"Committee Holds Hearing on Hedge Funds and the Financial Market"

From the testimony today in Congress Under Waxman:

First, Kenneth Griffin:

"At financial institutions, we often take risk by investing in securities.
However, we have all seen the consequences of taking imprudent risk. Failures to
understand and manage risk can be severe, as we have seen far too often in recent
weeks." ( Agree )

"In this crisis, the concept of "too interconnected to fail" has clearly replaced the concept
of "too big to fail." The rapid growth in the use of derivatives has created an opaque
market whose outstanding notional value is measured in the hundreds of trillions of
dollars. As a result, there is great concern about the systemic effects of the failure of
anyone financial institution.
In the area of credit default swaps, for example, there is an estimated 55 trillion dollars of
outstanding notional contracts between market participants. This number is almost four
times the GOP of our country"

Too interconnected to fail ( Agree ) Derivative and CDS stuff ( BS )

"The creation of central clearing houses to act as intermediaries and guarantors of
financial derivatives such as credit default swaps represents a straightforward solution to
the issues inherent in today's opaque over-the-counter market. Of greatest importance,
such a clearing house will dramatically reduce systematic risk -- allowing us to step away
from the "too interconnected to fail" paradigm. Numerous other benefits will accrue to
our economy. Regulators, for example, will have far greater transparency into this vast
and important market." ( Agree, everyone does )

"I believe, and have said before, that our financial markets work best when they are
competitive, fair, transparent and stable. Proper regulation is critical. But the best
regulation is created with an eye toward unleashing opportunities, not limiting
possibilities. To achieve this, Congress, regulators and industry must all work together.
Our markets are complex and they must be well understood if they are to be well
regulated. We must solve the serious issues we face but in a way that does not stifle the
best innovative qualities of our financial markets." ( Agree, but "proper" regulation, like Bush's same use, it BS for saying nothing specific. It's like saying we'll pass good laws )

From John Paulson:

"Hedge funds are an important investment category for investors as returns are generally noncorrelated with the traditional market" ( Sounds good )

"The Institute, launched with a $15 million grant from investment management firm Paulson &
Co. Inc., will provide funding and training to organizations that help homeowners negotiate
alternatives to foreclosure. The majority of the funds will be grants to support direct legal
assistance to borrowers in 10 or more states to fight foreclosure, predatory lenders and abusive
loan servicers. It will do this primarily by providing money to top non-profit legal-aid groups and
law school clinics.
Formation of the Institute comes as the rate of subprime foreclosures, already alarmingly high,
is set to accelerate. Analysts have predicted that as many as 1.7 million foreclosures will occur
in the next two to three years. Within the next eighteen months, up to four million subprime
borrowers will see their monthly mortgage payments jump approximately 40% as initial "teaser"
interest rates expire. Servicers and lenders have largely refused to modify these abusive
subprime loans. According to a recent study by Moody's, only 1% of loans that reset to a higher
interest rate were modified by servicers. lenders and servicers are simply not modifying these
mortgages in sufficient numbers to help homeowners.
"legal resources available to help struggling families fall far short of that needed to address the
millions of abusive loans that have been made in recent years," said Martin Eakes, Chief
Executive Officer of CRL. "By providing funding and other support for attorneys who can
review loan documents and negotiate with loan servicers, we believe that many more
homeowners will be able to stay in their homes."

Since this is mainly legal help, and the loans are called abusive, maybe we should be doing what I say, which is examine the legality of these loans.

"There are major problems with the Treasury plan. First, by buying banks' worst
assets at above-market prices, taxpayers take an immediate economic loss -while
transferring wealth to shareholders and executives of the very institutions
that brought on the financial crisis.
Second, this plan puts too much discretionary power in the hands ofTreasury
officials. Who determines what financial assets are purchased and at what prices?
Who determines which bank gets to benefit from these taxpayer subsidies? Will
bank shareholders continue to receive dividends, and executives continue to get
paid huge bonuses?
When financial institutions borrow massive amounts ofmoney to invest in assets
that are now found to be illiquid arid poorly performing, it is not the
responsibility oftaxpayers to bear the resulting losses. These losses should be
borne by the shareholders.
Iftaxpayers have to step in and provide capital to keep operating enterprises that
the government decides are key to the functioning of the economy as a whole,
taxpayers must receive protection."

The only thing here odd is the determination of prices. Clearly he has no clue who or how it will be done. Why not just say that.

"Treasury Secretary Henry Paulson said at the Senate Banking Committee hearing
this week, "[the] Fannie Mae and Freddie Mac [interventions] worked the way
they were supposed to." These enterprises continued to function, maintaining homeowner access to and lowering the cost of mortgage financing. However,
managements of these companies had to leave and forfeit the compensation
packages they had negotiated.
Shareholders had their dividends blocked and remain first in line to bear losses,
as they should have been. Taxpayers came both first and last ~:.. first to get paid
backJ as the new preferred stock is senior to all shareholders; and last in realizing
losses, as common and other preferred equity would be extinguished before the
taxpayers would be at risk.
This mechanism M_ purchases of senior preferred stock with warrants in troubled
institutions -- addresses the problems with the Treasmy plan. The financial
market is stabilized, companies get recapitalized, failures are avoidedJ debt
securities are supported, and time is gained for illiquid assets to mature.
The institutions continue to function, their cost of funding will decline as equity
capital increases, and innocent third parties like bank depositors, broker/dealer
clients and insurance-policy holders are all protected. The only difference is that
potential losses are kept with the shareholders where they belong."

Here's the explanation of why they're leaving management intact. They want to keep the company structure intact, and they already did this with Fannie/Freddie, so there's a precedent.

"The Treasury plan would also entail larger outlays than the Preferred plan. By
allowing all banks to sell their worst assets to Treasury at inflated prices,
taxpayers would be subsidizing healthy banks which have access to private
capital (Goldman SachsJ J.P. MorganJ Wells Fargo, and Bank ofAmerica, for
example) as well as banks that don't have a private alternative. But under a
Preferred plan, only banks that don't have a private alternative will be given
federal assistance. This would reduce the outlay otherwise required to solve the crisis."

We all pretty much hated it.

"Few people familiar with the issues deny that Treasury action is needed to
stabilize the financial markets. However, the question is who should bear the
cost?
Under the Treasury plan the taxpayer pays the price. Under a Preferred plan, the
shareholders of the firms who created the problems bear the first loss. Who do
you think should pay?"

Now, I think that the statement that Treasury action is needed shows that he believes that a bailout in this kind of crises was and is the best thing to do. I'm saying he believed that would be the case if needed before this crisis happened.

George Soros:

"The crisis was generated by the financial system itself. This fact-that the defect was
inherent in the system-eontradicts the prevailing theory, which holds that financial markets
tend toward equilibrium and that deviations from the equilibrium either occur in a random
manner or are caused by some sudden external event to which markets have difficulty adjusting.
The severity and amplitude of the crisis provides convincing evidence that there is something
fundamentally wrong with this prevailing theory and with the approach to market regulation that
has gone with it. To understand what has happened, and what should be done to avoid such a
catastrophic crisis in the future, will require a new way of thinking about how markets work."

( Total BS: Pure Mechanistic Thinking )

"Consider how the crisis has unfolded over the past eighteen months. The proximate
cause is to be found in the housing bubble or more exactly in the excesses of the subprime
mortgage market. The longer a double-digit rise in house prices lasted, the more lax the lending
practices became. In the end, people could borrow 100 percent of inflated house prices with no
money down. Insiders referred to subprime loans as ninja loans-no income, no job, no
questions asked." ( Correct: Poor Loans: Human Agency: Forget Talk Of Systems )

"Some highly leveraged hedge funds collapsed and some lightly regulated financial institutions declared bankruptcy" ( Correct: Undercapitalized: Human Agency: Forget Talk Of Systems )

"In quick succession, a variety of esoteric credit marketsranging from collateralized debt obligations [CDOs] to auction-rated municipal bonds-broke down one after another."

( Incorrect: Esoteric Has Nothing To Do With It )

"The deepest fall of all came in September, caused by the disorderly bankruptcy of
Lehman Brothers in which holders of commercial paper-for example, short-term, unsecured
promissory notes-issued by Lehman lost their money."

( Agree )

"With the financial system in cardiac arrest, resuscitating it took precedence over
considerations of moral hazard-i.e., the danger that coming to the rescue of a financial
institution in difficulties would reward and encourage reckless behavior in the future"

( Disagree: Moral Hazard Had Already Been Compromised: No Going Back )

"When that was not enough, the American and European financial authorities committed themselves not to allow any other major financial institution to fail" ( Agree )

"Unfortunately the authorities are always lagging behind events" ( Agree )

"First, financial markets do not reflect prevailing conditions accurately; they provide a picture that is always biased or distorted in one way or another. Second, the distorted views held by market participants and expressed in market prices can, under certain circumstances, affect the so-called fundamentals that market prices are supposed to reflect. This two-way circular connection between market prices and the underlying reality I call reflexivity.
While the two-way connection is present at all times, it is only occasionally, and
in special circumstances, that it gives rise to financial crises. Usually markets correct their own
mistakes, but occasionally there is a misconception or misinterpretation that finds a way to
reinforce a trend that is already present in reality and by doing so it also reinforces itself. Such
self-reinforcing processes may carry markets into far-from-equilibrium territory. Unless
something happens to abort the reflexive interaction sooner, it may persist until the
misconception becomes so glaring that it has to be recognized as such. When that happens the
trend becomes unsustainable and when it is reversed the self-reinforcing process starts working
in the opposite direction, causing a sharp downward movement."

Wow. I agree with this:

1) People misunderstand things
2) Sometimes very badly

Ignore the engineering jargon. Totally inappropriate.

"Take for example credit default swaps (CDSs), instruments intended to insure
against the possibility of bonds and other forms of debt going into default, and whose price
captures the perceived risk of such a possibility occurring. These instruments grew like Topsy
because they required much less capital than owning or shorting the underlying bonds.
Eventually they grew to more than $50 trillion in nominal size, which is a many-fold multiple of
the underlying bonds and five times the entire US national debt. Yet the market in credit default
swaps has remained entirely unregulated."

( Agree: but he misses the point. CDS's filled the need, which were investments with less capital. Something else would have worked if they didn't. It wasn't the investment, it was the need which created the investment )

"Since the risk management models used until now ignored the uncertainties inherent in reflexivity, limits on credit and leverage will have to be set substantially lower than those that were tolerated in the recent past"

( This borders on the absurd. He just admitted the investments fit the desired lack of capital. Forget this model BS. They weren't complex so much as undercapitalized. That's what they were designed for. Their complexity was due to using less capital. He writes like he's Foucault. )

I can't take anymore. Soros wore me out. I'd rather read Hegel.