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!
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.
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.
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.
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?
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?
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?
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
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?
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.
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