation committee learned on June 10 that the portfolio managers had known
since March about problems with a certain mortgage-backed security but had
failed to disclose it to the committee, the SEC said.
Question
When it came to evaluating internal controls under PCAOB rules, where were the
CPA auditing firms?
The FASB and IASB Won't Care For This Case
The Moral Hazard of Fair Value Accounting
From The Wall Street Journal Accounting
Weekly Review on June 12, 2009
Wells Fargo, BofA Pay to Settle Claims
by Jennifer
Levitz
The Wall Street Journal
Jun 09, 2009
Click here to view the full article on WSJ.com
http://online.wsj.com/article/SB124447741263994585.html?mod=djem_jiewr_AC
TOPICS: Advanced
Financial Accounting, Auditing, Fair-Value Accounting Rules, Internal
Controls, Investments
SUMMARY: "One
of the nation's largest mutual-fund companies allegedly overvalued its
holdings of mortgage securities during the housing bust, making its fund
appear to be one of the top performers, and then was forced to take big
write-downs, leaving some investors in the supposedly conservative offering
with losses approaching 25%....Evergreen began repricing the securities
after its valuation committee learned on June 10 that the portfolio managers
had known since March about problems with a certain mortgage-backed security
but had failed to disclose it to the committee", the SEC said.
CLASSROOM APPLICATION: The
implication of properly establishing fair values in a trading portfolio is
the major topic covered in this article. Also touched on are the internal
control procedures and related audit steps over this valuation process.
QUESTIONS:
1. (Introductory)
What was the implication of not properly valuing certain fund investment for
the reported performance of the Evergreen Ultra Fund?
2. (Introductory)
What also was the apparent problem with the type of investment made by
portfolio managers of this Evergreen fund? In your answer, comment on the
purpose of the fund and the risk of mortgage-backed securities in which it
invested.
3. (Introductory)
How should an entity such as the Evergreen Ultra Fund account for its
investments? Describe the balance and income implications and state what
accounting standard requires this treatment.
4. (Advanced)
What evidence should the Evergreen fund's portfolio managers have taken into
account in valuing investments? How did the fund managers allegedly avoid
using that evidence?
5. (Advanced)
What internal control procedures were apparently in place at Evergreen to
ensure that fund assets were properly valued by portfolio managers? What was
the apparent breakdown in internal control?
6. (Advanced)
Based on the description in the article of internal control processes at
Evergreen, design audit procedures to assess whether the internal control
over investment valuations is functioning properly. What evidence might
arise to indicate a failure in internal control?
Reviewed By: Judy Beckman, University of Rhode Island
"Wells Fargo, BofA Pay to Settle Claims," by Jennifer Levitz, The Wall
Street Journal, June 10, 2009 ---
http://online.wsj.com/article/SB124447741263994585.html?mod=djem_jiewr_AC
Wells Fargo & Co. and Bank of America Corp. agreed
Monday to settle claims that employees misled investors about the value and
safety of certain securities during the financial crisis.
Wells's Boston-based mutual fund Evergreen
Investment Management Co. agreed along with its brokerage unit to pay $40
million to end civil state and federal securities-fraud allegations that it
overvalued the holdings of its Evergreen Ultra Short Opportunities Fund and
then, when it was going to lower the value of the securities, informed only
select investors -- many of them customers of an Evergeen affiliate --
allowing them to cash out of the fund and lessen their losses.
Separately, Bank of America agreed to "facilitate"
the return of more than $3 billion to California clients who purchased
auction rate securities, an investment that went sour last year amid a
liquidity freeze. The bank reached the agreement with the California
Department of Corporations.
"We are pleased that the outcome of these
negotiations will result in the return of money to many investors who
suffered by the freezing of their assets when the auctions failed," said
California Department of Corporations Deputy Commissioner Alan Weinger. A
bank spokeswoman couldn't be reached for comment.
The Wells case highlights the valuing of securities
as a key issue during the financial crisis as banks, hedge funds and now
mutual funds have failed to take losses on their holdings even though there
was evidence in the market these securities were trading at lower prices.
In one case Evergreen, which had $164 billion in
assets at the end of the first quarter, was holding a security at nearly
full value when another fund at the firm purchased a similar security for 10
cents on the dollar.
Evergreen didn't admit or deny wrongdoing in a
settlement with the Securities and Exchange Commission and the Massachusetts
Securities Division. "We are committed to acting in the best interest of
shareholders, and continue to move forward with our primary goal of
safeguarding your investments," Evergreen stated in a letter to clients on
its Web site announcing the settlement.
Evergreen was a unit of Wachovia Corp. at the time
of the alleged overvaluations. Lisa Brown Premo and Robert Rowe, then
co-managers of the Ultra fund, have left Evergreen, as have two unidentified
senior vice presidents, said Evergreen spokeswoman Laura Fay. Wachovia was
acquired last year by Wells Fargo.
The Evergreen case is similar to an SEC fraud case
against Van Wagoner Funds in San Francisco. In 2004, Van Wagoner agreed to
pay $800,000 to settle civil charges by the SEC that it mispriced some
technology-company securities in its stock funds.
Regulators allege that Evergreen inflated the value
of mortgage-related securities in the Ultra fund -- which the company touted
as conservative -- by as much as 17% between February 2007 and June 2008,
when it closed and liquidated the fund. The overstatement caused the fund to
rank as one of the top five or 10 funds among between 40 and 50 similar
funds in 2007 and part of 2008. An accurate valuation would have placed the
fund at the bottom of its category, regulators said.
Regulators said that when Evergreen began to
reprice certain inflated holdings in the three weeks before the fund was
liquidated on June 18, the company only disclosed the adjustments -- and the
reason why -- to select customers, many of them customers of Evergreen
affiliate Wachovia Securities LLC. Those customers also were told more
pricing adjustments were likely.
At liquidation, the fund had $403 million in
assets, down from $739 million at the end of 2007, regulators said.
David Bergers, director of the SEC in Boston, said
that by law mutual funds must treat all shareholders equally, and that "it's
particularly troubling in these difficult times that that did not happen."
He said the SEC's "investigation is continuing relating to this matter."
Ms. Fay declined to comment on Mr. Bergers's
statement. Of Monday's settlement, she said it is in "Evergreen's and our
clients' best interest to resolve the matter and move forward."
Regulators say that in pricing Ultra fund
securities, Evergreen's portfolio managers didn't factor in readily
available information about the decline in mortgage-backed securities. By
law, mutual funds are supposed to take all available information into
account when valuing securities, and "that's especially true when the market
is shifting," Mr. Bergers said.
Massachusetts regulators cite one case in May 2008
in which the Ultra fund priced a subprime mortgage-backed security for
$98.93, even though another Evergreen fund purchased the same security for
$9.50.
After learning of the transaction, state regulators
allege, the Ultra fund's portfolio management team contacted the broker who
had sold the security to determine whether the sale was distressed and thus
could be disregarded for purposes of determining the fair value of the
security. The dealer responded that the security wasn't coming from a
distressed seller. Nonetheless, the Ultra fund team told Evergreen's
valuation committee they believed the sale was distressed and failed to
lower the price of the security for several days.
Evergreen began repricing the securities after its
valuation committee learned on June 10 that the portfolio managers had known
since March about problems with a certain mortgage-backed security but had
failed to disclose it to the committee, the SEC said.
Question
When it came to evaluating internal controls under PCAOB rules, where were the
CPA auditing firms?
When the litigation dust settles on all
shareholder lawsuits against auditing firms in the aftermath of the banking
crisis, there's serious doubt whether the Big Four international auditing firms
will survive?
Fiction Writer Rosie Scenario Heads Up the Accounting Division of Wells
Fargo
(with the FASB's FSP 157-4 blessing)
Before reading this note that Wells Fargo took over the toxic-asset laden
Wachovia on December 31, 2008. It was a government-forced sale of Wachovia
to prevent the total implosion of the poisoned Wachovia ---
http://en.wikipedia.org/wiki/Wachovia
However, Wells Fargo stood to profit from the poison in the sweet deal offered
by Paulson.
The Motley Fool
is a very popular commercial Website about stocks, investing, and personal
finance ---
http://en.wikipedia.org/wiki/Motley_Fool
Did you ever wonder about the “Fool” part of the company’s name?
The Gardner brothers considered themselves “fools” that were smarter than
some foxes. Although at many times the Gardners have shown that fools can
fool wannabe foxes, the Gardners brothers have at times also been out foxed.
My point here, Pat, is that people who
buy Wells Fargo Bank shares just because the price went up following an
accounting change (accounting change from Level 1 to Level 3 covered up the
smell of Wells Fargo’s enormous toxic loan portfolio) may not be ignorant
that accounting changes don’t really offset pending toxic deaths in the long
run.
Some “fools” buying Wells Fargo Bank
shares just think there are many fools more foolish than themselves.
Either way you look at it, investing is
a bit of a fools game with fools trying to outfool one another. The premise
is, however, that sophisticated fools ultimately win. That's most certainly
the case with casinos.
"Time to Call Out Wells Fargo's Balance Sheet," by Michael Shulman,
Seeking Alpha, September 22, 2009 ---
http://seekingalpha.com/article/162681-time-to-call-out-wells-fargo-s-balance-sheet
I have not written for a long time - roughly a
month - as the market has turned me into a hermit. I am afraid of the people
in my industry, recommending or buying stocks based on what the person next
to them just bought. My service, ChangeWave Shorts, only recommends puts so
short term momentum can kill a fundamentally sound position. That being
said, I sense the beginnings of a turn to rationality - a light turn, a
hesitant turn, but a turn - and the first place the market should and will
get rational is the banks. They led us into the mess, they led us out, and
they will lead us to stagnation and decline as reality sets in.
And the bank I really don't understand - excuse me,
the bank stock I don't understand - is Wells Fargo (WFC), an $8-$10 stock
masquerading as a $28 plus stock and trading at a multiple well beyond the
rest of the banking segment. It isn't that Wells should be valued alongside
the segment; it should be valued lower than the segment due to current and
future problems in its business, led by its balance sheet.
I have spent weeks pulling apart their balance
sheet and reading other analysts' deciphering of their financial Esperanto -
a universal language no one understands. And what I present below may
include mistakes but they are not of my own making - they are due to what at
best can be considered willful obfuscation - a time honored practice in most
financial reports - of extremely complex financial statements. But I gave it
a shot using my fourth grade math and common sense.
First, let's look at the garbage - excuse me, am I
being too negative? - on the balance sheet as it is written as of March 31
according to the TARP oversight folks. The garbage bin is called Level III
assets, their dodgiest class of assets (the Brits know how to coin a phrase,
don't they?) which according to recently and frantically revised accounting
rules, is an asset without a market, leaving management free to assess and
declare its value based on a model. Wells had, as of March 31 (and I am
using these numbers because they have been blessed by regulators), $61.7
billion in Level III assets. What are they really worth? Who knows - but
even if it is 50%, which I believe would be very high, that is 23% of the
company's market cap.
Second, they are using arcane - and perfectly legal
- rules of purchase accounting to mask loan losses. A Wall Street Journal
article (September 21) had a nice discussion of these rules. Under the rules
of purchase accounting, and these came into effect when Wells purchased
Wachovia, losses must be accounted for in the purchase price and subsequent
paper write off and cannot be incurred after an acquisition, with the loans
on the books now set at a new and lower value to reflect the write-off at
the time of the Wachovia acquisition. They must have been busy with
Christmas because this year they have adjusted these write offs and
increased them by $7.1 billion in the first half of 2009 - write-offs that
do not hit current earnings. This wonderful accounting chicanery can
continue for one year after the merger date, so they have until New Year's
eve to "discover" new losses.
It gets better. The company acquired $110 billion
in what it calls Pick and Pay and everyone else calls option ARM mortgages
with the purchase of Wachovia. These were valued at $90 billion and change
when the deal was closed. Wells shoved a big chunk under the umbrella of
purchase accounting and using these rules then got rid of $20 billion in
losses. Remember that write downs under these rules do not hit your current
books. Some percentage of the remainder, $38.9 billion, can still be
adjusted retroactively under purchase accounting - I think, I am not sure,
don't quote me - and ain't life grand? Of the option ARM mortgages still
held by the company, the loan to value ratio based on quarterly adjustments
is 87.2% but with home prices still falling I am willing to bet - as is
Meredith Whitney, who is predicting another sharp drop in nationwide home
values -- this is 100% in a year. And that means owners have no incentive to
stay in their homes as mortgages reset. More importantly, while the company
assumes future losses on these mortgages in a manner I literally cannot
fathom (but I think they are assuming a 31%-35% default rate), analysts from
Goldman Sachs (GS) see almost 61% of option ARMs originated in 2007 will
fall into default. The Goldman guys assumed a 10% decline in home prices,
and, over time, these same analysts estimate more than half of all option
ARMs ever issued will eventually default. If Goldman is correct, or close,
that is 25% of, well, what? They can write off a lot of this stuff via
purchase accounting. But let's be kind to me and my hard work and say it
will cost them $5 billion more than they are assuming.
Third, proposed accounting rule changes would force
banks, including WFC, to put off balance sheet assets on their balance
sheet. WFC has more than $2.0 trillion of this off balance sheet nonsense -
using the same acronyms, I might add, used by Enron (and that other great
bank, Citigroup (C)). Some healthy percentage of these assets can be assumed
to be headed to the balance sheet if the FDIC says they agree with the FASB
rules and insist banks live by them. In theory, and based on history, WFC
would then have to raise enormous amounts of capital or dump assets to stay
within regulatory guidelines. They cannot dump assets - they would have done
so if they could have - which means pounds of new shares and shareholder
dilutions. Of course, the FDIC is free to ignore GAAP rules when creating
regulatory requirements and it is possible they will do so again. But the
cat (let's say the cat's name is transparency), will be out of the bag and
lazy investors who have yet to consider Wells' off balance sheet follies
will now get a closer look at them.
Bernanke's money printing press
On March 18, the Federal Reserve announced it would purchase up to $300 billion
of long-term bonds as well as $750 billion of mortgage-backed securities. Of all
the Fed's moves, this "quantitative easing" gets money into the economy the
fastest -- basically by cranking the handle of the printing press and flooding
the market with dollars (in reality, with additional bank credit). Since these
dollars are not going into home building, coal-fired electric plants or auto
factories, they end up in the stock market. A rising market means that banks are
able to raise much-needed equity from private money funds instead of from the
feds. And last Thursday, accompanying this flood of new money, came the
reassuring results of the bank stress tests. The next day Morgan Stanley raised
$4 billion by selling stock at $24 in an oversubscribed deal. Wells Fargo also
raised $8.6 billion that day by selling stock at $22 a share, up from $8 two
months ago. And Bank of America registered 1.25 billion shares to sell this
week. Citi is next. It's almost as if someone engineered a stock-market rally to
entice private investors to fund the banks rather than taxpayers.
Andy Kessler, "Was It a Sucker's
Rally? You can have a jobless recovery but you can't have a profitless one,"
The Wall Street Journal, May 12, 2009 ---
http://online.wsj.com/article/SB124208415028908497.html
Have the auditors resumed handing out rose colored glasses to accompany
banking's bad debt reserves?
Last week, Wells Fargo (WFC) said it will report record
Q1 earnings. It caused the stock to shoot up, but it also raised a few eyebrows
as analysts wondered how realistic the company is being with respect to loan
losses . . . The bottom line is that if bank earnings are across-the-board too
strong, then it looks like the game is just totally rigged. The economy is still
going to crap, defaults are still increasing rapidly, and commercial real estate
is finally set to teeter -- how does it make sense for banks to be reporting
anything near record earnings? It doesn't. Unless Wells Fargo and Goldman Sachs
can explain exactly how they had such amazing quarters against the current
backdrop, the only conclusion will be that the banks are still fundamentally
black holes that can't be trusted or valued by investors and counterparties. And
when you factor in the stress test results -- which however ridiculous they may
be could result in forced capital raises -- the bloom could come off this rose
pretty fast.
Joe Weisenthall, "Banks Risk
Reporting Too-Good Earnings," Business Insider, April 13, 2009 ---
http://www.businessinsider.com/banks-risk-reporting-too-good-earnings-2009-4
Bob Jensen's threads on fair value accounting
are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Bob Jensen's threads on fair value accounting
are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
I'm sorry David Friehling, when you say you were duped I don't believe a
single word of your plea for leniency!
Madoff's CPA only pleads guilty to one (wink, wink) professional failure
apart from the crimes to which he confessed.
He should get 150 years in the same cell as Bernie.
From The Wall Street Journal Accounting Weekly Review on November 5,
2009
Madoff Auditor Says He Was Duped, Too
by Chad
Bray
Nov 04, 2009
Click here to view the full article on WSJ.com
TOPICS: Audit
Quality, Auditing, Auditing Services, Auditor Independence, Fraudulent
Financial Reporting
SUMMARY: David
Friehling, former accountant for the Bernard L. Madoff Investment
Securities, LLC, pleaded guilty to fraud and other charges in connection
with his auditing work for the firm of convicted swindler Bernard Madoff.
CLASSROOM APPLICATION: The
article can be used in an auditing class to cover topics of collecting
sufficient competent evidential matter, auditor responsibilities for
detecting fraud, business risk associated with taking on personal tax work
associated with corporate clients, and overall ethical conduct of an
accounting practice.
QUESTIONS:
1. (Introductory)
According to the article, what work did Mr. Friehling do for Bernard L.
Madoff Investment Securities LLC and for people related to those businesses?
List all work that you see identified in the article.
2. (Introductory)
Of what professional failure did Mr. Friehling plead guilty at a hearing
before U.S. District Judge in Manhattan?
3. (Advanced)
Mr. Friehling states that he "took the information given to him by Mr.
Madoff or Mr. Madoff's employees at 'face value.'" How does that statement
imply a failure to conduct adequate audit procedures?
4. (Advanced)
Is it evident from the results of the Madoff fraud case that the firm's
auditors must have been guilty of some audit failure? In your answer,
comment on an auditor's responsibility to detect fraud and on the likelihood
of detecting fraud in cases of collusion.
5. (Introductory)
How is the tax work done by Mr. Friehling for persons related to the Madoff
firm resulting in even greater violations of the law and ethical conduct of
his practice?
6. (Advanced)
Refer to the second related article. Is it a "GAAP rule" that prevents an
auditor or accountant from "just accepting what a client tells you about his
financial statements, without doing more..."?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Bernie Madoff's Small-Town CPA
by Thomas Coyle
Nov 04, 2009
Online Exclusive
Is Friehling's Guilty Plea A Warning Shot to Madoff's Family?
by Ashby Jones
Nov 04, 2009
Online Exclusive
"Madoff Auditor Says He Was Duped, Too: Friehling Pleads
Guilty, but Denies Knowing About the Scheme; 'Biggest Mistake of My Life',"
by Chad Bray, The Wall Street Journal, November 4, 2009 ---
http://online.wsj.com/article/SB125725853747925287.html?mod=djem_jiewr_AC
David Friehling, the former accountant to convicted
Ponzi-scheme operator Bernard Madoff, pleaded guilty to fraud and other
charges Tuesday in connection with his auditing work for Madoff's firm, but
denied knowing about the underlying Ponzi scheme.
Mr. Friehling pleaded guilty to securities fraud,
aiding or abetting investment advisor fraud, three counts of obstructing or
impeding the administration of Internal Revenue laws, and four counts of
making false filings with the Securities and Exchange Commission at a
hearing before U.S. District Judge Alvin K. Hellerstein in Manhattan.
Mr. Friehling, 49 years old, admitted that he
failed to conduct independent audits of Bernard L. Madoff Investment
Securities LLC's financial statements, saying he took the information given
to him by Mr. Madoff or Madoff's employees at "face value."
However, he denied any knowledge of Mr. Madoff's
Ponzi scheme and said he entrusted his own retirement and his family's
investments to Mr. Madoff, saying he had about $500,000 with the firm.
In what was "the biggest mistake of my life, I
placed my trust in Bernard Madoff," Mr. Friehling said.
Mr. Friehling, who is cooperating with prosecutors,
faces a statutory maximum of 114 years in prison on the charges.
He was previously charged in the matter in March.
Mr. Friehling will be allowed to remain free on $2.5 million bail pending
sentencing, which is tentatively set for February.
Separately, Mr. Friehling, without admitting or
denying wrongdoing, agreed to a partial settlement in the SEC's separate
civil case. Mr. Friehling, sole practitioner at Friehling & Horowitz CPAs
PC, agreed to a permanent injunction restraining him or his accounting firm
from violating securities laws.
Disgorgement, prejudgment interest and civil
penalties will be determined at a later date. Mr. Friehling and his firm
will be precluded from arguing that they didn't violate federal securities
laws as alleged by the SEC for the purposes of determining disgorgement and
any penalties.
Prosecutors from the U.S. Attorney's office in
Manhattan alleged that Mr. Friehling, from 1991 to 2008, created false and
fraudulent certified financial statements for Madoff's firm.
Mr. Friehling, who is married and has three
children, said Tuesday that he was introduced to Mr. Madoff by Mr.
Friehling's father-in-law, Jerome Horowitz.
Mr. Friehling, a certified public accountant, said
Mr. Horowitz retired in 1991 but continued to assist him with Madoff's
audits until 1998. Mr. Horowitz, who served as Madoff's auditor until the
1990s, died in March.
Prosecutors also alleged that Mr. Friehling failed
to conduct independent audits of Madoff's firm that complied with generally
accepted auditing standards and conformed with generally accepted accounting
principles, and falsely certified that he had done so.
At the hearing, Assistant U.S. Attorney Lisa Baroni
said Mr. Friehling prepared false tax returns for Mr. Madoff and others, but
declined to say who those others are. "Just 'others' at this time," Ms.
Baroni said.
The court-appointed trustee in charge of
liquidating Madoff's firm said recently that he had identified $21.2 billion
in cash investor losses.
Mr. Friehling is the third person to plead guilty
to criminal charges in the case, including Mr. Madoff himself.
Mr. Madoff, 71, admitted in March to running a
decades-long Ponzi scheme that bilked thousands of investors out of billions
of dollars and is serving a 150-year sentence in a federal prison in North
Carolina.
Frank DiPascali Jr., a key lieutenant to Mr. Madoff,
pleaded guilty to criminal charges in August. Mr. DiPascali, who also is
cooperating with prosecutors, has been jailed pending sentencing.
Mr. Madoff ran the scam for years through the
investment advisory arm of his business by promising steady returns and by
presenting an air of exclusivity by not taking all comers and recruiting
investors via friends and associates.
Mr. Madoff claimed to have as much as $65 billion
in his firm's accounts at the end of last November, but prosecutors said the
accounts only held a small fraction of that.
Bob Jensen's threads on index and mutual fund frauds are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
Reports are surfacing that CPA auditors were warned about
toxic assets and pending bank failures.
Yet virtually all of the failed banks in 2008 and early 2009 received clean
audit opinions not warning of "going concern" weaknesses
Aside from the massive lawsuits that have been or will soon be filed against
banks, mortgage finance companies, and their auditors, it the big question will
be investigations of the PCAOB into those failed audits. The Federal Government
PCAOB's reputation is somewhat at stake here ---
http://www.pcaobus.org/
"CPAs MIA," by Ralph Nader , Independent Political Report, April 12,
2009 ---
http://www.independentpoliticalreport.com/2009/04/ralph-nader-cpas-mia/
Where were the giant accounting firms, the CPAs,
and the rest of the accounting profession while the Wall Street towers of
fraud, deception and cover-ups were fracturing our economy, looting and
draining trillions of dollars of other peoples’ money?
This is the licensed profession that is paid to
exercise independent judgment with independent standards to give investors,
pension funds, mutual funds, and the rest of the financial world accurate
descriptions of corporate financial realities.
It is now obvious that the accountants collapsed
their own skill, integrity and self-respect faster and earlier than the
collapse of Wall Street and the corporate barons. The accountants—both
external and internal—could have blown the whistle on what Teddy Roosevelt
called the “malefactors of great wealth.”
The Big Four auditors knew what was going on with
these complex, abstractly structured finance instruments, these
collateralized debt obligations (CDOs) and other financial products too
abstruse to label. They were on high alert after early warning scandals
involving Long Term Capital Management, Enron, and others a decade or so
ago. These corporate casino capitalists used the latest tricks to cook the
books with many of the on-balance sheet or off-balance sheet structured
investment vehicles that metastasized big time in the first decade of this
new century. These big firms can’t excuse themselves for relying on
conflicted rating companies, like Moody’s or Standard & Poor, that gave
triple-A ratings to CDO tranches in return for big fees. Imagine the
conflict. After all, “prestigious” outside auditors were supposed to be on
the inside incisively examining the books and their footnotes, on which the
rating firms excessively relied.
Let’s be specific with names. Carl Olson, chairman
of the Fund for Stockowners Rights wrote in the letters column of The New
York Times Magazine (January 28, 2009) that “PricewaterhouseCoopers O.K.’d
AIG and FreddieMac. Deloitte & Touche certified Merrill Lynch and Bear
Stearns. Ernst & Young vouched for Lehman Brothers and IndyMac Bank. KPMG
assured over Countrywide and Wachovia. These ‘Big Four’ C.P.A. firms
apparently felt they could act with impunity.” “Undoubtedly they knew that
the state boards of accountancy,” continued Mr. Olson, “which granted them
their licenses to audit, would not consider these transgressions seriously.
And they were right…Not one of them has taken up any serious investigation
of the misbehaving auditors of the recent debacle companies.”
“Misbehaving” is too kind a word. The “Big Four”
destroyed their very reason for being by their involvement in these and
other boondoggles that have made headlines and dragooned our federal
government into bailing them out with disbursements, loans and guarantees
totaling trillions of dollars. “Criminally negligent” is a better phrase for
what these big accounting firms got rich doing—which is to look the other
way.
Holding accounting firms like these accountable is
very difficult. It got more difficult in 1995 when Congress passed a bill
shielding them from investor lawsuits charging that they “aided and abetted”
fraudulent or deceptive schemes by their corporate clients. Clinton vetoed
the legislation, but Senator Chris Dodd (D-CT) led the fight to over-ride
the veto.
Moreover, the under-funded and understaffed state
boards of accountancy are dominated by accountants and are beyond inaction.
What can you expect?
As for the Securities and Exchange Commission
(SEC), “asleep at the switch for years” would be a charitable description of
that now embarrassed agency whose mission is to supposedly protect savers
and shareholders. This agency even missed the massive Madoff Ponzi scheme.
The question of accounting probity will not go
away. In the past couple of weeks, the non-profit Financial Accounting
Standards Board (FASB)—assigned to be the professional conscience of
accountancy—buckled under overt pressure from Congress and the banks. It
loosened the mark-to-market requirement to value assets at fair market value
or what buyers are willing to pay.
This decision by the FASB is enforceable by the SEC
and immediately “cheered Wall Street” and pushed big bank stocks upward.
Robert Willens, an accounting analyst, estimated this change could boost
earnings at some banks by up to twenty percent. Voilà, just like that.
Magic!
Overpricing depressed assets may make bank bosses
happy, but not investors or a former SEC Chairman, Arthur Levitt, who was
“very disappointed” and called the FASB decision “a step toward the kind of
opaqueness that created the economic problems that we’re enduring today.”
To show the deterioration in standards, banks tried
to get the FASB and the SEC in the 1980s to water down fair-value accounting
during the savings and loan failures. Then-SEC Chairman Richard Breeden
refused outright. Not today.
Former SEC chief accountant, Lynn Turner, presently
a reformer of his own profession, supports mark-to-market or fair value
accounting as part of bringing all assets and liabilities, including credit
derivatives, back on the balance sheets of the financial firms. He wants
regulation of the credit rating agencies, mortgage originators and the
perverse incentives that lead to making bad loans. He even wants the SEC to
review these new financial products before they come to market, eliminating
“hidden financing.”
Now comes the life insurance industry, buying up
some small banks to qualify for their own large federal bailouts for making
bad, risky speculations.
The brilliant Joseph M. Belth, writing in his
astute newsletter, the Insurance Forum (May 2009), noted that life insurers
are lobbying state insurance departments to weaken statutory accounting
rules so as to “increase assets and/or decrease liabilities.” Some states
have already caved. Again, voilà, suddenly there is an increase in capital.
Magic. Here we go again.
Who among the brainy, head up accountants, in
practice or in academia, will join with Lynn Turner and rescue this
demeaned, chronically rubber-stamping “profession,” especially the “Big
Four,” from its pathetic pretension for which tens of millions of people are
paying dearly?
The Fate of the Large Auditing Firms After the
2008 Banking Meltdown
Questions
Where were the auditors when auditing those risky investments and bad
debt reserves of the ailing banks?
Answer: Not sure.
Where will the auditors be in after the shareholders in the failing
banks lose all or almost all in the meltdowns?
Answer: In court, because the shareholders are the fall guys not being
bailed out in when banks declare bankruptcy or are bought out cheap just
before declaring bankruptcy. Shareholder will
understandably turn to the deep pocket auditors.
"Financial Crisis Provides Fertile Ground for
Boom in Lawsuits," by Jonathan D. Glater, The New York Times, Octobver
17, 2008 ---
http://www.nytimes.com/2008/10/18/business/18suits.html?_r=1&partner=permalink&exprod=permalink&oref=slogin
It seems like just a few months ago — because it
was — that trial lawyers, those advocates who take on companies on behalf of
investors, customers or even other businesses, had a wretched reputation.
Three of the best known of those lawyers, William S. Lerach, Melvyn I. Weiss
and Richard F. Scruggs, had all pleaded guilty to crimes. Defense lawyers
were gleeful.
But the pendulum has shifted again, much as in the
years after the collapse of Enron and WorldCom.
Accusations of executive excess, accounting fraud
and lack of disclosure are far more credible now, since bad bets on real
estate and securities linked to home loans have caused some of the biggest
and most prestigious financial firms in the country — Lehman Brothers, the
American International Group, Fannie Mae, Freddie Mac — to collapse, sell
parts of themselves at fire-sale prices or suffer outright government
takeovers. A legal argument rarely used in investor lawsuits is tempting:
res ipsa loquitur, or the thing speaks for itself.
“There’s clearly going to be an erosion in the
presumption that these senior-ranking executives should be given the benefit
of the doubt,” said John P. Coffey, a partner at Bernstein Litowitz Berger &
Grossmann, adding that as a result of regulators’ investigations and angry
former employees, there is also more information available to plaintiffs
about questionable conduct. “There’s clearly going to be an effect there;
judges are human.”
So are investors, who are angry. Individual
shareholders as well as big companies want someone else to pay for their
losses on investments in everything from basic stocks to exotic swaps. And
lawyers are emboldened in their claims by the huge losses and obvious errors
in judgment at companies that, until recently, confidently asserted their
immunity to market turbulence.
Investors’ lawyers can point at statements and
actions by regulators to bolster their claims. In a suit filed in
mid-September by Fannie Mae shareholders, the plaintiffs blamed a government
plan to buy shares of the company and then take it over for helping to
depress the company’s stock price. The lawsuit names Merrill Lynch,
Citigroup, Morgan Stanley and others as defendants, accusing them of making
false statements about Fannie Mae’s financial condition.
“The more you think about it, there’re so many
different ways that so many different people could be responsible for this,”
said H. Adam Prussin, a partner at Pomerantz Haudek Block Grossman & Gross,
referring to losses suffered in this financial crisis. His firm is
representing Fannie Mae investors. “There are the lenders who screwed up in
the first place, there are the people who bought these things from the
lenders and then didn’t account correctly for them.”
A recent report by the law firm Fulbright &
Jaworski found that more than one-third of lawyers working internally for
companies expected to see more litigation in 2009. Lawyers at the biggest
companies were more likely to expect a boom in lawsuits, according to the
study.
One factor contributing to litigation is the rapid
availability of information about corporate mistakes and losses, which in
the past might have taken longer to circulate among investors, said Michael
Young, a partner at Willkie Farr & Gallagher in New York.
“What’s really going on here is a type of
accounting that is capturing changes in value and making them public much
faster than anything we’ve seen before,” Mr. Young said.
Armed with such data, shareholders have charged the
courthouse steps, claiming that companies failed to disclose their
vulnerability to declines in the real estate market, often through holdings
of securities backed by home loans. Even companies that have suffered huge
losses may still be worth pursuing because of their liability insurance.
“You can’t get blood from a stone,” said Joseph A.
Grundfest, a former commissioner of the Securities and Exchange Commission
who now teaches at Stanford Law School. “But you sure can get money from the
insurance company that covered the stone.”
There are other deep pockets, even in the current
economic climate. When confronted by bankruptcy filings or government
takeovers, the lawsuits name every possible defendant involved in a stock
offering — the underwriters, the rating agencies and individual executives —
but not the issuing company itself. That way, they avoid the problem of
fighting with other creditors in bankruptcy or the question of whether they
can sue the government.
In the case brought by Fannie shareholders, for
example, Fannie itself is not a defendant. A suit filed last month by
investors who bought Freddie Mac shares names only Goldman Sachs, JPMorgan
Chase and Citigroup. The suit claims that the investment firms, which
underwrote a Freddie Mac stock offering, did not disclose the company’s
“massive exposure to mortgage-related losses.” (JPMorgan Chase did not
underwrite the offering itself but it acquired Bear Sterns, which did).
Events have moved quickly enough that some lawyers
have found that their lawsuits may have been filed too early, before the
biggest losses and consequently before the biggest damage claims were
possible.
Continued in article
"The harder they fall: Will the
Big Four survive the credit crunch?" by Rob Lewis, AccountingWeb,
October 2008 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=106124
Ever since Arthur
Andersen left the market after its scandalous role in the fall of
Enron, people have been asking how long it will be before another
big firm follows suit. The (UK) Financial Reporting Council (FRC)
has been trying ever since to make sure that the Big Four will be
protected if found guilty of similar negligence. The introduction of
limited liability should help, but given the accelerating meltdown
of the global financial system, will it be enough?
As always, and as
was the case with Arthur Andersen, it will be events in America that
determine the fate of the Big Four. This summer the U.S. Treasury's
Advisory Committee of the Auditing Profession met in Washington and
heard that between them the six largest firms had 27 outstanding
litigation proceedings against them with damage exposure above $1
billion, seven of which exceed $10 billion. It is impossible to buy
insurance that will cover such catastrophic liability and any one of
them, if successful, could prove a fatal blow.
That U.S. Treasury
committee met again last week to discuss the viability of limited
liability for auditors in the U.S., but the 21-strong panel decided
against it. With that, the hope of some silver bullet solution to
the Big Four's problems expired. Committee member Lynn Turner,
formerly a chief accountant to the Securities and Exchange
Commission (SEC), was plainly baffled such an idea had even been
seriously suggested.
"Do you believe that
an auditor found to have been aware of financial reporting problems
but never reporting them to the public should be the subject of
liability caps or some type of litigation reform protecting them?"
he asked. Turner summed the situation up nicely when he described
the big accounting firms as a "federally mandated and authorized
cartel" which was "too big to [be allowed to] fail".
When Arthur Andersen
went down six years ago, Turner had never been quite able to believe
that the firm's bad behavior had really been all that anomalous.
"It's beyond Andersen," he told CBS Frontline that same year, "it's
something that's embedded in the system at this time. This notion
that everything is fine in the system just because you can't see it
is totally off-base."
The credibility of
the markets
Looking at recent
economic events, Turner's suspicions that the credibility of the
markets were at stake has plainly proved prescient. So too may his
belief that unethical accounting was not so much a case of a few bad
apples, but a bad barrel.
Consider some of the
recent and outstanding claims against the biggest six firms. In
Miami last August a jury ordered BDO Seidman to pay $521 million in
damages for its negligence in a Portuguese bank audit; almost as
much as the firm's estimated revenue for that year. In the U.S.,
banks and the shareholders of banks are perfectly prepared to go
after auditors, and when they win they tend to win big. Note than
when Her Majesty's Treasury hired the BDO's valuation partner Andrew
Caldwell for the controversial Northern Rock valuation, they hired
the man and not the firm. The firms are already worried enough about
litigation.
KPMG provides a
clear example of how the credit crunch might cull the Big Four. The
firm was already looking vulnerable before it hit: there was the
2005 'deferred prosecution' agreement with the New York Attorney's
Office, the damning German probe into the Siemens bribery scandal, a
lawsuit from superconductor company Vitesse for 'audit failures' and
a minor fine from the UK's Joint Disciplinary Scheme (JDS) for
allowing fraud to occur at Independent Insurance (it may only have
been half a million, but it was the JDS' biggest fine to date). But
when the subprime problems of U.S. lender New Century enter the
picture, the damages involved escalate drastically.
A U.S. Justice
Department report has already concluded that KPMG either helped
perpetrate the fraud at the mortgager or deliberately ignored it.
Class-action lawsuits are already pending. Only weeks before the
report was published the U.S. Supreme Court's Stone Ridge ruling
immunized third party advisers like accountants and bankers from the
disgruntled shareholders of other entities, but that may be not much
of a shield. Of course, New Century might not be KPMG's biggest
problem. That's probably the Federal National Mortgage Association,
or Fannie Mae.
Fannie Mae initiated
litigation way back in 2006, and is trying to reclaim more than $2
billion from its old auditors. That's on top of the $400 million
KPMG agreed to pay the SEC to settle the regulator's fraud
allegations. Its defense so far has been one of complete innocence,
asserting that Fannie Mae successfully hid all evidence of anything
untoward. Now that the FBI is investigating the mortgage lender,
such a position will have to be abandoned if incriminating evidence
turns up. Ostensibly, the Federal investigation relates to Fannie
Mae's relationship with ratings agencies, but you never know what
will fall out of the closet.
So KPMG is in a spot
of bother, but it's not alone. Ernst and Young will almost
inevitably see itself in court over the demise of its audit client
Lehman Brothers. Similarly, PricewaterhouseCoopers is surely going
to feel some heat for its auditing of what was once the world's
largest insurance company, AIG, assuming the Northern Rock
Shareholders Group doesn't take a pop at it first.
Continued in article
Bob Jensen's threads on the litigation woes
of the large auditing firms are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
The most serious problem in the U.S. audit model is that
clients are becoming bigger and bigger due to non-enforcement of anti-trust
laws. For example, the merger of Mobile and Exxon created an even larger single
client. The merger of Bear Stearns and JP Morgan created a much larger client.
The number of potential clients is shrinking while the size of the clients is
exploding. According to the CEO of Bank of America, in a CBS Sixty Minutes
interview on October 19, 2008, half of all banking customers in the United
States now have accounts with Bank of America. That was before Bank of America
bought out Merrill Lynch.
As these giants
merge to become bigger giants, it gets to a point where their auditors
cannot afford to lose a giant client producing upwards of $100 million
in audit revenue each year. Real independence of audits breaks down
because a giant client can become a bully with its audit firm fearful of
losing giant clients.
Enron was an extreme but not necessarily an outlier. It
will most likely be alleged in court over the next few years that giant Wall
Street banks bullied their auditors into going along with understating financial
risk before the 2008 banking meltdown. We certainly witnessed the understating
of financial risk in 2007 and 2008.
I think we need an
Accounting Court to deal with clients who become bullies ---
http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism
The Accounting Hall of Fame Citation for Leonard Spacek ---
http://fisher.osu.edu/acctmis/hof/spacek.html
It must be kept in mind
that the statements certified are not ours but are our clients--and our clients
do not care to mix explanations of accounting theory with explanations of their
business nor can we pass onto our readers the responsibility for appraisal of
differences in accounting theory. Those fields are for you and me to grapple
with, not the public. In general, clients are not primarily interested in
arguments of accounting theory at the time of preparing their reports. The
companies whose accounts are certified are chiefly interested in what is said to
their shareholders, and in the hard practical facts of how accounting rules
affect them, their competitors and other companies. Usually they are very
critical of what we call accounting principles when these called principles are
unrealistic, inconsistent, or do not protect or distinguish scrupulous
management from the scrupulous.
"The Need for An Accounting Court," by Leonard Spacek, The Accounting
Review, 1958, Pages 368-379 ---
http://faculty.trinity.edu/rjensen/FraudSpacek01.htm
Jensen Comment
Fifty years later I'm a strong advocate of an accounting court, but I envision a
somewhat different court than envisioned by the great Leonard Spacek in
1958. Since 1958, the failure of anti-trust enforcement has allowed business
firms to merge into enormous multi-billion or even trillion dollar clients
who've become powerful bullies that put extreme pressures on auditors to bend
accounting and auditing principles. For example see the way executives of Fannie
Mae pressured KPMG to bend the rules (an act that eventually got KPMG fired from
the audit).
In my opinion the time has come where auditors and
clients can take their major disputes to an Accounting Court that will use
expert independent judges to resolve these disputes much like the Derivatives
Implementation Group (DIG)
resolved technical issues for the implementation of FAS 133. The main
difference, however, is that an Accounting Court should hear and resolve
disputes in private confidence that allows auditors and clients to keep these
disputes away from the media. The main advantage of such an Accounting Court is
that it might restrain clients from bullying auditors such as became the case
when Fannie Mae bullied KPMG.
Who would sit on accounting courts is open to debate,
but the "judges" could be formed by the State Boards of Accountancy much like a
grand jury is formed by a court of law. Accounting court cases, however, should
be confidential since they deal with sensitive client information.
I really don't anticipate a flood o cases in an
accounting court. But I do view the threat of taking client-auditor disputes to
such courts (in confidence) as a means of curbing the bullying of auditors by
their enormous clients.
The problem is that poor anti-trust enforcement coupled
with mergers of huge companies have combined to create mega-clients that
auditing firms cannot afford to lose after gearing up to handle such large
clients. I think we saw this in the "clean opinions" given to all the enormous
failing banks (like WaMu) and enormous Wall Street investment banks (like
Lehman). The big auditing firms just could not afford to question bad debt
estimates, mortgage application lies, and CDO manipulations of such clients.
I find it hard to
believe that auditors failed to detect an undercurrent of massive subprime
"Sleaze, Bribery, and Lies" that transpired in the Main Street banks and
mortgage lending companies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
The sleaze was so prevalent the auditors must've worn their chest-high waders on
these auditsDeloitte is Included in the Shareholder Lawsuit Against Washington Mutual
"Feds Investigating WaMu Collapse," SmartPros, October 16, 2008 ---
http://accounting.smartpros.com/x63521.xml
Oct. 16, 2008 (The Seattle Times) — U.S. Attorney
Jeffrey Sullivan's office [Wednesday] announced that it is conducting an
investigation of Washington Mutual and the events leading up to its takeover
by the FDIC and sale to JP Morgan Chase.
Said Sullivan in a statement: "Due to the intense
public interest in the failure of Washington Mutual, I want to assure our
community that federal law enforcement is examining activities at the bank
to determine if any federal laws were violated."
Sullivan's task force includes investigators from
the FBI, Federal Deposit Insurance Corp.'s Office of Inspector General,
Securities and Exchange Commission and the Internal Revenue Service Criminal
Investigations division.
Sullivan's office asks that anyone with information
for the task force call 1-866-915-8299; or e-mail fbise@leo.gov.
"For more than 100 years Washington Mutual was a
highly regarded financial institution headquartered in Seattle," Sullivan
said. "Given the significant losses to investors, employees, and our
community, it is fully appropriate that we scrutinize the activities of the
bank, its leaders, and others to determine if any federal laws were
violated."
WaMu was seized by the FDIC on Sept. 25, and its
banking operations were sold to JPMorgan Chase, prompting a Chapter 11
bankruptcy filing by Washington Mutual Inc., the bank's holding company. The
takeover was preceded by an effort to sell the entire company, but no firm
bids emerged.
The Associated Press reported Sept. 23 that the FBI
is investigating four other major U.S. financial institutions whose collapse
helped trigger the $700 billion bailout plan by the Bush administration.
The AP report cited two unnamed law-enforcement
officials who said that the FBI is looking at potential fraud by
mortgage-finance giants Fannie Mae and Freddie Mac, and insurer American
International Group (AIG). Additionally, a senior law-enforcement official
said Lehman Brothers Holdings is under investigation. The inquiries will
focus on the financial institutions and the individuals who ran them, the
senior law-enforcement official said.
FBI Director Robert Mueller said in September that
about two dozen large financial firms were under investigation. He did not
name any of the companies but said the FBI also was looking at whether any
of them have misrepresented their assets.
"Federal Official Confirms Probe Into Washington Mutual's Collapse,"
by Pierre Thomas and Lauren Pearle, ABC News, October 15, 2008 ---
http://abcnews.go.com/TheLaw/story?id=6043588&page=1
The federal government is
investigating whether the
leadership of shuttered bank
Washington Mutual broke
federal laws in the run-up
to its collapse,
the largest in U.S. history.
. . .
Eighty-nine
former WaMu employees are confidential witnesses in
a
shareholder class action lawsuit against
the bank, and some former insiders
spoke exclusively to ABC News,
describing their claims that
the bank ignored key advice from its own risk
management team so they could maximize profits
during the housing boom.
In court documents, the
insiders said the company's risk managers, the
"gatekeepers" who were supposed to protect the bank
from taking undue risks, were ignored, marginalized
and, in some cases, fired. At the same time, some of
the bank's lenders and underwriters, who sold
mortgages directly to home owners, said they felt
pressure to sell as many loans as possible and push
risky, but lucrative, loans onto all borrowers,
according to insiders who spoke to ABC News.
Continued in article
Allegedly "Deloitte Failed to Audit WaMu in Accordance with GAAS" (see
Page 351) ---
Click Here
Deloitte issued unqualified opinions and is a defendant in this lawsuit (see
Page 335)
In particular note Paragraphs 893-901 with respect to the alleged negligence of
Deloitte.
Bob Jensen's threads on Deloitte's lawsuits and its $1 million PCAOB fine
are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Deloitte
Where were the auditors?
The was so much bad stuff going on, it's unbelievable that the auditors knew
nothing about the unethical and criminal behavior of clients
The sexual favors, whistleblower intimidation, and routine fraud behind the
fiasco that has triggered the global financial crisis
Some wholesalers turned a blind eye to broker fraud,
too. "I'd walk into mortgage shops and see brokers openly cutting and pasting
income documents and pay stubs, getting out the Wite-Out and changing Social
Security numbers," says Melissa Hernandez, a former wholesaler for Argent
Mortgage, a unit of now-defunct Ameriquest Mortgage, who says she never
knowingly bought bogus applications. "There was no ambiguity." Other wholesalers
took matters into their own hands, doctoring documents to qualify borrowers for
loans. A former Wells Fargo (WFC) wholesaler says he regularly used the copiers
at a nearby Kinko's to alter borrowers' pay stubs and bank account statements.
"Subprime: Borne of Sleaze, Bribery, and Lies," by Mara Der Hovanesian,
Business Week, November 13, 2008 ---
http://www.businessweek.com/magazine/content/08_47/b4109070638235.htm?link_position=link3
It may seem like ancient history now, but
not long ago the mortgage industry was turning ordinary people into
millionaires. One of them was Sharmen Lane, a high school dropout who, like
many other young women during the boom, found her way into an obscure
banking job with the clunky title "mortgage wholesaler." Her experience—and
the experiences of other wholesalers like her—offers a glimpse into the
recklessness and indulgence that drove the industry to ruin.
The rise of mortgage wholesalers from
grunts to rainmakers is one of the more curious developments of the housing
bubble. Wholesalers work for banks and other lenders. The wholesaler's job
is to buy other loan applications from independent mortgage brokers so that
lenders can turn them into loans. Wholesalers are paid on commission: the
more loans they generate, the more money they make. During the housing boom,
lenders typically approved the loans and then packaged them into securities.
That path—from mortgage brokers to wholesalers to lenders to
securities—turned out to be a road to disaster.
But as the housing bubble inflated,
wholesalers—though hidden from public view—became high-earning superstars.
Lane, a manicurist before joining now-defunct subprime lender New Century
Mortgage in 1997, says she brought home $1 million in 2002 and $1.2 million
in 2003.
Eventually the deal-making turned
frenetic. Multiple wholesalers began inundating mortgage brokers with offers
for the same applications. Some brokers chose to exercise their power by
asking for something extra in exchange for their business: sex.
Dozens of former brokers and wholesalers
say the trading of sexual favors was so common that it came to be expected.
Lane recalls one visit to a mortgage brokerage near San Jose (Calif.) in
which the manager lewdly propositioned her in his office. She says she
declined the advance, and he didn't sell her any applications. But other
female wholesalers didn't have the same qualms about crossing the line.
"Women who had sex for loans were known very quickly," says Lane, who left
New Century before it failed in 2007 and now works as a $200-an-hour life
coach and motivational speaker in New York. "I didn't want to be a mortgage
slut."
WHOLESALE CORRUPTION
Investment bubbles always spawn excesses, and housing was no exception. The
abuses went far beyond sexual dalliances. Court documents and interviews
with scores of industry players suggest that wholesalers also offered bribes
to fellow employees, fabricated documents, and coached brokers on how to
break the rules. And they weren't alone. Brokers, who work directly with
borrowers, altered and shredded documents. Underwriters, the bank employees
who actually approve mortgage loans, also skirted boundaries, demanding
secret payments from wholesalers to green-light loans they knew to be
fraudulent. Some employees who reported misdeeds were harassed or fired.
Federal and state prosecutors are picking through the industry's wreckage in
search of criminal activity.
Now wholesalers, who for a brief moment
rose to prominence, are an endangered species. The failures of large
subprime lenders like New Century, BNC (a unit of Lehman Brothers), and
GreenPoint Mortgage, owned by Capital One, threw thousands out of work. Some
lenders still in business have curtailed or shuttered their wholesale
operations.
In the end, the wholesalers were undone by
the same people who allowed for their rise: their Wall Street overlords.
During the boom investment banks bought as many loans as they could to pool
together and turn into securities. In 2006 the top 10 investment banks,
which included Merrill Lynch (MER), Bear Stearns (BSC), and Lehman Brothers,
sold mortgage-backed securities worth $1.5 trillion, up from $245 billion in
2000. To keep the supply of loans coming, the investment banks increasingly
took control of the industry's frontline players as well.
First they started buying small,
independent wholesaling firms. Next they extended billions in credit to
subprime lenders. Then they took stakes in some, and bought others outright.
At the height of the frenzy in 2006, six top investment banks shelled out a
total of $2.2 billion to buy subprime shops.
That gave Wall Street the power to demand
more subprime loans, which carried the highest interest rates and were the
most profitable. As a national account director for Deutsche Bank (DB), Mark
D. Toomey bought loans from mortgage lenders to turn into securities.
Sometimes, he says, he "twisted arms" to get more loans. "Nobody had the
[guts] to say no," says Toomey, who left the bank in 2007. Deutsche Bank
declined to comment.
But mostly, brokers and wholesalers were
happy to comply. The more loans they made, after all, the more they got
paid. One former wholesaler in Northern California who requested anonymity
joined subprime lender GreenPoint Mortgage in 1997, right out of college. By
2004, she says, she was pulling in several hundred thousand dollars a year.
She kept a chauffeur on call to shuttle her and her friends to "exclusive
clubs, restaurants, and parties," and treated friends to shopping sprees at
Neiman Marcus, Gucci, and Louis Vuitton. "It was the time of our lives,"
says the woman, who now works as an account executive for another lender in
the area.
Brokers say some female wholesalers
weren't up on the finer points of finance—but exploited other assets in
their quest for more loans. "You had boiler rooms of younger, predominantly
male brokerage operations and in would walk a gorgeous, fit [wholesaler] who
would go desk to desk," says Rick Arvielo, president of New American
Funding, a mortgage brokerage in Irvine, Calif. "Most of them didn't know
the product."
Of course, it's accepted practice in many
industries for companies to hire attractive saleswomen. What's more, on Wall
Street, lurid tales of erotic dancers livening up after-hours events are
common.
"INDECENT PROPOSALS" But in the mortgage
business, it went further: The women allegedly offering sexual favors were
bank employees. Evan Stone, president of Walnut Creek (Calif.) mortgage
brokerage Pacific Union Financial, says "minimally trained and minimally
dressed" wholesalers often wooed brokers. He says he regularly got visits in
his suburban office from representatives wearing unusually short skirts to
entice him and his team of brokers to party at the local Ruth's Chris Steak
House. Stone says one New Century wholesaler offered to fly him to Chicago
to "have a good time." He says he declined all offers of sexual favors.
"There were some indecent proposals made," he says. "That was part of
building the relationship."
Wholesalers also offered sexual favors to
co-workers. To drive up their commissions, some enticed loan underwriters at
their companies to approve questionable applications. A vice-president at
Washington Mutual who once wielded $500 million to make loans recalls an
incident in which a female wholesaler wanted him to approve a loan that
didn't fit guidelines. The manager, who requested anonymity, says the
co-worker, wearing a low-cut shirt, knelt down at his desk and said: "I
really need this. What do I have to do?"
Some wholesalers turned a blind eye to
broker fraud, too. "I'd walk into mortgage shops and see brokers openly
cutting and pasting income documents and pay stubs, getting out the Wite-Out
and changing Social Security numbers," says Melissa Hernandez, a former
wholesaler for Argent Mortgage, a unit of now-defunct Ameriquest Mortgage,
who says she never knowingly bought bogus applications. "There was no
ambiguity."
Other wholesalers took matters into their
own hands, doctoring documents to qualify borrowers for loans. A former
Wells Fargo (WFC) wholesaler says he regularly used the copiers at a nearby
Kinko's to alter borrowers' pay stubs and bank account statements.
Continued in article
Questions About Addictions to Consultancy
Will "independent" auditing firms ever overcome addictions to consultancy that
compromises "independence"?
"This banking inquiry is purely cosmetic: The pseudo-investigations
into the banking crisis are being run by firms with a history of unsavoury
financial arrangements," by Prim Sikka, The Guardian, May 5, 2009 ---
http://www.guardian.co.uk/commentisfree/2009/may/05/banking-inquiry-fsa
Nearly two years after the start of the economic
crisis and
£1.4bn of bailouts, the Treasury select committee
has provided
a scathing critique of the failures of the banking industry and its
regulators (pdf). To obfuscate the issues, the
Financial Services Authority (FSA) has already decided on
pseudo-investigations, which is unacceptable. For
any investigation to command public confidence it needs to be independent,
credible, thorough and on the public record. The FSA initiative fails on all
counts.
In the absence of any commitment to publish a
report and all the material at its disposal, the investigation will be
little more than cosmetic. The FSA's regulatory shortcomings are central to
the banking crisis. It presided over the development of a shadow banking
system and showed no inclination to regulate it. It allowed banks to publish
opaque accounts,
indulge in tax avoidance schemes and develop
dangerous financial products. It allowed banks to
run up excessive leverage (pdf) and paid little
attention to the adequacy of their capital base. It allowed bank executives
to collect huge bonuses for mediocre performance. Its ideology of light
regulation curried favour with banking elites and paid little attention to
the need to protect citizens and society.
The FSA is seeking help from the "big four"
accounting firms – Deloitte, PricewaterhouseCoopers, KPMG and Ernst & Young
– for its investigation. This is a tacit admission that it does not have
in-house capacity to understand the accounting practices of banks. It could
not have diligently monitored the accounting practices of banks either
before or since the crisis. By relying on consultants, the FSA is unlikely
to build any institutional expertise and thus will not be in a position to
efficiently monitor banks now or in the future.
Major accounting firms must be eyeing multimillion
pound contracts but have been involved in too many unsavoury episodes to
command public trust. Last year,
a court in Ireland designated a VAT avoidance scheme
designed by accountancy firm Deloitte & Touche as "an
abusive practice''. Last month,
two former US executives of KPMG were given a prison sentence
for their role in facilitating tax evasion.
Previously,
the firm had admitted "criminal wrongdoing" and
paid a fine of $456m (£304m). A former employee of Ernst & Young
has pleaded guilty (pdf) to facilitating tax fraud
and there are tax fraud trials ongoing of four current and former partners
of its US arm. Three former executives of ChuoAoyama PricewaterhouseCoopers,
the Japanese arm of PricewaterhouseCoopers,
received suspended prison sentences for helping a major client to falsify
accounts. These may be exceptional incidents, but
what credibility will these firms lend to the FSA's investigations?
Almost all major banks are audited by one of the
"big four" accounting firms. They collected millions of pounds in audit and
consultancy fees, but none reported any financial problems before the
banking crash. There were plenty of warnings. For example, in September
2007, Northern Rock,
was relying on government help (pdf) for its
survival. In April 2007, New Century Financial, the second largest subprime
mortgage provider in the US,
filed for bankruptcy protection.
Continued in article
Bob Jensen's threads on independence issues in auditing ---
http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism
The saga of lawsuits among the large auditing firms ---
http://faculty.trinity.edu/rjensen/fraud001.htm
It Just Gets Deeper and Deeper for KPMG
"Subprime Suit Accuses KPMG of Negligence: A trustee for New Century
Financial claims KPMG partners ignored lower ranks' concerns about the lender's
accounting for loan reserves," by Sarah Johnson, CFO.com, April 2, 2009
---
http://www.cfo.com/article.cfm/13431126/c_2984368?f=FinanceProfessor/SBU
Two complaints filed in federal courts yesterday
claim that KPMG auditors were complicit in allowing "aggressive accounting"
to occur under their watch at New Century Financial, the mortgage lender
that collapsed two years ago at the beginning of the subprime-mortgage mess.
The plaintiff, a New Century trustee, alleges that
misstated financial reports were filed with the audit firm's rubber stamp
because of its partners' fears of losing the lender's business. "KPMG acted
as a cheerleader for management, not the public interest," one of the
complaints says. The trustee further accuses the firm of "reckless and
grossly negligent audits."
The plaintiff's law firm, Thomas Alexander &
Forrester LLP, filed one action against KPMG LLP in California and another
in New York against KPMG International. With the authority to "manage and
control" its member firm, KPMG International failed to "ensure that audits
under the KPMG name" lived up to the quality control and branding value that
"it promised to the public," the lawsuit alleges.
Similar litigation has been unsuccessful in holding
international auditing firms responsible for their affiliated but
independent members. For example, a lawsuit that Thomas Alexander filed
against BDO Seidman in a negligence case involving Banco Espirito Santo's
financial statements resulted in a $521 million win for the plaintiff,
pending an appeal. A case against BDO International is expected to go to
trial later this year after an appeals court ruled that a jury should have
decided whether it should have also been considered liable in the Banco
case. Initially, a lower-court judge had dismissed the international
organization from the case.
the international arm was intitially ruled as not
being c, accused of also , the trial against BDO International for the same
matter has yet to occur; courts have yet to decide whether BDO International
could be held liable in the same matter after the international firm was but
lawyers have been unable to get a judgment against BDO International in the
same case. Steven Thomas, a partner at the law firm, did not immediately
return CFO.com's request for comment.
KPMG resigned as New Century's auditor soon after
the Irvine, California-based lender filed for bankruptcy protection in 2007.
The auditor's role in the firm's failure has been questioned since then, by
New Century's unsecured creditors and the bankruptcy court.
In the new lawsuit, KPMG LLP is accused of not
giving credence to lower-level employees' concerns about their client's
accounting flaws and not finishing its audit work before giving its final
opinion — an account the firm disputes. In 2005, for instance, a partner was
said to have "silenced" one of the firm's specialists who had questioned New
Century's "incorrect accounting practice." The partner allegedly said, "I am
very disappointed we are still discussing this.... The client thinks we are
done. All we are going to do is piss everybody off."
Dan Ginsburg, KPMG LLP spokesman,says the above
account is taken out of context and that the firm had followed its normal
process; the firm's national office had already reviewed and signed off on
the issue being disputed.
Furthermore, Ginsburg says any claims that the firm
gave in to its client's demands "is unsupportable." He adds, "any
implication that the collapse of New Century was related to accounting
issues ignores the reality of the global credit crisis. This was a business
failure, not an accounting issue."
New Century's business was heavy on loaning
subprime-level mortgages, but its accounting methods did not fully recognize
the risk of doing so, the lawsuit alleges. It also says the firm violated
GAAP by using inaccurate loan-reserve calculations by taking out certain
factors to keep its liability numbers down and its net income falsely
propped up. KPMG is accused of ignoring this GAAP violation and advising the
firm on how to get around the rules. The complaint says this was a $300
million mistake.
In its most recent inspection of KPMG, the Public
Company Accounting Oversight Board noted two occasions when the firm did not
do enough audit work to be able to confidently trust its clients' allowances
for loan losses.
From the Stanford
University Law School
Details about the class action lawsuit ---
http://securities.stanford.edu/1037/NEW_01/
Bob Jensen's threads on KPMG legal woes ---
http://faculty.trinity.edu/rjensen/Fraud001.htm#KPMG
Looking for blue sky above polluted bank accounting hot air
Bank Profits Appear Out of Thin Air in 2009
Question
What direction did the price of shares of Bank of America move when BofA
announced higher than expected earnings for the first quarter of 2009?
Answer
Down, because investors suspect that such earnings were not sustainable while
BofA holds billions of dollars of Countrywide and Merrill Lynch toxic paper that
will drive down future earnings due to non-performance of home owners and
business owners who will not fully perform on loans.
The magic
accounting tricks in 2009 are hurting rather than helping to restore faith in
accounting and auditing after the 2008 banking crash.
Sydney Finkelstein, the Steven Roth professor of management at the Tuck School
of Business at Dartmouth College, also pointed out that Bank of America booked a
$2.2 billion gain by increasing the value of Merrill Lynch’s assets it acquired
last quarter to prices that were higher than Merrill kept them. “Although
perfectly legal, this move is also perfectly delusional, because some day soon
these assets will be written down to their fair value, and it won’t be pretty,”
he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross Sorkin, The New
York Times, April 20, 2009 ---
http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk
This is starting to feel like amateur hour for aspiring magicians.
Another day, another attempt by a Wall Street bank to pull a bunny out of
the hat, showing off an earnings report that it hopes will elicit oohs and
aahs from the market. Goldman Sachs, JPMorgan Chase, Citigroup and, on
Monday, Bank of America all tried to wow their audiences with what appeared
to be — presto! — better-than-expected numbers.
But in each case, investors spotted the attempts at sleight of hand, and
didn’t buy it for a second.
With Goldman Sachs, the disappearing month of December didn’t quite
disappear (it changed its reporting calendar, effectively erasing the impact
of a $1.5 billion loss that month); JPMorgan Chase reported a dazzling
profit partly because the price of its bonds dropped (theoretically, they
could retire them and buy them back at a cheaper price; that’s sort of like
saying you’re richer because the value of your home has dropped); Citigroup
pulled the same trick.
Bank of America sold its shares in China Construction Bank to book a big
one-time profit, but Ken Lewis heralded the results as “a testament to the
value and breadth of the franchise.”
Sydney Finkelstein, the Steven Roth professor of management at the Tuck
School of Business at Dartmouth College, also pointed out that Bank of
America booked a $2.2 billion gain by increasing the value of Merrill
Lynch’s assets it acquired last quarter to prices that were higher than
Merrill kept them.
“Although perfectly legal, this move is also perfectly delusional, because
some day soon these assets will be written down to their fair value, and it
won’t be pretty,” he said.
Investors reacted by throwing tomatoes. Bank of America’s stock plunged 24
percent, as did other bank stocks. They’ve had enough.
Why can’t anybody read the room here? After all the financial wizardry that
got the country — actually, the world — into trouble, why don’t these
bankers give their audience what it seems to crave? Perhaps a bit of simple
math that could fit on the back of an envelope, with no asterisks and no
fine print, might win cheers instead of jeers from the market.
What’s particularly puzzling is why the banks don’t just try to make some
money the old-fashioned way. After all, earning it, if you could call it
that, has never been easier with a business model sponsored by the federal
government. That’s the one in which Uncle Sam and we taxpayers are offering
the banks dirt-cheap money, which they can turn around and lend at much
higher rates.
“If the federal government let me borrow money at zero percent interest, and
then lend it out at 4 to 12 percent interest, even I could make a profit,”
said Professor Finkelstein of the Tuck School. “And if a college professor
can make money in banking in 2009, what should we expect from the highly
paid C.E.O.’s that populate corner offices?”
But maybe now the banks are simply following the lead of Washington, which
keeps trotting out the latest idea for shoring up the financial system.
The latest big idea is the so-called stress test that is being applied to
the banks, with results expected at the end of this month.
This is playing to a tough crowd that long ago decided to stop suspending
disbelief. If the stress test is done honestly, it is impossible to believe
that some banks won’t fail. If no bank fails, then what’s the value of the
stress test? To tell us everything is fine, when people know it’s not?
“I can’t think of a single, positive thing to say about the stress test
concept — the process by which it will be carried out, or outcome it will
produce, no matter what the outcome is,” Thomas K. Brown, an analyst at
Bankstocks.com, wrote. “Nothing good can come of this and, under certain,
non-far-fetched scenarios, it might end up making the banking system’s
problems worse.”
The results of the stress test could lead to calls for capital for some of
the banks. Citi is mentioned most often as a candidate for more help, but
there could be others.
The expectation, before Monday at least, was that the government would pump
new money into the banks that needed it most.
But that was before the government reached into its bag of tricks again. Now
Treasury, instead of putting up new money, is considering swapping its
preferred shares in these banks for common shares.
The benefit to the bank is that it will have more capital to meet its ratio
requirements, and therefore won’t have to pay a 5 percent dividend to the
government. In the case of Citi, that would save the bank hundreds of
millions of dollars a year.
And — ta da! — it will miraculously stretch taxpayer dollars without
spending a penny more.
Bob Jensen's threads on fair value accounting or lack thereof are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Marvene is a poor and unemployed elderly woman who lost her shack to
foreclosure in 2008.
That's after Marvene stole over $100,000 when she refinanced her shack with a
subprime mortgage in 2007.
Marvene wants to steal some more or at least get her shack back for free.
Both the Executive and Congressional branches of the U.S. Government want to
give more to poor Marvene.
Why don't I feel the least bit sorry for poor Marvene?
Somehow I don't think she was the victim of unscrupulous mortgage brokers and
property value appraisers.
More than likely she was a co-conspirator in need of $75,000 just to pay
creditors bearing down in 2007.
She purchased the shack for $3,500 about 40 years ago ---
http://online.wsj.com/article/SB123093614987850083.html
Marvene Halterman, an unemployed Arizona woman with a
long history of creditors, took out a $103,000 mortgage on her 576
square-foot-house in 2007. Within a year she stopped making payments. Now the
investors with an interest in the house will likely recoup only $15,000.
The Wall Street Journal slide show
of indoor and outdoor pictures ---
http://online.wsj.com/article/SB123093614987850083.html#articleTabs%3Dslideshow
Jensen Comment
The $15,000 is mostly the value of the lot since at the time the mortgage was
granted the shack was virtually worthless even though corrupt mortgage brokers
and appraisers put a fraudulent value on the shack. Bob Jensen's threads on
these subprime mortgage frauds are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Probably the most common type of fraud in the Savings and Loan debacle of the
1980s was real estate investment fraud. The same can be said of the 21st Century
subprime mortgage fraud. Welcome to fair value accounting that will soon have us
relying upon real estate appraisers to revalue business real estate on business
balance sheets ---
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
The Rest of Marvene's Story ---
http://faculty.trinity.edu/rjensen/FraudMarvene.htm
Accounting Implications
CEO to his accountant: "What is our net earnings
this year?"
Accountant to CEO: "What net earnings figure do you want to report?"
The sad thing is that Lehman, AIG, CitiBank, Bear
Stearns, the Country Wide subsidiary of Bank America, Fannie Mae, Freddie
Mac, etc. bought these
subprime mortgages at face value and their Big 4 auditors supposedly
remained unaware of the millions upon millions of valuation frauds in the
investments. Does professionalism in auditing have a stronger stench since
Enron?
Where were the big-time auditors? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
September 30, 1999
Fannie Mae Eases
Credit To Aid Mortgage
Lending
By STEVEN A. HOLMES
In a move that could help increase home
ownership rates among minorities and low-income consumers, the Fannie
Mae Corporation is easing the credit requirements on loans that
it will purchase from banks and other lenders.
The action, which will begin as a pilot
program involving 24 banks in 15 markets -- including the New York
metropolitan region -- will encourage those banks to extend home
mortgages to individuals whose credit
is generally not good enough to qualify for conventional loans. Fannie
Mae officials say they hope to make it a nationwide program by next
spring.
Fannie Mae, the nation's biggest underwriter
of home mortgages, has been under
increasing pressure from the Clinton
Administration to
expand mortgage loans among low and moderate income people and felt
pressure from stock holders to maintain its phenomenal growth in
profits.
In addition, banks, thrift institutions and
mortgage companies have been pressing Fannie Mae to help them make more
loans to so-called subprime borrowers. These borrowers whose incomes,
credit ratings and savings are not good enough to qualify for
conventional loans, can only get loans from finance companies that
charge much higher interest rates -- anywhere from three to four
percentage points higher than conventional loans.
''Fannie Mae has expanded home ownership for
millions of families in the 1990's by reducing down payment
requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief
executive officer. ''Yet there remain too many borrowers whose credit is
just a notch below what our underwriting has required who have been
relegated to paying significantly higher mortgage rates in the so-called
subprime market.''
Demographic information on these borrowers is sketchy. But at least one
study indicates that 18 percent of the loans in the subprime market went
to black borrowers, compared to 5 per cent of loans in the conventional
loan market.
In moving, even tentatively, into this new
area of lending, Fannie Mae is taking on significantly more risk, which
may not pose any difficulties during flush economic times. But the
government-subsidized corporation may run into trouble in an economic
downturn, prompting a government rescue similar to that of the savings
and loan industry in the 1980's.
''From the perspective of many people, including me, this is another
thrift industry growing up around us,'' said Peter Wallison a resident
fellow at the Americ an Enterprise Institute. ''If
they fail, the government will have to step up and bail them out the way
it stepped up and bailed out the thrift industry.''
Under Fannie Mae's pilot program, consumers
who qualify can secure a mortgage with an interest rate one percentage
point above that of a conventional, 30-year fixed rate mortgage of less
than $240,000 -- a rate that currently averages about 7.76 per cent. If
the borrower makes his or her monthly payments on time for two years,
the one percentage point premium is dropped.
Fannie Mae, the nation's biggest underwriter
of home mortgages, does not lend money directly to consumers. Instead,
it purchases loans that banks make on what is called the secondary mark
et. By expanding the type of loans that it will buy, Fannie
Mae is hoping to spur banks to make more loans to people with
less-than-stellar credit ratings.
March 13, 2009 message from Zafar Khan
Why was Sarbanes-Oxley enacted?
Zafar Khan, Ph.D.
Professor
Eastern Michigan University
March 14, 2009 reply from Bob Jensen
Hi Zafar,
Sarbanes (SOX) was enacted to keep
investors from abandoning the U.S. stock market after enormous scandals
like Enron, WorldCom, and other huge scandals that revealed CPA audits
themselves were becoming both substandard and non-profitable ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm
To make money, auditing firms themselves
were profiting from irresponsible audit cost cutting and non-audit
consulting that compromised their auditing independence. Inside
corporations, internal controls for responsible financial reporting had
broken down or never existed in the first place.
Sarbanes forced auditors to become more
independent and also made it possible to double or triple audit fees,
thereby restoring auditing to profitable services rather than services
that lost money for auditing firms trying to be responsible auditors.
SOX also created the PCAOB that got
serious about reviewing auditor performance (including fining Deloitte a
million dollars). Many of the large and smaller CPA firms failed the
PCAOB tests early on and soon cleaned up their audit practices with the
PCAOB breathing down their backs.
Among other things SOX increased
government funding for the SEC and the FASB (which before SOX received
no taxpayer funding). This, in turn, made the FASB less dependent upon
sales of publications. The FASB then made many publications free
electronically, most notably free distribution of standards and
interpretations. The IASB, sadly, still depends upon publication revenue
such that IFRS are not free unless you play games like download the
equivalent Hong Kong accounting standards.
See
http://en.wikipedia.org/wiki/Sarbanes_and_Oxley
A variety of complex factors
created the conditions and culture in which a series of large
corporate frauds occurred between 2000-2002. The spectacular,
highly-publicized frauds at Enron (see
Enron scandal), WorldCom, and Tyco exposed significant problems
with conflicts of interest and incentive compensation practices. The
analysis of their complex and contentious root causes contributed to
the passage of SOX in 2002. In a 2004 interview, Senator Paul
Sarbanes stated:
|
The Senate Banking Committee
undertook a series of hearings on the problems in the
markets that had led to a loss of hundreds and hundreds of
billions, indeed trillions of dollars in market value. The
hearings set out to lay the foundation for legislation. We
scheduled 10 hearings over a six-week period, during which
we brought in some of the best people in the country to
testify...The hearings produced remarkable consensus on the
nature of the problems: inadequate oversight of accountants,
lack of auditor independence, weak corporate governance
procedures, stock analysts' conflict of interests,
inadequate disclosure provisions, and grossly inadequate
funding of the Securities and Exchange Commission. |
|
-
Auditor conflicts of interest: Prior to SOX,
auditing firms, the primary financial "watchdogs" for investors,
were self-regulated. They also performed significant non-audit
or consulting work for the companies they audited. Many of these
consulting agreements were far more lucrative than the auditing
engagement. This presented at least the appearance of a conflict
of interest. For example, challenging the company's accounting
approach might damage a client relationship, conceivably placing
a significant consulting arrangement at risk, damaging the
auditing firm's bottom line.
-
Boardroom failures: Boards of Directors,
specifically Audit Committees, are charged with establishing
oversight mechanisms for financial reporting in U.S.
corporations on the behalf of investors. These scandals
identified Board members who either did not exercise their
responsibilities or did not have the expertise to understand the
complexities of the businesses. In many cases, Audit Committee
members were not truly independent of management.
-
Securities analysts' conflicts of interest:
The roles of securities analysts, who make buy and sell
recommendations on company stocks and bonds, and investment
bankers, who help provide companies loans or handle mergers and
acquisitions, provide opportunities for conflicts. Similar to
the auditor conflict, issuing a buy or sell recommendation on a
stock while providing lucrative investment banking services
creates at least the appearance of a conflict of interest.
-
Inadequate funding of the SEC: The SEC budget
has steadily increased to nearly double the pre-SOX level.
In the interview cited above, Sarbanes
indicated that enforcement and rule-making are more effective
post-SOX.
-
Banking practices: Lending to a firm sends
signals to investors regarding the firm's risk. In the case of
Enron, several major banks provided large loans to the company
without understanding, or while ignoring, the risks of the
company. Investors of these banks and their clients were hurt by
such bad loans, resulting in large settlement payments by the
banks. Others interpreted the willingness of banks to lend money
to the company as an indication of its health and integrity, and
were led to invest in Enron as a result. These investors were
hurt as well.
-
Internet bubble: Investors had been stung
in 2000 by the sharp declines in technology stocks and to a
lesser extent, by declines in the overall market. Certain
mutual fund managers were alleged to have advocated the
purchasing of particular technology stocks, while quietly
selling them. The losses sustained also helped create a general
anger among investors.
-
Executive compensation: Stock option and bonus
practices, combined with volatility in stock prices for even
small earnings "misses," resulted in pressures to manage
earnings. Stock options were not treated as compensation expense
by companies, encouraging this form of compensation. With a
large stock-based bonus at risk, managers were pressured to meet
their targets.
Pay Me More and More and More
Sadly, SOX did not attack the root problems that led to the subsequent
subprime lending scandals. These root problems included
pay-for-performance compensation plans that motivated mortgage brokers,
real estate appraisers, banks, and investment banks to screw both
shareholders and home owners.
Pass the Trash
Added to this was Congressional pressure on Fannie Mae and Freddie Mack
to buy hopeless mortgages that had almost no chance of being repaid.
Banks commenced a practice of passing the trash to Freddie, Fannie, and
Wall Street investment banks that, in turn, passed the trash to their
customers in CDOs that were intended to diversify the bad loan risks
(but failed to do so when the real estate bubble burst).
SOX has worked in countless ways, but
not all ways
There are countless success stories where SOX led to better internal
controls and better auditing with more substantive testing in place of
lousy analytical reviews. However, SOX did almost nothing to prevent
fraud in the mortgage brokering and banking sectors.
You can read more about subprime sleaze at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
You can read more about auditing
professionalism at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism
Fiduciaries turned into whores
One of the most sad things for me is the way that CPA auditing firms
failed to signal the public that banks were filling up on toxic loans.
Equally unprofessional were the credit rating agencies like Standard and
Poors and Moody’s that in essence became Wall Street’s whores.
Why regulations fail and
succeed in the turning of the carousel
The main problem with government
regulations on industry is that industry eventually runs the regulators
(e.g., the Federal Reserve, SEC, FDA, FAA, FCC, etc.) until some
enormous scandals force the regulators to use the powers entrusted to
them. Then we get new regulations that industry eventually figures out
how to circumvent. Then we wait for more huge scandals. And so the
carousel goes round and round.
Socialism bypasses the regulation
process by owning and running the industries. Then the abuses really
begin
The
inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.
Winston Churchill
May 14, 2009 reply from Zafar Khan
[zkhan@EMICH.EDU]
Hi Bob, one can always depend upon you to set the
record straight. Otherwise, some might continue to believe that this (SOX)
was another gratuitous government intervention to disrupt the smooth
functioning of our self correcting financial markets.
I also read in a recent post that the government
should not do anything about executive compensation despite the obscene
abuse of power by the executives of public companies who have enriched
themselves while running their companies into the ground because the market
will in the end sort it out. My humble response to that is dream on.
Zafar Khan, Ph.D.
Professor
Eastern Michigan University
March 15, 2009 reply from Bob Jensen
Hi again Zafar,
After the fall of Andersen you would've
thought CPA auditors would've "self corrected" without having SOX since
their reputations had hit bottom.
In 2003 a former professor of accounting
at the University of Illinois and long-time executive partner with
Andersen told accounting professors that the CPA firm executives "still
didn't get it." This is probably why we needed SOX and the PCAOB to help
them "get it." Art Wyatt’s plenary session speech at the 2003 American
Accounting Association annual meetings is at
http://aaahq.org/AM2003/WyattSpeech.pdf
Art is also a former AAA President and a member of the Accounting Hall
of Fame. His opinions have a lot of clout in both the CPA profession and
academe.
From “Topics for Class Debate” at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
This might be a good topic of debate for an ethics and/or fraud course.
The topic is essentially the problem of regulating and/or punishing many
for the egregious actions of a few. The best example is the major
accounting firm of Andersen in which 84,000 mostly ethical and highly
professional employees lost their jobs when the firm's leadership
repeatedly failed to take action to prevent corrupt and/or incompetent
audits of a small number audit partners. Clearly the firm's management
failed and deserves to be fired and/or jailed for obstruction of justice
and failure to protect the public in general and 83,900 Andersen
employees. A former
Andersen executive partner,
Art Wyatt, contends that Andersen's leadership did not get the message
and that leadership in today's leading CPA firms is still not (just
before SOX) getting the message ---
http://aaahq.org/AM2003/WyattSpeech.pdf
Bob Jensen's threads on auditing professionalism are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism
New Off Balance Sheet Financing Vehicles
Accounting for the Shadow Economy
Property is much more than a body of norms. It is also a huge information system
that processes raw data until it is transformed into facts that can be tested
for truth, and thereby destroys the main catalysts of recessions and panics --
ambiguity and opacity.
See below
There are trillions of dollars of off balance sheet
obligations that cannot be easily accounted for.
Hernando de Soto
A Lesson for Auditors: Accounting for the shadow economy
"Toxic Assets Were Hidden Assets: We can't afford to allow shadow
economies to grow this big," by Hernando de Soto, The Wall Street
Journal, March 25, 2009 ---
http://online.wsj.com/article/SB123793811398132049.html?mod=djemEditorialPage
The Obama administration has finally come
up with a plan to deal with the real cause of the credit crunch: the
infamous "toxic assets" on bank balance sheets that have scared off
investors and borrowers, clogging credit markets around the world. But if
Treasury Secretary Timothy Geithner hopes to prevent a repeat of this global
economic crisis, his rescue plan must recognize that the real problem is not
the bad loans, but the debasement of the paper they are printed on.
Today's global crisis -- a loss on paper
of more than $50 trillion in stocks, real estate, commodities and
operational earnings within 15 months -- cannot be explained only by the
default on a meager 7% of subprime mortgages (worth probably no more than $1
trillion) that triggered it. The real villain is the lack of trust in the
paper on which they -- and all other assets -- are printed. If we don't
restore trust in paper, the next default -- on credit cards or student loans
-- will trigger another collapse in paper and bring the world economy to its
knees.
If you think about it, everything of
value we own travels on property paper.
At the beginning of the decade there was
about $100 trillion worth of property paper representing tangible goods such
as land, buildings, and patents world-wide, and some $170 trillion
representing ownership over such semiliquid assets as mortgages, stocks and
bonds. Since then, however, aggressive financiers have manufactured what the
Bank for International Settlements estimates to be $1 quadrillion worth of
new derivatives (mortgage-backed securities, collateralized debt
obligations, and credit default swaps) that have flooded the market.
These derivatives are the root of the
credit crunch. Why? Unlike all other property paper, derivatives are not
required by law to be recorded, continually tracked and tied to the assets
they represent. Nobody knows precisely how many there are, where they are,
and who is finally accountable for them. Thus, there is widespread fear that
potential borrowers and recipients of capital with too many nonperforming
derivatives will be unable to repay their loans. As trust in property paper
breaks down it sets off a chain reaction, paralyzing credit and investment,
which shrinks transactions and leads to a catastrophic drop in employment
and in the value of everyone's property.
Ever since humans started trading, lending
and investing beyond the confines of the family and the tribe, we have
depended on legally authenticated written statements to get the facts about
things of value. Over the past 200 years, that legal authority has matured
into a global consensus on the procedures, standards and principles required
to document facts in a way that everyone can easily understand and trust.
The result is a formidable property system
with rules and recording mechanisms that fix on paper the facts that allow
us to hold, transfer, transform and use everything we own, from stocks to
screenplays. The only paper representing an asset that is not centrally
recorded, standardized and easily tracked are derivatives.
Property is much more than a body of
norms. It is also a huge information system that processes raw data until it
is transformed into facts that can be tested for truth, and thereby destroys
the main catalysts of recessions and panics -- ambiguity and opacity.
To bring derivatives under the rule of law,
governments should ensure that they conform to six longstanding procedures
that guarantee the value and legitimacy of any kind of paper purporting to
represent an asset:
- All documents and the assets and
transactions they represent or are derived from must be recorded in
publicly accessible registries. It is only by recording and continually
updating such factual knowledge that we can detect the kind of overly
creative financial and contractual instruments that plunged us into this
recession.
- The law has to take into account the
"externalities" or side effects of all financial transactions according
to the legal principle of erga omnes ("toward all"), which was
originally developed to protect third parties from the negative
consequences of secret deals carried out by aristocracies accountable to
no one but themselves.
- Every financial deal must be firmly
tethered to the real performance of the asset from which it originated.
By aligning debts to assets, we can create simple and understandable
benchmarks for quickly detecting whether a financial transaction has
been created to help production or to bet on the performance of distant
"underlying assets."
- Governments should never forget that
production always takes priority over finance. As Adam Smith and Karl
Marx both recognized, finance supports wealth creation, but in itself
creates no value.
- Governments can encourage assets to
be leveraged, transformed, combined, recombined and repackaged into any
number of tranches, provided the process intends to improve the value of
the original asset. This has been the rule for awarding property since
the beginning of time.
- Governments can no longer tolerate
the use of opaque and confusing language in drafting financial
instruments. Clarity and precision are indispensable for the creation of
credit and capital through paper. Western politicians must not forget
what their greatest thinkers have been saying for centuries: All
obligations and commitments that stick are derived from words recorded
on paper with great precision.
Above all, governments should stop
clinging to the hope that the existing market will eventually sort things
out. "Let the market do its work" has come to mean, "let the shadow economy
do its work." But modern markets only work if the paper is reliable.
Continued in article
Bob Jensen's threads on accounting theory are at
http://faculty.trinity.edu/rjensen/Theory01.htm
Off Balance Sheet Vehicles
The Mother of All Ponzi Schemes According to Top Liberal (Progressive)
Economists
The Latest Bailout Plan’s a Disaster According to
Paul Krugman and
James K. Galbraith
And yet American policy-makers appear convinced
that more debt can rescue an economy already drowning in it. If we can just keep
the leverage party going, all will be well. $787 billion to fund “stimulus,”
another $9 trillion committed to guarantee bad debts, 0% interest rates and
quantitative easing to drive more lending, new
off balance sheet vehicles
to hide from the public the toxic assets they’ve absorbed. All of it to be
funded with debt, most of it the responsibility of taxpayers. If I may offer
just one reason this will all fail: rising interest rates. Interest rates need
only revert to their historical median in order to hammer asset values, and
balance sheets, into oblivion.
"Added Debt Won't Rescue the Great American Ponzi
Scheme," Seeking Alpha, March 23, 2009 ---
http://seekingalpha.com/article/127261-added-debt-won-t-rescue-the-great-american-ponzi-scheme?source=article_sb_picks
Bob Jensen's threads on off-balance sheet financing (OBSF) are at
http://faculty.trinity.edu/rjensen/Theory01.htm#OBSF2
How is bank regulation going in the United Kingdom?
Answer: Like the U.S., the U.K. has let the regulated control the
regulators
"Distancing regulator from regulated: A public debate on effective
regulation is long overdue, and would put an end to the constant pandering to
private interests," by Prem Sikka, The Guardian, March 17, 2009 ---
http://www.guardian.co.uk/commentisfree/2009/mar/16/regulators
The 1995 collapse of Barings Bank drew
attention to organised gambling, but no regulator questioned it. The high
court ruled that accountancy firm Deloitte & Touche was negligent in its
audit of Barings. Rather than exerting pressures on auditors to improve
quality of their work, the Limited Liability Partnership Act 2000 and the
Companies Act 2006 gave auditing firms liability concessions and made it
harder for injured parties to get redress from negligent auditors.
In 1996, after an explained 11 year delay,
a report on the alleged insider dealings at Guinness was finally published.
It concluded that the City of London is rife with "cynical disregard of laws
and regulations ... cavalier misuse of company monies ... contempt for truth
and common honesty". Some 12 years later the FSA chairman admitted that the
City did not take insider trading seriously.
Accountants and lawyers indulged in money
laundering, but regulators preferred cover-up to clean-up. UK-based
companies plundered developing countries through numerous tax avoidance
schemes. Former Nigerian dictator General Sani Abacha transferred billions
of pounds of stolen money via UK banks. Successive governments have failed
to repatriate the funds and refused to name the banks that played a central
role.
With complete failure of social steering
mechanisms, banks continued to pick people's pockets through exorbitant bank
charges, overdraft fees, credit card rates and payment protection insurance
(PPI), eventually culminating in the biggest financial crisis of all time.
There have been plenty of warnings, but successive governments and
regulators have been too enthralled with markets and business interests.
At the very least, an effective system of
regulation requires that there should be distance between the regulators and
the regulated. The regulators should not promote the industry and should not
have a cosy relationship with those to be regulated. Their prime concern
should be to protect the interests of stakeholders, consumers, depositors,
borrowers and citizens generally, even if that goes against the interests of
the industry. No industry should ever have an in-built majority on any
regulatory body. Thus regulatory practices would need to be negotiated with
other stakeholders. The possibilities of "capture" should be further checked
by ensuring that all meetings of the regulators are held in the open and all
files are on the public record.
A public debate on creating effective
regulatory system is long overdue and should be embedded to principles of
democracy, openness and accountability rather than pandering to private
interests.
November 25,
2008 message from Zane Swanson
Accounting could have a role
in addressing crisis situations but the current historical character of the
financial statements precludes explicit warnings about market failures. For
the most part (balance sheet fair value accounting notwithstanding),
statements present after-the-fact information. Only the auditors’
identification of a going concern problem gives an accounting advance
warning. But, how many of the 2008 failed financial institutions had going
concern opinions? None that I heard of this year … wait till next year. The
MD&A is the communication that management is supposed to use to discuss
trends. Once again, these reports come out once a year with the financial
statements. Even so, how many financial institution 2007 MD&As identified
the value at risk commensurate with the consequent 2008 disasters? Answer
that one yourself.
With the switch from US GAAP to the European style
IFRS, perhaps firms will also be coerced into preparing European style
sustainability reports. Sustainability reports may not be perfect (what is?)
as currently constituted, but they could be an avenue to more accurately
focus attention on future events / trends about impending crises.
Zane Swanson
November 25, 2008 reply from Bob Jensen
Hi Zane,
There are almost always warnings under most any accounting system. The
Paton and Littleton 1940 model required estimation of bad debts. Certainly
if bad debts had been properly estimated, we would’ve had ample warning with
virtually no fair value accounting other than bad debt estimation. It cannot
be argued that historical cost accounting as implemented in the 1940s and
1950s would’ve failed us if bad debts were properly estimated and auditors
were truly independent of their largest Wall Street clients. If bad debts
had been properly estimated for banks over the past two decades there
would’ve never been a crisis of this magnitude. Auditors simply caved in to
bullying clients who pressured for enormous underestimation of bad debts.
Under later GAAP with FAS 105, 115, and 133 in place there were even more
accounting warnings that a bubble was building and would one day burst. The
problem with accounting information is that it combines with other signals
in the economy that add noise and make it very difficult to predict just
when the bubble will burst. If investors and lawmakers paid close attention,
there were ample warnings.
Warren Buffett has been studying financial statements for the past two
decades and has been loudly warning about the dangers of a gigantic
derivatives bubble, and in many ways the present crisis is merely a
fulfillment of his prophecy.
Frank Partnoy (in Infectious Greed) and many other analysts and
academicians warned over and over again about the dangers of not regulating
the derivative markets, especially the credit derivatives market ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds A
lot of the blame falls at the feet of Alan Greenspan who, after the big
bang, finally admits he made a “terrible mistake” by not requiring greater
regulation ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The problem is that people in power just did not want to heed the
warnings. Rep. Barney Frank kept pressuring Fannie Mae and the other
mortgage lenders to make loans to poor people who really had no chance of
making their mortgage payments. The investment bankers and traditional
bankers were making such high commissions and bonuses that they were more
than willing to keep blowing up the bubble even when it became obvious that
their shareholders were going to take a beating. All along the line hogs
feeding on the trough from Wall Street to Main Street knew what they were
doing was wrong, but succumbed to their own greed. Accounting should not be
blamed completely, although the actions of the auditors, credit rating
agencies, and banks estimating bad debts were complicit in creating this
mess --- http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen
Were AIG losses hidden early on by creative
accounting?
PwC is the external auditor of AIG
"A Question for A.I.G.: Where Did the Cash
Go?" by Mary Williams Walsh, The New York Times, October 29, 2008 ---
http://www.nytimes.com/2008/10/30/business/30aig.html?dlbk
The American International Group is rapidly running
through $123 billion in emergency lending provided by the Federal Reserve,
raising questions about how a company claiming to be solvent in September
could have developed such a big hole by October. Some analysts say at least
part of the shortfall must have been there all along,
hidden by irregular accounting.
“You don’t just suddenly lose $120 billion
overnight,” said Donn Vickrey of Gradient Analytics, an independent
securities research firm in Scottsdale, Ariz.
Mr. Vickrey says he believes A.I.G. must have
already accumulated tens of billions of dollars worth of losses by
mid-September, when it came close to collapse and received an $85 billion
emergency line of credit by the Fed. That loan was later supplemented by a
$38 billion lending facility.
But losses on that scale do not show up in the
company’s financial filings. Instead, A.I.G. replenished its capital by
issuing $20 billion in stock and debt in May and reassured investors that it
had an ample cushion. It also said that it was making its accounting more
precise.
Mr. Vickrey and other analysts are examining the
company’s disclosures for clues that the cushion was threadbare and that
company officials knew they had major losses months before the bailout.
Tantalizing support for this argument comes from
what appears to have been a behind-the-scenes clash at the company over how
to value some of its derivatives contracts. An accountant brought in by the
company because of an earlier scandal was pushed to the sidelines on this
issue, and the company’s outside auditor, PricewaterhouseCoopers, warned of
a material weakness months before the government bailout.
The internal auditor resigned and is now in
seclusion, according to a former colleague. His account, from a prepared
text, was read by Representative Henry A. Waxman, Democrat of California and
chairman of the House Committee on Oversight and Government Reform, in a
hearing this month.
These accounting questions are of interest not only
because taxpayers are footing the bill at A.I.G. but also because the
post-mortems may point to a fundamental flaw in the Fed bailout: the money
is buoying an insurer — and its trading partners — whose cash needs could
easily exceed the existing government backstop if the housing sector
continues to deteriorate.
Edward M. Liddy, the insurance executive brought in
by the government to restructure A.I.G., has already said that although he
does not want to seek more money from the Fed, he may have to do so.
Continuing Risk
Fear that the losses are bigger and that more
surprises are in store is one of the factors beneath the turmoil in the
credit markets, market participants say.
“When investors don’t have full and honest
information, they tend to sell everything, both the good and bad assets,”
said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting
firm in Chicago. “It’s really bad for the markets. Things don’t heal until
you take care of that.”
A.I.G. has declined to provide a detailed account
of how it has used the Fed’s money. The company said it could not provide
more information ahead of its quarterly report, expected next week, the
first under new management. The Fed releases a weekly figure, most recently
showing that $90 billion of the $123 billion available has been drawn down.
A.I.G. has outlined only broad categories: some is
being used to shore up its securities-lending program, some to make good on
its guaranteed investment contracts, some to pay for day-to-day operations
and — of perhaps greatest interest to watchdogs — tens of billions of
dollars to post collateral with other financial institutions, as required by
A.I.G.’s many derivatives contracts.
No information has been supplied yet about who
these counterparties are, how much collateral they have received or what
additional tripwires may require even more collateral if the housing market
continues to slide.
Ms. Tavakoli said she thought that instead of
pouring in more and more money, the Fed should bring A.I.G. together with
all its derivatives counterparties and put a moratorium on the collateral
calls. “We did that with ACA,” she said, referring to ACA Capital Holdings,
a bond insurance company that was restructured in 2007.
Of the two big Fed loans, the smaller one, the $38
billion supplementary lending facility, was extended solely to prevent
further losses in the securities-lending business. So far, $18 billion has
been drawn down for that purpose.
Continued in Article
From Jim Mahar's blog on October 31, 2008 ---
http://financeprofessorblog.blogspot.com/
First and foremost it gets to a serious question.
Were the initial infusions (into AIG) by the government just a stop gap
measure and will even more be needed. (The idea of throwing good money after
bad comes to mind). Secondly in class yesterday we talked about information
asymmetries and how accounting can only partially lessen the problem and
that firms can have billions of dollars of losses that investors may not be
aware of even after reading the financial statements. And finally a student
in class is doing a paper on this and what the executives must have known
(or at least should have known) before hand.
Bob Jensen's threads on where the bailout
money paid to AIG went are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Hint: Think credit derivatives not backed with capital reserves
If AIG executives knew about these problems
early on, what did the auditor not insist on disclosing?
Sounds like a massive class action lawsuit here for AIG shareholders who lost
their investments.
Bob Jensen's threads on PwC auditors are at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Why Not Bail Out Everybody and Everything
Government officials are said to be concerned at the
risk that the collapse of Santa Claus could pose to the nation's intricately
related system of holiday happiness. Though a failure by Santa Claus poses the
largest systemic risk, the government is also prepared to step in to bail out
Christmas trees, caroling parties and mistletoe producers. President-elect
Barack Obama has been briefed on the initiative, and through a spokesman was
quoted as saying, "I'm OK with bailing out Christmas." Inside Treasury, some
officials privately worry that such a precedent could result in the
nationalization of Santa Claus, leading to similar calls for help next year from
the Easter Bunny and even Valentine's Day. Treasury Secretary Henry Paulson
personally concluded, however, that "Santa Claus is too big to fail."
"U.S. Says It Will Bail Out Christmas: Easter and even
Valentine's Day might be next," The Wall Street Journal, December 11,
2008 ---
http://online.wsj.com/article/SB122895773035096657.html?mod=djemEditorialPage
If the money is used to prop up failing companies,
that's particularly bad since it is an attempt to override market realities, an
attempt that is about as successful as trying to repeal gravity by throwing
things up in the air.
Jeffrey Tucker, "Best Explanation in
One Sentence," Ludwig von Mises Institute, November 25, 2008 ---
http://blog.mises.org/archives/009018.asp
PJ O’Rourke’s Parliament of
Whores ---
http://snipurl.com/parliamentwhores
Nobel economics prize winner Paul Krugman says the
troubled U.S. auto industry will "probably disappear" as a result of the
geographical forces he described in his award-winning analysis. Krugman told
reporters in Stockholm Sunday that congress support to the auto-industry was not
a long-term solution, but the result of a "lack of willingness to accept the
failure of a large industry in the midst of an economic crisis." However, he
said government aid was the only possible response to the current financial
crisis since the private sector would not be able to support itself.
"Nobel winner Krugman: U.S. auto industry will 'probably disappear'," CNN,
December 7, 2008 ---
http://edition.cnn.com/2008/BUSINESS/12/07/krugman.nobel.economics.auto.ap/
Is GM "too big" to fail? I do not believe the
company is too big to go into a reorganization-which is what bankruptcy would
involve. Such reorganization would abrogate its untenable labor contracts, and
give it a chance to survive in long run. A bailout, by contrast, would simply
postpone the needed reforms in these labor contracts, the business model of GM,
and its management.
Nobel Laureate Gary Becker, "Bail Out the Detroit Auto Manufacturers?"
The Becker-Posner Blog, November 16, 2008 ---
http://www.becker-posner-blog.com/
Cartoon link forwarded by David
Fordham
http://blogs.indystar.com/varvelblog/archives/2008/11/feeding_time.html
|
The problem
with the current bailout is that the government may be giving money
to companies that don't have a long-term future: zombies. On paper,
for example, the Treasury Dept. says it invests Troubled Asset
Relief Program (TARP) money only in "healthy banks—banks that are
considered viable without government investment" because "they are
best positioned to increase the flow of credit in their
communities." That's the right idea. In practice, though, the
criteria aren't so stringent. Banks like Citigroup still aren't
strong enough to lend. "The bailout model is socialism," says R.
Christopher Whalen, senior vice-president for consultancy
Institutional Risk Analytics. He advocates selling failed
institutions in pieces, as was done to resolve the savings and loan
crisis in the late '80s and early '90s. In fact, Washington may be
moving toward something like that with Citigroup. When a big
employer runs into trouble, it's tempting to keep it going at any
cost. Economists call this "lemon socialism"—the investment of
public money in the worst companies rather than the best. The
impulse is misguided, says Yale University economics professor
Eduardo M. Engel. "You don't want to protect the jobs," he says.
"What you want to protect is workers' income during the transition
from one job to another."
Peter Coy, "A New Menace
to the Economy: 'Zombie' Debtors Call them "zombie" companies. Many
more has-been companies will be feeding off taxpayers, investors,
and workers—sapping the lifeblood of healthier rivals," Business
Week, January 15, 2008 ---
http://www.businessweek.com/magazine/content/09_04/b4117024316675.htm?link_position=link2
But now we come to the most dangerous
assumption underlying the rumored Obama approach -- the idea that we
need something called Citi and BofA quickly liberated from their
past mistakes so they can go back to serving as the engines of the
economy. They aren't the engines of the economy -- we have a vast
and diversified financial sector. Today's real problem is a shortage
of reliable borrowers, especially given the uncertainty about house
prices. Washington's misguided goal, if you listen closely, seems to
be turning these giant banks into public utilities to "jumpstart
lending" under political duress. That is, shoveling money at an
overleveraged private sector in hopes of stopping the economy from
shrinking and markets from clearing.
Holman W. Jenkins, Jr.,
"Obama's Dangerous Bank Bailout: Restoring Citi and BofA to
greatness shouldn't be the goal," The Wall Street Journal,
February 4, 2009 ---
http://online.wsj.com/article/SB123371119661046143.html?mod=todays_us_opinion
|
Sad, because this is likely to be Obama's
last shot at getting this economy on its feet and running by 2010.
For Americans are not as patient as they were in the 1930s, when FDR
could try one idea, then another, then another for five years, and
continue to roll up massive electoral victories. If Obama gets this
one wrong, and all this pork and welfare fail to generate real
growth, his party could face a wipeout in 2010, and his opportunity
could be lost forever. Does he really want to bet the farm on the
nag Nancy Pelosi just trotted out of the House?
Patrick Buchanan, "Nancy
Pelosi's New Deal." WorldNetDaily, February 3, 2009 ---
http://www.worldnetdaily.com/index.php?fa=PAGE.view&pageId=87870
|
Lou Dobb's Video on Where the Pork is Embedded in the Stimulus Sausage
---
http://www.thehopeforamerica.com/play.php?id=340
Auntie Bev forwarded this $.02 added to the theory of economics
(original source unknown, but it sounds like Larry Brown to me)
However good or bad a situation is, it will change....but the best is yet to
come!
It's a slow day in the small town of Pumphandle and the streets are deserted.
Times are tough, everybody is in debt, and everybody is living on credit.
A tourist visiting the area drives through town, stops at the motel, and lays
a $100 bill on the desk saying he wants to inspect the rooms upstairs to pick
one for the night.
As soon as he walks upstairs, the motel owner grabs the bill and runs next
door to pay his debt to the butcher.
(Stay with this..... and pay attention)
The butcher takes the $100 and runs down the street to retire his debt to the
pig farmer.
The pig farmer takes the $100 and heads off to pay his bill to his supplier,
the Co-op.
The guy at the Co-op takes the $100 and runs to pay his debt to the local
prostitute, who has also been facing hard times and has had to offer her
"services" on credit.
The hooker rushes to the hotel and pays off her room bill with the hotel
Owner.
The hotel proprietor then places the $100 back on the counter so the traveler
will not suspect anything.
At that moment the traveler comes down the stairs, states that the rooms are
not satisfactory, picks up the $100 bill and leaves.
No one produced anything. No one earned anything. However, the whole town now
thinks that they are out of debt and there is a false atmosphere of optimism and
glee.
And that, my friends, is how a "stimulus package" works!
Auntie Bev
Question
If the job market does not improve, how long will it take for the Fed to own all
the real estate mortgages in the United States?
"Fed to Purchase $40 Billion Per Month in Bonds Until Job Market Improves,"
Time Magazine, September 12, 2012 ---
http://business.time.com/2012/09/13/fed-to-purchase-40-billion-per-month-in-bonds-until-job-market-improves/
The Federal Reserve says it will spend $40 billion
a month to buy mortgage-backed securities for long as necessary to stimulate
the still-weak economy and reduce high unemployment.
It also extended a plan to keep short-term interest
rates at record lows through mid-2015. And it said it’s ready to take other
steps to boost the economy even after it strengthens.
The Fed announced the series of bold steps after
its two-day policy meeting ended Thursday. Its actions pointed to how
sluggish the economy remains more than three years after the Great Recession
ended. “We’re not sure what the economic effects of this program will be –
it should help growth and employment on the margin,” Dan Greenhaus, chief
global strategist at BTIG LLC, said in a research note.
(VIDEO:
How the Federal Reserve Works)
Stocks rose after the announcement. The Dow Jones
industrial average was up 15 points for the day just before 12:30 p.m. It
surged by 105 points within minutes of the announcement, then gave up some
gains to be just 35 points higher.
The dollar dropped against major currencies, and
the price of gold shot up about $16 an ounce, roughly 1 percent, to $1,750.
“If the outlook for the labor market does not improve substantially, the
committee will continue its purchases of agency mortgage-backed securities,
undertake additional asset purchases and employ its other policy tools as
appropriate until such improvement is achieved in a context of price
stability,” the Fed said in a statement released after the meeting.
The statement was approved on an 11-1 vote. The
lone dissenter was Richmond Fed President Jeffrey Lacker, who worries about
igniting inflation.
The bond purchases are intended to lower long-term
interest rates to spur borrowing and spending. The Fed has previously bought
$2 trillion in Treasury bonds and mortgage-backed securities since the 2008
financial crisis.
(MORE:
U.S. Federal Reserve Earned $77 Billion Profit in 2011)
Skeptics caution that further bond buying might
provide little benefit. Rates are already near record lows. Critics also
warn that more bond purchases raise the risk of higher inflation later.
With less than eight weeks left until Election Day,
the economy remains the top issue on most voters’ minds. Many Republicans
have been critical of the Fed’s continued efforts to drive interest rates
lower, saying they fear it could ignite inflation.
The Fed is under pressure to act because the U.S.
economy is still growing too slowly to reduce high unemployment. The
unemployment rate has topped 8 percent every month since the Great Recession
officially ended more than three years ago.
Continued in article
"Unfunded Public Pensions—the Next
Quagmire A federal bailout would cost trillions and prevent necessary reforms.
But there are several ways states can rationalize their workers' retirement
benefits," by R. Eden, Martin, The Wall Street Journal, August 19,
2010 ---
http://online.wsj.com/article/SB10001424052748704017904575409813223662860.html?mod=djemEditorialPage_t
The next big issue on the national political
horizon may be whether the federal government should bail out the many
budget-strapped states and municipalities across the country, especially
their overly generous and badly underfunded pension plans.
My home state of Illinois is in the deepest
quagmire of all. We are essentially broke and getting by in the near term by
borrowing and not paying our bills. Our longer-term problem is even more
serious, as some of our pension plans may run out of money within about 10
years. Our unfunded pension obligations approach $80 billion, and our
unfunded retiree health obligations add approximately $40 billion more.
The troubles in Illinois and other states may soon
force the federal government to choose among three options. The first is to
do nothing—in which case some pension plans will go bankrupt, retirees will
suffer, and many local governments will face emergency cost-cutting and
taxing scenarios that will drive out businesses and jobs.
The second option is to yield to the pressures,
especially from state officials and organized labor, for condition-free
bailouts and loans. Finally, the feds could choose to pressure
("incentivize") states and cities to straighten out their own affairs
through loans to which they attach stringent conditions.
The consequences of doing nothing would be painful.
But they would be far less harmful than the consequences of an unconditioned
federal bailout, which would mean massive new fiscal commitments at the
federal level.
Unfortunately, leaders in Illinois and elsewhere
are now talking quietly about the possibility of a federal bailout. Such
speculation undermines state and local efforts to reform pension systems or
make other hard choices. Why agonize over unpopular budget cuts or tax
increases if the feds will ride to the rescue?
Bailing out state pensions would be astronomically
expensive. According to a Pew Foundation estimate this year, the total
unfunded liabilities of the 50 states' pension funds amounted to about $1
trillion in 2008. Another recent study, by Josh Rauh of Northwestern and
Robert Novy-Marx of the Chicago Booth School of Business, estimated that the
unfunded liability was closer to $3 trillion. Adding the liabilities of
municipal pension funds makes the total even larger.
The downside consequences of such expensive
bailouts would be governmental as well as financial. Among other things,
bailouts would seriously corrode one of the relief valves within our federal
structure. Today, when a state manages its affairs in a particularly
ineffective or costly way, its citizens can move to other states. If
Washington were to take responsibility for state and local pensions, all
taxpayers—in all states—would bear the burden.
A better approach would be for Washington to offer
states support coupled with sustained pressure over the next decade.
Participation by each state would be voluntary.
One form of support could be low-interest federal
loans. An alternative could be federal authorization to issue tax-subsidized
bonds, as suggested in June by Messrs. Rauh and Novy-Marx in The Economists'
Voice electronic journal. Either way, federal support should be conditioned
along the following lines:
• State and local pension funds—and not the federal
government or state and local governments (except where state or municipal
guarantees have already been made)—would be responsible for pension
obligations already incurred for past service.
• Current defined benefit pension plans would be
"frozen," meaning no new benefits would be accrued under those plans.
• Participating states could set up new retirement
programs for both current and new employees in the form of defined
contribution plans such as 401(k)s. Under this approach, the money
contributed by employers and employees would be used solely to generate
savings for those employees; it would not be used, Ponzi-style, to pay
pension benefits to current retirees under the old underfunded plans.
With defined contribution plans, states and cities
would not bear the risks associated with underfunding or the
underperformance of fund assets. Most state and municipal workers would be
able to start taking their money out of the plans at the same age as
private-sector employees (police and firemen could retire earlier, e.g., at
age 60). As an alternative to a defined contribution plan, states could
adopt new, lower-cost defined benefit programs, subject to the requirement
that funding be adequate to cover the costs.
These reforms would still leave the state plans
with their current underfunded, defined benefit pension liabilities. Though
state laws vary, many states and cities may be able to take the legal
position that they are not liable as guarantors if and when a pension fund
goes under. In Illinois, a retiree's contract claim would be against the
pension fund, not the state. In any event, practically speaking, it is not
likely that retirees would be able to recover tens of billions of dollars in
past pension claims against their states.
Where do they go? The federal Pension Benefit
Guaranty Corporation (PBGC) covers only private-sector plans, not state or
other public-service plans. These could not easily be brought under the PBGC
umbrella, and indeed, the last thing we need would be another, separate PBGC-type
federal guarantee program for state and municipal pensions.
But when a major state pension fund runs out of
money, there will be no good choices. Saddling states with billions in
pension-fund debt is unattractive, but so is leaving retirees who are not
under Social Security (like Illinois teachers and most Chicago workers) with
busted pensions and no relief.
States might consider adopting one element of the
federal PBGC plan. When a troubled private pension plan is administered by
the PBGC, the agency pays less than 100% of what pensioners would receive if
their plan were solvent. These reduced amounts vary with the retirement age:
the earlier the retirement, the lower the maximum payment. In Illinois,
where state employees can retire at 55 with enough years of service (and
Chicago employees can retire at 50), such an approach would lead to
significant haircuts.
Retirees and employees would not be happy with any
amount less than the full annuity owed by their plans. But when plans are
headed toward bankruptcy, such PBGC-type protection would be better than
nothing, which is what they would get from a bankrupt fund.
Public pension funds are in dire need of change,
but state and local hopes for a federal bailout now stand in the way of
change. Quashing that hope—which the Obama administration could do with an
explicit statement that it will not bail out state and local pension
funds—would spur the reforms we need.
The mortgage modification problem may be more with the second mortgage
than the first mortgage
"The Difficulty of Modifying Second Mortgages,:" The Atlantic,
January 8, 2010 ---
http://meganmcardle.theatlantic.com/archives/2010/01/the_difficulty_of_modifying_se.php
Question
Why not bail out everybody?
"Rolling up the TARP The $700 billion for banks has become an all-purpose
bailout fund," The Wall Street Journal, October 27, 2009 ---
Click Here
The Troubled Asset Relief Program will
expire on December 31, unless Treasury Secretary Timothy Geithner exercises
his authority to extend it to next October. We hope he doesn't. Historians
will debate TARP's role in ending the financial panic of 2008, but today
there is little evidence that the government needs or can prudently manage
what has evolved into a $700 billion all-purpose political bailout fund.
We supported TARP to deal with toxic bank
assets and resolve failing banks as a resolution agency of the kind that
worked with savings and loans in the 1980s. Some taxpayer money was needed
beyond what the FDIC's shrinking insurance fund had available. But TARP
quickly became a Treasury tool to save failing institutions without imposing
discipline (Citigroup) and even to force public capital onto banks that
didn't need it. This stigmatized all banks as taxpayer supplicants and is
now evolving into an excuse for the Federal Reserve to micromanage
compensation.
TARP was then redirected well beyond the
financial system into $80 billion in "investments" for auto companies. These
may never be repaid but served as a lever to abuse creditors and favor auto
unions. TARP also bought preferred stock in struggling insurers Lincoln and
Hartford, though insurance companies are not subject to bank runs and pose
no "systemic risk." They erode slowly as customers stop renewing policies.
TARP also became another fund for Congress
to pay off the already heavily subsidized housing industry by financing home
mortgage modifications. Not one cent of the $50 billion in TARP funds
earmarked to modify home mortgages will be returned to the Treasury, says
the Congressional Budget Office.
As of the end of September, Mr. Geithner
was sitting on $317 billion of uncommitted TARP funds, thanks in part to
bank repayments. But this sum isn't the limit of his check-writing ability.
Treasury considers TARP a "revolving fund." If taxpayers are ever paid back
by AIG, GM, Chrysler, Citigroup and the rest, Treasury believes it has the
authority to spend that returned money on new adventures in housing or other
parts of the economy.
A TARP renewal by Mr. Geithner could thus
put at risk the entire $700 billion. Rep. Jeb Hensarling (R., Texas) and
former SEC Commissioner Paul Atkins sit on TARP's Congressional Oversight
Panel. They warn that the entire taxpayer pot could be converted into
subsidies. They are especially concerned about expanding the foreclosure
prevention programs that have been failing by every measure.
TARP inspector general Neil Barofsky
agrees that the mortgage modifications "will yield no direct return" and
notes charitably that "full recovery is far from certain" on the money sent
to AIG and Detroit. Mr. Barofsky also notes that since Washington runs huge
deficits, and interest rates are almost sure to rise in coming years, TARP
will be increasingly expensive as the government pays more to borrow.
Even with the banks, TARP has been a
double-edged sword. While its capital injections saved some banks, its lack
of transparency created uncertainty that arguably prolonged the panic.
Federal Reserve Chairman Ben Bernanke and former Treasury Secretary Hank
Paulson recently admitted to Mr. Barofsky what everyone figured at the time
of the first capital injections. Although they claimed in October 2008 they
were providing capital only to healthy banks, Mr. Bernanke now says some of
the firms were under stress. Mr. Paulson now admits that he thought one in
particular was in danger of failing. By forcing all nine to take the money,
they prevented the weaklings from being stigmatized.
Says Mr. Barofsky, "In addition to the
basic transparency concern that this inconsistency raises, by stating
expressly that the 'healthy' institutions would be able to increase overall
lending, Treasury created unrealistic expectations about the institutions'
conditions and their ability to increase lending."
The government also endangered one of the
banks that they considered healthy at the time. In December, Mr. Paulson
pressured Bank of America to complete its purchase of Merrill Lynch. His
position is that a failed deal would have hurt both firms, but this is
highly speculative. Mr. Barofsky reports that, according to Fed documents,
the government viewed BofA as well-capitalized, but officials believed that
its tangible common equity would fall to dangerously low levels if it had to
absorb the sinking Merrill.
In other words, by insisting that BofA buy
Merrill, Messrs. Paulson and Bernanke were spreading systemic risk by
stuffing a failing institution into a relatively sound one. And they were
stuffing an investment bank into one of the nation's largest institutions
whose deposits were guaranteed by taxpayers. BofA would later need billions
of dollars more in TARP cash to survive that forced merger, and when that
news became public it helped to extend the overall financial panic.
Treasury and the Fed would prefer to keep
TARP as insurance in case the recovery falters and the banking system hits
the skids again. But the more transparent way to address this risk is by
buttressing the FDIC fund that insures bank deposits and resolves failing
banks. The political class has twisted TARP into a fund to finance its pet
programs and constituents, and the faster it fades away, the better for
taxpayers and the financial system.
Indeed it might not be worth breaking a sweat if
the stimulus bill was going to spend the measly $168 billion that George
Bush's tax rebates threw at the economy last year. Nobody gets upset anymore
if Washington wastes a hundred billion dollars. But coming after four months
of the TARP's dizzying billions spent in futility, we get a president
proposing to spend nearly $1,000,000,000,000 on what he calls "stimulus."
Even a populace numb to its government's compulsive spending woke up to that
fantastic sum. . . . The whole congressional effort is an irrelevant
sideshow; only the final spending number matters. The economics don't
matter, because the real political purpose of the bill is to neutralize this
issue until the economy recovers on its own. Much of its spending is a
massive cash transfer to the party's union constituencies; a percentage of
that cash will flow back into the 2010 congressional races. The bill in
great part is a Trojan horse of Democratic policies not related to anyone's
model of economic stimulus. Finally, if this bill's details are irrelevant
to the presumed multiplier effect of an $800 billion Keynesian stimulus, GOP
Sen. Susan Collins's good-faith participation in it looks rather foolish.
Daniel Henninger, "Exactly How
Does Stimulus Work? Separating economics from theatrics," The Wall Street
Journal, February 12, 2009 ---
http://online.wsj.com/article/SB123440338832275537.html?mod=djemEditorialPage
The butcher, baker, and automaker make her, why not me?
U.S. life insurers, weakened by losses on their
immense investment portfolios, are maneuvering to get a slice of government
bailout funds by buying up tiny banks. On Monday, Lincoln National Corp. said it
agreed to buy a small savings-and-loan institution in Goodland, Ind. In recent
days Genworth Financial Inc. said it agreed to buy a thrift in Maple Grove,
Minn., and Hartford Financial Services Group Inc. said it had struck a deal to
purchase Federal Trust Corp., in Sanford, Fla.
Leslie Scism, Michael Crittenden, Matthew, Karnitschnig, and Matthias Rieker,
"Insurers Buy Banks in Effort to Get Aid," The Wall Street Journal,
November 17, 2008 ---
http://online.wsj.com/article/SB122696868966435573.html?mod=todays_us_page_one
The butcher, the baker, the candlestick make her, why can't Ford?
"Treasury to Ford: Drop Dead The GMAC rescue plays favorites," The Wall Street
Journal, January 2, 2008 ---
http://online.wsj.com/article/SB123085986972148021.html?mod=djemEditorialPage
When the Bush Treasury decided to bail out
Detroit, GM and Chrysler quickly said yes to the taxpayer cash, but Ford
Motor Co. said it didn't need the money and declined. Ford's reward for this
show of self-reliance? Treasury is now helping GM again by giving it a
credit pricing advantage against Ford in the marketplace
That's one little-noted result of
Treasury's action earlier this week to rescue GMAC, the GM credit arm that,
as it happens, is 51% owned by the Cerberus private-equity shop that also
owns Chrysler. With $5 billion in taxpayer cash in its pocket, GMAC quickly
decided to offer 0% financing on several of its models. "I think it would be
fair to say that without this change . . . we would not be able to do this
today," explained GM Vice President Mark LaNeve in a conference call with
reporters this week.
GM said it will offer 0% financing for up
to 60 months on the 2008 Chevrolet TrailBlazer, GMC Envoy and Saab 9-7X
sport utility vehicles through GMAC. The Saab 9-3 and 9-5 sedans also
qualify for 0% financing. The car maker is also offering financing between
0.9% and 5.9% on more than three dozen other 2008 and 2009 models, including
many trucks and SUVs. The deal runs through January 5, and no doubt GM is
hoping for a booming sales weekend.
The messy little policy issue is that
these GM products compete with those sold by Ford, Toyota, Honda and
numerous other car makers that won't benefit from GMAC's cash infusion. And
with the cost of financing often crucial to buyer decisions, the feds have
now put the muscle of the state behind one company's products.
Ford in particular must wonder what it did
to deserve this slap. CEO Alan Mulally joined the GM and Chrysler chiefs in
testifying for the bailout even while insisting his company didn't want the
funds. And once the bailout was announced, Mr. Mulally said that "All of us
at Ford appreciate the prudent step the Administration has taken to address
the near-term liquidity issues of GM and Chrysler." So much for gratitude.
Ford -- and for that matter Honda and
Nissan and most others -- makes cars with American workers. President Bush
justified the auto bailout in the name of saving jobs, but apparently GM's
jobs are more valuable than others. And with the taxpayers now having a
stake in GM and Chrysler success, the Washington temptation will be to take
other steps to help the two companies gain market share at the expense of
their private competitors. Never mind that Ford is still struggling and
Toyota recently posted its first full-year loss in 70 years.
This is always what happens when
politicians decide to muck around in private industry. Even when made with
the best intentions, their policy decisions have unintended consequences
that help some companies at the expense of others. Meanwhile, your neighbor
who buys a GM SUV this weekend with 0% financing should thank you when he
pulls into the driveway. He did it with your money.
Why not bail out everybody and everything? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Everybody
Major liberal newspapers like The New York Times, The Washington Post, and
The Baltimore Sun were failing long before the current financial crisis, but
they too are trying, in return to really helping Obama be elected, to get
Bailout funding.
"Battered U.S. media prays for its bailout: With advertising sales running
off a cliff and share prices collapsing, some companies may not weather the
crisis," by Richard Siklos, The Globe and Mail, November 28, 2008 ---
Click Here
"Seizing pensions, the final step to bankruptcy," Pravda, November 10,
2008 ---
http://english.pravda.ru/world/americas/10-11-2008/106678-pensions-0
As these late autumn days of financial
disaster wind down into a winter of discontent across the world, the United
States Congress is discussing a step that will surely signal the final
collapse of America as anything more than a bankrupt and possibly failed
state.
What is this subject? The subject is none
other than pensions, the last refuge of money and the last source of fast
cash for spend thirsty politicos. In committees the US Congress is hearing
testimony from various leftist professors on how to redistribute, read
spend, the vast amount of money accumulated by the 60 million Americans at
or near retirement age.
What most of you, my dear readers, do not
understand, is that in America there is no longer such a thing as a pension
fund. These are dinosaurs, the last of which are paying out their monies, on
the way to total extinction. To replace these the government of America
created tax exempt (to a certain dollar per year value) accounts called
401Ks which are than invested into the stock markets, thus a great boom for
the number one owners of the United States government, banks. But the banks
are now themselves bankrupt and hold much less sway in DC, even as appetites
to spend have grown amongst the One Party, Two Branch politicos. Sure there
is Social Security, but even by under rating inflation by 2/3rds, and thus
upward payment adjustments, for over 20 years the United States government
is simply broke and does not have the actual money to pay Social Security
for the vast Baby Boomer generation, now retiring.
This is because all the money, from day
one in 1936, was spent and not invested. Each working generation pays for
the retiring generation. What changed? The Baby Boomers aborted 40 million
babies and thus are now larger than the combined next two generations. In
their Christless greed to spend on themselves, they have not only damned
their souls through the murder of children but their old age as well, to
poverty.
But even when Social Security pays, for
most people, the $2,000 to $3,000 it does pay per month is hardly the money
to live off of, let alone pay for ever more expensive medicines. The medical
costs in America routinely grow between 15-20% per year, while salaries at
best on average at 3-4%. This is all the product of short sightedness and
greed. The bill has come due and a large percentage has been added for
gratuity. The Devil will have his kilogram of flesh from a people who have
forsaken Christ for pride, vanity and greed.
So what is being contemplated by the
American Congress?
When is $25 billion in taxpayer cash insufficient to
bail out Detroit's auto makers? Answer: When the money is a tool of
Congressional industrial policy to turn GM, Ford and Chrysler into agents of the
Sierra Club and other green lobbies. That's the little-understood subplot of the
Washington melodrama over a taxpayer rescue for Detroit. In their public
statements, proponents describe the bailout as an attempt to save jobs, American
manufacturing and the middle-class way of life. But look closely and you can see
that what's really going on is an attempt to use taxpayer money to remake
Detroit in the image of the modern environmental movement. Given a choice
between greens and blue-collar workers, Congress puts the greens first.
"The Environmental Motor Company," The Wall Street Journal,
November 19, 2008 ---
http://online.wsj.com/article/SB122705379531139259.html?mod=djemEditorialPage
Jensen Comment
Detroit is seeking tens of billions of dollars to save a business model that
already has an F. As a subsidiary of the Sierra Club the business model grade
will go to F- and then F- and on out to Z-. Save your old jalopy. It will soon
be worth more than what Detroit will offer for sale.
This is America today―a country that is losing its
ability to manufacture things but has to continue to pander to rich Arabs and
the Chinese Communists for money just to survive. In addition to our jobs,
savings and investments, it looks like our sovereignty and national pride are
being sacrificed as part of this process. Whether the financial meltdown has
been engineered or not―and there are major questions about its timing, just six
weeks before the national elections―it will be up to President Obama to manage
America’s transition into this New Global Order. With his background in Marxism
and extensive Wall Street contacts and associations, he seems perfectly suited
for the task. But the powers that be, including those in the media, have simply
assumed that the American people will meekly go along with the demise of their
nation. That may be a miscalculation, if they manage to find a voice or voices
in the media.
Cliff Kincai, "Fed Bails Out Rich
Arabs in Citigroup Deal,"Canadian Free Press, November 25, 2008 ---
http://canadafreepress.com/index.php/article/6518
Jensen Comment
What Cliff Kincai and the rest of the world must be made to realize is that if
the U.S. government is to bail out Detroit's automakers, state governments,
butchers, bakers, and candlestick makers, it can only do so if trillions more in
bailout money are borrowed from the Middle East and Asia. Asia and the Middle
East could put an end to the United States in an instant by merely not rolling
matured Treasury bonds over or investing in the vast amount of our National Debt
that they now hold and are being relied upon to finance the present bailout of
just about every aspect of the U.S. Economy ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
I'm not saying that it is necessarily proper to bail out "Rich Arabs" who
invested in Citigroup, but would you try to squash the children of your boss,
your banker, and and your owner who can in turn squish you like a bug on the
windshield? Since the Democratic Party had a majority in the House and Senate
before the 2008 election, you should ask their leaders why they are not
objecting to the bailout of "Rich Arabs" while they're stalling on bailing out
Detroit's automakers. I think it's because our legislators know where the
trillions more in National Debt most be borrowed on top of the 45% if the
National Debt now held outside the U.S.
We can’t even pay the interest on the National Debt without borrowing to pay the
interest!
China now owns nearly 10% of the U.S. National Debt. Rich Arabs also own
hundreds of billions of this debt.
You maybe did not buy a GM or Chrysler car in 2009,
but you're going to pay for a big chunk of somebody else's new car.
According to the report, every American taxpayer has put up $12,200 for
every General Motors car sold through the beginning of 2011 and $7,600 for every
Chrysler sold.
"Study: Every GM Vehicle Sold Costs Taxpayers $12,200," National
Taxpayers Union, November 18, 2009 ---
http://www.ntu.org/main/press.php?PressID=1133&org_name=NTU
The American taxpayer has put up $12,200 for every
General Motors vehicle sold through the beginning of 2011, and $7,600 for
every Chrysler vehicle sold as well, according to a new report issued by the
362,000-member National Taxpayers Union (NTU).
The report, The Auto Bailout – A Taxpayer
Quagmire, authored by NTU Adjunct Scholar Thomas D. Hopkins, Professor
of Economics at the Rochester Institute of Technology, does the math on what
the government bailout of the auto industry – including General Motors,
Chrysler, and GMAC – actually means to American taxpayers, including how
much each taxpayer has contributed to the auto industry since December 2008
and how much each vehicle is costing us.
Every time someone in your neighborhood drives home
in a shiny new Chevy Silverado, remember that it cost American taxpayers
more than $12,000,” said Pete Sepp, NTU Vice President for Policy and
Communications. “Between this and GM's plan to payback their bailout debt
with other taxpayer funds, I wonder if all those Americans without work
right now could think of any better ways to spend that money. This is a play
out of the Bernie Madoff ponzi scheme playbook, and would be the equivalent
of paying your Master Card bill with your Visa.”
The study found that the average American taxpaying
family has invested roughly $800 in the auto bailouts so far. Moreover, the
study found, the government support poured into General Motors, Chrysler,
and GMAC – the financing subsidiary that supports sales at both – now stands
at a towering $78.9 billion. Given that figure, and an estimate of how many
vehicles GM and Chrysler will sell through the end of 2010, the study finds
that each vehicle one of the bailed-out companies sells costs taxpayers
$10,700.
Finally, breaking down the costs by company, the
study reports that every Chrysler vehicle sold costs taxpayers $7,600, and
every GM vehicle sold costs taxpayers $12,200.
The research is based upon a November study
released by the Government Accountability Office (GAO), entitled
Continued
Stewardship Needed as Treasury Develops Strategies for Monitoring and
Divesting Financial Interests in Chrysler and GM, ”
a follow-up report on the “Troubled Asset Relief
Program,” as well as statements and reports released from the U.S. Treasury.
Additional Findings Include:
GMAC receives government guarantees not
available to most private firms. Coincidentally, these are the same
private firms that are forced to compete with GMAC taxpayer-assisted
bank, Ally Bank. These guarantees save GMAC about $500 million annually
in interest costs.
During the first ten months of 2009, GM and
Chrysler sales fell further than other major auto producers, down 33.4
percent and 38.9 percent, respectively.
While the prospect of repayment of GM and
Chrysler loans might be expected, after bankruptcy the vast majority of
the bailout funds are no longer legal obligations of the
newly-structured GM and Chrysler.
If Americans are to believe public officials’
claims that the government will eventually reprivatize the auto
industry, the necessity of a thoughtful exit plan is essential. However,
at this time no such plan exists, making it likely that the Treasury
will not recover its investment.
“[T]he bailout has created moral hazard problems,
inadvertently handicapping the progress of stronger, non-subsidized
producers,” Professor Hopkins concluded. “The problems extend beyond just
the auto industry, as favored status for one financial company and its bank
necessarily complicates prospects for non-subsidized rivals. The time has
come to stop such bailouts, and in an orderly way, to seek at least some
recovery for taxpayers.”
Note: To view the complete issue brief, The Auto
Bailout – A Taxpayer Quagmire,
click here.
About the Author
Thomas D. Hopkins is Professor of Economics at
Rochester Institute of Technology. He served as Dean of the College of
Business 1998-2005 and as President, U.S. Business School in Prague, Czech
Republic, an RIT MBA program where he taught 1992-98. He was the Arthur J.
Gosnell Professor of Economics in RIT's College of Liberal Arts, 1988-98.
Hopkins held senior management positions in two White House agencies during
the Ford, Carter and Reagan Administrations; in 1979 President Carter
appointed him a charter member of the federal government’s Senior Executive
Service. In the early 1980s, he served as Deputy Administrator, Office of
Information & Regulatory Affairs, in the Office of Management & Budget. His
research on business burdens of government regulation has been sponsored by
the Organization for Economic Cooperation & Development (OECD) in Paris and
the U.S. Small Business Administration (SBA) in Washington. He has testified
on regulatory policy issues before committees of the U.S. Senate and House,
and Canada’s House of Commons. He co-authored a 2001 SBA report, “The Impact
of Regulatory Costs on Small Firms,” as well as National Research Council
reports on marine transportation, the Exxon Valdez oil spill, and
trucking/rail/barge transportation. He previously was on the faculty of
American University, University of Maryland, and Bowdoin College.
Background
The Auto Bailout – A Taxpayer Quagmire is based on
data obtained from the Government Accountability Office and Treasury reports
on the Troubled Asset Relief Program. The study was sponsored by the
National Taxpayers Union (NTU), a nonpartisan, nonprofit citizen
organization founded in 1969 to work for lower taxes, smaller government,
accountability from public officials, and economic freedom at all levels.
For further information, visit
www.ntu.org .
Jensen Comment
Some of the money spent on GM and Chrysler to date might be returned, but
then again more might be lost. Certainly if the GM and Chrysler experiments
fail, the government will be paying the pension costs of tens of thousands of
retirees.
The government is also guaranteeing the warranty coverage of both GM and
Chrysler cars. In the case of Chrysler this includes the ridiculous lifetime
warranty on power trains such that if a twenty year old kid buys a Chrysler, the
power train is fully guaranteed for 80 or more years. How dumb can you get?
General Moters: Robbing Sam to Pay
Sam
"The Flight of the Money: Where Has It Gone?," by David Kennedy,
Townhall, July 17, 2010 ---
http://townhall.com/columnists/DanKennedy/2010/07/17/the_flight_of_the_money_where_has_it_gone
Two months ago, the “new”
General Motors made possible by government bailouts, theft of shareholders’
equity for forced re-distribution to unions, and managerial change at
government’s gunpoint, was held up as shining example of success – it was
even repaying its debt to Uncle Sam early.
But the week of the
Independence Day, GM announced its urgent need to borrow five billion
dollars, to use in re-paying debt (ie. paying its VISA bill with a new
MasterCard) and as cash reserves to counter anticipated slumping sales.
As Arte Johnson used to say
on “Laugh-In:” v-e-r-y interesting.
If you go to a movie set,
you will see perfect-looking streets, each building front rich in detail,
looking as real as real can be. Yet its only façade. One thin piece of
painted sheetrock propped up. Walk around behind it, there’s nothing there.
That’s GM. State pension
funds in 30-plus states people are counting on, upside down in toto by
trillions. Obama’s stimulus. There are signs stuck here or there with his
logo on them, proclaiming the dirt mound or torn up street his “stimulus at
work.” The sign-maker was stimulated. Who else? That’s this entire economy.
A façade. Walk around behind it: there’s nothing there. No real job
creation, no business investment, no real estate investment, nothing much
happening but very un-hopeful hoarding. Where has all the money gone?
There is flight of capital.
Companies like Ford and Microsoft moving hundreds of millions of dollars to
investments overseas. Mega-investors like Buffett are breaking
long-standing, self-imposed prohibition on investing in non-U.S. companies
in foreign lands. Insurers and health care companies are quietly buying up
land beyond our borders.
A major business story going
unreported: the long, long list of iconic American brand companies closing
countless stores, shops and restaurant locations here while expanding and
opening outlets like mad in other countries. That means they are draining
money out of local economies here and moving it over there. Starbucks.
Wal-Mart. Etc. Can’t you hear this giant sucking sound?
There is capital on strike.
An estimated $2-trillion of excess cash reserves in companies other than
financial institutions – although they are hoarding rather than lending,
too. And this is calculated from examining big, public companies. As
somebody intimately in touch with thousands of small business owners, I can
personally assure you, their reluctance to invest or spend is profound, and,
in aggregate, they are likely keeping trillions more inactive.
Continued in article
More Cap and Play Bailout Absurdity: An Unbelievable Deal for Expensive
"Golf Carts"
Get up to a Federal $6,000 rebate on a $9,000 "golf cart"
"A Bailout ... for Golf Cars? Business Is Booming for Street-Legal Golf Cars
Thanks to the Bush-Era Bailout," by Alice Gomstyn, ABC News, October 21,
2009 ---
http://abcnews.go.com/Business/golf-car-sales-spike-08-bailout/story?id=8875161
Bill Morgan has been in business for a dozen
years, but he's never seen demand like this: Customers are flocking to his
showroom to purchase electric, street-legal golf cars -- golf carts that can
be driven on public roadways as well as golf courses.
"The economy is not good for golf right now,"
Morgan, the owner of Action Golf Cars in Ormond Beach, Fla., said. But the
golf cars are "selling so fast, it's amazing."
It's all thanks, he said, to the federal
government. The bailout bill that last year helped keep the U.S. banking
system afloat also contained lesser-known provisions to benefit other
industries, including the electric car business.
In April, the Internal Revenue Service
confirmed that "neighborhood electric vehicles" or NEVs -- a common term for
electric-powered golf cars and other low-speed vehicles allowed on public
roadways -- bought in 2009 qualified for the tax credit. (The IRS indicated
that traditional golf carts used mainly on golf courses -- as opposed to
street-legal vehicles -- aren't eligible for the credit. It said in its
April statement that "vehicles manufactured primarily for off-road use, such
as for use on a golf course, do not qualify." (
(But most of these were manufactured as golf carts with head lights
and tail lights added in later on.)
Under the Bush administration's Emergency
Economic Stabilization Act, buying a plug-in electric motor vehicle can make
a consumer eligible for a tax credit of at least $2,500 plus additional cash
depending on a car's battery capacity. The $787 billion stimulus package
signed by President Obama in Feburary contained similar provisions.
Morgan said the battery capacity on 12 cars he
sells qualifies them for tax credits of $5,335 each.
In recent months, he and golf car dealers
across the country have been advertising the tax credit as an incentive to
get buyers in the door -- and it's working, they say.
Unlike traditional golf carts, golf cars that
are street-legal must include safety features such as headlights, seat
belts, parking brakes and driver's side mirrors, according to federal
mandates. They are allowed to reach maximum speeds of 25 miles per hour and
individual states decide which roadways the cars may travel on.
Morgan said he's sold 40 cars priced between
$6,495 and $10,600 in the last six weeks -- more than $260,000 in sales,
which he said is a record for his company. Morgan's supplier, South
Carolina-based JH Global Services, Inc., told ABCNews.com that it's seen
spikes in sales too.
"A month of sales now is almost equal to a
couple of quarters in the past," JH Global CEO Jane Zhang said.
The wheels were in motion for the NEV tax
credit long before the now-famous Cash for Clunkers program -- last summer's
staggeringly popular government subsidy program for car trade-ins -- became
law, but buzz over the tax credit has appeared to only pick up speed in the
last two months, after NEV manufacturers received certifications from the
IRS that particular models did, in fact, qualify for the credit.
The credit is benefitting more than just golf
cart retailers. It applies to other low-speed vehicles, including those sold
by Susan Sistare of Star Electric Cars in Fort Lauderdale, Fla.
Sistare said she's seen calls from prospective
customers triple since she started advertising the tax credit.
Sistare sells neighborhood electric vehicles
that aren't much bigger than golf carts but look more like miniature
versions of your typical highway fare than something you'd take out on the
links. Her products include a Cadillac Escalade and a Hummer, made by
California-based ACG Inc. and licensed from Cadillac and Hummer,
respectively.
They are subject to the same speed and safety
rules as street-legal golf cars, but Sistare takes pains to emphasize that
her products aren't traditional golf carts. The tax credit, she said, is
raising awareness of neighborhood electric vehicles like hers.
"This is a wonderful educational tool --
people don't know what low-speed vehicles are," she said. "Every day, I
fight the golf car fight."
Both street-legal golf cars and other
neighborhood electric vehicles have increased in popularity in recent years.
Global Electric Motorcars, a subsidiary of Chrysler that bills itself as the
industry's leading NEV maker, says it now has more than 41,000 vehicles on
the road.
Ramon Faul, 68, of Pass Christian, Miss.,
bought his neighborhood electric vehicle in 2007, hoping to save money on
gas.
Today, he uses the golf car to pick up
groceries and visit neighbors. He can ride about 30 miles without recharging
its battery, he said.
"You can ride all week on it," he said.
Continued in article
Jensen Comment
There are a few downsides to this otherwise tremendous government gift.
- Golf carts can go on golf carts and some city streets. But they cannot
go on Interstate highways or other highways that specify minimum speed
limits.
- They are not safe when driving on country roads and some city streets
where other faster moving vehicles might rear end slow moving objects. There
are no air bags for safety in a golf cart, and they are very easy to be
thrown out of in collisions and sharp turns. Also these cars are often more
dangerous in ice, snow, and wet roads.
- These golf carts must have registration and liability insurance just
like any other vehicle (laws vary somewhat from state to state) ---
http://www.electriccarsociety.com/criticalev.htm
It's my understanding that you cannot get this huge Federal rebate for a
strictly off-road vehicle.
- You may get very wet operating these vehicles in a pouring rain.
Remember those rain coats and goggles that drivers of open-air Model T Fords
used to wear.
- Fifth, you may get very, very cold driving these things in a New
Hampshire winter. Also, they're not air conditioned for hot weather.
- Golf carts are pretty easy to steal since four men may be able to load
them into pick up trucks.
- There is no luggage carrier to speak of, but if you need to catch a
flight you can pack your clothing in a golf bag.
- If you live high up a hill you've got big troubles. For example, I can
take a golf cart down to the store in Franconia, but it does not have the
power to get back up the steep two-mile hill to my home. So if I want to go
to the Franconia store I must hire a tow truck to get my golf cart back up
the hill.
Bob Jensen's threads on more absurdities of the bailout are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Everybody
"The Obama Speech We're Waiting For:
Fannie Mae and Freddie Mac need to get the BP treatment," by William McGurn,
The Wall Street Journal, June 22, 2010 ---
http://online.wsj.com/article/SB10001424052748704895204575320922399530274.html?mod=djemEditorialPage_t
The President: Good evening. As we speak, our
nation faces a multitude of challenges. At home, our top priority is to
recover and rebuild from a recession. Abroad, our brave men and women in
uniform are taking the fight to al Qaeda wherever it exists. Tonight, I want
to speak with you about a battle we're waging against an enemy that is
assaulting the very homes our citizens live in.
In September 2008, Fannie Mae and Freddie Mac
imploded when their losses became unsustainable. In part because so many of
our financial institutions relied on mortgage-backed securities based on bad
loans, a housing crisis exploded into a financial crisis. And Americans
continue to suffer from the effects. Unlike a hurricane or oil spill, where
the damage is obvious to the eye, the damage wrought by Fannie and Freddie
is much more insidious. As president, I have many smart people in my
administration. But you do not need a Nobel Prize to know the problem here.
Fannie and Freddie bought mortgages offered by
banks, which it then resold as mortgaged-backed securities. Banks liked
this, because it meant more money to lend. In the name of enabling ever more
Americans to own their homes, and encouraged by Congress, Fannie and Freddie
expanded into ever more risky mortgages. In the end, these two companies
helped send billions in loans to Americans who lacked the means to pay them
back—while spreading risk throughout our financial system.
Think of these bad loans as a nasty leak polluting
our financial system. While most other large financial firms either have
failed or are now recovering, the damage caused by Fannie and Freddie
continues largely unabated. The Congressional Budget Office says that
plugging these bad loans has already cost taxpayers $145.9 billion, making
them the single largest bailout of all.
Make no mistake: We will fight Fannie and Freddie
with everything we have got for as long as it takes. We will make these two
government-created companies pay for the damage they have caused. In fact,
we are going to make Fannie and Freddie pay with their lives. Tonight I'd
like to lay out our battle plan going forward:
First, the cleanup. For more than three decades
there's been a culture of corruption in the regulatory oversight of these
companies. I inherited a situation in which these firms lobbied and captured
their regulators. Fannie and Freddie's privileged place in the market was
sustained because they were a source of riches for Washington's Republican
and Democratic establishments. Even today we see this oily alliance at work
in the recent decision by Congress to exempt Fannie and Freddie from their
financial reform bill.
Tonight I promise you: We will do whatever it
takes, for as long as it takes, to change this.
One of the lessons we've learned from Fannie and
Freddie is that you cannot combine private profit with taxpayers bearing
risk. For decades we've propped up Fannie and Freddie's near monopoly. And
for decades we have failed to face up to the fact that homeownership is not
the best path for everyone. Time and again, reform has been blocked by
former congressmen of both parties whom these companies hired to spread the
money around and persuade Congress to back off.
So the second thing I will do is meet with the
chairmen of Fannie Mae and Freddie Mac. And I will tell them the day of
reckoning has come. We are going to break up Fannie and Freddie and end the
privileges they enjoy from the government.
You know, for generations, Americans have scrimped
and saved to provide a better life for their families. That is now in
jeopardy. I have met with moms and dads who bought modest houses that were
within their means—and now find their tax dollars going to bail out
neighbors who bought bigger houses not within their means. I have stood with
retirees whose pensions have been devastated. And I have sat in the living
rooms of families who now face foreclosure on homes they were falsely
assured they could afford.
The sadness and the anger they feel is not just
about the money they've lost. It's about a wrenching anxiety that their way
of life may be lost. I am a prayerful man. But I do not believe that the
American people should have to pray that their own government isn't
undermining their homes, their savings, and the lives they have built for
their families.
The financial crisis was not caused by Fannie and
Freddie alone. But fixing them is essential. To this important task, we
bring hope, which comes from the confidence that free men and women in a
free economy will in the end make better decisions than any government. And
tonight we revive that hope by delivering change to two of the fattest cats
Washington has ever known.
Thank you, and may God bless America.
Bailout Humor and Music Videos (forwarded by David Albrecht)
Sponsor a CEO:
http://www.youtube.com/watch?v=qDC0qcf0kzE
http://www.youtube.com/watch?v=CKmzGPIx4YQ
Where's my bailout?
http://www.youtube.com/watch?v=kIjbMRU1EgU&feature=pyv&ad=2098126103
http://www.youtube.com/watch?v=d9nk8XwHbS4
http://www.youtube.com/watch?v=yTMp1Zl0eGM
http://www.youtube.com/watch?v=ipHNmneFwV0
Would buy weed if given bailout
http://www.youtube.com/watch?v=oYC25oNTx9o
Santa Claus bailout
http://www.youtube.com/watch?v=sxBl9BXLom4
Subprime meltdown
http://www.youtube.com/watch?v=Z5VeNwG3xms&feature=related
Bailout man song
http://www.youtube.com/watch?v=uZUXXSxZPhw
Twelve days of bailouts
http://www.youtube.com/watch?v=55xJnIqq9ZI
700 Billion Dollar Bailout - the Song
http://www.youtube.com/watch?v=HzzRzZJmwEM
Wall Street Bailout Song
http://www.youtube.com/watch?v=cD6z5IIWLTs
"Give it to me" Bailout Rap
http://www.youtube.com/watch?v=YRR80Eq3FQM
The SubPrime Blues #2, Will Inflate Stated Income for Food
http://www.youtube.com/watch?v=z5lTymSFxPU
SubPrime Blues
http://www.youtube.com/watch?v=N3G1PdipmtI
Foreclosure Blues
http://www.youtube.com/watch?v=LnYZJB-8tf8
"First-Time Fraudsters A tax credit so silly even a four-year-old can
exploit it," The Wall Street Journal, October 29, 2009 ---
http://online.wsj.com/article/SB10001424052748703574604574501253942115922.html?mod=djemEditorialPage
It's hard not to laugh when viewing the results of
the federal first-time home-buyer tax credit. The credit, worth up to $8,000
for the purchase of a home, has only been available since April of last
year. Yet news of the latest taxpayer-funded mortgage scam has traveled
fast. The Treasury's inspector general for tax administration, J. Russell
George, recently told Congress that at least 19,000 filers hadn't purchased
a home when they claimed the credit. For another 74,000 filers, claiming a
total of $500 million in credits, evidence suggests that they weren't
first-time buyers.
It's hard not to laugh when viewing the results of
the federal first-time home-buyer tax credit. The credit, worth up to $8,000
for the purchase of a home, has only been available since April of last
year. Yet news of the latest taxpayer-funded mortgage scam has traveled
fast. The Treasury's inspector general for tax administration, J. Russell
George, recently told Congress that at least 19,000 filers hadn't purchased
a home when they claimed the credit. For another 74,000 filers, claiming a
total of $500 million in credits, evidence suggests that they weren't
first-time buyers.
Among those claiming bogus credits, at least some
of them were definitely first-timers. The credit has already been claimed by
500 people under the age of 18, including a
four-year-old. This pre-K housing whiz
likely bought because mom and dad make too much to qualify for the full
credit, which starts to phase out at $150,000 of income for couples, $75,000
for singles.
As a "refundable" tax credit, it guarantees the
claimants will get cash back even if they paid no taxes. A lack of
documentation requirements also makes this program a slow pitch in the
middle of the strike zone for scammers. The Internal Revenue Service and the
Justice Department are pursuing more than 100 criminal investigations
related to the credit, and the IRS is reportedly trying to audit almost
everyone who claims it this year.
Speaking of the IRS, apparently its own staff
couldn't help but notice this opportunity to snag an easy $8,000. One day
after explaining to Congress how many "home-buyers" were climbing aboard
this gravy train, Mr. George appeared on Neil Cavuto's program on the Fox
Business Network. Mr. George said his staff has found at least 53 cases of
IRS employees filing "illegal or inappropriate" claims for the credit. "In
all honesty this is an interim report. I expect that the number would be
much larger than that number," he said.
The program is set to expire at the end of
November, so naturally given its record of abuse, Congress is preparing to
extend it. Republican Senator Johnny Isakson of Georgia is so pleased with
the results that he wants to expand the program beyond first-time buyers and
double the income limits.
This is the point in the story when a taxpayer's
sense of humor is bound to give way to a different emotion. The credit's
cost is running at about $1 billion a month and $15 billion for the year.
Also, even when employed by an honest buyer, it's another distortion that
drives capital into housing and away from other more productive uses. For
America's tens of millions of tax-paying renters, it's another subsidy they
provide for their neighbors to be able to sell their houses at a higher
price.
While the credit seems to have boosted home sales,
many of those sales would have happened anyway and have merely been stolen
from the future. Meanwhile, the credit continues to distort the housing
market and postpone the day when home prices can find a floor that is a
basis for a stable recovery.
More than two years into the housing bust,
trillions of dollars in taxpayer losses or guarantees via Fannie Mae and
Freddie Mac, and amid an ongoing plague of redefaults in federal programs to
prevent foreclosures, politicians are still trying to manipulate housing
prices. And leave it to Congress to design a program that even a
four-year-old can scam.
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
What do you want to bet that Marvene got back into the action? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Question
Where will the bailout end?
Answer: Why not bail out everybody and everything? It's not real money
anyway ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
From The Wall Street Journal Accounting Weekly Review on October 3, 2008
U.S. Auto Makers Seek Bailout for Bad Car Loans
by
Aparajita Saha-Bubna
The Wall Street Journal
Oct 01, 2008
Page: B3
Click here to view the full article on WSJ.com
TOPICS: Accounting,
Allowance For Doubtful Accounts, Bad Debts, Banking,
Bankruptcy, Mark-to-Market Accounting
SUMMARY: U.S.
auto companies are hoping a new bailout plan could stem a
growing credit crisis that threatens to further crimp their
industry. The article concludes with the comment that, since
two auto manufacturer's financing arms, GMAC and Chrysler
Financial, have been sold to Cerberus Capital Management LP,
"each is now being run to maximize profits, not auto sales."
CLASSROOM
APPLICATION: This article may be used to further enhance
students understanding of automobile financing and
allowances for bad debts.
QUESTIONS:
1. (Introductory) How were the automotive financing
companies created? Who now owns General Motors Acceptance
Corp. and Chrysler Financial Corp?
2. (Introductory) How are automobile financing
companies affected by the current financial crisis? How are
they affecting the automobile manufacturing industry itself?
Do you think legislators should consider helping the
automotive industry, as they have with the financial sector?
Support your answer.
3. (Advanced) Why does the author say that GMAC and
Chrysler Financial are "...now being run to maximize
profits, not auto sales"? Is there a difference? Explain.
4. (Advanced) Why are automotive companies no
longer supporting leases for their automobiles? How will
this change also impact consumers and the automotive
industry?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED
ARTICLES:
Why It's Getting Hard to Lease a Car
by Nathan Becker
Aug 10, 2008
Online Exclusive
|
From The Wall Street Journal Accounting Weekly Review on December 4,
2008
UAW Gives Concessions to Big Three
by
Alex P. Kellogg, Matthew Dolan, Greg Hitt, Jeffrey McCracken and Mike
Spector
The Wall Street Journal
Dec 04, 2008
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB122832097499675993.html?mod=djem_jiewr_AC
TOPICS: Accounting, Budgeting, Cash Flow
SUMMARY: In preparation for presenting revised turnaround plans to
Congress, Detroit's Big Three automakers have negotiated concessions from
the United Auto Workers' union to delay cash payments for post-employment
health benefits and to suspend the jobs bank program.
CLASSROOM APPLICATION: Questions focus on the cash budgeting
implications of the negotiations with UAW and the requests for Congressional
aid, asking students to differentiate cash flow problems from profitability
issues.
QUESTIONS:
1. (Introductory) Describe the need for cash by each of Detroit's
Big Three automakers. How do these companies determine the cash that will be
needed over the next 3 months to one year?
2. (Introductory) Why is the UAW negotiating terms of its contracts
with the Big Three Detroit automakers? Are the industry labor contracts up
for renewal? In your answer, comment on the union's relationship to all
three major U.S. automobile producers.
3. (Advanced) "...The union [will] allow the companies to delay
billions of dollars in payments into funds that will cover health-care cost
for retired workers." Will this concession actually reduce the expense
associated with providing post-employment health-care benefits? What help
will it provide to the automakers?
4. (Introductory) "The union also will suspend a controversial
'jobs bank' program..." What is this program? How will suspending it help
the Big Three weather the current crisis?
5. (Advanced) Ford Motor Co. is asking for a line of credit from
Congress, while General Motors and Chrysler are asking for low-cost federal
loans. If they are granted, what benefit will these plans provide? Will
these government supports help to return the auto manufacturers to
profitability?
6. (Advanced) "The Detroit makers insist bankruptcy isn't an
option" but others disagree. What can be done through bankruptcy to help
ensure that companies can emerge through this process?
7. (Advanced) What is an Altman Z score? What factors enter into
this model? In your answer, be sure to define the term "Z score".
8. (Introductory) Why do you think Congress is particularly
interested in an academic's view on this matter of support for the
automakers?
9. (Introductory) Chrysler "is not viable in its current
configuration" according to a former Chrysler executive, Jerome B. York. Why
not? What has changed about his company's configuration? What about today's
global economy has impacted this company?
Reviewed By: Judy Beckman, University of Rhode Island
"UAW Gives Concessions to Big Three: Banking Chairman Dodd Is Tapped to
Develop Rescue Package in Senate That Could Top $25 Billion," by Alex P.
Kellogg, Matthew Dolan, Greg Hitt, Jeffrey McCracken and Mike Spector, The
Wall Street Journal, December 4, 2008 ---
http://online.wsj.com/article/SB122832097499675993.html?mod=djem_jiewr_AC
The United Auto Workers union Wednesday offered two
major concessions to the Big Three auto makers, as Democratic leaders in the
Senate intensified efforts to find compromise legislation that would throw a
financial lifeline to the industry.
Late Wednesday, Senate Banking Chairman Christopher
Dodd was tapped to develop a consensus rescue package that could be brought
to the Senate floor next week. The Connecticut Democrat, who convenes a
hearing Thursday on the industry's latest appeal for assistance, is to focus
on legislation that would effectively create a bridge loan for the industry,
by diverting funds from an existing loan program originally intended to help
the industry retool to meet higher fuel economy standards. The senator would
impose much tougher conditions on the aid than a bipartisan bill developed
in the Senate last month, congressional aides said.
The goal of the initiative would be for the Senate
to move ahead of the House, where deep divisions exist on the issue. The
final cost of the package could exceed the $25 billion originally sought by
lawmakers last month. And to fund the measure the senator is also expected
to consider drawing on the $700 billion government pool created to rescue
financial markets, to form a dual-source of funding for the automakers,
congressional aides said.
Behind the moves is Senate Majority Leader Harry
Reid, the Nevada Democrat who pressed Sen. Dodd Wednesday to move forward.
Mr. Reid is trying to break a stalemate between Congress and White House on
the issue. Sen. Reid declared that a Democratic-backed bill -- which would
solely draw on the $700 billion market rescue fund -- couldn't pass
Congress, signaling to rank-and-file Democrats that compromise would be
needed to avoid another collapse of legislative efforts to help the
industry.
The maneuvering comes as the Detroit companies are
set to make a second appeal to Congress for a bailout, and underscores the
importance of the UAW's willingness to consider additional concessions.
Two weeks after insisting his union had already
done enough to help the car makers, UAW President Ron Gettelfinger said the
union would allow the companies to delay billions of dollars in payments
into funds that will cover health-care costs for retired workers. The union
also will suspend a "jobs bank" program under which workers continue to
collect most of their wages after they are laid off.
"We're willing to take an extra step here," Mr.
Gettelfinger said at a news conference after meeting with UAW leadership in
Detroit.
The union move comes amid increasing concern about
the future of General Motors Corp., Ford Motor Co. and Chrysler LLC, and
whether the written restructuring plans they submitted to Congress on
Tuesday go far enough to return the companies to financial health. Lawmakers
gave a cautious welcome to the turnaround plans, but significant opposition
remains to giving the companies a bailout.
On Wednesday, Ford Chief Executive Alan Mulally
said he was "very concerned" about the fate of GM and Chrysler after each
told Congress it needed an immediate cash infusion to survive. GM said it
needs $4 billion this month, and a total of $18 billion; Chrysler said it
needs $7 billion by the end of the month.
"Each revelation by our competitors has been of
growing concern," Mr. Mulally said in an interview with The Wall Street
Journal. Ford has greater cash reserves than GM and Chrysler, and asked the
government to extend a $9 billion credit line that it would tap only if the
U.S. recession proves worse than expected or one of its competitors fails.
Mr. Mulally, along with the CEOs of GM and Chrysler
and Mr. Gettelfinger, are due to testify Thursday and Friday before House
and Senate committees on how they intend to use low-cost federal loans to
reorganize. They appeared last month but lawmakers were unconvinced that
they had sound recovery strategies and told them to submit new plans by Dec.
2.
If the House and Senate panels are persuaded by the
new plans, lawmakers could reconvene next week to consider legislation to
provide funds.
Car-industry representatives held a briefing for
more than 100 congressional aides Wednesday. Their response was generally
positive, with little of the hostility displayed by lawmakers last month
when the CEOs of the three makers first testified before Congress, said one
person in attendance.
Rep. Brad Sherman (D., Calif.), a critic of the
Detroit auto companies, said the new plans were a big improvement. "The
original plan was, 'We flew here on our jets, we have enough room on each
jet for the cash, so where's the cash?'" Mr. Sherman said. "This is way
better than that."
Continued in article
"U.S. Auto Makers Seek Bailout for Bad Car Loans Relief Plan, Part of
Original Wall Street Rescue Package, Could Free Up Loans for Car Dealers as Well
as Their Customers," by Aparajita Saha-Bubna, The Wall Street Journal,
October 3, 2008 ---
http://online.wsj.com/article/SB122279948758891109.html?mod=djem_jiewr_AC
As Congress revises a bailout plan for Wall Street,
U.S. auto companies hope the new package will stem a growing credit crisis
that threatens to further crimp their industry.
The original $700 billion Wall Street deal, which
was rejected by the House on Monday, included a substantial bailout for auto
lenders. These companies hold a stable of bad auto loans that could shrink
in value and hurt both the lenders and the vehicle makers. This bailout
would have been separate from the $25 billion in low-cost loans for U.S.
auto makers that President Bush signed into law Tuesday.
Because of constrained capital, GMAC LLC, partially
owned by General Motors Corp.; Ford Motor Credit; and Chrysler Financial,
which finances Chrysler LLC's vehicles, have tightened lending standards in
recent months. The tightening happened just as the lenders decided to pull
out of the risky practice of leasing vehicles, which had long represented
about 20% of new-vehicle financing arrangements. The combination of
tougher-to-get loans and absence of leasing stung auto makers during the
summer selling season.
A Washington bailout of bad car loans could loosen
the flow of financing for potential car buyers and spark demand for new cars
and trucks. It likely would free up funds that could be invested in
securities backed by auto loans, bringing down borrowing costs for auto
lenders.
In August, tight credit caused General Motors to
lose sales of roughly 10,000 to 12,000 vehicles, the car maker said. When
extrapolated across the entire U.S. industry, that was the equivalent of
40,000 lost sales, or about $1 billion in revenue.
The growing credit crunch in the auto industry is
expected to have wreaked havoc on September vehicle sales, which will be
reported Wednesday. Research firm J.D. Power & Associates expects a 26%
volume decline compared with the same month in 2007.
"There are still quite a few deals getting done,
but they require a lot more work and a lot more back-and-forth between the
bank and the dealer," said Earl Hesterberg, chief executive of Houston-based
dealer chain Group 1 Automotive Inc. "It's become significantly more
difficult, particularly in the last month."
John Bergstrom, owner of the Bergstrom Automotive
Group dealership chain in Wisconsin, said the buyers having the most trouble
are those who are trading in a car they have owned for just a few years.
Because they don't have much equity in their vehicle, or may even owe more
on the loan than the car is worth, banks increasingly are requiring these
buyers to produce hefty down payments.
"The challenge is affordability," Mr. Bergstrom
said. "People's bills are getting higher, and then they're squeezed on
gasoline and they're squeezed on milk and so forth. When they look at a car,
they say they can't really afford them."
The tightening also has hit dealers as the car
makers' finance arms raise the cost of the "floor plan" credit they offer
dealers to buy cars for their inventory. Dealers typically repay lenders for
these loans as each vehicle is sold.
Existing bonds made up of floor-plan loans of the
three auto-finance arms total $25.8 billion, according to data provider
ABSNet. Ford Motor Credit and GMAC lead with $12.7 billion and $10.6
billion, respectively. Both companies have had unprecedented trouble
attracting investors in floor-plan assets in recent months, people familiar
with the matter have said.
That has prompted the finance companies to get
tougher on dealers with weak finances, raising their rates and fees for
some. This makes it costlier for dealers to buy cars, eroding their margins.
In addition, dealer inventories are getting leaner, meaning potential car
buyers have fewer options to choose from.
And since GMAC and Chrysler Financial are both
controlled by private-equity group Cerberus Capital Management LP, each is
now being run to maximize profits, not auto sales. Last week, one of GM's
largest Chevrolet dealers, Bill Heard Enterprises, closed all 14 of its
dealerships after GMAC canceled the dealer's credit line.
From The Wall Street Journal Accounting Weekly Review on December 4,
2008
UAW Gives Concessions to Big Three
by
Alex P. Kellogg, Matthew Dolan, Greg Hitt, Jeffrey McCracken and Mike
Spector
The Wall Street Journal
Dec 04, 2008
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB122832097499675993.html?mod=djem_jiewr_AC
TOPICS: Accounting, Budgeting, Cash Flow
SUMMARY: In preparation for presenting revised turnaround plans to
Congress, Detroit's Big Three automakers have negotiated concessions from
the United Auto Workers' union to delay cash payments for post-employment
health benefits and to suspend the jobs bank program.
CLASSROOM APPLICATION: Questions focus on the cash budgeting
implications of the negotiations with UAW and the requests for Congressional
aid, asking students to differentiate cash flow problems from profitability
issues.
QUESTIONS:
1. (Introductory) Describe the need for cash by each of Detroit's
Big Three automakers. How do these companies determine the cash that will be
needed over the next 3 months to one year?
2. (Introductory) Why is the UAW negotiating terms of its contracts
with the Big Three Detroit automakers? Are the industry labor contracts up
for renewal? In your answer, comment on the union's relationship to all
three major U.S. automobile producers.
3. (Advanced) "...The union [will] allow the companies to delay
billions of dollars in payments into funds that will cover health-care cost
for retired workers." Will this concession actually reduce the expense
associated with providing post-employment health-care benefits? What help
will it provide to the automakers?
4. (Introductory) "The union also will suspend a controversial
'jobs bank' program..." What is this program? How will suspending it help
the Big Three weather the current crisis?
5. (Advanced) Ford Motor Co. is asking for a line of credit from
Congress, while General Motors and Chrysler are asking for low-cost federal
loans. If they are granted, what benefit will these plans provide? Will
these government supports help to return the auto manufacturers to
profitability?
6. (Advanced) "The Detroit makers insist bankruptcy isn't an
option" but others disagree. What can be done through bankruptcy to help
ensure that companies can emerge through this process?
7. (Advanced) What is an Altman Z score? What factors enter into
this model? In your answer, be sure to define the term "Z score".
8. (Introductory) Why do you think Congress is particularly
interested in an academic's view on this matter of support for the
automakers?
9. (Introductory) Chrysler "is not viable in its current
configuration" according to a former Chrysler executive, Jerome B. York. Why
not? What has changed about his company's configuration? What about today's
global economy has impacted this company?
Reviewed By: Judy Beckman, University of Rhode Island
"UAW Gives Concessions to Big Three: Banking Chairman Dodd Is Tapped to
Develop Rescue Package in Senate That Could Top $25 Billion," by Alex P.
Kellogg, Matthew Dolan, Greg Hitt, Jeffrey McCracken and Mike Spector, The
Wall Street Journal, December 4, 2008 ---
http://online.wsj.com/article/SB122832097499675993.html?mod=djem_jiewr_AC
The United Auto Workers union Wednesday offered two
major concessions to the Big Three auto makers, as Democratic leaders in the
Senate intensified efforts to find compromise legislation that would throw a
financial lifeline to the industry.
Late Wednesday, Senate Banking Chairman Christopher
Dodd was tapped to develop a consensus rescue package that could be brought
to the Senate floor next week. The Connecticut Democrat, who convenes a
hearing Thursday on the industry's latest appeal for assistance, is to focus
on legislation that would effectively create a bridge loan for the industry,
by diverting funds from an existing loan program originally intended to help
the industry retool to meet higher fuel economy standards. The senator would
impose much tougher conditions on the aid than a bipartisan bill developed
in the Senate last month, congressional aides said.
The goal of the initiative would be for the Senate
to move ahead of the House, where deep divisions exist on the issue. The
final cost of the package could exceed the $25 billion originally sought by
lawmakers last month. And to fund the measure the senator is also expected
to consider drawing on the $700 billion government pool created to rescue
financial markets, to form a dual-source of funding for the automakers,
congressional aides said.
Behind the moves is Senate Majority Leader Harry
Reid, the Nevada Democrat who pressed Sen. Dodd Wednesday to move forward.
Mr. Reid is trying to break a stalemate between Congress and White House on
the issue. Sen. Reid declared that a Democratic-backed bill -- which would
solely draw on the $700 billion market rescue fund -- couldn't pass
Congress, signaling to rank-and-file Democrats that compromise would be
needed to avoid another collapse of legislative efforts to help the
industry.
The maneuvering comes as the Detroit companies are
set to make a second appeal to Congress for a bailout, and underscores the
importance of the UAW's willingness to consider additional concessions.
Two weeks after insisting his union had already
done enough to help the car makers, UAW President Ron Gettelfinger said the
union would allow the companies to delay billions of dollars in payments
into funds that will cover health-care costs for retired workers. The union
also will suspend a "jobs bank" program under which workers continue to
collect most of their wages after they are laid off.
"We're willing to take an extra step here," Mr.
Gettelfinger said at a news conference after meeting with UAW leadership in
Detroit.
The union move comes amid increasing concern about
the future of General Motors Corp., Ford Motor Co. and Chrysler LLC, and
whether the written restructuring plans they submitted to Congress on
Tuesday go far enough to return the companies to financial health. Lawmakers
gave a cautious welcome to the turnaround plans, but significant opposition
remains to giving the companies a bailout.
On Wednesday, Ford Chief Executive Alan Mulally
said he was "very concerned" about the fate of GM and Chrysler after each
told Congress it needed an immediate cash infusion to survive. GM said it
needs $4 billion this month, and a total of $18 billion; Chrysler said it
needs $7 billion by the end of the month.
"Each revelation by our competitors has been of
growing concern," Mr. Mulally said in an interview with The Wall Street
Journal. Ford has greater cash reserves than GM and Chrysler, and asked the
government to extend a $9 billion credit line that it would tap only if the
U.S. recession proves worse than expected or one of its competitors fails.
Mr. Mulally, along with the CEOs of GM and Chrysler
and Mr. Gettelfinger, are due to testify Thursday and Friday before House
and Senate committees on how they intend to use low-cost federal loans to
reorganize. They appeared last month but lawmakers were unconvinced that
they had sound recovery strategies and told them to submit new plans by Dec.
2.
If the House and Senate panels are persuaded by the
new plans, lawmakers could reconvene next week to consider legislation to
provide funds.
Car-industry representatives held a briefing for
more than 100 congressional aides Wednesday. Their response was generally
positive, with little of the hostility displayed by lawmakers last month
when the CEOs of the three makers first testified before Congress, said one
person in attendance.
Rep. Brad Sherman (D., Calif.), a critic of the
Detroit auto companies, said the new plans were a big improvement. "The
original plan was, 'We flew here on our jets, we have enough room on each
jet for the cash, so where's the cash?'" Mr. Sherman said. "This is way
better than that."
Continued in article
"General Motors: Myths And Reality," by Jerry Flint, Forbes,
December 5, 2008 ---
http://www.forbes.com/business/2008/12/04/general-motors-volt-biz-manufacturing-cz_jf_1205flint.html
Forget what some people in the media are saying.
General Motors is not going out of business. Yes, the company is in a
terrible crisis, but even if the business here completely fails, GM's
foreign empire--in Europe, Brazil and China--will carry on the fight.
In Europe, General Motors (nyse: GM - news - people
) newest sedan, the Opel Insignia, just won "car of the year" from the
Continent's car writers. GM's sales in Brazil and Argentina--574,000 cars
and trucks in 10 months--are 20% ahead of last year. This company will
endure, regardless of what happens in the U.S.
Another misunderstanding is that the high price of
labor is the company's greatest problem. Yes, labor costs are high, but that
$75 an hour includes benefits, such as Social Security and health care. Base
pay rates in the non-union auto plants are quite similar to the union rates,
but older, higher seniority workers get more. The foreigners also do not
have any pension costs--yet.
Keep in mind that volume is the key cost factor in
this industry. Run a factory at three shifts and sell every vehicle at top
dollar and the profits are great. Run at 50% capacity and the losses are
great, whether you are General Motors or Toyota Motor (nyse: TM - news -
people ).
The greatest problem for any automaker is creating
vehicles that win customers. Today, the industry faces a new challenge:
credit. Dealers need credit to finance their inventories and customers need
credit to buy new cars.
Another myth is that retraining will help if
Detroit goes down. Retraining does not work. I know because I read it in The
New York Times--and I remember because I wrote that story. The people who
get the most out of retraining are those hired to do it. If the trainees are
paid, then it is little more than extended unemployment compensation.
General Motors' great gamble is the Chevrolet Volt.
If it flops, GM falls on its face, bailout or no bailout. Just do not ask if
the Volt will make money. That is not the issue.
Continued in article
Edward Whitacre, Jr. ---
http://en.wikipedia.org/wiki/Ed_Whitacre
Ed Whitacre is the former AT&T CEO who oversaw the gobbling up of Baby Bells
back into Mamma Bell. He came out of retirement to become short-term CEO of GM
in GM's darkest moment (2009) --- the bailout and recovery from bankruptcy.
"Time for 'Government Motors' to Hit the Road: Until Washington sells its
shares of GM, the company won't be master of its own destiny and will remain
wrongly tagged a failure," by Ed Whitacre, The Wall Street Journal,
September 19, 2012 ---
http://professional.wsj.com/article/SB10000872396390444165804578006330477733900.html?mod=djemEditorialPage_t&mg=reno-wsj
The Treasury Department should sell every last
share that it owns of General Motors—as quickly as possible.
I don't say that critically, but the government has
been an active participant in GM's management for more than three years, and
that's long enough. It's time for Treasury to step out of the way so that GM
can fully focus on what it does best: designing, building and selling the
world's best vehicles.
Since 2009, when the government stepped in with
emergency funding, GM has gone from down on its knees in bankruptcy to
solvent and standing strong. By that measure alone, Treasury's $50 billion
gamble on General Motors has been a resounding success.
Millions of jobs were saved, along with the U.S.
auto industry as a whole: GM is the backbone of the domestic vehicle
business, so if the company had failed, other auto makers and suppliers
would likely have followed. The courageousness of that effort, which started
under President Bush and continued in force under President Obama, can't be
underemphasized.
Nor can its benefits. The U.S. government basically
saved American manufacturing, and in the process gave us hope for a brighter
economic future. That is the real story of the auto bailout, which I
supported 100%.
The government's authority over GM today isn't
concentrated in the 500,000 shares it still owns, which amount to a hefty
but not controlling 26.5% ownership stake. Rather, Washington's power comes
from the management apparatus of TARP, the Troubled Asset Relief Program,
from which the $50 billion bailout originally came.
TARP is funded by taxpayers, so there are many
rules about how that money can and can't be used. The result: GM spends an
awful lot of time checking in with the people who administer TARP over
everything from hiring to executive compensation and management. For a
global company, that adds up to a lot of distraction.
My view is influenced by personal experience. I was
brought in by the White House as GM's chairman in 2009, around the time of
the bankruptcy, and became CEO later that year. As a company, we were
grateful for the government's support. But as GM's financial health began to
improve, I could detect no real sense of urgency, or even interest, on the
part of the government to relinquish control. Quite the contrary, it seemed
that the TARP program at GM was expanding and digging in for the long haul.
This concerned me.
When planning got under way for the initial public
offering in 2010, I pushed for the government to sell its entire stake—all
912 million shares, or 61%—on day one. I thought that parting ways in one
clean sweep would send a strong signal to Wall Street and the world that GM
was back. If the stock sale fell short, GM could use its own cash to make up
the difference, ensuring that U.S. taxpayers got repaid in full. This, to
me, was a win-win: GM could return to running its own business, and Treasury
could rightly declare victory on the auto bailout.
But nobody who had decision-making authority on the
IPO—a show largely run by Treasury—liked my idea. I heard a raft of excuses,
mostly from bankers, but the bottom line was this: An offering of that size
had never been attempted before, so nobody wanted to try.
As the world now knows, the IPO was a roaring
success. GM was priced at $33 a share, and the response from the public for
common stock was overwhelming. The government sold a big chunk of its stake,
but it chose to hold on to a half-million shares. Three years later, the
government still holds that stake, and GM shares are trading well below the
IPO price.
According to published reports—and I claim no
special knowledge here—GM is now trying to convince Treasury to sell, for
some of the reasons I have mentioned. These same reports say that the
government may be willing, but not at the current stock price. GM stock
hasn't performed as well as everybody would like, but I remain hopeful that
it will rebound as the global economy improves.
Meantime, life in the hypercompetitive world of GM
goes on. The company already answers to a lot of constituencies:
stockholders, unions, Wall Street and global competitors. Adding TARP to the
mix for another few years, or even another few quarters, is not fair to GM
or to the one million people it employs, directly and indirectly.
So long as TARP money is wrapped up in GM, the
company will never shake its "Government Motors" image. That label, as
competitors and GM employees are keenly aware, is code for one thing: "GM is
a failure." And while GM might have been a failure three years ago, it's not
today. But it's also not the master of its own destiny—and it never will be
as long as it's under TARP.
Mr. Whitacre, a former chairman and CEO of General Motors, is the
author of "American Turnaround: Reinventing AT&T and GM and the Way We Do
Business in the USA," forthcoming from Business Plus.
Continued in article
Jensen Comment About China Motors
Currently over 70% of vehicles built by GM are manufactured outside the United
States. This is not such a bad thing for GM as a company, but admittedly a lot
of the taxpayer TARP money was spent overseas and not for U.S. factories. Still
having a profitable global GM goes a long way toward paying for U.S. pensions
and carrying some losing car models built in the United States ---
http://www.youtube.com/watch?v=Lvl5Gan69Wo
Bob Jensen's threads on the bailouts are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The Pentagon ordered 1,500 Turkeys for Thanksgiving
The expensive luxury and heavy Chevy Volt is a turkey and less environmentally
friendly than hybrid cars of competitors (because of low gas mileage and
miniscule electric power range). It appears that it's only customer is, get
this, the Pentagon that just ordered 1,500 Volts.
The (Liberal, Obama-Loving) Washington Post Editorial Board
admits that the Chevy Volt is on the road to nowhere fast
"GM’s vaunted Volt is on the road to nowhere fast," The Washington
Post, September 12, 2012 ---
http://www.washingtonpost.com/opinions/gms-volt-is-on-the-road-to-nowhere/2012/09/12/29cd8216-fd0d-11e1-a31e-804fccb658f9_story.html
AS A CANDIDATE for president in 2008, Barack Obama
set a goal of getting 1 million all-electric and plug-in hybrid vehicles on
the road by 2015. In February 2011, the Obama administration’s Energy
Department issued an analysis purporting to show that, with the help of
subsidies and tax credits, “the goal is achievable.” This was a paltry claim
in the first place, since 1 million cars amount to less than 1 percent of
the total U.S. fleet. Yet it is increasingly clear that, despite the
commitment of many millions of taxpayer dollars, the United States will not
hit Mr. Obama’s target by 2015. A recent CBS News analysis suggested that
we’ll be lucky to get a third of the way there.
The Energy Department study assumed that General
Motors would produce 120,000 plug-in hybrid Volts in 2012. GM never came
close to that and recently suspended Volt production at its Hamtramck,
Mich., plant, scene of a presidential photo-op. So far, GM has sold a little
more than 21,000 Volts, even with the help of a $7,500 tax credit, recent
dealer discounting and U.S. government purchases. When you factor in the
$1.2 billion cost of developing the Volt, GM loses tens of thousands of
dollars on each model.
Some such losses are normal in the early phases of
a product’s life cycle. Perhaps the knowledge and technological advances GM
has reaped from developing the Volt will help the company over the long
term. But this is cold comfort for the taxpayers who still own more than a
quarter of the firm.
The Energy Department predicted that Nissan,
recipient of a $1.5 billion government-guaranteed loan, would build 25,000
of its all-electric Leaf this year; that car has sold only 14,000 units in
the United States.
As these companies flail, they are taking the
much-ballyhooed U.S. advanced-battery industry down with them. A Chinese
company had to buy out distressed A123, to which the Energy Department has
committed $263 million in production aid and research money. Ener1, which
ran through $55 million of a $118 million federal grant before going
bankrupt, sold out to a Russian tycoon.
No matter how you slice it, the American taxpayer
has gotten precious little for the administration’s investment in
battery-powered vehicles, in terms of permanent jobs or lower carbon dioxide
emissions. There is no market, or not much of one, for vehicles that are
less convenient and cost thousands of dollars more than similar-sized
gas-powered alternatives — but do not save enough fuel to compensate. The
basic theory of the Obama push for electric vehicles — if you build them,
customers will come — was a myth. And an expensive one, at that.
Chevy Volt ---
http://en.wikipedia.org/wiki/Chevy_Volt#Controversies_and_criticism
Production cost and sales price
In 2009, the Presidential Task Force on the Auto
Industry said that "GM is at least one generation behind Toyota on advanced,
“green” powertrain development. In an attempt to leapfrog Toyota, GM has
devoted significant resources to the Chevy Volt." and that "while the Chevy
Volt holds promise, it is currently projected to be much more expensive than
its gasoline-fueled peers and will likely need substantial reductions in
manufacturing cost in order to become commercially viable." A 2009 Carnegie
Mellon University study found that a PHEV-40 will be less cost effective
than a HEV or a PHEV-7 in all of the scenarios considered, due to the cost
and weight of the battery Jon Lauckner, a Vice President at General Motors,
responded that the study did not consider the inconvenience of a 7 miles (11
km) electric range and that the study's cost estimate of US$1,000 per kWh
for the Volt's battery pack was "many hundreds of dollars per kilowatt hour
higher" than what it costs to make today." President Barack Obama behind the
wheel of a new Chevy Volt during his tour of the General Motors Auto Plant
in Hamtramck, Michigan
In early 2010, it was reported that General Motors
would lose money on the Volt for at least the first couple of generations,
but it hoped the car would create a green image that could rival the Prius.
After the Volt's sales price was announced in July
2010, there was concern expressed of the launch price of the Volt and its
affordability and resulting popularity, especially when the federal
subsidies of US$2.4 billion were taken into account in the development of
the car.
General Motors CEO Edward Whitacre Jr. rejected as
"ridiculous" criticism that the Volt's price is too expensive. He said that
"I think it's a very fair price. It's the only car that will go coast to
coast on electricity without plugging it in, and nobody else can come
close." Despite the federal government being the major GM shareholder due to
the 2009 government-led bankruptcy of the automaker, during a press briefing
at the White House a Treasury official clarified that the federal government
did not have any input on the pricing of the 2011 Chevrolet Volt.
There have also been complaints regarding price
markups due to the initial limited availability in 2010 of between US$5,000
to US$12,000 above the recommended price,[232] and at least in one case a
US$20,000 mark up in California.[233] Even though the carmaker cannot
dictate vehicle pricing to its dealers, GM said that it had requested its
dealers to keep prices in line with the company’s suggested retail price.
In May 2011 the National Legal and Policy Center
announced that some Chevrolet dealers were selling Volts to other dealers
and claiming the US$7,500 federal tax credit for themselves. Then the
dealers who bought the Volts sell them as used cars with low mileage to
private buyers, who no longer qualify for the credit. General Motors
acknowledged that 10 dealer-to-dealer Volt sales had taken place among
Chevrolet dealers, but the carmaker said they do not encourage such
practice.
In September 2012, Reuters published an
opinion/editorial article where it claimed that General Motors, nearly two
years after the introduction of the car, was losing $49,000 on each Volt it
built. The article concludes that the Volt is "over-engineered and
over-priced" and that its technological complexity has put off many
prospective buyers, due to fears the car may be unreliable. GM executives
replied that Reuters' estimates were grossly wrong as they allocated the
production costs only on the number of Volts sold instead of spreading the
production costs in the future, over the entire lifetime of the model. GM
explained that the investments will pay off once the innovative technologies
of the Volt will be applied across multiple current and future products
Continued in article
Is the Chevy Volt losing $49,000 on each model built?
Not any longer thanks to the Pentagon.
"Pentagon to Buy 1,500 Chevy Volts," by Brian Koenig, The New
American, September 12, 2012 ---
http://www.thenewamerican.com/usnews/politics/item/12819-pentagon-plans-to-buy-1500-chevy-volts
September 13, 2012 reply from Cheryl Dunn
Actually, I was told by our associate vice provost
that our engineering department bought a Volt that its staff drive back and
forth between Grand Rapids and Traverse City and they are getting 57 miles
per gallon. That does not seem like "low" gas mileage to me, and it would be
much higher if they weren't driving such long distances (Grand Rapids to
Traverse City is approximately 140 miles). I think the Volt may be getting a
bad rap, and the Pentagon may be making a good purchase.
Cheryl
September 13, 2012 reply from Bob Jensen
Hi Cheryl,
I'm don't agree that the Pentagon is getting such a good deal. It may take
several wars to hit the payback point.
The NYT reported that the Chevy Volt "would need to reach
US$12.50 a gallon for the Volt to
break even, while the
Nissan Leaf would be competitive with a similar gasoline-powered
compact car at US$8.53 a
gallon."
Chevy Volt ---
http://en.wikipedia.org/wiki/Chevy_Volt
According to
Edmunds.com, the price premium paid for the Volt, after discounting
the US$7,500
U.S. federal tax credit, takes a long time for consumers to recover
in fuel savings, often longer than the normal ownership time period.
Edmunds compared the Volt (priced at
US$31,712) with the same-size gasoline-powered
Chevrolet Cruze (priced at
US$19,656) and found that the payback period for the plug-in
hybrid is 15 years for gasoline prices at
US$3 per gallon, 12 years at
US$4 per gallon, and drops to 9
years with gasoline prices at US$5
per gallon. At February 2012 prices, the break even period is 14 years.
These estimates assume an average of 15,000 miles (24,000 km) annual
driving and vehicle prices correspond to Edmunds.com's true market value
estimates.[90]
In a similar comparison carried out by
TrueCar in April 2012 for
The New York Times, the analysis found that the payback period for
the Volt takes 26.6 years versus a Chevrolet Cruze Eco, assuming it was
regularly driven farther than its battery-only range allows, and with
gasoline priced at US$3.85 per
gallon. The analysis assumes an average of 15,000 miles (24,000 km)
driven a year, a fuel economy of 34.3 mpg-US
(6.86 L/100 km; 41.2 mpg-imp)
for the Cruze Eco, priced at US$19,925,
and a Volt price of US$31,767,
after discounting the US$7,500
federal tax. TrueCar also found that with gasoline priced at
US$5 per gallon, the payback
time could drop to about 8 years if the Volt were to be operated
exclusively on battery power. The newspaper also reported that according
to the March 2012 Lundberg Survey, gasoline prices would need to reach
US$12.50 a gallon for the Volt
to break even, while the
Nissan Leaf would be competitive with a similar gasoline-powered
compact car at US$8.53 a
gallon
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Appendix L
The trouble with crony capitalism isn't
capitalism. It's the cronies.
Bernanke Says Bailouts of Banks ‘Unconscionable’
Federal Reserve Chairman Ben S. Bernanke said
government bailouts of large financial firms are “unconscionable” and must be
ended as part of a regulatory overhaul following the worst financial crisis
since the 1930s. It is unconscionable that the fate of the world economy should
be so closely tied to the fortunes of a relatively small number of giant
financial firms,” Bernanke said today in a speech in Orlando, Florida. “If we
achieve nothing else in the wake of the crisis, we must ensure that we never
again face such a situation.”
Steve Matthews and Phil Mattingly, "Bernanke Says Bailouts of Banks
‘Unconscionable’ (Update2)," Business Week, March 20, 2010 ---
http://www.businessweek.com/news/2010-03-20/bernanke-says-bailouts-of-banks-unconscionable-update1-.html
"Why Are Some Sectors (Ahem, Finance) So Scandal-Plagued?" by Ben W.
Heineman, Jr., Harvard Business Review Blog, January 10, 2013 ---
Click Here
http://blogs.hbr.org/cs/2013/01/scandals_plague_sectors_not_ju.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
The trouble with crony capitalism isn't capitalism. It's the cronies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#CronyCapitalism
Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit
rating agencies) ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of
Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"Crony Capitalism at Work," by Scottie Hughes, Townhall, April 30,
2013 ---
Click Here
http://townhall.com/columnists/scottiehughes/2013/04/30/crony-capitalism-at-work-n1582146?utm_source=thdaily&utm_medium=email&utm_campaign=nl
Ah, the innocence of youth.
What really happened in the poisonous CDO markets?
Watch the MSNBC Video Featuring This Harvard Senior Who is Also a Very
Talented Violinist
"Harvard senior thesis on CDOs," by Stephen Hsu, MIT's Technology
Review, April 27, 2010 ---
http://www.technologyreview.com/blog/post.aspx?bid=354&bpid=25107&nlid=2934
I previously mentioned three CBS Sixty Minutes videos that are must-views for
understanding what happened in the CDO scandals. Two of those videos centered on
muckraker Michael Lewis. My friend, the Unknown Professor, who runs the
Financial Rounds Blog, recommended that readers examine the Senior Thesis of a
Harvard student.
"Michael Lewis’s ‘The Big Short’? Read the Harvard Thesis Instead," by Peter
Lattman, The Wall Street Journal, March 20, 2010 ---
http://blogs.wsj.com/deals/2010/03/15/michael-lewiss-the-big-short-read-the-harvard-thesis-instead/tab/article/
Deal Journal has yet to
read “The Big Short,” Michael Lewis’s yarn on the financial crisis that hit
stores today. We did, however, read his acknowledgments, where Lewis praises
“A.K. Barnett-Hart, a Harvard undergraduate who had just written a thesis about
the market for subprime mortgage-backed CDOs that remains more interesting than
any single piece of Wall Street research on the subject.”
While unsure if we can
stomach yet another book on the crisis, a killer thesis on the topic? Now that
piqued our curiosity. We tracked down Barnett-Hart, a 24-year-old financial
analyst at a large New York investment bank. She met us for coffee last week to
discuss her thesis, “The Story of the CDO Market Meltdown: An Empirical
Analysis.” Handed in a year ago this week at the depths of the market collapse,
the paper was awarded summa cum laude and won virtually every thesis honor,
including the Harvard Hoopes Prize for outstanding scholarly work.
Last October,
Barnett-Hart, already pulling all-nighters at the bank (we agreed to not name
her employer), received a call from Lewis, who had heard about her thesis from a
Harvard doctoral student. Lewis was blown away.
“It was a classic example
of the innocent going to Wall Street and asking the right questions,” said Mr.
Lewis, who in his 20s wrote “Liar’s Poker,” considered a defining book on Wall
Street culture. “Her thesis shows there were ways to discover things that
everyone should have wanted to know. That it took a 22-year-old Harvard student
to find them out is just outrageous.”
Barnett-Hart says she
wasn’t the most obvious candidate to produce such scholarship. She grew up in
Boulder, Colo., the daughter of a physics professor and full-time homemaker. A
gifted violinist, Barnett-Hart deferred admission at Harvard to attend
Juilliard, where she was accepted into a program studying the violin under
Itzhak Perlman. After a year, she headed to Cambridge, Mass., for a broader
education. There, with vague designs on being pre-Med, she randomly took “Ec
10,” the legendary introductory economics course taught by Martin Feldstein.
“I thought maybe this
would help me, like, learn to manage my money or something,” said Barnett-Hart,
digging into a granola parfait at Le Pain Quotidien. She enjoyed how the subject
mixed current events with history, got an A (natch) and declared economics her
concentration.
Barnett-Hart’s interest
in CDOs stemmed from a summer job at an investment bank in the summer of 2008
between junior and senior years. During a rotation on the mortgage
securitization desk, she noticed everyone was in a complete panic. “These CDOs
had contaminated everything,” she said. “The stock market was collapsing and
these securities were affecting the broader economy. At that moment I became
obsessed and decided I wanted to write about the financial crisis.”
Back at Harvard, against
the backdrop of the financial system’s near-total collapse, Barnett-Hart
approached professors with an idea of writing a thesis about CDOs and their role
in the crisis. “Everyone discouraged me because they said I’d never be able to
find the data,” she said. “I was urged to do something more narrow, more
focused, more knowable. That made me more determined.”
She emailed scores of
Harvard alumni. One pointed her toward LehmanLive, a comprehensive database on
CDOs. She received scores of other data leads. She began putting together charts
and visuals, holding off on analysis until she began to see patterns–how Merrill
Lynch and Citigroup were the top originators, how collateral became heavily
concentrated in subprime mortgages and other CDOs, how the credit ratings
procedures were flawed, etc.
“If you just randomly
start regressing everything, you can end up doing an unlimited amount of
regressions,” she said, rolling her eyes. She says nearly all the work was in
the research; once completed, she jammed out the paper in a couple of weeks.
“It’s an incredibly
impressive piece of work,” said Jeremy Stein, a Harvard economics professor who
included the thesis on a reading list for a course he’s teaching this semester
on the financial crisis. “She pulled together an enormous amount of information
in a way that’s both intelligent and accessible.”
Barnett-Hart’s thesis is
highly critical of Wall Street and “their irresponsible underwriting practices.”
So how is it that she can work for the very institutions that helped create the
notorious CDOs she wrote about?
“After writing my thesis,
it became clear to me that the culture at these investment banks needed to
change and that incentives needed to be realigned to reward more than just
short-term profit seeking,” she wrote in an email. “And how would Wall Street
ever change, I thought, if the people that work there do not change? What these
banks needed is for outsiders to come in with a fresh perspective, question the
way business was done, and bring a new appreciation for the true purpose of an
investment bank - providing necessary financial services, not creating
unnecessary products to bolster their own profits.”
Ah, the innocence of
youth.
The Senior Thesis
"The Story of the CDO Market Meltdown: An Empirical Analysis," by Anna
Katherine Barnett-Hart, Harvard University, March 19, 2010 ---
http://www.hks.harvard.edu/m-rcbg/students/dunlop/2009-CDOmeltdown.pdf
A former colleague and finance professor at Trinity
University recommends following up this Harvard student’s senior thesis with the
following:
Rene M. Stulz. 2010. Credit default swaps and the
credit crisis. J of Economic Perspectives, 24(1): 73-92 (not free) ---
http://www.aeaweb.org/jep/index.php
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.
The major lessons of videos 2 and 3 went over the head of my wife. I think
that viewers need to do a bit of homework in order to fully appreciate those
videos. Here's what I recommend before viewing Videos 2 and 3 if you've not been
following details of the 2008 Wall Street collapse closely:
This is not necessary to Videos 2
and 3, but to really appreciate what suckered the Wall Street Banks into
spreading the poison, you should read about how they all used the same risk
diversification mathematical function --- David Li's Gaussian Copula Function:
Can the
2008 investment banking failure
be traced to a math error?
Recipe for Disaster: The
Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's
formula, known as a
Gaussian copula function, looked like an
unambiguously positive breakthrough, a piece of financial technology that
allowed hugely complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities, expanding
financial markets to unimaginable levels.
His method was adopted
by everybody from bond investors and Wall Street banks to ratings agencies and
regulators. And it became so deeply entrenched—and was making people so much
money—that warnings about its limitations were largely ignored.
Then the model fell apart." The
article goes on to show that correlations are at the heart of the problem.
"The reason that
ratings agencies and investors felt so safe with the triple-A tranches was that
they believed there was no way hundreds of homeowners would all default on their
loans at the same time. One person might lose his job, another might fall ill.
But those are individual calamities that don't affect the mortgage pool much as
a whole: Everybody else is still making their payments on time.
But not all calamities
are individual, and tranching still hadn't solved all the problems of
mortgage-pool risk. Some things, like falling house prices, affect a large
number of people at once. If home values in your neighborhood decline and you
lose some of your equity, there's a good chance your neighbors will lose theirs
as well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree to
which one variable moves in line with another—and measuring it is an important
part of determining how risky mortgage bonds are."
I would highly recommend reading the
entire thing that gets much more involved with the
actual formula etc.
The “math error” might truly be have
been an error or it might have simply been a gamble with what was perceived as
miniscule odds of total market failure. Something similar happened in the case
of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management
formed by Nobel Prize winning economists and their doctoral students who took
similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is
ignorance in model building or risk taking using the model?
Bob Jensen’s threads on the CDO and CDS scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
"Cheat Sheet: What’s Happened to the Big Players in the Financial Crisis?"
by Braden Goyette, Publica, October 26, 2011 ---
http://www.propublica.org/article/cheat-sheet-whats-happened-to-the-big-players-in-the-financial-crisis
Widespread demonstrations in support of Occupy Wall Street have put the
financial crisis back into the national spotlight lately.
So here’s a
quick refresher on what’s happened to some of the main players, whose
behavior, whether merely reckless or downright deliberate, helped cause
or worsen the meltdown. This list isn’t exhaustive -- feel welcome to
add to it.
Mortgage originators
Mortgage lenders contributed to the financial crisis by issuing or
underwriting loans to people who
would have a difficult time paying them back, inflating a housing
bubble that was bound to pop.
Lax regulation allowed banks to stretch their mortgage lending
standards and use aggressive tactics to rope borrowers into complex
mortgages that were more expensive than they first appeared. Evidence
has also surfaced that
lenders were filing fraudulent documents to push some of these mortgages
through, and, in some cases, had been doing so as early as the
1990s. A 2005 Los Angeles Times
investigation of Ameriquest – then the nation’s largest
subprime lender
– found that “they forged documents, hyped
customers' creditworthiness and ‘juiced’ mortgages with hidden rates and
fees.” This behavior was reportedly typical for the subprime mortgage
industry. A similar culture existed at
Washington Mutual, which went under in 2008 in the
biggest bank collapse in U.S. history.
Countrywide, once the nation’s largest mortgage lender, also
pushed customers to sign on for
complex and costly mortgages that boosted the company’s profits.
Countrywide CEO Angelo Mozilo was
accused of misleading investors about the company’s mortgage lending
practices, a charge he denies. Merrill
Lynch and
Deutsche Bank both purchased subprime mortgage lending
outfits in 2006 to get in on the lucrative business. Deutsche Bank has
also been accused of
failing to adequately check on borrowers’ financial status before
issuing loans backed by government insurance. A lawsuit filed by U.S.
Attorney Preet Bharara claimed that, when employees at Deutsche Bank’s
mortgage received audits on the quality of their mortgages from an
outside firm, they
stuffed them in a closet without reading them. A Deutsche Bank
spokeswoman said the claims being made against the company are
“unreasonable and unfair,” and that most of the problems occurred before
the mortgage unit was bought by Deutsche Bank.
Where they are now: Few prosecutions have been brought against
subprime mortgage lenders. Ameriquest
went out of business in 2007, and Citigroup bought its mortgage
lending unit. Washington Mutual was bought by JP Morgan in 2008. A
Department of Justice investigation into alleged fraud at WaMu
closed with no charges this summer. WaMu also recently
settled a class action lawsuit brought by shareholders for $208.5
million. In an ongoing lawsuit, the FDIC is accusing former
Washington Mutual executives Kerry Killinger, Stephen Rotella and David
Schneider of going on a "lending
spree, knowing that the real-estate market was in a 'bubble.'" They
deny the allegations.
Bank of America purchased Countrywide in January of 2008, as
delinquencies on the company’s mortgages soared and investors began
pulling out. Mozilo left the company after the sale. Mozilo
settled an SEC lawsuit for $67.5 million with no admission of
wrongdoing, though he is now banned from serving as a top executive at a
public company. A criminal investigation into his activities fizzled out
earlier this year. Bank of America invited several senior Countrywide
executives to stay on and run its mortgage unit. Bank of America Home
Loans does not make subprime mortgage loans. Deutsche Bank is still
under investigation by the Justice Department.
Mortgage securitizers
In the years before the crash, banks took subprime mortgages, bundled
them together with prime mortgages and turned them into collateral for
bonds or securities, helping to seed the bad mortgages throughout the
financial system. Washington Mutual, Bank of America,
Morgan Stanley and others were securitizing mortgages as well as
originating them. Other companies, such as Bear Stearns, Lehman
Brothers, and Goldman Sachs,
bought mortgages straight from subprime lenders, bundled them into
securities and sold them to investors including pension funds and
insurance companies.
Where they are now: This spring, New York’s Attorney General
launched a
probe into mortgage securitization at Bank of America, JP Morgan,
UBS, Deutsche Bank, Goldman Sachs and Morgan Stanley during the housing
boom. Morgan Stanley
settled with Nevada’s Attorney General last month following an
investigation into problems with the securitization process.
As part of a proposed settlement with the 50 state attorneys general
over foreclosure abuses, several big banks were
offered immunity from charges related to improper mortgage
origination and securitization. California and New York have
withdrawn from those talks.
The people who created and dealt CDOs
Once mortgages had been bundled into mortgage-backed securities,
other bankers took groups of them and bundled them together into new
financial products called Collateralized Debt Obligations. CDOs are
composed of tiers with different levels of risk. As we’ve reported,
a hedge fund named Magnetar worked with banks to fill CDOs
with the riskiest possible materials, then used credit default swaps to
bet that they would fail. Magnetar says that the majority of its short
positions were against CDOs it didn’t own. Magnetar also says it didn’t
choose what went its own CDOs, though people involved in the deals who
spoke to ProPublica
contradict this account.
American International Group’s London-based financial products
unit was among the entities that
provided credit default swaps on CDOs. Though the business of
insuring the risky securities made AIG large short-term profits, it
eventually brought the company to the brink of collapse, prompting an
$85 billion government bailout.
Merrill Lynch, Citigroup, UBS, Deutsche Bank, Lehman
Brothers and JPMorgan all made CDO deals with Magnetar. The
hedge fund invested in 30 CDOs from the spring of 2006 to the summer of
2007. The bankers who worked on these deals almost always reaped hefty
bonuses. From
our story:
Even today, bankers and managers speak with awe at the elegance
of the Magnetar Trade. Others have become famous for betting big
against the housing market. But they had taken enormous risks.
Meanwhile, Magnetar had created a largely self-funding bet against
the market.
When banks found CDOs hard to sell, some of them, notably Merrill
Lynch and Citibank,
bought each other’s CDOs, creating the illusion of true investors
when there were almost none. That was one way they kept the market for
CDOs going longer than it otherwise would have. Eventually CDOs began
purchasing risky parts of other CDOs created by the same bank. Take a
look at our
comic strip explaining self-dealing, and our chart detailing
which banks bought their own CDOs.
Goldman Sachs and
Morgan Stanley also made similar deals in which they created,
then bet against, risky CDOs. The hedge fund
Paulson & Co helped decide which assets to put inside Goldman’s
CDOs.
Where they are now: Overall, the banks and individuals
involved in CDO deals haven’t been convicted on criminal charges. The
civil suits against them have produced fines that aren’t very big
compared to the profits they made in the leadup to the financial crisis.
JP Morgan paid $153.6 million to settle an SEC suit alleging they
hadn’t disclosed to investors that Magnetar was betting against Morgan’s
CDO.
Citigroup just agreed to pay a $285 million fine to the SEC for
betting against one of its mortgage-related CDOs. The lawsuit
doesn’t mention dozens of similar deals made by Citi.
Magnetar is still thriving (the deals they made weren’t illegal
according to the rules at the time). In 2007, Magnetar’s
founder took home $280 million, and the fund had $7.6 billion under
management. The SEC is considering banning hedge funds and banks from
betting against securities of their own creation. As of May 2010,
federal prosecutors were investigating
Morgan Stanley over their CDO deals, and
Goldman Sachs paid $550 million last year to settle a lawsuit
related to one of theirs. Only
one Goldman employee, Fabrice Tourre, has been charged criminally in
connection to the deals.
Though recorded phone calls suggest that former AIG CEO Joseph
Cassano misled investors about the credit default swaps that contributed
to his company’s troubles, the evidence wasn’t airtight, and federal
probes against him fell apart in 2010. Cassano’s lawyers deny any
wrongdoing.
The ratings agencies
Standard and Poor’s, Moody’s and Fitch gave
their highest rating to investments based on risky mortgages in the
years leading up to the financial crisis.
A Senate investigations panel found that S&P and Moody’s continued
doing so even as the housing market was collapsing. An SEC report also
found failures at 10 credit rating agencies.
Where they are now: The SEC is
considering suing Standard and Poor’s over one particular CDO deal
linked to the hedge fund Magnetar. The agency had previously
considered suing Moody’s, but instead issued a report
criticizing all of the rating agencies generally. Dodd-Frank created
a regulatory body to oversee the credit rating agencies, but its
development has been
stalled by budgetary constraints.
The regulators
The
Financial Crisis Inquiry Commission [PDF] concluded that the
Securities and Exchange Commission failed to crack down on risky
lending practices at banks and make them keep more substantial capital
reserves as a buffer against losses. They also found that the Federal
Reserve failed to stop the housing bubble by setting prudent
mortgage lending standards, though it was the one regulator that had the
power to do so.
An internal SEC audit
faulted the agency for missing warning signs about the poor
financial health of some of the banks it monitored,
particularly Bear Stearns. [PDF] Overall, SEC enforcement actions
went down under the leadership of Christopher Cox, and a 2009 GAO
report found that he
increased barriers to launching probes and levying fines.
Cox wasn’t the only regulator who resisted using his power to rein in
the financial industry. The former head of the Federal Reserve, Alan
Greenspan, reportedly
refused to heighten scrutiny of the subprime mortgage market.
Greenspan later said before Congress that
it was a mistake to presume that financial firms’ own rational
self-interest would serve as an adequate regulator. He has also said he
doubts the financial crisis could have been prevented.
The Office of Thrift Supervision, which was tasked with
overseeing savings and loan banks, also helped to scale back their own
regulatory powers in the years before the financial crisis. In 2003
James Gilleran and John Reich, then heads of the OTS and
Federal Deposit Insurance Corporation respectively,
brought a chainsaw to a press conference as an indication of how
they planned to cut back on regulation. The OTS was known for being so
friendly with the banks -- which it referred to as its “clients” -- that
Countrywide
reorganized its operations so it could be regulated by OTS. As we’ve
reported, the regulator failed to recognize serious
signs of trouble at AIG, and
didn’t disclose key information about IndyMac’s finances in the
years before the crisis. The Office of the Comptroller of the
Currency, which oversaw the biggest commercial banks, also
went easy on the banks.
Where they are now: Christopher Cox
stepped down in 2009 under
public pressure. The OTS was dissolved this summer and its duties
assumed by the OCC. As we’ve noted, the
head of the OCC has been advocating to weaken rules set out by the
Dodd Frank financial reform law. The Dodd Frank law
gives the SEC new regulatory powers, including the ability to bring
lawsuits in administrative courts, where the rules are more favorable to
them.
The politicians
Two bills supported by Phil Gramm and signed into law by
Bill Clinton created many of the conditions for the financial crisis
to take place. The Gramm-Leach-Bliley Act of 1999 repealed all the
remaining parts of Glass-Steagall, allowing firms to participate in
traditional banking, investment banking, and insurance at the same time.
The Commodity Futures Modernization Act, passed the year after,
deregulated
over-the-counter
derivatives – securities like CDOs and credit default swaps, that
derive their value from underlying assets and are traded directly
between two parties rather than through a stock exchange. Greenspan and
Robert Rubin, Treasury Secretary from 1995 to 1999, had both
opposed regulating derivatives. Lawrence Summers, who went
on to succeed Rubin as Treasury Secretary, also
testified before the Senate that derivatives shouldn’t be regulated.
Continued in article
Jensen Comment
This is a well-researched summary article of what happened between 2008 and 2011
to the "Major Players" in the enormous economic crisis, subprime mortgage, CDO,
and other scandals.
My criticism is that the article seems to let CPA auditors off the hook in
terms of being "Big Players" which, in my viewpoint is an enormouse oversight.
For example, it mentions the huge WaMu settlement without mentioning the lawsuit
against Deloitte. It mentions the Lehman Bros. scandal without mentioning Ernst
& Young. Nor does it mention the other dereliction of duty of all the
large international audit firms and the small audit firms who never warned the
public about pending failures of thousands of small banks and mortgage companies
on Main Street as well as Wall Strett. The large and small CPA audit firms fell
flat on their faces as important watchdogs over the Bigger Players and Smaller
Players ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Here are the only tidbits about audits and auditors in the above article:
U.S. Attorney Preet Bharara claimed that, when
employees at Deutsche Bank’s mortgage received audits on the quality of
their mortgages from an outside firm, they
stuffed them in a closet without reading them. A
Deutsche Bank spokeswoman said the claims being made against the company are
“unreasonable and unfair,” and that most of the problems occurred before the
mortgage unit was bought by Deutsche Bank
. . .
An internal SEC audit
faulted the agency for missing warning signs about
the poor financial health of some of the banks it monitored,
particularly Bear Stearns.
[PDF] Overall, SEC enforcement actions went down under the leadership of
Christopher Cox, and a 2009 GAO report found that he
increased barriers to launching probes and levying fines.
.
So my conclusion is that Braden Goyette did a pretty good job summarizing
what happened to what he called the "Big Players" in the economic crisis. He
just did not include all of the Big Players ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"The Triumph of Propaganda," by Nemo Almen, American Thinker,
January 2, 2011 ---
http://www.americanthinker.com/2011/01/the_triumph_of_propaganda.html
Does anyone
remember what happened on Christmas Eve last year? In one of the most
expensive Christmas presents ever, the government
removed the $400 billion limit on their Fannie and
Freddie guaranty. This act increased taxpayer liabilities by
six trillion dollars; however, the news was lost
in the holiday cheer. This is one instance in a broader campaign to
manipulate the public perception, gradually depriving us of independent
thought.
Consider another example: what news story broke on April 16, 2010? Most of
us would say the SEC's
lawsuit against Goldman Sachs. Goldman is the
market leader in "ripping the client's face off," in this instance creating
a worst-of-the-worst pool of securities so Paulson & Co could bet against
it. Many applauded the SEC for this action. Never mind that singling out
one vice president (the "Fabulous Fab") and one instance of fraud is like
charging Al Capone with tax evasion. The dog was wagged.
Very
few caught the real news that day, namely the damning
complicity of the SEC in the Stanford Ponzi
scheme. Clearly, Stanford was the bigger story, costing thousands of
investors
billions of dollars while Goldman later settled
for half a
billion. Worse, the SEC knew about Stanford since
1997, but instead of shutting it down, people left the SEC to
work
for Stanford. This story should have caused
widespread outrage and reform of the SEC; instead it was buried in the back
pages and lost to the public eye.
Lest we
think the timing of these was mere coincidence, the Goldman lawsuit was
settled on July 15, 2010, the same day the financial reform package
passed. The government threw Goldman to the
wolves in order to hide its own shame. When the government had its desired
financial reforms, it let Goldman settle. These examples demonstrate a
clear pattern of manipulation. Unfortunately, our propaganda problem runs
far deeper than lawsuits and Ponzi schemes.
Here is a
more important question: which companies own half of all
subprime and
Alt-A (liar loan) bonds? Paul Krugman writes that
these companies were "mainly out of the picture during the housing bubble's
most feverish period, from 2004 to 2006. As a result, the agencies played
only a minor role in the epidemic of bad lending."[iii] This phrase is
stupefying. How can a pair of companies comprise half of a market and yet
have no major influence in it? Subprime formed the core of the financial
crisis, and Fannie and Freddie (the "agencies") formed the core of the
subprime market. They were not "out of the picture" during the subprime
explosion, they were the picture. The fact that a respectable Nobel
prize-winner flatly denies this is extremely disturbing.
Amazingly, any attempt to hold the government accountable for its role in
the subprime meltdown is dismissed as right-wing
propaganda. This dismissal is left-wing
propaganda. It was the government that initiated securitization as a tool
to dispose of
RTC assets. Bill Clinton ducks all
responsibility, ignoring how his administration imposed arbitrary
quotas on any banks looking to merge as Attorney
General Janet Reno "threatened legal action against lenders whose racial
statistics raised her suspicions."[iv] Greenspan fueled the rise of
subprime derivatives by lowering rates,[v] lowering reserves,[vi] and
beating down reasonable
opposition. And at the center of it all were
Fannie and Freddie
bribing officials, committing
fraud,
dominating private-sector
competition, and expanding to a
six-trillion-dollar debacle. The fact that these facts are dismissed as
propaganda shows just how divorced from reality our ‘news' has become. Yes,
half of all economists are employed by the
government, but this is no reason to flout one's
professional responsibility. As a nation we need to consider all the facts,
not just those that are politically expedient.
Continued in article
Nemo Almen is the author of
The Last Dodo: The Great Recession and our Modern-Day Struggle for Survival.
Bob Jensen's Rotten to the
Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
"The Financial Reform Law: A 'Fig Leaf' It won't prevent bad bets by
banks, and hence won't prevent the next financial crisis, say the experts,"
by Christine Harper and Bradley Keoun, Business Week, July 1, 2010 ---
http://www.businessweek.com/magazine/content/10_28/b4186042369207.htm?link_position=link3
The financial reform bill will change the way banks
do business in everything from credit cards to credit default swaps. What it
won't do is fundamentally reshape Wall Street, and it doesn't seem likely to
prevent bad bets by bankers from causing another crisis. The legislation is
"largely a fig leaf," says Dean Baker, co-director of the Center for
Economic & Policy Research in Washington. "Given where we were when this got
started, I'd have to imagine the Wall Street firms are pretty happy."
The overhaul allows banks to remain in the
profitable derivatives business and won't shrink those deemed "too big to
fail," leaving largely intact a U.S. financial industry dominated by six
companies with a combined $9.4 trillion of assets. The changes also do
little to address the danger posed by banks relying on the fickle credit
markets for funding that can evaporate in a panic, like the one that spread
in late 2008.
A deal reached by members of a House and Senate
conference just after dawn on June 25 diluted provisions from the tougher
Senate bill, limiting rather than prohibiting the ability of banks to trade
derivatives and invest in hedge funds or private equity funds. Senator Scott
Brown (R-Mass.) made his support conditional on a loosening of restrictions
on hedge fund and private equity fund ownership by banks. Brown won another
concession when he demanded that the committee remove a $19 billion fee on
banks and hedge funds that had been tacked on at the last minute. The June
28 death of Senator Robert C. Byrd (D-W. Va.), who supported the bill, means
a final vote won't take place until mid-July.
Senator Blanche Lincoln (D-Ark.) had originally
advocated forbidding banks from trading swaps if they receive federal
support such as deposit insurance. That could have forced banks to spin off
those businesses. In the final legislation, bank holding companies such as
JPMorgan Chase (JPM) and Citigroup (C) will be required to move less than 10
percent of the derivatives in their deposit-taking banks to a broker-dealer
division over the next two years. Goldman Sachs (GS) and Morgan Stanley
(MS), the two biggest U.S. securities firms before they converted into banks
in 2008, have smaller deposit-taking units and already hold most of their
derivatives in their broker-dealer arms. The derivatives rules are "nowhere
near as bad as what the banks might have feared," William T. Winters, former
co-chief executive officer of JPMorgan's investment bank, told Bloomberg
Television on June 25.
Another portion of the legislation that was amended
in the final conference was the so-called Volcker rule, named for Paul A.
Volcker, the former Federal Reserve chairman who championed it. Originally
the rule would have prevented any systemically important bank holding
company from engaging in proprietary trading, or betting with its own money,
as well as investing its own capital in hedge funds or private equity funds.
In the final version, the banks will be allowed to
provide no more than 3 percent of a fund's equity and will be limited to
investing up to 3 percent of their Tier 1 capital—which includes common
stock, retained earnings, and some preferred stock—in hedge funds or private
equity funds. That represents a ceiling of about $3.9 billion for JPMorgan,
$3.6 billion for Citigroup, and $2.1 billion for Goldman Sachs, according to
the companies' latest quarterly reports.
Further diluting its impact, the Volcker rule
doesn't take effect for 15 to 24 months after the law is passed. Then the
banks have two years to comply, with the potential for three one-year
extensions after that. They could seek five more years to withdraw money
from funds that invest in "il- liquid" assets such as private equity and
real estate, says Lawrence D. Kaplan, an attorney at Paul, Hastings,
Janofsky & Walker in Washington. "I don't think it will have any impact at
all on most banks," Winters said of the amended Volcker rule.
Some provisions of the new law may require banks to
raise more capital as a buffer against setbacks. But they will still be able
to borrow heavily in the short-term credit markets to fund their operations,
rather than rely on deposits, which are more stable. Their dependence on
market-based funding made firms like Goldman Sachs and Morgan Stanley
vulnerable to the panic of 2008. "Something has to be put in place to cause
banks to have deposit-based liabilities and not market-based liabilities,"
says Benjamin B. Wallace, a securities analyst at money manager Grimes & Co.
The legislation will make the financial system
safer, says James Ellman, president of Seacliff Capital, a hedge fund that
specializes in financial industry stocks. Even so, he says, "It won't
satisfy anybody who wanted really strict additional regulation of banks."
The bottom line: The financial reform bill imposes
a raft of new rules, but critics say it does not go to the heart of the
problems that created the crisis.
Bob Jensen's threads on the current financial crisis and its aftermath ---
http://faculty.trinity.edu/rjensen/2008bailout.htm
Question
Do you ever get the feeling while we debate accounting theory and standards that
we're just fiddling while investors burn?
"Is stock market still a chump's game? Small investors won't have a fair
shot until a presumption of integrity is restored. It's not clear that Obama's
proposed remedy will resolve the conflicts," by Eliot Spitzer, Microsoft
News, August 19, 2009 ---
http://articles.moneycentral.msn.com/Investing/Extra/is-stock-market-still-a-chumps-game.aspx
Link forwarded by Steve Markoff
[smarkoff@KIMSTARR.ORG]
One of America's great accomplishments in the last
half-century was the so-called "democratization" of the financial markets.
No longer just for the upper crust, investing
became a way for the burgeoning middle class to accumulate wealth. Mutual
funds exploded in size and number, 401k plans made savings and investing
easy, and the excitement of participating in the growth of our economy
gripped an ever larger percentage of the population.
Despite a backdrop of doubters -- those who
knowingly asserted that outperforming the average was an impossibility for
the small investor -- there was a growing consensus that the rules were
sufficient to protect the mom-and-pop investor from the sharks that swam in
the water.
That sense of fair play in the market has been
virtually destroyed by the bubble burstings and market drops of the past few
years.
Recent rebounds notwithstanding, most people now
are asking whether the system is fundamentally rigged. It's not just that
they have an understandable aversion to losing their life savings when the
market crashes; it's that each of the scandals and crises has a common
pattern: The small investor was taken advantage of by the piranhas that hide
in the rapidly moving currents.
And underlying this pattern is a simple theme:
conflicts of interest that violated the duty the market players had to their
supposed clients.
It is no wonder that cynicism and anger have
replaced what had been the joy of participation in the capital markets.
Take a quick run through a few of the scandals:
-
Analysts at major investment banks promote stocks
they know to be worthless, misleading the investors who rely on their
advice yet helping their investment-banking colleagues generate fees and
woo clients.
-
Ratings agencies slap AAA ratings on debt they
know to be dicey in order to appease the issuers -- who happen to pay
the fees of the agencies, violating the rating agency's duty to provide
the marketplace with honest evaluations.
-
Executives receive outsized and grotesque
compensation packages -- the result of the perverted recommendations of
compensation consultants whose other business depends upon the goodwill
of the very CEOs whose pay they are opining upon, thus violating the
consultants' duty to the shareholders of the companies for whom they are
supposedly working.
-
Mutual funds charge exorbitant fees that investors
have to absorb -- fees that dramatically reduce any possibility of
outperforming the market and that are set by captive boards of captive
management companies, not one of which has been replaced for inadequate
performance, violating their duty to guard the interests of the fund
investors for whom they supposedly work.
-
"High-speed trading" produces not only the reality
of a two-tiered market but also the probability of front-running -- that
is, illegally trading on information not yet widely known -- that eats
into the possible profits of the retail clients supposedly being served
by these very same market players, violating the obligation of the banks
to get their clients "best execution" without stepping between their
customers and the best available price.
-
AIG (AIG,
news,
msgs) is bailed out, costing taxpayers
tens of billions of dollars, even though (as we later learned) the big
guys knew that AIG was going down and were able to hedge and cover their
positions. Smaller investors are left holding the stock, and all of us
are left picking up the tab.
The unifying theme is apparent: Access to
information and advice, the very lifeblood of a level playing field, is not
where it needs to be. The small investor still doesn't have a fair shot.
While there have been case-specific remedies, the
aggregate effect of all the scandals is still to deny the market the most
essential of ingredients: the presumption of integrity.
The issue confronting those who wish to solve this
problem is that there really is no simple fix.
Bob Jensen's Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Abusive off-balance sheet accounting was a major
cause of the financial crisis. These abuses triggered a daisy chain of
dysfunctional decision-making by removing transparency from investors,
markets, and regulators. Off-balance sheet accounting facilitating the
spread of the bad loans, securitizations, and derivative transactions that
brought the financial system to the brink of collapse.
As in the 1920s, the balance sheets of major
corporations recently failed to provide a clear picture of the financial
health of those entities. Banks in particular have become predisposed to
narrow the size of their balance sheets, because investors and regulators
use the balance sheet as an anchor in their assessment of risk. Banks use
financial engineering to make it appear that they are better capitalized and
less risky than they really are. Most people and businesses include all of
their assets and liabilities on their balance sheets. But large financial
institutions do not.
Click here to read the full chapter.---
http://www.rooseveltinstitute.org/sites/all/files/Off-Balance Sheet
Transactions.pdf
Frank Partnoy is the George E.
Barnett Professor of Law and Finance and is the director of the Center on
Coporate and Securities Law at the University of San Diego. He worked as a
derivatives structurer at Morgan Stanley and CS First Boston during the
mid-1990s and wrote F.I.A.S.C.O.:
Blook in the Water on Wall Street, a
best-selling book about his experiences there. His other books include
Infectious Greed: How Deceit and Risk Corrupted the Financial Markets
and
The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall
Street Scandals.
Lynn Turner has the unique
perspective of having been the Chief Accountant of the Securities and
Exchange Commission, a member of boards of public companies, a trustee of a
mutual fund and a public pension fund, a professor of accounting, a partner
in one of the major international auditing firms, the managing director of a
research firm and a chief financial officers and an executive in industry.
In 2007, Treasury Secretary Paulson appointed him to the Treasury Committee
on the Auditing Profession. He currently serves as a senior advisor to LECG,
an international forensics and economic consulting firm.
The views expressed in this paper are those of the authors and do not
necessarily reflect the positions of the Roosevelt Institute, its officers,
or its directors.
Bob Jensen's threads on OBSF are at
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
For over 15 years Frank Partnoy has been appealing in vain for financial
reform. My timeline of history of the scandals, the new accounting standards,
and the new ploys at OBSF and earnings management is at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
"A Missed Opportunity on Financial Reform: How could Fannie Mae and
Freddie Mac have escaped Congress's attention?" by Walter Levitt, The
Wall Street Journal, June 24, 2010 ---
http://online.wsj.com/article/SB10001424052748704853404575322491510468572.html#mod=djemEditorialPage_t
As a lifelong Democrat and public servant to four
presidents, I had hoped the financial reform bill would be the best example
of my party's long-standing reputation for standing on the side of
individual investors.
It's not. The bill, already weakened by deal-making
as it emerged from the Senate, has been bled dry of nearly every meaningful
protection of investors.
Ironically, the authors of this bill are the same
Democrats who normally would have opposed many of its features if they were
in the minority. Now in the majority, these politicians are investor
advocates in their press releases alone.
The Democrats had the chance to do this bill the
right way. They should have been motivated by Congress's previous failure to
adopt meaningful reform, which left investors unprepared for the crisis. And
they had the input of talented leaders and experts who attempted to help
lawmakers deal with systemic risk and gaps in basic investor protections.
Whatever these positive contributions, Congress
more than overwhelmed them with sins of commission and sins of omission. One
of many bad ideas that made it into the bill: Public companies will now have
a wider loophole to avoid doing internal audits investors can trust. This
requirement was the most important pro-investor reform of the last decade,
and it worked. Of the 522 U.S. financial restatements in 2009, 374 were at
small firms not subject to auditor reviews.
But the reform bill about to be passed expands the
number of small companies exempt from Sarbanes-Oxley audit requirements.
When fraud is happening at a public company, small or large, investors care.
Now, thanks to Democratic leadership, investors are less likely to know.
There are many missed opportunities in this bill,
but these are the biggest:
First, Democratic leaders in Congress failed to
revoke the 1975 law that prevents municipal bond issuers from facing the
kind of regulation and scrutiny of the corporate bond market. If the
municipal bond market melts down in the next few years, we'll know who to
blame.
Second, they failed to pass a meaningful
majority-vote or proxy access rule for corporate ballots. Instead, thanks to
Sen. Chris Dodd (D., Conn.), the Senate passed a proxy access rule that is
comically useless: You need 5% of shares to get on the proxy. Very rarely do
investors assemble such large stakes in any company.
Third, New York Sen. Chuck Schumer's wise idea to
let the Securities and Exchange Commission (SEC) become a self-funded agency
will likely be killed by appropriators who are unwilling to give up the
power of the purse.
Fourth, Democratic leaders left in place the
confusing dual regulatory structure of the SEC and the Commodity Futures
Trading Commission. A merger was necessary to eliminate regulatory arbitrage
and corrosive bureaucratic turf battles, yet it didn't happen.
Fifth, Senate Democrats failed to support Rep.
Barney Frank's (D., Mass.) effort to pass a new law to overcome the legal
precedent of the 2008 Supreme Court's Stoneridge decision, which allows
third-party consultants, accountants and other abettors of fraud to avoid
liability. Again, another sellout of investor interests.
Sixth, Congress didn't deal with the massive
problems of Fannie Mae and Freddie Mac. It's one thing to fail to see
trouble before it happens. Now, there's no excuse. The central role played
by these two organizations in the financial crisis is indisputable. Congress
had a chance to fully restrict these agencies from anything but the most
basic market-making activities, and it didn't.
Finally, Democrats could have proposed a law
obligating investment advisers to serve their clients' interests above all
others. That was in the House version of the bill, but the Senate punted the
idea, and it's is likely to end up kicked down the road even further.
The sad reality is that we may not have a chance to
enact these kinds of reforms until after the next major financial crisis.
For those of us who champion the rights of investors, that's too long to
wait—especially since until very recently we didn't think we would have to.
Mr. Levitt, chairman of the Securities and Exchange Commission from
1993 to 2001, now serves as an adviser to the Carlyle Group and Goldman
Sachs.
Bob Jensen's threads on Freddie and Fannie are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"They
Left Fannie Mae, but We Got the Legal Bills," by Grechen Morgenson,
The New York Times, September 5, 2009 ---
http://www.nytimes.com/2009/09/06/business/economy/06gret.html?_r=1&scp=2&sq=gretchen
morgensen&st=cse
I Saw Maxine Kissing Franklin Raines ---
http://www.youtube.com/watch?v=vbZnLxdCWkA
Before Franklin Raines resigned as CEO of Fannie Mae and paid over a
million dollar fine for accounting fraud to pad his bonus, he was the
darling of the liberal members of Congress. Frank Raines was creatively
managing earnings to the penny just enough to get his enormous bonus.
The auditing firm of KPMG was accordingly fired from its biggest
corporate client in history ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Manipulation
Video on the efforts of some members of Congress seeking to cover up
accounting fraud at Fannie Mae ---
http://www.youtube.com/watch?v=1RZVw3no2A4
The Largest Earnings Management Fraud in History and Congressional
Efforts to Cover it Up
Without trying to place the blame on Democrats or Republicans, here are
some of the facts that led to the eventual fining of Fannie Mae
executives for accounting fraud and the firing of KPMG as the auditor on
one of the largest and most lucrative audit clients in the history of
KPMG. The restated earnings purportedly took upwards of a million
journal entries, many of which were re-valuations of derivatives being
manipulated by Fannie Mae accountants and auditors (Deloitte was charged
with overseeing the financial statement revisions.
Fannie Mae may have conducted the largest earnings management scheme in
the history of accounting.
You can read the following at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
.
. . flexibility also gave Fannie the ability to manipulate earnings
to hit -- within pennies -- target numbers for executive bonuses.
Ofheo details an example from 1998, the year the Russian financial
crisis sent interest rates tumbling. Lower rates caused a lot of
mortgage holders to prepay their existing home mortgages. And Fannie
was suddenly facing an estimated expense of $400 million.
Well, in its wisdom, Fannie decided to recognize only $200 million,
deferring the other half. That allowed Fannie's executives -- whose
bonus plan is linked to earnings-per-share -- to meet the target for
maximum bonus payouts. The target EPS for maximum payout was $3.23
and Fannie reported exactly . . . $3.2309. This bull's-eye was worth
$1.932 million to then-CEO James Johnson, $1.19 million to
then-CEO-designate Franklin Raines, and $779,625 to then-Vice
Chairman Jamie Gorelick.
That same year Fannie installed software that allowed management to
produce multiple scenarios under different assumptions that,
according to a Fannie executive, "strengthens the earnings
management that is necessary when dealing with a volatile book of
business." Over the years, Fannie designed and added software that
allowed it to assess the impact of recognizing income or expense on
securities and loans. This practice fits with a Fannie corporate
culture that the report says considered volatility "artificial" and
measures of precision "spurious."
This disturbing culture was apparent in Fannie's manipulation of its
derivative accounting. Fannie runs a giant derivative book in an
attempt to hedge its massive exposure to interest-rate risk.
Derivatives must be marked-to-market, carried on the balance sheet
at fair value. The problem is that changes in fair-value can cause
some nasty volatility in earnings.
So, Fannie decided to classify a huge amount of its derivatives as
hedging transactions, thereby avoiding any impact on earnings. (And
we mean huge: In December 2003, Fan's derivatives had a notional
value of $1.04 trillion of which only a notional $43 million was not
classified in hedging relationships.) This misapplication continued
when Fannie closed out positions. The company did not record the
fair-value changes in earnings, but only in Accumulated Other
Comprehensive Income (AOCI) where losses can be amortized over a
long period.
Fannie had some $12.2 billion in deferred losses in the AOCI balance
at year-end 2003. If this amount must be reclassified into retained
earnings, it might punish Fannie's earnings for various periods over
the past three years, leaving its capital well below what is
required by regulators.
In all, the Ofheo report notes, "The misapplications of GAAP are not
limited occurrences, but appear to be pervasive . . . [and] raise
serious doubts as to the validity of previously reported financial
results, as well as adequacy of regulatory capital, management
supervision and overall safety and soundness. . . ." In an agreement
reached with Ofheo last week, Fannie promised to change the methods
involved in both the cookie-jar and derivative accounting and to
change its compensation "to avoid any inappropriate incentives."
But we don't think this goes nearly far enough for a company whose
executives have for years derided anyone who raised a doubt about
either its accounting or its growing risk profile. At a minimum
these executives are not the sort anyone would want running the U.S.
Treasury under John Kerry. With the Justice Department already
starting a criminal probe, we find it hard to comprehend that the
Fannie board still believes that investors can trust its management
team.
Fannie Mae isn't an ordinary company and this isn't a
run-of-the-mill accounting scandal. The U.S. government had no
financial stake in the failure of Enron or WorldCom. But because of
Fannie's implicit subsidy from the federal government, taxpayers are
on the hook if its capital cushion is insufficient to absorb big
losses. Private profit, public risk. That's quite a confidence game
-- and it's time to call it.
**********************************
:"Sometimes
the Wrong 'Notion': Lender Fannie Mae Used A Too-Simple Standard For
Its Complex Portfolio," by Michael MacKenzie, The Wall Street
Journal, October 5, 2004, Page C3
Lender Fannie
Mae Used A Too-Simple Standard For Its Complex Portfolio
What exactly
did
Fannie Mae do wrong?
Much has been
made of the accounting improprieties alleged by Fannie's regulator,
the Office of Federal Housing Enterprise Oversight.
Some investors
may even be aware the matter centers on the mortgage giant's $1
trillion "notional" portfolio of derivatives -- notional being the
Wall Street way of saying that that is how much those options and
other derivatives are worth on paper.
But
understanding exactly what is supposed to be wrong with Fannie's
handling of these instruments takes some doing. Herewith, an effort
to touch on what's what -- a notion of the problems with that
notional amount, if you will.
Ofheo alleges
that, in order to keep its earnings steady, Fannie used the wrong
accounting standards for these derivatives, classifying them under
complex (to put it mildly) requirements laid out by the Financial
Accounting Standards Board's rule 133, or FAS 133.
For most
companies using derivatives, FAS 133 has clear advantages, helping
to smooth out reported income. However, accounting experts say FAS
133 works best for companies that follow relatively simple hedging
programs, whereas Fannie Mae's huge cash needs and giant portfolio
requires constant fine-tuning as market rates change.
A Fannie
spokesman last week declined to comment on the issue of hedge
accounting for derivatives, but Fannie Mae has maintained that it
uses derivatives to manage its balance sheet of debt and mortgage
assets and doesn't take outright speculative positions. It also uses
swaps -- derivatives that generally are agreements to exchange
fixed- and floating-rate payments -- to protect its mortgage assets
against large swings in rates.
Under FAS 133, if
a swap is being used to hedge risk against another item on the
balance sheet, special hedge accounting is applied to any gains and
losses that result from the use of the swap. Within the application
of this accounting there are two separate classifications:
fair-value hedges and cash-flow hedges.
Fannie's
fair-value hedges generally aim to get fixed-rate payments by
agreeing to pay a counterparty floating interest rates, the idea
being to offset the risk of homeowners refinancing their mortgages
for lower rates. Any gain or loss, along with that of the asset or
liability being hedged, is supposed to go straight into earnings as
income. In other words, if the swap loses money but is being applied
against a mortgage that has risen in value, the gain and loss cancel
each other out, which actually smoothes the company's income.
Cash-flow
hedges, on the other hand, generally involve Fannie entering an
agreement to pay fixed rates in order to get floating-rates. The
profit or loss on these hedges don't immediately flow to earnings.
Instead, they go into the balance sheet under a line called
accumulated other comprehensive income, or AOCI, and are allocated
into earnings over time, a process known as amortization.
Ofheo claims
that instead of terminating swaps and amortizing gains and losses
over the life of the original asset or liability that the swap was
used to hedge, Fannie Mae had been entering swap transactions that
offset each other and keeping both the swaps under the hedge
classifications. That was a no-go, the regulator says.
"The major
risk facing Fannie is that by tainting a certain portion of the
portfolio with redesignations and improper documentation, it may
well lose hedge accounting for the whole derivatives portfolio,"
said Gerald Lucas, a bond strategist at Banc of America Securities
in New York.
The bottom line is that both the FASB and the IASB must someday soon
take another look at how the real world hedges portfolios rather than
individual securities. The problem is complex, but the problem has come
to roost in Fannie Mae's $1 trillion in hedging contracts. How the SEC
acts may well override the FASB. How the SEC acts may be a vindication
or a damnation for Fannie Mae and Fannie's auditor KPMG who let Fannie
violate the rules of IAS 133.
"Efficient Market Theory and the Crisis: Neither the rating agencies'
mistakes nor the overleveraging by financial firms was the fault of an academic
hypothesis," by Jeremy J. Siegel, The Wall Street Journal, October
27, 2009 ---
http://online.wsj.com/article/SB10001424052748703573604574491261905165886.html?mod=djemEditorialPage
Financial journalist and best-selling author Roger
Lowenstein didn't mince words in a piece for the Washington Post this
summer: "The upside of the current Great Recession is that it could drive a
stake through the heart of the academic nostrum known as the
efficient-market hypothesis." In a similar vein, the highly respected money
manager and financial analyst Jeremy Grantham wrote in his quarterly letter
last January: "The incredibly inaccurate efficient market theory [caused] a
lethally dangerous combination of asset bubbles, lax controls, pernicious
incentives and wickedly complicated instruments [that] led to our current
plight."
But is the Efficient Market Hypothesis (EMH) really
responsible for the current crisis? The answer is no. The EMH, originally
put forth by Eugene Fama of the University of Chicago in the 1960s, states
that the prices of securities reflect all known information that impacts
their value. The hypothesis does not claim that the market price is always
right. On the contrary, it implies that the prices in the market are mostly
wrong, but at any given moment it is not at all easy to say whether they are
too high or too low. The fact that the best and brightest on Wall Street
made so many mistakes shows how hard it is to beat the market.
This does not mean the EMH can be used as an excuse
by the CEOs of the failed financial firms or by the regulators who did not
see the risks that subprime mortgage-backed securities posed to the
financial stability of the economy. Regulators wrongly believed that
financial firms were offsetting their credit risks, while the banks and
credit rating agencies were fooled by faulty models that underestimated the
risk in real estate.
After the 1982 recession, the U.S. and world
economies entered into a long period where the fluctuations in variables
such as gross domestic product, industrial production, and employment were
significantly lower than they had been since World War II. Economists called
this period the "Great Moderation" and attributed the increased stability to
better monetary policy, a larger service sector and better inventory
control, among other factors.
The economic response to the Great Moderation was
predictable: risk premiums shrank and individuals and firms took on more
leverage. Housing prices were boosted by historically low nominal and real
interest rates and the development of the securitized subprime lending
market.
According to data collected by Prof. Robert Shiller
of Yale University, in the 61 years from 1945 through 2006 the maximum
cumulative decline in the average price of homes was 2.84% in 1991. If this
low volatility of home prices persisted into the future, a mortgage security
composed of a nationally diversified portfolio of loans comprising the first
80% of a home's value would have never come close to defaulting. The credit
quality of home buyers was secondary because it was thought that underlying
collateral—the home—could always cover the principal in the event the
homeowner defaulted. These models led credit agencies to rate these subprime
mortgages as "investment grade."
But this assessment was faulty. From 2000 through
2006, national home prices rose by 88.7%, far more than the 17.5% gain in
the consumer price index or the paltry 1% rise in median household income.
Never before have home prices jumped that far ahead of prices and incomes.
This should have sent up red flags and cast doubts
on using models that looked only at historical declines to judge future
risk. But these flags were ignored as Wall Street was reaping large profits
bundling and selling the securities while Congress was happy that more
Americans could enjoy the "American Dream" of home ownership. Indeed,
through government-sponsored enterprises such as Fannie Mae and Freddie Mac,
Washington helped fuel the subprime boom.
Neither the rating agencies' mistakes nor the
overleveraging by the financial firms in the subprime securities is the
fault of the Efficient Market Hypothesis. The fact that the yields on these
mortgages were high despite their investment-grade rating indicated that the
market was rightly suspicious of the quality of the securities, and this
should have served as a warning to prospective buyers.
With few exceptions (Goldman Sachs being one),
financial firms ignored these warnings. CEOs failed to exercise their
authority to monitor overall risk of the firm and instead put their faith in
technicians whose narrow models could not capture the big picture. One can
only wonder if the large investment banks would have taken on such risks
when they were all partnerships and the lead partner had all his wealth in
the firm, as they were just a few decades ago.
The misreading of these economic trends did not
just reside within the private sector. Former Fed Chairman Alan Greenspan
stated before congressional committees last December that he was "shocked"
that the top executives of the financial firms exposed their stockholders to
such risk. But had he looked at their balance sheets, he would have realized
that not only did they put their own shareholders at risk, but their
leveraged positions threatened the viability of the entire financial system.
As home prices continued to climb and subprime
mortgages proliferated, Mr. Greenspan and current Fed Chairman Ben Bernanke
were perhaps the only ones influential enough to sound an alarm and soften
the oncoming crisis. But they did not. For all the deserved kudos that the
central bank received for their management of the crisis after the Lehman
bankruptcy, the failure to see these problems building will stand as a
permanent blot on the Fed's record.
Our crisis wasn't due to blind faith in the
Efficient Market Hypothesis. The fact that risk premiums were low does not
mean they were nonexistent and that market prices were right. Despite the
recent recession, the Great Moderation is real and our economy is inherently
more stable.
But this does not mean that risks have disappeared.
To use an analogy, the fact that automobiles today are safer than they were
years ago does not mean that you can drive at 120 mph. A small bump on the
road, perhaps insignificant at lower speeds, will easily flip the
best-engineered car. Our financial firms drove too fast, our central bank
failed to stop them, and the housing deflation crashed the banks and the
economy.
Dr. Siegel, a professor of finance at the University of Pennsylvania's
Wharton School, is the author of "Stocks for the Long Run," now in its 4th
edition from McGraw-Hill.
Eugene Fama Lecture: Masters of Finance, Oct 2, 2009
Videos Fama Lecture: Masters of Finance From the American Finance Association's
"Masters in Finance" video series, Eugene F. Fama presents a brief history of
the efficient market theory. The lecture was recorded at the University of
Chicago in October 2008 with an introduction by John Cochrane.
http://www.dimensional.com/famafrench/2009/10/fama-lecture-masters-of-finance.html#more
Fama Video on Market Efficiency in a Volatile Market
Widely cited as the father of the efficient market hypothesis and one of its
strongest advocates, Professor Eugene Fama examines his groundbreaking idea in
the context of the 2008 and 2009 markets. He outlines the benefits and
limitations of efficient markets for everyday investors and is interviewed by
the Chairman of Dimensional Fund Advisors in Europe, David Salisbury.
http://www.dimensional.com/famafrench/2009/08/fama-on-market-efficiency-in-a-volatile-market.html#more
Other Fama and French Videos ---
http://www.dimensional.com/famafrench/videos/
Jensen Comment
This does not mean the EMH and its wildly popular stepchild CAPM are not in deep
keeshee (theory and practice) ---
http://faculty.trinity.edu/rjensen/theory01.htm#EMH
Warren
Buffett did a lot of almost fatal damage to the EMH
If you really want to understand the problem you’re apparently wanting to study,
read about how Warren Buffett changed the whole outlook of a great
econometrics/mathematics researcher (Janet Tavkoli). I’ve mentioned this
fantastic book before --- Dear Mr.
Buffett. What opened her eyes is how Warren Buffet built his vast, vast
fortune exploiting the errors of the sophisticated mathematical model builders
when valuing derivatives (especially options) where he became the writer of
enormous option contracts (hundreds of millions of dollars per contract). Warren
Buffet dared to go where mathematical models could not or would not venture when
the real world became too complicated to model. Warren reads financial
statements better than most anybody else in the world and has a fantastic
ability to retain and process what he’s studied. It’s impossible to model his
mind.
I finally grasped what Warren was saying. Warren has such a wide body of
knowledge that he does not need to rely on “systems.” . . . Warren’s vast
knowledge of corporations and their finances helps him identify derivatives
opportunities, too. He only participates in derivatives markets when Wall
Street gets it wrong and prices derivatives (with mathematical models)
incorrectly. Warren tells everyone that he only does certain derivatives
transactions when they are mispriced.
Wall Street derivatives traders construct trading models with no clear idea
of what they are doing. I know investment bank modelers with advanced math
and science degrees who have never read the financial statements of the
corporate credits they model. This is true of some credit derivatives
traders, too.
Janet Tavakoli, Dear Mr. Buffett, Page 19
Bob Jensen's threads on the economic crisis are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
What happened was an explosion of loans being made
outside of the regular banking system. It was largely the unregulated sector of
the lending industry and the underregulated and the lightly regulated that did
that.
Barney Frank
Question
How did banks circumvent mortgage regulations in before the subprime scandal
broke?
Jensen Comment
For once I would like to bless
Barney Frank,
although as chairman of the House Financial Services Committee when these
scandals were taking place, he should have stopped this banking house of cards
before this banking fraud came tumbling down. In spite of yelling foul now, Rep.
Frank helped create this pile of "Barney's Rubble." Pardon me for not blessing
Barney now ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
Was he left in the dark about mortgage fraud? Wink! Wink!
I'm about to puke!
Hint
They used a ploy much like corporations used to keep real estate and other debt
of the balance sheet before accounting standard setters put an end to the sham.
For example, Avis Car rental at one time avoided putting millions of debt for
financing its cars by creating a sham subsidiary financing subsidiary and then
(in those good old days) did not consolidate the financing subsidiary into the
consolidated balance sheet of Avis. Similarly, Safeway appeared to not own any
stores or have any mortage debt on those stores because all this was hidden in
an unconsolidated subsidiary. It took way to long in the United States for the
FASB to put an end to the sham of off-balance-sheet-financing (OBSF):
FAS 94: Consolidation of All Majority-owned Subsidiaries--an amendment of
ARB No. 51, with related amendments of APB Opinion No. 18 and ARB No. 43,
Chapter 12 (Issued 10/87) ---
http://www.fasb.org/summary/stsum94.shtml
In the case of banks circumventing regulations on selling mortgages,
here's how it worked with sham mortgage company subsidiaries.
"Subprime and the Banks: Guilty as Charged," by Joe Nocera. The New
York Times, October 14, 2009 ---
http://executivesuite.blogs.nytimes.com/2009/10/14/subprime-and-the-banks-guilty-as-charged/
“There has not been a case made that there is an
enforcement problem with banks,” Edward Yingling, the head of the American
Bankers Association, said last week. “There is a problem with enforcement on
nonbanks.”
As I wrote in
my column last week, this has become something of
a mantra for the banking industry. We aren’t the ones who brought
the world to the brink of financial disaster,
they proclaim. It was those awful nonbanks,
the mortgage brokers and originators, who peddled those terrible subprime
loans to unsuspecting or unsophisticated consumers. They’re the ones who
need to be regulated!
Apparently, when you say something long enough and
loud enough, people start to believe it, even when it defies reality. Here,
for instance, is the normally skeptical
Barney Frank on the subject: “What happened
was an explosion of loans being made outside of the regular banking system.
It was largely the unregulated sector of the lending industry and the
underregulated and the lightly regulated that did that.”
To which I can now triumphantly reply: Oh,
really???
Last weekend, after the column was published, an
angry mortgage broker — someone who felt she and her ilk were being unfairly
scapegoated by the banking industry — sent me a series of rather eye-opening
documents. They were a series of fliers and advertisements that had been
sent to her office (and mortgage brokers all over the country) from
JPMorgan Chase, advertising their latest wares.
They were dated 2005, which was before the subprime mortgage boom got
completely out of control. They’re still pretty sobering.
“The Top 10 Reasons to Choose Chase for All Your
Subprime Needs,” screams the headline on the first one. Another was titled,
“Chase No Doc,” and described the criteria for a borrower to receive a
so-called no-document loan. “Got Bank Statements?” asked a third flier. “Get
Approved!” In a number of the fliers, Chase makes it clear to the mortgage
brokers that the bank doesn’t need income or job verification — it just
needs to look at a handful of old bank statements.
“There were mortgage brokers who acted unethically,
absolutely,” my source told me when I called her on Monday. (She asked to
remain anonymous because she still has to work with JPMorgan Chase and the
other big banks.) “But where do you think mortgage brokers were getting the
subprime mortgages they were selling to customers? From the big banks,
that’s where. Chase,
Wells Fargo,
Bank of America — they were all doing it.”
So enough already about how the banks weren’t the
problem. Of course they were. Here’s the evidence,
right here. Read ’em and weep.
Jensen Comment
If you really want to see how sleazy mortgage lending became, read about the on
Marvene's shack in Phoenix. She purchased the shack for $3,500 and later, with
no improvements, got a $103,000 mortgage. When the mortgage was foreclosed,
neighbors bought the shack and tore it down ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on the banking scandals accompanied by taxpayer
bailouts ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
This is the Washinton DC Idea of Separation of the Regulated from the
Regulator
"Our primary focus has been in facilitating capital raising and strategic
transactions," John White, director of the SEC's division of corporation
finance, said at a Practising Law Institute conference in New York. "We do not
want to be in the way of what companies need to do," he added. He said his unit
was looking at how it could be more responsive to issues companies are having
with SEC restrictions that could stand in the way of or slow down deals. White
said the SEC had reprioritized in this way over the summer as Lehman Brothers
Holdings Inc looked for capital and suitors to rescue the firm. "We had a Lehman
summer," White said. "We spent basically the whole summer jumping through hoops
trying to help them." Lehman ultimately filed for bankruptcy protection on Sept.
15 in the largest U.S. bankruptcy filing in history.
SmartPros, November 13, 2008 ---
http://accounting.smartpros.com/x63794.xml
2008.09.30 From A Retired Banker
Written by Jack Kelly Thursday, 18 September 2008
Lending money to people who probably won't pay it
back isn't good business. If you wrap crummy loans in a clever package,
they're still crummy loans.
Your typical Wal-Mart shopper understands this. But
the Masters of the Universe on Wall Street and in Washington evidently
didn't.
Ostensibly to aid the poor [Ed. note: but really to
buy their votes], the Clinton administration and Congress encouraged lenders
to give mortgages to poor credit risks. The combination of easy money and
the expansion of the number of borrowers by extending loans to poor credit
risks sent housing prices through the roof, creating the bubble whose
bursting has led to this crisis.
Congress in 1999 repealed the law (the Glass-Steagall
Act) that established a bright line between commercial and investment banks.
This meant bad investments by banks could jeopardize depositors. Wall Street
created 'derivatives' which multiplied profits in good times, but which also
multiplied risk if there were defaults.
Most important was corruption and mismanagement at
the Federal National Mortgage Association (Fannie Mae) and the Federal Home
Loan Mortgage Corporation (Freddie Mac), which together controlled 90
percent of the secondary mortgage market.
Once your bank has lent you money to buy a house,
it can't lend the money again until you pay it back. But if your bank sells
your mortgage, it can make another loan right away. Without the secondary
market, most of the funds for home mortgages would dry up.
Fannie and Freddie went broke because they had
bought billions of dollars worth of subprime mortgages, on which borrowers
defaulted when the housing bubble popped. Fannie bought most of its bad
mortgages from Countrywide Financial, whose CEO, Angelo Mozilo, gave
sweetheart loans to senior executives of Fannie Mae.
Fannie and Freddie cooked their books so senior
executives would be paid millions of dollars in bonuses to which they were
not entitled. Inadequate regulation kept the book-cooking from being
discovered until the crisis had become a catastrophe.
President Bush proposed regulatory reforms in 2003
but Congress took no action. In 2005, John McCain and three other GOP
senators proposed a strong reform bill. It died when Democrats threatened a
filibuster. When the bill was reintroduced in this Congress, Sen. Chris
Dodd, the new Democratic chairman of Banking Committee, refused even to hold
a hearing on it.
Democrats opposed reform in part because they
feared it would mean fewer loans to poor people.
Fannie Mae and Freddie Mac are not facing any kind
of financial crisis,' Rep. Barney Frank, D-Mass, told the New York Times
when the Bush bill was introduced. 'The more pressure there is on these
companies, the less we will see in terms of affordable housing.'
The Democrats and some Republicans opposed reform
because Fannie and Freddie were very good at greasing palms. Fannie spent
$170 million on lobbying since 1998, and $19.3 million on political
contributions since 1990.
The principal recipient of Fannie Mae's largesse
was Sen. Dodd. Number two was Barack Hussein Obama.
Sen. Dodd was also the second largest recipient in
the Senate of contributions from Countrywide's PAC and its employees. The
number one senator on Countrywide's list? Barack Hussein Obama.
Fannie Mae CEO Franklin Raines was forced to resign
in December, 2004, because of 'accounting irregularities.'
The Washington Post reported July 16 the Obama
campaign has called Mr. Raines 'seeking his advice on mortgage and housing
policy matters.'
Sen. Obama appointed Mr. Raines' predecessor, James
Johnson, as head of his vice presidential search committee, until he was
also implicated in 'accounting irregularities,' and it was revealed he'd
received cut rate loans from Countrywide.
Chicago billionaire Penny Pritzker, chairman of
Sen. Obama's finance committee, cooked the books to conceal losses from
subprime mortgages at her now defunct Superior bank. The holding company her
family owned collected $200 million in dividends on phony profits.
The trouble with crony capitalism isn't capitalism.
It's the cronies.
Maybe some others ought to be informed.
Thanks to Pat Dougan, North Texas HOG
Youth ages;
Immaturity is outgrown;
Ignorance can be educated;
Drunkenness sobered;
but Stupidity lasts forever.
In a most egregious way, American's CEOs and Wall Street traders have led us
down the path to George Orwell's Big Brother ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Also see
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Perhaps this rottenness to the core in large corporations and Wall street caused
the free media of the United States to close ranks to a point where the media is
no longer free.
What Would Peter Drucker Think? B-schools face the financial crisis (video
from Business Week)---
Click Here
Reinventing the American Dream
The End of the American Dream
McJobs
An entire generation's prosperity vanishing, food stamp use exploding. Welcome
to the jobless future. This month's jobs numbers drive home the point. The
unemployment rate fell at the fastest rate for years — great news, right? Wrong.
The vast majority of the gains — 75% — came from (wait for it) "temporary help
services." See what just happened? We subtracted thousands of real jobs — and
replaced them with low-value, no-future McJobs instead.
"Solve America's Employment Crisis With a Netflix Prize," Harvard
Business School, December 4, 2009 ---
http://blogs.harvardbusiness.org/haque/2009/12/solve_americas_employment_cris.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE
Jensen Comment
I found it a bit ironic that included in the jobs creation statistics are the
hundreds of construction workers temporarily employed in cities like
Philadelphia constructing new or improved public housing like there's a real
long-term improvement to economic recovery in this type of job creation.
America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
"After 'GD2' in 2011, a 100-year bear market?" by Paul B. Farrell,
MarketWatch, November 28, 2008 ---
Click Here
Nightmare scenario No. 1:
No exit, a never-ending disaster Remember former Goldman Chairman John
Whitehead? He "sees" a tragic ending: This Reagan Deputy Secretary of State
and former New York Fed chairman "sees" America burning through trillions,
over many years: "Nothing but large increases in the deficit ... worse than
the Depression." See previous Paul B. Farrell. He worries that "tomorrow is
the day Moody's and S&P will announce a downgrade of U.S. government bonds."
Politicians and public are delusional, promising huge new programs plus tax
cutting: "This is a road to disaster.' Like Sartre's existential tragedy,
"No Exit," he says: "I don't see a solution." If this dialogue emerged in "Rashomon,"
deep in the forest, I could "see" Whitehead pointing a finger at Treasury
Secretary Henry Paulson, accusing him of terrible deeds.
Nightmare scenario No. 2:
Washington's unsustainable deficits True to the "Rashomon" narrative Warren
Buffett "sees" America sinking in a swamp of unsustainable debt to justify
our excessive spending -- government, consumer, corporate. Remember
Buffett's famous farmer's story: "We were taught in Economics 101 that
countries could not for long sustain large, ever-growing trade deficits."
America "has been behaving like an extraordinarily rich family that
possesses an immense farm. In order to consume 4% more than they produce,
that's the trade deficit, we have, day by day, been both selling pieces of
the farm and increasing the mortgage on what we still own." See previous
Paul B. Farrell. Like his farmers, we borrowed $700 billion a year to live
high on the hog, selling off American assets. Now foreign sovereign funds
own trillions of our assets. Today Uncle Warren's story is less a children's
fairy tale and more a "Rashomon" tragedy.
Nightmare scenario No. 3:
The endless 100-year bear market Robert Prechter's a brilliant market
forecaster and editor of the Elliott Wave Theorist newsletter. As early as
1978 he predicted the "raging bull market of the 1980s." Many laughed. Then
tech roared and he became "Guru of the Decade." In the "Rashomon" cast he's
credible. And ahead again: He "saw" the future in his "At the Crest of the
Wave: A Forecast of the Great Bear Market." Today's darkening markets ride
his "wave" theories: Rapidly unfolding, accelerating and intensifying
economic cycles. First the dot-com crash, then the subprime housing bull,
the credit meltdown, now the coming "Great Depression 2." In the '90s,
Prechter had another vision from deep in the forest. Again we ignored him.
No more. The same wisdom that let him "see" the 1980's bull years before it
took off, may accurately predict the coming 100-year bear market well ahead
of time. See previous Paul B. Farrell.
Nightmare scenario No. 4:
Pentagon 'warfare defines human life' In "Rashomon" they see all, we
nothing. In courtrooms, lawyers deceive, suppress the truth. Paulson and Fed
Chairman Ben Bernanke are masters of deception in the courtroom of public
opinion, as descendents of former Defense Secretary Donald Rumsfeld. One
intentional leak (obviously designed as a tactic to stoke public fear and
create budget support for the DOD's war machine) surfaced in the early days
of the Iraq War. Fortune analyzed a classified military report, the
Pentagon's "Weather Nightmare:" "Climate could change radically and fast.
That would be the mother of all national security issues ... massive
droughts, turning farmland into dust bowls and forests to ashes ... by 2020
there is little doubt that something drastic is happening ... an old pattern
could emerge; warfare defining human life." See previous Paul B. Farrell.
Today, as a "Great Depression" and a "100-year Bear Market" become more real
than a "Rashomon" sequel, ask yourself: Are there too many people? Too few
resources? Too many competing special interests? In America? Worldwide? Are
we all too greedy to compromise? Are we then left vulnerable to Paulson's
multiple Reaganomics "weapons of financial mass destruction," land mines
surviving his exit in bailout "sleeper cells," left to sabotage government
budgets, taxpayers and the future of America?
Today's news suggests we may already be
there, for the population explosion is the mother of all bubbles, a
"nuclear" bomb that will explode all other bubbles, ushering onto the "Rashomon"
stage a reality far beyond a 100-year bear, on a desolate, post-apocalyptic
WALL-E planet Earth. See previous Paul B. Farrell.
Nightmare scenario No. 5:
The Earth supports 6.5 billion
people. The United Nations predicts there will be 9.1 billion by 2050, all
competing against 400 million Americans for ever-scarcer resources. The L.A.
Times says that a U.N. report "paints a near-apocalyptic vision of Earth's
future: hundreds of millions of people short of water, extreme food
shortages in Africa, a landscape ravaged by floods and millions of species
sentenced to extinction." Today's news suggests we may already be there, for
the population explosion is the mother of all bubbles, a "nuclear" bomb that
will explode all other bubbles, ushering onto the "Rashomon" stage a reality
far beyond a 100-year bear, on a desolate, post-apocalyptic WALL-E planet
Earth.
Nightmare scenario No. 6:
Star Trek's bold new 'end of days' One "Star Trek: The Next Generation"
episode haunts me, much like "Rashomon." In it past and future collide. Set
in the 23rd century, "Inner Light" gives us a brief end-of-days look at the
star-crossed future of two civilizations, one boldly exploring new worlds,
the other leaving behind but a small sad trace of its mysterious
disappearance. Two planets, which is our metaphor? See previous Paul B.
Farrell. The Enterprise encounters a probe floating in space. Suddenly an
energy beam zaps Captain Picard. He wakes up on an alien planet. Recovering
from a fever he is "Kamin," can't recognize his "wife." Friends think he's
delusional, mumbling about being a starship captain. Trapped in this
parallel universe, time passes. Memories of his prior life fade. He falls in
love with his wife, raises a family, kids, grandkids, lives the peaceful
life he only imagined in space. But his new planet's resources gradually
disappear. Temperatures rise. Water scarcer. Desert lands spread. The
Pentagon scenario? Near the end, he watches a missile soar into space, an
intergalactic time capsule, a final record of a once-great civilization.
Suddenly the probe turns off. Picard awakes on floor of the Enterprise
bridge. Twenty minutes passed. Engine power returns. They continue boldly
going where no one has gone before, left with memories of a simple life on a
dying planet that vanished eons ago. Ask yourself: Are we boldly going
anywhere? Will someone, someday be reading our probe?
Nightmare scenario No. 7:
No-Growth Economics vs. Neo-Capitalism While Goldman former Chairman
Whitehead gave up, there is still a solution, one way to dodge the "Great
Depression 2," the "100-Year Bear." I reviewed this scenario in a recent
issue of Adbusters magazine, where legendary economist Herman Daly was
recently named "Man of the Year." The Center for the Advancement of the
Steady State Economy" says this new greener economic theory calls for
"stabilized population and consumption. Such stability means that the amount
of resource throughput and waste disposal remains roughly constant." In this
theory, all systems are in balance. "The key features of a steady state
economy are: sustainable scale, in which economic activities fit within the
capacity provided by ecosystems; fair distribution of wealth; and efficient
allocation of resources." This new economics may be what sustains the Star
Trek culture in the 23rd century, but unfortunately, it is unlikely to get
broad support in today's free market Reaganomics capitalism, let alone
support from America's political parties or any sovereign nations in today's
highly competitive international arena ... at least not until we've gone
past the point of no return, like that mysterious planet recorded on the
probe discovered in the 23rd century by Star Trek's Captain Picard. As in "Rashomon,"
we "see" many competing scenarios, "seen" through many competing "eyes.'
Yet, for the victims, the end game is always tragically irreversible. We
may, however, find some comfort in the "wave theory," for all waves emerge,
ripple, oscillate, accelerate until they inevitably self-destruct and fade.
Earth appears destined to accelerate to 9 billion ... exhausting Earth's
resources ... in a self-destructive Pentagon global warfare scenario ...
driven by another Great Depression ... and 100-year bear market. In the end
Whitehead said it all: "This is a road to disaster ... I don't see a
solution." Probe dims, fade to black. Or will we finally wake up ... and
take command of our starship?
"How to Create a Real Economic Stimulus Entitlement reform is key to
shrinking the ratio of debt to GDP and making room for pro-growth tax cuts,"
by Martin Feldstein, The Wall Street Journal, September 16, 2013 ---
http://online.wsj.com/article/SB10001424127887323595004579065361191486206.html?mod=djemEditorialPage_h
Earlier this year, former U.S. Treasury Secretary
Larry Summers expressed doubts about the Federal Reserve's quantitative
easing policy of buying $85 billion a month of government bonds and other
long-term assets. His skepticism antagonized some Fed insiders and liberal
Democrats, who recently opposed his consideration by President Obama as the
next Fed chairman.
When Mr. Summers on Sunday withdrew his candidacy
for the chairman's job, there was one immediate benefit: Now Larry Summers
will be free to voice an even clearer and stronger critique of current
policy.
The United States certainly needs a new strategy to
increase economic growth and employment. The U.S. growth rate has fallen to
less than 2%, and total employment is a smaller share of the population now
than it was five years ago. The official unemployment rate has declined
sharply (to 7.3% last month from 10% in October 2009) only because so many
people have stopped looking for work or are working part-time.
The Fed's monetary policy is no longer effective in
stimulating demand. The near-zero interest-rate policy and aggressive
quantitative easing, it has become increasingly clear, create dangerous
risks to future stability. The Fed's announcement in June that it will soon
reduce the rate of buying long-term assets raised long-term rates, slowing
the recovery in the housing market and other activity. And the unemployment
rate is approaching the 6.5% threshold that could lead the Fed to raise
short rates.
On the fiscal side, a replay of the $830 billion
"stimulus" in 2009 is politically out of the question. That poorly designed
package added more to the national debt than it did to aggregate spending.
The national debt has increased from 37% of gross domestic product before
the economic downturn to 75% now. The Congressional Budget Office warns that
the debt will remain at that level for the coming decade and then rise
rapidly as the aging population increases the cost of Social Security and
Medicare. The large projected national debt is a drag on the economy,
causing businesses and entrepreneurs to fear higher tax rates and a sharp
rise in interest rates when the Fed stops its massive bond purchases.
A successful growth and employment strategy would
combine substantial reductions in the relative size of the future national
debt with immediate permanent tax-rate cuts and a multiyear program of
infrastructure spending. The challenge is to reduce future government
spending by enough to make the ratio of debt to GDP predictably lower a
decade from now, despite the tax-rate cuts and near-term infrastructure
spending.
Fortunately, a relatively small change in annual
deficits would significantly shrink the debt ratio. With a national debt of
75% of GDP, a projected annual deficit of 4% of GDP would keep the debt
rising to 100% of GDP. In contrast, a deficit of 1% would cause the debt
ratio to decline year after year until it reaches 25% of GDP.
The only way to reduce future deficits without
weakening incentives and growth is by cutting future government spending.
The share of GDP devoted to defense and to nondefense discretionary programs
is already headed to its lowest level in the past half-century. Reducing
spending therefore requires slowing the growth of the benefits of
middle-class retirees and cutting the spending that is built into the tax
code.
Raising the age for full benefits is a simple but
powerful way to slow the cost of Social Security and Medicare. Thirty years
ago, Congress voted to increase gradually the age for full benefits from 65
to 67. Since then, the life expectancy at age 67 has increased by an
additional three years. Congress should vote now to continue raising the
full benefit age from 67 to 70. When that is fully phased in, the annual
cost of Social Security benefits would be reduced by about 20%, equivalent
to a saving in 2020 of $200 billion or about 1% of GDP.
Gradually raising the age of Medicare eligibility
in line with the age for full Social Security benefits would achieve a
budget saving of more than 1% of GDP in 2020 and later years. Individuals
between ages 65 and 70 could still enroll in Medicare by paying a fair
premium.
Limiting the tax breaks built into the tax code
would also help. The combination of tax credits, deductions and exclusions
increases the annual budget deficit by hundreds of billions of dollars.
Those tax breaks are really subsidies that should be seen as government
spending.
While many of the smaller tax subsidies should
simply be eliminated, it would be politically impossible to eliminate such
popular features as the deduction for mortgage interest or the exclusion of
employer payments for health insurance. A better alternative would be to
allow individuals to keep all of these tax benefits but to limit the amount
by which individuals can reduce their tax liabilities in this way to 2% of
adjusted gross income. This one change to the tax code would reduce the 2013
federal deficit by $140 billion or nearly 1% of GDP even if the deduction
for charitable contributions was fully retained.
Slower entitlement growth and reduced tax
expenditures should be phased in slowly to avoid weakening the recovery. But
by 2020 they could be producing annual savings equal to more than 3% of GDP.
With the future debt under control, it would be
fiscally responsible to enact permanent tax-rate reductions and an effective
short-term program of infrastructure investment in things like bridges,
airports and other projects that will boost demand. Each dollar spent on a
well-designed infrastructure program would increase GDP by a dollar or more,
unlike the 2009 "stimulus" program that spent its funds on transfer
payments, temporary tax cuts and other programs that did little to raise
total spending.
Lower personal tax rates would raise GDP by
increasing incentives for additional earning and increased entrepreneurial
activity. Bringing the U.S. corporate tax rate (35%) in line with the tax
rates in other industrial countries (closer to 25%) would spur investment
and production.
Continued in article
Bob Jensen's threads on entitlements ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
An Excellent Presentation on the Flaws of Finance, Particularly the Flaws
of Financial Theorists
A recent topic on the AECM listserv concerns the limitations of accounting
standard setters and researchers when it comes to understanding investors. One
point that was not raised in the thread to date is that a lot can be learned
about investors from the top financial analysts of the world --- their writings
and their conferences.
A Plenary Session Speech at a Chartered Financial Analysts Conference
Video: James Montier’s 2012 Chicago CFA Speech The
Flaws of Finance ---
http://cfapodcast.smartpros.com/web/live_events/Annual/Montier/index.html
Note that it takes over 15 minutes before James Montier begins
Major Themes
- The difference between physics versus finance models is that physicists
know the limitations of their models.
- Another difference is that components (e.g., atoms) of a physics model
are not trying to game the system.
- The more complicated the model in finance the more the analyst is trying
to substitute theory for experience.
- There's a lot wrong with Value at Risk (VaR) models that regulators
ignored.
- The assumption of market efficiency among regulators (such as Alan
Greenspan) was a huge mistake that led to excessively low interest rates and
bad behavior by banks and credit rating agencies.
- Auditors succumbed to self-serving biases of favoring their clients over
public investors.
- Banks were making huge gambles on other peoples' money.
- Investors themselves ignored risk such as poisoned CDO risks when they
should've known better. I love his analogy of black swans on a turkey farm.
- Why don't we see surprises coming (five
excellent reasons given here)?
- The only group of people who view the world realistically are the
clinically depressed.
- Model builders should stop substituting
elegance for reality.
- All financial theorists should be forced to
interact with practitioners.
- Practitioners need to abandon the myth of optimality before the fact.
Jensen Note
This also applies to abandoning the myth that we can set optimal accounting
standards.
- In the long term fundamentals matter.
- Don't get too bogged down in details at the expense of the big picture.
- Max Plank said science advances one funeral at a time.
- The speaker then entertains questions from the audience (some are very
good).
James Montier is a very good speaker from England!
Mr. Montier is a member of GMO’s asset allocation
team. Prior to joining GMO in 2009, he was co-head of Global Strategy at
Société Générale. Mr. Montier is the author of several books including
Behavioural Investing: A Practitioner’s Guide to Applying Behavioural
Finance; Value Investing: Tools and Techniques for Intelligent Investment;
and The Little Book of Behavioural Investing. Mr. Montier is a visiting
fellow at the University of Durham and a fellow of the Royal Society of
Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc.
in Economics from Warwick University
http://www.gmo.com/america/about/people/_departments/assetallocation.htm
There's a lot of useful information in this talk for accountics scientists.
Bob Jensen's threads on what went wrong with accountics research are at
http://faculty.trinity.edu/rjensen/theory01.htm#WhatWentWrong
"4 Reasons The American Dream Will Be Over Unless We Act," by John
Hawkins, Townhall, November 10, 2009 ---
http://townhall.com/columnists/JohnHawkins/2009/11/10/4_reasons_the_american_dream_will_be_over_unless_we_act
"Make no mistake about it, this generation is a
generation of thieves and the people who stole their parents and their
children’s money to make their own lives cushier are at it again. This time
the target is their grandchildren." --
Evan Sayet
Throughout American history, generations
of our countrymen took pride in leaving the country better than the one they
grew up in. Their attitude about sacrifice was summed up by this classic
quotation from
Tom Paine:
"If there must be trouble, let it be in
my day, that my child may have peace."
That is no longer the spirit that animates
our leaders or much of our country. Today, it's,
"If there must be trouble, let our
children and grandchildren handle it, so that I am not inconvenienced."
History is full of great nations that have
fallen from their lofty perches back into the ranks and the United States is
likely to be among them unless we change our attitude about the following
issues:
1) Takers Vs. Producers:
"In 1985, just
16.5% of filers paid no income tax." Today,
"roughly
120 million Americans – 40
percent of the U.S. population – are outside of the federal income tax
system."
Meanwhile, the top 50% of income earners
pay 97% percent of the income taxes. "In 1945, 41.9 workers supported each
(Social Security recipient), while today
only 3.3 workers support each retiree."
That number will continue to shrink.
In other words, we're developing into a
two-tiered society. Some people like to think of it as the "haves" and "have
nots." However, it would be more apt to describe it as the people who pay
the bills and the people who live off of the fruits of their labor.
This is an extraordinarily dangerous
development for our country. It makes us overly dependent on workers and
entrepreneurs who may flee the country or simply stop working as the burden
on them grows. It also leads to class warfare, with the producers becoming
increasingly resentful of an ever more demanding class of sows dining at the
government troth.
Of course, it's easy to be demanding when
you don't have to pay the full value of the services you receive. It's also
easy to be resentful when you don't get your money's worth in government
services and are treated as selfish for wanting to keep more of the money
you earned for yourself. This is not a recipe either for societal stability
or for long-term prosperity.
2) A degenerating society:
America's success has been because of our people, not because of our
government. It is almost impossible to overestimate the value our country
has gotten out of having a hard working, honest, charitable, patriotic,
culturally homogenous population.
Yet, the cultural elements that have made
this a great nation are under attack on every level. The stigma for taking
government assistance is fading, government is taking over the role of
charity, many liberals mock the idea of patriotism, divorce rates have grown
perilously high, support for gay marriage has increased, the percentage of
the population that's Christian is dropping, and multi-culturalism and even
dislike of America is replacing the idea of the Melting Pot.
The culture of a nation often tends to be
more resilient than people realize, but that doesn't mean it can be taken
for granted. If the bonds that hold us together disintegrate or the
fundamental decency of the American people is no longer a given, our nation
will no longer be great. As
Samuel Adams said back in 1779:
"A general dissolution of principles and
manners will more surely overthrow the liberties of America than the
whole force of the common enemy. While the people are virtuous they
cannot be subdued; but when once they lose their virtue then will be
ready to surrender their liberties to the first external or internal
invader."
3) Mounting debt: There's no peril
greater to this country's future than our rapidly increasing debt. We have
no idea how to pay for our Social Security and Medicare obligations, we seem
to be running larger and larger deficits every year, and neither political
party has the guts to make significant cuts in spending. Meanwhile, the
politicians in DC are so irresponsible that they're obsessed with adding yet
another cripplingly expensive entitlement program on top of the others we
already have now, despite the objections of the American people.
Could this lead to hyperinflation that
dramatically lessens the worth of a dollar? Could it, over the long haul,
give nations like China so much economic leverage over us that it would be
difficult to refuse them? Could the amount of money we have to pay in
interest on the debt become so odious that it could dramatically reduce
economic growth? Sadly, all of these scenarios are becoming more plausible
by the day.
4) Nuclear proliferation:
If we don't have the will to stop a "death to America" chanting terrorist
regime run by religious fanatics from getting nuclear weapons,
then
we don't have the will to stop any nation.
That's how it will be read across the Middle-East and across the world as
well if Iran gets nukes. Mahmoud Ahmadinejad and company wouldn't be alone
either. If they get nukes, we should expect at a minimum Egypt, Iraq,
Kuwait, Saudi Arabia to also build nuclear weapons. Once that genie is out
the bottle, it'll never be put back in and the United States will suffer
horribly as a result.
That's not just because of the much
greater potential for nuclear war and nuclear blackmail, but because the
strongest of all nations will always have a target on its back. Imagine
terrorists smuggling nuclear bombs into Los Angeles, DC, Chicago, and
Houston and then, after the explosion, not even being able to determine
which rogue nation produced the weapons that killed millions of Americans.
That's the future we're headed towards unless Iran is stopped and the
consequences will be more devastating than most Americans can imagine.
Continued in article
"Marx to Market: The economic crisis
has made the philosopher’s ideas relevant again, but the world shouldn’t forget
what Marx got wrong," by Peter Coy, Business Week, September 14, 2011 ---
http://www.businessweek.com/magazine/marx-to-market-09142011.html
. . .
Here’s the surprising thing, though: You don’t have
to sleep in a Che Guevara T-shirt or throw rocks at McDonald’s to
acknowledge that Marx’s thought is worth studying, grappling with, and
possibly even applying to our current challenges. Many of the great
capitalist thinkers did so, after all. Joseph Schumpeter, the guru of
“creative destruction” who is a hero to many free-marketeers, devoted the
first four chapters of his 1942 book, Capitalism, Socialism and Democracy,
to explorations of Marx the Prophet, Marx the Sociologist, Marx the
Economist, and Marx the Teacher. He went on to say Marx was wrong, but he
couldn’t ignore the man.
As misguided as Marx was about many things, and as
pernicious as his influence was in places like the U.S.S.R. and China, there
are pieces of his (voluminous) writings that are shockingly perceptive. One
of Marx’s most important contentions was that capitalism was inherently
unstable. One only has to look at the headlines out of Europe—which is
haunted by the specter of a possible Greek default, a banking disaster, and
the collapse of the single-currency euro zone—to see that he was right. Marx
diagnosed capitalism’s instability at a time when his contemporaries and
predecessors, such as Adam Smith and John Stuart Mill, were mostly
enthralled by its ability to serve human wants.
Marx has gotten an attentive reading recently from
the likes of New York University economist Nouriel Roubini and George
Magnus, the London-based senior economic adviser to UBS Investment Bank.
Magnus’s employer, Switzerland-based UBS, is a pillar of the financial
establishment, with offices in more than 50 countries and over $2 trillion
in assets. Yet in an Aug. 28 essay for Bloomberg View, Magnus wrote that
“today’s global economy bears some uncanny resemblances” to what Marx
foresaw. (Personal opinion only, he noted.)
Consider the particulars. As Magnus notes, Marx
predicted that companies would need fewer workers as they improved
productivity, creating an “industrial reserve army” of the unemployed whose
existence would keep downward pressure on wages for the employed. It’s hard
to argue with that these days, given that the U.S. unemployment rate is
still more than 9 percent. On Sept. 13 the U.S. Census Bureau released data
showing that median income fell from 1973 through 2010 for full-time,
year-round male workers aged 15 and up, adjusted for inflation. The
condition of blue-collar workers in the U.S. is still a far cry from the
subsistence wage and “accumulation of misery” that Marx conjured. But it’s
not morning in America, either.
Marx loved to bash French economist Jean-Baptiste
Say, who argued that general gluts cannot exist because the market will
always match supply and demand. Marx argued that overproduction was in fact
endemic to capitalism because the proletariat isn’t paid enough to buy the
stuff that the capitalists produce. Again, that theory has lately been hard
to dispute. The only way blue-collar Americans managed to maintain
consumption in the last decade was by overborrowing. When the housing market
collapsed, many were left with crippling debt. The resulting default
nightmare is still playing itself out.
Admirers of Marx view all this with a rueful
I-told-you-so. The radical geographer David Harvey, 75, has taught Marx’s
Capital for 40 years at schools including Oxford University, Johns Hopkins
University, and now the City University of New York Graduate Center.
Harvey’s office, a block from the Empire State Building, is decorated with a
silk-screen portrait of Marx, glowering from a bookcase. Harvey believes, as
Marx did, that capitalists tend to sow the seeds of their own destruction.
Unbridled capitalism tends toward wild excess, so complete deregulation is
actually disastrous for it in the long run, the professor argues. “The
Republican Party is en route to destroy capitalism,” Harvey says in a
pleasant tone, “and they may do a better job of it than the working class
could.”
But wait. What Marx and his acolytes
underappreciated was capitalism’s power to heal itself. It may have been his
fatal intellectual mistake. The Communist Manifesto said that when the
workers’ revolution came, it would bring free public education for children
and the abolition of “children’s factory labor in its present form.” And
yet, as it turned out, the world didn’t require a proletarian revolution for
those social reforms to occur; all it took was enlightened capitalism.
Doctrinaire Marxists love to say that the economic
“base” determines and controls the sociopolitical “superstructure,” but the
reverse can be true as well. Political leaders have corrected capitalism’s
excesses again and again, as in President Teddy Roosevelt’s trustbusting
campaign, President Franklin Roosevelt’s New Deal, and President Lyndon
Johnson’s Great Society.
Now, once again, unbridled capitalism is
threatening to undermine itself. The world’s biggest banks, financially weak
but politically powerful, are putting the screws on borrowers in an attempt
to rescue their own balance sheets. Likewise, creditor nations such as China
and Germany are attempting to shift the pain of rebalancing onto debtor
nations, even though squeezing them too hard threatens to cause an economic
and financial disaster.
It’s time for another burst of enlightenment. In
years past, Britain’s John Maynard Keynes and America’s Hyman P. Minsky
(author of Stabilizing an Unstable Economy) did capitalism a service by
diagnosing its tendency toward crisis and advising on ways to make things
better. The sooner policymakers today “recognize we’re facing a
once-in-a-lifetime crisis of capitalism,” as Magnus writes, “the better
equipped they will be to manage a way out of it.” Grasping the ways in which
Marx was right is the first step toward making sure that his predictions of
capitalism’s downfall remain wrong.
A Story About Joe and Mary Starbacks in Cuba
Joe and Mary Starbacks "worked" for a short time in the Cuban Coffee
House in Havana. Actually they did not really work very hard and mostly took
long and frequent coffee breaks where they spread a map of America on a
table and dreamed of where they might live the American Dream one day. They
learned from an old National Graphics Magazine that the Pacific
Northwest is a particularly nice place to live.
They soon quit their jobs when they discovered that by pooling their
Cuban Ration Books they could do about as well not working as working. Then
they started a small black market business by pushing a coffee making cart
along busy streets of Havana.
They could only have a small black market business, because anybody in
Cuba is sent to prison for becoming wealthy unless they are members of the
elate in the Cuban Communist Party.
After they prospered in America they agreed completely with the
assessment of Fidel Castro about what's wrong with communism and socialism:
"Report: Castro says Cuban model doesn't work," by Paul Haven.
Associated Press, Yahoo News, September 8, 2010 ---
http://news.yahoo.com/s/ap/20100908/ap_on_re_la_am_ca/cb_cuba_fidel_castro_5
Fidel Castro told a visiting American
journalist that Cuba's communist economic model doesn't work, a rare
comment on domestic affairs from a man who has conspicuously steered
clear of local issues since stepping down four years ago.
The fact that things are not working
efficiently on this cash-strapped Caribbean island is hardly news.
Fidel's brother Raul, the country's president, has said the same thing
repeatedly. But the blunt assessment by the father of Cuba's 1959
revolution is sure to raise eyebrows.
Jeffrey Goldberg, a national correspondent for
The Atlantic magazine, asked if Cuba's economic system was still worth
exporting to other countries, and Castro replied: "The Cuban model
doesn't even work for us anymore" Goldberg wrote Wednesday in a post on
his Atlantic blog.
He said Castro made the comment casually over
lunch following a long talk about the Middle East, and did not
elaborate. The Cuban government had no immediate comment on Goldberg's
account.
Since stepping down from power in 2006, the
ex-president has focused almost entirely on international affairs and
said very little about Cuba and its politics, perhaps to limit the
perception he is stepping on his brother's toes.
Goldberg, who traveled to Cuba at Castro's
invitation last week to discuss a recent Atlantic article he wrote about
Iran's nuclear program, also reported on Tuesday that Castro questioned
his own actions during the 1962 Cuban Missile Crisis, including his
recommendation to Soviet leaders that they use nuclear weapons against
the United States.
Even after the fall of the Soviet Union, Cuba
has clung to its communist system.
The state controls well over 90 percent of the
economy, paying workers salaries of about $20 a month in return for free
health care and education, and nearly free transportation and housing.
At least a portion of every citizen's food needs are sold to them
through ration books at heavily subsidized prices.
President Raul Castro and others have
instituted a series of limited economic reforms, and have warned Cubans
that they need to start working harder and expecting less from the
government. But the president has also made it clear he has no desire to
depart from Cuba's socialist system or embrace capitalism.
Fidel Castro stepped down temporarily in July
2006 due to a serious illness that nearly killed him.
He resigned permanently two years later, but
remains head of the Communist Party. After staying almost entirely out
of the spotlight for four years, he re-emerged in July and now speaks
frequently about international affairs. He has been warning for weeks of
the threat of a nuclear war over Iran.
Castro's interview with Goldberg is the only
one he has given to an American journalist since he left office.
A Story About Joe and Mary Starbacks in America
After sneaking into Miami, Joe and Mary Starbacks immediately commenced a
long bus trip to Seattle. They only had $2,000 of hard earned black market
profits in their pockets, but in Seattle they managed to borrow $10,000 from
the giant Washington Mutual (WaMu) Bank. Before it went bankrupt in 2009,
WaMu had a reputation of making loans to almost anybody who came off the
streets into a WaMu branch.
Joe and Mary commenced Starbacks Coffee House Number 1 on a busy downtown
Seattle street corner. They worked about 18 hours each day blending superior
coffee, baking great pastries, and keeping their store and bathrooms
spotless. They themselves rarely ever took a break during any day and put
off their dreams of having a family. This was a lot different than working
for a coffee house in Cuba. In Seattle they owned the store.
After the enormous financial success of their first store, they
opened Starbacks Coffee House Number 2 in Tacoma.
After ten years of booming success they opened Starbacks Coffee House
Number 8,317 in Miami.
Joe and Mary do indeed still live the great American Dream.
How Capitalism, Ambition, and Risk Taking are Fueled by the
Fires of Greed
Probably the best video ever made about how greed
fuels the fires of capitalism, ambition, and risk taking ---
http://www.youtube.com/watch?v=RWsx1X8PV_A
Now to your question Raza:
A serious wealth tax douses the fires of greed,
ambition, risk taking, and capitalism in general,
A serious wealth tax is quite simply a ploy to defeat capitalism and replace
it with egalitarian socialism or Cuban so-called communism
There are of course less-serious taxes on the wealthy such as enormous
property taxes on their mansions and luxury taxes on their yachts. But I
think you had more serious egalitarian wealth taxes in mind that destroy
capitalism, ambition, and risk taking.
Another fall out of serious wealth tax is that the wealthy flee with
their money to places like Switzerland.
Wealthy artists and authors flee to Ireland where they can live virtually
tax free.
"The Real Pending Crisis: Public Pensions," by Bruce Bialosky,
Townhall, November 2, 2009 ---
http://townhall.com/columnists/BruceBialosky/2009/11/02/the_real_pending_crisis_public_pensions
President Obama often states that the
federal budget cannot be balanced without health insurance reform. Even if
that were true, the real crisis that exists already and will only worsen
over time comes from the horrendous obligations taken on by state and local
governments for public employee pension plans.
Keith Richman caught on to this problem
while a California Assemblyman. He has formed the non-profit California
Foundation for Fiscal Responsibility to educate elected officials and the
public on the looming budget disaster. Fortunately, he is not the only one
touting this pending mess. Ron Seeling, the Chief Actuary for CalPERS (the
California public employees’ retirement program), has stated the plan is
unsustainable. CalPERS represents state employees and 1,500 local
governmental entities.
Some would say the pension problem starts
with the unionization of public employees. In California, the major catalyst
was SB400, signed by Gray Davis in his first year in office, 1999. The bill
lowered retirement age for public safety employees to 50 years old and to
non-public safety employees to 55 years old. We are in an era when people
are living on average until around 80 years old.
The law gives the employee pension
benefits of 3.0% of their final income for each year of service. It also
made the 3.0% amount retroactive to the beginning of their employment
period. That means if you work 20 years you receive a pension benefit equal
to 60% of your final income. The problem was compounded by how they
calculated the income on which to base the pension.
Everything including the kitchen sink adds
to the final income level. Things such as auto allowance and bonuses boost
the final number. If the employee did not use vacation pay or holiday pay
for the prior 10 years that adds to the base salary to determine the income.
Understanding that in most private sector jobs when you do not use your
vacation, you lose your vacation, the ability to accumulate vacation time
opens up the system for vast manipulation. Peter Nowicki, the Moraga Orinda
fire chief, retired at age 50. His final salary was a whopping $185,000, but
small compared to his annual pension benefit of $241,000. Making that matter
worse, Nowicki was hired as a consultant to the fire department for an
additional $176,000 per year -- on top of his retirement benefit.
This is not an isolated case. In Los
Angeles County there are over 3,000 people receiving greater than $100,000
per year in pension benefits. In San Francisco, it was found that 25% of
employees’ income spiked up over 10% in the final year of their work. The
San Francisco grand jury found that amount cost the city $132 million.
Some would argue why not game the system?
Let’s say you start working for the government when you are 30 years old and
work for 25 years. Your final income with all the fancy calculations ends up
at $120,000. That means you would receive $90,000 plus full health care
benefits. You can either live on that very nice retirement or you are free
to get another position. After all, being 55 years old, you are still in
your prime earnings years. Where in the private sector are there comparative
opportunities?
These kinds of retirement ages and
benefits are why the estimated unfunded liability is soaring. California has
estimated unfunded pension and health care liabilities ranging from $100 to
$300 billion. The school systems operate under their separate pension
program – CalSTRS. The Los Angeles Unified School System estimate for
unfunded retiree benefits comes in at about $10 billion. That is one school
system, be it the largest, in one state. Estimates show that the LAUSD will
soon carve out 30% of its budget for combined retiree health and pension
benefits.
California may be the worst example, but
not the only example of deplorable financial planning by governmental
entities. The original justification for rich benefits for public employees
centered on lower salaries, but that no longer rings true. A recent analysis
by the U.S. Bureau of Economics shows that federal employees receive
compensation that is double the average of the private sector. Other studies
have shown state and government employees to be receiving like levels of
compensation.
The genesis of this pending disaster comes
from the right of public employees to unionize. This was not always so. The
first opportunity occurred in 1958 in New York City under Mayor Robert
Wagner. President Kennedy instituted the right for federal employees to
unionize in 1962. Since then the right for public employees to unionize has
spread, but is not universal. States that have more restrictive laws have
blocked public employee unions and thus have not suffered the consequences.
In states like California, the public
employee unions fund huge political campaigns. To most observers, the unions
have a stranglehold on the state legislature, Los Angeles and San Francisco
city governments, and most if not all of the school districts in the state.
When the employees control the employers, the results are uncontrollable
obligations.
A recent report stated that children born
today will live an average life span of 100 years. With public employees
retiring at 50 or 55 years of age, it doesn’t take a deep thinker to
extrapolate that these retirement benefit programs are unsustainable.
Private sector employees now receive less
annual income than their public counterparts. Private sector employees will
have to work well into their seventies to pay for these public sector
employees’ retirement benefits which far exceed what the private sector
offers. The public will, little by little, become aware of this upside-down
arrangement. Heroes like Keith Richman are sacrificing to make the public
aware of this coming debacle. Our elected officials need to heed his
warnings.
U.S. Debt/Deficit Clock ---
http://www.usdebtclock.org/
IOUSA (the most frightening movie in American history) ---
(see a 30-minute version of the documentary at
www.iousathemovie.com
).
Bob Jensen's threads on the entitlements crisis ---
http://faculty.trinity.edu/rjensen/entitlements.htm
"Seizing pensions, the final step to bankruptcy," Pravda, November 10,
2008 ---
http://english.pravda.ru/world/americas/10-11-2008/106678-pensions-0
As these late autumn days of financial
disaster wind down into a winter of discontent across the world, the United
States Congress is discussing a step that will surely signal the final
collapse of America as anything more than a bankrupt and possibly failed
state.
What is this subject? The subject is none
other than pensions, the last refuge of money and the last source of fast
cash for spend thirsty politicos. In committees the US Congress is hearing
testimony from various leftist professors on how to redistribute, read
spend, the vast amount of money accumulated by the 60 million Americans at
or near retirement age.
What most of you, my dear readers, do not
understand, is that in America there is no longer such a thing as a pension
fund. These are dinosaurs, the last of which are paying out their monies, on
the way to total extinction. To replace these the government of America
created tax exempt (to a certain dollar per year value) accounts called
401Ks which are than invested into the stock markets, thus a great boom for
the number one owners of the United States government, banks. But the banks
are now themselves bankrupt and hold much less sway in DC, even as appetites
to spend have grown amongst the One Party, Two Branch politicos. Sure there
is Social Security, but even by under rating inflation by 2/3rds, and thus
upward payment adjustments, for over 20 years the United States government
is simply broke and does not have the actual money to pay Social Security
for the vast Baby Boomer generation, now retiring.
This is because all the money, from day
one in 1936, was spent and not invested. Each working generation pays for
the retiring generation. What changed? The Baby Boomers aborted 40 million
babies and thus are now larger than the combined next two generations. In
their Christless greed to spend on themselves, they have not only damned
their souls through the murder of children but their old age as well, to
poverty.
But even when Social Security pays, for
most people, the $2,000 to $3,000 it does pay per month is hardly the money
to live off of, let alone pay for ever more expensive medicines. The medical
costs in America routinely grow between 15-20% per year, while salaries at
best on average at 3-4%. This is all the product of short sightedness and
greed. The bill has come due and a large percentage has been added for
gratuity. The Devil will have his kilogram of flesh from a people who have
forsaken Christ for pride, vanity and greed.
So what is being contemplated by the
American Congress?
From a Brussels' Think Tank
THE FREEDOM NETWORK AUDIO PORTAL ---
http://workforall.net/audio-library-of-economics.html
Audio modules on
Economics,
Money,
Social Security,
Liberty,
Strategy &
Public Policy
From Jim Mahar's Finance Professor Blog on May 31, 2009
Free & Easy Access to worldwide Broadcasts on Economics, Social Security,
Policy and Strategy
THE FREEDOM NETWORK AUDIO PORTAL - Free & Easy Access to worldwide
Broadcasts on Economics, Social Security, Policy and Strategy: "Podcasts on
Economics, Social Security, Strategy, Liberty & Public Policy"
Wow. Amazing stuff. Thanks to Wayne Marr for point it out.
A Sobering Paper from the University of Pennsylvania
"Think the Credit Crisis Is Bad? Coalition Sees Bigger Problems Down the Road,"
Knowledge@Wharton, October 29, 2008 ---
http://knowledge.wharton.upenn.edu/article.cfm;jsessionid=9a30144044b07a406280?articleid=2077
When most people look at the turmoil in
the American economy over the last month -- wild gyrations in the stock
market, giants of finance failing or requiring government rescue, rising
unemployment, sinking home prices and a wave of mortgage foreclosures --
they see an immediate crisis and a bleak future.
But Alice Rivlin, who was head of the U.S.
Office of Management and Budget in the Clinton administration, also sees an
opportunity. Rivlin was among a number speakers who came to the University
of Pennsylvania recently as part of a "Fiscal Wake-Up Tour" organized by a
bipartisan coalition of think tanks and government watch-dog groups trying
to focus voters on America's mounting debt. A Wharton department was among
the sponsors of the tour's recent visit to the university.
Rivlin said she has long believed that
only a short-term crisis atmosphere might spur political leaders in
Washington to make some of the difficult long-term choices to head off a
rising tide of red ink. "I have said that a mini-crisis would actually be
useful, something like a rapid plunge in the dollar," said Rivlin, currently
director of economic studies for the liberal-leaning Brookings Institution.
Instead, she said, the much larger economic storm now unfolding could
convince Washington -- as it is pressed to take bold and sometimes unpopular
action related to the credit crisis -- to wrap in some forward-looking
solutions to rising costs associated with Medicare, Social Security and
Medicaid -- costs that will make the taxpayers' Wall Street rescue effort,
which could amount to more than $1 trillion, seem petty by comparison. A
General Accounting Office study concluded that in less than 20 years, the
cost of Social Security and Medicare will exceed all government revenues.
David M. Walker -- president and CEO of
the Peter G. Peterson Foundation, a non-profit that focuses on the national
debt and related challenges -- agreed with Rivlin that the current economic
crisis could be a teachable moment for the nation's leaders about the risks
of fiscal inaction. "They waited for a crisis until they did something about
it," said Walker, referring to the credit logjam that has locked up the flow
of credit that lubricates the economy. When it comes to government action on
tough economic issues, he said, "the system is dysfunctional."
Walker, Rivlin, and their co-panelists --
Robert L. Bixby, executive director of the debt-fighting Concord Coalition,
and Stuart M. Butler, vice president for domestic and economic policy
studies for the conservative-leaning Heritage Foundation -- are carrying on
the Fiscal Wake-Up Tour that was launched back in 2005. Since the beginning,
the campaign has been trying to persuade Americans to pay less attention to
day-to-day ups and downs of Wall Street and the U.S. economy, and focus more
on the bigger picture of projections for the staggering future costs of
federal entitlements.
Bringing the Message to Battleground
States
The tour's visit to the Penn campus was
co-sponsored by Wharton's Business and Public Policy Department as well as
the Annenberg School for Communication, the Department of Political Science,
the Fels Institute of Government and the Fox Leadership Program. Officials
said the selection of Pennsylvania -- a key battleground state in the
presidential election less than three weeks away -- is part of the Fiscal
Wake-Up Tour's strategy of visiting key states right before major political
events such as the New Hampshire primary or Iowa caucuses. Its ultimate
goal, organizers said, is a better-informed electorate.
"We're trying to elevate the issue in
front of key constituencies in key states," Bixby said. He later noted that
many of the group's events have been held on college campuses because the
anti-debt coalition believes any solution will ultimately come from greater
involvement by the generation now voting for the first time. "If young
people get involved, and we can view the situation as a leadership problem,
we'll go a long way toward getting it solved."
The broader problem quite simply is this:
America is already dangerously deep in debt, and will soon see an explosion
in costs to provide Social Security, Medicare and other entitlements it has
promised to tens of millions of retiring and soon-to-retire baby boomers.
While federal spending is now roughly 20% of the American gross national
product, which has been relatively constant in the last half-century, that
ratio could rise as high as 42% by 2050 if current federal policies on
entitlement spending and taxes remain unchanged, according to Bixby. That
would be the same rate as when the U.S. was waging World War II. The impact
would fall hardest on today's young people.
Driving this projection are the ticking
time bombs of benefit obligations to retirees and impoverished families
under Medicare, Medicaid and Social Security. Over the next three decades,
the percentage of Americans older than 64 will grow from 13% to 20% even as
health care costs continue to increase faster than inflation.
We Suggest... Richard Marston and Jeremy
Siegel: Will the Bank Plan Revive Global Markets?
Do the Answers to Our Current Financial
Woes Lie in the Past?
The Candidates on Taxes: Finding the Devil
in the Details
Obama and McCain: Different -- and
Evolving -- Visions for the U.S. Economy
What's Ahead for the Global Economy in
2008? Reports from the Knowledge@Wharton Network Walker, who was formerly
the nation's top auditor as its Comptroller General, said unrestrained
health care policies are a recipe for fiscal disaster. "We're the only
country on the face of the earth that is currently writing a blank check for
health care because every other country that has done that has gone
bankrupt."
'Arithmetic, Not Ideology'
"It's a matter of arithmetic, not
ideology," said Bixby, whose bipartisan Concord Coalition was founded by
Warren Rudman, a former Republican senator; the late Paul Tsongas, who
served in the Senate as a Democrat; and Pete Peterson, who was Secretary of
Commerce in the Nixon administration. Bixby believes part of the problem is
that Americans have been too willing to buy into certain myths about our
fiscal policies, including the notions that we can close our budget gap
simply through growing the economy and increasing revenues, or just by
eliminating waste, fraud and abuse in federal spending.
Several speakers emphasized that while
their Wake Up Tour can be heavy on charts and graphics outlining the grim
mathematics of the problem, the real problem with profligate government
spending has a moral component: Is it right for the current generation to
take on obligations and hand the bill to the next generation? Walker
concluded his presentation with a slide showing his three grandchildren who
will inherit the massive debt. "It's really not a fiscal issue," agreed
Bixby. "It's a moral issue."
The speakers acknowledged that -- given
the wide range of their ideological views -- they do not necessarily agree
on all the solutions to the problem, but they want their audience to
understand what the choices are -- continued but unsustainable borrowing
from overseas sources such as China or the oil-producing nations of OPEC,
raising taxes, or making decisions on spending cuts and priorities that so
far have proved too difficult for political leaders. In fact, the political
hurdles have been so great that some -- including the current co-chairs of
the Concord Coalition, Rudman and ex-Democratic senator Bob Kerrey -- have
suggested that the only solution would be the creation of a bi-partisan
panel to devise a set of solutions that Congress would be required to accept
or reject without amendment.
Where to start? Rivlin suggested that
longer-term solutions could be wrapped into the current legislative effort
to attack the credit crunch and expected recession. For example, she said,
"a relatively easy thing to do" would be to gradually raise the retirement
age. That would have no impact on current retirees, but would provide
significant long-term savings for Social Security.
Butler, of the Heritage Foundation, noted
simply raising taxes to cover the deficit is not a likely solution. By 2050,
he said, balancing the budget with tax increases but no other policy changes
would mean raising marginal income taxes on the wealthiest top bracket to
88%, with a 63% higher levy on the second bracket that comprises much of the
middle-class. "If there's a moral problem with passing the debt along to
younger people, is raising taxes and taking their money any less immoral?"
he asked. He also doubted that Congress would use such additional revenue
for debt reduction. If you believe it would, he said, "you're probably one
of those people who think professional wrestling is real."
A more likely scenario, as outlined by
Butler, would be to look at the most sensible ways to make the benefits that
now go to American retirees more affordable, such as reconsidering the
current prescription drug benefits for seniors and whether they should be
extended to the wealthiest citizens. He noted that billionaire Warren
Buffett now receives the same drug benefit as a low-income retiree. The
Heritage Foundation expert also said America needs to do a much better job
encouraging private citizens to save for the future, citing a recent study
that the lowest income households, making less than $13,000 a year, spend an
average of 9% of that income on lottery tickets.
Indeed, several of the speakers agreed
that the Baby Boom generation now running the country has never been asked
to sacrifice and rarely asks such measures of citizens. At the same time, he
noted, America's consumer-oriented economy and the rise of relatively cheap
credit beginning in the 1980s has resulted in a national personal savings
rate of zero. On top of that, Butler political debate has been dragged down
in some ways by the rise of the Internet and especially cable television,
which "emphasizes conflict while dialogue is eliminated."
In the meantime, the speakers said that
ongoing federal deficits -- and a debt service that now costs $238 billion
annually and is growing sharply -- are squeezing programs that could make
America more competitive in the global economy. These would include a
massive program to repair the nation's crumbling infrastructure as well as
improving education and health care, especially for children in low-income
families. "The large middle class is our backbone, but we can't compete on
wages in this country," Walker said, stressing instead the need for a better
educated workforce and also for a health care system that delivers better
results for the money. "We're mortgaging our future and increasing our
obligation on the backs of young people at the same time that we're
investing less in them," he warned.
Yet, according to Rivlin, despite all the
controversy about the government's current dramatic efforts to deal with the
immediate financial crisis, these measures may not contribute much to
solving the debt problem. She acknowledged that the Treasury may recover
some of the $950 billion it has pledged to unlock credit markets and
stabilize key banks, and that a new economic stimulus package under
discussion in Congress might stave off a lengthy recession that would also
sap tax revenues. "But the danger," she warned, "is that we will lose all
discipline, that the recession will be the excuse" to delay difficult
choices.
Still, there seemed to be a general
consensus among the speakers that the current crisis could raise the
public's awareness and interest in a long-term solution to government debt.
"There's nobody to bail out America," said Walker, "so the sooner we get
started, the better."
"Reinventing the American Dream," by Christopher Jencks, Chronicle of
Higher Education, October 17, 2008 ---
http://chronicle.com/free/v55/i08/08b00601.htm?utm_source=cr&utm_medium=en
The American Dream sounds like apple pie and motherhood. Everyone is for it.
But when everyone endorses an ideal, whether it's
the American Dream, equal opportunity, or justice, you can be pretty sure
that they disagree about what the ideal means, and that the appearance of
agreement is being achieved by talking past one another.
There are at least two competing versions of the
American Dream, and they are not only different but mutually incompatible.
Perhaps even more alarming is the fact that they will both need to be
reinvented if our children and grandchildren are to inhabit a livable
planet.
In one version, this country is the place where
anyone who builds a better mousetrap can get rich. To do that, the mousetrap
builder will need a lot of help: workers to make the mousetraps, salespeople
to put them in the hands of consumers, and security guards to prevent the
world from beating a path to the inventor's door and helping themselves. In
order to get rich, mousetrap developers will also have to pay their workers
far less than they make themselves. Otherwise there won't be enough money
left over from mousetrap sales to make the inventor rich.
This version of the American Dream emphasizes
individual talent and effort. It favors freedom and opposes government
regulation. And it belongs to the Republican Party.
Democrats have another version of the American
Dream: Everyone who works hard and behaves responsibly can achieve a decent
standard of living. But the definition of a decent standard of living is a
moving target. For those who came of age before 1950, it usually meant a
steady job, owning a house in a safe neighborhood with decent schools, and
believing that your children would have a chance to go to college even if
you did not.
True, lots of people who worked hard and behaved
responsibly didn't realize this dream. Blue-collar workers were laid off
during recessions through no fault of their own, and their jobs often
disappeared when technological progress allowed employers to produce more
stuff with fewer workers. Still, more and more people achieved this dream
between 1945 and 1970, so the Democratic version of the American Dream had
broader appeal than the Republican version, in which a smaller number of
people could get much richer.
Since the early 1970s, however, all that has
changed.
The American economy has been under siege. Real per
capita disposable income has continued to grow, but the average annual
increase has fallen, from 2.7 percent between 1947 and 1973 to 1.8 percent
between 1973 and 2005. Of course, even a 1.8-percent annual increase in
purchasing power is far more than the human species achieved during most of
its history, and it is also far more than we are likely to achieve in the
future unless we do a lot of creative accounting.
What transformed the political landscape was not
the slowdown in growth but the distributional change that accompanied it.
From 1947 to 1973, the purchasing power of those in the bottom 95 percent of
the income distribution rose at the same rate as per capita disposable
income, about 2.7 percent a year. Among families in the top 5 percent, the
growth rate was 2.2 percent. From 1973 to 2006, however, the average annual
increase in the purchasing power of the bottom 95 percent was only .6
percent. The top 5 percent, in contrast, managed to maintain annual growth
of 2.0 percent, which was almost the same as what they enjoyed before 1973.
That's a lot of numbers, but what my students at
the Kennedy School call the "take-away" is pretty simple: After 1973, when
economic growth slowed, America had a choice. We could have tried to share
the pain equally by maintaining the social contract under which living
standards had risen at roughly the same rate among families at all levels.
Or we could have treated the slowdown in growth as evidence that the
Democratic version of the American Dream didn't work, and that we should try
the Republican version, in which we all look out for ourselves, some people
get rich, and most get left behind.
We chose the Republican option.
That formulation is deceptive, of course, because
voters did not have a clear choice. Many Democratic politicians accepted the
Republican argument that the cure for slower growth was to make markets more
competitive and government regulation less onerous. Very few Democrats
argued that an adverse shift in the distribution of private-sector earnings
was something the government should insure Americans against, like a
Mississippi flood or a terrorist attack on the World Trade Center. In that
respect the Democrats were very different from the parties of the left in
Western Europe, but quite similar to the parties of the left in most other
English-speaking countries.
One reason for Anglophone caution about protecting
the citizenry from an adverse shift in the distribution of income is that
English-speaking economists (which is to say almost all economists, even in
non-English-speaking countries) were mostly blaming the rise in economic
inequality on what they called "skill-biased technological change." That
argument was correct as far as it went, but it didn't go very far and was
therefore deeply misleading.
In their new book, The Race Between Education and
Technology (Belknap Press/Harvard University Press, 2008), Claudia Goldin
and Lawrence F. Katz argue — convincingly, in my view — that demand for
skilled workers has indeed risen since 1973. But they also argue that demand
for skilled workers rose no faster after 1973 than it had between 1910 and
1973.
What changed was that before 1973, the supply of
skilled workers grew at about the same rate as demand, so relative wages
were fairly stable. After 1973 the supply of skilled workers grew far more
slowly, even though demand kept rising. That imbalance played a significant
role in raising inequality, at least between 1975 and 2000.
Between 1940 and 1980, the number of years of
school completed by the average worker rose almost one year every decade
(actually, .86 years). Between 1980 and 2005, the increase was only half
that (.43 years per decade). If you exclude GED's, administrative data
indicate that high-school graduation rates have hardly changed since the
early 1970s. At the same time, immigration has increased the supply of
unskilled workers.
Those changes might not have led to a deterioration
of wages and working conditions among unskilled workers if we had tried to
protect their livelihoods, but we didn't. Congress and presidents let the
minimum wage lag farther and farther behind inflation from 1981 to 2006.
Large employers and the National Labor Relations Board made it harder to
organize unions. Weaker unions found it harder to protect their members, and
that, in turn, reduced the number of workers who wanted to join.
Again, this is a complicated story, but the
take-away is pretty straightforward. Since 1973 both the federal government
and the states have made less effort to raise the educational attainment of
the young. They have also made less effort to protect the incomes of the
less educated.
Why should that be? I'm not sure, but I have a
hypothesis. Forty-some years ago, I was attending a White House conference
on higher education and ran into Edmund G. (Pat) Brown, who was then
governor of California, as we waited for an elevator. I had been studying at
the University of California, and I asked him about the university's budget
problems.
Brown, a Democrat, said the university always had
budget problems when the Democrats controlled the state. Having always
thought of Democrats as big spenders and friends of education, I was
startled and asked why, just as we reached his floor. His parting answer was
(roughly): "Democrats want to spend money on everything; Republicans only
want to spend money on highways and the university, where they went and
expect to send their children."
I don't know if that hypothesis holds up
empirically, but I do think one big reason we have done so little to raise
educational attainment since 1973 is that both federal and state budgets are
much tighter. We cut the share of the gross domestic product going to
national defense from 10 percent in 1959 to 5.5 percent in 1973 to 4.0
percent in 2006. But since 1973, that reduction has been more than offset by
the government's increased spending on health care and Social Security. Even
expenditures per student on K-through-12 education have risen faster than
expenditures per student on higher education. According to the National
Center for Education Statistics, expenditures per student in public
elementary and secondary schools doubled between 1970-71 and 2000-1, even
adjusted for inflation. Real expenditures per student in public colleges and
universities rose only 35 percent during that period.
One alternative to keeping young people in school
longer might have been to regulate the economy in ways analogous to what
Germany, France, the Low Countries, and Scandinavia did to keep wages
relatively equal. In truth, though, we would have had to both expand
education and regulate the labor market to keep alive the Democratic version
of the American Dream. Regulation arouses even more resistance from
employers than does taxation. And unlike their European counterparts,
American employers usually have something close to a veto over policy
changes that don't involve national security.
Employers argue that regulating the market drives
up costs and slows job growth. Growth statistics for the past 50 years offer
some support for that claim. But since 1970, annual growth has been only
about a tenth of a percentage point higher in inegalitarian countries than
in egalitarian countries. To be sure, income is not all that matters, and
dumb regulations can certainly slow job growth and generate high
unemployment. But there is no reason why egalitarian regulations have to be
dumb.
In any case, few Democratic politicians think
voters would accept that approach to solving the economic problems of the
bottom 95 percent, and I think they are right, at least in the short run. In
the long run, a concerted effort to revive a Democratic version of the
American Dream might change the rhetorical environment, but meanwhile, the
Democrats would have to resign themselves to a long period in the
wilderness, with no assurance that their strategy would ever appeal to most
voters. Few politicians want to take such a risk.
"Debtor Nation," by Clive Crook, Chronicle of Higher Education,
October 24, 2008 ---
http://chronicle.com/weekly/v55/i09/09b09901.htm?utm_source=cr&utm_medium=en
The intense financial crisis that started in the
American housing market is going to make it difficult, for quite a while
yet, to concentrate on remoter issues such as demographic pressures and
long-term trends in saving. That is a pity, because when legislators are
ready to turn their attention back in that direction, the problems
confronting them will be that much worse. Americans are saving less, living
longer, and retiring in a cluster. It is a potent combination that will
profoundly disrupt the country's economy and politics. The government, the
financial markets, and the ordinary households of the United States seem
equally unprepared.
Fiscal stress is just one manifestation. Within a
decade or so, payments from the Social Security system will exceed tax
revenues paid in. Keeping benefits at the present level will eventually
require tax increases and/or cuts in other programs. The soaring costs of
Medicare — also the result, in part, of demographic pressures — will add
hugely to the fiscal burden. The well-trodden line of least resistance to
that prospect is to let the budget deficit and the public debt expand.
Andrew L. Yarrow's Forgive Us Our Debts: The Intergenerational Dangers of
Fiscal Irresponsibility (Yale University Press, 2008) is a valuable primer
on the harm that would do.
Yarrow, vice president and Washington director of
the nonpartisan research group Public Agenda and a visiting professor of
American history at American University, explores the implications for
taxes, private investment, and growth but puts even more emphasis on the
crowding-out effects of Social Security and Medicare on other programs. That
is a point that some liberals are apt to miss. Politics puts limits on how
high taxes can go. Remorseless pressure from Social Security and Medicare
will push taxes and the public debt higher, but it will also squeeze, is
already squeezing, other public investments — in education and
infrastructure, for instance.
Yarrow's approach is appealingly nonsectarian. He
calls for a more effective safety net to protect against catastrophic
illness, loss of job, and helplessness in old age. But he also urges that
citizens be asked to take greater responsibility. An effective safety net,
he argues, does not imply "pensions for healthy middle-aged Americans or
health-care coverage that pays most costs for almost any care they want."
People have an obligation, he argues, to meet the costs of predictable
contingencies. To do that, they must save.
But they don't. Ronald T. Wilcox's Whatever
Happened to Thrift?: Why Americans Don't Save and What to Do About It (Yale,
2008) is another useful, slender primer, concentrating not on national
choices but on the saving and spending decisions of individuals and
households. Its complementary perspective makes it a good companion to
Forgive Us Our Debts.
Wilcox, a professor at the University of Virginia's
Darden School of Business, starts by affirming that the problem of low
personal savings is real — for the economy as a whole but particularly for
poor households. Then he turns to causes and remedies. Emphasizing the
social psychology of saving, he puts much of the blame for low saving on
rising inequality and the consequent demands of keeping up with the Joneses:
"The psychology of memory, the sociology of reference-group communication,
and the economics of a widening income distribution combine to form a
powerful witches' brew of self-defeating consumption behavior."
He has some good, common-sense advice about how to
save more intelligently. He calls on companies to do more to encourage their
employees to save — for instance, by setting default enrollment policies on
401(k) plans so that workers are included automatically unless they choose
otherwise. And he briefly makes the case for an array of policy changes,
both large (tax consumption rather than income) and small (improve the
marketing of U.S. Savings Bonds). He covers a lot of ground quickly and
well.
Missing, I think, is a sufficient emphasis on
housing and tax-subsidized mortgage borrowing. Many American families chose
to save by accumulating equity in their homes. The government's policy was
to encourage that through the tax system and in other ways. Then came the
housing-market collapse. Falling prices and rising foreclosures have left
many households with no savings, no home equity, and no home. The tax regime
for housing loans is deeply implicated in the national syndrome of borrowing
too much and saving too little.
Three other new books focus more tightly on
pensions and retirement. All start from the position that the traditional
model of income in retirement — Social Security plus employer-provided
pensions — is defunct. The main reason is not forthcoming pressures on
Social Security, real as those are, but the demise of the defined-benefit
pension.
Roger Lowenstein, one of the country's best
financial journalists, gives an absorbing account of that story through
three case studies, in While America Aged: How Pension Debts Ruined General
Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next
Financial Crisis (Penguin Press, 2008). At the end of the 1960s, 60 percent
of the private-sector work force had guaranteed pensions linked to earnings.
Today the figure is less than 20 percent. Many of the remaining schemes,
public and private, are underfinanced and in jeopardy. Companies have
learned from General Motors' calamitous experience, which the book recounts
in fascinating detail, and are no longer starting pension plans. In their
place is the typically far less generous, and (from the retiree's point of
view) much riskier, 401(k).
No pension, meager savings, Social Security and
Medicare under strain — in the future, many are going to find retirement a
severe financial shock.
Then why not keep working? Alicia H. Munnell and
Steven A. Sass, of Boston College's Center for Retirement Research, examine
that question in Working Longer: The Solution to the Retirement Income
Challenge (Brookings Institution Press, 2008), and explain that the idea is
not quite as simple as it seems.
They reckon that three extra years of employment —
a shift in the average retirement age from 63 to 66 — would be needed to
keep income-replacement ratios at their present level through 2030. That
would still leave workers with a longer retirement than was typical a few
decades ago. (The average retirement age in 1960 was 66. A man retiring at
that age could expect to live another 13 years. Since then male life
expectancy has increased by roughly five years.) But the people with the
least savings and the greatest need to work longer will be the low-paid, the
unskilled, and those in poor health — the very workers who will find it most
difficult to keep their jobs.
Munnell and Sass note that the end of the
defined-benefit pension has had a further, little-noticed consequence. It
militates against "orderly departures" from the work force. "Employers face
the prospect of workers with declining productivity and inadequate 401(k)
balances hanging on much longer than desirable. Employers will need new
tools, including an orderly severance process, to manage an older work
force. Without such tools, employers will avoid older workers."
Teresa Ghilarducci, a professor of economics at the
New School, rejects the idea that living longer ought to imply working
longer. In When I'm Sixty-Four: The Plot Against Pensions and the Plan to
Save Them (Princeton University Press, 2008), she proposes a system to
replace 70 percent of preretirement income after 40 years of work. People
who wished to work longer could do so, but they would not be forced to by a
lack of retirement income. Her key proposal is a mandatory system of
guaranteed retirement accounts. Workers not in defined-benefit schemes would
put 5 percent of earnings (up to the Social Security earnings cap) into a
fund managed by the Social Security Administration; that fund would be
invested, and the government would guarantee an inflation-adjusted return of
3 percent a year on each worker's account. A $600 refundable tax credit
would offset the cost for low-income workers. Balances would be converted to
inflation-indexed annuities upon retirement.
When I'm Sixty-Four is an excellent book — not the
clearest or best written, but the most thorough on the pensions issue — and
makes a bold and workable proposal. It calls, in effect, for a combined
expansion and partial privatization of Social Security, with a firmly
progressive tweak to the tax code thrown in. The guaranteed retirement
account itself, which is modeled on the TIAA-CREF scheme for college
professors, has much in common, Ghilarducci says, with systems in Sweden,
Italy, and elsewhere. There is no financial or economic reason that it could
not work — but it is a stretch, politically, as she half-acknowledges. (It
might be less of a stretch if she met more-timid reformers halfway and
relaxed her opposition to a slightly higher retirement age.)
Once the present crisis subsides, the
retirement-income problem can be solved. The economics is straightforward.
All the government has to do is tell voters to pay more taxes, hand over
part of their earnings for safekeeping, and work a few extra years.
The difficulty is to propose that solution and
still get elected.
Clive Crook writes for The Financial Times, Atlantic, and National
Journal. He was formerly deputy editor of The Economist and has
served as a consultant to the World Bank and as an official in the British
Treasury.
Bob Jensen's threads on entitlements are at
http://faculty.trinity.edu/rjensen/entitlements.htm
Also see Debating Our Destiny ---
http://www.pbs.org/newshour/debatingourdestiny/index.html
"Financial Restoration for the United States December 2008," by
James C. VanHorne, A. P. Giannini Professor of Banking and Finance at
Stanford University, December 2008 ---
http://www.gsb.stanford.edu/news/research/financial-restoration.html/?tr=kb0812
The Antecedents to 2008 During the past 200 years,
there have been 16 credit crises in the United States, all marked by
speculative excesses in the years immediately preceding. Following the 1907
and early 1930s crises, the Congress undertook substantial reform of the
financial services industry. Again it is time for substantial
regulatory/supervisory change. Recall that beginning in the late 1970s,
there began a period of deregulation of financial services in the United
States. Much good came in lowering costs and inconvenience, but it came with
greater risk taking and less disciplined behavior. No longer did a lender
need to carry a loan on its own books, but could securitize it and capture
fat front-end fees and not have to worry if the borrower paid.
Self-regulation and market discipline, frequently quixotic, cannot stem the
type of systemic risk we have recently experienced.
The Reform Needed As the ultimate safeguard to stem
a financial panic, the government should have in place the apparatus that
will allow it to curtail speculative excesses in advance of their triggering
a financial panic. “An ounce of prevention is worth a pound of cure,” if you
will. A number of things are in order. Regulatory authorities dealing with
the financial services industry broadly defined should be consolidated.
There are too many of them, often with conflicting objectives, and
competition among them—relics of the past. More specifically, I would have
the Securities and Exchange Commission responsible only for disclosure of
information to investors on new and existing securities, together with
oversight of mutual funds. No regulation of investment banks and others, for
which it has proven to be inept. The FDIC should continue its present role,
as should the Fed under its now expanded mandate.
I would consolidate all other regulatory agencies
into a new agency with broad powers to regulate investment banks, insurance
companies, mortgage companies, hedge funds, finance companies, thrifts,
credit unions, commodity firms, brokerage firms, prime brokers, derivative
and futures markets dealers, and banks not regulated by the Fed and FDIC.
Any U.S. or foreign financial institution that operates in U.S. financial
markets would fall under the agency’s purview. For other than depository
institutions, however, I would establish size thresholds for inclusion in
regulatory oversight; say, above $10 billion in assets and/or $40 billion in
derivative positions (notional amount) for a single institution or
collective institutions under interlocking ownership. Supervisory and
regulatory oversight would embrace asset quality, leverage, and counterparty
risk, as well as overall risk with full power of the agency to curtail
overly risky activities. The governing board should be independent and
appointed by the Congress and the president for, say, 10-year terms on a
staggered basis.
As part of the change, a new department should be
established to facilitate workouts for mortgages and other loans. Presently
many loans have been securitized with legal impediments to workouts.
Efficiently managed workouts benefit both the borrower, in reducing payment
outlays, and the lender, in not having to charge off as much of the loan.
While many other worthwhile changes are possible, I will mention only three.
1) Restore the uptick rule, where short sales can be consummated only upon a
rise in security price. This is a better remedy than periodically freezing
short sales. 2) Require loan originators to retain a small portion, say 5 to
7 percent, of loans that are securitized. This creates a discipline that
otherwise does not occur. 3) Have credit-rating agencies paid by the
government from fees collected by the government from security issuers. This
move will result in more objectivity and align the incentives of the rating
agencies with investors.
Social Allocation of Capital Finally, the method by
which the capital is socially allocated is a matter of concern. Fannie Mae
and Freddie Mac were actively pressured by the Congress and the Department
of Housing and Urban Development to promote housing ownership through low/no
down payment and deferred interest types of mortgages. Seemingly there is no
cost, as long as the government’s implicit guarantee of these agencies does
not occur. When it did in 2008, the cost is huge. A more efficient method
for socially allocating capital is for the government to pay an
interest-rate and/or principal subsidy to the lender or to the borrower for
certain types of socially desirable loans. In this manner, the lender
receives the market clearing rate of interest while the borrower pays this
rate minus the subsidy. The cost of socially allocating capital is
recognized up front and the allocation of capital in society is more
efficient.
A Closing Thought While not a complete or
comprehensive set of reforms, I believe the proposals outlined above would
do much to reduce systemic risk in the financial services industry and save
taxpayers much in the process.
James VanHorne
Note: Below are listed the credit crises in the United States during the
past 200 years by year in which they (approximately) began and/or peaked.
There is no beginning/peak in the 1930s, as there were several. During the
War of 1812 there was a credit crisis of sorts. However, it was not
occasioned by speculative excesses in the years preceding but rather by the
British occupying Washington and I have chosen not to include it. The
classifications are partially subjective on my part – particularly with
respect to the exact year in which a crisis occurred.
The credit crises by year are: 1819; 1837; 1857; 1873; 1893; 1907; 1919;
1930s; 1949; 1958; 1970; 1974; 1981; 1991; 2002; 2008.
Question
If the rich have been avoiding taxes, why is the State of New York about to
implode?
To his credit, the Democratic Governor is trying to
force Albany to confront its addictions. He's
said that a tax hike -- even one targeting only the "rich" -- would be damaging.
Mr. Paterson is urging labor unions to renegotiate
contracts on behalf of public employees. And he's proposed trimming as much as
$2 billion from this year's budget, including cuts to health care and education.
"Empire State Implosion: The financial meltdown and the welfare state,"
The Wall Street Journal, November 11, 2008 ---
http://online.wsj.com/article/SB122653542508722577.html?mod=djemEditorialPage
The global credit panic has swept away many
illusions, and we're about to find out if that includes those of the
politicians who have feasted for years on Wall Street tax revenues. Ground
Zero is New York, which has lived a tax-and-spend fantasy thanks to the long
bull market and "progressive" tax rates. Reality is now biting.
The financial services industry employs between 2%
and 3% of nongovernment workers in New York, the same as it did in the late
1970s. What's changed is the share of total wages in the state represented
by Wall Street jobs, which had skyrocketed to nearly 20% last year from a
little over 2% in 1977.
"This is 212,000 people making nearly $80 billion
in wages and salaries last year," explained E.J. McMahon of the Manhattan
Institute at a recent panel discussion on the financial crisis. "This is all
taxed at the margin, so it plays an outsized role in the state's finances."
This is also the dirty little secret of highly "progressive" tax rates: They
make a state dependent on relatively few taxpayers.
The financial industry doubled its percentage of
the national economy in the 1980s, and did so again between 1990 and 2006.
As Wall Street wages have grown, so has New York's dependence on revenue
from the personal income tax. In 1977 personal income taxes represented less
than 45% of all state taxes. In 2007 they represented about 60%. And for the
past 30 years, inflation-adjusted state spending has tracked closely with
booms and busts on Wall Street. According to John Cape, a former state
budget director, about 45,000 New York taxpayers provide the state "with
anywhere from 20% to 30% of total income tax receipts."
New York City has also done little to decrease its
addiction to revenue from a single industry. Mayor Michael Bloomberg missed
the chance to use 9/11 as an opportunity for reform, and he's declined to
challenge public unions over pay and benefits. Bigger and bigger budgets
have been submitted and approved as though record Wall Street profits would
never end. The financial industry is 14% of gross city product. In 2006, New
York City received 50% of its personal income tax revenue from the top 1% of
earners, many of whom work in finance.
During previous downturns Albany has resisted
structural reforms. Instead of lessening the state's dependence on this
narrow slice of the tax base, lawmakers have been content to wait for Wall
Street to come roaring back. To cover the rising costs of debt payments,
school aid, Medicaid, pensions and other budget drivers, they've raised
taxes, sometimes temporarily but often permanently.
It would be a tragic mistake to view the current
downturn as merely another cyclical blip. It may take Wall Street years to
come back, and once it does it certainly won't look the same. Fewer big
global banks are likely to emerge from the ashes; and while they will be
better capitalized, they will also be more highly regulated. More reasonable
leverage ratios mean less risk-taking and less profit even in good times.
Bonus pools are likely to be anemic for some time.
New York's revenue coffers are set to take a hit.
The only question is how big. The state budget deficit is already projected
to be $1.5 billion in the current fiscal year, and Governor David Paterson
estimates it could grow to $14 billion over the next two years if nothing is
done.
To his credit, the Democratic Governor is trying to
force Albany to confront its addictions. He's said that a tax hike -- even
one targeting only the "rich" -- would be damaging. Mr. Paterson is urging
labor unions to renegotiate contracts on behalf of public employees. And
he's proposed trimming as much as $2 billion from this year's budget,
including cuts to health care and education.
Naturally, union officials and hospital advocacy
groups are balking at the Governor's requests and pushing for tax increases,
but out-of-control education and Medicaid spending is what has fed the
state's structural deficit. New York spends more money per pupil ($14,000)
than any other state. Its only rivals are New Jersey and Connecticut and all
three are at least 40% above the national average. The state's Medicaid
costs of $2,260 per resident are twice the national average and equal to
what Texas and Florida spend combined.
If New York wants to make sure a rejuvenated
financial industry returns to Wall Street, it should be looking to reform
its steeply progressive tax code. A leaner, more risk-averse and heavily
regulated finance industry will be all the more sensitive to the high cost
of doing business in New York. The Big Apple already imposes the highest
personal income tax rate of any jurisdiction in the country (10.5%). And
it's significantly higher than neighboring New Jersey (8.97%) and
Connecticut (5%).
The financial industry has been having a painful
reckoning with more realistic assessments of risk. New York's politicians
need a similarly rude awakening.
Our National Debt is out of control ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
Our unbooked obligations for entitlement programs are out of control ---
http://faculty.trinity.edu/rjensen/entitlements.htm
The Largest Earnings Management Fraud in
History
and Congressional Efforts to Cover it Up
"The Great Fannie and Freddie Rip-Off: The GSEs' common shareholders
need to organize and make their voices heard in Congress," by Ralph Nadar,
The Wall Street Journal, January 26, 2011 ---
http://online.wsj.com/article/SB10001424052748703555804576102423446952218.html#mod=djemEditorialPage_t
For decades Fannie and Freddie behaved like other
large, publicly held financial corporations. They were profit-seeking
companies, listed on the New York Stock Exchange (NYSE). They displayed an
unfettered drive for greater sales, profits, executive bonuses and stock
options for the top brass. Their shareholders received dividends and rising
stock values.
These so-called government sponsored enterprises (GSEs)
dominated the secondary mortgage market. The implied government backstop
slightly lowered their borrowing costs in return for a poorly enforced
obligation to facilitate a mortgage market for lower-income home buyers.
Otherwise, the GSE moniker meant little, since everybody knew that, like
Citigroup, Goldman Sachs and other Wall Street giants, Washington viewed
them as "too big to fail."
With the onset of the subprime mortgage collapse,
Fannie and Freddie went down with the rest of the financial industry. The
federal government moved into high bailout gear during the latter half of
2008 with three distinct rescue models for Wall Street and Detroit.
One model provided capital and credit lines to Bank
of America, Citigroup, Morgan Stanley, J.P. Morgan Chase and AIG, leaving
their shareholders beaten down but intact to start recovering value.
The second model dispatched General Motors into a
well-orchestrated, stunningly quick bankruptcy process. While the bankruptcy
court treated the common shareholders like flotsam and jetsam, GM emerged
well subsidized and tax-privileged with a clean balance sheet under
temporary ownership by the U.S. and Canadian governments and the United Auto
Workers.
The third model placed Fannie and Freddie under an
indeterminate conservatorship scheme that kept but abused its common
shareholders, who had already lost up to 99% of their investment. Neither
vanquished nor given an opportunity to recover, the institutional and
individual shareholders are trapped in limbo.
Here is how the scheme congealed. In return for
providing an open credit line, the government received warrants to buy up to
79.9% of the GSEs' common stock for $0.00001 per share. The government's
share stayed under 80% to avoid forcing the liabilities of these two
behemoths onto the government's books. Treasury achieved this by having the
common shareholders nominally own the other 20%.
Here's the rub: The zombie common shareholders have
no rights or remedies against Fannie and Freddie, both operationally active
companies, or their regulator—the Federal Housing Finance Agency. FHFA
ordered the Fannie and Freddie boards and executives to suspend
communications with shareholders and abolish the annual stockholders
meeting.
In 2008, then-Treasury Secretary Henry Paulson and
Federal Reserve Chairman Ben Bernanke told Fannie and Freddie investors that
the companies "are adequately capitalized." Moreover, another regulator, the
Office of Federal Housing Enterprise Oversight (Ofheo), assured
investors—including many mutual funds, pension trusts and small banks—of the
soundness of their investment.
Fannie Mae's then-Senior Vice President Chuck
Greener, backed by his then-CEO Daniel Mudd, said, "We are maintaining a
strong capital base, building reserves for credit losses and generating
solid reserves as our business continues to serve the market." That was on
July 11, 2008.
These former officials (both have since left Fannie
Mae) should have known better. On Sept. 8, 2008, when Treasury announced the
conservatorship, the GSEs' common stock dropped to pennies and the
shareholders realized they were misled.
Such statements by private executives controlling a
publicly traded corporation should have prompted a Securities and Exchange
Commission investigation. Such was the betrayal of trust of investors who
were told for years that putting their money in these GSEs was second only
to investing in Treasury bonds.
Still, some faithful shareholders, including me,
held on, believing that they might have a chance to recover something—as did
their counterparts in Citigroup, AIG and the rest of the rescued.
Then came the cruelest and most unnecessary diktat
of all. On June 16, 2010, the FHFA directed Fannie and Freddie to delist
their common and preferred stock from the NYSE. The exchange did not demand
this move. True, Fannie had dropped slightly below the $1 per share
threshold stipulated by NYSE rules, but the Big Board is quite flexible with
time either to get back over $1 or to allow companies to offer a reverse
stock split. Freddie was comfortably over the $1 level. Why delist with one
irresponsible stroke of the government's pen and destroy billions of dollars
of remaining shareholder value? This move took the shares down to the range
of 30 cents, chasing away many institutional holders.
Continued in article
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Without trying to place the blame on
Democrats or Republicans, here are some of the facts that led to the
eventual fining of Fannie Mae executives for accounting fraud and the
firing of KPMG as the auditor on one of the largest and most lucrative
audit clients in the history of KPMG. The restated earnings purportedly
took upwards of a million journal entries, many of which were
re-valuations of derivatives being manipulated by Fannie Mae accountants
and auditors (PwC was charged with overseeing the financial statement
revisions.
Fannie Mae may have conducted the largest
earnings management scheme in the history of accounting.
. . . flexibility
also gave Fannie the ability to manipulate earnings to hit -- within
pennies -- target numbers for executive bonuses. Ofheo details an
example from 1998, the year the Russian financial crisis sent
interest rates tumbling. Lower rates caused a lot of mortgage
holders to prepay their existing home mortgages. And Fannie was
suddenly facing an estimated expense of $400 million.
Well, in its
wisdom, Fannie decided to recognize only $200 million, deferring the
other half. That allowed Fannie's executives -- whose bonus plan is
linked to earnings-per-share -- to meet the target for maximum bonus
payouts. The target EPS for maximum payout was $3.23 and Fannie
reported exactly . . . $3.2309. This bull's-eye was worth $1.932
million to then-CEO James Johnson, $1.19 million to
then-CEO-designate Franklin Raines, and $779,625 to then-Vice
Chairman Jamie Gorelick.
That same year
Fannie installed software that allowed management to produce
multiple scenarios under different assumptions that, according to a
Fannie executive, "strengthens the earnings management that is
necessary when dealing with a volatile book of business." Over the
years, Fannie designed and added software that allowed it to assess
the impact of recognizing income or expense on securities and loans.
This practice fits with a Fannie corporate culture that the report
says considered volatility "artificial" and measures of precision
"spurious."
This
disturbing culture was apparent in Fannie's manipulation of its
derivative accounting. Fannie runs a giant derivative book in an
attempt to hedge its massive exposure to interest-rate risk.
Derivatives must be marked-to-market, carried on the balance sheet
at fair value. The problem is that changes in fair-value can cause
some nasty volatility in earnings.
So, Fannie
decided to classify a huge amount of its derivatives as hedging
transactions, thereby avoiding any impact on earnings. (And we mean
huge: In December 2003, Fan's derivatives had a notional value of
$1.04 trillion of which only a notional $43 million was not
classified in hedging relationships.) This misapplication continued
when Fannie closed out positions. The company did not record the
fair-value changes in earnings, but only in Accumulated Other
Comprehensive Income (AOCI) where losses can be amortized over a
long period.
Fannie had
some $12.2 billion in deferred losses in the AOCI balance at
year-end 2003. If this amount must be reclassified into retained
earnings, it might punish Fannie's earnings for various periods over
the past three years, leaving its capital well below what is
required by regulators.
In all, the
Ofheo report notes, "The misapplications of GAAP are not limited
occurrences, but appear to be pervasive . . . [and] raise serious
doubts as to the validity of previously reported financial results,
as well as adequacy of regulatory capital, management supervision
and overall safety and soundness. . . ." In an agreement reached
with Ofheo last week, Fannie promised to change the methods involved
in both the cookie-jar and derivative accounting and to change its
compensation "to avoid any inappropriate incentives."
But we don't
think this goes nearly far enough for a company whose executives
have for years derided anyone who raised a doubt about either its
accounting or its growing risk profile. At a minimum these
executives are not the sort anyone would want running the U.S.
Treasury under John Kerry. With the Justice Department already
starting a criminal probe, we find it hard to comprehend that the
Fannie board still believes that investors can trust its management
team.
Fannie Mae
isn't an ordinary company and this isn't a run-of-the-mill
accounting scandal. The U.S. government had no financial stake in
the failure of Enron or WorldCom. But because of Fannie's implicit
subsidy from the federal government, taxpayers are on the hook if
its capital cushion is insufficient to absorb big losses. Private
profit, public risk. That's quite a confidence game -- and it's time
to call it.
**********************************
:"Sometimes
the Wrong 'Notion': Lender Fannie Mae Used A Too-Simple Standard For
Its Complex Portfolio," by Michael MacKenzie, The Wall Street
Journal, October 5, 2004, Page C3
Lender Fannie
Mae Used A Too-Simple Standard For Its Complex Portfolio
What exactly
did
Fannie Mae do wrong?
Much has been
made of the accounting improprieties alleged by Fannie's regulator,
the Office of Federal Housing Enterprise Oversight.
Some investors
may even be aware the matter centers on the mortgage giant's $1
trillion "notional" portfolio of derivatives -- notional being the
Wall Street way of saying that that is how much those options and
other derivatives are worth on paper.
But
understanding exactly what is supposed to be wrong with Fannie's
handling of these instruments takes some doing. Herewith, an effort
to touch on what's what -- a notion of the problems with that
notional amount, if you will.
Ofheo alleges
that, in order to keep its earnings steady, Fannie used the wrong
accounting standards for these derivatives, classifying them under
complex (to put it mildly) requirements laid out by the Financial
Accounting Standards Board's rule 133, or FAS 133.
For most
companies using derivatives, FAS 133 has clear advantages, helping
to smooth out reported income. However, accounting experts say FAS
133 works best for companies that follow relatively simple hedging
programs, whereas Fannie Mae's huge cash needs and giant portfolio
requires constant fine-tuning as market rates change.
A Fannie
spokesman last week declined to comment on the issue of hedge
accounting for derivatives, but Fannie Mae has maintained that it
uses derivatives to manage its balance sheet of debt and mortgage
assets and doesn't take outright speculative positions. It also uses
swaps -- derivatives that generally are agreements to exchange
fixed- and floating-rate payments -- to protect its mortgage assets
against large swings in rates.
Under FAS 133, if
a swap is being used to hedge risk against another item on the
balance sheet, special hedge accounting is applied to any gains and
losses that result from the use of the swap. Within the application
of this accounting there are two separate classifications:
fair-value hedges and cash-flow hedges.
Fannie's
fair-value hedges generally aim to get fixed-rate payments by
agreeing to pay a counterparty floating interest rates, the idea
being to offset the risk of homeowners refinancing their mortgages
for lower rates. Any gain or loss, along with that of the asset or
liability being hedged, is supposed to go straight into earnings as
income. In other words, if the swap loses money but is being applied
against a mortgage that has risen in value, the gain and loss cancel
each other out, which actually smoothes the company's income.
Cash-flow
hedges, on the other hand, generally involve Fannie entering an
agreement to pay fixed rates in order to get floating-rates. The
profit or loss on these hedges don't immediately flow to earnings.
Instead, they go into the balance sheet under a line called
accumulated other comprehensive income, or AOCI, and are allocated
into earnings over time, a process known as amortization.
Ofheo claims
that instead of terminating swaps and amortizing gains and losses
over the life of the original asset or liability that the swap was
used to hedge, Fannie Mae had been entering swap transactions that
offset each other and keeping both the swaps under the hedge
classifications. That was a no-go, the regulator says.
"The major
risk facing Fannie is that by tainting a certain portion of the
portfolio with redesignations and improper documentation, it may
well lose hedge accounting for the whole derivatives portfolio,"
said Gerald Lucas, a bond strategist at Banc of America Securities
in New York.
The bottom line is that both the FASB and the IASB must someday soon
take another look at how the real world hedges portfolios rather than
individual securities. The problem is complex, but the problem has come
to roost in Fannie Mae's $1 trillion in hedging contracts. How the SEC
acts may well override the FASB. How the SEC acts may be a vindication
or a damnation for Fannie Mae and Fannie's auditor KPMG who let Fannie
violate the rules of IAS 133.
I Saw Maxine Kissing Franklin Raines ---
http://www.youtube.com/watch?v=vbZnLxdCWkA
Before Franklin Raines resigned as CEO of Fannie Mae and paid over a million
dollar fine for accounting fraud to pad his bonus, he was the darling of the
liberal members of Congress. Frank Raines was creatively managing earnings to
the penny just enough to get his enormous bonus. The auditing firm of KPMG was
accordingly fired from its biggest corporate client in history ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Manipulation
Video on the efforts of some members of Congress seeking to cover up
accounting fraud at Fannie Mae ---
http://www.youtube.com/watch?v=1RZVw3no2A4
If Greenspan Caused the Subprime Real
Estate Bubble,
Who Caused the Second Bubble That's About to Burst?
"Derivatives Clearinghouses Are No Magic Bullet: Will the Dodd bill
create another kind of institution that's too big to fail?" by Harvard's
Mark J. Roe, The Wall Street Journal, May 6, 2010 ---
http://online.wsj.com/article/SB10001424052748703871904575216251915383146.html
As the Senate finalizes its financial reform
legislation, a consensus is developing that if we could just get derivatives
traded through a centralized clearinghouse we could avoid a financial crisis
like the one we just went through. This is false. Clearinghouses provide
efficiencies in transparency and trading, but they are no cure-all. They can
even exacerbate problems in a financial crisis.
If I agree to sell you a product next month through
a clearinghouse, I'll deliver the product to the clearinghouse and you'll
deliver the cash to the clearinghouse on the due date. Let's say we both
have many trades going through the clearinghouse and we've posted collateral
to cover any single trade that fails. This is more efficient than each of us
posting collateral privately for each trade. Moreover, we're not worried
that I won't deliver or you won't pay because we both count on the
clearinghouse to deliver and pay up if one of us doesn't.
This clearing system makes trading more efficient.
If you default, the cost is spread through the clearinghouse so I don't get
hurt severely. And if the clearinghouse has enough collateral from you,
there's no loss to spread. But there's also a potential downside: The
clearinghouse reduces our incentives to worry about counterparty risk. Your
business might collapse before you need to pay up, but that's not my problem
because the clearinghouse pays me anyway. The clearinghouse weakens private
market discipline.
Still, if the clearinghouse is as good or better at
checking up on your creditworthiness as I am, all will be well. But one has
to wonder how good a clearinghouse will be, or can be.
Consider two of our biggest derivatives-related
failures—Long-Term Capital Management in 1998 and the subprime market in
2008. When Russia's ruble dropped unexpectedly, LTCM was exposed on its more
than $1 trillion in interest-rate and foreign-exchange derivatives. It could
not pay up and collapsed. Ten years later the market rapidly revalued
subprime mortgage securities, rendering several institutions insolvent. AIG
was over-exposed in credit default swaps tied to the value of subprime
mortgages.
Could a clearinghouse really have been ahead of the
curve in getting sufficient capital posted before these problems became
serious and well-known? I'm not so sure. Worse yet, major types of
derivatives have built-in discontinuities—"jump-to-default" in
derivatives-speak.
For a credit default swap, one counterparty
guarantees the debt of another company to you, in return for you paying a
fee for that guarantee. If no one goes bankrupt, the counterparty just
collects the fees from you. But if the guarantee is called because the
company you were worried about goes bankrupt, the counterparty must all of a
sudden pay out a huge amount immediately.
Yet the guarantor is often called upon to pay in a
weak economy, just when it can itself be too weak to pay. You get credit
default protection on your real-estate investments from me, just in case the
economy turns sour. But just when you need me the most, in a sour economy, I
turn out to be so overextended I can't pay up. Collateralizing and
monitoring such discontinuous obligations will not be so easy for the
clearinghouse.
Moreover, if trillions of dollars of derivatives
trading goes through a clearinghouse, we will have created another
institution that's too big to fail. Regulators worried that an
interconnected Bear or AIG could drag down the economy. Imagine what an
interconnected clearinghouse's failure could do.
AIG needed $85 billion in government cash to avoid
defaulting on its debts, including its derivatives obligations. Could one
clearinghouse meet even a fraction of that call without backup from the
U.S.? True, we could have many clearinghouses, each not too big to fail—but
then maybe each would be too small to do enough good.
The Senate bill would allow a clearinghouse to grab
new collateral out from failing derivatives-trading banks to cover old, but
suddenly toxic, debts the banks owe to the clearinghouse. This could harm
other creditors and cause the firm to suffer a run. Nevertheless, to protect
itself in a declining market, a clearinghouse would have to make those big
collateral calls. That's good if it protects the clearinghouse. But it's bad
if it starts a run on a weakened but important bank.
One key but missing element in the search for
reform has yet to gain traction in Washington. Derivatives players obtained
exceptions from typical bankruptcy and bank resolution rules in the past few
decades for their contracts with a bankrupt counterparty. This allowed them
to grab and keep collateral other creditors cannot. That gives derivatives
traders reason to pay less attention to their counterparties' riskiness and
weakens market discipline. These rules should be changed before the Senate
is done.
To say that a clearinghouse solution is very
incomplete is not to say there is an easy solution out there. We may be
unable to do more than to make incomplete improvements and muddle through.
Derivatives trades first of all should not just be
centrally cleared, but should also be taken out from the
government-guaranteed entities, such as commercial banks (or at least we
need to impose tight capital requirements on those banks that deal in
derivatives). Derivatives traders like doing business with Citibank because
they know the government won't let Citibank go down. But this puts taxpayers
at risk. It would be better to run those trades through an affiliate, not
through the bank, so counterparties realize they might not be bailed out if
the affiliate failed. If a banking affiliate's counterparty is the
clearinghouse, then the clearinghouse will have incentives to make sure that
the affiliate is well-capitalized. This is particularly so if the
clearinghouse won't get any special priority treatment in a bankruptcy.
Critics of proposals to establish separate bank
affiliates for derivatives trading complain about the large amount of
capital that would be needed for such affiliates. But the capital that might
be needed to buttress a bank affiliate indicates some level of the value
(i.e., the taxpayer subsidy) to derivatives players of trading with a
too-big-to-fail entity that they know the government will step in to save.
They are implicitly getting insurance and should pay for it.
And, since a clearinghouse is itself at risk of
being too big to fail, regulators need to police its capital and collateral
requirements. If the derivatives market sees the clearinghouse as too big to
fail, the potential for derivatives players making overly risky derivatives
trades becomes real. Clearinghouses can help manage some systemic risk if
they're run right. If not, they can become the Fannie and Freddie of the
next financial meltdown.
Mr. Roe is a professor at Harvard Law School, where
he teaches bankruptcy and corporate law.
Bob Jensen's timeline on the history of derivative financial instruments
frauds and accounting rules for derivatives contracts ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
"Another Bubble Bursts: Subprime mortgages were just the beginning,"
The Wall Street Journal, October 24, 2008 ---
http://online.wsj.com/article/SB122480934587765107.html?mod=djemEditorialPage
Credit markets have started to thaw, yet stocks and
the larger economy keep sliding. What's going on? Among the problems are the
reality of recession and the uncertainty over Barack Obama's policies. But
the larger story is that the global economy is fast popping its latest
monetary bubble, the one over the last 14 months in commodity prices and
non-dollar currencies.
The original bubble was in housing prices and
mortgage-related assets, which the Federal Reserve helped to create with its
negative real interest rates from 2002 into 2005. This was Alan Greenspan's
tragic mistake, not that the former Fed chief will acknowledge it.
Testifying before Congress yesterday, Mr. Greenspan pinned the crisis on
mortgage securitizers, risk modelers and lending institutions, thus
contributing to the Washington narrative that government had little to do
with it. The Fed's monetary policy apparently gets a pass. The media and
Members of Congress will use Mr. Greenspan's testimony to impugn the very
free market principles that the former Ayn Rand protégé has spent his life
promoting. It was a painful spectacle to watch.
As for the second bubble, this one began in August
2007 with the onset of the credit panic. This is Ben Bernanke's creation.
The Fed chose to confront the credit crunch as if it were mainly a problem
of too little liquidity, not fear of insolvency. To that end it flooded the
economy with money, while taking short-term interest rates down to 2% from
5.25% in seven months. The panic only got worse, and this September's
stampede finally led the Treasury and Fed to address the solvency problem by
supplying public capital and numerous guarantees to the financial system.
The Fed's liquidity burst nonetheless sent markets
for a 14-month loop, as the nearby charts indicate. The Fed created a
commodity bubble of record proportions, with oil doing a round trip in a
single year from $70 up to $147 and back down to $69 yesterday. The dollar
also plunged along the way against most global currencies, notably the euro,
as the bottom chart illustrates.
The dollar price of oil and the dollar-euro
exchange rate are probably the two most important prices in the world. They
represent a huge share of global commerce, sending signals that shape trade
and capital flows. When those two prices move up and down so sharply in so
short a time -- based more on fear and expectations than on economic
realities -- they distort price signals and can lead to a misallocation of
resources. Commodity prices have now fallen back to Earth, as the reality of
global recession hits home and the Fed can't ease much further. Meanwhile,
the euro has fallen from the stratosphere as Europe heads into recession and
the dollar becomes a safer haven in a world of fear.
But even as this bubble recedes, its consequences
are hurting those countries and investors who bet on or benefited from
higher prices. That includes emerging markets that are largely commodity
plays, such as Russia and the Persian Gulf countries. Within the U.S., this
includes the farm belt and ethanol alley in the Midwest. The ethanol lobby
is already floating the prospect of a taxpayer bailout, as if it wasn't
floating on taxpayer subsidies already. Hong Kong conglomerate Citic Pacific
and a pair of Chinese companies may have lost hundreds of millions on faulty
currency bets. Hedge funds that gambled on commodities or a weaker greenback
have had to cover their bets and deleverage. You can expect more such
country and hedge-fund blowups in the coming weeks.
The tragedy of the second bubble is that it has
left the economy in a weaker position to ride out the housing slump and
credit panic. The American consumer has been whipsawed with $4 dollar gas
and food inflation, while entire industries have been put on the edge of
bankruptcy. Detroit's auto makers have spent the last year taking down their
truck and SUV assembly lines while gearing up to make hybrids and electric
cars, even as their cash flow has been ravaged. Their new investments are
based on the expectation that oil will stay high permanently, but will the
market for hybrids exist if oil is $50 a barrel?
As Congress plumbs the causes of our current mess,
the main one is hiding in plain sight: Reckless monetary policy that did so
much to create the credit mania and then compounded the felony with a
commodity bubble and run on the dollar whose damage is now becoming
apparent. The American people intuitively understand what's been done to
them, which is why they are so angry. If the next President ignores the
monetary roots of our troubles, he is courting the same fate as George W.
Bush.
Real estate appraisers in Hampton Roads and across
the nation say they have felt intense pressure from lenders, mortgage brokers
and real estate agents to deliver inflated valuations - a serious ethical breach
that may have played a role in puffing up the real estate bubble and promoting
mortgage fraud. The problem has been around for some time, says Woody Fincham, a
Chesapeake-based appraiser. For several years in the mid-2000s, Fincham said,
his company, FM & Associates, did steady business with a Virginia Beach mortgage
brokerage but faced escalating pressure to deliver inflated appraisals. "They
would get on the phone and scream at me to inflate values," he said. "They said,
'If you keep coming in low, we're not going to work with you anymore.' "
Finally, the brokerage delivered on the threat, cutting off business with
Fincham's company. "They said, 'You're not hitting the numbers we need you to
hit,' " Fincham said.
Bill Sizemore, "Appraisers say they were pushed to overvalue properties," The
Virginian-Pilot, December 5, 2008 ---
http://hamptonroads.com/2008/12/appraisers-say-they-were-pushed-overvalue-properties
Jensen Comment
Pressure to increase the appraisal beyond fair market value stems in many cases
from the buyers not having enough down payment to make up the difference between
what the seller is asking and the buyer has in cash for difference between an
amount borrowed on the mortgage and the seller's bottom price.
For "Sleaze (meaning sex), Bribery, and Lies " in the mortgage lending business
before and after the economic meltdown see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
But neither the Sub-Prime Mortgage Bubble nor the Commodity Bubble
compares with the huge bubble building from reckless deficit spending by the
U.S. Government, the near-bursting balloon of national debt, and the resulting
plunge of the U.S. dollar that is the main cause of rising prices and inflation
--- Click Here
"Why Economists Are Part of the Problem," by Stephen A.
Marglin, Chronicle of Higher Education's Chronicle Review, February 27,
2009 ---
http://chronicle.com/weekly/v55/i25/25b00701.htm?utm_source=at&utm_medium=en
I am one of the last members of an anomalous
generation of economists who came of age in the period from the Great
Depression and World War II to the antiwar movement of the 1960s. What made
this generation anomalous was that its leaders — including such Nobel
laureates as Jan Tinbergen, Paul A. Samuelson, James Tobin, and Kenneth J.
Arrow — included a disproportionate number who were aware not only of the
virtues of a market system but also of its limitations. Of course, even
anomaly is relative; the generation that came of age between the 1930s and
the 1960s also included Milton Friedman and Robert E. Lucas Jr., both Nobel
winners who held to a faith in the market and eventually came to dominate
the profession.
But for a time, students of economics were exposed
to substantive debate about the economy by teachers who were sympathetic to
the case for government intervention to manage the ups and downs of the
business cycle and who believed there was a case to be made for planning,
especially in the context of underdeveloped countries trying to escape
endemic poverty. There was even room for a minority disposed to the case for
democratic socialism. What characterized the anomaly, in short, was the
large grain of salt that accompanied the abiding lesson of economics before
and since: Markets are good.
For the youngest members of this generation, like
myself, the student-led antiwar movement of the 60s provided a refresher
course in what had attracted us to economics in the first place — apparent
precision and science linked to the possibility of a politics that would
transform real-world economies to better serve the interests and aspirations
of real-world people — only to have it drowned out by the siren song of
technique for the sake of technique. At the same time, the antiwar movement
alienated the older members of the anomalous generation, especially those
with vivid memories of a student movement in the service of Nazism in 1930s
Germany.
Both the Depression and the antiwar movement
sparked attempts to change economics, but with very different outcomes. And
the differences are instructive for the present: It is a good guess that out
of the present economic crisis will come many ideas for changing economics,
but it is less certain whether the outcome will mirror the positive changes
in economics that came out of the Depression or will reflect the
unsuccessful attempts at change that came out of the antiwar movement.
The Depression gave us the Keynesian revolution, a
new economics based on the denial of one of the most important premises of
mainstream economics: that if markets are left to themselves, the price
mechanism will generally adjust supply and demand, so that every potential
buyer and seller willing to accept the going price can find a trading
partner. The older generation of economists had been more or less unmoved
when unemployment in the United States, as a fraction of the nonagricultural
labor force, hit 33 percent in 1933, but younger economists, particularly
students, found it hard to credit the idea that the labor market was
adjusting as the theory said it should. They flocked to John Maynard Keynes,
whose 1936 book The General Theory of Employment, Interest and Money,
provided a theoretical framework with which to understand the huge breakdown
not only of the economy but also of economic theory. More important, it
provided a convincing — to the anomalous generation — intellectual
justification of the need for government intervention to manage aggregate
demand and thereby mitigate, if not eliminate, the excesses of the business
cycle.
This is not the place to tell the story of that
revolution, a long and complex story in which both the novelty of Keynes's
approach and whether or not it constituted a revolution are disputed.
Suffice it to say that what started out as a fundamental critique of the
mainstream has been absorbed into the canon. Over time Keynes's insights
have come to be regarded as minor aberrations, sand in the wheels of the
juggernaut of markets rather than a fundamentally new way of understanding
the economy.
The present crisis has brought renewed interest in
Keynes, and one of the consequences for economics, I dare say, is a long
overdue revival of The General Theory as a critique of mainstream
economics. Some of the insights that have been lost in the absorption
process will be taken more seriously, particularly the difference between
decision making in a world of radical uncertainty, where probability
calculations avail little, and in a textbook world, where all decisions are
made by optimizing agents equipped with, at the very least, the ability to
meaningfully calculate probabilities.
Even without waiting for an updated Keynes, it is
clear that the mainstream now takes seriously the idea that sand in the
wheels may impede forward economic motion for a considerable period of time.
As a result, the policy debate in 2009, as President Obama begins his term
of office, is very different from the policy debate in 1933, when Franklin
D. Roosevelt became president. Fiscal stimulus — increasing government
expenditure and cutting taxes, the heart of the Keynesian policy message —
is accepted as appropriate and necessary to limit the contagion of financial
crisis. That is real progress.
The attempt of the 60s generation to make further
inroads into the mantra of markets, however, made much less of a mark on
economics. Like the Keynesian revolution, the effort was largely in the
hands of young economists, just one side or the other of 30, who examined a
host of issues ranging from the economic determinants of imperialism (the
term "globalization" had not yet been invented) to the role of education,
not only in imparting skills but also in shaping attitudes and beliefs
appropriate to capitalism. I was one of those who focused on what was called
in Marxist jargon the "labor process," the organization of work in
capitalist enterprises. We generally accepted the Marxist idea that
relationships among the participants in the production process are central
to shaping society more broadly — its politics, its culture — but we
questioned the determinism of Marx's idea that technology and resources in
turn shape those so-called "social relations of production." At the same
time, we questioned the related emphasis in mainstream economics on
efficiency as the driver of history.
The purpose was political as well as intellectual.
We believed, along with Thomas Jefferson (a more respectable forefather than
Karl Marx), that "dependence begets subservience and venality." We took, as
did Jefferson, wage labor to be incompatible with genuine freedom, and we
challenged the concept that, in a world of complex technology, wage labor
made for more efficient production than alternatives at once less
hierarchical and more collaborative. (One might well wonder why we didn't
focus the critique on whether efficiency itself should be the central focus
of economics. Perhaps somebody, somewhere, did just that. For most of us, it
was unthinkable. We were radical, but not that radical.)
Our work on work did not go unnoticed. But it is
fair to say that, like other initiatives in so-called radical economics, we
had much more impact in allied fields like sociology than in economics
itself. I remember a younger colleague remarking, probably in the early 80s,
that he had had to read a paper of mine four times in various social-science
courses as an undergraduate but had never encountered it in an economics
course.
Why so little impact? For one thing, we lacked a
leader of the older generation with the stature of a Keynes; student
activism had scared off at least some of them. Far more important, the
political movement from which we drew sustenance died out very quickly once
American military involvement in Southeast Asia began to wind down. We had
thought, or rather hoped, that we were witnessing the beginning of a
movement that would change the economic, political, and social order. It
turned out to be more like the peasant rebellions that the great French
historian of the Middle Ages, Marc Bloch, compared to a conflagration of a
heap of straw, producing a bright flame but petering out quickly.
Keynes once suggested that economists aspire to the
level of dentists: "If economists could manage to get themselves thought of
as humble, competent people, on a level with dentists, that would be
splendid!" At the time, the idea of a humble economist might have seemed
plausible: Alfred Marshall, Keynes's teacher and longtime professor at the
University of Cambridge (at a time when students had just one economics
professor), began his canonical text, Principles of Economics, which
went through eight editions between 1890 and 1920, with a definition of
economics as the study of "mankind in the ordinary business of life." But
shortly thereafter, Lionel Charles Robbins, in his Essay on the Nature &
Significance of Economic Science, redefined economics as "a science
which studies human behavior as a relationship between ends and scarce means
which have alternative uses." Ever since, economists have pushed the
frontiers of the discipline to the study of scarcity — within the family,
the political arena, and myriad other places. Sometimes the fresh
perspective of the economist has provided real insight. Mostly it has
pre-empted a possible dialogue among various disciplines of social inquiry
with an intellectual presumption that stifles other voices.
The most glaring instance of that presumption is
how economists have intervened in the debate on global warming. Typically
they model global warming as an investment decision: to stabilize levels of
carbon dioxide and other greenhouse gases would impose costs on the economy
from now into an indefinite future, but would show benefits only after some
50 to 100 years had elapsed. So to decide whether stabilization is
economically worthwhile, we must compare two trajectories for the world
economy: a "carbon stabilized" trajectory, which incurs significant upfront
(and continuing) costs, and a "business as usual" trajectory, which incurs
no stabilization costs but eventually produces economic losses because of
global warming.
It turns out that stabilizing carbon levels is at
best a mediocre project when subjected to normal investment criteria. A key
determinant of the merit of any investment project, including investment in
preventing global warming, is the rate of interest "charged" on upfront
costs incurred to provide future benefits. No interest need actually be
paid, but it is customary to figure in its costs, or what amounts to the
same thing, to discount future benefits. Much hinges on the choice of
interest rate. The lower the rate, the more attractive the prospect of
preventing global warming, for which the upfront costs are large and the
benefits a long time coming.
Businesses often use interest rates of 10 percent
or more to screen projects. Consumers often pay more than 6 percent on
mortgage debt and much higher rates on credit-card debt. In poor countries,
interest rates typically run into double digits. At such rates, the future
benefits of preventing global warming fall far short of the costs. Indeed,
at any rate around 5.75 percent, the present value of the benefits is
less than the present value of the costs, even if the losses were ultimately
20 percent of global gross domestic product. In short, in terms of
mainstream criteria, the case for incurring the costs of carbon
stabilization is underwhelming.
The only problem is that such analysis pretty much
misses the point. The important issues are not intertemporal — consumption
forgone today versus more consumption tomorrow — but inter-regional. The
likely impact of global warming will be very different in the rich
countries, situated for the most part in the temperate North, than in the
tropical and subtropical South. For instance, rising sea levels may inundate
small areas of the coastal United States but wipe out much of Bangladesh.
And the rich countries are better placed to mitigate or adapt to the impact
of global warming. For the rich, global warming may be damaging; for the
poor, a catastrophe.
The influential Stern Review, a report
published in 2006 and named after Sir Nicholas Stern, its principal author,
then chief economist in the British government, takes note of that
difference. For him, a world stabilized at a level he regards as about the
best that can realistically be achieved "would be a dangerous place."
Dangerous indeed: "Deaths of hundreds of millions of people (due to food and
water shortages and extreme weather events)." Stern adds: "Social upheaval,
large-scale conflict and population movements, possibly triggered by severe
declines in food production and water supplies (globally or over large
vulnerable areas), massive coastal inundation (due to collapse of ice
sheets) and extreme weather events."
Distributional issues are thus at the heart of
climate change, but in a very different sense from the one implicit in the
standard economic model. The question is not, What is our obligation to our
progeny? It is, What is our obligation as citizens of the rich North to
inhabitants of the poor South? That ethical issue takes on added bite
because of the disproportionate contribution the North has made since the
Industrial Revolution to the increase in atmospheric carbon. (China has
recently overtaken the United States as the largest emitter of carbon
dioxide, but that fact is misleading for two reasons: first, because a
significant fraction of China's emissions results from the production of
goods consumed by Americans, and second, because on a per-capita basis,
China's emissions are barely a quarter of U.S. emissions.) Surely we who
have benefited so greatly in material terms from our ignorant and offhanded
treatment of the environment owe the people who are most threatened by the
consequences of global warming.
How do we reconcile that obligation with standard
economic computations? The economist once again has an answer: We should
keep our eyes firmly fixed on the prize of efficiency, and take the course
of action that maximizes the size of the economic pie rather than take
preventive measures against global warming. If the pie is larger because we
do nothing to prevent global warming, there is more for everybody. The
winners can compensate the losers.
There is significant sleight of hand there.
Transfers from winners to losers may not be sufficient compensation — how do
you compensate people for the loss of their way of life, as distinct from
their way of making a living? But that issue aside, compensation is
problematic even within a political entity like the nation-state, which has
both the power and the legitimacy to redistribute wealth and income. But the
"global" in global warming makes the notion of compensation totally
implausible. In the international arena, there is no institution with the
authority necessary for redistribution. Only by preventing, or at least
limiting, climate change will vulnerable populations be protected — even if
doing so is not "efficient."
But distribution is only one aspect of the problem.
A second issue rejoins a question that Keynes raised in a very different
context: How do we know when we do not know? Like the world of finance and
investment that Keynes studied, the most salient feature of the
global-warming debate is, in the end, how little we know. Probabilistic
models shed some light on the future, but quantification breaks down in the
face of the overwhelming uncertainty about the effect of the economy on
greenhouse-gas emissions; the effect of those emissions on global warming;
and, finally, to complete the circle, the effect of global warming on
economic activity.
Given the uncertainty, it makes little sense to
rely on a sophisticated calculation of the present value of benefits and
costs. That does not mean we should take uncertainty as a reason for doing
nothing. Prudence dictates that we accept the inconveniences of airport
security checks for the sake of forestalling terrorist attacks even though
we cannot meaningfully calculate the probabilities. By that logic, we should
accept the modest costs of forestalling the dangers that might result from
unchecked global warming.
Climate change is not the only example of
economics' becoming part of the problem rather than part of the solution.
For many years, I have been concerned with the negative impact of the market
on community and with how economics has facilitated the market in that
regard. The 19th-century physicist Lord Kelvin famously proclaimed the
virtue of knowledge imbued with the precision of number: "When you can
measure what you are speaking about, and express it in numbers, you know
something about it; but when you cannot measure it, when you cannot express
it in numbers, your knowledge is of a meager and unsatisfactory kind."
Economics goes physics one better: Anything you can't measure — like
community — simply doesn't exist. It goes without saying that economic
hardship, especially the kind caused by unemployment and shortened working
hours, will make community more necessary and more visible; people will have
to rely on one another more and more as the market fails them.
I have observed that politics is the key to the
difference between the impact of the economy on the discipline of economics
in the 30s and the absence of such an impact in the 60s. The Keynesian
revolution allied itself to a revitalization of politics, a broadening of
the political agenda, and that broadening of politics was a necessary
condition for influencing economics. By contrast, after the meteoric rise of
Eugene McCarthy and his equally rapid fall in 1968 (and the reprise of the
McGovern campaign in 1972), nothing much was left of the New Left.
Accordingly, the new ideas of radical economists had little impact on
mainstream economics. The revitalization of politics symbolized by the New
Deal became progressively watered down even as Richard Nixon proclaimed in
1971 that we were all Keynesians now. Ronald Reagan's ascent and his appeal
to working-class Democrats heralded the end, and Bill Clinton provided the
epitaph when he announced that the era of big government was over.
Like politics, economics has become progressively
narrower since the 1960s. In my undergraduate years, in the late 50s, the
ghost of Joseph Schumpeter still stalked Harvard Yard, and his immediate
disciples argued with the disciples of Keynes about the future of
capitalism. Even if few Marxists or radicals were to be found on American
campuses in those post-McCarthy years, the questions they had raised — like
whether American capitalism could survive without the huge government
military budgets that the cold war had legitimized — were very much on the
table. Today that kind of substantive discussion has no place in most
economics departments. We have gained technical sophistication, but we have
lost something much more valuable.
Economics is a two-faced discipline. It claims to
be a science, describing the world without preconception or value judgment.
(Never mind that the heyday of positivism that enshrined the separation
between fact and value is long past; economists have always lived in a time
warp.) The reality is that descriptive economics has been shaped by a
framework of assumptions geared more to its normative message than to its
pretensions. The self-interested individual — who rationally calculates how
to achieve ever more consumption, whose conception of community is limited
to the nation-state — is a myth, not exactly false but a half-truth at best.
That framework is essential to the normative side of an economics that
proclaims the virtues of markets and is maintained even when it gets in the
way of understanding how the economy really works.
At times of crisis, the emperor's sartorial lack
becomes more obvious and the need for clarity more acute. We are living
through such a crisis today, and we desperately need clarity on the
relationship between fixes for Wall Street and fixes for Main Street; on the
relationship between immediately mending the financial system and the
broader economy and the longer-term problems that face the economy, starting
with global warming. A beginning would be to update Robbins's definition of
economics as the allocation of scarce means among unlimited ends. That
one-size-fits-all definition hides the reality of two distinct problems.
In poor countries, the economic problem is to
produce an increasing amount of goods and services with limited means. Even
there, distribution, and making sure people in need reap the benefits of
growth, is an issue. However, the problem in the rich countries is not
scarcity. Let us be clear about why recession is a calamity in the rich
countries: It is not because of the output that is lost, but because the
loss of a job means a corresponding loss of income and consumption for many
people.
Consider this: Even if 10 percent of the labor
force were to become unemployed, the loss of production would be manageable
if we had mechanisms to share the losses of the unemployed among those who
remain employed, in ways that did not undermine the dignity of the
unemployed. Economic growth is the way out of recession not because we need
the goods, but because the new jobs created by a growing economy are the
only way that people laid off during the downturn can reclaim an adequate
standard of living, along with their dignity as full-fledged members of
society. Recessions are calamitous because the welfare state provides too
little, not because it provides too much.
A renewal of economics must include an awareness of
what is being sacrificed on the altar of endless growth: the environment and
community. It is a reasonably good bet that the present crisis will
stimulate bold thinking about both. Whether the seeds of intellectual change
will find a favorable soil in which to germinate and grow into healthy
plants, however, will depend in large measure on whether the questioning of
economics can ally itself to a movement to broaden the political discourse:
to include discussion of the purposes of growth and the virtues of
restraining our appetites, of a revival of social solidarity so that we can
fashion a new relationship between individual and community, between
government and market.
We need to take seriously the proposition that "we
are all in this together." The Obama campaign promised a revival of a
broader politics. It remains to be seen whether the Obama administration
will deliver on that promise. And what economists will learn from the
crisis.
Stephen A. Marglin is a professor of economics at Harvard University.
His latest book is The Dismal Science: How Thinking Like an Economist
Undermines Community (Harvard University Press, 2007).
Keynes: The Rise, Fall, and Return of the 20th Century's Most
Influential Economist by Peter Clarke (Bloomsbury; 2009, 211
pages; $20). Examines the life and legacy of the British economist (1883-1946).
Meanwhile in the U.K., the Government Protects
Reckless Bankers
"Off the legal hook: The law does not protect individuals from
the recklessness and failings of company directors. It should," by Prim
Sikka,
The Guardian, October 25, 2008 ---
http://www.guardian.co.uk/commentisfree/2008/oct/25/banking-law
The current financial crisis has been manufactured
in company boardrooms. Its authors include the best executive directors,
non-executive directors, accountants, lawyers and sundry business advisers.
Most directors received profit-related remuneration. Innocent stakeholders
lost savings, investments, jobs, homes and pensions.
Among many reckless acts, bank executives used
depositors' and investors' monies to place clever bets on the movement of
interest rates, exchange rates, commodity prices and virtually everything
else. They borrowed heavily. At some banks, for every £1 of shareholder
investment, directors borrowed £33 – inother words, they had a leverage
ratio of 33:1, meaning that just over 3% of the company was financed by
long-term funds. This meant that if the value of the bank's assets declined
by just over 3%, the bank would technically be bankrupt. Many banks had even
higher leverage ratios. With the full approval of auditors, most of them
reported toxic assets as good. They also moved more than $5tn of assets and
liabilities off balance sheet. All this helped to improve earnings and
maximise the profit related remuneration of bank directors. There is a clear
conflict of interests between the interests of directors and wellbeing of
business stakeholders. It is difficult to see how the directors exercised
reasonable care, skill and diligence in devising their policies.
Successive governments have been too keen to shield
their friends from public scrutiny. No independent inspectors were appointed
to investigate failures at Polly Peck, The Accident Group, Bank of Credit
and Commerce International (BCCI), or Versailles Group Plc. Such is the hold
of deregulationist philosophies that the Department of Business, Enterprise
and Regulatory Reform (BERR) does not even have an in-house unit to
investigate major corporate abuses. It outsources that function to major
auditing firms, the very firms which have given a clean bill of health to
the accounts of distressed banks.
Abuses by big names in the City have been flagged
before. For example, a 1997 government report on Guinness plc found
"firstly, the cynical disregard of laws and regulations; secondly the
cavalier misuse of company monies; thirdly, a contempt for truth and common
honesty. All these in a part of the City which was thought respectable". Yet
little has been done to enhance people's rights against executive abuses.
Section 171 of the Companies Act 2006 states that a
director must act in good faith, promote the success of the company for the
benefit of its members [shareholders] as a whole and in doing so have regard
(among other matters) to "(a) the likely consequences of any decision in the
long term, (b) the interests of the company's employees, (c) the need to
foster the company's business relationships with suppliers, customers and
others, (d) the impact of the company's operations on the community and the
environment, (e) the desirability of the company maintaining a reputation
for high standards of business conduct, and (f) the need to act fairly as
between members of the company".
Lawyers could use this law to argue that directors
have been negligent and harmed the interests of stakeholders. However,
directors do not owe a 'duty of care' to any individual shareholder,
employee, depositor or any other stakeholder. The interests of stakeholders,
such as employees, pension schemes members, suppliers, customers and local
communities have been subordinated to the interests of the company. Though
the shareholders may bring class actions to sue directors for negligence,
the law does not empower employees, pension scheme members or depositors to
do the same. Neither an individual shareholder nor any other stakeholder can
sue auditors as they only owe a 'duty of care' to the company, as a legal
person. Auditors enjoy too many liability shields and can escape liability
even after admitting negligence.
The UK is ill-equipped to investigate the current
financial crisis, or prosecute its architects. Individual stakeholders have
lost property, but are not in a position to sue negligent directors and
auditors. Thus the UK state is failing in its duty to protect the property
rights of its citizens. There is an urgent need to abandon deregulationist
policies and revise corporate laws.
Appendix Q
A Primer on Derivatives
I think there are two CBS Sixty Minutes
television modules by Steve Kroft that the entire world should view. These are
great videos for college students to view while keeping in mind that both videos
are negatively biased. What follows is my primer in defense of derivative
financial instruments and hedging activities.
CBS Video Module 1
Financial Derivatives Scandals Explode in 1995
|
CBS Video Module 2
Credit Derivatives Scandals Explode in 2008
|
Related to the above television programs is
"The Trillion Dollar Bet" video from PBS Nova ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#LTCM
Economists tend to differ on the role
derivative financial instruments played in the 2008 financial crisis
(certainly Bear Stearns and AIG were failing due to credit derivatives
obligations for bad mortgaged backed securities for which these two companies
did not have nearly enough money to pay their credit derivative obligations to
counterparites), but there are numerous economists still pleading that it would
be a mistake to heavily regulate derivatives because of this one crisis.
"Insight: Annihilation on Main Street By Mark Sunshine," Financial
Times, November 27, 2008
Warren Buffett called credit default swaps
“financial weapons of mass destruction” and they are about to annihilate
Main Street. In a disturbing new trend, international banks are creating
syndicated credit facilities that “weaponise” credit default swaps (CDS) by
using the trading price of a borrower’s CDS to set the interest rate paid by
the borrower. Unfortunately, banks don’t understand that they are arming
speculators to ambush and kill unsuspecting and otherwise healthy companies.
Regulators are oblivious to this danger as are the victims.
CDS are unregulated derivative instruments that are
essentially a bet on the creditworthiness of a company. CDS are traded in an
unregulated, opaque over-the-counter market where prices have questionable
value and can be easily manipulated and misrepresented.
Continued in article ---
Click Here
Bob Jensen's Timeline History of Derivatives
Instrument Scandals ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Bob Jensen's Primer on Derivatives
From Vanderbilt University (you have to watch
this video to the ending to appreciate it)
A Keynote Speech by Leo Melamed ---
Click Here
http://www.owen.vanderbilt.edu/vanderbilt/About/owen-newsroom/owen-podcasts/podcasts/FIC-Melamed-keynote.html
Who is Leo Melamed? ---
http://en.wikipedia.org/wiki/Leo_Melamed
Bob Jensen's Primer on Derivatives ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Primer
Although the roots of the
sub-prime mortgage scandal lie in Main Street lending or more money for
housing than borrowers could ever afford to pay off, the opportunity to do so
was afforded by lenders like Countrywide Financial (a mortgage lending company
owned by Bank of America) being able to pass on the default risk by selling the
high risk mortgages to Fannie Mae and Freddie Mac, quasi government corporations
that
took the brunt of the loan losses. But some banks like
Washington Mutual (WaMu became the largest bank failure in the history of
the world) were greedy and kept huge portfolios of these high-return and
high-risk mortgage investments.
Fannie, Freddie, WaMu and the other risk
takers assumed that the value of the real estate (the mortgage loan collateral)
would be sufficient to pay back the loans in case of mortgage default
foreclosures. But they underestimated the fraud going on on Main Street where
property appraisers were fraudulently estimating real estate values way above
market value and mortgage companies were lending way above amounts that
borrowers would ever be able to pay back. My essay on the sub-prime mortgage
scandal along with an alphabet soup set of appendices can be found at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
In addition much of the current scandal also
is attributed to Wall Street writing of
credit
derivative contracts that essentially "insured" against default of debt with
counterparties investing in debt instruments that were "insured" by credit
derivatives written by such giant firms as Bear Stearns and American Insurance
Group (AIG). But unlike insurance where sufficient capital reserves are
required, Congress
passed legislation in Year 2000 that allowed Wall Street to write credit
derivative insurance without having any capital reserves to cover the losses.
Congress and the Wall Street firms just never anticipated the massive amount of
mortgage defaults attributable to Main Street's lending frauds. When the
magnitude of the amounts owing to counterparties on credit derivatives became
known, giant firms like Bear Stearns and AIG would've defaulted due to credit
derivative obligations to counterparties. This would have led, in turn, to
counterparty failure of many giants in the world banking system. The Federal
Reserve decided early on to bail out Bear Stearns credit derivative losses, and
the first $70 billion given to AIG by Hank Paulson in the new Bailout Bill went
to pay off AIG's counterparties to AIG's credit derivative contracts ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#SEC
So what is a derivative financial instrument?
Consider first a financial debt instrument that historically was a contract in
which a borrower borrowed money from a lender and the risk for the entire
notional (the loan principal) passed from borrower to lender. For example, if
Company B sold bonds for $100 million to Company C, the entire notional ($100
million) is at risk of being paid back to Company B. Credit rating companies, in
turn, rate those bonds as to financial risk with such ratings as AAA (virtually
certain to be paid back) all the way down to junk bonds (very high risk of
default) of the entire notional amount. Credit ratings greatly impact the price
received by Company B for its bond sales.
A derivative financial instrument is similar
except that the notional amount is often not at risk because these contracts
"net settle." For example, if Airline A enters into futures contracts to buy a
million gallons of jet fuel one year from now at a forward price of $4 per
gallon, the notional full value of a million gallons of fuel never changes
hands. After a year passes, Airline A net settles with the counterparties on the
net difference between the current spot price and the contracted forward price.
Although in some cases a purchase/sale contract can specify physical delivery of
the notional, most derivative contracts net settle without putting the entire
notional amount at risk.
Hence, a derivative financial instrument has a
notional (a quantity such a a million bushels of corn), an underlying (such as
the market price of a particular grade of corn), and net settlement provisions
that do not put the value of the entire notional amount at risk. Only the
difference between forward and spot prices on the notional is at risk. The
entire notional becomes at risk only if the future spot prices fall to zero or
nearly zero. This is not likely to happen in the case of commodities like corn,
oil, copper, gold, silver, etc. It can happen in the case of credit ratings
where $100 million in AAA bonds fall to zero when the debtor is declared to be
hopelessly bankrupt. This is why credit derivatives are
much more risky than commodity derivatives. If a credit derivative is written on
a $100 million bond contract, the entire $100 million might be lost. The
probability of losing the entire value of the notional is much greater with
credit derivatives than with commodities that are almost certain not to decline
to $0 in value.
The underlying is generally called an index.
Examples include corn prices, oil prices, interest rates (e.g., Treasury rates
or LIBOR rates), and credit ratings (AAA, AAB, BBB, etc.). A huge difference
between commodity versus credit derivatives lies in the depth (number of buyers
and sellers) and the frequency of trades in the market. For example, in the
derivatives markets for corn futures or corn options (puts and calls) there are
thousands upon thousands of buyers and sellers and the market prices (e.g.,
futures, option, and spot prices) change by the minute each trading day. In the
case of a credit derivative written on the bond rating by a credit rating agency
there is no deep market and the credit rating rarely changes. There is no
underlying "market" in the case of a credit derivative.
Hence a credit derivative differs fundamentally from a commodity derivative
in the depth of the market and the frequency of trading on the market. Its a
mistake to lump credit derivatives and commodity derivatives in the same a
single type of contracting called derivatives.
By any other name, a credit
derivative is an insurance contract where risk of default is not market based
but depends upon some disaster just like casualty insurance protects against
such disasters as fire, wind, and flood. The entire value of the notional (the
entire value of each bond insured for credit risk or each house insured for fire
loss) is at risk.
In contrast, a commodity derivative
is market based and does not in general put the the entire notional at risk
because commodity values are not likely to be wiped out entirely. Commodities
may move up and down in value, thereby generating variations in the basis (which
is the difference between spot and forward prices), but it would be extremely
rare for the a commodity to fall to zero in value. It is much more common for an
insured house to be burned down entirely or an insured (with a credit
derivative) bond notional to fall into junk bond status.
AIG and Allstate and State Farm are
required by insurance laws to have capital reserves to cover a large number of
houses burning down at the same time. However, if all insured houses burned down
at the same time, insurance companies could not possibly cover all the losses.
This is why a single insurance company might refuse to insure more than a
certain percentage of houses in a give geographic area. Insurance written above
a company's limit is spread to other companies by a process called
reinsurance.
Insurance companies are subject to regulation that requires capital reserves to
cover actuary-determined expected losses and contract clauses that limit risk in
case of catastrophes such as nuclear holocaust.
Credit derivative insurers could not
write insurance contracts for credit default without capital reserves and other
catastrophe clauses until Congress in Year 2000 allowed investment banks like
Bear Stearns and insurance underwriters like AIG to enter into credit derivative
insurance without capital reserves and catastrophe clauses. The fraudulent
sub-prime loan market became a catastrophe in terms of real estate loans covered
against default by credit derivatives. Bear Stearns, AIG, and the other credit
derivative underwriters had insufficient capital reserves and would've defaulted
on their credit derivatives if the U.S. government had not stepped in to cover
amounts owed to credit derivative counterparties. The government justified
bailing out these obligations by stating that the domino effect would've
otherwise brought down the entire banking system. On this I'm a cynic, but
that's another matter entirely. History is history at this point.
What is sad today is that
derivatives in general are getting a bad name!
Commodity derivatives (including interest rate risk derivatives) are
great vehicles for managing financial risk provided
the commodities and their derivatives are both traded in deep markets with
virtually zero probability that commodity values will fall to zero. Sadly, most
people in the world just do not appreciate the importance of maintaining active
commodity derivative markets for managing risk.
Ignorant people, especially ignorant
members of Congress, may move to ban or severely restrain all derivative markets
rather than to merely reclassify credit derivatives as insurance contracts
subject to insurance laws. This does not mean, however, that I think that
commodity derivative contracting should be more regulated for protection against
unscrupulous sellers of derivative contracts. Like my hero Frank Partnoy, I've
argued for years that there should be more regulation of sellers of derivative
contracts.
I have a detailed history of
derivative instrument contract scandals and the evolution of accounting rules
(national and international) for derivative contracts at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
At each point in the way I've applauded Frank Partnoy's appeal for both expanded
use of derivative instruments for managing risk and expanded regulations to stop
firms like Merrill Lynch, Morgan Stanley, and other unscrupulous outfits from
writing derivatives with built-in financial complexity intended to obscure risk
and screw fund investors who did not understand what they were buying into.
Do we have a 2008 Orange County-type fraud instigated by JP Morgan Chase Bank?
"FBI Probe of JPMorgan Fees Focuses on Swaps Roiling Muni Debt," by William
Selway and Martin Z. Braun, Bloomberg News, October 27, 2008 --
http://www.bloomberg.com/apps/news?pid=20601109&sid=aIL9gsK5wG40&refer=exclusive
Ambrosini says the deal looked so easy. JPMorgan
Chase & Co. bankers told him there was really no risk. All he had to do was
sign a public financing contract, and the bank would give $280,000 to his
school district in New Castle, Pennsylvania.
``They basically said, unless the world goes under
the sea, we'd be in good shape,'' says Ambrosini, the district's business
manager.
In September, Ambrosini says, his 3,400-student
district went underwater. On Sept. 25, the week after Lehman Brothers
Holdings Inc. collapsed, the New Castle Area School District's interest rate
on $9.7 million of financing arranged by JPMorgan hit 10.6 percent, more
than doubling since the month began, as investors demanded skyrocketing
returns for municipal debt.
While JPMorgan has been relatively unscathed by the
subprime crisis that hit Bear Stearns Cos., Merrill Lynch & Co., Lehman and
other Wall Street firms, a little-known part of the largest bank in the U.S.
made a tidy profit peddling a different kind of corrosive debt to hundreds
of counties and school districts earlier this decade.
As the credit crunch froze lending globally,
causing stock markets to plunge, local officials who say they trusted
JPMorgan faced a crisis of their own. Wall Street's drive for profits over
the past decade has backfired on towns, cities and counties that borrow in
the $2.7 trillion municipal bond market.
Financings arranged by JPMorgan and other banks are
forcing hundreds of public agencies to spend billions of dollars they don't
have to pay for increased interest payments and penalties.
No Bailouts
These come in municipal bond and derivative deals
that have turned poisonous. Unlike JPMorgan, which has benefited from
federal bailouts, the towns and schools the bank has financed have received
no help from Washington.
In the midst of the Wall Street collapse, JPMorgan
and Jamie Dimon, its chief executive officer, have stood as pillars. The
bank helped the Federal Reserve bail out a tumbling Bear Stearns in March,
as the U.S. Treasury pledged $29 billion to Dimon's firm to cover losses.
In October, JPMorgan took over failing Washington
Mutual Inc., the largest savings and loan institution in the U.S., with $188
billion in deposits.
Behind the glow of favorable publicity in which
JPMorgan has basked, its municipal derivatives unit has operated in
obscurity. The financings it arranged have sparked lawsuits from local
governments alleging fraud.
Criminal Investigation
The muni derivatives unit has become snarled in the
largest-ever criminal investigation of public finance by the Department of
Justice.
Prosecutors have informed at least five former
JPMorgan derivative bankers that they're targets in an investigation of
whether banks conspired to overcharge local governments, according to the
Financial Industry Regulatory Authority, or Finra, the largest
self-regulator for securities firms doing business in the U.S.
The Securities and Exchange Commission is
conducting a civil probe of the deals.
On Sept. 3, JPMorgan shut down its unit selling
debt derivatives to municipalities because the risks outweighed the profit.
Even so, localities are still on the hook for explosive contracts arranged
by the bank.
``The legacy of this is going to resonate in state
and local governments for years,'' says Christopher Taylor, who ran the
Municipal Securities Rulemaking Board, the industry's regulator, from 1978
to 2007.
`Clean it Up'
``The culture started before Jamie Dimon got
there,'' Taylor says. ``The question is, Is he going to clean it up once and
for all? Because it stands in contrast to the rest of JPMorgan's public
image.''
The bank declined to make Dimon or any other
executives available to comment for this story.
JPMorgan lured municipalities into derivative deals
by offering upfront cash payments in exchange for a pledge by the local
government to agree to enter interest-rate swaps with the bank at a future
date.
In these deals, which were rarely put out for
public competitive bidding, the bank said its clients would come out ahead
if interest rates increased in the future.
JPMorgan and competitors routinely didn't disclose
their fees for these contracts, public records show. In some cases, the bank
made more money than it paid out. In Erie, Pennsylvania, JPMorgan gave the
school district $755,000 upfront and collected $1.2 million in fees.
How Fees Are Hidden
The bank was able to lock in its income by selling
a mirror-image swap contract on the open market for the higher amount. The
transactions involved derivatives, which are unregulated contracts tied to
the value of securities, indexes or interest rates.
The deals JPMorgan arranged used floating-rate
bonds and interest-rate swaps. The swaps required a municipality and the
bank to exchange payments as frequently as every month. The amounts that
changed hands were based on various global lending rates.
Some deals also gave JPMorgan the power over
decisions about taxpayer funds by allowing the bank to decide whether an
agency would enter a swap in the future.
Jefferson County on Brink
The bonds were backed by AAA-rated insurance
companies and worked well for several years because Wall Street had easy
access to cash. By the end of 2007, mortgage losses were undermining
insurance company credit ratings and money flows began to tighten.
Nowhere have JPMorgan's derivative deals wreaked
more havoc than in Jefferson County, Alabama, home of Birmingham, the
state's largest city. A combination of soaring rates on its bonds and
interest-rate swaps is threatening the county with the biggest municipal
bankruptcy since Orange County, California's default in 1994.
Jefferson County said it couldn't make its $84
million interest payment on Oct. 1. JPMorgan and other creditors gave it a
month to come up with a plan to rework its debts.
In April, the county's financial adviser approached
the Fed and the Treasury in Washington to explain its dilemma. On Oct. 6,
Alabama Governor Bob Riley asked the Treasury for financial help for
Jefferson County. Washington turned down the request.
`At Least a Conversation'
County Commissioner Shelia Smoot says that if the
U.S. government was willing to rescue Wall Street, it should have responded
to requests for help from a county on the brink of bankruptcy.
``If they're bailing out some of the very people
who got us in this mess, I think at least we could get a conversation,'' she
says.
JPMorgan and other banks have turned away from
traditional, competitively bid, fixed-rate municipal bond sales in the past
decade.
Fees banks collected for selling bonds that build
roads, schools and hospitals dropped 25 percent to $5.27 for every $1,000 of
debt in 2007 from 1998, as fixed-rate bonds became like commodities dropping
in sales value. Banks found they could charge 10 times as much for selling
municipal derivatives, public records show.
``The Street was driven into this stuff because the
cash products weren't profitable,'' says Christopher Whalen, a former Bear
Stearns bond trader who's now managing director of research firm
Institutional Risk Analytics. ``You've got to find new participants or the
game shrinks.''
`Wasn't Profitable'
If local authorities had stayed with old-fashioned,
fixed-rate municipal bonds for financing, they wouldn't be facing the rate
blasts hitting them today. But banks realized that plain-vanilla municipal
bond sales didn't make them enough money, says Steve Kohlhagen, former head
of debt derivatives at Wachovia Corp.
``It just wasn't a very profitable business, but
the derivatives part was,'' says Kohlhagen, who retired in 2002. ``So we
kept a minor presence in bonds. The reason was the derivatives.''
JPMorgan was the sixth-largest municipal bond
underwriter in 1985, with Citicorp and Merrill Lynch at the top of the list,
according to data compiled by Thomson Reuters. JPMorgan managed to gain on
its New York-based rivals by developing new methods of public finance.
Using derivatives, JPMorgan pitched a host of deals
whose names alone are indecipherable. For Philadelphia International
Airport, the bank sold something called a ``path-dependent knock-out
swaption.''
Selling Swaptions
JPMorgan also sold interest-rate swap options,
which are also known as swaptions, to school districts. When JPMorgan
exercises those options, municipalities must issue floating- rate bonds and
enter into interest-rate swaps with the bank.
The contracts allowed borrowers to tap money market
funds to secure short-term rates on bonds that wouldn't mature for decades.
The derivatives were meant to protect them against soaring rates.
For the arrangements to work, banks would have to
find buyers of municipal debt as often as every day. That included the
so-called auction-rate bond market, which for decades ran smoothly with a
surplus of buyers.
When the credit crunch hit in the second half of
2007, demand for such sales withered away. That sent the market for
variable-rate municipal debt and derivative contracts into a frenzy.
High and Dry
When banks couldn't find buyers for auction-rate
bonds, they stopped purchasing them themselves, so municipalities were left
high and dry, stuck with spiking interest rates. The turmoil later rippled
through the market for other variable- rate bonds as investors demanded high
yields for them, too.
That increased interest rates each month for cities
and towns.
Municipalities were stung again when the swap
contracts, which were written to protect against rising rates, didn't work.
Since the second half of 2007, lending rates have
declined, causing the payments banks made to municipalities to drop.
On Aug. 14, JPMorgan settled with regulators,
agreeing to buy back $3 billion of auction-rate bonds to settle industrywide
investigations of whether banks misled investors about the risks of the
auction bonds. That action didn't help Jefferson County. JPMorgan neither
admitted nor denied wrongdoing.
`Getting Crushed'
``A lot of people are getting killed; they're
getting crushed,'' says Steve Goldfield, a financial adviser at Public
Resources Advisory Group in Media, Pennsylvania, which was hired by a school
district now suing JPMorgan.
``Nobody is talking about the impact on the debt
side to taxpayers, how much school districts are going to pay in extra
interest expense because of this blowup,'' he says.
The seeds of JPMorgan's municipal derivative deals
were planted in the late 1980s. In 1987, the Fed relaxed provisions of the
Glass-Steagall Act, the Depression-era legislation that prevented commercial
banks from underwriting corporate securities and many types of local bonds.
The decision, which followed requests from Bankers
Trust Corp., Citicorp and JPMorgan, allowed all banks -- not just securities
firms -- to expand their sales of public debt.
Turning to Derivatives
JPMorgan seized the opportunity. It turned to its
strength: derivatives, says Peter Shapiro, managing director at Swap
Financial Group LLC, a South Orange, New Jersey-based financial adviser.
``More than anybody else, they used derivatives to
go from nowhere as an underwriter in 1987 into the group of leaders,''
Shapiro says.
The most common derivative JPMorgan sold to
municipalities was the interest-rate swap, in which two parties agree to
exchange periodic payments based on two different interest rates, one fixed
and the other floating.
Municipalities liked the deals because they could
get cash upfront.
``They were able to create very appealing products
for municipal issuers on what is known as the exotic side of the market,''
Shapiro says.
In 2000, J.P. Morgan & Co. and Chase Manhattan
Corp. merged. Douglas MacFaddin, the head of Chase's municipal derivatives
group, took over from Ajay Nagpal, who had headed J.P. Morgan's desk.
MacFaddin joined with former Chase bankers Samuel Gruer, James Hertz and
Hugh Nickola.
Bankers Fired
The Justice Department told Gruer, Hertz and
MacFaddin beginning in November 2007 that they were targets in the criminal
investigation of the municipal derivatives market, according to Finra.
JPMorgan fired MacFaddin and Hertz after learning
of the probe, federal records show. Nickola wasn't named as a target and
still works at JPMorgan. Gruer, who joined Deutsche Bank AG in 2006, denies
wrongdoing, records show.
MacFaddin, Nickola and Hertz didn't return requests
for comment. Gruer declined to comment.
MacFaddin, 47, a graduate of Union College in
Schenectady, New York, took J.P. Morgan's emphasis on exotic derivatives and
merged it with Chase's goal of doing many deals quickly, Shapiro says.
Landing Deals
Just as lenders that offered subprime mortgages
relied on an army of local brokers to sign up less-than-creditworthy
borrowers, JPMorgan developed ties with local municipal bond firms, advisers
and lawyers to land deals.
JPMorgan gave these firms work in return for
promoting the bank to elected officials, Charles LeCroy, JPMorgan's top
revenue producer in public finance, told an outside lawyer for the bank in
2004, according to court filings in Philadelphia.
In 2005, LeCroy, 54, and JPMorgan banker Anthony
Snell pleaded guilty in Philadelphia to charges of filing false invoices in
connection with swap and bond deals steeped in corruption.
LeCroy was sentenced to three months in jail. Snell
was sentenced to 90 days of house arrest and fined $15,000. Philadelphia
Treasurer Corey Kemp was found guilty after a trial in Federal District
Court in Philadelphia in 2005 and is serving 10 years in prison.
`A Lot of Stroke'
In Philadelphia, JPMorgan turned to bond lawyer Ron
White, a confidant and fundraiser for then-Mayor John Street.
``He carries a lot of stroke with the city,''
LeCroy wrote of White to a fellow JPMorgan banker in a December 2001 e-mail.
All of the deals that JPMorgan and White discussed
involved derivatives, LeCroy said during an SEC administrative hearing in
December 2006. JPMorgan agreed to train White so he could become the lawyer
on Philadelphia's interest-rate-swap deals, LeCroy told investigators.
In 2002, LeCroy held a meeting between White and
MacFaddin, who outlined what White would have to do, according to court
records.
JPMorgan also agreed to contribute to White's
charities. It gave $70,000 to a foundation for youth leadership and $20,000
for a minority scholarship fund in White's name at his alma mater, Wesleyan
University in Middletown, Connecticut.
$50,000 for Nothing
JPMorgan also paid White $50,000 in a Mobile,
Alabama, public finance transaction in which he played no role, court
records show.
On Feb. 19, 2003, White told Kemp that JPMorgan was
pushing swaps to generate fees, not because they were in the city's
interest, according to a tape recording by the Federal Bureau of
Investigation.
``You know, they don't watch your back,'' White
said. ``They're about getting fees and getting the most fees they can get.
If there was an issue between whether to do a bond deal or a swap, they
gonna take the swap, even though it may not be the best thing.'' White died
of cancer before the trial.
Richard Metcalfe, head of policy for the
International Swaps and Derivatives Association Inc., says swaps help to
manage risk.
``While an interest-rate swap will hedge against
movements in interest rates, it is simply not designed to address other
forms of risk,'' he says.
Ten Times as Much
In April 2002, Philadelphia International Airport
entered into a high-stakes derivative trade with JPMorgan. The airport got
$6.5 million; JPMorgan acquired the right to put the bank into an
interest-rate swap on $189 million of bonds.
JPMorgan took in $4 million-$4.5 million on the
deal in fees, according to LeCroy's SEC testimony. That was 10 times what
the bank earned for underwriting a floating-rate-bond issue for the airport
after the bank exercised the option.
The deal has turned out terribly for Philadelphia.
In June 2008, the interest rate on the floating-rate bonds the airport
issued surged to 7.2 percent from 1.8 percent the week before, after MBIA
Inc., the company that guaranteed the bonds, lost its AAA credit rating.
The rate on the debt reached a high of 10 percent
on Sept. 23. That wouldn't be so bad if the floating rates the airport
received from JPMorgan matched the increased rate it pays the bond
investors, which is what the contract is designed to do.
That hasn't happened. The average rate the bank
paid the airport from June to September was 2.27 percent.
`We'd Rather Not'
Philadelphia officials say they don't really have
the choice of canceling the swap. Based on prices at the end of September,
termination would cost Philadelphia about $24.4 million, according to the
city. That's almost $20 million more than what it received in 2002.
``Obviously, the termination payment would be
significant,'' City Treasurer Rebecca Rhynhart says. ``It's something we'd
rather not have to do.''
JPMorgan turned to other politically connected
friends to win contracts in Western Pennsylvania in 2003. That year, it
bought Cranberry Township-based underwriter RRZ Public Markets Inc., near
Pittsburgh.
Greg Zappala, the son of former Pennsylvania
Supreme Court Chief Justice Stephen Zappala and the brother of the Allegheny
County district attorney, brought his local government clients to the Wall
Street bank. Along with them, according to two lawsuits, came windfall
profits on derivative deals.
Zappala urged the Butler Area School District, in
the countryside 40 miles (64 kilometers) north of Pittsburgh, to take cash
out of bonds that couldn't be refinanced until 2008.
Bank Got More
In September 2003, the school district got $730,000
from JPMorgan by selling the bank the option to push the school district
into a swap beginning in 2008.
That exchange was more valuable to JPMorgan. The
bank made $894,000 at the same time, according to a lawsuit filed by the
district in September.
The district alleged that JPMorgan conspired with
adviser Investment Management Advisory Group Inc., or IMAGE, to hide the
fees and push the district into an unfair trade. As of mid-October, JPMorgan
and IMAGE hadn't filed a court response.
In July, JPMorgan told the school district it would
exercise the option on Oct. 1. That would lock the district into potentially
huge interest rate increases. So the district paid JPMorgan $5.2 million to
walk away, seven times more than the bank paid it in 2003.
Edward Fink, superintendent of the school district,
says it's now clear the risky deal was a mistake.
`Inappropriate Transactions'
``The last few months have led us to conclude that
swap transactions, although legal for public school districts in
Pennsylvania, are inappropriate transactions for public school districts,''
he says.
The New Castle school district is learning the same
lesson. In September, Ambrosini, the district's business manager, found that
the cash the schools accepted left him exposed to market chaos he never
anticipated.
In 2004, JPMorgan banker Michael Lena, one of those
under investigation by the Justice Department, made a deal with the district
in which the bank gave the schools $280,000 for the option to force the
district into interest-rate swaps on $9.7 million of bonds.
`They Assured Me'
It also purchased options on two other district
bond issues. Lena didn't respond to requests for comment.
Ambrosini says JPMorgan's bankers told him the deal
was nearly fail-safe and would allow the schools to collect money that would
disappear if interest rates rose.
``They assured me, 'You're going to be in great
shape,''' he says.
He's not.
The credit crisis caused the interest rate to jump
on Sept. 25 to 8.75 percent on $9.7 million of bonds he sold in May as
JPMorgan called in its option. The swap added another 1.9 percentage points,
bringing the district's interest rate to 10.6 percent.
Phil Conti, vice president of the New Castle school
board, says he doesn't know what to do.
``We're in a dilemma,'' he says. ``We're struggling
just to keep our head above water.''
Conflicts of Interest
Many municipalities, including Butler County,
Jefferson County and Philadelphia, hired financial advisers to analyze
prices, fees and interest rates to determine whether swap contracts were
fair.
Local officials didn't recognize the conflicts of
interest created by the relationships between the advisers and the banks.
Banks routinely pay these advisers and often refer them to government
issuers.
In Erie, JPMorgan recommended Pottstown,
Pennsylvania- based IMAGE to be the school district's independent financial
adviser. During a Sept. 4, 2003, meeting of the Erie City School District's
board, JPMorgan banker David DiCarlo praised the firm.
``There's only probably three or four firms in the
world that do these things, and IMAGE is probably the premier firm,''
DiCarlo said, according to a transcript of the meeting.
As in Butler, IMAGE never disclosed JPMorgan's fee.
Neither did the bank. In a written statement, IMAGE said it could only
estimate the bank's fees, which it described as normal for the industry. The
firm denied any conflict of interest.
`I Can't Quantify That'
Erie school board member Eva Tucker asked DiCarlo
how much JPMorgan would make in the deal.
``Everybody has asked, and it is a reasonable
question, what does JPMorgan, what do we get on this transaction?'' DiCarlo
said, according to minutes of a school board meeting.
``I can't quantify that to you,'' he said. ``What
this transaction is, is a financial transaction that is put into a huge
hedge fund that JPMorgan controls. There's a trillion dollars of investments
in that hedge fund. There's some other issuer in Tokyo or somewhere else
who's got an opposite bet and they're going to offset each other.''
JPMorgan, which, like other banks, balances the
swaps by selling similar derivative deals on the open market, took a fee of
$1.23 million, according to data compiled by Bloomberg. That's almost 10
times the fair rate, according to a lawsuit filed by the school district
against JPMorgan and its adviser in federal court.
There had been no court-filed responses as of mid-
October. DiCarlo, Zappala and IMAGE didn't return requests for comment.
$5.4 Billion in Swaps
The JPMorgan municipal finance deals that have
drawn the most national attention are those in Jefferson County, Alabama.
The county, with a population of 660,000, has $5.4 billion in swaps on its
books -- the most of any county in the U.S.
In ``The Banks That Fleeced Alabama'' (September
2005), Bloomberg Markets magazine reported that JPMorgan overcharged the
county by $45 million on its derivative deals.
The interest rate Jefferson County must pay on its
bonds jumped as high as 10 percent in February from about 3 percent two
months earlier. The swap agreements drove the county deeper in the hole. It
may be forced to file for bankruptcy.
Clarence Arnold, who lives in Birmingham on $738 a
month from Social Security, worries that people like him will wind up paying
the bill.
``We didn't get them in this mess,'' Arnold, 66,
says. ``But it doesn't matter what we do. It's going to end up in our hands.
It always does.''
$100 Million More
In 2002 to 2003, Jefferson County refinanced into
floating rate bonds almost all of the $3.2 billion of debt it sold to build
a sewerage system. The county paid JPMorgan and a group of banks $120.2
million in fees for derivatives that were supposed to protect it from the
risk of rising interest rates.
Those fees were about $100 million more than they
should have been based on prevailing rates, according to James White, an
adviser the county hired in 2007, after the SEC said it was investigating
the deals.
JPMorgan and seven other banks in the deals were
left holding most of the bonds after credit markets froze in early 2008. The
banks asked to get paid back with county tax money or higher sewer fees.
Such proposals caused a public outcry.
`We Were Boxed'
``We were boxed in because we couldn't raise taxes
and couldn't raise rates, which are already too high anyway,'' County
Commissioner Jim Carns says.
White traveled to Washington in April to tell
members of Congress and officials at the Federal Reserve and the Treasury
Department about the crisis that was threatening Jefferson County with
bankruptcy.
``We were told Jefferson County didn't have
national implications,'' he says.
The crisis triggered a seven-month standoff between
the county and the banks. In negotiations with the county, banks have sought
to be released from any liability in the swap and bond deals, Carns says.
``My constituents do not want to let Wall Street
off the hook,'' he says. Carns says he opposed the $700 billion Wall Street
bailout.
`Overwhelming Greed'
``Motivated by overwhelming greed, Wall Street
thrashed around creating financing structures divorced from reality and good
sense -- and paid lots of people way too much money,'' he says.
In Jefferson County, the local consequences may be
dire. In Birmingham, one in four people lives below the poverty line,
according to the U.S. Census Bureau. Those residents may be forced to bail
out the debt mess by paying higher sewer bills.
``The poor people are going to be suffering for
it,'' retiree Arnold says. It's not just in Birmingham. Across the country,
Wall Street made windfalls peddling risk and the illusion it could be kept
under control.
Beverly Schenck, a 71-year-old paralegal who lives
in Center Township, Pennsylvania, in the Butler school district, is livid.
``Why wasn't someone investigating these deals?''
she says. ``If it looks too good to be true, it is.''
For municipal governments, as for many of the
financial institutions themselves, the opaque derivative deals have broken
down. And taxpayers are left picking up the pieces.
Bob Jensen's free tutorials and
videos on complex accounting rules for accounting for derivative financial
instruments and hedging activities ---
http://faculty.trinity.edu/rjensen/caseans/000index.htm
Bob Jensen's glossary on derivative
financial instruments ---
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
If Greenspan Caused the Subprime Real Estate
Bubble, Who Caused the Second Bubble That's About to Burst?
Answer: See
http://faculty.trinity.edu/rjensen/2008Bailout.htm#LiquidityBubble
Reply to David Spener on October 29, 2008
Hi David
(Spener),
I updated my
Primer for the latest revelations about JPMorgan Chase ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Primer
The NPR summary
is great. With a tribute to you, I added a module on this show at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Where the NPR
show is weak is in pointing out how essential commodities derivatives
markets are in managing financial risk. The problem is not in the market
concept and the majority (hundreds of trillions of dollars worth) of
legitimate transactions for both hedging and speculation. The problem, as is
often the case, lies in the ability of oligopoly executives and their
Congressional puppets to exploit those free markets for outright fraud. The
JPMorgan and Orange County fiascos illustrate these abuses.
One book I would
definitely have students read all or part of is Infectious Greed by
Frank Partnoy. I quote liberally from that book at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
In your
sociology courses I recommend focusing on reasons why these “infectious
greed” frauds transpired. I like Jane Bryant Quinn’s answer which I
summarized in my Answer to Question 1 at
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm
You might also
find some use of my American fraud history summary at
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Thanks for your
helpful message.
Bob Jensen
Last month, the International Swaps and
Derivatives Association estimated that nearly $47 trillion in swaps were
outstanding as of June. That number might include transactions not cleared by
the depository corporation. The most default swaps have been written on the
countries of Turkey, Italy, Brazil and Russia, according to the new data. They
were followed by GMAC, the auto finance company that is partly owned by General
Motors. Others in the top 10 include Merrill Lynch, Goldman Sachs, Morgan
Stanley, General Electric Capital and Countrywide Home Loans. But that ranking
does not account for contracts written on multiple units of the same companies.
In a credit-default swap, a buyer of protection pays an insurance premium to a
seller who agrees to cover any lost interest or principal on bonds or loans
issued by companies, countries or other organizations. The buyers and sellers
are typically securities firms, hedge funds, banks and insurance companies.
Policy makers have been unnerved by the rise of the market because they are
worried that sellers of protection may not have enough reserves to pay future
claims and that default by one party could lead to a cascade of failures
throughout the financial system. That fear led the Federal Reserve Board to
extend an $85 billion bridge loan to the American International Group and
prompted the Fed to arrange a sale of Bear Stearns to JPMorgan Chase. Both AIG
and Bear Stearns had bought and sold billions in swaps. Industry officials,
however, have argued that while the total amount of credit-default swaps appears
large, many of the contracts offset one another. Many players in the market
hedged their positions so if they had bought protection in one transaction they
would sell it in another.
Vekas Bejaj, "Look at
credit-default swaps reveals surprises," International Herald Tribune,
November 5, 2008 ---
http://www.iht.com/articles/2008/11/05/business/05swap.php
Jensen Comment
Don't count too heavily on the netting out offsets because these credit default
swap hedging slights of hand are not all perfectly symmetrical. One one
counterparty to the swap may default so there's no offset. Unlike market-based
derivatives (e.g., commodities derivatives), credit default swaps put the entire
notional at risk. If it were possible to offset insurance risks this way, all
casualty insurance companies would thereby have no risk. Huh?
In retrospect
between 2001 and the credit derivatives fiasco of 2008 (where Wall Street had
millions of such contracts) is that Janet M. Tavakoli’s credit derivative models
in 2001 looked almost perfect but ignored the Black Swan of 2008 that some might
arguably helped to bring down the world of finance to the extent that so many
credit derivatives were used, in a failing effort, to insure against investment
failures. This, of course, was a much larger specification problem than the
Euclidean difference between cylinders and cones. I wonder how Ms. Tavokoli is
sleeping these days. See
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Who is Nassim Nicholas Taleb?
---
http://en.wikipedia.org/wiki/Taleb
Many finance professors make students watch some of Taleb's videos, especially
the Black Swan ---
http://video.google.com/videosearch?q=taleb+black+swan+&www_google_domain=www.google.com&emb=0&aq=f&aq=f#
Black Swan Financial Collapse Black Swan ---
http://www.dailymotion.com/video/x720r3_black-swan-paradigm-financial-colla_tech
(People underestimate the probability of rare events)
"Testimony
Concerning Credit Default Swaps," by Erik Sirri Director, Division of
Trading and Markets U.S. Securities and Exchange Commission, SEC, November 20,
2008 ---
http://www.sec.gov/news/testimony/2008/ts112008ers.htm
I am pleased to have the opportunity today to again
testify regarding the credit default swaps (CDS) market. My testimony today
summarizes the key points from my testimony before this committee five weeks
ago and updates it to reflect the Commission's activities since then.
CDS can serve important purposes. They can be
employed to closely calibrate risk exposure to a credit or a sector. CDS can
be especially useful for the business model of some financial institutions
that results in the institution making heavily directional bets, and others
— such as dealer banks — that take both long and short positions through
their market-making and proprietary trading activities. Through CDS, market
participants can shift credit risk from one party to another, and thus the
CDS market may be an important element to a particular firm's willingness to
participate in an issuer's securities offering.
The current CDS market operates solely on a
bilateral, over-the-counter basis and has grown to many times the size of
the market for the underlying credit instruments. In light of the problems
involving AIG, Lehman, Fannie, Freddie, and others, attention has focused on
the systemic risks posed by CDS. The ability of protection sellers (such as
AIG and Lehman) to meet their CDS obligations has raised questions about the
potentially destabilizing effects of the CDS market on other markets. Also,
the deterioration of credit markets generally has increased the likelihood
of CDS payouts, thus prompting protection buyers to seek additional margin
from protection sellers. These margin calls have strained protection
sellers' balance sheets and may be forcing asset sales that contribute to
downward pressure on the cash securities markets.
In addition to the risks that CDS pose systemically
to financial stability, CDS also present the risk of manipulation. Like all
financial instruments, there is the risk that CDS are used for manipulative
purposes, and there is a risk of fraud in the CDS market.
The SEC has a great interest in the CDS market
because of its impact on the securities markets and the Commission's
responsibility to maintain fair, orderly, and efficient securities markets.
These markets are directly affected by CDS due to the interrelationship
between the CDS market and the securities that compose the capital structure
of the underlying issuers on which the protection is written. In addition,
we have seen CDS spreads move in tandem with falling stock prices, a
correlation that suggests that activities in the OTC CDS market may in fact
be spilling over into the cash securities markets.
OTC market participants generally structure their
acivities in CDS to comply with the CFMA's swap exclusion from the
Securities Act and the Exchange Act. These CDS are "security-based swap
agreements" under the CFMA, which means that the SEC currently has limited
authority to enforce anti-fraud prohibitions under the federal securities
laws, including prohibitions against insider trading. If CDS were
standardized as a result of centralized clearing or exchange trading or
other changes in the market, and no longer subject to individual
negotiation, the "swap exclusion" from the securities laws under the CFMA
would be unavailable.
Progress on Establishing a Central Counterparty for
CDS
As announced on November 14th, a top priority for
The President's Working Group on Financial Markets, in which the SEC
Chairman is a member, is to oversee the implementation of central
counterparty services for CDS. A central counterparty ("CCP") for CDS could
be an important step in reducing the counterparty risks inherent in the CDS
market, and thereby help mitigate potential systemic impacts.
By clearing and settling CDS contracts submitted by
participants in the CCP, the CCP could substitute itself as the purchaser to
the CDS seller and the seller to the CDS buyer. This novation process by a
CCP would mean that the two counterparties to a CDS would no longer be
exposed to each others' credit risk. A single, well-managed, regulated CCP
could vastly simplify the containment of the failure of a major market
participant. In addition, the CCP could net positions in similar
instruments, thereby reducing the risk of collateral flows.
Moreover, a CCP could further reduce risk through
carefully regulated uniform margining and other robust risk controls over
its exposures to its participants, including specific controls on
market-wide concentrations that cannot be implemented effectively when
counterparty risk management is uncoordinated. A CCP also could aid in
preventing the failure of a single market participant from destabilizing
other market participants and, ultimately, the broader financial system.
A CCP also could help ensure that eligible trades
are cleared and settled in a timely manner, thereby reducing the operational
risks associated with significant volumes of unconfirmed and failed trades.
It may also help to reduce the negative effects of misinformation and rumors
that can occur during high volume periods, for example when one market
participant is rumored to "not be taking the name" or not trading with
another market participant because of concerns about its financial condition
and taking on incremental credit risk exposure to the counterparty. Finally,
a CCP could be a source of records regarding CDS transactions, including the
identity of each party that engaged in one or more CDS transactions. Of
course, to the extent that participation in a CCP is voluntary, its value as
a device to prevent and detect manipulation and other fraud and abuse in the
CDS market may be limited.
The Commission staff, together with Federal Reserve
and CFTC staff, has been evaluating proposals to establish CCPs for CDS. SEC
staff has participated in on-site assessments of these CCP proposals,
including review of their risk management systems. The SEC brings to this
exercise its experience over more than 30 years of regulating the clearance
and settlement of securities, including derivatives on securities. The
Commission will use this expertise, and its regulatory and supervisory
authorities over any CCPs for CDS that may be established, to strengthen the
market infrastructure and protect investors.
To facilitate the speedy establishment of one or
more CCPs for CDS and to encourage market participants to voluntarily submit
their CDS trades to the CCP, Commission staff are preparing conditional
exemptions from the requirements of the securities laws for Commission
consideration. SEC staff have been discussing the potential scope and
conditions of these draft exemptions with each prospective CCP and have been
coordinating with relevant U.S. and foreign regulators.
In addition, last Friday, Chairman Cox, on behalf
of the SEC, signed a Memorandum of Understanding (MOU) with the Federal
Reserve Board and the Commodity Futures Trading Commission. This MOU
establishes a framework for consultation and information sharing on issues
related to CCPs for CDS. Cooperation and coordination under the MOU will
enhance each agency's ability to effectively carry out its respective
regulatory responsibilities, minimize the burden on CCPs, and reduce
duplicative efforts.
Other Potential Improvements to OTC Derivatives
Market
As explained above, the SEC has limited authority
over the current OTC CDS market. The SEC, however, is statutorily prohibited
under current law from promulgating any rules regarding CDS trading in the
over-the-counter market. Thus, the tools necessary to oversee this market
effectively and efficiently do not exist. Chairman Cox has urged Congress to
repeal this swap exclusion, which specifically prohibits the SEC from
regulating the OTC swaps market.
Recordkeeping and Reporting to the SEC
The repeal of this swap exclusion would allow the
SEC to promulgate recordkeeping requirements and require reporting of CDS
trades to the SEC. As I discussed in my earlier testimony, a mandatory
system of recordkeeping and reporting of all CDS trades to the SEC, is
essential to guarding against misinformation and fraud. The information that
would result from such a system would not only reduce the potential for
abuse of the market, but would aid the SEC in detection of fraud in the
market quickly and efficiently.
Investigations of over-the-counter CDS transactions
have been far more difficult and time-consuming than those involving cash
equities and options. Because these markets lack a central clearing house
and are not exchange traded, audit trail data is not readily available and
must be reconstructed manually. The SEC has used its anti-fraud authority
over security-based swaps, including the CDS market, to expand its
investigation of possible market manipulation involving certain financial
institutions. The expanded investigation required hedge fund managers and
other persons with positions in CDS and other derivative instruments to
disclose those positions to the Commission and provide certain other
information under oath. This expanded investigation is ongoing and should
help to reveal the extent to which the risks I have identified played a role
in recent events. Depending on its results, this investigation may lead to
more specific policy recommendations.
However, because of the lack of uniform
recordkeeping and reporting to the SEC, the information on security-based
CDS transactions gathered from market participants has been incomplete and
inconsistent. Given the interdependency of financial institutions and
financial products, it is crucial for our enforcement efforts that we have a
mechanism for promptly obtaining CDS trading information — who traded, how
much and when — that is complete and accurate.
Recent private sector efforts may help to alleviate
some of these concerns. For example, Deriv/SERV, an unregulated subsidiary
of DTCC, provides automated matching and confirmation services for
over-the-counter derivatives trades, including CDS. Deriv/SERV's customers
include dealers and buy-side firms from more than 30 countries. According to
Deriv/SERV, more than 80% of credit derivatives traded globally are now
confirmed through Deriv/SERV, up from 15% in 2004. Its customer base
includes 25 global dealers and more than 1,100 buy-side firms in 31
countries. While programs like Deriv/SERV may aid the Commission's efforts,
from an enforcement perspective, such voluntary programs would not be
expected to take the place of mandatory recordkeeping and reporting
requirements to the SEC.
In the future, Deriv/SERV and similar services may
be a source of reliable information about most CDS transactions. However,
participation in Deriv/SERV is elective at present, and the platform does
not support some of the most complex credit derivatives products.
Consequently, not all persons that engage in CDS transactions are members of
Deriv/SERV or similar platforms. Greater information on CDS trades,
maintained in consistent form, would be useful to financial supervisors. In
addition to better recordkeeping by market participants, ready information
on trades and positions of dealers also would aid the SEC in its enforcement
of anti-fraud and anti-manipulation rules. Finally, because Deriv/SERV is
unregulated, the SEC has no authority to obtain the information stored in
this facility for supervision of risk associated with the OTC CDS market and
can only obtain it if given voluntarily or by subpoena.
Market Transparency
Market transparency is another improvement to the
CDS market that the Commission supports. The development of a CCP could
facilitate greater market transparency, including the reporting of prices
for CDS, trading volumes, and aggregate open interest. The availability of
pricing information can improve the fairness, efficiency, and
competitiveness of markets — all of which enhance investor protection and
facilitate capital formation. The degree of transparency, of course, depends
on participation in the CCP, which currently is not mandatory.
Exchange Trading
A CCP also could facilitate the exchange trading of
CDS because the CDS would be in standardized form. Exchange trading of
credit derivatives could add both pre- and post-trade transparency to the
market that would enhance efficient pricing of credit derivatives. Exchange
trading also could reduce liquidity risk by providing a centralized market
that allows participants to efficiently initiate and close out positions at
the best available prices.
Continued in article
Bob Jensen's threads on accounting for credit default
swaps can be found under the C-terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
"Accused of Deception, Citi Agrees to Pay $285 Million," by Edward
Wyatt, The New York Times, October 19, 2011 ---
http://www.nytimes.com/2011/10/20/business/citigroup-to-pay-285-million-to-settle-sec-charges.html?hp
Citigroup agreed to pay $285 million to settle
charges that it misled investors in a $1 billion derivatives deal tied to
the United States housing market, then bet against investors as the housing
market began to show signs of distress, the Securities and Exchange
Commission said Wednesday.
The S.E.C. also brought charges against a Citigroup
employee who was responsible for structuring the transaction, and brought
and settled charges against the asset management unit of Credit Suisse and a
Credit Suisse employee who also had responsibility for the derivative
security.
¶ The S.E.C. said that the $285 million would be
returned to investors in the deal, a collateralized debt obligation known as
Class V Funding III. The commission said that Citigroup exercised
significant influence over the selection of $500 million of assets in the
deal’s portfolio.
¶ Citigroup then took a short position against
those mortgage-related assets, an investment in which Citigroup would profit
if the assets declined in value. The company did not disclose to the
investors to whom it sold the collateralized debt obligation that it had
helped to select the assets or that it was betting against them.
¶ The S.E.C. also charged Brian Stoker, the
Citigroup employee who was primarily responsible for putting together the
deal, and Samir H. Bhatt, a Credit Suisse portfolio manager who was
primarily responsible for the transaction. Credit Suisse served as the
collateral manager for the C.D.O. transaction.
¶ “The securities laws demand that investors
receive more care and candor than Citigroup provided to these C.D.O.
investors,” said Robert Khuzami, director of the S.E.C.’s division of
enforcement. “Investors were not informed that Citigroup had decided to bet
against them and had helped choose the assets that would determine who won
or lost.”
¶ Citigroup received fees of $34 million for
structuring and marketing the transaction and realized net profits of at
least $126 million from its short position. The $285 million settlement
includes $160 million in disgorgement plus $30 million in prejudgment
interest and a $95 million penalty, all of which will be returned to
investors.
¶ The companies and individuals who settled the
charges neither admitted nor denied the charges.
Continued in article
Ah, the innocence of youth.
What really happened in the poisonous CDO markets?
I previously mentioned three CBS Sixty Minutes videos that are must-views for
understanding what happened in the CDO scandals. Two of those videos centered on
muckraker Michael Lewis. My friend, the Unknown Professor, who runs the
Financial Rounds Blog, recommended that readers examine the Senior Thesis of a
Harvard student.
"Michael Lewis’s ‘The Big Short’? Read the Harvard Thesis Instead," by Peter
Lattman, The Wall Street Journal, March 20, 2010 ---
http://blogs.wsj.com/deals/2010/03/15/michael-lewiss-the-big-short-read-the-harvard-thesis-instead/tab/article/
Deal Journal has yet to
read “The Big Short,” Michael Lewis’s yarn on the financial crisis that hit
stores today. We did, however, read his acknowledgments, where Lewis praises
“A.K. Barnett-Hart, a Harvard undergraduate who had just written a thesis about
the market for subprime mortgage-backed CDOs that remains more interesting than
any single piece of Wall Street research on the subject.”
While unsure if we can
stomach yet another book on the crisis, a killer thesis on the topic? Now that
piqued our curiosity. We tracked down Barnett-Hart, a 24-year-old financial
analyst at a large New York investment bank. She met us for coffee last week to
discuss her thesis, “The Story of the CDO Market Meltdown: An Empirical
Analysis.” Handed in a year ago this week at the depths of the market collapse,
the paper was awarded summa cum laude and won virtually every thesis honor,
including the Harvard Hoopes Prize for outstanding scholarly work.
Last October,
Barnett-Hart, already pulling all-nighters at the bank (we agreed to not name
her employer), received a call from Lewis, who had heard about her thesis from a
Harvard doctoral student. Lewis was blown away.
“It was a classic example
of the innocent going to Wall Street and asking the right questions,” said Mr.
Lewis, who in his 20s wrote “Liar’s Poker,” considered a defining book on Wall
Street culture. “Her thesis shows there were ways to discover things that
everyone should have wanted to know. That it took a 22-year-old Harvard student
to find them out is just outrageous.”
Barnett-Hart says she
wasn’t the most obvious candidate to produce such scholarship. She grew up in
Boulder, Colo., the daughter of a physics professor and full-time homemaker. A
gifted violinist, Barnett-Hart deferred admission at Harvard to attend
Juilliard, where she was accepted into a program studying the violin under
Itzhak Perlman. After a year, she headed to Cambridge, Mass., for a broader
education. There, with vague designs on being pre-Med, she randomly took “Ec
10,” the legendary introductory economics course taught by Martin Feldstein.
“I thought maybe this
would help me, like, learn to manage my money or something,” said Barnett-Hart,
digging into a granola parfait at Le Pain Quotidien. She enjoyed how the subject
mixed current events with history, got an A (natch) and declared economics her
concentration.
Barnett-Hart’s interest
in CDOs stemmed from a summer job at an investment bank in the summer of 2008
between junior and senior years. During a rotation on the mortgage
securitization desk, she noticed everyone was in a complete panic. “These CDOs
had contaminated everything,” she said. “The stock market was collapsing and
these securities were affecting the broader economy. At that moment I became
obsessed and decided I wanted to write about the financial crisis.”
Back at Harvard, against
the backdrop of the financial system’s near-total collapse, Barnett-Hart
approached professors with an idea of writing a thesis about CDOs and their role
in the crisis. “Everyone discouraged me because they said I’d never be able to
find the data,” she said. “I was urged to do something more narrow, more
focused, more knowable. That made me more determined.”
She emailed scores of
Harvard alumni. One pointed her toward LehmanLive, a comprehensive database on
CDOs. She received scores of other data leads. She began putting together charts
and visuals, holding off on analysis until she began to see patterns–how Merrill
Lynch and Citigroup were the top originators, how collateral became heavily
concentrated in subprime mortgages and other CDOs, how the credit ratings
procedures were flawed, etc.
“If you just randomly
start regressing everything, you can end up doing an unlimited amount of
regressions,” she said, rolling her eyes. She says nearly all the work was in
the research; once completed, she jammed out the paper in a couple of weeks.
“It’s an incredibly
impressive piece of work,” said Jeremy Stein, a Harvard economics professor who
included the thesis on a reading list for a course he’s teaching this semester
on the financial crisis. “She pulled together an enormous amount of information
in a way that’s both intelligent and accessible.”
Barnett-Hart’s thesis is
highly critical of Wall Street and “their irresponsible underwriting practices.”
So how is it that she can work for the very institutions that helped create the
notorious CDOs she wrote about?
“After writing my thesis,
it became clear to me that the culture at these investment banks needed to
change and that incentives needed to be realigned to reward more than just
short-term profit seeking,” she wrote in an email. “And how would Wall Street
ever change, I thought, if the people that work there do not change? What these
banks needed is for outsiders to come in with a fresh perspective, question the
way business was done, and bring a new appreciation for the true purpose of an
investment bank - providing necessary financial services, not creating
unnecessary products to bolster their own profits.”
Ah, the innocence of
youth.
The Senior Thesis
"The Story of the CDO Market Meltdown: An Empirical Analysis," by Anna
Katherine Barnett-Hart, Harvard University, March 19, 2010 ---
http://www.hks.harvard.edu/m-rcbg/students/dunlop/2009-CDOmeltdown.pdf
A former colleague and finance professor at Trinity
University recommends following up this Harvard student’s senior thesis with the
following:
Rene M. Stulz. 2010. Credit default swaps and the
credit crisis. J of Economic Perspectives, 24(1): 73-92 (not free) ---
http://www.aeaweb.org/jep/index.php
Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.
Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.
First Read About Mervene ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Then Watch Video 1 at
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
Videos 2 and 3
Inside the Wall Street Collapse (Parts 1 and 2) first shown on March 14,
2010
Video 2 (Greatest Swindle in the History of the World) ---
http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux
Video 3 (Swindler's Compensation Scandals) ---
http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux
My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.
The major lessons of videos 2 and 3 went over the head of my wife. I think
that viewers need to do a bit of homework in order to fully appreciate those
videos. Here's what I recommend before viewing Videos 2 and 3 if you've not been
following details of the 2008 Wall Street collapse closely:
This is not necessary to Videos 2
and 3, but to really appreciate what suckered the Wall Street Banks into
spreading the poison, you should read about how they all used the same risk
diversification mathematical function --- David Li's Gaussian Copula Function:
Can the
2008 investment banking failure
be traced to a math error?
Recipe for Disaster: The
Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's
formula, known as a
Gaussian copula function, looked like an
unambiguously positive breakthrough, a piece of financial technology that
allowed hugely complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities, expanding
financial markets to unimaginable levels.
His method was adopted
by everybody from bond investors and Wall Street banks to ratings agencies and
regulators. And it became so deeply entrenched—and was making people so much
money—that warnings about its limitations were largely ignored.
Then the model fell apart." The
article goes on to show that correlations are at the heart of the problem.
"The reason that
ratings agencies and investors felt so safe with the triple-A tranches was that
they believed there was no way hundreds of homeowners would all default on their
loans at the same time. One person might lose his job, another might fall ill.
But those are individual calamities that don't affect the mortgage pool much as
a whole: Everybody else is still making their payments on time.
But not all calamities
are individual, and tranching still hadn't solved all the problems of
mortgage-pool risk. Some things, like falling house prices, affect a large
number of people at once. If home values in your neighborhood decline and you
lose some of your equity, there's a good chance your neighbors will lose theirs
as well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree to
which one variable moves in line with another—and measuring it is an important
part of determining how risky mortgage bonds are."
I would highly recommend reading the
entire thing that gets much more involved with the
actual formula etc.
The “math error” might truly be have
been an error or it might have simply been a gamble with what was perceived as
miniscule odds of total market failure. Something similar happened in the case
of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management
formed by Nobel Prize winning economists and their doctoral students who took
similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is
ignorance in model building or risk taking using the model?
Bob Jensen’s threads on the CDO and CDS scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Credit Default Swaps (CDS) ---
http://en.wikipedia.org/wiki/Credit_default_swap
"Global Financial Stability Report: Old Risks, New Challenges"
International Monetary Fund
April 2013
http://www.docstoc.com/docs/154106200/IMF Report
The Global Financial Stability Report (GFSR)
assesses key risks facing the global financial system. In normal times, the
report seeks to play a role in preventing crises by highlighting policies
that may mitigate systemic risks, thereby contributing to global financial
stability and the sustained economic growth of the IMF’s member countries.
Risks to financial stability have declined since the October 2012 GFSR,
providing support to the economy and prompting a rally in risk assets. These
favorable conditions reflect a combination of deeper policy commitments,
renewed monetary stimulus, and continued liquidity support. The current
report analyzes the key challenges facing financial and nonfinancial firms
as they continue to repair their balance sheets and unwind debt overhangs.
The report also takes a closer look at the sovereign credit default swaps
market to determine its usefulness and its susceptibility to speculative
excesses. Lastly, the report examines the issue of unconventional monetary
policy (“MP-plus”) and its potential side effects, and suggests the use of
macroprudential policies, as needed, to lessen vulnerabilities, allowing
country authorities to continue using MP-plus to support growth while
protecting financial stability.
The analysis in this report has been coordinated by
the Monetary and Capital Markets (MCM) Department under the general
direction of José Viñals, Financial Counsellor and Director. The project has
been directed by Jan Brockmeijer and Robert Sheehy, both Deputy Directors;
Peter Dattels and Laura Kodres, Assistant Directors; and Matthew Jones,
Advisor. It has benefited from comments and suggestions from the senior
staff in the MCM department.
Individual contributors to the report are: Ali Al-Eyd,
Sergei Antoshin, Serkan Arslanalp, Craig Botham, Jorge A. Chan-Lau, Yingyuan
Chen, Ken Chikada, Julian Chow, Nehad Chowdhury, Sean Craig, Reinout De
Bock, Jennifer Elliott, Michaela Erbenova, Jeanne Gobat, Brenda González-Hermosillo,
Dale Gray, Sanjay Hazarika, Heiko Hesse, Changchun Hua, Anna Ilyina, Tommaso
Mancini-Griffoli, S. Erik Oppers, Bradley Jones, Marcel Kasumovich, William
Kerry, John Kiff, Frederic Lambert, Rebecca McCaughrin, Peter Lindner, André
Meier, Paul Mills, Nada Oulidi, Hiroko Oura, Evan Papageorgiou, Vladimir
Pillonca, Jaume Puig, Jochen Schmittmann, Miguel Segoviano, Jongsoon Shin,
Stephen Smith, Nobuyasu Sugimoto, Narayan Suryakumar, Takahiro Tsuda,
Kenichi Ueda, Nico Valckx, and Chris Walker. Martin Edmonds, Mustafa Jamal,
Oksana Khadarina, and Yoon Sook Kim provided analytical support. Gerald
Gloria, Nirmaleen Jayawardane, Juan Rigat, Adriana Rota, and Ramanjeet Singh
were responsible for word processing. Eugenio Cerutti, Ali Sharifkhani, and
Hui Tong provided database and programming support. Joanne Johnson and Gregg
Forte of the External Relations Department edited the manuscript and the
External Relations Department coordinated production of the publication.
This particular issue draws, in part, on a series
of discussions with banks, clearing organizations, securities firms, asset
management companies, hedge funds, standards setters, financial consultants,
pension funds, central banks, national treasuries, and academic researchers.
The report reflects information available up to April 2, 2013.
The report benefited from comments and suggestions
from staff in other IMF departments, as well as from Executive Directors
following their discussion of the Global Financial Stability Report on April
1, 2013. However, the analysis and policy considerations are those of the
contributing staff and should not be attributed to the Executive Directors,
their national authorities, or the IMF.
Jensen Comment
Note that much of this report deals with the state of Credit Default Swaps.
Appendix R
Accounting Standard Setters Bowing to Industry
and Government Pressures
To Hide the Value of Dogs
Question
Can we put the following quotations to a test in a logic course in the
philosophy department?
"Some Lessons of the Financial Crisis," by Stephen Schwarzman, The Wall
Street Journal, November 4, 2008 ---
http://online.wsj.com/article/SB122576100620095567.html?mod=djemEditorialPage
Third, you need full transparency for financial
statements. Nothing should be
eliminated. Off-balance-sheet vehicles that
suddenly return to the balance sheet to wreak havoc make a mockery of
principles of disclosure.
Fourth, you need full
disclosure of all financial instruments to the
regulator. No regulator can do its job of assessing risk and systemic
soundness if large parts of the financial markets are invisible to it. A
regulator must be able to monitor all derivatives, including, for example,
$60 trillion in credit default swaps.
Sixth, we need to
abolish mark-to-market accounting for hard-to-value assets.
There is now emerging a broad realization that mark-to-market accounting has
exacerbated the current crisis. We are not talking about publicly traded
equities with a readily ascertainable value. The problem involves securities
held for investment purposes, and those instruments during certain times of
the cycle for which there is no readily observable market. These securities
and instruments would be fully disclosed to the regulator. However, a
financial institution would not be forced to suddenly take huge write downs
at artificial, fire-sale prices and thus contribute to financial
instability.
Bob Jensen's threads on a bull crap case against fair value accounting are
at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#FairValueAccounting
Bob Jensen's threads on earnings management are at
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
IFRS (or maybe just the EU) Accounting Rule
Flexibility in Action
"Accounting Changes Help Deutsche Bank Avoid Loss,"
Reuters, The New York Times, October 30, 2008 ---
Click Here
New accounting rules
allowed Deutsche Bank to dodge a loss in the third quarter, the company said
Thursday as it also announced heavy losses in proprietary trading.
Josef Ackermann, the chairman of Deutsche, which is
Germany’s flagship bank and once was seen as having escaped the worst of the
market turmoil, declared a year ago that the financial crisis for his bank
was over.
On Thursday, however, Mr. Ackermann departed from
the optimism that had led him to declare seeing the light at the end of the
tunnel several times over.
“Conditions in equity and credit markets remain
extremely difficult,” he said, warning that the bank could cut its dividend
to shore up capital in a “highly uncertain environment.”
Also Thursday, Germany’s finance minister, Peer
Steinbrück, said that a number of German banks were expected to turn to
Berlin for help. Mr. Steinbrück appeared to make a veiled reference to
Deutsche Bank when he told a newspaper that those seeking help could include
banks that had publicly opposed taking it in the past. Mr. Ackermann
recently was quoted as saying he would be “ashamed” to take taxpayer money.
Deutsche Bank made a pretax profit of 93 million
euros ($118.5 million) in the third quarter, a result possible only because
of changed accounting rules. These allowed it to cut write-downs by more
than 800 million euros, to 1.2 billion euros, during the period.
The new rules, sanctioned by Brussels lawmakers,
soften the old system that demanded all assets reflect market prices.
Deutsche Bank, for example, has more than 22
billion euros of leveraged loans — commitments often made to private equity
investors to lend money to buy companies.
Farming out these loans had become difficult as
worried investors retreated to safe havens and their value had fallen. The
new accounting rules allow Deutsche to hold some of these loans on their
books at a fixed price.
Like all other banks, Deutsche is grappling with a
freeze in interbank lending. Banks around the world have largely stopped
lending to one another after the Wall Street investment bank Lehman Brothers
collapsed in mid-September.
The crisis prompted the German government to start
a rescue fund of 500 billion euros, under which it can give guarantees for
banks seeking financing on this market or by issuing bonds, for example.
November 3, 2008 reply from Patricia Walters
[patricia@DISCLOSUREANALYTICS.COM]
Beware, believing what's reported in the press as truth. Reporters
generally do not study accounting as part of the academic experience.
To the best of my knowledge, the recent change made by the IASB was to
converge with US GAAP in permitting companies to re-classify financial
assets from held for trading to available for sale. This move does not
permit these assets to be held at other than fair value. It does report the
change in fair value to equity, rather than in income.
This change was made specifically to create a level playing field across
Europe and the US. The same change was made in Canada for the same reason.
Do I regret they made this change? Yes. I suspect they do too, but the
alternative was to let the European Commission "do their own thing" in this
crisis.
Regards,
Pat
November 3, 2008 reply from Dennis Beresford
[dberesfo@TERRY.UGA.EDU]
Pat,
Actually, as I understand it the IASB change allows
companies to reclassify securities out of the mark to market through income
category (i.e., trading) to held to maturity in which case the securities
will be carried at cost. Further, the change can be made retroactive to July
1 before most of the market disruption occurred. U.S rules allow this only
in "rare" circumstances.
See
http://www.iasb.org/NR/rdonlyres/BE8B72FB-B7B8-49D9-95A3-CE2BDCFB915F/0/AmdmentsIAS39andIFRS7.pdf
which includes a dissent by Jim Leisenring and John
Smith from the U.S.
Denny Beresford
November 3, 2008 reply from Bob Jensen
Hi Pat and Denny,
But isn’t it interesting banks are suddenly reclassifying their
portfolios seemingly to avoid reporting losses? Is this good judgment based
upon principles-based standards or earnings management under flexible
accounting standards?
Surely the reporters are all wrong and these reputable banks are merely
using good judgments under principles-based standards. Certainly they would
not use flexible accounting rules to manage earnings!
Are we making a mockery out of accounting “standards?” What you are
saying Pat is that the IASB would rather change an accounting standard under
political pressure from the EU than to face up to another EU carve out of
IFRS. Surely this is a mockery since the change in IFRS to suit the EU (and
U.S.) affects all other nations using IFRS who are not in the EU and the
U.S.
What you are really telling us Pat is that IFRS adapts to threats from
the EU when you stated:
Do I regret they made this change? Yes. I
suspect they do too, but the alternative
was to let the European Commission "do their own thing” . . .
Pat Walters
I call this making a mockery out of the conceptual framework that
dictates that accounting standards are to be based upon what is the best
accounting for investors. Instead the IASB acted in fear that the EU would
“do-their-own-thing” accounting standards for banks. Of course there’s some
history of this in the U.S., notably dry hole accounting for oil and gas.
But the FASB has a better record of going nose-to-nose with Congress on FAS
133 and FAS 123-R.
FASB standards are sometimes flexible to a fault as well. Surely Franklin
Raines would not (ha, ha) reclassify just enough macro mortgage portfolios
under FAS 133 rules to meet the e.p.s target (to the penny) to get his bonus
before he was fired as CEO of Fannie Mae ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
How can those of you teaching ethics and intermediate accounting and
auditing look your students straight in the eye?
Should accountancy be reclassified in the Literature Department since
financial reports are becoming more flexible fiction than fact?
Bob Jensen
November 3, 2008 reply from Tom Selling
[tom.selling@GROVESITE.COM]
The following statement
by Pat is not fully correct:
“…the recent change made by the IASB was to
converge with US GAAP in permitting companies to re-classify financial
assets from held for trading to available for sale. This move does not
permit these assets to be held at other than fair value. It does report
the change in fair value to equity, rather than in income.”
The revisions to IAS 39 (and FAS 133)
permit loans and receivables that were being measured
at fair value to be reclassified to “held to maturity”, if the entity does
not intend to sell them in the “foreseeable future” (whatever the heck that
means). Thus, fair value accounting would cease for these assets. Moreover,
there would be a new rule for measuring impairment on these assets, which
diverges from GAAP.
Best,
Tom Selling
November 3, 2008 reply from Bob Jensen
Hi Tom,
What the reclassification to “held-to-maturity” means in these times is
that nobody else (now not even our government) is foolish enough to buy this
hopeless dog that the bank can’t possibly unload. Paulson’s new bail out
plan entails buying into bank equity rather than buying up the
banks’dog/junk mortgages. The trick now is to get these dogs on the books at
historical cost as “held-to-maturity” rather than, choke, fair value.
Interestingly, this is precisely what Fannie Mae’s CEO, Franklin Raines,
was doing when cherry picking which investments to designate as
“held-to-maturity” in his earnings management scheme to pad his bonus ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Think of the irony. The good mortgages that perhaps increased in value
with declining interest rates are marked upwards to fair value as
“available-for-sale” or “trading” securities. The dogs that should be
unloaded are instead designated as “held-to-maturity.”
A clever professor here could design a case where all the good mortgages
are sold for profit, the enormous executive bonuses are paid, and the
shareholders are left with the “held-to-maturity” dog kennel that is grossly
overvalued on the balance sheet. What’s even worse is that this is possible
under FASB and IASB accounting standards. Our standard setters are now
telling us there’s nothing wrong with being left with the dog kennel.
The
shareholders’ class action lawyers think otherwise.
Is this what we call making investors our number one concern when setting
accounting standards?
My problem here is that in theory I can and do in my FAS 133 seminars
make a darn good case for not marking up HTM securities to fair value. But
then I never envisioned the dog kennel problem.
I think the IASB is a bit tougher than the FASB on a decision to sell HTM
investments before maturity. In IFRS it’s a bit like breaking the honor
code. You may sell an insignificant sick puppy on occasion from the HTM dog
kennel, but you must never sell a valuable dog before its maturity date
without putting the other sick HTM dogs in the kennel up for sale as well.
Selling them all might result in huge losses under the new IASB/FASB rulings
allowing for the placement of very sick dogs in an HTM kennel to avoid
recognizing huge losses in their value. Thus when Deutsche Bank put a lot of
sick dogs in the HTM kennel to shore up 2008 reported earnings (actually to
avoid a huge reported 2008 loss), Deutsche Bank better be prepared on its
honor to keep virtually all of them in the kennel until they expire.
The following is a direct quotation from IAS 39.
B.19 Definition of held-to-maturity financial
assets: 'tainting'
In response to unsolicited tender offers,
Entity A sells a significant amount of financial assets classified as
held to maturity on economically favourable terms. Entity A does not
classify any financial assets acquired after the date of the sale as
held to maturity. However, it does not reclassify the remaining
held-to-maturity investments since it maintains that it still intends to
hold them to maturity. Is Entity A in compliance with IAS 39?
No. Whenever a sale or transfer of more than an
insignificant amount of financial assets classified as held to maturity
(HTM) results in the conditions in IAS 39.9 and IAS 39.AG22 not being
satisfied, no instruments should be classified in that category.
Accordingly, any remaining HTM assets are reclassified as
available-for-sale financial assets. The reclassification is recorded in
the reporting period in which the sales or transfers occurred and is
accounted for as a change in classification under IAS 39.51. IAS 39.9
makes it clear that at least two full financial years must pass before
an entity can again classify financial assets as HTM.
Bob Jensen
Bob Jensen's threads on earnings management are
at
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Claims of IFRS Accounting Rule Flexibility ---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
Press Release from IAS
Plus on October 13, 2008 ---
http://www.iasplus.com/pressrel/0810reclassifications.pdf
IASB amendments permit reclassification of financial
instruments
The International Accounting Standards
Board (IASB) today issued amendments to IAS 39
Financial
Instruments: Recognition and Measurement
and IFRS 7
Financial Instruments: Disclosures
that would
permit the reclassification of some financial instruments. The amendments to
IAS 39 introduces the possibility of reclassifications for companies
applying International Financial Reporting Standards (IFRSs), which were
already permitted under US generally accepted accounting principles (GAAP)
in rare circumstances.
The deterioration of the world’s
financial markets that has occurred during the third quarter of this year is
a possible example of rare circumstances cited in these IFRS amendments and
therefore justifies its immediate publication. Today’s action enables
companies reporting according to IFRSs to use the reclassification
amendments, if they so wish, from 1 July 2008.
These amendments are the latest in a
series of steps that the IASB has undertaken to respond to the credit
crisis. The IASB has worked with a number of other regional and
international bodies, including the Financial Stability Forum (FSF), to
address financial reporting issues associated with the credit crisis. In
responding to the crisis, the IASB notes the concern expressed by EU leaders
and finance ministers through the ECOFIN Council to ensure that ‘European
financial institutions are not disadvantaged vis-à-vis their international
competitors in terms of accounting rules and of their interpretation.’ The
amendments today address the desire to reduce differences between IFRSs and
US GAAP in a manner thatproduces high quality financial information for
investors across the global capital markets.
Sir David Tweedie, Chairman of the IASB, said:
In addressing the rare
circumstances of the current credit crisis, the IASB is committed to
taking urgent action to ensure that transparency and confidence are
restored to financial markets. The IASB has acted quickly to address the
concerns raised by EU leaders and others regarding the issue of
reclassification. Our response is consistent with the request made by
European leaders and finance ministers; it is important that these
amendments are permitted for use rapidly and without modification.’
For more information about the IASB’s
response to the credit crisis, see the Website at
http://www.iasb.org/credit+crisis.htm.
Reclassification of Financial Assets (
Amendments
to IAS 39 Financial Instruments:
Recognition and Measurement and IFRS 7
Financial Instruments:
Disclosures)
is available for eIFRS subscribers from today. Those
wishing to subscribe to eIFRSs should visit the online shop or contact:
IASC Foundation Publications
Department,
30 Cannon Street, London EC4M 6XH, United Kingdom.
Tel: +44 (0)20 7332 2730 Fax +44 (0)20 7332 2749
Email:
publications@iasb.org
Web:
www.iasb.org
The following table illustrates how
reclassification will be dealt with following this announcement by IFRSs
when compared with US GAAP.
|
US GAAP |
Amended IAS 39 |
Reclassification of securities out of the trading
category in rare circumstances |
Permitted |
Permitted (as amended) |
Reclassification to loan category (cost basis) if
intention and ability to hold for the foreseeable future (loans) or
until maturity (debt securities) |
Permitted |
Permitted (as amended) |
Reclassification if fair value option previously
elected |
Not Permitted |
Not Permitted |
"Amended IAS 39: Exploding the Myth of an Independent IASB,"
by Tom Selling, The Accounting Onion, November 3, 2008
---
http://accountingonion.typepad.com/theaccountingonion/2008/11/amended-ias-39.html
Jensen Comment
In fairness, the IASB did a commendable job crafting IAS 39, although there's no
doubt it could not have done so without the help of the FASB and other help from
the FASB. IAS 39 was hammered out under great pressure from the U.S. SEC to get
an international standard out on derivatives accounting before the SEC would
even consider adopting IFRS for foreign registrants. You can read about the
evolving history of derivative instrument accounting scandals and the evolution
of IAS 39 and its amendments at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Especially revealing about the early history of IASC/IASB standards, and IAS 39
in particular, is Paul Pacter's presentation at
In its early history, the IASB was extremely influenced by lobbying forces in
industry and politics. This is because conformance with the IASB's international
standards was virtually voluntary in all member nations, and the large
industrial nations were not even members. Then, in its efforts to get its
standards recognized or required by the major stock exchanges (see
IOSCO), the IASB generated some tougher standards. Winning over the European
Union is the biggest feather in the IASB's hat to date, and currently the IASB
is working harder than ever to win over the SEC, the FASB, and the NY Stock
Exchange. Sadly, it has had to revert to political concessions both before and
during the 2008 economic crisis to win over banks in the EU and the US. In
fairness, however, the FASB also made an uncharacteristically fast cave-in to
the banking industry during the 2008 economic crisis.
November 3, 2008 reply from Dennis Beresford
[dberesfo@TERRY.UGA.EDU]
Actually, as I understand it the IASB change allows
companies to reclassify securities out of the mark to market through income
category (i.e., trading) to held to maturity in which case the securities
will be carried at cost. Further, the change can be made retroactive to July
1 before most of the market disruption occurred. U.S rules allow this only
in "rare" circumstances.
See
http://www.iasb.org/NR/rdonlyres/BE8B72FB-B7B8-49D9-95A3-CE2BDCFB915F/0/AmdmentsIAS39andIFRS7.pdf
which includes a dissent by Jim Leisenring and John
Smith from the U.S.
Denny Beresford
Although most accountants are not particularly happy with the bull crap
coming out of Washington and Brussels these days, most of us have no choice but
to accept what is happening in this worldwide economic crisis ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#FairValueAccounting
As far as the big bang versus the evolution in the conversion of U.S. GAAP to
international standards, here is my stance for what it's worth:
Notwithstanding
Shaum Sunder’s excellent argument against an IASB monopoly and my preference for
bright line rules, I’ve viewed all along that “resistance is futile” in trying
to prevent the ultimate replacement of U.S. domestic accounting standards with
international standards.
At this point
I’m merely trying to prevent both a premature Big Bang (Mary Barth’s wording) or
a bunch of Little Bangs (Pat Walter’s wording) prematurely. By prematurely, I
mean having at least until 2018 to evolve into this in an orderly manner for
business firms, auditors, accounting educators, textbook writers, students, and
CPA examiners. Cox is rushing this thing too fast at the SEC, and I think the
FASB is trying to avoid having to rewrite FASB standards, interpretations, and
guidelines to be consistent with IFRS.
I think we’ve
given the FASB sufficient resources to rewrite U.S. GAAP in an evolutionary
manner that will greatly enrich the illustrations and implementation guidelines
that are sorely lacking in the present IASB standards. In other words I would
like to have FASB Standards and a greatly improved FASB Codification Database
after 2018 even if IFRS is virtually written into U.S. GAAP. And yes, I will
concede to removing most of the bright line rules! Sigh!
I also think the
U.S. should maintain its leverage by not fully committing to IFRS until the IASB
is better able to handle the enormous U.S. economy in terms of a better IASB
infrastructure, greatly increased IASB research funds, many more IASB full-time
members, and a demonstration that it is not under the thumb of the EU
politicians and bankers.
I also agree
fully with Mary Barth that our academy’s accounting researchers worldwide should
play a greater role in making IFRS better able handle its eventual monopoly on
all accounting standards for the free world.
I would also
like time to let the smell to dissipate concerning how Chris Cox, while Director
of the SEC, abused his authority by trying for force international standards
down our throats too suddenly in a chaotic Big Bang.
As to GAAS, I just don’t think we’re
ready for International GAAS until we have better international law, especially
international law regarding bribery, corruption, white collar crime enforcement,
and international civil litigation procedures.Bob Jensen
Far more dangerous is what is happening around the world to destroy capital
markets and create government dominance in the allocation of capital and
resources in the world. Both FASB and IASB standards may soon be irrelevant
footnotes in our history books. We may soon all be government accountants. Won't
that be fun?
From Vanderbilt University (you have to watch this video to the ending to
appreciate it)
A Keynote Speech by Leo Melamed ---
Click Here
http://www.owen.vanderbilt.edu/vanderbilt/About/owen-newsroom/owen-podcasts/podcasts/FIC-Melamed-keynote.html
Who is Leo Melamed? ---
http://en.wikipedia.org/wiki/Leo_Melamed
Bob Jensen's Primer on Derivatives ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Primer
Fooling Some People All the Time
Selling New
Equity to Pay Dividends: Reminds Me About the South Sea Bubble of
1720 ---
http://en.wikipedia.org/wiki/South_Sea_bubble
"Fooling Some
People All the Time"
"Melting into
Air: Before the financial system went bust, it went postmodern," by
John Lanchester, The New Yorker, November 10, 2008 ---
http://www.newyorker.com/arts/critics/atlarge/2008/11/10/081110crat_atlarge_lanchester
This is also why the financial masters of the
universe tend not to write books. If you have been proved—proved—right, why
bother? If you need to tell it, you can’t truly know it. The story of David
Einhorn and Allied Capital is an example of a moneyman who believed, with
absolute certainty, that he was in the right, who said so, and who then
watched the world fail to react to his irrefutable demonstration of his own
rightness. This drove him so crazy that he did what was, for a hedge-fund
manager, a bizarre thing: he wrote a book about it.
The story began on May 15, 2002, when Einhorn, who
runs a hedge fund called Greenlight Capital, made a speech for a
children’s-cancer charity in Hackensack, New Jersey. The charity holds an
annual fund-raiser at which investment luminaries give advice on specific
shares. Einhorn was one of eleven speakers that day, but his speech had a
twist: he recommended shorting—betting against—a firm called Allied Capital.
Allied is a “business development company,” which invests in companies in
their early stages. Einhorn found things not to like in Allied’s accounting
practices—in particular, its way of assessing the value of its investments.
The mark-to-market accounting
that Einhorn favored is based on the price an asset would fetch if it were
sold today, but many of Allied’s investments were in small startups that
had, in effect, no market to which they could be marked. In Einhorn’s view,
Allied’s way of pricing its holdings amounted to “the
you-have-got-to-be-kidding-me method of accounting.” At the same time,
Allied was issuing new equity,
and, according to Einhorn, the revenue from this could
be used to fund the dividend payments that were keeping Allied’s investors
happy. To Einhorn, this looked like a potential
Ponzi scheme.
The next day, Allied’s stock dipped more than
twenty per cent, and a storm of controversy and counter-accusations began to
rage. “Those engaging in the current misinformation campaign against Allied
Capital are cynically trying to take advantage of the current post-Enron
environment by tarring a great and honest company like Allied Capital with
the broad brush of a Big Lie,” Allied’s C.E.O. said. Einhorn would be the
first to admit that he wanted Allied’s stock to drop, which might make his
motives seem impure to the general reader, but not to him. The function of
hedge funds is, by his account, to expose faulty companies and make money in
the process. Joseph Schumpeter described capitalism as “creative
destruction”: hedge funds are destructive agents, predators targeting the
weak and infirm. As Einhorn might see it, people like him are especially
necessary because so many others have been asleep at the wheel. His book
about his five-year battle with Allied, “Fooling Some of the People All
of the Time” (Wiley; $29.95), depicts analysts, financial journalists,
and the S.E.C. as being culpably complacent. The S.E.C. spent three years
investigating Allied. It found that Allied violated accounting guidelines,
but noted that the company had since made improvements. There were no
penalties. Einhorn calls the S.E.C. judgment “the lightest of taps on the
wrist with the softest of feathers.” He deeply minds this, not least because
the complacency of the watchdogs prevents him from being proved right on a
reasonable schedule: if they had seen things his way, Allied’s stock price
would have promptly collapsed and his short selling would be hugely
profitable. As it was, Greenlight shorted Allied at $26.25, only to spend
the next years watching the stock drift sideways and upward; eventually, in
January of 2007, it hit thirty-three dollars.
All this has a great deal of resonance now,
because, on May 21st of this year, at the same charity event, Einhorn
announced that Greenlight had shorted another stock, on the ground of the
company’s exposure to financial derivatives based on dangerous subprime
loans. The company was Lehman Brothers. There was little delay in Einhorn’s
being proved right about that one: the toppling company shook the entire
financial system. A global cascade of bank
implosions ensued—Wachovia, Washington Mutual, and the Icelandic banking
system being merely some of the highlights to date—and a global bailout of
the entire system had to be put in train. The
short sellers were proved right, and also came to be seen as culprits; so
was mark-to-market accounting, since it caused sudden, cataclysmic drops in
the book value of companies whose holdings had become illiquid. It is
therefore the perfect moment for a short-selling advocate of marking to
market to publish his account. One can only speculate whether Einhorn would
have written his book if he had known what was going to happen next. (One of
the things that have happened is that, on September 30th, Ciena Capital, an
Allied portfolio company to whose fraudulent lending Einhorn dedicates many
pages, went into bankruptcy; this coincided with a collapse in the value of
Allied stock—finally!—to a price of around six dollars a share.) Given the
esteem with which Einhorn’s profession is regarded these days, it’s a little
as if the assassin of Archduke Franz Ferdinand had taken the outbreak of the
First World War as the timely moment to publish a book advocating
bomb-throwing—and the book had turned out to be unexpectedly persuasive.
Heavy Insider
Trading ---
http://investing.businessweek.com/research/stocks/ownership/ownership.asp?symbol=ALD
Allied's
independent auditor is KPMG
KPMG has a lot of problems
with litigation ---
http://faculty.trinity.edu/rjensen/fraud001.htm
Bob Jensen's
threads on the collapse of the Banking System are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's
threads on fraud are at
http://faculty.trinity.edu/rjensen/Fraud.htm
Also see Fraud Rotten at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's
threads on accounting theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
Also see the theory of fair value accounting at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
History of Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Instead of reducing government spending, just a few
weeks ago he adopted the largest increase in government spending in world
history through his so-called economic stimulus bill, which will only stimulate
the increased welfare and Big Government that Obama believes in ideologically.
Obama's new budget proposes the largest increase in Federal spending since World
War II, an insane one-year increase of 33% over the prior budget, from $3
trillion in fiscal 2008 to $4 trillion for fiscal 2009. That whopping $4
trillion is the largest Federal spending total in U.S. history. Obama says in
his budget message that we have arrived at this present crisis "as a result of
an era of profound irresponsibility…." Does this wild spending increase to
record levels sound responsible to you?
Peter Ferara, "Obama's Fantasy
Budget," American Spectator, March 4, 2009 ---
http://spectator.org/archives/2009/03/04/obamas-fantasy-budget
"Obama’s last hope on housing," by Christopher Joye, Financial
Times, March 3, 2009 ---
http://blogs.ft.com/economistsforum/2009/03/obamas-last-hope-on-housing/
Make no mistake: President Obama’s $75bn
housing plan is a policy disaster. It merely treats the symptoms of the
calamity in an extremely costly manner via short-term interest rate relief
and remarkably does nothing to prevent the next generation of borrowers
experiencing the same problems.
The administration’s response also
exacerbates the underlying dysfunction that is the root cause of the US’s
housing market woes by, for example, offering defaulting borrowers scope to
wriggle out of their contracts through the judicial system.
This will only undermine the
enforceability of US mortgages and embed a new risk premium that will
inevitably lead to higher interest rates and likely funding uncertainty.
By reinvigorating Fannie Mae and Freddie
Mac without genuine reforms, the administration has demonstrated that it
does not understand the fundamental flaws inherent in the US financing
system, which precipitated this crisis in the first place.
There remains, however, hope that the more
thoughtful decision-makers will search for superior long-term reforms. In
this context, I was fortunate enough to be able to present a tractable
solution to the US’s housing market problems at a summit in New York for
Obama administration officials.
The plan I presented directly cauterises
the US’s housing market dysfunction, delivers far greater and more permanent
interest rate relief for distressed borrowers, allows banks to immediately
recapitalise their balance-sheets with a $77bn cash injection, and costs
taxpayers much less than the administration’s initiative. On all objective
counts I feel that it is an unambiguous improvement on the administration’s
alternative.
As I’ve noted previously, one of the most
critical lessons from the global financial crisis has been that many
households had far too much leverage, particularly in the US where the
average borrower’s mortgage is now worth an astonishing 95 per cent of their
home. The only genuine policy solution to the desire to deleverage is the
development of external markets in housing equity – or ‘shared equity’ –
which borrowers can use synergistically in combination with traditional debt
finance.
Here’s how a government ‘debt for equity
swap’ programme would allow distressed US borrowers to radically deleverage
their balance-sheets:
Assume that the average ‘distressed’
borrower’s loan-to-value ratio is, say, 115 per cent. Under the
debt-for-equity swap, the traditional lender would only write off 15 per
cent of the value of their loan to bring the LTV back to 100 per cent (as
opposed to writing off most of the loan). A similar write-down is
anticipated in the administration’s scheme.
Yet instead of making a gift to lenders to
temporarily cut borrowers’ repayments, the government would refinance 25 per
cent of the reset home loan by swapping it with a taxpayer-funded ‘shared
equity’ loan (this could be operationally achieved by having borrowers pay
down 25 per cent of the reset loan).
Importantly, the shared equity loan
carries no monthly repayments during its maximum 30-year life. In exchange,
taxpayers receive half of the property’s future capital growth in lieu of
interest when the home owner elects to repay the loan either on refinancing
or sale of the property. The lender also owns no legal interest in the home
since it is structured using a traditional mortgage contract; i.e. the owner
retains control over what they do with their property.
The traditional lender is now left with a
dramatically less risky 75 per cent LTV. They are also directly paid 25 per
cent of the face value of their reset loan by the government and thus get
the benefit of a significant cash injection – which is worth about $77bn –
onto their balance-sheets.
The borrower is now only paying a full
rate of interest on a home loan that is 65 per cent of its original value.
They therefore benefit from a permanent 35 per cent reduction in their
interest and principal repayments over the 30 year life of the package. In
contrast, the lower repayments realised by borrowers under the
administration’s proposal only last five years – after which rates are
ratcheted back up, thereby raising the risk of ‘redefault’.
Assuming that house prices increase at a
rate no greater than nominal gross domestic product during the next 30
years, which given the recent 25 per cent correction seems defendable,
taxpayers could expect to earn a 5-10 per cent annualised, ungeared rate of
return. This is patently superior to the 100 per cent losses that taxpayers
will realise on their $75bn ‘gift’ to distressed borrowers under the
existing plan.
How much would this cost? According to the
Mortgage Bankers’ Association, 6.6 per cent of the circa $11tn of US home
loans are in 60 days or more arrears. Assume that half of these borrowers go
into foreclosure and need to access the programme. That gives $363bn worth
of loans in distress. If the average LTV is 115 per cent, and the lender
wears a 15 per cent write-down, a 25 per cent debt for equity swap would
cost taxpayers roughly $77bn, which, coincidentally, is almost exactly the
same size as the administration’s package.
Importantly, once the shared equity loans
are repaid the government can recycle the capital to assist the next
generation of households in distress. The $77bn equity fund could therefore
be used to reduce the risk of families facing foreclosure in perpetuity. And
since traditional lenders are minimising their foreclosure risk, they could
ultimately contribute.
Successful private and publicly markets in
housing equity now exist in Australia, NZ, and the UK. Combined with the
fact that leading academics such as Ian Ayers and Barry Nalebuff, Luigi
Zingales, and Edward Glaeser have recently made similar calls for the US
government to help borrowers swap their debt for equity, it is hard not to
acknowledge that there is immense merit to this plan.
Nobody would begrudge the administration
the opportunity to refine their response to this calamity. I just hope they
have the humility and foresight to listen.
Oil and Water Must Read: Economists versus Criminologists
:"Why the ‘Experts’ Failed to See How Financial Fraud Collapsed the Economy,"
by "James K. Galbraith, Big Picture, June 2, 2010 ---
http://www.ritholtz.com/blog/2010/06/james-k-galbraith-why-the-experts-failed-to-see-how-financial-fraud-collapsed-the-economy/
The following is the text of a James K. Galbraith’s written statement
to members of the Senate Judiciary Committee delivered this May. Original
PDF text is here.
Chairman Specter, Ranking Member Graham, Members of
the Subcommittee, as a former member of the congressional staff it is a
pleasure to submit this statement for your record.
I write to you from a disgraced profession.
Economic theory, as widely taught since the 1980s, failed miserably to
understand the forces behind the financial crisis. Concepts including
“rational expectations,” “market discipline,” and the “efficient markets
hypothesis” led economists to argue that speculation would stabilize prices,
that sellers would act to protect their reputations, that caveat emptor
could be relied on, and that widespread fraud therefore could not occur. Not
all economists believed this – but most did.
Thus the study of financial fraud received little
attention. Practically no research institutes exist; collaboration between
economists and criminologists is rare; in the leading departments there are
few specialists and very few students. Economists have soft- pedaled the
role of fraud in every crisis they examined, including the Savings & Loan
debacle, the Russian transition, the Asian meltdown and the dot.com bubble.
They continue to do so now. At a conference sponsored by the Levy Economics
Institute in New York on April 17, the closest a former Under Secretary of
the Treasury, Peter Fisher, got to this question was to use the word
“naughtiness.” This was on the day that the SEC charged Goldman Sachs with
fraud.
There are exceptions. A famous 1993 article
entitled “Looting: Bankruptcy for Profit,” by George Akerlof and Paul Romer,
drew exceptionally on the experience of regulators who understood fraud. The
criminologist-economist William K. Black of the University of
Missouri-Kansas City is our leading systematic analyst of the relationship
between financial crime and financial crisis. Black points out that
accounting fraud is a sure thing when you can control the institution
engaging in it: “the best way to rob a bank is to own one.” The experience
of the Savings and Loan crisis was of businesses taken over for the explicit
purpose of stripping them, of bleeding them dry. This was established in
court: there were over one thousand felony convictions in the wake of that
debacle. Other useful chronicles of modern financial fraud include James
Stewart’s Den of Thieves on the Boesky-Milken era and Kurt Eichenwald’s
Conspiracy of Fools, on the Enron scandal. Yet a large gap between this
history and formal analysis remains.
Formal analysis tells us that control frauds follow
certain patterns. They grow rapidly, reporting high profitability, certified
by top accounting firms. They pay exceedingly well. At the same time, they
radically lower standards, building new businesses in markets previously
considered too risky for honest business. In the financial sector, this
takes the form of relaxed – no, gutted – underwriting, combined with the
capacity to pass the bad penny to the greater fool. In California in the
1980s, Charles Keating realized that an S&L charter was a “license to
steal.” In the 2000s, sub-prime mortgage origination was much the same
thing. Given a license to steal, thieves get busy. And because their
performance seems so good, they quickly come to dominate their markets; the
bad players driving out the good.
The complexity of the mortgage finance sector
before the crisis highlights another characteristic marker of fraud. In the
system that developed, the original mortgage documents lay buried – where
they remain – in the records of the loan originators, many of them since
defunct or taken over. Those records, if examined, would reveal the extent
of missing documentation, of abusive practices, and of fraud. So far, we
have only very limited evidence on this, notably a 2007 Fitch Ratings study
of a very small sample of highly-rated RMBS, which found “fraud, abuse or
missing documentation in virtually every file.” An efforts a year ago by
Representative Doggett to persuade Secretary Geithner to examine and report
thoroughly on the extent of fraud in the underlying mortgage records
received an epic run-around.
When sub-prime mortgages were bundled and
securitized, the ratings agencies failed to examine the underlying loan
quality. Instead they substituted statistical models, in order to generate
ratings that would make the resulting RMBS acceptable to investors. When one
assumes that prices will always rise, it follows that a loan secured by the
asset can always be refinanced; therefore the actual condition of the
borrower does not matter. That projection is, of course, only as good as the
underlying assumption, but in this perversely-designed marketplace those who
paid for ratings had no reason to care about the quality of assumptions.
Meanwhile, mortgage originators now had a formula for extending loans to the
worst borrowers they could find, secure that in this reverse Lake Wobegon no
child would be deemed below average even though they all were. Credit
quality collapsed because the system was designed for it to collapse.
A third element in the toxic brew was a simulacrum
of “insurance,” provided by the market in credit default swaps. These are
doomsday instruments in a precise sense: they generate cash-flow for the
issuer until the credit event occurs. If the event is large enough, the
issuer then fails, at which point the government faces blackmail: it must
either step in or the system will collapse. CDS spread the consequences of a
housing-price downturn through the entire financial sector, across the
globe. They also provided the means to short the market in residential
mortgage-backed securities, so that the largest players could turn tail and
bet against the instruments they had previously been selling, just before
the house of cards crashed.
Latter-day financial economics is blind to all of
this. It necessarily treats stocks, bonds, options, derivatives and so forth
as securities whose properties can be accepted largely at face value, and
quantified in terms of return and risk. That quantification permits the
calculation of price, using standard formulae. But everything in the
formulae depends on the instruments being as they are represented to be. For
if they are not, then what formula could possibly apply?
An older strand of institutional economics
understood that a security is a contract in law. It can only be as good as
the legal system that stands behind it. Some fraud is inevitable, but in a
functioning system it must be rare. It must be considered – and rightly – a
minor problem. If fraud – or even the perception of fraud – comes to
dominate the system, then there is no foundation for a market in the
securities. They become trash. And more deeply, so do the institutions
responsible for creating, rating and selling them. Including, so long as it
fails to respond with appropriate force, the legal system itself.
Control frauds always fail in the end. But the
failure of the firm does not mean the fraud fails: the perpetrators often
walk away rich. At some point, this requires subverting, suborning or
defeating the law. This is where crime and politics intersect. At its heart,
therefore, the financial crisis was a breakdown in the rule of law in
America.
Ask yourselves: is it possible for mortgage
originators, ratings agencies, underwriters, insurers and supervising
agencies NOT to have known that the system of housing finance had become
infested with fraud? Every statistical indicator of fraudulent practice –
growth and profitability – suggests otherwise. Every examination of the
record so far suggests otherwise. The very language in use: “liars’ loans,”
“ninja loans,” “neutron loans,” and “toxic waste,” tells you that people
knew. I have also heard the expression, “IBG,YBG;” the meaning of that bit
of code was: “I’ll be gone, you’ll be gone.”
If doubt remains, investigation into the internal
communications of the firms and agencies in question can clear it up. Emails
are revealing. The government already possesses critical documentary trails
— those of AIG, Fannie Mae and Freddie Mac, the Treasury Department and the
Federal Reserve. Those documents should be investigated, in full, by
competent authority and also released, as appropriate, to the public. For
instance, did AIG knowingly issue CDS against instruments that Goldman had
designed on behalf of Mr. John Paulson to fail? If so, why? Or again: Did
Fannie Mae and Freddie Mac appreciate the poor quality of the RMBS they were
acquiring? Did they do so under pressure from Mr. Henry Paulson? If so, did
Secretary Paulson know? And if he did, why did he act as he did? In a recent
paper, Thomas Ferguson and Robert Johnson argue that the “Paulson Put” was
intended to delay an inevitable crisis past the election. Does the internal
record support this view?
Let us suppose that the investigation that you are
about to begin confirms the existence of pervasive fraud, involving millions
of mortgages, thousands of appraisers, underwriters, analysts, and the
executives of the companies in which they worked, as well as public
officials who assisted by turning a Nelson’s Eye. What is the appropriate
response?
Some appear to believe that “confidence in the
banks” can be rebuilt by a new round of good economic news, by rising stock
prices, by the reassurances of high officials – and by not looking too
closely at the underlying evidence of fraud, abuse, deception and deceit. As
you pursue your investigations, you will undermine, and I believe you may
destroy, that illusion.
But you have to act. The true alternative is a
failure extending over time from the economic to the political system. Just
as too few predicted the financial crisis, it may be that too few are today
speaking frankly about where a failure to deal with the aftermath may lead.
In this situation, let me suggest, the country
faces an existential threat. Either the legal system must do its work. Or
the market system cannot be restored. There must be a thorough, transparent,
effective, radical cleaning of the financial sector and also of those public
officials who failed the public trust. The financiers must be made to feel,
in their bones, the power of the law. And the public, which lives by the
law, must see very clearly and unambiguously that this is the case.
Thank you.
~~~
James K. Galbraith is the author of
The Predator State: How Conservatives Abandoned the Free Market and Why
Liberals Should Too, and of a new preface to The Great Crash, 1929, by
John Kenneth Galbraith. He teaches at The University of Texas at Austin
June 9, 2010 reply from Thompson, Shari
[shari.thompson@PVPL.COM]
Bob, that is an awesome article! I can only hope
that the system listens!
Bob Jensen's threads on the subprime sleaze is at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Looking
for blue sky above polluted bankaccounting hot air
Bank Profits Appear Out of Thin Air in 2009
Question
What direction did the price of shares of Bank of America move when BofA
announced higher than expected earnings for the first quarter of 2009?
Answer
Down, because investors suspect that such earnings were not sustainable while
BofA holds billions of dollars of Countrywide and Merrill Lynch toxic paper that
will drive down future earnings due to non-performance of home owners and
business owners who will not fully perform on loans.
The magic
accounting tricks in 2009 are hurting rather than helping to restore faith in
accounting and auditing after the 2008 banking crash.
Sydney Finkelstein, the Steven Roth professor of management at the Tuck School
of Business at Dartmouth College, also pointed out that Bank of America booked a
$2.2 billion gain by increasing the value of Merrill Lynch’s assets it acquired
last quarter to prices that were higher than Merrill kept them. “Although
perfectly legal, this move is also perfectly delusional, because some day soon
these assets will be written down to their fair value, and it won’t be pretty,”
he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross Sorkin, The New
York Times, April 20, 2009 ---
http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk
This is starting to feel like amateur hour for aspiring magicians.
Another day, another attempt by a Wall Street bank to pull a bunny out of
the hat, showing off an earnings report that it hopes will elicit oohs and
aahs from the market. Goldman Sachs, JPMorgan Chase, Citigroup and, on
Monday, Bank of America all tried to wow their audiences with what appeared
to be — presto! — better-than-expected numbers.
But in each case, investors spotted the attempts at sleight of hand, and
didn’t buy it for a second.
With Goldman Sachs, the disappearing month of December didn’t quite
disappear (it changed its reporting calendar, effectively erasing the impact
of a $1.5 billion loss that month); JPMorgan Chase reported a dazzling
profit partly because the price of its bonds dropped (theoretically, they
could retire them and buy them back at a cheaper price; that’s sort of like
saying you’re richer because the value of your home has dropped); Citigroup
pulled the same trick.
Bank of America sold its shares in China Construction Bank to book a big
one-time profit, but Ken Lewis heralded the results as “a testament to the
value and breadth of the franchise.”
Sydney Finkelstein, the Steven Roth professor of management at the Tuck
School of Business at Dartmouth College, also pointed out that Bank of
America booked a $2.2 billion gain by increasing the value of Merrill
Lynch’s assets it acquired last quarter to prices that were higher than
Merrill kept them.
“Although perfectly legal, this move is also perfectly delusional, because
some day soon these assets will be written down to their fair value, and it
won’t be pretty,” he said.
Investors reacted by throwing tomatoes. Bank of America’s stock plunged 24
percent, as did other bank stocks. They’ve had enough.
Why can’t anybody read the room here? After all the financial wizardry that
got the country — actually, the world — into trouble, why don’t these
bankers give their audience what it seems to crave? Perhaps a bit of simple
math that could fit on the back of an envelope, with no asterisks and no
fine print, might win cheers instead of jeers from the market.
What’s particularly puzzling is why the banks don’t just try to make some
money the old-fashioned way. After all, earning it, if you could call it
that, has never been easier with a business model sponsored by the federal
government. That’s the one in which Uncle Sam and we taxpayers are offering
the banks dirt-cheap money, which they can turn around and lend at much
higher rates.
“If the federal government let me borrow money at zero percent interest, and
then lend it out at 4 to 12 percent interest, even I could make a profit,”
said Professor Finkelstein of the Tuck School. “And if a college professor
can make money in banking in 2009, what should we expect from the highly
paid C.E.O.’s that populate corner offices?”
But maybe now the banks are simply following the lead of Washington, which
keeps trotting out the latest idea for shoring up the financial system.
The latest big idea is the so-called stress test that is being applied to
the banks, with results expected at the end of this month.
This is playing to a tough crowd that long ago decided to stop suspending
disbelief. If the stress test is done honestly, it is impossible to believe
that some banks won’t fail. If no bank fails, then what’s the value of the
stress test? To tell us everything is fine, when people know it’s not?
“I can’t think of a single, positive thing to say about the stress test
concept — the process by which it will be carried out, or outcome it will
produce, no matter what the outcome is,” Thomas K. Brown, an analyst at
Bankstocks.com, wrote. “Nothing good can come of this and, under certain,
non-far-fetched scenarios, it might end up making the banking system’s
problems worse.”
The results of the stress test could lead to calls for capital for some of
the banks. Citi is mentioned most often as a candidate for more help, but
there could be others.
The expectation, before Monday at least, was that the government would pump
new money into the banks that needed it most.
But that was before the government reached into its bag of tricks again. Now
Treasury, instead of putting up new money, is considering swapping its
preferred shares in these banks for common shares.
The benefit to the bank is that it will have more capital to meet its ratio
requirements, and therefore won’t have to pay a 5 percent dividend to the
government. In the case of Citi, that would save the bank hundreds of
millions of dollars a year.
And — ta da! — it will miraculously stretch taxpayer dollars without
spending a penny more.
Appendix T
Regulation
Recommendations
My all-time heroes Frank Partnoy and Lynn Turner contend
that Wall Street bank accounting is an exercise in writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper "Make Markets Be
Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://makemarketsbemarkets.org/modals/report_off.php
Watch the above video!
Abusive off-balance sheet accounting was a major
cause of the financial crisis. These abuses triggered a daisy chain of
dysfunctional decision-making by removing transparency from investors,
markets, and regulators. Off-balance sheet accounting facilitating the
spread of the bad loans, securitizations, and derivative transactions that
brought the financial system to the brink of collapse.
As in the 1920s, the balance sheets of major
corporations recently failed to provide a clear picture of the financial
health of those entities. Banks in particular have become predisposed to
narrow the size of their balance sheets, because investors and regulators
use the balance sheet as an anchor in their assessment of risk. Banks use
financial engineering to make it appear that they are better capitalized and
less risky than they really are. Most people and businesses include all of
their assets and liabilities on their balance sheets. But large financial
institutions do not.
Click here to read the full chapter.---
http://www.rooseveltinstitute.org/sites/all/files/Off-Balance Sheet
Transactions.pdf
Frank Partnoy is the George E.
Barnett Professor of Law and Finance and is the director of the Center on
Coporate and Securities Law at the University of San Diego. He worked as a
derivatives structurer at Morgan Stanley and CS First Boston during the
mid-1990s and wrote F.I.A.S.C.O.:
Blook in the Water on Wall Street, a
best-selling book about his experiences there. His other books include
Infectious Greed: How Deceit and Risk Corrupted the Financial Markets
and
The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall
Street Scandals.
Lynn Turner has the unique
perspective of having been the Chief Accountant of the Securities and
Exchange Commission, a member of boards of public companies, a trustee of a
mutual fund and a public pension fund, a professor of accounting, a partner
in one of the major international auditing firms, the managing director of a
research firm and a chief financial officers and an executive in industry.
In 2007, Treasury Secretary Paulson appointed him to the Treasury Committee
on the Auditing Profession. He currently serves as a senior advisor to LECG,
an international forensics and economic consulting firm.
The views expressed in this paper are those of the authors and do not
necessarily reflect the positions of the Roosevelt Institute, its officers,
or its directors.
Bob Jensen's threads on OBSF are at
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
For over 15 years Frank Partnoy has been appealing in vain for financial
reform. My timeline of history of the scandals, the new accounting standards,
and the new ploys at OBSF and earnings management is at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Wharton: Not Too Big To Fail: Why Lehman Had to Go Bankrupt ---
http://knowledge.wharton.upenn.edu/article/the-good-reasons-why-lehman-failed/
"SEC’s New Credit Rating Office Opens as Pressure Mounts on Firms," by
Emily Chason, CFO Journal, June 15, 2012 ---
http://blogs.wsj.com/cfo/2012/06/15/sec%E2%80%99s-new-credit-rating-office-opens-as-pressure-mounts-on-firms/?mod=wsjcfo_hp_cforeport#
"Two Cheers for the New Bank Capital Standards: Why do we still rely
on the rating agencies, and why are we still allowing Lehman Brothers levels of
leverage," by Alan S. Blinder, The Wall Street Journal, September 30,
2010 ---
http://online.wsj.com/article/SB10001424052748704523604575511813933977160.html#mod=djemEditorialPage_t
On Sept. 12 the heads of the world's major central
banks and bank-supervisory agencies met to bless what is called "Basel III,"
the latest international agreement on bank capital requirements. Should we
be applauding or frowning upon this agreement? A little of each.
The first big achievement, and it is a big
achievement, is that 27 countries, each with its own disparate views and
parochial interests, were able to agree at all—just 18 months after many of
them were still fighting the last acute phase of the financial crisis.
But what about the substance of the agreement? What
was it supposed to fix, and did it?
Remember, the essence of the Basel accords is
establishing a minimum ratio—of capital to risk-weighted assets—and ratios
have both numerators and denominators. It turns out that defining the
numerator, a bank's capital, is fraught with difficulties: What counts and
what doesn't? Most of the changes from Basel II to Basel III are about the
numerator: raising the amount of capital required and stiffening the
definition of what counts. Measuring assets is more straightforward, but
risk-weighting them is not, which is the essence of the denominator problem.
Before the crisis, at least three major
shortcomings of Basel II were apparent:
• Once you cut through the complexities, Basel II
actually reduced capital requirements relative to Basel I. Even before the
financial wreckage of 2007-2009, that looked like a mistake. After the
crisis, it looked absurd.
• In determining risk weights for the denominator,
Basel II assigned a major role to risk assessments by credit rating agencies
like Moody's and Standard & Poor's. Once again, that looked dubious before
the crisis and ludicrous thereafter.
• Basel II allowed the largest—did someone say, the
"most sophisticated"?—banks to use their own internal models to measure
risk. Let me repeat that: The biggest foxes were allowed to assess the
safety of the chicken coops—another serious risk-weighting (denominator)
problem.
Then along came the crisis, revealing two more
glaring weaknesses:
• One was the startling extent to which some banks
had used structured investment vehicles (SIVs) and similar arrangements to
avoid capital requirements by shifting assets off balance sheet. This
loophole cried out for plugging.
• The Basel Accords have always focused on minimum
capital requirements. But the crisis demonstrated that, in a crunch,
shortages of liquidity can be just as hazardous as shortages of capital.
Indeed, it was often hard to tell one from the other. That made the need for
minimum liquidity requirements apparent.
Those five issues should have formed the core of
the Basel III agenda. What was actually accomplished? Let's go down the
list.
First the good news: Capital requirements will be
raised substantially. Right now so-called Tier 1 capital must be at least 4%
of risk-weighted assets and Tier 2 capital must be at least 8%. The Basel II
definition of Tier 1 capital includes some things that are not common
equity, such as some types of preferred stock; and Tier 2 includes many more
things, such as certain types of reserves and subordinated debt. Basel III
places the focus squarely where it belongs: on common equity, which is
undoubtedly real capital. And, after a long phase-in period, it will raise
the minimum common-equity requirement to 7%. Hooray for both. But, folks,
couldn't we have asked the world's bankers to comply with the higher
standard before 2019? Maybe if we said, "pretty please"?
Because of demonstrable problems in assigning
appropriate risk weights, Basel III also resurrects, as a kind of backstop,
the old-fashioned leverage ratio: Tier 1 capital divided by total assets,
with no risk weighting. Good idea. But, once again, why must we wait until
2018 for full implementation? Furthermore, the chosen capital requirement is
only 3%—which you may know by its other name: 33-to-1 leverage. Isn't that
about what Lehman Brothers had?
Second, while the Dodd-Frank Act wisely removed
most provisions in U.S. law that gave the rating agencies special exalted
status, Basel III did not. So the agencies that did so poorly in rating
mortgage-backed securities and collateralized debt obligations will continue
to play major roles in the risk-weighting process.
It gets worse. Didn't the Basel Committee notice
that the internal risk models of most of the world's leading financial
institutions led to disaster? Whether it was gross-but-honest errors in
assessing risk or self-serving behavior is an important moral question,
though not an important operational one. Either way, letting banks grade
themselves worked out about as well as letting students grade themselves.
Yet this grotesque shortcoming of Basel II remains in place.
Fourth on the list is the off-balance-sheet
entities that caused the world so much grief. Here, some technical
improvements were made, thank goodness. For example, SIVs and the like will
be put back on banks' balance sheets for purposes of computing the leverage
ratio. But unfortunately not for the main risk-weighted capital
requirements.
Last, but not least, genuine progress was made
toward new minimum liquidity requirements. The technical problems and
novelty in defining liquidity proved to be formidable, as did the opposition
from the banking industry. So this job is not finished. But the Basel
Committee did at least institute a new liquidity requirement that will
become effective in 2015.
Beyond that, the committee kicked most of the novel
ideas down the road. For example, imposing higher capital requirements on
systemically-important institutions is left for the future.
So let's applaud Basel III, though one-handedly.
More capital, better capital, a leverage ratio, and a liquidity requirement
are all important steps forward. But the unwarranted reliance on rating
agencies, the disgraceful internal risk models of banks, and the disastrous
SIVs should have been easy marks for reformers.
Should the U.S. adopt the Basel III changes?
Absolutely, with no hesitation. But work on Basel IV should begin
immediately.
Mr. Blinder, a professor of economics and public affairs at Princeton
University and vice chairman of the Promontory Interfinancial Network, is a
former vice chairman of the Federal Reserve Board.
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
This is one of the few times I've seen a Harvard accounting faculty member
contribute to the daily Harvard Business Review Blog that has a steady
flow of contributions form management, marketing, and finance faculty that
sustain this blog.
"Dodd-Frank Financial Commentary from HBS Faculty," Harvard
Business Review Blog, July 20, 2010 ---
http://blogs.hbr.org/hbsfaculty/2010/07/dodd-frank-commentary-from-hbs.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE
"Five Major Defects of the Financial Reform Bill," by Nobel Laureate
Gary Becker, Becker-Posner Blog, July 11, 2010 ---
http://www.becker-posner-blog.com/2010/07/five-major-defects-of-the-financial-reform-bill-becker.html
A 2300 page bill is usually an indication of many
political compromises. The Dodd-Frank financial reform bill is no exception,
for it is a complex, disorderly, politically motivated, and not well thought
out reaction to the financial crisis that erupted beginning with the panic
of the fall of 2008. Not everything about the bill is bad-e.g., the
requirement that various derivatives trade through exchanges may be a good
suggestion- but the disturbing parts of the bill are far more important. I
will concentrate on five major defects, including omissions.
1. The bill adds regulations and rules about many
activities that had little or nothing to do with the crisis. For example, it
creates a consumer financial protection bureau to be housed at the Fed that
is supposed to protect consumers from fraud and other abusive financial
practices. Yet it is not apparent that many consumers were victimized during
the financial boom years, or that consumer behavior had anything of
importance to do with the crisis. For example, consumers who took out
subprime mortgages that required almost no down payments and had low
interest rates were not victimized since these conditions enabled them to
cheaply own houses, at least for a while. The “victims” were the banks, and
especially Fannie Mae and Freddie Mac, that were foolishly willing to hold
such risky mortgages.
The bill gives the Fed authority to limit
interchange or “swipe” fees that merchants pay for each debit-card
transaction, although these fees had not the slightest connection to the
financial crisis. Such price controls are in general undesirable, and hardly
seem to require the attention of the Federal Reserve. The bill also gives
the SEC authority to empower stockholders to run their own candidates for
corporate boards of directors. Corporate boards often receive some blame for
the crisis-mainly unjustified in my opinion- but stockholder election of
some members will not improve corporate governance, and will probably make
that worse.
2. The Dodd-Frank bill gives several government
agencies considerable additional discretion to try to forestall another
crisis, even though they already had the authority to take many actions. The
Fed could have tightened the monetary base and interest rates as the crisis
was developing, but chose not to do so. The SEC and various Federal Reserve
banks-especially the New York Fed- had the authority to stop questionable
lending practices and increase liquidity requirements. These and other
government bodies did not use their authority to try to head off the crisis
partly because they got caught up in the same bubble hysteria as did banks
and consumers. In addition, regulators are often “captured” by the firms
they are regulating, not necessarily because the regulators are corrupt, but
because they are mainly exposed to arguments made by the banks and other
groups they are regulating.
Despite the fact that regulators failed to use the
powers they already had, the bill mainly adds not clear rules of behavior
for banks, but additional governmental discretionary power. For example, the
bill creates the Financial Stability Oversight Council, a nine-member panel
drawn from the Fed, SEC, and other government agencies, that is supposed to
monitor Wall Street’s largest companies and other market participants to
spot and respond to any emerging growth in systemic risk in the economy.
With a two-thirds vote this Council could impose higher capital requirements
on lenders and place hedge funds and dealers under the Fed’s authority.
Given the regulators reluctance to use the power they already had to
forestall the crisis, it seems highly unlikely that this Council will act
decisively prior to the emergence of a crisis, especially when a two thirds
majority is required.
3. Insufficient capital relative to bank assets was
an important cause of the financial crisis. The bill does reduce the ability
of banks to count as bank capital certain risky assets, such as trust
preferred securities, and gives the Fed authority to impose additional
capital and liquidity requirements on banks and non-bank financial
companies, including insurers. I would have preferred a simple rule that
raised capital requirements of banks relative to their assets, especially
capital of larger and more interconnected banks. As suggested by Raghu Rajan
and the Squam Lake group of economists, the bill probably should have
required larger banks to issue “contingent” capital, such as debt that
automatically converts to equity when the banks are experiencing large
losses, or when a bank’s capital to asset ratio falls below a certain level.
4. One of the most serious omissions is that the
bill essentially says nothing about Freddie Mac or Fannie Mae. In 2008 these
organizations were placed into conservatorship of the Federal Housing
Finance Agency. During the run up to the crisis, Barney Frank and others in
Congress encouraged Freddie and Fannie to absorb most of the subprime
mortgages. In 2008 they held over half of all mortgages, and almost all the
subprimes. They have absorbed even a larger fraction of the relatively few
mortgages written after 2008. Freddie and Fannie deserve a considerable
share of the blame for the crisis, but they continue to have strong
political support. I would like to see both of them eventually dissolved,
but that is unlikely to happen. Instead we are promised that they will be
dealt with in future legislation, but I am skeptical that anything will be
done to terminate either organization, or even improve their functioning.
5. Many proposals in the bill will have highly
uncertain impacts on the economy. These include, among many other
provisions, the requirement that originators of mortgages and other assets
retain at least 5% of the assets they originate, that many derivatives go on
organized exchanges (may be an improvement but far from certain), that hedge
funds become more closely regulated, and that consumer be “protected” from
their financial decisions.
Most of these and other changes in the bill are not
based on a serious analysis of what contributed to the financial crisis, but
rather are the result of political and emotional reactions to the crisis.
Usually, such reactions do more harm than good. That is likely to be the
fate of the great majority of the provisions of the Dodd-Frank bill.
"Let's (Credit) Grade Wall Street Like Colleges: The more rating
agencies the better," The Wall Street Journal, September 15, 2009 ---
http://online.wsj.com/article/SB10001424052970203917304574413072842297920.html#mod=djemEditorialPage
Is Harvard really the best?
It turns out that depends on who you ask—and what
you ask. As students across America return to campus for the new school
year, new editions of three prominent college guides variously rank Harvard
at No. 1, No. 5, and No. 11. Therein lies a timely lesson for our system of
credit ratings.
Some students know from their earliest days they
want to go to Harvard, while others may want to follow mom or dad to East
Carolina or Purdue. Many more rely on the annual college guides to help them
make one of the most important financial decisions in their lives—in much
the same way an investor might look to Moody's to tell them about the
reliability of a corporate bond. The question with both is just how reliable
those ratings are.
When the housing bubble popped, our financial
institutions learned—the hard way—that the mortgage-backed securities on
their balance sheets did not merit the AAA-grades the credit ratings
agencies had assigned them. Similar complaints have long been advanced about
the trustworthiness of college guides. As the dominant player, U.S. News &
World Report's annual America's Best Colleges guide has borne the brunt of
this criticism.
In public, college presidents, deans, and spokesmen
pooh-pooh the U.S. News rankings. In private, however, many do what they can
to boost their schools up the rankings ladder. One area open to manipulation
has to do with the "peer assessment" category that accounts for a quarter of
the U.S. News ranking.
Earlier this year, Inside Higher Ed reported on a
charmingly frank presentation by a Clemson University official who admitted
her school's officials use the peer assessment to rate "all programs other
than Clemson below average." The university denied the charge. But further
reporting revealed that Clemson President James Barker had given his only
"strong" rating to his own school, while giving lower grades to every other
college in the land.
The revelations have been an embarrassment for
Clemson. Still, the woman who set off the firestorm was surely right when
she said, "I'm confident my president is not the only one who does that."
Other schools, after all, have found themselves in the news for manipulating
the way they report to U.S. News everything from their average SAT scores
and alumni giving to per pupil spending and class profiles.
So if the U.S. News report is so flawed, where's
the lesson for Wall Street? The answer lies in the new competition the U.S.
News guide has spawned. In the last few years, the Washington Monthly and
Forbes have each offered guides of their own. They are joined by the
American Council of Trustees and Alumni, which measures colleges by whether
they require seven core subjects the authors deem essential for a solid
liberal arts education. There's even the conservative Intercollegiate
Studies Institute's "Choosing the Right College," which offers advice about
the best professors and courses to seek out on campuses.
Different measures, of course, lead to different
results. The latest U.S. News guide has Harvard and Princeton tied for No.
1, followed by Yale. Over at the Washington Monthly, by contrast—where
editors measure colleges by how well they do at promoting social mobility,
national service and research—Harvard falls to No. 11. And the top three
slots are taken by public universities in the University of California
system: UC Berkeley, UC San Diego and UCLA.
Then there's Forbes, which just ranked West Point
as "America's Best College." The Forbes ratings include student satisfaction
with courses, post-graduate employment success (including salary data and
entries in Who's Who), the likelihood of graduation within four years, and
the average level of debt graduates are stuck with.
Which guide is best at picking the best? The answer
is that no single measurement or guide can tell everyone everything. The
more measures students and parents have, the fuller the picture before them,
and the better equipped they are to make a smart decision. Because the
federal government is not in the business of certifying particular college
guides, moreover, they compete by persuading students and parents to buy
them on the quality and relevance of their findings.
At a time when the Securities and Exchange
Commission is looking for ways to improve the flawed credit ratings that
contributed so much to our financial crisis, it might do well to stop
anointing particular credit rating agencies. Forcing these firms to compete
for customers the way the college guides do would give us better ratings—and
fewer investors lulled into the complacency that comes from thinking Uncle
Sam has done the due diligence. At least when it comes to ratings, the
Groves of Academe have a thing or two to teach our captains of finance about
competition.
Bob Jensen's threads on systemic problems of accountancy (including the
aggregation ratings of nutrients in vegetables) are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews
- Systemic Problem:
All Aggregations Are Arbitrary
- Systemic Problem:
All Aggregations Combine Different Measurements With Varying
Accuracies
- Systemic Problem:
All Aggregations Leave Out Important Components
- Systemic Problem:
All Aggregations Ignore Complex & Synergistic Interactions
of Value and Risk
- Systemic Problem: Disaggregating of Value or Cost is
Generally Arbitrary
- Systemic Problem:
Systems Are Too Fragile
- Systemic Problem:
More Rules Do Not Necessarily Make Accounting for
Performance More Transparent
- Systemic Problem:
Economies of Scale vs. Consulting Red Herrings in Auditing
- Systemic Problem:
Intangibles Are Intractable
|
Bob Jensen's threads on credit rating agencies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
The Woman Who Tried Early On to Save Our Money and Prevent This Economic
Crisis and Countless Financial Frauds
Brooksley Born ---
http://en.wikipedia.org/wiki/Brooksley_Born
In 1964, Brooksley was the first female student in history to become
President of Stanford's Law Review.
The Obama administration has pledged an overhaul of
the financial system, including the way derivatives are regulated. Worrisome to
some observers is the fact that his economic team includes some former Treasury
officials who were lined up in opposition to Born a decade ago.
"Prophet and Loss," by Rick Schmitt, Stanford Magazine, March/April 2009,
pp. 40-47.
Brooksley Born (the first woman at Stanford to be
president of the Law Review) was named to head the Commodity Futures Trading
Commission in 1996. She “advocated reigning in the huge and growing market
for financial derivatives…Back in the 1990’s, however, Born’s proposal
stirred an almost visceral response from other regulators in the Clinton
administration (notably explosive and rude 1998 reactions from
Treasury Secretary Robert Rubin and Deputy Secretary Larry Summers and SEC
Chairman Arthur Levitt to her suggestion that derivatives swap markets be
regulated) as well as members of Congress and
lobbyists…Ultimately Greenspan and the other regulators foiled Born’s
efforts and Congress took the extraordinary step of enacting legislation
that prohibited her agency from taking any action…Speaking out for the first
time, Born says she takes no pleasure from the turn of events. She says she
was just doing her job based on the evidence in front of her. Looking back,
she laments what she says was the outsized influence of Wall Stret lobbyists
on the process, and the refusal of her fellow regulators, especially
Greenspan, to discuss even modest reforms. ‘Recognizing the dangers…was not
rocket science, but it was contrary to the conventional wisdom and certainly
contrary to the economic interests of Wall Street at the moment,‘ she says.”
As quoted on March 20, 2009 at
http://openpalm.wordpress.com/2009/03/20/the-woman-who-tried-to-save-our-money/
Bob Jensen's timeline of derivatives markets scandals the evolution of
accounting standards for derivative financial instruments ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
One Feature of the Proposed Regulation of OTC Derivatives is Insane
OTC Derivatives Should Be Regulated in Some Respects, But They Should Never Be
Standardized
PwC Notes one of the main reasons (shown in read) at
Click Here
Why should the right
balance be struck when it comes to regulating OTC derivatives?
Some OTC derivatives have
been criticized for contributing to the financial crisis. But new proposals may
affect how all derivatives are traded and designed.
Most financial
derivatives have been safely and prudently used over the years by thousands of
companies seeking to manage specific risks.
OTC derivatives are
privately negotiated because they are often highly customized. They enable
businesses to offset nearly any fi nancial risk exposure, including foreign
exchange, interest rate, and commodity price risks.
Proposals to standardize
terms for all OTC derivatives could inadvertently limit the ability of companies
to fully manage their risks.
Jensen Comment
The reason that it would "limit the ability of companies to fully manage their
risks" is that OTC derivatives are currently very popular hedging contracts
because it is often possible over-the-counter to write customized hedging
contracts that exactly match (in mirror form) the terms of a hedged item
contract or forecasted transaction such that the hedge becomes perfectly
effective over the life of the hedge.
If companies have to hedge with standardized contracts such as futures and
options contracts traded on organized exchange markets it's either impossible or
very difficult to obtain a perfectly matched and effective hedge. For example,
corn futures are traded in contracts of 25,000 bushels for a given grade of
corn. If Frito Lay wants to hedge a forecasted transaction to purchase 237,000
bushels of corn, it can only perfectly hedge 225,000 bu. with five futures
contracts or 250,000 bu. with six futures contracts. Hence it's impossible to
perfectly hedge 237,000 bu. with standardized contracts.
However, if Frito Lay wants to perfectly hedge 237,000 bu. of corn it can
presently enter into one OTC forward contract for 237,000 bu. or an OTC options
contract for 237,000 bu. If the hedged item is eventually purchased in the same
geographic region as the hedging contract (such as Chicago), the hedge should be
perfectly effective at all points in time during the contracted hedging period.
If the hedging contract is written in terms of a Chicago market and the corn
is eventually purchased in a Minneapolis market, then their may be slight
hedging ineffectiveness (due mainly to transportation cost differences between
the two markets), but there is absolutely no mismatch due to quantity (notional)
differences.
Why is customization so important from the standpoint of accounting and
auditing?
Under FAS 133 and IAS 39, hedge accounting relief is available only to the
extent hedges are deemed effective. The ineffective portion of value changes in
the hedging contracts must be posted to current earnings, thereby increasing the
volatility of earnings for unrealized value changes of the hedging contracts.
If new regulations requiring standardization of
OTC derivatives, then the regulations themselves may dictate that many or most
hedging contacts are, at least in part, ineffective. As a result reported
earnings will needlessly fluctuate to a greater extent due to the regulations
rather than because of economic substance. Dumb! Dumb! Dumb!
In particular, students may want to refer to
the hedge accounting ineffectiveness testing Appendix B Example 7 beginning in
Paragraph 144 of FAS 133 and Appendix A Example 7
beginning in Paragraph 93 of FAS 133. Bob
Jensen's extensions and spreadsheet analysis of the Paragraph 144 illustration
are available in Excel worksheet file 133ex07a.xls
listed at
http://www.cs.trinity.edu/~rjensen/
Sadly, the FASB left both of these examples, along with the other outstanding
Appendix A and B examples out of its sparse handling of accounting for
derivative financial instruments in its Codification Database.
In particular, Examples 1 thru 10 in Appendix B of FAS 133 are the best
places that I know of to learn about hedge accounting and effectiveness testing.
My extended analysis of each example can be found in the 133ex01a.xls thru
133ex10a.xls Excel workbooks at
http://www.cs.trinity.edu/~rjensen/
My students focused heavily on those ten examples to learn about hedge
accounting. They also learned from my videos 133ex05a.wmv and 133ex08a.wmv files
listed at
http://www.cs.trinity.edu/~rjensen/video/acct5341/
Teaching Cases: Hedge Accounting Scenario 1 versus Scenario 2
Two Teaching Cases Involving Southwest Airlines, Hedging, and Hedge
Accounting Controversies ---
http://faculty.trinity.edu/rjensen/caseans/SouthwestAirlinesQuestions.htm
From The Wall Street Journal Accounting Weekly Review on
Bank Capital Gets Stress Test
by Deborah
Solomon and Jon Hilsenrath
Feb 26, 2009
Click here to view the full article on WSJ.com
http://online.wsj.com/article/SB123557705225772665.html?mod=djem_jiewr_AC
TOPICS: Bad
Debts, Banking, Financial Analysis, Financial Statement Analysis
SUMMARY: The
Obama administration is proposing new bank capital requirement tests that
will be designed to assess whether "...banks can survive even if the
unemployment rate rises above 10% and home prices fall by another
25%....worse than most economists and the Federal Reserve currently expect."
If banks fail to demonstrate sufficient capital to weather those
circumstances, they may either raise additional funds privately or accept
further investment from the U.S. government. "The government's investment
would come in the form of convertible preferred shares, which institutions
could choose to convert into common equity at any time....Officials said
they expect banks would convert the shares to common equity as needed to
help protect against losses."
CLASSROOM APPLICATION: Questions
help students to understand the meaning of capital beyond the balance sheet
definition of assets - liabilities = equity and to understand the
relationship between economic forecasting and bank capital requirements. The
article also discusses the use of preferred shares versus common stock and
the use of convertible preferred shares.
QUESTIONS:
1. (Introductory)
Define bank capital in terms of the balance sheet equation.
2. (Advanced)
What tests are used to assess a bank's health based on the level of its
capital or equity? (Hint: for background information and an international
perspective, you may investigate the Basel and Basel II Accords of the Basel
Committee on Banking Supervision of the Group of Ten nations. See the
related articles.)
3. (Introductory)
How can economic and financial advisors relate the potential unemployment
rate and mortgage default rate in the U.S. economy to banks' capital needs?
4. (Advanced)
If financial institutions fail capital requirement tests based on new
thresholds as outlined by the Obama administration, the U.S. government may
invest in "...convertible preferred shares, which institutions could choose
to convert into common equity at any time." Define and describe the
differences between preferred and common shares. Also define convertibility
features.
5. (Introductory)
Why might financial institutions not want to issue common shares of stock
but be allowed to do so by converting preferred shares whenever they so
choose?
6. (Introductory)
What is the difference between financial institutions issuing stock to the
U.S. government in the ways described in this article and nationalizing our
financial institutions?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
Rules on Capital Roil U.S. Bankers
by Damian Paletta
Nov 01, 2006
Page: C3
http://online.wsj.com/article/SB116234873761209749.html
by Damian Paletta and Alistair MacDonald
Mar 04, 2008
Page: 03/04
"Bank Capital Gets Stress Test," by Deborah Solomon and Jon Hilsenrath, The
Wall Street Journal, Feb 26, 2009
http://online.wsj.com/article/SB123557705225772665.html?mod=djem_jiewr_AC
The Obama administration, in unveiling details of
its financial-rescue plan, laid out a dark economic scenario it expects
banks to be able to withstand, the starting point for what could become a
significant new infusion of government cash into the banking system.
To ensure banks can survive even if the
unemployment rate rises above 10% and home prices fall by another 25%, the
administration will require some institutions to either raise private money
or accept a bigger investment from the U.S. government. U.S. officials don't
expect the economy to deteriorate that sharply, but they want to be sure
banks are prepared nonetheless.
The first step in the latest effort to shore up the
banking sector will be a series of "stress tests" to assess whether the
largest U.S. banks can survive a protracted slump. The tests aren't expected
to be finished until April. Banks will then have up to six months to address
any shortfall.
Unlike the Bush administration's effort to pump
$250 billion into banks, the Obama team didn't commit a set amount of money
to the effort and President Barack Obama said Tuesday it is likely that
banks will need additional funds beyond the $700 billion rescue package
approved by Congress last fall.
The government's investment would come in the form
of convertible preferred shares, which institutions could choose to convert
into common equity at any time. Regulators and investors have become more
concerned about the amount of common stock banks hold, since that is a
bank's first line of defense against losses.
To ensure their balance sheets are strong, the
biggest banks will be required to undergo a tough assessment, including
whether they have the right type of capital. Officials said they expect
banks would convert the shares to common equity as needed to help protect
against losses.
A bank's capital is its cushion against losses, a
buffer that ensures its depositors and other lenders will get paid even if
the bank runs into trouble.
Economists said most of the nation's largest banks
will likely have to raise capital under the economic assumptions that
regulators plan to use. The stress test assumes an unemployment rate
averaging 8.9% in 2009 and 10.3% in 2010. Because that is an average for a
whole year, the test envisions the jobless rate reaching higher than those
levels on a monthly basis during these stretches. It was 7.6% in January
Under some circumstances, the government might end
up owning majority stakes in banks.
"I think you'll find most firms need more capital
and that Bank of America and Citigroup are going to need a boatful of new
capital," said Douglas Elliott, a fellow at the Brookings Institution.
Discuss Would nationalizing banks improve or worsen
the crisis? Share your thoughts at Journal Community.Banks that get a
government investment will have to comply with strict executive-compensation
restrictions, including curtailed bonuses for top executives and earners.
The securities will pay a 9% dividend -- higher than the 5% banks are
required to pay under the Bush-era program -- and banks would be restricted
in paying dividends and from buying back their own stock. The securities
would automatically convert to common stock after seven years.
Banks that have already sold preferred shares to
the government as part of the $250 billion program would also be able to
swap the preferred shares for convertible securities that can convert to
common shares.
Administration officials said the effort is an
attempt to avoid nationalizing banks and to make sure institutions can lend
money. While officials said most banks are considered well capitalized,
uncertainty about economic conditions is hindering their ability to lend
money or attract private capital.
Treasury Secretary Timothy Geithner sought to knock
down speculation that the government may nationalize banks, saying such a
move is "the wrong strategy for the country and I don't think it's the
necessary strategy." Mr. Geithner, speaking on The NewsHour with Jim Lehrer,
said there may be situations where the government provides "exceptional
support" but that the best outcome is if the banks "are managed and remain
in private hands."
U.S. officials will demand that financial
institutions test the resilience of their portfolios and capital against a
grim, though not catastrophic, economic landscape. The test assumes a 3.3%
contraction in gross domestic product in 2009, which would be the worst
performance since 1946. And it assumes home-price declines of another 22% in
2009 and 7% in 2010.
That would be worse than most economists and the
Federal Reserve currently expect. Private economists on average forecast a
2% contraction in economic output this year and a 2% rebound next year, with
the jobless rate remaining below 10%.
Some private forecasters said they can imagine
worse.
"I don't have any problem believing the
unemployment rate is going to move to 12% or that vicinity," said Laurence
Meyer, vice chairman of Macroeconomic Advisers LLC, a forecasting firm whose
models are widely used in Washington and New York.
Mr. Meyer said regulators had to strike a delicate
balance in designing their test. If they painted a truly grim scenario --
the economy contracted by 9% in 1930, 6% in 1931 and 13% in 1932 -- it could
force banks to raise more capital than they are capable of raising, driving
them further into the government's arms.
"You don't want to know the answer to some of the
questions you might ask," Mr. Meyer said.
Bob Jensen's threads on accounting theory are at
http://faculty.trinity.edu/rjensen/theory01.htm
Capital Requirement in Bank Regulation ---
http://en.wikipedia.org/wiki/Capital_ratio
The capital requirement is a bank regulation, which
sets a framework on how banks and depository institutions must handle their
capital. The categorization of assets and capital is highly standardized so
that it can be risk weighted[clarification needed]. Internationally, the
Basel Committee on Banking Supervision housed at the Bank for International
Settlements influence each country's banking capital requirements. In 1988,
the Committee decided to introduce a capital measurement system commonly
referred to as the Basel Accord. This framework is now being replaced by a
new and significantly more complex capital adequacy framework commonly known
as Basel II. While Basel II significantly alters the calculation of the risk
weights, it leaves alone the calculation of the capital. The capital ratio
is the percentage of a bank's capital to its risk-weighted assets. Weights
are defined by risk-sensitivity ratios whose calculation is dictated under
the relevant Accord.
Each national regulator normally has a very
slightly different way of calculating bank capital, designed to meet the
common requirements within their individual national legal framework.
Most developed countries and Basel I and II,
stipulate lending limits as a multiple of a banks capital eroded by the
yearly inflation rate.
The 5 C's of Credit, Character, Cash Flow,
Collateral, Conditions and Capital, have been replaced by one single
criterion. While the international standards of bank capital were laid down
in the 1988 Basel I accord, Basel II makes significant alterations to the
interpretation, if not the calculation, of the capital requirement.
Examples of national regulators implementing Basel
II include the FSA in the UK, BAFIN in Germany, and OSFI in Canada.
An example of a national regulator implementing
Basel I, but not Basel II, is in the United States.[verification needed]
Depository institutions are subject to risk-based capital guidelines issued
by the Board of Governors of the Federal Reserve System (FRB). These
guidelines are used to evaluate capital adequacy based primarily on the
perceived credit risk associated with balance sheet assets, as well as
certain off-balance sheet exposures such as unfunded loan commitments,
letters of credit, and derivatives and foreign exchange contracts. The
risk-based capital guidelines are supplemented by a leverage ratio
requirement. To be adequately capitalized under federal bank regulatory
agency definitions, a bank holding company must have a Tier 1 capital ratio
of at least 4%, a combined Tier 1 and Tier 2 capital ratio of at least 8%,
and a leverage ratio of at least 4%, and not be subject to a directive,
order, or written agreement to meet and maintain specific capital levels. To
be well-capitalized under federal bank regulatory agency definitions, a bank
holding company must have a Tier 1 capital ratio of at least 6%, a combined
Tier 1 and Tier 2 capital ratio of at least 10%, and a leverage ratio of at
least 5%, and not be subject to a directive, order, or written agreement to
meet and maintain specific capital levels. These capital ratios are reported
quarterly on the Call Report or Thrift Financial Report.
Different International
Implementations
Regulators in each country
have some discretion on how they implement capital
requirements in their jurisdiction.
For example, it has been
reported that Australia's
Commonwealth Bank is measured as having 7.6% Tier 1
capital under the rules of the
Australian Prudential Regulation Authority, but this
would be measured as 10.1% if the bank was under the
jurisdiction of the UK's
Financial Services Authority. This demonstrates that
international differences in implementation of the rule can
vary considerably in their level of strictness.
Common capital ratios
- Tier 1 capital ratio =
Tier 1 capital / Risk-adjusted assets >=6%
- Total capital (Tier 1
and Tier 2) ratio = Total capital (Tier 1 and Tier 2) /
Risk-adjusted assets >=10%
- Leverage ratio = Tier 1
capital / Average total consolidated assets >=5%
- Common stockholders’
equity ratio = Common stockholders’ equity / Balance
sheet assets
Listed below are
the capital ratios in
Citigroup at the end of 2003
Ratios
At year-end |
2003 |
Tier 1 capital |
8.91% |
Total capital (Tier
1 and Tier 2) |
12.00% |
Leverage (1) |
5.56% |
Common
stockholders’ equity |
7.67% |
- (1) Tier 1 capital
divided by
adjusted average assets.
Components of
Capital Under Regulatory Guidelines
In millions of
dollars at year-end |
2003 |
Tier 1
capital |
Common
stockholders’ equity |
$
96,889 |
Qualifying
perpetual preferred stock |
1,125 |
Qualifying
mandatorily redeemable securities of subsidiary
trusts |
6,257 |
Minority interest |
1,158 |
Less: Net
unrealized gains on securities available-for-sale
(1) |
(2,908) |
Accumulated net
gains on cash flow hedges, net of tax (751) (1,242) |
(751) |
Intangible assets: (2) |
Goodwill |
(27,581) |
Other disallowed
intangible assets |
(6,725) |
50% investment in
certain subsidiaries (3) |
(45) |
Other |
(548) |
Total Tier 1
capital |
66,871 |
Tier 2
capital |
Allowance for
credit losses (4) |
9,545 |
Qualifying debt
(5) |
13,573 |
Unrealized
marketable equity securities gains (1) |
399 |
Less: 50%
investment in certain subsidiaries (3) |
(45) |
Total Tier 2
capital |
23,472 |
Total capital (Tier
1 and Tier 2) |
$
90,343 |
Risk-adjusted
assets (6) |
$750,293 |
"How Stressed is Your Bank?" by Stephen Gandel, Time Magazine,
March 2, 2009 ---
http://www.time.com/time/business/article/0,8599,1880499-1,00.html
Citigroup
.038 = Assets/Equity = $2,000,000,000,000/$150,000,000,000
Loan losses: Even after making a government deal, the bank is still on the
hook for the first $40 billion in loan losses in the pool it has insured.
Citi also has $277 billion in other, nonhousing consumer loans, such as
credit cards and student debt. Roubini estimates that about 17% of consumer
loans will go unpaid nationwide. That translates into a $47 billion river of
red ink. Add in everything else (commercial real estate, corporate loans),
and Citigroup will have to swallow $106 billion in loan losses by the end of
2010.
Capital cushion: Thanks to the Troubled Asset
Relief Program (TARP), Citigroup now has $151 billion in equity, up from
$113 billion a year ago. Alas, it will have a $76 billion hit from bad
loans. Along with a projected bottom-line loss of $3.5 billion, that drops
the bank's capital to $70.5 billion.
Prognosis: On the way to the ICU. Citigroup has a
projected leverage ratio of just 3.8% — far lower than what it would need to
be considered well capitalized. How much would the U.S. have to give the
bank to nurse it back to good health? About $22 billion.
JPMorgan Chase
.078 = Assets/Equity =
$2,100,000,000,000/$166,000,000,000
Loan losses: JPMorgan largely avoided the troubled subprime-lending game.
Not so Washington Mutual, which JPMorgan acquired in 2008 in an
FDIC-brokered deal. With housing prices still falling, many of those WaMu
loans are going unpaid. JPMorgan has $105 billion in credit card loans,
which could cost the company some $18 billion. And there is an additional
$262 billion in corporate and commercial loans, which, according to Roubini,
could tally $26 billion more in red ink. All told, it's a $97 billion loss
for JPMorgan.
Capital cushion: JPMorgan has $23 billion in its
rainy-day fund for such losses. Not enough. Shareholders' equity will drop
to $121 billion, from the current $167 billion.
Prognosis: Looking good. JPMorgan is in better
shape than other big banks are. Its post-test leverage ratio drops to 6.4%,
from nearly 8% — still a picture of financial health.
Bank of America
.046 = Assets/Equity =
$2,000,000,000,000/$176,000,000,000
Loan losses: BofA's buyout of mortgage broker Countrywide means the bank has
$400 billion in home loans outstanding — more than its competitors. Worse,
Countrywide, by nearly all accounts, had shockingly low lending standards.
Chalk up a higher-than-average $40 billion in losses there. On top of that,
BofA has made $87 billion in loans to commercial real estate developers.
Roubini predicts 17% of those loans will go bad as developers hit the skids.
For BofA, that's $15 billion more in losses. Toss in $55 billion in
commercial- and consumer-loan losses, and you get $121 billion in lending
deficits by the end of 2010.
Capital cushion: BofA has put away $23 billion to
cover future losses, and it has more equity — $177 billion — than JPMorgan
or Citigroup. But that might not be enough to preserve it without government
help.
Prognosis: Prepare the transfusion. BofA is still
on the monitor, but it's not far from being healthy again. It has a stressed
leverage ratio of 4.6%. Just $7.3 billion in new capital would put BofA back
on its feet. And with Uncle Sam finalizing its deal to guarantee $118
billion of BofA debt, the bank may already be on the mend. (See
the top 10 financial-crisis buzzwords.)
Wells Fargo
.076 = Assets/Equity =
$1,300,000,000,000/$99,000,000,000
Loan losses: When Wells Fargo acquired Wachovia late last year, it more than
doubled its loan book. In good times, that would be a major coup. These
days, it's major trouble. Home buyers owe the bank $360 billion, up from
about $150 billion just three months ago. Next, Wells has $154 billion in
commercial real estate loans, as well as $200 billion in other types of
commercial debt. Apply Roubini's overall 13% loss projection, and the
conclusion is that Wells may be sitting on a $117 billion loss.
Capital cushion: The good news for Wells is that it
has been aggressive in identifying problem loans — $37 billion from Wachovia
alone. Wells officials argue that will lead to lower losses than its
competitors'. But if not, the bank could be in trouble.
Even after the $25 billion Wells got from the
government last year, it has just under $100 billion in equity, trailing
other major banks by more than 50%.
Prognosis: Defibrillator. Stat! Wells Fargo is
generally considered one of the banks that are least likely to fail. But our
stress test says otherwise. Even with its $58 billion loan-loss buffer,
Wells is still in the hole for $59 billion, or 60% of its capital. With $40
billion remaining and an expected $5 billion in income, the bank could sink
to a less-than-rosy leverage ratio of 3.7%.
From the November 10, 2008 Securities Law Blog at
http://lawprofessors.typepad.com/securities/
CFTC Chair Outlines Reform Proposal
CFTC Acting Chairman Walter L. Lukken gave the
keynote speech before FIA Futures and Options
Expo, in Chicago today and put forth his vision of regulatory reform.
Specifically:
I believe the United States should scrap the
current outdated regulatory framework in favor of an objectives-based
regulatory system consisting of three primary authorities: a new
Systemic Risk Regulator, a new Market Integrity Regulator and a new
Investor Protection Regulator. This objectives–based framework is
similar in concept to the reforms advanced by Treasury Secretary
Paulson’s Blueprint and Paul Volcker’s Group of Thirty Report.
A new Systemic Risk Regulator would have the
responsibility of policing the entirety of the financial system for
“black swan”
risks that could cause a contagion
event and take preventative action against such occurrences. Such a
regulator does not exist in the current framework but is absolutely
necessary given the witnessed interconnections of our financial markets
and the speed of the current global crisis. A new Market Integrity
Regulator would oversee the safety and soundness of key financial
institutions, including exchanges, investment firms and commercial banks
whose failure may jeopardize the integrity of the markets. A new
Investor Protection Regulator would broadly oversee investor protection
and business conduct across all firms in the marketplace. This
objectives-based framework focuses on risks from the macro to micro
levels and would be a radical departure from the current structure. The
different functions of the CFTC, as well as the SEC and the various
banking regulators, would be dispersed among these three regulatory
authorities.
The CFTC Chairman disagreed with SEC
Chairman Cox's proposal for a merger of the CFTC and SEC:
One idea that has been put forth as
both a permanent and interim reform step is a simple merger of the CFTC
and the SEC. In Washington, this is code for the larger SEC—along with
its rules-based model and culture—taking over the principles-based CFTC.
In my view, this would be ineffective and would only reinforce our
outdated regulatory structure. Simple merger is a recycled idea when
bold solutions are needed.
Who is Nassim Nicholas Taleb? ---
http://en.wikipedia.org/wiki/Taleb
Many finance professors make students watch some of Taleb's videos, especially
the Black Swan ---
http://video.google.com/videosearch?q=taleb+black+swan+&www_google_domain=www.google.com&emb=0&aq=f&aq=f#
Black Swan Financial Collapse Black Swan ---
http://www.dailymotion.com/video/x720r3_black-swan-paradigm-financial-colla_tech
(People underestimate the probability of rare events)
Subprime: Borne of
Greed, Sleaze, Bribery, and Lies
Peter Pan, the manager of Countrywide Financial on Main Street, thought he had
little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures
would be Wall Street’s problems and not his local bank’s problems. And he got
his nice little commission on the sale of the Emma Nobody’s mortgage for
$180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was
almost certain in Emma’s case, because she only makes $12,000 waitressing at the
Country Café. So what if Peter Pan fudged her income a mite in the loan
application along with the fudged home appraisal value? Let Wall Street or Fat
Fannie or Foolish Freddie worry about Emma after closing the pre-approved
mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter Pan is
more concerned with his own conventional mortgage on his precious house just two
blocks south of Main Street. This is what happens when risk is
spread even farther than Tinkerbell can fly!
Sadly, Peter Pan also engaged in lease, bribery, and lies.
From the CFO Journal's Morning Ledger on March 30, 2018
Barclays to pay $2 billion to
resolve securities claims.
Barclays PLC agreed to pay $2
billion in civil penalties to resolve U.S. Justice Department claims that
the U.K. lender fraudulently sold mortgage securities that helped fuel the
financial crisis, causing investors “enormous losses,” the government said
Thursday.
Bob
Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
The root cause of the fraud was
the ability of lenders (often felon criminals) to issue mortgages ten or more
times the value of the real estate collateral and then sell those mortgages
upstream to Fannie Mae, Freddie Mack, and Wall Street Banks without bearing any
risk of 1005 certain defaults on those mortgages. These default risks became the
poison of the mortgages later sold in CDO bond portfolios that later brought
down Bear Stearns, Lehman Bros,, Merrill Lynch, etc.
See Below
Wharton: Not Too Big To Fail: Why Lehman Had to Go Bankrupt ---
http://knowledge.wharton.upenn.edu/article/the-good-reasons-why-lehman-failed/
Wells Fargo just agreed to pay $1.2 billion to settle
'shoddy' mortgage practices (phony property appraisals, loans with zero
chance of repayment passed upstream to Fannie and Freddie, etc.) ---
http://www.businessinsider.com/wells-fargo-mortgage-settlement-2016-4
A Pissing Contest Between Bob and Jagdish: An Illustration of How to Lie
With Statistics ---
http://www.cs.trinity.edu/~rjensen/temp/LieWithStatistics01.htm
"Why Are Some Sectors (Ahem, Finance) So Scandal-Plagued?" by Ben W.
Heineman, Jr., Harvard Business Review Blog, January 10, 2013 ---
Click Here
http://blogs.hbr.org/cs/2013/01/scandals_plague_sectors_not_ju.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
The trouble with crony capitalism isn't capitalism. It's the cronies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#CronyCapitalism
Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit
rating agencies) ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of
Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
Rotten to the Core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Credit Rating Firms ---
http://en.wikipedia.org/wiki/Credit_rating_firms
Credit Rating Firms are rotten to the core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
From the CFO Journal's
Morning Ledger on March 10, 2016
Moody’s to pay Calpers $130 million to settle lawsuit
Moody’s Investors Service has agreed to pay $130
million to end a prominent lawsuit alleging crisis-era misconduct, a record
settlement for the world’s second-largest ratings firm. The California
Public Employees’ Retirement System alleged in a 2009 lawsuit that Moody’s
and two other ratings firms made “negligent misrepresentations” when they
awarded rosy grades to residential mortgage bonds that later soured.
"Ending the Credit Ratings Racket: Seven years after the financial
crisis, the SEC enacts a critical reform," The Wall Street Journal,
September 18, 2015 ---
http://www.wsj.com/articles/ending-the-ratings-racket-1442615384?mod=djemMER
America’s financial system is sturdier today thanks
to some rare good news from a Washington regulator. Seven years after the
financial crisis, the Securities and Exchange Commission has taken a big
step toward ending a policy that helped cause the mess.
For decades before the crisis, SEC staff had
recognized a small group of private credit-rating agencies—including
Standard & Poor’s, Moody’s and Fitch—as official judges of risk. Federal
regulators referred to these favored companies in their rules and even
forced financial institutions to invest in paper rated highly by this
anointed cartel.
When the members of the cartel turned out to be
wrong about the risks in mortgage-backed securities, the result was
catastrophic because the government had forced so many other firms to follow
their advice.
The new rule enacted by the commission this week
says that instead of simply holding assets rated highly by the cartel, the
operators of money-market mutual funds must instead rely on their own
analysis to select securities presenting minimal credit risk. Investors
probably assume that’s what mutual fund companies do already, and many of
them do. All of them should.
Kudos to SEC Commissioner Daniel Gallagher, who has
the welcome habit of breaking Beltway decorum. In various public fora, Mr.
Gallagher kept reminding his colleagues that this needed reform was being
ignored while they went about drafting rules that had nothing to do with
addressing the causes of the last crisis or preventing the next one.
This week’s reform leaves one SEC rule that still
carries an endorsement of the ratings cartel—so-called Regulation M for
securities offerings. SEC Chair Mary Jo White should now get her agency all
the way out of the business of deciding whose opinions about credit risk
ought to be followed. Let markets decide whose opinions have value. It will
make financial crises less likely.
There’s also need for reform outside Washington.
Too many state pension systems still show too much deference to the cartel.
A rating expresses a point of view, not a guarantee.
Continued in article
Credit Rating Firms Were Rotten
to the Core: At last the DOJ is
taking some action (Bailout,
Credit Rating Agendies,
Agencies, Banks, CDO, Bond
Ratings, CDO. Auditing, Fraud)
citation:
"DOJ vs. Rating Firms,"
by David Hall, CFO.com
Morning Ledger, February 5,
2013
journal/magazine/etc.:
CFO.com Morning Ledger
publication date:
Februry 5, 2013
article text:
There are two superpowers in
the world today in my opinion.
There’s the United States and
there’s Moody’s Bond Rating
Service. The United States can
destroy you by dropping bombs,
and Moody’s can destroy you by
down grading your bonds. And
believe me, it’s not clear
sometimes who’s more powerful.
The most that we can safely
assert about the evolutionary
process underlying market
equilibrium is that harmful
heuristics, like harmful
mutations in nature, will die
out.
Martin Miller, Debt and Taxes as
quoted by Frank Partnoy, "The
Siskel and Ebert of Financial
Matters: Two Thumbs Down for
Credit Reporting Agencies,"
Washington University Law
Quarterly, Volume 77, No.
3, 1999 ---
http://faculty.trinity.edu/rjensen/FraudCongressPartnoyWULawReview.htm
Credit rating agencies gave AAA
ratings to mortgage-backed
securities that didn't deserve
them. "These ratings not only
gave false comfort to investors,
but also skewed the computer
risk models and regulatory
capital computations," Cox said
in written testimony.
SEC Chairman Christopher
Cox as quoted on
October 23, 2008 at
http://www.nytimes.com/external/idg/2008/10/23/23idg-Greenspan-Bad.html
"CREDIT RATING AGENCIES:
USELESS TO INVESTORS," by
Anthony H. Catanch Jr. and J.
Edward Ketz, Grumpy Old
Accountants Blog, June 6,
2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/113
In 2008 it became evident
that credit rating firms were
giving AAA ratings to bonds that
they knew were worthless,
especially CDO bonds of their
big Wall Street clients like
Bear Stearns, Merrill Lynch,
Lehman Bros., JP Morgan,
Goldman, etc. ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on the fraudulent credit rating agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
Liar Loans: Canadians Taking Cheating Lessons from USA Mortgage
Lenders
"Liar loans' are popping up in Canada's housing bubble," by Wolf Richter,
Business Insider, July 31, 2015 ---
http://www.businessinsider.com/liar-loans-pop-up-canada-housing-bubble-2015-7
For a long time, the conservative mortgage lending
standards in Canada, including a slew of new ones since 2008, have been
touted as one of the reasons why Canada’s magnificent housing bubble, when
it implodes, will not take down the financial system, unlike the US housing
bubble, which terminated in the Financial Crisis.
Canada is different. Regulators are on top of it.
There are strict down payment requirements. Mortgages are full-recourse, so
strung-out borrowers couldn’t just mail in their keys and walk away, as they
did in the US. And yada-yada-yada.
But Wednesday afterhours, Home Capital Group,
Canada’s largest non-bank mortgage lender, threw a monkey wrench into this
theory.
Through its subsidiary, Home Trust, the company
focuses on “alternative” mortgages: high-profit mortgages to risky borrowers
with dented credit or unreliable incomes who don’t qualify for mortgage
insurance and were turned down by the banks. They include subprime
borrowers.
So it disclosed, upon the urging of the Ontario
Securities Commission, the results of an investigation that had been going
on secretly since September: “falsification of income information.” Liar
loans.
Liar loans had been the scourge of the US housing
bust. Lenders were either actively involved or blissfully closed their eyes.
And everyone made a ton of money.
Bob Jensen's Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
There are two
superpowers in the world today in my opinion. There’s the United States and
there’s Moody’s Bond Rating Service. The United States can destroy you by
dropping bombs, and Moody’s can destroy you by down grading your bonds. And
believe me, it’s not clear sometimes who’s more powerful. The most that we can
safely assert about the evolutionary process underlying market equilibrium is
that harmful heuristics, like harmful mutations in nature, will die out.
Martin Miller, Debt and Taxes as quoted by Frank Partnoy, "The Siskel and Ebert
of Financial Matters: Two Thumbs Down for Credit Reporting Agencies,"
Washington University Law Quarterly, Volume 77, No. 3, 1999 ---
http://faculty.trinity.edu/rjensen/FraudCongressPartnoyWULawReview.htm
Credit rating agencies gave AAA ratings to
mortgage-backed securities that didn't deserve them. "These ratings not only
gave false comfort to investors, but also skewed the computer risk models and
regulatory capital computations," Cox said in written testimony.
SEC Chairman Christopher Cox
as quoted on October 23, 2008 at
http://www.nytimes.com/external/idg/2008/10/23/23idg-Greenspan-Bad.html
"CREDIT RATING AGENCIES: USELESS TO INVESTORS," by Anthony H. Catanch Jr. and
J. Edward Ketz, Grumpy Old Accountants Blog, June 6, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/113
The Advantage of a Shredded Paper Trail
From the CFO Morning Ledger Newsletter on February 11, 2012
S&P left paper trail, but not Moody’s. The reason the DOJ may be
going after Standard & Poor’s and not rival Moody’s may be because S&P left
a paper trail and Moody’s didn’t. Former Moody’s
employees tell the WSJ that Moody’s took careful
steps to avoid creating a trove of potentially embarrassing employee
messages like those that came back to haunt S&P in the U.S.’s lawsuit.
Moody’s analysts had limited access to instant-message programs and were
directed by executives to discuss sensitive matters face to face. The
crackdown on communications came after a 2005 investigation by then-New York
Attorney General Eliot Spitzer into Moody’s ratings on some mortgage-backed
deals.
Bob Jensen's threads on the credit rating agency scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Credit Rating Firms ---
http://en.wikipedia.org/wiki/Credit_rating_firms
Credit Rating Firms were rotten to the core ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
In 2008 it became evident that credit rating firms were giving AAA ratings to
bonds that they knew were worthless, especially CDO bonds of their big Wall
Street clients like Bear Stearns, Merrill Lynch, Lehman Bros., JP Morgan,
Goldman, etc. ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
There are two
superpowers in the world today in my opinion. There’s the United States and
there’s Moody’s Bond Rating Service. The United States can destroy you by
dropping bombs, and Moody’s can destroy you by down grading your bonds. And
believe me, it’s not clear sometimes who’s more powerful. The most that we can
safely assert about the evolutionary process underlying market equilibrium is
that harmful heuristics, like harmful mutations in nature, will die out.
Martin Miller, Debt and Taxes as quoted by Frank Partnoy, "The Siskel and Ebert
of Financial Matters: Two Thumbs Down for Credit Reporting Agencies,"
Washington University Law Quarterly, Volume 77, No. 3, 1999 ---
http://faculty.trinity.edu/rjensen/FraudCongressPartnoyWULawReview.htm
Credit rating agencies gave AAA ratings to
mortgage-backed securities that didn't deserve them. "These ratings not only
gave false comfort to investors, but also skewed the computer risk models and
regulatory capital computations," Cox said in written testimony.
SEC Chairman Christopher Cox
as quoted on October 23, 2008 at
http://www.nytimes.com/external/idg/2008/10/23/23idg-Greenspan-Bad.html
"CREDIT RATING AGENCIES: USELESS TO INVESTORS," by Anthony H. Catanch Jr. and
J. Edward Ketz, Grumpy Old Accountants Blog, June 6, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/113
"DOJ vs. Rating Firms," by David Hall, CFO.com Morning Ledger,
February 5, 2013
The government is taking its
get-tough-on-Wall-Street stance to the next level with the DOJ’s lawsuit
against Standard & Poor’s. The suit alleges that S&P from September 2004
through October 2007 “knowingly and with the intent to defraud, devised,
participated in, and executed a scheme to defraud investors in” CDOs and
securities backed by residential mortgages, the WSJ reports at the top of A1
today. The two sides have been discussing a possible settlement for months,
but the penalties the DOJ was targeting – more than $1 billion – made S&P
squeamish. The firm was also worried that if it admitted wrongdoing, as the
DOJ wanted, that could leave it vulnerable to other lawsuits.
S&P and other rating firms have argued in the past
that their opinions are protected by the First Amendment — and judges have
thrown out dozens of suits based on that argument, the Journal says. This
case will test that argument against the Justice Department’s view that the
First Amendment wouldn’t protect a ratings firm if it defrauded investors by
ignoring its own standards.
Neil Barofsky, the former inspector general for the
Troubled Asset Relief Program, said the DOJ move looks like an effort to get
“some measure of accountability” for the financial crisis, which was
“something that’s been really lacking across the board.” And Jeffrey Manns,
a law professor at George Washington University, tells Reuters that the suit
sends a message to “the rating industry at large that the government is
serious about holding rating agencies responsible, and that they must be
much more careful.”
http://online.wsj.com/public/page/cfo-journal.html
Jensen Comment
The DOJ actions do not worry the credit rating firms nearly so much as the
hundreds of billions of potential tort lawsuits awaiting in the wings, lawsuits
by damaged investors who relied on those phony credit ratings.
The credit rating firms, in turn, will blame CPA audit firms who gave clean
audit opinions on junk.
Where were the auditors?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"Cheat Sheet: What’s Happened to the Big Players in the Financial Crisis?"
by Braden Goyette, Publica, October 26, 2011 ---
http://www.propublica.org/article/cheat-sheet-whats-happened-to-the-big-players-in-the-financial-crisis
Widespread demonstrations in support of Occupy Wall Street have put the
financial crisis back into the national spotlight lately.
So here’s a
quick refresher on what’s happened to some of the main players, whose
behavior, whether merely reckless or downright deliberate, helped cause
or worsen the meltdown. This list isn’t exhaustive -- feel welcome to
add to it.
Mortgage originators
Mortgage lenders contributed to the financial crisis by issuing or
underwriting loans to people who
would have a difficult time paying them back, inflating a housing
bubble that was bound to pop.
Lax regulation allowed banks to stretch their mortgage lending
standards and use aggressive tactics to rope borrowers into complex
mortgages that were more expensive than they first appeared. Evidence
has also surfaced that
lenders were filing fraudulent documents to push some of these mortgages
through, and, in some cases, had been doing so as early as the
1990s. A 2005 Los Angeles Times
investigation of Ameriquest – then the nation’s largest
subprime lender
– found that “they forged documents, hyped
customers' creditworthiness and ‘juiced’ mortgages with hidden rates and
fees.” This behavior was reportedly typical for the subprime mortgage
industry. A similar culture existed at
Washington Mutual, which went under in 2008 in the
biggest bank collapse in U.S. history.
Countrywide, once the nation’s largest mortgage lender, also
pushed customers to sign on for
complex and costly mortgages that boosted the company’s profits.
Countrywide CEO Angelo Mozilo was
accused of misleading investors about the company’s mortgage lending
practices, a charge he denies. Merrill
Lynch and
Deutsche Bank both purchased subprime mortgage lending
outfits in 2006 to get in on the lucrative business. Deutsche Bank has
also been accused of
failing to adequately check on borrowers’ financial status before
issuing loans backed by government insurance. A lawsuit filed by U.S.
Attorney Preet Bharara claimed that, when employees at Deutsche Bank’s
mortgage received audits on the quality of their mortgages from an
outside firm, they
stuffed them in a closet without reading them. A Deutsche Bank
spokeswoman said the claims being made against the company are
“unreasonable and unfair,” and that most of the problems occurred before
the mortgage unit was bought by Deutsche Bank.
Where they are now: Few prosecutions have been brought against
subprime mortgage lenders. Ameriquest
went out of business in 2007, and Citigroup bought its mortgage
lending unit. Washington Mutual was bought by JP Morgan in 2008. A
Department of Justice investigation into alleged fraud at WaMu
closed with no charges this summer. WaMu also recently
settled a class action lawsuit brought by shareholders for $208.5
million. In an ongoing lawsuit, the FDIC is accusing former
Washington Mutual executives Kerry Killinger, Stephen Rotella and David
Schneider of going on a "lending
spree, knowing that the real-estate market was in a 'bubble.'" They
deny the allegations.
Bank of America purchased Countrywide in January of 2008, as
delinquencies on the company’s mortgages soared and investors began
pulling out. Mozilo left the company after the sale. Mozilo
settled an SEC lawsuit for $67.5 million with no admission of
wrongdoing, though he is now banned from serving as a top executive at a
public company. A criminal investigation into his activities fizzled out
earlier this year. Bank of America invited several senior Countrywide
executives to stay on and run its mortgage unit. Bank of America Home
Loans does not make subprime mortgage loans. Deutsche Bank is still
under investigation by the Justice Department.
Mortgage securitizers
In the years before the crash, banks took subprime mortgages, bundled
them together with prime mortgages and turned them into collateral for
bonds or securities, helping to seed the bad mortgages throughout the
financial system. Washington Mutual, Bank of America,
Morgan Stanley and others were securitizing mortgages as well as
originating them. Other companies, such as Bear Stearns, Lehman
Brothers, and Goldman Sachs,
bought mortgages straight from subprime lenders, bundled them into
securities and sold them to investors including pension funds and
insurance companies.
Where they are now: This spring, New York’s Attorney General
launched a
probe into mortgage securitization at Bank of America, JP Morgan,
UBS, Deutsche Bank, Goldman Sachs and Morgan Stanley during the housing
boom. Morgan Stanley
settled with Nevada’s Attorney General last month following an
investigation into problems with the securitization process.
As part of a proposed settlement with the 50 state attorneys general
over foreclosure abuses, several big banks were
offered immunity from charges related to improper mortgage
origination and securitization. California and New York have
withdrawn from those talks.
The people who created and dealt CDOs
Once mortgages had been bundled into mortgage-backed securities,
other bankers took groups of them and bundled them together into new
financial products called Collateralized Debt Obligations. CDOs are
composed of tiers with different levels of risk. As we’ve reported,
a hedge fund named Magnetar worked with banks to fill CDOs
with the riskiest possible materials, then used credit default swaps to
bet that they would fail. Magnetar says that the majority of its short
positions were against CDOs it didn’t own. Magnetar also says it didn’t
choose what went its own CDOs, though people involved in the deals who
spoke to ProPublica
contradict this account.
American International Group’s London-based financial products
unit was among the entities that
provided credit default swaps on CDOs. Though the business of
insuring the risky securities made AIG large short-term profits, it
eventually brought the company to the brink of collapse, prompting an
$85 billion government bailout.
Merrill Lynch, Citigroup, UBS, Deutsche Bank, Lehman
Brothers and JPMorgan all made CDO deals with Magnetar. The
hedge fund invested in 30 CDOs from the spring of 2006 to the summer of
2007. The bankers who worked on these deals almost always reaped hefty
bonuses. From
our story:
Even today, bankers and managers speak with awe at the elegance
of the Magnetar Trade. Others have become famous for betting big
against the housing market. But they had taken enormous risks.
Meanwhile, Magnetar had created a largely self-funding bet against
the market.
When banks found CDOs hard to sell, some of them, notably Merrill
Lynch and Citibank,
bought each other’s CDOs, creating the illusion of true investors
when there were almost none. That was one way they kept the market for
CDOs going longer than it otherwise would have. Eventually CDOs began
purchasing risky parts of other CDOs created by the same bank. Take a
look at our
comic strip explaining self-dealing, and our chart detailing
which banks bought their own CDOs.
Goldman Sachs and
Morgan Stanley also made similar deals in which they created,
then bet against, risky CDOs. The hedge fund
Paulson & Co helped decide which assets to put inside Goldman’s
CDOs.
Where they are now: Overall, the banks and individuals
involved in CDO deals haven’t been convicted on criminal charges. The
civil suits against them have produced fines that aren’t very big
compared to the profits they made in the leadup to the financial crisis.
JP Morgan paid $153.6 million to settle an SEC suit alleging they
hadn’t disclosed to investors that Magnetar was betting against Morgan’s
CDO.
Citigroup just agreed to pay a $285 million fine to the SEC for
betting against one of its mortgage-related CDOs. The lawsuit
doesn’t mention dozens of similar deals made by Citi.
Magnetar is still thriving (the deals they made weren’t illegal
according to the rules at the time). In 2007, Magnetar’s
founder took home $280 million, and the fund had $7.6 billion under
management. The SEC is considering banning hedge funds and banks from
betting against securities of their own creation. As of May 2010,
federal prosecutors were investigating
Morgan Stanley over their CDO deals, and
Goldman Sachs paid $550 million last year to settle a lawsuit
related to one of theirs. Only
one Goldman employee, Fabrice Tourre, has been charged criminally in
connection to the deals.
Though recorded phone calls suggest that former AIG CEO Joseph
Cassano misled investors about the credit default swaps that contributed
to his company’s troubles, the evidence wasn’t airtight, and federal
probes against him fell apart in 2010. Cassano’s lawyers deny any
wrongdoing.
The ratings agencies
Standard and Poor’s, Moody’s and Fitch gave
their highest rating to investments based on risky mortgages in the
years leading up to the financial crisis.
A Senate investigations panel found that S&P and Moody’s continued
doing so even as the housing market was collapsing. An SEC report also
found failures at 10 credit rating agencies.
Where they are now: The SEC is
considering suing Standard and Poor’s over one particular CDO deal
linked to the hedge fund Magnetar. The agency had previously
considered suing Moody’s, but instead issued a report
criticizing all of the rating agencies generally. Dodd-Frank created
a regulatory body to oversee the credit rating agencies, but its
development has been
stalled by budgetary constraints.
The regulators
The
Financial Crisis Inquiry Commission [PDF] concluded that the
Securities and Exchange Commission failed to crack down on risky
lending practices at banks and make them keep more substantial capital
reserves as a buffer against losses. They also found that the Federal
Reserve failed to stop the housing bubble by setting prudent
mortgage lending standards, though it was the one regulator that had the
power to do so.
An internal SEC audit
faulted the agency for missing warning signs about the poor
financial health of some of the banks it monitored,
particularly Bear Stearns. [PDF] Overall, SEC enforcement actions
went down under the leadership of Christopher Cox, and a 2009 GAO
report found that he
increased barriers to launching probes and levying fines.
Cox wasn’t the only regulator who resisted using his power to rein in
the financial industry. The former head of the Federal Reserve, Alan
Greenspan, reportedly
refused to heighten scrutiny of the subprime mortgage market.
Greenspan later said before Congress that
it was a mistake to presume that financial firms’ own rational
self-interest would serve as an adequate regulator. He has also said he
doubts the financial crisis could have been prevented.
The Office of Thrift Supervision, which was tasked with
overseeing savings and loan banks, also helped to scale back their own
regulatory powers in the years before the financial crisis. In 2003
James Gilleran and John Reich, then heads of the OTS and
Federal Deposit Insurance Corporation respectively,
brought a chainsaw to a press conference as an indication of how
they planned to cut back on regulation. The OTS was known for being so
friendly with the banks -- which it referred to as its “clients” -- that
Countrywide
reorganized its operations so it could be regulated by OTS. As we’ve
reported, the regulator failed to recognize serious
signs of trouble at AIG, and
didn’t disclose key information about IndyMac’s finances in the
years before the crisis. The Office of the Comptroller of the
Currency, which oversaw the biggest commercial banks, also
went easy on the banks.
Where they are now: Christopher Cox
stepped down in 2009 under
public pressure. The OTS was dissolved this summer and its duties
assumed by the OCC. As we’ve noted, the
head of the OCC has been advocating to weaken rules set out by the
Dodd Frank financial reform law. The Dodd Frank law
gives the SEC new regulatory powers, including the ability to bring
lawsuits in administrative courts, where the rules are more favorable to
them.
The politicians
Two bills supported by Phil Gramm and signed into law by
Bill Clinton created many of the conditions for the financial crisis
to take place. The Gramm-Leach-Bliley Act of 1999 repealed all the
remaining parts of Glass-Steagall, allowing firms to participate in
traditional banking, investment banking, and insurance at the same time.
The Commodity Futures Modernization Act, passed the year after,
deregulated
over-the-counter
derivatives – securities like CDOs and credit default swaps, that
derive their value from underlying assets and are traded directly
between two parties rather than through a stock exchange. Greenspan and
Robert Rubin, Treasury Secretary from 1995 to 1999, had both
opposed regulating derivatives. Lawrence Summers, who went
on to succeed Rubin as Treasury Secretary, also
testified before the Senate that derivatives shouldn’t be regulated.
Continued in article
Jensen Comment
This is a well-researched summary article of what happened between 2008 and 2011
to the "Major Players" in the enormous economic crisis, subprime mortgage, CDO,
and other scandals.
My criticism is that the article seems to let CPA auditors off the hook in
terms of being "Big Players" which, in my viewpoint is an enormouse oversight.
For example, it mentions the huge WaMu settlement without mentioning the lawsuit
against Deloitte. It mentions the Lehman Bros. scandal without mentioning Ernst
& Young. Nor does it mention the other dereliction of duty of all the
large international audit firms and the small audit firms who never warned the
public about pending failures of thousands of small banks and mortgage companies
on Main Street as well as Wall Strett. The large and small CPA audit firms fell
flat on their faces as important watchdogs over the Bigger Players and Smaller
Players ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Here are the only tidbits about audits and auditors in the above article:
U.S. Attorney Preet Bharara claimed that, when
employees at Deutsche Bank’s mortgage received audits on the quality of
their mortgages from an outside firm, they
stuffed them in a closet without reading them. A
Deutsche Bank spokeswoman said the claims being made against the company are
“unreasonable and unfair,” and that most of the problems occurred before the
mortgage unit was bought by Deutsche Bank
. . .
An internal SEC audit
faulted the agency for missing warning signs about
the poor financial health of some of the banks it monitored,
particularly Bear Stearns.
[PDF] Overall, SEC enforcement actions went down under the leadership of
Christopher Cox, and a 2009 GAO report found that he
increased barriers to launching probes and levying fines.
.
So my conclusion is that Braden Goyette did a pretty good job summarizing
what happened to what he called the "Big Players" in the economic crisis. He
just did not include all of the Big Players ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"How One "Sack Of S**t" Mortgage-Backed Security Came To Define The
Financial Crisis," by Matthew Zeitlin, Buzzfeed News, August 11, 2014
---
http://www.buzzfeed.com/matthewzeitlin/how-one-sack-of-shit-mortgage-backed-security-came-to-define#1ek09p6
The history of SACO 2006-8, as told through court
documents dating back more than six years, provides a view into how the
mortgage-backed security industry was built up and spectacularly collapsed.
For JPMorgan, it has become the mortgage-backed security from hell.
Last week, JPMorgan Chase’s costly legal troubles
took another step toward completion when trustees for 311 mortgage-backed
securities sold by the bank or inherited through acquisitions prior to the
financial crisis agreed to a $4.5 billion settlement. Another 14 got an
extension to still consider the deal, while five trusts wholly rejected the
settlement, leaving open the option for them to continue litigation against
the bank. SACO 2006-8, created and marketed by Bear Stearns two years prior
to its government-supported acquisition by JPMorgan in 2008, was one of the
trusts that rejected the deal.
The detailed history of this one trust’s creation
and sale, as told through court documents dating back to a lawsuit filed by
the bond insurer Ambac six years ago, provides a view into how the
mortgage-backed security industry was built up and spectacularly collapsed.
And it may be one of the very few chances that the investors who bought
these securities — and the insurance companies that guaranteed them — can
find out what actually happened.
More importantly, it may be the only chance left
for the public to get a granular view of what actually happened in the
run-up to the financial crisis.
The best way to understand the importance of SACO
2006-8 to both the inner workings of the mortgage-backed securities industry
and JPMorgan is to start in the present and travel back to the past.
A large chunk of JPMorgan’s more than $20 billion
legal tab last year over the bank and its affiliates’ practices in marketing
and selling mortgage-backed securities before the financial crisis is owed
to two settlements: one with the Department of Justice for $13 billion and
the previously mentioned $4.5 billion deal. (The latter deal still requires
approval by a judge, and if granted will finally remove the bulk of
financial crisis-era legal liabilities from the bank.) The combined $17.5
billion cost of those two settlements, reached less than a week apart,
nearly matched JPMorgan’s net income of $17.9 billion last year.
The settlement included a statement of facts that
JPMorgan agreed to — not a guilty plea — describing generally how its
employees (and those of Bear Stearns and Washington Mutual) marketed
mortgage-backed securities to investors even though some of the loans didn’t
comply with the loan underwriters’ own guidelines for selling and
securitizing them. The civil penalty of $2 billion only applied to what
JPMorgan did before the crisis, not Bear Stearns or Washington Mutual, and
released the bank from civil liability for claims arising from the
securities included in the settlement.
“Without a doubt, the conduct uncovered in this
investigation helped sow the seeds of the mortgage meltdown,” Attorney
General Eric Holder said when announcing the deal between the Justice
Department, several states, and other regulatory agencies and JPMorgan,
which ranks as the country’s largest bank by assets.
JPMorgan’s chairman and Chief Executive Officer
Jamie Dimon described 2013 in a letter to investors as “the best of times
[and] the worst of times,” and said that the bank came through “scarred but
strengthened — steadfast in our commitment to do the best we can.”
Many of the same mortgage-backed securities covered
by the Justice Department deal were also among those included in the $4.5
billion trustee settlement, SACO 2006-8 being one of them.
“We believe the acceptance by the Trustees of the
overwhelming majority of the 330 trusts is a significant step toward
finalizing the settlement,” a JPMorgan spokesman said in a statement earlier
this month. The spokesman declined further comment for this story.
SACO 2006-8 was one of many mortgage-backed
securities pumped out by Bear Stearns during the housing and credit boom.
Made up of almost 5,300 home equity lines of credit from California,
Virginia, Florida, and Illinois acquired by a Bear subsidiary called EMC,
the trust had a principal balance of $356 million. Its most senior notes,
the “Class A Notes” that would get paid off first by the stream of home
equity payments, got the highest possible ratings from Moody’s and Standard
& Poor’s, and were buoyed by an insurance policy from the AAA-rated
Wisconsin-based bond insurer Ambac that guaranteed payments on the senior
debt.
Almost a third of the home equity lines came from
American Home Mortgage Corporation, which would declare bankruptcy less than
a year later — not coincidentally, the same year home equity origination
would peak. By March 2008, Bear Stearns would be acquired by JPMorgan after
its stock plummeted as clients and investors got nervous about its
mortgage-backed securities holdings. Two years and a few months later, in
November 2010, Ambac would file for bankruptcy.
But SACO 2006-8 continued to live. It would be
quickly downgraded and, by the end of 2010, it had already experienced some
$141 million worth of losses and had 41% of its loans go delinquent or
charged off entirely.
A lawsuit filed in 2008 by Ambac, unsealed in 2011,
included an email from a Bears Stearns manager to a trader describing the
loans that would make up SACO 2006-8 as a “SACK OF SHIT” and, alternately, a
“shit breather.”
“I hope you’re making a lot of money off of this
trade,” the manager also wrote to a trader. When asked to explain himself in
a deposition, the manager said that “shit breather” was a “term of
endearment.”
SACO 2006-8 was hardly the only Bear Stearns
mortgage deal that Ambac and others have said was put together by hiding the
low quality of the underlying mortgages from investors and insurers. Ambac’s
complaint alleges that Bear “knew and actively concealed that it was
building a house of cards.”
Ambac further said in its complaint that less than
25% of the loans Bear Stearns had acquired from American Home Mortgage were
current and 60% had been delinquent for a month. Of those loans, 1,600 ended
up in SACO 2006-8. The four transactions covered in the first Ambac suit (it
has also filed a second suit against JPMorgan) had $1.2 billion in losses by
2011 and lead to Ambac paying out $641 million on their insurance coverage
to bondholders.
JPMorgan, which inherited the suit from Bear,
responded in court documents that Ambac was a financially sophisticated
company that actively sought Bear’s business and had access to the
underlying loan data used in constructing the securities.
Selling mortgages based on home equity lines of
credit were a relatively new but quickly growing portion of Bear’s mortgage
securities business. Ambac’s complaint says that Bear’s EMC subsidiary in
2005 had 9,300 home equity lines worth $509 million, but by the end of 2006
those figures had grown to some 18,000 loans worth $1.2 billion. Moreover,
the home equity business was just one portion of Bear’s mortgage machine.
From 2003 to 2007, EMC would purchase and then package for investors over
345,000 loans worth some $69 billion.
As Ambac’s lawsuit was winding its way through the
courts, SACO 2006-8 emerged again, this time in a lawsuit brought by New
York Attorney General Eric Schneiderman.
As co-chairman of the Residential Mortgage-Backed
Securities Working Group, a group of law enforcement officials convened by
the Obama administration to investigate mortgage fraud before the financial
crisis, Schneiderman said Bear Stearns sold mortgage-backed securities
featuring “material misrepresentations and flagrant omissions.”
Bear’s representations as to the quality of the
loans “were false, misleading, and designed to conceal fundamental flaws and
defects in the defendants’ due diligence systems,” Schneiderman said.
The complaint said “thousands of investors” were
harmed by “systemic fraud” and that losses on more than 100 mortgage-backed
securities it identified from 2006 and 2007 were $22.5 billion on an
original balance of $87 billion. One of those securities was SACO 2006-8.
For its part, JPMorgan said that Schneiderman’s
suit was based on “recycled claims already made by private plaintiffs.” To
be sure, one of the lawyers in Schneiderman’s office, Karla Sanchez, was one
of Ambac’s lawyers during her time at Patterson Belknap Webb & Tyler. But a
source told the Wall Street Journal at the time that Sanchez did not work on
the case.
JPMorgan settled the Schneiderman case as part of
its $13 billion deal with the Justice Department, with the state of New York
receiving $613 million of that amount.
“We’ve won a major victory today in the fight to
hold those who caused the financial crisis accountable,” Schneiderman said
at the time of the settlement.
Continued in article
Bob Jensen's threads on Subprime: Borne of Greed, Sleaze, Bribery, and
Lies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
"J.P. Morgan's Mortgage Troubles Ran Deep: Deals With Subprime
Lenders at Heart of $5.1 Billion Settlement," by Al Yoon, The Wall Street
Journal, October 27, 2013 ---
http://online.wsj.com/news/articles/SB10001424052702304470504579161532779973534?mod=djemCFO_h
A 1,625-square-foot bungalow at 51 Perthshire Lane
in Palm Coast, Fla., is among the thousands of homes at the heart of J.P.
Morgan Chase JPM +0.55% & Co.'s $5.1 billion settlement with a federal
housing regulator on Friday.
In 2006, J.P. Morgan bought one of two mortgage
loans on the home made by subprime lender New Century Financial Corp. J.P.
Morgan then bundled the loan with 4,208 others from New Century into a
mortgage-backed security it sold to investors including housing-finance
giant Freddie Mac. FMCC +11.89%
By the end of 2007, the borrower had stopped paying
back the loan, setting off yearslong delinquency and foreclosure proceedings
that halted income to the investors, according to BlackBox Logic LLC, a
mortgage-data company. Current Account
Settlement Puts U.S. in Tight Spot
The Palm Coast loan wasn't the only troubled one in
the New Century deal: Within a year, 15% of the borrowers were
delinquent—more than 60 days late on a payment, in some stage of foreclosure
or in bankruptcy—according to BlackBox. By 2010, that number exceeded 50%.
"That's much worse than anyone's expectations when
the deal was put together," said Cory Lambert, an analyst at BlackBox and
former mortgage-bond trader. "It's all pretty bad."
J.P. Morgan sidestepped many of the
subprime-mortgage problems that bedeviled rivals during the financial
crisis, and avoided much of the postcrisis scrutiny that dragged down others
on Wall Street. But now its own behavior during the housing boom is coming
under close examination as investigators work through a backlog of cases.
The bank dealt with some of the biggest subprime
lenders of the time, including Countrywide Financial Corp., Fremont
Investment & Loan and WMC Mortgage Corp., a former unit of General Electric,
according to the Federal Housing Finance Agency complaint.
J.P. Morgan's relationship with New Century, a
subprime lender that went bankrupt in 2007 and later faced a Securities and
Exchange Commission investigation and shareholder suits, shows that the New
York bank was part of the frenzied push to package mortgages for investors
at the end of the housing boom.
The New Century deal, J.P. Morgan Mortgage
Acquisition Trust 2006-NC1, was one of 103 cited in the lawsuit against J.P.
Morgan brought by the FHFA, which oversees Freddie Mac and home-loan giant
Fannie Mae. FNMA +13.40%
The $5.1 billion settlement is part of a larger
tentative deal with the Justice Department and other agencies that would
have J.P. Morgan pay a total of $13 billion. That deal is expected to be
completed this week.
"While these settlements seem huge, given the
nature of the offenses, they are trivially small," said William Frey, chief
executive of Greenwich Financial Services LLC, a broker-dealer that has
participated in investor lawsuits against banks that packaged mortgages.
J.P. Morgan declined to comment on the settlement or any loans in the bonds
it bought.
The FHFA has gotten aggressive in recouping losses
from mortgages and securities sold to Fannie and Freddie. In 2011 it sued 18
lenders, and J.P. Morgan was only the fourth to settle.
To be sure, the New Century deal was among J.P.
Morgan's worst performers, and other mortgage-backed securities it issued at
the time have held up better. An improving economy and housing market have
lifted many mortgage bonds sold in 2006 and 2007.
But that is of little consolation to Freddie Mac,
which bought more than a third of the $910 million New Century bond deal in
2006 and still is sitting on losses.
The group of loans backing Freddie's chunk of the
deal had more high-risk loans than the rest of the pool. Nearly 44% of
Freddie's piece had loan-to-value ratios between 80% and 100%, compared with
31% for the rest, according to the deal prospectus.
What's more, nearly half the loans backing the New
Century deal were from California and Florida, two states hit hard by the
housing bust. Of the 4,209 loans in the bond, more than half have some
experienced distress, according to BlackBox data.
Three debt-rating firms gave the top slice of the
deal AAA ratings. But as the housing market soured, a series of downgrades
starting in 2007 took them all into "junk" territory by July 2011. As of
last month, nearly a quarter of the principal of the underlying loans in the
deal had been wiped out, with a third of the remaining balance delinquent or
in some stage of foreclosure, according to BlackBox.
Continued in article
From the CFO Journal's Morning Ledger on October 28, 2013
J.P. Morgan settlement puts government in tight spot
Will the U.S. government have to refund
J.P. Morgan part
of the bank’s expected $13 billion payment over soured mortgage securities?
The question is the biggest stumbling block to completing the record
settlement between the bank and the Justice Department,
writes the WSJ’s Francesco Guerrera.
The crux of the issue is whether the government can go
after J.P. Morgan for (alleged) sins committed by others. And investors,
bankers and lawyers are watching the process closely, worried that it could
set a bad precedent for the relationship between buyers, regulators and
creditors in future deals for troubled banks.
"JPMorgan's $13 Billion Settlement: Jamie Dimon Is a Colossus No More,"
by Nick Summers, Bloomberg Businessweek, October 24, 2013 ---
http://www.businessweek.com/articles/2013-10-24/jpmorgans-13-billion-settlement-jamie-dimon-is-a-colossus-no-more
Thirteen billion dollars
requires some perspective. The record amount that
JPMorgan Chase (JPM)
has tentatively agreed to pay the
U.S. Department of Justice, to settle civil investigations into
mortgage-backed securities it sold in the runup to the 2008 financial
crisis, is equal to the gross domestic product of Namibia. It’s more
than the combined salaries of every athlete in every major U.S.
professional sport, with enough left over to buy every American a
stadium hotdog. More significantly to JPMorgan’s executives and
shareholders, $13 billion is equivalent to 61 percent of the bank’s
profits in all of 2012. Anticipating the settlement in early October,
the bank recorded its first quarterly loss under the leadership of Chief
Executive Officer Jamie Dimon.
That makes it real money, even for the
country’s biggest bank by assets. Despite this walloping, there’s reason
for the company to exhale. The most valuable thing Dimon, 57, gets out
of the deal with U.S. Attorney General Eric Holder is clarity. The
discussed agreement folds in settlements with a variety of federal and
state regulators, including the Federal Deposit Insurance Corp. and the
attorneys general of California and New York. JPMorgan negotiated a
similar tack in September, trading the gut punch of a huge headline
number—nearly $1 billion in penalties related to the 2012 London Whale
trading fiasco—for the chance to resolve four investigations in two
countries in one stroke. In both cases, the bank’s stock barely budged;
its shares have returned 25 percent this year, exactly in line with the
performance of Standard & Poor’s 500-stock index.
That JPMorgan is able to withstand
penalties and regulatory pressure that would cripple many of its
competitors attests both to the bank’s vast resources and the influence
of the man who leads it. The sight of Dimon arriving at the Justice
Department on Sept. 26 for a meeting with the attorney general
underscored Dimon’s extraordinary access to Washington
decision-makers—although the Wall Street chieftain did have to humble
himself by presenting his New York State driver license to a guard on
the street. As news of the settlement with Justice trickled out, the
admirers on Dimon’s gilded list rushed to his defense, arguing that he
struck the best deal he could. “If you’re a financial institution and
you’re threatened with criminal prosecution, you have no ability to
negotiate,”
Berkshire Hathaway (BRK/A)
Chairman Warren Buffett told
Bloomberg TV. “Basically, you’ve got to be like a wolf that bares its
throat, you know, when it gets to the end. You cannot win.”
The challenges facing Dimon and his
company are far from over. With the $13 billion payout, JPMorgan is
still the subject of a criminal probe into its mortgage-bond sales,
which could end in charges against the bank or its executives. And other
federal investigations—into suspected bribery in China, the bank’s role
in the Bernie Madoff Ponzi scheme, and more—are ongoing.
The ceaseless scrutiny has tarnished
Dimon’s public image, perhaps irreparably. Once seen as the white knight
of the financial crisis, he’s now the executive stuck paying the bill
for Wall Street’s misdeeds. And as the bank’s legal fights drag on, it’s
worth asking just how many more blows the famously pugnacious Dimon can
take.
Although the $13 billion settlement
would amount to the largest of its kind in the history of regulated
capitalism, it looks quite different broken into its component pieces.
While the relative amounts could shift, JPMorgan is expected to pay
fines of only $2 billion to $3 billion for misrepresenting the quality
of mortgage securities it sold during the subprime housing boom.
Overburdened homeowners would get $4 billion; another $4 billion would
go to the Federal Housing Finance Agency, which regulates
Freddie Mac (FMCC)
and
Fannie Mae (FNMA);
and about $3 billion would go to investors who lost money on the
securities, Bloomberg News reported.
JPMorgan will only pay fines (as
distinct from compensation to investors or homeowner relief) related to
its own actions—and not those of Bear Stearns or Washington Mutual, the
two troubled institutions the bank bought at discount-rack prices during
the crisis. Aside from shaving some unknown amount off the final
settlement, this proviso enhances Dimon’s reputation as the shrewdest
banker of that era. In 2008, with the backing of the U.S. Department of
the Treasury and the Federal Reserve, who saw JPMorgan as a port in a
storm, Dimon got the two properties for just $3.4 billion. Extending
JPMorgan’s retail reach overnight into Florida and California, Bear and
WaMu helped the bank become the largest in the U.S. by 2011. The
portions of the settlement attributable to their liabilities are almost
certainly outweighed by the profits they’ve brought and will continue to
bring.
There are two
superpowers in the world today in my opinion. There’s the United States and
there’s Moody’s Bond Rating Service. The United States can destroy you by
dropping bombs, and Moody’s can destroy you by down grading your bonds. And
believe me, it’s not clear sometimes who’s more powerful. The most that we can
safely assert about the evolutionary process underlying market equilibrium is
that harmful heuristics, like harmful mutations in nature, will die out.
Martin Miller, Debt and Taxes as quoted by Frank Partnoy, "The Siskel and Ebert
of Financial Matters: Two Thumbs Down for Credit Reporting Agencies,"
Washington University Law Quarterly, Volume 77, No. 3, 1999 ---
http://faculty.trinity.edu/rjensen/FraudCongressPartnoyWULawReview.htm
Credit rating agencies gave AAA ratings to
mortgage-backed securities that didn't deserve them. "These ratings not only
gave false comfort to investors, but also skewed the computer risk models and
regulatory capital computations," Cox said in written testimony.
SEC Chairman Christopher Cox
as quoted on October 23, 2008 at
http://www.nytimes.com/external/idg/2008/10/23/23idg-Greenspan-Bad.html
"CREDIT RATING AGENCIES: USELESS TO INVESTORS," by Anthony H. Catanch Jr. and
J. Edward Ketz, Grumpy Old Accountants Blog, June 6, 2011 ---
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/113
Credit Rating Firms ---
http://en.wikipedia.org/wiki/Credit_rating_firms
In 2008 it became evident that credit rating firms were giving AAA ratings to
bonds that they knew were worthless, especially CDO bonds of their big Wall
Street clients like Bear Stearns, Merrill Lynch, Lehman Bros., JP Morgan,
Goldman, etc. ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
"DOJ vs. Rating Firms," by David Hall, CFO.com Morning Ledger,
February 5, 2013
The government is taking its
get-tough-on-Wall-Street stance to the next level with the DOJ’s lawsuit
against Standard & Poor’s. The suit alleges that S&P from September 2004
through October 2007 “knowingly and with the intent to defraud, devised,
participated in, and executed a scheme to defraud investors in” CDOs and
securities backed by residential mortgages, the WSJ reports at the top of A1
today. The two sides have been discussing a possible settlement for months,
but the penalties the DOJ was targeting – more than $1 billion – made S&P
squeamish. The firm was also worried that if it admitted wrongdoing, as the
DOJ wanted, that could leave it vulnerable to other lawsuits.
S&P and other rating firms have argued in the past
that their opinions are protected by the First Amendment — and judges have
thrown out dozens of suits based on that argument, the Journal says. This
case will test that argument against the Justice Department’s view that the
First Amendment wouldn’t protect a ratings firm if it defrauded investors by
ignoring its own standards.
Neil Barofsky, the former inspector general for the
Troubled Asset Relief Program, said the DOJ move looks like an effort to get
“some measure of accountability” for the financial crisis, which was
“something that’s been really lacking across the board.” And Jeffrey Manns,
a law professor at George Washington University, tells Reuters that the suit
sends a message to “the rating industry at large that the government is
serious about holding rating agencies responsible, and that they must be
much more careful.”
http://online.wsj.com/public/page/cfo-journal.html
Jensen Comment
The DOJs actions do not worry the credit rating firms nearly so much as the
hundreds of billions of potential tort lawsuits awaiting in the wings, lawsuits
by damaged investors who relied on those phony credit ratings.
The credit rating firms, in turn, will blame CPA audit firms who gave clean
audit opinions on junk.
Where were the auditors?
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
May 31, 2011 message from Roger Collins
Of possible interest...
http://www.nytimes.com/2011/05/29/books/review/book-review-reckless-endangerment-by-gretchen-morgenson-and-joshua-rosner.html?ref=books
"It’s hardly news that the near meltdown of
America’s financial system enriched a few at the expense of the rest of us.
Who’s responsible? The recent report of the Financial Crisis Inquiry Commission
blamed all the usual suspects — Wall Street banks, financial regulators, the
mortgage giants Fannie Mae and Freddie Mac,
and subprime lenders — which is tantamount to blaming
no one. “Reckless Endangerment” concentrates on particular individuals who
played key roles.
The authors, Gretchen Morgenson, a Pulitzer
Prize-winning business reporter and columnist at The New York Times, and Joshua
Rosner, an expert on housing finance, deftly trace the beginnings of the
collapse to the mid-1990s, when the Clinton administration called for a
partnership between the private sector and Fannie and Freddie to encourage home
buying. The mortgage agencies’ government backing was, in effect, a valuable
subsidy, which was used by Fannie’s C.E.O.,
James A. Johnson, to increase home ownership while
enriching himself and other executives. A 1996 study by the Congressional Budget
Office found that Fannie pocketed about a third of the subsidy rather than
passing it on to homeowners. Over his nine years heading Fannie, Johnson
personally took home roughly $100 million. His successor, Franklin D. Raines,
was treated no less lavishly...."
continued in
article...
Roger
Bob Jensen's threads on earnings management fraud at Fanny Mae ---
http://faculty.trinity.edu/rjensen/Theory02.htm#Manipulation
Bob Jensen's threads on slease in thesubprime scandals ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Why must we worry about the hiring-away pipeline?
Credit Rating Agencies ----
http://en.wikipedia.org/wiki/Credit_rating_agency
A credit rating agency (CRA) is a
company that assigns
credit ratings for
issuers of certain types of
debt obligations as well as the debt instruments
themselves. In some cases, the servicers of the underlying
debt are also given ratings. In most cases, the
issuers of
securities are companies,
special purpose entities, state and local
governments,
non-profit organizations, or national governments
issuing debt-like securities (i.e.,
bonds) that can be traded on a
secondary market. A credit rating for an issuer
takes into consideration the issuer's
credit worthiness (i.e., its ability to pay back a
loan), and affects the
interest rate applied to the particular security
being issued. (In contrast to CRAs, a company that issues
credit scores for individual credit-worthiness is
generally called a
credit bureau or
consumer credit reporting agency.) The value of
such ratings has been widely questioned after the 2008 financial crisis. In
2003 the
Securities and Exchange Commission submitted a
report to Congress detailing plans to launch an investigation into the
anti-competitive practices of credit rating agencies and issues including
conflicts of interest.
Agencies that assign credit ratings for
corporations include:
How to Get AAA Ratings on Junk Bonds
- Pay cash under the table to credit rating agencies
- Promise a particular credit rating agency future multi-million
contracts for rating future issues of bonds
- Hire away top-level credit rating agency
employees with insider information and great networks inside the credit
rating agencies
By now it is widely known that the big credit rating agencies (like Moody's,
Standard & Poor's, and Fitch) that rate bonds as AAA to BBB to Junk were
unethically selling AAA ratings to CDO mortgage-sliced bonds that should've been
rated Junk. Up to now I thought the credit rating agencies were merely selling
out for cash or to maintain "goodwill" with their best customers to giant Wall
Street banks and investment banks like Lehman Bros., AIG., Merrill Lynch, Bear
Stearns, Goldman Sachs, etc. ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
But it turns out that the credit rating agencies were also in that "hiring-away"
pipeline.
Wall
Street banks and nvestment banks were employing a questionable tactic used by
large clients of auditing firms. It is common for large clients to hire away the
lead auditors of their CPA auditing firms. This is a questionable practice,
although the intent in most instances (we hope) is to obtain accounting experts
rather than to influence the rigor of the audits themselves. The tactic is much
more common and much more sinister when corporations hire away top-level
government employees of regulating agencies like the FDA, FAA, FPC, EPA, etc.
This is a tactic used by industry to gain more control and influence over its
regulating agency. Current regulating government employees
who get too tough on industry will, thereby, be cutting off their chances of
getting future high compensation offers from the companies they now regulate.
The
investigations of credit rating agencies by the New York Attorney General and
current Senate hearings, however, are revealing that the hiring-away tactic was
employed by Wall Street Banks for more sinister purposes in order to get AAA
ratings on junk bonds. Top-level employees of the credit rating agencies were
lured away with enormous salary offers if they could use their insider networks
in the credit rating agencies so that higher credit ratings could be stamped on
junk bonds.
"Rating Agency Data Aided Wall Street in
Deals," The New York Times, April 24, 2010 ---
http://dealbook.blogs.nytimes.com/2010/04/24/rating-agency-data-aided-wall-street-in-deals/#more-214847
One of the mysteries of the financial crisis is how
mortgage investments that turned out to be so bad earned credit ratings that
made them look so good, The New York Times’s Gretchen Morgenson and Louise
Story
report. One answer is that Wall Street was given
access to the formulas behind those magic ratings —
and hired away some of the very people who had devised
them.
In essence, banks started with the answers and
worked backward, reverse-engineering top-flight ratings for investments that
were, in some cases, riskier than ratings suggested, according to former
agency employees.
Read More »
"Credit rating agencies
should not be dupes," Reuters, May 13, 2010 ---
http://www.reuters.com/article/idUSTRE64C4W320100513
THE PROFIT INCENTIVE
In fact, rating agencies sometimes discouraged
analysts from asking too many questions, critics have said.
In testimony last month before a Senate
subcommittee, Eric Kolchinsky, a former Moody's ratings analyst, claimed
that he was fired by the rating agency for being too harsh on a series of
deals and costing the company market share.
Rating agencies spent too much time looking for
profit and market share, instead of monitoring credit quality, said David
Reiss, a professor at Brooklyn Law School who has done extensive work on
subprime mortgage lending.
"It was incestuous -- banks and rating agencies had
a mutual profit motive, and if the agency didn't go along with a bank, it
would be punished."
The Senate amendment passed on Thursday aims to
prevent that dynamic in the future, by having a government clearinghouse
that assigns issuers to rating agencies instead of allowing issuers to
choose which agencies to work with.
For investigators to portray rating agencies as
victims is "far fetched," and what needs to be fixed runs deeper than banks
fooling ratings analysts, said Daniel Alpert, a banker at Westwood Capital.
"It's a structural problem," Alpert said.
Continued in article
Also see
http://blogs.reuters.com/reuters-dealzone/
Jensen Comment
CPA auditing firms have much to worry about these investigations and pending new
regulations of credit rating agencies.
Firstly, auditing firms are at the higher end
of the tort lawyer food chain. If credit rating agencies lose class action
lawsuits by investors, the credit rating agencies themselves will sue the bank
auditors who certified highly misleading financial statements that greatly
underestimated load losses. In fact, top level analysts are now claiming that
certified Wall Street Bank financial statement were pure fiction:
"Calpers
Sues Over Ratings of Securities," by Leslie Wayne, The New York Times,
July 14, 2009 ---
http://www.nytimes.com/2009/07/15/business/15calpers.html
Secondly, the CPA profession must begin to question the ethics of allowing
lead CPA auditors to become high-level executives of clients such as when a lead
Ernst & Young audit partner jumped ship to become the CFO of Lehman Bros. and as
CFO devised the questionable Repo 105 contracts that were then audited/reviewed
by Ernst & Yound auditors. Above you read that: "In
fact, rating agencies sometimes discouraged analysts from asking too many
questions, critics have said." We must also
worry that former auditors sometimes discourage current auditors from asking too
many questions.
http://retheauditors.com/2010/03/15/liberte-egalite-fraternite-lehman-brothers-troubles-for-ernst-young-threaten-the-big-4-fraternity/
Credit rating of CDO mortgage-sliced bonds
turned into fiction writing by hired away raters!
Frank Partnoy and Lynn Turner contend that Wall Street bank accounting is an
exercise in writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 ---
http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
At the height of the mortgage boom, companies like
Goldman offered million-dollar pay packages to
(credit agency) workers like Mr. Yukawa
who had been working at much lower pay at the rating agencies, according to
several former workers at the agencies.
In some cases, once these (former credit
agency) workers were at the banks, they had dealings
with their former colleagues at the agencies. In the fall of 2007, when banks
were hard-pressed to get mortgage deals done, the Fitch analyst on a Goldman
deal was a friend of Mr. Yukawa, according to two people with knowledge of the
situation.
"Prosecutors Ask if 8 Banks Duped Rating Agencies," by Loise Story,
The New York Times, May 12, 2010 ---
http://www.nytimes.com/2010/05/13/business/13street.html
The New York attorney general has started an
investigation of eight banks to determine whether they provided misleading
information to rating agencies in order to inflate the grades of certain
mortgage securities, according to two people with knowledge of the
investigation.
The investigation parallels federal inquiries into
the business practices of a broad range of financial companies in the years
before the collapse of the housing market.
Where those investigations have focused on
interactions between the banks and their clients who bought mortgage
securities, this one expands the scope of scrutiny to the interplay between
banks and the agencies that rate their securities.
The agencies themselves have been widely criticized
for overstating the quality of many mortgage securities that ended up losing
money once the housing market collapsed. The inquiry by the attorney general
of New York,
Andrew M. Cuomo,
suggests that he thinks the agencies may have been duped by one or more of
the targets of his investigation.
Those targets are
Goldman Sachs,
Morgan Stanley,
UBS,
Citigroup, Credit Suisse,
Deutsche Bank, Crédit Agricole and
Merrill Lynch, which is now owned by
Bank of America.
The companies that rated the mortgage deals are
Standard & Poor’s,
Fitch Ratings and
Moody’s Investors Service. Investors used their
ratings to decide whether to buy mortgage securities.
Mr. Cuomo’s investigation
follows an article in The New York Times that
described some of the techniques bankers used to get more positive
evaluations from the rating agencies.
Mr. Cuomo is also interested in the revolving door
of employees of the rating agencies who were hired by bank mortgage desks to
help create mortgage deals that got better ratings than they deserved, said
the people with knowledge of the investigation, who were not authorized to
discuss it publicly.
Contacted after subpoenas were issued by Mr.
Cuomo’s office notifying the banks of his investigation, representatives for
Morgan Stanley, Credit Suisse, UBS and Deutsche Bank declined to comment.
Other banks did not immediately respond to requests for comment.
In response to questions for the Times article in
April, a Goldman Sachs spokesman, Samuel Robinson, said: “Any suggestion
that Goldman Sachs improperly influenced rating agencies is without
foundation. We relied on the independence of the ratings agencies’ processes
and the ratings they assigned.”
Goldman, which is already under investigation by
federal prosecutors, has been defending itself against civil fraud
accusations made in a complaint last month by the
Securities and Exchange Commission. The deal at
the heart of that complaint — called Abacus 2007-AC1 — was devised in part
by a former Fitch Ratings employee named Shin Yukawa, whom Goldman recruited
in 2005.
At the height of the mortgage boom, companies like
Goldman offered million-dollar pay packages to workers like Mr. Yukawa who
had been working at much lower pay at the rating agencies, according to
several former workers at the agencies.
Around the same time that Mr. Yukawa left Fitch,
three other analysts in his unit also joined financial companies like
Deutsche Bank.
In some cases, once these workers were at the
banks, they had dealings with their former colleagues at the agencies. In
the fall of 2007, when banks were hard-pressed to get mortgage deals done,
the Fitch analyst on a Goldman deal was a friend of Mr. Yukawa, according to
two people with knowledge of the situation.
Mr. Yukawa did not respond to requests for comment.
A Fitch spokesman said Thursday that the firm would cooperate with Mr.
Cuomo’s inquiry.
Wall Street played a crucial role in the mortgage
market’s path to collapse. Investment banks bundled mortgage loans into
securities and then often rebundled those securities one or two more times.
Those securities were given high ratings and sold to investors, who have
since lost billions of dollars on them.
. . .
At Goldman, there was even a phrase for the way
bankers put together mortgage securities. The practice was known as “ratings
arbitrage,” according to former workers. The idea was to find ways to put
the very worst bonds into a deal for a given rating. The cheaper the bonds,
the greater the profit to the bank.
The rating agencies may have facilitated the banks’
actions by publishing their rating models on their corporate Web sites. The
agencies argued that being open about their models offered transparency to
investors.
But several former agency workers said the practice
put too much power in the bankers’ hands. “The models were posted for
bankers who develop C.D.O.’s to be able to reverse engineer C.D.O.’s to a
certain rating,” one former rating agency employee said in an interview,
referring to
collateralized debt obligations.
A central concern of investors in these securities
was the diversification of the deals’ loans. If a C.D.O. was based on mostly
similar bonds — like those holding mortgages from one region — investors
would view it as riskier than an instrument made up of more diversified
assets. Mr. Cuomo’s office plans to investigate whether the bankers
accurately portrayed the diversification of the mortgage loans to the rating
agencies.
Bob Jensen's Rotten to the Core threads on banks and investment banks ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Bob Jensen's Rotten to the Core threads on credit rating agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
Marvene is a poor and unemployed elderly woman who lost her shack to
foreclosure in 2008.
That's after Marvene stole over $100,000 when she refinanced her shack with a
subprime mortgage in 2007.
Marvene wants to steal some more or at least get her shack back for free.
Both the Executive and Congressional branches of the U.S. Government want to
give more to poor Marvene.
Why don't I feel the least bit sorry for poor Marvene?
Somehow I don't think she was the victim of unscrupulous mortgage brokers and
property value appraisers.
More than likely she was a co-conspirator in need of $75,000 just to pay
creditors bearing down in 2007.
She purchased the shack for $3,500 about 40 years ago ---
http://online.wsj.com/article/SB123093614987850083.html
Marvene Halterman, an unemployed Arizona woman with a
long history of creditors, took out a $103,000 mortgage on her 576
square-foot-house in 2007. Within a year she stopped making payments. Now the
investors with an interest in the house will likely recoup only $15,000.
The Wall Street Journal slide show
of indoor and outdoor pictures ---
http://online.wsj.com/article/SB123093614987850083.html#articleTabs%3Dslideshow
Jensen Comment
The $15,000 is mostly the value of the lot since at the time the mortgage was
granted the shack was virtually worthless even though corrupt mortgage brokers
and appraisers put a fraudulent value on the shack. Bob Jensen's threads on
these subprime mortgage frauds are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Probably the most common type of fraud in the Savings and Loan debacle of the
1980s was real estate investment fraud. The same can be said of the 21st Century
subprime mortgage fraud. Welcome to fair value accounting that will soon have us
relying upon real estate appraisers to revalue business real estate on business
balance sheets ---
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
The Rest of Marvene's Story ---
http://faculty.trinity.edu/rjensen/FraudMarvene.htm
Accounting Implications
CEO to his accountant: "What is our net earnings
this year?"
Accountant to CEO: "What net earnings figure do you want to report?"
The sad thing is that Lehman, AIG, CitiBank, Bear
Stearns, the Country Wide subsidiary of Bank America, Fannie Mae, Freddie
Mac, etc. bought these
subprime mortgages at face value and their Big 4 auditors supposedly
remained unaware of the millions upon millions of valuation frauds in the
investments. Does professionalism in auditing have a stronger stench since
Enron?
Where were the big-time auditors? ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"Silencing the Whistleblowers: Financial reform won’t prevent
another bubble if banks bulldoze their internal warning systems," by Michael
W. Hudson, The Big Money (Slate), May 9, 2010 ---
http://www.thebigmoney.com/articles/judgments/2010/05/07/silencing-whistleblowers
In early 2006, Darcy Parmer began to worry about
her job. She was a mortgage fraud investigator at Wells Fargo Bank. Her
managers weren’t happy with her. It wasn’t that she wasn’t doing a good job
of sniffing out questionable loans in the bank’s massive home-loan program.
The problem, she said, was that she was doing too good a job.
The bank’s executives and mortgage salesmen didn’t
like it, Parmer later claimed in a lawsuit, when she tried to block loans
that she suspected were underpinned by paperwork that exaggerated borrowers’
incomes and inflated their home values. One manager, she said, accused her
of launching “witch hunts” against the bank’s loan officers.
One of the skirmishes involved a borrower she later
referred to in court papers as “Ms. A.” An IRS document showed Ms. A earned
$5,030 a month. But Wells Fargo’s sales staff had won approval for Ms. A’s
loan by claiming she made more than twice that—$11,830 a month. When Parmer
questioned the deal, she said, a supervisor ordered her to close the
investigation, complaining, “This is what you do every time.”
Amid the frenzy of the nation’s mortgage boom, the
back-of-the-hand treatment that Parmer describes wasn’t out of the ordinary.
Parmer was one of a small band of in-house gumshoes at various financial
institutions who uncovered evidence of corruption in the mortgage
business—including made-up addresses, pyramid schemes, and organized
criminal rings—and tried to warn their employers that this wave of fraud
threatened consumers as well as the stability of the financial system.
Instead of heeding their warnings, they say, company officials ignored them,
harassed them, demoted them, or fired them.
In interviews and in court records, 10 former fraud
investigators at seven of the nation’s biggest banks and lenders—including
Wells Fargo (WFC), IndyMac Bank, and Countrywide Financial—describe
corporate cultures that allowed fraud to thrive in the pursuit of loan
volume and market share. Mortgage salesmen stuck homeowners into loans they
couldn’t afford by exaggerating borrowers’ assets and, in some cases,
forging their signatures on disclosure documents. In other instances, banks
opened their vaults to professional fraudsters who arranged millions of
dollars in loans using “straw buyers,” bogus identities, or, in a few
instances, dead people’s names and Social Security numbers.
Corporate managers looked the other way as these
practices flourished, the investigators say, because they didn’t want to
crimp loan sales. The investigators discovered that they’d been hired not so
much to find fraud but rather to provide window dressing—the illusion that
lenders were vetting borrowers before they booked loans and sold them to
Wall Street investors. “You’re like a dog on a leash. You’re allowed to go
as far as a company allows you to go,” recalled Kelly Dragna, who worked as
a fraud investigator at Ameriquest Mortgage Co., the largest subprime lender
during the home-loan boom. “At Ameriquest, we were on pretty short leash. We
were there for show. We were there to show people that they had a lot of
investigators on staff.”
Continued in article
Bob Jensen's threads on the subprime sleaze ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on how whistle blowing is not rewarded ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing
Oil and Water Must Read: Economists versus Criminologists
:"Why the ‘Experts’ Failed to See How Financial Fraud Collapsed the Economy,"
by "James K. Galbraith, Big Picture, June 2, 2010 ---
http://www.ritholtz.com/blog/2010/06/james-k-galbraith-why-the-experts-failed-to-see-how-financial-fraud-collapsed-the-economy/
The following is the text of a James K. Galbraith’s written statement
to members of the Senate Judiciary Committee delivered this May. Original
PDF text is here.
Chairman Specter, Ranking Member Graham, Members of
the Subcommittee, as a former member of the congressional staff it is a
pleasure to submit this statement for your record.
I write to you from a disgraced profession.
Economic theory, as widely taught since the 1980s, failed miserably to
understand the forces behind the financial crisis. Concepts including
“rational expectations,” “market discipline,” and the “efficient markets
hypothesis” led economists to argue that speculation would stabilize prices,
that sellers would act to protect their reputations, that caveat emptor
could be relied on, and that widespread fraud therefore could not occur. Not
all economists believed this – but most did.
Thus the study of financial fraud received little
attention. Practically no research institutes exist; collaboration between
economists and criminologists is rare; in the leading departments there are
few specialists and very few students. Economists have soft- pedaled the
role of fraud in every crisis they examined, including the Savings & Loan
debacle, the Russian transition, the Asian meltdown and the dot.com bubble.
They continue to do so now. At a conference sponsored by the Levy Economics
Institute in New York on April 17, the closest a former Under Secretary of
the Treasury, Peter Fisher, got to this question was to use the word
“naughtiness.” This was on the day that the SEC charged Goldman Sachs with
fraud.
There are exceptions. A famous 1993 article
entitled “Looting: Bankruptcy for Profit,” by George Akerlof and Paul Romer,
drew exceptionally on the experience of regulators who understood fraud. The
criminologist-economist William K. Black of the University of
Missouri-Kansas City is our leading systematic analyst of the relationship
between financial crime and financial crisis. Black points out that
accounting fraud is a sure thing when you can control the institution
engaging in it: “the best way to rob a bank is to own one.” The experience
of the Savings and Loan crisis was of businesses taken over for the explicit
purpose of stripping them, of bleeding them dry. This was established in
court: there were over one thousand felony convictions in the wake of that
debacle. Other useful chronicles of modern financial fraud include James
Stewart’s Den of Thieves on the Boesky-Milken era and Kurt Eichenwald’s
Conspiracy of Fools, on the Enron scandal. Yet a large gap between this
history and formal analysis remains.
Formal analysis tells us that control frauds follow
certain patterns. They grow rapidly, reporting high profitability, certified
by top accounting firms. They pay exceedingly well. At the same time, they
radically lower standards, building new businesses in markets previously
considered too risky for honest business. In the financial sector, this
takes the form of relaxed – no, gutted – underwriting, combined with the
capacity to pass the bad penny to the greater fool. In California in the
1980s, Charles Keating realized that an S&L charter was a “license to
steal.” In the 2000s, sub-prime mortgage origination was much the same
thing. Given a license to steal, thieves get busy. And because their
performance seems so good, they quickly come to dominate their markets; the
bad players driving out the good.
The complexity of the mortgage finance sector
before the crisis highlights another characteristic marker of fraud. In the
system that developed, the original mortgage documents lay buried – where
they remain – in the records of the loan originators, many of them since
defunct or taken over. Those records, if examined, would reveal the extent
of missing documentation, of abusive practices, and of fraud. So far, we
have only very limited evidence on this, notably a 2007 Fitch Ratings study
of a very small sample of highly-rated RMBS, which found “fraud, abuse or
missing documentation in virtually every file.” An efforts a year ago by
Representative Doggett to persuade Secretary Geithner to examine and report
thoroughly on the extent of fraud in the underlying mortgage records
received an epic run-around.
When sub-prime mortgages were bundled and
securitized, the ratings agencies failed to examine the underlying loan
quality. Instead they substituted statistical models, in order to generate
ratings that would make the resulting RMBS acceptable to investors. When one
assumes that prices will always rise, it follows that a loan secured by the
asset can always be refinanced; therefore the actual condition of the
borrower does not matter. That projection is, of course, only as good as the
underlying assumption, but in this perversely-designed marketplace those who
paid for ratings had no reason to care about the quality of assumptions.
Meanwhile, mortgage originators now had a formula for extending loans to the
worst borrowers they could find, secure that in this reverse Lake Wobegon no
child would be deemed below average even though they all were. Credit
quality collapsed because the system was designed for it to collapse.
A third element in the toxic brew was a simulacrum
of “insurance,” provided by the market in credit default swaps. These are
doomsday instruments in a precise sense: they generate cash-flow for the
issuer until the credit event occurs. If the event is large enough, the
issuer then fails, at which point the government faces blackmail: it must
either step in or the system will collapse. CDS spread the consequences of a
housing-price downturn through the entire financial sector, across the
globe. They also provided the means to short the market in residential
mortgage-backed securities, so that the largest players could turn tail and
bet against the instruments they had previously been selling, just before
the house of cards crashed.
Latter-day financial economics is blind to all of
this. It necessarily treats stocks, bonds, options, derivatives and so forth
as securities whose properties can be accepted largely at face value, and
quantified in terms of return and risk. That quantification permits the
calculation of price, using standard formulae. But everything in the
formulae depends on the instruments being as they are represented to be. For
if they are not, then what formula could possibly apply?
An older strand of institutional economics
understood that a security is a contract in law. It can only be as good as
the legal system that stands behind it. Some fraud is inevitable, but in a
functioning system it must be rare. It must be considered – and rightly – a
minor problem. If fraud – or even the perception of fraud – comes to
dominate the system, then there is no foundation for a market in the
securities. They become trash. And more deeply, so do the institutions
responsible for creating, rating and selling them. Including, so long as it
fails to respond with appropriate force, the legal system itself.
Control frauds always fail in the end. But the
failure of the firm does not mean the fraud fails: the perpetrators often
walk away rich. At some point, this requires subverting, suborning or
defeating the law. This is where crime and politics intersect. At its heart,
therefore, the financial crisis was a breakdown in the rule of law in
America.
Ask yourselves: is it possible for mortgage
originators, ratings agencies, underwriters, insurers and supervising
agencies NOT to have known that the system of housing finance had become
infested with fraud? Every statistical indicator of fraudulent practice –
growth and profitability – suggests otherwise. Every examination of the
record so far suggests otherwise. The very language in use: “liars’ loans,”
“ninja loans,” “neutron loans,” and “toxic waste,” tells you that people
knew. I have also heard the expression, “IBG,YBG;” the meaning of that bit
of code was: “I’ll be gone, you’ll be gone.”
If doubt remains, investigation into the internal
communications of the firms and agencies in question can clear it up. Emails
are revealing. The government already possesses critical documentary trails
— those of AIG, Fannie Mae and Freddie Mac, the Treasury Department and the
Federal Reserve. Those documents should be investigated, in full, by
competent authority and also released, as appropriate, to the public. For
instance, did AIG knowingly issue CDS against instruments that Goldman had
designed on behalf of Mr. John Paulson to fail? If so, why? Or again: Did
Fannie Mae and Freddie Mac appreciate the poor quality of the RMBS they were
acquiring? Did they do so under pressure from Mr. Henry Paulson? If so, did
Secretary Paulson know? And if he did, why did he act as he did? In a recent
paper, Thomas Ferguson and Robert Johnson argue that the “Paulson Put” was
intended to delay an inevitable crisis past the election. Does the internal
record support this view?
Let us suppose that the investigation that you are
about to begin confirms the existence of pervasive fraud, involving millions
of mortgages, thousands of appraisers, underwriters, analysts, and the
executives of the companies in which they worked, as well as public
officials who assisted by turning a Nelson’s Eye. What is the appropriate
response?
Some appear to believe that “confidence in the
banks” can be rebuilt by a new round of good economic news, by rising stock
prices, by the reassurances of high officials – and by not looking too
closely at the underlying evidence of fraud, abuse, deception and deceit. As
you pursue your investigations, you will undermine, and I believe you may
destroy, that illusion.
But you have to act. The true alternative is a
failure extending over time from the economic to the political system. Just
as too few predicted the financial crisis, it may be that too few are today
speaking frankly about where a failure to deal with the aftermath may lead.
In this situation, let me suggest, the country
faces an existential threat. Either the legal system must do its work. Or
the market system cannot be restored. There must be a thorough, transparent,
effective, radical cleaning of the financial sector and also of those public
officials who failed the public trust. The financiers must be made to feel,
in their bones, the power of the law. And the public, which lives by the
law, must see very clearly and unambiguously that this is the case.
Thank you.
~~~
James K. Galbraith is the author of
The Predator State: How Conservatives Abandoned the Free Market and Why
Liberals Should Too, and of a new preface to The Great Crash, 1929, by
John Kenneth Galbraith. He teaches at The University of Texas at Austin
June 9, 2010 reply from Thompson, Shari
[shari.thompson@PVPL.COM]
Bob, that is an awesome article! I can only hope
that the system listens!
Bob Jensen's threads on the subprime sleaze is at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
"Ratings agencies Crisis in ratings land? The greater-fool defence takes a
blow," The Economist, November 10, 2012 ---
http://www.economist.com/news/finance-and-economics/21565983-greater-fool-defence-takes-blow-crisis-ratings-land
PROTESTING that only fools would rely on your
product to make investment decisions may seem a dangerous argument to make.
Yet it is one that has served credit-ratings agencies well over the years,
allowing them to sell ratings to debt issuers while abjuring legal
responsibility for the quality of their work. A ruling by an Australian
court this week, however, has raised questions for the industry about its
immunity from prosecution.
The ruling in the Federal Court of Australia on
November 5th held Standard & Poor’s (S&P) jointly liable with ABN AMRO, a
bank, for the losses suffered by local councils that had invested in credit
derivatives that were designed to pay a high rate of interest yet were also
meant to be very safe. The derivatives in question were “constant proportion
debt obligations” (CPDOs). These instruments make even the most ardent fans
of complex financial engineering blush: they are designed to add leverage
when they take losses in order to make up the shortfall. S&P’s models, which
the court said blindly adopted inputs provided by ABN AMRO, gave the notes a
AAA rating, judging they had about as much chance of going bust as the
American government. In this section
Asia’s great moderation Desperately seeking yield
The OECD's forecasts Charged atmosphere Where others fear to tread »Crisis
in ratings land? Keep digging The X factor Old-fashioned but in favour
Strength in numbers
S&P denies that its ratings were inappropriate, and
plans to appeal. But evidence before the court suggests a world of harried
analysts being outsmarted by spivvy bankers. It also indicated a disturbing
lack of curiosity by S&P analysts and a desire to cover up for the firm’s
failings even when they fretted about a “crisis in CPDO land” and worried
that some buyers of these products were “in no hurry to stay in front of the
truck”. Instead of warning investors that it had made mistakes, the court
found that the firm continued to provide glowing opinions on new CPDOs
coming out of the ABN AMRO factory.
There is nothing in the ruling to suggest the
shoddy behaviour that took place in this instance was widespread across the
firm. It would be a mistake to attribute all ratings that subsequently turn
out to be wrong to negligence. Making predictions is hard, as Yogi Berra, a
famously quotable baseball player, noted, especially when they are about the
future.
But the Australian case does challenge a central
part of the defence proffered by S&P and other ratings agencies (Moody’s and
Fitch are the other two big ones) in some 40 ongoing cases worldwide
alleging negligence. They argue that ratings are merely opinions and
protected by constitutional safeguards on free speech, and that only
imprudent investors would take decisions solely based on them.
This defence has already worked in a number of
high-profile cases in America. Investment analysts and lawyers reckon that
there is no sign that courts elsewhere are likely to follow the Australian
ruling; it may not even survive the appeal. But the reasoning in the
Australian case is persuasive. The judge argued that agencies could not wash
their hands of all responsibility if investors took their ratings at face
value and then lost money. “The issuer of the product is willing to pay for
the rating not because it may be used by participants and others interested
in financial markets for a whole range of purposes but because the rating
will be highly material to the decision of potential investors to invest or
not,” the judge wrote.
The tendency of investors to rely on ratings is
reinforced by the privileged access that agencies have to information about
issuers. The agencies’ defence that theirs is just an opinion wears thin
when, having looked under the hood and kicked the tyres, they then tell
investors to make up their own mind from a distance. It would help if
regulators forced issuers of bonds and other rated securities to provide
more public information. That would allow investors to do more of their own
due diligence and enable more competition between agencies to provide the
best analysis to investors rather than the best service to issuers.
Collateralized Debt Obligation ---
http://en.wikipedia.org/wiki/Collateralized_debt_obligation
"CDOs Are Back: Will They Lead to Another Financial Crisis?"
Knowledge@wharton, April 10, 2013 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=3230
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Wall Street’s Math Wizards Forgot a Few Variables
What wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/
Bob Jensen's threads on CDOs ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"The Mortgage Crisis: Some Inside Views Emails show that risk managers at
Freddie Mac warned about lower underwriting standards—in vain, and with lessons
for today," by Charles W. Calomiris, The Wall Street Journal, October
28, 2011 ---
http://online.wsj.com/article/SB10001424053111903927204576574433454435452.html?mod=djemEditorialPage_t
Occupy Wall Street is denouncing banks and Wall
Street for "selling toxic mortgages" while "screwing investors and
homeowners." And the federal government recently announced it will be suing
mortgage originators whose low-quality underwriting standards produced
ballooning losses for Fannie Mae and Freddie Mac.
Have they fingered the right culprits?
There is no doubt that reductions in
mortgage-underwriting standards were at the heart of the subprime crisis,
and Fannie and Freddie's losses reflect those declining standards. Yet the
decline in underwriting standards was largely a response to mandates,
beginning in the Clinton administration, that required Fannie Mae and
Freddie Mac to steadily increase their mortgages or mortgage-backed
securities that targeted low-income or minority borrowers and "underserved"
locations.
The turning point was the spring and summer of
2004. Fannie and Freddie had kept their exposures low to loans made with
little or no documentation (no-doc and low-doc loans), owing to their
internal risk-management guidelines that limited such lending. In early
2004, however, senior management realized that the only way to meet the
political mandates was to massively cut underwriting standards.
The risk managers complained, especially at Freddie
Mac, as their emails to senior management show. They refused to endorse the
move to no-docs and battled unsuccessfully against the reduced underwriting
standards from April to September 2004. Here are some highlights:
On April 1, 2004, Freddie Mac risk manager David
Andrukonis wrote to Tracy Mooney, a vice president, that "while you, Don [Bisenius,
a senior vice president] and I will make the case for sound credit, it's not
the theme coming from the top of the company and inevitably people down the
line play follow the leader."
Risk managers had already experimented with lower
lending standards and knew the dangers. In another email that day, Mr.
Bisenius wrote to Michael May (another senior vice president), "we did
no-doc lending before, took inordinate losses and generated significant
fraud cases. I'm not sure what makes us think we're so much smarter this
time around."
On April 5, Mr. Andrukonis wrote to Chief Operating
Officer Paul Peterson, "In 1990 we called this product 'dangerous' and
eliminated it from the marketplace." He also argued that housing prices were
already high and unlikely to rise further: "We are less likely to get the
house price appreciation we've had in the past 10 years to bail this program
out if there's a hole in it."
Donna Cogswell, a colleague of Mr. Andrukonis,
warned that Fannie and Freddie's decisions to debase underwriting standards
would have widespread ramifications for the mortgage market. In a Sept. 7
email to Freddie Mac CEO Dick Syron and others, she specifically described
the ramifications of Freddie Mac's continuing participation in the market as
effectively "mak[ing] a market" in no-doc mortgages.
Ms. Cogswell's Sept. 4 email to Mr. Syron and
others also anticipated the potential human costs of the mortgage crisis.
She tried to sway management by appealing to their decency: "[W]hat better
way to highlight our sense of mission than to walk away from profitable
business because it hurts the borrowers we are trying to serve?"
Politics—not shortsightedness or incompetent risk
managers—drove Freddie Mac to eliminate its previous limits on no-doc
lending. Commenting on what others referred to as the "push to do more
affordable [lending] business," Senior Vice President Robert Tsien wrote to
Dick Syron on July 14, 2004: "Tipping the scale in favor of no cap [on
no-doc lending] at this time was the pragmatic consideration that, under the
current circumstances, a cap would be interpreted by external critics as
additional proof we are not really committed to affordable lending."
Sensing that his warnings were being ignored, Mr.
Andrukonis wrote to Michael May on Sept. 8: "At last week's risk management
meeting I mentioned that I had reached my own conclusion on this product
from a reputation risk perspective. I said that I thought you and or Bob
Tsien had the responsibility to bring the business recommendation to Dick [Syron],
who was going to make the decision. . . . What I want Dick to know is that
he can approve of us doing these loans, but it will be against my
recommendation."
The decision by Fannie and Freddie to embrace
no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for
example, total subprime and Alt-A mortgage originations were $395 billion.
In 2004, they rose to $715 billion. By 2006, they were more than $1
trillion.
In a painstaking forensic analysis of the sources
of increased mortgage risk during the 2000s, "The Failure of Models that
Predict Failure," Uday Rajan of the University of Michigan, Amit Seru of the
University of Chicago and Vikrant Vig of London Business School show that
more than half of the mortgage losses that occurred in excess of the rosy
forecasts of expected loss at the time of mortgage origination reflected the
predictable consequences of low-doc and no-doc lending. In other words, if
the mortgage-underwriting standards at Fannie and Freddie circa 2003 had
remained in place, nothing like the magnitude of the subprime crisis would
have occurred.
Taxpayer losses at Fannie and Freddie alone may
exceed $300 billion. The costs of the financial collapse and recession
brought on by the mortgage bust are immeasurably higher. Unfortunately, the
Obama administration has perpetuated the low underwriting standards that
gave us the crisis and encouraged the postponement of foreclosures by
lending support to various states' efforts to sue originators for robo-signing
violations.
Continued in article
"Countrywide (now part of Bank of America) Pays $108 Million to Settle
Fees Complaint." by Edward Wyatt, The New York Times, June 7, 2010 ---
http://www.nytimes.com/2010/06/08/business/08ftc.html?hp
The Federal Trade Commission announced Monday that
two Countrywide mortgage servicing companies had agreed to pay $108 million
to settle charges that they collected excessive fees from financially
troubled homeowners.
The $108 million payment is one of the largest
overall judgments in the commission’s history and resolves its largest
mortgage servicing case. The money will go to more than 200,000 homeowners
whose loans were serviced by Countrywide before July 2008, when it was
acquired by Bank of America.
Jon Leibowitz, the chairman of the Federal Trade
Commission, said that Countrywide’s loan servicing operation charged
excessive fees to homeowners who were behind on their mortgage payments, in
some cases asserting that customers were in default when they were not.
The fees, which were billed as the cost of services
like property inspections and lawn mowing, were grossly inflated after
Countrywide created subsidiaries to hire vendors to supply the services,
increasing the cost several-fold in the process, the commission said.
In addition, the commission said that Countrywide
at times imposed a new round of fees on homeowners who had recently emerged
from bankruptcy protection, sometimes threatening the consumers with a new
foreclosure.
“Countrywide profited from making risky loans to
homeowners during the boom years, and then profited again when the loans
failed,” Mr. Leibowitz said.
The $108 million settlement represents the agency’s
estimate of consumer losses, but does not include a penalty, which the
commission is not allowed to impose.
Clifford J. White III, the director of the
executive office for the United States Trustees Program, which enforces
bankruptcy laws for the Department of Justice, said that the commission’s
settlement “will help prevent future harm to homeowners in dire financial
straits who legitimately seek bankruptcy protection.”
The settlement bars Countrywide from making false
representations about amounts owed by homeowners, from charging fees for
services that are not authorized by loan agreements, and from charging
unreasonable amounts for work.
In addition, the settlement requires Countrywide to
establish internal procedures and an independent third party to verify that
bills and claims filed in bankruptcy court are valid.
“Now more than ever, companies that service
consumers’ mortgages need to do so in an honest and fair way,” Mr. Leibowitz
said.
The F.T.C. has not yet established how much will be
paid to each consumer, in part, Mr. Leibowitz said, because Countrywide’s
record keeping was “abysmal.” About $35 million of the $108 million total
was charged to homeowners already in bankruptcy proceedings, with the
remainder charged to customers whom Countrywide said were in default on
their mortgages.
Jensen Comment
I think Countrywide got off too easy. The evil Countrywide brokered mortgages to
borrowers that had no hope of paying back the debt and then charged they
excessive fees when they got behind in their payments.
Bob Jensen's threads on the sleaze of Countrywide are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
"First-Time Fraudsters A tax credit so silly even a four-year-old can
exploit it," The Wall Street Journal, October 29, 2009 ---
http://online.wsj.com/article/SB10001424052748703574604574501253942115922.html?mod=djemEditorialPage
It's hard not to laugh when viewing the results of
the federal first-time home-buyer tax credit. The credit, worth up to $8,000
for the purchase of a home, has only been available since April of last
year. Yet news of the latest taxpayer-funded mortgage scam has traveled
fast. The Treasury's inspector general for tax administration, J. Russell
George, recently told Congress that at least 19,000 filers hadn't purchased
a home when they claimed the credit. For another 74,000 filers, claiming a
total of $500 million in credits, evidence suggests that they weren't
first-time buyers.
It's hard not to laugh when viewing the results of
the federal first-time home-buyer tax credit. The credit, worth up to $8,000
for the purchase of a home, has only been available since April of last
year. Yet news of the latest taxpayer-funded mortgage scam has traveled
fast. The Treasury's inspector general for tax administration, J. Russell
George, recently told Congress that at least 19,000 filers hadn't purchased
a home when they claimed the credit. For another 74,000 filers, claiming a
total of $500 million in credits, evidence suggests that they weren't
first-time buyers.
Among those claiming bogus credits, at least some
of them were definitely first-timers. The credit has already been claimed by
500 people under the age of 18, including a
four-year-old. This pre-K housing whiz
likely bought because mom and dad make too much to qualify for the full
credit, which starts to phase out at $150,000 of income for couples, $75,000
for singles.
As a "refundable" tax credit, it guarantees the
claimants will get cash back even if they paid no taxes. A lack of
documentation requirements also makes this program a slow pitch in the
middle of the strike zone for scammers. The Internal Revenue Service and the
Justice Department are pursuing more than 100 criminal investigations
related to the credit, and the IRS is reportedly trying to audit almost
everyone who claims it this year.
Speaking of the IRS, apparently its own staff
couldn't help but notice this opportunity to snag an easy $8,000. One day
after explaining to Congress how many "home-buyers" were climbing aboard
this gravy train, Mr. George appeared on Neil Cavuto's program on the Fox
Business Network. Mr. George said his staff has found at least 53 cases of
IRS employees filing "illegal or inappropriate" claims for the credit. "In
all honesty this is an interim report. I expect that the number would be
much larger than that number," he said.
The program is set to expire at the end of
November, so naturally given its record of abuse, Congress is preparing to
extend it. Republican Senator Johnny Isakson of Georgia is so pleased with
the results that he wants to expand the program beyond first-time buyers and
double the income limits.
This is the point in the story when a taxpayer's
sense of humor is bound to give way to a different emotion. The credit's
cost is running at about $1 billion a month and $15 billion for the year.
Also, even when employed by an honest buyer, it's another distortion that
drives capital into housing and away from other more productive uses. For
America's tens of millions of tax-paying renters, it's another subsidy they
provide for their neighbors to be able to sell their houses at a higher
price.
While the credit seems to have boosted home sales,
many of those sales would have happened anyway and have merely been stolen
from the future. Meanwhile, the credit continues to distort the housing
market and postpone the day when home prices can find a floor that is a
basis for a stable recovery.
More than two years into the housing bust,
trillions of dollars in taxpayer losses or guarantees via Fannie Mae and
Freddie Mac, and amid an ongoing plague of redefaults in federal programs to
prevent foreclosures, politicians are still trying to manipulate housing
prices. And leave it to Congress to design a program that even a
four-year-old can scam.
Bob Jensen's Fraud Updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
What do you want to bet that Marvene got back into the action? (See above)
A Video of Hope compared with a Video of Despair
Video 1
University of the Pacific President Pamela A. Eibeck addresses the campus
community and online viewers in a Fall Welcome address on September 10, 2009
---
http://www.vimeo.com/6534192
Jensen Comment
What impressed me is the enthusiasm of the University of the Pacific's new
president who selected to move to a community hardest hit by the subprime
mortgage scandals, economic crises of empty houses, very high unemployment, and
several years of really severe drought on the surrounding farms and ranches.
Stockton is largely an agricultural community.
Video 2
CBS Sixty Minutes featured how bad things became in Stockton's economy and its
fraudulent mortgage lenders..
The Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This is an example of a community and a university and new university
president that are not giving up as the "house of cards" collapses about them.
The fall was aided and abetted by the credit rating agencies like Moody's and
Standard & Poors.
As for Pamela Eibeck and her son, you might also read the November 22, 2009
tidbit in the Chronicle of Higher Education ---
http://chronicle.com/article/Moms-the-PresidentIm/49228/
"Goldman Sachs accused of fraud by US regulator SEC," BBC News,
April 16, 2010 ---
http://news.bbc.co.uk/2/hi/business/8625931.stm
Link forwarded by Roger Collins
Goldman Sachs, the Wall Street powerhouse, has been
accused of defrauding investors by America's financial regulator.
The Securities and Exchange Commission (SEC)
alleges that Goldman failed to disclose conflicts of interest.
The claims concern Goldman's marketing of sub-prime
mortgage investments just as the US housing market faltered.
Goldman rejected the SEC's allegations, saying that
it would "vigorously" defend its reputation.
News that the SEC was pressing civil fraud charges
against Goldman and one of its London-based vice presidents, Fabrice Tourre,
sent shares in the investment bank tumbling 12%.
The SEC says Goldman failed to disclose "vital
information" that one of its clients, Paulson & Co, helped choose which
securities were packaged into the mortgage portfolio.
These securities were sold to investors in 2007.
But Goldman did not disclose that Paulson, one of
the world's largest hedge funds, had bet that the value of the securities
would fall.
The SEC said: "Unbeknownst to investors, Paulson...
which was posed to benefit if the [securities] defaulted, played a
significant role in selecting which [securities] should make up the
portfolio."
"In sum, Goldman Sachs arranged a transaction at
Paulson's request in which Paulson heavily influenced the selection of the
portfolio to suit its economic interests," said the Commission.
Housing collapse
The whole building is about to collapse anytime
now... Only potential survivor, the fabulous Fabrice...
Email by Fabrice Tourre The SEC alleges that
investors in the mortgage securities, packaged into a vehicle called Abacus,
lost more than $1bn (£650m) in the US housing collapse.
Mr Tourre was principally behind the creation of
Abacus, which agreed its deal with Paulson in April 2007, the SEC said.
The Commission alleges that Mr Tourre knew the
market in mortgage-backed securities was about to be hit well before this
date.
The SEC's court document quotes an email from Mr
Tourre to a friend in January 2007. "More and more leverage in the system.
Only potential survivor, the fabulous Fab[rice Tourre]... standing in the
middle of all these complex, highly leveraged, exotic trades he created
without necessarily understanding all of the implications of those
monstrosities!!!"
Goldman denied any wrongdoing, saying in a brief
statement: "The SEC's charges are completely unfounded in law and fact and
we will vigorously contest them and defend the firm and its reputation."
The firm said that, rather than make money from the
deal, it lost $90m.
The two investors that lost the most money, German
bank IKB and ACA Capital Management, were two "sophisticated mortgage
investors" who knew the risk, Goldman said.
And nor was there any failure of disclosure,
because "market makers do not disclose the identities of a buyer to a seller
and vice versa."
Calls to Mr Tourre's office were referred to the
Goldman press office. Paulson has not been charged.
Asked why the SEC did not also pursue a case
against Paulson, Enforcement Director Robert Khuzami told reporters: "It was
Goldman that made the representations to investors. Paulson did not."
The firm's owner, John Paulson - no relation to
former US Treasury Secretary Henry Paulson - made billions of dollars
betting against sub-prime mortgage securities.
In a statement, Paulson & Co. said: "As the SEC
said at its press conference, Paulson is not the subject of this complaint,
made no misrepresentations and is not the subject of any charges."
'Regulation risk'
Goldman, arguably the world's most prestigious
investment bank, had escaped relatively unscathed from the global financial
meltdown.
This is the first time regulators have acted
against a Wall Street deal that allegedly helped investors take advantage of
the US housing market collapse.
The charges come as US lawmakers get tough on Wall
Street practices that helped cause the financial crisis. Among proposals
being considered by Congress is tougher rules for complex investments like
those involved in the alleged Goldman fraud.
Observers said the SEC's move dealt a blow to
Goldman's standing. "It undermines their brand," said Simon Johnson, a
professor at the Massachusetts Institute of Technology and a Goldman critic.
"It undermines their political clout."
Analyst Matt McCormick of Bahl & Gaynor said that
the allegation could "be a fulcrum to push for even tighter regulation".
"Goldman has a fight in front of it," he said.
The Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Allegedly, Goldman Sachs sold (to suckers) securities
backed by risky home loans while it simultaneously bet that those bonds would
lose value
January 27, 2010 message from my friend Larry (who prefers
to remain anonymous)
WASHINGTON — One of Congress' premier watchdog
panels is investigating Goldman Sachs' role in the subprime mortgage
meltdown, including how the firm sold securities backed by risky home loans
while it simultaneously bet that those bonds would lose value, people
familiar with the inquiry said Friday.
The investigation is part of a broader examination
by the Senate Permanent Subcommittee on Investigations into the roots of the
economic crisis and whether financial institutions behaved improperly, said
the individuals, who insisted upon anonymity because the matter is
sensitive.....
Federal auditors found that Goldman placed $22
billion of its swap bets against subprime securities, including many it had
issued, with the giant insurer American International Group. In late 2008,
when the government bailed out AIG, Goldman received $13.9 billion....
http://www.mcclatchydc.com/251/story/82899.html
"Goldman under investigation for its securities dealings,"
by Greg Gordon, McClatchy Newspapers, January 22, 2010 ---
http://www.mcclatchydc.com/251/story/82899.html
WASHINGTON — One of Congress' premier watchdog
panels is investigating Goldman Sachs' role in the subprime mortgage
meltdown, including how the firm sold securities backed by risky home loans
while it simultaneously bet that those bonds would lose value, people
familiar with the inquiry said Friday.
The investigation is part of a broader examination
by the Senate Permanent Subcommittee on Investigations into the roots of the
economic crisis and whether financial institutions behaved improperly, said
the individuals, who insisted upon anonymity because the matter is
sensitive.
Disclosure of the investigation comes amid a
darkening mood at the White House, in Congress and among the American public
over the long-term economic impact of the subprime crisis, prompting demands
to hold the culprits accountable.
It marks at least the third federal inquiry
touching on Goldman's dealings related to securities backed by risky home
mortgages.
The separate, congressionally appointed Financial
Crisis Inquiry Commission, which was created to investigate causes of the
crisis, began holding hearings Jan. 13 and took sworn testimony from
Goldman's top officer. In addition, the Securities and Exchange Commission,
which polices Wall Street, is investigating Goldman's exotic bets against
the housing market, using insurance-like contracts known as credit-default
swaps, in offshore deals, knowledgeable people have told McClatchy.
Goldman, the world's most prestigious investment
bank, has denied any improprieties and said that the use of "hedges," or
contrary bets, is a "cornerstone of prudent risk management."
Asked about the Senate inquiry late Friday, Goldman
spokesman Michael DuVally said only: "As a matter of policy, Goldman Sachs
does not comment on legal or regulatory matters."
A spokeswoman for the Senate subcommittee declined
to comment on the investigation, which was spawned by a four-part McClatchy
series published in November that detailed the Wall Street firm's role in
the debacle, which stemmed from subprime loans to millions of marginally
qualified borrowers.
The subcommittee, part of the Homeland Security and
Governmental Affairs Committee, is led by veteran Democratic Sen. Carl Levin
of Michigan, who said last year that his panel was "looking into some of the
causes and consequences of the financial crisis."
The panel has a history of conducting formal,
highly secretive investigations in which it typically issues subpoenas for
documents and witnesses, produces extensive reports and sometimes refers
evidence to the Justice Department for possible criminal prosecution.
It couldn't immediately be learned whether the
panel has subpoenaed Goldman executives or company records. However, the
subcommittee has issued at least one major subpoena seeking records related
to Seattle-based Washington Mutual, which collapsed in September 2008 after
being swamped by losses from its subprime lending. J.P. Morgan Chase then
purchased WaMu's banking assets.
Goldman was the only major Wall Street firm to
safely exit the subprime mortgage market. McClatchy reported, however, that
Goldman sold off more than $40 billion in securities backed by over 200,000
risky home loans in 2006 and 2007 without telling investors of its secret
bets on a sharp housing downturn, prompting some experts to question whether
it had crossed legal lines.
McClatchy also has reported that Goldman peddled
unregulated securities to foreign investors through the Cayman Islands, a
Caribbean tax haven, in some cases exaggerating the soundness of the
underlying home mortgages. In numerous deals, records indicate, the company
required investors to pay Goldman massive sums if bundles of risky mortgages
defaulted. Goldman has said its investors were fully informed of the risks.
Federal auditors found that Goldman placed $22
billion of its swap bets against subprime securities, including many it had
issued, with the giant insurer American International Group. In late 2008,
when the government bailed out AIG, Goldman received $13.9 billion.
Goldman's chairman and chief executive, Lloyd
Blankfein, appeared to acknowledge last week that the firm behaved
inappropriately when he was asked about the secret bets in sworn testimony
to the Financial Crisis Inquiry Commission.
Blankfein first said that the firm's contrary
trades were "the practice of a market maker," then added: "But the answer is
I do think that the behavior is improper, and we regret the result — the
consequence that people have lost money in it."
A day later, Goldman issued a statement denying
that Blankfein had admitted improper company behavior and said that his
ensuing answer stressed that the firm's conduct was "entirely appropriate."
Senate investigators were described as having pored
over Goldman's SEC filings in recent weeks.
Underscoring the breadth of the Senate
investigation is the disclosure by federal banking regulators in a recent
filing in the WaMu bankruptcy case.
In it, the Federal Deposit Insurance Corp. revealed
that the Senate subcommittee had served the agency with "a comprehensive
subpoena" for documents relating to WaMu, whose primary regulator was the
Office of Thrift Supervision.
The subcommittee's jurisdiction is "wide-ranging,"
the FDIC's lawyers wrote. "It covers, among other things, the study or
investigation of the compliance or noncompliance of corporations, companies,
or individual or other entities with the rules, regulations and laws
governing the various governmental agencies and their relationships with the
public." The subpoena, they said, "is correspondingly broad."
The Puget Sound Business Journal first reported on
the FDIC's disclosure.
Goldman's former chairman, Henry Paulson, served as
Treasury secretary during the bailouts that benefitted the firm and while
other Wall Street investment banks foundered because of their subprime
market exposure, its profits have soared.
In reporting a $13.4 billion profit for 2009 on
Thursday, the bank sought to quell a furor over its taxpayer-aided success
by scaling back employee bonuses. It also has limited bonuses for its 30
most senior executives to restricted stock that can't be sold for five years.
MORE FROM MCCLATCHY
Goldman Sachs: Low Road to High Finance
Justice Department eyes possible fraud on Wall Street
Goldman admits 'improper' actions in sales of securities
Goldman: Blankfein didn't say firm's practices were 'improper'
Facing frustrated voters, more senators oppose Bernanke
Obama moves to restrict banks, take on Wall Street
Check
out McClatchy's politics blog: Planet Washington
Bob Jensen's threads on subprime sleaze are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Bob Jensen's threads on banking fraud are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
That some bankers have ended up in
prison is not a matter of scandal, but what is outrageous is the fact that all
the others are free.
Honoré de Balzac
"Banks Bundled Bad Debt, Bet Against It and
Won," by Gretchen Morgenson and Louise Story, The New York Times,
December 23, 2009 ---
http://www.nytimes.com/2009/12/24/business/24trading.html?em
My friend Larry clued me in to this link.
In late October 2007, as the
financial markets were starting to come unglued, a Goldman Sachs trader,
Jonathan M. Egol, received very good news. At 37, he was named a managing
director at the firm.
Mr. Egol, a Princeton
graduate, had risen to prominence inside the bank by creating
mortgage-related securities, named Abacus, that were at first intended to
protect Goldman from investment losses if the housing market collapsed. As
the market soured, Goldman created even more of these securities, enabling
it to pocket huge profits.
Goldman’s own clients who
bought them, however, were less fortunate.
Pension funds and insurance
companies lost billions of dollars on securities that they believed were
solid investments, according to former Goldman employees with direct
knowledge of the deals who asked not to be identified because they have
confidentiality agreements with the firm.
Goldman was not the only
firm that peddled these complex securities — known as synthetic
collateralized debt obligations, or C.D.O.’s — and then made financial bets
against them, called selling short in Wall Street parlance. Others that
created similar securities and then bet they would fail, according to Wall
Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller
firms like Tricadia Inc., an investment company whose parent firm was
overseen by Lewis A. Sachs, who this year became a special counselor to
Treasury Secretary Timothy F. Geithner.
How these disastrously
performing securities were devised is now the subject of scrutiny by
investigators in Congress, at the Securities and Exchange Commission and at
the Financial Industry Regulatory Authority, Wall Street’s self-regulatory
organization, according to people briefed on the investigations. Those
involved with the inquiries declined to comment.
While the investigations are
in the early phases, authorities appear to be looking at whether securities
laws or rules of fair dealing were violated by firms that created and sold
these mortgage-linked debt instruments and then bet against the clients who
purchased them, people briefed on the matter say.
One focus of the inquiry is
whether the firms creating the securities purposely helped to select
especially risky mortgage-linked assets that would be most likely to crater,
setting their clients up to lose billions of dollars if the housing market
imploded.
Some securities packaged by
Goldman and Tricadia ended up being so vulnerable that they soured within
months of being created.
Goldman and other Wall
Street firms maintain there is nothing improper about synthetic C.D.O.’s,
saying that they typically employ many trading techniques to hedge
investments and protect against losses. They add that many prudent investors
often do the same. Goldman used these securities initially to offset any
potential losses stemming from its positive bets on mortgage securities.
But Goldman and other firms
eventually used the C.D.O.’s to place unusually large negative bets that
were not mainly for hedging purposes, and investors and industry experts say
that put the firms at odds with their own clients’ interests.
“The simultaneous selling of
securities to customers and shorting them because they believed they were
going to default is the most cynical use of credit information that I have
ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R
Consulting in New York. “When you buy protection against an event that you
have a hand in causing, you are buying fire insurance on someone else’s
house and then committing arson.”
Investment banks were not
alone in reaping rich rewards by placing trades against synthetic C.D.O.’s.
Some hedge funds also benefited, including Paulson & Company, according to
former Goldman workers and people at other banks familiar with that firm’s
trading.
Michael DuVally, a Goldman
Sachs spokesman, declined to make Mr. Egol available for comment. But Mr.
DuVally said many of the C.D.O.’s created by Wall Street were made to
satisfy client demand for such products, which the clients thought would
produce profits because they had an optimistic view of the housing market.
In addition, he said that clients knew Goldman might be betting against
mortgages linked to the securities, and that the buyers of synthetic
mortgage C.D.O.’s were large, sophisticated investors, he said.
The creation and sale of
synthetic C.D.O.’s helped make the financial crisis worse than it might
otherwise have been, effectively multiplying losses by providing more
securities to bet against. Some $8 billion in these securities remain on the
books at American International Group, the giant insurer rescued by the
government in September 2008.
From 2005 through 2007, at
least $108 billion in these securities was issued, according to Dealogic, a
financial data firm. And the actual volume was much higher because synthetic
C.D.O.’s and other customized trades are unregulated and often not reported
to any financial exchange or market.
Goldman Saw It Coming
Before the financial
crisis, many investors — large American and European banks, pension funds,
insurance companies and even some hedge funds — failed to recognize that
overextended borrowers would default on their mortgages, and they kept
increasing their investments in mortgage-related securities. As the mortgage
market collapsed, they suffered steep losses.
Continued in article
Bob Jensen's threads on banking and
investment banking frauds are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Accounting for Collateralized Debt
Obligations (CDOs)
As to CDOs in
VIEs, you might take a look at
http://www.mayerbrown.com/public_docs/cdo_heartland2004_FIN46R.pdf
Evergreen
Investment Management case at
http://www.sec.gov/litigation/admin/2009/34-60059.pdf
Bob Jensen's
threads on CDO accounting ---
http://faculty.trinity.edu/rjensen/theory01.htm#CDO
Bob Jensen's
threads on SPEs, SPVs, and VIEs ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
"Guest Post – Fraud Girl: “Fraud by Hindsight”- How Wall Street Firms
[Legally] Get Away With Fraudulent Behavior!," Fraud Girl, Simoleon Sense,
June 6, 2010 ---
Click Here
http://www.simoleonsense.com/guest-post-fraud-girl-%e2%80%9cfraud-by-hindsight%e2%80%9d-how-wall-street-firms-legally-get-away-with-fraudulent-behavior/
Last week we discussed the credit rating
agencies and their roles the financial crisis. These agencies provided false
ratings on credit they knew was faulty prior to the crisis. In defense,
these agencies (as well as Warren Buffet) said that they did not foresee the
crisis to be as severe as it was and therefore could not be blamed for
making mistakes in their predictions. This week’s post focuses on
foreseeability and the extent to which firms are liable for incorrect
predictions.
Like credit agencies, Wall Street firms have
been accused of knowing the dangers in the market prior to its collapse. I
came across this post (Black
Swans*, Fraud by hindsight, and Mortgage-Backed Securities)
via the Wall Street Law Blog that discusses how
firms could assert that they can’t be blamed for events they couldn’t
foresee. It’s a doctrine known as Fraud by Hindsight (“FBH”) where
defendants claim “that there is no fraud if the alleged deceit can only be
discerned after the fact”. This claim has been used in numerous securities
fraud lawsuits and surprisingly it has worked in the defendant’s favor on
most occasions.
Many Wall Street firms say they “could not
foresee the collapse of the housing market, and therefore any allegations of
fraud are merely impermissible claims of fraud by hindsight”. Was Wall
Street able to foresee the housing market crash prior to its collapse?
According to the writers at WSL Blog, they did foresee it saying, “From 1895
through 1996 home price appreciation very closely corresponded to the rate
of inflation (roughly 3% per year). From 1995 through 2006 alone – even
after adjusting for inflation – housing prices rose by more than 70%”. Wall
Street must (or should) have foreseen a drastic change in the market when
rises in housing costs were so abnormal. By claiming FBH, however, firms can
inevitably “get away with murder”.
What exactly is FBH and how is it used in
court? The case below from Northwestern University Law Review details the
psychology and legalities behind FBH while attempting to show how the FBH
doctrine is being used as a means to dismiss cases rather than to control
the influence of Wall Street’s foreseeability claims.
Link Provided to Download "Fraud by Hindsight" (Registration Required)
I’ve broken down the case into two parts. The
first part provides two theories on hindsight in securities litigation: The
Debiasing Hypothesis & The Case Management Hypothesis. The Debiasing
Hypothesis provides that FBH is being used in court as a way to control the
influence of ‘hindsight bias’. This bias says that people “overstate the
predictability of outcomes” and “tend to view what has happened as having
been inevitable but also view it as having appeared ‘relatively inevitable’
before it happened”. The Debiasing Hypothesis tries to prove that FBH aids
judges in “weeding out” the biases so that they can focus on the allegations
at hand.
The Case Management Hypothesis states that FBH
is a claim used by judges to easily dismiss cases that they deem too
complicated or confusing. According to the analysis, “…academics have
complained that these [securities fraud] suits settle without regard to
merit and do little to deter real fraud, operating instead as a needless
tax on capital raising. Federal judges, faced with overwhelming caseloads,
must allocate their limited resources. Securities lawsuits that are often
complex, lengthy, and perceived to be extortionate are unlikely to be a
high priority. Judges might thus embrace any doctrine [i.e. FBH
doctrine] that allows them to dispose of these cases quickly” (782-783). The
case attempts to prove that FBH is primarily used for case management
purposes rather than for controlling hindsight bias.
The psychological aspects behind hindsight
bias are discussed thoroughly in this case. Here are a few excerpts from the
case regarding this bias:
(1)“Studies show that judges are vulnerable
to the bias, and that mere awareness of the phenomenon does not ameliorate
its influence on judgment. The failure to develop a doctrine that
addresses the underlying problem of judging in hindsight means that the
adverse consequences of the hindsight bias remain a part of securities
litigation. Judges are not accurately sorting fraud from mistake, thereby
undermining the system, even as they seek to improve it” (777).
(2) “Judges assert that a company’s
announcement of bad results, by itself, does not mean that a prior
optimistic statement was fraudulent. This seems to be an effort to divert
attention away from the bad outcome and toward the circumstances that gave
rise to that outcome, which is exactly the problem that hindsight bias
raises. That is, if people overweigh the fact of a bad outcome in
hindsight, then the cure is to reconstruct the situation as people saw it
beforehand. Thus, the development of the FBH doctrine suggests a
judicial understanding of the biasing effect of judging in hindsight and of
a means to address the problem” (781).
(3) “Once a bad event occurs, the evaluation
of a warning that was given earlier will be biased. In terms of evaluating a
decision-maker’s failure to heed a warning, knowledge that the warned-of
outcome occurred will increase the salience of the warning in the
evaluator’s mind and bias her in the direction of finding fault with the
failure to heed the warning. In effect, the hindsight bias becomes an
‘I-told-you-so’ bias.” (793).
(4) “In foresight, managers might reasonably
believe that the contingency as too unlikely to merit disclosure, whereas in
hindsight it seems obvious a reasonable investor would have wanted to know
it. Likewise, as to warning a company actually made, in foresight most
investors might reasonably ignore them, whereas in hindsight they seem
profoundly important. If defendants are allowed to defend themselves by
arguing that a reasonable investor would have attended closely to these
warnings, then the hindsight bias might benefit defendants” (794).
Next week we’ll explore the second part of the
case and discuss the importance of utilizing FBH as a means of deterring the
hindsight bias. We’ll see how the case proves that FBH is not being used for
this purpose and is instead used as a mechanism to dismiss cases that simply
do not want to be heard.
See you next week…
-Fraud Girl
Bob Jensen's Rotten to the Core threads on credit rating agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
Bob Jensen's Rotten to the Core threads on banks and brokerages ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking
Bob Jensen's Fraud updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
June 8, 2010 reply from Robert Bruce Walker
[walkerrb@ACTRIX.CO.NZ]
The link below is a book review of Michael Lewis’s
latest book ‘The Big Short’. The book is clearly based on an article that
Bob uncovered about 9 months ago. The mechanism underpinning the ‘short’ is
better explained in the NYRB essay and, presumably, in the book itself. It
seems that the ‘mezzanine’ tranches (BBB rated) of a series of MBS were
packaged, rated AAA and then issued in another MBS. Dubious this might be,
but fraud it will not be. It lacks the central element of mens rea. In the
face of an accusation of fraud the accused will generally resort to the
defence of incompetence or inadequacy – a dangerous thing when facing civil
action as well – but better than being seen to have acted ‘knowingly’.
No-one knew the property markets would collapse. Many people, including me*,
thought that it was inevitable – but we did not know it.
http://www.nybooks.com/articles/archives/2010/jun/10/heart-crash/?pagination=false
*When I was first told of the ‘low doc’ loan
concept by an investment manager, I could hardly believe it. He, on the
other hand, described the packager of such products as very clever. The
investor in question failed badly due to an over-exposure to MBS. Funny
that.
PJ O’Rourke’s Parliament of
Whores ---
http://snipurl.com/parliamentwhores
"They Left Fannie Mae, but We Got the Legal Bills," by Grechen
Morgenson, The New York Times, September 5, 2009 ---
http://www.nytimes.com/2009/09/06/business/economy/06gret.html?_r=1&scp=2&sq=gretchen
morgensen&st=cse
PRECISELY one year ago, we lucky taxpayers
took over Fannie Mae and Freddie Mac, the mortgage finance giants that
contributed mightily to the wild and crazy home-loan-boom-turned-bust. In
that rescue operation, the Treasury agreed to pony up as much as $200
billion to keep Fannie in the black, coughing up cash whenever its
liabilities exceed its assets. According to the company’s most recent
quarterly financial statement, the Treasury will, by Sept. 30, have handed
over $45 billion to shore up the company’s net worth.
It is still unclear what the ultimate cost
of this bailout will be. But thanks to inquiries by Representative Alan
Grayson, a Florida Democrat, we do know of another, simply outrageous cost.
As a result of the Fannie takeover, taxpayers are paying millions of dollars
in legal defense bills for three top former executives, including Franklin
D. Raines, who left the company in late 2004 under accusations of accounting
improprieties. From Sept. 6, 2008, to July 21, these legal payments totaled
$6.3 million.
With all the turmoil of the financial
crisis, you may have forgotten about the book-cooking that went on at Fannie
Mae. Government inquiries found that between 1998 and 2004, senior
executives at Fannie manipulated its results to hit earnings targets and
generate $115 million in bonus compensation. Fannie had to restate its
financial results by $6.3 billion.
Almost two years later, in 2006, Fannie’s
regulator concluded an investigation of the accounting with a scathing
report. “The conduct of Mr. Raines, chief financial officer J. Timothy
Howard, and other members of the inner circle of senior executives at Fannie
Mae was inconsistent with the values of responsibility, accountability, and
integrity,” it said.
That year, the government sued Mr. Raines,
Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100
million in fines and $115 million in restitution from bonuses the government
contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr.
Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation.
When these top executives left Fannie, the
company was obligated to cover the legal costs associated with shareholder
suits brought against them in the wake of the accounting scandal.
Now those costs are ours. Between Sept. 6,
2008, and July 21, we taxpayers spent $2.43 million to defend Mr. Raines,
$1.35 million for Mr. Howard, and $2.52 million to defend Ms. Spencer.
“I cannot see the justification of people
who led these organizations into insolvency getting a free ride,” Mr.
Grayson said. “It goes right to the heart of what people find most
disturbing in this situation — the absolute lack of justice.”
Lawyers for the three executives did not
returns calls seeking comment.
An additional $16.8 million was paid in
the period to cover legal expenses of workers at the Office of Federal
Housing Enterprise Oversight, Fannie’s former regulator. These costs are
associated with defending the regulator in litigation against former Fannie
executives.
This tally of taxpayer legal costs took
several months for Mr. Grayson to extract. On June 4, after Congressional
hearings on the current and future status of Fannie and Freddie, he
requested the information from the Federal Housing Finance Agency, now their
regulator. He got its response on Aug. 26.
A spokeswoman for the agency said it would
not comment for this article.
THE lawyers’ billable hours, meanwhile,
keep piling up. As the F.H.F.A. explained to Mr. Grayson, the $6.3 million
in costs generated by 10 months of legal defense work for Mr. Raines, Mr.
Howard and Ms. Spencer includes not a single deposition for any of them.
Instead, those bills covered 33 depositions of “other parties” relating to
the shareholder suits and requiring the presence of the three executives’
counsel.
One of Mr. Grayson’s questions about these
payments remains unanswered — whether placing Fannie Mae into receivership,
rather than conservatorship, would have negated the agreement to cover the
former executives’ legal costs. Choosing conservatorship allowed Fannie to
stabilize and meant that it was going to continue to operate, not wind down
immediately.
But, Mr. Grayson pointed out: “If these
companies had gone into receivership instead of conservatorship, the trustee
in bankruptcy or the receiver would have been free, legally, to reject these
contracts that called for indemnification. Raines, Howard and Spencer would
have had to pay their own fees.”
When asked about this, Fannie’s regulator,
the F.H.F.A., waffled. “Whether these costs could have been avoided would
depend on the facts and circumstances surrounding any receivership,” it
said. “It is possible that receiverships could have reduced the costs of the
litigation, but by no means certain.”
Mr. Grayson said he intended to find out
whether there are any legal options under the conservatorship to stop paying
for the defense of the Fannie Mae three. “When did Uncle Sam become Uncle
Sap?” he said. “In a situation where billions of losses have already
occurred, is it really asking too much that people pay their own legal
fees?”
While the $6.3 million paid to defend Mr.
Raines, Mr. Howard and Ms. Spencer is a pittance compared with other bills
coming due in the bailout binge, it is still disturbing for these costs to
be covered by those who had nothing to do with the problems and certainly
did not benefit from them. The money may be small, but the episode’s message
looms large: those who presided over this debacle aren’t being held
accountable.
“It is wrong in a very deep sense,” Mr.
Grayson said. “The essence of our society is that people who do good things
are rewarded and people who do bad things are punished. Where is the
punishment for Raines, Howard and Spencer? There is none.”
Barney's Rubble ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Rubble
The Disastrous Bailout ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Taibbi vs. Goldman Sachs: Whose side are you on?
The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26,
2009 ---
http://www.thenation.com/doc/20090608/kroll/print
Place a barf bag in your lap before watching
these videos!
But are they accurate?
In June and July Goldman Sachs put up a pretty good defense.
Now I'm not so sure.
Questions
Why is the SEC still hiding the names of these tremendously lucky naked short
sellers in Bear Sterns and Lehman Bros.?
Was it because these lucky speculators were such good friends of Hank Paulson
and Timothy Geithner?
Or is Matt Taibbi himself a fraud as suggested last summer by Wall Street media
such as
Business Insider?
Jensen Comment
Evidence suggests that the SEC may be protecting these Wall Street thieves!
Or was all of this stealing perfectly legal? If so why the continued secrecy on
the part of the SEC?
Suspicion: The stealing may have taken place in top investors needed by
the government for bailout (Goldman Sachs?)
"Wall Street's Naked Swindle" by Matt
Taibbi
Watch the Video at one of the following sites:
You Tube ---
http://www.youtube.com/watch?v=OqZUbe9KIMs
Google video ---
Click Here
Read the complete article ---
Click Here
Video Updates for Matt Taibbi
GRITtv: Matt Taibbi & Michael Lux: Goldman's Coup
---
http://www.youtube.com/watch?v=nFWjXQLDkXg
"Matt Taibbi's Goldman Sachs Story Is A Joke,"
Joe Weisenthal, Business Insider, July 13, 2009 ---
http://www.businessinsider.com/matt-taibbis-goldman-sachs-story-is-a-joke-2009-7
"Goldman Sachs responds to Taibbi Post," by:
Felix Salmon, Rueters, June 26, 2009 ---
Calls Taibbi "Hysterical" ---
http://blogs.reuters.com/felix-salmon/2009/06/26/goldman-sachs-responds-to-taibbi/
Others Now Argue it Is Not a Joke
"Taibbi's Naked-Shorting Rage: Goldman's Lobbying, SEC's Fail,"l by bobswern.
Daily Kohs, September 30, 2009 ---
http://www.dailykos.com/story/2009/9/30/787963/-Taibbis-Naked-Shorting-Rage:-Goldmans-Lobbying,-SECs-Fail
Now, off we go to Goldman Sachs' notorious lobbying
hubris, the historically-annotated, umpteenth oversight failure of the
Securities Exchange Commission ("SEC"), and what I'm quickly realizing may
well turnout to be the story with regard to it becoming the poster
child for regulatory capture and supervisory breakdown as far as our Wall
Street-based corporatocracy/oligarchy is concerned. Here's the link to
Taibbi's preview blog post: "An
Inside Look at How Goldman Sachs Lobbies the Senate."
Yesterday, as described in this lead-in piece from
the Wall Street Journal, the SEC held a public roundtable discussion
on "New Rules for Lending of Securities." (See link here: "SEC
Weighs New Rules for Lending of Securities.")
SEC Weighs New Rules for Lending of Securities
BY KARA SCANNELL AND CRAIG KARMIN
Wall Street Journal
Saturday, September 26th, 2009
Securities regulators are exploring new
regulations for the multitrillion-dollar securities-lending market, the
first major step regulators have taken in the area in decades.
Securities and Exchange Commission Chairman
Mary Schapiro said she wants to shine a light on the "opaque market."
After many large investors lost millions in last year's credit crunch,
she said, "we need to consider ways to enhance investor-oriented
oversight."
The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants...
Enter Taibbi: "An
Inside Look at How Goldman Sachs Lobbies the Senate."
An Inside Look at How Goldman Sachs Lobbies the
Senate
Matt Taibbi
TruSlant.com
(very early) Tuesday, September 29th, 2009
The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants contend.
Securities lending is central to the practice of short selling, in which
investors borrow shares and sell them in a bet that the price will
decline. Short sellers later hope to buy back the shares at a lower
price and return them to the securities lender, booking a profit.
Lending and borrowing also help market makers keep stock trading
functioning smoothly.
--SNIP--
Later on this week I have a story coming out in
Rolling Stone that looks at the history of the Bear Stearns and Lehman
Brothers collapses. The story ends up being more about naked
short-selling and the role it played in those incidents than I had
originally planned -- when I first started looking at the story months
ago, I had some other issues in mind, but it turns out that there's no
way to talk about Bear and Lehman without going into the weeds of naked
short-selling, and to do that takes up a lot of magazine inches. So
among other things, this issue takes up a lot of space in the upcoming
story.
Naked short-selling is a kind of counterfeiting
scheme in which short-sellers sell shares of stock they either don't
have or won't deliver to the buyer. The piece gets into all of this, so
I won't repeat the full description in this space now. But as this week
goes on I'm going to be putting up on this site information I had to
leave out of the magazine article, as well as some more timely material
that I'm only just getting now.
Included in that last category is some of the
fallout from this week's SEC "round table" on the naked short-selling
issue.
The real significance of the naked
short-selling issue isn't so much the actual volume of the behavior,
i.e. the concrete effect it has on the market and on individual
companies -- and that has been significant, don't get me wrong -- but
the fact that the practice is absurdly widespread and takes place right
under the noses of the regulators, and really nothing is ever done about
it.
It's the conspicuousness of the crime that is
the issue here, and the degree to which the SEC and the other financial
regulators have proven themselves completely incapable of addressing the
issue seriously, constantly giving in to the demands of the major banks
to pare back (or shelf altogether) planned regulatory actions. There
probably isn't a better example of "regulatory capture," i.e. the
phenomenon of regulators being captives of the industry they ostensibly
regulate, than this issue.
Taibbi continues on to inform us that none of the
invited speakers to this government-sponsored event represented stockholders
or companies that could, or have, become targets/victims of naked
short-selling. Also "...no activists of any kind in favor of tougher rules
against the practice. Instead, all of the invitees are (were) either banks,
financial firms, or companies that sell stuff to the first two groups."
Taibbi then informs us that there is only one
panelist invited that's in favor of what may be, perhaps, the most basic
level of regulatory control with regard to this industry practice: a "simple
reform" called "pre-borrowing." Pre-borrowing requires short-sellers to
actually possess the stock shares before they're sold.
It's been proven to work, as last summer the SEC,
concerned about predatory naked short-selling of big companies in the
wake of the Bear Stearns wipeout, instituted a temporary pre-borrow
requirement for the shares of 19 fat cat companies (no other companies
were worth protecting, apparently). Naked shorting of those firms
dropped off almost completely during that time.
The lack of pre-borrow voices invited to this
panel is analogous to the Max Baucus health care round table last
spring, when no single-payer advocates were invited. So who will get to
speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a
hedge fund that has done the occasional short sale, to put it gently),
Credit Suisse, NYSE Euronext, and so on.
Taibbi then tells us of increased efforts by
industry players, specifically noting Goldman Sachs being at the forefront
of this effort, and having "their presence felt."
Taibbi mentioned that he'd received two completely
separate calls from two congressional staffers from different offices--folks
whom Taibbi never met before--who felt compelled to inform him of Goldman's
actions.
We learn that these folks both commented on how
these Goldman folks were lobbying against restrictions on naked
short-selling. One of the aides told Taibbi that they had passed out a "fact
sheet about the issue that was so ridiculous that one of the other staffers
immediately thought to send it to me. "
I would later hear that Senate aides between
themselves had discussed Goldman's lobbying efforts and concluded that
it was one of the most shameless performances they'd ever seen from any
group of lobbyists, and that the "fact sheet" the company had had the
balls to hand to sitting U.S. Senators was, to quote one person familiar
with the situation, "disgraceful" and "hilarious."
Checkout the whole story on his blog. Apparently,
in the upcoming Rolling Stone piece, he gets into the nitty gritty with
regard to how naked short-selling brought down both Bear Stearns and Lehman,
last year.
Should be pretty powerful stuff.
Meanwhile, getting back to the SEC roundtable,
noted above, strike up the fifth item that I've now documented in the past
48 hours where it's becoming self-evident that our elected representatives
and our government agencies aren't even bothering to author the new
regulations and legislation that's so needed to prevent a recurrence of
events such as those we witnessed through the economic/market catastrophes
of the past 24 months; these legislators and high-ranking government
officials are actually having the lobbyists navigate the discussion and
write the damn stuff, too!
How much worse can it get? I really don't want
to know the answer to that rhetorical question. But, with the inmates
running the asylum, we may just find out sooner than we think!
Bob Jensen's threads on noble and ignoble
agendas of the bailout machine ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#IgnobleAgendas
"It’s Mine, Mine All Mine: Can Anyone Catch Lehman Stealing?" by
Francine McKenna, re: The Auditors, February 22, 2010 ---
http://retheauditors.com/2010/02/22/its-mine-mine-all-mine-can-anyone-catch-lehman-stealing/
Most of what’s been written about the financial
crisis and the firms that were forcibly acquired, failed, or bailed out
tends to focus on “fair value” as the feckless culprit.
Satyajit Das
wrote for the site,
Naked Capitalism:
“MtM [mark-to-market] accounting itself is
flawed… There are difficulties in establishing real values of many
instruments. It creates volatility in earnings attributable to
inefficiencies in markets rather than real changes in financial
position…Valuation for all but the simplest instruments today requires a
higher degree in a quantitative discipline, a super computer and a vivid
imagination. For complex structured securities and exotic derivatives,
the only available price is from the bank that originally sold the
security to the investor. Prices available from the purveyor of the
instrument (a concept known as mark-to-myself) strain reasonable
concepts of independence and objectivity…In the global financial crisis,
with the capital markets virtually frozen, the extent of losses on bank
inventories of hard-to-value products and commitments (structured debt
and leveraged loans) was difficult to establish.”
We know that the banks’ “independent” external
auditors had a hard time establishing both fair values and the “extent of
losses on bank inventories of hard-to-value products and commitments.” We
know this because their clients did not tell us about the extent of the
losses until it was too late. There were no
“going concern” warnings for any of the financial
institutions that went bankrupt, were taken over, or were nationalized via
bailout.
We also know that the auditors did a poor and
inconsistent job of
establishing fair values and forcing disclosure of the “extent of losses” on
banks’ investments because
their regulator, the PCAOB, told us so.
Inspection teams also observed instances
where firms’ procedures to test the fair values of financial
instruments, including derivative instruments, loans, and securities,
were inadequate. In these instances, deficiencies included (a) the
failure to gain an understanding of the methods and assumptions used to
develop the fair value measurements of financial instruments that were
illiquid or difficult to price, (b) the reliance on issuer-supplied
pricing information without obtaining corroboration of that information,
and (c) the reliance on confirmation responses from third parties or
counterparties that included disclaimers as to their accuracy and
appropriateness for use in the preparation of financial statements.
How do the auditors, one step removed and ten steps
behind, determine fair values of complex instruments especially in illiquid
markets if even the super-bankers couldn’t get it right? This question
supposes that it’s the auditors’ obligation to determine the values and that
the bankers didn’t get it right.
Neither is true.
What are the auditors’ obligations with regard to
clients’ fair value measurements and disclosures? Auditors do not establish
fair values. Instead, their role is to, “test management’s fair value
measurements and disclosures.” But that obligation is broader than just
taking the word of the
“masters of the universe.”
The auditor should consider using the work
of a specialist if the auditor does not have the necessary skill and
knowledge to plan and perform audit procedures related to fair value.[1]
Observable market prices may exist to assist in testing fair values.
Where they do not and other valuation methods are used, the auditor’s
substantive tests of fair value may involve (a) testing the significant
assumptions, the valuation model, and the underlying data, (b)
developing an independent estimate of fair value for corroborative
purposes or, where applicable, (c) reviewing events or transactions
occurring after the period covered by the financial statements and
before the date of the auditor’s report.
I say it’s outrageous to see
ongoing material “disputes” regarding the fair
value of complex derivatives between counterparties, especially if they are
clients of the same auditor. Critics have suggested that I condone breaches
of client confidentiality. Without betraying client confidentiality, they
ask, how can distinct audit teams compare the values assigned to either side
of same transaction?
One of my
commenters explained it:
Just how many PhD’s with CDS valuation
expertise do you think PwC has lying around in New York? The valuation
of these instruments and the testing of the assumptions would have been
sent to a centralized derivative valuation group to review and test.
Such a team would have had a fairly standard set of guidelines and
testing approach regardless of the team sending it. After validating the
inputs, they would have likely put it through their own sausage machine
/ valuation tool and compared the results. I think there would be a high
probability that the same analysts would have been reviewing the same
instrument for both GS and AIG. And when they notice that GS is using
market derived inputs for the referenced MBS while AIG is using the
historical average default rates and ignoring the market you would have
hoped they might speak up. And when the partner (finally) heard the
rumblings of a problem, even after it has been filtered through the
manager / senior manager “make-it-go-away” screen, he would have asked
“who else deals with this cr_p in the firm? GS… ah, [insert name of old
white guy here] is an old buddy of mine, I’ll just give him a call and
ask him what they do…”
When one excuses the auditors for not getting fair
value right, there’s a follow-on argument that claims no one got it right.
No one could possibly get it right. That’s why the crisis
occurred. That’s what the scoundrels that benefited most from the crisis
would like you to believe.
Reality is the opposite.
Much has been written about how well Goldman Sachs made out as a result
of the crisis. But there are others. Some are getting prosecuted like
Bank of America’s Ken Lewis for hiding losses to
further their interest in millions of bonus dollars. That’s why some are
starting to use the word “fraud” when speaking of Lehman’s collapse.
On February 11th,
Bloomberg’s Jonathan Weil asked why no one is prosecuting Lehman
Brothers executives for fraud:
It is so widely accepted that Lehman Brothers Holdings Inc.’s
balance sheet was bogus that even former Treasury Secretary Hank Paulson
can say it in his new memoir. And still, the government hasn’t found
anyone who did anything wrong at the failed investment bank…In his new
book, “On the Brink,” Paulson doesn’t
point fingers at specific Lehman executives for violating any rules. He
displays amazing candor, though, in describing how Lehman’s asset values
were a gross distortion of the truth. It doesn’t take much imagination
to figure out they didn’t get that way all by themselves.”
A reader, I’ll call him David the CFE,
repeats a story to me to illustrate this point:
“Casey Stengel probably said it best when
he said after the Mets 40-120 season, ‘Gentlemen, not one of you could
have done this on your own. This was a team effort.’ “
Losing $156 billion requires a team effort.
When former Lehman Managing Director
Arthur Doyle reviewed Larry McDonald’s book on Lehman,
he asked the same questions about fraud and Lehman
executives:
“The most important questions of all are
not even asked in “A Colossal Failure of Common Sense,” or in any other
account I have so far seen of the Lehman failure. Simply put, how did
Lehman’s published financial statements, as recently as its final 10-Q
published in July of 2008, show a positive net worth of $26 billion,
when the bankruptcy liquidators are saying that they are looking at a
negative net worth of $130 billion? Doesn’t any or all this constitute
securities fraud? And shouldn’t there be criminal liability for the
executives who signed the firm’s 10-K and 10-Q’s, who under
Sarbanes-Oxley are responsible for material misstatements made in those
documents?”
Bloomberg’s Weil has a theory about why these
crimes are not being prosecuted:
“There’s been much talk the past two years
about moral hazard, which is the risk that companies and their investors
will behave more recklessly when they believe the government will bail
them out. Less has been made of a similar hazard: The danger that
powerful companies won’t follow the law when their executives believe
the government won’t hold them to it…The latter risk threatens not only
our economy, but our democracy. There’s every reason to believe both
kinds are growing.”
David the CFE and I have
another theory:
Collusion.
The crimes are too numerous to prosecute without
indicting the whole system and most of the major players. And because they
were part of the problem before they were theoretically part of the
solution, culpability also attaches to Paulson and Tim Geithner.
David the CFE’s theory is
premised on some of the oldest tricks in the book for manipulating
revenue recognition and, therefore, reported
profits and incentive compensation payouts including stock options -
roundtrips, parking, and channel stuffing. In
another variation on the theme, global trading company Refco used
a round trip loan to
repeatedly hide a related-party transaction incurred to delay disclosure of
significant uncollectible accounts. It’s not like these techniques haven’t
been used before (by AIG, for example) to offload risk and smooth earnings
at quarter- and year-end.
“This
case shows that the Commission will
pursue insurance companies and other financial institutions that market
or sell so-called financial products that are, in reality, just vehicles
to commit financial fraud,” said Stephen M. Cutler, director of the
SEC’s Division of Enforcement.
With regard to
the financial crisis, these revenue recognition fraud techniques may have
been most useful in establishing
“observability” of market prices for otherwise
illiquid assets. Establishing “market prices” via fraudulent, sham
transactions amongst the market participants before quarter-end and year-end
reporting periods would have allowed assets to remain on the books longer at
inflated values and, therefore, to inflate profits and bonuses. “Market
prices” that appeared to support existing valuations sustained the myth. The
investments were not written down until long after the market for subprime
real estate securities started to wilt.
David the CFE explains
this theory in the case of Lehman Brothers:
Nassim Taleb
says about banks: “Banks hire dull people and
train them to be even duller. If they look conservative, it’s only
because their loans go bust on rare, very rare occasions. But bankers
are not conservative at all. They are just phenomenally skilled at
self-deception by burying the possibility of a large, devastating loss
under the rug.
Taleb further states: “Executives will
game the system by showing good performance so they can get their yearly
bonus.”
Lehman paid out $5.2 billion in bonuses in 2006
and $5.7 billion in bonuses in 2007. Did this result from the
executives at the bank gaming the system to increase their bonuses? An
example of burying a large loss under the rug can be found in this
excerpt from Lehman Brothers in its
2006 10-K:
We held
approximately $2.0 billion and $0.7 billion of non-investment grade
retained interests at November 30, 2006 and 2005, respectively. Because
these interests primarily represent the junior interests in
securitizations for which there are not active trading markets,
estimates generally are required in determining fair value. We value
these instruments using prudent estimates of expected cash flows and
consider the valuation of similar transactions in the market.
Junior interests in securitizations.
Lehman and other firms purchased
mortgages that would effectively be resold by them as collateralized
debt obligations. Each of Lehman’s securitizations was broken into
tranches in which senior interests received greater preference with
respect to collections of interest and principal than junior interests
that were entitled to greater profits, if such profits were realized. A
junior interest in a securitization is the lowest level of the tranches
for collateralized debt obligations. Generally, only the
bottom 3% of a
securitization was labeled as equity.
During 2006, housing prices dropped nationally
by at least 5% from the spring of 2006 to Lehman’s Nov. 30, 2006 and the
default rate was increasing as well. With prices of houses dropping and
the default rate increasing, there was a risk of large losses when the
buyer defaults. Thus, the junior interests in securitizations that
Lehman was purportedly investing in were probably already worthless at
the time that Lehman invested in them or at November 30, 2006.
An auditor would have to suspect a material
loss is being hidden and that collusion between several departments at
Lehman Brothers and management’s participation in the deception was
possible.
Ernst and Young, Lehman’s auditors, were
probably unwilling to consider such a possibility because auditors
accept as dogma that collusion between many employees and multiple
departments is unlikely no matter what the motive, i.e., $5.2 billion in
bonuses. Auditing standards also do not consider collusion likely.
Apparently, auditors did not consider the possibility that two different
groups at Lehman Brothers such as the underwriters who sold the
securitization IPOs and the trading departments would collude to hide a
$1.3 billion loss in a junior equity position that could not be sold.
Hiding losses on CDOs
and mortgages purchased for securitization. A reasonable
question to ask was: If Lehman Brothers started the fiscal year ending
Nov. 2007 with $57 billion of CDOs and held them for the year, what
would their estimated loss be? Also: What would the additional loss be
with $32 billion in CDOs and/or mortgages purchased?
Presumably, the losses would be in the range of
$10 billion to $30 billion. By Nov. 2007, everyone knew of the problems
with CDOs. Bear Stearns had already closed two hedge funds investing in
CDOs. Merrill Lynch had made huge write downs and forced out its CEO. My
guess is that Lehman Brothers engaged in schemes to fool the auditor in
order to avoid disclosing losses from their securitizations and
investments in CDOs.
Lehman probably pulled a variation of the old
“telecom swap.” In the “telecom swap” cases,
one telecom company would sell telecom capacity to another telecom and
then purchase the same amount of telecom capacity from the other party.
The firm selling the capacity would book the amount received as revenue
and the firm purchasing the capacity would book the amount received as a
fixed asset. It worked very well in creating fictitious profits for
those firms.
That same trick could be used by financial
institutions in the case of CDOs/CDSs. Let’s say Financial Institution A
sells collateralized debt obligations with a true fair market value of
90 million to Financial Institution B for 100 million dollars in cash.
Financial Institution B purchases collateralized debt obligations with a
true fair market value of 90 million dollars from Financial Institution
A for 100 million dollars in cash.
And then those phony trades are shown as the
“observable” similar transactions in the market.
Did the auditors check for this item? Probably
not. Why not? Because it’s an example of collusion between Lehman and
other companies. Auditors don’t check for collusion no matter how many
times they get fooled by it!
Continued in article
"Update: Mortgage Servicer Foreclosure Review Process," by Francine
McKenna, re:TheAuditors, December 27, 2011 ---
http://retheauditors.com/2011/12/27/update-mortgage-servicer-foreclosure-review-process/
On November
22, 2011, the Office of the Comptroller of the
Currency (OCC) issued a report on the actions by 12 national bank and
federal savings association mortgage servicers to comply with consent orders
issued in April 2011. These consent orders are intended to correct deficient
and unsafe or unsound foreclosure practices by the servicers. The OCC also
posted the twelve engagement letters between the consultants and the
servicers on the OCC website.
These disclosures were a result of pressure brought
to bear by Congresswoman Maxine Waters and several other congressional
members who sent a letter to the OCC and the Fed on October 28. This letter
expressed the legislators’ displeasure with the way the OCC and the Federal
Reserve Bank had so far run the “independent” foreclosure review process
that is intended to overhaul mortgage-servicing processes and controls and
to compensate borrowers harmed financially by wrongdoing or negligence.
Congresswoman Waters cited my October
6 column for American Banker in this
letter to the OCC and Fed when demanding that the regulators
manage conflicts of interest in the foreclosure review process as well as
make a full disclosure of vendors and their engagement letters with the
banks.
On December 6, I wrote again in American Banker
after I reviewed the engagement letters that were posted by the OCC. I had
several concerns. Congresswoman Waters did, too.
“[The OCC] issued a report on the actions of a
dozen national bank and federal savings association mortgage servicers
aimed at complying with the consent orders issued in April 2011 to
correct deficient and unsafe or unsound foreclosure practices. (The two
remaining consent order recipients — GMAC/Ally and SunTrust — have not
yet finalized their terms with vendors and as a result their overseers,
Fed Chairman Bernanke and the Federal Reserve Bank, have not yet
responded to the request for full disclosure, according to the Water’s
office.)
Waters was less than impressed with what she
saw and so am I. She told me, “My letters specifically asked for
information on conflicts of interest between the banks and the
consultants — which is precisely what the OCC redacted
in the information they released last week. A cursory look into the
banks and their consultants indicates that in some cases, there are
substantial pre-existing relationships between the firms.”
Redacted is an
understatement.
Here’s what was redacted, according to OCC
spokesman Bryan Hubbard:
Limited proprietary and personal information has
been redacted from the engagement letters including, but not limited to:
- Names,titles and biographies of individuals;
- Proprietary systems information;
- References to specific bank policy;
- Fees and costs associated with the engagement;
- Specific descriptions of past work performed
by the independent consultants.
So what’s left? It’s interesting enough, as a
start, to look at which consultants and law firms were selected by which
servicers. It’s also interesting to look at the scope of services to be
performed and the time and volume estimates for project activities where
they were not redacted.
Continued in article
Adjustable Rate Mortgage ---
http://en.wikipedia.org/wiki/Adjustable_Rate_Mortgage
Video: Strong ARM of Mortgage Bubble is Building to Burst:
"Second Financial Economic Crash Coming - Huge & Soon," CBS Sixty Minutes
---
http://www.youtube.com/watch?v=JKlBJavw_X4
"Dear Bank of America, I'd Like to Schedule a Default," by Austin
Hill, Townhall, January 3, 2009 ---
http://townhall.com/columnists/AustinHill/2010/01/03/dear_bank_of_america,_id_like_to_schedule_a_default
Dear Bank of America;
Hi, it’s me, your customer Austin. I’m writing to
schedule my mortgage default.
That’s right, I’m ready to schedule my mortgage
default. Does that sound strange?
Well, believe me, Bank of America, I had hoped that
our relationship wouldn’t come to this. But after months of trying to do
business with you, I’ve decided that it’s probably in my best interest to
just, you know - “walk away” from my mortgage.
How could it ever be in anyone’s best interest to
default on a mortgage? And why would anyone ever want to default on a
mortgage?
Well, here’s the deal: I have one of those
now-famous “Option ARM” loans on my residence – the interest rate is
adjustable, and the loan provides optional payment plans. And yes, Bank of
America, you inherited my loan when Countrywide Lending went down the tubes
in 2008, and you merged your company with theirs.
And here are some other details about me, Bank of
America: I am fortunate to have a great job with a solid income, and I work
under a long term employment contract. While my full time occupation is
being a daily talk show host, I am also a writer and a public speaker, so I
have multiple streams of income. I own real estate in multiple regions of
the U.S., and I’m a big believer in real estate as a long term investment.
And perhaps most interesting for you, Bank of America, I have a great credit
score, and I’m current on all my debt payments.
During the recent real estate “boom,” I took some
equity out of my home. Now, in the aftermath of the real estate “bust,” my
house is slightly “under water” – not by much, but a little. And the
interest rate on my loan won’t begin to move upward for another two years,
so I’m not in any crisis right now.
The value of my property has actually begun to move
upward a bit in the past few months, but it’s going to be a few years before
the value reaches parity with my debt. And that’s why I was thrilled to get
that little note you sent me in the mail last summer, Bank of America.
Remember? You sent me that nice letter asking if I’d like to have my loan
modified to a 30 year, fixed rate mortgage.
I responded quickly to that letter, Bank of
America. And I’ve called repeatedly for over half a year. But here’s the sad
truth that I’ve discovered about you: you’re not really interested in
working with me, because I’m not behind on my payments
With each and every call, Bank of America, I get
the same treatment. Once your customer service representative checks the
data base and realizes that I’m current on my payments, they “transfer my
call” to “another department” – and from there, I’m left on hold. If another
representative picks up, they want to transfer me again. And if I actually
have a conversation with anybody, I’m treated to a person reading through a
litany of “assessment questions” and surveys and evaluations. And then I’m
transferred again.
After repeatedly being told that there is immediate
help available to Bank of America customers who are delinquent, I finally
started asking, “so will you talk to me about a loan modification if I stop
making payments?” And to that question, I’ve repeatedly heard the same
answer: “I could never advise you to not make your payments Mr. Hill” the
representative will say, “I’m just telling you that if you become delinquent
we have help available…”
I’m not the only person who has this disturbing
kind of relationship with you, Bank of America. I discussed this on my talk
show in Boise, Idaho, and was inundated with calls and email detailing the
same sad story. I even addressed this over the holidays on a radio talk show
where I was guest hosting in Phoenix, Arizona – one of the most tumultuous
real estate markets in the country – and got the same response.
I’ve also talked with lots of personal friends
about this, Bank of America. People from Los Angeles to Chicago to
Washington, D.C., and from all walks of life. People with high school
diplomas and M.D.’s and MBA’s and Ph.D’s and J.D.’s. We’re current on our
payments, have great credit, and want to continue our relationships with
you. But you’re not taking our calls.
It’s sad to realize that as you focus on your
“troubled assets,” and ignore those of us with good credit, you’re likely
creating more troubled assets in the process. But that’s the system you’ve
put in place, Bank of America. It’s a system that rewards people’s bad
behavior, while punishing other people’s good behavior.
So after spending half a year trying to take
advantage of the offer you extended to me in the mail, I now understand what
your actual system entails. And I’ve calculated the risks of working within
the system you’ve put in place.
I’m ready to schedule my default. What would you
like to do next?
Bailing Out Big Banks Engaged in Sleaze and Sex
"Goldman Laid Down with Dogs," by Ryan Chittum, Columbia Journalism
Review, November 4, 2009 ---
http://www.cjr.org/index.php
This link was forwarded by my friend Larry.
Dean Starkman has been applauding McClatchy’s
series on Goldman Sachs (an Audit funder) for
a couple of
days now. Add another Audit appreciation today.
McClatchy has been doing what Dean has been calling
for for a long time now: Looking much more closely at
how Wall Street
fueled the mortgage crisis and how it
was deeply connected
to the
shadier parts of the
housing industry. Or as McClatchy’s Greg Gordon puts it:
… one of Wall Street’s proudest and most
prestigious firms helped create a market for junk mortgages,
contributing to the economic morass that’s cost millions of Americans
their jobs and their homes.
Today,
McClatchy examines Goldman’s relationship with New
Century Financial, a firm that was something of the canary in the coalmine
of this financial crisis—it was the second-biggest subprime mortgage lender
when it went belly-up in April 2007, which was very, very early. In other
words, it was one of the worst actors in the whole mess:
Perhaps no mortgage lender was more emblematic of
the go-go atmosphere in the sprouting industry that was seizing an
outsize share of the home loan market.
Traversing the country in private jets and
zipping around Southern California in Mercedes Benzes, Porsches and even
a Lamborghini, New Century executives reveled as the firm’s annual
residential mortgage sales rocketed from $357 million in 1996 to nearly
$60 billion a decade later…
What does that have to do with Goldman Sachs and
Wall Street?
For $100 million in mortgages, New Century could
command fees from Wall Street of $4 million to $11 million, ex-employees
told McClatchy. The goal was to close loans fast, bundle them into pools
and sell them to generate money for the next round.
Inside the mortgage company, the former
employees said, pressure was intense to increase the firm’s share of an
exploding market for mortgages that depended almost entirely on Wall
Street’s seemingly unlimited hunger for bigger, faster returns.
Aha! But wait—why did Wall Street want to buy this
trash?
Goldman and other investment banks could put $20
million in the till by taking a 1 percent fee for assembling,
securitizing and selling a $2 billion pool of mostly triple-A rated
bonds backed by subprime loans — and that was just stage one.
That takes you to “The
Giant Pool of Money.” And that was far from the
only juice being squeezed from these lemons. Goldman et al got servicing
fees and the like, plus they “extended lines of credit to New Century —
known as “warehouse loans” — totaling billions of dollars to finance the
issuance of more home loans to other marginal borrowers. Goldman Sachs’
mortgage subsidiary gave the firm a $450 million credit line.”
In other words, Wall Street lent the money to the
predatory firms to create the shady loans so it could buy them from them,
slice them into securities and sell them to the greater fools. This was so
profitable there weren’t enough decent loans to be made. So to feed the
beast, mortgage lenders came up with disastrous inventions like NINJA loans
(No Income, No Jobs, No Assets) and Wall Street, ahem, looked the other way.
It was a vicious circle of profit (virtuous—if you
were one of those who lined their pockets through it) and was interrupted
only when the underlying loans got so bad that borrowers like the ones with
no income, no jobs, and no assets in many instances couldn’t even make a
single payment on the loan. Panic!
McClatchy does well to report on the New Century
culture, helpful in illustrating the lie-down-with-dogs-get-up-with-fleas
thing, writing about the sexualization of some of the work, something
reminds us of
BusinessWeek’s
fascinating story on the subprime
industry’s descent into decadence (the sub headline on that one should be
all that’s needed to entice you to read that one: “The sexual favors,
whistleblower intimidation, and routine fraud behind the fiasco that has
triggered the global financial crisis.”)
But it wasn’t just sex. New Century was giving
kickbacks to mortgage brokers to get their loans, McClatchy quotes a former
top underwriter there as saying.
Let’s not forget, and McClatchy doesn’t,
thankfully, that borrowers were the marks here and took it on the chin:
The loans laid out financial terms that protected
investors but punished homebuyers. They offered above-market interest
rates, typically starting at 8 percent, with provisions that Lee said
were “rigged” to guarantee the maximum 3 percent rise in interest rates
after two years and almost assuredly another 3 percent increase through
ensuing, twice-yearly adjustments.
This is top-notch work by McClatchy. It deserves a
wide airing.
"Going Concern Audit Opinions: Why So Few Warning Flares?" by Francine
McKenna, re: The Auditors, September 18, 2009 ---
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Lehman Brothers. Bear Stearns. Washington Mutual.
AIG. Countrywide. New Century. American Home Mortgage. Citigroup. Merrill
Lynch. GE Capital. Fannie Mae. Freddie Mac. Fortis. Royal Bank of Scotland.
Lloyds TSB. HBOS. Northern Rock.
When each of the notorious “financial crisis”
institutions collapsed, were bailed out/nationalized by their governments or
were acquired/rescued by “healthier” institutions, they were all carrying in
their wallets non-qualified, clean opinions on their financial statements
from their auditors. In none of the cases had the auditors warned
shareholders and the markets that there was “ a substantial doubt about the
company’s ability to continue as a going concern for a reasonable period of
time, not to exceed one year beyond the date of the financial statements
being audited.”
Continued in a very good article by Francine (she talks with some major
players)
http://retheauditors.com/2009/09/18/going-concern-audit-opinions-why-so-few-warning-flares/
Francine maintains an outstanding auditing blog at
http://retheauditors.com/
Bob Jensen's threads on "Where Were the Auditors?" ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
Some auditing firms are now being hauled into court in bank shareholder
and pension fund lawsuits ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Auditors
"Why academia failed to see the financial crash coming," Los
Angeles Times, April 28, 2009 ---
Click Here
One interpretation, understandably popular
given our current plight, is that the basic economic theory informing
the actions of central bankers and regulators was fatally flawed.
But another view, considerably closer to the
truth, is that the problem lay not so much with the poverty of the
underlying theory as with selective reading of it . . . [which]
encouraged financial decision makers to cherry-pick the theories that
supported excessive risk-taking.
It discouraged whistle-blowing, not just by
risk-management officers in large financial institutions, but also by
the economists whose scholarship provided intellectual justification for
the financial institutions’ decisions. The consequence was that
scholarship that warned of potential disaster was ignored.
. . .
Generous speaker’s fees were . . . available to
those prepared to drink the Kool-Aid. Not everyone indulged. But there
was nonetheless a subconscious tendency to embrace the arguments of
one’s more "successful" colleagues in a discipline where money, in this
case earned through speaking engagements and consultancies, is the
common denominator of success.
April 29, 2009 reply from Bob Jensen
Where was the Center for Disease Control of Toxic Mortgages?
It's easy in hindsight to attribute failure of professors to predict
disaster and forcefully warn the public.
However, I don't think academics had any more advanced warning than the
general public about the massive extent to which frauds being generated by
reputable banks, mortgage brokers, and real estate appraisers --- the
millions upon millions of intentional lies being put forth about borrowers'
credit personal incomes and lies about the values of real estate needed to
obtain loans.
Certainly there were eventual second-order frauds regarding CDO cookie
crumbling dispersions of default risk farther than Tinkerbelle can fly, but
I doubt that any respected academic had inside information on the massive
amount of poison being manufactured on Main Street itself. Certainly many
professors saw the unhealthy risks of sub-prime loans with short-term teaser
rates, but the general public not was not aware of the massive deceptions
generated by brokers and appraisers having a feeding frenzy on commission
fees for mortgages to be passed along to Fannie, Freddie, and investment
banks like Merrill Lynch.
In other words there was no Center for Disease Control of Toxic
Mortgages. Certainly, there were responsibilities of internal and external
auditors of banks and mortgage companies to verify the "truth" of some
mortgage applications and real estate appraisals, so audit failure
contributed to our prolonged ignorance.
I most certainly think that banks issuing mortgages would've done a
better job of internal auditing if they had to keep those mortgage
investments on their own books. But when these mortgages were sold without
recourse at the speed of light to suckers up the line, the incentives for
internal auditing evaporated. Default risk became somebody else's problem
before the ink was dry on the contracts.
But much of the problem was a professional responsibility problem rather
than an academic problem. The risk dispersion models would've worked if they
were not fed in lethal doses of arsenic administered on Main Streets of
America.
Ironically one of the Comments published beneath this article states the
following:
*****Begin Quotation
Michael Hudson, Distinguished Research Professor of Economics at the
University of Missouri, Kansas City, saw it coming--and said so.
In addition to writing magazine articles, Prof.
Hudson was Rep. Dennis Kucinich's economic adviser.
Had the mainstream media allowed Mr. Kucinich
to be heard during the 2008 presidential campaign, we would have had a
chance to hear the thoughts of Mr. Hudson--and perhaps avert the
economic horror now upon us.
And folks like Mr. Hudson are still not being
heeded. .
*****End Quotation
Firstly note that none of Hudson so-called publications are cited and I
doubt that they are in the mainstream of academic literature. Secondly, and
more importantly, ACORN has never had a better friend than the one of the
most liberal members of Congress --- Dennis Kucinich. Rep. Kucinich along
with Barney Frank was on the forefront of forcing Fannie Mae and Freddie
Mack to buy up mortgages of poor people who had zero chance of making
mortgage payments. Fannie had to knowingly gulp down toxins when powerful
members of Congress like Frank and Kucinich made it impossible to demand
greater creditworthiness of poor people applying for mortgages.
Bob Jensen
What should be done about credit rating companies?
"Ratings Downgrade," by James Surowiecki, The New Yorker, September
28, 2009 ---
http://www.newyorker.com/talk/financial/2009/09/28/090928ta_talk_surowiecki
When
Barack Obama went to Wall Street last week to make the case for meaningful
financial regulation, he took well-deserved shots at some of the villains of the
financial crisis: greedy bankers, reckless investors, and captive regulators.
But to that list he could have added credit-rating agencies like Standard &
Poor’s and Moody’s. By giving dubious mortgage-backed securities top ratings,
and by dramatically underestimating the risk of default and foreclosure, the
agencies played a key role in inflating the housing bubble. If we’re going to
reform the system, fixing them should be high on the list.
Unfortunately, that’s not an easy task, since over the years the government has
made the agencies an increasingly important part of the financial system. Rating
agencies have been around for a century, and their ratings have been used by
regulators since the thirties. But in the seventies the S.E.C. dubbed the three
biggest agencies—S. & P., Moody’s, and Fitch—Nationally Recognized Statistical
Rating Organizations, effectively making them official arbiters of financial
soundness. The decision had a certain logic: it was supposed to make it easier
for investors to know that the money in their pension or money-market funds was
going into safe and secure investments. But the new regulations also turned the
agencies from opinion-givers into indispensable gatekeepers. If you want to sell
a corporate bond, or package a bunch of mortgages together into a security, you
pretty much need a rating from one of the agencies. And though the agencies are
private companies, their opinions can effectively have the force of law. The
ratings often dictate what institutions like banks, insurance companies, and
money-market funds can and can’t do: money-market funds can’t have more than
five per cent of their assets in low-rated commercial paper, there are limits on
the percentage of non-investment-grade assets that banks can own, and so on.
The
conventional explanation of what’s wrong with the rating agencies focusses on
the fact that most of them are paid by the very people whose financial products
they rate. That problem needs to be fixed, and last week the S.E.C. proposed new
rules to address conflicts of interest. But there’s a much bigger problem, which
is that, even though nearly everyone knows that the agencies are compromised and
exert too much influence, the system makes it impossible not to rely on them. In
theory, of course, the mere fact that a rating agency says a particular bond is
AAA (close to risk-free) doesn’t mean that investors have to buy it; the
agencies’ opinions should be just one ingredient in any decision. In practice,
the government’s seal of approval, coupled with those regulatory requirements,
encourages investors to put far too much weight on the ratings. According to a
recent paper on the subject by the academics Darren Kisgen and Philip Strahan,
that’s true even when the agency doing the rating doesn’t have a long track
record. During the housing bubble, investors put a huge amount of money into
AAA-rated mortgage-backed securities—which would have been fine had the rating
agencies’ judgments been sound. Needless to say, they weren’t. Despite subprime
borrowers’ notoriously shaky finances, the agencies failed to allow for the
possibility that housing prices might fall sharply.
The
rating agencies’ role in inflating the bubble is well known. Less obvious is
their role in accelerating the crash. Agencies have typically resisted changing
their ratings on a frequent basis, so changes, when they occur, tend to be
belated, widespread, and big. In the space of just a few months between late
2007 and mid-2008 (after the housing bubble burst), the agencies collectively
downgraded an astonishing $1.9 trillion in mortgage-backed securities: some
securities that had carried a AAA rating one day were downgraded to CCC the
next. Because many institutional investors are prohibited from owning too many
low-rated securities, these downgrades necessarily led to forced selling,
magnifying the panic, and prevented other investors from swooping in and buying
the distressed debt cheaply. In effect, the current system pushes many big
investors to buy high and sell low.
Rating
agencies existed long before they carried a government imprimatur, and, their
recent dismal performance notwithstanding, they’ll exist in the future, if only
because few investors have the patience to sort through all the bond offerings
and structured-finance deals out there. But we need a divorce: the rating
agencies shouldn’t be government-sanctioned and government-protected
institutions and their judgments shouldn’t be part of the rules that govern how
investors can act.
Given
how rarely real reform happens in Washington, that may sound like a hopeless
goal. But last summer the S.E.C. seriously considered enacting a series of
proposals that would have gone some way toward uncoupling the rating agencies
from the regulatory system. The plan fizzled, however, thanks in part to
pressure from a surprising source: big investors. Oddly, the ratings system,
broken as it is, remains attractive to many investors who have been burned by
it. For one thing, it provides an easily comprehensible standard: without it,
we’d need to come up with new ways of measuring risk. More insidiously, the
ratings system provides a ready-made excuse for failure: as long as you’re
buying AAA-rated assets, you can say you’re being responsible. After the housing
crash, though, we know how illusory those AAA ratings can be. It’s time for
investors to face reality: working with a fake safety net is more dangerous than
working without any net at all.
Bob Jensen's threads on credit rating agencies ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
"Rating agencies lose free-speech claim," by Jonathon Stempel,
Reuters, September 3, 2009 ---
http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE5824KN20090903
Credit rating agencies may find it harder to argue
that their opinions deserve free speech protection after a judge rejected
efforts by Moody's Investors Service and Standard & Poor's to dismiss a
fraud lawsuit.
In a case alleging that inflated ratings on risky
mortgages led to investment losses, U.S. District Judge Shira Scheindlin
said on Wednesday that ratings on notes sold privately to a group of
investors were not "matters of public concern" deserving broad protection
under the First Amendment of the U.S. Constitution.
The Manhattan judge said investors may pursue their
lawsuit accusing Moody's, S&P and Morgan Stanley (MS.N), which marketed the
notes, of issuing false and misleading statements about the notes, which
were backed by subprime mortgages and other debt.
Scheindlin's ruling may affect lawsuits by pension
funds -- including the nation's largest, the California Public Employees'
Retirement System, or CalPERS -- and other investors that want to hold banks
and rating agencies responsible for exaggerating the value and safety of
debt in order to win fees.
"This is potentially a very significant opinion,"
said Joseph Mason, a finance professor at Louisiana State University's
business school in Baton Rouge.
"It seems they have found a hole in the First
Amendment defense, the agencies' primary line of defense," he said. "There
is a feeling throughout the investment industry that agencies committed an
egregious breach, but the issue is how to gain traction under the law. This
opinion seems to give hope."
Rating agencies typically get broad free-speech
protection similar to that afforded journalists and plaintiffs must often
show that ratings reflect "actual malice" before they can recover. That
protection, of course, is not absolute.
"The First Amendment doesn't allow anyone to commit
fraud," said George Cohen, a professor at the University of Virginia School
of Law.
Sean Egan, managing director of Egan-Jones Ratings
Co, an independent agency critical of how rivals are compensated, called
Scheindlin's ruling "a watershed event. This is the first major breach in
the First Amendment defense, and makes it substantially easier for other
plaintiffs."
FEES TIED TO RATINGS
The ruling concerned the Cheyne Structured
Investment Vehicle, a package of debt that included subprime mortgages.
Scheindlin said Cheyne issued some notes with
"triple-A" ratings, the same as the U.S. government, and others that won
"the highest credit ratings ever given to capital notes."
Meanwhile, the rating agencies were paid more than
three times their normal rate and their fees were "contingent upon the
receipt of desired ratings," she said.
Desirable ratings did nothing to save the Cheyne
SIV. It went bankrupt in August 2007.
"You can't yell fire in a crowded theater, but here
it seems the agencies were doing the opposite," said Jonathan Macey, a
professor at Yale Law School. "There was a fire, but they were saying there
was nothing to worry about and taking money for saying that."
Continued in article
Jensen Comment
Expert Financial Predictions (John Stewart's hindsight video scrapbook) ---
http://www.technologyreview.com/blog/post.aspx?bid=354&bpid=23077&nlid=1840
You have to watch the first third of this video before it gets into the
scrapbook itself
The problem unmentioned here is one faced by auditors and credit rating agencies
of risky clients every day: Predictions are often self fulfilling
If an auditor issues going concern exceptions in audit reports, the
exceptions themselves will probably contribute to the downfall of the clients
The same can be said by financial analysts who elect to trash a company's
financial outlook
Hence we have the age-old conflict between holding back on what you really
secretly predict versus pulling the fire alarm on a troubled company
There are no easy answers here except to conclude that it auditors and credit
rating agencies appeared to not reveal many of their inner secret predictions in
2008
Auditing firms and credit rating agencies lost a lot of credibility in this
economic crisis, but they've survived many such stains on their reputations in
the past
By now we're used to the fact that the public is generally aware of the fire
before the auditors and credit rating agencies pull the alarm lever
On the other hand, financial wizards who pull the alarm lever on nearly every
company all the time lose their credibility in a hurry
Bob Jensen's threads on fraud in the subprime lending scandals ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies
Bob Jensen's threads on fraud in credit rating agencies are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Where were the auditors ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"Let's (Credit) Grade Wall Street Like Colleges: The more rating
agencies the better," The Wall Street Journal, September 15, 2009 ---
http://online.wsj.com/article/SB10001424052970203917304574413072842297920.html#mod=djemEditorialPage
Is Harvard really the best?
It turns out that depends on who you ask—and what
you ask. As students across America return to campus for the new school
year, new editions of three prominent college guides variously rank Harvard
at No. 1, No. 5, and No. 11. Therein lies a timely lesson for our system of
credit ratings.
Some students know from their earliest days they
want to go to Harvard, while others may want to follow mom or dad to East
Carolina or Purdue. Many more rely on the annual college guides to help them
make one of the most important financial decisions in their lives—in much
the same way an investor might look to Moody's to tell them about the
reliability of a corporate bond. The question with both is just how reliable
those ratings are.
When the housing bubble popped, our financial
institutions learned—the hard way—that the mortgage-backed securities on
their balance sheets did not merit the AAA-grades the credit ratings
agencies had assigned them. Similar complaints have long been advanced about
the trustworthiness of college guides. As the dominant player, U.S. News &
World Report's annual America's Best Colleges guide has borne the brunt of
this criticism.
In public, college presidents, deans, and spokesmen
pooh-pooh the U.S. News rankings. In private, however, many do what they can
to boost their schools up the rankings ladder. One area open to manipulation
has to do with the "peer assessment" category that accounts for a quarter of
the U.S. News ranking.
Earlier this year, Inside Higher Ed reported on a
charmingly frank presentation by a Clemson University official who admitted
her school's officials use the peer assessment to rate "all programs other
than Clemson below average." The university denied the charge. But further
reporting revealed that Clemson President James Barker had given his only
"strong" rating to his own school, while giving lower grades to every other
college in the land.
The revelations have been an embarrassment for
Clemson. Still, the woman who set off the firestorm was surely right when
she said, "I'm confident my president is not the only one who does that."
Other schools, after all, have found themselves in the news for manipulating
the way they report to U.S. News everything from their average SAT scores
and alumni giving to per pupil spending and class profiles.
So if the U.S. News report is so flawed, where's
the lesson for Wall Street? The answer lies in the new competition the U.S.
News guide has spawned. In the last few years, the Washington Monthly and
Forbes have each offered guides of their own. They are joined by the
American Council of Trustees and Alumni, which measures colleges by whether
they require seven core subjects the authors deem essential for a solid
liberal arts education. There's even the conservative Intercollegiate
Studies Institute's "Choosing the Right College," which offers advice about
the best professors and courses to seek out on campuses.
Different measures, of course, lead to different
results. The latest U.S. News guide has Harvard and Princeton tied for No.
1, followed by Yale. Over at the Washington Monthly, by contrast—where
editors measure colleges by how well they do at promoting social mobility,
national service and research—Harvard falls to No. 11. And the top three
slots are taken by public universities in the University of California
system: UC Berkeley, UC San Diego and UCLA.
Then there's Forbes, which just ranked West Point
as "America's Best College." The Forbes ratings include student satisfaction
with courses, post-graduate employment success (including salary data and
entries in Who's Who), the likelihood of graduation within four years, and
the average level of debt graduates are stuck with.
Which guide is best at picking the best? The answer
is that no single measurement or guide can tell everyone everything. The
more measures students and parents have, the fuller the picture before them,
and the better equipped they are to make a smart decision. Because the
federal government is not in the business of certifying particular college
guides, moreover, they compete by persuading students and parents to buy
them on the quality and relevance of their findings.
At a time when the Securities and Exchange
Commission is looking for ways to improve the flawed credit ratings that
contributed so much to our financial crisis, it might do well to stop
anointing particular credit rating agencies. Forcing these firms to compete
for customers the way the college guides do would give us better ratings—and
fewer investors lulled into the complacency that comes from thinking Uncle
Sam has done the due diligence. At least when it comes to ratings, the
Groves of Academe have a thing or two to teach our captains of finance about
competition.
Bob Jensen's threads on systemic problems of accountancy (including the
aggregation ratings of nutrients in vegetables) are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews
- Systemic Problem:
All Aggregations Are Arbitrary
- Systemic Problem:
All Aggregations Combine Different Measurements With Varying
Accuracies
- Systemic Problem:
All Aggregations Leave Out Important Components
- Systemic Problem:
All Aggregations Ignore Complex & Synergistic Interactions
of Value and Risk
- Systemic Problem: Disaggregating of Value or Cost is
Generally Arbitrary
- Systemic Problem:
Systems Are Too Fragile
- Systemic Problem:
More Rules Do Not Necessarily Make Accounting for
Performance More Transparent
- Systemic Problem:
Economies of Scale vs. Consulting Red Herrings in Auditing
- Systemic Problem:
Intangibles Are Intractable
|
Bob Jensen's threads on credit rating agencies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
When Private Equity Owners Screw Their Bankers
The sad part is that Wachovia did not require independent audits
Now there are no deep pocket auditors to sue
Wachovia, for instance, provided tens of millions of
dollars in loans and lines of credit backed by assets to Archway despite the
fact the company had not had a formal independent audit of its financial
statements in three years. A spokeswoman for Wells Fargo, which acquired
Wachovia last year, declined comment.
"Oh, No! What Happened to Archway?" by Julie Creswell, The New York Times,
May 30, 2009 ---
http://www.nytimes.com/2009/05/31/business/31archway.html?_r=1
SITTING in his office late one evening in April
last year, Keith Roberts, the director of finance for the Archway & Mother’s
Cookie Company, stared in shocked silence at the numbers on his desk.
He knew things had been bad — daily reports he had
been monitoring for six months showed that cookie sales at the company had
been dismal. But the financial data he was looking at showed much more
robust sales.
“Where on earth had all of these sales come from?”
Mr. Roberts recalls thinking to himself.
Tired, but intrigued, he began digging through
orders and shipping and inventory records until, well after midnight, he
reached the conclusion that Archway, based in Battle Creek, Mich., was
booking nonexistent sales.
He reasoned that sham transactions allowed Archway,
which was owned by a private-equity firm, Catterton Partners, to maintain
access to badly needed money from its lender, Wachovia. Mr. Roberts’s
investigation eventually caused Wachovia to pull its financing lines,
helping to push Archway into bankruptcy last fall. Two other food companies
picked off much of its assets earlier this year for $42 million and are
churning out the brands’ cookies again.
As accounting scandals go, Archway is no Enron. Not
in the size of the possible accounting fraud itself — sales were probably
overstated by a few million dollars — or in its sophistication or ingenuity.
Yet what court documents filed in Delaware describe as a fairly simplistic
fraud went on for months, seemingly missed by the company’s lenders as well
as its savvy, private-equity stewards.
And Archway’s collapse is a reminder of the
apparent lengths to which some of the nation’s biggest banks went to do
deals with private-equity firms during the recent buyout boom.
Wachovia, for instance, provided tens of millions
of dollars in loans and lines of credit backed by assets to Archway despite
the fact the company had not had a formal independent audit of its financial
statements in three years. A spokeswoman for Wells Fargo, which acquired
Wachovia last year, declined comment.
Archway’s failure also raises questions about how
some private-equity shops operate. When they acquire broken companies, the
firms pledge to use their financial, strategic and operational expertise to
fix them. The firms receive management fees from their portfolio companies
while also charging investors — large institutions and pension funds — fees
for managing their money.
Although Catterton placed three of its partners on
Archway’s board, naming one as vice chairman, it hired a management company,
Insight Holdings, to handle day-to-day operations at Archway. Several former
executives and employees who worked at Archway’s headquarters say Insight
conducted most of its oversight of the company via telephone and
videoconferences.
The Catterton partners, these former employees say,
were never seen at Archway. Catterton and Insight nonetheless collected
about $6 million in management fees and compensation during their nearly
four-year tenure running Archway, court documents assert.
In an e-mailed statement, a spokeswoman for
Catterton said the firm did make on-site visits to Archway and stopped
receiving fees in October 2007. In total, she said, Catterton received only
$2.75 million in fees, half of which was distributed to its investors.
A multitude of lawsuits have been filed in
connection with Archway’s collapse, including suits brought by former
employees as well as independent distributors. In one suit filed earlier
this year in Delaware bankruptcy court, a committee of unsecured creditors
contends that the alleged accounting fraud continued for as long as it did
because of the “control, participation and acquiescence” of Catterton.
Continued in article
"13 Indicted In $100 Million Mortgage Fraud Case," by Lisa Chow, NPR
(audio), July 9, 2009 ---
http://www.npr.org/templates/story/story.php?storyId=106415891
Prosecutors in New York
have charged 13 people with running a massive mortgage fraud scheme. They say
everyone was in on the alleged scheme: lawyers, appraisers and mortgage brokers.
According to the
indictment, mortgage company AFG Financial Group, based on Long Island, targeted
properties whose owners were starting to default on their mortgages.
The company recruited
"straw buyers" — people with good credit scores — to apply for a loan to buy the
target property, while promising the distressed owners that they'd get to stay
in the home.
The indictment says they
paid appraisers to inflate the value of the property. Then they allegedly paid
off lawyers to represent all parties: the seller, the buyer and the bank at the
closing.
Manhattan District
Attorney Robert Morgenthau says the group fraudulently obtained $100 million in
mortgage loans.
"One of the morals of
this case is there is no free lunch," Morgenthau says. "People with distressed
properties thought they were being bailed out. They didn't look carefully at all
at what the transaction was."
Morgenthau says 25 people
were involved in the scheme, and 12 already have pleaded guilty.
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
CPA auditors will undoubtedly be drawn into the
Calpers lawsuit because of the way auditors went along with absurd
underestimations of bad debt and loan loss reserves. For claims that auditors
knew these reserves were badly underestimated see the citations at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
"Calpers Sues Over Ratings of Securities,"
by Leslie Wayne, The New York Times, July 14, 2009 ---
http://www.nytimes.com/2009/07/15/business/15calpers.html
The nation’s
largest public pension fund has filed suit in California state court in
connection with $1 billion in losses that it says were caused by “wildly
inaccurate” credit ratings from the three leading ratings agencies.
The suit from the
California Public Employees Retirement System, or
Calpers, a public fund known for its shareholder
activism, is the latest sign of renewed scrutiny
over the role that credit ratings agencies played in
providing positive reports about risky securities
issued during the subprime boom that have lost
nearly all of their value.
The
lawsuit, filed late last week in California Superior
Court in San Francisco, is focused on a form of debt
called structured investment vehicles, highly
complex packages of securities made up of a variety
of assets, including subprime mortgages. Calpers
bought $1.3 billion of them in 2006; they collapsed
in 2007 and 2008.
Calpers maintains that in
giving these packages of securities the agencies’
highest credit rating, the three top ratings
agencies —
Moody’s Investors Service,
Standard & Poor’s and
Fitch — “made negligent
misrepresentation” to the pension fund, which
provides retirement benefits to 1.6 million public
employees in California.
The
AAA ratings given by the agencies “proved to be
wildly inaccurate and unreasonably high,” according
to the suit, which also said that the methods used
by the rating agencies to assess these packages of
securities “were seriously flawed in conception and
incompetently applied.”
Calpers is seeking damages,
but did not specify an amount. Steven Weiss, a
spokesman for McGraw Hill, the parent company of
Standard and Poor’s, said the company could not
comment until it had been served and seen the
complaint.
Moody’s and Fitch did not
respond to a request for comment.
As the Obama administration
considers an overhaul of the
financial regulatory system,
credit rating agencies have
come in for their share of the blame in the recent
market collapse. Critics contend that, rather than
being watchdogs, the agencies stamped high ratings
on many securities linked to subprime mortgages and
other forms of risky debt.
Their approval helped fuel a boom on Wall Street,
which issued billions of dollars in these securities
to investors who were unaware of their inherent
risk. Lawmakers have conducted hearings and debated
whether to impose stricter regulations on the
agencies.
While the lawsuit is not the first against the
credit rating agencies, some of which face
litigation not only from investors in the securities
they rated but from their own shareholders, too, it
does lay out how an investor as sophisticated as
Calpers, which has $173 billion in assets, could be
led astray.
The
security packages were so opaque that only the hedge
funds that put them together — Sigma S.I.V. and
Cheyne Capital Management in London, and Stanfield
Capital Partners in New York — and the ratings
agencies knew what the packages contained.
Information about the securities in these packages
was considered proprietary and not provided to the
investors who bought them.
Calpers also criticized what contends are conflicts
of interest by the rating agencies, which are paid
by the companies issuing the securities — an
arrangement that has come under fire as a
disincentive for the agencies to be vigilant on
behalf of investors.
In
the case of these structured investment vehicles,
the agencies went one step further: All three
received lucrative fees for helping to structure the
deals and then issued ratings on the deals they
helped create.
Calpers said that the three agencies were “actively
involved” in the creation of the Cheyne, Stanfield
and Sigma securitized packages that they then gave
their top credit ratings. Fees received by the
ratings agencies for helping to construct these
packages would typically range from $300,000 to
$500,000 and up to $1 million for each deal.
These fees were on top of the revenue generated by
the agencies for their more traditional work of
issuing credit ratings, which in the case of complex
securities like structured investment vehicles
generated higher fees than for rating simpler
securities.
“The
ratings agencies no longer played a passive role but
would help the arrangers structure their deals so
that they could rate them as highly as possible,”
according to the Calpers suit.
The
suit also contends that the ratings agencies
continued to publicly promote structured investment
vehicles even while beginning to downgrade them. Ten
days after Moody’s had downgraded some securitized
packages in 2007, it issued a report titled
“Structured Investment Vehicles: An Oasis of Calm in
the Subprime Maelstrom.”
Bob Jensen's threads on the bad behavior of credit ratings agencies see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
At the Airport With $70,000 in his shoes
An American fugitive accused in a $100-million (U.S.) mortgage fraud was caught
at the Canadian border after taking a taxi from Toronto with $1-million in Swiss
bank certificates and $70,000 stuffed in his shoes, authorities said Wednesay.
Authorities said Christopher Warren also was carrying four ounces of platinum
valued at more than $1,000 an ounce when he was arrested entering the United
States at Buffalo, N.Y., before midnight Tuesday. Mr. Warren is the second of
three fugitives to be caught in the investigation of Loomis Wealth Solutions, an
investment company based in Roseville, Calif., and several related companies.
Court documents say they had defrauded investors and mortgage companies of
$100-million since 2006. The deals involved 500 homes and condominiums in
California, Florida, Nevada, Illinois, Colorado and Arizona, Internal Revenue
Service affidavits said. Mr. Warren admits his guilt in an essay appearing
online, and blames himself and his colleagues for helping to cause the U.S.
financial meltdown by creating hundreds of millions of dollars in fraudulent
mortgages that went bad.
"Fugitive financier arrested at U.S. border," The Globe and
Mail (Canada), February 12, 2009 ---
http://www.theglobeandmail.com/servlet/story/RTGAM.20090212.wfugitive12/BNStory/International/home?cid=al_gam_mostview
Read about poor Marvene ---
http://faculty.trinity.edu/rjensen/FraudMarvene.htm
How you can adopt Christopher Warren --- ----
http://www.youtube.com/watch?v=qDC0qcf0kzE
"The role fraud played in the mortgage crisis...interview with an industry
insider," by Dave Gibson, Norfolk Examiner, Aprill 11, 2009 ---
Click Here
http://www.examiner.com/x-5919-Norfolk-Crime-Examiner~y2009m4d11-The-role-fraud-played-in-the-mortgage-crisisinterview-with-an-industry-insider
After writing several articles about this country’s
mortgage meltdown and the little-talked about role which illegal aliens have
played in this crisis, a woman who I will call “Mary” contacted me with
inside information on the crisis. What follows is a brief interview I
conducted with Mary. (I am protecting her identity because she still works
in the mortgage business.)
Q) What is your background and who have you worked
for?
A) I am in the Mortgage Industry and personally
audited thousands of sub prime loans while working as a contractor. The last
company I worked for was EMC, previously owned by Bear Stearns so I thought
I would share the caveat on these loans.
Q) When my wife and I bought our home, we had to
provide a mountain of documentation, including federal tax returns. How have
the mortgage lenders allowed illegal aliens to enter into a mortgage loan
without the proper documents?
A) The Sub Prime underwriting guidelines had
special requirements for, what was called, Foreign Nationals….30% down and
full credit package including credit references from their country of origin
and a valid Visa. To circumvent this requirement, the applications were
marked that the borrower was a US citizen then, regardless if the credit
profile did not support such a claim, an underwriter was not allowed to
question. This along with use of stolen SS# or use of their American born
child’s SS# and lax credit requirements that allowed alternative credit,
helped cover the ruse. All required documentation was fraudulent and with
the large use of a/k/a’s, information was hard to track.
Q) What did management do when it was discovered
that a stolen Social Security number was being used by a borrower?
A) It was not uncommon to find a SS# being used by
up to 23 other people or a borrower with 27 a/k/a’s. Management would often
clear a loan that you tagged as fraudulent so it wouldn’t be shelved.
Q) What was the worst case you have seen?
A) One borrower stole the SS# of a retiree and took
out $3.5 million in loans, turned around and did cash-out refi’s, then fled
the country. The retiree was left with ruined credit, $3.5 million in loans
and trouble with the IRS. Over 50% of the sub primes were for cash-out
refi’s. Regardless of the loan criteria used to pull random samplings for
audits, the majority of the last names were Hispanic. The loans I audited
were primarily in CA, NV, AZ, FL, CO, compare those to the states with the
highest number of foreclosures & illegal aliens.
Q) What is your opinion on the $750 billion bailout
engineered by former Treasurer Hank Paulson and approved by Congress?
A) During the bailout, I called my Congressman and
other leadership including Barney Frank and asked if there was a provision
within the Bill that prohibited illegal aliens from being bailed-out…..the
answer was no. I asked if there was a provision in the Bill that helped
homeowners that did not take out sub primes but are faced with losing their
home due to the negative impact of sub primes and was told…..no. So in other
words, those that committed crimes to obtain the loans will get a helping
hand to bail them out, compliments of the US Taxpayer!
Q) Any final thoughts?
A) I cannot tell you how angry I am over this and
you are right…..Congress will not talk about it. I have written to mine
[Congressman] several times over the last year, yet my only response is
their standard form letter. When I call and demand an answer, I have been
told someone will get back with me, of course that never happens. Looks like
we are picking up where we left off before the bail-out.
If Mary’s observations did not anger you, I am
certain that the next bit of information will do the trick.
Of course, we all know that, on October 26, 2001,
President Bush signed the USA Patriot Act. However, I would wager to say
that almost no one knows that contained in section 326(b) of the USA Patriot
Act is a provision that allows US banks to accept Mexican Matricula Consular
cards as a valid form of ID for opening bank accounts.
It should be noted that while our President and
Congress ordered American banks to recognize these Mexican-issued cards,
there is not one Mexican bank which accepts their own government’s Matricula
Consular card as a valid form of ID, because the bearer’s identity is
basically untraceable.
The following is a list of U.S. banks (both
regional and national) and mortgage insurers which are known to offer home
loan programs targeted at illegal aliens:
-Bank of America
-Citigroup
-Deutsche Bank AG
-Fifth Third Bancorp
-Genworth Financial Inc.
-J.P. Morgan Chase
-Liberty Financial
-Mortgage Guarantee Insurance Corp.
-Plaza Bank
-Wachovia
-Wells Fargo
So there you have it. Those elected to represent we
the American people, decided instead to represent the bankers and allow
illegal aliens to borrow money, often using the stolen Social Security
numbers of American citizens. This so-called sub-prime mortgage crisis was
actually a crisis of massive fraud.
And why not?…The banks who made the loans have lost
nothing, because the taxpayers have been forced to bail them out for their
risky and even illegal loans.
Message from Bob Jensen on March 3, 2009
Hi Robin,
Tom Selling is correct. I’m sorry I forwarded this banking crisis explanation
depicting the failing homeowners as alcoholics in Heidi's Bar. It’s very bitter
and equates the people behind on their mortgages to alcoholics intent on
screwing taxpayers. Most were merely sober hopefuls at the racetrack.
Certainly there were many borrowers who conspired with crooked brokers when
refinancing their houses for far more than the house would ever be worth. A
typical scam was Marvene’s scam in Arizona. Marvene’s been in a few bars and has
an income of about $3,000 a month from welfare programs, food stamps and
disability payments related to a back injury. Marvene got in with a crooked
lender called “Integrity” that loaded her up on credit of $75,500 knowing full
well that Marvene could never repay. Marvene got her big luxury truck, her new
electronics, and financed the drug habit of her son. Marvene knew she could
never repay Integrity from her monthly income.
Integrity’s CEO Barry Rybicki and his loan officer, however, had a plan from the
start. They never laid eyes on Marvene’s shack but brokered a $103,000 mortgage
on her shack that neighbors ultimately bought in foreclosure for $10,000 and
tore down because it was such an eyesore. The 107 mortgages that Integrity sold
for $47 million included Marvene’s adjustable rate mortgage. Fannie Mae and
Freddie Mack were forced by Rep. Barney Frank and Sen. Chris Dodd to buy up
mortgages of poor people like Marvene. Of course Integrity, Fannie, and Freddie
knew full well that mortgages like these would never be repaid --- but that was
the big game in town in the subprime era.
You can read about Marvene’s case and see pictures at
http://faculty.trinity.edu/rjensen/FraudMarvene.htm
At the time her shack was still for sale for $15,000 in foreclosure.
Marvene is not an innocent. She’s dumb like a fox in playing the games (read
that government) offered to her in life.
What was wrong about the credit crisis story below is that it equates the credit
crisis with the Marvenes of this world. Sure there were over a million of
Marvenes. But there were also millions of Nelson families (if
you’re old enough you remember little Rick Nelson and his mother Harriet on
television) of middle or upper class means that were conned by unscrupulous
mortgage brokers to get spendable cash by refinancing with subprime adjustable
rate mortgages on homes valued at $200,000 or more. Often it was the mortgage
brokers who lied about their incomes and home values in order to get them to
sign huge mortgages. The Nelsons were honest and law abiding citizens. They were
good family folks that we call yuppies who really believed that their incomes
would increase in time to pay the eventual kick-up in mortgage rates. If their
incomes were not sufficient increased to pay the eventual increase in mortgage
payments, they just assumed real estate values always went up such that they
could sell their home for well above their loan balance and still come out
ahead.
But the real estate market bubble burst!
Harriet Nelson and Marvene are not at all alike.
Harriet Nelson and her loving husband Ozzie defaulted on their subprime
mortgage just like millions of other Nelson-like church-going families defaulted
on their mortgages. These were not alcoholics sitting in bars drinking up
taxpayer money.
Now we move up the ladder of shame. I honestly believe that Rep. Barney Frank
and Sen. Chris Dodd never suspected the real estate bubble would burst. They
were not as street smart as they like to pretend and did not anticipate that
Main Street mortgage brokers would cheat so drastically when submitting lies
about borrower incomes and home values. More importantly, Frank and Dodd, like
the Nelson family, assumed that the odds were 100% that the real estate boom
would never burst.
And those investment banks on Wall Street and other banks made the same
assumption that real estate was better than gold since they had watched their
own homes go up as much as ten times what they paid for them only a few years
back. Sure they knew that there are always loan foreclosures and the odds of
foreclosure were higher with subprime mortgages. But they assumed that they
could diversify this foreclosure risk in
Markowitz-based mathematical models that diversified risk. They let Fannie
and Freddie get stuck with the hopeless Marvene-type mortgages. But they bought
up Nelson-type mortgage cookies and then crumbled the cookies into CDO bonds in
anticipation that a few spoiled crumbs in a CDO bond would not make the entire
bond toxic. And they would’ve been correct if the real estate bubble had not
burst!
The legal and moral issues here concern intention of fraud. Barry Rybicki at
Integrity is an outright crook! Marvene is a willing cheat when given a chance.
The Nelsons simply took what looked like a pretty good gamble. The Harvard and
Wharton graduates at Lehman Brothers and other Wall Street firms violated their
responsibilities to their companies and shareholders by creating trillions upon
trillions of CDO cookie crumble bonds that they probably knew were building up
into too much risk in one type of business. But they badly wanted their
commissions and bonuses and fees that they got for each new CDO bag of crumbles
they sold.
Hence, Robin, the only people sitting Heidi’s bar were Marvene, Barry Rybicki,
and some greedy Harvard and Wharton alumni willing to drink up shareholder
value. The millions of Nelson families, Barney Frank, Chris Dodd, and even some
bank CEOs made what they thought were good bets that were totally wiped out when
the real estate market imploded. They were not in Heidi’s bar at the time. They
were at the racetrack.
The Economic Crisis Created a Perfect Storm for Progressives in Congress
Speaking of race tracks, we at last come to the U.S. Congress after the 2008
election. Democrats have monopoly power and most of them are progressives with
good intentions. They reason that if the U.S. could afford to wage war in Iraq
it can afford free education, training, and health care for over 300 million
U.S. citizens and unknown millions of pretenders living in the United States.
The banking crisis along with the economic crash (I still don’t think it’s an
economic depression) afford the monopolist progressives an excuse to more than
double the booked National Debt of $10 trillion today to about $20 trillion by
2012. Worse the unbooked entitlements OBSF of about $60 trillion today will jump
to about $100 trillion by 2012.
What's great about the Recovery Act and the trillions that will be spent in
ensuing deficit budgets is that hundreds of millions of people in the U.S. will
eventually get free education, training, and health care. Housing will be a
whole lot cheaper and the government will pay out trillions of dollars to keep
homeowners from losing their homes. If it sounds too good to be true, it
probably is too good to be true.
The new healthy graduates with their free training and education will be like
dead atheists in open coffins. They’ll be all dressed up with no place to go.
Congress is creating public works job opportunities while destroying career
opportunities. The reason is that the progressives, with all their good
intentions, will have placed trillions of stimulus money into part-time laboring
jobs like road building that are physically demanding and not at all suited for
people with career aspirations. Only so many can work in the health care and
education fields, and careers there will become pretty low paying due to the
need to minimize the cost of free health and education services and rationing.
Prosperous businesses create career opportunity growth. Congress at present is
destroying business opportunity. It is only creating government work
opportunity. Paul Williams cringes at thinking of his university as a socialist
organization owned and operated by government. By whatever name it’s owned and
managed by the government and it’s principle service graduates students into the
working world. I would like this to be a business world with career
opportunities. Yes I know that he will counter this by saying that for the past
four decades business has depended upon government in one way or another for its
prosperity, often with subsidies in one form or another. But until George W.
Bush went to war and could not say no to Congress on progressive spending
programs like the Medicare Drug Plan, the National Debt was only $6 trillion and
entitlements were perhaps around $30 trillion. Virtually all college graduates
had career hopes and most of these were hopes for careers in some type of
business or profession.
Compare this with a National Debt load of $20 trillion and unbooked OBSF
entitlements of $100 trillion. There’s no hope of carrying such booked and
unbooked debt without resorting to the Abraham Lincoln School of Finance (see
Honest Abe’s quote below). Career aspirations in most disciplines are shrinking
to near nothing.
A democracy cannot exist as a
permanent form of government. It can only exist until the voters discover that
they can vote themselves largesse from the public treasury. From that moment on,
the majority always votes for the candidates promising the most benefits from
the public treasury, with the result that a democracy always collapses over
loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh
your browser for updates by the second) ---
http://www.brillig.com/debt_clock/
America, what is happening to you?
“One thing seems probable to me,” said Peer
Steinbrück, the German finance minister, in September 2008....“the United States
will lose its status as the superpower of the global financial system.” You
don’t have to strain too hard to see the financial crisis as the death knell for
a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida,
"How the Crash Will Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography
The inherent vice of capitalism is the unequal
sharing of the blessings. The inherent blessing of socialism is the equal
sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)
From the Abraham Lincoln School of Finance
The government should create, issue, and circulate all the currency and credits
needed to satisfy the spending power of the government and the buying power of
consumers. By adoption of these principles, the taxpayers will be saved immense
sums of interest. Money will cease to be master and become the servant of
humanity.
Abraham Lincoln
(I wonder why this just does not work in Zimbabwe where Robert Mugabe adopted
Lincoln's fiscal policy?)
Bob Jensen
From:
AECM, Accounting Education using Computers and Multimedia [mailto:AECM@LISTSERV.LOYOLA.EDU]
On Behalf Of Alexander Robin A
Sent: Monday, March 02, 2009 8:30 PM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: Re: Bank Crisis explained
Ok,
please elaborate.
Robin A
From:
Tom Selling
Sent: Sun 3/1/2009 6:19 PM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: Re: Bank Crisis explained
This is not
a “simple” explanation; it is dangerously simplistic, and obviously written
by someone with an ax to grind. I would feel sorry for the students who
were fed this CRAP.
Tom Selling
From:
AECM, Accounting Education using Computers and Multimedia [mailto:AECM@LISTSERV.LOYOLA.EDU]
On Behalf Of Jensen, Robert
Sent: Sunday, March 01, 2009 4:11 AM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: FW: Bank Crisis explained
Forwarded by a close friend.
They
keep trying to make it sound complicated but it's really very simple!
Even your students will understand now.
Bank Crisis in Terms Understood
Heidi
is the proprietor of a bar in Washington, DC. In order to increase sales and
comply with CRAP (Community Reinvestment Act Program reinforced by
Socialist Progressive Congressmen),
she decides to allow her loyal customers - most of whom are unemployed
alcoholics - to drink now but pay later. She keeps track of the drinks
consumed on a ledger (thereby granting the customers loans).
Word gets around and as a result increasing numbers of customers flood into
Heidi's bar.
Taking advantage of her customers' freedom from immediate payment
constraints, Heidi increases her prices for wine and beer, the most-consumed
beverages. Her sales volume increases massively.
A young and dynamic customer service consultant at the local bank recognizes
these customer debts as valuable future assets and increases Heidi's
borrowing limit.
He sees no reason for undue concern since he has the debts of the alcoholics
as collateral.
At the bank's corporate headquarters, expert bankers transform these
customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities
are then traded on markets worldwide. No one really understands what these
abbreviations mean and how the securities are guaranteed. Nevertheless, as
their prices continuously climb, the securities become top-selling items.
One day, although the prices are still climbing, a risk manager
(subsequently of course fired due his negativity) of the bank decides that
slowly the time has come to demand payment of the debts incurred by the
drinkers at Heidi's bar.
However they cannot pay back the debts.
Heidi cannot fulfill her loan obligations and claims bankruptcy.
DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better,
stabilizing in price after dropping by 90 %.
The suppliers of Heidi's bar, having granted her generous payment due dates
and having invested in the securities are faced with a new situation. Her
wine supplier claims bankruptcy, her beer supplier is taken over by a
competitor.
The bank is saved by the Government following dramatic round-the-clock
consultations by leaders from the governing political parties.
The funds required for this purpose are obtained by a tax levied on the
non-drinkers.
Finally an explanation I understand...
"Busted At Last: KB Home, Countrywide (now owned by Bank of America) Hit
With $2.8 Billion Racketeering Charge," Money News, May 8, 2009 ---
http://moneynews.newsmax.com/headlines/kb_home_countrywide/2009/05/08/212443.html
Homeowners brought a federal racketeering lawsuit
on Thursday against KB Home (KBH.N), the former Countrywide Financial Corp
and appraiser LandSafe Inc, accusing the companies of operating a scheme to
fraudulently inflate sales prices of KB homes in Arizona and Nevada.
The lawsuit, filed in federal court in Phoenix,
claims the three companies colluded to overprice as many as 14,000 homes in
the two states by an average of $20,000, for an estimated total of $2.8
billion between 2006 and the present. The plaintiffs seek class action
status and triple damages.
A KB Home spokeswoman said the Los Angeles-based
home builder had not seen the lawsuit and had no comment. Calabasas,
California-based Countrywide, which was acquired last year by Bank of
America (BAC.N), could not be reached for comment.
The lawsuit contends that KB and Countrywide formed
the joint venture Countrywide KB Home Loans to "rig and falsify" appraised
values of the homes they were selling and financing in the two states.
The joint venture steered prospective buyers of KB
Homes to hand-picked appraisers at Countrywide subsidiary LandSafe who would
"come in with the appraisal at whatever number was necessary to close the
deal," the lawsuit said.
LandSafe appraisers "blatantly falsified" sales
prices for comparable properties, using prices from homes as much as 10
miles away, and citing comparable properties that were in different planned
communities, the suit said.
The homes were generally priced between $250,000
and $350,000 -- inflated sums that homeowners discovered when they attempted
to sell their homes and hired independent appraisers, said plaintiffs
attorney Steve Berman of Hagens Berman Sobol Shapiro LLP in Seattle.
"Most of these people were underwater from the
get-go," said Berman.
The Hagens firm filed a similar lawsuit against KB
and Countrywide earlier this year in California, citing claims under the
Racketeer Influenced and Corrupt Organizations Act and violation of the
state's unfair competition law.
The case is Nathaniel Johnson v. KB Home et al.,
2:09-CV-00972-MHB, in U.S. District Court in Arizona.
Bob Jensen's threads on Rotten to the Core are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Charles B. Reed, chancellor of the California State
University system, explains why he wants the federal government to provide
billions of dollars in direct aid to four-year colleges, based on the number of
students they enroll who are eligible for Pell Grants or who are from
underrepresented minority groups.
"To Reach Obama's Goal, Colleges Should Get Billions From U.S., Cal State Chief
(Video)," Chronicle of Higher Education, March 2009 ---
http://chronicle.com/media/audio/v55/i26/reed/?utm_source=at&utm_medium=en
Jensen Comment
The new graduates with their free training and education will be like dead
atheists in open coffins. They’ll be all dressed up with no place to go.
Congress is creating public works job opportunities while destroying career
opportunities. The reason is that the progressives, with all their good
intentions, will have placed trillions of stimulus money into part-time laboring
jobs like road building that are physically demanding and not at all suited for
people with career aspirations. Only so many can work in the health care and
education fields, and careers there will become pretty low paying due to the
need to minimize the cost of free health and education services and rationing.
"Graduation is what President
Obama is all about," says Charles B. Reed in the above video
Jensen Comment
Prosperous businesses create career opportunity growth. Congress at present is
destroying business opportunity. It is only creating government work
opportunity. Paul Williams cringes at thinking of his university as a socialist
organization owned and operated by government. By whatever name it’s owned and
managed by the government and it’s principle service graduates students into the
working world. I would like this to be a business world with career
opportunities. Yes I know that he will counter this by saying that for the past
four decades business has depended upon government in one way or another for its
prosperity, often with subsidies in one form or another. But until George W.
Bush went to war and could not say no to Congress on progressive spending
programs like the Medicare Drug Plan, the National Debt was only $6 trillion and
entitlements were perhaps around $30 trillion. Virtually all college graduates
had career hopes and most of these were hopes for careers in some type of
business or profession.
Wouldn’t it be fantastic if progressives could
provide free education and training and health care to about 400 million U.S.
residents without destroying their career hopes in the process? Somehow
progressives have to provide more incentives to businesses, especially small
businesses, to create 400 million career opportunities. Many of those new
graduates would start up new businesses if they were not discouraged by
prospects that their success will be confiscated to pay for social programs.
Critics of Congressional earmarks harshly attacked
President Obama and members of his administration Monday, accusing the White
House of ignoring the president's campaign promise to end the use of
lawmaker-directed projects as a way of allocating precious federal funds. But
it's unlikely that many of those complaints will be coming from colleges, which
stand to benefit -- to the tune of hundreds of millions of dollars -- from the
pork barrel-laden fiscal 2009 spending bill that is prompting the outcry . . .
Shhhh, Stop Complaining!
"Plenty of Pork," Inside Higher Ed, March 3, 2009 ---
http://www.insidehighered.com/news/2009/03/03/pork
Jensen
I'm complaining, but nobody is listening since everybody wants on the gravy
train.
Real estate appraisers in Hampton Roads and across
the nation say they have felt intense pressure from lenders, mortgage brokers
and real estate agents to deliver inflated valuations - a serious ethical breach
that may have played a role in puffing up the real estate bubble and promoting
mortgage fraud. The problem has been around for some time, says Woody Fincham, a
Chesapeake-based appraiser. For several years in the mid-2000s, Fincham said,
his company, FM & Associates, did steady business with a Virginia Beach mortgage
brokerage but faced escalating pressure to deliver inflated appraisals. "They
would get on the phone and scream at me to inflate values," he said. "They said,
'If you keep coming in low, we're not going to work with you anymore.' "
Finally, the brokerage delivered on the threat, cutting off business with
Fincham's company. "They said, 'You're not hitting the numbers we need you to
hit,' " Fincham said.
Bill Sizemore, "Appraisers say they
were pushed to overvalue properties," The Virginian-Pilot, December 5,
2008 ---
http://hamptonroads.com/2008/12/appraisers-say-they-were-pushed-overvalue-properties
Jensen Comment
Pressure to increase the appraisal beyond fair market value stems in many cases
from the buyers not having enough down payment to make up the difference between
what the seller is asking and the buyer has in cash for difference between an
amount borrowed on the mortgage and the seller's bottom price.
For "Sleaze (meaning sex), Bribery, and Lies " in the mortgage lending business
before and after the economic meltdown see
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
When Wall Street investment banks sliced and diced the
mortgage-backed loans into Collateralized Debt Obligations (CDOs) that were sold
as millions of Forrest Gump AAA Investment Grade chocolate boxes, inflated
real estate appraisals where the collateral was way above market value resulted
in turds being mixed into those highly complex CDO chocolate boxes. Now the
mortgage brokers and real estate agents are once again marketing turds as
chocolates. The sewers are once again backing up on Main Street real estate
markets. Here we go again!
The broad
mass of a nation will more easily fall victim to a big lie than to a small one.
Adolph Hitler, Mein Kampf.
Bankers
(Men in Black) bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign
Relations, as quoted by Avital Louria Hahn, "Missing: How Poor
Risk-Management Techniques Contributed to the Subprime Mess," CFO
Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Jensen Comment
Now that the Government is going to bail out these speculators with
taxpayer funds makes it all the worse. I received an email message
claiming that if you had purchased $1,000 of AIG stock one year ago,
you would have $42 left; with Lehman, you would have $6.60 left;
with Fannie or Freddie, you would have less than $5 left. But if you
had purchased $1,000 worth of beer one year ago, drank all of the
beer, then turned in the cans for the aluminum recycling REFUND, you
would have had $214. Based on the above, the best current investment
advice is to drink heavily and recycle. It's called the 401-Keg. Why
let others gamble your money away when you can piss it away on your
own? |
"Mortgage Fraud at All-Time High Incidents of Mortgage Fraud Increase 26%
from 2007 to 2008," SmartPros, April 7, 2009 ---
http://accounting.smartpros.com/x65845.xml
Reported incidents of mortgage fraud in the U.S.
are at an all-time high and increased by 26 percent from 2007 to 2008
according to a new report released by the Mortgage Asset Research Institute
(MARI).
Rhode Island, Florida and Illinois top the list of
states with highest mortgage fraud rates. The 11th Periodic Mortgage Fraud
Case Report to the Mortgage Banker's Association (MBA) examines the current
state of residential mortgage fraud and misrepresentation in the U.S. based
on data submitted by MARI subscribers.
The report found that, for the first time, Rhode
Island ranked first in the country for mortgage fraud with more than three
times the expected amount of reported mortgage fraud for its origination
volume. This is also Rhode Island's first appearance on the MARI report
Top-Ten list, indicating a problematic and overlooked mortgage fraud problem
in the state. Florida, ranked first in 2007 and 2006, dropped to second
place and is followed by Illinois, Georgia, Maryland, New York, Michigan,
California, Missouri and Colorado. The report was presented during MBA's
annual National Fraud Issues Conference in Las Vegas. It is available on the
MARI Web site at: www.marisolutions.com.
“With fewer loan originations today, the data
suggests that the economic downturn may have created more desperation,
causing more people than ever before to try to commit mortgage fraud,” said
Denise James, LexisNexis Risk & Information Analytics Group director of
Residential Mortgage Solutions. “Not only are we seeing traditional fraud
trends, such as application fraud, but we are also seeing new types of
emerging fraud occur,” said James. “It is therefore imperative that the
mortgage industry continue to share information and insights, and
collaborate in the fight against mortgage fraud.”
The top fraud incident type in 2008 – representing
61% of all reported frauds – was application fraud, the fifth year in a row
it topped the list. Second were frauds related to tax returns and financial
statements which jumped 60% from 17% of reported frauds in 2007, to 28% of
reported frauds in 2008. Additional documented fraud types included, in
order of volume, frauds related to appraisals or valuations, verifications
of deposit, verifications of employment, escrow or closing costs, and credit
reports.
“MARI data shows that mortgage fraud is more
prevalent today than it was at the height of the boom in mortgage loan
originations,” said John Courson, president and chief executive officer of
the Mortgage Bankers Association. “This report is essential reading for
mortgage bankers who need to understand where mortgage fraud is coming from,
what to watch for and how to protect our companies and communities.”
The report also found that:
After improving in 2006 and 2007, Georgia jumped
from seventh to fourth place in 2008; California, ranked fourth in 2007,
declined to eighth in 2008; Maryland jumped from fifteenth in 2007 to fifth
in 2008; and The volume of reported frauds related to credit reports dropped
from 9% to 4% between 2007 and 2008.
FBI, April 14, 2009 ---
http://cincinnati.fbi.gov/doj/pressrel/2009/ci041409.htm
Kamal J. Gregory, 35, of Centerville, pleaded
guilty in United States District Court here today to one count of conspiracy
to commit mail fraud, wire fraud and money laundering and one count of
conspiracy to commit money laundering. Gregory committed the crimes in
connection with an extensive mortgage fraud scheme affecting 210 residential
properties, including 205 located in Montgomery County. The scheme affected
63 investors and led to foreclosure against owners of more than 90 percent
of the properties.
Gregory G. Lockhart, United States Attorney for the
Southern District of Ohio; Keith L. Bennett, Special Agent in Charge,
Federal Bureau of Investigation; Jose A. Gonzalez, Special Agent in Charge,
Internal Revenue Service Criminal Investigation, and other members of the
Greater Dayton Mortgage Fraud Task Force announced the plea entered today
before U.S. District Judge Michael R. Barrett.
In court documents, Gregory admitted that, between
March 2002 and June 2008, he along with eleven other named individuals
prepared and submitted on behalf of various purchasers/investors certain
mortgage loan application packages to various lending institutions located
throughout the United States.
These loan applications included documents that
made fraudulent claims involving the income of the borrowers and values of
the properties involved. Most of the homes involved were dilapidated and
otherwise depressed properties located in the greater Dayton area. The loan
application packages claimed the properties were worth prices which had been
artificially inflated above legitimate fair-market values.
Gregory and his co-conspirators created the
fraudulent loans as a way of making money for their own benefit.
Gregory admitted during his guilty plea hearing to
participating in 46 separate fraudulent real estate closings between
February 2003 and April 2005. The net fraudulent loan amounts associated
with these closings exceeded $4,200,000. Gregory worked as a loan officer
under individual or company names including Alliance Mortgage, Gregory
Investments Inc., KG Enterprises, Mad River Properties, Premier Mortgage
Funding of Ohio, Star Point Mortgage, and Ohio Financial Group.
A federal grand jury indicted Gregory and five
co-conspirators, Julian M. Hickman, Robert Mitchell, Kenneth O. McGee,
Edward McGee, and Jessica A. Zbacnik, in June 2008. Hickman pleaded guilty
on December 12, 2008 to conspiracy and tax crimes and Mitchell pleaded
guilty on March 11, 2009 to two counts of conspiracy. Both are awaiting
sentencing.
Charges against Kenneth O. McGee, Edward McGee, and
Jessica A. Zbacnik are pending.
The conspiracy to commit mail fraud, wire fraud,
and money laundering is punishable by up to 30 years and a $1,000,000 fine.
The conspiracy to commit money laundering is punishable by up to 20 years
imprisonment and a fine in the greater amount of $500,000 or twice the value
of the property involved.
Continued in article
Bob Jensen's fraud updates are at
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on how to prevent mortgage fraud are at
http://faculty.trinity.edu/rjensen/FraudReporting.htm
Long Time WSJ Defenders of Wall Street's Outrageous Compensation Morph
Into Hypocrites
At each stage of the disaster, Mr. Black told me --
loan officers, real-estate appraisers, accountants, bond ratings agencies -- it
was pay-for-performance systems that "sent them wrong." The need for new
compensation rules is most urgent at failed banks. This is not merely because is
would make for good PR, but because lavish executive bonuses sometimes create an
incentive to hide losses, to take crazy risks, and even, according to Mr. Black,
to "loot the place through seemingly normal corporate mechanisms." This is why,
he continues, it is "essential to redesign and limit executive compensation when
regulating failed or failing banks." Our leaders may not know it yet, but this
showdown between rival populisms is in fact a battle over political legitimacy.
Is Wall Street the rightful master of our economic fate? Or should we choose a
broader form of sovereignty? Let the conservatives' hosannas turn to sneers. The
market god has failed.
Thomas Frank, "Wall Street Bonuses Are an Outrage: The public sees
a self-serving system for what it," The Wall Street Journal, February 4,
2009 ---
http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion
Bob Jensen's threads on outrageous compensation are at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance
Lawyers Like the Subprime Litigation Cash Cow
"The finger of suspicion," The Economist, December 19, 2007 ---
http://www.economist.com/finance/displaystory.cfm?story_id=10337884
FINANCIAL firms have already been drenched by
mortgage-related losses. Now a wave of litigation threatens to assail them.
According to RiskMetrics, a consulting firm, between August and October
federal securities class-action lawsuits were filed in America at an
annualised pace of around 270—more than double last year's total and well
above the historical average. At this rate, claims could easily exceed those
of the dotcom bust and options-backdating scandal combined.
At most risk are banks that peddled mortgages or
mortgage-backed securities. Investors have handed several writs to Citigroup
and Merrill Lynch. Bear Stearns has received dozens over the collapse of two
leveraged hedge funds. A typical complaint accuses it of failing to make
adequate reserves or to explain the risks of its subprime investments, and
of dubious related-party transactions with the funds. Several firms,
including E*Trade, a discount broker with a banking arm sitting on a
radioactive pile of mortgage debt, are being sued for allegedly failing to
disclose problems as they became apparent to managers.
But one thing that sets the subprime litigation
wave apart from that of the 2001-03 bear market is its breadth. After the
collapses of Enron and WorldCom, lawsuits were targeted at a fairly narrow
range of parties: bust internet firms, their accountants and some banks.
This time, investors are aiming not only at mortgage lenders, brokers and
investment banks but also insurers (American International Group), bond
funds (State Street, Morgan Keegan), rating agencies (Moody's and Standard &
Poor's) and homebuilders (Beazer Homes, Toll Brothers et al).
Borrowers, too, are suing both their lenders and
the Wall Street firms that wrapped up their loans. Several groups of
employees and pension-fund participants have filed so-called ERISA/401(k)
suits against their own firms. Local councils in Australia are threatening
to sue a subsidiary of Lehman Brothers over the sale of collateralised-debt
obligations (CDOs), the Financial Times has reported. Lenders are even
turning on each other; Deutsche Bank has filed large numbers of lawsuits
against mortgage firms, claiming they owe money for failing to buy back
loans that soured within months of being made.
“It seems that everyone is suing everyone,” says
Adam Savett of RiskMetrics' securities-litigation group. “It surely can't be
long before we get the legal equivalent of man bites dog, where a lender
sues its borrowers for some breach of contract.”
Continued in article
Crooked Lawyers ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#Lawyers
Friends of Angelo
Executives at Countrywide Financial Corp., one of the
biggest names of the housing boom, routinely violated internal company policies
to provide below-market rates on home loans to the politically connected and
powerful, according to a congressional report to be released today. Loan
documents show how far Calabasas-based Countrywide went to give loans to VIPs
through a special program known as "Friends of Angelo," named after former Chief
Executive Angelo R. Mozilo, according to congressional investigators.
Zachary A. Goldfarb, "Report details Countrywide's efforts to benefit
VIPs," Los Angeles Times, March 18, 2009 ---
http://www.latimes.com/business/la-fi-countrywide19-2009mar19,0,4389863.story?track=rss
Executives manually overrode the company's computer
software that routinely warned that certain additional fees would be
necessary to accommodate below-market rates. That was in addition to lengthy
discussions on the merits of giving a special deal to a particular borrower,
missives from Mozilo to employees telling them to give VIPs breaks and other
activities.
A report by House Republicans on the investigation
was obtained by the Washington Post in advance of its release.
Recipients of special loans included Sen. Kent
Conrad (D-N.D.), Sen. Christopher J. Dodd (D-Conn.), former U.N. Ambassador
Richard C. Holbrooke, former Fannie Mae Chief Executive James A. Johnson and
former Housing and Urban Development Secretary Alphonso Jackson.
Countrywide, which handed out many of the loans
that turned out to be toxic waste on the books of banks, faltered in 2007 at
the onset of the financial crisis and was sold to Bank of America Corp.
Bank of America said it would cooperate fully with
any official inquiry into this Countrywide program.
Most recipients of VIP loans have said in news
accounts that they had no idea they were receiving a special deal. But the
report states that Countrywide clearly indicated to borrowers they were
getting special deals, usually by including business cards indicating the
loan came from a VIP unit.
Robert Feinberg, a 12-year Countrywide employee who
processed VIP loans, told investigators that it was standard practice to
tell borrowers, "Your loan was specially priced by Angelo."
Jensen Comment
Because the name “Countrywide Financial” has become synonymous with
fraudulent mortgage brokering, Bank of America is tearing down the
Countrywide logo on all of Countrywide’s places of business.
The Sleazy Subprime Mortgage Lending Companies Have a
New (actually renewed old) Scheme to Make Billions at Taxpayer Expense
As if they haven't done enough damage. Thousands
of subprime mortgage lenders and brokers—many of them the very sorts of firms
that helped create the current financial crisis—are going strong. Their new
strategy: taking advantage of a long-standing federal program designed to
encourage homeownership by insuring mortgages for buyers of modest means. You
read that correctly. Some of the same people who propelled us toward the housing
market calamity are now seeking to profit by exploiting billions in federally
insured mortgages. Washington, meanwhile, has vastly expanded the availability
of such taxpayer-backed loans as part of the emergency campaign to rescue the
country's swooning economy.
Chad Terhune
and Robert Berner, "FHA-Backed Loans: The New Subprime: The same people
whose reckless practices triggered the global financial crisis are onto a
similar scheme that could cost taxpayers tons more," Business Week,
November 19, 2008 ---
http://www.businessweek.com/magazine/content/08_48/b4110036448352.htm?link_position=link2
"The FHA's Bailout Warning: Whoops, there it is," The Wall
Street Journal, November 13, 2009 ---
Click Here
Critics of Fannie Mae and Freddie Mac were waved
off as cranks and assured that the companies wouldn't need a taxpayer
bailout right up until the moment that they did. Some $112 billion later and
counting, this political history may be repeating itself with the Federal
Housing Administration, which yesterday announced that its capital reserve
ratio has fallen to 0.53%.
That cushion is far below the 2% of its liabilities
that Congress mandates, itself a 50 to 1 leverage ratio, and down from 3%
last autumn. The FHA's mortgage guarantees in 2009 are four times higher
than they were in 2007. Nearly 18% of its loans are 30 days or more past
due, while mortgages guaranteed in 2007 are "on par with FHA's worst-ever
books from the early 1980s," according to the Department of Housing and
Urban Development's report to Congress. The financial deterioration is the
result of the agency's plunge into high-risk loans over the last two years,
asking dangerously low down payments of 3.5% from unqualified borrowers.
The FHA strikes a note of optimism by claiming that
its book of business is improving and that "the just-completed actuarial
studies show that FHA's capital reserve ratio will not dip below zero under
most of the economic scenarios considered." The Administration has also made
some modest reforms. Still, if housing values don't recover, or if by some
chance the agency can't outrun its problems, the report admits that the FHA
could ask taxpayers for $1.6 billion in 2012. Judging from history, that's
probably a low-ball estimate.
Congress doesn't mind because these liabilities are
technically off budget, until they aren't. This was all so predictable—and,
ahem, predicted.
Jensen Comment
That's right. The greedy slime balls "Borne of Sleaze, Bribery, and Lies" are
resurfacing with Barney Frank's blessing ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
A democracy cannot
exist as a permanent form of government. It can only exist until the voters
discover that they can vote themselves largesse from the public treasury. From
that moment on, the majority always votes for the candidates promising the most
benefits from the public treasury, with the result that a democracy always
collapses over loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm
(where the debt clock in real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for updates by the
second) ---
http://www.brillig.com/debt_clock/
The current financial turmoil shows that
private sector can bankrupt nation states. The US government has committed more
than $5 trillion and the UK has committed around £500 billion, nearly one-third
of their respective GDPs, to support the financial sector. The bailouts may
stabilise the financial sector and help economic recovery but they have also
created new moral hazards. In the absence of effective regulation and
accountability, company directors, who have already behaved badly, will continue
to behave recklessly and play their selfish games, at virtually no cost to
themselves. Leaders of major industrialised countries have paid little attention
to moral hazards and how bailouts reward bad behaviour. There is an urgent need
to address the moral hazards problem.
Prem Sikka, "Hold them to account: The traditional mechanisms for disciplining,"
The Guardian, November 18, 2008 ---
http://www.guardian.co.uk/commentisfree/2008/nov/18/marketturmoil-banks
Some wholesalers turned a blind eye to broker fraud,
too. "I'd walk into mortgage shops and see brokers openly cutting and pasting
income documents and pay stubs, getting out the Wite-Out and changing Social
Security numbers," says Melissa Hernandez, a former wholesaler for Argent
Mortgage, a unit of now-defunct Ameriquest Mortgage, who says she never
knowingly bought bogus applications. "There was no ambiguity." Other wholesalers
took matters into their own hands, doctoring documents to qualify borrowers for
loans. A former Wells Fargo (WFC) wholesaler says he regularly used the copiers
at a nearby Kinko's to alter borrowers' pay stubs and bank account statements.
"Subprime: Borne of Sleaze, Bribery, and Lies," by Mara Der Hovanesian,
Business Week, November 13, 2008 ---
http://www.businessweek.com/magazine/content/08_47/b4109070638235.htm?link_position=link3
It may seem like ancient history now, but
not long ago the mortgage industry was turning ordinary people into
millionaires. One of them was Sharmen Lane, a high school dropout who, like
many other young women during the boom, found her way into an obscure
banking job with the clunky title "mortgage wholesaler." Her experience—and
the experiences of other wholesalers like her—offers a glimpse into the
recklessness and indulgence that drove the industry to ruin.
The rise of mortgage wholesalers from
grunts to rainmakers is one of the more curious developments of the housing
bubble. Wholesalers work for banks and other lenders. The wholesaler's job
is to buy other loan applications from independent mortgage brokers so that
lenders can turn them into loans. Wholesalers are paid on commission: the
more loans they generate, the more money they make. During the housing boom,
lenders typically approved the loans and then packaged them into securities.
That path—from mortgage brokers to wholesalers to lenders to
securities—turned out to be a road to disaster.
But as the housing bubble inflated,
wholesalers—though hidden from public view—became high-earning superstars.
Lane, a manicurist before joining now-defunct subprime lender New Century
Mortgage in 1997, says she brought home $1 million in 2002 and $1.2 million
in 2003.
Eventually the deal-making turned
frenetic. Multiple wholesalers began inundating mortgage brokers with offers
for the same applications. Some brokers chose to exercise their power by
asking for something extra in exchange for their business: sex.
Dozens of former brokers and wholesalers
say the trading of sexual favors was so common that it came to be expected.
Lane recalls one visit to a mortgage brokerage near San Jose (Calif.) in
which the manager lewdly propositioned her in his office. She says she
declined the advance, and he didn't sell her any applications. But other
female wholesalers didn't have the same qualms about crossing the line.
"Women who had sex for loans were known very quickly," says Lane, who left
New Century before it failed in 2007 and now works as a $200-an-hour life
coach and motivational speaker in New York. "I didn't want to be a mortgage
slut."
WHOLESALE CORRUPTION
Investment bubbles always spawn excesses, and housing was no exception. The
abuses went far beyond sexual dalliances. Court documents and interviews
with scores of industry players suggest that wholesalers also offered bribes
to fellow employees, fabricated documents, and coached brokers on how to
break the rules. And they weren't alone. Brokers, who work directly with
borrowers, altered and shredded documents. Underwriters, the bank employees
who actually approve mortgage loans, also skirted boundaries, demanding
secret payments from wholesalers to green-light loans they knew to be
fraudulent. Some employees who reported misdeeds were harassed or fired.
Federal and state prosecutors are picking through the industry's wreckage in
search of criminal activity.
Now wholesalers, who for a brief moment
rose to prominence, are an endangered species. The failures of large
subprime lenders like New Century, BNC (a unit of Lehman Brothers), and
GreenPoint Mortgage, owned by Capital One, threw thousands out of work. Some
lenders still in business have curtailed or shuttered their wholesale
operations.
In the end, the wholesalers were undone by
the same people who allowed for their rise: their Wall Street overlords.
During the boom investment banks bought as many loans as they could to pool
together and turn into securities. In 2006 the top 10 investment banks,
which included Merrill Lynch (MER), Bear Stearns (BSC), and Lehman Brothers,
sold mortgage-backed securities worth $1.5 trillion, up from $245 billion in
2000. To keep the supply of loans coming, the investment banks increasingly
took control of the industry's frontline players as well.
First they started buying small,
independent wholesaling firms. Next they extended billions in credit to
subprime lenders. Then they took stakes in some, and bought others outright.
At the height of the frenzy in 2006, six top investment banks shelled out a
total of $2.2 billion to buy subprime shops.
That gave Wall Street the power to demand
more subprime loans, which carried the highest interest rates and were the
most profitable. As a national account director for Deutsche Bank (DB), Mark
D. Toomey bought loans from mortgage lenders to turn into securities.
Sometimes, he says, he "twisted arms" to get more loans. "Nobody had the
[guts] to say no," says Toomey, who left the bank in 2007. Deutsche Bank
declined to comment.
But mostly, brokers and wholesalers were
happy to comply. The more loans they made, after all, the more they got
paid. One former wholesaler in Northern California who requested anonymity
joined subprime lender GreenPoint Mortgage in 1997, right out of college. By
2004, she says, she was pulling in several hundred thousand dollars a year.
She kept a chauffeur on call to shuttle her and her friends to "exclusive
clubs, restaurants, and parties," and treated friends to shopping sprees at
Neiman Marcus, Gucci, and Louis Vuitton. "It was the time of our lives,"
says the woman, who now works as an account executive for another lender in
the area.
Brokers say some female wholesalers
weren't up on the finer points of finance—but exploited other assets in
their quest for more loans. "You had boiler rooms of younger, predominantly
male brokerage operations and in would walk a gorgeous, fit [wholesaler] who
would go desk to desk," says Rick Arvielo, president of New American
Funding, a mortgage brokerage in Irvine, Calif. "Most of them didn't know
the product."
Of course, it's accepted practice in many
industries for companies to hire attractive saleswomen. What's more, on Wall
Street, lurid tales of erotic dancers livening up after-hours events are
common.
"INDECENT PROPOSALS"
But in the mortgage business, it went further: The women allegedly offering
sexual favors were bank employees. Evan Stone, president of Walnut Creek
(Calif.) mortgage brokerage Pacific Union Financial, says "minimally trained
and minimally dressed" wholesalers often wooed brokers. He says he regularly
got visits in his suburban office from representatives wearing unusually
short skirts to entice him and his team of brokers to party at the local
Ruth's Chris Steak House. Stone says one New Century wholesaler offered to
fly him to Chicago to "have a good time." He says he declined all offers of
sexual favors. "There were some indecent proposals made," he says. "That was
part of building the relationship."
Wholesalers also offered sexual favors to
co-workers. To drive up their commissions, some enticed loan underwriters at
their companies to approve questionable applications. A vice-president at
Washington Mutual who once wielded $500 million to make loans recalls an
incident in which a female wholesaler wanted him to approve a loan that
didn't fit guidelines. The manager, who requested anonymity, says the
co-worker, wearing a low-cut shirt, knelt down at his desk and said: "I
really need this. What do I have to do?"
Some wholesalers turned a blind eye to
broker fraud, too. "I'd walk into mortgage shops and see brokers openly
cutting and pasting income documents and pay stubs, getting out the Wite-Out
and changing Social Security numbers," says Melissa Hernandez, a former
wholesaler for Argent Mortgage, a unit of now-defunct Ameriquest Mortgage,
who says she never knowingly bought bogus applications. "There was no
ambiguity."
Other wholesalers took matters into their
own hands, doctoring documents to qualify borrowers for loans. A former
Wells Fargo (WFC) wholesaler says he regularly used the copiers at a nearby
Kinko's to alter borrowers' pay stubs and bank account statements.
Continued in article
Also see
http://papers.nber.org/papers/w14358
Ten Times More Complex Than Enron
"The Creditors of Lehman Can Do Little but Wait," by Julia Werdigier,
The New York Times, November 14, 2008 ---
http://www.nytimes.com/2008/11/15/business/worldbusiness/15lehman.html?_r=2&oref=slogin&oref=slogin
Creditors of Lehman Brothers’ international
business, arriving at London’s gigantic O2 concert hall on Friday, had no
illusions about getting their money back any time soon.
In a three-hour meeting in a hall usually reserved
for rock bands like the Who, Lehman’s administrators explained to about
1,000 creditors that dismantling the bank’s European business would take
“many years.”
This is at least “ten times more complex than
Enron,” the administrators from PricewaterhouseCoopers said, adding that
they had no idea what the company’s total liabilities may be.
“It’s frustrating that after nine weeks, we still
haven’t come to any clarity,” especially on how much counterparties hold
with Lehman’s European business, said Tony Lomas, the PricewaterhouseCoopers
partner leading the administration. “The prospect is that the creditors will
lose money.”
PricewaterhouseCoopers identified 11,500 creditors
and counterparties of Lehman’s European business, ranging from the coffee
machine maker Nespresso and taxi companies in Milan and Zurich to Bulgari
hotels and resorts and the financial news company Bloomberg.
From Lehman’s glass and steel offices in London’s
Canary Wharf, the administrators are working through the bank’s $1 trillion
of assets and said they cannot pay creditors until they have a “reasonable
grip” on liabilities.
Continued in article
Investigators have subpoenaed
Ernst & Young LLP, Lehman's auditor;
U.K.-based bank Barclays Plc, which bought Lehman's North American brokerage;
and the New Jersey Division of Investments, which runs a pension fund that lost
$115.6 million on a $180 million investment in the June stock sale, according to
people familiar with the case.
Linda Sandler and Christopher Scinta, "Lehman's
Collapse, Stock Sale Probed by Three U.S. Prosecutors ," Bloomberg,
October 18, 2008 ---
http://www.bloomberg.com/apps/news?pid=20601087&sid=ai0XSrkkEKEM&refer=worldwide
"Calif County Accuses Lehman Executives, Auditor Of Fraud In Suit,"
CNN, November 13, 2008 ---
Click Here
http://money.cnn.com/news/newsfeeds/articles/djf500/200811131743DOWJONESDJONLINE000915_FORTUNE5.htm
The San Mateo County (Calif.) Investment Pool sued
executives of bankrupt Lehman Brothers Holdings Inc. (LEHMQ) and their
accountants, accusing them of fraud, deceit and misleading accounting
practices that led to the loss of more than $150 million in county funds.
The suit, filed in San Francisco Superior Court,
said executives of the former Wall Street investment bank made repeated
public statements about its financial strength while privately scrambling to
save it from collapse.
The suit names former Lehman Chief Executive
Richard S. Fuld Jr., former Chief Financial Officers Christopher M. O'Meara
and Erin Callan, former President Joseph M. Gregory, certain directors and
Ernst & Young, Lehman's auditor.
It accused Lehman of hiding its exposure to
mortgage-related losses while reporting record profits for fiscal year 2007
and giving bonuses to its executives.
"The defendants focused their efforts on trying to
save their company and their jobs with little or no regard to how their
egregious actions harmed those who in good faith invested in Lehman
Brothers," said San Mateo County Counsel Michael Murphy. "In our view, their
actions were blatantly illegal."
The San Mateo County Investment Pool consists of
the county, school districts, special districts and other public agencies in
the county.
San Mateo County Supervisors Richard Gordon and
Rose Jacobs Gibson called for a federal investigation of the allegations in
the suit, and Supervisor Jerry Hill, newly elected to the state Assembly,
will request hearings on how many California public entities face similar
losses.
Representatives of Lehman and of Ernst & Young were
not immediately available to comment.
This is but one of many lawsuits and criminal investigations to be faced
Ernst & Young and the other large auditing firms. Survival of the Big Four will
be precarious ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
Also see
Appendix H
Where were the auditors?
Deloitte is Included in the Shareholder Lawsuit Against Washington Mutual
"Feds Investigating WaMu Collapse," SmartPros, October 16, 2008 ---
http://accounting.smartpros.com/x63521.xml
Oct. 16, 2008 (The Seattle Times) — U.S. Attorney
Jeffrey Sullivan's office [Wednesday] announced that it is conducting an
investigation of Washington Mutual and the events leading up to its takeover
by the FDIC and sale to JP Morgan Chase.
Said Sullivan in a statement: "Due to the intense
public interest in the failure of Washington Mutual, I want to assure our
community that federal law enforcement is examining activities at the bank
to determine if any federal laws were violated."
Sullivan's task force includes investigators from
the FBI, Federal Deposit Insurance Corp.'s Office of Inspector General,
Securities and Exchange Commission and the Internal Revenue Service Criminal
Investigations division.
Sullivan's office asks that anyone with information
for the task force call 1-866-915-8299; or e-mail fbise@leo.gov.
"For more than 100 years Washington Mutual was a
highly regarded financial institution headquartered in Seattle," Sullivan
said. "Given the significant losses to investors, employees, and our
community, it is fully appropriate that we scrutinize the activities of the
bank, its leaders, and others to determine if any federal laws were
violated."
WaMu was seized by the FDIC on Sept. 25, and its
banking operations were sold to JPMorgan Chase, prompting a Chapter 11
bankruptcy filing by Washington Mutual Inc., the bank's holding company. The
takeover was preceded by an effort to sell the entire company, but no firm
bids emerged.
The Associated Press reported Sept. 23 that the FBI
is investigating four other major U.S. financial institutions whose collapse
helped trigger the $700 billion bailout plan by the Bush administration.
The AP report cited two unnamed law-enforcement
officials who said that the FBI is looking at potential fraud by
mortgage-finance giants Fannie Mae and Freddie Mac, and insurer American
International Group (AIG). Additionally, a senior law-enforcement official
said Lehman Brothers Holdings is under investigation. The inquiries will
focus on the financial institutions and the individuals who ran them, the
senior law-enforcement official said.
FBI Director Robert Mueller said in September that
about two dozen large financial firms were under investigation. He did not
name any of the companies but said the FBI also was looking at whether any
of them have misrepresented their assets.
"Federal Official Confirms Probe Into Washington Mutual's Collapse,"
by Pierre Thomas and Lauren Pearle, ABC News, October 15, 2008 ---
http://abcnews.go.com/TheLaw/story?id=6043588&page=1
The federal government is
investigating whether the
leadership of shuttered bank
Washington Mutual broke
federal laws in the run-up
to its collapse,
the largest in U.S. history.
. . .
Eighty-nine
former WaMu employees are confidential witnesses in
a
shareholder class action lawsuit against
the bank, and some former insiders
spoke exclusively to ABC News,
describing their claims that
the bank ignored key advice from its own risk
management team so they could maximize profits
during the housing boom.
In court documents, the
insiders said the company's risk managers, the
"gatekeepers" who were supposed to protect the bank
from taking undue risks, were ignored, marginalized
and, in some cases, fired. At the same time, some of
the bank's lenders and underwriters, who sold
mortgages directly to home owners, said they felt
pressure to sell as many loans as possible and push
risky, but lucrative, loans onto all borrowers,
according to insiders who spoke to ABC News.
Continued in article
Allegedly "Deloitte Failed to Audit WaMu in Accordance with GAAS" (see
Page 351) ---
Click Here
Deloitte issued unqualified opinions and is a defendant in this lawsuit (see
Page 335)
In particular note Paragraphs 893-901 with respect to the alleged negligence of
Deloitte.
Where were the auditors?
The aftermath will leave the large auditing firms in a precarious state?
See Appendix H
Implications
for Educators, Colleges, and Students
Even the Top Ranked Business Schools are in a Crisis in 2008 (including a
slide show) ---
http://www.businessweek.com/magazine/toc/08_47/B4109best_business_schools.htm
Applications for MBA programs are up, but job opportunities for second-year
students in finance or consulting have turned wretched.
The scary part is that it will be a long, long time before finance and economics
students will have rising opportunities.
But accounting students fair well in rain or shine ---
http://accounting.smartpros.com/accountingstudents.xml
Bob Jensen's threads on careers ---
http://faculty.trinity.edu/rjensen/Bookbob1.htm#careers
Bob Jensen’s
threads on the financial markets meltdown ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
"Why We Didn’t Learn Enough From the Financial Crisis," by Justin Fox,
Harvard Business Review Blog, September 13, 2013 ---
Click Here
http://blogs.hbr.org/2013/09/why-we-didnt-learn-enough-from-the-financial-crisis/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+harvardbusiness+%28HBR.org%29&cm_ite=DailyAlert-091613+%281%29&cm_lm=sp%3Arjensen%40trinity.edu&cm_ven=Spop-Email
“Liquidate labor, liquidate stocks, liquidate real
estate,” Treasury Secretary Andrew Mellon
may or may not have told Herbert Hoover in the
early years of the Great Depression. “It will purge the rottenness out of of
the system.” This is what has since become known as the “Austrian” view
(although most of its modern proselytizers are American): economic actors
need to learn from their mistakes, “malinvestment”
must be punished, busts are needed to wring out the
excesses created during boom times.
Within the economic mainstream, there is some
sympathy for the idea that crisis interventions can create “moral hazard” by
bailing out the irresponsible. But the argument that financial crises should
be allowed to wreak their havoc unchecked has few if any adherents. As
Milton Friedman
put it in 1998:
I think the Austrian business-cycle theory has
done the world a great deal of harm. If you go back to the 1930s, … you
had the Austrians sitting in London, Hayek and Lionel Robbins, and
saying you just have to let the bottom drop out of the world. You’ve
just got to let it cure itself. You can’t do anything about it. You will
only make it worse. You have Rothbard saying it was a great mistake not
to let the whole banking system collapse. I think by encouraging that
kind of do-nothing policy both in Britain and in the United States, they
did harm.
When a financial crisis hit in 2008 that was
probably worse than anything the world had seen since the early 1930s, it
was this mainstream view that won out. The bailout of the big banks in late
2008, while hugely unpopular with the general populace, has garnered
near-unanimous support from the economics profession. In a paper eventually
published in the Journal of Financial Economics in 2010, the
University of Chicago’s Pietro Veronesi and Luigi Zingales — two economists
who aren’t generally big fans of government economic intervention —
concluded that even
without including the impossible-to-measure systemic benefits, the cash
infusions and guarantees orchestrated by Treasury Secretary Hank Paulson
created between $73 billion and $91 billion in economic value after costs.
The Federal Reserve’s subsequent (and continuing)
support of asset markets has been somewhat more controversial, but still
meets widespread approval among economists. More controversial yet have been
fiscal stimulus efforts like the
American Recovery and Reinvestment Act of 2009,
but the tide of economic opinion and evidence seems to have turned in their
favor too, with the
bulk of post-stimulus empirical studies showing a
positive effect and the former austerity advocates at the International
Monetary Fund
dramatically changing their tune starting late
last year.
In sum, the economic mainstream got its way, the
Austrians didn’t, and we all appear to be better off for it. It has been a
tough five years, but not nearly as tough as the early 1930s. And the
biggest economic policy mistake made was probably not the bailouts or the
deficit spending or the printing of money, but the failure to stop Lehman
Brothers from failing on Sept. 15, 2008.
Yet despite this record of relative success, most
the commentaries being published in the lead-up to the fifth anniversary of
that fateful day seem to focus instead on the opportunities missed.
Princeton economist
Alan Blinder’s op-ed piece in the Wall Street
Journal is a prime example of this. Blinder laments that the dangerous
financial-sector practices that precipitated the crisis have mostly been
left in place. Contrasting the tepid regulatory measures taken since 2008
with the remaking of the financial system that took place during and after
the Great Depression, he writes:
Far from being tamed, the financial beast has
gotten its mojo back — and is winning. The people have forgotten — and
are losing.
What Blinder and his kindred spirits (and I should
add that I am one of them) generally fail to discuss, though, is that one of
the main reasons the people have forgotten is because economic policy-makers
succeeded in averting anything quite as memorable as the wave after wave of
bank failures and widespread economic misery that swept the U.S. in the
early 1930s. By giving us a Great Recession in place of a Great Depression,
they made it much harder to assemble a political consensus for truly
dramatic change.
Continued in article
"We’re All Still Hostages to the Big Banks," by Anat R. Admati, The
New York Times, August 25, 2013 ---
Click Here
http://www.nytimes.com/2013/08/26/opinion/were-all-still-hostages-to-the-big-banks.html?utm_source=Stanford+Business+Re%3AThink&utm_campaign=6076b3a7fe-Re_Think_Twenty_Two9_9_2013&utm_medium=email&utm_term=0_0b5214e34b-6076b3a7fe-70265733&ct=t%28Re_Think_Twenty_Two9_9_2013%29&_r=0
NEARLY five years after the bankruptcy of Lehman
Brothers touched off a global financial crisis, we are no safer. Huge,
complex and opaque banks continue to take enormous risks that endanger the
economy. From Washington to Berlin, banking lobbyists have blocked essential
reforms at every turn. Their efforts at obfuscation and influence-buying are
no surprise. What’s shameful is how easily our leaders have caved in, and
how quickly the lessons of the crisis have been forgotten.
We will never have a safe and healthy global
financial system until banks are forced to rely much more on money from
their owners and shareholders to finance their loans and investments. Forget
all the jargon, and just focus on this simple rule.
Mindful, perhaps, of the coming five-year
anniversary, regulators have recently taken some actions along these lines.
In June, a committee of global banking regulators based in Basel,
Switzerland, proposed changes to how banks calculate their leverage ratios,
a measure of how much borrowed money they can use to conduct their business.
Last month, federal regulators proposed going
somewhat beyond the internationally agreed minimum known as Basel III, which
is being phased in. Last Monday, President Obama scolded regulators for
dragging their feet on implementing Dodd-Frank, the gargantuan 2010 law that
was supposed to prevent another crisis but in fact punted on most of the
tough decisions.
Don’t let the flurry of activity confuse you. The
regulations being proposed offer little to celebrate.
From Wall Street to the City of London comes the
same wailing: requiring banks to rely less on borrowing will hurt their
ability to lend to companies and individuals. These bankers falsely imply
that capital (unborrowed money) is idle cash set aside in a vault. In fact,
they want to keep placing new bets at the poker table — while putting
taxpayers at risk.
When we deposit money in a bank, we are making a
loan. JPMorgan Chase, America’s largest bank, had $2.4 trillion in assets as
of June 30, and debts of $2.2 trillion: $1.2 trillion in deposits and $1
trillion in other debt (owed to money market funds, other banks, bondholders
and the like). It was notable for surviving the crisis, but no bank that is
so heavily indebted can be considered truly safe.
The six largest American banks — the others are
Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley —
collectively owe about $8.7 trillion. Only a fraction of this is used to
make loans. JPMorgan Chase used some excess deposits to trade complex
derivatives in London — losing more than $6 billion last year in a
notoriously bad bet.
Risk, taken properly, is essential for innovation
and growth. But outside of banking, healthy corporations rarely carry debts
totaling more than 70 percent of their assets. Many thriving corporations
borrow very little.
Banks, by contrast, routinely have liabilities in
excess of 90 percent of their assets. JPMorgan Chase’s $2.2 trillion in debt
represented some 91 percent of its $2.4 trillion in assets. (Under
accounting conventions used in Europe, the figure would be around 94
percent.)
Basel III would permit banks to borrow up to 97
percent of their assets. The proposed regulations in the United States —
which Wall Street is fighting — would still allow even the largest bank
holding companies to borrow up to 95 percent (though how to measure bank
assets is often a matter of debate).
If equity (the bank’s own money) is only 5 percent
of assets, even a tiny loss of 2 percent of its assets could prompt, in
essence, a run on the bank. Creditors may refuse to renew their loans,
causing the bank to stop lending or to sell assets in a hurry. If too many
banks are distressed at once, a systemic crisis results.
Prudent banks would not lend to borrowers like
themselves unless the risks were borne by someone else. But insured
depositors, and creditors who expect to be paid by authorities if not by the
bank, agree to lend to banks at attractive terms, allowing them to enjoy the
upside of risks while others — you, the taxpayer — share the downside.
Implicit guarantees of government support
perversely encouraged banks to borrow, take risk and become “too big to
fail.” Recent scandals — JPMorgan’s $6 billion London trading loss, an HSBC
money laundering scandal that resulted in a $1.9 billion settlement, and
inappropriate sales of credit-card protection insurance that resulted, on
Thursday, in a $2 billion settlement by British banks — suggest that the
largest banks are also too big to manage, control and regulate.
NOTHING suggests that banks couldn’t do what they
do if they financed, for example, 30 percent of their assets with equity (unborrowed
funds) — a level considered perfectly normal, or even low, for healthy
corporations. Yet this simple idea is considered radical, even heretical, in
the hermetic bubble of banking.
Bankers and regulators want us to believe that the
banks’ high levels of borrowing are acceptable because banks are good at
managing their risks and regulators know how to measure them. The failures
of both were manifest in 2008, and yet regulators have ignored the lessons.
If banks could absorb much more of their losses,
regulators would need to worry less about risk measurements, because banks
would have better incentives to manage their risks and make appropriate
investment decisions. That’s why raising equity requirements substantially
is the single best step for making banking safer and healthier.
The transition to a better system could be managed
quickly. Companies commonly rely on their profits to grow and invest,
without needing to borrow. Banks should do the same.
Banks can also sell more shares to become stronger.
If a bank cannot persuade investors to buy its shares at any price because
its assets are too opaque, unsteady or overvalued, it fails a basic “stress
test,” suggesting it may be too weak without subsidies.
Ben S. Bernanke, chairman of the Federal Reserve,
has acknowledged that the “too big to fail” problem has not been solved, but
the Fed counterproductively allows most large banks to make payouts to their
shareholders, repeating some of the Fed’s most obvious mistakes in the
run-up to the crisis. Its stress tests fail to consider the collateral
damage of banks’ distress. They are a charade.
Dodd-Frank was supposed to spell the end to all
bailouts. It gave the Federal Deposit Insurance Corporation “resolution
authority” to seize and “wind down” banks, a kind of orderly liquidation —
no more panics. Don’t count on it. The F.D.I.C. does not have authority in
the scores of nations where global banks operate, and even the mere
possibility that banks would go into this untested “resolution authority”
would be disruptive to the markets.
The state of financial reform is grim in most other
nations.
Continued in article
Greatest Swindle in the History of the World ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Fractal ---
http://en.wikipedia.org/wiki/Fractal
Question
Why do markets misbehave? How should you measure market risk? And what’s wrong
with academic finance?
These are a few questions that polymath Benoit
Mandelbrot addresses in the fascinating book The Misbehavior of Markets.
Mandelbrot suggests all of these questions can be properly understood by
rejecting the standard assumptions of academic finance and instead using a
“fractal view” of risk and markets.
"The Misbehavior of Markets," Simoleon Sense, April 6, 2009 ---
http://www.simoleonsense.com/
Fractals are at the heart of this book. Fractal
geometry is a form of mathematics developed by Mandelbrot that deals with
rough but highly self-similar structures like trees, coastlines, and
mountains. Fractals have helped explain a wide range of natural phenomena
and revolutionized computer graphics, influencing movies like Star Wars
Episode III. There is room for more applications in this early science, and
fractals may help explain the jagged but predictably irrational patterns in
the stock market, claims Mandelbrot.
In this book, Mandelbrot contends that fractals are
the key to modeling the market. The interesting part is that Mandelbrot does
not merely explain why he’s right but he goes to great length to explain why
others-those using the standard theories of academic finance-are wrong.
Mandelbrot offers interesting history, anecdotes, trivia, and beautiful
illustrations to make his case. The stock market does not act like a random
walk, he says, but rather it’s like the flight of an arrow down an infinite
hallway. It sounds a bit abstract at first, but this is exactly where the
book shines. There are stories and illustrations that make such abstract
concepts easily understandable. I literally felt smarter after reading each
chapter…
Question
What recent 3-2 FASB vote riles the feathers of Tom Selling with innuendos that
the banking industry and large accounting firms had too much influence on a vote
that was not in the best interests of accounting transparency for investors?
"FSP EITF 99-20-1: Dissenting Board Members Hit the Nail on the Head," by Tom
Selling, The Accounting Onion, January 14, 2009 ---
http://accountingonion.typepad.com/theaccountingonion/2009/01/fsp-eitf-99-20.html
Jensen Comment
I perform the despicable deed of (almost) revealing the ending of his mystery to
those who've not yet read the mystery. What must our students think?
About Those Brave Dissenters
And, who were those masked men (or woman)? If I
give you a list of the current FASB members along with a brief description
of their backgrounds, I'm betting you can guess correctly, even without
knowing anything else about them:
* Robert Herz -- former ...
* Thomas Linsmeier -- former ...
* Leslie Seidman -- former ...
* Marc Siegel -- a recognized ...
* Lawrence Smith -- former ...
They are X and Y, of course -- the only two who did
not spend the bulk of their careers serving corporate clients. And
incidentally, they are the two most recent additions to the FASB.
The likes of X and Y give me some hope for the
future of standard setting following the second major financial reporting
crisis of the decade. If we could somehow get just one more on the board
like them, the SEC's recommendations to the FASB can become a reality long
before the IASB gets its act together.
Bob Jensen's threads on fair value accounting are at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Oil and Water Must Read: Economists versus Criminologists
:"Why the ‘Experts’ Failed to See How Financial Fraud Collapsed the Economy,"
by "James K. Galbraith, Big Picture, June 2, 2010 ---
http://www.ritholtz.com/blog/2010/06/james-k-galbraith-why-the-experts-failed-to-see-how-financial-fraud-collapsed-the-economy/
The following is the text of a James K. Galbraith’s written statement
to members of the Senate Judiciary Committee delivered this May. Original
PDF text is here.
Chairman Specter, Ranking Member Graham, Members of
the Subcommittee, as a former member of the congressional staff it is a
pleasure to submit this statement for your record.
I write to you from a disgraced profession.
Economic theory, as widely taught since the 1980s, failed miserably to
understand the forces behind the financial crisis. Concepts including
“rational expectations,” “market discipline,” and the “efficient markets
hypothesis” led economists to argue that speculation would stabilize prices,
that sellers would act to protect their reputations, that caveat emptor
could be relied on, and that widespread fraud therefore could not occur. Not
all economists believed this – but most did.
Thus the study of financial fraud received little
attention. Practically no research institutes exist; collaboration between
economists and criminologists is rare; in the leading departments there are
few specialists and very few students. Economists have soft- pedaled the
role of fraud in every crisis they examined, including the Savings & Loan
debacle, the Russian transition, the Asian meltdown and the dot.com bubble.
They continue to do so now. At a conference sponsored by the Levy Economics
Institute in New York on April 17, the closest a former Under Secretary of
the Treasury, Peter Fisher, got to this question was to use the word
“naughtiness.” This was on the day that the SEC charged Goldman Sachs with
fraud.
There are exceptions. A famous 1993 article
entitled “Looting: Bankruptcy for Profit,” by George Akerlof and Paul Romer,
drew exceptionally on the experience of regulators who understood fraud. The
criminologist-economist William K. Black of the University of
Missouri-Kansas City is our leading systematic analyst of the relationship
between financial crime and financial crisis. Black points out that
accounting fraud is a sure thing when you can control the institution
engaging in it: “the best way to rob a bank is to own one.” The experience
of the Savings and Loan crisis was of businesses taken over for the explicit
purpose of stripping them, of bleeding them dry. This was established in
court: there were over one thousand felony convictions in the wake of that
debacle. Other useful chronicles of modern financial fraud include James
Stewart’s Den of Thieves on the Boesky-Milken era and Kurt Eichenwald’s
Conspiracy of Fools, on the Enron scandal. Yet a large gap between this
history and formal analysis remains.
Formal analysis tells us that control frauds follow
certain patterns. They grow rapidly, reporting high profitability, certified
by top accounting firms. They pay exceedingly well. At the same time, they
radically lower standards, building new businesses in markets previously
considered too risky for honest business. In the financial sector, this
takes the form of relaxed – no, gutted – underwriting, combined with the
capacity to pass the bad penny to the greater fool. In California in the
1980s, Charles Keating realized that an S&L charter was a “license to
steal.” In the 2000s, sub-prime mortgage origination was much the same
thing. Given a license to steal, thieves get busy. And because their
performance seems so good, they quickly come to dominate their markets; the
bad players driving out the good.
The complexity of the mortgage finance sector
before the crisis highlights another characteristic marker of fraud. In the
system that developed, the original mortgage documents lay buried – where
they remain – in the records of the loan originators, many of them since
defunct or taken over. Those records, if examined, would reveal the extent
of missing documentation, of abusive practices, and of fraud. So far, we
have only very limited evidence on this, notably a 2007 Fitch Ratings study
of a very small sample of highly-rated RMBS, which found “fraud, abuse or
missing documentation in virtually every file.” An efforts a year ago by
Representative Doggett to persuade Secretary Geithner to examine and report
thoroughly on the extent of fraud in the underlying mortgage records
received an epic run-around.
When sub-prime mortgages were bundled and
securitized, the ratings agencies failed to examine the underlying loan
quality. Instead they substituted statistical models, in order to generate
ratings that would make the resulting RMBS acceptable to investors. When one
assumes that prices will always rise, it follows that a loan secured by the
asset can always be refinanced; therefore the actual condition of the
borrower does not matter. That projection is, of course, only as good as the
underlying assumption, but in this perversely-designed marketplace those who
paid for ratings had no reason to care about the quality of assumptions.
Meanwhile, mortgage originators now had a formula for extending loans to the
worst borrowers they could find, secure that in this reverse Lake Wobegon no
child would be deemed below average even though they all were. Credit
quality collapsed because the system was designed for it to collapse.
A third element in the toxic brew was a simulacrum
of “insurance,” provided by the market in credit default swaps. These are
doomsday instruments in a precise sense: they generate cash-flow for the
issuer until the credit event occurs. If the event is large enough, the
issuer then fails, at which point the government faces blackmail: it must
either step in or the system will collapse. CDS spread the consequences of a
housing-price downturn through the entire financial sector, across the
globe. They also provided the means to short the market in residential
mortgage-backed securities, so that the largest players could turn tail and
bet against the instruments they had previously been selling, just before
the house of cards crashed.
Latter-day financial economics is blind to all of
this. It necessarily treats stocks, bonds, options, derivatives and so forth
as securities whose properties can be accepted largely at face value, and
quantified in terms of return and risk. That quantification permits the
calculation of price, using standard formulae. But everything in the
formulae depends on the instruments being as they are represented to be. For
if they are not, then what formula could possibly apply?
An older strand of institutional economics
understood that a security is a contract in law. It can only be as good as
the legal system that stands behind it. Some fraud is inevitable, but in a
functioning system it must be rare. It must be considered – and rightly – a
minor problem. If fraud – or even the perception of fraud – comes to
dominate the system, then there is no foundation for a market in the
securities. They become trash. And more deeply, so do the institutions
responsible for creating, rating and selling them. Including, so long as it
fails to respond with appropriate force, the legal system itself.
Control frauds always fail in the end. But the
failure of the firm does not mean the fraud fails: the perpetrators often
walk away rich. At some point, this requires subverting, suborning or
defeating the law. This is where crime and politics intersect. At its heart,
therefore, the financial crisis was a breakdown in the rule of law in
America.
Ask yourselves: is it possible for mortgage
originators, ratings agencies, underwriters, insurers and supervising
agencies NOT to have known that the system of housing finance had become
infested with fraud? Every statistical indicator of fraudulent practice –
growth and profitability – suggests otherwise. Every examination of the
record so far suggests otherwise. The very language in use: “liars’ loans,”
“ninja loans,” “neutron loans,” and “toxic waste,” tells you that people
knew. I have also heard the expression, “IBG,YBG;” the meaning of that bit
of code was: “I’ll be gone, you’ll be gone.”
If doubt remains, investigation into the internal
communications of the firms and agencies in question can clear it up. Emails
are revealing. The government already possesses critical documentary trails
— those of AIG, Fannie Mae and Freddie Mac, the Treasury Department and the
Federal Reserve. Those documents should be investigated, in full, by
competent authority and also released, as appropriate, to the public. For
instance, did AIG knowingly issue CDS against instruments that Goldman had
designed on behalf of Mr. John Paulson to fail? If so, why? Or again: Did
Fannie Mae and Freddie Mac appreciate the poor quality of the RMBS they were
acquiring? Did they do so under pressure from Mr. Henry Paulson? If so, did
Secretary Paulson know? And if he did, why did he act as he did? In a recent
paper, Thomas Ferguson and Robert Johnson argue that the “Paulson Put” was
intended to delay an inevitable crisis past the election. Does the internal
record support this view?
Let us suppose that the investigation that you are
about to begin confirms the existence of pervasive fraud, involving millions
of mortgages, thousands of appraisers, underwriters, analysts, and the
executives of the companies in which they worked, as well as public
officials who assisted by turning a Nelson’s Eye. What is the appropriate
response?
Some appear to believe that “confidence in the
banks” can be rebuilt by a new round of good economic news, by rising stock
prices, by the reassurances of high officials – and by not looking too
closely at the underlying evidence of fraud, abuse, deception and deceit. As
you pursue your investigations, you will undermine, and I believe you may
destroy, that illusion.
But you have to act. The true alternative is a
failure extending over time from the economic to the political system. Just
as too few predicted the financial crisis, it may be that too few are today
speaking frankly about where a failure to deal with the aftermath may lead.
In this situation, let me suggest, the country
faces an existential threat. Either the legal system must do its work. Or
the market system cannot be restored. There must be a thorough, transparent,
effective, radical cleaning of the financial sector and also of those public
officials who failed the public trust. The financiers must be made to feel,
in their bones, the power of the law. And the public, which lives by the
law, must see very clearly and unambiguously that this is the case.
Thank you.
~~~
James K. Galbraith is the author of
The Predator State: How Conservatives Abandoned the Free Market and Why
Liberals Should Too, and of a new preface to The Great Crash, 1929, by
John Kenneth Galbraith. He teaches at The University of Texas at Austin
Bob Jensen's threads on the subprime sleaze is at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
History of Fraud in America ---
http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm
"How Scientists Helped Cause Our Financial Crisis," by John Carney,
ClusterStock, November 25, 2008
http://faculty.trinity.edu/rjensen/2008bailout.htm#Scientists
Warnings from a Theoretical Physicist With an Interest in Economics and
Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models,"
by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html
. . .
In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the way
millions of people and companies interact in a handful of pretty equations.
The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the probabilities of
all possible futures and responding in an optimal way to unexpected shocks.
Surreal Models
Surreal as such models might seem, they have played
a significant role in informing policy at the world’s largest central banks.
Unfortunately, they don’t work very well, and they proved spectacularly
incapable of accommodating the way markets and the economy acted before,
during and after the recent crisis.
Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.
Take, for example, a 2012 (and still somewhat
preliminary)
study by a group of
economists, social scientists, mathematicians and physicists examining the
causes of the housing boom and subsequent collapse from 2000 to 2006.
Starting with data for the Washington D.C. area, the study’s authors built
up a computational model mimicking the behavior of more than two million
potential homeowners over more than a decade. The model included detail on
each individual at the level of race, income, wealth, age and marital
status, and on how these characteristics correlate with home buying
behavior.
Led by further empirical data, the model makes some
simple, yet plausible, assumptions about the way people behave. For example,
homebuyers try to spend about a third of their annual income on housing, and
treat any expected house-price appreciation as income. Within those
constraints, they borrow as much money as lenders’ credit standards allow,
and bid on the highest-value houses they can. Sellers put their houses on
the market at about 10 percent above fair market value, and reduce the price
gradually until they find a buyer.
The model captures things that dynamic stochastic
general equilibrium models do not, such as how rising prices and the
possibility of refinancing entice some people to speculate, buying
more-expensive houses than they otherwise would. The model accurately fits
data on the housing market over the period from 1997 to 2010 (not
surprisingly, as it was designed to do so). More interesting, it can be used
to probe the deeper causes of what happened.
Consider, for example, the assertion of some
prominent economists, such as
Stanford University’s
John Taylor, that the
low-interest-rate policies of the
Federal Reserve were
to blame for the housing bubble. Some dynamic stochastic general equilibrium
models can be used to support this view. The agent- based model, however,
suggests that
interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom and
bust do become smaller, but only marginally.
Leverage Boom
A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were able
to borrow as much as 100 percent of the value of a house -- a form of easy
credit that had a big effect on housing demand. In the model, freezing
leverage at historically normal levels completely eliminates both the
housing boom and the subsequent bust.
Does this mean leverage was the culprit behind the
subprime debacle and the related global financial crisis? Not necessarily.
The model is only a start and might turn out to be wrong in important ways.
That said, it makes the most convincing case to date (see my
blog for more
detail), and it seems likely that any stronger case will have to be based on
an even deeper plunge into the messy details of how people behaved. It will
entail more data, more agents, more computation and less elegance.
If economists jettisoned elegance and got to work
developing more realistic models, we might gain a better understanding of
how crises happen, and learn how to anticipate similarly unstable episodes
in the future. The theories won’t be pretty, and probably won’t show off any
clever mathematics. But we ought to prefer ugly realism to beautiful
fantasy.
(Mark Buchanan, a theoretical physicist and the author of “The Social
Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually
Looks Like You,” is a Bloomberg View columnist. The opinions expressed are
his own.)
Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned mortgages
---
Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Wall Street’s Math Wizards Forgot a Few Variables
What wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/
"They Did Their Homework (800 Years of It)," by Catherine Rampell,
The New York Times, July 2, 2010 ---
http://www.nytimes.com/2010/07/04/business/economy/04econ.html?_r=1&th&emc=th
Thank you Roger
Collins for the heads up.
The advertisement warns of speculative financial
bubbles. It mocks a group of gullible Frenchmen seduced into a silly,
18th-century investment scheme, noting that the modern shareholder, armed
with superior information, can avoid the pitfalls of the past. “How
different the position of the investor today!” the ad enthuses.
It ran in The Saturday Evening Post on Sept. 14,
1929. A month later, the stock market crashed.
“Everyone wants to think they’re smarter than the
poor souls in developing countries, and smarter than their predecessors,”
says
Carmen M. Reinhart,
an economist at the
University of Maryland. “They’re wrong. And we can
prove it.”
Like a pair of financial sleuths, Ms. Reinhart and
her collaborator from
Harvard,
Kenneth S. Rogoff, have spent years investigating
wreckage scattered across documents from nearly a millennium of economic
crises and collapses. They have wandered the basements of rare-book
libraries, riffled through monks’ yellowed journals and begged central banks
worldwide for centuries-old debt records. And they have manually entered
their findings, digit by digit, into one of the biggest spreadsheets you’ve
ever seen.
Their handiwork is contained in their recent best
seller, “This
Time Is Different,” a quantitative reconstruction
of hundreds of historical episodes in which perfectly smart people made
perfectly disastrous decisions. It is a panoramic opus, both geographically
and temporally, covering crises from 66 countries over the last 800 years.
The book, and Ms. Reinhart’s and Mr. Rogoff’s own
professional journeys as economists, zero in on some of the broader
shortcomings of their trade — thrown into harsh relief by economists’
widespread failure to anticipate or address the
financial crisis that began in 2007.
“The mainstream of academic research in
macroeconomics puts theoretical coherence and elegance first, and
investigating the data second,” says Mr. Rogoff. For that reason, he says,
much of the profession’s celebrated work “was not terribly useful in either
predicting the financial crisis, or in assessing how it would it play out
once it happened.”
“People almost pride themselves on not paying
attention to current events,” he says.
In the past, other economists often took the same
empirical approach as the Reinhart-Rogoff team. But this approach fell into
disfavor over the last few decades as economists glorified financial papers
that were theory-rich and data-poor.
Much of that theory-driven work, critics say, is
built on the same disassembled and reassembled sets of data points —
generally from just the last 25 years or so and from the same handful of
rich countries — that quants have whisked into ever more dazzling and
complicated mathematical formations.
But in the wake of the recent crisis, a few
economists — like Professors Reinhart and Rogoff, and other like-minded
colleagues like Barry Eichengreen and Alan Taylor — have been encouraging
others in their field to look beyond hermetically sealed theoretical models
and into the historical record.
“There is so much inbredness in this profession,”
says Ms. Reinhart. “They all read the same sources. They all use the same
data sets. They all talk to the same people. There is endless extrapolation
on extrapolation on extrapolation, and for years that is what has been
rewarded.”
ONE of Ken Rogoff’s favorite economics jokes — yes,
there are economics jokes — is “the one about the lamppost”: A drunk on his
way home from a bar one night realizes that he has dropped his keys. He gets
down on his hands and knees and starts groping around beneath a lamppost. A
policeman asks what he’s doing.
“I lost my keys in the park,” says the drunk.
“Then why are you looking for them under the
lamppost?” asks the puzzled cop.
“Because,” says the drunk, “that’s where the light
is.”
Mr. Rogoff, 57, has spent a lifetime exploring
places and ideas off the beaten track. Tall, thin and bespectacled, he grew
up in Rochester. There, he attended a “tough inner-city school,” where his
“true liberal parents” — a radiologist and a librarian — sent him so he
would be exposed to students from a variety of social and economic classes.
He received a chess set for his 13th birthday, and
he quickly discovered that he was something of a prodigy, a fact he decided
to hide so he wouldn’t get beaten up in the lunchroom.
“I think chess may be a relatively cool thing for
kids to do now, on par with soccer or other sports,” he says. “It really
wasn’t then.”
Soon, he began traveling alone to competitions
around the United States, paying his way with his prize winnings. He earned
the rank of American “master” by the age of 14, was a New York State Open
champion and soon became a “senior master,” the highest national title.
When he was 16, he left home against his parents’
wishes to become a professional chess player in Europe. He enrolled
fleetingly in high schools in London and Sarajevo, Yugoslavia, but rarely
attended. “I wasn’t quite sure what I was supposed to be doing,” he recalls.
He spent the next 18 months or so wandering to
competitions around Europe, supporting himself with winnings and by
participating in exhibitions in which he played dozens of opponents
simultaneously, sometimes while wearing a blindfold.
Occasionally, he slept in five-star hotels, but
other nights, when his prize winnings thinned, he crashed in grimy train
stations. He had few friends, and spent most of his time alone, studying
chess and analyzing previous games. Clean-cut and favoring a coat and tie
these days, he described himself as a ragged “hippie” during his time in
Europe. He also found life in Eastern Europe friendly but strained, he says,
throttled by black markets, scarcity and unmet government promises.
After much hand-wringing, he decided to return to
the United States to attend Yale, which overlooked his threadbare high
school transcript. He considered majoring in Russian until Jeremy Bulow, a
classmate who is now an economics professor at Stanford, began evangelizing
about economics.
Mr. Rogoff took an econometrics course, reveling in
its precision and rigor, and went on to focus on comparative economic
systems. He interrupted a brief stint in a graduate program in economics at
the Massachusetts Institute of Technology to prepare for the world chess
championships, which were held only every three years.
After becoming an “international grandmaster,” the
highest title awarded in chess, when he was 25, he decided to quit chess
entirely and to return to M.I.T. He did so because he had snared the
grandmaster title and because he realized that he would probably never be
ranked No. 1.
He says it took him a long time to get over the
game, and the euphoric, almost omnipotent highs of his past victories.
“To this day I get letters, maybe every two years,
from top players asking me: ‘How do I quit? I want to quit like you did, and
I can’t figure out how to do it,’ ” he says. “I tell them that it’s hard to
go from being at the top of a field, because you really feel that way when
you’re playing chess and winning, to being at the bottom — and they need to
prepare themselves for that.”
He returned to M.I.T., rushed through what he
acknowledges was a mediocre doctoral dissertation, and then became a
researcher at the Federal Reserve — where he said he had good role models
who taught him how to be, at last, “professional” and “serious.”
Teaching stints followed, before the International
Monetary Fund chose him as its chief economist in 2001. It was at the I.M.F.
that he began collaborating with a relatively unfamiliar economist named
Carmen Reinhart, whom he appointed as his deputy after admiring her work
from afar.
MS. REINHART, 54, is hardly a household name. And,
unlike Mr. Rogoff, she has never been hired by an Ivy League school. But
measured by how often her work is cited by colleagues and others, this woman
whom several colleagues describe as a “firecracker” is, by a long shot, the
most influential female economist in the world.
Like Mr. Rogoff, she took a circuitous route to her
present position.
Born in Havana as Carmen Castellanos, she is
quick-witted and favors bright, boldly printed blouses and blazers. As a
girl, she memorized the lore of pirates and their trade routes, which she
says was her first exposure to the idea that economic fortunes — and state
revenue in particular — “can suddenly disappear without warning.”
She also lived with more personal financial and
social instability. After her family fled Havana for the United States with
just three suitcases when she was 10, her father traded a comfortable living
as an accountant for long, less lucrative hours as a carpenter. Her mother,
who had never worked outside the home before, became a seamstress.
“Most kids don’t grow up with that kind of real
economic shock,” she says. “But I learned the value of scarcity, and even
the sort of tensions between East and West. And at a very early age that had
an imprint on me.”
With a passion for art and literature — even today,
her academic papers pun on the writings of Gabriel García Márquez — she
enrolled in a two-year college in Miami, intending to study fashion
merchandising. Then, on a whim, she took an economics course and got hooked.
When she went to Florida International University
to study economics, she met Peter Montiel, an M.I.T. graduate who was
teaching there. Recognizing her talent, he helped her apply to a top-tier
graduate program in economics, at Columbia University.
At Columbia, she met her future husband, Vincent
Reinhart, who is now an occasional co-author with her. They married while in
graduate school, and she quit school before writing her dissertation to try
to make some money on Wall Street.
“We were newlyweds, and neither of us had a penny
to our name,” she says. She left school so that they “could have nice things
and a house, the kind of things I imagined a family should have.”
She spent a few years at Bear Stearns, including
one as chief economist, before deciding to finish her graduate work at
Columbia and return to her true love: data mining. “I have a talent for
rounding up data like cattle, all over the plain,” she says.
After earning her doctorate in 1988, Ms. Reinhart
started work at the I.M.F.
“Carmen in many ways pioneered a bigger segment in
economics, this push to look at history more,” says Mr. Rogoff, explaining
why he chose her. “She was just so ahead of the curve.”
She honed her knack for economic archaeology at the
I.M.F., spending several years performing “checkups” on member countries to
make sure they were in good economic health.
While at the fund, she teamed up with Graciela
Kaminsky, another member of that exceptionally rare species — the female
economist — to write their seminal paper, “The Twin Crises.”
The article looked at the interaction between
banking and currency crises, and why contemporary theory couldn’t explain
why those ugly events usually happened together. The paper bore one of Ms.
Reinhart’s hallmarks: a vast web of data, compiled from 20 countries over
several decades.
In digging through old records and piecing together
a vast puzzle of disconnected data points, her ultimate goal, in that paper
and others, has always been “to see the forest,” she says, “and explain it.”
Ms. Reinhart has bounced back and forth across the
Beltway: she left the I.M.F. in Washington and began teaching in 1996 at the
University of Maryland, from which Mr. Rogoff recruited her when he needed a
deputy at the I.M.F. in 2001. When she left that post, she returned to the
university.
Despite the large following that her work has
drawn, she says she feels that the heavyweights of her profession have
looked down upon her research as useful but too simplistic.
“You know, everything is simple when it’s clearly
explained,” she contends. “It’s like with Sherlock Holmes. He goes through
this incredible deductive process from Point A to Point B, and by the time
he explains everything, it makes so much sense that it sounds obvious and
simple. It doesn’t sound clever anymore.”
But, she says, “economists love being clever.”
“THIS TIME IS DIFFERENT” was published last
September, just as the nation was coming to grips with a financial crisis
that had nearly spiraled out of control and a job market that lay in
tatters. Despite bailout after bailout, stimulus after stimulus, economic
armageddon still seemed nigh.
Given this backdrop, it’s perhaps not surprising
that a book arguing that the crisis was a rerun, and not a wholly novel
catastrophe, managed to become a best seller. So far, nearly 100,000 copies
have been sold, according to its publisher, the Princeton University Press.
Still, its authors laugh when asked about the
book’s opportune timing.
“We didn’t start the book thinking that, ‘Oh, in
exactly seven years there will be a housing bust leading to a global
financial crisis that will be the perfect environment in which to sell this
giant book,’ ” says Mr. Rogoff. “But I suppose the way things work, we
expected that whenever the book came out there would probably be some crisis
or other to peg it to.”
They began the book around 2003, not long after Mr.
Rogoff lured Ms. Reinhart back to the I.M.F. to serve as his deputy. The
pair had already been collaborating fruitfully, finding that her dogged
pursuit of data and his more theoretical public policy eye were well
matched.
Although their book is studiously nonideological,
and is more focused on patterns than on policy recommendations, it has
become fodder for the highly charged debate over the recent growth in
government debt.
Continued in article
What went wrong in accounting/accountics
research?
http://faculty.trinity.edu/rjensen/theory01.htm#WhatWentWrong
574 Shields Against Validity
Challenges in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
- With a Rejoinder from the 2010 Senior
Editor of The Accounting Review (TAR), Steven J. Kachelmeier
- With Replies in Appendix 4 to Professor
Kachemeier by Professors Jagdish Gangolly and Paul Williams
- With Added Conjectures in Appendix 1 as
to Why the Profession of Accountancy Ignores TAR
- With Suggestions in Appendix 2 for
Incorporating Accounting Research into Undergraduate Accounting Courses
Gaming for Tenure as an Accounting Professor ---
http://faculty.trinity.edu/rjensen/TheoryTenure.htm
(with a reply about tenure publication point systems from Linda Kidwell)
Definition of Millenials (Generation Y or Net Generation) ---
http://en.wikipedia.org/wiki/Millennials
"The Millennials Invade the B-Schools: They're pursuing MBAs to
change the world, but first they're forcing business schools to make changes in
order to accommodate them," Business Week, November 13, 2008 ---
http://www.businessweek.com/magazine/content/08_47/b4109046025427.htm?link_position=link2
Best International Business Schools According to Business Week ---
http://images.businessweek.com/ss/08/11/1112_best_international_business_schools/index.htm?link_position=link5
Controversies in College Rankings ---
http://faculty.trinity.edu/rjensen/HigherEdControversies.htm#BusinessSchoolRankings
Financial Education For All: Federal Reserve Bank of New York ---
http://www.newyorkfed.org/education/econ_eduforall.html
Question
What will happen to all the future capital markets studies and
CAPM when the assumed
risk-free
interest rate is no longer "risk free?"
Is “Risk Free” an
oxymoron?
"Uncle Sam's Credit Line Running Out," by Randall Forsyth, Barron's,
November 11, 2008 ---
http://online.barrons.com/article/SB122633310980913759.html
Be that as it may, it's all
(new National Debt at now $6 billion per day)
adding up. If the late Sen. Everett Dirksen were around today, he might
comment that a trillion here, a trillion there and pretty soon you're
talking about real money.
Trillions are no hyperbole. The Treasury
is set to borrow $550 billion in the current quarter alone and $368 billion
in the first quarter of 2009. "Near-term pressures on Treasury finances are
much more intense than we had thought," Goldman Sachs economists commented
when the government announced its borrowing projections last week.
It may finally be catching up with Uncle
Sam. That's what the yield curve may be whispering. But some economists are
too deaf, or dumb, to get it.
The yield curve simply is the graph of
Treasury yields of increasing maturities, starting from one-month bills to
30-year bonds. The slope of the line typically is ascending -- positive in
math terms -- because investors would want more to tie up their money for
longer periods, all else being equal. Which it never is.
If they expect yields to rise in the
future, they'll want a bigger premium to commit to longer maturities.
Otherwise, they'd rather stay short and wait for more generous yields later
on. Conversely, if they think rates will fall, investors will want to lock
in today's yields for a longer period.
The Treasury yield curve -- from two to 10
years, which is how the bond market tracks it -- has rarely been steeper.
The spread is up to 250 basis points (2.5 percentage points, a level matched
only in the past quarter century in 2002 and 1992, at the trough of economic
cycles.
Based on a simplistic reading of that
history and the Cliff Notes version of theory, one economist whose main area
of expertise is to get quoted by reporters even less knowledgeable than he,
asserts such a steep yield curve typically reflects investors' anticipation
of economic recovery. Never mind that the yield curve has steepened as the
economy has worsened and prospects for recovery have diminished. Like the
Bourbons, the French royal family up to the Revolution, he learns nothing
and forgets nothing.
As with so much other things, something
else is happening this year.
The steepening of the Treasury yield curve
has been accompanied by an increase in the cost of insuring against default
by the U.S. Treasury. It may come as a shock, but there are credit-default
swaps on the U.S. government and they have become more expensive -- in
tandem with an increase in the spread between two- and 10-year notes.
This link has been brought to light by Tim
Backshall, the chief analyst of Credit Derivatives Research. The attraction
of investors to the short end of the Treasury market is "juxtaposed with the
massive oversupply and inflationary expectations of the longer end," he
writes.
Backshall is not alone in this dire
assessment. Scott Minerd, the chief investment officer for fixed income at
Guggenheim Partners, a Los Angeles money manager, estimates that total
Treasury borrowing for fiscal 2009 will total $1.5 trillion-$2 trillion.
That was based on $700 billion for TARP, a $500 billion-$750 billion
"cyclical deficit," an additional $500 billion stimulus program and some
uncertain amount for the Federal Deposit Insurance Corp.
Minerd doubts that private savings in the
U.S. and foreign purchases of Treasury debt will be sufficient to meet those
government cash requirements. That leaves the Fed to take up the slack; that
is, monetization of the debt.
However it comes about, Backshall's charts
of the yield curve and the spread on U.S. Treasury CDS paint a dramatic
picture. Both the yield spread and the cost of insuring debt moved up
sharply together starting in September.
Let's recall what happened that month: the
Fannie Mae-Freddie Mac bailouts, the AIG bailout and the Lehman Brothers
failure. The two lines continued their parallel ascent with the announcement
and ultimate passage of the TARP last month. And evidence mounted of an
accelerating slide in growth.
Cutting through the technical jargon, the
yield curve and the credit-default swaps market both indicate the markets
are exacting a greater cost to lend to Uncle Sam. And it's not because of
anticipated recovery, which would reduce, not increase, the cost of insuring
Treasury debt against default.
All of which suggests America's credit
line has its limits.
Continued in article
The End
So
where does that leave us? The writer and philosopher Laurens van der Post, in
his memoir of his friendship with Carl Jung, said, "We live not only our own
lives but, whether we know it or not, also the life of our time." We are actors
in a moment of history, taking part in it, moving it this way or that as we move
forward or back. The moment we are living now is a strange one, a disquieting
one, a time that seems full of endings.
Peggy Noonan,
"Declarations: Six months after the collapse, a 'pandemic of fear'," The Wall
Street Journal, March 13, 2009 ---
http://online.wsj.com/article/SB123689292159011723.html#mod=djemEditorialPage
Question
What's the difference in expected income when a finance graduates in a bull
market relative to a bear market?
Is it bad
timing or is it “The End?”
Timing may be everything in
life from getting the right spouse to getting the best job opportunities,
But for finance majors the career timing factor is huge relative to other
college majors such as majors in accounting and engineering
I
estimate that a person who graduates in a bull market and goes to work in
investment banking after graduation earns an additional $1.5 million to $5
million relative to what the same person would have earned if he or she had
graduated during a bear market and had started his or her career in some other
industry.
Paul Oyer, Stanford University, "The Making Of A Banker: Macroeconomic Shocks,
Career Choice, and Lifetime Income," as quoted in the Financial Rounds Blog on
January 21, 2009 ---
http://financialrounds.blogspot.com/
Jensen Comment
Actually, the high flying opportunities for finance majors and MBAs hired by
Wall Street firms are probably "ended" for good.
See below:
Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek Explanation
of the Meltdown on Wall Street!
Now I asked
Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of
the other Wall Street firms—all said what an awful thing it was to go public
(beg for a government bailout)
and how could you do such a thing. But when the
temptation arose, they all gave in to it.” He agreed that the main effect of
turning a partnership into a corporation was to transfer the financial risk
to the shareholders. “When things go wrong, it’s their problem,” he said—and
obviously not theirs alone. When a Wall Street investment bank screwed up
badly enough, its risks became the problem of the U.S. government. “It’s
laissez-faire until you get in deep shit,” he said, with a half chuckle. He
was out of the game.
This is a must read to understand what went wrong on Wall Street ---
especially the punch line!
"The End," by Michael Lewis December 2008 Issue The era that defined Wall Street
is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s
Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true
To this day, the willingness of a Wall Street
investment bank to pay me hundreds of thousands of dollars to dispense
investment advice to grownups remains a mystery to me. I was 24 years old,
with no experience of, or particular interest in, guessing which stocks and
bonds would rise and which would fall. The essential function of Wall Street
is to allocate capital—to decide who should get it and who should not.
Believe me when I tell you that I hadn’t the first clue.
I’d never taken an accounting course, never run a
business, never even had savings of my own to manage. I stumbled into a job
at Salomon Brothers in 1985 and stumbled out much richer three years later,
and even though I wrote a book about the experience, the whole thing still
strikes me as preposterous—which is one of the reasons the money was so easy
to walk away from. I figured the situation was unsustainable. Sooner rather
than later, someone was going to identify me, along with a lot of people
more or less like me, as a fraud. Sooner rather than later, there would come
a Great Reckoning when Wall Street would wake up and hundreds if not
thousands of young people like me, who had no business making huge bets with
other people’s money, would be expelled from finance.
When I sat down to write my account of the
experience in 1989—Liar’s Poker, it was called—it was in the spirit of a
young man who thought he was getting out while the getting was good. I was
merely scribbling down a message on my way out and stuffing it into a bottle
for those who would pass through these parts in the far distant future.
Unless some insider got all of this down on paper,
I figured, no future human would believe that it happened.
I thought I was writing a period piece about the
1980s in America. Not for a moment did I suspect that the financial 1980s
would last two full decades longer or that the difference in degree between
Wall Street and ordinary life would swell into a difference in kind. I
expected readers of the future to be outraged that back in 1986, the C.E.O.
of Salomon Brothers, John Gutfreund, was paid $3.1 million; I expected them
to gape in horror when I reported that one of our traders, Howie Rubin, had
moved to Merrill Lynch, where he lost $250 million; I assumed they’d be
shocked to learn that a Wall Street C.E.O. had only the vaguest idea of the
risks his traders were running. What I didn’t expect was that any future
reader would look on my experience and say, “How quaint.”
I had no great agenda, apart from telling what I
took to be a remarkable tale, but if you got a few drinks in me and then
asked what effect I thought my book would have on the world, I might have
said something like, “I hope that college students trying to figure out what
to do with their lives will read it and decide that it’s silly to phony it
up and abandon their passions to become financiers.” I hoped that some
bright kid at, say, Ohio State University who really wanted to be an
oceanographer would read my book, spurn the offer from Morgan Stanley, and
set out to sea.
Somehow that message failed to come across. Six
months after Liar’s Poker was published, I was knee-deep in letters from
students at Ohio State who wanted to know if I had any other secrets to
share about Wall Street. They’d read my book as a how-to manual.
In the two decades since then, I had been waiting
for the end of Wall Street. The outrageous bonuses, the slender returns to
shareholders, the never-ending scandals, the bursting of the internet
bubble, the crisis following the collapse of Long-Term Capital Management:
Over and over again, the big Wall Street investment banks would be, in some
narrow way, discredited. Yet they just kept on growing, along with the sums
of money that they doled out to 26-year-olds to perform tasks of no obvious
social utility. The rebellion by American youth against the money culture
never happened. Why bother to overturn your parents’ world when you can buy
it, slice it up into tranches, and sell off the pieces?
At some point, I gave up waiting for the end. There
was no scandal or reversal, I assumed, that could sink the system.
The New Order The crash did more than wipe out
money. It also reordered the power on Wall Street. What a Swell Party A
pictorial timeline of some Wall Street highs and lows from 1985 to 2007.
Worst of Times Most economists predict a recovery late next year. Don’t bet
on it. Then came Meredith Whitney with news. Whitney was an obscure analyst
of financial firms for Oppenheimer Securities who, on October 31, 2007,
ceased to be obscure. On that day, she predicted that Citigroup had so
mismanaged its affairs that it would need to slash its dividend or go bust.
It’s never entirely clear on any given day what causes what in the stock
market, but it was pretty obvious that on October 31, Meredith Whitney
caused the market in financial stocks to crash. By the end of the trading
day, a woman whom basically no one had ever heard of had shaved $369 billion
off the value of financial firms in the market. Four days later, Citigroup’s
C.E.O., Chuck Prince, resigned. In January, Citigroup slashed its dividend.
From that moment, Whitney became E.F. Hutton: When
she spoke, people listened. Her message was clear. If you want to know what
these Wall Street firms are really worth, take a hard look at the crappy
assets they bought with huge sums of borrowed money, and imagine what
they’d fetch in a fire sale. The vast assemblages of highly paid people
inside the firms were essentially worth nothing. For better than a year now,
Whitney has responded to the claims by bankers and brokers that they had put
their problems behind them with this write-down or that capital raise with a
claim of her own: You’re wrong. You’re still not facing up to how badly you
have mismanaged your business.
Rivals accused Whitney of being overrated; bloggers
accused her of being lucky. What she was, mainly, was right. But it’s true
that she was, in part, guessing. There was no way she could have known what
was going to happen to these Wall Street firms. The C.E.O.’s themselves
didn’t know.
Now, obviously, Meredith Whitney didn’t sink Wall
Street. She just expressed most clearly and loudly a view that was, in
retrospect, far more seditious to the financial order than, say, Eliot
Spitzer’s campaign against Wall Street corruption. If mere scandal could
have destroyed the big Wall Street investment banks, they’d have vanished
long ago. This woman wasn’t saying that Wall Street bankers were corrupt.
She was saying they were stupid. These people whose job it was to allocate
capital apparently didn’t even know how to manage their own.
At some point, I could no longer contain myself: I
called Whitney. This was back in March, when Wall Street’s fate still hung
in the balance. I thought, If she’s right, then this really could be the end
of Wall Street as we’ve known it. I was curious to see if she made sense but
also to know where this young woman who was crashing the stock market with
her every utterance had come from.
It turned out that she made a great deal of sense
and that she’d arrived on Wall Street in 1993, from the Brown University
history department. “I got to New York, and I didn’t even know research
existed,” she says. She’d wound up at Oppenheimer and had the most
incredible piece of luck: to be trained by a man who helped her establish
not merely a career but a worldview. His name, she says, was Steve Eisman.
Eisman had moved on, but they kept in touch. “After
I made the Citi call,” she says, “one of the best things that happened was
when Steve called and told me how proud he was of me.”
Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called Whitney again and asked
her, as I was asking others, whom she knew who had anticipated the cataclysm
and set themselves up to make a fortune from it. There’s a long list of
people who now say they saw it coming all along but a far shorter one of
people who actually did. Of those, even fewer had the nerve to bet on their
vision. It’s not easy to stand apart from mass hysteria—to believe that most
of what’s in the financial news is wrong or distorted, to believe that most
important financial people are either lying or deluded—without actually
being insane. A handful of people had been inside the black box, understood
how it worked, and bet on it blowing up. Whitney rattled off a list with a
half-dozen names on it. At the top was Steve Eisman.
Steve Eisman entered finance about the time I
exited it. He’d grown up in New York City and gone to a Jewish day school,
the University of Pennsylvania, and Harvard Law School. In 1991, he was a
30-year-old corporate lawyer. “I hated it,” he says. “I hated being a
lawyer. My parents worked as brokers at Oppenheimer. They managed to finagle
me a job. It’s not pretty, but that’s what happened.”
He was hired as a junior equity analyst, a helpmate
who didn’t actually offer his opinions. That changed in December 1991, less
than a year into his new job, when a subprime mortgage lender called Ames
Financial went public and no one at Oppenheimer particularly cared to
express an opinion about it. One of Oppenheimer’s investment bankers stomped
around the research department looking for anyone who knew anything about
the mortgage business. Recalls Eisman: “I’m a junior analyst and just trying
to figure out which end is up, but I told him that as a lawyer I’d worked on
a deal for the Money Store.” He was promptly appointed the lead analyst for
Ames Financial. “What I didn’t tell him was that my job had been to
proofread the documents and that I hadn’t understood a word of the fucking
things.”
Ames Financial belonged to a category of firms
known as nonbank financial institutions. The category didn’t include J.P.
Morgan, but it did encompass many little-known companies that one way or
another were involved in the early-1990s boom in subprime mortgage
lending—the lower class of American finance.
The second company for which Eisman was given sole
responsibility was Lomas Financial, which had just emerged from bankruptcy.
“I put a sell rating on the thing because it was a piece of shit,” Eisman
says. “I didn’t know that you weren’t supposed to put a sell rating on
companies. I thought there were three boxes—buy, hold, sell—and you could
pick the one you thought you should.” He was pressured generally to be a bit
more upbeat, but upbeat wasn’t Steve Eisman’s style. Upbeat and Eisman
didn’t occupy the same planet. A hedge fund manager who counts Eisman as a
friend set out to explain him to me but quit a minute into it. After
describing how Eisman exposed various important people as either liars or
idiots, the hedge fund manager started to laugh. “He’s sort of a prick in a
way, but he’s smart and honest and fearless.”
“A lot of people don’t get Steve,” Whitney says.
“But the people who get him love him.” Eisman stuck to his sell rating on
Lomas Financial, even after the company announced that investors needn’t
worry about its financial condition, as it had hedged its market risk. “The
single greatest line I ever wrote as an analyst,” says Eisman, “was after
Lomas said they were hedged.” He recited the line from memory: “ ‘The Lomas
Financial Corp. is a perfectly hedged financial institution: It loses money
in every conceivable interest-rate environment.’ I enjoyed writing that
sentence more than any sentence I ever wrote.” A few months after he’d
delivered that line in his report, Lomas Financial returned to bankruptcy.
Continued in article
Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999, ISBN
0340767006)
Lewis writes in Partnoy’s earlier whistleblower
style with somewhat more intense and comic portrayals of the major players
in describing the double dealing and break down of integrity on the trading
floor of Salomon Brothers.
Reply from Tom Hood
Thanks Bob for the Michael Lewis article, “The End” – great explanation of
the mess we a re in and how we got here. Just found this one that does a great
job of summarizing the mess – visually
http://flowingdata.com/2008/11/25/visual-guide-to-the-financial-crisis/
Tom Hood, CPA.CITP, CEO & Executive Director, Maryland Association of CPAs
443-632-2301,
http://www.macpa.org
Check out our blogs for CPAs
http://www.cpasuvvess.com
http://www.newcpas.com
http://www.cpaisland.com
January 22, 2009 reply from Robert B Walker
[walkerrb@ACTRIX.CO.NZ]
I had a look at Bob’s material from the links
above. The issue of immediate interest was the fate of the audit firms. No
doubt there will be some measure put in place to prevent their failure in
the manner of Andersen on the basis that they are too big to fail. That
being so, a phrase I read in one of the Michael Lewis pieces Bob directed us
to resonated loud and clear:
‘If it is too big to fail, break it up.’
Plain, simple common sense and a lesson, amongst
many, to be learned from the financial fiasco that reverberates in a way
that terrifies me.
An interesting article on the history of money
appeared in the second to last issue of the New York Review (
www.nybooks.com/contents ) Unfortunately it is not
available for free. It is a review of a book written by Niall Ferguson
called The Ascent of Money. Robert Skidelsky is the author of the review. He
admires Ferguson’s book in large measure though he says Ferguson doesn’t
understand money completely. Skidelsky finishes his review by citing J M
Keynes on the nature of money and why people hoard it in the face of
uncertainty (Skidelsky is a biographer of Keynes). I have difficulty getting
my head around the concept but it left me even more fearful than before.
"How to Create a Real Economic Stimulus Entitlement reform is key to
shrinking the ratio of debt to GDP and making room for pro-growth tax cuts,"
by Martin Feldstein, The Wall Street Journal, September 16, 2013 ---
http://online.wsj.com/article/SB10001424127887323595004579065361191486206.html?mod=djemEditorialPage_h
Earlier this year, former U.S. Treasury Secretary
Larry Summers expressed doubts about the Federal Reserve's quantitative
easing policy of buying $85 billion a month of government bonds and other
long-term assets. His skepticism antagonized some Fed insiders and liberal
Democrats, who recently opposed his consideration by President Obama as the
next Fed chairman.
When Mr. Summers on Sunday withdrew his candidacy
for the chairman's job, there was one immediate benefit: Now Larry Summers
will be free to voice an even clearer and stronger critique of current
policy.
The United States certainly needs a new strategy to
increase economic growth and employment. The U.S. growth rate has fallen to
less than 2%, and total employment is a smaller share of the population now
than it was five years ago. The official unemployment rate has declined
sharply (to 7.3% last month from 10% in October 2009) only because so many
people have stopped looking for work or are working part-time.
The Fed's monetary policy is no longer effective in
stimulating demand. The near-zero interest-rate policy and aggressive
quantitative easing, it has become increasingly clear, create dangerous
risks to future stability. The Fed's announcement in June that it will soon
reduce the rate of buying long-term assets raised long-term rates, slowing
the recovery in the housing market and other activity. And the unemployment
rate is approaching the 6.5% threshold that could lead the Fed to raise
short rates.
On the fiscal side, a replay of the $830 billion
"stimulus" in 2009 is politically out of the question. That poorly designed
package added more to the national debt than it did to aggregate spending.
The national debt has increased from 37% of gross domestic product before
the economic downturn to 75% now. The Congressional Budget Office warns that
the debt will remain at that level for the coming decade and then rise
rapidly as the aging population increases the cost of Social Security and
Medicare. The large projected national debt is a drag on the economy,
causing businesses and entrepreneurs to fear higher tax rates and a sharp
rise in interest rates when the Fed stops its massive bond purchases.
A successful growth and employment strategy would
combine substantial reductions in the relative size of the future national
debt with immediate permanent tax-rate cuts and a multiyear program of
infrastructure spending. The challenge is to reduce future government
spending by enough to make the ratio of debt to GDP predictably lower a
decade from now, despite the tax-rate cuts and near-term infrastructure
spending.
Fortunately, a relatively small change in annual
deficits would significantly shrink the debt ratio. With a national debt of
75% of GDP, a projected annual deficit of 4% of GDP would keep the debt
rising to 100% of GDP. In contrast, a deficit of 1% would cause the debt
ratio to decline year after year until it reaches 25% of GDP.
The only way to reduce future deficits without
weakening incentives and growth is by cutting future government spending.
The share of GDP devoted to defense and to nondefense discretionary programs
is already headed to its lowest level in the past half-century. Reducing
spending therefore requires slowing the growth of the benefits of
middle-class retirees and cutting the spending that is built into the tax
code.
Raising the age for full benefits is a simple but
powerful way to slow the cost of Social Security and Medicare. Thirty years
ago, Congress voted to increase gradually the age for full benefits from 65
to 67. Since then, the life expectancy at age 67 has increased by an
additional three years. Congress should vote now to continue raising the
full benefit age from 67 to 70. When that is fully phased in, the annual
cost of Social Security benefits would be reduced by about 20%, equivalent
to a saving in 2020 of $200 billion or about 1% of GDP.
Gradually raising the age of Medicare eligibility
in line with the age for full Social Security benefits would achieve a
budget saving of more than 1% of GDP in 2020 and later years. Individuals
between ages 65 and 70 could still enroll in Medicare by paying a fair
premium.
Limiting the tax breaks built into the tax code
would also help. The combination of tax credits, deductions and exclusions
increases the annual budget deficit by hundreds of billions of dollars.
Those tax breaks are really subsidies that should be seen as government
spending.
While many of the smaller tax subsidies should
simply be eliminated, it would be politically impossible to eliminate such
popular features as the deduction for mortgage interest or the exclusion of
employer payments for health insurance. A better alternative would be to
allow individuals to keep all of these tax benefits but to limit the amount
by which individuals can reduce their tax liabilities in this way to 2% of
adjusted gross income. This one change to the tax code would reduce the 2013
federal deficit by $140 billion or nearly 1% of GDP even if the deduction
for charitable contributions was fully retained.
Slower entitlement growth and reduced tax
expenditures should be phased in slowly to avoid weakening the recovery. But
by 2020 they could be producing annual savings equal to more than 3% of GDP.
With the future debt under control, it would be
fiscally responsible to enact permanent tax-rate reductions and an effective
short-term program of infrastructure investment in things like bridges,
airports and other projects that will boost demand. Each dollar spent on a
well-designed infrastructure program would increase GDP by a dollar or more,
unlike the 2009 "stimulus" program that spent its funds on transfer
payments, temporary tax cuts and other programs that did little to raise
total spending.
Lower personal tax rates would raise GDP by
increasing incentives for additional earning and increased entrepreneurial
activity. Bringing the U.S. corporate tax rate (35%) in line with the tax
rates in other industrial countries (closer to 25%) would spur investment
and production.
Continued in article
Bob Jensen's threads on entitlements ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
A Bit of History from the Roaring 1990s
What are some of
Frank Partnoy’s best-known works?
Frank Partnoy,
FIASCO: Blood in the Water on Wall Street (W. W.
Norton & Company, 1997, ISBN 0393046222, 252 pages).
This is the first of a somewhat
repetitive succession of Partnoy’s “FIASCO” books that
influenced my life. The most important revelation from
his insider’s perspective is that the most trusted firms
on Wall Street and financial centers in other major
cities in the U.S., that were once highly professional
and trustworthy, excoriated the guts of integrity
leaving a façade behind which crooks less violent than
the Mafia but far more greedy took control in the
roaring 1990s.
After selling a succession of phony
derivatives deals while at Morgan Stanley, Partnoy blew
the whistle in this book about a number of his
employer’s shady and outright fraudulent deals sold in
rigged markets using bait and switch tactics.
Customers, many of them pension fund investors for
schools and municipal employees, were duped into complex
and enormously risky deals that were billed as safe as
the U.S. Treasury.
His books have received mixed reviews,
but I question some of the integrity of the reviewers
from the investment banking industry who in some
instances tried to whitewash some of the deals described
by Partnoy. His books have received a bit less praise
than the book Liars Poker by Michael Lewis, but
critics of Partnoy fail to give credit that Partnoy’s
exposes preceded those of Lewis.
Frank Partnoy,
FIASCO: Guns, Booze and Bloodlust: the Truth About High
Finance (Profile Books, 1998, 305 Pages)
Like his earlier books, some investment
bankers and literary dilettantes who reviewed this book
were critical of Partnoy and claimed that he
misrepresented some legitimate structured financings.
However, my reading of the reviewers is that they were
trying to lend credence to highly questionable offshore
deals documented by Partnoy. Be that as it may, it
would have helped if Partnoy had been a bit more
explicit in some of his illustrations.
Frank Partnoy,
FIASCO: The Inside Story of a Wall Street Trader
(Penguin, 1999, ISBN 0140278796, 283 pages).
This is a
blistering indictment of the unregulated OTC market
for derivative financial instruments and the million
and billion dollar deals conceived in investment
banking. Among other things, Partnoy describes
Morgan Stanley’s annual drunken skeet-shooting
competition organized by a “gun-toting strip-joint
connoisseur” former combat officer (fanatic) who
loved the motto: “When derivatives are outlawed
only outlaws will have derivatives.” At that event,
derivatives salesmen were forced to shoot entrapped
bunnies between the eyes on the pretense that the
bunnies were just like “defenseless animals” that
were Morgan Stanley’s customers to be shot down even
if they might eventually “lose a billion dollars on
derivatives.”
This book has one of the best accounts of the
“fiasco” caused almost entirely by the duping of
Orange
County ’s Treasurer (Robert Citron)
by the unscrupulous Merrill Lynch derivatives
salesman named Michael
Stamenson. Orange
County eventually lost over a billion
dollars and was forced into bankruptcy. Much of
this was later recovered in court from Merrill
Lynch. Partnoy calls
Citron and Stamenson
“The Odd Couple,” which is also the title of Chapter
8 in the book.Frank Partnoy, Infectious Greed:
How Deceit and Risk Corrupted the Financial Markets
(Henry Holt & Company, Incorporated, 2003, ISBN:
080507510-0, 477 pages)Frank Partnoy, Infectious
Greed: How Deceit and Risk Corrupted the Financial
Markets (Henry Holt & Company, Incorporated,
2003, ISBN: 080507510-0, 477 pages)
Partnoy shows how corporations gradually
increased financial risk and lost control over overly
complex structured financing deals that obscured the
losses and disguised frauds pushed corporate officers
and their boards into successive and ingenious
deceptions." Major corporations such as Enron, Global
Crossing, and WorldCom entered into enormous illegal
corporate finance and accounting. Partnoy documents the
spread of this epidemic stage and provides some
suggestions for restraining the disease.
"The Siskel and
Ebert of Financial Matters: Two Thumbs Down for the
Credit Reporting Agencies" by Frank Partnoy,
Washington University Law Quarterly, Volume 77, No. 3,
1999 ---
http://ls.wustl.edu/WULQ/
4. What are
examples of related books that are somewhat more
entertaining than Partnoy’s early books?
Michael Lewis,
Liar's Poker: Playing the Money Markets (Coronet,
1999, ISBN 0340767006)
Lewis writes in Partnoy’s earlier
whistleblower style with somewhat more intense and comic
portrayals of the major players in describing the double
dealing and break down of integrity on the trading floor
of Salomon Brothers.
John Rolfe and Peter
Troob, Monkey Business: Swinging Through the Wall
Street Jungle (Warner Books, Incorporated, 2002,
ISBN: 0446676950, 288 Pages)
This is
a hilarious tongue-in-cheek account by Wharton and
Harvard MBAs who thought they were starting out as
stock brokers for $200,000 a year until they
realized that they were on the phones in a bucket
shop selling sleazy IPOs to unsuspecting
institutional investors who in turn passed them
along to widows and orphans. They write. "It took
us another six months after that to realize
that we were, in fact, selling crappy public
offerings to investors."
There are other books along a similar
vein that may be more revealing and entertaining
than the early books of Frank Partnoy, but he was
one of the first, if not the first, in the roaring
1990s to reveal the high crime taking place behind
the concrete and glass of Wall Street. He was the
first to anticipate many of the scandals that soon
followed. And his testimony before the U.S. Senate
is the best concise account of the crime that
transpired at Enron. He lays the blame clearly at
the feet of government officials (read that Wendy
Gramm) who sold the farm when they deregulated the
energy markets and opened the doors to unregulated
OTC derivatives trading in energy. That is when
Enron really began bilking the public.
Some of the many, many
lawsuits settled by auditing firms can be found at
http://faculty.trinity.edu/rjensen/Fraud001.htm
Bob Jensen's timeline of
Derivatives Financial Instruments scams ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
|
|
Bob Jensen's Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's timeline of Derivatives
Financial Instruments scams ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Bob Jensen's essay with its alphabet soup of appendices ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm
How Scientists Helped
Cause Our Financial Crisis
Are the model builders having fun yet?
"How Scientists Helped Cause Our Financial Crisis," by John Carney,
ClusterStock, November 25, 2008 ---
http://clusterstock.alleyinsider.com/2008/11/how-scientists-helped-cause-our-financial-crisis
In retrospect, the financial planning by
our most sophisticated financial institution looks incredibly stupid.
Merrill Lynch never included in its plans the risk that its counterparties
could demand more collateral. Citigroup proceeded to dive headlong into the
mortgage market on the assumption that a national housing decline was
impossible. Everyone, it seems, failed to guard against the risk that they
might be forced to sell assets to raise capital during a downturn. So it's
worth asking: how did so many rich guys get so dumb?
If we're really cynical about it we'd say:
they weren't dumb. They took huge risks, got paid immense amounts and the
worst that happened is they lost their job. A few guys with hundreds of
millions now have dozens of millions instead. Give them a few years, or even
a few months, and many of them will be back in the drivers seat again, at a
new bank or a hedge fund. Even the public scorn attached to bank failures is
vague and undirected. Except for a few CEOs, almost no one is living with a
scarlet letter attached to their name.
But a good many of these guys and gals
probably thought they were making the right decisions. One of the reasons
they thought that was because the super-smart math dudes and physicists they
hired told them that they had calculated the risks involved in various
positions and proved that everything would be okay.
Scientific American, in an editorial,
blasts the "quants" and other scientists who helped contribute to this
horrendous financial destruction.
The causes of this fiasco are
multifold—the Federal Reserve’s easy-money policy played a big role—but the
rocket scientists and geeks also bear their share of the blame. After the
crash, the quants and traders they serve need to accept the necessity for a
total makeover. The government bailout has already left the U.S. Treasury
and Federal Reserve with extraordinary powers. The regulators must ensure
that the many lessons of this debacle are not forgotten by the institutions
that trade these securities. One important take-home message: capital safety
nets (now restored) should never be slashed again, even if a crisis is not
looming.
For its part, the quant community needs to
undertake a search for better models—perhaps seeking help from behavioral
economics, which studies irrationality of investors’ decision making, and
from virtual market tools that use “intelligent agents” to mimic more
faithfully the ups and downs of the activities of buyers and sellers. These
number wizards and their superiors need to study lessons that were never
learned during previous market smashups involving intricate financial
engineering: risk management models should serve only as aids not
substitutes for the critical human factor. Like an airplane, financial
models can never be allowed to fly solo.
Melissa Lafsky, who writes the Reality
Based blog for Discover magazine, seconds this condemnation and call for
reform. "In other words, maybe we should start calculating risk using models
that take into account actual human behavior, as opposed to some nebulous
dreamland where markets don’t freeze solid and eras don’t go down in a haze
of napalm," she writes.
Can the 2008 investment banking failure be traced to a
math error?
Recipe for Disaster: The Formula That Killed Wall Street ---
http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
Some highlights:
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Also see
"In Plato's Cave: Mathematical models are a
powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Wall Street’s Math Wizards Forgot a Few Variables
What wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/
"They Did Their Homework (800 Years of It)," by Catherine Rampell,
The New York Times, July 2, 2010 ---
http://www.nytimes.com/2010/07/04/business/economy/04econ.html?_r=1&th&emc=th
Thank you Roger
Collins for the heads up.
The advertisement warns of speculative financial
bubbles. It mocks a group of gullible Frenchmen seduced into a silly,
18th-century investment scheme, noting that the modern shareholder, armed
with superior information, can avoid the pitfalls of the past. “How
different the position of the investor today!” the ad enthuses.
It ran in The Saturday Evening Post on Sept. 14,
1929. A month later, the stock market crashed.
“Everyone wants to think they’re smarter than the
poor souls in developing countries, and smarter than their predecessors,”
says
Carmen M. Reinhart,
an economist at the
University of Maryland. “They’re wrong. And we can
prove it.”
Like a pair of financial sleuths, Ms. Reinhart and
her collaborator from
Harvard,
Kenneth S. Rogoff, have spent years investigating
wreckage scattered across documents from nearly a millennium of economic
crises and collapses. They have wandered the basements of rare-book
libraries, riffled through monks’ yellowed journals and begged central banks
worldwide for centuries-old debt records. And they have manually entered
their findings, digit by digit, into one of the biggest spreadsheets you’ve
ever seen.
Their handiwork is contained in their recent best
seller, “This
Time Is Different,” a quantitative reconstruction
of hundreds of historical episodes in which perfectly smart people made
perfectly disastrous decisions. It is a panoramic opus, both geographically
and temporally, covering crises from 66 countries over the last 800 years.
The book, and Ms. Reinhart’s and Mr. Rogoff’s own
professional journeys as economists, zero in on some of the broader
shortcomings of their trade — thrown into harsh relief by economists’
widespread failure to anticipate or address the
financial crisis that began in 2007.
“The mainstream of academic research in
macroeconomics puts theoretical coherence and elegance first, and
investigating the data second,” says Mr. Rogoff. For that reason, he says,
much of the profession’s celebrated work “was not terribly useful in either
predicting the financial crisis, or in assessing how it would it play out
once it happened.”
“People almost pride themselves on not paying
attention to current events,” he says.
In the past, other economists often took the same
empirical approach as the Reinhart-Rogoff team. But this approach fell into
disfavor over the last few decades as economists glorified financial papers
that were theory-rich and data-poor.
Much of that theory-driven work, critics say, is
built on the same disassembled and reassembled sets of data points —
generally from just the last 25 years or so and from the same handful of
rich countries — that quants have whisked into ever more dazzling and
complicated mathematical formations.
But in the wake of the recent crisis, a few
economists — like Professors Reinhart and Rogoff, and other like-minded
colleagues like Barry Eichengreen and Alan Taylor — have been encouraging
others in their field to look beyond hermetically sealed theoretical models
and into the historical record.
“There is so much inbredness in this profession,”
says Ms. Reinhart. “They all read the same sources. They all use the same
data sets. They all talk to the same people. There is endless extrapolation
on extrapolation on extrapolation, and for years that is what has been
rewarded.”
ONE of Ken Rogoff’s favorite economics jokes — yes,
there are economics jokes — is “the one about the lamppost”: A drunk on his
way home from a bar one night realizes that he has dropped his keys. He gets
down on his hands and knees and starts groping around beneath a lamppost. A
policeman asks what he’s doing.
“I lost my keys in the park,” says the drunk.
“Then why are you looking for them under the
lamppost?” asks the puzzled cop.
“Because,” says the drunk, “that’s where the light
is.”
Mr. Rogoff, 57, has spent a lifetime exploring
places and ideas off the beaten track. Tall, thin and bespectacled, he grew
up in Rochester. There, he attended a “tough inner-city school,” where his
“true liberal parents” — a radiologist and a librarian — sent him so he
would be exposed to students from a variety of social and economic classes.
He received a chess set for his 13th birthday, and
he quickly discovered that he was something of a prodigy, a fact he decided
to hide so he wouldn’t get beaten up in the lunchroom.
“I think chess may be a relatively cool thing for
kids to do now, on par with soccer or other sports,” he says. “It really
wasn’t then.”
Soon, he began traveling alone to competitions
around the United States, paying his way with his prize winnings. He earned
the rank of American “master” by the age of 14, was a New York State Open
champion and soon became a “senior master,” the highest national title.
When he was 16, he left home against his parents’
wishes to become a professional chess player in Europe. He enrolled
fleetingly in high schools in London and Sarajevo, Yugoslavia, but rarely
attended. “I wasn’t quite sure what I was supposed to be doing,” he recalls.
He spent the next 18 months or so wandering to
competitions around Europe, supporting himself with winnings and by
participating in exhibitions in which he played dozens of opponents
simultaneously, sometimes while wearing a blindfold.
Occasionally, he slept in five-star hotels, but
other nights, when his prize winnings thinned, he crashed in grimy train
stations. He had few friends, and spent most of his time alone, studying
chess and analyzing previous games. Clean-cut and favoring a coat and tie
these days, he described himself as a ragged “hippie” during his time in
Europe. He also found life in Eastern Europe friendly but strained, he says,
throttled by black markets, scarcity and unmet government promises.
After much hand-wringing, he decided to return to
the United States to attend Yale, which overlooked his threadbare high
school transcript. He considered majoring in Russian until Jeremy Bulow, a
classmate who is now an economics professor at Stanford, began evangelizing
about economics.
Mr. Rogoff took an econometrics course, reveling in
its precision and rigor, and went on to focus on comparative economic
systems. He interrupted a brief stint in a graduate program in economics at
the Massachusetts Institute of Technology to prepare for the world chess
championships, which were held only every three years.
After becoming an “international grandmaster,” the
highest title awarded in chess, when he was 25, he decided to quit chess
entirely and to return to M.I.T. He did so because he had snared the
grandmaster title and because he realized that he would probably never be
ranked No. 1.
He says it took him a long time to get over the
game, and the euphoric, almost omnipotent highs of his past victories.
“To this day I get letters, maybe every two years,
from top players asking me: ‘How do I quit? I want to quit like you did, and
I can’t figure out how to do it,’ ” he says. “I tell them that it’s hard to
go from being at the top of a field, because you really feel that way when
you’re playing chess and winning, to being at the bottom — and they need to
prepare themselves for that.”
He returned to M.I.T., rushed through what he
acknowledges was a mediocre doctoral dissertation, and then became a
researcher at the Federal Reserve — where he said he had good role models
who taught him how to be, at last, “professional” and “serious.”
Teaching stints followed, before the International
Monetary Fund chose him as its chief economist in 2001. It was at the I.M.F.
that he began collaborating with a relatively unfamiliar economist named
Carmen Reinhart, whom he appointed as his deputy after admiring her work
from afar.
MS. REINHART, 54, is hardly a household name. And,
unlike Mr. Rogoff, she has never been hired by an Ivy League school. But
measured by how often her work is cited by colleagues and others, this woman
whom several colleagues describe as a “firecracker” is, by a long shot, the
most influential female economist in the world.
Like Mr. Rogoff, she took a circuitous route to her
present position.
Born in Havana as Carmen Castellanos, she is
quick-witted and favors bright, boldly printed blouses and blazers. As a
girl, she memorized the lore of pirates and their trade routes, which she
says was her first exposure to the idea that economic fortunes — and state
revenue in particular — “can suddenly disappear without warning.”
She also lived with more personal financial and
social instability. After her family fled Havana for the United States with
just three suitcases when she was 10, her father traded a comfortable living
as an accountant for long, less lucrative hours as a carpenter. Her mother,
who had never worked outside the home before, became a seamstress.
“Most kids don’t grow up with that kind of real
economic shock,” she says. “But I learned the value of scarcity, and even
the sort of tensions between East and West. And at a very early age that had
an imprint on me.”
With a passion for art and literature — even today,
her academic papers pun on the writings of Gabriel García Márquez — she
enrolled in a two-year college in Miami, intending to study fashion
merchandising. Then, on a whim, she took an economics course and got hooked.
When she went to Florida International University
to study economics, she met Peter Montiel, an M.I.T. graduate who was
teaching there. Recognizing her talent, he helped her apply to a top-tier
graduate program in economics, at Columbia University.
At Columbia, she met her future husband, Vincent
Reinhart, who is now an occasional co-author with her. They married while in
graduate school, and she quit school before writing her dissertation to try
to make some money on Wall Street.
“We were newlyweds, and neither of us had a penny
to our name,” she says. She left school so that they “could have nice things
and a house, the kind of things I imagined a family should have.”
She spent a few years at Bear Stearns, including
one as chief economist, before deciding to finish her graduate work at
Columbia and return to her true love: data mining. “I have a talent for
rounding up data like cattle, all over the plain,” she says.
After earning her doctorate in 1988, Ms. Reinhart
started work at the I.M.F.
“Carmen in many ways pioneered a bigger segment in
economics, this push to look at history more,” says Mr. Rogoff, explaining
why he chose her. “She was just so ahead of the curve.”
She honed her knack for economic archaeology at the
I.M.F., spending several years performing “checkups” on member countries to
make sure they were in good economic health.
While at the fund, she teamed up with Graciela
Kaminsky, another member of that exceptionally rare species — the female
economist — to write their seminal paper, “The Twin Crises.”
The article looked at the interaction between
banking and currency crises, and why contemporary theory couldn’t explain
why those ugly events usually happened together. The paper bore one of Ms.
Reinhart’s hallmarks: a vast web of data, compiled from 20 countries over
several decades.
In digging through old records and piecing together
a vast puzzle of disconnected data points, her ultimate goal, in that paper
and others, has always been “to see the forest,” she says, “and explain it.”
Ms. Reinhart has bounced back and forth across the
Beltway: she left the I.M.F. in Washington and began teaching in 1996 at the
University of Maryland, from which Mr. Rogoff recruited her when he needed a
deputy at the I.M.F. in 2001. When she left that post, she returned to the
university.
Despite the large following that her work has
drawn, she says she feels that the heavyweights of her profession have
looked down upon her research as useful but too simplistic.
“You know, everything is simple when it’s clearly
explained,” she contends. “It’s like with Sherlock Holmes. He goes through
this incredible deductive process from Point A to Point B, and by the time
he explains everything, it makes so much sense that it sounds obvious and
simple. It doesn’t sound clever anymore.”
But, she says, “economists love being clever.”
“THIS TIME IS DIFFERENT” was published last
September, just as the nation was coming to grips with a financial crisis
that had nearly spiraled out of control and a job market that lay in
tatters. Despite bailout after bailout, stimulus after stimulus, economic
armageddon still seemed nigh.
Given this backdrop, it’s perhaps not surprising
that a book arguing that the crisis was a rerun, and not a wholly novel
catastrophe, managed to become a best seller. So far, nearly 100,000 copies
have been sold, according to its publisher, the Princeton University Press.
Still, its authors laugh when asked about the
book’s opportune timing.
“We didn’t start the book thinking that, ‘Oh, in
exactly seven years there will be a housing bust leading to a global
financial crisis that will be the perfect environment in which to sell this
giant book,’ ” says Mr. Rogoff. “But I suppose the way things work, we
expected that whenever the book came out there would probably be some crisis
or other to peg it to.”
They began the book around 2003, not long after Mr.
Rogoff lured Ms. Reinhart back to the I.M.F. to serve as his deputy. The
pair had already been collaborating fruitfully, finding that her dogged
pursuit of data and his more theoretical public policy eye were well
matched.
Although their book is studiously nonideological,
and is more focused on patterns than on policy recommendations, it has
become fodder for the highly charged debate over the recent growth in
government debt.
Continued in article
What went wrong in accounting/accountics
research?
http://faculty.trinity.edu/rjensen/theory01.htm#WhatWentWrong
574 Shields Against Validity
Challenges in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
- With a Rejoinder from the 2010 Senior
Editor of The Accounting Review (TAR), Steven J. Kachelmeier
- With Replies in Appendix 4 to Professor
Kachemeier by Professors Jagdish Gangolly and Paul Williams
- With Added Conjectures in Appendix 1 as
to Why the Profession of Accountancy Ignores TAR
- With Suggestions in Appendix 2 for
Incorporating Accounting Research into Undergraduate Accounting Courses
Gaming for Tenure as an Accounting Professor ---
http://faculty.trinity.edu/rjensen/TheoryTenure.htm
(with a reply about tenure publication point systems from Linda Kidwell)
The Bailout's Hidden
Agenda Details
"America's Financial Future: Our
Choice... But Not For Long," by Ken Blackwell, Townhall, December 23, 2010
---
http://townhall.com/columnists/KenBlackwell/2010/12/23/americas_financial_future_our_choice_but_not_for_long
In August of this year, Admiral Michael Mullens,
Chairman of the Joint Chiefs of Staff, advised Congress that “The National
debt is the biggest threat to our national security.” In November, voter
sentiment against the debt and deficit led to an historic rebuke of
Congressional incumbents. In December, the President’s Debt Commission laid
out in stark terms the imminent economic impact of continued deficit
spending.
Apparently rejecting these clarion calls, the
President and Congress acted in the lame-duck session to cut not one dime of
federal spending, while increasing the national debt by nearly $1 trillion.
They are ignoring a glaring problem that, if not addressed soon, will cause
a panoply of other problems.
Some insist that the problem with increasing the
debt by nearly $1 trillion is that the borrowed money will be loaned to us
by China. Concerning as it is that we have become the world’s largest debtor
to a foreign sovereign whose interests are (to put it mildly) not always in
harmony with our own, that's not the biggest problem. What ought to be of
even greater, more immediate concern is the fact that China will refuse to
loan us the money.
From October 2009 to October 2010, we financed $734
billion of our $1.690 trillion deficit through loans from foreign entities.
And while China remains our largest creditor, China actually reduced the
amount of U.S. debt it holds by $32 billion over the last year—from $938
billion to $906 billion. Through its actions, China has indicated that it
will no longer fund the U.S. government's practice of perpetual deficit
spending.
So if not China, then who? That's the problem.
The largest increase in U.S. debt holdings over the
past year was a near five-fold increase by the U.K.—from $108 billion to
$477 billion — and a near three-fold increase by Canada — from $44 billion
to $125 billion.
The reality is that the U.K. and Canada do not have
another half-trillion dollars to loan the U.S. in 2011. According to the
World Bank, the entire economic output of the U.K. and Canada combined is
only about $3.5 trillion annually.
So if China won't and the U.K. and Canada can't,
who is going to loan us a trillion dollars in the next 12 months? Nobody
knows.
The economic threat from China and other foreign
countries loaning us trillions of dollars is like falling off the Empire
State Building. It isn't the fall itself that kills you ... it's the sudden
stop.
Commonwealth investors increased their U.S.
holdings last year as they fled debt holdings in the Eurozone, nearly
collapsing several E.U. government-bond markets derisively referred to as
the PIIGS—Portugal, Italy, Ireland, Greece and Spain.
Continued in article
Jensen Comment
We're worrying about a paper tiger here. Zimbabwe has shown us the light. We
simply print trillions of dollars to make up for the deficits. Ben Bernanke
listed when he took a continuing education course from Robert Mugabe.
I worte this sometime in 2008
Hi David Fordham,
Your long message involves much more than your original question about why we
refer to the National Debt as "Debt."
Below I will describe a "hidden agenda" about why Hank Paulson elected to
save AIG and not Lehman Brothers. I will also predict that the U.S. will one day
give China its entire Navy.
The U.S. Government has two types of financial obligations.
Booked Debt = National Debt ---
http://en.wikipedia.org/wiki/National_Debt
This is simply the cash we've borrowed (treasury bonds, savings
bonds, etc.) upon which we are paying interest of slightly less than a million
dollars a minute at the moment. Due to budget deficits National Debt will double
in the next few years from the present level of between $10 and $11 trillion.
Most of the interest on our National Debt is being funded with more borrowing
rather than taxation. This is one of the main reasons why the U.S. Budget has
become the mother of all Ponzi schemes.
Unbooked Debt = Entitlement obligations that are not yet booked ---
http://faculty.trinity.edu/rjensen/Entitlements.htm
Entitlement obligations are not yet booked but in most cases
they are already legislated and can be measured with reasonable accuracy by
actuarial methods, including obligations for military retirement, Veterans
medical benefits, Social Security retirement and disability pay, Congressional
retirement and medical benefits, Medicare, a portion of Medicaid, etc.
Entitlements also include many contingency obligations such when the President
declares disaster areas of the country after hurricanes, tornados, forest fires,
etc. The government also has millions of pending lawsuits.
Former Controller General, David Walker, places the unbooked debt at around
$60 trillion, but it will soon explode to $100 trillion under proposed
entitlement programs for universal education, universal health care, and massive
environmental protection legislation being proposed. Since U.S. voters will
almost never vote for massive tax increases, the Government has little choice
for legislated entitlements other than adding to the National Debt or
Zimbabwe-style printing of money that spells economic disaster.
Until David Walker got serious about the magnitude of the unbooked
obligations, I don't think anybody tried to seriously measure this unbooked
debt. Now David is trying his best to warn the public about how these
entitlements may destroy the United States unless we start taxing to pay for
them.
IOUSA (the most frightening movie in American history) --- (see a 30-minute
version of the documentary at
www.iousathemovie.com
).
A Must Read for All Americans
The most important article for the world to read now is the following interview
with a former Andersen Partner and former Chief Accountant of the United States:
"Debt Crusader David Walker sounds the alarm for America's financial future,"
Journal of Accountancy, March 2009 ---
http://www.journalofaccountancy.com/Issues/2009/Mar/DebtCrusader.htm
The good news about entitlement obligations is that, until they come due, we
are not usually paying interest. The bad news is that legislated entitlements
are so massive before we legislate the proposed Obama entitlements. Universal
health care is the mother of all entitlements unless U.S. voters are willing to
devote half their incomes to a universal health care tax (which is how Canada
and European nations fund health care). U.S. voters are not likely to accept
such a 50% universal health care tax.
Thus far most of the stimulus outflows to date have been with borrowed money,
although a small portion was printed money. There's a huge difference in terms
of inflation. Printed money directly boosts inflation and angers former
investors in our National Debt such as China, Germany, and oil-rich rich Arabs.
It would be curtains for the United States if those investors stopped rolling
over their investments in our National Debt. Of course they don't want to see
their investments go up in smoke.
Hank Paulson's Suspected Hidden Agenda
It's not likely that cash-rich nations like China, Germany, and oil-Arabs will
destroy their own investments in our National Debt by not rolling over the debt
at maturity dates. However, they are likely to be less willing to add trillions
more investing in our newer annual spendthrift deficits.
I think what perplexed Hank Paulson, as Treasury Secretary, was that AIG's
main problem was undercapitalized credit derivative obligations that insured
toxic CDO mortgage bonds purchased by the same investors who hold much of our
National Debt.
If Paulson allowed AIG's credit derivative defaults to really piss off
investors needed for added National Debt, the U.S. Treasury would have been in
deep, deep trouble. We had to keep those investors content by making good on
AIG's trillions in credit derivatives. And thus we bailed out AIG.
Lehman Bothers was an investor counterparty in AIG's credit derivatives, but
Lehman was not obligated to China, Germany, and oil-Arabs like AIG was obligated
to investors in our National Debt. Hence, Paulson could let Lehman fail without
the same massive repercussions on our issuance of new Treasury Bonds.
That was my "Hidden Agenda" speculation early on, although I don't claim to
be the only one suspecting a hidden bailout agenda for AIG ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails
There are two ways to really piss off investors in our massive National Debt.
The first way is to print money that has an indirect effect of greatly
cheapening their investments of dear dollars in our National Debt. The second
way is to not make good credit insurance (credit derivatives) purchased from
U.S. companies like AIG.
I suspect that if we continue to become better allies with China, we will
find innovative methods for reducing our National Debt. One way will be to give
China the U.S. Navy. I'm not really trying to be funny here. I only hope that
China also takes on the entitlement obligations that accompany the U.S. Navy.
September 20, 2008 message from Ganesh M. Pandit, DBA, CPA, CMA
[profgmp@HOTMAIL.COM]
Yesterday, on CNBC, one of the anchors asked a
question: "Who is it that the U.S. Government is bailing out with billions
of dollars? The U.S. financial institutions or the governments of various
countries that are concerned about the impact of the bad loans and the
related financial instruments on the banks in their own countries?"
Does anybody have any opinion about that?
Ganesh M Pandit
Adelphi University
The September 21, 2008 reply from Bob Jensen was updated on November 28, 2008
by Bob Jensen who now suspects a Hidden Agenda for the bailout!
Hi Ganesh,
The answer to your question turns out to be quite obscure and complicated as
Hank Paulson gives upwards of
$500 billion in bailout funds to save CitiBank and
AIG while giving zero bailout funds to Washington Mutual Bank (the largest bank
failure in the history of the world), Lehman Brothers, and Merrill Lynch. I
think the answer is that both Hank Paulson and the U.S. Congress that so
willingly voted for the bailout funding have a Hidden Agenda that I've never
seen them explain to the public. If I am correct,
it's a noble Hidden Agenda to save the United States of America!
If Hank Paulson or Nancy Pelosi really explained this Hidden Agenda it would
reveal how fragile the economic future of America has become and would be
counterproductive to virtually all of Barack Obama's spending promises during
his campaign. I do wish, however, that Paulson, Pelosi, and Obama would
explain it to Senator Waxman so he would shut his yap.
As events unfolded I've re-written my answer to you, Ganesh, due to questions
arising that suggest a U.S. Government Hidden Agenda in the Bailout Program that
commenced in late in 2008 after it became possible that the subprime mortgage
scandal was going to drag down both the U.S. economy into a total collapse from
which it might never emerge. Clues about a Hidden Agenda are suggested in the
following questions concerning bailout funding that has emerged. These questions
include the following: while Hank Paulson, as Secretary of the Treasury, was
responsible for obtaining and spending the bailout funds:
- Why did Paulson give $85 billion to bail out American Insurance
Group (AIG) and later increased it to over $100 billion in spite of
evidence that AIG's historic record of accounting fraud (hundreds of
billions), settlements by AIG's independent auditor, PwC), for
alleged complicity and incompetence in the audit (for which PwC
settled a $1.4 billion shareholder lawsuit for close to $100
million, and other lesser settlements such as Ernst & Young's
consulting settlement for $1 million? You can read more about AIG's
accounting fraud at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds
- As of November 2008, 2008 there were
22 banks that Paulson elected to let fail rather than to bail
out. Why did Paulson give out upwards of $300 billion to bail out CitiBank while letting Washington Mutual (WaMu), Lehman Brothers,
and Merrill Lynch fail or be bought out for a dime on the dollar
that wiped out shareholders in WaMu, Lehman, and Merrill while
saving shareholders of CitiBank? It's important to note that
CitiBank's bailout commenced privately early in 2007 long before
Paulson ever suspected the U.S. Government would eventually bail out
any banks. Citicorp was seeking bailout funds from wealthy Arabs
long before it sought out government funding. Its also important to
note that WaMu is the largest FDIC failed bank in the history of the
world, while CitiBank is the largest saved bank in the history of
the world.
To answer such questions about why some banks (and AIG) get hundreds of
billions from Hank Paulson to save creditors and shareholders and other banks
get zero in bail out funds, I begin with some important definitions.
Chocolate
This is a mortgage issued on Main Street, USA that is highly likely to be
paid in full. If an occasional default takes place, a chocolate mortgage
balance is well below the collateral value of the real estate in
foreclosure such that the unpaid balance is fully paid by the sale of the
collateral.
Turd
This is a mortgage issued on Main Street, USA that is highly likely not to
be paid in full. If a common default takes place, a turd mortgage is well
below the collateral value of the real estate in foreclosure such that the
unpaid balance is not able to be paid in full when the property is
foreclosed. Furthermore, political pressure from Congress may prevent many
foreclosures of turd mortgages.
Mortgaged Back Securities (MBSs) that were sliced up into Collateralized Debt
Obligations (CDOs)
This is a box of supposed chocolates bundled into a single security with an
AAA investment grade rating that was sold by Wall Street investment banks
who purchased the mortgage notes and bundled them up into CDO securities
that were in term sold at relatively high profits to investors, particularly
investors in foreign nations.
Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes
bad due to having turds mixed in with the chocolates, the "counterparty" who
purchased the CDO will recover the value fraudulently invested in turds. On
September 30, 2008 Gretchen Morgenson of The New York Times aptly explained
that the huge CDO underwriter of CDOs was the insurance firm called AIG. She
also explained that the first $85 billion given in bailout money by Hank
Paulson to AIG was to pay the counterparties to CDS swaps. She also
explained that, unlike its casualty insurance operations, AIG had no capital
reserves for paying the counterparties for the the turds they purchased from
Wall Street investment banks.
"Testimony
Concerning Credit Default Swaps," by Erik Sirri Director, Division of
Trading and Markets U.S. Securities and Exchange Commission, SEC, November 20,
2008 ---
http://www.sec.gov/news/testimony/2008/ts112008ers.htm
"Your Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson,
The New York Times, September 20, 2008 ---
http://www.nytimes.com/2008/09/21/business/21gret.html
What Ms. Morgenson failed to explain, when Paulson eventually gave over
$100 billion for AIG's obligations to counterparties in CDS contracts, was
who were the counterparties who received those bailout funds. It turns out
that most of them were wealthy Arabs and some Asians who we were getting
bailed out
while Paulson was telling shareholders of WaMu, Lehman Brothers, and Merrill
Lynch to eat their turds.
You tube has a lot of videos about a CDS. Go to YouTube and read in the
phrase "credit default swap" ---
http://www.youtube.com/results?search_query=Credit+Default+Swaps&search_type=&aq=f
In particular note this video by Paddy Hirsch ---
http://www.youtube.com/watch?v=kaui9e_4vXU
Paddy has some other YouTube videos about the financial crisis.
Bob
Jensen’s threads on accounting for credit default swaps are under the
C-Terms at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
CitiBank Foreign Investment Shareholders
Although CitiBank is one of the largest banks in the world with millions of
shareholders, it's important to note that CitiBank in particular has a high
proportion of wealthy Arabs and some wealthy Chinese investors who invested
billions in 2007 and 2008 to help keep CitiBank from failing. Hence these
wealthy Arab and Chinese investors not only bought MBS-CDO investments that
unexpectedly contained turds, they also bought heavily into CitiBank common
stock that they predicted would be a high return investment. Saudi Arabian
prince Alwaleed bin Talal, has a major stake (billions of dollars) in
Citigroup.
Recently, the investment arm of the Abu Dhabi
government agreed to invest $7.5 Billion into Citigroup – a company that
makes its money through riba. The move exposes the reality of the “Islamic
Banking” initiative supported by the same government. Shar’iah compliant
transactions cannot come into reality without courts and governments that
solely abide by what Allah (swt) has revealed. Islamic economics cannot
exist without an Islamic State.
"CitiBank Bailout: A Failed Investment," The Politically Aware Muslim,"
December 14, 2007 ---
http://awaremuslim.blogspot.com/2007/12/citibank-bailout-failed-investment.html
"CitiBank Bailout is $14 B From China, Kuwait," by Henry Sender,
Financial Times (UK), January 11 2008 ---
http://johnibii.wordpress.com/2008/01/12/citibank-bailout-is-14-b-from-china-kuwait/
Subprime Mortgage Fraud as
Explained by Forrest Gump
Mortgage Backed Securities are like boxes of
chocolates. Criminals on Wall Street and one particular U.S. Congressional
Committee stole a few chocolates from the boxes and replaced them with turds.
Their criminal buddies at Standard & Poors rated these boxes AAA Investment
Grade chocolates. These boxes were then sold all over the world to investors.
Eventually somebody bites into a turd and discovers the crime. Suddenly nobody
trusts American chocolates anymore worldwide. Hank Paulson now wants the
American taxpayers to buy up and hold all these boxes of turd-infested
chocolates for $700 billion dollars until the market for turds returns to
normal. Meanwhile, Hank's buddies, the Wall Street criminals who stole all the
good chocolates are not being investigated, arrested, or indicted. Momma always
said: "Sniff the chocolates first Forrest." Things generally don't pass the
smell test if they came from Wall Street or from Washington DC.
Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html
Unbooked Entitlements Debt
This is the amount owing for future entitlement obligations of the United
States for which money has not been borrowed or set aside from taxes to meet
these obligations, including unfunded military retirement pay, Veterans
Administration benefits, Social Security benefits, Medicare benefits, the
Medicare drug program, etc. The amount is unknown, but experts set this
obligation between $40 and $65 trillion --- See
Appendix A.
Booked National Debt
This is the debt of the United States that has been borrowed and interest
expense is charged for debt that has not been paid. This booked national
debt is now over $10 trillion. This was growing at a rate of nearly $4
billion per day, but it is much higher now that the bail out funds are being
borrowed as well and are not funded by taxpayers.
The National Debt has continued
to increase an average of $3.93 billion per day since September 28, 2007!
The National Debt Amount This Instant (Refresh your browser
for updates by the second) ---
http://www.brillig.com/debt_clock/
History of the National Debt ---
http://en.wikipedia.org/wiki/National_Debt
Entitlements ---
http://faculty.trinity.edu/rjensen/entitlements.htm
History of the National Debt ---
http://en.wikipedia.org/wiki/National_Debt
In 2007, 61.82% of America's public debt was held by foreign investors,
most of them Asian. So the U.S. public debt held by nonresident foreigners is
equal to about 109.39% (113.86%) of GDP.
U.S. Secretary of State Hillary Clinton urged
China to continue buying U.S. Treasury bonds to help finance President
Barack Obama's stimulus plan, saying "we are truly going to rise or fall
together." "Our economies are so intertwined," Clinton said in an interview
today in Beijing with Shanghai-based Dragon Television. "It would not be in
China's interest" if the U.S. were unable to finance deficit spending to
stimulate its stalled economy. The U.S. is the single largest buyer of the
exports that drive growth in China, the world's third-largest economy. China
in turn invests surplus earnings from shipments of goods such as toys,
clothing, and steel primarily in Treasury securities, making it the world's
largest holder of U.S. government debt at the end of last year with $696.2
billion. China's leaders understand that "the United States has to take some
very drastic measures with the stimulus package, which means we have to
incur debt," Clinton said. The Chinese are "making a very smart decision by
continuing to invest in Treasury bonds," which she called a "safe
investment," because a speedy U.S. recovery will fuel China's growth as
well. China boosted purchases of U.S. debt by 46 percent last year to a
record. The Chinese government said last week it plans to keep buying
Treasuries, adding that future purchases will depend on the preservation of
their value and the safety of the investment. China's currency reserves of
$1.95 trillion are about 29 percent of the world total.
Indira A.R. Lakshmanan "Clinton
Urges China to Keep Buying Treasuries," Bloomberg News, February 22,
2009 ---
http://www.gata.org/node/7190
"U.S. debt approaches insolvency In 2007, 61.82% of America's public debt
was held by foreign investors, most of them Asian," Spero News, December 19,
2008 ---
http://www.speroforum.com/a/17305/US-debt-approaches-insolvency
In the United States, the danger
of debt insolvency is growing, putting at risk the currency reserves of
foreign countries, China chief among them. According to new figures
published by Bloomberg in recent
days (Nov. 25, 2008 [1]),
the American government has employed a total of 8.549 trillion dollars
to stop the financial crisis. This means a total of about 24-25.4
trillion dollars of direct or indirect public debt weighing on American
taxpayers. The complete tally must also include the debt - about 5-6
trillion dollars - of Fannie Mae and Freddie Mac, which are now
quasi-public companies, because 79.9% of their capital is controlled by
a public entity, the Federal Housing Finance Agency, which manages them
as a public conservatorship.
In 2007, public debt in the
United States was 10.6 trillion dollars, compared to a GDP (gross
domestic product) of 13.811 trillion dollars. In just one year, direct
and indirect public debt have grown to more than 100% of GDP, reaching
176.9% to 184.2%. These percentages exclude the debt guaranteed by
policies underwritten by AIG, also nationalized, and liabilities for
health spending (Medicaid and Medicare) and pensions (Social Security)[2].
By way of comparison, the Maastricht accords require member states of
the European Union (EU) to reduce their public debt to no more than 60%
of GDP. Again by way of comparison, in one of the EU countries with the
largest public debt, Italy, public debt in 2007 was equal to 104% of
GDP.
In 2007, 61.82%
[3]
of America's public debt was held by foreign investors, most of them
Asian. So the U.S. public debt held by nonresident foreigners is equal
to about 109.39% (113.86%) of GDP. According to a study by the
International Monetary Fund, countries with more than 60% of their
public debt held by nonresident foreigners run a high risk of currency
crisis and insolvency, or debt default. On the historical level, there
are no recent examples of countries with currencies valued at reserve
status that have lapsed into public debt insolvency. There are also few
or no precedents of such a vast and rapid expansion of public debt.
The United States also runs large
deficits in its public balance sheet and balance of trade. Families and
businesses are also deeply in debt: in 2007, American private debt was
equal to a little more than 100% of GDP. At the moment, it is not clear
how much of America's private debt has been "nationalized" with the
recent bailouts.
In the early months of next year, when
the official data are published, the United States will run a serious
risk of insolvency. This would involve, in the first place, a valuation
crisis for the dollar. After this, the United States could face a social
crisis like that in Argentina in 2001. A crisis in U.S. public debt
would likely have a severe impact on the Asian countries that are the
main exporters to the United States, China first among them. Chinese
monetary authorities, thanks to a steeply undervalued artificial
exchange rate, at about 55% of its fair value, have limited imports
(including food) and have achieved an export surplus. This has allowed
them to accumulate a large stockpile of dollar reserves. In a currency
crisis, China risks losing much of the value of its accumulated currency
reserves. At the same time, pressure on imports (wheat, other grains,
and meat) have led to inflation in the prices of food, the most
important expenditure for more than 900 million Chinese. This is nothing
more than a small confirmation of the recent statements of the pope, in
his message for the World Day for Peace, where the pontiff calls the
current financial system and its methods "based upon very short-term
thinking," without depth and breadth (nos. 10-12), preoccupied with
creating wealth from nothing and leading the planet to its current
disaster. [4]
[1] See Bloomberg, 2008, 11-25 16:35:48.130 GMT “U.S.
Pledges Top $8.5 Trillion to Ease Frozen Credit (Table)”
[2] In this case, exluding AIG policies, one arrives
at a total equal to 429.37 of GDP.
[3] Cf.
Economic crisis: US, China and the coming monetary storm
[4] Cf. AsiaNews.it 11/2/2008
Message for
Peace 2009: the poor, wealth of the world;
Global solidarity to fight poverty and build peace, says
Pope
Bob Jensen's threads on the National Debt time bomb are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on the Bailout's Hidden Agenda are at
http://faculty.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails
Foreign Investment Bankers (FIBs)
I define this group as comprised of
foreign sovereign wealth funds, foreign banks, and foreign individuals
holding more than a billion of U.S. Treasury Bonds that comprise most of the
$10 trillion current booked U.S. National Debt. These foreign "bankers" now
hold nearly over 60% of what the U.S. Government currently owes. We rely heavily
on them to also buy the new U.S. Treasury borrowings that average well over
$4 billion per day. They buy this debt at relatively low interest rates due
to the historic tradition of U.S. debt as being "risk free" ---
http://en.wikipedia.org/wiki/Risk-free_interest_rate
Though a truly risk-free asset exists only in
theory, in practice most professionals and academics use short-dated
government
bonds of the currency in question. For USD
investments, usually
US Treasury bills are used, while a common
choice for EUR investments are
German government bills
or
Euribor rates.
The mean real interest rate of US treasury bills during the 20th century
was 0.9% p.a. (Corresponding figures for Germany are inapplicable due to
hyperinflation during the 1920s.)
These securities are considered to be risk-free
because the likelihood of these governments
defaulting is extremely low, and because the
short maturity of the bill protects the investor from interest-rate risk
that is present in all
fixed rate bonds (if interest rates go up soon
after the bill is purchased, the investor will miss out on a fairly
small amount of
interest before
the bill matures and can be reinvested at the new interest rate).
Since this interest rate can be obtained with
no risk, it is implied that any additional risk taken by an investor
should be rewarded with an interest rate higher than the risk-free rate
(on an after-tax basis, which may be achieved with preferential tax
treatment; some local government US bonds give below the risk-free
rate).
Since news of the subprime mortgage scandal and the roughly $1 trillion
being borrowed for the bail out of the financial industry, the U.S. Treasury
bonds are becoming more risky in terms of the rising slope of their yield
curves. This means that the cost of borrowing more National Debt is
increasing.
The 2008 Bailout's Hidden Agenda
I speculate that the Hidden Agenda of Hank Paulson, Nancy Pelosi, Senator
Dodd, Senator Reid, and others directly engaged in obtaining the bail out
funding is to first save the FIBs, those foreign investors upon whom we
depend too heavily for obtaining both new and rolled over National Debt
at relatively low (and less steep yield curve) interest rates. The FIBs hold nearly
$5 trillion of the present National Debt and buy nearly half of the $4+
billion debt added each day on average to the National Debt. If the FIBs
commence to demand higher interest rates for new U.S. Treasury Bonds and for
maturing bonds that need to be rolled over (refinanced), the United States
of America is in deep, deep trouble because for the last eight years of the
Bush Administration, the U.S. Government's credit bubble has been ballooning
to the point of bursting when the growth in GDP can no longer absorb such
billions in debt added each day.
For evidence of this Hidden Agenda first consider the $100 billion of bailout
funds give to AIG at the blink of an eye. If AIG declared bankruptcy and could
not meet its CDS credit default obligations to reimburse chocolate investors
who got turds, the investors hit the hardest would be the FIBs foreign investors
who now hold the lion's share of our National Debt. When Wall Street either
knowingly or unknowingly sold mortgage backed security turds and chocolates, the
FIBs would be very, very angry if we did not pay billions to buy back those
turds or otherwise repay the FIBs for their losses. Hence we gave AIG the
bailout funds to make good on the credit derivate insurance against bad mortgage
investments. This probably also accounts for the bailout funding given to Bear
Stearns.
Apparently Washington Mutual, Lehman Brothers, and Merrill Lynch were stupid
enough to keep high proportions of turds in their own portfolios. Perhaps these
were CDO investments that they had not yet unloaded on the FIBs. Whatever the
reason, wiping out the shareholder value in those companies would not impact the
cost of our National Debt nearly as much as if we let AIG fail. Since the
"Hidden Agenda" was to hold down the cost of our National Debt, AIG got bailed
out, and the others got nothing other than what it took the FDIC to make good on
banking demand deposits (checking accounts) held by customers. For example,
unlike AIG shareholders, the WaMu shareholders were wiped out.
Now Consider Citibank. For several years CitiBank has been in trouble and
FIBs from the Middle East and Asia have been investing billions in CitiBank
common stock. They in fact held large voting blocks of power in CitiBank. If
Hank Paulsen did not guarantee upwards of $300 million for the mortgage turds
held by CitiBank, the FIB foreign investors in CitiBank would be wiped out much
like the investors in WaMu were wiped out. But the "Hidden Agenda" dictates that
we keep the FIBs happy since they hold nearly 50% of our $10 trillion National
Debt.
If the FIBs decided to significantly raise the interest rates required to
roll over maturing National Debt and to purchase new U.S. Treasury Bonds, the
entire future of the United States of America is at stake. All the promises,
dreams, and plans of our new President Obama and the huge majority of Democratic
Party legislators would be dashed since the U.S. worldwide interest rate would
be much higher and no longer be viewed as risk-free. Programs such as national
health care, increased aid to states for human services, environmental
protection, energy independence, and a modernized military force would be dashed
all due to turds created by Turds on Main Street such as mortgage brokers and
banks on Main Street and Wall Street scammers who sold them off to the FIBs and
others in chocolate boxes.
I’ve often wondered why Hank Paulson never tried to explain this in the
Congressional Hearings questioning his judgment for bailing out only selected
outfits like Bear Stearns, AIG, and CitiBank. Now I think I have an answer, and
if you discover anybody who has written something similar I would really like to
know, because the media still does not seem to understand why CitiBank (the
largest saved bank in the world) is more important to the Treasury Department
than Washington Mutual (the largest bank failure in the world).
All of this of course begs the question of why the
Bailout's Hidden Agenda remains hidden when Hank Paulsen and other
leaders are asked to explain why the "fat cats" of AIG and CitiBank get bailed
out for upwards of $500 billion and the small shareholders of WaMu, Lehman, and
Merrill Lynch are told to take a hike? I think the reason is that virtually all
our leaders in Washington DC prefer not to explain or dwell upon how our booked
National Debt and our unbooked entitlement obligations have put the United
States of America in a terribly deep hole in which the
only hope of crawling back out rests in the hands of the foreign investors,
particularly those in China (which owns nearly 20% of the Federal Debt), Japan,
Singapore, and wealthy Middle Eastern oil producing states. The best we can hope
for now is continued rolling over of U.S. Treasury Bonds at the lowest possible
rates such tat our low cost of capital remains lower than the long-term fixed
rates of interest needed to revive the real estate market in the U.S. See
Appendix A.
If the cost of the National Debt should rise higher than the low interest
rate that the U.S. Government may soon be setting for home owners refinancing
their mortgages and buyers seeking new long term mortgages, then the only way
out of the deep hole may be slow the rate of increase in the National Debt with
destructive inflation that comes with printing money to pay the difference
between the borrowing rates and the spending rates of the U.S. Government.
Zimbabwe has shown us how destructive inflation can become when a nation tries
to pay its debts by simply printing more currency.
Hence I conclude that the Hidden Agenda is a noble cause to save the good
faith and credit of the United States when the National Debt is increasing $4
billion to $6 billion a day and greater deficits to come when the U.S. Congress
intends to deficit finance over the next eight years at unsurpassed billions
separating tax revenues from program expenditures.
Even if the FIBs continue to give the U.S. a great deal on borrowing rates
for the National Debt, we are in deeper trouble due to our unbooked entitlements
debt that will be coming increasingly expensive as the baby boomers age ---
http://faculty.trinity.edu/rjensen/entitlements.htm
"Uncle Sam's Credit Line Running Out," by Randall Forsyth, Barron's,
November 11, 2008 ---
http://online.barrons.com/article/SB122633310980913759.html
We Can't Tax Our Way Out of the Entitlement
Crisis," by R. Glenn Hubbard, The Wall Street Journal, August 21,
2008; Page A13 ---
http://online.wsj.com/article/SB121927694295558513.html
We can also secure a firm
financial footing for Social Security (and Medicare) without choking off
economic growth or curtailing our flexibility to pursue other spending
priorities. Three actions are essential: (1) reduce entitlement spending
growth through some form of means testing; (2) eliminate all nonessential
spending in the rest of the budget; and (3) adopt policies that promote
economic growth. This 180-degree difference from Mr. Obama's fiscal plan
forms the basis of Sen. McCain's priorities for spending, taxes and health
care.
The problem with Mr. Obama's
fiscal plans is not that that they lack vision. On the contrary, the vision
is plain enough: a larger welfare state paid for by higher taxes. The
problem is not even that they imply change. The problem is that his plans
are statist.
While the candidate is
sending a fiscal "Ich bin ein Berliner" message to Americans, European
critics of his call for greater spending on defense are the canary in the
coal mine for what lies ahead with his vision for the United States.
Professor R. Glenn Hubbard is Dean of the
College of Business at Columbia University and a member of the President's
Council of Economic Advisors.
Bob Jensen's threads on the "Entitlement
Crisis" are at
http://faculty.trinity.edu/rjensen/entitlements.htm
Bob Jensen's threads on entitlements are at
http://faculty.trinity.edu/rjensen/entitlements.htm
"Fed Bails Out Rich Arabs in Citigroup Deal,"
by Cliff Kincai, "Canadian Free Press, November 25, 2008 ---
http://canadafreepress.com/index.php/article/6518
For several days there was a fierce
national debate over whether American car companies in Detroit deserved $25
billion of taxpayer money and whether American jobs should be saved. The
automakers and a union representative were ridiculed, didn’t get the money,
and were told to come up with a “plan” to save the companies. After backing
the $700-billion Wall Street bailout, Bill O’Reilly of Fox News
said Detroit didn’t deserve any federal money
because the car companies had been mismanaged. This was a point made by many
in the media.
But Citigroup got $20 billion over
the weekend from the Treasury Department without any national debate or
discussion at all. The Federal Reserve simply issued a
press release on
Sunday afternoon announcing that the taxpayers were on the hook not only for
the $20 billion but $306 billion in loans to the company. That’s on top of a
previous $25 billion invested in the company by the Treasury Department.
It will be interesting to see if
O’Reilly and other commentators, having excoriated the American automakers,
will take issue with the Citigroup bailout, which was subjected to no public
debate and no congressional hearings.
Auto company executives may have
flown to Washington, D.C. on private jets, as O’Reilly and others noted, but
Saudi Arabian prince Alwaleed bin Talal, who has a major stake in Citigroup
and also invests in the Fox News parent company, News Corporation,
reportedly lives in a $100-million 317-room Riyadh palace. A nephew of Saudi
King Abdullah, Alwaleed has been called the “Warren Buffet of the Gulf” and
runs the
Kingdom
Holding Company.
Is this somebody who should be
bailed out by American taxpayers?
The Citigroup bailout demonstrates,
once again, that the Federal Reserve does anything it wants with our money,
with no accountability to the Congress or the American people.
The Federal Reserve is so out of
control that it refuses to comply with a legitimate and lawful Bloomberg
News
Freedom of Information
Act (FOIA) request for information about nearly $2 trillion in loans
extended to foreign banks and other interests during the current financial
meltdown.
Members of Congress, including Rep.
Walter Jones and Senator
John Cornyn, have
expressed outrage at the Fed’s conduct.
Jones
declared, “At a time when many Americans
have serious concerns about their own financial security, it is important
for our nation to have confidence in the actions of the Federal Reserve.
When taxpayer dollars are used to bail out financial institutions, the
American people deserve full disclosure on who receives those funds and
under what terms. Americans need to know how their hard-earned dollars are
being spent.”
Cornyn
declared, “Over the past year, the Federal Reserve
has taken unprecedented action in the marketplace by providing almost $2
trillion in taxpayer-funded loans to troubled financial institutions. This
is in addition to the $700 billion approved by Congress to fund the Troubled
Asset Relief Program (TARP). Unfortunately, the Federal Reserve has refused
to submit to even the most modest level of transparency regarding its
actions. This should trouble taxpayers and policymakers alike. It certainly
troubles me.”
Announcing the Citigroup bailout,
the Federal Reserve said that “With these transactions, the U.S. government
is taking the actions necessary to strengthen the financial system and
protect U.S. taxpayers and the U.S. economy.”
That sounds reassuring. But another
and more accurate way to put it is to say that U.S. tax dollars are being
pumped into a failed bank to save a Saudi prince. But will the American
people be given the true story of the Citigroup bailout?
Consider the fact that Alwaleed,
one of the richest men in the world, not only owns a stake in Citigroup but
News Corporation, Time Warner (parent of Time and CNN) and The Walt Disney
Company (parent of ABC News).
The stories appearing on Monday
about the “rescue” of Citigroup suggest that the media are up to their old
tricks of masking the looting of American taxpayers and will not bother to
investigate what really happened.
Some of the details are available
on Alwaleed’s website. “Perhaps no single transaction has catapulted Prince
Alwaleed to the world’s financial stage in as spectacular a fashion as did
his acquisition in 1991 of Citibank (subsequently, Citigroup) stocks,” notes
his website. “Few people could then imagine that a
Saudi Arabian, and a royal at that, would burst onto the international
scene, seemingly out of nowhere, to invest so heavily in one of the major
banks of the world and to help restore it to such health that it would
become the leading financial institution in the world.”
And now that the firm is in
trouble, the Federal Reserve―and by extension, the U.S. taxpayer―comes to
his rescue.
Not surprisingly, Alwaleed was
included in the “Time 100” 2008 list of most powerful people. “In the
mid-’90s, he bailed out Citibank when no one else would step in—including
Americans,”
stated Alwaleed biographer Riz Khan, formerly of
CNN and now with Al-Jazeera.
“Saudi prince comes to rescue of
Citigroup” was a headline over an article in the UK Guardian on November 20,
2008, when Alwaleed announced that he would increase his stake from about 4
to 5 percent in Citigroup. But that clearly wasn’t enough to make a
difference. Did he invest more knowing that he would ultimately be bailed
out? Will we see any stories on this? Or congressional hearings?
What happened behind closed Federal
Reserve doors?
It is important to note that
Alwaleed isn’t alone. Earlier this year, the
story in the Guardian noted, Citigroup “raised
more than $50 billion in new capital from sovereign wealth funds and other
investors.” This included the Kuwait Investment Authority investing $3
billion in Citigroup in January and the Abu Dhabi Investment Authority
buying $7.5 billion of securities from Citigroup in November 2007.
“Over the weekend,” the British
Telegraph reported, in discussing the bailout, “Citigroup was understood to
have approached its existing sovereign wealth fund shareholders from the
Middle East and Asia to gauge their appetite for buying additional stakes in
the bank, as well as holding talks with the US government.”
It looks like the foreigners with a
stake in Citigroup preferred a U.S. taxpayer bailout. They got something
quickly and secretly that the U.S. automakers haven’t yet obtained from the
Fed, the Treasury Department, or Congress. GM, Ford and Chrysler are
American companies in competition with foreigners, who have their own auto
production plants on U.S. soil. If Detroit ever gets the money, it will come
after intense negotiations and detailed legislation providing conditions for
repayment of the money. In exchange for the money, they will be made to
resemble the foreign firms.
The rationale for letting the “Big
Three” fail is that we don’t need American car companies anymore. On the
other hand, we need foreign money and foreigners to invest in our country
and our firms.
This is America today―a country
that is losing its ability to manufacture things but has to continue to
pander to rich Arabs and the Chinese Communists for money just to survive.
In addition to our jobs, savings and investments, it looks like our
sovereignty and national pride are being sacrificed as part of this
process.
Whether the financial meltdown has
been engineered or not―and there are major questions about its timing, just
six weeks before the national elections―it will be up to President Obama to
manage America’s transition into this New Global Order. With his background
in Marxism and extensive
Wall Street contacts and associations, he seems
perfectly suited for the task.
But the powers that be, including
those in the media, have simply assumed that the American people will meekly
go along with the demise of their nation. That may be a miscalculation, if
they manage to find a voice or voices in the media.
In closing this appendix, I might note that the
FIBs are among the most sophisticated investors in the world as well as being
the largest investors in the world. Especially note where the book below is
published.
Exotic Derivatives And Risk Theory, Extensions and Applications,
by Mondher Bellalah (Universite de Cergy-Pontoise, France;
Dubai Group, UAE)
"Herein follows a remarkable volume, suitable
as both a textbook and a reference book. Mondher Bellalah starts with an
introduction to options and basic hedges built from specific options. He
then presents an accessible account of the formulae used in valuing
options ... Bellalah then proceeds to the main task of the volume, to
show how to value an endless assortment of exotic options."
Harry M Markowitz, University of California, San Diego
1990 Nobel Prize Laureate in Economics
For more information, please visit
http://www.worldscibooks.com/custserv/textbook_inspect.shtml
If there is a "hidden agenda" that gave priority of AIG and CitiBank over
Lehman Brothers, not all of our National Debt holder, especially in Asia, were
saved by not also bailing out Lehman Brothers. The problems in Asia and the
Middle East would, however, have been greatly magnified if AIG and CitiBank were
allowed to fail.
"Thanks, Hank: Troubled Securities in Asia," The Economist,
November 20, 2008, Page 89 ---
http://www.economist.com/finance/displaystory.cfm?story_id=12652247
WHEN Hank Paulson, America’s treasury
secretary, let Lehman Brothers fail in September, he surely did not consider
the damage the investment bank’s collapse would inflict on elderly savers a
continent away. In Hong Kong, Singapore and Taiwan, thousands of people have
taken to the streets to protest against the implosion of a series of retail
securities which resulted from the bankruptcy.
Banks and regulators were taken off guard
and are only now totting up the damage. Singaporean authorities estimate
that 11,000 residents held duff securities with a face value in excess of
S$530m ($347m). In Hong Kong, 43,700 residents held HK$20.1 billion-worth
($2.6 billion). In Taiwan, 51,000 people had tainted holdings of NT$40
billion ($1.2 billion). Some Taiwanese are expected to stage a mass protest
on November 29th.
Although many different securities were
affected, they shared a common trait: fiendish complexity. One firm would
arrange the structure and handle dividend payments. This was often Lehman,
which was why they were commonly called “Lehman minibonds” (even though they
were not bonds and were never simply Lehman obligations). Below the arranger
were half a dozen or so “reference” banks which held collateralised-debt
obligations and sometimes equity, issued by as many as 100-150 institutions.
From 2006 onwards, banks and brokers sold
these now troubled securities to individuals desperate to earn more than the
1% or less on guaranteed deposits. Buyers were betting on modest returns,
typically 5-6%, low enough perhaps for them not to have been too suspicious
about the instruments’ complexity.
Lehman’s bankruptcy filing undermined its
ability to pass along dividends even when the underlying structures were
sound, which triggered the first defaults. Securities arranged by Merrill
Lynch and DBS Bank in Singapore then collapsed because Lehman credit was an
ingredient in their composition.
Inevitably, lawsuits will be filed.
Because most securities were sold with lengthy prospectuses that made clear
the lack of principal protection, the cases are likely to rest on the
premise that the investments were unsuitable for the customers, or not
understood by the salespeople.
Rather than waiting for messy court
battles, Singapore has taken the novel step of asking firms to reimburse
“vulnerable customers”, meaning those who are old or illiterate or who lost
a lot. Authorities plan to investigate and say they will take into account
how generously institutions treat their customers in the aftermath.
Continued in article
It may well be that the U.S. Treasury pledge most of the bailout money to AIG
and CitiBank because "they are just too big to fail" in a sense that failure of
these two might bring down the entire world wide financial house of cards. I
just don't think this is the case since CitiBank could've saved the CitiBank
creditors without saving the shareholders. This is essentially what happened
when Freddie Mac and Fannie Mae shareholders were wiped out.
Question
What's the significance of the off-balance sheet liabilities in CitiBank versus
the U.S. Treasury?
Answer
Both CitiBank and the U.S. Treasury have managed to keep more of their debts off
balance sheet than they have booked on the balance sheet. According to the
former top accountant in the U.S., David Walker, the total debt of the U.S. is
about $55 trillion (now in excess of $100 trillion), of which $11 trillion is booked on the balance sheet as
National Debt --- See Appendix A.
The total debt of CitiBank is over $2 trillion with slightly over half being
booked on the balance sheet. Some analysts argued that Citibank had a handle on
its total debt before the meltdown, but this is no longer the case ---
http://www.monkeybusinessblog.com/mbb_weblog/2008/07/citi-off-balanc.html
“Be Nice to the Countries That Lend You Money,” by James Fallows,
The Atlantic Monthly, December 2008 ---
http://www.theatlantic.com/doc/200812/fallows-chinese-banker
Americans know that China has
financed much of their nation’s public and private debt. During the
presidential campaign, Barack Obama and John McCain generally agreed on the
peril of borrowing so heavily from this one foreign source. For instance, in
their final debate, McCain warned about the “$10 trillion debt we’re giving
to our kids, a half a trillion dollars we owe China,” and Obama said,
“Nothing is more important than us no longer borrowing $700billion or more
from China and sending it to Saudi Arabia.” Their numbers on the debt
differed, and both were way low. One year ago, when I wrote about China’s
U.S. dollar holdings, the article was called “The $1.4 trillion Question.”
When Barack Obama takes office, the figure will be well over $2 trillion.
During the late stages of this year’s
campaign, I had several chances to talk with the man who oversees many of
China’s American holdings. He is Gao Xiqing, president of the China
Investment Corporation, which manages “only” about $200billion of the
country’s foreign assets but makes most of the high-visibility investments,
like buying stakes in Blackstone and Morgan Stanley, as opposed to just
holding Treasury notes.
Gao, whom I mentioned in my article, would
fit no American’s preexisting idea of a Communist Chinese official. He
speaks accented but fully colloquial and very high-speed English. He has a
law degree from Duke, which he earned in the 1980s after working as a lawyer
and professor in China, and he was an associate in Richard Nixon’s former
Wall Street law firm. His office, in one of the more tasteful new
glass-walled high-rises in Beijing, itself seems less Chinese than
internationally “fusion”-minded in its aesthetic and furnishings. Bonsai
trees in large pots, elegant Japanese-looking arrangements of individual
smooth stones on display shelves, Chinese and Western financial textbooks
behind the desk, with a photo of Martin Luther King Jr. perched among the
books. Two very large, very thin desktop monitors read out financial data
from around the world. As we spoke, Western classical music played softly
from a good sound system.
Gao dressed and acted like a Silicon
Valley moneyman rather than one from Wall Street—open-necked tattersall
shirt, muted plaid jacket, dark slacks, scuffed walking shoes. Rimless
glasses. His father was a Red Army officer who was on the Long March with
Mao. As a teenager during the Cultural Revolution, Gao worked on a
railroad-building gang and in an ammunition factory. He is 55, fit-looking,
with crew-cut hair and a jokey demeanor rather than an air of sternness.
His comments below are from our one
on-the-record discussion, two weeks before the U.S. elections. As I
transcribed his words, I realized that many will look more astringent on the
page than they sounded when coming from him. In person, he seemed to be
relying on shared experience in the United States—that is, his and mine—to
entitle him to criticize the country the way its own people might. The
conversation was entirely in English. Because Gao’s answers tended to be
long, I am not presenting them in straight Q&A form but instead grouping his
comments about his main recurring themes.
Does America wonder who its new Chinese
banking overlords might be? This is what one of the very most influential of
them had to say about the world financial crisis, what is wrong with Wall
Street, whether one still-poor country with tremendous internal needs could
continue subsidizing a still-rich one, and how he thought America could
adjust to its “realistic” place in the world. My point for the moment is to
convey what it is like to hear from such a man, rather than to expand upon,
challenge, or agree with his stated views.
.....
About the financial crisis of 2008, which
eliminated hundreds of billions of dollars’ worth of savings that the
Chinese government had extracted from its people, through deliberately
suppressed consumption levels:
We are not quite at the bottom yet.
Because we don’t really know what’s going to happen next. Everyone is
saying, “Oh, look, the dollar is getting stronger!” [As it was when we
spoke.] I say, that’s really temporary. It’s simply because a lot of people
need to cash in, they need U.S. dollars in order to pay back their
creditors. But after a short while, the dollar may be going down again. I’d
like to bet on that!
The overall financial situation in the
U.S. is changing, and that’s what we don’t know about. It’s going to be
changed fundamentally in many ways.
Think about the way we’ve been living the
past 30 years. Thirty years ago, the leverage of the investment banks was
like 4-to-1, 5-to-1. Today, it’s 30-to-1. This is not just a change of
numbers. This is a change of fundamental thinking.
People, especially Americans, started
believing that they can live on other people’s money. And more and more so.
First other people’s money in your own country. And then the savings rate
comes down, and you start living on other people’s money from outside. At
first it was the Japanese. Now the Chinese and the Middle Easterners.
We—the Chinese, the Middle Easterners, the
Japanese—we can see this too. Okay, we’d love to support you guys—if it’s
sustainable. But if it’s not, why should we be doing this? After we are
gone, you cannot just go to the moon to get more money. So, forget it. Let’s
change the way of living. [By which he meant: less debt, lower rewards for
financial wizardry, more attention to the “real economy,” etc.]
.....
About stock market derivatives and their
role as source of evil:
If you look at every one of these
[derivative] products, they make sense. But in aggregate, they are bullshit.
They are crap. They serve to cheat people.
I was predicting this many years ago. In
1999 or 2000, I gave a talk to the State Council [China’s main ruling body],
with Premier Zhu Rongji. They wanted me to explain about capital markets and
how they worked. These were all ministers and mostly not from a financial
background. So I wondered, How do I explain derivatives?, and I used the
model of mirrors.
First of all, you have this book to sell.
[He picks up a leather-bound book.] This is worth something, because of all
the labor and so on you put in it. But then someone says, “I don’t have to
sell the book itself! I have a mirror, and I can sell the mirror image of
the book!” Okay. That’s a stock certificate. And then someone else says, “I
have another mirror—I can sell a mirror image of that mirror.” Derivatives.
That’s fine too, for a while. Then you have 10,000 mirrors, and the image is
almost perfect. People start to believe that these mirrors are almost the
real thing. But at some point, the image is interrupted. And all the rest
will go.
When I told the State Council about the
mirrors, they all started laughing. “How can you sell a mirror image! Won’t
there be distortion?” But this is what happened with the American economy,
and it will be a long and painful process to come down.
I think we should do an overhaul and say,
“Let’s get rid of 90 percent of the derivatives.” Of course, that’s going to
be very unpopular, because many people will lose jobs.
.....
About Wall Street jobs, wealth, and the
cultural distortion of America:
I have to say it: you have to do something
about pay in the financial system. People in this field have way too much
money. And this is not right.
When I graduated from Duke [in 1986], as a
first-year lawyer, I got $60,000. I thought it was astronomical! I was
making somewhere a bit more than $80,000 when I came back to China in 1988.
And that first month’s salary I got in China, on a little slip of paper, was
59 yuan. A few dollars! With a few yuan deducted for my rent and my water
bill. I laughed when I saw it: 59 yuan!
The thing is, we are working as hard as,
if not harder than, those people. And we’re not stupid. Today those people
fresh out of law school would get $130,000, or $150,000. It doesn’t sound
right.
Individually, everyone needs to be
compensated. But collectively, this directs the resources of the country. It
distorts the talents of the country. The best and brightest minds go to
lawyering, go to M.B.A.s. And that affects our country, too! Many of the
brightest youngsters come to me and say, “Okay, I want to go to the U.S. and
get into business school, or law school.” I say, “Why? Why not science and
engineering?” They say, “Look at some of my primary-school classmates. Their
IQ is half of mine, but they’re in finance and now they’re making all this
money.” So you have all these clever people going into financial
engineering, where they come up with all these complicated products to sell
to people.
.....
About the $700 billion U.S.
financial-rescue plan enacted in October:
Finally, after months and months of
struggling with your own ideology, with your own pride, your self-right-eousness
… finally [the U.S. applied] one of the great gifts of Americans, which is
that you’re pragmatic. Now our people are joking that we look at the U.S.
and see “socialism with American characteristics.” [The Chinese term for its
mainly capitalist market-opening of the last 30 years is “socialism with
Chinese characteristics.”]
It is joking, and many people are saying:
“No, Americans still believe in free capitalism and they think this is just
a hiccup.” This is like our great leader Deng Xiaoping, who said that it
doesn’t matter if the cat is white or black, as long as it catches the
mouse. It doesn’t matter what we call this. It’s pragmatic.
Continued in article
What's sad is that even saving the shareholders in Citibank in order to
prevent shareholder wipeouts of the shareholders from China, Singapore, Japan,
and the Middle East, that may not be enough to keep the interest rates on the
U.S. National Debt as low as we would like.
"The issuance issue," The Economist, Nov. 2--Dec. 5, 2008, Page 77 ---
http://www.economist.com/finance/displaystory.cfm?story_id=12700894
“ROLL up, roll up. Get your government bonds here.
They may not pay much, but they’re safe. Buy ’em now in case stockmarkets
don’t last.”
As the recession deepens, finance ministers round
the world may be forced to resort to the tactics of the market stallholder.
Politicians hope that deficit financing will be the way to stimulate the
economy. But someone has to buy all those bonds.
They are easy to sell at the moment. The prices of
risky assets like shares and corporate bonds have been plunging. Banks are
so desperate for the security of government paper that they are accepting
yields close to zero on three-month Treasury bills. Yields on American
ten-year Treasury bonds have fallen to around 3%, their lowest in a
generation. British government bonds, or gilts, with the same maturity are
returning about 4%, despite the rise in the budget deficit planned by
Alistair Darling, the chancellor.
Government-bond markets are benefiting from the
deteriorating economic outlook, which is leading some forecasters to predict
both a recession and a brief period of deflation in 2009. A nominal yield of
3-4% looks attractive in real terms if prices are falling.
A surge in supply could be matched by higher
demand. The potential precedent is Japan, where nearly two decades of fiscal
deficits and a deteriorating debt-to-GDP ratio have not stopped investors
from buying bonds at yields of less than 2%.
But is this really an encouraging example? Most
Americans and Europeans would not consider low government-bond yields to be
adequate compensation for the nearly two decades of sluggish economic growth
that Japan has suffered. And Japan is different from America and Britain: it
runs current-account surpluses and thus has not been dependent on foreign
capital. The Anglo-American economies rely on the kindness of strangers.
There has been no sign, so far, that foreigners are
tiring of funding the American deficit. Indeed, the dollar has risen against
most currencies (the yen is a notable exception) in recent months. Being the
world’s largest economy has helped, as has the flight out of emerging-market
currencies. But Britain does not have the same advantages. The pound was
treated for many years as a high-yielding version of the euro. That is no
longer so after recent rate cuts and sterling has suffered against both the
euro and the dollar.
Mr Islam reckons overseas investors have been
buying around 30% of recent gilt issuance. Given the losses they have
already suffered through the pound’s fall, will they step up their
purchases, especially as the growth rate of global foreign-exchange reserves
is slowing?
So domestic investors may be required to shoulder
the burden. Pension funds may be eager to add to their holdings, given the
losses they have suffered on shares and in alternative asset classes, such
as hedge funds and private equity.
But retail investors may also be needed. A rise in
the savings rate is widely forecast as the economy slows (although this is
likely to be driven by a fall in borrowing more than by a surge in savings
itself). If, as many economists forecast, the Bank of England cuts
short-term rates to 2%, British savers could be tempted by the allure of
government bonds yielding 3-4%. The same may be true in America, where
money-market funds are already offering paltry returns. This will be a big
change of habit: according to Morgan Stanley, America’s net Treasury-bond
purchases, outside those by the finance industry, have been zero since 1992.
Perhaps a more cautious generation of investors
will rediscover the virtues of government debt, as they did in the 1930s and
1940s. “People will be buying bonds as Christmas presents,” predicts Matt
King, a credit strategist at Citigroup.
Paradoxically, the real problem for governments may
only occur if they manage to revive their economies. At that point,
deflation worries will disappear and investors will switch to riskier
assets. Given the deficits in both Britain and America, it seems unlikely
that any cyclical rebound will be strong enough to bring the budget back to
balance. In 2010 or 2011, issuing government bonds may prove a much harder
(and more expensive) task.
Also I might note there could be another hidden agenda (Hidden Agenda 2?) why
AIG and CitiBank got favored in the Bailout.
High-ranking members of Congress were flown to a lush
Caribbean resort this month for a three-day conference planned and paid for by
several of the country's most powerful corporations - a violation of federal
ethics rules, critics say. . . . Officials with those companies were
observed at the conference - sometimes acting as featured speakers at daily
seminars and freely mingling among the pols at social events.
Citigroup - which just last week received a massive
bailout from the federal government - was one of the conference's biggest
sponsors, ponying up $100,000 to help finance
the event, according to one of the lobbyists at the gathering.
Ginger Adams Otis, "SHADY ISLAND
'HOUSE' PARTY POLS' TRIP TO CARIBBEAN SKIRTED RULES," New York Post,
November 30, 2008 ---
http://www.nypost.com/seven/11302008/news/regionalnews/shady_island_house_party_141513.htm
Jensen Comment
But I don't think funding lavish parties for members of Congress is behind the
favored treatment of CitiBank. Financial institutions that were not saved also
contributed for lavish members of Congress who work so hard for the people.
PJ O’Rourke’s Parliament of
Whores ---
http://snipurl.com/parliamentwhores
For an in-depth legal study of the Bailout decisions, go to
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1306342
November 29, 2008 reply from Mark Shapiro
[mshapiro@irascibleprofessor.com]
Dear Bob,
I believe you are at least partially correct about
the difference between WaMu and Citi, but it also was far easier for the
FDIC to find a buyer for an outfit like WaMu, which had a mint of insured
deposits making them very attractive for Chase, which in turn needed to
boost its capital. Citi, on the other hand, is much more of an international
operation, and it's clear that Paulson was trying to keep the international
financial system from completely collapsing.
The consequences of WaMu or Country-Wide failing,
and being taken over by Chase and B of A respectively, were not nearly as
bad as some of the other ones going down -- though they probably could have
let Bear Stearns fail.
At some point I may try my hand at writing an
analysis of this financial collapse.
Dr. S.
November 30. 2008 reply from Bob Jensen
Hi Mark,
It’s the shareholders that I’m thinking of when comparing these two
banks. WaMu shareholders were made up of nobody in particular and lost
virtually everything by not being bailed out. CitiBank’s biggest
shareholders included China, Singapore, Japan, Saudi Arabia, and rich Arabs
from all over the Middle East. Saudi Arabian prince Alwaleed bin Talal, has
a major stake (billions of dollars) in Citigroup. These are people that you
do not want to victimize in fraud, because they are essential to keeping
America’s cost of National Debt capital low as we continue to add to this
debt by $4 to $6 billion per day and will have a lot of the older U.S.
Treasury Bonds they own coming up for roll over almost every day. Their
stake in our National Debt is now approaching $5 trillion. What if they
decide not to bid against each other in U.S. Treasury Bond auctions? Or
rather, suppose they merely do not bid aggressively in these auctions.
Incidentally, I see where JP Morgan just fired half (about 40,000) of the
WaMu employees. Virtually all of them were also shareholders in Washington
Mutual.
Oops what am I doing making the
Hidden Agenda Theory public?
Bob Jensen
Appendix Z
Why the Rush to Re-inflate the Stock Market?
Question
Is the stock market down to where it should be on average?
Or put in another way, is the Fed at great inflationary risk trying to blow the
bubble back up too quickly?
From Jim Mahar's Blog, December 3, 2008 ---
http://financeprofessorblog.blogspot.com/
How Stocks Have Returned 10% Per Year
After
Henry Blodget from Clusterstock was on NPR saying that stocks were back to
"fair value" (i.e. their long run average), he had
a listener email him about how the 10% annual return in stocks is found. His
answer is below:
How Stocks Have Returned 10% Per Year:
"...the 10% number includes dividends, which
is the way people normally look at stock market returns. On a pure
price basis, returns have been far lower.
In fact, here's an approximate breakdown of the 10% average return
for the last 80 years:
4 points: Dividends
2 points: Real EPS growth
3 points: Inflation (reflected in EPS growth)
1 point: Multiple expansion
Now that stocks have finally dropped back to fair value again, I think the
long-term return from here is likely to be in the average range again. The
multiple expansion might not continue, and dividends are currently about 3%, not
4%, so it could be lower. But the dividend payout ratio could rise again, and it
may be that structural changes (more cash-efficient services companies vs.
low-return-on-capital industrial companies) will lead to continued PE expansion"
A Personal Note from Bob Jensen Written Before
the November 8. 2008 Election
A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/
Personal Note from Bob Jensen on October 17, 2008 (before the election)
Why I'm going to vote a straight Democratic Party ticket in November 2008
Get your facts first, then
you can distort them as you please.
Mark Twain
Economic
Recessions Throughout History ---
http://blog.eogn.com/eastmans_online_genealogy/2008/10/economic-recess.html
(Actually only the severe recessions)
A
media-fueled stock market panic does not equate directly to a severe economic
recession.
''I don't think things can get much worse,'' said Brian Bethune, chief
financial economist at Global Insight Inc. in Lexington, Massachusetts.
``September was a terrible month in terms of the overall situation, in both
sales and production. The fourth quarter is guaranteed to be a terrible
quarter.'' ---
http://www.bloomberg.com/apps/news?pid=20601087&sid=aZ0o8ZBt6hos&refer=home
Jensen Comment
We may well experience a severe economic recession running into 2009, but things
will have to get a “whole lot worse” Brian. But let’s borrow yet another
trillion to stimulate the economy out of this downturn no matter how small or
how large it is in fact. I’m ready for another $1,200 stimulus gift from
Washington DC. Let unborn generations pay back what the Government borrows for
my luxuries in retirement.
The current “recession” is a bit odd due to the credit
freeze and energy price fears. But recession claims are exaggerated thus far in
the media and in academe. Sure retail sales were down 1.2% in September
following three months of relatively small declines. But does that equate to a
severe recession?
The unemployment rate of 6.1% in September was
unchanged from August 2008 and is actually on the decline in terms of seasonal
adjustments ---
http://www.bls.gov/news.release/pdf/empsit.pdf
Is this a severe-recession unemployment rate?
Much of the recession alarms sounding in the
media may be media efforts to impact election outcomes and grasping at straws to
explain the stock market crash. Far more important to date has been media
sensationalism coupled with efforts of the banks and their Administration and
Congressional allies to extort “taxpayers.” But since taxpayers for the next few
generations will not have to really pay for this in taxes, most of today’s
taxpayers really aren’t footing the bill.
I chuckle to myself when the analysts claim that
these bailouts and stimulus payments are being paid for by taxpayers ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
Far more devastating is the Government-spending credit
bubble built up during eight years of severely unbalanced budgets plus billions
(trillions?) being wasted on the present bailout and stimulus spending plans ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
I just want to say thanks to the Government for borrowing
the money to pay for prescription drugs that would otherwise cost my wife and me
over $5,000 per year on the other side of the donut hole. This new Medicare Drug
Plan entitlement is great for us senior citizens as long as we don’t let it
bother our conscience how much the Government is borrowing today at millions of
dollars a minute --- borrowings that will one day break the backs of the younger
generations. As for me, I’m greedy for a succession of $1,200 stimulus checks on
top of my drug benefits. Keep them coming! These gifts sure do stimulate me!
For what
it’s worth, I’m actually (seriously) going to vote a straight Democratic Party
ticket. I anticipate that a Democratic Party monopoly in the executive branch
and the legislative branch in Washington DC will be the most “stimulating” to me
personally. And billions awaiting to be spent on stem cell research may help me
live forever. It’s a win, win situation as far as I’m concerned. I’d probably
vote otherwise if any candidate for elective office promised to seek a balanced
budget for U.S. spending, but it’s literally impossible to elect any president,
senator, or Congressional representative who promises to actively seek a
balanced budget. As Pogo says: “The real enemy is us.”
So what
the heck? Eat, drink, and be merry for the moment! It’s a good time for me to
shop for a big heavy Hummer and a top-deck world cruise. I’m entitled to all
this ---
http://faculty.trinity.edu/rjensen/entitlements.htm
When 30-year mortgage rates drop below 5%, I may even re-finance so that I can
have more to spend on eating, drinking, and making merry with more useless
luxuries.
And since my Government benefits are all being paid for on
credit, I’m not costing any of you working stiffs a penny. I can’t say the same
for your eventual grandchildren, but who cares about them?
I’ve become Father Goose.
Pass Me By (lyrics by Carolyn Leigh) ---
http://hk.youtube.com/watch?v=C-F3vSrJIUQ
Peggy Lee's "Pass Me By" ---
http://hk.youtube.com/watch?v=GpxKaBLDXDg
Bob Jensen's threads on fair value accounting are at
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_weil&sid=aJFrPa3rqhHw
Bob Jensen's Rotten to the Core threads are at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Bob Jensen's Threads ---
http://faculty.trinity.edu/rjensen/threads.htm
Bob Jensen's Summary of Accounting History and Accounting Theory ---
http://faculty.trinity.edu/rjensen/theory01.htm
Creative Earnings Management, Agency Theory, and Accounting
Manipulations to Cook the Books ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Bob Jensen's home page is at
http://faculty.trinity.edu/rjensen/