FedUpUSA

Archive for April 22nd, 2010

Bond Market Will Never Be the Same After Goldman: Michael Lewis

April 22 (Bloomberg) — If you happen to be sitting on the Goldman Sachs bond-trading floor life must feel horribly unfair.

You did nothing worse than live by the ethical assumptions of your market — any money-making event short of obviously illegal is admirable — and now your own grandfather thinks you’re some kind of monster. Your world feels upside down: What was right is now wrong; what was good is now bad; what once felt like winning now feels like losing.

You are probably wondering: What next? What will the angry rabble — all those ordinary people who can never really understand your business — now demand that you explain to them, so they can disapprove of you all over again?

A few possibilities:

No. 1 — Full knowledge of the inner workings of your proprietary trading desk.

In particular: the moment-to-moment dealings of your correlations traders from late 2004 (when they first exploited American International Group’s idiotic willingness to sell cheap insurance on pools of subprime mortgage loans) until the end of 2007, when they would have taken most of their profits from the total collapse of the subprime bond markets.

Your bosses claim to have lost almost $100 million on the Abacus trade for which your firm is being sued. This seems, to put it mildly, disingenuous. In March 2007, the time of this particular Abacus trade, your prop traders were already short the subprime market. Would they really have taken a naked long position in a deal you helped to construct precisely so that it would fail without offsetting in some other way on their books?

Ritual Sacrifice

Sadly, it will not suffice to offer up Fabrice Tourre as a ritual sacrifice. No one is going to accept a then 27-year-old Frenchman, whose job was apparently to keep sweet the patsies on the other end of your trades, as the world’s authority on your trading positions.

His name isn’t even on the top of the list of Goldman traders listed on the $2 billion Abacus deal for which you are being sued. The name on top of that document is Jonathan Egol. Egol appears to have been the bond trader at the center of your Abacus program. The same Jonathan Egol who told fellow traders in 2006 — a year before this transaction — that the subprime market was doomed.

The public eventually will ask: Who is Jonathan Egol and what exactly was his game?

No. 2 — A far better understanding of your relations with the inaptly named “CDO manager.”

Clearly Clueless

In this case the manager was ACA Management, but there were other CDO managers at least as pliable as ACA. The SEC suit charges you with using ACA as a shill: the end investors in your CDO assumed that it was ACA’s job to figure out whether the bonds inside the CDO were intelligent investments.

But ACA quite clearly had no idea what it was doing — and you quite clearly understood that.

The telling details here are the e-mails between your French salesman and ACA, in which ACA feels it needs to understand exactly what John Paulson’s interest are in this new CDO. Paulson, who had done a great deal of analysis on the underlying bonds, was of course picking the ones he wanted to see inside the CDO. (Hard to understand why it didn’t disturb you that he was even in the room, by the way, but that’s another conversation.)

The SEC accuses you of lying to ACA, by suggesting Paulson was a long investor in the deal when he was in fact selling the deal short.

Good From Bad

But what’s interesting here is what you appear to take for granted: that ACA has no talent for evaluating the bonds picked by Paulson. After all, if ACA was doing its job it wouldn’t have cared one way or the other what Paulson (then a little-known hedge fund manager) was up to. ACA would have known which bonds were good and which were bad, and picked the good ones.

In their anxiety about Paulson’s motives we can all glimpse their incompetence. They want to know that Paulson has an interest in picking the good ones because they themselves have no clue which ones they are.

But if a CDO manager had no independent ability to select the bonds inside a CDO what, please explain to us, was his financial function? Why did you select ACA to manage your deal?

No. 3 — A far better sense of why, and when, you ceased completely to concern yourself with the consequences of your actions.

The masses will be curious to know, for instance, how you became blinded to the very simple difference between right and wrong. The more moralistic among them will ask the question mainly to fuel their own outrage; the more tactical will ask the question because they sense that the financial system doesn’t function unless you have the incentive to think in these terms – - and you clearly do not.

Soul-Changing

What begins as an effort to change your business may well end up as an attempt to change your soul.

Among the many likely consequences of the SEC’s decision to sue Goldman Sachs for fraud is a social upheaval in the bond markets.

Indeed, the social effects of the SEC’s action will almost certainly be greater than the narrow legal ones. Just as there was a time when people could smoke on airplanes, or drive drunk without guilt, there was a time when a Wall Street bond trader could work with a short seller to create a bond to fail, trick and bribe the ratings companies into blessing the bond, then sell the bond to a slow-witted German without having to worry if anyone would ever know, or care, what he’d just done.

That just changed.

(Michael Lewis, most recently author of the best-selling “The Big Short,” is a columnist for Bloomberg News. The opinions he expresses are his own.)

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To contact the writer of this column: Michael Lewis at mlewis1@bloomberg.net

President Obama: Where Are The HANDCUFFS?

Posted by Karl Denninger

So the speech now has been given….  Let’s analyze it:

Since I last spoke here two years ago, our country has been through a terrible trial.  More than 8 million people have lost their jobs.  Countless small businesses have had to shut their doors.  Trillions of dollars in savings has been lost, forcing seniors to put off retirement, young people to postpone college, and entrepreneurs to give up on the dream of starting a company.  And as a nation we were forced to take unprecedented steps to rescue the financial system and the broader economy.

Yet those who committed the acts that led us to this terrible place, that is the bankers, even when bribery of public officials was going on and the bankers knew it, have not been indicted or prosecuted.

Instead, we bailed them out.

As a result of the decisions we made – some which were unpopular – we are seeing hopeful signs.  Little more than one year ago, we were losing an average of 750,000 jobs each month.  Today, America is adding jobs again.  One year ago, the economy was shrinking rapidly.  Today, the economy is growing.  In fact, we’ve seen the fastest turnaround in growth in nearly three decades.

We blew $1.5 trillion a year, or about 10% of GDP for the last two years.  President Obama’s policies in this regard are a mirror-image of George Bush’s, and of course GDP appears to be “growing” when one does this.  But this is no more “growth” than it is when you take a cash advance on your credit card – it is simply pulled-forward demand, and now the economy has become dependent on it. 

Again, these policies are an extension and in fact an engrossment of what George Bush did.  Proof is right here:

That makes the reality rather clear….. and is taken right from Treasury’s own data.

But we have more work to do.  Until this progress is felt not just on Wall Street but Main Street we cannot be satisfied.  Until the millions of our neighbors who are looking for work can find jobs, and wages are growing at a meaningful pace, we may be able to claim a recovery – but we will not have recovered.

This cannot happen so long as government replaces final private demand and outrageous or even felonious conduct remains unpunished.  Indeed, the acts of the last decade can be best characterized as financial terrorism, and instead of meeting this challenge head-on our government has cowered under the desk.

One of the most significant contributors to this recession was a financial crisis as dire as any we’ve known in generations.  And that crisis was born of a failure of responsibility – from Wall Street to Washington – that brought down many of the world’s largest financial firms and nearly dragged our economy into a second Great Depression.

Then why haven’t we held anyone responsible?

Changes for the future are fine, but if both Wall Street and Washington engaged in improper conduct, then punishment is necessary to deter future violators.

We’ve seen none.

As I said two years ago on this stage, I believe in the power of the free market.  I believe in a strong financial sector that helps people to raise capital and get loans and invest their savings.  But a free market was never meant to be a free license to take whatever you can get, however you can get it.

That’s called theft.  When will we see the thieves prosecuted Mr. President?

I have also spoken before about the need to build a new foundation for economic growth in the 21st century.  And, given the importance of the financial sector, Wall Street reform is an absolutely essential part of that foundation.  Without it, our house will continue to sit on shifting sands, leaving our families, businesses and the global economy vulnerable to future crises.  That is why I feel so strongly that we need to enact a set of updated, commonsense rules to ensure accountability on Wall Street and to protect consumers in our financial system.

How about enforcing existing law?  Ripping people off, no matter the means, is already illegal.  Fraud is against the law and has been.  We do not need new laws, we need existing laws enforced.  Your administration has utterly refused to do so. 

Eric Holder’s best and highest use thus far as been to warm the chair as the US Attorney General.  Why is he not bringing cases?  Why is not the FBI prosecuting bankers, mortgage lenders, appraisers and Real Estate agents where felonious conduct has taken place? 

Why have not the banks involved in the Jefferson County Alabama scandal been prosecuted?  It has been disclosed that they knew bribery was involved and in fact some of them paid other banks off so as not to “interfere” in their “deals”!

A comprehensive plan to achieve these reforms has passed the House of Representatives.  A Senate version is currently being debated, drawing on the ideas of Democrats and Republicans.  Both bills represent significant improvement on the flawed rules we have in place today, despite the furious efforts of industry lobbyists to shape them to their special interests.  I am sure that many of those lobbyists work for some of you.  But I am here today because I want to urge you to join us, instead of fighting us in this effort.  I am here because I believe that these reforms are, in the end, not only in the best interest of our country, but in the best interest of our financial sector.  And I am here to explain what reform will look like, and why it matters. 

Wall Street cannot make outsized profits unless they can bamboozle and obscure.  It is simply not possible in an efficient market to strip 20% or more of it for the financial system.  Financial market intermediation is primarily a ministerial, not “innovative”, function.

The “innovation” has all been focused on obscuring the facts behind deals for a sufficient amount of time to enable the banks to vacuum someone’s wallet.  Ultimately, that “someone” is always the American public and citizens around the world.

First, the bill being considered in the Senate would create what we did not have before: a way to protect the financial system, the broader economy, and American taxpayers in the event that a large financial firm begins to fail.  If an ordinary local bank approaches insolvency, we have a process through the FDIC that insures depositors and maintains confidence in the banking system.  And it works.  Customers and taxpayers are protected and the owners and management lose their equity.  But we don’t have any kind of process designed to contain the failure of a Lehman Brothers or any of the largest and most interconnected financial firms in our country.

Then break them up.  If you stick your tentacles into the system so deeply that bankruptcy is a cataclysmic event you have committed an act of financial terrorism at that instant.  You have effectively loaded a gun and stuck it in the mouth of the President of the United States and the United States Congress.

This is unacceptable behavior.  It is (correctly) prosecuted when committed by a deranged citizen.  But when committed by our largest financial institutions the government acquiesces and makes “special arrangements” instead of demanding that the gun be put down now before it can be loaded.

Your approach is fatally flawed Mr. President.

That’s why, when this crisis began, crucial decisions about what would happen to some of the world’s biggest companies – companies employing tens of thousands of people and holding hundreds of billions of dollars in assets – had to take place in hurried discussions in the middle of the night.  That’s why, to save the entire economy from an even worse catastrophe, we had to deploy taxpayer dollars. 

No, the crisis “began” and these acts were “necessary” because both previous Administrations and you personally have permitted the financial industry to hold up the American people.  This heist occurred over the space of 20 years and was committed via bribery of the American Legislature and Executive.  The largest firms in the United States financial industry were permitted to write their own regulations and, when that wasn’t enough, they shuffled their executives into and out of Washington DC.

This has created a two-class system where these institutions and Washington politicians do not have to obey the laws that the rest of us follow every day – most especially those that prohibit fraud in all of its forms.

Now, there is a legitimate debate taking place about how best to ensure taxpayers are held harmless in this process.  But what is not legitimate is to suggest that we’re enabling or encouraging future taxpayer bailouts, as some have claimed.  That may make for a good sound bite, but it’s not factually accurate.  In fact, the system as it stands is what led to a series of massive, costly taxpayer bailouts.  Only with reform can we avoid a similar outcome in the future.  A vote for reform is a vote to put a stop to taxpayer-funded bailouts.  That’s the truth. 

Then break the monsters up and force all derivatives onto an exchange, as I have called for since 2007.  Defang the monster – don’t try to cage it when the monster has a history of bribing the people with the keys to the cage.

Second, reform would bring new transparency to many financial markets.  As you know, part of what led to this crisis was firms like AIG and others making huge and risky bets – using derivatives and other complicated financial instruments – in ways that defied accountability, or even common sense.  In fact, many practices were so opaque and complex that few within these companies – let alone those charged with oversight – were fully aware of the massive wagers being made.  That’s what led Warren Buffett to describe derivatives that were bought and sold with little oversight as “financial weapons of mass destruction.”  And that’s why reform will rein in excess and help ensure that these kinds of transactions take place in the light of day.

No it doesn’t.  The bill has sufficient exceptions to allow the big financial institutions to claim that any particular transaction is “bespoke” – that is, customized – and thus exempt from central exchange clearing.  Registration is insufficient – the market must have nightly margin maintenance enforced by a neutral party who bears the cost of failure to enforce margin requirements themselves, thereby guaranteeing that gaming the system will not occur.

We have this now with listed options and futures contracts.  There is no reason for it not to apply to all derivatives.

There has been a great deal of concern about these changes.  So I want to reiterate: there is a legitimate role for these financial instruments in our economy.  They help allay risk and spur investment.  And there are a great many companies that use these instruments to that end – managing exposure to fluctuating prices, currencies, and markets.  A business might hedge against rising oil prices, for example, by buying a financial product to secure stable fuel costs.  That’s how markets are supposed to work.  The problem is, these markets operated in the shadows of our economy, invisible to regulators and to the public.  Reckless practices were rampant.  Risks accrued until they threatened our entire financial system.

These practices were not reckless, they were fraudulent.

I was encouraged to see a Republican Senator join with Democrats this week in moving forward on this issue.  For without action, we’ll continue to see what amounts to highly-leveraged, loosely-monitored gambling in our financial system, putting taxpayers and the economy in jeopardy.  And the only people who ought to fear this kind of oversight and transparency are those whose conduct will fail its scrutiny. 

Then put back in place the 14:1 leverage limit that was present until Henry Paulson, before becoming Treasury Secretary, had removed when he ran Goldman Sachs.  That happened in 2004 and can be reversed administratively just as it was dropped administratively – by the SEC.

Until and unless you do so, you’re lying.

Third, this plan would enact the strongest consumer financial protections ever.  This is absolutely necessary.  Because this financial crisis wasn’t just the result of decisions made in the executive suites on Wall Street; it was also the result of decisions made around kitchen tables across America, by folks taking on mortgages and credit cards and auto loans.  And while it’s true that many Americans took on financial obligations they knew – or should have known – they could not afford, millions of others were, frankly, duped.  They were misled by deceptive terms and conditions, buried deep in the fine print.

Again, this is called fraud.  Where are the handcuffs?

And while a few companies made out like bandits by exploiting their customers, our entire economy suffered.  Millions of people have lost homes – and tens of millions more have lost value in their homes.  Just about every sector of our economy has felt the pain, whether you’re paving driveways in Arizona or selling houses in Ohio, doing home repairs in California or using your home equity to start a small business in Florida.

Again – WHERE ARE THE HANDCUFFS?

Finally, these Wall Street reforms will give shareholders new power in the financial system. They’ll get a say on pay: a voice with respect to the salaries and bonuses awarded to top executives.  And the SEC will have the authority to give shareholders more say in corporate elections, so that investors and pension holders have a stronger role in determining who manages the companies in which they’ve placed their savings.

Until shareholders have binding authority, they’re not real owners.  The proposals to date are, in this regard, a sham.

Now, Americans don’t begrudge anybody for success when that success is earned.  But when we read in the past about enormous executive bonuses at firms even as they were relying on assistance from taxpayers, it offended our fundamental values.

I don’t care how much anyone makes – so long as the income is earned honestly.  I care very much when it is “earned” by various schemes, including felonious ones that (in some instances) included outright bribery – yet the banking system people who made that money not only are not prosecuted they get to keep the ill-gotten gains!

I’ll close by saying this.  I have laid out a set of Wall Street reforms.  These are reforms that would put an end to taxpayer bailouts; that would bring complex financial dealings out of the shadows; that would protect consumers; and that would give shareholders more power in the financial system.

No they won’t.  In order for that to happen, WE NEED TO SEE HANDCUFFS.

There has always been a tension between the desire to allow markets to function without interference – and the absolute necessity of rules to prevent markets from falling out of balance.

They’re not RULES, THEY ARE LAWS.

Re-impose Glass-Steagall.  17 pages of legislation that kept the system safe and sound for FIFTY YEARS.

We started dismantling it in the 1980s by circumventions and outright unlawful acts including Alan Greenspan granting an illegal waiver to legitimate an illegal merger.

This culminated in Gramm-Leach-Bliley and the Commodities Futures Modernization Act – the latter overruling anti-bucket-shop laws put in place to prevent the precise same acts that caused the meltdown in 1929.  As one would expect, we got the same result we had in the 1920s. 

Seventeen pages Mr. President. 

Re-enact Glass-Steagall - the original seventeen pages.  No ifs, no ands, no carve-outs, no buts, no exceptions and no edits.

SEVENTEEN PAGES.

Without them you have fixed nothing.

More Squid Tentacles And Government Reaction

Posted by Karl Denninger