FedUpUSA

Archive for February 16th, 2011

Damn those deadbeat borrowers…

From the Allstate vs JP Morgan lawsuit:

Allstate selected a random sample of loans from each offering in which it invested to test Defendants’ representations on a loan-level basis. Using techniques and methodologies that only recently became available, Allstate conducted loan-level analyses on nearly 26,809 mortgage loans underlying its Certificates, across 17 of the offerings at issue here.

For each offering, Allstate attempted to analyze 800 defaulted loans and 800 randomly-sampled loans from within the collateral pool. These sample sizes are more than sufficient to provide statistically-significant data to demonstrate the degree of misrepresentation of the Mortgage Loans’ characteristics. Analyzing data for each Mortgage Loan in each Offering would have been cost-prohibitive and unnecessary. Statistical sampling is an accepted method of establishing reliable conclusions about broader data sets, and is routinely used by courts, government agencies, and private businesses. As the size of a sample increases, the reliability of its estimations of the total population’s characteristics increase as well. Experts in RMBS cases have found that a sample size of just 400 loans can provide statistically significant data, regardless of the size of the actual loan pool, because it is unlikely that such a sample would yield results markedly different from results for the entire population.

Specifically, Allstate did the following:

To determine whether a given borrower actually occupied the property as claimed, Allstate investigated tax information for the sampled loans. One would expect that a borrower residing at a property would have his or her tax bills sent to that address, and would take all applicable tax exemptions available to residents of that property. If a borrower had his or her tax records sent to another address, that is good evidence that he or she was not actually residing at the mortgaged property. If a borrower declined to make certain tax exemption elections that depend on the borrower living at the property, that also is strong evidence the borrower was living elsewhere.

A review of credit records was also conducted. One would expect that people have bills sent to their primary address. If a borrower was telling creditors to send bills to another address, even six months after buying the property, it is good evidence he or she was living elsewhere.

A review of property records was also conducted. It is less likely that a borrower lives in any one property if in fact that borrower owns multiple properties. It is even less likely the borrower resides at the mortgaged property if a concurrently-owned separate property did not have its own tax bills sent to the property included in the mortgage pool.

A review of other lien records was also conducted. If the property was subject to additional liens but those materials were sent elsewhere, that is good evidence the borrower was not living at the mortgaged property. If the other lien involved a conflicting declaration of residency, that too would be good evidence that the borrower did not live in the subject property.

In a nutshell, as Allstate summarizes, it was lies all the way:

the disclosed underwriting standards were systematically ignored in originating or otherwise acquiring non-compliant loans. For instance, recent reviews of the loan files underlying some of Allstate’s Certificates reveal a pervasive lack of proper documentation, facially absurd (yet unchecked) claims about the borrower’s purported income, and the routine disregard of purported underwriting guidelines. Based on data compiled from third-party due diligence firms, the federal Financial Crisis Inquiry Commission (“FCIC”) noted in its January 2011 report:

The Commission concludes that firms securitizing mortgages failed to perform adequate due diligence on the mortgages they purchased and at times knowingly waived compliance with underwriting standards. Potential investors were not fully informed or were misled about the poor quality of the mortgages contained in some mortgage-related securities. These problems appear to be significant.

Some of the unbelievable findings are presented below. They speak for themselves…and, again in any normal non-banana republic, would lead to at least several criminal prosecutions. In America? No way.

Not surprisingly, the performance of loans issued by JPM and its acquisition Bear, deteriorated rapidly post issuance:

Read more at ZeroHedge

Allstate vs JP Morgan 2-16-2011

ZeroHedge

4closureFraud

He sees this the way I do, and note carefully: He was right about the subprime and housing in general too. 

Two parts:

Note that when he presented his views years ago to the big banks, he was told “I hope to God you’re wrong.”

He wasn’t.

The Market-Ticker

Financial crooks brought down the world’s economy — but the feds are doing more to protect them than to prosecute them

By Matt Taibbi – Rolling Stone

Over drinks at a bar on a dreary, snowy night in Washington this past month, a former Senate investigator laughed as he polished off his beer.

“Everything’s fucked up, and nobody goes to jail,” he said. “That’s your whole story right there. Hell, you don’t even have to write the rest of it. Just write that.”

I put down my notebook. “Just that?”

“That’s right,” he said, signaling to the waitress for the check. “Everything’s fucked up, and nobody goes to jail. You can end the piece right there.”

Nobody goes to jail. This is the mantra of the financial-crisis era, one that saw virtually every major bank and financial company on Wall Street embroiled in obscene criminal scandals that impoverished millions and collectively destroyed hundreds of billions, in fact, trillions of dollars of the world’s wealth — and nobody went to jail. Nobody, that is, except Bernie Madoff, a flamboyant and pathological celebrity con artist, whose victims happened to be other rich and famous people.

This article appears in the March 3, 2011 issue of Rolling Stone. The issue is available now on newsstands and will appear in the online archive February 18.

The rest of them, all of them, got off. Not a single executive who ran the companies that cooked up and cashed in on the phony financial boom — an industrywide scam that involved the mass sale of mismarked, fraudulent mortgage-backed securities — has ever been convicted. Their names by now are familiar to even the most casual Middle American news consumer: companies like AIG, Goldman Sachs, Lehman Brothers, JP Morgan Chase, Bank of America and Morgan Stanley. Most of these firms were directly involved in elaborate fraud and theft. Lehman Brothers hid billions in loans from its investors. Bank of America lied about billions in bonuses. Goldman Sachs failed to tell clients how it put together the born-to-lose toxic mortgage deals it was selling. What’s more, many of these companies had corporate chieftains whose actions cost investors billions — from AIG derivatives chief Joe Cassano, who assured investors they would not lose even “one dollar” just months before his unit imploded, to the $263 million in compensation that former Lehman chief Dick “The Gorilla” Fuld conveniently failed to disclose. Yet not one of them has faced time behind bars.

Invasion of the Home Snatchers

Instead, federal regulators and prosecutors have let the banks and finance companies that tried to burn the world economy to the ground get off with carefully orchestrated settlements — whitewash jobs that involve the firms paying pathetically small fines without even being required to admit wrongdoing. To add insult to injury, the people who actually committed the crimes almost never pay the fines themselves; banks caught defrauding their shareholders often use shareholder money to foot the tab of justice. “If the allegations in these settlements are true,” says Jed Rakoff, a federal judge in the Southern District of New York, “it’s management buying its way off cheap, from the pockets of their victims.”

Taibblog: Commentary on politics and the economy by Matt Taibbi

To understand the significance of this, one has to think carefully about the efficacy of fines as a punishment for a defendant pool that includes the richest people on earth — people who simply get their companies to pay their fines for them. Conversely, one has to consider the powerful deterrent to further wrongdoing that the state is missing by not introducing this particular class of people to the experience of incarceration. “You put Lloyd Blankfein in pound-me-in-the-ass prison for one six-month term, and all this bullshit would stop, all over Wall Street,” says a former congressional aide. “That’s all it would take. Just once.”

But that hasn’t happened. Because the entire system set up to monitor and regulate Wall Street is fucked up.

Just ask the people who tried to do the right thing.

Wall Street’s Naked Swindle

Here’s how regulation of Wall Street is supposed to work. To begin with, there’s a semigigantic list of public and quasi-public agencies ostensibly keeping their eyes on the economy, a dense alphabet soup of banking, insurance, S&L, securities and commodities regulators like the Federal Reserve, the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the Currency (OCC) and the Commodity Futures Trading Commission (CFTC), as well as supposedly “self-regulating organizations” like the New York Stock Exchange. All of these outfits, by law, can at least begin the process of catching and investigating financial criminals, though none of them has prosecutorial power.

The major federal agency on the Wall Street beat is the Securities and Exchange Commission. The SEC watches for violations like insider trading, and also deals with so-called “disclosure violations” — i.e., making sure that all the financial information that publicly traded companies are required to make public actually jibes with reality. But the SEC doesn’t have prosecutorial power either, so in practice, when it looks like someone needs to go to jail, they refer the case to the Justice Department. And since the vast majority of crimes in the financial services industry take place in Lower Manhattan, cases referred by the SEC often end up in the U.S. Attorney’s Office for the Southern District of New York. Thus, the two top cops on Wall Street are generally considered to be that U.S. attorney — a job that has been held by thunderous prosecutorial personae like Robert Morgenthau and Rudy Giuliani — and the SEC’s director of enforcement.

The relationship between the SEC and the DOJ is necessarily close, even symbiotic. Since financial crime-fighting requires a high degree of financial expertise — and since the typical drug-and-terrorism-obsessed FBI agent can’t balance his own checkbook, let alone tell a synthetic CDO from a credit default swap — the Justice Department ends up leaning heavily on the SEC’s army of 1,100 number-crunching investigators to make their cases. In theory, it’s a well-oiled, tag-team affair: Billionaire Wall Street Asshole commits fraud, the NYSE catches on and tips off the SEC, the SEC works the case and delivers it to Justice, and Justice perp-walks the Asshole out of Nobu, into a Crown Victoria and off to 36 months of push-ups, license-plate making and Salisbury steak.

That’s the way it’s supposed to work. But a veritable mountain of evidence indicates that when it comes to Wall Street, the justice system not only sucks at punishing financial criminals, it has actually evolved into a highly effective mechanism for protecting financial criminals. This institutional reality has absolutely nothing to do with politics or ideology — it takes place no matter who’s in office or which party’s in power. To understand how the machinery functions, you have to start back at least a decade ago, as case after case of financial malfeasance was pursued too slowly or not at all, fumbled by a government bureaucracy that too often is on a first-name basis with its targets. Indeed, the shocking pattern of nonenforcement with regard to Wall Street is so deeply ingrained in Washington that it raises a profound and difficult question about the very nature of our society: whether we have created a class of people whose misdeeds are no longer perceived as crimes, almost no matter what those misdeeds are. The SEC and the Justice Department have evolved into a bizarre species of social surgeon serving this nonjailable class, expert not at administering punishment and justice, but at finding and removing criminal responsibility from the bodies of the accused.

The systematic lack of regulation has left even the country’s top regulators frustrated. Lynn Turner, a former chief accountant for the SEC, laughs darkly at the idea that the criminal justice system is broken when it comes to Wall Street. “I think you’ve got a wrong assumption — that we even have a law-enforcement agency when it comes to Wall Street,” he says.

In the hierarchy of the SEC, the chief accountant plays a major role in working to pursue misleading and phony financial disclosures. Turner held the post a decade ago, when one of the most significant cases was swallowed up by the SEC bureaucracy. In the late 1990s, the agency had an open-and-shut case against the Rite Aid drugstore chain, which was using diabolical accounting tricks to cook their books. But instead of moving swiftly to crack down on such scams, the SEC shoved the case into the “deal with it later” file. “The Philadelphia office literally did nothing with the case for a year,” Turner recalls. “Very much like the New York office with Madoff.” The Rite Aid case dragged on for years — and by the time it was finished, similar accounting fiascoes at Enron and WorldCom had exploded into a full-blown financial crisis. The same was true for another SEC case that presaged the Enron disaster. The agency knew that appliance-maker Sunbeam was using the same kind of accounting scams to systematically hide losses from its investors. But in the end, the SEC’s punishment for Sunbeam’s CEO, Al “Chainsaw” Dunlap — widely regarded as one of the biggest assholes in the history of American finance — was a fine of $500,000. Dunlap’s net worth at the time was an estimated $100 million. The SEC also barred Dunlap from ever running a public company again — forcing him to retire with a mere $99.5 million. Dunlap passed the time collecting royalties from his self-congratulatory memoir. Its title: Mean Business.

The pattern of inaction toward shady deals on Wall Street grew worse and worse after Turner left, with one slam-dunk case after another either languishing for years or disappearing altogether. Perhaps the most notorious example involved Gary Aguirre, an SEC investigator who was literally fired after he questioned the agency’s failure to pursue an insider-trading case against John Mack, now the chairman of Morgan Stanley and one of America’s most powerful bankers.

Aguirre joined the SEC in September 2004. Two days into his career as a financial investigator, he was asked to look into an insider-trading complaint against a hedge-fund megastar named Art Samberg. One day, with no advance research or discussion, Samberg had suddenly started buying up huge quantities of shares in a firm called Heller Financial. “It was as if Art Samberg woke up one morning and a voice from the heavens told him to start buying Heller,” Aguirre recalls. “And he wasn’t just buying shares — there were some days when he was trying to buy three times as many shares as were being traded that day.” A few weeks later, Heller was bought by General Electric — and Samberg pocketed $18 million.

After some digging, Aguirre found himself focusing on one suspect as the likely source who had tipped Samberg off: John Mack, a close friend of Samberg’s who had just stepped down as president of Morgan Stanley. At the time, Mack had been on Samberg’s case to cut him into a deal involving a spinoff of the tech company Lucent — an investment that stood to make Mack a lot of money. “Mack is busting my chops” to give him a piece of the action, Samberg told an employee in an e-mail.

A week later, Mack flew to Switzerland to interview for a top job at Credit Suisse First Boston. Among the investment bank’s clients, as it happened, was a firm called Heller Financial. We don’t know for sure what Mack learned on his Swiss trip; years later, Mack would claim that he had thrown away his notes about the meetings. But we do know that as soon as Mack returned from the trip, on a Friday, he called up his buddy Samberg. The very next morning, Mack was cut into the Lucent deal — a favor that netted him more than $10 million. And as soon as the market reopened after the weekend, Samberg started buying every Heller share in sight, right before it was snapped up by GE — a suspiciously timed move that earned him the equivalent of Derek Jeter’s annual salary for just a few minutes of work.

The deal looked like a classic case of insider trading. But in the summer of 2005, when Aguirre told his boss he planned to interview Mack, things started getting weird. His boss told him the case wasn’t likely to fly, explaining that Mack had “powerful political connections.” (The investment banker had been a fundraising “Ranger” for George Bush in 2004, and would go on to be a key backer of Hillary Clinton in 2008.)

Aguirre also started to feel pressure from Morgan Stanley, which was in the process of trying to rehire Mack as CEO. At first, Aguirre was contacted by the bank’s regulatory liaison, Eric Dinallo, a former top aide to Eliot Spitzer. But it didn’t take long for Morgan Stanley to work its way up the SEC chain of command. Within three days, another of the firm’s lawyers, Mary Jo White, was on the phone with the SEC’s director of enforcement. In a shocking move that was later singled out by Senate investigators, the director actually appeared to reassure White, dismissing the case against Mack as “smoke” rather than “fire.” White, incidentally, was herself the former U.S. attorney of the Southern District of New York — one of the top cops on Wall Street.

Pause for a minute to take this in. Aguirre, an SEC foot soldier, is trying to interview a major Wall Street executive — not handcuff the guy or impound his yacht, mind you, just talk to him. In the course of doing so, he finds out that his target’s firm is being represented not only by Eliot Spitzer’s former top aide, but by the former U.S. attorney overseeing Wall Street, who is going four levels over his head to speak directly to the chief of the SEC’s enforcement division — not Aguirre’s boss, but his boss’s boss’s boss’s boss. Mack himself, meanwhile, was being represented by Gary Lynch, a former SEC director of enforcement.

Aguirre didn’t stand a chance. A month after he complained to his supervisors that he was being blocked from interviewing Mack, he was summarily fired, without notice. The case against Mack was immediately dropped: all depositions canceled, no further subpoenas issued. “It all happened so fast, I needed a seat belt,” recalls Aguirre, who had just received a stellar performance review from his bosses. The SEC eventually paid Aguirre a settlement of $755,000 for wrongful dismissal.

Rather than going after Mack, the SEC started looking for someone else to blame for tipping off Samberg. (It was, Aguirre quips, “O.J.’s search for the real killers.”) It wasn’t until a year later that the agency finally got around to interviewing Mack, who denied any wrongdoing. The four-hour deposition took place on August 1st, 2006 — just days after the five-year statute of limitations on insider trading had expired in the case.

“At best, the picture shows extraordinarily lax enforcement by the SEC,” Senate investigators would later conclude. “At worse, the picture is colored with overtones of a possible cover-up.”

READ THE REST HERE

The 10 economic charts that you are about to see are completely and totally shocking.  If you know anyone that still does not believe that the United States is in the midst of a long-term economic decline, just show them these charts.  Sometimes you can quote economic statistics to people until you are blue in the face and it won’t do any good, but when those same people see charts and pictures suddenly it all sinks in.  What is great about charts is that you can very easily demonstrate what has been happening to the economy over an extended period of time.  As you examine the economic charts below, pay special attention to what has been happening to the U.S. economy over the last 30 or 40 years.  The truth is that what is wrong with the U.S. economy is not a great mystery.  All of the economic problems that we are experiencing now have taken decades to develop.  Hopefully the charts in this article will help people realize just how nightmarish our economic problems have become, because until people start realizing how incredibly bad things have gotten they will never be willing to accept the dramatic solutions that are necessary to fix our financial system.

The sad fact of the matter is that we have been living in the biggest debt bubble in the history of the world over the last 40 years.  All of this debt has purchased a wonderful standard of living for the vast majority of us, but all of this debt has also destroyed the economic future of our children and our grandchildren.  Someday future generations will look back on what we have done in absolute horror.

The 10 economic charts posted below are meant to shock you.  Most Americans today need to be shocked before they will be motivated to take action.  Please share these charts with as many people as you can.  Hopefully we can wake enough people up that something will be done about all of these problems while there is still time.

1 – Government spending is expanding at an exponential rate.  As you can see from the chart below, federal spending is almost 18 times higher than it was back in 1970.  Now Barack Obama has proposed a budget that would increase U.S. government spending to 5.6 trillion dollars in 2021.  Just imagine what the following chart would look like if that happens….

2 – U.S. government debt is absolutely exploding.  The U.S. national debt is currently $14,081,561,324,681.83.  It is more than 14 times larger than it was back in 1980.  Unfortunately, the national debt continues to grow at breathtaking speed.  In fact, the Obama administration is projecting that the federal budget deficit for this year will be an all-time record 1.6 trillion dollars.  Can we afford to continue to accumulate debt at this rate?….

3 – Unless something changes right now, the outlook for U.S. government finances in future years is downright apocalyptic.  The chart posted below is from an official U.S. government report to Congress.  As you can see, it is projected that interest on our exploding national debt is absolutely going to spiral out of control if we continue on the path that we are currently on….

4 – Household debt has soared to almost unbelievable levels over the last 30 years.  The sad truth is that it is not just the U.S. government that has a massive debt problem.  U.S. households have also been accumulating debt at a staggering rate.  Total U.S. household debt did not pass the 2 trillion dollar mark until the mid-1980s, but now total U.S. household debt is well over 13 trillion dollars….

5 – The total of all debt (government, business and consumer) in the United States is now well over 50 trillion dollars.  For the past couple of years this figure has been hovering around a level that is equivalent to approximately 360 percent of GDP.  This is a debt bubble that is absolutely unprecedented in U.S. history….

6 – As tens of thousands of U.S. factories get shut down and as millions of our jobs get shipped overseas, the number of unemployed Americans continues to go up and up and up.  As you can see from the chart below, there has been a long-term trend of increasing unemployment in the United States.  In fact, there are about 3 and a half times as many unemployed workers in the United States today as there were when 1970 began.  These jobs losses are going to continue as long as we allow our corporations to pay slave labor wages to workers on the other side of the globe.  All of the major trends in global trade are very bad for the U.S. middle class.  For example, the U.S. trade deficit with China for 2010 was 27 times larger than it was back in 1990.  How long will our politicians stand by as our nation bleeds jobs?….

7 – The median duration of unemployment in the United States is in unprecedented territory.  For most of the post-World War 2 era, when the median duration of unemployment in America reached 10 weeks that was considered a national crisis.  Well, today competition for jobs is so intense that the median duration of unemployment is now well over 20 weeks….

8 – Since the Federal Reserve was created in 1913, the value of the U.S. dollar has declined by over 95 percent.  One of the reasons given for the existence of the Federal Reserve is that the Fed helps control inflation.  But that is a huge lie.  The truth is that the United States never had consistently rampant inflation until the Federal Reserve took control.  In particular, once the U.S. totally went off the gold standard in the 1970s inflation really started escalating out of control….

9 – Now the Federal Reserve says that the solution to our current economic problems is to print even more money out of thin air.  The games that the Federal Reserve is playing with our money supply are simply inexcusable.  Just look at what the Federal Reserve has done to the monetary base since the beginning of the recession….

10 – All of this new money is creating tremendous inflation.  In particular, the price of oil is now ridiculously high.  A high price for oil is very, very bad for the U.S. economy.  Our entire economic system is based on being able to use massive quantities of very cheap oil.  Unfortunately, that paradigm is starting to break down and the consequences will be very bitter.  Back in mid-2008, the price of oil hit an all-time record of $147 a barrel and subsequently the world financial system imploded a few months later.  Well, the price of oil is on the march again and that is very bad news for the U.S. economy….

Needless to say, if the economic trends documented by the charts above continue the U.S. economy will be totally wiped out.  The U.S. economy as it currently exists is unsustainable by definition.  It is only a matter of time before we slam into an economic brick wall.

We have developed an economy that cannot function without debt, and at this point it seems like almost everyone is drowning in red ink.  The federal government is massively overextended, most of our state and local governments are massively overextended, most of our major corporations are massively overextended and the majority of U.S. consumers are massively overextended.

The only way that the game can continue is for the Federal Reserve to print increasingly larger amounts of paper money out of thin air and for everyone in the economic food chain to go into increasingly larger amounts of debt.

But no debt spiral can go on forever.  At some point this entire house of cards is going to collapse.

When that happens, there is going to be economic pain that is greater than anything that this country has ever seen before.

Someday we will all desperately wish that we could go back to the “good times” of 2011.  A great economic collapse is coming, and all of us had better get ready.

The Economic Collapse

Gee, I wonder why Ben didn’t want this released?

Hmmmm….. there might be some good tidbits in here.  Oh hell, let’s just do this one page at a time, starting right up front where we find this little tidbit on Page 7:

….and related to that is the general issue, which has become very hot in monetary policy circles, which is, should monetary policy be used to try to knock down bubbles or not?

Just for the record, my view is that it can be a backup, but that the first line of defense ought to be supervision/regulation.

Really? So how much regulating did The Fed do when there was a housing bubble brewing?  Why you denied that the bubble existed, remember?  Just like you deny there’s a commodity bubble (that’s right, all these people suddenly started eating and buying blue jeans after you announced QE2 and they were literally starving before, right?)  And when there was an announcement yesterday of cessation of creating new units in a commodity ETF and in response oats went lock-limit down, that wasn’t actually speculative demand collapsing, right?  Suddenly, horses and other animals (not to mention people) stopped needing to eat too!

Uh huh.

What I’d like to call your attention to is the broader phenomenon of the so-called shadow banking system, which subprime mortgages were only one type of asset which were bundled together into securities, and then these securities were then sold through various legal off-balance-sheet type mechanisms to investors, usually with AAA ratings from the credit-rating agencies.

Ah yes, those fine instruments.  First, didn’t we learn anything about off-balance sheet games after ENRON?  Why are we still doing that?  Oh yes, Ben, we still are too.  How much does Wells Fargo have off-balance sheet?  Hmmmm…. over a trillion in alleged assets, right?  What are they really worth?

See, this is the problem, in the general sense: Securitization is a scam.

Why?

Because it’s not possible to get something for nothing.  So if you take a complex product and a simple one, the simple one returns more for the lender (in yield) and costs less for the borrower (in interest.)  It cannot be otherwise since nobody works for free.

In a free market the highly complex product is thus not offered.  Why?  Because nobody will buy as a lender (“certificate holder”) it if you price the money to the borrower competitively with the simple product.  And if you don’t, well, then nobody borrows with that product because they can go down the street and get the loan for less from someone else.

So how did these products become so “successful”?

There’s only one way: Someone has to lie, extort or get laws passed so that the simple product can’t be offered any more.  But we know the simple product was offered – by credit unions, by local banks and by others.

See, the common law of business balance doesn’t make any other explanation possible.  You either have to force the other products out of the market by legislative action or the complex product has to be in some way defective.  It’s not marketable if it isn’t.  Remember, money is fungible – all $100 bills, or $200,000 mortgages, spend exactly the same.  They’re just money.

But what created the contagion, or one of the things that created the contagion, was that the
subprime mortgages were entangled in these huge securitized pools, so they started to take losses and in some cases, the credit-rating agencies, which had done a bad job basically of rating them began to downgrade them. And once there was fear that these securitized credit instruments were not perfectly safe, then it was just like an old-fashioned bank run.

Except that if the bank had actually reserved against the underwater parts of these notes, and they were sold appropriately, then there wouldn’t have been a problem.  The so-called “bank run” couldn’t have happened.

Oh wait – but it did, because of the commercial paper market.  Ah, now I get it.  See, this was the scam.  We’ll lend you money but we don’t actually have anything behind that loan.  We’ll go into the daily lending market and roll some commercial paper for a day – or three.  The problem of course is that the guy who lends on that paper doesn’t have to say “Yes!” tomorrow.  He can say “No!”   And if he does, then you have to sell those instruments.

Well, that’s all well and good if the instruments are worth anything.  But if you make loans to people who are not credit-worthy then you can’t sell them for anywhere near what you claim they were worth.  And since the entire scheme was one of forcing serial refinances before the loans blew up, which we know to be the case for OptionARMs, 2/28 and 3/27s, the outcome was obvious.  At the first sign the lender on that commercial paper got that he had been rooked, he said “NO DAMNIT!” and the game came crashing down.

But the problem wasn’t duration mismatch – it was that the lenders sold unmarketable paper to people, funded it with short-term loans that had to be rolled and lied to the funding sources about the quality of the loans that were being made with their money.

Of course, again, flaws in the securitization process. I’m sure you’ll want to look at the
credit-rating agencies. There were a lot of things they did wrong. There were issues of conflict of interest. There’s issues of whether they used the right models. Clearly, they did not. They did not take into account the appropriate correlation between — across the categories of mortgages and so on.

Yeah, the fundamental flaw is that you can’t get something for nothing.  The complex loan always costs more and/or returns less than the simple.  It has to – all the money available to pay everyone involved comes from the borrower. 

The more hands in the pot, the lower the yield. 

Period.

For example, runs in the tri-party repo market, where what we used to think was very stable funding, which is funding through repurchase agreements where the investment banks would put out assets overnight and use that as collateral, they thought that was a pretty much foolproof form of short-term funding. But in a crisis where people began to doubt the liquidity or the value of those assets, the haircuts went up and you got into a vicious cycle which led to the Bear Stearns collapse and was important in the Lehman collapse as well.

They didn’t doubt the value of the assets, they knew they were crap.  Citibank’s chief underwriter testified before the FCIC that in 2006 a full 60% of the loans they were originating and selling did not meet guidelines.  By 2007 that was an astounding 80%.  So the folks on the desk at Citi knew full good and damn well that they were marketing dogcrap in a box and calling it pristine chocolate!

Is it a surprise that when the first evidence of this got forced into the public via the Bear Steans Hedge Funds that everyone else started to take a sniff before biting down?  I think not.  If you’re in a den of vipers, you’re a viper, and you’ve been biting everything in sight, well, until proven otherwise anything that slithers is a snake!

And the last comment — and with Ms. Born here and others that I don’t need to go into in much
detail — but obviously OTC derivatives were a problem. They may not have been a causal problem, but they transmitted stocks. There were problems with the clearing of settlement of OTC derivatives. And there were problems with the risk management, AIG being the poster child example of that.

Yeah, the primary problem is that when written against nothing but air they’re an outright scam.

There’s a simple solution to this, of course.  No OTC anything.  You want to trade this crap, do it on an exchange.  No more chain risk, no more zero-margin crap, and at the same time force all margin to be posted not in “collateral” (of unknown actual value) but in cash, and be 100% of the underwater position each and every night.

You don’t like your position?  Sell (or cover) it.  Eat your loss before it turns into a bigger one.

So now we come to this very intense period in September and October. As a scholar of the Great Depression, I honestly believe that September and October of 2008 was the worst financial crisis in global history, including the Great Depression. If you look at the firms that came under pressure in that period. . . only one . . . was not at serious risk of failure. So out of maybe the 13 — 13 of the most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two.

Read that paragraph carefully folks.

Now consider this: What has changed?

Have the assets involved been accurately disclosed as to character and type?

Have they been sold and removed from the balance sheets?

Have the OTC derivatives been nulled, bought back or sold off, and removed from the system?

Are we more-concentrated or less today, than we were before the crisis?  That is, are there more or fewer banks, and of those that exist, are they larger or smaller?  Hmmmm….

So let me say now for the record, for the tape — you know, I’ve said the following under oath and I’ll say it again under oath if necessary — we wanted to save Lehman. We made every possible effort to save Lehman.

Why?  For the same reason that Continental Illinois was saved?  So the bondholders wouldn’t suffer for their stupid decision to buy the firm’s debt?

I thought when you invested you had the risk of loss?  Does this suddenly not apply if you’re a big, interconnected bank?  Where in the law do you see a mandate to prop up buyers of crap paper from financial institutions?  You just made that one up out of whole cloth, right Ben?

In the case of AIG, the reason AIG was set up the way it was originally, the financial products
division, which did the CDS, attached itself to AIG precisely because it was a large, highly-rated insurance company with lots of assets. Therefore, it could sell CDS without what would otherwise be sufficient capitalization and protections because the counterparties would know that this was a highly rated firm with lots and lots of assets.

Attached. 

You mean, like a parasite?

Oh yes, you do mean like a parasite.  And while The Fed had no authority to regulate AIG, it certainly had the authority to demand that those large institutions it had control over either proved that AIG could pay every dollar of alleged coverage or it could have declared those contracts of no value for regulatory capital purposes.

If The Fed had done so, there would have been no AIGfp, no housing bubble and no crisis.  And that’s a fact.

It was precisely because the so-called “paper” in the system was feared worthless – literally worthless – that the run happened.

Now how do we know it’s not worthless today?

That paper is still there.  Wells Fargo, as just one example, has some one trillion off balance sheet.

What’s in the box Ben? Is it good assets, a bunch of rattlesnakes, or might it be used dogfood?  Do you know what’s in there?  I freely admit I don’t.  But what I know is that in 2007 and 2008 you either didn’t know or intentionally hid what you knew.  Neither is acceptable and this problem hasn’t been fixed.

First, is that “viewed too big to fail” is a very, very serious problem, and one that was much bigger than was expected. And I think it’s absolutely critical that if we do only one thing in financial reform, it is to get rid of that problem.

So what have you done Ben to get rid of this problem?

ANSWER: NOTHING.  You have in fact made it worse!

MR. BERNANKE: Well, I think the most elementary thing they could have done would have been to put together a list of the biggest, most complicated central firms. Anybody on Wall Street could put that list together in 30 minutes. And then they should have reviewed — they could have reviewed the system of supervision for each one of these firms and had asked for reports on what are the principal risks, you know, within these firms, et cetera.

So where’s the report?  You’ve had more than two years to write and present it.

The other part, though — and, again, I just want to say this as strongly as possible — the reform
will be a failure if we could not contemplate the failure of Goldman Sachs. That is, there needs to be a system by which Goldman Sachs will go bankrupt and Goldman Sachs’ creditors could lose money. If we don’t have that, then we might as well treat them as a utility, because that’s what they are.

Yes, a regulated utility where the pay is kinda crappy and there are no bonuses.

So let’s ask this question Ben: Two years beyond the panic, where is that plan?

I would have to say that, broadly speaking, financial regulation is one of those areas where there’s more international cooperation than in almost any other area of regulation. You know, we regularly go to Basel, they talk of the Basel Capital Committee, and they have many other subcommittees and various other types, and there’s called the Financial Stability Board, which is a body that brings together the regulators and the central bankers from around the world.

You know there’s absolutely nothing complicated about lending.  It’s only complicated if you insist on letting banks loan against nothing, which under the clear limits of the Constitution, they cannot do.  If you actually honor The Constitution and safe banking principles then a bank must hold one dollar of capital against each dollar of unsecured credit it has outstanding.  It can get that dollar from selling debt or equity, but it has to have it.

Do that – really do it, so that there are no games like off-balance sheet crap and OTC derivatives – and there’s no systemic risk.  At all.

MR. BERNANKE: The only way, what gave financial products its AAA rating was the full faith in credit, essentially, of the whole AIG company.

Vice Chairman Thomas: Of the whole company.

MR. BERNANKE: There’s no way to say that financial products is bankrupt without bringing down the whole company, and that was the dilemma.

Someone’s either lying or massively – and possibly criminally - negligent.  Pick one. It appears that either the insurance regulators should be under indictment for criminal malfeasance or Bernanke’s not telling the truth.  Was AIGfp a separate legal entity or not?  If it was, yes you can cut it off.  If it was not, then the entirety of AIG was in violation of insurance covenants.  In the latter case we must ask should not people inside and beyond the firm should be in prison right now for having set up and operated the firm with this structure?

Pick one.

MR. BERNANKE: I think, unfortunately for you, it’s the latter. I think, one of the –

CHAIR ANGELIDES: The latter being?

MR. BERNANKE: The integration, the interaction of all these different factors. So one of the reasons — so, again, I fully admit that I did not forecast this crisis.

The reason you didn’t forecast this is that you believed that trees grow to the sky.  That compound debt and interest can continue forever at rates double that of GDP.  Which, incidentally, we’ve done three times in thirty years, and now you’re trying to do it again, even though we hit the wall because people couldn’t cover the debt service the last time in 2007!

There’s dumb and then there’s intentionally blind.  Which is it Ben?  Did you fail fifth-grade math?  It appears that way, which leads one to ask: How in the hell does Princeton award a Piled Higher and Deeper to someone who can’t do basic exponential math?

MR. BERNANKE: Particularly — so there are parts of the system which you can call the plumbing or the infrastructure, and those have to do mostly with funding, financing, or simply trading in and price discovery and clearing and settlement. Anything that threatens the integrity of those infrastructure things is very dangerous. So, fortunately, J.P. Morgan was pretty stable. But J.P. Morgan actually is the bank that runs — one of the two banks — that runs the tri-party repo market.

J.P. Morgan’s failure would have been a huge problem because that market would have essentially been inoperative because there are only two banks that run in that market, and they don’t have compatible computer systems. So that’s an example.

So what have you done to break up the concentration of those risks in the last two and a half years, Bernanke? 

NOTHING, RIGHT?

You’ve intentionally allowed JP Morgan to keep what amounts to effective oligopoly control of a critical infrastructure component of the financial system?

This is macro-prudential regulation?

Or is it really willful and intentional malfeasance?

MR. BERNANKE: Now, the other problem, though, which distinguishes credit default swaps from interest rate swaps, for example, has to do with how they are traded and cleared. So the CDS market grew really, really quickly from nothing, and didn’t have an appropriate infrastructure for — I mean — to give Tim Geithner credit,  when he was at the Federal Reserve Bank in New York, the Federal Reserve Bank in New York was working really hard on a voluntary basis with all the CDS dealers in New York to try to set up a rational system just for keeping track of trades. I mean, they were doing everything on paper, and it was days behind and nobody knew who owned what or who owed what to whom.

So instead of saying to those banks which the NY Fed regulated: “Ok guys, either prove capital adequacy and cash reserves against every underwater position – every night – or your CDS is considered not to exist for regulatory purposes” he instead asked for help?

You have a market segment that is providing…… insurance….. and nobody knows who has what?

He continues….

They were assigning contracts to others without telling the original — et cetera, et cetera. So just the basics of having a well-working infrastructure for trading, clearing, and settlement was
missing in that huge, rapidly expanding sector.

Vice Chairman Thomas: So I can stay with you on this –

MR. BERNANKE: Yes.

Vice Chairman Thomas: — why was it expanding so rapidly? Because there was no tent to put it under?

MR. BERNANKE: Well, it’s actually a — from a finance theory point of view, it’s actually a very
clever instrument.

Vice Chairman Thomas: Oh, yeah?

MR. BERNANKE: What it does, it allows you very cheaply and efficiently to insure yourself against the credit risk of a particular firm or even an index of firms.

Cheaply and efficiently eh? 

Insure?

I thought that everyone said these things were not insurance?  Didn’t Brooksley Born get run out of town on a rail for insisting that they were insurance and had to be regulated as insurance?  Why I think she did.  And I seem to remember Greenspan arguing the opposite point and you agreeing with him through continuing his policies, both behind the scenes and once you took the Chair.  Now you admit under oath that these were and are insurance but yet today, there is still no insurance regulation on the contracts.  Hmmm….

Let’s see if I can explain this in a way that everyone will understand.

I can very “cheaply and efficiency” write auto insurance for you.  All you do is give me $100 and I will print you a nice card that says you have auto insurance.  The cops will even accept it and think you have auto insurance if you get stopped for speeding.

Just don’t ever get in a wreck and come asking me to pay, because I don’t got any money!  I blew it all on blow and hookers, you see, ’cause I never expect to actually pay on that alleged “insurance” – that’s why it was so damn cheap!

By the way these were called “side letters” in the old reinsurance business.  In that line of work they’re illegal.  Companies have gotten caught doing it too.

But now Bernanke goes WAY off the deep end with this one:

More generally, you know, it’s kind of expensive to buy and sell corporate bonds. You can
buy it — it’s much cheaper to buy and sell to CDS, which have the same risk. And if you want to bet on Ford, instead of buying a Ford bond, you can just insure Ford against –- you know, insure against Ford credit risk. It’s essentially the same bet. It’s the same reason why people use S & P futures instead of trading a basket of 500 stocks. It’s just much more efficient to do it that way.

That’s a goddamned lie Ben and you know it.  As a futures trader I also know it.  Where are the damned handcuffs?

A futures contract is bought or sold instead of the ETF for the S&P 500 for two primary reasons: It is more tax efficient due to statutory considerations but more importantly it provides much, much more leverage than a cash purchase.  Like five times as much leverage and sometimes more!

The other side of it, however, is that if you’re underwater on a futures contract you have to post margin every single night and that margin is supervised by the exchange.  That is, if I’m underwater at the end of the day or even in the middle of the day I have to either make good on my position or I am margined out and eat my loss.  There are no ifs, ands, buts or maybes.

The CDS market is nothing like this, because there is no central maintenance of margin.  Leverage is used as a license to steal exactly as it was in this case – take big bets with no damn money behind them and then whine for a bailout when they go bad, threatening financial Armageddon. 

That, incidentally, is exactly what Bernanke participated in come 2008.  Anyone remember?  I sure do.

MR. BERNANKE: Used by people, and grew very, very quickly. And became — frankly, the regulators probably didn’t help here. Because in the sort of capital regulation of banks, to the extent that banks can show that they have hedged their risks, they can hold less capital.

That’s because you let them – and still do - even if the “hedges” are potentially worthless!

MR. BERNANKE: Used by people, and grew very, very quickly. And became — frankly, the regulators probably didn’t help here. Because in the sort of capital regulation of banks, to the extent that banks can show that they have hedged their risks, they can hold less capital. So if I made a loan to Ford and I have a credit default swap that protects me against Ford’s loss, I could say, “Well, I don’t have to hold any” — but, of course, the other problem here, besides just the primitiveness of this system in which they cleared and settled, was that the counterparty risk wasn’t taken into account.

So people who lost — you know, you could lose money because you took a bad position on Ford, but you could also lose money because you made that bet with AIG and they couldn’t pay off.

So the advantage of interest-rate swaps, for example, is that they are traded on sophisticated, mature exchanges where everybody knows what the price is, the price discovery process is clear, the clearing and settlement is well-understood, rapid. And most important, there being a central counterparty, you don’t have to know who you’re trading with because the central counterparty will, through use of margins of capital, et cetera, will make sure that if your counterparty fails, you won’t even know it, you’ll still get paid off.

Read that however many times it takes for you to understand it.

Bernanke is well-aware of the unique dangers that OTC derivatives pose.  He also knows that the rest of the derivative market is immune from those dangers, for the very reasons that I have advocated making these instruments illegal.

Yet he has not stopped them.  At all. 

This section of text is a bald admission that he is well aware of exactly what they were doing, that it was dangerous, and that he pointedly failed or refused to step in – and is still refusing.

And then he continues with….

There are people identified — and the trouble is — and particularly in this blogosphere we live in
now — at any given moment, there are people identifying 19 different problems, crises.

There is one primary problem, Ben.

That’s lending against nothing.  Creating credit money without a damn thing behind it.  Doing it through subterfuge, schemes, even scams. Cranking asset bubbles through this effective naked short on the currency. 

CDS in the OTC market were impossible in a free, open and fair market.  You can’t misprice things like this without there being some sort of collusion.  If there’s a regulator out there who actually regulates, he stops it, because as soon as you say “I’m hedged” he says “prove it“, and until you can, he disallows your hedge.

Since your derivative is OTC, you can’t prove it unless you have the cash for the underwater position each and every night – in both directions.  Well, did you?  No.  Did anyone else make someone do that?  No.  Did the market do it?  No, because everyone in the market – all five or six of the big banks that were involved in this, were colluding in a closed market where bids, offers and size were not visible to the public.

It was nothing more than a computerized version of Three-Card Monte and you know it.

Worse, it still is.

And I’ll say one other thing about that, which is that, in looking at AIG — think about this in a
cost-benefit perspective. Looking at AIG, I thought to myself — and I believe now — that if we let it fail, that the probability was 80 percent that we would have had a second depression.

Suppose you believe it was 5 percent. I don’t think any rational person could say it was less than
5 percent. How much would you pay to avert a 5 percent chance of a second depression? $5 billion?

That’s probably what we’ll end up paying.

You didn’t avert a damned thing.  In fact you made it worse.  Exactly how are we going to double the systemic debt again over the next nine years, not to mention federal debt? 

If we don’t with where we are now an immediate 10% or more of GDP comes off.  That’s the economist’s definition of a Depression.

So how have we “averted” it Ben?  The total Deficit last year (calendar) was $1.7 trillion.  This year it is estimated over two trillion dollars, or roughly 14% of GDP.  If you withdraw that it is at least 14% of GDP that comes off, plus whatever knock-in effects you get – which will be huge!

Averted my ass.

Delayed and compounded, yes.

And we’ve all got front-row seats.

In a just world you’d be in the stocks – the sort out in front of the courthouse where we can all throw rotten tomatoes, not the kind on Wall Street. 

I’d be ripening a whole bushel of ‘em – just for you.

FCIC Interview with Ben Bernanke, Federal Reserve

The Market-Ticker

I’ll add to Mr. Denninger’s post by pointing out yet another egregious lie by Bernanke.

I think the biggest problems were in those two categories you mentioned. There are two related — well, the problems that arose were, first, where derivatives, for whatever reason, were thought to be creating risk-sharing and they weren’t forone reason or another — and so the complexity of the derivatives positions. In some cases, you know, for banks, we have simple leverage ratios. For hedge funds and so on, it’s almost impossible to figure out what their true leverage is because derivative positions create effective — you know, de facto leverage, and so on.

Banks having leverage ratios? Where? Did you fail to discuss this with Hank Paulson?  I guess you could also say you never could have predicted what happened….oh, in November 2009?!

This is a chart showing exactly what happened to reserves immediately following the implementation of capital reserves being eliminated.  Leverage anyone?  Hank Paulson and Ben Bernanke themselves were integral in this being included in the EESA (Emergency Economic Stabilization Act).

EESA also authorized the Board to lower the level of reserve requirements on transaction accounts below the ranges established by the Monetary Control Act of 1980. On October 9, 2008, the Board issued an interim final rule implementing this new authority.

Source:  Federal Reserve
EESA