We have existing laws that make that conduct illegal. Investigate the activity, charge the wrongdoers, prosecute them, get your convictions

TO BE NOTED: From The Market Ticker:

Posted by Karl Denninger in Editorial at 18:10

"Had Enough FRAUD America?

Let's expand a bit on a couple of Tickers from the last couple days; "AIG: More Samurai Swords Please" and "What SCHEME Is AIG", specifically.

This is what I said in May of 2008:

The solution to this entire mess is the same that it was (but not taken) back when the Bank of England was essentially looted, and when our banking system was looted in the early 1900s - find the market participants who have engaged in fraud via various forms, whether they be mortgage bankers handing out liar loans and misrepresenting them as "AAA Prime" paper or whether they be people in the marketplace who initiated the plethora of (false) rumors over the last many years about various companies, irrespective of whether the intent was to drive prices up or down, and prosecute them.

We have existing laws that make that conduct illegal. Investigate the activity, charge the wrongdoers, prosecute them, get your convictions and toss the lot of 'em in prison with a bunch of 7' tall rapists in the exercise yard, no guards, and a $100 video camera in the guard shack.

Then post the "results" on YouTube as a warning to the world - try that again in this country and this is the consequence you will receive.

That will be the last time it happens.

But until we take that sort of step and hold people to account, this sort of "looting operation" will continue, and we the people will continue to get screwed.

And specifically with regards to CDS, in the same article:

The entire claim and chain of events rests on the fact that market participants, up to and including Ben Bernanke at The Federal Reserve, were and are aware that these CDS contracts are in fact fraudulent in that there is no way performance can take place, yet everyone up and down the line is allowing these "assets" to be counted as "money good" on the books of banks and other financial institutions!

THIS is the key item in the debate folks.

The rest of this noise making is mental masturbation and intentional misdirection intended to keep you from asking the tough questions and demanding that existing law be enforced.

Congress and prosecutors across the board, both State and Federal, need to start bringing indictments, starting with the fraudulent accounting.

You can't value something at "par" when you are well-aware that the underlying credit quality has gone straight in the toilet and that there is not a snowball's chance in hell that the "insurance" you bought to protect yourself has no chance of being "money good." As soon as you become aware of the impairment under the law you are required to reserve against it!

While any one company could claim that its insurance is "money good" that's not the point.

Everyone in the marketplace today now has proof that these swaps in aggregate are worthless, with proof of this found in the fact that The Fed claimed under oath exactly that as justification for the Bear Stearns bailout!

So you have a situation here where the entire banking regulatory system has declared these contracts worthless in the aggregate and yet company after company continues to claim in their financial statements and results that these contracts are "money good"!

This is out and out fraud and must be stopped.

We the people are being systematically looted by these people and our prosecutorial apparatus sits on its butt and sips Starbucks Lattes instead of doing their job!

It is time for we the people to say ENOUGH.

Call Congress and demand that they stop this charade here and now. Every firm that has claimed their paper is "protected" by these wraps must be forced to identify the counterparty that currently holds the risk and those parties must be forced to prove that they can pay any and all claims against those policies.

If they can't (and the default case must be "they can't", since that was in fact Bernanke's and Geithner's position under oath!) then those wraps must be considered "doubtful" and reserves must be taken against the underlying credit quality.

Do this and we immediately identify who is broke and who is not, the market finds its proper price for these assets, and as a consequence the market will clear.

Everyone wants to make this whole mess complicated.

Its not.

It is in fact very simple.

The only "complication" is that there are thousands of people who are ripping the American People off wholesale, waving their arms around in the hope that you'll let them get away with it.

Don't fall for it.

Nearly a year ago folks.

There it was, laid out for everyone both in government and here.

In plain, black (digital) ink.

Now I want answers. You should want answers. And if you think that the answer is to flood AIG's derivatives desk with threatening calls, it is not.

It is to flood CONGRESS with calls demanding that this crap STOP.

Right now.

Specifically, we must insist that:

Every person involved with an identifiable criminal offense embedded in here (and I bet we can find plenty) be investigated, indicted, prosecuted AND if found guilty IMPRISONED.

Every firm that was unjustly enriched be told that they either return the funds or face a suit for that unjust enrichment and, in the case of a bank (or bank holding company) immediate confiscation by the FDIC and decertification of their federal banking charter.

The Federal Reserve be told that either IT cooperates in this matter and both disgorges its garbage on the balance sheet back to its originators, ceases all non-lending actions and opens its kimono here and forward or its charter will be revoked by Congress and The Fed's function will be subsumed by Treasury.

What I laid forth as my postulate has now been proved correct in the fullness of time.

Gee, Eliot Spitzer is back and says the same thing:

The appearance that this was all an inside job is overwhelming. AIG was nothing more than a conduit for huge capital flows to the same old suspects, with no reason or explanation. (No really? - me)

So here are several questions that should be answered, in public, under oath, to clear the air:

What was the precise conversation among Bernanke, Geithner, Paulson, and Blankfein that preceded the initial $80 billion grant?

Was it already known who the counterparties were and what the exposure was for each of the counterparties?

What did Goldman, and all the other counterparties, know about AIG's financial condition at the time they executed the swaps or other contracts? Had they done adequate due diligence to see whether they were buying real protection? And why shouldn't they bear a percentage of the risk of failure of their own counterparty?

What is the deeper relationship between Goldman and AIG? Didn't they almost merge a few years ago but did not because Goldman couldn't get its arms around the black box that is AIG? If that is true, why should Goldman get bailed out? After all, they should have known as well as anybody that a big part of AIG's business model was not to pay on insurance it had issued.

Why weren't the counterparties immediately and fully disclosed?

No kidding.

These bonuses aren't "news" to Geithner (who was at the NY Fed, remember, when this entire AIG mess started) or to anyone else:

WASHINGTON (AP) — Cue the outrage. For months, the Obama administration and members of Congress have known that insurance giant AIG was getting ready to pay huge bonuses while living off government bailouts. It wasn't until the money was flowing and news was trickling out to the public that official Washington rose up in anger and vowed to yank the money back.

Cut the crap Mr. President, Mr. Geithner and Congress. You are lying and this entire "bonus" game is a smokescreen to try to divert attention from the real theft - nearly $100 billion dollars of taxpayer money that has gone to Goldman and other banks, including foreign banks, to pay off Credit Default Swaps written by AIG that were worthless as the company had no capital behind them. This in turn means that the accounting of these firms has in fact fraudulently overstated earnings - perhaps for years - and still is!

The Fed, OTS and OCC have and had jurisdiction over American banks that bought these products, and were clearly derelict in their duty to prevent these regulated entities from purchasing these CDS from a firm that was unable to prove capital adequacy to cover its bets.

The European regulators have similar jurisdiction over those institutions and similarly have been derelict in their duty.

What the hell are we doing bailing out FOREIGN REGULATORS AND GOVERNMENTS who were derelict in their duty with regards to the institutions under their control?

Finally, TurboTimmy, it is not acceptable for you to simply "deduct" the amount of the bonuses from AIG's "aid package". Uh uh. This entire bonus question is a smokescreen for the massive conflicts of interest where an investment bank buys billions of dollars of "credit protection" from a company, then the CEO goes to work for Treasury and makes sure those contracts are good by siphoning off money from the taxpayer to cover them when the seller turns out to be insolvent.

It is time to hold people to account, here and now, for what certainly looks to me like an intentional and outrageous looting operation conducted against the American Taxpayer for the benefit of covering up the outrageous malfeasance and misfeasance by both American and foreign governments and regulatory bodies.

I refuse to believe this has all been some big accident.

I firmly believe it has been an intentional series of actions and it is time for America and stand up and say NOT THIS TIME YOU WON'T.

How long will you sit for this America before you either obtain proper redress for these actions or go purchase these two items

and prepare to use them?

No more excuses Mr. President, Mr. Bernanke, Mr. Geithner and Mr. Summers.

It is time to cut the crap, because if we don't do the right thing here and now foreigners will do it for us:

Foreigners sold a net $60.9 billion in long-dated U.S. securities in January, after buying $24.3 billion in December. Including changes in banks' dollar holdings, short-term securities and nonmarket transactions, net foreign capital outflows totaled a record $148.9 billion in January, compared with $86.2 billion in inflows in the previous month.

Michael Woolfolk, senior currency strategist at the Bank of New York Mellon Corp., said the big outflows are a concern and could represent a trend away from the flight to quality that has boosted purchases in U.S. assets in recent months.

"This was a truly awful report, throwing into question the funding of the U.S. current-account deficit," he said in a statement.

Mr. Woolfolk misses the essence of this signal from foreigners. That signal is, quite simply, one of disgust with what is happening over here in the realm of outright theft and fraud, and is best summarized thus:

Stop the looting and start the prosecuting right now or we will take our ball and bat and depart, leaving you with an un-fundable government budget that will be forced to contract by more than 75% within days, along with a smoking hole where your capital markets and economy once were.

Need I remind Ticker readers that I predicted exactly this potential course of action by our government and the potential outcome back when these "bailouts" and "handouts" first began over a year ago?

Time's up folks."

I'd like to offer the following links:

From Paul Kedrosky:

"Readings 03/12/09

By Paul Kedrosky · Thursday, March 12, 2009 · ShareThis

• Thanks to the Bank it's a crisis; in the eurozone it's a total catastrophe (Telegraph)
• The case for netting CDS faster (Sudden Debt)
• Latest U.S. railroad data showing stabilization at 15% decline (Association of American Railroads)
• U.K. house prices 'could fall by further 55 per cent' (Telegraph)
• Debating the future of China’s economy (The National Interest)
• Letters from Samuel Beckett (TLS)

Me:

I'd like to offer the following links:

http://www.nytimes.com/2009/03/12/opinion/12cohan...

Op-Ed Contributor
A Tsunami of Excuses

By WILLIAM D. COHAN
Published: March 11, 2009

Argues against stupidity defense.

http://dealbook.blogs.nytimes.com/2009/03/11/fina...

"Financial Fraud Is Focus of Attack by Prosecutors
By DAVID SEGAL

Argues against stupidity defense, but also explains why it often works ( here's a hint: everybody was doing it ).

http://www.nytimes.com/2009/03/11/business/econom...

The Looting of America’s Coffers

By DAVID LEONHARDT
Published: March 10, 2009

Argues against the "They drank the Kool-Aid" defense, and, about those govt guarantees, it turns out that they matter.

As long as the Too Big To Fail doctrine holds, the banks’ implicit government guarantee is more explicit than it ever has been.

From The Baseline Scenario:

"Looting Goes Mainstream (Media)

with 3 comments

A week ago, Simon wrote his “Confusion, Tunneling, and Looting” post, which argued that the confusion created by crises helps the powerful and well-positioned siphon assets out of institutions and out of the government. The revelations that much of the AIG bailout money has gone straight to its large bank counterparties in the form of collateral could fall under this heading.

The looting theme has gone mainstream, with David Leonhardt in The New York Times. I think Leonhardt’s article is good, but it describes looting (taking advantage of implicit government guarantees to take excessive risks) as a cause of the mess we are now in - and as something we’ll need to worry about in preventing crises in the future. But, as Simon argued, it’s also something to worry about right now. As long as the Too Big To Fail doctrine holds, the banks’ implicit government guarantee is more explicit than it ever has been. So whatever perverse incentives helped bring on the crisis are even stronger today.

Written by James Kwak

March 12, 2009 at 8:15 am"

Me:

From Bloomberg:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aKqHkkFlnvfM

“Most U.S. bank debt is held by insurers and foreign investors, with a small portion owned by mutual funds, said FTN’s Darst. The Investment Company Institute, a trade group representing mutual funds, doesn’t keep statistics on fund ownership of bank debt, spokeswoman Ianthe Zabel said.

Investors shouldn’t increase holdings that lack explicit government guarantees because “extreme losses” could force senior creditors to share in bailout costs, JPMorgan Chase & Co. said in a March 6 report by Srini Ramaswamy. While the scenario remains remote, owning the banks’ senior debt isn’t attractive when there’s concern about systemic risk, Ramaswamy wrote.

“We’re seeing the start of the next leg of the crisis and that’s going to be financial bondholders taking a haircut as lenders default,” Mehernosh Engineer, a London-based strategist at BNP Paribas SA, said this week. “There’s been a perception that banks’ senior bondholders are untouchable, but that’s going to change.”

Look at who owns this debt: Insurers, Foreign Investors.

Let’s say we allow defaults on this. Who are the insurers? Will we simply have to then prop them up instead? Have you seen any recent headlines about insurers being the next big problem?

Foreign investors? Try this:

http://blogs.cfr.org/setser/2009/01/29/read-dean-areddy-and-ng-on-the-management-of-chinas-reserves-during-the-crisis/

“It turns out that one of China’s main criticism of US policy is simple: the government didn’t stand by institutions that China expected the US to support. Lehman. Wamu. And the Reserve Primary Fund. Dean, Areddy and Ng:

“Leaders in China, the world’s third-largest economy, have been surprised and upset over how much the problems of the U.S. financial sector have hurt China’s holdings. In response, Beijing is re-examining its U.S. investments, say people familiar with the government’s thinking. …

Chinese leaders have felt burned by a series of bad experiences with U.S. investments they had believed were safe, say people familiar with their thinking, including holdings in Morgan Stanley, the collapsed Reserve Primary Fund and mortgage giants Fannie Mae and Freddie Mac.”

….. The Reserve issue “is causing a lot of concern with a lot of financial institutions in China,” said the Chinese official. Some officials expected that the U.S. and its financial institutions would better protect China from loss. “If the U.S. is treating us this way, eventually that will be enough cause for concern in the stability of the [U.S.] system,” the official said.”

Why does this bother me? Because this shifts the focus to Treasuries. From Buiter:

“In addition to (1) and (2) being met, there must be sufficient ‘fiscal spare capacity’ - confidence and trust in the financial markets and among permanent-income consumers, that the government will raise future taxes or cut future public spending by the same amount, in present discounted value terms, that they want to boost spending or cut taxes today. Without this confidence and trust, financial markets and forward-looking consumers will be spooked by the spectre of unsustainable fiscal deficits. Fear of future monetisation of public debt and deficits, or of future sovereign default will cause nominal and real long-term interest rates to rise. Ultimately, the sovereign will be rationed out of its own debt market. The US government (and the US economy as a whole) will encounter a ’sudden stop’.

These are not tales to frighten the children. I am deeply concerned that, when the US Federal government starts to run Federal budget deficits of 14 percent of GDP or over, the markets will get spooked and will simply refuse to fund the US authorities at any interest rate. Summers’ naive proposal for expansion now, virtue later, is simply not credible given the political economy of the US budget, now and in the foreseeable future.”

We’re in a bind. Either we default on these bonds, leading foreign investors to suspect that we’re default happy, or we guarantee the bonds, possibly adding to our debt. In all honesty, it might be better to guarantee the debt, and pray we don’t have to honor it.

Since I consider looting ( govt guarantees ) and fraud, negligence, collusion, and fiduciary mismanagement, as the main causes of this crisis, I don’t like giving in. But it’s important to consider that, in this case, we’re giving in to foreign investors who we need, and insurers who will probably come calling as well with lobbying debts in tow. The one benefit is that it would make seizure easier.

So, let’s guarantee the bondholders, and seize the big banks, and remember that this isn’t going to be a battle quickly won.

Just one view.

“Rules don’t work if people have no fear of them,”

From the NY Times:

Spurred by rising public anger, federal and state investigators are preparing for a surge of prosecutions of financial fraud, The New York Times’s David Segal reports.

Across the country, attorneys general have already begun indicting dozens of loan processors, mortgage brokers and bank officers. Last week alone, there were guilty pleas in Minnesota, Delaware, North Carolina and Connecticut and sentences in Florida and Vermont — all stemming from home loan scams.

With the Obama administration focused on stabilizing the banks and restoring confidence in the stock market, it has said little about civil or criminal charges at the federal level. But its proposed budget contains hints that it will add to this weight of litigation, including money for more F.B.I. agents to investigate mortgage fraud and white-collar crime, and a 13 percent raise for the Securities and Exchange Commission.

Officials at the Justice Department have said little in public about their plans. But people who have met with Attorney General Eric H. Holder Jr. say he is considering a range of strategies.

“It’s clear that he and other top-level members of the Obama administration want to seize the opportunity to send a message of zero tolerance for mortgage fraud,” said Connecticut’s attorney general, Richard Blumenthal, who attended a meeting with Mr. Holder and a number of state attorneys general last week in Washington. “The only question is when and how they will do it.”

One person who had discussed the matter with Mr. Holder, but declined to be identified because he was not authorized to speak for the Justice Department, said that the attorney general was deciding whether to form a task force to centralize the effort or allow state attorneys general to develop cases on their own.

A Justice Department spokesman, Matthew A. Miller would not comment, other than to write by e-mail, “It will be a top priority of the Justice Department to hold accountable executives who have engaged in fraudulent activities.”

At the low end of the mortgage transaction ladder, state prosecutors have had a relatively easy time prevailing, but recent history suggests that the government’s odds of winning drop when they go after Wall Street executives. Some high-profile convictions have been won in the last decade, but several of the Enron prosecutions and some cases brought by Eliot Spitzer when he was New York’s attorney general fell apart or were overturned on appeal.

As federal authorities decide on a course of action, members of Congress are becoming impatient. Representative Barney Frank, chairman of the House Financial Services Committee, announced plans last week for a hearing on March 20, inviting Mr. Holder, bank regulators and leaders of the S.E.C. to answer questions about their enforcement plans.

“Rules don’t work if people have no fear of them,” Mr. Frank, Democrat of Massachusetts, said at a news conference last week.

State and local prosecutors, it seems, do not need the nudge. Last week, the district attorney’s office in Brooklyn announced the creation of a real estate fraud unit, with 12 employees and a mandate to “address the recent flood of mortgage fraud cases plaguing New Yorkers.” In late February, Maryland unveiled a mortgage fraud task force, bringing together 17 agencies to streamline investigations.

With all the state activity and portents of a new resolve at the federal level, lawyers who defend white-collar clients sense growing momentum to perp walk and prosecute executives involved in the mortgage meltdown.

“It’s going to be open season,” says Daniel M. Petrocelli, a defense lawyer whose clients include Jeffrey K. Skilling, the former chief executive of Enron. “You’ll see a lot of indictments down the road, and you’ll see a lot of prosecutions that rely on vague theories of ‘deprivation of honest services.’ ”

Many financial executives have hired lawyers in the last few months, either through in-house counsels or, more discreetly, on their own, several lawyers who defend white-collar clients said. While assorted Wall Street executives have been prosecuted over the years, any concerted legal attack on the financial sector would have little precedent.

After the Depression, Congress formed what became known as the Pecora Commission, which grilled leading financiers. But the point was mostly to embarrass them, and the upshot was to set the stage for stricter regulations. The most indelible image of the commission’s hearings was a photo of J.P. Morgan with a midget who had been plopped in his lap by an opportunistic publicist.

The question behind any cases brought against Wall Street will boil down to this: Was the worst economic crisis in decades caused by law-breaking or some terrible, but noncriminal, combination of greed, naiveté and blunders? The challenge for the Obama administration will be to prove that it was the former, said Michael F. Buchanan, a partner at Jenner & Block and a former United States attorney in New Jersey.

“We punish people for intentional misconduct, we don’t punish them for stupidity or innocent mistakes,” Mr. Buchanan said. “If you’re a prosecutor, you want evidence that shows real dishonesty. You want something that shows that these people were doing something wrong, and they knew it.”

That nearly the entire banking industry acted in the same, possibly reckless, way could actually help any executive who winds up in court, lawyers said.

The herdlike nature of the behavior suggested that bankers were competing for business using assumptions that were widely shared, rather than trying to get away with a crime. And it would be hard to prove that anyone broke the rules, these lawyers said, given that regulations in the riskiest parts of the mortgage industry were so lax.

One defense lawyer said he expected to argue that either his clients did not understand the financial instruments they were marketing, or were not adequately warned of the dangers by underlings.

“We’ll all sing the stupidity song,” said the lawyer, who said he feared that speaking publicly by name would deter potential clients. “We’ll all sing the ‘These guys never told me’ song.”

But for government lawyers, the environment for corporate fraud cases could scarcely be more inviting. It is not just that the public’s zeal for Wall Street pelts is high. The resources are there, too, because some of the money once used to fight terrorism is being shifted to fighting financial fraud.

And in recent years the use of wire fraud statutes has expanded, allowing prosecutors to turn virtually anything said or sent by e-mail in private into a federal crime, if it contradicts what investors were told in public disclosures.

Wire fraud charges were among those brought against two former Bear Stearns managers, arrested in June, who are accused of praising their hedge fund to clients as they worried about its future to others in the company. The cases have yet to go to trial.

Federal sentencing guidelines also link the length of a prison sentence to the size of the financial loss to the public. Given that so many billions have vaporized in recent months, convictions could easily lead to life sentences, defense lawyers said, and the mere threat of such sentences gives prosecutors enormous leverage in settlement talks.

“There are executives now getting sentences longer than murderers and rapists,” said Mr. Petrocelli, the lawyer, referring to white-collar prosecutions in recent years, including that of Mr. Skilling of Enron, who is now serving a 24-year sentence for securities fraud and other crimes.

Why has there not been a batch of subpoenas at the federal level already? The Department of Justice is settling in and is missing important staff members, says Reid H. Weingarten, a defense lawyer and former trial lawyer for the Justice Department. In addition, former members of the Justice Department say that prosecutors and regulators are reluctant to act while the markets are in such disarray for fear of further unnerving investors and the public.

Lawyers for white-collar clients say they expect to be busy, but not all of them predict that means they will be earning huge fees. In the past, the legal bills of Wall Street higher-ups were paid by insurers that indemnified them. But that is not necessarily the case with banks that have gone bankrupt or disappeared.

“I know bankers are not now evoking much sympathy from the public at large,” Mr. Weingarten said. “But these days many Wall Street types are struggling mightily with mortgage payments, tuition bills and health insurance. It’s a very different world out there now.”

Me:

Add this to Leonhardt’s piece about looting, and you have the two main causes of this crisis. What’s interesting to me is that people seem to be missing the irony that so-called free market reforms were supported by a government guarantee. That’s the point about looting. It was not free market, and the actors didn’t think that it was. They assumed government backing.

Then this:

“One defense lawyer said he expected to argue that either his clients did not understand the financial instruments they were marketing, or were not adequately warned of the dangers by underlings.

“We’ll all sing the stupidity song,” said the lawyer, who said he feared that speaking publicly by name would deter potential clients. “We’ll all sing the ‘These guys never told me’ song.”

How many stories have we read about how complex these investments were? They drank their own Kool-Aid? They didn’t understand? Please.

It was Fraud, Negligence, Fiduciary Mismanagement, and Collusion. Now that we have these two stories, maybe we can get rid of all the systemic excuses meant to cover this up.

Without Fraud and Looting, this crisis wouldn’t have occurred.

— Posted by Don the libertarian Democrat

The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

From the WSJ:

"Secondary Sources: Greenspan’s Defense, Depression, Looting

A roundup of economic news from around the Web.

• Greenspan Defense: On the Journal’s opinion pages, former Federal Reserve Chairman Alan Greenspan says the central bank wasn’t responsible for the housing bubble. “There are at least two broad and competing explanations of the origins of this crisis. The first is that the “easy money” policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today’s financial mess. The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages. Between 2002 and 2005, home mortgage rates led U.S. home price change by 11 months. This correlation between home prices and mortgage rates was highly significant, and a far better indicator of rising home prices than the fed-funds rate.”
• What Is Depression?: Calculated Risk looks at what would need to happen for this recession to become a depression. “Some people argue the duration of the economic slump defines a depression - and the current recession is already 15 months old. That is longer than the recessions of ‘90/’91 and ‘01. The ‘73-’75 recession lasted 16 months peak to trough, and the early ’80s recession (a double dip) was classified as a 6 month recession followed by a 16 month recession (22 months total). Those earlier periods weren’t “depressions”, so if duration is the key measure, the current recession still has a ways to go… Even though the current recession is already one of the worst since 1947, it is only about 1/3 of the way to a depression (assuming a terrible Q1). To reach a depression, the economy would have to decline at about a 6.6% annual rate each quarter for the next year… I still think a depression is very unlikely. More likely the economy will bottom later this year or at least the rate of economic decline will slow sharply. I also still believe that the eventual recovery will be very sluggish, and it will take some time to return to normal growth.”
• Looting: David Leonhardt of the New York Times looks at a 1993 paper titled “Looting” by George Akerlof and Paul Romer, and he sees parallels to the current crisis. ““Looting” provides a really useful framework. The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem. Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame. But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem. Do you remember the mea culpa that Alan Greenspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess. He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all.”

Compiled by Phil Izzo"

Me:
11:26 am March 11, 2009

• • • Don the libertarian Democrat wrote:

    “The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.”

    You’ve got it. This is the main cause of the crisis, even though it’s practically impossible to get people to see this. Maybe this post will help.

In layman’s terms, he was asking for a clearer legal path to nationalization.

From the NY Times:

"Banks Counted on Looting America’s Coffers

By DAVID LEONHARDT

Sixteen years ago, two economists published a research paper with a delightfully simple title: “Looting.”

The economists were George Akerlof, who would later win a Nobel Prize, and Paul Romer, the renowned expert on economic growth. In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

On Tuesday morning in Washington, Ben Bernanke, the Federal Reserve chairman, gave a speech that read like a sad coda to the “Looting” paper. Because the government is unwilling to let big, interconnected financial firms fail — and because people at those firms knew it — they engaged in what Mr. Bernanke called “excessive risk-taking.” To prevent such problems in the future, he called for tougher regulation.

Now, it would have been nice if the Fed had shown some of this regulatory zeal before the worst financial crisis since the Great Depression. But that day has passed. So people are rightly starting to think about building a new, less vulnerable financial system.

And “Looting” provides a really useful framework. The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa that Alan Greenspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all.

•

The term that’s used to describe this general problem, of course, is moral hazard. When people are protected from the consequences of risky behavior, they behave in a pretty risky fashion. Bankers can make long-shot investments, knowing that they will keep the profits if they succeed, while the taxpayers will cover the losses.

This form of moral hazard — when profits are privatized and losses are socialized — certainly played a role in creating the current mess. But when I spoke with Mr. Romer on Tuesday, he was careful to make a distinction between classic moral hazard and looting. It’s an important distinction.

With moral hazard, bankers are making real wagers. If those wagers pay off, the government has no role in the transaction. With looting, the government’s involvement is crucial to the whole enterprise.

Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains. As Gretchen Morgenson has reported, Merrill Lynch’s losses from the last two years wiped out its profits from the previous decade.

What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.

In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent it.

I understand this chain of events sounds a bit like a conspiracy. And in some cases, it surely was. Some A.I.G. employees, to take one example, had to have understood what their credit derivative division in London was doing. But more innocent optimism probably played a role, too. The human mind has a tremendous ability to rationalize, and the possibility of making millions of dollars invites some hard-core rationalization.

Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

Unfortunately, we can’t very well stop the flow of that money now. The bankers have already walked away with their profits (though many more of them deserve a subpoena to a Congressional hearing room). Allowing A.I.G. to collapse, out of spite, could cause a financial shock bigger than the one that followed the collapse of Lehman Brothers. Modern economies can’t function without credit, which means the financial system needs to be bailed out.

But the future also requires the kind of overhaul that Mr. Bernanke has begun to sketch out. Firms will have to be monitored much more seriously than they were during the Greenspan era. They can’t be allowed to shop around for the regulatory agency that least understands what they’re doing. The biggest Wall Street paydays should be held in escrow until it’s clear they weren’t based on fictional profits.

Above all, as Mr. Romer says, the federal government needs the power and the will to take over a firm as soon as its potential losses exceed its assets. Anything short of that is an invitation to loot.

Mr. Bernanke actually took a step in this direction on Tuesday. He said the government “needs improved tools to allow the orderly resolution of a systemically important nonbank financial firm.” In layman’s terms, he was asking for a clearer legal path to nationalization.

At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.

Mr. Akerlof and Mr. Romer finished writing their paper in the early 1990s, when the economy was still suffering a hangover from the excesses of the 1980s. But Mr. Akerlof told Mr. Romer — a skeptical Mr. Romer, as he acknowledged with a laugh on Tuesday — that the next candidate for looting already seemed to be taking shape.

It was an obscure little market called credit derivatives."

Me:

"With moral hazard, bankers are making real wagers. If those wagers pay off, the government has no role in the transaction. With looting, the government’s involvement is crucial to the whole enterprise."

"Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

Thank you for this post. I believe that looting was the main cause of this crisis. At least now, some people will finally see its importance.

I'd like to add this quote:

WHY BANKS FAILED THE STRESS TEST
Andrew G Haldane*
Executive Director for Financial Stability
Bank of England
13 February 2009

http://www.bankofengland.co.uk...

"No. There was a much simpler explanation according to one of those present. There was absolutely no incentive for individuals or teams to run severe stress tests and
show these to management. First, because if there were such a severe shock, they would very likely lose their bonus and possibly their jobs. Second, because in that
event the authorities would have to step-in anyway to save a bank and others suffering a similar plight.
All of the other assembled bankers began subjecting their shoes to intense scrutiny. The unspoken words had been spoken. The officials in the room were aghast. Did
banks not understand that the official sector would not underwrite banks mismanaging their risks? Yet history now tells us that the unnamed banker was spot-on. His was a brilliant articulation of the internal and external incentive problem within banks. When the big
one came, his bonus went and the government duly rode to the rescue. The timeconsistency problem, and its associated negative consequences for risk management, was real ahead of crisis. Events since will have done nothing to lessen this problem, as successively larger waves of institutions have been supported by the authorities"

Don the libertarian Democrat

— Don, Tacoma, WA