THINK!

It's been a while ... sorry.

At varying times in the past, I've hinted at the possibility that the previous administration, with the help of the congress, facilitated the mortgage mess through increasing loan limits and decreasing qualification guidelines for the GSE's. That is, it became easier for Fannie and Freddie to buy junk. Nobody gave any real thought to the possible fallout, and here we are.

How can our rulers possibly be that obtuse? you may ask.

Lately, there has been some evidence that my worst possible suspicions might actually be true. The ascension of some not too bright people into the upper echelons of American politics has, sort of, codified the idea that the over extension of credit to American families was allowed to happen for political reasons.

One can easily conclude, that when people are so pre-occupied with staving off creditors, they don't pay enough attention to what is happening outside their immediate environment. This enables politicians, and judges, to tilt the playing field to their advantage.

It couldn't be more obvious that the only thing that our elected officials really care about is raising money. It matters not, that the corporations and the really wealthy few that supply the money, have only their very selfish interests at heart.

If you think about it, the dumber (and greedier) the politicians, the easier it is for the "donors" to get their way. Does anybody else appreciate the irony expressed by political hacks for the most elite in our society, dumping on Obama as an elitist? Does anyone else think that American society really is getting dumbed down - just listen to any sports broadcast - the announcers are idiots - they have no clue as to how to express themselves using proper English.

Not to sound overly cynical, but it really seems to me that this whole tea party movement is nothing more than a bunch of very well meaning people that have been duped into doing the bidding of a very few elitists. You can see the same thing happening in California as it relates to a proposition on next November's ballot overturning the states well crafted emission guidelines.

How could any politician of any party, under the present economic circumstances, not let the ill-advised Bush tax cuts expire for the top earners?

Anyhow, I've always been paranoid about the whole Big Brother thing so it's been easy for me to ignore my instinct on the subject of an actual policy that facilitated people buying houses that they could not afford. In retrospect though, I really don't think that there is another rational explanation. A very potent brew consisting of naive consumers, predatory mortgage lenders and avaricious investment bankers all facilitated by the SEC, lawyers, accountants and rating agencies that had blinders on and here we are ... and here we deserve to be!

Will The Other Shoe Drop?

yes, it will ... the only question is when.

Gretchen Morgenson's column in today's Times focuses on Fannie and Freddie. It's a tad on the sobering side and should not be ignored. As an example, were you aware that the treasury raised the limit on the amount of bailout money that can be allotted to these paragons of ignorance? The article also points to the losses that Freddie reported on Friday and how the trend is likely to continue.

Never one to toot my own horn, I did point out here and in letters to my congressional representatives (when there was time to do something about it) how a one percent rise in defaults would bankrupt the GSE's. Wouldn't it be nice if that's where the losses stopped? Instead, it's closer to four percent and rising. Remember, defaults in conventional single-family conforming loans averaged about 1/2 of one percent since the advent of the MBS programs at the agencies. Now, for Alt-A and adjustable rate loans combined, the default rate is over 10%.

The point is, at the GSE's, it's business as usual and they are THE bid in the secondary market. If they go away, there will be no mortgage market.

So, you have to ask yourself, has the other shoe fallen? What are treasuries and the gold market telling us, HUH?

NOW, It's The Rating Agencies Fault?

A NY Times editorial today puts the blame on the rating agencies. While this is true, it's a bit late and it ignores the most fundamental aspect of the crash, e.g., the naivety related to thinking that the single family market would continue to rise and make everything all right.

Crash White's comment on my last post - hey, I'm a snake, what did you expect - hits the nail squarely on the head as it relates to the bankers who sold the deals.Their folly was in keeping the equity slices of their deals. They should have listened to the buy side - my assumption is, that the "smart" people at the insurance companies and money managers were full, so the Street went ahead and kept the equity slices. That's the single biggest mistake. The next one, and the one that happened first, is Gresham's Law, paraphrased as, "bad money drives out the good". In order for this to happen, the Street boots commissions thereby motivating salespeople to entice new investors into a market about which they haven't a clue. But hey, it's AAA. Can you say Iceland?

When the deals got downgraded, the Street lost its ability to finance at haircuts that were commiserate with their net capital. This really started the liquidity crisis that triggered the shutdown of lending and the knee jerk response by the banks and eventually, the Fed.

These deals NEVER should have been rated AAA in the first place. The Street had to have known that. The rating agencies had to have known that. That they all bought into the charade is a monument to ignorance.

Remember folks, never give a sucker an even break.

Bulls Make Money, Bears Make Money and Pigs ...

Go To The Slaughter House ... or do they?

Turns out that there were several sets of pigs in the story of the great depression of 2008 - the Street, the rating agencies, mortgage originators, Congress, the GSE's, law firms and the poor saps that were naive enough to buy into the single family cycle at the top and BTW, the only members of the list that went to the slaughter house.

This IS the last time that I'll summarize the reasons why the whole mess happened. Before I do though, wouldn't it be interesting to actually know if anyone, like one of the authors who have written about the causes, read this blog? We'll never know. Anyhow, here it is again; AVARICE! What? you can sum it up in one word? well, not quite but pretty close.

Here is what's in this blog and what can be built upon to set the stage for the meltdown:
1. The K Street Project opens Congress to a vast increase in donations and a shift in the way that legislation is drafted and by whom.
2. A paradigm sift in morality relating to the establishment of the rationality of the end justifies the means - Business Ethics, WMD, mushroom cloud, Carlyle Group & etc.
3. Off Balance Sheet Finance
4. Small Brains and smaller penises and the negative affect that one exerts on the other.
5. I've only alluded to this one but each and every American's right to get their shot at the big bucks.

Hold that thought. Here is my story - again - My shot was the CMO. It took several years and several machinations to refine to the point where it could be stolen from me and grown into the monster that it eventually became. In spite of that however, I still got my shot. With two friends, I started the first "private label" CMO issuer. We structured a deal with Lehman that would have paid me alone, $60 million 1984 dollars. When I brought the whole thing together, Lehman restructured the profit split and we told them, so long, (big mistake) thinking that we could replace them quickly. The market moved, I got one more chance with Morgan Stanley, but in the end, missed my shot at the easy bucks.

The point of the story is this this, we each deserve our shot. That it may be marginally illegal or built on a foundation of sand, matters little in modern US society.

Don't judge the people who did the Abacus deal - look at the name, do you know how to use an abacus? or even what one is? It wasn't supposed to be understood. That's the point. Paulson got his shot. Goldman did what investment banks are supposed to do ... they underwrote and distributed the deal and got paid a fee. The deal did what it was structured to do. It imploded and the firms that were naive or greedy enough to fund it lost money ... sorry.

Like most of what is written here, I've lost concentration.

Think about this though. We created a system and the system worked. It raised trillions of dollars for US and international housing finance. It worked so well that the players lost sight of where it was heading and, just like tulips and other financial fiascos, it fell apart. The problem, dear reader, lies in the system that created the atmosphere that enabled the whole mess to get out of hand.

Do you actually think that that same system is actually going to do anything about changing itself?

Too bad we can't legislate intelligence.

The Experts Are Off Again

So, now the whole mortgage mess was a fraud. The fraud is, that regulators as well as other facilitators, such as rating agencies and law firms stood aside and let the whole thing happen.

The fact of the matter is, the Street exists to make money. There was a ton of it to be made doing CMO's, CDO's and CDS'. The problem was, they went too far and broke the cardinal rule of doing these deals which should have been, find a buyer for the most toxic tranche of the deal before you step up and buy the collateral. I actually think that people at Lehman and Bear let themselves think that the housing market would continue to go up and lost sight of the fact that the crap that is sub-prime is exactly that ... crap, not worthy of a AAA rating regardless of over-callateralization. They bungled it when they became owners of the toxic tranches and kidded themselves into thinking that they could finance it until maturity.

Look back at my posts. 1. the rating agencies were way too naive, 2. Congress really dropped the ball by letting Fannie and Freddie (who should have known better) buy sub-prime and 3. the institutions who bought the paper had way too much faith in the system that had convinced itself that the single-family market was, in fact, one dimensional.

Now, I hope that Goldman will fight the SEC because its own complicity as well as that of the entire regulatory structure will be exposed for the incompetence that pervaded it.

More detail on the Goldman case

"Never give a sucker an even break"

Here is a quick summary from the Times:
Investor Devised a Bet Against Risky Loans
Three and half years ago, a New York hedge fund manager with a bearish view on the housing market was pounding the pavement on Wall Street. Eager to up his bets against subprime mortgages, the investor, John A. Paulson, canvassed firm after firm, looking for new ways to profit from home loans that he was sure would go sour. Only a few investment banks agreed to help him. One was Deutsche Bank. The other was the mighty Goldman Sachs. Paulson struck gold. His pre- science made him billions and transformed him into something of a rock star both on Wall Street and in Washington.
But now his brassy bets have thrust Paulson, 54, into an un- comfortable spotlight. On Friday, the S.E.C. filed a civil fraud suit against Goldman for neglecting to tell its customers that mort- gage investments they were buy ing consisted of pools of dubious loans that had been selected by Paulson because they were highly likely to fail. By betting against the pool of questionable mortgage bonds, Paulson made $1 billion when they collapsed just a few months later, the S.E.C. said. Investors who bought what regulators are essentially calling a pig in a poke lost the same amount. Although Paulson, 54, is not a defendant in the S.E.C. suit, the commission found that he was deeply involved in the creation of the investment, known as Abacus 2007-AC1.
After analyzing mortgages made on homes in Arizona, California, Florida and Nevada, Paulson went to Goldman to talk about how he could bet against those loans. He focused his analysis on adjustable rate loans taken out by borrowers with relatively low credit scores and turned up more than 100 loan pools that he considered vulnerable, the S.E.C. said.
Paulson then asked Goldman to put together a portfolio of these loan pools, or others like them that he could wager against. He paid $15 million to Goldman for creating and marketing the Abacus deal, according to the complaint.
One of a small cohort of money managers who saw the mortgage market in late 2006 as a bubble waiting to burst, Paulson capitalized on the opacity of mortgage related securities that Wall Street cobbled together and sold to clients. These instruments held thousands of mortgage loans that few investors analyzed.
GRETCHEN MORGENSON and LOUISE STORY - who, BTW broke this story months before the SEC even had the smallest clue as to what was going on.

And a quick editorial from the Times:

Months ago, The Times exposed Goldman Sachs’s practice of creating and selling mortgage-backed investments and then placing financial bets that those investments would fail. It wasn’t clear whether the practice was fraud. The Securities and Exchange Commission has now decided that it was.
Keep a close eye on this case. If it is handled correctly, it should finally answer the question of whether malfeasance was partly responsible for the financial meltdown.
Goldman insists that what it was doing was prudent risk management. In its annual report, it argued that “although Goldman Sachs held various positions in residential mortgage-related products in 2007, our short positions were not a "bet against our clients.’” The bank also insists that the investors who bought the structured vehicles were professionals who knew what they were doing. The S.E.C. is now charging just the opposite.
It accuses Goldman of intentionally designing a financial product that would have a high chance of falling in value, at the request of a client, and lying about it to the customers who bought it. It says that Goldman allowed John Paulson, a hedge fund manager, to pick bonds he wanted to bet against, and then packaged those bonds into a new investment. Goldman then sold this investment to its clients, telling them the bonds were chosen by an independent manager, and omitted that Paul- son was on the other side of the trade, shorting it. Five months after Goldman sold the investments, 83 percent of the bonds contained in the packaged securities were downgraded by rating agencies.
Goldman vigorously denies any wrongdoing, calling the S.E.C.’s charges “completely unfounded in law and fact.” It will undoubtedly assemble a daunting legal team. But if the S.E.C. makes its case, it will be a watershed moment, changing the dominant narrative of the financial crisis.
Up to now, the bankers have argued that the financial crisis was like what insurers call an “act of God,” a cataclysm over which they had no control. This has allowed them to shrug off responsibility, even as taxpayers bailed them out. It has allowed them to sleep soundly after collecting their huge bonuses. Goldman is not the only bank to have sold mortgage-backed securities and then bet against them. We sus- pect that after Friday, others on Wall Street may have a harder time sleeping.
Watch This Case

USA V. Goldman

This is going to be really interesting. It's likely that Goldman will settle. The real fraud though, is the degree of closeness that the firm had to Treasury Secretary Paulson during the period just before Lehman failed and not its internal asset management which, if done correctly, should be separated from the trading desk anyhow. Its not going to happen, but it would be pretty cool to see if anyone with insider type knowledge has the nerve to step up and rat them out.

It'll be fun to watch ...

Brain Drain

In response to questions asking about how a particular firm was able lose lots of money on any given trade, I always responded using an analogy related to baseball or the original six team NHL. Because we have inserted an image of the greatest player who ever lived, YAZ, let's use baseball in hopes that what I have been saying about the financial sector's lack of comprehension of risk might actually make more sense. BTW, this intelligence void exists in all sectors of our society at the moment ... it's just a bit more obvious in Wall Street.

So, Yaz was the last triple crown winner in baseball, 1967 the year of the "Impossible Dream" when the Sox dropped the World Series to St. Louis. The sports analogy is relevant because, the pool from which players are selected, consists of a very small sample of really talented people. As an example, a pitcher with an ERA of 4.5 is considered an ace today but 50 years ago, he would have been lucky to get three of four starts per season. Today's player earns several million dollars and not much, on a relative basis, is expected of him. Just as a greater number of teams playing today has diluted the available talent pool, so has the IQ of Wall Street dropped as the firms grew in size. That is, there is a finite number of people that have the ability to really understand the risk inherent in structured securities such as CMO's and CDS' - maybe ten people. Unfortunately, given the vastness of the the market and its complexity during the boom years, in order to execute it safely, about 200 competent risk managers were needed.

Just as the one-eyed man is king in the land of the blind and just as an average hitter can bat over 300 when pitching sucks, Wall Street will listen to inexperienced very average people lacking a fundamental understanding of risk. Team owners ask, what fills the seats? Home runs. Wall Street owners ask, what fills the coffers? High risk securities.

When we don't expect much, we get what we expect ... average.

Average people who like to take risk do more stupid things with worse consequences because they lack a fundamental understanding of the result of their actions. Remove well crafted regulations, like Glass Steagall, and well-intentioned people who do not understand risk set the stage for disaster.

I'm rambling, but you get the point. As long as we are governed by average people who really don't grasp what can go wrong, or right, things are not going to improve.

And, unemployment is not going to improve and deficits are not going to go away because the entire public sector suffers from bloat. The bureaucracy exists to perpetuate itself and is not about to commit suicide.

Here's a Really Swell Idea

LOOK! Up in the sky ... it's a new agency that will provide early warnings about the health of Wall Street firms by analyzing their balance sheets and other stuff that they provide to the SEC. BY the way, did these firms actually have all of the swaps and underlying on their books? I wonder if they will in the future? Golly, I really feel safe with the US Congress calling the shots.

What do you think?

Senators Endorse New Financial Analysis Agency

WASHINGTON — Senate Banking Committee members from both parties said Wednes- day they had agreed to include in their regulatory overhaul bill a new Office of Research and Analysis that would provide ear- ly warnings of possible systemic meltdowns.
The proposed agency, which has sometimes been referred to as the National Institute of Fi- nance, is intended to give regula- tors daily updates on the stability of individual firms as well as that of their trading partners, includ- ing hedge funds.
The agency would give regulators a broader view of the health of participants in the financial markets and the potential for problems to spread. The idea’s supporters say that kind of in- formation was lacking in recent years as the housing bubble burst and troubles spread from firm to firm.
The new agency would have no policy responsibilities but would instead collect and analyze data, building models to assess rela- tive risk levels and predict how one firm’s problems might affect others.
As proposed, the agency would be housed in the Treasury Depart- ment with a director, appointed by the president and confirmed by the Senate, who would be an ex-officio member of a systemic risk council that would be cre- ated by the bill. It would draw its budget from assessments on the largest financial firms, according
to people who are close to the ne- gotiations but who were not au- thorized to speak publicly.
The financial reform bill ap- proved last year by the House would create a systemic risk council that would collect simi- lar data without establishing an independent agency to do so, a difference that will have to be re- solved before a bill is sent to the president.
“One of the problems we ob- served in the recent crisis is that nobody knew who had what,” said Sen. Jack Reed, D-R.I., who last month introduced a separate bill to establish a National Insti- tute of Finance. “The result was a cascading effect of uncertainty and doubt.” NY Times

It begs the question, if a decent analyst can earn five times as much in the Street, why would she work for some agency that is only providing window dressing?

Escalating In A Quagmire

Haven't I tried to make the point that a felicitating congress as well as the SEC in their lack of supervision and enforcement of FASB guidelines, got the country into the debacle in which we currently reside? Can it possibly be, that the justices of our supreme court do not read this blog? How can they be so naive?

Just in case anybody out there doesn't think that the K Street Project was a success, yesterday's Supreme Court decision on campaign finance ought to put you over the top. Thanks Hammer.


So, who got us into this mess, and who benefitted from it? More importantly, upon whom did congress and the administration rely to craft the bailout legislation and has that legislation benefitted the American people?

Here is an excerpt from today's WSJ: Critics contended that corporations and unions continued to spend general funds on electioneering through ads masquerading as commentary on public issues that implicitly urged a particular candidate's election or defeat. McCain-Feingold aimed to plug that purported loophole by restricting those ads in the weeks before a federal election.

But Justice Anthony Kennedy, writing for the majority in a 57-page opinion, said the effort to divide corporate political spending into legal and illegal forms chilled political speech.

"When government seeks to use its full power, including the criminal law, to command where a person may get his or her information or what distrusted source he or she may not hear, it uses censorship to control thought," he wrote.

Justice Kennedy wrote that, taken to its extreme, the restriction on corporate spending could silence media organizations or even allow banning such political-themed movies as "Mr. Smith Goes to Washington."

He rejected the view that government had an interest in preventing corporations or unions from "distorting" political debate by funding ads. To the contrary, "corporations may possess valuable expertise, leaving them the best equipped to point out errors of fallacies in speech of all sorts," he wrote.

I think that the justices failed to grasp the the meaning of the golden rule, e.g., he who has the gold rules ...

THINK!

Questions For the Big Guys

The Times asked some experts to submit three questions that they would ask the heads of Golda, and a couple of banks about what happened to cause the financial crisis. Here are the only really relevant questions that were submitted:

1. Describe in detail the three worst investments your bank made in 2007 and 2008 — that is, those transactions on which you lost the most money. How much did the bank lose in each case?

2. What was the total compensation of each manager or executive supervising those three transactions — including yourself — in 2007 and 2008?

3. Are those executives still with your bank? What investments do they supervise today? How much will they be paid for 2009, including their bonuses?

— SIMON JOHNSON, a professor at the M.I.T. Sloan School of Management and a senior fellow at the Peterson Institute for International Economics

Here is my submission:

1. Do you suffer from dementia or any other memory altering malady? No? Well then, how could you possibly get involved in a flawed market that mirrors exactly what happened to mortgage lenders during the period from 1989 to 1991 (see post of 01/06/09), e.g., how could you possibly be a party to a market that allowed borrowers to be qualified at teaser rates?

2. If Billy's mother let him jump off of the Mystic River Bridge, would you let your little Lloyd or Jamie or Johnny?

3. WRT to the GSE's - Fannie and Freddie, were you aware that they employed greater than 100 times leverage in their risk management? Yes? Given a simple default analysis, you were therefore aware that a modest increase in defaults would bankrupt them, were you not? Yes? Were you also aware that the government's line of credit to them was far less than what was at risk? Yes? We take it therefore, that you were confident that the government would step in and bail out the market? Yes? Knowing the potential for loss, you proceeded anyhow ...

Parry and Thrust

So, we have heard from Ben Bernanke again. As in the past, he has absolved the Fed from any responsibility for the current economic mess. Here's the quote:

“Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates,” Mr. Bernanke, whose nomination for a second term awaits Senate confirmation, said in remarks to the American Economic Association.

He has a point, because the Fed is really responsible for the regulation of national banks and setting monetary policy and not direct supervision of the capital markets. But, let us not lose sight of the fact that Bernanke was a member of the Open Market Committee and as such, should have seen, along with the rest of the Board, the very simple relationship between median income and median home prices in the markets. The fact that some three trillion dollars was running through the mortgage market in 2006 should have raised concern - ABSOLUTELY! That it did not is the reason why we are here. OOPS, that would be blame, and we can't have that, can we?

So, who is to blame? We know, that it's not the Fed, because Bernanke just said that it was not. It is also not the Congress because they did a superlative job of supervising the GSE's and removing any accounting obstacles that relate to reporting by the company's that issued the derivatives that didn't cause the mess. It also couldn't be the Wall Street firms that caused it, because, after all, the securities were rated. It also could not be Fannie Mae and Freddie Mac because companies that employ leverage of greater than 100 times are really well managed and the decision makers are really smart and very conservative and really understand risk. Also, it definitely was not the rating agencies, because, they too really understand risk and know a AAA security when they see one. It was also not the SEC because we all know, that their supervision of FASB was right on the money and definitely NOT influenced by the Congress and Congress was, in turn, NOT influenced by K Street. It also was not the mortgage bankers because they really know how to underwrite and would never, under any circumstances, put a bad credit risk in a house that they could not afford. It's also not the Realtors because we all know that the affordability index is a really well constructed economic indicator and that they would never publish it if it were not. WAIT! I think I figured it out ... it was the housing market itself! It had the absolute cheek to stop going up in price.

What else could it possibly have been?