On this blog, I post stories, comments, anything that interests me. Sometimes, I comment upon them. I post the entire story, column, or whatever, in order to save it for my reference. On the right are comments, blogs, etc., that I find useful, or that express what qualify as my opinions. Feel free to contact me via the comment option. Rest assured, you will be treated civilly. On this blog, the assumption is that, properly presented, anyone can understand anything.
Saturday, February 28, 2009
Dmitry Orlov's take on U.S. declinism is much-loved among the apocalypse set
"Best Practices in the End of the World
I think I mostly just dig the ironies in the title, “Social Collapse Best Practices", but Dmitry Orlov's take on U.S. declinism is much-loved among the apocalypse set. Here he is recently in San Francisco:
Me:
I have a hard time with end of the world talks that begin with a reminder about the reception after the talk, but that's just me. For some reason, anytime I hear talk about some great cataclysm, I think of two scenes from one of my favorite movies, which is called "The Wind And The Lion":
"Capt. Jerome, USMC: It seems quite obvious, I would think, sir - we must seize the government and make our own negotiations.
Gummere: [incredulous] Seize the government?
Capt. Jerome, USMC: At BAYONET point!
Gummere: [snidely; to Dreighton] Well, I certainly would like to see that old son-of-a-bitch at bayonet point, huh?
[chuckles]
Gummere: But it's ridiculous; it's outrageous, it's lunatic!
Adm. Chadwick: Yes, isn't it though? I think Teddy should love it!
Gummere: But, what about the French, the Germans - the British? Why we're in the shadow of Gibraltar!
Adm. Chadwick: [slams his hand on table and stands up] DAMN THE LEGATIONS!
Gummere: [uneasily] You realize, of course, that if we fail in even the slightest way, we'll all be killed?
Adm. Chadwick: Yes, and the whole world will probably go to war.
Capt. Jerome, USMC: Gentlemen, if we fail and are killed, I certainly hope the world DOES go to war!
[raises glass as a toast]
Adm. Chadwick: The world at war!
Gummere: A world war? Now THAT would be something to go out on... "
And:
Sherif of Wazan: Great Raisuli, we have lost everything. All is drifting on the wind as you said. We have lost everything.
Raisuli: Sherif, is there not one thing in your life that is worth losing everything for?
All of these officials have to survive a Senate confirmation hearing in a brutal political environment
"Understaffing at Treasury
Paul Volcker is obviously right that it's shameful that the Treasury Department is so badly understaffed right now (the "Treasury Officials" page is hilarious):
"There is an area that I think is, I don't know, shameful is the word," Paul Volcker said this morning at a Joint Economic Committee hearing. "The Secretary of the Treasury is sitting there without a deputy, without any undersecretaries, without any, as far as I know, assistant secretaries responsible in substantive areas at a time of very severe crisis. He shouldn't be sitting there alone."Felix Salmon agrees (the same Salmon who called the lack of detail in Geithner's banking rescue "inexplicable" a couple weeks ago). Salmon considers this a huge blunder by the Obama administration, as well as an indication that the Obama administration is being managed inefficiently.
This isn't the Obama administration's fault. The reason Geithner is sitting there alone is that the top 33 positions in the Treasury Department are Senate-confirmable, and not only does that slow down the hiring process by introducing political factors into the search, but the Senate confirmation process also takes a long time. The following Treasury positions are Senate-confirmable:
Deputy Secretary of the Treasury
Undersecretary for Domestic Finance
Assistant Secretary for Financial Institutions
Assistant Secretary for Financial Markets
Assistant Secretary for Economic Policy
Undersecretary for International Affairs
Assistant Secretary for International Financial Markets and Investment Policy
Assistant Secretary for International Economics and Development
General Counsel
Assistant Secretary for Legislative Affairs
All of these officials have to survive a Senate confirmation hearing in a brutal political environment, especially for anyone who has ever worked on Wall Street (at any point during his/her life). Even if the Obama administration announced nominees for all of these positions tomorrow, it would still take weeks to get them all confirmed—and that's assuming they all do get confirmed, which isn't a foregone conclusion in the current environment.
People seem to be surprised that the Treasury is understaffed. Do people think entire federal executive departments are magically staffed in the first week or something? The Treasury won't be fully staffed until June at the earliest, and it's one of the smallest executive departments. Washington is slow. Always has been, always will be. "
Me:
Marcel Proust, The Guermantes Way, 1920-21 Translated by C. K. Scott Moncrieff & Terence Kilmartin Revised by D. J. Enright
"My mother spoke: "Oh, but then Mamma will be having trouble with her breathing again."
The doctor reassured her: "Oh, no! The effect of the oxygen will last a good while yet. We can begin again presently."
It seemed to me that he would not have said this of a dying woman, that if this good effect was going to last it meant that it was still possible to do something to keep her alive. The hiss of the oxygen ceased for a few moments. But the happy plaint of her breathing still poured forth, light, troubled, unfinished, ceaselessly recommencing. Now and then it seemed that all was over; her breath stopped, whether owing to one of those transpositions to another octave that occur in the respiration of a sleeper, or else from a natural intermittence, an effect of anaesthesia, the progress of asphyxia, some failure of the heart. The doctor stooped to feel my grandmother’s pulse, but already, as if a tributary had come to irrigate the dried-up river-bed, a new chant had taken up the interrupted phrase, which resumed in another key with the same inexhaustible momentum. Who knows whether, without my grandmother’s even being conscious of them, countless happy and tender memories compressed by suffering were not escaping from her now, like those lighter gases which had long been compress in the cylinders? It was as though everything that she had to tell us was pouring out, that it was us that she was addressing with this prolixity, this eagerness, this effusion. At the foot of the bed, convulsed by every gasp of this agony, not weeping but at moments drenched with tears, my mother stood with the unheeding desolation of a tree lashed by the rain and shaken by the wind. I was made to dry my eyes before I went up to kiss my grandmother."
executed a massive Ponzi scheme
"[The Stanford Series] From “investment fraud” to “massive Ponzi scheme” Posted by Stacy-Marie Ishmael on Feb 27 19:25.
The SEC has amended its complaint against R. Allen Stanford, Laura Pendergast-Holt and James Davies.
Here’s a summary of the allegations, emphasis FT Alphaville’s:
1. For at least a decade, R. Allen Stanford and James M. Davis, through companies they control, including Stanford International Bank, Ltd. (”SIB”) and its affiliated Houston-based investment advisers, Stanford Group Company (”SGC”) and Stanford Capital Management (”SCM”), executed a massive Ponzi scheme. In carrying out the scheme, Stanford and Davis misappropriated billions of dollars of investor funds and falsified SIB’s financial statements in an effort to conceal their fraudulent conduct.
2. Laura Pendergest-Holt, the chief investment officer of Stanford Financial Group (”SFG”) and a member of SIB’s investment committee, facilitated the fraudulent scheme by misrepresenting to investors that she managed SIB’s multi-billion investment portfolio of assets and employed a sizeable team of analysts to monitor the portfolio.
3. By year-end 2008, SIB had sold approximately $8 billion of self-styled “certificates of deposits” (the “CD”) by touting: (i) the bank’s safety and security; (ii) consistent, double-digit returns on the bank’s investment portfolio; and (iii) high return rates on the CD that greatly exceeded those offered by commercial banks in the United States.
4. Contrary to SIB’s public statements, Stanford and Davis, by February 2009, had misappropriated at least $1.6 billion of investor money through bogus personal loans to Stanford and “invested” an undetermined amount of investor funds in speculative, unprofitable private businesses controlled by Stanford.
5. In an effort to conceal their fraudulent conduct and maintain the flow of investor money into SIB’s coffers, Stanford and Davis fabricated the performance of the bank’s investment portfolio. Each month, Stanford and Davis decided on a pre-determined return on investment for SIB’s portfolio. Using this pre-determined number, SIB’s internal accountants reverse-engineered the bank’s financial statements to report investment income that the bank did not actually earn. SIB’s financial statements, which were approved and signed by Stanford and Davis, bore no relationship to the actual performance of the bank’s investment portfolio.
6. In addition to sales of the CD, SGC and SCM advisers, since 2004, have sold more than $1 billion of a proprietary mutual fund wrap program, called Stanford Allocation Strategy (”SAS”), using materially false and misleading historical performance data. The false data enabled SGC/SCM to grow the SAS program from less than $10 million in 2004 to over $1.2 billion in 2009 and generate fees for SGC/SCM (and ultimately Stanford) in excess of $25 million. The fraudulent SAS performance results were also used to recruit registered financial advisers with significant books of business, who were then heavily incentivized to re-allocate their clients’ assets to SIB’s CD program.
7. By engaging in the conduct described in this Complaint, Defendants directly or indirectly, singly or in concert, have engaged, and unless enjoined and restrained, will again engage in transactions acts, practices, and courses of business that constitute violations of Section 17(a) of the Securities Act of 1933 (”Securities Act”) [15 U.S.C. §§ 77q(a)], and Section 10(b) of the Securities Exchange Act of 1934 (”Exchange Act”) [15 U.S.C. § 78j(b)], and Exchange Act Rule 10b-5 [17 C.F.R. § 240.10b-5] or, in the alternative, have aided and abetted such violations. In addition, through their conduct described herein, Stanford, SGC, and SCM have violated Section 206(1) and (2) of the Investment Advisers Act of 1940 (”Adviser’s Act”) [15 U.S.C. §§ 80b-6(1) and 80b-6(2)] and Davis and Pendergest-Holt have aided and abetted such violations. Finally, through their actions, SIB and SGC have violated Section 7(d) of the Investment Company Act of 1940 (”Investment Company Act”) [15 U.S.C. § 80a-7(d)].
(HT the ever-vigilant Joanna Chung)
Article Series - The Stanford Series
- The fractal Stanford
- As Stanford allegations fly, the SEC investigates...
- Sir Allen's Antigua, or the curious case of Stanford International Bank
- US MARSHALS SEEN ENTERING HOUSTON OFFICE OF STANFORD FINANCIAL GROUP - REUTERS EYEWITNESS
- ROBERT STANFORD ACCUSED OF `MASSIVE FRAUD' BY SEC
- Arise, Sir Allen...lest we assume the worst
- The full SEC complaint against Stanford
- Stanford scandal in pictures
- It's just not cricket
- Have you seen this bank?
- Where in the world is Sir Allen?
- What does the 'F' stand for in FINRA?
- Stanford's mysterious billions
- Stanford's AIM foray
- A Freudian slip?
- Sir Allen Stanford, you've been served
- But which passport will he surrender?
- SIB and Stanford Trust Company Limited put into receivership
- Eastern Caribbean Central Bank "takes control" of the Bank of Antigua
- The Stanford campaign donations: pay 'em back, not forward
- Clients of Allen, by the numbers
- This land is our land, Antigua government to say
- Antigua government moves closer to seizing Stanford properties
- From "investment fraud" to "massive Ponzi scheme"
- New details on alleged "massive Ponzi scheme"
This entry was posted by Stacy-Marie Ishmael on Friday, February 27th, 2009 at 19:25 and is filed under Capital markets. Tagged with james davies, Laura Pendergest-Holt, Sir Allen Stanford, Stanford Capital Management, stanford group company, Stanford International Bank."
Me:Don the libertarian Democrat Feb 28 20:31
Actually, you could tell that it was a Ponzi Scheme because it involved so much money and so long a time. Ponzi Schemes are the safest and most remunerative way to commit fraud, since they mirror shrewd investments for so long, and keep authorities from trying to horn in on a bunch of rich investors, all of whom have teams of lawyers. I'm just puzzled by the poor flight strategies.
because the current partial nationalization is actually the worst situation of all
"Roubini: Citi Is Already Nationalized, Just Need To Finish The Job (C)
1.50 | Change | % Change |
---|---|---|
-0.96 | -39.02% |
Nouriel Roubini points out the truth in Vikram Pandit's strange statement yesterday about how the latest bailout should put nationalization concerns to rest. Yes, the concerns have been put to rest, Nouriel says, because Citi has already been nationalized. The only question remaining is whether we go all the way.
Nouriel says we should, because the current partial nationalization is actually the worst situation of all. And because we're just delaying the inevitable.
Aaron Task, TechTicker: Friday's announcement the government will convert up to $25 billion of its Citigroup preferred stock into common equity represents Uncle Sam's third direct attempt to rescue the floundering bank.
The conversion would give the government up to 36% control of Citigroup stock and leave existing common shareholders with as little as 26% of the company's common stock. That explains why the stock tumbled 39% to $1.50 Friday despite CEO Vikram Pandit's strange declaration: "In many ways for those people who have a concern about nationalization, this announcement should put those concerns to rest."
Pandit's claim is "like saying you're half-pregnant," says Nouriel Roubini and economics professor at NYU's Stern School and chairman of RGE Monitor.
"The government has already taken over the financial system," Roubini says, noting U.S. policymakers have committed $9 trillion to rescue the financial system and already spent $2 trillion. "So let's stop the delusion about 'no nationalization.'"
Roubini, who has publicly advocated for temporary nationalization of insolvent banks, says fully nationalizing Citigroup and/or Bank of America would have a minimal effect on the Dow, which is a price-weighted average. More importantly, he believes full nationalizations (vs. the current partial, piecemeal effort) would be better for the market and the economy because it's the first step in the process of cleaning up "bad" banks so they can later be sold back to private investors, i.e. "re-privatized", as was the case last year with IndyMac.
Tune in Monday as we'll have more from Roubini on:
- Why nationalization is the right course and Bill Gross is wrong.
- Why Ben Bernanke's "reasonable prospect" for a recovery in 2010 is unreasonable.
- What the Tresaury's ongoing "stress tests" of big banks means, and doesn't mean."
an excellent article about the dangers and advantages of nationalization
"Faster, Please: Four Lessons From Sweden's Bank Rescue
Matthew Richardson, who teaches applied economics at NYU's Stern business school, has written an excellent article about the dangers and advantages of nationalization. Most important, he says, are that we learn the four central lessons of the example of Sweden.
What are those? Here you go:
- Decisive action in terms of evaluating the solvency of the financial institutions.
- Some form of “nationalisation” of the insolvent firms.
- Separation of these insolvent firms into good and bad ones with the idea of reprivatising them.
- The management of the process was delegated to professionals, as opposed to government regulators.
1) The FDIC couldn't just swoop in and take the big banks over.
2) That meant that we needed a special FDIC entity or a separate entity to take care of the big banks.
3) We needed to begin to work out how to break them apart.
If the FDIC could have handled them, then there would have been no need of a Swedish Plan. By the way, I believe that the Swedish Plan was partly based on the RTC. The only reason the RTC wasn't mentioned is because, at least from my point of view, that's where I first heard the phrase "Too Big To Fail". We didn't need a little bank fix.
Of course, I was assuming that we didn't want to, once again, show by our actions that some banks are too big to fail. Silly me. Also, the idea that these businesses can unwind themselves is belied by the fact that nobody wants to buy anything from them for any real money, because nobody trusts them. Joe Isuzu would be a better bet to sell theses assets.
As for the people who will take losses here, it's in their interest to predict the end of our way of life. We're going to take a big gamble whatever we do. I'd prefer a road that doesn't keep us subservient to these bank's interests, but that's just me.
This is the rub. Squeezing these creditors could potentially lead to a Lehman-like systemic threat
"More perspectives on Japan and nationalisation
- Posted by:
- Economist.com | WASHINGTON
- Categories:
- Financial markets
VIEWS on the nature of the problem in America's banking system continue to roll in. Justin Fox quotes an analysis of the situation by Richard Katz, who suggests that the Japan parallel is overblown:
It took the Bank of Japan nearly nine years to bring the overnight interest rate from its 1991 peak of eight percent down to zero. The U.S. Federal Reserve did that within 16 months of declaring a financial emergency, which it did in August 2007. It has also applied all sorts of unconventional measures to keep credit from drying up.
It took Tokyo eight years to use public money to recapitalize the banks; Washington began to do so in less than a year. Worse yet, Tokyo used government money to help the banks keep lending to insolvent borrowers; U.S. banks have been rapidly writing off their bad debt. Although Tokyo did eventually apply many fiscal stimulus measures, it did so too late and too erratically to have a sufficient impact. The U.S. government, by contrast, has already applied fiscal stimulus, and the Obama administration is proposing a multiyear program totaling as much as five to six percent of U.S. GDP.
On the other hand, when Japan finally did pull out of its slump, recovery was entirely export driven. It seems extremely unlikely that America will be able to duplicate that feat, particularly since other major exporters, like Germany, China, and Japan, will be trying to do the same thing at the same time.
Also very much worth reading is Matthew Richardson's detailed explication of the advantages and disadvantages of nationalisation. There are distinct advantages to such an approach. It's the surest way to clean up a bank's balance sheet, and it addresses moral hazard issues. But there are serious risks:
Of course, the tricky part of nationalisation is the handling of the bad assets. The bad assets would be broken into two types – those that need to be managed, such as defaulted loans in which the bank would own the underlying asset, and those that could be held, such as the AAA- and subordinated tranches of asset-backed securities. With respect to the former, the government could hire outside distressed investors or create partnerships with outside investors as was done with the Resolution Trust Corporation in the 1980s savings and loan crisis.
Along with the equity of the good bank, these assets would be owned by the existing creditors. The proceeds over time would accrue to the various creditors according to the priority of the claims. Most likely, the existing equity and preferred shares would be wiped out, and the debt would effectively have been swapped into equity in the new structure. Under this scenario, it is quite possible, even likely, that taxpayers would end up paying nothing. This is because, for the large complex financial institutions, these creditors cover well over half the liabilities.
Emphasis mine. This is the rub. Squeezing these creditors could potentially lead to a Lehman-like systemic threat. That's something the government would obviously wish to avoid."
Me:In order to stop it, the government needs to be seen as standing as a reliable backstop to our crisis. Lehman showed the opposite. The problem was not poor intervention, but no intervention. No one here can argue that we haven't intervened.
So, in my view, the losses from the scenario in this case will in fact be localized. It will effect banking stocks and some other investments, but it will be confined to just those areas, not a general Calling Run.
On the other hand, for many of the rest of us, including investors, the Government will be seen as finally being willing to do what it takes to end this crisis, and in a way that is dedicated to the general taxpayer first, not a view which says that we are held hostage by private financial businesses. That aspect, of the government in effect saying that the banks own us, has been a real drag on confidence. As well, since the banks are considered worse than incompetent, leaving them running the show has also been a real drag on confidence. Add in the fact that this cowering by the government makes it appear that nothing will change going forward, and you have a confidence destroying brew.
If what I just argued comes true, it will be a huge confidence booster for the government and average taxpayer, and might well be the one action that can begin a real clean up of this mess and transformation to a saner financial arrangement. If what I argue comes to pass and it's a disaster, don't blame me. I'm just a guy at a PC posting his view's on a blog trying to get a discussion started.
"5. Finally, the shares are non voting so as to give the impression, albeit rather feebly, that RBS has not been nationalized. Look, the Taxpayer owns 90% of RBS, and can vote on 75% of the shares. Why keep up the charade? Nationalize all dangerous banks, across the globe, immediately. Guarantee the deposits of the man in the street. And clean up the mess in an atmosphere of relative stability."
http://www.wilmott.com/blogs/paul/index.cfm/2009/2/28/The-Mother-Of-All-CDOs
Let's end the charade. That's the name of this movement. I don't think that I'd be allowed in any of the clubs of St.James's, unless I came in by the servant's entrance.
Friday, February 27, 2009
If you look where the bubble is, there too will be the crooks.
"Crime and Bubbles
Willie Sutton is supposed to have explained that he robbed banks because that was where the money was.
So it is with white collar crime. If you look where the bubble is, there too will be the crooks.
In the late 1990s, a company could be rewarded with a soaring stock price, and a valuation far beyond anything the company had actually accomplished — if it could show rapid growth. And stock options let executives monetize that gain almost immediately.
On the other hand, if your company was not hot, its share price could languish.
The result was a great temptation to fudge the numbers. At the extreme, we got Enron and WorldCom.
More recently, as soaring asset prices were pumped up by easy credit, it was money managers who could make zillions. Run a $500 million hedge fund and you get $10 million a year, plus 20 percent of the profits. Run a really big one that does very well, and you can take in a billion dollars.
And how do you attract enough money to manage? You show that you can produce outstanding investment results.
It turns out that the easiest way to do that was to lie about the results, and we are now seeing a succession of Ponzi schemes unveiled. The case involving Bernie Madoff may have been the largest, but others are multiplying.
It is no coincidence that we learn about the scandals after the bubbles burst. Enron had used its own high stock price to produce phony profits. When the stock price started to fall, it sparked a crisis and the facts eventually came out. So long as everyone believed assets were going up, money managers could siphon off new cash to pay those few investors who wanted to cash out. But when losses in other investments caused investors to flee, the game was up.
My suspicion is that there are more such schemes to be revealed."
I keep asking: When was the last time that you heard of a Ponzi Scheme being stopped as soon as it began?
Apparently, they cannot be distinguished from a very good investment for years and years. This means, for anyone looking for a way to live like a king for many years, a Ponzi Scheme just might be the ticket. It’s really a matter of anticipating and avoiding arrest when you’re finally discovered. That seems to be the only flaw.
Not only do I suspect many more to be revealed, I suspect that they will be a growing concern going forward. Fraud was a huge part of this crisis, but it will never be investigated or prosecuted as it should be. That will be the lesson that many remember.
— Don the libertarian DemocratI know that this is silly in a serious time, but I keep hearing Don Ho singing that title.
— Don the libertarian DemocratThat would be us, the taxpayers.
"Is A.I.G. the Worst of Them All? By Joe Nocera
I realize that there is a lot of competition for the title of “Rottenest Financial Institution,” but if you ask me, the American International Group should be right at the top of the list. Given that the company is about to report a $60 billion loss — and the government is going to have to devise yet another plan to keep it from defaulting — I took the opportunity this week to take a deeper look into the practices that led to its troubles.
To put it bluntly, they were shocking. But they are also extremely complicated and difficult to understand, much less explain. Suffice it to say here that A.I.G.’s credit default swaps — insuring toxic assets that soon went sour — were a form of Wall Street gamesmanship, built on bad assumptions and fueled by short-term greed. When I asked one former A.I.G. executive, Robert J. Arvinitis, what the larger economic purpose of A.I.G.’s credit default swaps were, he laughed. “The purpose was to keep the sausage factory going for the investment banks.”
My column this week is an attempt to unravel, and explain, some of A.I.G.’s seamier practices. It may be easier to get outraged at Merrill’s bonuses, or Lehman’s bankruptcy, or Bank or America’s idiotic deal-making. But you ought to put aside at least a little anger for A.I.G. No company has cost you, the taxpayer, more money. And no company deserves it less."
Next week, perhaps as early as Monday, the American International Group is going to report the largest quarterly loss in history. Rumors suggest it will be around $60 billion, which will affirm, yet again, A.I.G.’s sorry status as the most crippled of all the nation’s wounded financial institutions. The recent quarterly losses suffered by Merrill Lynch and Citigroup — “only” $15.4 billion and $8.3 billion, respectively — pale by comparison.
At the same time A.I.G. reveals its loss, the federal government is also likely to announce — yet again! — a new plan to save A.I.G., the third since September. So far the government has thrown $150 billion at the company, in loans, investments and equity injections, to keep it afloat. It has softened the terms it set for the original $85 billion loan it made back in September. To ease the pressure even more, the Federal Reserve actually runs a facility that buys toxic assets that A.I.G. had insured. A.I.G. effectively has been nationalized, with the government owning a hair under 80 percent of the stock. Not that it’s worth very much; A.I.G. shares closed Friday at 42 cents.
Donn Vickrey, who runs the independent research firm Gradient Analytics, predicts that A.I.G. is going to cost taxpayers at least $100 billion more before it finally stabilizes, by which time the company will almost surely have been broken into pieces, with the government owning large chunks of it. A quarter of a trillion dollars, if it comes to that, is an astounding amount of money to hand over to one company to prevent it from going bust. Yet the government feels it has no choice: because of A.I.G.’s dubious business practices during the housing bubble it pretty much has the world’s financial system by the throat.
If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz & Company, other institutions, including pension funds and American and European banks “will face their own capital and liquidity crisis, and we could have a domino effect.” A bailout of A.I.G. is really a bailout of its trading partners — which essentially constitutes the entire Western banking system.
I don’t doubt this bit of conventional wisdom; after the calamity that followed the fall of Lehman Brothers, which was far less enmeshed in the global financial system than A.I.G., who would dare allow the world’s biggest insurer to fail? Who would want to take that risk? But that doesn’t mean we should feel resigned about what is happening at A.I.G. In fact, we should be furious. More than even Citi or Merrill, A.I.G. is ground zero for the practices that led the financial system to ruin.
“They were the worst of them all,” said Frank Partnoy, a law professor at the University of San Diego and a derivatives expert. Mr. Vickrey of Gradient Analytics said, “It was extreme hubris, fueled by greed.” Other firms used many of the same shady techniques as A.I.G., but none did them on such a broad scale and with such utter recklessness. And yet — and this is the part that should make your blood boil — the company is being kept alive precisely because it behaved so badly.
•
When you start asking around about how A.I.G. made money during the housing bubble, you hear the same two phrases again and again: “regulatory arbitrage” and “ratings arbitrage.” The word “arbitrage” usually means taking advantage of a price differential between two securities — a bond and stock of the same company, for instance — that are related in some way. When the word is used to describe A.I.G.’s actions, however, it means something entirely different. It means taking advantage of a loophole in the rules. A less polite but perhaps more accurate term would be “scam.”
As a huge multinational insurance company, with a storied history and a reputation for being extremely well run, A.I.G. had one of the most precious prizes in all of business: an AAA rating, held by no more than a dozen or so companies in the United States. That meant ratings agencies believed its chance of defaulting was just about zero. It also meant it could borrow more cheaply than other companies with lower ratings.
To be sure, most of A.I.G. operated the way it always had, like a normal, regulated insurance company. (Its insurance divisions remain profitable today.) But one division, its “financial practices” unit in London, was filled with go-go financial wizards who devised new and clever ways of taking advantage of Wall Street’s insatiable appetite for mortgage-backed securities. Unlike many of the Wall Street investment banks, A.I.G. didn’t specialize in pooling subprime mortgages into securities. Instead, it sold credit-default swaps.
These exotic instruments acted as a form of insurance for the securities. In effect, A.I.G. was saying if, by some remote chance (ha!) those mortgage-backed securities suffered losses, the company would be on the hook for the losses. And because A.I.G. had that AAA rating, when it sprinkled its holy water over those mortgage-backed securities, suddenly they had AAA ratings too. That was the ratings arbitrage. “It was a way to exploit the triple A rating,” said Robert J. Arvanitis, a former A.I.G. executive who has since become a leading A.I.G. critic.
Why would Wall Street and the banks go for this? Because it shifted the risk of default from themselves to A.I.G., and the AAA rating made the securities much easier to market. What was in it for A.I.G.? Lucrative fees, naturally. But it also saw the fees as risk-free money; surely it would never have to actually pay up. Like everyone else on Wall Street, A.I.G. operated on the belief that the underlying assets — housing — could only go up in price.
That foolhardy belief, in turn, led A.I.G. to commit several other stupid mistakes. When a company insures against, say, floods or earthquakes, it has to put money in reserve in case a flood happens. That’s why, as a rule, insurance companies are usually overcapitalized, with low debt ratios. But because credit-default swaps were not regulated, and were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses. And it didn’t. Its leverage was more akin to an investment bank than an insurance company. So when housing prices started falling, and losses started piling up, it had no way to pay them off. Not understanding the real risk, the company grievously mispriced it.
Second, in many of its derivative contracts, A.I.G. included a provision that has since come back to haunt it. It agreed to something called “collateral triggers,” meaning that if certain events took place, like a ratings downgrade for either A.I.G. or the securities it was insuring, it would have to put up collateral against those securities. Again, the reasons it agreed to the collateral triggers was pure greed: it could get higher fees by including them. And again, it assumed that the triggers would never actually kick in and the provisions were therefore meaningless. Those collateral triggers have since cost A.I.G. many, many billions of dollars. Or, rather, they’ve cost American taxpayers billions.
The regulatory arbitrage was even seamier. A huge part of the company’s credit-default swap business was devised, quite simply, to allow banks to make their balance sheets look safer than they really were. Under a misguided set of international rules that took hold toward the end of the 1990s, banks were allowed to use their own internal risk measurements to set their capital requirements. The less risky the assets, obviously, the lower the regulatory capital requirement.
How did banks get their risk measures low? It certainly wasn’t by owning less risky assets. Instead, they simply bought A.I.G.’s credit-default swaps. The swaps meant that the risk of loss was transferred to A.I.G., and the collateral triggers made the bank portfolios look absolutely risk-free. Which meant minimal capital requirements, which the banks all wanted so they could increase their leverage and buy yet more “risk-free” assets. This practice became especially rampant in Europe. That lack of capital is one of the reasons the European banks have been in such trouble since the crisis began.
•
At its peak, the A.I.G. credit-default business had a “notional value” of $450 billion, and as recently as September, it was still over $300 billion. (Notional value is the amount A.I.G. would owe if every one of its bets went to zero.) And unlike most Wall Street firms, it didn’t hedge its credit-default swaps; it bore the risk, which is what insurance companies do.
It’s not as if this was some Enron-esque secret, either. Everybody knew the capital requirements were being gamed, including the regulators. Indeed, A.I.G. openly labeled that part of the business as “regulatory capital.” That is how they, and their customers, thought of it.
There’s more, believe it or not. A.I.G. sold something called 2a-7 puts, which allowed money market funds to invest in risky bonds even though they are supposed to be holding only the safest commercial paper. How could they do this? A.I.G. agreed to buy back the bonds if they went bad. (Incredibly, the Securities and Exchange Commission went along with this.) A.I.G. had a securities lending program, in which it would lend securities to investors, like short-sellers, in return for cash collateral. What did it do with the money it received? Incredibly, it bought mortgage-backed securities. When the firms wanted their collateral back, it had sunk in value, thanks to A.I.G.’s foolish investment strategy. The practice has cost A.I.G. — oops, I mean American taxpayers — billions.
Here’s what is most infuriating: Here we are now, fully aware of how these scams worked. Yet for all practical purposes, the government has to keep them going. Indeed, that may be the single most important reason it can’t let A.I.G. fail. If the company defaulted, hundreds of billions of dollars’ worth of credit-default swaps would “blow up,” and all those European banks whose toxic assets are supposedly insured by A.I.G. would suddenly be sitting on immense losses. Their already shaky capital structures would be destroyed. A.I.G. helped create the illusion of regulatory capital with its swaps, and now the government has to actually back up those contracts with taxpayer money to keep the banks from collapsing. It would be funny if it weren’t so awful.
I asked Mr. Arvanitis, the former A.I.G. executive, if the company viewed what it had done during the bubble as a form of gaming the system. “Oh no,” he said, “they never thought of it as abuse. They thought of themselves as satisfying their customers.”
That’s either a remarkable example of the power of rationalization, or they were lying to themselves, figuring that when the house of cards finally fell, somebody else would have to clean up the mess.
That would be us, the taxpayers."
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“or they were lying to themselves, figuring that when the house of cards finally fell, somebody else would have to clean it up.
That would be us, the taxpayers.”
This gets my vote. Of course, we keep doing it, so why shouldn’t they?
— Don the libertarian DemocratThe Financial Times writes that some clarity for the pricing of toxic assets might spell bad news for hopes of valuing these instruments.
"Secondary Sources: Valuing Toxic Assets, Budget, Animal Spirits
A roundup of economic news from around the Web.
Compiled by Phil Izzo"
The FT post was right. Investors have been buying the TAs. The people that own them don’t like the price that they would receive for them. There’s a huge gap between bid and ask, subsidized by the belief that the government will intervene enough to allow these assets to appreciate. If they do not or would take years and years to do so, we have been wasting an enormous amount of time and money delaying the liquidation of these losses at fire sale prices. Unfortunately, this also holds true for the housing market. At best, we can help create a more orderly and efficient process of people eating these losses. As far as I’m concerned, these delays are not helping.
“it always takes longer than you think; but when it happens, it always happens faster than you can imagine.”
"The Smell Of Coffee
The late Rudi Dornbsuch of MIT had a way of cutting to the chase, preferably in public and with a minister of finance present. He knew a huge amount about financial crisis, and could distill a lifetime of study and involvement in collapses succinctly: “it always takes longer than you think; but when it happens, it always happens faster than you can imagine.”
The latest credit default swap data for European banks bring Rudi’s perspective to mind - for the United States. We’ve debated this week what to do about U.S. banks, arguing about which unappealing options are less bad. In my view, the choice is not “nationalize vs. don’t nationalize,” but rather “keep our current partial nationalization/bottomless pit subsidy systemvs. start down the road to reprivatization.”
But, honestly, this entire debate may be overtaken by events.
Economic developments in East-Central Europe are very bad. Almost everyone will get IMF loans but, be that as it may, there is a big contraction underway. Nonperforming loans will increase for the West European banks lending to East-Central Europe or lending to firms that are (or were) exporting. Prominent European governments will struggle to afford the implied bailouts - remember, back in October these governments made it quite clear they are on the hook if their banks come under pressure. At the same time, of course, we have a nose dive in property in Ireland, Spain, and the UK.
My point is not that Europe is in big trouble, with no plausible regional rescue mechanisms in place. This is completely obvious - the debate among prominent Europeans is now whether or not to send distressed eurozone members to the IMF, and on what basis.
Focus on this instead: the European banking and fiscal fiasco is a dagger pointed at the heart of major US banks, which have a great deal of exposure - one way or another - to much of Europe. Ask any U.S.-based ”global bank”.
Treasury is constructing an elaborate transfer mechanism through which big banks can be kept in business, thanks to the public purse, without the taxpayer acquiring a majority of the common stock. The contortions required are striking. But this entire approach is predicated on a rosy stress scenario, which assumes the global economy cannot get much worse, at least in the short run.
It may soon be time to wake up.
Written by Simon Johnson
February 27, 2009 at 7:18 am"
I don’t know about you chaps, but I’m not smelling coffee this morning. I smelling something inedible. By the way, I looked at the amount of money Citi ( $25 Billion ) is getting, and how much money Eastern Europe is getting ( $31 Billion ), and I found it odd. But that’s just me. As for the new bank plan, we need Martin Gardner to do an annotated edition. Actually, James Kwak did it. I wonder how his head feels this morning. I bet he needs coffee.
Thursday, February 26, 2009
Companies are slashing jobs and orders at a faster pace in the U.S.
"U.S. Economy: Companies Cut Jobs, Durable Orders (Update2)
By Bob Willis and Sho Chandra
Feb. 26 (Bloomberg) -- Companies are slashing jobs and orders at a faster pace in the U.S., reports today showed, signaling the economy will contract more sharply this quarter than analysts anticipated.
Orders for durable goods fell 5.2 percent in January, more than twice as much as forecast, Commerce Department figures showed in Washington. The Labor Department said 667,000 Americans filed initial applications for jobless benefits last week. Sales of new homes reached a record low in January.
“What we’re looking at in this recession overall might be the biggest slowdown in economic growth in the postwar era,” said Tim Quinlan, an economist at Wachovia Corp. in Charlotte, North Carolina.
The economy’s deterioration reflects a tightening credit crunch that the Obama administration aims to counter with as much as $750 billion in new aid to the financial industry. The U.S. is caught in a “vicious cycle” where economic and financial weaknesses are feeding on each other, White House National Economic Council Director Lawrence Summers said today.
“Our economic problems” will “not be solved in a week or month or a year,” Summers said at a conference in Arlington, Virginia. The White House today unveiled a budget outline that includes a $1.75 trillion deficit for the current financial year as officials implement the fiscal stimulus and financial-bailout programs.
Treasury Yields
Treasuries fell as investors anticipated greater issuance of government debt. Yields on benchmark 10-year notes rose to 2.99 percent at 4:08 p.m. in New York, from 2.93 percent late yesterday. The Standard & Poor’s 500 Stock Index reversed early gains to close at 752.83, down 1.6 percent.
Morgan Stanley analysts today cut their estimate for gross domestic product in the first quarter to a 6 percent decline from 5 percent previously. Deutsche Bank Securities economist Joseph LaVorgna said the slide in January to March may be closer to 10 percent, the worst since 1958.
The Commerce Department may tomorrow revise its estimate of fourth-quarter GDP to a 5.4 percent drop at an annual pace, from the 3.8 percent decline previously reported, according to the median forecast in a Bloomberg News survey.
Economists projected a 2.5 percent drop in goods orders, according to the median of 71 estimates in a Bloomberg News survey. The fall extended the string of decreases to six months, the longest stretch since records began in 1992.
Growth Impact
Demand for non-defense capital goods excluding aircraft, a proxy for future business investment, plunged 5.4 percent after falling 5.8 percent the prior month. Shipments of those items, used in calculating GDP, dropped 6.6 percent.
The auto industry has led the recession in manufacturing. General Motors Corp., which is seeking $16.6 billion in new federal loans, today reported a $30.9 billion annual loss, the second-biggest in its 100-year history. The automaker this month said it is cutting another 47,000 jobs globally this year, closing an additional five U.S. plants by 2012 and selling or shuttering its Saab, Hummer and Saturn brands as part of a restructuring campaign.
“We expect these challenging conditions will continue through 2009,” GM Chief Executive Officer Rick Wagoner said in a statement today. GM has already received $13.4 billion in federal loans since December to stay in business.
The Labor Department’s claims report showed the number of people staying on benefit rolls rose by 114,000 to a record 5.112 million in the week ended Feb. 14.
No Bottom
“The labor market weakness has not found a bottom,” said Rudy Narvas, a senior economist at 4Cast Inc. in New York. “The payrolls report for February could be really bad.”
Those figures, due from Labor next week, may show job cuts exceeded half a million for a fourth consecutive month, according to a Bloomberg survey. The unemployment rate probably climbed to 7.9 percent, the highest level since 1984.
Already, the 3.6 million jobs lost since the U.S. recession began in December 2007 mark the biggest employment slump of any economic contraction in the postwar period.
JPMorgan Chase & Co. said today it will eliminate 2,800 jobs at Washington Mutual through attrition, bringing to 12,000 the total number of positions lost since the bank purchased the failed thrift in September.
Soaring unemployment and mounting foreclosures are driving away prospective home buyers. Sales of new houses dropped 10 percent in January to an annual pace of 309,000, the lowest level since data began in 1963, Commerce also reported today. The median price decreased 13.5 percent, the most in almost four decades.
Housing Slump
Sales are falling even faster than builders can trim inventory. The number of new homes for sale at the end of the month fell 3.1 percent to 342,000. Still, at the current sales pace, it would take a record 13.3 months to eliminate supply.
“The market is still very much out of equilibrium and in fact things are getting worse,” Michelle Meyer, an economist at Barclays Capital Inc. in New York, said in an interview with Bloomberg Television. “We’re going to see further construction cuts and further declines in home prices. We haven’t seen the peak in foreclosures, which means that prices have further to fall.”
Housing and Urban Development Secretary Shaun Donovan said today 6 million families in the U.S. may face foreclosure if policy makers don’t act faster to stem the housing decline."
Can't people be hired to do work before they are confirmed? Departments often go out and hire independent contractors. Or is that they can't leave their current positions until they are confirmed? It does seem possible for Geithner to have been able to hire help, although he would not have a full staff.
Don the libertarian Democrat
February 28, 2009 4:58 PM