Peter, Paul, and Barney:
An Evolving Essay On the Hidden Agenda of the U.S. Government Bailout
Bob Jensen at Trinity University

National Debt-Inflation Crisis



The booked National Debt on July 31, 2012 was pennies under $16 trillion ---
U.S. National Debt Clock --- http://www.usdebtclock.org/
Also see http://www.brillig.com/debt_clock/
The unbooked entitlements have a present value between $80 and $100 trillion. But who's counting?

The Real National Debt (booked + unbooked entitlements) 2008
Source --- http://www.pgpf.org/about/nationaldebt/


American Experience: The Crash of 1929 (Video) ---  http://www.pbs.org/wgbh/amex/crash/

Iowa Sen. Charles Grassley suggested that AIG executives should accept responsibility for the collapse of the insurance giant by resigning or killing themselves. The Republican lawmaker's harsh comments came during an interview Monday with Cedar Rapids, Iowa, radio station WMT . . . Sen. Charles Grassley wants AIG executives to apologize for the collapse of the insurance giant — but said Tuesday that "obviously" he didn't really mean that they should kill themselves. The Iowa Republican raised eyebrows with his comments Monday that the executives — under fire for passing out big bonuses even as they were taking a taxpayer bailout — perhaps should "resign or go commit suicide." But he backtracked Tuesday morning in a conference call with reporters. He said he would like executives of failed businesses to make a more formal public apology, as business leaders have done in Japan.
Noel Duara, "Grassley: AIG execs should repent, not kill selves," Yahoo News, March 17, 2009 --- http://news.yahoo.com/s/ap/20090317/ap_on_re_us/grassley_aig

Video:  Is Anyone Minding the Store at the Federal Reserve? ---
http://www.silverbearcafe.com/private/05.09/mindingthestore.html

U.S. Debt/Deficit Clock --- http://www.usdebtclock.org/

The Obama Debt Tracker
He added $1.7 trillion of debt in his first year
http://www.treasurydirect.gov/NP/BPDLogin?application=np

Video of Detroit in Ruins --- http://www.youtube.com/watch?v=1hhJ_49leBw

Video:  Steve Wynn Takes On Washington  --- http://www.infowars.com/steve-wynn-takes-on-washington/

Debate Assignment:  Should We Never Pay Down the National Deficit or Debt (even partly)?
http://www.cs.trinity.edu/~rjensen/temp/NationalDeficit-Debt.htm

A Pissing Contest Between Bob and Jagdish:  An Illustration of How to Lie With Statistics ---
http://www.cs.trinity.edu/~rjensen/temp/LieWithStatistics01.htm

"Why Are Some Sectors (Ahem, Finance) So Scandal-Plagued?" by Ben W. Heineman, Jr., Harvard Business Review Blog,  January 10, 2013 --- Click Here
http://blogs.hbr.org/cs/2013/01/scandals_plague_sectors_not_ju.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date

Greatest Swindle in the History of the World ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

The trouble with crony capitalism isn't capitalism. It's the cronies ---
http://www.trinity.edu/rjensen/2008Bailout.htm#CronyCapitalism

Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit rating agencies) ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze

History of Fraud in America --- 
http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

Bob Jensen's Fraud Updates are at
http://www.trinity.edu/rjensen/FraudUpdates.htm

Mortgage Fraud Task Force Stats: Did You See This? WOW  ---
http://www.senseoncents.com/2013/08/mortgage-fraud-task-force-stats-did-you-see-this-wow/

Inside Job: 2010 Oscar-Winning Documentary Now Online --- Click Here
http://www.openculture.com/2011/04/inside_job.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+OpenCulture+%28Open+Culture%29

In late February, Charles Ferguson’s film – Inside Job – won the Academy Award for Best Documentary. And now the film documenting the causes of the 2008 global financial meltdown has made its way online (thanks to the Internet Archive). A corrupt financial industry, its corrosive relationship with politicians, academics and regulators, and the trillions of damage done, it all gets documented in this film that runs a little shy of 2 hours.

To watch the film, you will need to do the following. 1.) Look at the bottom of the film. 2.) Click the forward button twice so that it moves beyond the initial trailer and the Academy Awards ceremony. 3.) Wait for the little circle to stop spinning. And 4.) click play to watch film.

Inside Job (now listed in our Free Movie Collection) can be purchased on DVD at Amazon. We all love free, but let’s remember that good projects cost real money to develop, and they could use real financial support. So please consider buying a copy.

Hopefully watching or buying this film won’t be a pointless act, even though it can rightly feel that way. As Charles Ferguson reminded us during his Oscar acceptance speech, we are three years beyond the Wall Street crisis and taxpayers (you) got fleeced for billions. But still not one Wall Street exec is facing criminal charges. Welcome to your plutocracy…

Bob Jensen's threads on the global financial meltdown and its aftershocks are at
http://www.trinity.edu/rjensen/2008Bailout.htm

 

 

Essay

Appendix APending Disaster in the U.S.

Appendix BThe Trillion Dollar Bet in 1993

Appendix CDon't Blame Fair Value Accounting Standards (except in terms of executive bonus payments)
                      This includes a bull crap case based on an article by the former head of the FDIC

Appendix DThe End of Capitalism, Economics, and Investment Banking as We Know It

Appendix E:  Greatest Swindle in the History of the World
                     
Your Money at Work, Fixing Others’ Mistakes (includes a great NPR public radio audio module)

Appendix F:  Christopher Cox Waits Until Now to Tell Us His Horse Was Lame All Along
                      S.E.C. Concedes Oversight Flaws Fueled Collapse
                      And This is the Man Who Wants Accounting Standards to Have Fewer Rules

Appendix G:  Why the Trillion-Dollar Bankster Bailout Won't Work

Appendix H:  Where were the auditors?
                        The aftermath will leave the large auditing firms in a precarious state?

Appendix I:   1999 Quote from The New York Times
                    ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Appendix J:  Will the large auditing firms survive the 2008 banking meltdown?

Appendix K:  Why not bail out everybody and everything?

Appendix L:  The trouble with crony capitalism isn't capitalism. It's the cronies.

Appendix M:  Reinventing the American Dream

Appendix N:  Accounting Fraud at Fannie Mae

Appendix O:  If Greenspan Caused the Subprime Real Estate Bubble, Who Caused the Second Bubble That's About to Burst?
                       Harvard Professors Says Economists are a Huge Part of the Problem

Appendix P:  Meanwhile in the U.K., the Government Protects Reckless Bankers

Appendix Q:  Bob Jensen's Primer on Derivatives (with great videos from CBS)

Appendix R:  Accounting Standard Setters Bending to Industry and Government Pressure to Hide the Value of Dogs

Appendix S:   Fooling Some People All the Time

Appendix T:  Regulations Recommendations

Appendix U:  Subprime: Borne of Greed, Sleaze, Bribery, and Lies (including the credit rating agencies)

Appendix V:  Implications for Educators, Colleges, and Students

Appendix W: The End

Appendix X:  How Scientists Help Cause Our Financial Crisis

Appendix Y:  The Bailout's Hidden Agenda Details

Appendix Z:  What's the rush to re-inflate the stock market?

The Commission's Final Report --- http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_full.pdf

American History of Fraud and White Collar Crime --- http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

"The Financial Crisis, From A-Z," by Tunku Varadarajan, Forbes, November 10, 2008 ---
http://www.forbes.com/opinions/2008/11/09/financial-crisis-tarp-oped-cx_tv_1110varadarajan.html
Jensen Comment
This is a clever use of the alphabet and an understanding of what happened.

Shielding Against Validity Challenges in Plato's Cave ---
http://www.trinity.edu/rjensen/TheoryTAR.htm

What went wrong in accounting/accountics research?  ---
http://www.trinity.edu/rjensen/theory01.htm#WhatWentWrong

The Sad State of Accountancy Doctoral Programs That Do Not Appeal to Most Accountants ---
http://www.trinity.edu/rjensen/theory01.htm#DoctoralPrograms

AN ANALYSIS OF THE EVOLUTION OF RESEARCH CONTRIBUTIONS BY THE ACCOUNTING REVIEW: 1926-2005 ---
http://www.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm#_msocom_1

Bob Jensen's threads on accounting theory ---
http://www.trinity.edu/rjensen/theory01.htm

Tom Lehrer on Mathematical Models and Statistics ---
http://www.youtube.com/watch?v=gfZWyUXn3So

Systemic problems of accountancy (especially the vegetable nutrition paradox) that probably will never be solved ---
http://www.trinity.edu/rjensen/FraudConclusion.htm#BadNews

 

A New Definition of Life on the Edge
 

 Loss of dollar purchasing power since 1775 --- http://manualofideas.com/blog/2009/03/declining_value_of_us_dollar_s.html

Peter Schiff is a widely-known economist who predicted the financial crisis well ahead of most everybody, but  nobody listened when he blared out warnings throughout the media, some of which are on YouTube
No, the main issue with Schiff seems to be that he hasn't changed his tune (in 2009) --- and it isn't a pleasant tune to listen to. He thinks the "phony economy" of the U.S. is headed for even harder times. He believes that the crisis-fighting measures coming out of Washington are merely delaying the inevitable, debasing the dollar and loading future taxpayers with huge debts.
Justin Fox, "Excluding the Extremist:  Peter Schiff predicted the credit collapse long before the 'experts." So why is it so hard to hear him now," Time Magazine, June 1, 2009, Page 48.

Barney Frank: I've destroyed the economy, my work here is done.
Washington Times headline, Nov. 29, 2011
Barney's Rubble --- http://www.trinity.edu/rjensen/2008Bailout.htm#Rubble

Oh, and don't forget Fannie Mae and Freddie Mac, those two government-sponsored mortgage giants that engineered the 2008 subprime mortgage fiasco and are now on the public dole. The Fed kept them afloat by buying over a trillion dollars of their paper. Now, part of the Treasury's borrowing from the public covers their continuing large losses.
George Melloan, "Hard Knocks From Easy Money:  The Federal Reserve is feeding big government and harming middle-class savers," The Wall Street Journal, July 6, 2010 --- http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t

"Did Harvard (and then President Larry Summers) Ignore Warnings on Harvard's Investments?" Inside Higher Ed, November 29, 2009 --- http://www.insidehighered.com/news/2009/11/30/qt#214304

Senior Harvard University officials -- especially then-president Lawrence Summers -- repeatedly ignored warnings that the university's investment strategies were placing far too much cash (needed for short-term spending) in risky investments, The Boston Globe reported. The placement of the cash in risky investments has been a key reason why Harvard, which even after investment losses is by far the wealthiest university in the world, has been forced to make many cuts in the last year; such cash reserves, had the advice been followed, would have been easily accessible. Summers declined to comment for the article, but a friend of his familiar with the Harvard investment strategy noted that conditions changed after Summers left the presidency and that the university had the time to change its strategy prior to last year's Wall Street collapse.

Jensen Comment
There were advanced warnings before the fall, especially those of Peter Schiff ---
http://en.wikipedia.org/wiki/Peter_Schiff
But he missed the early timing and thus is still not a billionaire.
Larry Summers resigned from Harvard in a clash with feminists and is now the chief economic advisor to President Obama.

Wave Goodbye to this nation's top economic advisor
"Lawrence Summers Will Leave White House Post and Return to Harvard," Chronicle of Higher Education, September 21, 2010 ---
http://chronicle.com/blogPost/Lawrence-Summers-Will-Leave/27092/

An entire generation's prosperity vanishing, food stamp use exploding. Welcome to the jobless future. This month's jobs numbers drive home the point. The unemployment rate fell at the fastest rate for years — great news, right? Wrong. The vast majority of the gains — 75% — came from (wait for it) "temporary help services." See what just happened? We subtracted thousands of real jobs — and replaced them with low-value, no-future McJobs instead.
"Solve America's Employment Crisis With a Netflix Prize," Harvard Business School, December 4, 2009 ---
http://blogs.harvardbusiness.org/haque/2009/12/solve_americas_employment_cris.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE


"Why I don’t like Larry Summers," by Massimo Pigliucci, Rationally Speaking, July 22, 2011 ---
http://rationallyspeaking.blogspot.com/2011/07/why-i-dont-like-larry-summers.html

I have to admit to a profound dislike for former Harvard President and former Obama (and Clinton) advisor Larry Summers. Besides the fact that, at least going by a number of reports of people who have known him, he can only be characterized as a dick, he represents precisely what is wrong with a particularly popular mode of thinking in this country and, increasingly, in the rest of the world.
 
Lawrence was famously forced to resign as president of Harvard in 2006 because of a no-confidence vote by the faculty (wait, academics still have any say in how universities are run? Who knew) because of a variety of reasons, including his conflict with academic star Cornel West, financial conflict of interests regarding his dealings with economist Andrei Shleifer, and particularly his remarks to the effect that perhaps the scarcity of women in science and engineering is the result of innate intellectual differences (for a critical analysis of that particular episode see Cornelia Fine’s Delusions of Gender and the corresponding Rationally Speaking podcast).
 
Now I have acquired yet another reason to dislike Summers, while reading Debra Satz’s Why Some Things Should not Be for Sale: The Moral Limits of Markets, which I highly recommend to my libertarian friends, as much as I realize of course that it will be entirely wasted on them. The book is a historical and philosophical analysis of ideas about markets, and makes a very compelling case for why thinking that “the markets will take care of it” where “it” is pretty much anything of interest to human beings is downright idiotic (as well as profoundly unethical).
 
But I’m not concerned here with Satz’s book per se, as much as with the instance in which she discusses for her purposes, a memo written by Summers when he was chief economist of the World Bank (side note to people who still don’t think we are in a plutocracy: please simply make the effort to track Summers’ career and his influence as an example, or check this short video by one of my favorite philosophers, George Carlin). The memo was intended for internal WB use only, but it caused a public uproar when the, surely not left-wing, magazine The Economist leaked it to the public. Here is an extract from the memo (emphasis mine):
 
“Just between you and me, shouldn’t the World Bank be encouraging more migration of the dirty industries to the less developed countries? I can think of three reasons:
 
1. The measurement of the costs of health-impairing pollution depends on the foregone earnings from increased morbidity and mortality. From this point of view a given amount of health-impairing pollution should be done in the country with the lowest cost, which will be the country with the lowest wages. I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that.
 
2. The costs of pollution are likely to be non-linear as the initial increments of pollution probably have very low cost ... Only the lamentable facts that so much pollution is generated by non-tradable industries (transport, electrical generation) and that the unit transport costs of solid waste are so high prevent world-welfare enhancing trade in air pollution and waste.
 
3. The demand for a clean environment for aesthetic and health reasons is likely to have very high income elasticity ... Clearly trade in goods that embody aesthetic pollution concerns could be welfare enhancing.
 
The problem with the arguments against all of these proposals for more pollution in least developed countries (intrinsic rights to certain goods, social concerns, lack of adequate markets, etc.) could be turned around and used more or less effectively against every Bank proposal for liberalization.
 
Now, pause for a minute, go back to the top of the memo, and read it again. I suggest that if you find nothing disturbing about it, your empathic circuitry needs a major overhaul or at the very least a serious tuneup. But it’s interesting to consider why.
 
As both The Economist (who called the memo “crass”) and Satz herself note, the economic logic of the memo is indeed impeccable. If one’s only considerations are economic in nature, it does make perfect sense for less developed countries to accept (for a — probably low — price) the waste generated by richer countries, for which in turn it makes perfect sense to pay a price to literally get rid of their shit.
 
And yet, as I mentioned, the leaking of the memo was accompanied by an outcry similar to the one generated by the equally infamous “Ford Pinto memo back in 1968. Why? Here I actually have a take that is somewhat different from, though complementary to, that of Satz. For her, there are three ethical objections that can be raised to the memo: first, she maintains that there is unequal vulnerability of the parties involved in the bargain. That is, the poor countries are in a position of marked disadvantage and are easy for the rich ones to exploit. Second, the less developed countries likely suffer from what she calls weak agency, since they tend to be run by corrupt governments whose actions are not in the interest of the population at large (whether the latter isn’t also true of American plutocracy is, of course, a matter worth pondering). Third, the bargain is likely to result in an unacceptable degree of harm to a number of individuals (living in the poor countries) who are not going to simultaneously enjoy any of the profits generated from the “exchange.”

Continued in article


Video:  Peter Schiff was right 2006-2007 (CNBC edition) ---
http://www.youtube.com/watch?v=Z0YTY5TWtmU

Five Speaker Videos from the Stanford Graduate School of Business (on the economic crisis and leadership)  [Scroll Down]
 Top 5 Speaker Videos for 2009 --- http://www.gsb.stanford.edu/news/top-videos.html?cmpid=alumni&source=gsbtoday

"The dominant public policy imperative motivating reform is to address the moral hazard risk created by what we did, what we had to do in the crisis to save the economy," Treasury Secretary Timothy F. Geithner said in an interview. That's from today's Washington Post. The "moral hazard risk" arises when government encourages people to gamble by suggesting that government will rescue them if they fail. By bailing out the banks, the federal government has essentially declared to the world that they will do it again. That created a moral hazard. It's refreshing to know that Administration is aware of...
John Stossel, "Geithner Moral Hazard," ABC News, August 28, 2009 ---
http://blogs.abcnews.com/johnstossel/2009/08/geithner-moral-hazard.html

Ten (now eleven) Trillion and Counting (a full-length PBS Frontline video) --- http://www.pbs.org/wgbh/pages/frontline/tentrillion/view/
 
All of the federal government's efforts to stem the tide of the financial meltdown have added hundreds of billions of dollars to an already staggering national debt, a sum that is expected to double over the next 10 years to more than $23 trillion. In Ten Trillion and Counting, FRONTLINE traces the politics behind this mounting debt and investigates what some say is a looming crisis that makes the current financial situation pale in comparison

This is a great learning resource:  Very Effective
Visual Guide to the Federal Reserve," Simoleon Sense, May 22, 2009 --- http://www.simoleonsense.com/
Jensen Comment
The Fed's easy credit and low-interest policies of the past two decades got us into this financial crisis, and the Fed's approach to getting us out of this mess is like putting gasoline on political fire.

 I’d been working for the bank for about five weeks when I woke up on the balcony of a ski resort in the Swiss Alps. It was midnight and I was drunk. One of my fellow management trainees was urinating onto the skylight of the lobby below us; another was hurling wine glasses into the courtyard. Behind us, someone had stolen the hotel’s shoe-polishing machine and carried it into the room; there were a line of drunken bankers waiting to use it. Half of them were dripping wet, having gone swimming in all their clothes and been too drunk to remember to take them off. It took several more weeks of this before the bank considered us properly trained. . . . By the time I arrived on Wall Street in 1999, the link between derivatives and the real world had broken down. Instead of being used to reduce risk, 95 per cent of their use was speculation - a polite term for gambling. And leveraging - which means taking a large amount of risk for a small amount of money. So while derivatives, and the financial industry more broadly, had started out serving industry, by the late 1990s the situation had reversed. The Market had become a near-religious force in our culture; industry, society, and politicians all bowed down to it. It was pretty clear what The Market didn’t like. It didn’t like being closely watched. It didn’t like rules that governed its behaviour. It didn’t like goods produced in First-World countries or workers who made high wages, with the notable exception of financial sector employees. This last point bothered me especially.
Philipp Meyer, American Rust (Simon & Schuster, 2009) --- http://search.barnesandnoble.com/American-Rust/Philipp-Meyer/e/9780385527514/?itm=1
American excess: A Wall Street trader tells all - Americas, World - The Independent
http://www.independent.co.uk/news/world/americas/american-excess--a-wall-street-trader-tells-all-1674614.html 
Jensen Comment
This book reads pretty much like an update on the derivatives scandals featured by Frank Partnoy covering the Roaring 1990s before the dot.com scandals broke. There were of course other insiders writing about these scandals as well --- http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
It would seem that bankers and investment bankers do not learn from their own mistake. The main cause of the scandals is always pay for performance schemes run amuck.

A growing concern for Fed policy makers is a weakening in the US dollar against major currencies. The price of the euro in US-dollar terms climbed from a low of $1.27 in November last year to around $1.41 in May and $1.43 in early June — an increase of 12.6% from November. The major currencies dollar index fell to 78.89 in May from 82.3 in April — a fall of 4.1%. If the declining trend in the US dollar were to consolidate, this could cause foreign holders of US-dollar assets to divest into non-dollar-denominated assets and precious metals.
Frank Shostak, "The Fed Might Have Painted Itself into a Corner," Mises Institute, June 12, 2009 ---
http://mises.org/story/3518

Let me conclude with a political note. The main reason for reform is to serve the nation. If we don’t get major financial reform now, we’re laying the foundations for the next crisis. But there are also political reasons to act. For there’s a populist rage building in this country, and President Obama’s kid-gloves treatment of the bankers has put Democrats on the wrong side of this rage. If Congressional Democrats don’t take a tough line with the banks in the months ahead, they will pay a big price in November.
Paul Krugman, Bubbles and the Banks," The New York Times, January 7, 2010 ---
http://www.nytimes.com/2010/01/08/opinion/08krugman.html?hpw

Teaching Case from The Wall Street Journal Accounting Weekly Review on October 5, 2012

BofA Takes New Crisis-Era Hit
by: Dan Fitzpatrick, Christian Berthelsen and Robin Sidel
Sep 29, 2012
Click here to view the full article on WSJ.com
Click here to view the video on WSJ.com WSJ Video
 

TOPICS: Contingent Liabilities

SUMMARY: "Bank of America Corp. agreed to pay $2.43 billion to settle claims it misled investors about the acquisition of troubled brokerage firm Merrill Lynch & Co...." during the financial crisis in 2008. At the time it acquired Merrill Lynch in September 2008, BofA became the biggest U.S. bank; the value of the bank then fell by more than half by the time the acquisition of Merrill Lynch closed 3 months later. These losses were not disclosed by then CEO Ken Lewis and his management team to shareholders before they voted on the merger transaction with Merrill.

CLASSROOM APPLICATION: The article addresses accounting for litigation contingent liabilities. The related video clearly discusses the history of the transactions.

QUESTIONS: 
1. (Introductory) To whom did Bank of America Corp. (BofA) agree to pay $2.43 billion dollars?

2. (Introductory) For what losses did BofA agree to make this payment?

3. (Advanced) How could losses have occurred and a payment of $2.4 billion be required if "Bank of America executives now say Merrill...has become a big profit contributor... [and that] it's clear that Merrill is a significant positive any way you want to look at it..."?

4. (Advanced) What accounting standards provide the requirements to account for costs such as this $2.4 billion payment by BofA?

5. (Advanced) According to the article, BofA has "set aside more than $42 billion in litigation expenses, payouts and reserves...[which] includes $1.6 billion taken in the third quarter [of 2012]...." According to the related video, what period will be affected by $1.6 billion being recorded as an expense related to this $2.43 billion settlement? Explain your answer.
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
BofA-Merrill: Still A Bottom-Line Success
by David Benoit
Sep 28, 2012
Online Exclusive

"BofA Takes New Crisis-Era Hit," by Dan Fitzpatrick, Christian Berthelsen and Robin Sidel, The Wall Street Journal, September 29, 2012 ---
http://professional.wsj.com/article/SB10000872396390443843904578024110468736042.html?mod=djem_jiewr_AC_domainid&mg=reno-wsj

Bank of America Corp. agreed to pay $2.43 billion to settle claims it misled investors about the acquisition of troubled brokerage firm Merrill Lynch & Co., in the latest financial-crisis aftershock to rattle the banking sector.

The payment is the largest settlement of a shareholder claim by a financial-services firm since the upheaval of 2008 and 2009. It also ranks as the eighth-largest securities class-action settlement, behind payouts like the $7.2 billion settlement with shareholders of Enron Corp. and the $6.1 billion pact with WorldCom Inc. investors, both in 2005.

The deal is a sign that U.S. banks' battle to contain the high cost of the crisis continues to escalate, despite a four-year slog of lawsuits, losses and profit-sapping regulations. Bank of America's total exposure to crisis-era litigation is "seemingly never-ending," said Sterne Agee & Leach Inc. in a note Friday.

Is the era that produced all of this legal exposure "history?" the Sterne Agee & Leach analysts said. "Unlikely."

The settlement ends a three-year fight with a group of five plaintiffs, including the State Teachers Retirement System of Ohio and the Teacher Retirement System of Texas. They accused the bank and its officers of making false or misleading statements about the health of Bank of America and Merrill Lynch and were planning to seek $20 billion if the case went to trial as scheduled on Oct. 22.The size of the pact highlights how hasty acquisitions engineered during the height of the financial crisis by Kenneth Lewis, then the bank's chief executive, are still haunting the company four years later. Decisions to buy mortgage lender Countrywide Financial Corp. and Merrill have forced Bank of America, run since 2010 by Chief Executive Brian Moynihan, to set aside more than $42 billion in litigation expenses, payouts and reserves, according to company figures. The funds are meant to absorb a litany of Merrill-related lawsuits and claims from investors who say Countrywide wasn't honest about the quality of mortgage-backed securities it issued before the crisis.

That total includes $1.6 billion taken in the third quarter to help pay for the Merrill settlement announced Friday and a landmark $8.5 billion agreement reached last year with a group of high-profile mortgage-bond investors.

The company's shares lost more than half their value between when Bank of America announced its late-2008 plan to purchase Merrill Lynch and the date the deal closed 3½ months later, wiping out $70 billion in shareholder value. The shares have fallen further since then, and investors who owned the shares won't be made whole by the settlement.

"We find it simply amazing the sheer magnitude of value destruction over the years," said Sterne Agee in the note issued Friday. And "the bill is surely set to increase" as the research firm expects the bank to reach other legal settlements over the next 12 to 24 months. Bank of America is still engaged in a legal clash with bond insurer MBIA Inc., MBI +3.91% which has alleged that Countrywide wasn't honest about the quality of mortgage-backed securities it issued before the financial crisis.

The move to buy Merrill over one weekend in September 2008 was initially hailed as a rare piece of good news during a week when much of Wall Street appeared to be teetering on the brink. It also vaulted the Charlotte, N.C., lender to the top of the U.S. banking heap, capping a goal pursued over two decades by Mr. Lewis and his predecessor, Hugh McColl.

The Merrill deal, initially valued at $50 billion in Bank of America stock, was the "deal of a lifetime," Mr. Lewis said on the day it was announced.

But the agreement soon became a problem as analysts questioned whether Mr. Lewis paid too much and Merrill's losses spiraled out of control in the weeks before the deal closed. Investor fears stemming from the financial crisis sent shares of Bank of America and other financial companies into free fall, and the deal was worth roughly $19 billion at its completion on Jan. 1, 2009.

Mr. Lewis and his top executives made the decision not to say anything publicly about the mounting problems before shareholders signed off on the merger—a decision that formed the basis of a number of Merrill-related suits, including an action brought by the Securities and Exchange Commission. The bank also didn't disclose that it sought $20 billion in U.S. aid to digest Merrill, or that the deal allowed Merrill to award up to $5.8 billion in performance bonuses. When Bank of America threatened to pull out of the deal because of the losses, then-Treasury Secretary Henry Paulson told Mr. Lewis that current management would be removed if the deal wasn't completed.

The legal scrutiny surrounding the Merrill acquisition contributed to Mr. Lewis's decision to step down at the end of 2009. Mr. Lewis's lawyer declined to comment.

"Any way you slice it, $2.4 billion is a big number," says Kevin LaCroix, a lawyer at RT ProExec, a firm that focuses on management-liability issues.

Bank of America executives now say Merrill, unlike Countrywide, has become a big profit contributor, while the company continues to work to absorb massive losses in its mortgage division. The divisions inherited from Merrill produced $31.9 billion in net income between 2009 and 2011 and $164.4 billion in revenue. Bank of America's total net income over the period was just $5.5 billion, on $326.8 billion in revenue, reflecting in part the hefty losses tied to the Countrywide deal.

"I think it's clear that Merrill is a significant positive any way you want to look at it," said spokesman Jerry Dubrowski.

The settlement doesn't end all Merrill-related headaches. The New York attorney general's office still is pursuing a separate civil fraud suit relating to the Merrill takeover that began under former Attorney General Andrew Cuomo. Defendants in that case include the bank, Mr. Lewis and former Chief Financial Officer Joe Price. A spokesman for New York State Attorney General Eric Schneiderman declined to comment.

It isn't known how much all shareholders will receive as a result of the Merrill settlement announced Friday. The amount shareholders receive will ultimately depend on how long they held the shares and how much they paid. Mr. Lewis, also a shareholder, won't receive a payout because defendants in the suit are excluded from the class that the court certified.

But because the decline in Bank of America stock was so steep—the shares fell from $32 to $14 between Sept. 12, 2008, the day before the Merrill acquisition was announced, and the Jan. 1, 2009, closing—no shareholders can expect to recover their full losses.

Before the settlement was reached, a targeted recovery for at least three million shareholders who were part of the class was $2.52 a share, said a spokesman for Ohio Attorney General Mike DeWine. The State Teachers Retirement System of Ohio and the Ohio Public Employees Retirement System, which held between 18 million and 20 million shares, now expect to recover $1.19 per share, or roughly $20 million.

Continued in article

CDO --- http://en.wikipedia.org/wiki/Collateralized_debt_obligation

Countrywide Financial --- http://en.wikipedia.org/wiki/Countrywide_Financial

Those Poisoned CDOs
"Bank of America Ordered to Unseal Documents in MBIA Case," by Dan Freed, The Street, June 4, 2013 ---
http://www.thestreet.com/story/11804771/1/bank-of-america-ordered-to-unseal-documents-in-mbia-case.html

Jensen Comment
Arguably the worst decision in the 2008 economic bailout was Bank of America's decision to buy the bankrupt Countrywide Financial. BofA then CEO Lewis claims to this day that Treasury Secretary Hank Paulsen held a gun to his head and said buy Countrywide Financial or else. Countrywide has been nothing but a cash flow hemorrhage for BofA ever since.

 

Breaking the Bank Frontline Video
In Breaking the Bank, FRONTLINE producer Michael Kirk (Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to reveal the story of two banks at the heart of the financial crisis, the rocky merger, and the government’s new role in taking over — some call it “nationalizing” — the American banking system.
Simoleon Sense, September 18, 2009 --- http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout --- http://www.trinity.edu/rjensen/2008Bailout.htm

 

U.S. loan relief program may have made things worse
The Obama administration’s $75 billion program to protect homeowners from foreclosure has been widely pronounced a disappointment, and some economists and real estate experts now contend it has done more harm than good. Since President Obama announced the program in February, it has lowered mortgage payments on a trial basis for hundreds of thousands of people but has largely failed to provide permanent relief. Critics increasingly argue that the program, Making Home Affordable, has raised false hopes among people who simply cannot afford their homes.
Peter S. Goodman, "U.S. loan program may have made things worse," MSNBC, January 1, 2010 ---
http://www.msnbc.msn.com/id/34663078/ns/business-the_new_york_times/

Selling the debt in the left pocket to the right pocket:  The Fed is all smoke and mirrors

"Fed Is Buying 61 Percent of U.S. Government Debt," by Bob Adelmann, The New American, March 29, 2012
http://thenewamerican.com/economy/commentary-mainmenu-43/11357-fed-is-buying-61-of-us-government-debt

In his attempt to explode the myth that there is unlimited demand for U.S. government debt, former Treasury official Lawrence Goodman explained that there is high perceived demand because the Federal Reserve is doing most of the buying.

Wrote Goodman,

Last year the Fed purchased a stunning 61% of the total net Treasury issuance, up from negligible amounts prior to the 2008 financial crisis.

This not only creates the false impression of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized budget deficits.

What about Japan and China? Aren’t they the major purchasers of U.S. debt? Not any more, notes Goodman. Foreign purchases of U.S. debt dropped to less than 2 percent  of GDP (Gross Domestic Product) from almost 6 percent just three years ago. And private sector investors — banks, money market and bond mutual funds, individuals and corporations — have cut their buying way back as well, to less than 1 percent of GDP, down from 6 percent. This serves to hide the fact that the government can’t find outside buyers willing to accept rates of return that are below the inflation rate (“negative interest”) given the precarious financial condition of the government. It also hides the impact of $1.3 trillion deficits from the public who would likely get much more concerned if real, true market rates of interest were being demanded for purchasing U.S. debt, as such higher rates would increase the deficit even further. Finally it takes pressure off Congress to “do something” because there is no public clamor over the matter, at least for the moment. 

One of those promoting the myth that buyers of U.S. debt must exist because interest rates are so low is none other than one of those recently seated at the Federal Reserve’s Open Market Committee table, Alan BlinderNow a professor of economics at Princeton University, Blinder was vice chairman of the Fed in the mid-nineties and should know all about the Fed’s manipulations and machinations in the money markets. Apparently not. 

On January 19 Blinder wrote in the Wall Street Journal that

Strange as it may seem with trillion-dollar-plus deficits, the U.S. government doesn’t have a short-run borrowing problem at all. On the contrary, investors all over the world are clamoring to lend us money at negative real interest rates.

In purchasing power terms, they are paying the U.S. government to borrow their money!

Blinder repeated the error in front of the Senate Banking Committee just one week later: "In fact, world financial markets are eager to lend the United States government vast amounts at negative real interest rates. That means that, in purchasing power terms, they are paying us to borrow their money!"

Aggressive promotion of a myth never makes it a fact. All it does is hide, for a period, the reality that the world isn’t willing to lend to the United States at negative interest rates. This places the burden on the Fed to make the myth appear real by expanding its own balance sheet and gobbling up U.S. debt. 

There are going to be consequences. As Goodman put it,

The failure by officials to normalize conditions in the U.S. Treasury market and curtail ballooning deficits puts the U.S. economy and markets at risk for a sharp correction…. [Emphasis added.]

In other words, budget deficits often take years to build or reduce, while financial markets react rapidly and often unexpectedly to deficit spending and debt.

The recent release by the Congressional Budget Office (CBO) of future inflation expectations provides little assurance either as it mimics the line that inflation will stay low for the foreseeable future: "In CBO’s forecast, the price index for personal consumption expenditures increases by just 1.2 percent in 2012 and 1.3 percent in 2013."

With the Fed continuing to buy U.S. government debt, which keeps interest rates artificially low, when will reality set in? Amity Shlaes has the answer. Writing in Bloomberg last week, Shlaes explains:

The thing about [price] inflation is that it comes out of nowhere and hits you….

[It] has happened to us before. In World War I … the CPI [Consumer Price Index] went from 1 percent for 1915 to 7 percent in 1916 and 17 percent in 1917….

In 1945, all seemed well. Inflation was at 2 percent, at least officially. Within two years that level hit 14 percent.

All appeared calm in 1972, too, before inflation jumped to 11 percent by 1974 and stayed high for the rest of the decade….

One thing is clear: pretty soon, we’ll all be in deep water.

Doug Casey agrees: “Don’t think there are no consequences to our unwise fiscal and monetary course; a potentially ugly tipping point is more likely than not at some point.”

Coninued in article

The video is a anti-Bernanke musical performance by the Dean of Columbia Business School ---
http://www.youtube.com/watch?v=3u2qRXb4xCU
Ben Bernanke (Chairman of the Federal Reserve and a great friend of big banks) --- http://en.wikipedia.org/wiki/Ben_Bernanke
R. Glenn Hubbard (Dean of the Columbia Business School) ---
http://en.wikipedia.org/wiki/Glenn_Hubbard_(economics)

I don't want to make this statement of fact seem political.
It applies no matter what political side is in power!
The Science of Macroeconomics is quite literally blameless.

If the economy improves and unemployment drops, Obama can take credit. If it fails to improve and unemployment rises, though, he can say he averted an even worse showing. Republicans will take the opposite tack—attributing any improvement to the natural resilience of the economy and blaming the administration if things get worse. And neither side will really know who's right. I have long been a believer in the value of economics in understanding the world. But the chief effect of the current crisis is to raise the possibility that economists—at least those macroeconomists, who study the broad economy—don't have a blessed clue.
"Baffled by the Economy:  Why being a macroeconomist means never having to say you're sorry," by Steve Chapman, Reason Magazine, June 11, 2009 --- http://www.reason.com/news/show/134059.html

The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance.
Taylor Caldwell, A Pillar of Iron (wrongly attributed to Cicero in 55 B.C.)

Five Speaker Videos from the Stanford Graduate School of Business (on the economic crisis and leadership)  [Scroll Down]
 Top 5 Speaker Videos for 2009 --- http://www.gsb.stanford.edu/news/top-videos.html?cmpid=alumni&source=gsbtoday

Great PBS Video on the Crash of 1929 --- http://www.pbs.org/wgbh/americanexperience/crash/

Yale School of Management Cosponsors NYC Roundtable Discussion on the Financial Crisis (Full Video Now Available)
http://mba.yale.edu/news_events/CMS/Articles/6608.shtml 


Collateralized Debt Obligation --- http://en.wikipedia.org/wiki/Collateralized_debt_obligation

"CDOs Are Back: Will They Lead to Another Financial Crisis?" Knowledge@wharton, April 10, 2013 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=3230

Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster:  The Formula That Killed Wall Street --- http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html 

Some highlights:

"For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations are at the heart of the problem.

"The reason that ratings agencies and investors felt so safe with the triple-A tranches was that they believed there was no way hundreds of homeowners would all default on their loans at the same time. One person might lose his job, another might fall ill. But those are individual calamities that don't affect the mortgage pool much as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and tranching still hadn't solved all the problems of mortgage-pool risk. Some things, like falling house prices, affect a large number of people at once. If home values in your neighborhood decline and you lose some of your equity, there's a good chance your neighbors will lose theirs as well. If, as a result, you default on your mortgage, there's a higher probability they will default, too. That's called correlation—the degree to which one variable moves in line with another—and measuring it is an important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more involved with the actual formula etc.

The “math error” might truly be have been an error or it might have simply been a gamble with what was perceived as miniscule odds of total market failure. Something similar happened in the case of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management formed by Nobel Prize winning economists and their doctoral students who took similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM  

The rhetorical question is whether the failure is ignorance in model building or risk taking using the model?

Also see
"In Plato's Cave:  Mathematical models are a powerful way of predicting financial markets. But they are fallible" The Economist, January 24, 2009, pp. 10-14 --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Wall Street’s Math Wizards Forgot a Few Variables
What wasn’t recognized was the importance of a different species of risk — liquidity risk,” Stephen Figlewski, a professor of finance at the Leonard N. Stern School of Business at New York University, told The Times. “When trust in counterparties is lost, and markets freeze up so there are no prices,” he said, it “really showed how different the real world was from our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/

Bob Jensen's threads on CDOs ---
http://www.trinity.edu/rjensen/2008Bailout.htm


 


"Saturn (Now Defunct Automobile): A Wealth of Lessons from Failure," University of Pennsylvania's Knowledge@Wharton, October 28, 2009 --- http://knowledge.wharton.upenn.edu/article.cfm?articleid=2366

Did the Cash for Clunkers Program cost taxpayers $24,000 for each success story?
"(Lots of) Cash for Clunkers," by Steven D. Levitt (University of Chicago economics professor and principal author of Freakonomics, Superfreakonomics, and the Freakonomics Blog at The New York Times), November 2, 2009 ---
http://freakonomics.blogs.nytimes.com/2009/11/02/lots-of-cash-for-clunkers/ 

Edmunds.com reports that its statistical analysis of the Cash for Clunkers program finds that the program generated only 125,000 extra new vehicle sales, meaning that the cost to the U.S. government was $24,000 for each of those new cars.

The reason the cost per incremental car is so high is that, according to Edmunds.com’s modeling, 82 percent of the vehicles purchased under the program would have been bought this year anyway, even without the subsidy. So Cash for Clunkers mostly just turned out to be a gift from the government to people who happened to be in the market for a new car at the right time. The auto manufacturers and dealers did not end up getting a very big chunk of the money ultimately, although they did get paid earlier rather than later in the year.

Is this surprising? Not to an economist. It is relatively easy to move around the timing of when someone purchases a durable good, but much harder to affect whether they buy a durable good or not.

For the second time in a week, I am deeply disappointed at the response of the Department of Transportation to research into areas of relevance to the department. The first case was Secretary LaHood’s response to my research on car seats. Here is what the agency had to say in response to the Edmunds.com analysis:

“It is unfortunate that Edmunds.com has had nothing but negative things to say about a wildly successful program that sold nearly 250,000 cars in its first four days alone,” said Bill Adams, spokesman for the Department of Transportation.

The right response, it seems to me, is either to say 1) that this new evidence convinces us not to do the program again, or 2) that this analysis is wrong. That’s the response  that Macon Phillips had on the White House blog (who knew the White House had a blog!):

The Edmunds analysis rests on the assumption that the market for cars that didn’t qualify for Cash for Clunkers was completely unaffected by this program. In other words, all the other cars were being sold on Mars, while the rest of the country was caught up in the excitement of the Cash for Clunkers program. This analysis ignores not only the price impacts that a program like Cash for Clunkers has on the rest of the vehicle market, but the reports from across the country that people were drawn into dealerships by the Cash for Clunkers program and ended up buying cars even though their old car was not eligible for the program.

I’m not sure whether this argument is empirically important or not, but at least it is actually engaging in a meaningful way with the Edmunds.com analysis.

Jensen Comment
My objection to the Cash for Clunkers Program was not how much it cost in terms of subsidies to some buyers (like me) and most dealers, although the benefits to buyers are probably overstated when compared to deals that are not being made by dealers. My objection is that the program destroyed perfectly good cars needed badly by poor people around the world such as poor people in Latin America and South America. Mathematicians would call the degree of impact epsilon with respect to reducing global warming and fuel consumption. The so-called "jobs created" were mostly temporary since backlogged vehicle inventories are now growing and growing and growing.

A very small example was the cash for clunkers program in the US that ended a short time ago. The 19th century French essayist Frederic Bastiat discussed facetiously the gain to an economy when a boy breaks the windows of a shopkeeper since that creates work for the glazier to repair them, and the glazier then spends his additional income on food and other consumer goods. The moral of that story is to hire boys to go around breaking windows! The clunkers program was hardly any better than that (see our discussion of the clunkers program on August 24th).
Gary Becker, Nobel Prize Winning Economist, "How Much Should We Care About Government Deficits?" The Becker-Posner Blog, September 15, 2009 --- http://www.becker-posner-blog.com/archives/2009/09/how_much_should.html
Also see Gary Becker, "
The Cash for Clunkers Program: A Bad Idea at the Wrong Time, The Becker-Posner Blog, August 24, 2009 --- http://www.becker-posner-blog.com/archives/2009/08/the_cash_for_cl.html

The burden on the government budget that this imposes depends on the interest rates on the debt. At an average interest rate of 5%, that means 5% of GDP would go to servicing the debt, which is a little less than 20% of total federal government spending. This might be manageable but it is not trivial. On the other hand, if average interest rates were only 3%, servicing costs would be far more tolerable. In fact, the US has been paying about 3% on its debt, so even a considerable increase of the debt to 100% of GDP would still be manageable. But if the Fed starts raising real interest rates to head off the inflation potential in the $800 billion of excess reserves, the debt burden could become a major problem. Another factor is the savings rates coming from the Asian countries, like China. If their savings decline sharply, that too would raise world interest rates and increase the debt burden for all countries.
Gary Becker, Nobel Prize Winning Economist, "How Much Should We Care About Government Deficits?" The Becker-Posner Blog, September 15, 2009 --- http://www.becker-posner-blog.com/archives/2009/09/how_much_should.html


Mortgage Fraud Increasing
Despite the attention paid to mortgage fraud committed by borrowers and lenders since declines in the real estate values and the subprime loan crisis triggered severe problems in the banking industry, the number of Federal Bureau of Investigation’s (FBI) investigations of mortgage fraud and associated financial crimes is increasing. “The FBI has experienced and continues to experience an exponential rise in mortgage fraud investigations,” John Pistole, Deputy Director, told the Senate Judiciary Committee in April.
AccountingWeb, August 18, 2009 --- http://www.accountingweb.com/topic/mortgage-loan-fraud-increasing
Jensen Comment
I think mortgage fraud will continue to rise as long as remote third parties like Fannie Mae, Freddie Mac, and FHA continue to buy up mortgages negotiated by banks and mortgage companies basking in moral hazard. The biggest hazards are fraudulent real estate appraisals and lies about income in mortgage applications. We need to bring back George Bailey (James Stewart) in It's a Wonderful Life --- http://en.wikipedia.org/wiki/It%27s_a_Wonderful_Life
The banks that negotiate the mortgages should have to hang on to those mortgages.
Watch the video at http://www.youtube.com/watch?v=MJJN9qwhkkE

Bob Jensen's fraud updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm


"The FHA's Bailout Warning:  Whoops, there it is," The Wall Street Journal, November 13, 2009 ---
Click Here

Critics of Fannie Mae and Freddie Mac were waved off as cranks and assured that the companies wouldn't need a taxpayer bailout right up until the moment that they did. Some $112 billion later and counting, this political history may be repeating itself with the Federal Housing Administration, which yesterday announced that its capital reserve ratio has fallen to 0.53%.

That cushion is far below the 2% of its liabilities that Congress mandates, itself a 50 to 1 leverage ratio, and down from 3% last autumn. The FHA's mortgage guarantees in 2009 are four times higher than they were in 2007. Nearly 18% of its loans are 30 days or more past due, while mortgages guaranteed in 2007 are "on par with FHA's worst-ever books from the early 1980s," according to the Department of Housing and Urban Development's report to Congress. The financial deterioration is the result of the agency's plunge into high-risk loans over the last two years, asking dangerously low down payments of 3.5% from unqualified borrowers.

The FHA strikes a note of optimism by claiming that its book of business is improving and that "the just-completed actuarial studies show that FHA's capital reserve ratio will not dip below zero under most of the economic scenarios considered." The Administration has also made some modest reforms. Still, if housing values don't recover, or if by some chance the agency can't outrun its problems, the report admits that the FHA could ask taxpayers for $1.6 billion in 2012. Judging from history, that's probably a low-ball estimate.

Congress doesn't mind because these liabilities are technically off budget, until they aren't. This was all so predictable—and, ahem, predicted.


Are economists worse than the Keystone Cops?
"The Financial Crisis and the Systemic Failure of Academic Economics," 2008
Dahlem Report on the Economic Crisis --- http://www.cs.trinity.edu/~rjensen/temp/Dahlem_Report_EconCrisis021809.pdf

Abstract:
The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.


Two Videos Damning Capitalism: One Stupid, One Smart

Michael Moore cheered the bankruptcy of General Motors and absolutely despises the comeback of General Motors
He has a relatively long list (some lucrative to him) leftist documentaries --- http://en.wikipedia.org/wiki/Michael_Moore
His documentary Sicko got it wrong --- Cuba is not the dream country of equity and quality in health care for the masses
Now he has a new documentary entitled:  Capitalism:  A Love Story

 

The Stupid Video
"Michael Moore Gets It Wrong," by John Stossel, ABC News, July 11, 2009 --- http://blogs.abcnews.com/johnstossel/2009/07/michael-moore-gets-it-wrong.html

Michael Moore has been working on another documentaryThis time, he’s taking on capitalism:

"The wealthy, at some point, decided they didn't have enough wealth. They wanted more -- a lot more. So they systematically set about to fleece the American people out of their hard-earned money."

How ridiculous is that?  The wealthy, and everyone else, almost always decide that they don’t have enough wealth.  People ask their bosses for raises.  We invest in stocks hoping for bigger returns than Treasury Bonds bring.  “Greed” is a constant.  The beauty of free markets, when government doesn’t meddle in them, is that they turn this greed into a phenomenal force for good.  The way to win big money is to serve your customers well.  Profit-seeking entrepreneurs have given us better products, shorter work days, extended lives, and more opportunities to write the script of our own life.

On Thursday, Moore announced the title of the movie:  Capitalism: A Love Story.

It’s a title I might have picked to make a point opposite of what I assume Moore has in mind.  

Moore also fails to understand is that it was not “capitalism” run amok that caused today’s financial problems.   In reality, it was a combination of ill-conceived government policies and an overzealous Federal Reserve artificially lowering interest rates to fuel a bubble in the housing market.  Then it was government that took money from taxpayers and forced banks to accept it.

Moore ought to understand that, because he makes a good point when he says his movie will be about "the biggest robbery in the history of this country - the massive transfer of U.S. taxpayer money to private financial institutions."

That is indeed robbery.  It sure doesn’t sound like capitalism.

The Smart Video
Better Video Damning "Managerial Capitalism" and It's Free Online ---
Click Here
http://snipurl.com/managerialcapitalism  
 [fora_tv]  

The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print

Being Honest About Being Dishonest
Democrats openly admit that most of the stimulus money is going to counties that voted for Obama

A new study released by USA Today also finds that counties that voted for Obama received about twice as much stimulus money per capita as those that voted for McCain. "The stimulus bill is designed to help those who have been hurt by the economic downturn.... Do you see disparity out there in where the money is going? Certainly," a Democratic congressional staffer knowledgeable about the process told FOXNews.com.
John Lott, "ANALYSIS: States Hit Hardest by Recession Get Least Stimulus Money," Fox News, July 19, 2009--- http://www.foxnews.com/story/0,2933,533841,00.html


 

 

Their report, "Dreaming with BRICs: The Path to 2050," predicted that within 40 years, the economies of Brazil, Russia, India and China - the BRICs - would be larger than the US, Germany, Japan, Britain, France and Italy combined. China would overtake the US as the world's largest economy and India would be third, outpacing all other industrialised nations. 
"Out of the shadows," Sydney Morning Herald, February 5, 2005 --- http://www.smh.com.au/text/articles/2005/02/04/1107476799248.html 

The first economist, an early  Nobel Prize Winning economist, to raise the alarm of entitlements in my head was Milton Friedman.  He has written extensively about the lurking dangers of entitlements.  I highly recommend his fantastic "Free to Choose" series of PBS videos where his "Welfare of Entitlements" warning becomes his principle concern for the future of the Untied States 25 years ago --- http://www.ideachannel.com/FreeToChoose.htm 

Our legislators did not heed his early warnings, and now we are no longer "free to choose."


 

Alan Blinder --- http://en.wikipedia.org/wiki/Alan_Blinder

Disclaimer
I've never been a fan of the progressive scholarship of Alan Blinder. He's been a promoter of low (virtually zero) interest rates for megabanks that I think are turning into a disaster in this economic recovery. Ben Bernanke can do no wrong in the eyes of Professor Blinder. In my opinion, the real Bernanke-Blinder disaster is their support of restraining the government budget deficit with Zimbabwe economics that entails printing more greenbacks (over $2 trillion to date) rather than taxing or borrowing what is needed to fight the deficit. Actually the government does not add to the money supply by literally printing greenbacks. But having the Fed buy up over 60% of the new government debt is tantamount to printing greenbacks.

Taxing and borrowing to support government spending are going out of style.
The main problem with Zimbabwe economics is that it does little to restrain the excesses of government spending --- which we are now witnessing in the economic mess in Greece. Greece, of course, cannot simply print Euros to continue to feed government spending excesses. Greece has to get out of the Euro Zone to engage in the Zimbabwe economics of Benanke and Blinder. Of course all of Europe might soon engage in Zimbabwe economics to pay its debts. Taxing and borrowing to support government spending are going out of style.

The video is a anti-Bernanke musical performance by the Dean of Columbia Business School ---
http://www.youtube.com/watch?v=3u2qRXb4xCU
Ben Bernanke (Chairman of the Federal Reserve and a great friend of megabanks) --- http://en.wikipedia.org/wiki/Ben_Bernanke
R. Glenn Hubbard (Dean of the Columbia Business School) ---
http://en.wikipedia.org/wiki/Glenn_Hubbard_(economics)

The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance.
Taylor Caldwell, A Pillar of Iron (wrongly attributed to Cicero in 55 B.C.)

But under my philosophy of sharing all sides of arguments, I forward the following case.
Teaching Case from The Wall Street Journal Accounting Weekly Review on May 25, 2012

The Long and Short of Fiscal Policy
by: Alan S. Blinder
May 22, 2012
Click here to view the full article on WSJ.com
 

TOPICS: Governmental Accounting, Income Tax, Tax Laws, Tax Policy, Taxation

SUMMARY: Alan S. Blinder "...is a former vice chairman of the Federal Reserve [and is now] a professor of economics and public affairs at Princeton University." This opinion page piece provides a clear explanation of macroeconomic effects of budget deficits, tax cuts, and spending cuts, emphasizing the "macroeconomic effects of budget deficits in the short and long runs."

CLASSROOM APPLICATION: The article is useful in either a tax course or a governmental accounting class. The related article presents letters to the editor with more Republican viewpoints than Mr. Blinder's.

QUESTIONS: 
1. (Advanced) What are budget deficits?

2. (Introductory) Why can budget deficit spending be beneficial for the U.S. economy in the short run?

3. (Introductory) Why are budget deficits bad for the U.S. economy in the long run?

4. (Advanced) What tax law changes are imminent in January 2013? How do they relate to the comic graphic associated with this opinion piece? In your answer, comment on the size of these changes relative to the total economy.

5. (Introductory) How might specific choices in spending be more helpful than other possible choices? In your answer, explain the use of return on investment in these decisions, defining that finance concept as well.

6. (Introductory) What is the biggest cost component that could most readily reduce the long term budget deficit problem we face in the U.S.?

7. (Introductory) What does Mr. Blinder recommend as a plan for our national fiscal policy?
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
Perhaps the 2013 Fiscal Cliff Presents an Opportunity
by Letters to the Editor: Carroll Hoke, Frank Peel, and Keith Colonna
Mar 23, 2012
Page: A14

"The Long and Short of Fiscal Policy," by: Alan S. Blinder, The Wall Street Journal, May 22, 2012 ---
http://online.wsj.com/article/SB10001424052702303360504577408490648029470.html?mod=djem_jiewr_AC_domainid

Can we talk about the federal budget deficit? Better yet, can we think about it? For there has been a lot more talking than thinking. One persistent point of confusion arises from the radically different macroeconomic effects of larger budget deficits in the short and long runs.

In the short run—let's say within a year or so—a larger deficit, whether achieved by spending more or taxing less, boosts economic growth by increasing aggregate demand. It's pretty simple. If the government spends more money without raising anyone's taxes to pay the bills, that adds to total demand directly.

That's true, by the way, whether you like the specific expenditures or hate them. Similarly, cutting somebody's taxes without also cutting spending raises spending indirectly—again, whether you like the tax cut or not.

A second layer of subtlety recognizes that some types of spending and some types of tax cuts have larger effects on spending than others, and similarly, that some types are more sharply targeted on job creation than others. Such details matter in designing a cost-effective stimulus package. But for present purposes, let's keep it simple: Higher spending or lower taxes speed up growth by adding to demand.

So, as long as the government can borrow on reasonable terms, the crucial short-run question is: Does the economy need more or less demand? For the last several years, the answer has been clear: more. Bolstering demand was the rationale for fiscal stimulus under President Bush in 2008 and under President Obama in 2009. It remains a persuasive rationale for further stimulus today.

But that's not going to happen. Instead, the operational budget objective for the coming months is to ensure that we don't shoot ourselves in the collective foot with fiscal austerity while the economy is still weak. Sounds foolish, but we could make that grievous error either by letting ourselves fall off the so-called fiscal cliff that awaits us in January (tax increases and spending cuts amounting to 3.5%-4% of GDP), or by crashing headlong into the national debt ceiling, as we almost did last summer.

But don't we need to reduce the deficit—and by large amounts? Yes, we do, but that's in the long run, where the effects of larger deficits are mostly harmful to economic growth. In the jargon, more government borrowing tends to "crowd out" private borrowers by pushing interest rates up. Those crowded-out borrowers include both consumers who want to buy cars and businesses that want to buy equipment. In the latter case, higher government budget deficits take a toll on growth by slowing down capital formation.

There is an important exception, however, which is highly germane to today's situation. Suppose government borrowing is used to finance productive investments in public capital—such as highways, bridges, and tunnels. Right now, the U.S. government can borrow for 10 years at under 2% per annum. At these super-low interest rates, you don't have to be a genius to find many public infrastructure projects with strongly positive net present values. Borrowing to make such investments will enhance long-run growth, not retard it. And I can't, for the life of me, understand why we are not doing more of it.

But other types of spending, and any tax cut that does not boost capital formation enough, will slow down growth. And that's the fundamental indictment of large deficits.

To think clearly about how to shrink the long-run deficit, we must understand its origins. Looking ahead, the lion's share of projected future deficits comes from rising health-care expenditures.

Some of this cost escalation stems from heavier usage—consuming more health services per capita. But most of it comes from ever-rising relative prices; health care just keeps getting more expensive relative to almost everything else. The good news is that, if we could somehow limit health-care inflation to the overall inflation rate, much of the long-run budget problem would virtually vanish. The bad news is that nobody knows how to do that.

Given this ignorance, President Obama's health-care reform law, which Republicans want to repeal and the Supreme Court may vacate, takes a sensible approach to cost control. It includes—either on an experimental, small-scale, or pilot basis—virtually every cost-containment idea that has been suggested. The pragmatic attitude is: Let's try everything and go with what works.

But what about the middle, between the short run and the long run? When should the federal government get serious about paring its deficit? There is no formulaic answer, but U.S. Treasury borrowing rates will provide a clue. When they start rising on a sustained basis, it will be time to push deficits down. Another important clue will be the health of the economy. The government should stop supporting aggregate demand when the economy is strong enough to stand on its own two feet.

Continued in article

Jensen Comment
What Blinder does not admit to is that government borrowing rates are not allowed to go up as long as the Fed buys over 60% of the new debt issues in its Zimbabwe economic policy. I think I'm going to throw up!

Alan Blinder is all smoke and mirrors in an election year.

Bob Jensen's threads on The Greatest Swindle in the History of the World ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout


Bernanke's money printing press
On March 18, the Federal Reserve announced it would purchase up to $300 billion of long-term bonds as well as $750 billion of mortgage-backed securities. Of all the Fed's moves, this "quantitative easing" gets money into the economy the fastest -- basically by cranking the handle of the printing press and flooding the market with dollars (in reality, with additional bank credit). Since these dollars are not going into home building, coal-fired electric plants or auto factories, they end up in the stock market. A rising market means that banks are able to raise much-needed equity from private money funds instead of from the feds. And last Thursday, accompanying this flood of new money, came the reassuring results of the bank stress tests. The next day Morgan Stanley raised $4 billion by selling stock at $24 in an oversubscribed deal. Wells Fargo also raised $8.6 billion that day by selling stock at $22 a share, up from $8 two months ago. And Bank of America registered 1.25 billion shares to sell this week. Citi is next. It's almost as if someone engineered a stock-market rally to entice private investors to fund the banks rather than taxpayers.

Andy Kessler, "Was It a Sucker's Rally? You can have a jobless recovery but you can't have a profitless one," The Wall Street Journal, May 12, 2009 --- http://online.wsj.com/article/SB124208415028908497.html

Bernanke is insanely printing hundreds of millions of dollars that do not arise from taxes or borrowing
We remember that 2003 debate because it turns out we played a part in it. The Fed recently released the transcripts of its 2003 FOMC meetings, and what a surprise to find a Journal editorial the subject of an insider rebuttal from none other than Ben Bernanke, then a Fed Governor and now Chairman. We had run an editorial on monetary policy on the same day as the Dec. 9, 2003 FOMC meeting, and Mr. Bernanke clearly didn't take well to our warning about "Speed Demons at the Fed."We reprint nearby both Mr. Bernanke's comments and our editorial from that day. Readers can judge who got the better of the argument, but far more important is what Mr. Bernanke's reasoning tells us about the Fed today. Our guess is that it won't reassure holders of dollar assets
"Bernanke at the Creation: What the Fed Chairman said at the onset of the credit bubble, and the lesson for today," The Wall Street Journal, June 23, 2009 --- http://online.wsj.com/article/SB124572415681540109.html

Video on the Long-term Disaster of Beranke's Money Supply Printing Press That Will Kick in Hyperinflation ---
http://www.youtube.com/watch?v=dlHBYQrCnIk
Will the U.S. become Zimbabwe? --- http://www.trinity.edu/rjensen/entitlements.htm

Can you see why I believe this is a sucker's rally?
The stock market still has big hurdles to clear. You can have a jobless recovery, but you can't have a profitless recovery. Consider: Earnings are subpar (and may get worse with more concessions to labor unions), Treasury's last auction was a bust because of weak demand, the dollar is suspect, the stimulus is pork, the latest budget projects a $1.84 trillion deficit, the administration is berating investment firms and hedge funds saying "I don't stand with them," California is dead broke, health care may be nationalized, cap and trade will bump electric bills by 30% . . . Shall I go on? Until these issues are resolved, I don't see the stock market going much higher. I'm not disagreeing with the Fed's policies -- but I won't buy into a rising stock market based on them. I'm bullish when I see productivity driving wealth.
Andy Kessler, "Was It a Sucker's Rally? You can have a jobless recovery but you can't have a profitless one," The Wall Street Journal, May 12, 2009 --- http://online.wsj.com/article/SB124208415028908497.html
Jensen Comment
Nobody can be counted on to predict the stock market and the unpredictable shocks that affect it. One shock that will ultimately drive equity market prices up is inflation, and inflation is inevitable with Obama's annual egalitarian deficits of $2 trillion or more. One problem with inflation is that nobody can accurately predict just when the stock market will make huge upward moves for Zimbabwe-like inflation. A second problem is that paper profits on equity are not real profits. They're probably losses in spending power. If these huge Obama deficits continue in the future, both debt and equity will have to be indexed for inflation when investors cease to be suckers. For many years investors in high-inflation nations like Brazil stopped being suckers. Virtually all security investments in Brazil are indexed for inflation.

America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück, the German finance minister, in September 2008....“the United States will lose its status as the superpower of the global financial system.” You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire.
Richard Florida, "How the Crash Will Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

Bob Jensen’s threads on impending disaster --- http://www.trinity.edu/rjensen/2008Bailout.htm#NationalDebt

 

Once the spigot is turned on it's almost never turned off:  That's how special appropriations become entitlements
Several university presidents and higher-education officials went to Capitol Hill on Tuesday to thank lawmakers for committing more
($21.5 billion) funds for scientific research, but they worried about what might happen to their budgets if that commitment didn't continue.
Paul Baskey, "Universities Are Wary of Drawbacks to a Huge Boost in Federal Spending," Chronicle of Higher Education, March 25, 2009 --- http://chronicle.com/daily/2009/03/14470n.htm?utm_source=at&utm_medium=en
Jensen Comment
This is the same argument that will be raised by virtually all recipients of the 2009 massive Stimulus (Recovery) Act handouts to states, education/research institutions, welfare programs, public works projects, etc. Once the spigot is turned on such handouts are hard to stop in future budget years. They become entitlements that will make President Obama's promise to reduce the Year 2012 budget deficit a complete and utter failure. Both logic and sob stories make it virtually impossible to turn the spigots off once they've been turned on. This is one of the common problems of budgeting in general except for Zero-Based Budgeting that almost never takes place in industry and probably has never taken place in state and federal governments.
Bob Jensen's threads on the entitlements disaster are at http://www.trinity.edu/rjensen/Entitlements.htm

Tim Geithner Draws a Big Laugh and Lots of Sighs In China
U.S. Treasury Secretary Timothy Geithner on Monday reassured the Chinese government that its huge holdings of dollar assets are safe and reaffirmed his faith in a strong U.S. currency. A major goal of Geithner's maiden visit to China as Treasury chief is to allay concerns that Washington's bulging budget deficit and ultra-loose monetary policy will fan inflation, undermining both the dollar and U.S. bonds. China is the biggest foreign owner of U.S. Treasury bonds. U.S. data shows that it held $768 billion in Treasuries as of March, but some analysts believe China's total U.S. dollar-denominated investments could be twice as high. "Chinese assets are very safe," Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s. His answer drew loud laughter from his student audience, reflecting skepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.
Glenn Somerville, Reuters, June 1, 2009 --- Click Here


The salary of the chief executive of a large corporation is not a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.
John Kenneth Galbraith --- Click Here

The total return of the S&P 500 index fell by nearly 40% last year, the second-worst performance by America’s stockmarket since 1825 --- http://www.simoleonsense.com/us-stockmarket-returns-since-1825/
But Wall Street's pay packages in 2009 are shooting for all time highs --- Click Here
Bob Jensen's threads on outrageous compensation --- http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation


Instead of adding more regulating agencies, I think we should simply make the FBI tougher on crime and the IRS tougher on cheats

Our Main Financial Regulating Agency:  The SEC Screw Everybody Commission
One of the biggest regulation failures in history is the way the SEC failed to seriously investigate Bernie Madoff's fund even after being warned by Wall Street experts across six years before Bernie himself disclosed that he was running a $65 billion Ponzi fund.

I’m deeply suspicious that there was possibly too much “experience” of a different type as well as “inexperience” cited as the main cause of the SEC’s negligence. The Inspector General’s Report leaves a lot to be desired.

"Statement by SEC Chairman: Statement on the Inspector General's Report Regarding the Bernard Madoff Fraud," by SEC Chairman Mary Shapiro, SEC Speech, September 4, 2009 --- http://sec.gov/news/speech/2009/spch090409mls.htm

Inspector General's Report --- http://sec.gov/news/speech/2009/spch090409mls.htm

Swanson Acknowledged in Testimony that If He Had Carefully Reviewed the Complaint, He Would Have Investigated

Additional Red Flags That Were Raised Swanson stated the Hedge Fund Manager’s complaint and the 2001 articles mean something different to him today than they did at the time of the examination in 20032004, noting, “I didn’t know anything, very little anyway, about hedge funds and mutual funds and how they operated.” Id. at p. 39. Swanson admitted that to someone who understood the hedge fund world, Madoff’s failure to charge money management fees “would probably be a little surprising.” Id. at p. 37. Swanson now reads the Hedge Fund Manager’s complaint to “indicate to me … [BMIS] may be not trading as much in options as they’re saying they’re doing,” and the red flag about the auditor to “signal some level of a lack of independence with respect to the auditor.” Id. at pgs. 37-38. Swanson testified that if he had reviewed the complaint, he would have wanted to look into the auditor issue. Swanson Testimony Tr. at p. 50. McCarthy and Donohue also thought that the allegation that the auditor was a related party to the principal was noteworthy and something that should have been followed up upon. Donohue Testimony Tr. at p. 42; McCarthy Testimony Tr. at p. 58. As Donohue explained, “His statement that the auditor of the firm is a related party to the principal would indicate that there are potential conflicts with the firm and the auditor.” Donohue Testimony Tr. at p. 42. However, during the course of the examination, the exam team did not examine whether the auditor of the firm was a related party to the principal.

. . .

ALLEGATIONS OF CONFLICT OF INTEREST OR IMPROPER INFLUENCE ARISING FROM THE RELATIONSHIP BETWEEN ERIC SWANSON AND SHANA MADOFF (Pages 389-404)

After his sworn testimony on June 19, 2009, Swanson provided supplemental information to the Office of the Inspector General, stating that he had a vague recollection that, “prior to 2005, he and Mr. McCarthy discussed the appropriateness of working on matters involving Madoff in light of their participation in the compliance breakfasts, and that neither he nor McCarthy determined that they should be recused.” Letter dated June 19, 2009 from Michael Wolk, Counsel to Swanson, to IG Kotz, at p. 2, at Exhibit 183. Swanson also stated that he “took comfort in the fact that Lori Richards, Director, Office of Compliance Inspections and Examinations, was aware that the breakfasts were sponsored by the Securities Industry Association (SIA).” Id.

Jensen Comment
This part of the Inspector General's report relies a lot upon Eric Swanson's claims of not being able to remember much about his early-on relationships with Shana Madoff. About this part of the Report I am very suspicious. However, early news accounts are also somewhat inconsistent.

"Ponzi Schemer's Label-Whoring Niece Married SEC Lawyer," by Owen Thomas, December 16, 2008 ---
http://gawker.com/5111942/ponzi-schemers-label+whoring-niece-married-sec-lawyer

Shana Madoff, whose uncle Bernie Madoff stands accused of defrauding investors of $50 billion (later raised to over $65 billion), is the wife of Eric Swanson, a former top lawyer at the Securities and Exchange Commission. A goy, but well-placed!

So well-placed that SEC chairman Christopher Cox is now elaborately raising his eyebrows about the relationship — especially since Shana Madoff worked as the compliance lawyer at Bernard L. Madoff Investment Securities, and met Swanson at a trade association event. . . . 

Swanson resigned from the SEC in 2006, and the couple married in 2007. But they clearly dated for a while before that.

Some have suggested that Shana Madoff is a "shopaholic." So not technically true! Why, she married the manager of a men's clothing store in 1997, but that didn't work out. A 2004 New York profile detailed her simultaneous affection for Narciso Rodriguez and aversion to actually going out and shopping. Instead of trying on clothes at the store, she had salespeople messenger the entire collection to her office, and charge her only for what she didn't return. The article mentions her having a boyfriend. Was that Swanson, whom one SEC colleague said conducted a review of Madoff's firm in 1999 and 2004?

A spokesman for Swanson — they get flacks quickly these days, don't they — told ABC News that he "did not participate in any inquiry of Bernard Madoff Securities or its affiliates while involved" (it was later shown that he was very involved in the Madoff "investigation" while at the SEC) with Shana Madoff. How convenient!

But that could be said about pretty much all of his coworkers. The SEC first fielded complaints about the Madoff firm in 1999, but never opened a formal investigation that would have allowed it to subpoena records. In 2006, Bernard Madoff registered as an investment advisor with the SEC, but the agency never conducted a standard review. Are you beginning to get a picture of why Shana Madoff, who was charged with keeping the company out of trouble with regulators, was so busy she couldn't even go shopping?

Swanson was at the commission in 2003 when the agency was examining the Madoff firm. More importantly, he was also part (leader) of the SEC team that was conducting the actual inquiry into the firm . . .  What does all this mean? Nothing, according to Shana Madoff or her husband, whom she married in 2007. A spokesman for Shana Madoff and one for Swanson confirm that both knew each other professionally during the time of the examination.
"Madoff Victims Claim Conflict of Interest at SEC," CNBC, December 15, 2008 ---
http://www.cnbc.com/id/28242487

Madoff Timeline --- http://www.madoff-help.com/wp-content/uploads/2009/06/timeline.pdf

 

"Madoff Inquiry Was Fumbled by S.E.C., Report Says," by David Stout, The New York Times, September 2, 2009 ---
http://www.nytimes.com/2009/09/03/business/03madoff.html?_r=1&hp

In a damning report on the S.E.C.’s performance, the agency’s inspector general, H. David Kotz, said numerous “red flags” had been missed by the agency, including some warnings sounded by journalists, well before Mr. Madoff’s Ponzi scheme imploded in 2008.

Mr. Kotz concluded that, “despite numerous credible and detailed complaints,” the S.E.C. never properly investigated Mr. Madoff “and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme.”

“Had these efforts been made with appropriate follow-up at any time beginning in June of 1992 until December 2008, the S.E.C. could have uncovered the Ponzi scheme well before Madoff confessed,” the report concluded.

That Mr. Madoff’s scheme, estimated to have fleeced as much as $65 billion from investors who ranged from the famous to middle-class people who entrusted him with their life savings, was not caught earlier was not because of his cleverness, the report said. Rather, it was because the S.E.C. fumbled three agency exams and two investigations because of inexperience, incompetence and lack of internal communications.

Continued in article

Bob Jensen's fraud updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm


"Ponzi Schemer's Label-Whoring Niece Married SEC Lawyer," by Owen Thomas, December 16, 2008 ---
http://gawker.com/5111942/ponzi-schemers-label+whoring-niece-married-sec-lawyer

Shana Madoff, whose uncle Bernie Madoff stands accused of defrauding investors of $50 billion (later raised to over $65 billion), is the wife of Eric Swanson, a former top lawyer at the Securities and Exchange Commission. A goy, but well-placed!

So well-placed that SEC chairman Christopher Cox is now elaborately raising his eyebrows about the relationship — especially since Shana Madoff worked as the compliance lawyer at Bernard L. Madoff Investment Securities, and met Swanson at a trade association event. (Can you imagine what a swinging scene that was?)

Swanson resigned from the SEC in 2006, and the couple married in 2007. But they clearly dated for a while before that.

Some have suggested that Shana Madoff is a "shopaholic." So not technically true! Why, she married the manager of a men's clothing store in 1997, but that didn't work out. A 2004 New York profile detailed her simultaneous affection for Narciso Rodriguez and aversion to actually going out and shopping. Instead of trying on clothes at the store, she had salespeople messenger the entire collection to her office, and charge her only for what she didn't return. The article mentions her having a boyfriend. Was that Swanson, whom one SEC colleague said conducted a review of Madoff's firm in 1999 and 2004?

A spokesman for Swanson — they get flacks quickly these days, don't they — told ABC News that he "did not participate in any inquiry of Bernard Madoff Securities or its affiliates while involved" (it was later shown that he was veru involved in the Madoff "investigation" while at the SEC) with Shana Madoff. How convenient!

But that could be said about pretty much all of his coworkers. The SEC first fielded complaints about the Madoff firm in 1999, but never opened a formal investigation that would have allowed it to subpoena records. In 2006, Bernard Madoff registered as an investment advisor with the SEC, but the agency never conducted a standard review. Are you beginning to get a picture of why Shana Madoff, who was charged with keeping the company out of trouble with regulators, was so busy she couldn't even go shopping?

Swanson was at the commission in 2003 when the agency was examining the Madoff firm. More importantly, he was also part of the SEC team that was conducting the actual inquiry into the firm . . .  What does all this mean? Nothing, according to Shana Madoff or her husband, whom she married in 2007. A spokesman for Shana Madoff and one for Swanson confirm that both knew each other professionally during the time of the examination.
"Madoff Victims Claim Conflict of Interest at SEC," CNBC, December 15, 2008 ---
http://www.cnbc.com/id/28242487

Madoff Timeline --- http://www.madoff-help.com/wp-content/uploads/2009/06/timeline.pdf


CBS Sixty Minutes on June 14, 2009 ran a rerun that is devastatingly critical of the SEC. If you’ve not seen it, it may still be available for free (for a short time only) at http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
The title of the video is “The Man Who Would Be King.”
Also see http://www.fraud-magazine.com/FeatureArticle.aspx

Between 2002 and 2008 Harry Markopolos repeatedly told (with indisputable proof) the Securities and Exchange Commission that Bernie Madoff's investment fund was a fraud. Markopolos was ignored and, as a result, investors lost more and more billions of dollars. Steve Kroft reports.

Markoplos makes the SEC look truly incompetent or outright conspiratorial in fraud.

I'm really surprised that the SEC survived after Chris Cox messed it up so many things so badly.

As Far as Regulations Go

An annual report issued by the Competitive Enterprise Institute (CEI) shows that the U.S. government imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the $1.2 trillion generated by individual income taxes, and amounts to $3,849 for every American citizen. According the 2009 edition of Ten Thousand Commandments: An Annual Snapshot of the Federal Regulatory State, the government issued 3,830 new rules last year, and The Federal Register, where such rules are listed, ballooned to a record 79,435 pages. “The costs of federal regulations too often exceed the benefits, yet these regulations receive little official scrutiny from Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report. “The U.S. economy lost value in 2008 for the first time since 1990,” Crews said. “Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on Americans beyond the $3 trillion officially budgeted” through the regulations.
 Adam Brickley, "Government Implemented Thousands of New Regulations Costing $1.17 Trillion in 2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487

Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur Levitt to Chris Cox do absolutely nothing to change my belief ---
http://www.trinity.edu/rjensen/FraudRotten.htm

How do industries leverage the regulatory agencies?
The primary control mechanism is to have high paying jobs waiting in industry for regulators who play ball while they are still employed by the government. It happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so many people work for the FBI and IRS, it's a little harder for industry to manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of the worst offenders whereas other agencies often deal with top management of the largest companies in America.


Why Obama's Big Spending, Big Taxing Regime Will Cripple the U.S. Economy
Before any article on savings and investment can really make sense, it must first define what savings and investment really mean. Saving is the process of transforming present goods into future goods. Present goods are consumption goods and future goods are capital goods. When we save, we transfer purchasing power from consumption to the production of capital goods, many of which will then be used to produce more capital goods. (This is why growth is sometimes called forgone consumption.) Investment in more capital (the material means of production) makes for increased future consumption, i.e., higher living standards. It needs little imagination to realise that taxing savings amounts to taxing future living standards. What needs to be remembered is that when defined in real terms, investment and savings are (a) always equal and (b) saving is clearly the only means by which resources can be directed from consumption to investment. To put it another way: The function of savings is to redirect resources from the production of consumption goods to the production of capital goods.
"Why Obama's Big Spending, Big Taxing Regime Will Cripple the U.S. Economy," Seeking Alpha, March 23, 2009 ---
http://seekingalpha.com/article/127312-why-obama-s-big-spending-big-taxing-regime-will-cripple-the-u-s-economy

Not a single county in the entire state (California) voted for the tax-and-spend propositions on yesterday's referendum ballot, not even the peculiar folks who live in Nancy Pelosi's far-left 8th Congressional District who persist in sending the Wicked Witch of the West to the Nation's Capitol to wage war on the CIA and the nation's taxpayers. The only measure voters did approve was one to freeze salaries of senior public officials during budget emergencies.
Michael Reagan, "Terminating the Terminator," Townhall, May 20, 2009 ---
http://townhall.com/columnists/MichaelReagan/2009/05/20/terminating_the_terminator
Jensen Comment
What's worse in many respects is that California voters sent a message to President Obama that taxing the middle class (the only way to raise serious deficit-cutting revenue) to halt deficit-induced halt hyperinflation of the U.S. dollar will not be supported by voters.
See http://townhall.com/columnists/MattTowery/2009/05/21/california,_here_we_come

A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury, with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had this to say about 2000 years after "The Fall of the Athenian Republic" and about the time our original 13 states adopted their new constitution.
As quoted at http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for updates by the second) --- http://www.brillig.com/debt_clock/

America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück, the German finance minister, in September 2008....“the United States will lose its status as the superpower of the global financial system.” You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office and replaced it with a bust of Lincoln who wrote that Government should print all the money it needs without borrowing)

2001 Economic Crisis Prediction of George W. Bush (video) --- http://www.youtube.com/watch?v=cMnSp4qEXNM&NR=1

The government should create, issue, and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers. By adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity.
Abraham Lincoln (I wonder why this just does not work in Zimbabwe where Robert Mugabe adopted Lincoln's fiscal policy?)

The Abraham Lincoln School of Finance in Action
Zimbabwe's central bank will introduce a 100 trillion Zimbabwe dollar banknote, worth about $33 on the black market, to try to ease desperate cash shortages, state-run media said on Friday.

 KyivPost, January 16, 2009 --- http://www.kyivpost.com/world/33522

Who stands between the Obama and the Abraham Lincoln School of Finance?
If China won't lend trillions more to the U.S., Obama may have to print those trillions of dollars:  Watch inflation/trade deficits soar like a NASA rocket
The Chinese prime minister, Wen Jiabao, expressed unusually blunt concern on Friday about the safety of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to provide assurances that the securities would maintain their value in the face of a global financial crisis.
Michael Wines and Keith Bradsher, "China’s Leader Says He Is ‘Worried’ Over U.S. Treasuries," The New York Times, March 13, 2009 --- http://www.nytimes.com/2009/03/14/world/asia/14china.html?_r=1&hp

America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück, the German finance minister, in September 2008....“the United States will lose its status as the superpower of the global financial system.” You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will Reshape America," The Atlantic, March 2009 --- http://www.theatlantic.com/doc/200903/meltdown-geography

And while you are at it, you might read another book published the same year as Hayek's book was: The Great Transformation by Karl Polanyi. It is Polanyi who is truly in the tradition of Adam Smith in that he incorporates ethics and sociological considerations into his economics. Smith was a moral philosopher before he was an economist. Hayek was used as a spokesperson by the ultra-conservative anti-Keynesians of the time. Life magazine even put out a cartoon version of Hayek's book. Academics might want to get a fuller picture and read both Polanyi and Hayek to understand two major currents of thought at the time.
Sue Ravenscroft, Iowa State University

The US government is on a “burning platform” of unsustainable policies and practices with fiscal deficits, chronic healthcare underfunding, immigration and overseas military commitments threatening a crisis if action is not taken soon.
David M. Walker, Former Chief Accountant of the United States --- http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt for entitlements (over five times the booked national debt and soaring with new entitlements) --- http://www.trinity.edu/rjensen/entitlements.htm

South Park's animated cartoon solutions to the economic crisis Part 1 --- http://www.youtube.com/watch?v=Qx_sH_G38oY
South Park's animated cartoon solutions to the economic crisis Part 2 --- http://www.youtube.com/watch?v=KUIDG0n74J0
South Park's animated cartoon solutions to the economic crisis Part 3 --- http://www.youtube.com/watch?v=UbFcYuJ_H8c

Question
What caused the credit crisis and why can't credit be unlocked after throwing over $1 trillion at the big banks?

Great answers on Video --- this is a must-see video for you, your family, and your students who want to understand these banking failures
The Short and Simple Video About What Caused the Credit Crisis --- http://vimeo.com/3261363
Also at http://www.youtube.com/watch?v=Q0zEXdDO5JU
Ed Scribner forwarded the above links


The 2008-2009 Economic Downfall
Great Graphic:  Infographic: Anatomy of the Crash
http://www.simoleonsense.com/infographic-anatomy-of-the-crash/
Bob Jensen's threads on the downfall --- http://www.trinity.edu/rjensen/2008Bailout.htm 


Questions
Although all 50 states are in deep financial troubles, what state is in the worst shape at the moment and is unable to pay its bills?
Hint: The state in deepest trouble is not California, although California is in dire straights!

How did accountants hide the pending disasters?

Watch the Video
This module on 60 Minutes on December 19 was one of the most worrisome episodes I've ever watched
It appears that a huge number of cities and towns and some states will default on bonds within12 months from now
"State Budgets: The Day of Reckoning Steve Kroft Reports On The Growing Financial Woes States Are Facing," CBS Sixty Minutes, December 19, 2010 ---
http://www.cbsnews.com/stories/2010/12/19/60minutes/main7166220.shtml

The problem with that, according to Wall Street analyst Meredith Whitney, is that no one really knows how deep the holes are. She and her staff spent two years and thousands of man hours trying to analyze the financial condition of the 15 largest states. She wanted to find out if they would be able to pay back the money they've borrowed and what kind of risk they pose to the $3 trillion municipal bond market, where state and local governments go to finance their schools, highways, and other projects.

"How accurate is the financial information that's public on the states? And municipalities," Kroft asked.

"The lack of transparency with the state disclosure is the worst I have ever seen," Whitney said. "Ultimately we have to use what's publicly available data and a lot of it is as old as June 2008. So that's before the financial collapse in the fall of 2008."

Whitney believes the states will find a way to honor their debts, but she's afraid some local governments which depend on their state for a third of their revenues will get squeezed as the states are forced to tighten their belts. She's convinced that some cities and counties will be unable to meet their obligations to municipal bond holders who financed their debt. Earlier this year, the state of Pennsylvania had to rescue the city of Harrisburg, its capital, from defaulting on hundreds of millions of dollars in debt for an incinerator project.

"There's not a doubt in my mind that you will see a spate of municipal bond defaults," Whitney predicted.

Asked how many is a "spate," Whitney said, "You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars' worth of defaults."

Municipal bonds have long been considered to be among the safest investments, bought by small investors saving for retirement, and held in huge numbers by big banks. Even a few defaults could affect the entire market. Right now the big bond rating agencies like Standard & Poor's and Moody's, who got everything wrong in the housing collapse, say there's no cause for concern, but Meredith Whitney doesn't believe it.

"When individual investors look to people that are supposed to know better, they're patted on the head and told, 'It's not something you need to worry about.' It'll be something to worry about within the next 12 months," she said.

No one is talking about it now, but the big test will come this spring. That's when $160 billion in federal stimulus money, that has helped states and local governments limp through the great recession, will run out.

The states are going to need some more cash and will almost certainly ask for another bailout. Only this time there are no guarantees that Washington will ride to the rescue.

Continued in article

The Government' Recipe for Off-Budget Debt
"US Government 'hiding true amount of debt'," by Gregory Bresiger, news,com ---
http://www.news.com.au/business/breaking-news/us-government-hiding-true-amount-of-debt/story-e6frfkur-1225926567256#ixzz106MjZzOz 

Bob Jensen's threads on the economic crisis ---
http://www.trinity.edu/rjensen/2008Bailout.htm

The Sad State of Government Accounting and Accountability ---
http://www.trinity.edu/rjensen/theory02.htm#GovernmentalAccounting

 


Question
Who more than anybody else is at fault for wiping out shareholders in AIG, Bear Stearns, Merrill Lynch, CitiBank, Bank of America, Washington Mutual, Fannie Mae, Freddie Mack, etc.

Answers
I primarily blame the CPA auditors, internal auditors, and credit rating agencies that failed to disclose the off-balance-sheet risks that fee-loving bankers had created. The auditors and credit rating agencies have a fiduciary and professional responsibility to disclose to investors the extent of looming uncollectable investments. For many years auditors have been knowingly understating banks' bad debt risks and failing to warn investors about such banking risks. I also think auditors, along with credit rating agencies, knew full well about the financial risks of their huge clients but were afraid to jeopardize their fees by blowing whistles.

Question
What more than anything else saved United Airlines and who is primarily at fault for wiping out the shareholders of United Airlines in 2002?

Answer
In December 2002 United Airlines filed Chapter 11 Bankruptcy. In order to get United's airplanes back in the air, the single most important saving device was to have Uncle Sam's taxpayers take over the lifetime retirement obligations to be paid to United's retired pilots, flight attendants, mechanics, passenger agents, and ground crews. This saved United Airlines with the help of some major wage concessions of existing employees who decided that keeping their jobs was the most important thing to them.

Once again the auditors are primarily at fault for not warning investors soon enough that United Airlines was not a viable going concern and would not be able to meet its unbooked liabilities called Off-Balance-Sheet-Financing (OBSF) by accountants. If investors had been warned years earlier, the stock market would've forced United Airlines to become more serious about pricing and funding of retirement obligations. But since investors were not forewarned by the auditors and credit rating agencies, the equity holders (many of them United Airlines employees) got wiped out by the 2002 declaration of bankruptcy.

Question
What more than anything else will save General Motors in 2009 and who is primarily at fault for wiping out the shareholders of General Motors?

In 2009 or 2010 filed General Motors will most likely declare Chapter 11 Bankruptcy. It will be Deja Vu United Airlines. In order to get GM's vehicles back on the road, the single most important saving device was to have Uncle Sam's taxpayers take over the retirement obligations (pensions and health care obligations) to be paid to GM's retired management and factory workers and GMAC retired employees as well. This will save GM with the help of some major wage concessions of existing GM employees who eventually decide that keeping their jobs was the most important thing to them.

Once again the auditors are primarily at fault for not warning investors soon enough that General Motors was not a viable going concern and would not be able to meet its unbooked liabilities called Off-Balance-Sheet-Financing (OBSF). If investors had been warned years earlier, the stock market would've forced General Motors to become more serious about pricing and funding of retirement obligations. But since investors were not forewarned by the auditors and credit rating agencies, the equity holders (many of them being huge investment funds) got wiped out by the forthcoming 2009 declaration of bankruptcy.

In fairness, the accountants did give more warning about OBSF unfunded retirement obligations in GM's case relative the United Airlines. Accountants did disclose some years ago that about $1,500 of each new vehicle sold went toward current funding of for retirement and health care of GM's retired workers. It's been widely known for some time that GM's retirement obligations were badly underfunded. What made it especially difficult for GM is that it's major foreign competitors were making longer-lasting vehicles that beat GM prices. The reason Toyota, Subaru, Nissan, etc. could undercut GM prices is that these foreign automakers did not have the serious unbooked OBSF obligations that GM carried on its back.

Question
What are the two secret numbers that you will never hear mentioned by Uncle Sam's current leaders like President Obama, House Speaker Pelosi, and Senate Leader Reid?

Answer
They will never mention the extent of Uncle Sam's unbooked OBSF liabilities. Accountants have no accurate estimates of these liabilities, but the former Chief Accountant of the United States, David Walker, estimates that these are about $60 trillion at the moment. They may well be $100 trillion in four years if Congress is successful in legislating tens of trillions of dollars in new entitlements for education, energy, welfare, and health care.

Uncle Sam's leaders are now focusing our attention on problems with the annual spending deficit (which may well approach $ trillion at the end of 2009) and the booked National Debt (which may well approach $12 trillion by the end of 2009). But these booked items will not break the back of Uncle Sam. What will break the back of Uncle Sam is what broke the back of United Airlines and General Motors. It's the unbooked OBSF debt which the companies, auditors, and credit rating agencies tried to keep secret.

Uncle Sam saved United Airlines by taking over United's OBSF retirement debt. Uncle Sam will probably do the same for GM, Ford, and Chrysler unfunded OBSF debt. But who will save Uncle Sam from its $60-$100 trillion of unfunded and unbooked OBSF debt?
Answer
Only the Abraham Lincoln School of Finance (see Lincoln’s quote below) will save Uncle Sam from its unsustainable OBSF

You, your family, and your students may learn a great deal from the links to David Walker's warning videos and the most worrisome CBS Sixty Minutes module ever produced --- http://www.trinity.edu/rjensen/entitlements.htm

The US government is on a “burning platform” of unsustainable policies and practices with fiscal deficits, chronic healthcare underfunding, immigration and overseas military commitments threatening a crisis if action is not taken soon.
David M. Walker, Former Chief Accountant of the United States --- http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt for entitlements (over five times the booked national debt and soaring with new entitlements) --- http://www.trinity.edu/rjensen/entitlements.htm

A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury, with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had this to say about 2000 years after "The Fall of the Athenian Republic" and about the time our original 13 states adopted their new constitution.
As quoted at http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for updates by the second) --- http://www.brillig.com/debt_clock/

America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück, the German finance minister, in September 2008....“the United States will lose its status as the superpower of the global financial system.” You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will Reshape America," The Atlantic, March 2009 --- http://www.theatlantic.com/doc/200903/meltdown-geography

The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office and replaced it with a bust of Lincoln who wrote that Government should print all the money it needs without  borrowing)

From the Abraham Lincoln School of Finance
The government should create, issue, and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers. By adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity.

Abraham Lincoln (I wonder why this just does not work in Zimbabwe where Robert Mugabe adopted Lincoln's fiscal policy?)

 For the sake of future America, we’d better hope that Lincoln was correct. But Lincoln’s fiscal policy sure did not work for Zimbabwe.

Facing mounting criticism of a spending package packed with billions of dollars in earmarks, the Obama administration made a vow Sunday: This president will bring a halt to pork-laden bills.
"Obama budget director: We'll cut pork after '09 spending bill," CNN, March 8, 2009 --- http://www.cnn.com/2009/POLITICS/03/08/obama.earmarks/index.html
Jensen Comment
If you believe this, I have a great deal on ocean front property in Arizona just for you. I'll also let you have the Brooklyn Bridge for $5,000.

Fannie Mae and Freddie Mac, the two troubled companies at the heart of the nation’s mortgage market, are set to pay their employees “retention bonuses” totaling $210 million, despite calls from lawmakers to cancel the payments. The bonuses, which were made public on Friday, were defended by the companies’ federal regulator, James B. Lockhart, who said he intended to let them proceed , , , Mr. Lockhart declined to discuss his conversations with the White House, which declined to comment on Friday. “This is a de facto White House endorsement of these payments, which is a little odd considering that everyone spent days talking about how they were shocked by the bonuses given to A.I.G.,” said Karen Shaw Petrou, a managing partner at Federal Financial Analytics, a consulting firm in Washington and a longtime observer of the companies. “It’s also a tempest in a teapot. We should worry less about $210 million in bonuses, and more about the fact that these companies are sitting atop $5 trillion of risks, and if they stumble, the American economy could disappear.”
Charles Duhigg, "Big Bonuses at Fannie and Freddie Draw Fire," The New York Times, April 3, 2009 --- http://www.nytimes.com/2009/04/04/business/04bonus.html?_r=1

New restrictions proposed for ratings agencies -- including Moody's, Fitch and Standard & Poor's -- could have unintended consequences, warn experts in the United States. Europe, however, has clamped down on the agencies, whose stamps of approval on a broad spectrum of subprime mortgage securities helped pave the way to the credit crash of 2007 and the continuing global recession.
"Reforming the Ratings Agencies: Will the U.S. Follow Europe's Tougher Rules?" Knowledge@Wharton , May 27, 2009 --- http://knowledge.wharton.upenn.edu/article.cfm?articleid=2242


Simoleon Sense Reviews Janet Tavakoli’s Dear Mr. Buffett ---
http://www.simoleonsense.com/simoleon-sense-reviews-janet-tavakolis-dear-mr-buffett/

What’s The Book (Dear Mr. Buffett) About

Dear Mr. Buffett, chronicles the agency problems, poor regulations, and participants which led to the current financial crisis. Janet accomplishes this herculean task by capitalizing on her experiences with derivatives, Wall St, and her relationship with Warren Buffett. One wonders how she managed to pack so much material in such few pages!

Unlike many books which only analyze past events, Dear Mr. Buffett, offers proactive advice for improving financial markets. Janet is clearly very concerned about protecting individual rights, promoting honesty, and enhancing financial integrity. This is exactly the kind of character we should require of our financial leaders.

Business week once called Janet the Cassandra of Credit Derivatives. Without a doubt Janet should have been listened to. I’m confident that from now on she will be.

Closing thoughts

Rather than a complicated book on financial esoterica, Janet has created a simple guide to understanding the current crisis. This book is a must read for all students of finance, economics, and business. If you haven’t read this book, please do so.

Warning –This book is likely to infuriate you, and that’s a good thing! Janet provides indicting evidence and citizens may be tempted to initiate vigilante like witch trials. Please consult with your doctor before taking this financial medication.

Continued in article

September 1, 2009 reply from Rick Lillie [rlillie@CSUSB.EDU]

Hi Bob,

I am reading Dear Mr. Buffett, What an Investor Learns 1,269 Miles from Wall Street, by Janet Tavakoli. I am just about finished with the book. I am thinking about giving a copy of the book to students who perform well in my upper-level financial reporting classes.

I agree with the reviewer’s comments about Tavakoli’s book. Her explanations are clear and concise and do not require expertise in finance or financial derivatives in order to understand what she (or Warren Buffet) says. She explains the underlying problems of the financial meltdown with ease. Tavakoli does not blow you over with “finance BS.” She does in print what Steve Kroft does in the 60 Minutes story.

Tavakoli delivers a unique perspective throughout the book. She looks through the eyes of Warren Buffett and explains issues as Buffett sees them, while peppering the discussion with her experience and perspective.

The reviewer is correct. Tavakoli lets the finance world, along with accountants, attorneys, bankers, Congress, and regulators, have it with both barrels!

Tavakoli’s book is the highlight of my summer reading.

Best wishes,

Rick Lillie

Rick Lillie, MAS, Ed.D., CPA Assistant Professor of Accounting Coordinator - Master of Science in Accountancy (MSA) Program Department of Accounting and Finance College of Business and Public Administration CSU San Bernardino 5500 University Pkwy, JB-547 San Bernardino, CA. 92407-2397

Telephone Numbers: San Bernardino Campus: (909) 537-5726 Palm Desert Campus: (760) 341-2883, Ext. 78158

For technical details see the following book:
Structured Finance and Collateralized Debt Obligations: New Developments in Cash and Synthetic Securitization (Wiley Finance) by Janet M. Tavakoli (2008)

Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30, 2009 ---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this video (a little over 5 Mbs) using a free updated version of RealMedia --- Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP

 

Steve Kroft examines the complicated financial instruments known as credit default swaps and the central role they are playing in the unfolding economic crisis. The interview features my hero Frank Partnoy. I don't know of anybody who knows derivative securities contracts and frauds better than Frank Partnoy, who once sold these derivatives in bucket shops. You can find links to Partnoy's books and many, many quotations at http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

For years I've used the term "bucket shop" in financial securities marketing without realizing that the first bucket shops in the early 20th Century were bought and sold only gambles on stock pricing moves, not the selling of any financial securities. The analogy of a bucket shop would be a room full of bookies selling bets on NFL playoff games.
See "Bucket Shop" at http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)

 

I was not aware how fraudulent the credit derivatives markets had become. I always viewed credit derivatives as an unregulated insurance market for credit protection. But in 2007 and 2008 this market turned into a betting operation more like a rolling crap game on Wall Street.

 

Bob Jensen's Rotten to the Core threads are at http://www.trinity.edu/rjensen/FraudRotten.htm

Bob Jensen's threads on the current economic crisis are at http://www.trinity.edu/rjensen/2008Bailout.htm
For credit derivative problems see http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Also see "Credit Derivatives" under the C-Terms at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms

Bob Jensen's free tutorials and videos on how to account for derivatives under FAS 133 and IAS 39 ---
http://www.trinity.edu/rjensen/caseans/000index.htm

 


Outrageous Bonus Frenzy

AIG now says it paid out more than $454 million in bonuses to its employees for work performed in 2008. That is nearly four times more than the company revealed in late March when asked by POLITICO to detail its total bonus payments. At that time, AIG spokesman Nick Ashooh said the firm paid about $120 million in 2008 bonuses to a pool of more than 6,000 employees. The figure Ashooh offered was, in turn, substantially higher than company CEO Edward Liddy claimed days earlier in testimony before a House Financial Services Subcommittee. Asked how much AIG had paid in 2008 bonuses, Liddy responded: “I think it might have been in the range of $9 million.”
Emon Javers, "AIG bonuses four times higher than reported," Politico, May 5, 2009 --- http://www.politico.com/news/stories/0509/22134.html

"Let's Move Their Cheese:  We can get better bank management for a fraction of the cost," The Wall Street Journal on May 6,  2009 --- http://online.wsj.com/article/SB124157594861790347.html

Incentives work, all right. Just look at the way our bankers come back to bonuses, finding in every occasion a good opportunity to cut themselves a slice of largess. Their determination is unrelenting, monomaniacal. It's like Republicans returning to tax cuts, the universal solution to every problem.

Some institutions, we read, are struggling to free themselves from the TARP, because of its exuberance-chilling compensation limits. Others have decimated their workforces, apparently so they might continue to shower money on the favored ones. Still other institutions have signaled that they would rather borrow at higher rates of interest than accept the compensation limits that come with cheaper federal loans. And certain banks are on track to return to pre-recession compensation levels this year, according to a story last week in the New York Times. Goldman Sachs, for example, set aside $4.7 billion for compensation in the first quarter alone.

Another way incentives work is this: They have kept the debate over incentives from getting off the dime for years. There is no amount of shame that will deter the bonus class from pressing their demand, no scandal that will put it off limits, no public outrage over AIG or Enron or really expensive Merrill Lynch trash cans that will silence the managers' monotonous warble: "Attract and retain top talent!"

And there is no possible objection to inflated compensation you can make that will not be instantly maligned as senseless populism.

In truth, however, the verdict has been in for years. Pay for performance systems, at least as they exist in many places, are a recipe for disaster.

What they have "incentivized" executives to do, in countless cases, is not to perform, but to game the system, to smooth the numbers, to take insane risks with other people's money, to do whatever had to be done to ring the bell and send the dollars coursing their way into the designated bank account.

It may well be true that those in our bonus class are geniuses, but in far too many cases their fantastic brain power is focused not on serving shareholders or guiding our economy but simply on getting that bonus.

One might say that events of the last year had proved this fairly conclusively.

Or one could quote the immortal words of Franklin Raines, the onetime CEO of Fannie Mae, as they were recorded by Business Week in 2003: "My experience is where there is a one-to-one relation between if I do X, money will hit my pocket, you tend to see people doing X a lot. You've got to be very careful about that. Don't just say: 'If you hit this revenue number, your bonus is going to be this.' It sets up an incentive that's overwhelming. You wave enough money in front of people, and good people will do bad things."

Will they ever. They might, for example, pull an accounting fraud of the kind Fannie Mae itself was accused of committing in 2004, in which earnings were allegedly manipulated to, ahem, hit certain revenue numbers and make the bonuses go bang.

They might rig the game to take the credit -- and reap the rewards -- when good luck befalls an entire industry. If they're bankers, they might even try to claim that their firm's recovery, made possible by TARP money and government guarantees, was actually a fruit of their personal ingenuity. Bring on the billions!

Of course, they will also threaten to leave if they don't get exactly what they want. Take last week's news story about the supersuccessful energy trading unit of Citibank, whose star trader scored $125 million in 2005, owns a castle in Germany, and collects Julian Schnabel paintings. This merry band of traders is apparently thinking about a white-collar walkout should the government refuse to lift its compensation restrictions.

At first one feels pity for Citi and its resident geniuses, brought to these straits by the interfering hand of government. But then it dawns on you: Should a company receiving billions of public dollars really be gambling on speculative energy trades? After all, the bank's ordinary, everyday deposits would have to be made good by you and me through the FDIC should one of their bright traders pull a Nick Leeson someday.

Besides, why is Citi so anxious to give in to these guys? It can't be that hard to "retain top talent" when New York is awash with unemployed bankers and traders who are no doubt anxious for a chance to prove their own brilliance.

Here's a Wall Street solution to Wall Street's problems: Let's offshore trading operations to lands where ethics are more highly esteemed -- Norway, for instance. And while we're at it, let's replace our gold-plated, Lear-jetting American CEOs with thrifty Europeans, who may not write management books but who will do the work better, and for a fraction of the cost.

Bob Jensen's threads on outrageous compensation are at
http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation


"The Bailout of AIG: Mission Accomplished?" by Francine McKenna, re:TheAuditors, September 17, 2012 ---
http://retheauditors.com/2012/09/17/the-bailout-of-aig-mission-accomplished/

On Friday September 14, the US government announced the completion of the sale of AIG stock taxpayers bought during the financial crisis bailout of the insurer. The government took in $20.7 billion for the sale and is no longer the majority owner of the company. At the peak of the crisis, taxpayers owned almost 80% of AIG.

Andrew Ross Sorkin, New York Times reporter, CNBC host, and author of “Too Big To Fail” used his DealBook column to ask former Special Inspector General of TARP Neil Barofsky if he was satisfied, finally. Sorkin says the US Treasury made a profit on the AIG transaction.

As we approach the four-year anniversary of the collapse of Lehman Brothers and the rescue of A.I.G. next week, sadly, much of the public — and people like Mr. Barofsky, as well-intentioned as he is — are still criticizing and debating the merits of the bailout. It’s almost become a cottage industry.

In his book, Mr. Barofsky wrote, “Treasury’s desperate attempt to bail out Wall Street was setting the country up for potentially catastrophic losses.”

As distasteful as the rescue effort was, it should be clear by now that without it, we faced an economic Armageddon. And the results thus far of bailing out the big banks, and A.I.G., indicate a profit.

Treasury never uses the term “profit” to describe what taxpayers would receive. The GAO did in a report in May when it estimated the proceeds that could be realized at various sale prices.

I wrote in American Banker about Sorkin’s claim that the bank bailouts prevented “financial system Armageddon” and his debate with Barofsky. I think “profit” is not only the wrong term but an answer to the wrong question.

It can never be proven that the crisis bailouts saved us from financial Armageddon. That’s the logical fallacy of asserting a claim with no way to disprove the opposite, so saying we made a profit on the deal is the next best thing. The New York Times’ Andrew Ross Sorkin claims, if you combine Treasury actions and “positive returns” on Federal Reserve activities, the Treasury is now “on a path to actually turn a profit.” That’s where the debate starts.

Former Special Inspector General for the Troubled Asset Relief Program Neil Barofsky says, “Not so fast.” I agree. If your intention is to try to prove or disprove the government PR claims that the taxpayer has made an accounting profit on any of the bailouts, or even broken even, you must remember this: That’s not why the government supposedly did what they did. And on the two counts of failing to unfreeze credit and failing to help homeowners – how the bailouts were justified to Congress – the government is guilty.

Treasury never uses the term “profit,” even in press releases. The term it does use, “positive return,” is a non-Generally Accepted Accounting Principles metric. Treasury has sunk to the level of a social commerce IPO like Groupon, whose infamous Consolidated Segment Operating Income (CSOI)which was slammed by the Securities and Exchange Commission glossed over losses to convince investors there was a gain instead.

“Yves Smith” at Naked Capitalism also points out that AIG enjoyed a tax benefit that negates Treasury”s claim. Who reported that deal? Andrew Ross Sorkin in February.

In a February article, Bending the Tax Code, and Lifting A.I.G.’s Profit,” Sorkin described how AIG was allowed to retain $26.2 billion of net operating losses that should have been wiped out as a part of the rescue of the company as well as an additional $9 billion of “unrealized loss on investments.” That increased AIG’s fourth quarter and hence fiscal year earnings by a remarkable $17.7 billion, which dwarfs the mere $1.6 billion its operations produced that quarter. And the article includes this juicy bit:

Analysts at Bank of America and JPMorgan Chase last year estimated that the tax benefits from the losses propped up A.I.G. stock by $5 to $6 a share. Its shares closed at $28.66 on Monday, just shy of the $29 mark that the government says it needs to sell its shares to break even.

General Motors, another bailout “success story” – because saving GM supposedly averted jobs and economic disaster in Detroit – also benefited from the IRS rule change regarding retention of net operating loss carry forwards and “fresh start” accounting.  I wrote about that in Forbes in November of 2010.

Reporting profits means new GM doesn’t lose the valuable deferred tax assets they carried over from old GM, thanks to a last minute fix from the US Treasury in September.  The accountants can pull dollars from a cookie jar valuation allowance to prop up earnings when needed.

The IPO would probably have never passed even a minimal “smell test” by the SEC’s Division of Corporate Finance if  ”fresh start accounting” hadn’t put millions in goodwill on their balance sheetThat gave GM a positive balance in shareholder’s equity.  In a perverse example of accounting chicanery, the better GM does the less valuable that asset is.

Read the rest of my column about the AIG share sale at American Banker.

Iowa Sen. Charles Grassley suggested that AIG executives should accept responsibility for the collapse of the insurance giant by resigning or killing themselves. The Republican lawmaker's harsh comments came during an interview Monday with Cedar Rapids, Iowa, radio station WMT . . . Sen. Charles Grassley wants AIG executives to apologize for the collapse of the insurance giant — but said Tuesday that "obviously" he didn't really mean that they should kill themselves. The Iowa Republican raised eyebrows with his comments Monday that the executives — under fire for passing out big bonuses even as they were taking a taxpayer bailout — perhaps should "resign or go commit suicide." But he backtracked Tuesday morning in a conference call with reporters. He said he would like executives of failed businesses to make a more formal public apology, as business leaders have done in Japan.
Noel Duara, "Grassley: AIG execs should repent, not kill selves," Yahoo News, March 17, 2009 --- http://news.yahoo.com/s/ap/20090317/ap_on_re_us/grassley_aig

"AIG, Surprise:  Moneymaker Its profits for taxpayers cast doubt on the notion that it behaved recklessly before the panic struck," by Holman W. Jenkins, Jr., The Wall Street Journal, August 31, 2012 ---
http://professional.wsj.com/article/SB10000872396390443618604577623373568029572.html?mg=reno64-wsj#mod=djemEditorialPage_t

AIG's bailout is getting the revisionist treatment. The rescue hasn't been the dismal federal experience that, say, GM's has been. Taxpayers are showing a $5 billion profit on their 53% stake in the insurer, as of yesterday's closing price.

What's more, in the last few days, the New York Fed liquidated the last of the complex mortgage derivatives it acquired from AIG's counterparties as part of the bailout. Such transactions and related fees have netted the government about $18 billion.

This is good news but requires some revising of theories of the crisis itself. The "toxic" and "shaky" housing derivatives that got AIG in trouble turn out, even amid the worst housing slump in 70 years, not to have been the crud many assumed they were.

A lot of renditions skip over this part, dismissing AIG's pre-crash mortgage activities as "reckless," thereby making a mystery of how the refinancing of AIG could be paying off so handsomely for taxpayers. Taxpayers are making out because they bought valuable assets on the cheap.

This is as it should be. But let's remember how AIG got in trouble. It wrote insurance to guarantee the very senior portions of securities derived from underlying mortgages—that is, the portions already designed to withstand a sizeable increase in defaults.

AIG failed not because of the failure of these securities to keep paying as expected, but because of its own promise to fork up cash collateral if the market price of these securities fell or if the rating agencies downgraded what they had previously rated Triple-A.

In the systemic panic that climaxed with the Lehman failure, both things happened in spades, even as AIG itself no longer could raise the cash to make good on its commitments. Some now claim AIG could have waved off the collateral calls, citing exceptional circumstances. But even that wouldn't have changed the fact that, because of the panic, AIG itself was no longer trusted despite being chock-full of good assets.

We'll never know if the company might have finessed its way out of its jam (quite possibly its counterparties, including Goldman Sachs, would have acted to keep AIG afloat if the alternative of a government bailout weren't available). Instead AIG turned to taxpayers to finance the collateral calls it couldn't finance itself, and taxpayers took advantage.

For all the desire to name villains and blame bad incentives for the financial crisis, notice that panic itself was the key player. Panic is a variable about which it's disconcertingly hard for government to do anything useful in advance.

Panic is systemic—an uncertainty or loss of trust in how the system will behave. Here's a simple but relevant example: What happens to the market value of mortgages if investors lose confidence in the legal system to permit them to foreclose on borrowers who stop paying?

We don't need to retread the history. Letting Lehman fail was a disaster because the rescue of Bear Stearns had conditioned the market to believe Washington wouldn't permit major institutional failures. The mixed signals sent about Fannie and Freddie only undermined the effort to recruit fresh capital to other financial institutions distressed by uncertainty over the value of mortgage securities.

AIG is the most dramatic example of the general case. A lot of things become good or bad collateral depending on what the government is expected to do. It's not too strong to say Washington had to bail out AIG because the market was uncertain whether Washington would bail out AIG. (An additional complexity we won't go into is how the Fed's QE exercises subsequently boosted the bailout's profits.)

Let us be careful here: A host of private and public behaviors contributed to the housing bubble and meltdown, whose losses were destined to be felt widely. Our system has no problem accommodating the failure of individual institutions, even very big ones. But systemic panic always comes to the door of government. It can't be otherwise.

Governments can try to duck this burden, as European governments have done, only by renouncing the ability to print money and so soiling their own credit that substituting their own credit for the financial system's is no longer an option. Make no mistake: This would be a real cure for too-big-to-fail if the Europeans were inclined to let the chips fall. They're not. Instead the self-disabling governments want Germany to supply the bailout.

Continued in article

 

Outrageous Bonus Frenzy

AIG now says it paid out more than $454 million in bonuses to its employees for work performed in 2008. That is nearly four times more than the company revealed in late March when asked by POLITICO to detail its total bonus payments. At that time, AIG spokesman Nick Ashooh said the firm paid about $120 million in 2008 bonuses to a pool of more than 6,000 employees. The figure Ashooh offered was, in turn, substantially higher than company CEO Edward Liddy claimed days earlier in testimony before a House Financial Services Subcommittee. Asked how much AIG had paid in 2008 bonuses, Liddy responded: “I think it might have been in the range of $9 million.”
Emon Javers, "AIG bonuses four times higher than reported," Politico, May 5, 2009 --- http://www.politico.com/news/stories/0509/22134.html

 

Bob Jensen's threads on AIG are at
http://www.trinity.edu/rjensen/2008Bailout.htm

Search for the term "AIG"

 


Professor Ketz Asserts Other Comprehensive Income (OCI from FAS 130)
may be More Important to Study Than Reported Income

"Citigroup Remains in Critical Condition," by: J. Edward Ketz , SmartPros, May 2009 ---
http://accounting.smartpros.com/x66534.xml
Note that all Citigroup dollar amounts are in millions of dollars such that  $(27,684) is really a $27,684,000,000 billion loss.

The stress tests conducted by the Fed are a farce inasmuch as the stress isn't too strenuous. That the Fed ascertained additional capital requirements for several banks merely points out the obvious - the banking sector remains in serious trouble.

That the financial industry was and remains in trouble is not revelatory to those who pay attention to fair value measurements. Take Citigroup for instance. This firm, once a giant among banks, now gasps for its existence.

Citi’s reported net income was $(27,684) for 2008 (all accounting numbers in millions of dollars). While this is a smelly number, the odor grows worse when one adjusts it for various items that bypass the income statement.

Ever since the FASB invented the comprehensive income statement in a political move to get business enterprises to do some accounting for items they didn’t want to disclose, I have advocated that investors use comprehensive income instead of net income. Comprehensive income includes relevant items that have had a real economic impact on the business entity; therefore, investors will find these items informative.

For fiscal 2008, Citi shows unrealized losses on its available-for-sale securities of $(10,118). It also shows a loss on the foreign currency translation adjustment of $(6,972), a loss on its cash flow hedges of $(2,026), and a loss for additional pension liability adjustment of $(1,419). This makes Citi’s comprehensive income $(48,219).

But the bad news doesn’t end there. The pension footnote (footnote 9) shows the expected rate of return is 7.75%. While this is what is required per FAS 87, it is nonsense. Did anybody know the 2008 rate of return in (say) 2005? The FASB should get rid of such fantasyland assumptions and require business enterprises to employ the actual rate of return. If Citi had done so on its pension assets, it would have had an actual return of (5.42)%, so we shall adjust downward the 2008 income by another $1,370.

The most interesting item is Citi’s move with respect to its investments. It reports debt securities in its 2007 held-to-maturity portfolio of only $1. By year end 2008, however, this amount mushroomed to $64,459. Clearly, Citi is shielding these debt instruments from fair value accounting and the reporting of additional losses. Footnote 16 indicates that these losses for 2008 amounted to $(4,082).

Another item concerns the firm’s deferred income tax assets. For 2008, Citi discloses $52,079 in deferred income tax assets and a valuation allowance of zero. Given that Citi paid no federal income taxes in 2007 or 2008 and likely will pay no federal income taxes in the near future, if ever, how can the company justify a valuation allowance of zero? Whatever amount it should be would further reduce the profits of the firm. Since we don’t know how to estimate this valuation allowance correctly, we shall continue to hold its balance at zero, even though this is clearly wrong.

Putting these considerations together, Citigroup has an adjusted income in 2008 of $(53,671). This is still an estimate but clearly it is more nearly accurate than the reported number. And it reveals that Citi lost twice as much as it reported.

Recently, we have been hearing how Citi has turned things around and that the first quarter in 2009 returns Citi to the black column with a profit of $1,593. Don’t believe a word of it!

Items in comprehensive income shows a modest gain in the available-for-sale portfolio of $20, gains on cash flow hedges of $1,483, and a gain because of the pension liability adjustment of $66. Unfortunately, these gains are wiped out by a loss in the foreign currency translation adjustment of $(2,974). Comprehensive remains ugly at $(225).

We don’t have any disclosure in the quarterly report about actual versus expected returns on pension assets, so we cannot adjust them to show the truth.

But, the strategy to move debt securities from available-to-sale to held-to-maturity paid off significantly. First quarter results show a staggering loss on these securities of $(7,772).

So far, the adjusted earnings for Citigroup for the first quarter of 2009 is $(7,584). Don’t tell me that Citi has improved its operations.

Further, these numbers have been improved by an eccentricity in FAS 157. For some silly reason, the board allows entities to show a gain on their liabilities if the firm’s own credit risk has increased. This takes a perfectly good notion of fair value of liabilities to an absurd result. Failing companies might be able to make liabilities disappear by claiming a sufficiently high increase in their own credit ratings! Utter rubbish—and the FASB should amend its statement.

Citi disclosed in a conference call that the first quarter results include a gain of $2,700 because of this increase in its own nonperformance risk. This gain is total nonsense, so I would adjust quarterly income further, giving Citi adjusted earnings of $(10,284).

Citigroup suffered a cardiac arrest in 2008, and it remains in critical condition. Any other conclusion is propaganda or self deception. And forget the stress tests; they are so flawed that Lehman Brothers might pass them. The Fed says that Citi needs another $5,500 in capital to weather any additional economic crises it might face. It isn’t true. Citi needs a lot more capital than that just to weather current conditions. If a real crisis occurs, Citi will become a flat-liner; it might die anyway.

If you want to protect your portfolio, don’t listen to the optimistic forecasts coming from Washington and don’t stop at the reported income number. Look at the fair value disclosures within SEC filings, adjust reported earnings for these fair value gains and losses, and then you will obtain the truth.


Poor government workers who sacrifice so much just to serve President Obama: 
Biding time before their book royalties eventually flow

Lawrence Summers, a top economic adviser to President Barack Obama, pulled in more than $2.7 million in speaking fees paid by firms at the heart of the financial crisis, including Citigroup, Goldman Sachs, JPMorgan, Merrill Lynch, Bank of America Corp. and the now-defunct Lehman Brothers. He pulled in another $5.2 million from D.E. Shaw, a hedge fund for which he served as managing director from October 2006 until joining the administration. Thomas E. Donilon, Obama’s deputy national security adviser, was paid $3.9 million by the power law firm O’Melveny & Myers to represent clients including two firms that received federal bailout funds: Citigroup and Goldman Sachs. He also disclosed that he’s a member of the Trilateral Commission and sits on the steering committee of the supersecret Bilderberg group. Both groups are favorite targets of conspiracy theorists. And White House Counsel Greg Craig earned $1.7 million in private practice representing an exiled Bolivian president, a Panamanian lawmaker wanted by the U.S. government for allegedly murdering a U.S. soldier and a tech billionaire accused of securities fraud and various sensational drug and sex crimes. Those are among the associations detailed in personal financial disclosure statements released Friday night by the White House.
Kenneth P. Vogel, "W.H. team discloses TARP firm ties," Politico, April 3, 2009 --- http://www.politico.com/news/stories/0409/20889.html

Wave Goodbye to this nation's top economic advisor
"Lawrence Summers Will Leave White House Post and Return to Harvard," Chronicle of Higher Education, September 21, 2010 ---
http://chronicle.com/blogPost/Lawrence-Summers-Will-Leave/27092/

I can't believe The New York Times published this Op-Ed from a former (ten-year) CEO of the Federal Reserve Bank of St. Louis
This WSJ-like heresy would never appear on NBC or MSNBC
"
Stop the Bailouts ," by William Poole, The New York Times, February 28, 2009 ---
http://www.nytimes.com/2009/03/01/opinion/01poole.html?_r=2&ref=todayspaper

THE fundamental causes of this recession, unique in the experience of the United States, were mortgage defaults and the consequent insolvency of major financial firms. These insolvencies, and especially fear of them, damaged normal credit mechanisms.

The self-correcting nature of markets will ultimately prevail. We should not underestimate the power of monetary policy; with the sharp increase in the nation’s money stock starting in September, monetary policy is now extraordinarily expansionary. I believe, though without great confidence, that the recession will end in the second half of this year.

Federal policy is damaging the economy’s prospects.
It fails to provide the needed tax incentives for investment in factories and equipment, incentives that were central to efforts to revive the economy during the Kennedy-Johnson era and under Ronald Reagan. But government spending can’t lead the way to sustained recovery, because its stimulating effect will be offset by anticipated higher taxes and the need to finance the deficit.

Heavy-handed federal intervention into the management of companies from banks to auto makers will also delay recovery. And misguided efforts to help distressed homeowners by permitting courts to rewrite the terms of mortgages will cause banks to limit mortgage lending, which will prevent housing from contributing to the recovery.

The unrelenting anger across the country over bailouts of corporations and households that made unwise and even irresponsible financial decisions is influencing federal policy. Punitive measures, like forcing companies receiving federal dollars to cancel employee events, will increase uncertainty over where the government will strike next in its effort to deflect public outrage. Instead of more bailouts, we need a clear and consistent path to fundamental reform of our financial system.

William Poole is a senior fellow at the Cato Institute and the president and chief executive of the Federal Reserve Bank of St. Louis from 1998 to 2008.

A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury, with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had this to say about 2000 years after "The Fall of the Athenian Republic" and about the time our original 13 states adopted their new constitution.
As quoted at http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for updates by the second) --- http://www.brillig.com/debt_clock/

America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück, the German finance minister, in September 2008....“the United States will lose its status as the superpower of the global financial system.” You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will Reshape America," The Atlantic, March 2009 --- http://www.theatlantic.com/doc/200903/meltdown-geography

The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery.
Winston Churchill
(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office and replaced it with a bust of Lincoln who wrote that Government should print all the money it needs without borrowing)

 

A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury, with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had this to say about 2000 years after "The Fall of the Athenian Republic" and about the time our original 13 states adopted their new constitution.
As quoted at http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for updates by the second) --- http://www.brillig.com/debt_clock/

America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück, the German finance minister, in September 2008....“the United States will lose its status as the superpower of the global financial system.” You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will Reshape America," The Atlantic, March 2009 --- http://www.theatlantic.com/doc/200903/meltdown-geography

America Bought a Pig in a Poke
It's like going on a spending binge at the Titanic's passenger store just after hitting the iceberg
Alas, that opportunity was squandered. Mr Obama ceded control of the stimulus to the fractious congressional Democrats, allowing a plan that should have had broad support from both parties to become a divisive partisan battle. More serious still was Mr Geithner’s financial-rescue blueprint which, though touted as a bold departure from the incrementalism and uncertainty that had plagued the Bush administration’s Wall Street fixes, in fact looked depressingly like his predecessors’ efforts: timid, incomplete and short on detail. Despite talk of trillion-dollar sums, stock markets tumbled. Far from boosting confidence, Mr Obama seems at sea.  . . . Mr Obama’s team must recognise this or they, like their predecessors, will come to be seen as part of the problem, not the solution.
"The Obama Rescue," The Economist, February 14, 2008, Page 13 ---
http://www.economist.com/opinion/displaystory.cfm?story_id=13108724&CFID=45050187&CFTOKEN=28690481

Barack Obama promised to get the economy's mojo working again with the passage of an almost $800 billion stimulus package. Wall Street responded with a Bronx Cheer and a 300 drop in the Dow Jones Industrial Average. What gives? . . . It is unclear how many more boondoggles will be uncovered in the 1000+ page bill. People are still pouring through its mass of pages. Few, if any, members of Congress read the bill before it was passed. Scare tactics well known to every salesman were used to facilitate its passage. The President proclaimed the sky was falling. An economic catastrophe was just around the corner. Congress had to do "something" immediately to forestall disaster. There was no time to read the fine print or to deliberate in a thoughtful manner. And in lemming like fashion, the Democrats poured over the cliff. It was their prerogative they claimed. After all, as Mr. Obama declared, "We won the election."
Ken Connor, "Pork and Pitchforks ," Townhall, February 22, 2009 --- http://townhall.com/columnists/KenConnor/2009/02/22/pork_and_pitchforks

IOUSA (the most frightening movie in American history) --- (see a 30-minute version of the documentary at www.iousathemovie.com ).
A Must Read for All Americans --- The Fact Accountant That Liberals Progressives Will Never Interview or Even Discuss

The most important article for the world to read now is the following interview with a former Andersen Partner and former Chief Accountant of the United States:
"Debt Crusader David Walker sounds the alarm for America's financial future," Journal of Accountancy, March 2009 --- http://www.journalofaccountancy.com/Issues/2009/Mar/DebtCrusader.htm 

David Walker is a man on a mission. As U.S. comptroller general, he used the bully pulpit to fuel a campaign of town hall meetings highlighting the country’s ballooning federal deficit. The Fiscal Wake-Up Tour and the publicity it generated begat the documentary I.O.U.S.A. Walker hopes the film will do for fiscal irresponsibility what Al Gore’s An Inconvenient Truth did for global warming—mobilize new citizen activists and pressure politicians to act.

A year ago, Walker stepped away from the five-plus remaining years on his term as comptroller general and head of the Government Accountability Office. He had been recruited by billionaire Pete Peterson, a co-founder of the private- equity fund The Blackstone Group, to become president and CEO of Peterson’s foundation. The Peter G. Peterson Foundation, a nonprofit to which Peterson has pledged $1 billion, focuses on issues such as the deficit, savings levels, entitlement benefits, health care costs, and the nation’s tax system.

Walker talked with the JofA recently about the deficit and the financial crisis. What follow are excerpts from that conversation.

JofA: What did you hope to accomplish when you set out on your speaking tour and got involved with the documentary I.O.U.S.A., and what progress has been made on those goals?

Walker: I have been to over 42 states, giving speeches, participating in town hall meetings, meeting with business community leaders, local television and radio stations, and editorial boards with the objective of trying to state the facts and speak the truth about the deteriorating financial condition of the United States government and the need for us to start making some tough choices on budget controls, tax policy, entitlement reform and spending constraints. And the good news is that people get it. The American people are a lot smarter than many people give them credit for—especially elected officials

Well, a lot has happened since we started the Fiscal Wake-Up Tour. Two significant events would be the 60 Minutes piece, which ran twice in 2007, and that led to the commercial documentary I.O.U.S.A. (see a 30-minute version of the documentary at www.iousathemovie.com ). So there’s a lot more visibility on our issue, and I think that’s encouraging. The other thing that has happened is the recent market meltdown and bailouts of some very venerable institutions in the financial services industry have served to bring things home to America. The concept of “too big to fail” is just not reality anymore, and when you take on too much debt and you don’t have adequate cash flow, some very bad things can happen.

Here’s the key. The factors that led to the mortgage-based subprime crisis exist for the federal government’s finances. Therefore, we must take steps to avoid a super subprime crisis, which frankly would have much more disastrous effects not only domestically but around the world.

JofA:
How does the economic crisis affect your message and the outlook for the kind of wide-scale changes you think need to be made?

Walker:
What’s critical is that we take advantage of the teachable moment associated with the market meltdown and the failure of some of the most prominent financial institutions in the country to help the American people know that nobody can live beyond his means forever. And that goes for government, too.

We have a new president, and therefore we have an opportunity to press the reset button, and I hope President Obama will do two things: That he will assure Americans that he will do what it takes to turn the economy around. I think it is critically important that he also focus on the future and be able to put a mechanism in place like a fiscal future commission so that once we turn the corner on the economy, we have a set of recommendations Congress and the president would be able to consider about budget controls, tax reform, entitlement reform—things that are clear and compelling that we need to act on.

Individuals need to understand that the government has overpromised and under-delivered for far too long. It is going to have to engage in some dramatic and fundamental reform of existing entitlement programs, spending policies and tax policies. The government will be there to provide a safety net through Social Security, a foundation of retirement security, and it will be there to help those that are in need. In general, most individuals are going to have to assume more responsibility for their own financial future, and the earlier they understand that the better off they are going to be. They need to have a financial plan, a budget, make prudent use of debt, save, invest their savings for specified purposes and, very importantly, preserve their savings for the intended purpose, including retirement income.

I believe the government policies are going to have to encourage people to work longer by increasing the eligibility ages for many government programs. So if people want to retire at an earlier age, they are going to have to plan, save, invest and preserve those savings for retirement purposes.

JofA:
You’ve called the current U.S. health care system unsustainable. How can the system be fixed without negatively affecting the care Americans need?

Walker:
Our current health care system is not really a system. It’s an amalgamation of a bunch of different things that have occurred over the years, and it’s unacceptable and unsustainable. We spend twice per capita what any other country on the Earth does. We have the highest uninsured population of any industrialized nation. We have below average health care outcomes. So the value of the equation just does not compute.

We are going to need to do two things on health care. We are going to need to take some steps quickly to reduce the rate of increase in health care cost. We are also going to have to better target taxpayer subsidies and tax preferences for health care.

We are also going to end up needing to move toward trying to achieve comprehensive health care reform that accomplishes four key goals. First: achieve universal coverage for basic and essential health care—based on broad-based societal needs, not unlimited individual wants—that’s affordable and sustainable over time and that avoids taxpayer-funded heroic measures. Secondly, the federal government has to have a budget for health care. We are the only nation on Earth dumb enough to write a blank check for health care. It could bankrupt the country. We have to have constraints. Thirdly, we need national evidence-based practice standards for the practice of medicine and for the issuance of prescription drugs to improve consistency, enhance quality, reduce costs and dramatically reduce litigation risks. And last, but certainly not least, we have to require personal responsibility and accountability for our own health and wellness in a whole range of areas including obesity.

JofA:
What drives you?

Walker: My family has been in this country since the 1680s, and I have ancestors who fought and died in the American Revolution. So I care very deeply about this country, and I am a big history buff. I believe you need to study history in order to learn from it in order not to make some of the same mistakes that others have made in the past.

Secondly, I am only the second person in my direct Walker line to graduate from college. My dad was the first. Therefore, I am somewhat of an example of what someone can accomplish in this great country if you get an education, if you have a positive attitude, if you work hard, if you have good morals and ethical values.

My personal mission in life is to be able to make a difference, to try and make a difference in the lives of others, to try and help make sure our country stays strong, that the American dream stays alive, and that the future will be better for my children and my grandchildren.

Links to David Walkers videos, including his famous CBS Sixty Minutes bell ringer that is far more frightening and sobering than anything Rush Limbaugh is screaming about. You never, ever hear Keith Olbermann, Jon Stewart, Barack Obama, Nancy Pelosi, or Harry Reid so much as whisper the name of David Walker --- http://www.trinity.edu/rjensen/entitlements.htm

"Obama's Economic Fish Stories:  On unemployment, the president claims that the stimulus bill was several times more potent than his chief economic adviser estimates. Such statements hurt his credibility," by Michael J. Boskin, The Wall Street Journal, July 21, 2010 ---
http://online.wsj.com/article/SB10001424052748703724104575378751776758256.html?mod=djemEditorialPage_t

A president's most valuable asset—with voters, Congress, allies and enemies—is credibility. So it is unfortunate when extreme exaggeration emanates from the White House.

All presidents wind up saying some things that make even their own economists cringe (often the brainchild of political advisers unconstrained by economic principles, facts or arithmetic). Usually, economic advisers manage to correct these problematic statements before delivery. Sometimes they get channeled into relatively harmless nonsense, such as President Gerald Ford's "Whip Inflation Now" buttons. Other times they produce damaging policies, such as President Richard Nixon's wage and price controls. The most illiterate statement was President Jimmy Carter's late-1970s plea to the Federal Reserve to lower interest rates to combat high inflation, the exact opposite of what it should do. Not surprisingly, the value of the dollar collapsed.

President Obama says "every economist who's looked at it says that the Recovery Act has done its job"—i.e., the stimulus bill has turned the economy around. That's nonsense. Opinions differ widely and many leading economists believe that its impact has been small. Why? The expectation of future spending and future tax hikes to pay for the stimulus and Mr. Obama's vast expansion of government are offsetting the direct short-run expansionary effect. That is standard in all macroeconomic theories.

So, as I and others warned in 2008, the permanent government expansion and higher tax rate agenda is a classic example of what not to do during bad economic times. Worse yet, all the subsidies, bailouts, regulations and mandates are forcing noncommercial decisions on the economy, which now awaits literally thousands of new diktats as a result of things like ObamaCare and the financial reform bill. The uncertainty is impeding investment and hiring.

The president does not say that economists agree that the high future taxes to finance the stimulus will hurt the economy. (The University of Chicago's Harald Uhlig estimates $3.40 of lost output for every dollar of government spending.) Either the president is not being told of serious alternative viewpoints, or serious viewpoints are defined as only those that support his position. In either case, he is being ill-served by his staff.

Mr. Obama's economic statements are increasingly divorced not only from competing viewpoints but from those of his own economic advisers. It is surprising how many numerically challenged pronouncements come from this most scripted and political of White Houses. One slip is eventually forgiven, but when a pattern emerges, no one believes it is an accident.

For example, on the anniversary of the stimulus bill, Mr. Obama declared, "It is largely thanks to the Recovery Act that a second Depression is no longer a possibility." Yet his Council of Economic Advisers just estimated the stimulus bill's effect on GDP at its trough was 1%-2%.

The most common definition of a depression is a long period in which GDP or consumption declines at least 10%. The decline in GDP in the recent recession was 3.8%, in consumption 2%. No one disputes the recession was severe, but to reach a 10% GDP decline requires tripling the administration's estimate (three times their 2% effect) added to the actual 3.8% decline. On the alternative consumption standard, the math is even more absurd. The depression statement isn't credible. The stimulus bill has assumed certain mystic powers in administration discourse, but revoking the laws of arithmetic shouldn't be one of them.

The recession would have been worse if not for the Fed's monetary policy and quantitative easing. Also important were the unmentioned automatic stabilizers—taxes falling more than income, cushioning declines in after-tax incomes and consumption—which were far larger than the spending and tax rebates in the stimulus bill. Arguing that all these policies (including injecting capital into banks, which was necessary but done poorly) may have prevented a depression is perhaps still an exaggeration but at least is within hailing distance of plausibility. On that scale, the effect of the stimulus was puny.

On his recent "Recovery Tour," Mr. Obama boasted, "The stimulus bill prevented the unemployment rate from "getting up to . . . 15%." But the president's own chief economic adviser, Christina Romer, has estimated that the stimulus bill reduced peak unemployment by one percentage point—i.e., since the unemployment rate peaked at 10.1%, it prevented the unemployment rate from rising to just over 11%. So Mr. Obama claims that the stimulus bill was several times more potent than his chief economic adviser estimates.

Perhaps the most serious disconnect concerns the impending expiration of the 2001 and 2003 tax cuts, which will raise the top two income tax rates and the rates on dividends and capital gains. If these growth inhibiting tax increases occur—about $75 billion in tax increases next year, $1.4 trillion over 10 years—there will be serious economic damage.

In the most recent issue of the American Economic Review, Ms. Romer (and her husband David H. Romer) conclude that "tax increases are highly contractionary . . . tax cuts have very large and persistent positive output effects." Their estimates imply the tax increases would depress GDP by roughly half the growth rate in this so-far-anemic recovery.

If Mr. Obama is really serious about a second stimulus, by far the best thing he can do is have Congress quickly extend the expiring Bush tax cuts, combined with real spending cuts set to take effect as the economy improves.

The president badly needs to make more realistic pronouncements. No one expects him to say his policies have failed (although most have delivered far less than claimed at large cost). A little candor about the results of experimentation in uncharted waters would go a long way. But at the very least, his staff needs to avoid putting these exaggerations on the teleprompter. It undermines confidence and raises concerns about competence. It's doing nobody any good—not the economy and certainly not Mr. Obama.

Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.

Harvard professor says economists are a huge part of the problem --- http://www.trinity.edu/rjensen/2008Bailout.htm#LiquidityBubble
Stephen A. Marglin is a professor of economics at Harvard University. His latest book is The Dismal Science: How Thinking Like an Economist Undermines Community (Harvard University Press, 2007).


Fractal --- http://en.wikipedia.org/wiki/Fractal

Question
Why do markets misbehave? How should you measure market risk? And what’s wrong with academic finance?

These are a few questions that polymath Benoit Mandelbrot addresses in the fascinating book The Misbehavior of Markets. Mandelbrot suggests all of these questions can be properly understood by rejecting the standard assumptions of academic finance and instead using a “fractal view” of risk and markets.
"The Misbehavior of Markets," Simoleon Sense, April 6, 2009 --- http://www.simoleonsense.com/

Fractals are at the heart of this book. Fractal geometry is a form of mathematics developed by Mandelbrot that deals with rough but highly self-similar structures like trees, coastlines, and mountains. Fractals have helped explain a wide range of natural phenomena and revolutionized computer graphics, influencing movies like Star Wars Episode III. There is room for more applications in this early science, and fractals may help explain the jagged but predictably irrational patterns in the stock market, claims Mandelbrot.

In this book, Mandelbrot contends that fractals are the key to modeling the market. The interesting part is that Mandelbrot does not merely explain why he’s right but he goes to great length to explain why others-those using the standard theories of academic finance-are wrong. Mandelbrot offers interesting history, anecdotes, trivia, and beautiful illustrations to make his case. The stock market does not act like a random walk, he says, but rather it’s like the flight of an arrow down an infinite hallway. It sounds a bit abstract at first, but this is exactly where the book shines. There are stories and illustrations that make such abstract concepts easily understandable. I literally felt smarter after reading each chapter…

 


Winning the Lotto jackpot has become a key factor in my retirement plan.
New Yorker Cartoon

"Two billion more bourgeois," The Economist, February 14, 2009, Page 18 ---
http://www.economist.com/opinion/displaystory.cfm?story_id=13109687&CFID=45050187&CFTOKEN=28690481

PEOPLE love to mock the middle class. Its narrow-mindedness, complacency and conformism are the mother lode of material for sitcom writers and novelists. But Marx thought “the bourgeoisie…has played a most revolutionary part” in history. And although The Economist rarely sees eye to eye with the father of communism, on this Marx was right.

During the past 15 years a new middle class has sprung up in emerging markets, producing a silent revolution in human affairs—a revolution of wealth-creation and new aspirations. The change has been silent because its beneficiaries have gone about transforming countries unobtrusively while enjoying the fruits of success. But that success has been a product of growth. As growth collapses, the way the new middle class reacts to the thwarting of its expectations could change history in a direction that is still impossible to foresee.

The new middle consists of people with about a third of their income left for discretionary spending after providing basic food and shelter. They are neither rich, inheriting enough to escape the struggle for existence, nor poor, living from hand to mouth, or season to season. One of their most important characteristics is variety: middle-class people vary hugely by background, profession and income. As our special report in this week’s issue argues, their numbers do not grow gently, shadowing economic growth and rising 2%, or 5%, or 10% a year. At some point, they surge. That happened in China about ten years ago. It is happening in India now. In emerging markets as a whole, it has propelled the middle class from a third of the developing world’s population in 1990 to over half today. The developing world is no longer simply poor.

As people emerge into the middle class, they do not merely create a new market. They think and behave differently. They are more open-minded, more concerned about their children’s future, more influenced by abstract values than traditional mores. In the words of David Riesman, an American sociologist, their minds work like radar, taking in signals from near and far, not like a gyroscope, pivoting on a point. Ideologically they lean towards free markets and democracy, which tend to be better than other systems at balancing out varied and conflicting interests. A poll we commissioned for our special report on the middle class in the developing world finds that such people are happier, more optimistic and more supportive of democracy than are the poor.

These attitudes transform countries and economies. The middle class is more likely to invest in new products and new technologies than the rich, who tend to defend their existing assets. It is better able than the poor to leap barriers to entry into business and can therefore set up companies big enough to generate jobs. With its aspirations and capacity for delayed gratification, the middle class is more likely to invest in education and other sources of human capital, which are vital to prosperity. For years, policymakers have tied economic success to the rich (“trickle-down economics”) and to the poor (“inclusive growth”). But it is the middle class that is the real motor of economic growth.

Now the middle class everywhere is under a great threat. Its members have flourished in places and countries that have opened up to the world economy—the eastern seaboard of China, southern India, metropolitan Brazil. They are products of globalisation, and as globalisation goes into reverse they may well be hit harder than the rich or poor. They work in export industries, so their jobs are unsafe. They have started to borrow, so are hurt by the credit crunch. They have houses and shares, so their wealth is diminished by falling asset prices.

What will they do when the music stops? Those at the bottom of the ladder do not have far to fall. But what happens if you have clambered up a few rungs, joined the new middle class and now face the prospect of slipping back into poverty? History suggests middle-class people can behave in radically different ways. The rising middle class of 19th-century Britain agitated peacefully for the vote; in Latin America in the 1990s the same sorts of people backed democracy. Yet the middle class also supported fascist governments in Europe in the 1930s and initially backed military juntas in Latin America in the 1980s.

Nobody can be sure what direction today’s new bourgeoisie of some 2.5 billion people will take if its aspirations are dashed. If the downturn lasts only a year or two the attitudes of such people may survive the pain of retrenchment. But a prolonged crash might well undo much of the progress the developing world has lately made towards democracy and political stability. It is hard to imagine the stakes being higher.

Question:     What's $2+$3,269,999,999,998?
Accountant   What would you like it to total? We strive to keep our clients happy.
Politician:     I voted for $789,000,000 but I've never been real good with big numbers having lots of commas.
Economist:   Why it's 33 Yen in terms of the anticpated foreign exchange rate ten years from now.
Congressional Budget Office:
$3,270,000,000,000 --- but please don't tell on us

All of the major news outlets are reporting that the stimulus bill voted out of conference committee last night has a meager $789 billion price tag. This number is pure fantasy. No one believes that the increased funding for programs the left loves like Head Start, Medicaid, COBRA, and the Earned Income Tax Credit is in anyway temporary. No Congress under control of the left will ever cut funding for these programs. So what is the true cost of the stimulus if these spending increases are made permanent? Rep. Paul Ryan (R-WI) asked the Congressional Budget Office to estimate the impact of permanently extending the 20 most popular provisions of the stimulus bill. What did the CBO find? As you can see from the table below, the true 10 year cost of the stimulus bill $2.527 trillion in in spending with another $744 billion cost in debt servicing. Total bill for the Generational Theft Act: $3.27 trillion.
"True Cost of Stimulus: $3.27 Trillion," Heritage Foundation,  February 12, 2009 ---
http://blog.heritage.org/2009/02/12/true-cost-of-stimulus-327-trillion/
Jensen Comment
The above article has a pretty good summary table --- the best that I've seen to date.

The US government is on a “burning platform” of unsustainable policies and practices with fiscal deficits, chronic healthcare underfunding, immigration and overseas military commitments threatening a crisis if action is not taken soon.
David M. Walker, Former Chief Accountant of the United States --- http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt for entitlements (over five times the booked national debt and soaring with new entitlements) --- http://www.trinity.edu/rjensen/entitlements.htm

Delay is preferable to error.
Thomas Jefferson


Are economists worse than the Keystone Cops?
"The Financial Crisis and the Systemic Failure of Academic Economics," 2008
Dahlem Report on the Economic Crisis --- http://www.cs.trinity.edu/~rjensen/temp/Dahlem_Report_EconCrisis021809.pdf

Abstract:
The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.


The first major model of systematic risk and diversification theory was the 1959 Princeton thesis of Harry Markowitz. But the model was totally impractical since we could not and still cannot invert matrices with 500 or more rows and columns. Along came Bill Sharpe and others who tried to approximate the Markowitz model with the much more practical CAPM. With simplification a model almost always sacrifices accuracy and robustness. The CAPM has had some good applications and some disastrous applications such as the Trillion Dollar Bet disaster of Long Term Capital Management --- http://www.trinity.edu/rjensen/2008Bailout.htm#LTCM

Whenever I get news about increased interest in mathematical models (especially economics and finance) professors on Wall Street, I think back to "The Trillion Dollar Bet" in 1993 (Nova on PBS Video) a bond trader, two Nobel Laureates, and their doctoral students who very nearly brought down all of Wall Street and the U.S. banking system in the crash of a hedge fund known as Long Term Capital Management where the biggest and most prestigious firms lost an unimaginable amount of money --- http://en.wikipedia.org/wiki/LTCM

The blame for bad decisions that use models must fall on the analysts who apply the model and not on the people that merely derive the seminal model as long as the model builders point out all know limitations of their models. There are some instances of research that should perhaps be banned such as research that could put cheap and effective biological weapons of mass destruction in the hands of any teenager in the world who has a basement laboratory or effective date rape drugs that can be generated quickly, cheaply, and easily from bananas and tomatoes.

There is also a question of enforcement of a ban on research and model building. For example, if we’d had a ban on development of nuclear fission in the U.S., what would’ve prevented Russia, Germany, and Japan from development of nuclear fission in 1940? If David Li was not allowed to invent the credit risk diversification model, who’s to say that China could not invent such a model?

I think the limitations of Li’s model were well known to the bankers who used the disastrous model. In reality it is like the Black Swan theory that a model has a known miniscule (epsilon) chance of disaster but the rewards of using the model seemed to greatly outweigh the risks --- http://en.wikipedia.org/wiki/Black_Swan_Theory

The CDO bond risks became compounded when so many investment banks commenced to crumble mortgage contracts into diversified CDO bonds dictated by David Li’s model. CDO bond sellers and holders commenced to use this model that essentially leaves out the covariance terms for interactive defaults on investments. The chances that everything would blow up seemed negligible at the time.  Probably the best summary of what happens appears in “In Plato’s Cave.”
Also see
"In Plato's Cave:  Mathematical models are a powerful way of predicting financial markets. But they are fallible" The Economist, January 24, 2009, pp. 10-14 --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Shielding Against Validity Challenges in Plato's Cave ---
http://www.trinity.edu/rjensen/TheoryTAR.htm

Warnings from a Theoretical Physicist With an Interest in Economics and Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models," by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html 

. . .

In one very practical and consequential area, though, the allure of elegance has exercised a perverse and lasting influence. For several decades, economists have sought to express the way millions of people and companies interact in a handful of pretty equations.

The resulting mathematical structures, known as dynamic stochastic general equilibrium models, seek to reflect our messy reality without making too much actual contact with it. They assume that economic trends emerge from the decisions of only a few “representative” agents -- one for households, one for firms, and so on. The agents are supposed to plan and act in a rational way, considering the probabilities of all possible futures and responding in an optimal way to unexpected shocks.

Surreal Models

Surreal as such models might seem, they have played a significant role in informing policy at the world’s largest central banks. Unfortunately, they don’t work very well, and they proved spectacularly incapable of accommodating the way markets and the economy acted before, during and after the recent crisis.

Now, some economists are beginning to pursue a rather obvious, but uglier, alternative. Recognizing that an economy consists of the actions of millions of individuals and firms thinking, planning and perceiving things differently, they are trying to model all this messy behavior in considerable detail. Known as agent-based computational economics, the approach is showing promise.

Take, for example, a 2012 (and still somewhat preliminary) study by a group of economists, social scientists, mathematicians and physicists examining the causes of the housing boom and subsequent collapse from 2000 to 2006. Starting with data for the Washington D.C. area, the study’s authors built up a computational model mimicking the behavior of more than two million potential homeowners over more than a decade. The model included detail on each individual at the level of race, income, wealth, age and marital status, and on how these characteristics correlate with home buying behavior.

Led by further empirical data, the model makes some simple, yet plausible, assumptions about the way people behave. For example, homebuyers try to spend about a third of their annual income on housing, and treat any expected house-price appreciation as income. Within those constraints, they borrow as much money as lenders’ credit standards allow, and bid on the highest-value houses they can. Sellers put their houses on the market at about 10 percent above fair market value, and reduce the price gradually until they find a buyer.

The model captures things that dynamic stochastic general equilibrium models do not, such as how rising prices and the possibility of refinancing entice some people to speculate, buying more-expensive houses than they otherwise would. The model accurately fits data on the housing market over the period from 1997 to 2010 (not surprisingly, as it was designed to do so). More interesting, it can be used to probe the deeper causes of what happened.

Consider, for example, the assertion of some prominent economists, such as Stanford University’s John Taylor, that the low-interest-rate policies of the Federal Reserve were to blame for the housing bubble. Some dynamic stochastic general equilibrium models can be used to support this view. The agent- based model, however, suggests that interest rates weren’t the primary driver: If you keep rates at higher levels, the boom and bust do become smaller, but only marginally.

Leverage Boom

A much more important driver might have been leverage -- that is, the amount of money a homebuyer could borrow for a given down payment. In the heady days of the housing boom, people were able to borrow as much as 100 percent of the value of a house -- a form of easy credit that had a big effect on housing demand. In the model, freezing leverage at historically normal levels completely eliminates both the housing boom and the subsequent bust.

Does this mean leverage was the culprit behind the subprime debacle and the related global financial crisis? Not necessarily. The model is only a start and might turn out to be wrong in important ways. That said, it makes the most convincing case to date (see my blog for more detail), and it seems likely that any stronger case will have to be based on an even deeper plunge into the messy details of how people behaved. It will entail more data, more agents, more computation and less elegance.

If economists jettisoned elegance and got to work developing more realistic models, we might gain a better understanding of how crises happen, and learn how to anticipate similarly unstable episodes in the future. The theories won’t be pretty, and probably won’t show off any clever mathematics. But we ought to prefer ugly realism to beautiful fantasy.

(Mark Buchanan, a theoretical physicist and the author of “The Social Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually Looks Like You,” is a Bloomberg View columnist. The opinions expressed are his own.)

Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the economic collapse after mortgage lenders peddled all those poisoned mortgages ---

Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster:  The Formula That Killed Wall Street --- http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html 

Some highlights:

"For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations are at the heart of the problem.

"The reason that ratings agencies and investors felt so safe with the triple-A tranches was that they believed there was no way hundreds of homeowners would all default on their loans at the same time. One person might lose his job, another might fall ill. But those are individual calamities that don't affect the mortgage pool much as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and tranching still hadn't solved all the problems of mortgage-pool risk. Some things, like falling house prices, affect a large number of people at once. If home values in your neighborhood decline and you lose some of your equity, there's a good chance your neighbors will lose theirs as well. If, as a result, you default on your mortgage, there's a higher probability they will default, too. That's called correlation—the degree to which one variable moves in line with another—and measuring it is an important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more involved with the actual formula etc.

The “math error” might truly be have been an error or it might have simply been a gamble with what was perceived as miniscule odds of total market failure. Something similar happened in the case of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management formed by Nobel Prize winning economists and their doctoral students who took similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM  

The rhetorical question is whether the failure is ignorance in model building or risk taking using the model?

Also see
"In Plato's Cave:  Mathematical models are a powerful way of predicting financial markets. But they are fallible" The Economist, January 24, 2009, pp. 10-14 --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Wall Street’s Math Wizards Forgot a Few Variables
What wasn’t recognized was the importance of a different species of risk — liquidity risk,” Stephen Figlewski, a professor of finance at the Leonard N. Stern School of Business at New York University, told The Times. “When trust in counterparties is lost, and markets freeze up so there are no prices,” he said, it “really showed how different the real world was from our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/

An Excellent Presentation on the Flaws of Finance, Particularly the Flaws of Financial Theorists

A recent topic on the AECM listserv concerns the limitations of accounting standard setters and researchers when it comes to understanding investors. One point that was not raised in the thread to date is that a lot can be learned about investors from the top financial analysts of the world --- their writings and their conferences.

A Plenary Session Speech at a Chartered Financial Analysts Conference
Video: James Montier’s 2012 Chicago CFA Speech The Flaws of Finance ---
http://cfapodcast.smartpros.com/web/live_events/Annual/Montier/index.html
Note that it takes over 15 minutes before James Montier begins

Major Themes

  1. The difference between physics versus finance models is that physicists know the limitations of their models.
     
  2. Another difference is that components (e.g., atoms) of a physics model are not trying to game the system.
     
  3. The more complicated the model in finance the more the analyst is trying to substitute theory for experience.
     
  4. There's a lot wrong with Value at Risk (VaR) models that regulators ignored.
     
  5. The assumption of market efficiency among regulators (such as Alan Greenspan) was a huge mistake that led to excessively low interest rates and bad behavior by banks and credit rating agencies.
     
  6. Auditors succumbed to self-serving biases of favoring their clients over public investors.
     
  7. Banks were making huge gambles on other peoples' money.
     
  8. Investors themselves ignored risk such as poisoned CDO risks when they should've known better. I love his analogy of black swans on a turkey farm.
     
  9. Why don't we see surprises coming (five excellent reasons given here)?
     
  10. The only group of people who view the world realistically are the clinically depressed.
     
  11. Model builders should stop substituting elegance for reality.
     
  12. All financial theorists should be forced to interact with practitioners.
     
  13. Practitioners need to abandon the myth of optimality before the fact.
    Jensen Note
    This also applies to abandoning the myth that we can set optimal accounting standards.
     
  14. In the long term fundamentals matter.
     
  15. Don't get too bogged down in details at the expense of the big picture.
     
  16. Max Plank said science advances one funeral at a time.
     
  17. The speaker then entertains questions from the audience (some are very good).

 

James Montier is a very good speaker from England!

Mr. Montier is a member of GMO’s asset allocation team. Prior to joining GMO in 2009, he was co-head of Global Strategy at Société Générale. Mr. Montier is the author of several books including Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance; Value Investing: Tools and Techniques for Intelligent Investment; and The Little Book of Behavioural Investing. Mr. Montier is a visiting fellow at the University of Durham and a fellow of the Royal Society of Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc. in Economics from Warwick University
http://www.gmo.com/america/about/people/_departments/assetallocation.htm

There's a lot of useful information in this talk for accountics scientists.

Bob Jensen's threads on what went wrong with accountics research are at
http://www.trinity.edu/rjensen/theory01.htm#WhatWentWrong

 


Remember when the 2007/2008 severe economic collapse was caused by "street events":

Fraud on Main Street
Issuance of "poison" mortgages (many subprime) that lenders knew could never be repaid by borrowers.
Lenders didn't care about loan defaults because they sold the poison mortgages to suckers like Fannie and Freddie.
        http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze
For low income borrowers the Federal Government forced Fannie and Freddie to buy up the poisoned mortgages ---
         http://www.trinity.edu/rjensen/2008Bailout.htm#Rubble
 

Math Error on Wall Street
Issuance of CDO portfolio bonds laced with a portion of healthy mortgages and a portion of poisoned mortgages.
The math error is based on an assumption that risk of poison can be diversified and diluted using a risk diversification formula.
The risk diversification formula is called the
Gaussian copula function
The formula made a fatal assumption that loan defaults would be random events and not correlated.
When the real estate bubble burst, home values plunged and loan defaults became correlated and enormous.
 

 Fraud on Wall Street
All the happenings on Wall Street were not merely innocent math errors
Banks and investment banks were selling CDO bonds that they knew were overvalued.
Credit rating agencies knew they were giving AAA high credit ratings to bonds that would collapse.
The banking industry used powerful friends in government to pass its default losses on to taxpayers.
Greatest Swindle in the History of the World ---
      
 http://www.trinity.edu/rjensen/2008Bailout.htm#B
ailout
 

Warnings from a Theoretical Physicist With an Interest in Economics and Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models," by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html 

. . .

In one very practical and consequential area, though, the allure of elegance has exercised a perverse and lasting influence. For several decades, economists have sought to express the way millions of people and companies interact in a handful of pretty equations.

The resulting mathematical structures, known as dynamic stochastic general equilibrium models, seek to reflect our messy reality without making too much actual contact with it. They assume that economic trends emerge from the decisions of only a few “representative” agents -- one for households, one for firms, and so on. The agents are supposed to plan and act in a rational way, considering the probabilities of all possible futures and responding in an optimal way to unexpected shocks.

Surreal Models

Surreal as such models might seem, they have played a significant role in informing policy at the world’s largest central banks. Unfortunately, they don’t work very well, and they proved spectacularly incapable of accommodating the way markets and the economy acted before, during and after the recent crisis.

Now, some economists are beginning to pursue a rather obvious, but uglier, alternative. Recognizing that an economy consists of the actions of millions of individuals and firms thinking, planning and perceiving things differently, they are trying to model all this messy behavior in considerable detail. Known as agent-based computational economics, the approach is showing promise.

Take, for example, a 2012 (and still somewhat preliminary) study by a group of economists, social scientists, mathematicians and physicists examining the causes of the housing boom and subsequent collapse from 2000 to 2006. Starting with data for the Washington D.C. area, the study’s authors built up a computational model mimicking the behavior of more than two million potential homeowners over more than a decade. The model included detail on each individual at the level of race, income, wealth, age and marital status, and on how these characteristics correlate with home buying behavior.

Led by further empirical data, the model makes some simple, yet plausible, assumptions about the way people behave. For example, homebuyers try to spend about a third of their annual income on housing, and treat any expected house-price appreciation as income. Within those constraints, they borrow as much money as lenders’ credit standards allow, and bid on the highest-value houses they can. Sellers put their houses on the market at about 10 percent above fair market value, and reduce the price gradually until they find a buyer.

The model captures things that dynamic stochastic general equilibrium models do not, such as how rising prices and the possibility of refinancing entice some people to speculate, buying more-expensive houses than they otherwise would. The model accurately fits data on the housing market over the period from 1997 to 2010 (not surprisingly, as it was designed to do so). More interesting, it can be used to probe the deeper causes of what happened.

Consider, for example, the assertion of some prominent economists, such as Stanford University’s John Taylor, that the low-interest-rate policies of the Federal Reserve were to blame for the housing bubble. Some dynamic stochastic general equilibrium models can be used to support this view. The agent- based model, however, suggests that interest rates weren’t the primary driver: If you keep rates at higher levels, the boom and bust do become smaller, but only marginally.

Leverage Boom

A much more important driver might have been leverage -- that is, the amount of money a homebuyer could borrow for a given down payment. In the heady days of the housing boom, people were able to borrow as much as 100 percent of the value of a house -- a form of easy credit that had a big effect on housing demand. In the model, freezing leverage at historically normal levels completely eliminates both the housing boom and the subsequent bust.

Does this mean leverage was the culprit behind the subprime debacle and the related global financial crisis? Not necessarily. The model is only a start and might turn out to be wrong in important ways. That said, it makes the most convincing case to date (see my blog for more detail), and it seems likely that any stronger case will have to be based on an even deeper plunge into the messy details of how people behaved. It will entail more data, more agents, more computation and less elegance.

If economists jettisoned elegance and got to work developing more realistic models, we might gain a better understanding of how crises happen, and learn how to anticipate similarly unstable episodes in the future. The theories won’t be pretty, and probably won’t show off any clever mathematics. But we ought to prefer ugly realism to beautiful fantasy.

(Mark Buchanan, a theoretical physicist and the author of “The Social Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually Looks Like You,” is a Bloomberg View columnist. The opinions expressed are his own.)

Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the economic collapse after mortgage lenders peddled all those poisoned mortgages ---

Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster:  The Formula That Killed Wall Street --- http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html 

Some highlights:

"For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations are at the heart of the problem.

"The reason that ratings agencies and investors felt so safe with the triple-A tranches was that they believed there was no way hundreds of homeowners would all default on their loans at the same time. One person might lose his job, another might fall ill. But those are individual calamities that don't affect the mortgage pool much as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and tranching still hadn't solved all the problems of mortgage-pool risk. Some things, like falling house prices, affect a large number of people at once. If home values in your neighborhood decline and you lose some of your equity, there's a good chance your neighbors will lose theirs as well. If, as a result, you default on your mortgage, there's a higher probability they will default, too. That's called correlation—the degree to which one variable moves in line with another—and measuring it is an important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more involved with the actual formula etc.

The “math error” might truly be have been an error or it might have simply been a gamble with what was perceived as miniscule odds of total market failure. Something similar happened in the case of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management formed by Nobel Prize winning economists and their doctoral students who took similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM  

 

History (Long Term Capital Management and CDO Gaussian Coppola failures) Repeats Itself in Over a Billion Lost in MF Global

"Models (formulas) Behaving Badly Led to MF’s Global Collapse – People Too," by Aaron Task, Yahoo Finance, November 21, 2011 ---
http://finance.yahoo.com/blogs/daily-ticker/models-behaving-badly-led-mf-global-collapse-people-174954374.html

"The entire system has been utterly destroyed by the MF Global collapse," Ann Barnhardt, founder and CEO of Barnhardt Capital Management, declared last week in a letter to clients.

Whether that's hyperbole or not is a matter of opinion, but MF Global's collapse — and the inability of investigators to find about $1.2 billion in "missing" customer funds, which is twice the amount previously thought — has only further undermined confidence among investors and market participants alike.

Emanuel Derman, a professor at Columbia University and former Goldman Sachs managing director, says MF Global was undone by an over-reliance on short-term funding, which dried up as revelations of its leveraged bets on European sovereign debt came to light.

In the accompanying video, Derman says MF Global was much more like Long Term Capital Management than Goldman Sachs, where he worked on the risk committee for then-CEO John Corzine.

A widely respected expert on risk management, Derman is the author of a new book Models. Behaving. Badly: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life.

As discussed in the accompanying video, Derman says the "idolatry" of financial models puts Wall Street firms — if not the entire banking system — at risk of catastrophe. MF Global was an extreme example of what can happen when the models — and the people who run them -- behave badly, but if Barnhardt is even a little bit right, expect more casualties to emerge.

Jensen Comment
MF Global's auditor (PwC) will now be ensnared, as seems appropriate in this case, the massive lawsuits that are certain to take place in the future ---
http://www.trinity.edu/rjensen/Fraud001.htm


America Bought a Pig in a Poke:  It's like going on a spending binge at the Titanic's store just after hitting the iceberg
Barack Obama promised to get the economy's mojo working again with the passage of an almost $800 billion stimulus package. Wall Street responded with a Bronx Cheer and a 300 drop in the Dow Jones Industrial Average. What gives? . . . It is unclear how many more boondoggles will be uncovered in the 1000+ page bill. People are still pouring through its mass of pages. Few, if any, members of Congress read the bill before it was passed. Scare tactics well known to every salesman were used to facilitate its passage. The President proclaimed the sky was falling. An economic catastrophe was just around the corner. Congress had to do "something" immediately to forestall disaster. There was no time to read the fine print or to deliberate in a thoughtful manner. And in lemming like fashion, the Democrats poured over the cliff. It was their prerogative they claimed. After all, as Mr. Obama declared, "We won the election."
Ken Connor, "Pork and Pitchforks ," Townhall, February 22, 2009 --- http://townhall.com/columnists/KenConnor/2009/02/22/pork_and_pitchforks

Lou Dobb's Video on Where the Pork is Embedded in the Stimulus Sausage --- http://www.thehopeforamerica.com/play.php?id=340
But Lou fails to look at the long-term, multi-year entitlement links in this string of sausage.

The National Debt has continued to increase an average of $3.93(now $6) billion per day since September 28, 2007!
The National Debt Amount This Instant (Refresh your browser for updates by the second) --- http://www.brillig.com/debt_clock/
History of the National Debt --- http://en.wikipedia.org/wiki/National_Debt 
Entitlements --- http://www.trinity.edu/rjensen/entitlements.htm


History of the National Debt --- http://en.wikipedia.org/wiki/National_Debt 

 

You cannot legislate the poor into freedom by legislating the wealthy out of freedom. What one person receives without working for, another person must work for without receiving. The government cannot give to anybody anything that the government does not first take from somebody else. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that my dear friend, is about the end of any nation. You cannot multiply wealth by dividing it.
Ronald Reagan

America, what is happening to you?
“One thing seems probable to me,” said Peer Steinbrück, the German finance minister, in September 2008....“the United States will lose its status as the superpower of the global financial system.” You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida, "How the Crash Will Reshape America," The Atlantic, March 2009 --- http://www.theatlantic.com/doc/200903/meltdown-geography

Professor Schiller at Yale asserts housing prices are still overvalued and need to come down to reality
The median value of a U.S. home in 2000 was $119,600. It peaked at $221,900 in 2006. Historically, home prices have risen annually in line with CPI. If they had followed the long-term trend, they would have increased by 17% to $140,000. Instead, they skyrocketed by 86% due to Alan Greenspan’s irrational lowering of interest rates to 1%, the criminal pushing of loans by lowlife mortgage brokers, the greed and hubris of investment bankers and the foolishness and stupidity of home buyers. It is now 2009 and the median value should be $150,000 based on historical precedent. The median value at the end of 2008 was $180,100. Therefore, home prices are still 20% overvalued. Long-term averages are created by periods of overvaluation followed by periods of undervaluation. Prices need to fall 20% and could fall 30%.....
Watch the video on Yahoo Finance --- Click Here
See the chart at http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
Also see Jim Mahar's blog at http://financeprofessorblog.blogspot.com/2009/02/shiller-house-prices-still-way-too-high.html
Jensen Comment
In the worldwide move toward fair value accounting that replaces cost allocation accounting, the above analysis by Professor Schiller is sobering. It suggests how much policy and widespread fraud can generate misleading "fair values" in deep markets with many buyers and sellers, although the housing market is a bit more like the used car market than the stock market. Each house and each used car are unique, non-fungible items that are many times more difficult to update with fair value accounting relative to fungible market securities and new car markets.

The government gave them 105% for their $200,000 subprime mortgage.
They then sold the house for $37,000, got married, and are escaping from California.

So are we now that we flipped the doghouse!

 

It is apparent that we've learned nothing from several millennia of monetary destruction. The persistent demonstration that capital, not paper, is the basis for prosperity has fallen on deaf ears. Daily, we face the sad spectacle of government officials, pundits, and even Nobel laureates (read that Paul Klugman from the Zimbabwe School of Finance) telling us that printing money is the answer to an economic downturn.
"Printing Like Mad," Mises Economic Blog, February 15, 2009 --- http://blog.mises.org/archives/009457.asp

I started saving up in the barn to buy a new snow shovel in about six years.

 

 

Question
As of December 2008, what do Zimbabwe and the United States have in common?

Answer
Rather than taxing or borrowing to cover deficit spending, both governments are simply printing more money?

What's wrong with that?
First look at what it did to Zimbabwe. Then read about Gresham's Law --- http://en.wikipedia.org/wiki/Gresham%27s_Law
The instant the Federal Reserve announced this new funding policy in December, the U.S. dollar plunged in value relative to foreign currencies. The reason is obvious.

Zimbabwe's central bank will introduce a 100 trillion Zimbabwe dollar banknote, worth about $33 on the black market, to try to ease desperate cash shortages, state-run media said on Friday.
KyivPost, January 16, 2009 --- http://www.kyivpost.com/world/33522
Jensen Comment
This is a direct result of raising money by simply printing it, and the U.S. should take note since this is how our Federal government has decided to pay for anticipated trillion-dollar budget deficits --- http://www.trinity.edu/rjensen/2008Bailout.htm#NationalDebt

The United States will "look like a banana republic" unless it gains control over its budget deficit and federal debt, economist Allen Sinai warned Congress on Thursday. "The deficit and debt prospects under almost any scenario are daunting," Mr. Sinai, chief global economist for Decision Economics Inc., told the Senate Budget Committee. "This territory is uncharted, with no real historical analogue to this kind of financial situation for a major global economic power." Asked by committee Chairman Kent Conrad, North Dakota Democrat, whether the U.S. government's creditworthiness is at risk, Mr. Sinai replied, "Unequivocally yes." Richard Berner, chief U.S. economist at Morgan Stanley, told the committee one measure of America's creditworthiness -- credit default swap spreads -- already shows some deterioration. The worse a nation's credit rating becomes, the more its CDS spread rises. U.S. sovereign CDS spreads have widened to about 0.6 percent from 0.1 percent last summer, Mr. Berner noted. "So the message is that you ignore global investors at your peril," he told the committee.
David M. Dixon
, "Congress warned about debt U.S. advised to gain control," The Washington Times, January 16, 2009 --- http://washingtontimes.com/news/2009/jan/16/policies-on-debt-a-risk-to-economy/


"Economics has met the enemy, and it is economics," by Ira Basen, Globe and Mail, October 15, 2011 ---
http://www.theglobeandmail.com/news/politics/economics-has-met-the-enemy-and-it-is-economics/article2202027/page1/ 
Thank you Jerry Trites for the heads up.

After Thomas Sargent learned on Monday morning that he and colleague Christopher Sims had been awarded the Nobel Prize in Economics for 2011, the 68-year-old New York University professor struck an aw-shucks tone with an interviewer from the official Nobel website: “We're just bookish types that look at numbers and try to figure out what's going on.”

But no one who'd followed Prof. Sargent's long, distinguished career would have been fooled by his attempt at modesty. He'd won for his part in developing one of economists' main models of cause and effect: How can we expect people to respond to changes in prices, for example, or interest rates? According to the laureates' theories, they'll do whatever's most beneficial to them, and they'll do it every time. They don't need governments to instruct them; they figure it out for themselves. Economists call this the “rational expectations” model. And it's not just an abstraction: Bankers and policy-makers apply these formulae in the real world, so bad models lead to bad policy.

Which is perhaps why, by the end of that interview on Monday, Prof. Sargent was adopting a more realistic tone: “We experiment with our models,” he explained, “before we wreck the world.”

Rational-expectations theory and its corollary, the efficient-market hypothesis, have been central to mainstream economics for more than 40 years. And while they may not have “wrecked the world,” some critics argue these models have blinded economists to reality: Certain the universe was unfolding as it should, they failed both to anticipate the financial crisis of 2008 and to chart an effective path to recovery.

The economic crisis has produced a crisis in the study of economics – a growing realization that if the field is going to offer meaningful solutions, greater attention must be paid to what is happening in university lecture halls and seminar rooms.

While the protesters occupying Wall Street are not carrying signs denouncing rational-expectations and efficient-market modelling, perhaps they should be.

They wouldn't be the first young dissenters to call economics to account. In June of 2000, a small group of elite graduate students at some of France's most prestigious universities declared war on the economic establishment. This was an unlikely group of student radicals, whose degrees could be expected to lead them to lucrative careers in finance, business or government if they didn't rock the boat. Instead, they protested – not about tuition or workloads, but that too much of what they studied bore no relation to what was happening outside the classroom walls.

They launched an online petition demanding greater realism in economics teaching, less reliance on mathematics “as an end in itself” and more space for approaches beyond the dominant neoclassical model, including input from other disciplines, such as psychology, history and sociology. Their conclusion was that economics had become an “autistic science,” lost in “imaginary worlds.” They called their movement Autisme-economie.

The students' timing is notable: It was the spring of 2000, when the world was still basking in the glow of “the Great Moderation,” when for most of a decade Western economies had been enjoying a prolonged period of moderate but fairly steady growth.

Some economists were daring to think the unthinkable – that their understanding of how advanced capitalist economies worked had become so sophisticated that they might finally have succeeded in smoothing out the destructive gyrations of capitalism's boom-and-bust cycle. (“The central problem of depression prevention has been solved,” declared another Nobel laureate, Robert Lucas of the University of Chicago, in 2003 – five years before the greatest economic collapse in more than half a century.)

The students' petition sparked a lively debate. The French minister of education established a committee on economic education. Economics students across Europe and North America began meeting and circulating petitions of their own, even as defenders of the status quo denounced the movement as a Trotskyite conspiracy. By September, the first issue of the Post-Autistic Economic Newsletter was published in Britain.

As The Independent summarized the students' message: “If there is a daily prayer for the global economy, it should be, ‘Deliver us from abstraction.'”

It seems that entreaty went unheard through most of the discipline before the economic crisis, not to mention in the offices of hedge funds and the Stockholm Nobel selection committee. But is it ringing louder now? And how did economics become so abstract in the first place?

The great classical economists of the late 18th and early 19th centuries had no problem connecting to the real world – the Industrial Revolution had unleashed profound social and economic changes, and they were trying to make sense of what they were seeing. Yet Adam Smith, who is considered the founding father of modern economics, would have had trouble understanding the meaning of the word “economist.”

What is today known as economics arose out of two larger intellectual traditions that have since been largely abandoned. One is political economy, which is based on the simple idea that economic outcomes are often determined largely by political factors (as well as vice versa). But when political-economy courses first started appearing in Canadian universities in the 1870s, it was still viewed as a small offshoot of a far more important topic: moral philosophy.

In The Wealth of Nations (1776), Adam Smith famously argued that the pursuit of enlightened self-interest by individuals and companies could benefit society as a whole. His notion of the market's “invisible hand” laid the groundwork for much of modern neoclassical and neo-liberal, laissez-faire economics. But unlike today's free marketers, Smith didn't believe that the morality of the market was appropriate for society at large. Honesty, discipline, thrift and co-operation, not consumption and unbridled self-interest, were the keys to happiness and social cohesion. Smith's vision was a capitalist economy in a society governed by non-capitalist morality.

But by the end of the 19th century, the new field of economics no longer concerned itself with moral philosophy, and less and less with political economy. What was coming to dominate was a conviction that markets could be trusted to produce the most efficient allocation of scarce resources, that individuals would always seek to maximize their utility in an economically rational way, and that all of this would ultimately lead to some kind of overall equilibrium of prices, wages, supply and demand.

Political economy was less vital because government intervention disrupted the path to equilibrium and should therefore be avoided except in exceptional circumstances. And as for morality, economics would concern itself with the behaviour of rational, self-interested, utility-maximizing Homo economicus. What he did outside the confines of the marketplace would be someone else's field of study.

As those notions took hold, a new idea emerged that would have surprised and probably horrified Adam Smith – that economics, divorced from the study of morality and politics, could be considered a science. By the beginning of the 20th century, economists were looking for theorems and models that could help to explain the universe. One historian described them as suffering from “physics envy.” Although they were dealing with the behaviour of humans, not atoms and particles, they came to believe they could accurately predict the trajectory of human decision-making in the marketplace.

In their desire to have their field be recognized as a science, economists increasingly decided to speak the language of science. From Smith's innovations through John Maynard Keynes's work in the 1930s, economics was argued in words. Now, it would go by the numbers.

Continued in a long article

Mathematical Analytics in Plato's Cave ---
http://www.trinity.edu/rjensen/TheoryTAR.htm#Analytics

 


Federal securities class action lawsuits increased 19 percent in 2008, with almost half involving firms in the financial services sector according to the annual report prepared by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research --- http://securities.stanford.edu/scac_press/20080106_YIR08_Press_Release.pdf

Especially note the 2008 Year in Review link at http://securities.stanford.edu/clearinghouse_research/2008_YIR/20080106.pdf


"Fed Cuts Key Rate to a Record Low," by Edmund L. Andrews and Jackie Calmes, The New York Times, December 16, 2008 ---
http://www.nytimes.com/2008/12/17/business/economy/17fed.html?_r=1&scp=1&sq=printing money&st=cse

In effect, the Fed is stepping in as a substitute for banks and other lenders and acting more like a bank itself.
“The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth,” it said. Those tools include buying “large quantities” of mortgage-related bonds, longer-term Treasury bonds, corporate debt and even consumer loans.

The move came as President-elect Barack Obama summoned his economic team to a four-hour meeting in Chicago to map out plans for an enormous economic stimulus measure that could cost anywhere from $600 billion to $1 trillion over the next two years.

The two huge economic stimulus programs, one from the Fed and one from the White House and Congress, set the stage for a powerful but potentially risky partnership between Mr. Obama and the Fed’s Republican chairman, Ben S. Bernanke.

“We are running out of the traditional ammunition that’s used in a recession, which is to lower interest rates,” Mr. Obama said at a news conference Tuesday. “It is critical that the other branches of government step up, and that’s why the economic recovery plan is so essential.”

Financial markets were electrified by the Fed action. The Dow Jones industrial average jumped 4.2 percent, or 359.61 points, to close at 8,924.14.

Investors rushed to buy long-term Treasury bonds. Yields on 10-year Treasuries, which have traditionally served as a guide for mortgage rates, plunged immediately after the announcement to 2.26 percent, their lowest level in decades, from 2.51 percent earlier in the day.

Yields on investment-grade corporate bonds edged down to 7.215 percent on Tuesday, from 7.355 on Monday. Yields on riskier high-yielding corporate bonds remained in the stratosphere at 22.493 percent, almost unchanged from 22.732 on Monday.

By contrast, the dollar dropped sharply against the euro and other major currencies for the second consecutive day — a sign that currency markets were nervous about a flood of newly printed dollars.
Some analysts predict that the Treasury will have to sell $2 trillion worth of new securities over the next year to finance its existing budget deficit, a new stimulus program and to refinance about $600 billion worth of maturing government debt.

For the moment, Mr. Obama and Mr. Bernanke appear to be on the same page, though that could abruptly change if the economy starts to revive. Fed officials have already assumed that Congress will pass a major spending program to stimulate the economy, and they are counting on it to contribute to economic growth next year.

In more normal times, the Fed might easily start raising interest rates in reaction to a huge new spending program, out of concern about rising inflation.

But data on Tuesday provided new evidence that the biggest threat to prices right now was not inflation but deflation.

The federal government reported on Tuesday that the Consumer Price Index fell 1.7 percent in November, the steepest monthly drop since the government began tracking prices in 1947. The decline was largely driven by the recent plunge in energy prices, but even the so-called core inflation rate, which excludes the volatile food and energy sectors, was essentially zero.

Mr. Obama’s goal is to have a package ready when the new Congress convenes on Jan. 6. His hope is that the House and Senate, with their bigger Democratic majorities, can agree quickly on a plan for Mr. Obama to sign into law soon after he is sworn into office two weeks later.

The Fed, in a statement accompanying its rate decision, acknowledged that the recession was more severe than officials had thought at their last meeting in October.

“Over all, the outlook for economic activity has weakened further,” the central bank said.

“Labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment and industrial production have declined.”

The central bank added: “The committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

With fewer than 10 days until Christmas, retailers from Saks Fifth Avenue to Wal-Mart have been slashing prices to draw in consumers, who have sharply reduced their spending over the last six months. On Tuesday, Banana Republic offered customers $50 off on any purchases that total $125. The clothing retailer DKNY offered customers $50 off any purchase totaling $250.

Ian Shepherdson, an analyst at High Frequency Economics, said falling energy prices were likely to bring the year-over-year rate of inflation to below zero in January.

The Fed has already announced or outlined a range of unorthodox new tools that it can use to keep stimulating the economy once the federal funds rate effectively reaches zero. On Tuesday, Fed officials said they stood ready to expand them or create new ones to relieve bottlenecks in the credit markets.

All of the tools involve borrowing by the Fed, which amounts to printing money in vast new quantities, a process the Fed has already started.
Since September, the Fed’s balance sheet has ballooned from about $900 billion to more than $2 trillion as it has created money and lent it out. As soon as the Fed completes its plans to buy mortgage-backed debt and consumer debt, the balance sheet will be up to about $3 trillion.

“At some point, and without knowing the timing, the Fed is going to have to destroy all that money it is creating,” said Alan Blinder, a professor of economics at Princeton and a former vice chairman of the Federal Reserve.

“Right now, the crisis is created by the huge demand by banks for hoarding cash. The Fed is providing cash, and the banks want to hoard it. When things start returning to normal, the banks will want to start lending it out. If that much money is left in the monetary base, it would be extremely inflationary.”

This is the thing I’ve been afraid of ever since I realized that Japan really was in the dreaded, possibly mythical liquidity trap. You can read my 1998 Brookings Paper on the issue here. Incidentally, there were a bunch of us at Princeton worrying about the Japan problem in the early years of this decade. I was one; Lars Svensson, currently at Sweden’s Riksbank, was another; a third was a guy named Ben Bernanke. I wonder whatever happened to him?
Paul Krugman, "ZIRP," The New York Times, December 16, 2008 ---
http://krugman.blogs.nytimes.com/2008/12/16/zirp/?scp=8&sq=printing money&st=cse

How much to bail out the banks now? $3.5 trillion by one estimate
America, what is happening to you?

A federal program to guarantee or buy bad assets from the ailing U.S. bank sector could come with a $3.5 trillion price tag. That would push the accumulated costs of rescuing the financial markets over the last year through various federal loan, stock purchase, debt guarantee and other programs close to $9 trillion and counting, with practically no end in sight for the bad news battering the banking industry. That figure doesn't count the $825 billion economic stimulus plan also under consideration. "We expect massive federal intervention into the financial sector from the new administration in the coming months," says Keefe Bruyette & Woods analyst Frederick Cannon, who calculated the $3.5 trillion figure, which is one-quarter of the banking sector's $14 trillion in combined assets.
Liz Moyer
, "A TARP In The Trillions?" Forbes, January 21, 2009 --- http://www.forbes.com/2009/01/21/tarp-banking-treasury-biz-wall-cx_lm_0121tarp.html
Jensen Comment
The estimate is now almost double the above figure.
So how much are we talking about in the already-existing toxic paper already held by Fannie, Freddie, and the most poisoned banks?
Estimates place these at $6 trillion, which is well over half our out-of-control existing National Debt --- http://online.wsj.com/article/SB123396703401759083.html?mod=djemEditorialPage

Plus another $3,6 trillion maybe
America, what is happening to you?
Much has been made of the subprime debacle. But few seem to be willing to talk about another looming crisis: credit card debt. People like Nouriel Roubini, the professor who has predicted much of this crisis, have estimated that you could have losses of as much as $3.6 trillion, which would bankrupt the industry. What do you make of that number? And since credit card defaults are correlated to employment, what happens if unemployment goes as high as 10 percent or more? What is the highest unemployment level that you’ve used in your forecasting models? And do you have adequate reserves for your worst-case situation? If your assumptions are wrong, what happens?

Andrew Ross Sorkin, "Up Next for Bankers: A Flogging," The New York Times, February 9, 2009 ---
http://www.nytimes.com/2009/02/10/business/10sorkin.html?_r=1&partner=permalink&exprod=permalink

As it has so often in recent months, the market elation that greeted the Federal Reserve's epic monetary easing earlier this week has turned to worry. Stocks fell off again yesterday, but the big news of the week has been the slide in the dollar. The nearby chart shows the greenback's story since September. From its dangerous summer lows, the buck soared at the height of the credit panic as investors looked for safety in a hurricane. But the dollar has fallen like Newton's apple in December, as Chairman Ben Bernanke and his comrades signaled that they are willing to cut interest rates to near-zero and print as much money as it takes to prevent a deflation.
"A Dollar Referendum Currency markets reflect a lack of faith in Bernanke," The Wall Street Journal, December 19, 2008 ---
http://online.wsj.com/article/SB122965017184420567.html

A few quick facts about Wall Street bonuses. The pretext for the political outrage was the New York comptroller's report this week on the aggregate data for bonuses in 2008. That "irresponsible" bonus pool of $18 billion was for every worker in the New York financial industry, from top dogs to secretaries. This bonus pool fell 44% in 2008, the largest percentage decline in 30 years. The average bonus was $112,000; bonuses typically make up most of an employee's salary on Wall Street. The comptroller estimates that this decline will cost New York State $1 billion in lost tax revenue and New York City $275 million. Both city and state may have to announce layoffs.
"'Idiots' Indeed," The Wall Street Journal, January 31, 2009 --- http://online.wsj.com/article/SB123336371503735447.html?mod=djemEditorialPage
Jensen Comment
Although this puts our bonus contempt somewhat in a new light, it also does not lesson opinion that John Thain and the other crooks who declared themselves multi-million bonuses are one of the reasons that America now despises Wall Street. Actually Thain wanted a $10 million bonus while captain of his sinking ship (Merrill Lynch).
Bob Jensen's threads on outrageous executive compensation --- http://online.wsj.com/article/SB123336371503735447.html?mod=djemEditorialPage

Rep. Manzullo Questions Bailout Czar Neel Kashkari (Watch a Butt Get Chewed Out) --- http://www.youtube.com/watch?v=UP73cK3GXdo
Bob Jensen's threads on outrageous executive compensation --- http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation


Bank of America --- http://en.wikipedia.org/wiki/Bank_of_America
BofA was riding high after the 2009 financial crises until it acquired the disasters called Countrywide and Merrill Lynch!

Teaching Case from The Wall Street Journal Accounting Weekly Review on October 5, 2012

BofA Takes New Crisis-Era Hit
by: Dan Fitzpatrick, Christian Berthelsen and Robin Sidel
Sep 29, 2012
Click here to view the full article on WSJ.com
Click here to view the video on WSJ.com WSJ Video
 

TOPICS: Contingent Liabilities

SUMMARY: "Bank of America Corp. agreed to pay $2.43 billion to settle claims it misled investors about the acquisition of troubled brokerage firm Merrill Lynch & Co...." during the financial crisis in 2008. At the time it acquired Merrill Lynch in September 2008, BofA became the biggest U.S. bank; the value of the bank then fell by more than half by the time the acquisition of Merrill Lynch closed 3 months later. These losses were not disclosed by then CEO Ken Lewis and his management team to shareholders before they voted on the merger transaction with Merrill.

CLASSROOM APPLICATION: The article addresses accounting for litigation contingent liabilities. The related video clearly discusses the history of the transactions.

QUESTIONS: 
1. (Introductory) To whom did Bank of America Corp. (BofA) agree to pay $2.43 billion dollars?

2. (Introductory) For what losses did BofA agree to make this payment?

3. (Advanced) How could losses have occurred and a payment of $2.4 billion be required if "Bank of America executives now say Merrill...has become a big profit contributor... [and that] it's clear that Merrill is a significant positive any way you want to look at it..."?

4. (Advanced) What accounting standards provide the requirements to account for costs such as this $2.4 billion payment by BofA?

5. (Advanced) According to the article, BofA has "set aside more than $42 billion in litigation expenses, payouts and reserves...[which] includes $1.6 billion taken in the third quarter [of 2012]...." According to the related video, what period will be affected by $1.6 billion being recorded as an expense related to this $2.43 billion settlement? Explain your answer.
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
BofA-Merrill: Still A Bottom-Line Success
by David Benoit
Sep 28, 2012
Online Exclusive

"BofA Takes New Crisis-Era Hit," by Dan Fitzpatrick, Christian Berthelsen and Robin Sidel, The Wall Street Journal, September 29, 2012 ---
http://professional.wsj.com/article/SB10000872396390443843904578024110468736042.html?mod=djem_jiewr_AC_domainid&mg=reno-wsj

Bank of America Corp. agreed to pay $2.43 billion to settle claims it misled investors about the acquisition of troubled brokerage firm Merrill Lynch & Co., in the latest financial-crisis aftershock to rattle the banking sector.

The payment is the largest settlement of a shareholder claim by a financial-services firm since the upheaval of 2008 and 2009. It also ranks as the eighth-largest securities class-action settlement, behind payouts like the $7.2 billion settlement with shareholders of Enron Corp. and the $6.1 billion pact with WorldCom Inc. investors, both in 2005.

The deal is a sign that U.S. banks' battle to contain the high cost of the crisis continues to escalate, despite a four-year slog of lawsuits, losses and profit-sapping regulations. Bank of America's total exposure to crisis-era litigation is "seemingly never-ending," said Sterne Agee & Leach Inc. in a note Friday.

Is the era that produced all of this legal exposure "history?" the Sterne Agee & Leach analysts said. "Unlikely."

The settlement ends a three-year fight with a group of five plaintiffs, including the State Teachers Retirement System of Ohio and the Teacher Retirement System of Texas. They accused the bank and its officers of making false or misleading statements about the health of Bank of America and Merrill Lynch and were planning to seek $20 billion if the case went to trial as scheduled on Oct. 22.The size of the pact highlights how hasty acquisitions engineered during the height of the financial crisis by Kenneth Lewis, then the bank's chief executive, are still haunting the company four years later. Decisions to buy mortgage lender Countrywide Financial Corp. and Merrill have forced Bank of America, run since 2010 by Chief Executive Brian Moynihan, to set aside more than $42 billion in litigation expenses, payouts and reserves, according to company figures. The funds are meant to absorb a litany of Merrill-related lawsuits and claims from investors who say Countrywide wasn't honest about the quality of mortgage-backed securities it issued before the crisis.

That total includes $1.6 billion taken in the third quarter to help pay for the Merrill settlement announced Friday and a landmark $8.5 billion agreement reached last year with a group of high-profile mortgage-bond investors.

The company's shares lost more than half their value between when Bank of America announced its late-2008 plan to purchase Merrill Lynch and the date the deal closed 3½ months later, wiping out $70 billion in shareholder value. The shares have fallen further since then, and investors who owned the shares won't be made whole by the settlement.

"We find it simply amazing the sheer magnitude of value destruction over the years," said Sterne Agee in the note issued Friday. And "the bill is surely set to increase" as the research firm expects the bank to reach other legal settlements over the next 12 to 24 months. Bank of America is still engaged in a legal clash with bond insurer MBIA Inc., MBI +3.91% which has alleged that Countrywide wasn't honest about the quality of mortgage-backed securities it issued before the financial crisis.

The move to buy Merrill over one weekend in September 2008 was initially hailed as a rare piece of good news during a week when much of Wall Street appeared to be teetering on the brink. It also vaulted the Charlotte, N.C., lender to the top of the U.S. banking heap, capping a goal pursued over two decades by Mr. Lewis and his predecessor, Hugh McColl.

The Merrill deal, initially valued at $50 billion in Bank of America stock, was the "deal of a lifetime," Mr. Lewis said on the day it was announced.

But the agreement soon became a problem as analysts questioned whether Mr. Lewis paid too much and Merrill's losses spiraled out of control in the weeks before the deal closed. Investor fears stemming from the financial crisis sent shares of Bank of America and other financial companies into free fall, and the deal was worth roughly $19 billion at its completion on Jan. 1, 2009.

Mr. Lewis and his top executives made the decision not to say anything publicly about the mounting problems before shareholders signed off on the merger—a decision that formed the basis of a number of Merrill-related suits, including an action brought by the Securities and Exchange Commission. The bank also didn't disclose that it sought $20 billion in U.S. aid to digest Merrill, or that the deal allowed Merrill to award up to $5.8 billion in performance bonuses. When Bank of America threatened to pull out of the deal because of the losses, then-Treasury Secretary Henry Paulson told Mr. Lewis that current management would be removed if the deal wasn't completed.

The legal scrutiny surrounding the Merrill acquisition contributed to Mr. Lewis's decision to step down at the end of 2009. Mr. Lewis's lawyer declined to comment.

"Any way you slice it, $2.4 billion is a big number," says Kevin LaCroix, a lawyer at RT ProExec, a firm that focuses on management-liability issues.

Bank of America executives now say Merrill, unlike Countrywide, has become a big profit contributor, while the company continues to work to absorb massive losses in its mortgage division. The divisions inherited from Merrill produced $31.9 billion in net income between 2009 and 2011 and $164.4 billion in revenue. Bank of America's total net income over the period was just $5.5 billion, on $326.8 billion in revenue, reflecting in part the hefty losses tied to the Countrywide deal.

"I think it's clear that Merrill is a significant positive any way you want to look at it," said spokesman Jerry Dubrowski.

The settlement doesn't end all Merrill-related headaches. The New York attorney general's office still is pursuing a separate civil fraud suit relating to the Merrill takeover that began under former Attorney General Andrew Cuomo. Defendants in that case include the bank, Mr. Lewis and former Chief Financial Officer Joe Price. A spokesman for New York State Attorney General Eric Schneiderman declined to comment.

It isn't known how much all shareholders will receive as a result of the Merrill settlement announced Friday. The amount shareholders receive will ultimately depend on how long they held the shares and how much they paid. Mr. Lewis, also a shareholder, won't receive a payout because defendants in the suit are excluded from the class that the court certified.

But because the decline in Bank of America stock was so steep—the shares fell from $32 to $14 between Sept. 12, 2008, the day before the Merrill acquisition was announced, and the Jan. 1, 2009, closing—no shareholders can expect to recover their full losses.

Before the settlement was reached, a targeted recovery for at least three million shareholders who were part of the class was $2.52 a share, said a spokesman for Ohio Attorney General Mike DeWine. The State Teachers Retirement System of Ohio and the Ohio Public Employees Retirement System, which held between 18 million and 20 million shares, now expect to recover $1.19 per share, or roughly $20 million.

Continued in article

Breaking the Bank Frontline Video
In Breaking the Bank, FRONTLINE producer Michael Kirk (Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to reveal the story of two banks at the heart of the financial crisis, the rocky merger, and the government’s new role in taking over — some call it “nationalizing” — the American banking system.
Simoleon Sense, September 18, 2009 --- http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout --- http://www.trinity.edu/rjensen/2008Bailout.htm

Merrill Lynch had a friend in Hank Paulson, but he was no friend to Bank of America shareholders
The ex-US Treasury Secretary has admitted telling the Bank of America boss he might lose his job if he walked away from a merger from Merrill Lynch. The former US Treasury Secretary says the merger was necessary Hank Paulson warned the bank's chief executive Kenneth Lewis that the Federal Reserve could oust him and the board if the rescue did not proceed. But Mr. Paulson insisted that remarks he made were "appropriate." Bank of America bought Merrill during the height of the financial crisis and suffered severe losses.
"Paulson admits bank merger threat," BBC News, July 15, 2009 ---
http://news.bbc.co.uk/2/hi/business/8152858.stm
 

Jensen Comment
Paulson's claim that his threats were "appropriate" comes as little comfort to Bank of America shareholders who will be losing greatly because of the threats.

Bank of America is now paying a steep (fatal?) price for having purchased the fraudulent Countrywide and Merrill Lynch companies. The poison-laced Countrywide was a lousy investment decision. However, then CEO Kenneth D. Lewis contends that then Treasury Secretary Hank Paulson held a gun to his head and forced BofA to buy the deeply corrupt and poison-laced Merrill Lynch.

CDO --- http://en.wikipedia.org/wiki/Collateralized_debt_obligation

Countrywide Financial --- http://en.wikipedia.org/wiki/Countrywide_Financial

Those Poisoned CDOs
"Bank of America Ordered to Unseal Documents in MBIA Case," by Dan Freed, The Street, June 4, 2013 ---
http://www.thestreet.com/story/11804771/1/bank-of-america-ordered-to-unseal-documents-in-mbia-case.html

Jensen Comment
Arguably the worst decision in the 2008 economic bailout was Bank of America's decision to buy the bankrupt Countrywide Financial. BofA then CEO Lewis claims to this day that Treasury Secretary Hank Paulsen held a gun to his head and said buy Countrywide Financial or else. Countrywide has been nothing but a cash flow hemorrhage for BofA ever since.

 

"BofA plunges as AIG sues for $10 billion "fraud," by Jonathan Stempel and Joe Rauch, Reuters, August 8, 2011 ---
http://www.reuters.com/article/2011/08/08/us-bankofamerica-aig-lawsuit-idUSTRE7772LN20110808

Bank of America Corp shares plunged more than 20 percent on Monday, capping a three-day rout in which the largest U.S. bank lost nearly one-third of its market value.

Monday's decline was triggered by a $10 billion lawsuit from American International Group Inc alleging a "massive" mortgage fraud.

The action raised new concerns about burgeoning losses related to the bank's $2.5 billion purchase of Countrywide Financial Corp in 2008 and prompted questions about the stability of the bank's management team.

"The bank just can't get its hands around the liabilities it's facing," said Paul Miller, an analyst at FBR Capital Markets.

He said investors fear the bank will have to raise equity to cover potential losses, diluting existing shareholdings.

Bank of America spokesman Jerry Dubrowski countered that the bank has adequate reserves to buy back mortgages if necessary and is comfortable with its strategic plans.

"We don't think we need to raise capital to run our businesses," he said. "We have the right strategy and management team in place."

In a separate court filing on Monday AIG, challenged an $8.5 billion agreement Bank of America reached in late June to end litigation by several large investors who bought securities backed by subprime Countrywide loans.

New York Attorney General Eric Schneiderman and other investors have previously tried to block that accord, saying the settlement amount is too small.

Bank of America shares closed down $1.66 at $6.51 after earlier plunging to $6.31, their lowest since March 2009. More than $30 billion of the company's market value has been wiped out since August 3.

Monday's drop came amid a broad market selloff, led by financial stocks, on the first trading day after Standard & Poor's downgraded its rating of U.S. government debt.

The shares of Citigroup Inc, another large bank, fell 16.4 percent to $27.95.

The cost of insuring Bank of America debt against default, an indicator of potential trouble at companies, rose roughly 50 percent on Monday to a level higher than several of the bank's main rivals, data provider Markit said.

It now costs $310,000 a year to insure the bank's bonds for five years, compared with $143,000 for the bonds of JP Morgan Chase & Co, the second largest U.S. bank.

CONFIDENCE AND TRUST

AIG's lawsuit also upped the ante for Bank of America Chief Executive Brian Moynihan, who is struggling to contain losses from the Countrywide deal engineered by his predecessor, Kenneth Lewis.

"Brian Moynihan and the management team have not gained the confidence and trust of investors," said Jonathan Finger, whose Finger Interests Number One Ltd in Houston owns BofA stock and was a vocal critic of Lewis.

Moynihan is scheduled to participate in a public conference call on Wednesday hosted by Fairholme Capital Management LLC, one of its largest shareholders.

"Brian will have to give the performance of his life," said Tony Plath, a professor at the University of North Carolina at Charlotte, where Bank of America is based.

Moynihan's saving grace might be that the bank's board has no obvious candidates to replace him, said Miller of FBR Capital Markets.

Some large investors appeared to have avoided some of the debacle.

Hedge fund manager David Tepper, who has made a fortune betting against financial company shares, sold nearly half of his stake in Bank of America during the second quarter, according to a regulatory filing from his company, Appaloosa Management.

"Bank of America's stock price will remain under duress," said Michael Mullaney, who helps invest $9.5 billion at Fiduciary Trust Co in Boston and who said his company has sold nearly all its BofA shares.

Continued in article


Thain Pain:  Merrill Lynch Bonuses of Over $1 Million to 696 Executives
Rewarded for making their company so profitable for shareholders? (Barf Alert!)

Merrill Lynch quietly paid out at least one million dollars bonus each to about 700 top executive even when the investment house was bleeding with losses last year, a probe has revealed. They were part of 3.6 billion dollars in the firm's bonus payments in December before the announcement of its fourth quarterly losses and takeover by Bank of America, the investigation by the New York state Attorney General's office showed. "696 individuals received bonuses of one million dollars or more," New York Attorney General Andrew Cuomo said of the Merrill scandal in a letter to a lawmaker heading the House of Representatives financial services committee.
"Merrill bonuses made 696 millionaires: probe," Yahoo News, February 11, 2009 --- http://news.yahoo.com/s/afp/20090211/bs_afp/usbankingjusticeprobecompanymerrillbofa_20090211201133

John Alexander Thain (born May 26, 1955) was the last chairman and chief executive officer of Merrill Lynch before its merger with Bank of America. Thain was designated to become president of global banking, securities, and wealth management at the newly combined company, but he resigned on January 22, 2009. Bank of America lost confidence in Thain after he failed to tell the bank about mounting losses at Merrill in late 2008. The Associated Press identified him as the best paid among the executives of the S&P 500 companies in 2007. On December 8, 2008, Thain gave up on pursuing a controversial bonus of $10 million from the compensation committee at Merrill.[2] Thain also decided to accelerate payments of bonus to employees at Merrill, giving out between $3 billion and $4 billion using money that appeared to come directly from the $15 billion Bank of America and Merrill Lynch had received from US government taxpayers (via the Troubled Assets Relief Program). Thain has additionally become infamous for spending $1.22 million in corporate funds to decorate his office, even as he was asking the government for a bailout of his troubled company.
Quoted from Wikipedia *** http://en.wikipedia.org/wiki/John_Thain
Thain has since been fired by Bank of America and has agreed to pay for over $1 million spent redecorating his new office.
My question is how Bank of America could buy Merrill without audit verification of Merrill’s 2008 losses and cash flows --- these should've never been a surprise to Bank of America unless Bank of America was plain stupid about accounting. The final settlement price at a minimum could've been contingent on an audit of 2008 earnings.

Added Jensen Comment
I've never been a big fan of Merrill Lynch after repeated disclosures emerged about the repeated frauds instigated by employees of Merrill in the 1990s. Just do a word search on "Merrill" and note the number of frauds that are documented, not the least of which is the Orange County massive derivatives instruments fraud --- http://www.trinity.edu/rjensen/FraudRotten.htm

Good Bank, Bad Bank by Dr. Seuss --- http://thereformedbroker.com/2009/01/29/good-bank-bad-bank-by-dr-seuss/

The Short and Simple Video About What Caused the Credit Crisis --- http://vimeo.com/3261363
Also at http://www.youtube.com/watch?v=Q0zEXdDO5JU
Ed Scribner forwarded the above links

"Six Errors on the Path to the Financial Crisis," by Alan S. Blinder, The New York Times, January 24, 2009 --- http://www.nytimes.com/2009/01/25/business/economy/25view.html?_r=1&ref=business

My list of errors has six whoppers, in chronologically order. I omit mistakes that became clear only in hindsight, limiting myself to those where prominent voices advocated a different course at the time. Had these six choices been different, I believe the inevitable bursting of the housing bubble would have caused far less harm.

WILD DERIVATIVES
In 1998, when Brooksley E. Born, then chairwoman of the Commodity Futures Trading Commission, sought to extend its regulatory reach into the derivatives world, top officials of the Treasury Department, the Federal Reserve and the Securities and Exchange Commission squelched the idea. While her specific plan may not have been ideal, does anyone doubt that the financial turmoil would have been less severe if derivatives trading had acquired a zookeeper a decade ago?

SKY-HIGH LEVERAGE
The second error came in 2004, when the S.E.C. let securities firms raise their leverage sharply. Before then, leverage of 12 to 1 was typical; afterward, it shot up to more like 33 to 1. What were the S.E.C. and the heads of the firms thinking? Remember, under 33-to-1 leverage, a mere 3 percent decline in asset values wipes out a company. Had leverage stayed at 12 to 1, these firms wouldn’t have grown as big or been as fragile.

A SUBPRIME SURGE
The next error came in stages, from 2004 to 2007, as subprime lending grew from a small corner of the mortgage market into a large, dangerous one. Lending standards fell disgracefully, and dubious transactions became common.

Why wasn’t this insanity stopped? There are two answers, and each holds a lesson. One is that bank regulators were asleep at the switch. Entranced by laissez faire-y tales, they ignored warnings from those like Edward M. Gramlich, then a Fed governor, who saw the problem brewing years before the fall.

The other answer is that many of the worst subprime mortgages originated outside the banking system, beyond the reach of any federal regulator. That regulatory hole needs to be plugged.

FIDDLING ON FORECLOSURES
The government’s continuing failure to do anything large and serious to limit foreclosures is tragic. The broad contours of the foreclosure tsunami were clear more than a year ago — and people like Representative
Barney Frank, Democrat of Massachusetts, and Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, were sounding alarms.

Yet the Treasury and Congress fiddled while homes burned. Why? Free-market ideology, denial and an unwillingness to commit taxpayer funds all played roles. Sadly, the problem should now be much smaller than it is.

LETTING LEHMAN GO
The next whopper came in September, when Lehman Brothers, unlike Bear Stearns before it, was allowed to fail. Perhaps it was a case of misjudgment by officials who deemed Lehman neither too big nor too entangled — with other financial institutions — to fail. Or perhaps they wanted to make an offering to the moral-hazard gods. Regardless, everything fell apart after Lehman.

People in the market often say they can make money under any set of rules, as long as they know what they are. Coming just six months after Bear’s rescue, the Lehman decision tossed the presumed rule book out the window. If Bear was too big to fail, how could Lehman, at twice its size, not be? If Bear was too entangled to fail, why was Lehman not?

After Lehman went over the cliff, no financial institution seemed safe. So lending froze, and the economy sank like a stone. It was a colossal error, and many people said so at the time.

TARP’S DETOUR
The final major error is mismanagement of the
Troubled Asset Relief Program, the $700 billion bailout fund. As I wrote here last month, decisions of Henry M. Paulson Jr., the former Treasury secretary, about using the TARP’s first $350 billion were an inconsistent mess. Instead of pursuing the TARP’s intended purposes, he used most of the funds to inject capital into banks — which he did poorly.

To illustrate what might have been, consider Fed programs to buy commercial paper and mortgage-backed securities. These facilities do roughly what TARP was supposed to do: buy troubled assets. And they have breathed some life into those moribund markets. The lesson for the new Treasury secretary is clear: use TARP money to buy troubled assets and to mitigate foreclosures.

Six fateful decisions — all made the wrong way. Imagine what the world would be like now if the housing bubble burst but those six things were different: if derivatives were traded on organized exchanges, if leverage were far lower, if subprime lending were smaller and done responsibly, if strong actions to limit foreclosures were taken right away, if Lehman were not allowed to fail, and if the TARP funds were used as directed.

All of this was possible. And if history had gone that way, I believe that the financial world and the economy would look far less grim than they do today.

Jensen Comment
Alan Blinder missed some whoppers.

  1. The SEC was authorized to regulate investment banking and consistently failed to do so through several crises, including the dot-com crisis of the 1990s and credit default swap crisis commencing in 2008 --- http://www.trinity.edu/rjensen/2008Bailout.htm#SEC
    Also so see http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout
    This is an admitted failure of SEC Directors from Arthur Levitt though Christopher Cox.

     
  2. The Federal Reserve failed in regulating investment banks. Alan Greenspan belatedly admitted that he was largely at fault.
    "‘I made a mistake,’ admits Greenspan," by Alan Beattie and James Politi, Financial Times, October 23, 2008 ---
    http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1

    “I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders,” he said.

    In the second of two days of tense hearings on Capitol Hill, Henry Waxman, chairman of the House of Representatives, clashed with current and former regulators and with Republicans on his own committee over blame for the financial crisis.

    Mr Waxman said Mr Greenspan’s Federal Reserve – along with the Securities and Exchange Commission and the US Treasury – had propagated “the prevailing attitude in Washington... that the market always knows best.”

    Mr Waxman blamed the Fed for failing to curb aggressive lending practices, the SEC for allowing credit rating agencies to operate under lax standards and the Treasury for opposing “responsible oversight” of financial derivatives.

    Christopher Cox, chairman of the Securities and Exchange Commission, defended himself, saying that virtually no one had foreseen the meltdown of the mortgage market, or the inadequacy of banking capital standards in preventing the collapse of institutions such as Bear Stearns.

    Mr Waxman accused the SEC chairman of being wise after the event. “Mr Cox has come in with a long list of regulations he wants... But the reality is, Mr Cox, you weren’t doing that beforehand.”

    Mr Cox blamed the fact that Congressional responsibility was divided between the banking and financial services committees, which regulate banking, insurance and securities, and the agriculture committees, which regulate futures.

    “This jurisdictional split threatens to for ever stand in the way of rationalising the regulation of these products and markets,” he said.

    Mr Greenspan accepted that the crisis had “found a flaw” in his thinking but said that the kind of heavy regulation that could have prevented the crisis would have damaged US economic growth. He described the past two decades as a “period of euphoria” that encouraged participants in the financial markets to misprice securities.

    He had wrongly assumed that lending institutions would carry out proper surveillance of their counterparties, he said. “I had been going for 40 years with considerable evidence that it was working very well”.

    Continued in the article

    Jensen Comment
    In other words, he assumed the agency theory model that corporate employees, as agents of their owners and creditors, would act hand and hand in the best interest for themselves and their investors. But agency theory has a flaw in that it does not understand Peter Pan.

    Peter Pan, the manager of Countrywide Financial on Main Street, thought he had little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures would be Wall Street’s problems and not his local bank’s problems. And he got his nice little commission on the sale of the Emma Nobody’s mortgage for $180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was almost certain in Emma’s case, because she only makes $12,000 waitressing at the Country Café. So what if Peter Pan fudged her income a mite in the loan application along with the fudged home appraisal value? Let Wall Street or Fat Fannie or Foolish Freddie worry about Emma after closing the pre-approved mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over millions of wealthy shareholders of Wall Street investment banks. Peter Pan is more concerned with his own conventional mortgage on his precious house just two blocks south of Main Street. This is what happens when risk is spread even farther than Tinkerbell can fly!
    Read about the extent of cheating, sleaze, and subprime sex on Main Street in Appendix U.

    March 1, 2009 reply from Henry Schwarzbach [henryschwarzbach@gmail.com]

    What happened is exactly what agency theory posits. The fly by night mortgage brokers were agents for the investment banks. They were given incentives to originate mortgages which could provide benefits for divergent behavior, fraudlent applications. There was great assemetry since the bankers had no primary info on the borrowers. Agency theory tells us that we can reduce agency costs with proper incentives (e.g. the originators could be pentalized for late payments and defaults.) and/or monitoring. What existed was a system with no incentives or monitoring to reduce the very high agency cost. Mortgage brokers and investment banks both enriched themselves at the expense of the investors. That's exactly what agency theory would predict.

    Henry Schwarzbach PhD
    URI College of Business
    7 Lippitt Road Kingston, RI 02881
    Phone 401 874-4327 Email:
    henrys@uri.edu

     

3.     U.S auditing standards explicitly require careful estimation of bad debts. The auditing firms failed the world when auditing sub-prime mortgage receivables, the collateralized debt obligation (CDOs) investments, and the credit derivative instruments sold to insure those investments? Where were the auditing firms that were paid millions to audit commercial and investment banks as well as Fannie Mae and Freddie Mack?
See http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
 

4, Subprime: Borne of Sleaze, Bribery, and Lies --- http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Much of this began with good intentions to make housing credit available to minorities and poor people in general, but politicians figured out how to play Robin Hood with taxpayer money and used Congressional power over Fannie Mae and Freddie Mack to do just that.

 

"Busted At Last: KB Home, Countrywide (now owned by Bank of America) Hit With $2.8 Billion Racketeering Charge," Money News, May 8, 2009 ---
http://moneynews.newsmax.com/headlines/kb_home_countrywide/2009/05/08/212443.html

Homeowners brought a federal racketeering lawsuit on Thursday against KB Home (KBH.N), the former Countrywide Financial Corp and appraiser LandSafe Inc, accusing the companies of operating a scheme to fraudulently inflate sales prices of KB homes in Arizona and Nevada.

The lawsuit, filed in federal court in Phoenix, claims the three companies colluded to overprice as many as 14,000 homes in the two states by an average of $20,000, for an estimated total of $2.8 billion between 2006 and the present. The plaintiffs seek class action status and triple damages.

A KB Home spokeswoman said the Los Angeles-based home builder had not seen the lawsuit and had no comment. Calabasas, California-based Countrywide, which was acquired last year by Bank of America (BAC.N), could not be reached for comment.

The lawsuit contends that KB and Countrywide formed the joint venture Countrywide KB Home Loans to "rig and falsify" appraised values of the homes they were selling and financing in the two states.

The joint venture steered prospective buyers of KB Homes to hand-picked appraisers at Countrywide subsidiary LandSafe who would "come in with the appraisal at whatever number was necessary to close the deal," the lawsuit said.

LandSafe appraisers "blatantly falsified" sales prices for comparable properties, using prices from homes as much as 10 miles away, and citing comparable properties that were in different planned communities, the suit said.

The homes were generally priced between $250,000 and $350,000 -- inflated sums that homeowners discovered when they attempted to sell their homes and hired independent appraisers, said plaintiffs attorney Steve Berman of Hagens Berman Sobol Shapiro LLP in Seattle.

"Most of these people were underwater from the get-go," said Berman.

The Hagens firm filed a similar lawsuit against KB and Countrywide earlier this year in California, citing claims under the Racketeer Influenced and Corrupt Organizations Act and violation of the state's unfair competition law.

The case is Nathaniel Johnson v. KB Home et al., 2:09-CV-00972-MHB, in U.S. District Court in Arizona.

Bob Jensen's threads on Rotten to the Core are at http://www.trinity.edu/rjensen/FraudRotten.htm

Bob Jensen's threads on Countrywide Financial (now owned by Bank of America) fraud are at
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze

Professor Schiller at Yale assets housing prices are still overvalued and need to come down to reality
The median value of a U.S. home in 2000 was $119,600. It peaked at $221,900 in 2006. Historically, home prices have risen annually in line with CPI. If they had followed the long-term trend, they would have increased by 17% to $140,000. Instead, they skyrocketed by 86% due to Alan Greenspan’s irrational lowering of interest rates to 1%, the criminal pushing of loans by lowlife mortgage brokers, the greed and hubris of investment bankers and the foolishness and stupidity of home buyers. It is now 2009 and the median value should be $150,000 based on historical precedent. The median value at the end of 2008 was $180,100. Therefore, home prices are still 20% overvalued. Long-term averages are created by periods of overvaluation followed by periods of undervaluation. Prices need to fall 20% and could fall 30%.....
Watch the video on Yahoo Finance --- Click Here
See the chart at http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
Also see Jim Mahar's blog at http://financeprofessorblog.blogspot.com/2009/02/shiller-house-prices-still-way-too-high.html
Jensen Comment
In the worldwide move toward fair value accounting that replaces cost allocation accounting, the above analysis by Professor Schiller is sobering. It suggests how much policy and widespread fraud can generate misleading "fair values" in deep markets with many buyers and sellers, although the housing market is a bit more like the used car market than the stock market. Each house and each used car are unique, non-fungible items that are many times more difficult to update with fair value accounting relative to fungible market securities and new car markets.

Thain Pain:  Merrill Lynch Bonuses of Over $1 Million to Each of 696 Executives
Rewarded for making their company so profitable for shareholders? (Barf Alert!)

Merrill Lynch quietly paid out at least one million dollars bonus each to about 700 top executive even when the investment house was bleeding with losses last year, a probe has revealed. They were part of 3.6 billion dollars in the firm's bonus payments in December before the announcement of its fourth quarterly losses and takeover by Bank of America, the investigation by the New York state Attorney General's office showed. "696 individuals received bonuses of one million dollars or more," New York Attorney General Andrew Cuomo said of the Merrill scandal in a letter to a lawmaker heading the House of Representatives financial services committee.
"Merrill bonuses made 696 millionaires: probe," Yahoo News, February 11, 2009 --- http://news.yahoo.com/s/afp/20090211/bs_afp/usbankingjusticeprobecompanymerrillbofa_20090211201133

Long Time WSJ Defenders of Wall Street's Outrageous Compensation Morph Into Hypocrites
At each stage of the disaster, Mr. Black told me -- loan officers, real-estate appraisers, accountants, bond ratings agencies -- it was pay-for-performance systems that "sent them wrong." The need for new compensation rules is most urgent at failed banks. This is not merely because is would make for good PR, but because lavish executive bonuses sometimes create an incentive to hide losses, to take crazy risks, and even, according to Mr. Black, to "loot the place through seemingly normal corporate mechanisms." This is why, he continues, it is "essential to redesign and limit executive compensation when regulating failed or failing banks." Our leaders may not know it yet, but this showdown between rival populisms is in fact a battle over political legitimacy. Is Wall Street the rightful master of our economic fate? Or should we choose a broader form of sovereignty? Let the conservatives' hosannas turn to sneers. The market god has failed.
Thomas Frank, "Wall Street Bonuses Are an Outrage:  The public sees a self-serving system for what it," The Wall Street Journal, February 4, 2009 --- http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion 
Bob Jensen's threads on outrageous compensation are at http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation

Bob Jensen's threads on corporate governance are at
http://www.trinity.edu/rjensen/Fraud001.htm#Governance

5. Congress, perhaps intentionally under the leadership of President Obama, is now turning the economic crisis into a perfect storm to bailout spendthrift state governments, ailing companies and unions such as American automobile manufacturers and the United Auto Workers, most anybody else with a sob story.

 

Cartoon link forwarded by David Fordham
http://blogs.indystar.com/varvelblog/archives/2008/11/feeding_time.html

 

 

The problem with the current bailout is that the government may be giving money to companies that don't have a long-term future: zombies. On paper, for example, the Treasury Dept. says it invests Troubled Asset Relief Program (TARP) money only in "healthy banks—banks that are considered viable without government investment" because "they are best positioned to increase the flow of credit in their communities." That's the right idea. In practice, though, the criteria aren't so stringent. Banks like Citigroup still aren't strong enough to lend. "The bailout model is socialism," says R. Christopher Whalen, senior vice-president for consultancy Institutional Risk Analytics. He advocates selling failed institutions in pieces, as was done to resolve the savings and loan crisis in the late '80s and early '90s. In fact, Washington may be moving toward something like that with Citigroup. When a big employer runs into trouble, it's tempting to keep it going at any cost. Economists call this "lemon socialism"—the investment of public money in the worst companies rather than the best. The impulse is misguided, says Yale University economics professor Eduardo M. Engel. "You don't want to protect the jobs," he says. "What you want to protect is workers' income during the transition from one job to another."
Peter Coy, "A New Menace to the Economy:  'Zombie' Debtors Call them "zombie" companies. Many more has-been companies will be feeding off taxpayers, investors, and workers—sapping the lifeblood of healthier rivals," Business Week, January 15, 2008 --- http://www.businessweek.com/magazine/content/09_04/b4117024316675.htm?link_position=link2

The Perfect (Stimulus) Storm:  $646,214 per saved government job
"$646,214 Per Government Job Spending where unemployment is already low," by Alan Reynolds, The Wall Street Journal, January 28, 2009 --- http://online.wsj.com/article/SB123310498020322323.html?mod=djemEditorialPage

After subtracting what House Democrats hope to spend on government payrolls, health, education and welfare, only a fifth of the original $550 billion is left for notoriously slow infrastructure projects, such as rebuilding highways and the electricity grid.

The Obama administration claims the stimulus bill will "create or save three or four million jobs over the next two years . . . with over 90% [of those jobs] in the private sector." To prove it, they issued a report from Christina Romer, chairman of the Council of Economic Advisers, and Jared Bernstein, chief economic adviser to Vice President Joe Biden. Its key estimates, however, were simply lifted from an outdated paper by Mark Zandi of Moody's economy.com.

Mr. Zandi's current estimates have government employment growing by 330,400 over two years as a result of the House bill (compared with 244,000 in Bernstein-Romer paper). Yet even that updated figure still amounts to only 8.3% of total jobs added, even though state and local governments are to receive 39% of the funds ($214.5 billion). Spending $214.5 billion to create or save 330,400 government jobs implies that taxpayers are being asked to spend $646,214 per job.

Does that make sense?

Simulations with his macroeconomic model, according to Mr. Zandi, reveal that "every dollar spent on unemployment benefits generates an estimated $1.63 in near-term GDP." By contrast, such "multipliers" simulate that tax cuts for business or investors would add only 30-38 cents on the dollar.

But econometric models are parables, not facts. The big multipliers for transfer payments and tiny multipliers for capital taxes in Mr. Zandi's model reveal more about the way the model was constructed than about the way the economy works. If model builders make Keynesian assumptions, their model will generate Keynesian results. Yet as Harvard economist Robert Barro recently pointed out on this page, contemporary academic economic research does not support the multipliers used to justify the House stimulus bill.

In the March 2006 IMF Research Bulletin, economist Giovanni Ganelli summarized recent International Monetary Fund research on fiscal policy. Several studies find that reductions in government spending "can have expansionary effects, since they can contribute to a consumption and investment boom owing to altered expectations regarding future taxation."

A 2002 study of U.S. data by Roberto Perotti of Università Bocconi did find that the effect of debt-financed spending increases was somewhat positive, but the multiplier effect was much less than one. A 2004 IMF study of recessions in advanced economies likewise found that "multipliers are unlikely to exceed unity." A 2006 study of U.S. data by IMF economist Magda Kandil found the effect of "fiscal expansion appears insignificant on aggregate demand and economic activity."

Continued in article

Video Lecture:  John Maynard Keynes and Hayek: Bruce Caldwell ---
http://www.youtube.com/watch?v=t4a_SkJzoIg

Video Rap:  Keynes and Hayek Rap from PBS  ---
http://www.pbs.org/newshour/bb/business/july-dec09/keynes_12-16.html
Also see http://financeprofessorblog.blogspot.com/2009/12/keynes-and-hayek-rap-from-pbs.html

The Perfect (Stimulus) Storm
A new analysis shows that California would get a whopping $21.5 billion under an economic stimulus plan that's expected to be approved by the House next week, making it the biggest winner among the 50 states. That's according to the National Conference of State Legislatures, which analyzed the new spending proposals offered by House leaders.
Rob Hotakainen ,
"California could reap $21.5 billion from U.S. stimulus plan,"  The Sacramento Bee, January 24, 2009 --- http://www.sacbee.com/capitolandcalifornia/story/1569761.html

The Less-Than-Perfect (Stimulus) Storm for Illinois
None of the funds provided by this Act may be made available to the State of Illinois, or any agency of the State, unless (1) the use of such funds by the State is approved in legislation enacted by the State after the date of the enactment of this Act, or (2) Rod R. Blagojevich no longer holds the office of Governor of the State of Illinois.
Draft of the Stimulus Act
I’m unaware of any previous case of the Congress dangling a bag of money over state legislators’ heads like this before. I’d also be surprised if it fails, no matter how commanding Blagojevich looks on “The View.” Illinois is not really in the position to turn down cash right now.
David Weigel, "Starving Out Blago," The Washington Independent, January 26, 2009 --- http://washingtonindependent.com/27252/starving-out-blago

The Perfect (Stimulus) Storm for Construction After the Recession
An analysis by Forbes publications of where most jobs will be created singles out engineering, accounting, nursing, and information technology, along with construction managers, computer-aided drafting specialists, and project managers. Unemployment rates among most of these specialists are not high. The rebuilding of "crumbling roads, bridges, and schools" highlighted by in various speeches by President Obama is likely to make greater use of unemployed workers in the construction sector. However, such spending will be a small fraction of the total stimulus package, and it is not easy for workers who helped build residential housing to shift to building highways . . . The likelihood that such a rapid and large public spending program will be of low efficiency is compounded by political realities. Groups that have lots of political clout with Congress will get a disproportionate amount of the spending with only limited regard for the merits of the spending they advocate compared to alternative ways to spend the stimulus. The politically influential will also redefine various projects so that they can fall under the "infrastructure" rubric. A report called Ready to Go by the U.S. Conference of Mayors lists $73 billion worth of projects that they claim could be begun quickly. These projects include senior citizen centers, recreation facilities, and much other expenditure that are really private consumption items, many of dubious value, that the mayors call infrastructure spending. Recessions would be a good time to increase infrastructure spending only if these projects can mainly utilize unemployed resources. This does not seem to be the case in most of the so-called infrastructure spending proposed under various stimulus plans.
Nobel Laureate Gary Becker, The Becker-Posner Blog, January 18, 2009 --- http://www.becker-posner-blog.com/

The Perfect (Stimulus) Storm for Signing Up Voters for the Democratic Party
The House Democrats’ trillion dollar spending bill, approved on January 21 by the Appropriations Committee and headed to the House floor next week for a vote, could open billions of taxpayer dollars to left-wing groups like the Association of Community Organizations for Reform Now (ACORN). ACORN has been accused of perpetrating voter registration fraud numerous times in the last several elections; is reportedly under federal investigation; and played a key role in the irresponsible schemes that caused a financial meltdown that has cost American taxpayers hundreds of billions of dollars since last fall. House Republican Leader John Boehner (R-OH) and other Republicans are asking a simple question: what does this have to do with job creation? Are Congressional Democrats really going to borrow money from our children and grandchildren to give handouts to ACORN in the name of economic “stimulus?” Incredibly, the Democrats’ bill makes groups like ACORN eligible for a $4.19 billion pot of money for “neighborhood stabilization activities.” Funds for this purpose were authorized in the Housing and Economic Recovery Act, signed into law in 2008. However, these funds were limited to state and local governments. Now House Democrats are taking the unprecedented step of making ACORN and other groups eligible for these funds:
Rick Moran, "ACORN eligible for billions from stimulus plan," American Thinker, January 26, 2009 --- http://www.americanthinker.com/blog/2009/01/acorn_eligible_for_billions_fr.html
Jensen Comment
Keith Olbermann correctly points out that ACORN will not get the funds directly but must bid competitively for such funds. What he does not explain is why ACORN disserves to be allowed to bid for billions of bailout funds given its biased political activities.

The group (ACORN) that pushed banks into the risky loans that brought the economy down is now eligible for a huge chunk of stimulus cash. The stimulus plan does create jobs — for community activists.
"ACORN's Seed Money," Investor's Business Daily, January 27, 2009 --- http://www.ibdeditorials.com/IBDArticles.aspx?id=317952439188615
Jensen Comment
It's never too late to give jobs to register fictitious people to vote for Democrats. Soon ACORN will have stimulus funds to register more Democrats.

"Another Bogus ACORN Lawsuit," by Michelle Malkin, Townhall, November 13, 2009 ---
http://townhall.com/columnists/MichelleMalkin/2009/11/13/another_bogus_acorn_lawsuit 

ACORN is doing what it does best: playing the victim, blaming everyone else for its self-inflicted wounds, perpetuating false narratives and defending the entitlement industry to the death.

On Thursday, the disgraced welfare rights organization filed suit over a congressional funding ban passed in September after nationwide undercover sting videos exposed ACORN's criminal element.

The group and its web of nonprofit, tax-exempt affiliates have collected an estimated $53 million in government funds since 1994. This pipeline is apparently a constitutionally protected right. According to ACORN's lawyers at the far-left Center for Constitutional Rights, the congressional funding ban constitutes a "bill of attainder" -- an act of the legislature declaring a person(s) guilty of a crime without trial.

Now cue the world's smallest violin and pass the Kleenex: ACORN's lawyers say the group has suffered cutbacks and layoffs as a result of the punitive funding ban. The congressional persecution means ACORN can no longer teach first-time-homebuyer indoctrination classes and -- gasp -- the loss of an $800,000 contract to conduct "outreach" on "asthma."

Message: The demons in the House who defunded ACORN (345 of them, including 172 Democrats) are cutting off oxygen to poor people!

"It's not the job of Congress to be the judge, jury and executioner," CCR lawyer Jules Lobel moaned as he equated the House's act of fiscal responsibility with the death penalty.

"It is outrageous to see Congress violating the Constitution for purposes of political grandstanding," CCR Legal Director Bill Quigley seethed without a shred of irony.

"Congress bowed to FOX News and joined in the scapegoating of an organization that helps average Americans going through hard times to get homes, pay their taxes and vote. Shame on them," ACORN head Bertha Lewis piled on in an affidavit lamenting the loss of state, local and private foundation grants, which she blamed on the resolution. It "gave the green light for others to terminate our funds, as well."

What ACORN's sob-story tellers leave out is the inconvenient fact that nonprofits were bailing on ACORN long before undercover journalists Hannah Giles and James O'Keefe and BigGovernment.com publisher Andrew Breitbart entered the scene. Internal ACORN records from a Washington, D.C., meeting held last August noted that more than $2 million in foundation money was being withheld as a result of the group's embezzlement scandal involving founder Wade Rathke's brother, Dale -- reportedly involving upward of $5 million.

Rathke admitted he suppressed disclosure of his brother's massive theft -- first discovered in 2000 -- because "word of the embezzlement would have put a 'weapon' into the hands of enemies of ACORN." In other words: The protection of ACORN's political viability came before the protection of members' dues (and taxpayers' funds).

A small group of ACORN executives helped cover up Dale Rathke's crime by carrying the amount he embezzled as a "loan" on the books of Citizens Consulting Inc. CCI, the accounting and financial management arm of ACORN and its affiliates, is housed in the same building as the national ACORN headquarters in New Orleans. It's also home to ACORN International, now operating under a different name, which Wade Rathke continues to head.

ACORN brass cooked up a "restitution" plan to allow the Rathkes to pay back a measly $30,000 a year in exchange for secrecy about the deal. ACORN's lawyers issued a decree to its employees to keep their "yaps" shut. Dale Rathke kept his job and his $38,000 annual salary until the story leaked to donors and board members outside the Rathke circle.

In June 2008, the left-wing Catholic Campaign for Human Development cut off grant money to ACORN "because of questions that arose about financial management, fiscal transparency and organizational accountability of the national ACORN structures." In November 2008 -- ahem, more than a year before the congressional ACORN funding ban was passed -- CCHD voted unanimously to extend and make permanent its ban on funding of ACORN organizations. "This decision was made because of serious concerns regarding ACORN's lack of financial transparency, organizational performance and questions surrounding political partisanship," according to Bishop Roger Morin.

Did ACORN's lawyers call that withdrawal of funding "political grandstanding" and "scapegoating," too?

The lawsuit over the congressional funding ban is just the latest desperate legal measure to distract from ACORN's long-festering ethics and financial scandals. ACORN's attorneys have sued Giles, O'Keefe, Breitbart and former ACORN/Project Vote whistleblower Anita MonCrief. And they'll sue anyone else who gets in the way of rehabilitating the scandal-plagued enterprise's image.

It took decades to build up its massive coffers and intricate web of affiliates across the country. It will take months and years to untangle the entire operation. And it will take time, money and relentless sunshine to dismantle the government-subsidized partisan racket.

ACORN can never be "reformed." It is constitutionally corrupt. Sue me.

Bob Jensen's fraud updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

 

The Perfect (Stimulus) Storm for Transfer Payments to Medicaid and the Poor
Another "stimulus" secret is that some $252 billion is for income-transfer payments -- that is, not investments that arguably help everyone, but cash or benefits to individuals for doing nothing at all. There's $81 billion for Medicaid, $36 billion for expanded unemployment benefits, $20 billion for food stamps, and $83 billion for the earned income credit for people who don't pay income tax. While some of that may be justified to help poorer Americans ride out the recession, they aren't job creators.
"A 40-Year Wish List You won't believe what's in that stimulus bill," The Wall Street Journal, January 28, 2009 --- http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage

The Perfect (Stimulus) Storm for Amtrak, Artists, Child Care Businesses, and Global Warming Research
We've looked it over, and even we can't quite believe it. There's $1 billion for Amtrak, the federal railroad that hasn't turned a profit in 40 years; $2 billion for child-care subsidies; $50 million for that great engine of job creation, the National Endowment for the Arts; $400 million for global-warming research and another $2.4 billion for carbon-capture demonstration projects. There's even $650 million on top of the billions already doled out to pay for digital TV conversion coupons.
"A 40-Year Wish List You won't believe what's in that stimulus bill," The Wall Street Journal, January 28, 2009 --- http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage

The Perfect (Stimulus) Storm for Democrats in Congress
This is supposed to be a new era of bipartisanship, but this bill was written based on the wish list of every living -- or dead -- Democratic interest group. As Speaker Nancy Pelosi put it, "We won the election. We wrote the bill." So they did. Republicans should let them take all of the credit.
"A 40-Year Wish List You won't believe what's in that stimulus bill," The Wall Street Journal, January 28, 2009 --- http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage
Jensen Comment
Of course it goes without saying that it's already been a perfect (stimulus) storm for bankers and Wall Street executives who brought on this chaos by reckless investment in fraudulent subprime mortgages. They inadvertently created an excuse for the largest populist spending spree in the history of the world.

The Perfect (Stimulus) Storm for a Universal Healthcare Entitlement in the United States
The more we dig into the pile of spending and tax favors known as the "stimulus bill," the more amazing discoveries we make. Namely, Democrats have apparently decided that the way to gun the economy is to spend even more on health care. This is notable because if there has been one truly bipartisan idea in Washington, it's that the U.S. as a whole spends too much on health care. President Obama has been talking up entitlement reform as a way to free up the money for his other social priorities. But it turns out that Congress is using the stimulus as cover for a massive expansion of federal entitlements.
"The Entitlement Stimulus:  More giant steps toward government," The Wall Street Journal, January 29, 2009 --- http://online.wsj.com/article/SB123318915075926757.html?mod=djemEditorialPage
Jensen Comment
On January 28, ABC News reported how the Canadian Universal Health Care Plan was so much more efficient in terms of accounting efficiency, largely because third party billing in the U.S. has become a quagmire. However, what ABC failed to mention, probably deliberately, is that over half of the average Canadian's salary is taxed mostly for health care. Much has been made about the months or years Canadians wait for non-emergency medical treatments. But seldom does the liberal U.S. press mention the enormous tax bill that goes with the Canadian Universal Health Care Plan. Taxpayers need not worry in the United States however. The new entitlement payment plan in the U.S. simply entails printing money rather than taxing or borrowing --- http://www.trinity.edu/rjensen/Entitlements.htm

The Perfect (Stimulus) Storm for Fannie Mae and Freddie Mac
Although shareholders in Fannie and Fred sucked gas, the companies themselves are being bailed out
"Fan and Fred's Lunch Tab A quarter-trillion dollars, and rising," The Wall Street Journal, January 29, 2009 ---
http://online.wsj.com/article/SB123318925593626697.html?mod=djemEditorialPage

It seems a lifetime ago, but it's only been six months since the Congressional Budget Office put a $25 billion price tag on the legislation to bail out Fannie Mae and Freddie Mac. At the time, then CBO Director Peter Orszag told Congress that there was a "probably better than 50%" chance that the government would never have to spend a dime to shore up the two government-sponsored mortgage giants.

So much for that. In the past few days Fannie and Freddie have requested a combined $51 billion from the Treasury to compensate for losses in their loan portfolios. This comes on top of the $13.8 billion that Freddie needed in November.

The latest requests take the tab to $70 billion or so -- but that's not the end of the story by a long shot. Earlier this month, CBO released its biannual budget outlook. And largely ignored underneath the $1.2 trillion deficit estimate for fiscal 2009 was the little matter of a $238 billion charge for rescuing Fan and Fred. To put that in perspective, $238 billion is more than the entire federal budget deficit in fiscal 2007

The CBO's $238 billion estimate represents its guess of the long-term cost of paying for the guarantees that Fannie and Freddie write on their mortgage-backed securities. Nor is that just a post-bubble hangover. The last $38 billion of that is for losses on new business this year. And for all anyone knows, that number, like the earlier estimates, is wildly optimistic.

For starters, that $238 billion doesn't include $18 billion that the CBO expected the Treasury to lend the wonder twins this year. But in any case we're already well beyond $18 billion on that score: As of this week they've already requested $70 billion since the fiscal year began -- and we still have eight months to go. So you can add $70 billion to the $238 billion, which gets us to $308 billion -- and even that might be conservative. Rajiv Setia, an analyst at Barclays, figures the duo will need $120 billion from Treasury this year alone, which would mean another $50 billion on top of the $70 billion already requested.

Back when the bailout was being debated last July, Senator Jon Tester (D., Mont.) worried that the Fan and Fred bailout could cost $1 trillion. Given that the two companies combined have more than $5 trillion in debt and mortgage backed securities outstanding, Mr. Tester's guess isn't looking worse than anyone else's.

At that same time, Senator Kent Conrad (D., N.D.) said that the CBO's $25 billion estimate would be "very helpful to those who want to advance this legislation." And no doubt it was. A spokeswoman for Fannie promoter Barney Frank said then, "we especially like that there is less than a 50% chance that it will be used." The CBO had figured that there was a 5% chance that losses would reach the $100 billion cap on the credit line created by the July law. Now CBO's best guess is more than double that.

The bigger picture here is that politicians like Mr. Frank have been telling us for years that Fannie and Freddie's federal subsidy was a free lunch. We are now slowly, and painfully, learning the price of Mr. Frank's famous desire to "roll the dice" with Fan and Fred. Keep that in mind the next time you hear a politician propose a taxpayer guarantee. The only sure thing is that the taxpayers will pay.

Barney's Rubble --- http://www.trinity.edu/rjensen/2008Bailout.htm#Rubble

Accounting Fraud (when Frank Raines was CEO) at Fannie Mae --- http://www.trinity.edu/rjensen/theory01.htm#Manipulation

 

Glenn Beck Explain's What's Wrong With Obama's Stimulus Program (video) ---
http://www.thehopeforamerica.com/play.php?id=249

 

 

 Quotations forwarded by Jagdish

In my many years I have come to a conclusion that one useless man is a shame, two is a law firm and three or more is a congress.
John Adams

If you don't read the newspaper you are uninformed, if you do read the newspaper you are misinformed.
Mark Twain

Suppose you were an idiot. And suppose you were a member of Congress. But then I repeat myself.
Mark Twain

I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.
Winston Churchill

A government which robs Peter to pay Paul can always depend on the support of Paul.
George Bernard Shaw

A liberal is someone who feels a great debt to his fellow man, which debt he proposes to pay off with your money.
G. Gordon Liddy

Democracy must be something more than two wolves and a sheep voting on what to have for dinner.
James Bovard, Civil Libertarian (1994)

Foreign aid might be defined as a transfer of money from poor people in rich countries to rich people in poor countries.
Douglas Casey, Classmate of Bill Clinton at Georgetown University

Giving money and power to government is like giving whiskey and car keys to teenage boys.
P.J. O'Rourke, Civil Libertarian

Government is the great fiction, through which everybody endeavors to live at the expense of everybody else.
Frederic Bastiat, French Economist (1801-1850)

Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.
Ronald Reagan (1986)

I don't make jokes. I just watch the government and report the facts.
Will Rogers


13. If you think health care is expensive now, wait until you see what it costs when it's free!
P.J. O'Rourke

In general, the art of government consists of taking as much money as possible from one party of the citizenry to give to the other.
Voltaire (1764)

Just because you do not take an interest in politics doesn't mean politics won't take an interest in you!
Pericles (430 B.C.)

No man's life, liberty, or property is safe while the legislature is in session.
Mark Twain (1866)

Talk is cheap ... except when Congress does it.
Anonymous

The government is like a baby's alimentary canal, with a happy appetite at one end and no responsibility at the other.
Ronald Reagan

The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery.
Winston Churchill (Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office and replaced it with a bust of Lincoln who wrote that Government should print all the money it needs without taxation and borrowing)

The only difference between a tax man and a taxidermist is that the taxidermist leaves the skin.
Mark Twain

The ultimate result of shielding men from the effects of folly is to fill the world with fools.
Herbert Spencer, English Philosopher (1820-1903)

There is no distinctly native American criminal class ... save Congress.
Mark Twain

What this country needs are more unemployed politicians.
 Edward Langley, Artist (1928-1995)

A government big enough to give you everything you want, is strong enough to take everything you have.
Thomas Jefferson

 

 

Madoff made off with $50 Billion!
Where did it go?
Who will pay it back?

"Ponzi Schemer's Label-Whoring Niece Married SEC Lawyer," by Owen Thomas, December 16, 2008 ---
http://gawker.com/5111942/ponzi-schemers-label+whoring-niece-married-sec-lawyer

Shana Madoff, whose uncle Bernie Madoff stands accused of defrauding investors of $50 billion (later raised to over $65 billion), is the wife of Eric Swanson, a former top lawyer at the Securities and Exchange Commission. A goy, but well-placed!

So well-placed that SEC chairman Christopher Cox is now elaborately raising his eyebrows about the relationship — especially since Shana Madoff worked as the compliance lawyer at Bernard L. Madoff Investment Securities, and met Swanson at a trade association event. (Can you imagine what a swinging scene that was?)

Swanson resigned from the SEC in 2006, and the couple married in 2007. But they clearly dated for a while before that.

Some have suggested that Shana Madoff is a "shopaholic." So not technically true! Why, she married the manager of a men's clothing store in 1997, but that didn't work out. A 2004 New York profile detailed her simultaneous affection for Narciso Rodriguez and aversion to actually going out and shopping. Instead of trying on clothes at the store, she had salespeople messenger the entire collection to her office, and charge her only for what she didn't return. The article mentions her having a boyfriend. Was that Swanson, whom one SEC colleague said conducted a review of Madoff's firm in 1999 and 2004?

A spokesman for Swanson — they get flacks quickly these days, don't they — told ABC News that he "did not participate in any inquiry of Bernard Madoff Securities or its affiliates while involved" (it was later shown that he was veru involved in the Madoff "investigation" while at the SEC) with Shana Madoff. How convenient!

But that could be said about pretty much all of his coworkers. The SEC first fielded complaints about the Madoff firm in 1999, but never opened a formal investigation that would have allowed it to subpoena records. In 2006, Bernard Madoff registered as an investment advisor with the SEC, but the agency never conducted a standard review. Are you beginning to get a picture of why Shana Madoff, who was charged with keeping the company out of trouble with regulators, was so busy she couldn't even go shopping?

Swanson was at the commission in 2003 when the agency was examining the Madoff firm. More importantly, he was also part of the SEC team that was conducting the actual inquiry into the firm . . .  What does all this mean? Nothing, according to Shana Madoff or her husband, whom she married in 2007. A spokesman for Shana Madoff and one for Swanson confirm that both knew each other professionally during the time of the examination.
"Madoff Victims Claim Conflict of Interest at SEC," CNBC, December 15, 2008 ---
http://www.cnbc.com/id/28242487

Madoff Timeline --- http://www.madoff-help.com/wp-content/uploads/2009/06/timeline.pdf

 

Larry Brown's Ponzi hypothetical is now turning into Ponzi reality

Madoff made off with $50 Billion!
Where did it go?
Who will pay it back?

A Tale of Four Investors
Forwarded by Dennis Beresford

Four investors made different investment decisions 10 years ago.  Investor one was extremely risk averse so he put $1 million in a safe deposit box.  Today he still has $1 million.  Investor two was a bit less risk averse so she bought $1 million of 6% Fanny Mae Preferred.  She put the $15,000 she received in dividends each quarter in a safe deposit box.  After receiving 40 dividends, she recently sold her investment for $20,000 so she now has $620,000 in her safe deposit box.  Investor three was less risk averse so he bought and held a $1 million well diversified U.S. stock portfolio which he recently sold for $1 million, putting the $1 million in his safe deposit box.  Investor four had a friend who knew someone who was able to invest her $1 million with Bernie Madoff.  Like clockwork, she received a $10,000 check each and every month for 120 months.  She cashed all the checks, putting the money in her safe deposit box.  She was outraged to learn that she will no longer receive her monthly checks.  Even worse, she lost all her principal.  She only has $1,200,000 in her safe deposit box. She hopes the government will bail her out.

 Lawrence D. Brown
J. Mack Robinson Distinguished Professor of Accounting
Georgia State University
December 18, 2008

 


"Madoff 'Victims' Do Math, Realize They Profited," SmartPros, January 2009 --- http://accounting.smartpros.com/x64396.xml

The many Bernard Madoff investors who withdrew money from their accounts over the years are now wrestling with an ethical and legal quandary. What they thought were profits was likely money stolen from other clients in what prosecutors are calling the largest Ponzi scheme in history. Now, they are confronting the possibility they may have to pay some of it back.

The issue came to the forefront this week as about 8,000 former Madoff clients began to receive letters inviting them to apply for up to $500,000 in aid from the Securities Investor Protection Corp.

Lawyers for investors have been warning clients to do some tough math before they apply for any funds set aside for the victims, and figure out whether they were a winner or loser in the scheme.

Hundreds and maybe thousands of investors in Madoff's funds have been withdrawing money from their accounts for many years. In many cases, those investors have withdrawn far more than their principal investment.

"I had a call yesterday from a guy who said, 'I've taken out more money then I originally put in, but I still had $1 million left with Madoff. Should I file a $1 million claim?'" said Steven Caruso, a New York attorney specializing in securities and investment fraud.

"I'm hard-pressed to give advice in that situation," Caruso said.

Among the options: Get in line with other victims looking for restitution. Keep quiet and hope nobody notices. Return the money. Or hire a lawyer and fight to keep profits that were probably fraudulent.

No one knows yet how many people will emerge as net winners in the scandal, but the numbers appear to be substantial. Many of Madoff's long-term investors have, over time, cashed out millions of dollars of their supposed profits, which routinely amounted to 11 percent to 15 percent per year.

Jonathan Levitt, a New Jersey attorney who represents several former Madoff clients, said more than half of the victims who called his office looking for help have turned out to be people whose long-term profits exceeded their principal investment.

"There are a lot of net winners," he said.

Asked for an example, Levitt said one caller, whom he declined to name, invested $1.8 million with Madoff more than a decade ago, then cashed out nearly $3 million worth of "profits" as the years went by.

On paper, he still had $4 million invested with Madoff when the scheme collapsed, but it now looks as if that figure was almost entirely comprised of fictitious profits on investments that were never actually made, leaving his claim to be owed anything unclear.

Other attorneys report getting similar calls.

Under federal law, the court-appointed trustee trying to unravel Madoff's business can demand that people who profited from the scheme return some or all of the money.

These so-called "clawbacks" are generally limited to payouts over the last six years, but could still amount to big bucks for some investors.

When a hedge fund run by the Bayou Group collapsed and was revealed to be a Ponzi scheme in 2005, the trustee handling the case sought court orders forcing investors to return false profits. Many experts anticipate a similar process in the Madoff case.

Applying for the aid could give the trustee evidence he needs to initiate a clawback claim. On the other hand, investors who ignore the letter would most likely forfeit any chance of recovering lost funds.

No matter how they respond, it may only be a matter of time before investors wiped out in the scandal turn on those who unknowingly enjoyed the fruits of the fraud.

"The sharks are all circling," Caruso said.

Some hedge funds that had billions of dollars invested with Madoff are already going through years worth of records, trying to figure out which of their investors withdrew more than they put in.

That data could be used by the fund managers to defend themselves against lawsuits, or go after clients deemed to have profited from the scheme and get them to return the cash.

The future is equally cloudy for investors who cashed out entirely before Madoff's arrest.

Continued in article


NY Post's video quiz on top scandals ---
http://www.nypost.com/entertainment/comicsgames/popjax_game.htm?gameId=1149
Bonus Question
Why are there two prices ($100 versus $5,000) for a good massage?
Madoff enjoyed "frequent massages" during work, hurled vicious insults at underlings and physically fell to pieces as his scheme unraveled. Eleanor Squillari, his secretary reveals in an explosive Vanity Fair article.....a shocking, inside look at the day-to-day operations of Madoff's investment firm....his lusty penchant for the ladies as he bilked billions. The 70-year-old Madoff had a roving eye ...." I caught him scouting the escort pages alongside pictures of scantily clad women." Madoff had numbers for "masseuses" in his address book....Madoff would playfully "try to pat me on the ass" and say, "You know it excites you" when he would exit his office bathroom zipping his fly. Squillari said. "..... clients would frequently complain about the lack of customer service..... Bernie would say, "Most of these customers are a pain in the ass." As it became clear to her uber-controlling boss that he couldn't stop his world from crashing, he started to physically buckle... "He seemed to be in a coma. He was bunkered down in his palatial Manhattan pad with his wife, who had been "handl[ing] all the invoices that came in," Squillari said.

Dan Mangan, "BERNIE MADOFF'S LUST FOR LADIES & MONEY (unzipped scammer liked 'massages' from females" New York Post, May 6, 2009 ---
http://www.nypost.com/seven/05062009/news/nationalnews/lust_for_ladies__money_167836.htm?page=0

Swine Flew:  Madoff's Piggy Bank
For months lawyers and investors have been asking convicted conman Bernie Madoff, "Where's the money?" We got a partial answer to that question Wednesday from Irving Picard, the trustee liquidating Madoff Investment Securities LLC: Madoff turned his investment firm into his "personal piggy bank," using tens of millions of dollars in client funds to cover costs for employees and family members, court papers say. Madoff used money from his firm to pay loans, satisfy capital calls, fund real estate purchases and hire employees for his children, wife, brother and workers, according to a filing by Picard (see below). "He essentially used BLMIS as his 'personal piggy bank,' having BLMIS pay for his lavish lifestyle and that of his family," David Sheehan, a lawyer for Picard, wrote in a legal brief filed in U.S. Bankruptcy Court in New York. "Madoff used BLMIS to siphon funds which were, in reality, other people's money, for his personal use and the benefit of his inner circle. Plain and simple, he stole it."
"Where is Madoff's money?" The Deal, May 7, 2009 --- http://www.thedeal.com/dealscape/2009/05/madoff_piggy_bank_money.php
Jensen Comment
But ohhh those massages.

"Ponzi Schemer's Label-Whoring Niece Married SEC Lawyer," by Owen Thomas, December 16, 2008 ---
http://gawker.com/5111942/ponzi-schemers-label+whoring-niece-married-sec-lawyer

Shana Madoff, whose uncle Bernie Madoff stands accused of defrauding investors of $50 billion (later raised to over $65 billion), is the wife of Eric Swanson, a former top lawyer at the Securities and Exchange Commission. A goy, but well-placed!

So well-placed that SEC chairman Christopher Cox is now elaborately raising his eyebrows about the relationship — especially since Shana Madoff worked as the compliance lawyer at Bernard L. Madoff Investment Securities, and met Swanson at a trade association event. (Can you imagine what a swinging scene that was?)

Swanson resigned from the SEC in 2006, and the couple married in 2007. But they clearly dated for a while before that.

Some have suggested that Shana Madoff is a "shopaholic." So not technically true! Why, she married the manager of a men's clothing store in 1997, but that didn't work out. A 2004 New York profile detailed her simultaneous affection for Narciso Rodriguez and aversion to actually going out and shopping. Instead of trying on clothes at the store, she had salespeople messenger the entire collection to her office, and charge her only for what she didn't return. The article mentions her having a boyfriend. Was that Swanson, whom one SEC colleague said conducted a review of Madoff's firm in 1999 and 2004?

A spokesman for Swanson — they get flacks quickly these days, don't they — told ABC News that he "did not participate in any inquiry of Bernard Madoff Securities or its affiliates while involved" (it was later shown that he was veru involved in the Madoff "investigation" while at the SEC) with Shana Madoff. How convenient!

But that could be said about pretty much all of his coworkers. The SEC first fielded complaints about the Madoff firm in 1999, but never opened a formal investigation that would have allowed it to subpoena records. In 2006, Bernard Madoff registered as an investment advisor with the SEC, but the agency never conducted a standard review. Are you beginning to get a picture of why Shana Madoff, who was charged with keeping the company out of trouble with regulators, was so busy she couldn't even go shopping?

Swanson was at the commission in 2003 when the agency was examining the Madoff firm. More importantly, he was also part of the SEC team that was conducting the actual inquiry into the firm . . .  What does all this mean? Nothing, according to Shana Madoff or her husband, whom she married in 2007. A spokesman for Shana Madoff and one for Swanson confirm that both knew each other professionally during the time of the examination.
"Madoff Victims Claim Conflict of Interest at SEC," CNBC, December 15, 2008 ---
http://www.cnbc.com/id/28242487

Madoff Timeline --- http://www.madoff-help.com/wp-content/uploads/2009/06/timeline.pdf

 


All Reported Trades in Madoff's Investment Fund Were Fakes for 28 Years:  How could the "auditors" not be complicit in the Ponzi fraud?
"BERNIE'S FAKE TRADES REGULATORS: NO TRACE OF MADOFF STOCK BUYS SINCE 1960s," by James Doran, The New York Post, January 16, 2009 --- http://www.nypost.com/seven/01162009/business/bernies_fake_trades_150467.htm

The mystery surrounding Bernard Madoff's alleged $50 billion Ponzi scheme deepened further yesterday after the securities industry's watchdog said there was no evidence that the accused swindler ever traded a single share on behalf of his clients, suggesting financial irregularities going back to the 1960s.

Officials at the Financial Industry Regulatory Authority, known as FINRA, told The Post that after examining more than 40 years' worth of financial records from Madoff's now-defunct broker dealer, there are no signs that Bernard L. Madoff Investment Securities ever traded shares on behalf of the investment-advisory business at the center of the scandal.

The startling findings contradict statements that Madoff's advisory clients received showing hundreds, if not thousands of trades, completed by the broker dealer every year.

"Our investigations of Bernard Madoff's broker dealership showed no evidence that any shares were ever traded on behalf of his investment advisory business," a FINRA spokesman said, adding that the regulator has looked at Madoff's books going back to 1960.

Ira Lee Sorkin, a Madoff lawyer, declined to comment.

Madoff was arrested last month after his sons said their father had confessed to them that his investment-advisory business was a Ponzi scheme that had bilked $50 billion out of wealthy friends, vulnerable charities and universities. Madoff remains free on $10 million bail.

While his advisory business is at the center of the scandal, all signs point to Madoff's broker dealer being a legitimate business that traded shares wholesale on behalf of investment banks, mutual funds and other institutions.

Madoff was previously vice chairman of FINRA's predecessor NASD. He was also a member of the Nasdaq stock exchange, where he served as chairman of its trading committee.

Richard Rampell, a Florida-based certified accountant who counts as clients several of Madoff's victims, said his review of dozens of statements supports FINRA's findings.

"Everything I saw on those statements told me that Madoff was clearing his own trades," he said. "There was no third party mentioned on any of those statements."

Steve Harbeck, CEO of Securities Industry Protection Corp., the outfit overseeing the Madoff bankruptcy to ensure clients get some sort of compensation, said his findings are similar to FINRA's.

"I do not have any evidence to contradict that," he said. "This is an amazing story that something like this could have gone on undetected for so long."

Harbeck added that he believed Madoff has been defrauding clients for at least 28 years. "I have seen evidence to that end and I have nothing to contradict it," he said.

Question
If Madoff's stock trades were faked for 28 years, where did the cash come from to pay some investors?

Answer
The definition of a Ponzi scheme depends upon new investors paying cash to pay earlier investors --- http://en.wikipedia.org/wiki/Ponzi
This almost eliminates the amount of $50 billion Madoff stole that can be recovered for the latest investors in his investment fund.

 

Why Madoff's Hedge Fund Could Be Audited by Non-registered Auditors
We all know that Bernie Madoff's brokerage firm was audited by an obscure 3-person accounting firm that is not registered with the Public Company Accounting Oversight Board.  This was permitted because the SEC exempted privately owned brokerage firms from the SOX requirement that firms are audited by registered accountants.  Floyd Norris reports, in today's NY Times, that the SEC has now quietly rescinded that exemption.  As a result, firms that audit broker-dealers for fiscal years that end December 2008 or later will have to be registered.  However, under another SOX provision, PCAOB is allowed to inspect only audits of publicly held companies.  NYTimes, Oversight for Auditor of Madoff.
"Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law Professor Blog, January 9, 2008 ---
http://lawprofessors.typepad.com/securities/


Why Madoff's Hedge Fund Could Be Audited by Non-registered Auditors
We all know that Bernie Madoff's brokerage firm was audited by an obscure 3-person accounting firm that is not registered with the Public Company Accounting Oversight Board.  This was permitted because the SEC exempted privately owned brokerage firms from the SOX requirement that firms are audited by registered accountants.  Floyd Norris reports, in today's NY Times, that the SEC has now quietly rescinded that exemption.  As a result, firms that audit broker-dealers for fiscal years that end December 2008 or later will have to be registered.  However, under another SOX provision, PCAOB is allowed to inspect only audits of publicly held companies.  NYTimes, Oversight for Auditor of Madoff.
"Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law Professor Blog, January 9, 2008 ---
http://lawprofessors.typepad.com/securities/

Ruth was just due to get her hair and nails done:  That's not suspicious or anything
Ruth Madoff Withdrew $15.5 Million From Madoff Brokerage Before Bust
Joe Weisenthal, The New York Times, February 11, 2009 --- Click Here

 


"We need to get out there and get names and get unified so that we can go to the government and make our case," she said. "Everybody has a horror story, everybody has bills, and everybody is devastated."
Joe Bruno quoting a Madoff Hedge Fund investor, "Madoff investors hope for bailout," Associated Press, December 18, 2008
http://www.google.com/hostednews/ap/article/ALeqM5hfAsiWtv09AYdmjEEn6e8BEaI-tgD955ECK80

But government program limits claims to $500,000 even if claims are honored.
 

Moral of the story: If you want to design such a scheme (with unlimited claims) and get away with it, make it legal — like investments in subprime mortgages, or investments in energy from water. Then involve as many people as possible, so that it becomes “too big to fail.” Some of the $700 billion bailout money may actually be used to rescue some of your investors.
Utpal Bhattacharya, "Do Bailouts Encourage Ponzi Schemes?" The New York Times, December 18, 2008 --- http://economix.blogs.nytimes.com/2008/12/18/do-bailouts-encourage-ponzi-schemes/?hp 
Utpal Bhattacharya is finance professor at the Kelley School of Business at Indiana University.
 


Banks Secretive About How Bailout Money is Spent
But after receiving billions in aid from U.S. taxpayers, the nation's largest banks say they can't track exactly how they're spending the money or they simply refuse to discuss it. "We've lent some of it. We've not lent some of it. We've not given any accounting of, 'Here's how we're doing it,'" said Thomas Kelly, a spokesman for JPMorgan Chase, which received $25 billion in emergency bailout money. "We have not disclosed that to the public. We're declining to." The Associated Press contacted 21 banks that received at least $1 billion in government money and asked four questions: How much has been spent? What was it spent on? How much is being held in savings, and what's the plan for the rest? None of the banks provided specific answers.
"Where'd the Bailout Money Go? Shhhh, It's a Secret," AccountingWeb, December 22, 2008 ---
http://accounting.smartpros.com/x64188.xml


"How to spend $350 billion in 77 days:  In two-and-a-half months, the Treasury has used up half of the money from the Troubled Asset Relief Program. Here's how it came and went so fast," by Jeanne Sahadi, CNN, December 19, 2008 --- http://money.cnn.com/2008/12/19/news/economy/tarp_tale_of_first350b/

By Friday, Oct. 3, Congress had passed a 451-page bill that President Bush signed into law within hours. The law granted Treasury up to $700 billion, half of which was made available right away.

Since then, Treasury has:

  • sent checks totaling $168 billion in varying amounts to 116 banks;
  • committed another $82 billion to capitalize more banks;
  • bought $40 billion in preferred shares of American International Group (AIG, Fortune 500) so the troubled insurer could pay off an earlier loan from the Federal Reserve;
  • committed $20 billion to back any losses that the Federal Reserve Bank of New York might incur in a new program to lend money to owners of securities backed by credit card debt, student loans, auto loans and small business loans;
  • committed to invest $20 billion in Citigroup on top of $25 billion the bank had already received;
  • committed $5 billion as a loan loss backstop to Citigroup;
  • agreed to loan $13.4 billion to GM and Chrysler to get them through the next few months.
That next $350B? Maybe not yet, Hank

Now, it's likely that Treasury will ask for the second tranche of $350 billion.


Beleaguered Citigroup is upgrading its mile-high club with a brand-new $50 million corporate jet - only this time, it's the taxpayers who are getting screwed. Even though the bank's stock is as cheap as a gallon of gas and it's burning through a $45 billion taxpayer-funded rescue, the airhead execs pushed through the purchase of a new Dassault Falcon 7X, according to a source familiar with the deal.
Jennifer Gould Keil and Chuck Bennett, "Just Plane Despicable," New York Post, January 26, 2009 --- http://www.nypost.com/seven/01262009/news/nationalnews/just_plane_despicable_152033.htm
Jensen Comment
After Citi's executives pay themselves millions in bonuses they'll need a fast way to get out of town.


The problem with the current bailout is that the government may be giving money to companies that don't have a long-term future: zombies. On paper, for example, the Treasury Dept. says it invests Troubled Asset Relief Program (TARP) money only in "healthy banks—banks that are considered viable without government investment" because "they are best positioned to increase the flow of credit in their communities." That's the right idea. In practice, though, the criteria aren't so stringent. Banks like Citigroup still aren't strong enough to lend. "The bailout model is socialism," says R. Christopher Whalen, senior vice-president for consultancy Institutional Risk Analytics. He advocates selling failed institutions in pieces, as was done to resolve the savings and loan crisis in the late '80s and early '90s. In fact, Washington may be moving toward something like that with Citigroup. When a big employer runs into trouble, it's tempting to keep it going at any cost. Economists call this "lemon socialism"—the investment of public money in the worst companies rather than the best. The impulse is misguided, says Yale University economics professor Eduardo M. Engel. "You don't want to protect the jobs," he says. "What you want to protect is workers' income during the transition from one job to another."
Peter Coy
, "A New Menace to the Economy:  'Zombie' Debtors Call them "zombie" companies. Many more has-been companies will be feeding off taxpayers, investors, and workers—sapping the lifeblood of healthier rivals," Business Week, January 15, 2008 --- http://www.businessweek.com/magazine/content/09_04/b4117024316675.htm?link_position=link2

So how much are we talking about in the already-existing toxic paper already held by Fannie, Freddie, and the most poisoned banks?
Estimates place these at $6 trillion, which is well over half our out-of-control existing National Debt --- http://online.wsj.com/article/SB123396703401759083.html?mod=djemEditorialPage

 


At the same time, HUD pressured the federally subsidized giants to lower their loan-to-value ratios and other underwriting requirements to accommodate minority borrowers. HUD Secretary Andrew Cuomo even admitted that the administration was mandating a policy of "affirmative action" lending (his words, not ours).And it was Clinton who initially spread the subprime rot to Wall Street. To help Fannie and Freddie reach their "affirmative action" lending quotas, HUD in 1995 let them get affordable-housing credit for buying subprime securities that included loans to low-income borrowers.Less than two years later, Freddie partnered with Wall Street investment banker Bear Stearns to issue the first securitizations of low-income CRA loans.There's even a press release still available on the Web that memorializes the historic deal, which dumped hundreds of millions of dollars in the risky loans on the market — a down payment on the hundreds of billions that were to follow.
"The Subprime Lending Bias," Investors Business Daily, December 19, 2008 --- http://www.ibdeditorials.com/IBDArticles.aspx?id=314582096700459

Bank of America (BoA) has received an extra $20bn in US government funding and a guarantee back-stopping the losses on $118bn of its most toxic assets in the latest bail-out of a major US financial institution.
James Quinn, "Bank of America to receive $138bn lifeline from US," Telegraph, January 16, 2009 --- Click Here
Jensen Comment
The shame is that BoA owned the mortgage brokering company, Countrywide Financial, that caused much of the mess with crappy sub-prime loans .

For those who like a simple (yeah right) explanation of the financial crisis ---
http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/2008/12/05/origins-of-the-economic-crisis-in-one-chart/

Lesson One: What Really Lies Behind the Financial Crisis?
According to Siegel: Financial firms bought, held and insured large quantities of risky, mortgage-related assets on borrowed money. The irony is that these financial giants had little need to hold these securities; they were already making enormous profits simply from creating, bundling and selling them. 'During dot-com IPOs of the early 1990s, the firms that underwrote the stock offerings did not hold on to those stocks,' Siegel says. 'They flipped them. But in the case of mortgage-backed securities, the financial firms decided these were good assets to hold. That was their fatal flaw.'
"Lesson One: What Really Lies Behind the Financial Crisis?" Knowledge@Wharton, January 21, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2148
Jensen Comment
Lesson Two of what lies behind the financial crisis is that investment banks and others like AIG wrote credit derivatives on the on the CDO collateralized debt obligations that used mortgage backed securities as collateral. The companies that wrote these derivatives did not have the insurance reserves to cover the melt down of those CDOs. To avoid bankruptcy of giants such as AIG, the U.S. treasury gave billions in bailout funds to cover the credit derivatives.
See Appendix E --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout
I think there was a hidden agenda with respect to why Hank Paulson's first billions in bailout funds went to cover the credit derivative obligations.
See Appendix Y --- http://www.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails

How much to bail out the banks now? $3.5 trillion by one estimate
A federal program to guarantee or buy bad assets from the ailing U.S. bank sector could come with a $3.5 trillion price tag. That would push the accumulated costs of rescuing the financial markets over the last year through various federal loan, stock purchase, debt guarantee and other programs close to $9 trillion and counting, with practically no end in sight for the bad news battering the banking industry. That figure doesn't count the $825 billion economic stimulus plan also under consideration. "We expect massive federal intervention into the financial sector from the new administration in the coming months," says Keefe Bruyette & Woods analyst Frederick Cannon, who calculated the $3.5 trillion figure, which is one-quarter of the banking sector's $14 trillion in combined assets.
Liz Moyer
, "A TARP In The Trillions?" Forbes, January 21, 2009 --- http://www.forbes.com/2009/01/21/tarp-banking-treasury-biz-wall-cx_lm_0121tarp.html

Robert Shiller visits Google’s Mountain View, CA headquarters to discuss his book “The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do About It.” This event took place on October 30, 2008, as part of the Authors@Google series. The subprime mortgage crisis has already wreaked havoc on the lives of millions of people and now it threatens to derail the U.S. economy and economies around the world. In The Subprime Solution, best-selling economist Robert Shiller reveals the origins of this crisis and puts forward bold measures to solve it. He calls for an aggressive response–a restructuring of the institutional foundations of the financial system that will not only allow people once again to buy and sell homes with confidence, but will create the conditions for greater prosperity in America and throughout the deeply interconnected world economy. Robert J. Shiller is the best-selling author of “Irrational Exuberance” and “Subprime Solution” (both Princeton), among other books. He is the Arthur M. Okun Professor of Economics at Yale University.
"Authors@Google: Robert Shiller," January 8, 2009 --- http://www.ritholtz.com/blog/2009/01/authorsgoogle-robert-shiller/


"AIG, Surprise:  Moneymaker Its profits for taxpayers cast doubt on the notion that it behaved recklessly before the panic struck," by Holman W. Jenkins, Jr., The Wall Street Journal, August 31, 2012 ---
http://professional.wsj.com/article/SB10000872396390443618604577623373568029572.html?mg=reno64-wsj#mod=djemEditorialPage_t

AIG's bailout is getting the revisionist treatment. The rescue hasn't been the dismal federal experience that, say, GM's has been. Taxpayers are showing a $5 billion profit on their 53% stake in the insurer, as of yesterday's closing price.

What's more, in the last few days, the New York Fed liquidated the last of the complex mortgage derivatives it acquired from AIG's counterparties as part of the bailout. Such transactions and related fees have netted the government about $18 billion.

This is good news but requires some revising of theories of the crisis itself. The "toxic" and "shaky" housing derivatives that got AIG in trouble turn out, even amid the worst housing slump in 70 years, not to have been the crud many assumed they were.

A lot of renditions skip over this part, dismissing AIG's pre-crash mortgage activities as "reckless," thereby making a mystery of how the refinancing of AIG could be paying off so handsomely for taxpayers. Taxpayers are making out because they bought valuable assets on the cheap.

This is as it should be. But let's remember how AIG got in trouble. It wrote insurance to guarantee the very senior portions of securities derived from underlying mortgages—that is, the portions already designed to withstand a sizeable increase in defaults.

AIG failed not because of the failure of these securities to keep paying as expected, but because of its own promise to fork up cash collateral if the market price of these securities fell or if the rating agencies downgraded what they had previously rated Triple-A.

In the systemic panic that climaxed with the Lehman failure, both things happened in spades, even as AIG itself no longer could raise the cash to make good on its commitments. Some now claim AIG could have waved off the collateral calls, citing exceptional circumstances. But even that wouldn't have changed the fact that, because of the panic, AIG itself was no longer trusted despite being chock-full of good assets.

We'll never know if the company might have finessed its way out of its jam (quite possibly its counterparties, including Goldman Sachs, would have acted to keep AIG afloat if the alternative of a government bailout weren't available). Instead AIG turned to taxpayers to finance the collateral calls it couldn't finance itself, and taxpayers took advantage.

For all the desire to name villains and blame bad incentives for the financial crisis, notice that panic itself was the key player. Panic is a variable about which it's disconcertingly hard for government to do anything useful in advance.

Panic is systemic—an uncertainty or loss of trust in how the system will behave. Here's a simple but relevant example: What happens to the market value of mortgages if investors lose confidence in the legal system to permit them to foreclose on borrowers who stop paying?

We don't need to retread the history. Letting Lehman fail was a disaster because the rescue of Bear Stearns had conditioned the market to believe Washington wouldn't permit major institutional failures. The mixed signals sent about Fannie and Freddie only undermined the effort to recruit fresh capital to other financial institutions distressed by uncertainty over the value of mortgage securities.

AIG is the most dramatic example of the general case. A lot of things become good or bad collateral depending on what the government is expected to do. It's not too strong to say Washington had to bail out AIG because the market was uncertain whether Washington would bail out AIG. (An additional complexity we won't go into is how the Fed's QE exercises subsequently boosted the bailout's profits.)

Let us be careful here: A host of private and public behaviors contributed to the housing bubble and meltdown, whose losses were destined to be felt widely. Our system has no problem accommodating the failure of individual institutions, even very big ones. But systemic panic always comes to the door of government. It can't be otherwise.

Governments can try to duck this burden, as European governments have done, only by renouncing the ability to print money and so soiling their own credit that substituting their own credit for the financial system's is no longer an option. Make no mistake: This would be a real cure for too-big-to-fail if the Europeans were inclined to let the chips fall. They're not. Instead the self-disabling governments want Germany to supply the bailout.

Continued in article


New Financial Terms forwarded by my good neighbors

Subject: New Financial Terms

CEO- Chief Embezzlement Officer

CFO - Corporate Fraud Officer

BULL MARKET- A random market movement causing investors to mistake themselves for financial geniuses.

BEAR MARKET- a 6-to-18-month period when the kids get no allowance, the wife gets no jewelry, and the husband gets no sex.

VALUE INVESTING- The art of buying low and selling lower.

P/E RATIO- The percentage of investors wetting their pants as the market keeps crashing.

BROKER - What my financial planner has made me.

STANDARD & POOR- Your life in a nutshell.

STOCK ANALYST- Idiot who just downgraded your stock.

STOCK SPLIT- When your ex-wife and her lawyer split your assets equally between themselves.

MARKET CORRECTION- The day after you buy stocks.

CASH FLOW- The movement your money makes as it disappears down the toilet.

YAHOO! - What you yell after selling it to some poor sucker for $240 per share.

WINDOWS- What you jump out of when you're the sucker who bought Yahoo at $240 per share.

INSTITUTIONAL INVESTOR- Past year investor who's now locked up in a nuthouse.

PROFIT - Archaic word no longer in use.

To which David Albrecht added the following:

Here's another list, from: http://247wallst.com/2008/11/26/new-bear-market/

Below is the long list:
  • "201/K": What used to be your 401/K, but cut in at least half.
  • "I.R.A.": This is the paramilitary group you want to sick on thepeople who created the over-the-counter instruments and financialderivatives that are making this financial mess much worse than itshould have been.
  • "IPO": The acronym that one yells when they see their brokerage accounts or discover the balance of the 201/K.  "I’m Pissed Off!"
  • "Short Squeeze": This is what you think your chair is doing to you when you try to calculate the new balance of your investments.
  • "Foreclosure": The time that the stock market stops dropping each day.
  • "Stock Broker": The value of your shares each day.
  • "Discount Broker": The value of your shares of the brokerage firm you own.
  • "Bond Broker": That guy who puts up court money to get you out of jail.
  • "Market Sell-off": Daily news reports.
  • "Selling Short": The notion you get every time you decide to not go with one of your winning stock picks.
  • "Dollar Cost Averaging": Sticking with a strategy that isn’t working.
  • "Market Crash": The last sound of Alec Baldwin jumping out of the window at the end of this SNL commercial.
  • "Market Rally": A church vigil for investors praying for this stock market selling to end.
  • "Bailout": What investors have been doing for weeks and weeks.
  • "Credit Default Swap": When you trade canceled credit cards with your friends and family.
  • "Treasury Bill": $700 billion to $3 trillion that your kids will have to pay for this mess, plus interest.
  • "Over The Counter Derivative": The same stuff meth is made with.
  • “CDO”: Community Debt Onus
  • "Financial Adviser": Bookie.
  • "Hedge Fund": The money, jewelry, and silver coins you buried in your back yard or stuck in a safe.
  • "Analyst": Your proctologist’s trainee.
  • "Risk Manager": The guy who rubber-stamped AAA ratings as the second coming.
  • "Underwriter": That creepy guy that works for the funeral home.
  • "Margin Call": What your former financial adviser keeps calling you about.
  • "Options Expiration Date": When you decide to give up on the stock market forever.
  • "Recession-Proof": That really strong and cheap booze that everyone is drinking now; formerly called rot gut.
  • "Stock Split": What you think happened with your shares when you see the share price each week.  But it didn’t split.
  • "Bottom Sniffing": When bottom fishing doesn’t work.
  • "52-Week Low": How you feel each new day when you get home.
  • "TARP": What you sleep under after you lost your job, car, and house.
  • "Going Private": Telling your friends you are out of the stock market but aren’t really out.
  • "Private Equity": What Eliot Spitzer got in trouble over.
  • "Resistance": Almost every penny price increment above the current price.
  • "Support": Tomorrow’s new resistance.
  • "Gap and Crap": When the market opens up and almost immediately sells off. That’s actually a real term used.
  • "Poison Pill": What investors want to take when they see their 201/K balance.
  • "Junk Bond": Government agency investments.
  • "DJIA": Down Jones Industrial Average
  • "Blue Chip": The color of your skin around that broken piece of knuckle you got slamming your first into your desk or keyboard.
  • "Penny Stock": Former DJIA and S&P 500 index components that have been kicked out of the index.
  • "Reiterated Guidance": The new absolute best case scenario for future earnings.
  • "Microsoft": A Man’s libido after talking about the current stock market.
  • "Socialism": The new-age definition of Free Market Capitalism
  • "Recession": A mild downturn in the economy where some friends and neighbors become jobless.
  • "Depression": A mild downturn in the economy that has now turned horrible, and now you are jobless along with friends and neighbors.

We don't have a moment to spare, but evidently we have $1 trillion (to spare).
Jacob Sullum, "The New Era of Irresponsibility," Reason Magazine, February 4, 2009 --- http://www.reason.com/news/show/131468.html

"Washington and the Jobs Market:  The U.S. needs to stop pouring money into a Keynesian cul-de-sac," The Wall Street Journal, November 7, 2009 --- Click Here

A familiar definition of insanity is to keep doing the same thing and expecting different results. So in the wake of yesterday's report that the national jobless rate climbed to 10.2% in October, we suppose we can expect the political class to demand another "stimulus." Maybe if Congress spends another $787 billion in the name of job creation, it can get the jobless rate up to 12% or 13%.

It's hard to imagine a more complete repudiation of Keynesian stimulus than the evidence of the last year's job market. We've now had two examples of such stimulus—President Bush's $160 billion effort in February 2008 and President Obama's mega-version a year later—and neither has made even the smallest dent in employment. As the nearby chart shows, Mr. Obama's economic advisers sold the stimulus by saying it would keep the jobless rate below 8%. Actual results may differ, as they say.

The economy shed another 190,000 jobs in October, taking the total job losses to 3.5 million since January. The larger measure of joblessness that includes marginal and part-time workers jumped 0.5% to 17.5%. And the average hours worked in a week stayed the same at 33.0, which means that millions of Americans working part-time will have to become full-time before employers start hiring new workers.

Job creation typically lags coming out of recession, and there were some signs of hope in the October report. Temporary employment increased for the third month in a row, often a key early sign of a healthier jobs market. The job losses for August and September were also revised lower. But with an economic recovery clearly under way, corporate earnings rising and productivity soaring, we should be seeing a sharper turn in the job market.

The White House says the stimulus created as many as one million new jobs, but this is single-entry economic bookkeeping. No one doubted that such spending would create some jobs and "save" others, especially in government. But such spending isn't free. Every dollar in new government spending is taxed or borrowed from the private economy, which might have put it to better use.

If the government takes $1 from Paul, who would have invested it in a new business, and gives it to Peter, who spends it on a new lawn mower, the government records it as a net gain for economic growth via consumption. But the economy is hardly more productive as a result. Especially with so much of the Obama stimulus going to transfer payments—such as Medicaid and jobless benefits—the net effect on job creation has probably been negative. The ballyhooed Keynesian multiplier that every dollar of government spending yields 1.5 times that in economic growth has been exposed again as false.

The policy lesson here is for both political parties. President Bush's cave-in to Democrats in 2008 meant that there was no debate in Washington over policies that might have produced a much better stimulus at that early point in the recession. Like so much else in Mr. Bush's final year, he lost his policy bearings and forgot the lesson of 2003: A stimulating tax cut needs to be immediate, permanent and at the margin of the next dollar earned. Instead, for the last two years, the U.S. and most of the world have been pouring money into a Keynesian cul-de-sac.

Not that businesses can expect anything better now from Washington. Congress's panicked response this week has been to extend and expand the $8,000 first-time home-buyer credit and to add another 20 weeks in jobless benefits.

Continued in article

Video Lecture:  John Maynard Keynes and Hayek: Bruce Caldwell ---
http://www.youtube.com/watch?v=t4a_SkJzoIg

Video Rap:  Keynes and Hayek Rap from PBS  ---
http://www.pbs.org/newshour/bb/business/july-dec09/keynes_12-16.html
Also see http://financeprofessorblog.blogspot.com/2009/12/keynes-and-hayek-rap-from-pbs.html

 

A Famous Economist Explains What's Wrong With Obama's Stimulus Program
But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory of Employment, Interest and Money." The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936. Much more focus should be on incentives for people and businesses to invest, produce and work. On the tax side, we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant. On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis. Just as in the 1980s, when extreme supply-side views on tax cuts were unjustified, it is wrong now to think that added government spending is free.

Robert J. Barro, "Government Spending Is No Free Lunch:  Now the Democrats are peddling voodoo economics," The Wall Street Journal, January 22, 2009 ---
http://online.wsj.com/article/SB123258618204604599.html?mod=djemEditorialPage
Robert Barro is an economics professor at Harvard University and a senior fellow at Stanford University's Hoover Institution.

Back in the 1980s, many commentators ridiculed as voodoo economics the extreme supply-side view that across-the-board cuts in income-tax rates might raise overall tax revenues. Now we have the extreme demand-side view that the so-called "multiplier" effect of government spending on economic output is greater than one -- Team Obama is reportedly using a number around 1.5.

To think about what this means, first assume that the multiplier was 1.0. In this case, an increase by one unit in government purchases and, thereby, in the aggregate demand for goods would lead to an increase by one unit in real gross domestic product (GDP). Thus, the added public goods are essentially free to society. If the government buys another airplane or bridge, the economy's total output expands by enough to create the airplane or bridge without requiring a cut in anyone's consumption or investment.

The explanation for this magic is that idle resources -- unemployed labor and capital -- are put to work to produce the added goods and services.

If the multiplier is greater than 1.0, as is apparently assumed by Team Obama, the process is even more wonderful. In this case, real GDP rises by more than the increase in government purchases. Thus, in addition to the free airplane or bridge, we also have more goods and services left over to raise private consumption or investment. In this scenario, the added government spending is a good idea even if the bridge goes to nowhere, or if public employees are just filling useless holes. Of course, if this mechanism is genuine, one might ask why the government should stop with only $1 trillion of added purchases.

What's the flaw? The theory (a simple Keynesian macroeconomic model) implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system.

John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall. So, something deeper must be involved -- but economists have not come up with explanations, such as incomplete information, for multipliers above one.

A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP -- consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one.

This approach is the one usually applied to cost-benefit analyses of public projects. In particular, the value of the project (counting, say, the whole flow of future benefits from a bridge or a road) has to justify the social cost. I think this perspective, not the supposed macroeconomic benefits from fiscal stimulus, is the right one to apply to the many new and expanded government programs that we are likely to see this year and next.

What do the data show about multipliers? Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II. The usual Keynesian view is that the World War II fiscal expansion provided the stimulus that finally got us out of the Great Depression. Thus, I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists.

I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports -- personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses -- there was a dampener, rather than a multiplier.

We can consider similarly three other U.S. wartime experiences -- World War I, the Korean War, and the Vietnam War -- although the magnitudes of the added defense expenditures were much smaller in comparison to GDP. Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 -- the same value as before. (These estimates were published last year in my book, "Macroeconomics, a Modern Approach.")

There are reasons to believe that the war-based multiplier of 0.8 substantially overstates the multiplier that applies to peacetime government purchases. For one thing, people would expect the added wartime outlays to be partly temporary (so that consumer demand would not fall a lot). Second, the use of the military draft in wartime has a direct, coercive effect on total employment. Finally, the U.S. economy was already growing rapidly after 1933 (aside from the 1938 recession), and it is probably unfair to ascribe all of the rapid GDP growth from 1941 to 1945 to the added military outlays. In any event, when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.

As we all know, we are in the middle of what will likely be the worst U.S. economic contraction since the 1930s. In this context and from the history of the Great Depression, I can understand various attempts to prop up the financial system. These efforts, akin to avoiding bank runs in prior periods, recognize that the social consequences of credit-market decisions extend well beyond the individuals and businesses making the decisions.

But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory of Employment, Interest and Money." The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936.

Much more focus should be on incentives for people and businesses to invest, produce and work. On the tax side, we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant. On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis. Just as in the 1980s, when extreme supply-side views on tax cuts were unjustified, it is wrong now to think that added government spending is free.

Keynes: The Rise, Fall, and Return of the 20th Century's Most Influential Economist by Peter Clarke (Bloomsbury; 2009,  211 pages; $20). Examines the life and legacy of the British economist (1883-1946).
 


Denny Beresford forwarded the following link. I don't know how long it will be a free download.
"The Crash: What Went Wrong? How did the most dynamic and sophisticated financial markets in the world come to the brink of collapse? The Washington Post examines how Wall Street innovation outpaced Washington regulation.," The Washington Post, January 2009 ---
http://www.washingtonpost.com/wp-srv/business/risk/index.html
Jensen Comment
The above site has three links to AIG and what went wrong with their credit default swaps.
Part 1 "The Beautiful Machine" --- http://www.washingtonpost.com/wp-dyn/content/article/2008/12/28/AR2008122801916.html
Part 2 "A Crack in the System"--- http://www.washingtonpost.com/wp-dyn/content/article/2008/12/29/AR2008122902670.html
Part 3 "Downgrades and Downfall"--- http://www.washingtonpost.com/wp-dyn/content/article/2008/12/30/AR2008123003431.html

Few forecast these (2008 economic meltdown) events; although, in an outbreak of retrospective foresight, an increasing number now claim they saw it coming. The reality is that among all the banks, investors, academics and policy-makers, only a handful were able to identify ahead of time the causes and potential scale of the crisis. (The Handful were - Bill White, formerly of both the Bank of Canada and the Bank for International Settlements; Harvard University’s Ken Rogoff; Nouriel Roubini of New York University; Wynne Godley of Cambridge; and Bernard Connolly of AIG Financial Products). I came across this paper by Caludio Borio of BIS.
Amol Agrawal, Mostly Economics Blog, December 19, 2008 --- http://mostlyeconomics.wordpress.com/
Jensen Comment
Hindsight:   This 2006 video makes fools out of Ben Stein and Art Laffer and makes a hero out of Peter Schiff.
To this I might add Peter Schiff. Arthur Laffer's preditions in 2006 predictions became a sick joke. Also you Ben Stein lovers may have second thoughts watching him proclaim, in 2006, that the subprime problem is going to be a "tiny" problem. Watch Peter Schiff make fools out of Art Laffer, Ben Stein, and other finance “experts” in this video.  Watch Ben Stein recommend that you invest heavily in Merrill Lynch before its shares tanked. Some of these popular media "experts" need to spend more time studying and reading and less time broadcasting poorly-researched advice to investors. Peter Schiff, on the other hand, does his homework. This video is really revealing about the advice we get on television.
The video is available at the Financial Rounds Blog, November 18 at
http://financeprofessorblog.blogspot.com/2008/11/peter-schiff-prophet-from-past.html
Update on the bet Art Laffer made with Peter Schiff ---
Listen to Laffer try to weasel out of paying up --- http://www.youtube.com/watch?v=z3WjgKUf-kA

"What Exactly is Nouriel Roubini Good For?" by Justin Fox, Harvard Business Review Blog, May 26, 2010 ---
http://blogs.hbr.org/fox/2010/05/what-exactly-is-nouriel-roubini.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE

If you're like me, you've seen and heard a lot of economist Nouriel Roubini lately. Just in the past couple of weeks, the NYU professor known as Dr. Doom has been interviewed on NPR's Morning Edition, in the FT, in Der Spiegel, on HBO's Real Time with Bill Maher. Not to mention CNBC, but then he's always on CNBC. (Wanna know where he'll be next? Check the Twitter.)

It's partly that Roubini has a new book out, but also just that markets are in crisis (or something approaching it) yet again and so reporters and TV hosts turn again to the man who predicted the last crisis. Or so the story usually goes. In fact, Roubini didn't exactly predict the crisis that began in mid-2007. As Damien Hoffman has documented, Roubini spent several years predicting a very different sort of crisis — one in which foreign central banks diversifying their holdings out of Treasuries sparked a run on the dollar — only to turn in late 2006 to warning of a U.S. housing bust and a global "hard landing."

He still didn't give a perfectly clear or (in retrospect) accurate vision of how exactly this would play out. Who could? The global economy is an awfully complicated thing. And once the troubles became apparent to all in the summer of 2007, Roubini adroitly adjusted his forecasts to rapidly changing circumstances, weaving a gloomy but realistic course between those who at every turn hinted that the worst was over and the growing ranks (especially in early 2009) who predicted an uninterrupted slide into economic and financial chaos.

Continued in article


Is the U.S. Dollar About to Plunge in a Crash?
"Face-Off: The Dollar’s Doldrums." Newsweek Magazine, June 22, 2009 --- http://www.newsweek.com/id/201975  

Last fall, the dollar surged as the world turned to U.S. Treasuries as a safe haven. But its recent decline has some wondering: is the dollar headed for a crash?

Peter Schiff :  Absolutely!
"At some point, the world will want out of the U.S. economy, and the dollar will rapidly lose value. The bailouts and stimulus have only worsened our problems. We can't afford our huge government because we don't produce enough, so we spend borrowed money. We're sealing the fate of our currency by printing it into oblivion."

Brad Setser:  Not so fast.!
"Whenever a country runs a large trade deficit for a long period of time, there's some risk for a disorderly correction. But there are two things mitigating that risk: the trade deficit has come down signif- icantly, and our savings rate has gone up. If sustained, together they reduce the risk of a crash and the needed adjustment is smaller."

Our (Newweek's) Verdict
The potential for a crash depends on what happens abroad, as the dollar's value is relative to that of other currencies. As long as the U.S. doesn't get left behind in a global recovery, the dollar will be fine.

Schiff is president of Euro Pacific Capital and author of Crash Proof.
Setser is a fellow for Geoeconomics at the Council on Foreign Relations.

Jensen Comment
Since Newsweek Magazine is owned by NBC, Newsweek would never take a position that made President Obama's policies look bad. To do otherwise might not keep the GOP buried beneath its 2008 ashes. No other nation is entering into trillion-dollar deficits for the next 10 years. I side with Peter Schiff 100%, although the timing of the dollar's crash is very unpredictable. Peter Schiff correctly predicted (and publically warned the public) well in advance that there would be a subprime mortgage crisis and an economic collapse. But the funds he manages did not make excess profits on these correct predictions due largely to the fact that he predicted treasury yields would soar and the dollar would crash long before major events transpired (if they do indeed transpire). It's one thing to correctly predict economic happenings and quite another to predict their timings.


One of the Most Enlightening Debates I've Ever Watched
Video of Peter Schiff Making Accurate Predictions in 2007
---
http://www.youtube.com/watch?v=2I0QN-FYkpw
He makes Art Laffer and Ben Stein look like they should’ve instead been limited to making commercials with Shaq. Keep in mind that at the time Bush was still President of the United States, although the Democrats had the majorities in the House and Senate.

I find the above video to be incredible in making us lose your faith in “financial experts.”

Treasury statistics indicate that, at the end of 2006, foreigners held 44% of federal debt held by the public. About 66% of that 44% was held by the central banks of other countries, in particular the central banks of Japan and China. In total, lenders from Japan and China held 47% of the foreign-owned debt. This exposure to potential financial or political risk should foreign banks stop buying Treasury securities or start selling them heavily was addressed in a recent report issued by the Bank of International Settlements which stated, "'Foreign investors in U.S. dollar assets have seen big losses measured in dollars, and still bigger ones measured in their own currency. While unlikely, indeed highly improbable for public sector investors, a sudden rush for the exits cannot be ruled out completely." --- http://en.wikipedia.org/wiki/United_States_public_debt 

The Community Reinvestment Act of 1977 coerces banks into making loans based on political correctness, and little else, to people who can't afford them. Enforced like never before by the Clinton administration, the regulation destroyed credit standards across the mortgage industry, created the subprime market, and caused the housing bubble that has now burst and left us with the worst housing and banking crises since the Great Depression.
"Stop Covering Up And Kill The CRA," Investor's Business Daily, November 28, 2008 --- http://www.ibdeditorials.com/IBDArticles.aspx?id=312766781716725
Jensen Comment
The CRA was not the sole cause of the housing bubble, but when combined with Rep. Barney Frank's later coercion of Freddie Mac and Fannie Mae to buy the high risk political correctness mortgages, the CRA added a lot of air to the housing bubble.

Mortgage Backed Securities are like boxes of chocolates. Criminals on Wall Street and one particular U.S. Congressional Committee stole a few chocolates from the boxes and replaced them with turds. Their criminal buddies at Standard & Poors rated these boxes AAA Investment Grade chocolates. These boxes were then sold all over the world to investors. Eventually somebody bites into a turd and discovers the crime. Suddenly nobody trusts American chocolates anymore worldwide. Hank Paulson now wants the American taxpayers to buy up and hold all these boxes of turd-infested chocolates for $700 billion dollars until the market for turds returns to normal. Meanwhile, Hank's buddies, the Wall Street criminals who stole all the good chocolates are not being investigated, arrested, or indicted. Momma always said: "Sniff the chocolates first Forrest." Things generally don't pass the smell test if they came from Wall Street or from Washington DC.
Forrest Gump as quoted at http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html
 


               Forrest Gump's Momma

 

The Sleazy Subprime Mortgage Lending Companies Have a New (actually renewed old) Scheme to Make Billions at Taxpayer Expense
As if they haven't done enough damage. Thousands of subprime mortgage lenders and brokers—many of them the very sorts of firms that helped create the current financial crisis—are going strong. Their new strategy: taking advantage of a long-standing federal program designed to encourage homeownership by insuring mortgages for buyers of modest means. You read that correctly. Some of the same people who propelled us toward the housing market calamity are now seeking to profit by exploiting billions in federally insured mortgages. Washington, meanwhile, has vastly expanded the availability of such taxpayer-backed loans as part of the emergency campaign to rescue the country's swooning economy.
Chad Terhune and Robert Berner, "FHA-Backed Loans: The New Subprime The same people whose reckless practices triggered the global financial crisis are onto a similar scheme that could cost taxpayers tons more," Business Week, November 19, 2008 --- http://www.businessweek.com/magazine/content/08_48/b4110036448352.htm?link_position=link2
Jensen Comment
That's right. The greedy slime balls "Borne of Sleaze, Bribery, and Lies" are resurfacing with Barney Frank's blessing --- http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze

"Financial Reversals:  Everything bad is good again," by  Jacob Sullum, Reason Magazine, November 19, 2008 ---
http://www.reason.com/news/show/130142.html

"Proposed new Bailout Plan," by Andreas Hippin, Bloomberg, November 20, 2008 ---
http://www.wallstreetoasis.com/forums/proposed-new-bailout-plan

The Somali pirates, renegade Somalis known for hijacking ships for ransom in the Gulf of Aden, are negotiating a purchase of Citigroup.

The pirates would buy Citigroup with new debt and their existing cash stockpiles, earned most recently from hijacking numerous ships, including most recently a $200 million Saudi Arabian oil tanker. The Somali pirates are offering up to $0.10 per share for Citigroup, pirate spokesman Sugule Ali said earlier today. The negotiations have entered the final stage, Ali said. ``You may not like our price, but we are not in the business of paying for things. Be happy we are in the mood to offer the shareholders anything," said Ali.

The pirates will finance part of the purchase by selling new Pirate Ransom Backed Securities. The PRBS's are backed by the cash flows from future ransom payments from hijackings in the Gulf of Aden. Moody's and S&P have already issued their top investment grade ratings for the PRBS's.

Head pirate, Ubu Kalid Shandu, said "we need a bank so that we have a place to keep all of our ransom money. Thankfully, the dislocations in the capital markets has allowed us to purchase Citigroup at an attractive valuation and to take advantage of TARP capital to grow the business even faster." Shandu added, "We don't call ourselves pirates. We are coastguards and this will just allow us to guard our coasts better."

"New Michael Lewis Book on Financial World Will Be Published in March," by Julie Bosmanian, New York Times, January 14, 2014 ---
http://www.nytimes.com/2014/01/15/business/media/new-michael-lewis-book-on-financial-world-will-be-published-in-march.html?partner=socialflow&smid=tw-nytimesbusiness&_r=0

 Michael Lewis, whose colorful reporting on money and excess on Wall Street has made him one of the country’s most popular business journalists, has written a new book on the financial world, his publisher said on Tuesday.

The book, titled “Flash Boys,” will be released by W.W. Norton & Company on March 31. A spokeswoman for Norton said the new book “is squarely in the realm of Wall Street.”

Starling Lawrence, Mr. Lewis’s editor, said in a statement: “Michael is brilliant at finding the perfect narrative line for any subject. That’s what makes his books, no matter the topic, so indelibly memorable.”

Mr. Lewis is the author of “Moneyball,” “Liar’s Poker” and “The Big Short.”

Jensen Comment
His books are both humorous and well-researched.

Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.

Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan portfolios. This older Sixty Minutes Module is entitled "House of Cards" --- http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody

This segment can be understood without much preparation except that it would help for viewers to first read about Mervene and how the mortgage lenders brokering the mortgages got their commissions for poisoned mortgages passed along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On some occasions the lenders like Washington Mutual also naively kept some of the poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages from the responsibility for collecting the payments until the final payoff dates.

First Read About Mervene --- http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze

Then Watch Video 1 at http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody

 

Videos 2 and 3
Inside the Wall Street Collapse
(Parts 1 and 2) first shown on March 14, 2010

Video 2 (Greatest Swindle in the History of the World) --- http://www.cbsnews.com/video/watch/?id=6298154n&tag=contentMain;contentAux

Video 3 (Swindler's Compensation Scandals) --- http://www.cbsnews.com/video/watch/?id=6298084n&tag=contentMain;contentAux

 

My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of my favorite authors of all time, Michael Lewis, who hhs been writing (humorously with tongue in cheek) about Wall Street scandals since he was a bond salesman on Wall Street in the 1980s. The other person featured on in these videos is a one-eyed physician with Asperger Syndrome who made hundreds of millions of dollars anticipating the collapse of the CDO markets while the shareholders of companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left holding the empty bags.

 

"The End," by Michael Lewis December 2008 Issue The era that defined Wall Street is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s Poker, returns to his old haunt to figure out what went wrong.
http://www.trinity.edu/rjensen/2008Bailout.htm#TheEnd 

Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek Explanation of the Meltdown on Wall Street!

Now I asked Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of the other Wall Street firms—all said what an awful thing it was to go public (beg for a government bailout) and how could you do such a thing. But when the temptation arose, they all gave in to it.” He agreed that the main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. “When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle. He was out of the game.

This is a must read to understand what went wrong on Wall Street --- especially the punch line!
"The End," by Michael Lewis December 2008 Issue The era that defined Wall Street is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s Poker, returns to his old haunt to figure out what went wrong.
http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom?tid=true

To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue.

I’d never taken an accounting course, never run a business, never even had savings of my own to manage. I stumbled into a job at Salomon Brothers in 1985 and stumbled out much richer three years later, and even though I wrote a book about the experience, the whole thing still strikes me as preposterous—which is one of the reasons the money was so easy to walk away from. I figured the situation was unsustainable. Sooner rather than later, someone was going to identify me, along with a lot of people more or less like me, as a fraud. Sooner rather than later, there would come a Great Reckoning when Wall Street would wake up and hundreds if not thousands of young people like me, who had no business making huge bets with other people’s money, would be expelled from finance.

When I sat down to write my account of the experience in 1989—Liar’s Poker, it was called—it was in the spirit of a young man who thought he was getting out while the getting was good. I was merely scribbling down a message on my way out and stuffing it into a bottle for those who would pass through these parts in the far distant future.

Unless some insider got all of this down on paper, I figured, no future human would believe that it happened.

I thought I was writing a period piece about the 1980s in America. Not for a moment did I suspect that the financial 1980s would last two full decades longer or that the difference in degree between Wall Street and ordinary life would swell into a difference in kind. I expected readers of the future to be outraged that back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid $3.1 million; I expected them to gape in horror when I reported that one of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost $250 million; I assumed they’d be shocked to learn that a Wall Street C.E.O. had only the vaguest idea of the risks his traders were running. What I didn’t expect was that any future reader would look on my experience and say, “How quaint.”

I had no great agenda, apart from telling what I took to be a remarkable tale, but if you got a few drinks in me and then asked what effect I thought my book would have on the world, I might have said something like, “I hope that college students trying to figure out what to do with their lives will read it and decide that it’s silly to phony it up and abandon their passions to become financiers.” I hoped that some bright kid at, say, Ohio State University who really wanted to be an oceanographer would read my book, spurn the offer from Morgan Stanley, and set out to sea.

Somehow that message failed to come across. Six months after Liar’s Poker was published, I was knee-deep in letters from students at Ohio State who wanted to know if I had any other secrets to share about Wall Street. They’d read my book as a how-to manual.

In the two decades since then, I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces?

At some point, I gave up waiting for the end. There was no scandal or reversal, I assumed, that could sink the system.

The New Order The crash did more than wipe out money. It also reordered the power on Wall Street. What a Swell Party A pictorial timeline of some Wall Street highs and lows from 1985 to 2007. Worst of Times Most economists predict a recovery late next year. Don’t bet on it. Then came Meredith Whitney with news. Whitney was an obscure analyst of financial firms for Oppenheimer Securities who, on October 31, 2007, ceased to be obscure. On that day, she predicted that Citigroup had so mismanaged its affairs that it would need to slash its dividend or go bust. It’s never entirely clear on any given day what causes what in the stock market, but it was pretty obvious that on October 31, Meredith Whitney caused the market in financial stocks to crash. By the end of the trading day, a woman whom basically no one had ever heard of had shaved $369 billion off the value of financial firms in the market. Four days later, Citigroup’s C.E.O., Chuck Prince, resigned. In January, Citigroup slashed its dividend.

From that moment, Whitney became E.F. Hutton: When she spoke, people listened. Her message was clear. If you want to know what these Wall Street firms are really worth, take a hard look at the crappy assets they bought with huge sums of ­borrowed money, and imagine what they’d fetch in a fire sale. The vast assemblages of highly paid people inside the firms were essentially worth nothing. For better than a year now, Whitney has responded to the claims by bankers and brokers that they had put their problems behind them with this write-down or that capital raise with a claim of her own: You’re wrong. You’re still not facing up to how badly you have mismanaged your business.

Rivals accused Whitney of being overrated; bloggers accused her of being lucky. What she was, mainly, was right. But it’s true that she was, in part, guessing. There was no way she could have known what was going to happen to these Wall Street firms. The C.E.O.’s themselves didn’t know.

Now, obviously, Meredith Whitney didn’t sink Wall Street. She just expressed most clearly and loudly a view that was, in retrospect, far more seditious to the financial order than, say, Eliot Spitzer’s campaign against Wall Street corruption. If mere scandal could have destroyed the big Wall Street investment banks, they’d have vanished long ago. This woman wasn’t saying that Wall Street bankers were corrupt. She was saying they were stupid. These people whose job it was to allocate capital apparently didn’t even know how to manage their own.

At some point, I could no longer contain myself: I called Whitney. This was back in March, when Wall Street’s fate still hung in the balance. I thought, If she’s right, then this really could be the end of Wall Street as we’ve known it. I was curious to see if she made sense but also to know where this young woman who was crashing the stock market with her every utterance had come from.

It turned out that she made a great deal of sense and that she’d arrived on Wall Street in 1993, from the Brown University history department. “I got to New York, and I didn’t even know research existed,” she says. She’d wound up at Oppenheimer and had the most incredible piece of luck: to be trained by a man who helped her establish not merely a career but a worldview. His name, she says, was Steve Eisman.

Eisman had moved on, but they kept in touch. “After I made the Citi call,” she says, “one of the best things that happened was when Steve called and told me how proud he was of me.”

Having never heard of Eisman, I didn’t think anything of this. But a few months later, I called Whitney again and asked her, as I was asking others, whom she knew who had anticipated the cataclysm and set themselves up to make a fortune from it. There’s a long list of people who now say they saw it coming all along but a far shorter one of people who actually did. Of those, even fewer had the nerve to bet on their vision. It’s not easy to stand apart from mass hysteria—to believe that most of what’s in the financial news is wrong or distorted, to believe that most important financial people are either lying or deluded—without actually being insane. A handful of people had been inside the black box, understood how it worked, and bet on it blowing up. Whitney rattled off a list with a half-dozen names on it. At the top was Steve Eisman.

Steve Eisman entered finance about the time I exited it. He’d grown up in New York City and gone to a Jewish day school, the University of Pennsylvania, and Harvard Law School. In 1991, he was a 30-year-old corporate lawyer. “I hated it,” he says. “I hated being a lawyer. My parents worked as brokers at Oppenheimer. They managed to finagle me a job. It’s not pretty, but that’s what happened.”

He was hired as a junior equity analyst, a helpmate who didn’t actually offer his opinions. That changed in December 1991, less than a year into his new job, when a subprime mortgage lender called Ames Financial went public and no one at Oppenheimer particularly cared to express an opinion about it. One of Oppenheimer’s investment bankers stomped around the research department looking for anyone who knew anything about the mortgage business. Recalls Eisman: “I’m a junior analyst and just trying to figure out which end is up, but I told him that as a lawyer I’d worked on a deal for the Money Store.” He was promptly appointed the lead analyst for Ames Financial. “What I didn’t tell him was that my job had been to proofread the ­documents and that I hadn’t understood a word of the fucking things.”

Ames Financial belonged to a category of firms known as nonbank financial institutions. The category didn’t include J.P. Morgan, but it did encompass many little-known companies that one way or another were involved in the early-1990s boom in subprime mortgage lending—the lower class of American finance.

The second company for which Eisman was given sole responsibility was Lomas Financial, which had just emerged from bankruptcy. “I put a sell rating on the thing because it was a piece of shit,” Eisman says. “I didn’t know that you weren’t supposed to put a sell rating on companies. I thought there were three boxes—buy, hold, sell—and you could pick the one you thought you should.” He was pressured generally to be a bit more upbeat, but upbeat wasn’t Steve Eisman’s style. Upbeat and Eisman didn’t occupy the same planet. A hedge fund manager who counts Eisman as a friend set out to explain him to me but quit a minute into it. After describing how Eisman exposed various important people as either liars or idiots, the hedge fund manager started to laugh. “He’s sort of a prick in a way, but he’s smart and honest and fearless.”

“A lot of people don’t get Steve,” Whitney says. “But the people who get him love him.” Eisman stuck to his sell rating on Lomas Financial, even after the company announced that investors needn’t worry about its financial condition, as it had hedged its market risk. “The single greatest line I ever wrote as an analyst,” says Eisman, “was after Lomas said they were hedged.” He recited the line from memory: “ ‘The Lomas Financial Corp. is a perfectly hedged financial institution: It loses money in every conceivable interest-rate environment.’ I enjoyed writing that sentence more than any sentence I ever wrote.” A few months after he’d delivered that line in his report, Lomas Financial returned to bankruptcy.

Continued in article

Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999, ISBN 0340767006)

Lewis writes in Partnoy’s earlier whistleblower style with somewhat more intense and comic portrayals of the major players in describing the double dealing and break down of integrity on the trading floor of Salomon Brothers.

Reply from Tom Hood
Thanks Bob for the Michael Lewis article, “The End” – great explanation of the mess we a re in and how we got here. Just found this one that does a great job of summarizing the mess – visually http://flowingdata.com/2008/11/25/visual-guide-to-the-financial-crisis/
Tom Hood, CPA.CITP, CEO & Executive Director, Maryland Association of CPAs
443-632-2301, http://www.macpa.org 
Check out our blogs for CPAs http://www.cpasuvvess.com
http://www.newcpas.com 
http://www.cpaisland.com 

 

Financial WMDs (Credit Derivatives) on Sixty Minutes (CBS) on August 30, 2009 ---
http://www.cbsnews.com/video/watch/?id=5274961n&tag=contentBody;housing
The free download will only be available for a short while. I downloaded this video (a little over 5 Mbs) using a free updated version of RealMedia --- Click Here
http://www.real.com/dmm/superpass?pcode=cj&ocode=cj&cpath=aff&rsrc=1275588_10303897_SPLP

Steve Kroft examines the complicated financial instruments known as credit default swaps and the central role they are playing in the unfolding economic crisis. The interview features my hero Frank Partnoy. I don't know of anybody who knows derivative securities contracts and frauds better than Frank Partnoy, who once sold these derivatives in bucket shops. You can find links to Partnoy's books and many, many quotations at http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

For years I've used the term "bucket shop" in financial securities marketing without realizing that the first bucket shops in the early 20th Century were bought and sold only gambles on stock pricing moves, not the selling of any financial securities. The analogy of a bucket shop would be a room full of bookies selling bets on NFL playoff games.
See "Bucket Shop" at http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)

 

Bob Jensen's Rotten to the Core threads ---
http://www.trinity.edu/rjensen/FraudRotten.htm

From the Financial Clippings Blog on October 22, 2008 --- http://financeclippings.blogspot.com/

I wrote earlier that credit rating agencies seem to be run like protection rackets..

from CNBC
In a hearing today before the House Oversight Committee, the credit rating agencies are being portrayed as profit-hungry institutions that would give any deal their blessing for the right price.

Case in point: this instant message exchange between two unidentified Standard & Poor's officials about a mortgage-backed security deal on 4/5/2007:

Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right...model def (definitely) does not capture half the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we would rate it.

A former executive of Moody's says conflicts of interest got in the way of rating agencies properly valuing mortgage backed securities.

Former Managing Director Jerome Fons, who worked at Moody's until August of 2007, says Moody's was focused on "maxmizing revenues," leading it to make the firm more "issuer friendly.
"

The three firms that dominate the $5 billion-a-year credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch Ratings - have been faulted for failing to identify risks in subprime mortgage investments, whose collapse helped set off the global financial crisis. The rating agencies had to downgrade thousands of securities backed by mortgages as home-loan delinquencies have soared and the value of those investments plummeted. The downgrades have contributed to hundreds of billions in losses and writedowns at major banks and investment firms. The agencies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company's ability to raise or borrow money, and at what cost which securities will be purchased by banks, mutual funds, state pension funds or local governments. A yearlong review by the SEC, which issued the results last summer, found that the three big (credit rating) agencies failed to rein in conflicts of interest in giving high ratings to risky securities backed by subprime mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November 19, 2008 --- http://accounting.smartpros.com/x63855.xml
Jensen Comment
It’s beginning to look like Wall Street is rearing up once again to prevent the SEC from imposing reforms on credit rating agencies. In spite of the crisis, it will once again be business as usual with the credit rating agencies having conflicts of interest not in the interest of investors.

Fraud and incompetence among credit rating agencies --- http://www.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury, with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship.
Alexander Tyler. 1787 - Tyler was a Scottish history professor that had this to say about 2000 years after "The Fall of the Athenian Republic" and about the time our original 13 states adopted their new constitution.
As quoted at http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in real time is a few months behind)
This leads to contemplation of democracy versus a "social contract."

The broad mass of a nation will more easily fall victim to a big lie than to a small one.
Adolph Hitler, Mein Kampf.

Bankers (Men in Black) bet with their bank's capital, not their own. If the bet goes right, they get a huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital Louria Hahn, "Missing:  How Poor Risk-Management Techniques Contributed to the Subprime Mess," CFO Magazine, March 2008, Page 53 --- http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Jensen Comment
Now that the Government is going to bail out these speculators with taxpayer funds makes it all the worse. I received an email message claiming that i
f you had purchased $1,000 of AIG stock one year ago, you would have $42 left;  with Lehman, you would have $6.60 left; with Fannie or Freddie, you would have less than $5 left. But if you had purchased $1,000 worth of beer one year ago, drank all of the beer, then turned in the cans for the aluminum recycling REFUND, you would have had $214. Based on the above, the best current investment advice is to drink heavily and recycle. It's called the 401-Keg. Why let others gamble your money away when you can piss it away on your own?

High-ranking members of Congress were flown to a lush Caribbean resort this month for a three-day conference planned and paid for by several of the country's most powerful corporations - a violation of federal ethics rules, critics say.  . . . Officials with those companies were observed at the conference - sometimes acting as featured speakers at daily seminars and freely mingling among the pols at social events. Citigroup - which just last week received a massive bailout from the federal government - was one of the conference's biggest sponsors, ponying up $100,000 to help finance the event, according to one of the lobbyists at the gathering.
Ginger Adams Otis, "SHADY ISLAND 'HOUSE' PARTY POLS' TRIP TO CARIBBEAN SKIRTED RULES," New York Post, November 30, 2008 --- http://www.nypost.com/seven/11302008/news/regionalnews/shady_island_house_party_141513.htm

Hitler's Credit Crisis --- http://www.youtube.com/watch?v=bNmcf4Y3lGM 

The current financial turmoil shows that private sector can bankrupt nation states. The US government has committed more than $5 trillion and the UK has committed around £500 billion, nearly one-third of their respective GDPs, to support the financial sector. The bailouts may stabilise the financial sector and help economic recovery but they have also created new moral hazards. In the absence of effective regulation and accountability, company directors, who have already behaved badly, will continue to behave recklessly and play their selfish games, at virtually no cost to themselves. Leaders of major industrialised countries have paid little attention to moral hazards and how bailouts reward bad behaviour. There is an urgent need to address the moral hazards problem.
Prem Sikka, "Hold them to account: The traditional mechanisms for disciplining," The Guardian, November 18, 2008 --- http://www.guardian.co.uk/commentisfree/2008/nov/18/marketturmoil-banks

However, the looting of the taxpayers, which was initially $700 billion for Wall Street and has now ballooned to an estimated $1.8 (now closer to $5) trillion and is not over yet, was not labeled as corruption by our media. Instead, it was called a “rescue” and was demanded by many anchors and reporters. We were told it would stabilize the markets and help ordinary people. It didn’t. Kevin Howley, Associate Professor of Communication at DePauw University, says this was deliberate propaganda on their part. He comments that “…the phrase ‘bailout’―with its connotation that the government is letting Wall Street off the hook for questionable business practices―has given way to a far more agreeable term― ‘rescue plan.’ This phrasing appeals to the basic decency of the American people and suggests that we’re all in this thing together.” In a real-life corruption case, which was just as suspiciously timed as the financial crisis itself, Alaska Senator Ted Stevens was indicted and then convicted in this election year on all seven charges of making false statements on Senate financial documents. One of the charges was that he had received a $1,000 Alaskan sled dog puppy that he valued at only $250 and claimed had come from a charity. This is chicken feed compared to what the politicians and their appointees have done by bringing the U.S. to the point of bankruptcy. But can we ever expect the Department of Justice to turn on the politicians for these financial crimes? Not likely.
Cliff Kincaid, "The Financial “Rescue” that Bankrupted America," Accuracy in the Media, November 9, 2008 ---
http://www.aim.org/aim-column/the-financial-rescue-that-bankrupted-america/


This sure beats having the government buy the garbage!
If your executives got you into garbage investments, pay their bonuses in garbage.

From the "Best of the Web Today" newsletter of The Wall Street Journal on December 19, 2008

A Financial Innovation Everyone Should Love
"Credit Suisse Group AG's investment bank has found a new way to reduce the risk of losses from about $5 billion of its most illiquid loans and bonds: using them to pay employees' year-end bonuses," Bloomberg reports:

The bank will use leveraged loans and commercial mortgage- backed debt, some of the securities blamed for generating the worst financial crisis since the Great Depression, to fund executive compensation packages, people familiar with the matter said. The new policy applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today.
"While the solution we have come up with may not be ideal for everyone, we believe it strikes the appropriate balance among the interests of our employees, shareholders and regulators and helps position us well for 2009," Chief Executive Officer Brady Dougan and Paul Calello, CEO of the investment bank, said in the memo.
The securities will be placed into a so-called Partner Asset Facility, and affected employees at the bank, Switzerland's second biggest, will be given stakes in the facility as part of their pay. Bonuses will take the first hit should the securities decline further in value.

This is such a great idea, we're surprised it took this long for someone to think of it. And contrary to the memo, this does seem "ideal for everyone." Shareholders gets relief from the risk associated with imprudent investments. Credit Suisse executives get their bonuses despite having made those imprudent investments--and if the risk pays off, they get the reward. What's not to like?


Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.
Alan Greenspan in 2004 as quoted by Peter S. Goodman, Taking a Good Look at the Greenspan Legacy," The New York Times, October 8, 2008 --- http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html?em

The problem is not that the contracts failed, he says. Rather, the people using them got greedy. A lack of integrity spawned the crisis, he argued in a speech a week ago at Georgetown University, intimating that those peddling derivatives were not as reliable as “the pharmacist who fills the prescription ordered by our physician.”

But others hold a starkly different view of how global markets unwound, and the role that Mr. Greenspan played in setting up this unrest.

“Clearly, derivatives are a centerpiece of the crisis, and he was the leading proponent of the deregulation of derivatives,” said Frank Partnoy, a law professor at the University of San Diego and an expert on financial regulation.

The derivatives market is $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago. Theoretically intended to limit risk and ward off financial problems, the contracts instead have stoked uncertainty and actually spread risk amid doubts about how companies value them.

If Mr. Greenspan had acted differently during his tenure as Federal Reserve chairman from 1987 to 2006, many economists say, the current crisis might have been averted or muted.

Over the years, Mr. Greenspan helped enable an ambitious American experiment in letting market forces run free. Now, the nation is confronting the consequences.

Derivatives were created to soften — or in the argot of Wall Street, “hedge” — investment losses. For example, some of the contracts protect debt holders against losses on mortgage securities. (Their name comes from the fact that their value “derives” from underlying assets like stocks, bonds and commodities.) Many individuals own a common derivative: the insurance contract on their homes.

On a grander scale, such contracts allow financial services firms and corporations to take more complex risks that they might otherwise avoid — for example, issuing more mortgages or corporate debt. And the contracts can be traded, further limiting risk but also increasing the number of parties exposed if problems occur.

Throughout the 1990s, some argued that derivatives had become so vast, intertwined and inscrutable that they required federal oversight to protect the financial system. In meetings with federal officials, celebrated appearances on Capitol Hill and heavily attended speeches, Mr. Greenspan banked on the good will of Wall Street to self-regulate as he fended off restrictions.

Ever since housing began to collapse, Mr. Greenspan’s record has been up for revision. Economists from across the ideological spectrum have criticized his decision to let the nation’s real estate market continue to boom with cheap credit, courtesy of low interest rates, rather than snuffing out price increases with higher rates. Others have criticized Mr. Greenspan for not disciplining institutions that lent indiscriminately.

But whatever history ends up saying about those decisions, Mr. Greenspan’s legacy may ultimately rest on a more deeply embedded and much less scrutinized phenomenon: the spectacular boom and calamitous bust in derivatives trading.

Bob Jensen's timeline of derivatives scandals and the evolution of accounting standards for accounting for derivatives financial instruments can be found at http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

"‘I made a mistake,’ admits Greenspan," by Alan Beattie and James Politi, Financial Times, October 23, 2008 ---
http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1

“I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders,” he said.

In the second of two days of tense hearings on Capitol Hill, Henry Waxman, chairman of the House of Representatives, clashed with current and former regulators and with Republicans on his own committee over blame for the financial crisis.

Mr Waxman said Mr Greenspan’s Federal Reserve – along with the Securities and Exchange Commission and the US Treasury – had propagated “the prevailing attitude in Washington... that the market always knows best.”

Mr Waxman blamed the Fed for failing to curb aggressive lending practices, the SEC for allowing credit rating agencies to operate under lax standards and the Treasury for opposing “responsible oversight” of financial derivatives.

Christopher Cox, chairman of the Securities and Exchange Commission, defended himself, saying that virtually no one had foreseen the meltdown of the mortgage market, or the inadequacy of banking capital standards in preventing the collapse of institutions such as Bear Stearns.

Mr Waxman accused the SEC chairman of being wise after the event. “Mr Cox has come in with a long list of regulations he wants... But the reality is, Mr Cox, you weren’t doing that beforehand.”

Mr Cox blamed the fact that Congressional responsibility was divided between the banking and financial services committees, which regulate banking, insurance and securities, and the agriculture committees, which regulate futures.

“This jurisdictional split threatens to for ever stand in the way of rationalising the regulation of these products and markets,” he said.

Mr Greenspan accepted that the crisis had “found a flaw” in his thinking but said that the kind of heavy regulation that could have prevented the crisis would have damaged US economic growth. He described the past two decades as a “period of euphoria” that encouraged participants in the financial markets to misprice securities.

He had wrongly assumed that lending institutions would carry out proper surveillance of their counterparties, he said. “I had been going for 40 years with considerable evidence that it was working very well”.

Continued in the article

Jensen Comment
In other words, he assumed the agency theory model that corporate employees, as agents of their owners and creditors, would act hand and hand in the best interest for themselves and their investors. But agency theory has a flaw in that it does not understand Peter Pan.

Long Time WSJ Defenders of Wall Street's Outrageous Compensation Morph Into Hypocrites
At each stage of the disaster, Mr. Black told me -- loan officers, real-estate appraisers, accountants, bond ratings agencies -- it was pay-for-performance systems that "sent them wrong." The need for new compensation rules is most urgent at failed banks. This is not merely because is would make for good PR, but because lavish executive bonuses sometimes create an incentive to hide losses, to take crazy risks, and even, according to Mr. Black, to "loot the place through seemingly normal corporate mechanisms." This is why, he continues, it is "essential to redesign and limit executive compensation when regulating failed or failing banks." Our leaders may not know it yet, but this showdown between rival populisms is in fact a battle over political legitimacy. Is Wall Street the rightful master of our economic fate? Or should we choose a broader form of sovereignty? Let the conservatives' hosannas turn to sneers. The market god has failed.
Thomas Frank, "Wall Street Bonuses Are an Outrage:  The public sees a self-serving system for what it," The Wall Street Journal, February 4, 2009 --- http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion
Bob Jensen's threads on outrageous compensation are at http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Bob Jensen's threads on the Bailout mess are at http://www.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on corporate governance are at http://www.trinity.edu/rjensen/Fraud001.htm#Governance

Peter Pan, the manager of Countrywide Financial on Main Street, thought he had little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures would be Wall Street’s problems and not his local bank’s problems. And he got his nice little commission on the sale of the Emma Nobody’s mortgage for $180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was almost certain in Emma’s case, because she only makes $12,000 waitressing at the Country Café. So what if Peter Pan fudged her income a mite in the loan application along with the fudged home appraisal value? Let Wall Street or Fat Fannie or Foolish Freddie worry about Emma after closing the pre-approved mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over millions of wealthy shareholders of Wall Street investment banks. Peter Pan is more concerned with his own conventional mortgage on his precious house just two blocks south of Main Street. This is what happens when risk is spread even farther than Tinkerbell can fly!
Read about the extent of cheating, sleaze, and subprime sex on Main Street in Appendix U.

The Saturday Night Live Skit (now banned) on the Bailout --- http://patdollard.com/2008/10/it-is-here-the-banned-snl-skit-cannot-hide-from-louie/ 

Banks and homeowners aren't the only ones looking to Washington for help these days. The nation's automakers are bleeding red ink. Given the Big Three's outsize role in the U.S. economy, it may make sense for taxpayers to lend Detroit a helping hand, argue David Kiley and David Welch in a provocative essay. While Republicans in Washington have been expanding the role of government in financial services, microcredit pioneer Muhammad Yunus, of Bangladesh's Grameen Bank, is advocating a market-based solution to the financial crisis.
Monica Gagnier, "The Fed's Next Step," Business Week's Insider Newsletter, October 17, 2008
Jensen Comment
The latest trend is that government will bail out failing industries like banks, automobile manufacturers, and airlines. And why not? The government can spend trillions doing so without costing taxpayers a penny --- http://www.trinity.edu/rjensen/2008bailout.htm#NationalDebt

On the left side, there is nothing right... And on the right side, there is nothing left.
 The December 31, 2008 Statement of Financial Position (a fancy phrase for the balance sheet) of every investment bank.
 The meanings in English are so varied for some words like "right" and "left."
 Fat Fannie and Fearless Freddie leaned too far to the left on the left end of the Congressional roof and fell into a pile of leftist Acorns.
 Now there's nothing left but millions of empty homes left behind when the owners left.
 

Governmental Accounting 101 Tutorial, by Dr. Seuss
Because of future property taxes, insurance costs, and upkeep costs, it's not clear to accountants if Fannie and Freddie should put their foreclosed homes on the right-side or the left-side of the balance sheet. But now that Freddie and Fannie are owned by the government, the GAO tells us that on balance sheets the left goes right and the right goes left. It's so confusing, but then in the Federal Government's balance sheet nearly everything bad is left out entirely so who cares what appears of the left versus what appears on the right. Nothing is correct in the first place.

A more palatable approach would be for the government to drive a Warren Buffett style hard bargain, in which, rather than buying anything from banks, the government would invest in them in a form, such as purchase of newly issued preferred stock, or bonds with a long maturity, that would augment the banks' capital and thus enable banks to make more loans. That would avoid conferring a windfall on the banks by overpaying them for their bad securities; no one thinks Buffett is conferring a windfall on Goldman Sachs. After the industry was back on its feet, the government could sell the bank stocks or bonds that it had acquired.
Richard Posner, "The $700+ Billion Bailout," The Becker-Posner Blog, September 28, 2008 --- http://www.becker-posner-blog.com/
Jensen Comment
This appears to be a solution the government is belatedly adopting.

Current U.S. budget policy is unsustainable because it violates the intertemporal budget constraint. While the resulting fiscal gap will eventually be eliminated whether we like it or not, the big issue in current budget debate is whether the ultimately unavoidable course corrections should start now or be left for later. This paper argues that concerns of generational equity, which often are relied on by those demanding a prompt course correction, do not convincingly settle the issue, given empirical uncertainties about future generations' circumstances. However, efficiency issues create powerful grounds for urging a course correction sooner rather than later, on three main grounds: to eliminate the risk of a catastrophic fiscal collapse, achieve the advantages of tax smoothing, and smooth adjustments to the consumption made possible by various government outlays. Political economy considerations suggest that the risk of a catastrophic fiscal collapse may be significant even though in principle it could easily be avoided.
Danial Shaviro, "The Long-Term Fiscal Gap: Is the Main Problem Generational Inequity?" --- Click Here
Also see Paul Caron's blog from the NYU Law School  on January 15, 2009 --- Click Here

As we've documented the myriad ways that Washington encouraged the housing bubble, the media and Democrats continue to search for evidence to blame it all on "deregulation." One alleged perpetrator, the Gramm-Leach-Bliley Act, was released without charges after the record revealed that Joe Biden voted for it and Bill Clinton signed it. More to the point, investment banks were already free, prior to the 1999 law, to invest in the same assets that have wreaked such havoc today.
Editors of The Wall Street Journal, October 18, 2008 --- http://online.wsj.com/article/SB122428201410246019.html?mod=djemEditorialPage

Video Links (humor) forwarded by Jagdish Gangolly

The Long Johns - George Parr http://www.youtube.com/watch?v=aKxVPrUIpBY 

Credit Crunch http://www.youtube.com/watch?v=DXJtnqXubK0&feature=related 

subprime derivatives http://www.youtube.com/watch?v=0YNyn1XGyWg&feature=related 

From Vanderbilt University (you have to watch this video to the ending to appreciate it)
 A Keynote Speech by Leo Melamed --- Click Here 
http://www.owen.vanderbilt.edu/vanderbilt/About/owen-newsroom/owen-podcasts/podcasts/FIC-Melamed-keynote.html
 Who is Leo Melamed? --- http://en.wikipedia.org/wiki/Leo_Melamed
 Bob Jensen's Primer on Derivatives ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Primer

A second paper in this series will examine the theoretical justifications for the importance of the stock market as perhaps the central financial institution in the United States.
"Who Needs the Stock Market? Part I: The Empirical Evidence," by Lawrence E. Mitchell George Washington University - Law School, SSRN, October 30, 2008 --- http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1292403

Data on historical and current corporate finance trends drawn from a variety of sources present a paradox. External equity has never played a significant role in financing industrial enterprises in the United States. The only American industry that has relied heavily upon external financing is the finance industry itself. Yet it is commonly accepted among legal scholars and economists that the stock market plays a valuable role in American economic life, and a recent, large body of macroeconomic work on economic development links the growth of financial institutions (including, in the U.S, the stock market) to growth in real economic output. How can this be the case if external equity as represented by the stock market plays an insignificant role in financing productivity? This paradox has been largely ignored in the legal and economic literature.

This paper surveys the history of American corporate finance, presents original and secondary data demonstrating the paradox, and raises questions regarding the structure of American capital markets, the appropriate rights of stockholders, the desirable regulatory structure (whether the stock market should be regulated by the Securities and Exchange Commission or the Commodities Futures Trading Commission, for example), and the overall relationship between finance and growth.

The answers to these questions are particularly pressing in light of a dramatic increase in stock market volatility since the turn of the century creating distorted incentives for long-term corporate management, especially trenchant in light of the recent global financial collapse.

A second paper in this series will examine the theoretical justifications for the importance of the stock market as perhaps the central financial institution in the United States.

"The Financial Crisis, From A-Z," by Tunku Varadarajan, Forbes, November 10, 2008 ---
http://www.forbes.com/opinions/2008/11/09/financial-crisis-tarp-oped-cx_tv_1110varadarajan.html


Few forecast these (2008 economic meltdown) events; although, in an outbreak of retrospective foresight, an increasing number now claim they saw it coming. The reality is that among all the banks, investors, academics and policy-makers, only a handful were able to identify ahead of time the causes and potential scale of the crisis. (The Handful were - Bill White, formerly of both the Bank of Canada and the Bank for International Settlements; Harvard University’s Ken Rogoff; Nouriel Roubini of New York University; Wynne Godley of Cambridge; and Bernard Connolly of AIG Financial Products). I came across this paper by Caludio Borio of BIS.
Amol Agrawal, Mostly Economics Blog, December 19, 2008 --- http://mostlyeconomics.wordpress.com/
Jensen Comment
Hindsight:   This 2006 video makes fools out of Ben Stein and Art Laffer and makes a hero out of Peter Schiff.
To this I might add Peter Schiff. Arthur Laffer's preditions in 2006 predictions became a sick joke. Also you Ben Stein lovers may have second thoughts watching him proclaim, in 2006, that the subprime problem is going to be a "tiny" problem. Watch Peter Schiff make fools out of Art Laffer, Ben Stein, and other finance “experts” in this video.  Watch Ben Stein recommend that you invest heavily in Merrill Lynch before its shares tanked. Some of these popular media "experts" need to spend more time studying and reading and less time broadcasting poorly-researched advice to investors. Peter Schiff, on the other hand, does his homework. This video is really revealing about the advice we get on television.
The video is available at the Financial Rounds Blog, November 18 at
http://financeprofessorblog.blogspot.com/2008/11/peter-schiff-prophet-from-past.html
Update on the bet Art Laffer made with Peter Schiff ---
Listen to Laffer try to weasel out of paying up --- http://www.youtube.com/watch?v=z3WjgKUf-kA


Introductory Comment
Henry Paulson knows his $700 billion (read that $1 trillion) bailout plan is not going to save the banks that are now submerged in nearly-worthless mortgaged investments. I think Jonathon Weil (see Appendix G) hit the nail on the head as to why Paulson chose this particular bailout proposal. Paulson is really buying time while leaders in Congress dine on crow instead of lobster. Read this as meaning that Paulson is saving us from runaway populism al Barney Frank and Chris Dodd. But Paulson cannot save the banks that are truly submerged. Read the following in Appendix G.

The plan goes like this: Treasury will pay financial institutions above-market prices for garbage assets nobody else wants. Then, through the magic of mark-to-Paulson accounting, everybody else that owns similar stuff will use those same prices, or marks, to value the trash on their own balance sheets.

Shazam! Banks and insurance companies write up the asset values on their books. They post big profits. Their capital goes up. Everyone gets fooled. And nobody knows the difference.

Except, we do. And that's why the plan probably won't work.

Still, give Paulson and Federal Reserve Chairman Ben Bernanke credit for ingenuity. At the same time banks are begging regulators to suspend mark-to-market accounting rules so they can avoid disclosing more losses, Paulson and Bernanke instead devise a way to abuse the same rules for the same banks' benefit.

Jensen Comment
But most bankrupted banks will stay in business. Some will be bought out at bargain basement prices by stronger banks. Some will simply have new owners. The original owners (shareholders) will suck gas in either of these two outcomes.

November 12, 2008 Update:  Paulson finally came to his senses and opted for direct investment in banks via loans and equity rather than buying up all the junk mortgages owned by troubled banks.

A more palatable approach would be for the government to drive a Warren Buffett style hard bargain, in which, rather than buying anything from banks, the government would invest in them in a form, such as purchase of newly issued preferred stock, or bonds with a long maturity, that would augment the banks' capital and thus enable banks to make more loans. That would avoid conferring a windfall on the banks by overpaying them for their bad securities; no one thinks Buffett is conferring a windfall on Goldman Sachs. After the industry was back on its feet, the government could sell the bank stocks or bonds that it had acquired.
Richard Posner, "The $700+ Billion Bailout," The Becker-Posner Blog, September 28, 2008 --- http://www.becker-posner-blog.com/

Finally, the "too big to fail" approach to banks and other companies should be abandoned as new long-term financial policies are developed. Such an approach is inconsistent with a free market economy. It also has caused dubious company bailouts in the past, such as the large government loan years ago to Chrysler, a company that remained weak and should have been allowed to go into bankruptcy. All the American auto companies are now asking for handouts too since they cannot compete against Japanese, Korean, and German carmakers. They will probably get these subsidies, even though these American companies have been badly managed. A "too many to fail" principle, as in the present financial crisis, may still be necessary on hopefully rare occasions, but failure of badly run big financial and other companies is healthy and indeed necessary for the survival of a robust free enterprise competitive system.
Nobel Laureate Gary Becker, "The $700+ Billion Bailout," The Becker-Posner Blog, September 28, 2008 --- http://www.becker-posner-blog.com/

What will happen to some of the banks that are submerged in bad debts?
Hundreds of banks will have three options if they are not transfused with bailout billions:

  1. They can (or will be forced to) close their doors. This will rarely happen except in the case of a few remote banks among Sarah Palin’s constituency.
     
  2. They will sell out at bargain-basement prices to stronger banks. To date the  largest (record holder) of the banks infested with trash mortgage securities is the WaMu system of banks that sold really cheap to JP Morgan. Wachovia may become a new record breaker in this department. The badly injured parties in these deals are shareholders that get wiped out, which translates in some respects to wounded mutual funds and pension funds. CREF is so big and so diversified that losses on Wachovia probably won’t be felt much in your eventual retirement checks. You should worry more about what the $55+ trillion in the Federal Government’s liabilities will do to your future --- http://www.trinity.edu/rjensen/2008Bailout.htm#NationalDebt
     
  3. They can continue to operate in bankruptcy and screw their shareholders and creditors. Then they can get shareholders who will be buying into pretty good deals or they won’t buy in to save the bankrupted banks.

Keep in mind that none of the above outcomes will damage depositors unless they had account balances above $100,000. Those depositors will be paid off when Congress makes it $56+ trillion or more. See Appendix A
Actually the best solution, in my opinion, is not bail the banks out with billions. Read about the best options in the following article:
“Bridge Loan to Nowhere,” by Thomas Ferguson & Robert Johnson, The Nation, September 22, 2008 --- http://www.thenation.com/doc/20081006/ferguson_johnson  

Everett Dirksen, as Minority Senate Leader beginning in 1959, is most widely noted for a quotation that he never made in these exact words:  "A billion here, a billion there, pretty soon, you're talking real money". What he really meant to say was "A trillion here and a trillion there means you can't possibly be talking about real money."

The National Debt Clock --- http://www.brillig.com/debt_clock/
At the above site it appears to be a fixed number.
But now hit your refresh button to see how much it's changed in just a few seconds.
At 9:34 a.m. on September 23, 2008 it was $9,734,361,140,920.08 trillion
At 9:35 a.m. on September 23, 2008 it was $9,734,365,595,383.82 trillion
What was added in that minute was mostly added to pay the interest on the National Debt.
The annual amount of interest per year on the above number at 6% is $584,061,935,723.03 billion
This translates to well over a million dollars a minute, most of which is funded by adding to the National Debt.
There's no
real money here since the U.S. Government never intends to pay off the National Debt, not one farthing.
There's a greatly increased chance in 2008 that U.S. debt will receive a lowered credit rating, which will greatly increase the cost of out national debt each minute.

But the National Debt is only the amount we have actually borrowed on notes because the U.S. needed cash to pay current bills due. Every accountant knows that the unbooked liabilities can be much, much larger because we've not yet needed to currently borrow the money to pay bills that are coming in to us or our grandchildren in the future.

Because U.S. Government accounting is in such chaos (the GAO will not even sign off on its annual audits of the Pentagon), nobody on earth really knows what our total liabilities are. The former top accountant in the Federal government estimates that the total is well in excess of $55+ trillion (present value discounted) before the 2008 deficit is factored in.

See Appendix A for details.

It really doesn't matter since the present $55+ trillion U.S. Government mortgage is really a problem passed on to our unborn grandchildren who, by 2050, will be street beggars in Brazil, China, India, and Russia --- http://www.trinity.edu/rjensen/entitlements.htm

Their report, "Dreaming with BRICs: The Path to 2050," predicted that within 40 years, the economies of Brazil, Russia, India and China - the BRICs - would be larger than the US, Germany, Japan, Britain, France and Italy combined. China would overtake the US as the world's largest economy and India would be third, outpacing all other industrialised nations. 
"Out of the shadows," Sydney Morning Herald, February 5, 2005 --- http://www.smh.com.au/text/articles/2005/02/04/1107476799248.html 

In the end, Mr. Bush’s appearance (address to the nation urging an added $700 billion to bailout the bankers) was just another reminder of something that has been worrying us throughout this crisis: the absence of any real national leadership, including on the campaign trail. Given Mr. Bush’s shockingly weak performance, the only ones who could provide that are the two men battling to succeed him. So far, neither John McCain nor Barack Obama is offering that leadership. What makes it especially frustrating is that this crisis should provide each man a chance to explain his economic policies and offer a concrete solution to the current crisis.
Editorial, The New York Times, September 25, 2008 --- http://www.nytimes.com/2008/09/25/opinion/25thu1.html?_r=1&oref=slogin

"Pittsburgh Public Schools officials say they want to give struggling children a chance, but the district is raising eyebrows with a policy that sets 50 percent as the minimum score a student can receive for assignments, tests and other work," reports the Pittsburgh Post-Gazette . . . Of course, there's an obvious (better) solution to this: Make the minimum score 100% instead of 50%. That ensures that Pittsburgh students will have the highest grades in the country (as long as no other school district learns the secret), and also that there will be no awkwardness, since no one will know any math.
"Eyebrows raised over city school policy that sets 50% as minimum score: 1+1=3? In city schools, it's half right," Pittsburgh Post-Gazette, September 22, 2008 ---
http://www.post-gazette.com/pg/08266/914029-298.stm 
Jensen Comment
Actually the Pittsburgh schools learned about the 10% Rule in Texas and decided to one-up the Lone Star State with a 50% Rule. This gave Hank Paulson an idea. What if a homeowner made no payments on a sub-prime mortgage? Why not give 50% minimum credit for each non-payment to lower the amount owed.? That way the bailout recoveries won't look so bad since the government can thereby receive half of what is owing to it with each bailed out mortgage. This will appeal to Congress since there is public aversion to receiving zero on bailed out mortgages. Yikes! I'm beginning to think like an accountant selling tax shelters.

What did the top executives of the failed banks and AIG earn receive in pay per year? ---
http://finance.yahoo.com/career-work/article/105862/What-the-Wall-Street-Titans-Earned

From the Financial Clippings Blog on October 22, 2008 --- http://financeclippings.blogspot.com/

I wrote earlier that credit rating agencies seem to be run like protection rackets..

from CNBC
In a hearing today before the House Oversight Committee, the credit rating agencies are being portrayed as profit-hungry institutions that would give any deal their blessing for the right price.

Case in point: this instant message exchange between two unidentified Standard & Poor's officials about a mortgage-backed security deal on 4/5/2007:

Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right...model def (definitely) does not capture half the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we would rate it.

A former executive of Moody's says conflicts of interest got in the way of rating agencies properly valuing mortgage backed securities.

Former Managing Director Jerome Fons, who worked at Moody's until August of 2007, says Moody's was focused on "maxmizing revenues," leading it to make the firm more "issuer friendly.
"

The three firms that dominate the $5 billion-a-year credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch Ratings - have been faulted for failing to identify risks in subprime mortgage investments, whose collapse helped set off the global financial crisis. The rating agencies had to downgrade thousands of securities backed by mortgages as home-loan delinquencies have soared and the value of those investments plummeted. The downgrades have contributed to hundreds of billions in losses and writedowns at major banks and investment firms. The agencies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company's ability to raise or borrow money, and at what cost which securities will be purchased by banks, mutual funds, state pension funds or local governments. A yearlong review by the SEC, which issued the results last summer, found that the three big (credit rating) agencies failed to rein in conflicts of interest in giving high ratings to risky securities backed by subprime mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November 19, 2008 --- http://accounting.smartpros.com/x63855.xml
Jensen Comment
It’s beginning to look like Wall Street is rearing up once again to prevent the SEC from imposing reforms on credit rating agencies. In spite of the crisis, it will once again be business as usual with the credit rating agencies having conflicts of interest not in the interest of investors.
Bob Jensen's threads on historic abuses by credit rating agencies are at http://www.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

"Economists Urge Congress Not to Rush on Rescue Plan," by Matthew Benjamin, Bloomberg, September 26, 2008 ---
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aNhbZSQz2Vws

More than 150 U.S. economists, including three Nobel Prize winners, urged Congress to hold off on passing a $700 billion financial market rescue plan until it can be studied more closely.

In a Sept. 24 letter to Congressional leaders, 166 academic economists said they oppose Treasury Secretary Henry Paulson's plan because it's a ``subsidy'' for business, it's ambiguous and it may have adverse market consequences in the long term. They also expressed alarm at the haste of lawmakers and the Bush administration to pass legislation.

``It doesn't seem to me that a lot decisions that we're going to have to live with for a long time have to be made by Friday,'' said Robert Lucas, a University of Chicago economist and 1995 Nobel Prize winner who signed the letter. ``The situation may get urgent, but it's not urgent right now. Right now it's a financial sector problem.''

The economists who signed the letter represent various disciplines, including macroeconomics, microeconomics, behavioral and information economics, and game theory. They also span the political spectrum, from liberal to conservative to libertarian.

Continued in article
Also see Senator Jim Bunning's incredible Senate Floor speech on September 26, 2008 --- Click Here
And see a Nobel Economist's (Stiglitz) very negative response to the bailout plan --- http://www.thenation.com/doc/20081013/stiglitz

The United States is almost back in the credit pyramid scheme!
The mechanics of Hank Paulson's bailout plan for bankers ---
http://www.redstate.com/diaries/blackhedd/2008/oct/04/the-mechanics-of-the-paulson-rescue-plan/

On October 3, 2005 Bush signed the $700 billion bankers' bailout bill, with half the money subject to a Congressional veto, Congressional aides said. Under the plan, the Treasury secretary receives $250 billion immediately and could have an additional $100 billion if he certifies it is also needed. What do you think the chances are that he’ll eventually say: “Nah, that first $250 billion is more than enough?”

Treasury Secretary Henry Paulson came up with a cockamamie bailout that he claimed would end up making money for the US Treasury. However, backroom Democrats connived to siphon off any repayment of the people’s money back to the treasury by adding one small inocuous line to the agreement----a line that would end up stealing money from any repayments and giving it to left-wing political advocacy groups like ACORN, the National Urban League and the Hispanic atrocity---La Raza. Instead of trying to help the economy, the Democrats want to loot taxpayers for their left-wing political constituents. It’s business as usual for the Democrats.
Free Republic, September 27, 2008 --- http://www.freerepublic.com/focus/f-news/2091697/posts
Here's some more about ACORN --- http://www.rottenacorn.com/index.html
They Don't Fall Far From the Tree ---
http://www.thetimesonline.com/articles/2008/10/04/columnists/mark_kiesling/doc1a3a97a75d06708b862574d70007769d.txt

What if you were buying an albino horse for your kid that had a Bush Stables sticker price of $7,000? You offer $2,500 plus another $1,000 if Hi Ho Silver lasts for more than a month.

Instantly the Masked Man whips out the contract and says “sign here." He hurriedly scoops up the $2,500 and races out the door while the heavens are playing the William Tell Overture --- http://hk.youtube.com/watch?v=krKTMKnTGsE

With such an eager horse trader aren’t you the least bit suspicious about that original $700 billion sticker price?

Of course there is that added $350 billion kicker that Congress might additionally offer if and only if the first $350 billion is doing such a good job. I think we should spend another $350 billion only if the first $350 billion is doing a rotten job keeping us out a deep economic depression.

Sarah Palin was utterly naive when becoming a vice presidential candidate. She believed that meaningful Congressional reforms were actually possible. She did not truly understand how House Speaker Pelosi controls Congressional voting by doling out earmarked corruption and, now, bailout corruption. An even worse problem with Palin is that, yikes, she wants to balance the Federal Budget. I mean how naive can can the a hockey mom be?

In reality the added $350 billion option is for any remaining bad car and motorcycle loans held by local banks, some pork for Byrd’s nests in West Virginia, and millions of new seeds for Barney Frank's Acorn farm. To avoid a Congressional veto, Nancy Pelosi gets a new Airbus to fly nonstop back and forth to San Francisco for the next eight years, and Sarah Palin gets a saddle for a snow goose on her return flight to Alaska. Because she has such large glasses, there’s no need for a goggles in Palin’s courtesy appropriation.

This time of year it’s growing very cold when riding a snow goose near the arctic. There’s a good possibility that Pelosi will instead drop Palin off in Fairbanks if the hockey mom political reformer promises to never leave Alaska henceforth and forevermore. At this point Pelosi’s offer looks like the best option available to Gov. Palin. Alaska’s Governor might even bag a moose or two while the Airbus is on its landing approach. There's precedent here. Nancy Pelosi booted reformer Jeff Flake of the House Judiciary Committee because he's repeatedly tried to end earmark fraud in Congress. Sorry Jeff! No free ride for lowlifes on the Speaker's Airbus.

But why should we worry? The two presidential candidates are offering tax reductions rather than increases, so even if the ultimate cost of the bailout is $5 trillion that’s just a trifle in annual interest to add to the million+ dollars a minute taxpayers are already paying in interest on the present National Debt. It’s a relief now that Bank America will get a bailout appropriation of $200 billion to cover the fraud losses on its wholly owned Subsidiary, Countrywide Financial. Countrywide can once again offer you a sweet sub-prime mortgage and extend your credit card limit to $5 million. The United States is back in the credit  pyramid business.

This trillion dollar (probably) bailout proposal before Congress is beginning to smell like the bottom of a lobster boat. The trouble is that both Democrats and Republicans love to dine on lobster dinners paid for by their lobbyist friends.

Maybe the lobster analogy is even better than I thought since the Men in Black (bankers) are now trying to get their claws into us on the way down --- sort of like getting clawed by a big one before you can dump him in the pot.

I’m told that bankers are now furiously combing the books to find out how many defaulted car loans then can sell to the government.

But my hunch is that, in relative proportions, the amount of the National Debt held by the Men in Black on Wall Street is negligible. The Men in Black were heavy speculators seeking higher commissions and higher returns that is paid out on our National Debt.

Bankers (Men in Black) bet with their bank's capital, not their own. If the bet goes right, they get a huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital Louria Hahn, "Missing:  How Poor Risk-Management Techniques Contributed to the Subprime Mess," CFO Magazine, March 2008, Page 53 --- http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Jensen Comment
Now that the Government is going to bail out these speculators with taxpayer funds makes it all the worse. I received an email message claiming that i
f you had purchased $1,000 of AIG stock one year ago, you would have $42 left;  with Lehman, you would have $6.60 left; with Fannie or Freddie, you would have less than $5 left. But if you had purchased $1,000 worth of beer one year ago, drank all of the beer, then turned in the cans for the aluminum recycling REFUND, you would have had $214. Based on the above, the best current investment advice is to drink heavily and recycle. It's called the 401-Keg. Why let others gamble your money away when you can piss it away on your own?


Causes of the Bubble

Video
Looking back at the events leading up to the 2008 crisis by Michael Burry
Vanderbilt University Chancellor's Lecture
April 5, 2011
Thank you Jim Mahar for the heads up
http://financeprofessorblog.blogspot.com/2011/04/video-looking-back-at-events-leading-up.html

Jensen Comment
Michael Burry is the physician who anticipated the subprime scandal and made a fortune on short positions.


PwC's Appeal to Upgrade the Shameful Valuation Profession Smitten With Non-independence and Unreliability

Jensen Comment
Tom Selling repeatedly assumes there is a valuation profession of men and women in white robes and gold halos who can be called upon to reliably and independently valuate such things as troubled loan investments having no deep markets. Bob Jensen argues that the valuation profession is one of the least-independent and least-reliable professions in the world, especially in the USA as evidenced in part by the shameful valuations of mortgage collateral on tens of millions of properties, thereby enabling subprime mortgages that never should have been granted in the first place. Furthermore credit rating agencies that value securities participated wildly in overvaluing poisoned CDO bonds that brought down some of the big investment banks of Wall Street like Bear Sterns, Merrill Lynch, and Lehman Bros.

In the article below, PwC calls the valuation profession shameful and calls for major upgrades that, while falling short of issuing white robes with gold halos, would go a long way toward improving a rotten profession.

"PwC Calls for New Approach to Valuations," by Tammy Whitehouse, Compliance Week, November 26, 2013 ---
http://www.complianceweek.com/pwc-calls-for-new-approach-to-valuations/article/322671/

The largely unregulated valuation profession could use a shake-up, in the view of some who rely on valuations to achieve regulatory compliance.

PwC recently published two white papers calling on the valuation profession to up their game in terms of unifying themselves under a single professional framework and improving their standards. The financial reporting world needs greater quality and consistency, the Big 4 firms says, as financial reporting grows increasingly reliant on valuations to help prepare and audit financial statements steeped in fair value measurements. One paper focuses on the need for the valuation profession to unify itself under a single professional infrastructure, while the other addresses the need for better valuation standards.

The message is consistent with one delivered earlier by Paul Beswick, now chief accountant at the Securities and Exchange Commission. “The fragmented nature of the profession creates an environment where expectation gaps can exist between valuators, management, and auditors, as well as standard setters and regulators,” he said at a 2011 accounting conference. The SEC and the Public Company Accounting Oversight Board both have called on preparers and auditors to pay closer attention to the valuations they are relying on and not simply accept them at face value.

“Historically, the valuation profession hasn't been front and center in capital markets,” says John Glynn, U.S. valuation services leader for PwC. “The accounting model didn't have as many pieces measured at fair value as we have today. Some of the questions about the professional infrastructure that didn't matter previously have become more apparent.”

The valuation profession is governed by a number of different professional organizations, PwC says, each with different credentialing and membership requirements and none of them specific to the needs of capital markets. “To maintain its professional standing in an increasingly rigorous environment and promote greater confidence in its work, the valuation profession needs to address questions about the quality, consistency, and reliability of its valuations, particularly those performed for financial reporting purposes,” PwC writes. “A key element to successfully addressing such questions is having a leading global standard setter that issues technical valuation standards governing the performance of valuations for financial reporting purposes.”

The answer is not necessarily a new regulatory channel, says Glynn. “We need to give the valuation profession a way to build a self-regulatory mechanism,” he says. “One or or more of the professional organizations need to agree to build something that is focused on building a high-quality infrastructure to support the valuation professionals that are working in public capital markets, particularly around financial reporting.” That should include education requirements, accreditations, certifications, as well as professional standards and performance standards developed under a robust system of due process, he says. The International Valuations Standards Council is showing potential to become a leader in driving the profession to a unified, global valuation approach, Glynn says.


"Ex-IndyMac Executives Found Liable for Negligent Loans," by Edvard Pettersson, Bloomberg News, December 8, 2012 ---
http://www.bloomberg.com/news/2012-12-08/indymac-executives-found-liable-for-negligent-loans.html

Three former IndyMac Bancorp Inc. executives must pay $169 million in damages to federal regulators for making negligent loans to homebuilders as the real estate market was deteriorating, a jury decided.

The federal court jury in Los Angeles issued the verdict against Scott Van Dellen, the former chief executive officer of IndyMac’s Homebuilder Division; Richard Koon, the unit’s former chief lending officer; and Kenneth Shellem, the former chief credit officer. Jurors yesterday found them liable for negligence and breach of fiduciary duty.

The jury awarded the damages to the Federal Deposit Insurance Corp., which brought the lawsuit in 2010.

The FDIC, which took over the failed subprime mortgage lender in 2008, alleged the men caused $500 million in losses at the homebuilders unit by continuing to push for growth in loan production without regard for credit quality and despite being aware a downturn in the real estate market was imminent.

The agency said the executives made loans to homebuilders that weren’t creditworthy or didn’t provide sufficient collateral.

“Today’s verdict is the result of a deliberate effort by the government to scapegoat a few men for the impact that the unforeseen and unprecedented housing collapse in 2007 had at IndyMac,” Kirby Behre, a lawyer for Shellem and Koon, said in an e-mailed statement after yesterday’s verdict.

“Mr. Shellem and Mr. Koon used the utmost care in making loan decisions, and there is no doubt that all of the loans at issue would have been repaid except for the housing crash,” Behre said.

Robert Corbin, a lawyer for Van Dellen, didn’t immediately return a call to his office yesterday after regular business hours seeking comment on the verdict.

The verdict was reported earlier by the Los Angeles Daily Journal.

The case is FDIC v. Van Dellen, 10-04915, U.S. District Court, Central District of California (Los Angeles).

 

 To read about the sleaze go to
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze


An Excellent Presentation on the Flaws of Finance, Particularly the Flaws of Financial Theorists

A recent topic on the AECM listserv concerns the limitations of accounting standard setters and researchers when it comes to understanding investors. One point that was not raised in the thread to date is that a lot can be learned about investors from the top financial analysts of the world --- their writings and their conferences.

A Plenary Session Speech at a Chartered Financial Analysts Conference
Video: James Montier’s 2012 Chicago CFA Speech The Flaws of Finance ---
http://cfapodcast.smartpros.com/web/live_events/Annual/Montier/index.html
Note that it takes over 15 minutes before James Montier begins

Major Themes

  1. The difference between physics versus finance models is that physicists know the limitations of their models.
     
  2. Another difference is that components (e.g., atoms) of a physics model are not trying to game the system.
     
  3. The more complicated the model in finance the more the analyst is trying to substitute theory for experience.
     
  4. There's a lot wrong with Value at Risk (VaR) models that regulators ignored.
     
  5. The assumption of market efficiency among regulators (such as Alan Greenspan) was a huge mistake that led to excessively low interest rates and bad behavior by banks and credit rating agencies.
     
  6. Auditors succumbed to self-serving biases of favoring their clients over public investors.
     
  7. Banks were making huge gambles on other peoples' money.
     
  8. Investors themselves ignored risk such as poisoned CDO risks when they should've known better. I love his analogy of black swans on a turkey farm.
     
  9. Why don't we see surprises coming (five excellent reasons given here)?
     
  10. The only group of people who view the world realistically are the clinically depressed.
     
  11. Model builders should stop substituting elegance for reality.
     
  12. All financial theorists should be forced to interact with practitioners.
     
  13. Practitioners need to abandon the myth of optimality before the fact.
    Jensen Note
    This also applies to abandoning the myth that we can set optimal accounting standards.
     
  14. In the long term fundamentals matter.
     
  15. Don't get too bogged down in details at the expense of the big picture.
     
  16. Max Plank said science advances one funeral at a time.
     
  17. The speaker then entertains questions from the audience (some are very good).

 

James Montier is a very good speaker from England!

Mr. Montier is a member of GMO’s asset allocation team. Prior to joining GMO in 2009, he was co-head of Global Strategy at Société Générale. Mr. Montier is the author of several books including Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance; Value Investing: Tools and Techniques for Intelligent Investment; and The Little Book of Behavioural Investing. Mr. Montier is a visiting fellow at the University of Durham and a fellow of the Royal Society of Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc. in Economics from Warwick University
http://www.gmo.com/america/about/people/_departments/assetallocation.htm

There's a lot of useful information in this talk for accountics scientists.

Bob Jensen's threads on what went wrong with accountics research are at
http://www.trinity.edu/rjensen/theory01.htm#WhatWentWrong


Darrell Duffie: Big Risks Remain In the Financial System
A Stanford theoretician of financial risk looks at how to fix the "pipes and valves" of modern finance
Stanford Graduate School of Business, May 2013
Click Here
http://www.gsb.stanford.edu/news/headlines/darrell-duffie-big-risks-remain-financial-system?utm_source=Stanford+Business+Re%3AThink&utm_campaign=edfd4f11fb-Stanford_Business_Re_Think_Issue_Thirteen5_17_2013&utm_medium=email&utm_term=0_0b5214e34b-edfd4f11fb-70265733&ct=t%28Stanford_Business_Re_Think_Issue_Thirteen5_17_2013%29

. . .

In March, Duffie and the Squam Lake Group proposed a dramatic new restriction on executive pay at “systemically important” financial institutions. Duffie argues that top bank executives still have lopsided incentives to take excessive risks. The proposal: Force them to defer 20 percent of their pay for five years, and to forfeit that money entirely if the bank’s capital sinks to unspecified but worrisome levels before the five years is up.

“On most issues,” Duffie said, “the banks would be glad to see me go away.”

Jensen Comment
Squam Lake and its 30 islands is in the Lakes Region of New Hampshire --- http://en.wikipedia.org/wiki/Squam_Lake
It is better known as "Golden Pond" after Jane Fonda, her father (Henry) and Katherine Hepburn appeared in the Academy Award winning movie called "On Golden Pond" that was filmed on Squam Lake. Professor Duffie now has some "golden ideas" for finance reforms.


"Woman Who Couldn’t Be Intimidated by Citigroup Wins $31 Million," by Bob Ivry, Bloomberg News, May 31, 2012 ---
file:///C:/Documents and Settings/rjensen/My Documents/My Web Sites/images

Sherry Hunt never expected to be a senior manager at a Wall Street bank. She was a country girl, raised in rural Michigan by a dad who taught her to fish and a mom who showed her how to find wild mushrooms. She listened to Marty Robbins and Buck Owens on the radio and came to believe that God has a bigger plan, that everything happens for a reason.

She got married at 16 and didn’t go to college. After she had her first child at 17, she needed a job. A friend helped her find one in 1975, processing home loans at a small bank in Alaska. Over the next 30 years, Hunt moved up the ladder to mortgage-banking positions in Indiana, Minnesota and Missouri, Bloomberg Markets magazine reports in its July issue.

On her days off, when she wasn’t fishing with her husband, Jonathan, she rode her horse, Cody, in Wild West shows. She sometimes dressed up as the legendary cowgirl Annie Oakley, firing blanks from a vintage rifle to entertain an audience. She liked the mortgage business, liked that she was helping people buy houses.

In November 2004, Hunt, now 55, joined Citigroup (C) Inc. as a vice president in the mortgage unit. It looked like a great career move. The housing market was booming, and the New York- based bank, the sixth-largest lender in the U.S. at the time, was responsible for 3.5 percent of all home loans. Hunt supervised 65 mortgage underwriters at CitiMortgage Inc.’s sprawling headquarters in O’Fallon, Missouri, 45 minutes west of St. Louis.

Avoiding Fraud

Hunt’s team was responsible for protecting Citigroup from fraud and bad investments. She and her colleagues inspected loans Citi wanted to buy from outside brokers and lenders to see whether they met the bank’s standards. The mortgages had to have properly signed paperwork, verifiable borrower income and realistic appraisals.

Citi would vouch for the quality of these loans when it sold them to investors or approved them for government mortgage insurance.

Investor demand was so strong for mortgages packaged into securities that Citigroup couldn’t process them fast enough. The Citi stamp of approval told investors that the bank would stand behind the mortgages if borrowers quit paying.

At the mortgage-processing factory in O’Fallon, Hunt was working on an assembly line that helped inflate a housing bubble whose implosion would shake the world. The O’Fallon mortgage machinery was moving too fast to check every loan, Hunt says.

Phony Appraisals

By 2006, the bank was buying mortgages from outside lenders with doctored tax forms, phony appraisals and missing signatures, she says. It was Hunt’s job to identify these defects, and she did, in regular reports to her bosses.

Executives buried her findings, Hunt says, before, during and after the financial crisis, and even into 2012.

In March 2011, more than two years after Citigroup took $45 billion in bailouts from the U.S. government and billions more from the Federal Reserve -- more in total than any other U.S. bank -- Jeffery Polkinghorne, an O’Fallon executive in charge of loan quality, asked Hunt and a colleague to stay in a conference room after a meeting.

The encounter with Polkinghorne was brief and tense, Hunt says. The number of loans classified as defective would have to fall, he told them, or it would be “your asses on the line.”

Hunt says it was clear what Polkinghorne was asking -- and she wanted no part of it.

‘I Wouldn’t Play Along’

“All a dishonest person had to do was change the reports to make things look better than they were,” Hunt says. “I wouldn’t play along.”

Instead, she took her employer to court -- and won. In August 2011, five months after the meeting with Polkinghorne, Hunt sued Citigroup in Manhattan federal court, accusing its home-loan division of systematically violating U.S. mortgage regulations.

The U.S. Justice Department decided to join her suit in January. Citigroup didn’t dispute any of Hunt’s facts; it didn’t mount a defense in public or in court. On Feb. 15, 2012, the bank agreed to pay $158.3 million to the U.S. government to settle the case.

Citigroup admitted approving loans for government insurance that didn’t qualify under Federal Housing Administration rules. Prosecutors kept open the possibility of bringing criminal charges, without specifying targets.

‘Pure Myth’

Citigroup behaving badly as late as 2012 shows how a big bank hasn’t yet absorbed the lessons of the credit crisis despite billions of dollars in bailouts, says Neil Barofsky, former special inspector general of the Troubled Asset Relief Program.

“This case demonstrates that the notion that the bailed-out banks have somehow found God and have reformed their ways in the aftermath of the financial crisis is pure myth,” he says.

As a reward for blowing the whistle on her employer, Hunt, the country girl turned banker, got $31 million out of the settlement paid by Citigroup.

Hunt still remembers her first impressions of CitiMortgage’s O’Fallon headquarters, a complex of three concrete-and-glass buildings surrounded by manicured lawns and vast parking lots. Inside are endless rows of cubicles where 3,800 employees trade e-mails and conduct conference calls. Hunt says at first she felt like a mouse in a maze.

“You only see people’s faces when someone brings in doughnuts and the smell gets them peeking over the tops of their cubicles,” she says.

Jean Charities

Over time, she came to appreciate the camaraderie. Every month, workers conducted the so-called Jean Charities. Employees contributed $20 for the privilege of wearing jeans every day, with the money going to local nonprofit organizations. With so many workers, it added up to $25,000 a month.

“Citi is full of wonderful people, conscientious people,” Hunt says.

Those people worked on different teams to process mortgages, all of them focused on keeping home loans moving through the system. One team bought loans from brokers and other lenders. Another team, called underwriters, made sure loan paperwork was complete and the mortgages met the bank’s and the government’s guidelines.

Yet another group did spot-checks on loans already purchased. It was such a high-volume business that one group’s assignment was simply to keep loans moving on the assembly line.

Powerful Incentive

Still another unit sold loans to Fannie Mae, Freddie Mac and Ginnie Mae, the government-controlled companies that bundled them into securities for sale to investors. Those were the types of securities that blew up in 2007, igniting a global financial crisis.

Workers had a powerful incentive to push mortgages through the process even if flaws were found: compensation. The pay of CitiMortgage employees all the way up to the division’s chief executive officer depended on a high percentage of approved loans, the government’s complaint says.

By 2006, Hunt’s team was processing $50 billion in loans that Citi-Mortgage bought from hundreds of mortgage companies. Because her unit couldn’t possibly review them all, they checked a sample.

When a mortgage wasn’t up to federal standards -- which could be any error ranging from an unsigned document to a false income statement or a hyped-up appraisal -- her team labeled the loan as defective.

Missing Documentation

In late 2007, Hunt’s group estimated that about 60 percent of the mortgages Citigroup was buying and selling were missing some form of documentation. Hunt says she took her concerns to her boss, Richard Bowen III.

Bowen, 64, is a religious man, a former Air Force Reserve Officer Training Corps cadet at Texas Tech University in Lubbock with an attention to detail that befits his background as a certified public accountant. When he saw the magnitude of the mortgage defects, Bowen says he prayed for guidance.

In a Nov. 3, 2007, e-mail, he alerted Citigroup executives, including Robert Rubin, then chairman of Citigroup’s executive committee and a former Treasury secretary; Chief Financial Officer Gary Crittenden; the bank’s senior risk officer; and its chief auditor.

Bowen put the words “URGENT -- READ IMMEDIATELY -- FINANCIAL ISSUES” in the subject line.

“The reason for this urgent e-mail concerns breakdowns of internal controls and resulting significant but possibly unrecognized financial losses existing within our organization,” Bowen wrote. “We continue to be significantly out of compliance.”

No Change

There were no noticeable changes in the mortgage machinery as a result of Bowen’s warning, Hunt says.

Just a week after Bowen sent his e-mail, Sherry and Jonathan were driving their Toyota Camry about 55 miles (89 kilometers) per hour on four-lane Providence Road in Columbia, Missouri, when a driver in a Honda Civic hit them head-on. Sherry broke a foot and her sternum. Jonathan broke an arm and his sternum.

Doctors used four bones harvested from a cadaver and titanium screws to stabilize his neck.

“You come out of an experience like that with a commitment to making the most of the time you have and making the world a better place,” Sherry says.

Three months after the accident, attorneys from Paul, Weiss, Rifkind, Wharton & Garrison LLP, a New York law firm representing Citigroup, interviewed Hunt. She had no idea at the time that it was related to Bowen’s complaint, she says.

Home Computer

The lawyers’ questions made her search her memory for details of loans and conversations with colleagues, she says. She decided to take notes from that time forward on a spreadsheet she kept on her home computer.

Bowen’s e-mail is now part of the archive of the Financial Crisis Inquiry Commission, a panel created by Congress in 2009. Citigroup’s response to the commission, FCIC records show, came from Brad Karp, chairman of Paul Weiss.

He said Citigroup had reviewed Bowen’s issues, fired a supervisor and changed its underwriting system, without providing specifics.

Continued in article

A CBS Sixty Minutes Blockbuster (December 4, 2011)
"Prosecuting Wall Street"
Free download for a short while
http://www.cbsnews.com/8301-18560_162-57336042/prosecuting-wall-street/?tag=pop;stories
Note that this episode features my hero Frank Partnoy

Sarbanes–Oxley Act (Sarbox, SOX) ---
http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act

 Key provisions of Sarbox with respect to the Sixty Minutes revelations:

The act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure.

Sarbanes–Oxley Section 404: Assessment of internal control ---
http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Sarbanes.E2.80.93Oxley_Section_404:_Assessment_of_internal_control

Both the corporate CEO and the external auditing firm are to explicitly sign off on the following and are subject (turns out to be a ha, ha joke)  to huge fines and jail time for egregious failure to do so:

  • Assess both the design and operating effectiveness of selected internal controls related to significant accounts and relevant assertions, in the context of material misstatement risks;
  • Understand the flow of transactions, including IT aspects, in sufficient detail to identify points at which a misstatement could arise;
  • Evaluate company-level (entity-level) controls, which correspond to the components of the COSO framework;
  • Perform a fraud risk assessment;
  • Evaluate controls designed to prevent or detect fraud, including management override of controls;
  • Evaluate controls over the period-end financial reporting process;
  • Scale the assessment based on the size and complexity of the company;
  • Rely on management's work based on factors such as competency, objectivity, and risk;
  • Conclude on the adequacy of internal control over financial reporting.

Most importantly as far as the CPA auditing firms are concerned is that Sarbox gave those firms both a responsibility to verify that internal controls were effective and the authority to charge more (possibly twice as much) for each audit. Whereas in the 1990s auditing was becoming less and less profitable, Sarbox made the auditing industry quite prosperous after 2002.

There's a great gap between the theory of Sarbox and its enforcement

In theory, the U.S. Justice Department (including the FBI) is to enforce the provisions of Section 404 and subject top corporate executives and audit firm partners to huge fines (personal fines beyond corporate fines) and jail time for signing off on Section 404 provisions that they know to be false. But to date, there has not been one indictment in enormous frauds where the Justice Department knows that executives signed off on Section 404 with intentional lies.

In theory the SEC is to also enforce Section 404, but the SEC in Frank Partnoy's words is toothless. The SEC cannot send anybody to jail. And the SEC has established what seems to be a policy of fining white collar criminals less than 20% of the haul, thereby making white collar crime profitable even if you get caught. Thus, white collar criminals willingly pay their SEC fines and ride off into the sunset with a life of luxury awaiting.

And thus we come to the December 4 Sixty Minutes module that features two of the most egregious failures to enforce Section 404:
The astonishing case of CitiBank
The astonishing case of Countrywide (now part of Bank of America)

The Astonishing Case of CitiBank
What makes the Sixty Minutes show most interesting are the whistle blowing  revelations by a former Citi Vice President in Charge of Fraud Investigations

The astonishing case of Countrywide (now part of Bank of America)

I was disappointed in the CBS Sixty Minutes show in that it completely ignored the complicity of the auditing firms to sign off on the Section 404 violations of the big Wall Street banks and other huge banks that failed. Washington Mutual was the largest bank in the world to ever go bankrupt. Its auditor, Deloitte, settled with the SEC for Washington Mutual for $18.5 million. This isn't even a hand slap relative to the billions lost by WaMu's investors and creditors.

 No jail time is expected for any partners of the negligent auditing firms. .KPMG settled for peanuts with Countrywide for $24 million of negligence and New Century for $45 million of negligence costing investors billions.

"Citigroup Finds Obeying the Law Is Too Darn Hard: Jonathan Weil," by Jonothan Weil, Bloomberg News, November 2 , 2011 ---
http://www.bloomberg.com/news/2011-11-02/citigroup-finds-obeying-the-law-is-too-darn-hard-jonathan-weil.html
 

Bob Jensen's Rotten to the Core threads ---
http://www.trinity.edu/rjensen/FraudRotten.htm

Bob Jensen's threads on how white collar crime pays even if you get caught ---
http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

"Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank Partnoy, New York Review of Books, November 10, 2011 ---
http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
Thank you Robert Walker for the heads up!


"Wall Street's Gullible Occupiers The protesters have been sold a bill of goods. Reckless government policies, not private greed, brought about the housing bubble and resulting financial crisis," by Peter J. Wallison, The Wall Street Journal, October 12, 2011 ---
http://online.wsj.com/article/SB10001424052970203633104576623083437396142.html?mod=djemEditorialPage_t

There is no mystery where the Occupy Wall Street movement came from: It is an offspring of the same false narrative about the causes of the financial crisis that exculpated the government and brought us the Dodd-Frank Act. According to this story, the financial crisis and ensuing deep recession was caused by a reckless private sector driven by greed and insufficiently regulated. It is no wonder that people who hear this tale repeated endlessly in the media turn on Wall Street to express their frustration with the current conditions in the economy.

Their anger should be directed at those who developed and supported the federal government's housing policies that were responsible for the financial crisis.

Beginning in 1992, the government required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities. The original legislative quota was 30%. But the Department of Housing and Urban Development was given authority to adjust it, and through the Bill Clinton and George W. Bush administrations HUD raised the quota to 50% by 2000 and 55% by 2007.

It is certainly possible to find prime borrowers among people with incomes below the median. But when more than half of the mortgages Fannie and Freddie were required to buy were required to have that characteristic, these two government-sponsored enterprises had to significantly reduce their underwriting standards.

Fannie and Freddie were not the only government-backed or government-controlled organizations that were enlisted in this process. The Federal Housing Administration was competing with Fannie and Freddie for the same mortgages. And thanks to rules adopted in 1995 under the Community Reinvestment Act, regulated banks as well as savings and loan associations had to make a certain number of loans to borrowers who were at or below 80% of the median income in the areas they served.

Research by Edward Pinto, a former chief credit officer of Fannie Mae (now a colleague of mine at the American Enterprise Institute) has shown that 27 million loans—half of all mortgages in the U.S.—were subprime or otherwise weak by 2008. That is, the loans were made to borrowers with blemished credit, or were loans with no or low down payments, no documentation, or required only interest payments.

Of these, over 70% were held or guaranteed by Fannie and Freddie or some other government agency or government-regulated institution. Thus it is clear where the demand for these deficient mortgages came from.

The huge government investment in subprime mortgages achieved its purpose. Home ownership in the U.S. increased to 69% from 65% (where it had been for 30 years). But it also led to the biggest housing bubble in American history. This bubble, which lasted from 1997 to 2007, also created a huge private market for mortgage-backed securities (MBS) based on pools of subprime loans.

As housing bubbles grow, rising prices suppress delinquencies and defaults. People who could not meet their mortgage obligations could refinance or sell, because their houses were now worth more.

Accordingly, by the mid-2000s, investors had begun to notice that securities based on subprime mortgages were producing the high yields, but not showing the large number of defaults, that are usually associated with subprime loans. This triggered strong investor demand for these securities, causing the growth of the first significant private market for MBS based on subprime and other risky mortgages.

By 2008, Mr. Pinto has shown, this market consisted of about 7.8 million subprime loans, somewhat less than one-third of the 27 million that were then outstanding. The private financial sector must certainly share some blame for the financial crisis, but it cannot fairly be accused of causing that crisis when only a small minority of subprime and other risky mortgages outstanding in 2008 were the result of that private activity.

When the bubble deflated in 2007, an unprecedented number of weak mortgages went into default, driving down housing prices throughout the U.S. and throwing Fannie and Freddie into insolvency. Seeing these sudden losses, investors fled from the market for privately issued MBS, and mark-to-market accounting required banks and others to write down the value of their mortgage-backed assets to the distress levels in a market that now had few buyers. This raised questions about the solvency and liquidity of the largest financial institutions and began a period of great investor anxiety.

The government's rescue of Bear Stearns in March 2008 temporarily calmed the market. But it created significant moral hazard: Market participants were led to believe that the government would rescue all large financial institutions. When Lehman Brothers was allowed to fail in September, investors panicked. They withdrew their funds from the institutions that held large amounts of privately issued MBS, causing banks and others—such as investment banks, finance companies and insurers—to hoard cash against the risk of further withdrawals. Their refusal to lend to one another in these conditions froze credit markets, bringing on what we now call the financial crisis.

Continued in article

 


"Weekly Book List, June 13, 2011," Chronicle of Higher Education, June 12, 2011 ---
http://chronicle.com/article/Weekly-Book-List-June-13/127897/?sid=cr&utm_source=cr&utm_medium=en

Economics
Corporate Governance Failures: The Role of Institutional Investors in the Global Financial Crisis edited by James P. Hawley, Shyam J. Kamath, and Andrew T. Williams (University of Pennsylvania Press; 344 pages; $69.95). Writings on such topics as the limits of corporate governance in dealing with asset bubbles.

From Financial Crisis to Global Recovery by Padma Desai (Columbia University Press; 254 pages; $27.50). Considers the origins of the contemporary crisis and the prospects for recovery; includes comparative discussion of the Great Depression.

Bob Jensen's threads on the economic crisis ---
http://www.trinity.edu/rjensen/2008Bailout.htm


"What Caused the Bubble? Mission accomplished: Phil Angelides succeeds in not upsetting the politicians," by Holman W, Jenkins, Jr., The Wall Street Journal, January 29. 2011 ---
http://online.wsj.com/article/SB10001424052748704268104576108000415603970.html#mod=djemEditorialPage_t

The 2008 financial crisis happened because no one prevented it. Those who might have stopped it didn't. They are to blame.

Greedy bankers, incompetent managers and inattentive regulators created the greatest financial breakdown in nearly a century. Doesn't that make you feel better? After all, how likely is it that some human beings will be greedy at exactly the same time others are incompetent and still others are inattentive?

Oh wait.

You could almost defend the Financial Crisis Inquiry Commission's (FCIC) new report if the question had been who, in hindsight, might have prevented the crisis. Alas, the answer is always going to be the Fed, which has the power to stop just about any macro trend in the financial markets if it really wants to. But the commission was asked to explain why the bubble happened. In that sense, its report doesn't seem even to know what a proper answer might look like, as if presented with the question "What is 2 + 2?" and responding "Toledo" or "feral cat."

The dissenters at least propose answers that might be answers. Peter Wallison focuses on U.S. housing policy, a diagnosis that has the advantage of being actionable.

The other dissent, by Keith Hennessey, Bill Thomas and Douglas Holtz-Eakin, sees 10 causal factors, but emphasizes the pan-global nature of the housing bubble, which it attributes to ungovernable global capital flows.

That is also true, but less actionable.

Let's try our hand at an answer that, like Mr. Wallison's, attempts to be useful.

The Fed will make errors. International capital flows will sometimes be disruptive. Speculators will be attracted to hot markets. Bubbles will be a feature of financial life: Building a bunch of new houses is not necessarily a bad idea; only when too many others do the same does it become a bad idea. On that point, not the least of the commission's failings was its persistent mistaking of effects for causes, such as when banks finally began treating their mortgage portfolios as hot potatoes to be got rid of.

If all that can't be changed, what can? How about the incentives that invited various parties to shovel capital into housing without worrying about the consequences?

The central banks of China, Russia and various Asian and Arab nations knew nothing about U.S. housing. They poured hundreds of billions into it only because Fannie and Freddie were perceived as federally guaranteed and paid a slightly higher yield than U.S. Treasury bonds. (And one of the first U.S. actions in the crisis was to assure China it wouldn't lose money.)

Borrowers in most states are allowed to walk away from their mortgages, surrendering only their downpayments (if any) while dumping their soured housing bets on a bank. Change that even slightly and mortgage brokers and home builders would find it a lot harder to coax people into more house than they can afford.

Mortgage middlemen who don't have "skin in the game" and feckless rating agencies have also been routine targets of blame. But both are basically ticket punchers for large institutions that should have and would have been assessing their own risk, except that their own creditors, including depositors, judged them "too big to fail," creating a milieu where they could prosper without being either transparent or cautious. We haven't even tried to fix this, say by requiring banks to take on a class of debtholder who would agree to be converted to equity in a bailout. Then there'd be at least one sophisticated marketplace demanding assurance that a bank is being run in a safe and sound manner. (Sadly, the commission's report only reinforces the notion that regulators are responsible for keeping your money safe, not you.)

The FCIC Chairman Phil Angelides is not stupid, but he is a politician. His report contains tidbits that will be useful to historians and economists. But it's also a report that "explains" poorly. His highly calculated sound bite, peddled from one interview to the next, that the crisis was "avoidable" is worthless, a nonrevelation. Everything that happens could be said to happen because somebody didn't prevent it. So what? Saying so is saying nothing.

Mr. Angelides has gone around trying to convince audiences that the commission's finding was hard hitting. It wasn't. It was soft hitting. More than any other goal, it strives mainly to say nothing that would actually be inconvenient to Barack Obama, Harry Reid, Barney Frank or even most Republicans in Congress. In that, it succeeded.

"The Mortgage Crisis: Some Inside Views Emails show that risk managers at Freddie Mac warned about lower underwriting standards—in vain, and with lessons for today," by Charles W. Calomiris, The Wall Street Journal, October 28, 2011 ---
http://online.wsj.com/article/SB10001424053111903927204576574433454435452.html?mod=djemEditorialPage_t

Occupy Wall Street is denouncing banks and Wall Street for "selling toxic mortgages" while "screwing investors and homeowners." And the federal government recently announced it will be suing mortgage originators whose low-quality underwriting standards produced ballooning losses for Fannie Mae and Freddie Mac.

Have they fingered the right culprits?

There is no doubt that reductions in mortgage-underwriting standards were at the heart of the subprime crisis, and Fannie and Freddie's losses reflect those declining standards. Yet the decline in underwriting standards was largely a response to mandates, beginning in the Clinton administration, that required Fannie Mae and Freddie Mac to steadily increase their mortgages or mortgage-backed securities that targeted low-income or minority borrowers and "underserved" locations.

The turning point was the spring and summer of 2004. Fannie and Freddie had kept their exposures low to loans made with little or no documentation (no-doc and low-doc loans), owing to their internal risk-management guidelines that limited such lending. In early 2004, however, senior management realized that the only way to meet the political mandates was to massively cut underwriting standards.

The risk managers complained, especially at Freddie Mac, as their emails to senior management show. They refused to endorse the move to no-docs and battled unsuccessfully against the reduced underwriting standards from April to September 2004. Here are some highlights:

On April 1, 2004, Freddie Mac risk manager David Andrukonis wrote to Tracy Mooney, a vice president, that "while you, Don [Bisenius, a senior vice president] and I will make the case for sound credit, it's not the theme coming from the top of the company and inevitably people down the line play follow the leader."

Risk managers had already experimented with lower lending standards and knew the dangers. In another email that day, Mr. Bisenius wrote to Michael May (another senior vice president), "we did no-doc lending before, took inordinate losses and generated significant fraud cases. I'm not sure what makes us think we're so much smarter this time around."

On April 5, Mr. Andrukonis wrote to Chief Operating Officer Paul Peterson, "In 1990 we called this product 'dangerous' and eliminated it from the marketplace." He also argued that housing prices were already high and unlikely to rise further: "We are less likely to get the house price appreciation we've had in the past 10 years to bail this program out if there's a hole in it."

Donna Cogswell, a colleague of Mr. Andrukonis, warned that Fannie and Freddie's decisions to debase underwriting standards would have widespread ramifications for the mortgage market. In a Sept. 7 email to Freddie Mac CEO Dick Syron and others, she specifically described the ramifications of Freddie Mac's continuing participation in the market as effectively "mak[ing] a market" in no-doc mortgages.

Ms. Cogswell's Sept. 4 email to Mr. Syron and others also anticipated the potential human costs of the mortgage crisis. She tried to sway management by appealing to their decency: "[W]hat better way to highlight our sense of mission than to walk away from profitable business because it hurts the borrowers we are trying to serve?"

Politics—not shortsightedness or incompetent risk managers—drove Freddie Mac to eliminate its previous limits on no-doc lending. Commenting on what others referred to as the "push to do more affordable [lending] business," Senior Vice President Robert Tsien wrote to Dick Syron on July 14, 2004: "Tipping the scale in favor of no cap [on no-doc lending] at this time was the pragmatic consideration that, under the current circumstances, a cap would be interpreted by external critics as additional proof we are not really committed to affordable lending."

Sensing that his warnings were being ignored, Mr. Andrukonis wrote to Michael May on Sept. 8: "At last week's risk management meeting I mentioned that I had reached my own conclusion on this product from a reputation risk perspective. I said that I thought you and or Bob Tsien had the responsibility to bring the business recommendation to Dick [Syron], who was going to make the decision. . . . What I want Dick to know is that he can approve of us doing these loans, but it will be against my recommendation."

The decision by Fannie and Freddie to embrace no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for example, total subprime and Alt-A mortgage originations were $395 billion. In 2004, they rose to $715 billion. By 2006, they were more than $1 trillion.

In a painstaking forensic analysis of the sources of increased mortgage risk during the 2000s, "The Failure of Models that Predict Failure," Uday Rajan of the University of Michigan, Amit Seru of the University of Chicago and Vikrant Vig of London Business School show that more than half of the mortgage losses that occurred in excess of the rosy forecasts of expected loss at the time of mortgage origination reflected the predictable consequences of low-doc and no-doc lending. In other words, if the mortgage-underwriting standards at Fannie and Freddie circa 2003 had remained in place, nothing like the magnitude of the subprime crisis would have occurred.

Taxpayer losses at Fannie and Freddie alone may exceed $300 billion. The costs of the financial collapse and recession brought on by the mortgage bust are immeasurably higher. Unfortunately, the Obama administration has perpetuated the low underwriting standards that gave us the crisis and encouraged the postponement of foreclosures by lending support to various states' efforts to sue originators for robo-signing violations.

Continued in article

 

Jensen Comment
And then the subprime crisis was followed by the biggest swindle in the history of the world ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

At this point time in 2011 there's only marginal benefit in identifying all the groups like credit agencies and CPA audit firms that violated professionalism leading up to the subprime crisis. The credit agencies, auditors, Wall Street investment banks, Fannie Mae, and Freddie Mack were all just hogs feeding on the trough of bad and good loans originating on Main Streets of every town in the United States.

If the Folks on Main Street that Approved the Mortgage Loans in the First Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon by the Hogs With Their Noses in the Trough Up to and Including Wall Street and Fannie and Freddie.

If the Folks on Main Street that Approved the Mortgage Loans in the First Stage Had to Bear the Bad Debt Risks All Would've Been Avoided
The most interesting question in my mind is what might've prevented the poison (uncollectability) in the real estate loans from being concocted in the first place. What might've prevented it was for those that approved the loans (Main Street banks and mortgage companies in towns throughout the United States) to have to bear all or a big share of the losses when borrowers they approved defaulted.

Instead those lenders that approved the loans easily passed those loans up the system without any responsibility for their reckless approval of the loans in the first place. It's easy to blame Barney Frank for making it easier for poor people to borrow more than they could ever repay. But the fact of the matter is that the original lenders like Countrywide were approving subprime mortgages to high income people that also could not afford their payments once the higher prime rates kicked in under terms of the subprime contracts. If lenders like Countrywide had to bear a major share of the bad debt losses the lenders themselves would've been more responsible about only approving mortgages that had a high probability of not going into default. Instead Countrywide and the other Main Street lenders got off scott free until the real estate bubble finally burst.

And why would a high income couple refinance a fixed rate mortgage with a risky subprime mortgage that they could not afford when the higher rates kicked in down the road? The answer is that the hot real estate market before the crash made that couple greedy. They believed that if they took out a subprime loan with a very low rate of interest temporarily that they could turn over their home for a relatively huge profit and then upgrade to a much nicer mansion on the hill from the profits earned prior to when the subprime rates kicked into higher rates.

When the real estate bubble burst this couple got left holding the bag and received foreclosure notices on the homes that they had gambled away. And the Wall Street investment banks, Fannie, and Freddie got stuck with all the poison that the Main Street banks and mortgage companies had recklessly approved without any risk of recourse for their recklessness.

If the Folks on Main Street that Approved the Mortgage Loans in the First Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon by the Hogs With Their Noses in the Trough Up to and Including Wall Street and Fannie and Freddie.

Bob Jensen's threads on this entire mess are at
http://www.trinity.edu/rjensen/2008Bailout.htm


Inside Job: 2010 Oscar-Winning Documentary Now Online --- Click Here
http://www.openculture.com/2011/04/inside_job.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+OpenCulture+%28Open+Culture%29

In late February, Charles Ferguson’s film – Inside Job – won the Academy Award for Best Documentary. And now the film documenting the causes of the 2008 global financial meltdown has made its way online (thanks to the Internet Archive). A corrupt financial industry, its corrosive relationship with politicians, academics and regulators, and the trillions of damage done, it all gets documented in this film that runs a little shy of 2 hours.

To watch the film, you will need to do the following. 1.) Look at the bottom of the film. 2.) Click the forward button twice so that it moves beyond the initial trailer and the Academy Awards ceremony. 3.) Wait for the little circle to stop spinning. And 4.) click play to watch film.

Inside Job (now listed in our Free Movie Collection) can be purchased on DVD at Amazon. We all love free, but let’s remember that good projects cost real money to develop, and they could use real financial support. So please consider buying a copy.

Hopefully watching or buying this film won’t be a pointless act, even though it can rightly feel that way. As Charles Ferguson reminded us during his Oscar acceptance speech, we are three years beyond the Wall Street crisis and taxpayers (you) got fleeced for billions. But still not one Wall Street exec is facing criminal charges. Welcome to your plutocracy…

Bob Jensen's threads on the global financial meltdown and its aftershocks are at
http://www.trinity.edu/rjensen/2008Bailout.htm


"Washington’s Financial Disaster," by Frank Partnoy, The New York Times, January 29, 2011 ---
http://www.nytimes.com/2011/01/30/opinion/30partnoy.html?_r=1&nl=todaysheadlines&emc=tha212

THE long-awaited Financial Crisis Inquiry Commission report, finally published on Thursday, was supposed to be the economic equivalent of the 9/11 commission report. But instead of a lucid narrative explaining what happened when the economy imploded in 2008, why, and who was to blame, the report is a confusing and contradictory mess, part rehash, part mishmash, as impenetrable as the collateralized debt obligations at the core of the crisis.

The main reason so much time, money and ink were wasted — politics — is apparent just from eyeballing the report, or really the three reports. There is a 410-page volume signed by the commission’s six Democrats, a leaner 10-pronged dissent from three of the four Republicans, and a nearly 100-page dissent-from-the-dissent filed by Peter J. Wallison, a fellow at the American Enterprise Institute. The primary volume contains familiar vignettes on topics like deregulation, excess pay and poor risk management, and is infused with populist rhetoric and an anti-Wall Street tone. The dissent, which explores such root causes as the housing bubble and excess debt, is less lively. And then there is Mr. Wallison’s screed against the government’s subsidizing of mortgage loans.

These documents resemble not an investigative trilogy but a left-leaning essay collection, a right-leaning PowerPoint presentation and a colorful far-right magazine. And the confusion only continued during a press conference on Thursday in which the commissioners had little to show and nothing to tell. There was certainly no Richard Feynman dipping an O ring in ice water to show how the space shuttle Challenger went down.

That we ended up with a political split is not entirely surprising, given the structure and composition of the commission. Congress shackled it by requiring bipartisan approval for subpoenas, yet also appointed strongly partisan figures. It was only a matter of time before the group fractured. When Republicans proposed removing the term “Wall Street” from the report, saying it was too pejorative and imprecise, the peace ended. And the public is still without a full factual account.

For example, most experts say credit ratings and derivatives were central to the crisis. Yet on these issues, the reports are like three blind men feeling different parts of an elephant. The Democrats focused on the credit rating agencies’ conflicts of interest; the Republicans blamed investors for not looking beyond ratings. The Democrats stressed the dangers of deregulated shadow markets; the Republicans blamed contagion, the risk that the failure of one derivatives counterparty could cause the other banks to topple. Mr. Wallison played down both topics. None of these ideas is new. All are incomplete.

Another problem was the commission’s sprawling, ambiguous mission. Congress required that it study 22 topics, but appropriated just $8 million for the job. The pressure to cover this wide turf was intense and led to infighting and resignations. The 19 hearings themselves were unfocused, more theater than investigation.

In the end, the commission was the opposite of Ferdinand Pecora’s famous Congressional investigation in 1933. Pecora’s 10-day inquisition of banking leaders was supposed to be this commission’s exemplar. But Pecora, a former assistant district attorney from New York, was backed by new evidence of widespread fraud and insider dealings, shocking documents that the public had never seen or imagined. His fierce cross-examination of Charles E. Mitchell, the head of National City Bank, Citigroup’s predecessor, put a face on the crisis.

This commission’s investigation was spiritless and sometimes plain wrong. Richard Fuld, the former head of Lehman Brothers, was thrown softballs, like “Can you talk a bit about the risk management practices at Lehman Brothers, and why you didn’t see this coming?” Other bankers were scolded, as when Phil Angelides, the commission’s chairman, admonished Lloyd Blankfein, the chief executive of Goldman Sachs, for practices akin to “selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars.” But he couldn’t back up this rebuke with new evidence.

The report then oversteps the facts in its demonization of Goldman, claiming that Goldman “retained” $2.9 billion of the A.I.G. bailout money as “proprietary trades.” Few dispute that Goldman, on behalf of its clients, took both sides of trades and benefited from the A.I.G. bailout. But a Goldman spokesman told me that the report’s assertion was false and that these trades were neither proprietary nor a windfall. The commission’s staff apparently didn’t consider Goldman’s losing trades with other clients, because they were focused only on deals with A.I.G. If they wanted to tar Mr. Blankfein, they should have gotten their facts right.

Lawmakers would have been wiser to listen to Senator Richard Shelby of Alabama, who in early 2009 proposed a bipartisan investigation by the banking committee. That way seasoned prosecutors could have issued subpoenas, cross-examined witnesses and developed cases. Instead, a few months later, Congress opted for this commission, the last act of which was to coyly recommend a few cases to prosecutors, who already have been accumulating evidence the commissioners have never seen.

There is still hope. Few people remember that the early investigations of the 1929 crash also failed due to political battles and ambiguous missions. Ferdinand Pecora was Congress’s fourth chief counsel, not its first, and he did not complete his work until five years after the crisis. Congress should try again.

Frank Partnoy is a law professor at the University of San Diego and the author of “The Match King: Ivar Kreuger, the Financial Genius Behind a Century of Wall Street Scandals.”

Jensen Comment
Professor Partnoy is one of my all-time fraud fighting heroes. He was at one time an insider in marketing Wall Street financial instrument derivatives products and, while he was one of the bad guys, became conscience-stricken about how the bad guys work. Although his many books are somewhat repetitive, his books are among the best in exposing how the Wall Street investment banks are rotten to the core.

Frank Partnoy has been a a strong advocate of regulation of the derivatives markets even before Enron's energy trading scams came to light. His testimony before the U.S. Senate about Enron's infamous Footnote 16 ---
http://www.trinity.edu/rjensen/FraudEnron.htm#Senator

I quote Professor Partnoy's books frequently in my Timeline of Derivative Financial Instruments Frauds ---
http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

 


Every now and then the so-called "quants" in economics and finance make enormous mistakes. Probably the best known mistake, before the trillion-dollar CDO mistakes that came to light the collapse of the real estate market in 2007, was the "Trillion Dollar Bet" made by two Nobel Prize winning quants and their partners in Long-Term Capital Management (LTCM) that came within a hair of destroying most big banks and investment firms on Wall Street ---
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

Whenever I get news of increased power of quants on Wall Street, I think back to "The Trillion Dollar Bet" (Nova on PBS Video) a bond trader, two Nobel Laureates, and their doctoral students who very nearly brought down all of Wall Street and the U.S. banking system in the crash of a hedge fund known as Long Term Capital Management where the biggest and most prestigious firms lost an unimaginable amount of money --- http://en.wikipedia.org/wiki/LTCM

The Trillion Dollar Bet transcripts are free --- http://www.pbs.org/wgbh/nova/transcripts/2704stockmarket.html
However, you really have to watch the graphics in the video to appreciate this educational video --- http://www.pbs.org/wgbh/nova/stockmarket/

Warnings from a Theoretical Physicist With an Interest in Economics and Finance
"Beware of Economists (and accoutnics scientists) Peddling Elegant Models," by Mark Buchanan, Bloomberg, April 7, 2013 ---
http://www.bloomberg.com/news/2013-04-07/beware-of-economists-peddling-elegant-models.html 

. . .

In one very practical and consequential area, though, the allure of elegance has exercised a perverse and lasting influence. For several decades, economists have sought to express the way millions of people and companies interact in a handful of pretty equations.

The resulting mathematical structures, known as dynamic stochastic general equilibrium models, seek to reflect our messy reality without making too much actual contact with it. They assume that economic trends emerge from the decisions of only a few “representative” agents -- one for households, one for firms, and so on. The agents are supposed to plan and act in a rational way, considering the probabilities of all possible futures and responding in an optimal way to unexpected shocks.

Surreal Models

Surreal as such models might seem, they have played a significant role in informing policy at the world’s largest central banks. Unfortunately, they don’t work very well, and they proved spectacularly incapable of accommodating the way markets and the economy acted before, during and after the recent crisis.

Now, some economists are beginning to pursue a rather obvious, but uglier, alternative. Recognizing that an economy consists of the actions of millions of individuals and firms thinking, planning and perceiving things differently, they are trying to model all this messy behavior in considerable detail. Known as agent-based computational economics, the approach is showing promise.

Take, for example, a 2012 (and still somewhat preliminary) study by a group of economists, social scientists, mathematicians and physicists examining the causes of the housing boom and subsequent collapse from 2000 to 2006. Starting with data for the Washington D.C. area, the study’s authors built up a computational model mimicking the behavior of more than two million potential homeowners over more than a decade. The model included detail on each individual at the level of race, income, wealth, age and marital status, and on how these characteristics correlate with home buying behavior.

Led by further empirical data, the model makes some simple, yet plausible, assumptions about the way people behave. For example, homebuyers try to spend about a third of their annual income on housing, and treat any expected house-price appreciation as income. Within those constraints, they borrow as much money as lenders’ credit standards allow, and bid on the highest-value houses they can. Sellers put their houses on the market at about 10 percent above fair market value, and reduce the price gradually until they find a buyer.

The model captures things that dynamic stochastic general equilibrium models do not, such as how rising prices and the possibility of refinancing entice some people to speculate, buying more-expensive houses than they otherwise would. The model accurately fits data on the housing market over the period from 1997 to 2010 (not surprisingly, as it was designed to do so). More interesting, it can be used to probe the deeper causes of what happened.

Consider, for example, the assertion of some prominent economists, such as Stanford University’s John Taylor, that the low-interest-rate policies of the Federal Reserve were to blame for the housing bubble. Some dynamic stochastic general equilibrium models can be used to support this view. The agent- based model, however, suggests that interest rates weren’t the primary driver: If you keep rates at higher levels, the boom and bust do become smaller, but only marginally.

Leverage Boom

A much more important driver might have been leverage -- that is, the amount of money a homebuyer could borrow for a given down payment. In the heady days of the housing boom, people were able to borrow as much as 100 percent of the value of a house -- a form of easy credit that had a big effect on housing demand. In the model, freezing leverage at historically normal levels completely eliminates both the housing boom and the subsequent bust.

Does this mean leverage was the culprit behind the subprime debacle and the related global financial crisis? Not necessarily. The model is only a start and might turn out to be wrong in important ways. That said, it makes the most convincing case to date (see my blog for more detail), and it seems likely that any stronger case will have to be based on an even deeper plunge into the messy details of how people behaved. It will entail more data, more agents, more computation and less elegance.

If economists jettisoned elegance and got to work developing more realistic models, we might gain a better understanding of how crises happen, and learn how to anticipate similarly unstable episodes in the future. The theories won’t be pretty, and probably won’t show off any clever mathematics. But we ought to prefer ugly realism to beautiful fantasy.

(Mark Buchanan, a theoretical physicist and the author of “The Social Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually Looks Like You,” is a Bloomberg View columnist. The opinions expressed are his own.)

Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the economic collapse after mortgage lenders peddled all those poisoned mortgages ---

Can the 2008 investment banking failure be traced to a math error?
Recipe for Disaster:  The Formula That Killed Wall Street --- http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
Link forwarded by Jim Mahar ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html 

Some highlights:

"For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations are at the heart of the problem.

"The reason that ratings agencies and investors felt so safe with the triple-A tranches was that they believed there was no way hundreds of homeowners would all default on their loans at the same time. One person might lose his job, another might fall ill. But those are individual calamities that don't affect the mortgage pool much as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and tranching still hadn't solved all the problems of mortgage-pool risk. Some things, like falling house prices, affect a large number of people at once. If home values in your neighborhood decline and you lose some of your equity, there's a good chance your neighbors will lose theirs as well. If, as a result, you default on your mortgage, there's a higher probability they will default, too. That's called correlation—the degree to which one variable moves in line with another—and measuring it is an important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more involved with the actual formula etc.

The “math error” might truly be have been an error or it might have simply been a gamble with what was perceived as miniscule odds of total market failure. Something similar happened in the case of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management formed by Nobel Prize winning economists and their doctoral students who took similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM  

The rhetorical question is whether the failure is ignorance in model building or risk taking using the model?

Also see
"In Plato's Cave:  Mathematical models are a powerful way of predicting financial markets. But they are fallible" The Economist, January 24, 2009, pp. 10-14 --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

 

Learning From Mistakes
"School for quants: Inside UCL’s Financial Computing Centre, the planet’s brightest quantitative analysts are now calculating our future," by Sam Knight, Financial Times Magazine, March 2, 2012 ---
http://www.ft.com/intl/cms/s/2/0664cd92-6277-11e1-872e-00144feabdc0.html#axzz1oEeYcqi8

High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email ftsales.support@ft.com to buy additional rights. http://www.ft.com/cms/s/2/0664cd92-6277-11e1-872e-00144feabdc0.html#ixzz1pxufR2kw

On a recent winter’s afternoon, nine computer science students were sitting around a conference table in the engineering faculty at University College London. The room was strip-lit, unadorned, and windowless. On the wall, a formerly white whiteboard was a dirty cloud, tormented by the weight of technical scribblings and rubbings-out upon it. A poster in the corner described the importance of having a heterogenous experimental network, or Hen.

Every now and again, though, the discussion became comprehensible. The students discussed annoyances – so much data about animals! – and possibilities. One of the PhD students, Ilya Zheludev, talked about “Wikipedia deltas” – records of deleted sections from the online encyclopaedia. Immediately, the students hit on the idea of tracking the Wikipedia entries of large companies and seeing what was deleted, and when.

The mood of the meeting was casual and exacting at the same time. Galas, who is from Gdansk and once had ambitions to be a hacker, is something of a giant at the Financial Computing Centre. One of the first students to enrol in 2009, he has a gift for writing extremely large computer programs. In order to carry out his own research, Galas has built an electronic trading platform that he estimates would satisfy the needs of a small bank. As a result, what he says goes. Galas closed the meeting by giving the undergraduates a hard time about the overall messiness of their programming. “I like beauty!” he declared, staring around the room.

The Financial Computing Centre at UCL, a collaboration with the London School of Economics, the London Business School and 20 leading financial institutions, claims to be the only institute of its kind in Europe. Each year since its establishment in late 2008, between 600 and 800 students have applied for its 12 fully funded PhD places, which each cost the taxpayer £30,000 per year. Dozens more applicants come from the financial industry, where employers are willing to subsidise up to five years of research at the tantalising intersection of computers, data and money.

As of this winter, the centre had about 60 PhD students, of whom 80 per cent were men. Virtually all hailed from such forbiddingly numerate subjects as electrical engineering, computational statistics, pure mathematics and artificial intelligence. These realms of knowledge contain concepts such as data mining, non-linear dynamics and chaos theory that make many of us nervous just to see written down. Philip Treleaven, the centre’s director, is delighted by this. “Bright buggers,” he calls his students. “They want to do great things.”

In one sense, the centre is the logical culmination of a relationship between the financial industry and the natural sciences that has been deepening for the past 40 years. The first postgraduate scientists began to crop up on trading floors in the early 1970s, when rising interest rates transformed the previously staid calculations of bond trading into a field of complex mathematics. The most successful financial equation of all time – the Black-Scholes model of options pricing – was published in 1973 (the authors were awarded a Nobel prize in 1997).

Continued in article

Bob Jensen's threads on The Greatest Swindle in the History of the World ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout


 

The Bailout's Hidden, Albeit Noble, Agenda (for added details see Appendix Y)

This section of the Essay with additional details is reproduced in Appendix Y --- Click Here

September 20, 2008 message from Ganesh M. Pandit, DBA, CPA, CMA [profgmp@HOTMAIL.COM]

Yesterday, on CNBC, one of the anchors asked a question: "Who is it that the U.S. Government is bailing out with billions of dollars? The U.S. financial institutions or the governments of various countries that are concerned about the impact of the bad loans and the related financial instruments on the banks in their own countries?"

Does anybody have any opinion about that?

Ganesh M Pandit
Adelphi University

 

September 21, 2008 reply from Bob Jensen

Hi Ganesh,

The answer to your question turns out to be quite obscure and complicated as Hank Paulson gives upwards of  of $500 billion in bailout funds to save CitiBank and AIG while giving zero bailout funds to Washington Mutual Bank (the largest bank failure in the history of the world), Lehman Brothers, and Merrill Lynch. I think the answer is that both Hank Paulson and the U.S. Congress that so willingly voted for the bailout funding have a Hidden Agenda that I've never seen them explain to the public. If I'm correct, it's a noble Hidden Agenda to save the United States of America! If Hank Paulson or Nancy Pelosi really explained this Hidden Agenda it would reveal how fragile the economic future of America has become and would be counterproductive to virtually all of Barack Obama's spending promises during his campaign. I do wish, however, that Paulson, Pelosi, and Obama would explain it to Senator Waxman so he would shut his yap.

As events unfolded I've re-written my answer to you, Ganesh, due to questions arising that suggest a U.S. Government Hidden Agenda in the Bailout Program that commenced in late in 2008 after it became possible that the subprime mortgage scandal was going to drag down both the U.S. economy into a total collapse from which it might never emerge. Clues about a Hidden Agenda are suggested in the following questions concerning bailout funding that has emerged. These questions include the following: while Hank Paulson, as Secretary of the Treasury, was responsible for obtaining and spending the bailout funds:

  1. Why did Paulson give $85 billion to bail out American Insurance Group (AIG) and later increased it to over $100 billion in spite of evidence that AIG's historic record of accounting fraud (hundreds of billions), settlements by AIG's independent auditor, PwC, for alleged complicity and incompetence in the audit (for which PwC settled a $1.4 billion shareholder lawsuit for close to $100 million, and other lesser settlements such as Ernst & Young's consulting settlement for $1 million? You can read more about AIG's accounting fraud at http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

     
  2. As of November 2008, 2008 there were 22 banks that Paulson elected to let fail rather than to bail out. Why did Paulson give out upwards of $300 billion to bail out CitiBank while letting Washington Mutual (WaMu), Lehman Brothers, and Merrill Lynch fail or be bought out for a dime on the dollar that wiped out shareholders in WaMu, Lehman, and Merrill while saving shareholders of CitiBank? It's important to note that CitiBank's bailout commenced privately early in 2007 long before Paulson ever suspected the U.S. Government would eventually bail out any banks. Citicorp was seeking bailout funds from wealthy Arabs long before it sought out government funding. Its also important to note that WaMu is the largest FDIC failed bank in the history of the world, while CitiBank is the largest saved bank in the history of the world.

     

To answer such questions about why some banks (and AIG) get hundreds of billions from Hank Paulson to save creditors and shareholders and other banks get zero in bail out funds, I begin with some important definitions.

Chocolate
This is a mortgage issued on Main Street, USA that is highly likely to be paid in full. If an occasional default takes place, a chocolate mortgage balance  is well below the collateral value of the real estate in foreclosure such that the unpaid balance is fully paid by the sale of the collateral.

Turd
This is a mortgage issued on Main Street, USA that is highly likely not to be paid in full. If a common default takes place, a turd mortgage is well below the collateral value of the real estate in foreclosure such that the unpaid balance is not able to be paid in full when the property is foreclosed. Furthermore, political pressure from Congress may prevent many foreclosures of turd mortgages.

Mortgaged Back Securities (MBSs) that were sliced up into Collateralized Debt Obligations (CDOs)
This is a box of supposed chocolates bundled into a single security with an AAA investment grade rating that was sold by Wall Street investment banks who purchased the mortgage notes and bundled them up into CDO securities that were in term sold at relatively high profits to investors, particularly investors in foreign nations.


Questions
What's a financial long bet and how does it win or lose?
What's the distinction between a long bet speculation versus hedge?

From The Wall Street Journal Accounting Weekly Review on April 1, 2011

Hedge Funds Had Bets Against Japan
by: Gregory Zuckerman and Tom Lauricella
Date: Mar 15, 2011 

SUMMARY: The catastrophe in Japan has placed renewed focus on the country's already fragile economy-and brought unexpected profits to investors who have long bet that the nation eventually will be dragged down by its debt problems.

DISCUSSION: 

  1. What is a hedge fund? How is a hedge fund different from mutual funds or individual investing? What type of investor would invest in such funds? What are the risk levels involved with investing in hedge funds?
  2. How did these hedge funds 'bet against Japan'? Why did some investors think it wise to invest this way? How has the earthquake in Japan impacted this type of investment?
  3. What were the issues facing Japan before the earthquake? How has the earthquake changed the situation? What is the long-term outlook for business in the country? What are Japan's borrowing levels? How would this impact investment in the country by businesses? By individuals?

"Hedge Funds Had Bets Against Japan," by: Gregory Zuckerman and Tom Lauricella, The Wall Street Journal, March 15, 2011 ---
http://online.wsj.com/article/SB10001424052748703363904576200990107993916.html?mod=djem_jie_360

The catastrophe in Japan has placed renewed focus on the country's already fragile economy—and brought unexpected profits to investors who have long bet that the nation eventually will be dragged down by its debt problems.

In recent years, a chorus of voices has warned that Japan is facing an inevitable crisis to be brought on by a stagnant economy, a shrinking population and the worst debt profile of any major industrialized country.

Hedge-fund managers from Kyle Bass of Hayman Advisors LP in Dallas to smaller firms like Commonwealth Opportunity Capital have made money since the earthquake on long-held bets on Japan's government and corporate bonds.

Though the economic toll of the earthquake is far from clear, the immediate response in the financial markets has been a decline in stock prices, with the Nikkei Stock Average down 7.8% in two days (including Friday, when the quake hit near the end of the trading day). The price for insuring against a default by Japan on its government debt, a popular way to position for a financial crisis in Japan, has jumped. But in a move that runs counter to the expectations of some long-term Japan bears, the yen has strengthened on expectations that Japanese investors and corporations will be buying yen as they bring money home in coming weeks and months.

The price for insuring $10 million of Japanese sovereign debt for five years in the credit-default-swap market soared to $103,000 on Monday, from $79,000 on Friday, according to data provider Markit.

Reflecting the skepticism about Japan's outlook, even before the disaster, the net notional amount of Japanese debt being insured in the swaps market had surged to $7.4 billion from $4.1 billion a year ago, according to data from the Depository Trust & Clearing Corp. through March 4. The number of contracts outstanding has more than doubled.

Fresh DTCC data are due on Tuesday and will include only the early effects of the earthquake.

Credit-default swaps of many corporate bonds have become even more valuable, rewarding those that bet on them. Among the biggest moves was in Tokyo Electric Power Co., owner of the nuclear-power plants crippled by the earthquake.

Commonwealth Opportunity Capital, a $90 million hedge fund in Los Angeles, made a profit of several million dollars on Tokyo Electric on Monday, from an investment of less than $200,000. The annual cost of protecting $10 million of Tokyo Electric's debt jumped to $240,000 on Monday from $40,700 on Friday.

"Nobody wants bad things to happen to people," said Adam Fisher, who helps run Commonwealth Opportunity Capital. He said the firm has been betting against Japanese corporate bonds for two years. "But it shows how fragile that heavily levered nation is; there's very little margin for error."

Betting against Japan has been a losing proposition for many investors for years. Despite all the debt problems, bond prices have continued to move higher partly because deflation, not inflation, has been the concern. Also, domestic investors own most of the government's debt and have been reluctant to sell.

But now, facing at least a short-term hit to the economy from the earthquake and the likely need to issue more debt to pay for reconstruction efforts, Japan is seeing its problems magnified.

"Japan's choices are very, very bad," said John Mauldin, president of Millennium Wave Advisors. "Japan has an aging population, which is saving less, their savings rate will go negative sometime in the next few years at which point they will have to significantly reduce their spending, increase taxes or print money or some combination of the three.

"In the grand scheme of things, does the earthquake technically move it up further? Yes, but they were already well down the path."

Continued in article

Jensen Comment
Note how long positions on national debt are often a losing proposition unless they are hedges. In hedging situations these gains and losses are offset by gains and losses on the hedged items to the extent that the hedging contracts are effective. For example, a hedge fund might invest in U.S. Treasury bonds paying a fixed rate. There is no cash flow risk on interest payments or repayment of the face value of the bonds. However, there is value risk since the price of these outstanding bonds in the financial markets goes up and down daily. The hedge fund can lock in fixed value by entering into a fair value hedge such as by entering into a plain vanilla interest rate swap in which the fixed-amount interest payments are swapped for variable rate payments. The value of the bonds plus the value of the swap is thereby locked into a fixed value for which there is no value risk. However, when hedging value risk the investor has inevitably taken on cash flow risk. It's impossible to hedge both fair value risk and cash flow risk. Investors must choose between one or the other.

Hedging against debt default entire is an extreme form of fair value hedging and is usually done with a different type of hedging contract. Here the investor is not so much concerned with interim interest payments (or interim changes in value due to shifts in market interest rates) as he/she is concerned with possible default on payback of the entire principal of the debt. In other words it's more like insurance against a creditor declaring bankruptcy to get out of repayment of all or a great portion of debt repayment.

Credit Default Swap --- http://en.wikipedia.org/wiki/Credit_default_swap

A credit default swap (CDS) can almost be thought of as a form of insurance. If a borrower of money does not repay her loan, she "defaults." If a lender has purchased a CDS on that loan from an insurance company, the lender can then use the default as a credit to swap it in exchange for a repayment from an insurance company. However, one does not need to be the lender to profit from this situation. Anyone (usually called a speculator) can purchase a CDS. If a borrower does not repay his loan on time and defaults not only does the lender get paid by the insurance company, but the speculator gets paid as well. It is in the lender's best interest that he gets his money back, either from the borrower, or from the insurance company if the borrower is unable to pay back his loan. However, it is in the speculator's best interest that the borrower never repay his loan and default because that is the only way that the speculator can then take that default, turn it into a credit, and swap it for a cash payment from an insurance company.

A more technical way of looking at it is that a credit default swap (CDS) is a swap contract and agreement in which the protection buyer of the CDS makes a series of payments (often referred to as the CDS "fee" or "spread") to the protection seller and, in exchange, receives a payoff if a credit instrument (typically a bond or loan) experiences a credit event. It is a form of reverse trading.

A credit default swap is a bilateral contract between the buyer and seller of protection. The CDS will refer to a "reference entity" or "reference obligor", usually a corporation or government. The reference entity is not a party to the contract. The protection buyer makes quarterly premium payments—the "spread"—to the protection seller. If the reference entity defaults, the protection seller pays the buyer the par value of the bond in exchange for physical delivery of the bond, although settlement may also be by cash or auction. A default is referred to as a "credit event" and includes such events as failure to pay, restructuring and bankruptcy.[2] Most CDSs are in the $10–$20 million range with maturities between one and 10 years.

A holder of a bond may “buy protection” to hedge its risk of default. In this way, a CDS is similar to credit insurance, although CDS are not similar to or subject to regulations governing casualty or life insurance. Also, investors can buy and sell protection without owning any debt of the reference entity. These “naked credit default swaps” allow traders to speculate on debt issues and the creditworthiness of reference entities. Credit default swaps can be used to create synthetic long and short positions in the reference entity. Naked CDS constitute most of the market in CDS. In addition, credit default swaps can also be used in capital structure arbitrage.

Credit default swaps have existed since the early 1990s, but the market increased tremendously starting in 2003. By the end of 2007, the outstanding amount was $62.2 trillion, falling to $38.6 trillion by the end of 2008.

Most CDSs are documented using standard forms promulgated by the International Swaps and Derivatives Association (ISDA), although some are tailored to meet specific needs. Credit default swaps have many variations.[2] In addition to the basic, single-name swaps, there are basket default swaps (BDS), index CDS, funded CDS (also called a credit linked notes), as well as loan only credit default swaps (LCDS). In addition to corporations or governments, the reference entity can include a special purpose vehicle issuing asset backed securities.

Credit default swaps are not traded on an exchange and there is no required reporting of transactions to a government agency. During the 2007-2010 financial crisis the lack of transparency became a concern to regulators, as was the trillion dollar size of the market, which could pose a systemic risk to the economy. In March 2010, the DTCC Trade Information Warehouse (see Sources of Market Data) announced it would voluntarily give regulators greater access to its credit default swaps database

Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes bad due to having turds mixed in chocolates in a diversified portfolio, the "counterparty" who purchased the CDO will recover the value fraudulently invested in turds. On September 30, 2008 Gretchen Morgenson of The New York Times aptly explained that the huge CDO underwriter of CDOs was the insurance firm called AIG. She also explained that the first $85 billion given in bailout money by Hank Paulson to AIG was to pay the counterparties to CDS swaps. She also explained that, unlike its casualty insurance operations, AIG had no capital reserves for paying the counterparties for the the turds they purchased from Wall Street investment banks.

"Your Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson, The New York Times, September 20, 2008 --- http://www.nytimes.com/2008/09/21/business/21gret.html
Also see "A.I.G., Where Taxpayers’ Dollars Go to Die," The New York Times, March 7, 2009 --- http://www.nytimes.com/2009/03/08/business/08gret.html

What Ms. Morgenson failed to explain, when Paulson eventually gave over $100 billion for AIG's obligations to counterparties in CDS contracts, was who were the counterparties who received those bailout funds. It turns out that most of them were wealthy Arabs and some Asians who we were getting bailed out while Paulson was telling shareholders of WaMu, Lehman Brothers, and Merrill Lynch to eat their turds.

You tube has a lot of videos about a CDS. Go to YouTube and read in the phrase "credit default swap" ---
http://www.youtube.com/results?search_query=Credit+Default+Swaps&search_type=&aq=f
In particular note this video by Paddy Hirsch --- http://www.youtube.com/watch?v=kaui9e_4vXU
Paddy has some other YouTube videos about the financial crisis.

 

Bob Jensen's discussion of accounting rules for credit default swaps can be found under the C-Terms at
http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm

Credit default swaps turned into a disaster for AIG and the U.S. Government when black swans flew over in 2008 ---
http://www.trinity.edu/rjensen/2008Bailout.htm

The Commission's Final Report --- http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_full.pdf
(This report is really more of a misleading whitewash of government agencies and Congress relative to the real causes of the subprime disaster.)

Greatest Swindle in the History of the World ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Bob Jensen's discussion of accounting rules for credit default swaps can be found under the C-Terms at
http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm


Collateralized Debt Obligation (CDO) --- http://en.wikipedia.org/wiki/CDOs

"Sleight of hand: BofA moves dodgy Merrill derivatives to bank," by Mark December, The New York Post, October 21, 2011 ---
http://www.nypost.com/p/news/business/sleight_of_hand_uy96iNSbW99JHMRnbxgvfL

A plan by beleaguered Bank of America to foist trillions of dollars of funky Merrill Lynch derivatives onto its depositors is raising eyebrows on Wall Street.

The rarely used move will likely save the bank millions of dollars in collateral but could put depositors’ cash behind the eight ball.

The move also brought to light fissures between the nation’s top banking regulators, the Federal Deposit Insurance Corp. and the Federal Reserve, in the wake of new regulations meant to curb the free-wheeling habits that fostered the worst crisis in a generation back in 2008.

At issue is BofA’s decision to shift what sources say is some $55 trillion in derivatives at Merrill Lynch to the retail bank unit, which houses trillions in deposits insured by the FDIC.

Critics say the move potentially imperils everyday depositors by placing their money and savings at risk should BofA run into trouble.

Sources say that the derivative transfers from Merrill to BofA’s bank subsidiary were sparked by credit-rating downgrades to the bank holding company and are meant to help BofA avoid having to fork over more money to post as collateral to its derivative counterparties.

BofA officials who have talked privately say the move was requested by its counterparties and shouldn’t be perceived as problematic for the bank giant, sources said.

A BofA spokesman declined to comment.

For weeks, BofA CEO Brian Moynihan has been dogged about the health of one of the nation’s largest banking franchises and its massive exposures to toxic debt after its shotgun mergers with Merrill and Countrywide Financial during the credit crisis three years ago.

Under Moynihan, BofA has been attempting to right the bank’s ship and convince shareholders that the firm is healthy and doesn’t need to raise fresh capital to backstop against potential losses from faulty foreclosures and other mortgage-related lawsuits.

In the third quarter, BofA posted profit of $6.23 billion, or 56 cents a share, down 15 percent from the same period a year ago.

The bank’s shares gained 1 percent yesterday, to $6.47. They are off 51 percent this year.

BofA’s third-quarter performance comes as fears persist about the big bank’s ability to make money amid stiff economic headwinds and a host of potential land mines that could see it shelling out billions.

The derivatives transfer has irked officials at the FDIC which, sources said, was informed of BofA’s plan to shift the contracts to a retail deposit-taking entity just last week.

One source says that the FDIC is in the process of reviewing the transfer and will relay its opinion to the Federal Reserve.

But ultimately it’s the Fed that has the final say on authorizing any transfers.

Neither the Fed nor the FDIC would comment on BofA’s plans, which were first reported by Bloomberg.

Continued in article

Jensen Comment
What is more bizarre is that BofA really did not want to buy Merrill Lynch at any price in the 2008 Bailout after digging deeper into the financial records of CDO-battered Merrill Lynch.. Then Treasury Secretary Hank Paulson for some unknown reason did not want throw Merrill Lynch under the bus in the same manner that he threw Bear Stearns under the bus. In my opinion, both of these giants should have been ground up in the tires of the bus.

After the subprime collapse then BofA CEO, Ken Lewis, most certainly did not want to use BofA money to stop the free fall of Merrill Lynch. However, U.S. Treasury Secretary Hank Paulson resorted to personal blackmail according to Ken Lewis.
"Bank Chief Tells of U.S. Pressure to Buy Merrill Lynch," by Louise Story and Jo Becker, The New York Times, June 11. 2009 ---
http://www.nytimes.com/2009/06/12/business/12bank.html

Of course once BofA decided to concede to Paulson's demands does not condone the alleged behavior of BofA executives or Merrill Lynch executives in closing the deal.
"Ken Lewis BLASTS Merrill Lynch-Bank Of America Merger Lawsuit, Calls It 'Implausible'," by David B. Caruso, August 21, 2010 ---
http://www.huffingtonpost.com/2010/08/21/ken-lewis-blasts-merrill-_n_690215.html

Actually BofA was in great shape well into the subprime mortgage crisis. BofA had been smart enough in 2007 to hold none of the poisoned mortgages and CDOs that plagued most of the big banks and brokerage houses like Merrill Lynch. But in a twist of fate BofA became drawn to the fire sale pricing of big outfits like Countrywide and Merrill Lynch that were dying from subprime poison. BofA just did not look these gift horses in the mouth until it was too late to get them out of the BofA stables. There's no excuse for the stupid purchase of Countrywide which left BofA will millions of defaulted mortgages. There is purportedly an excuse for the purchase of Merrill Lynch. Ken Lewis was a chicken sh*t. Ironically, he eventually lost his job anyway.

Now it appears that BofA wants to pass trillions in Merrill Lynch CDO losses on to depositors who will pay for these losses in nickels and dimes of daily bank charges for things like debit cards for the next 1,000 years. In reality, the counterparties to the CDO contracts should've absorbed the loan loss poison, but Treasury Secretary Paulson and President George Bush did not want to piss off the investors who finance U.S. Government budget deficits --- especially our friends in Asia and the Middle East and large banks like Goldman that had bought these poison-laced CDO bonds.

Ironically, it is now BofA depositors who will now be paying off the bad debts that rightfully belonged to sovereign funds of Asia and the Middle East as well as derivatives contract counterparties at Goldman.


Credit Default Swaps (CDS) --- http://en.wikipedia.org/wiki/Credit_default_swap

"Global Financial Stability Report:  Old Risks, New Challenges"
International Monetary Fund
April 2013
http://www.docstoc.com/docs/154106200/IMF Report

The Global Financial Stability Report (GFSR) assesses key risks facing the global financial system. In normal times, the report seeks to play a role in preventing crises by highlighting policies that may mitigate systemic risks, thereby contributing to global financial stability and the sustained economic growth of the IMF’s member countries. Risks to financial stability have declined since the October 2012 GFSR, providing support to the economy and prompting a rally in risk assets. These favorable conditions reflect a combination of deeper policy commitments, renewed monetary stimulus, and continued liquidity support. The current report analyzes the key challenges facing financial and nonfinancial firms as they continue to repair their balance sheets and unwind debt overhangs. The report also takes a closer look at the sovereign credit default swaps market to determine its usefulness and its susceptibility to speculative excesses. Lastly, the report examines the issue of unconventional monetary policy (“MP-plus”) and its potential side effects, and suggests the use of macroprudential policies, as needed, to lessen vulnerabilities, allowing country authorities to continue using MP-plus to support growth while protecting financial stability.

The analysis in this report has been coordinated by the Monetary and Capital Markets (MCM) Department under the general direction of José Viñals, Financial Counsellor and Director. The project has been directed by Jan Brockmeijer and Robert Sheehy, both Deputy Directors; Peter Dattels and Laura Kodres, Assistant Directors; and Matthew Jones, Advisor. It has benefited from comments and suggestions from the senior staff in the MCM department.

Individual contributors to the report are: Ali Al-Eyd, Sergei Antoshin, Serkan Arslanalp, Craig Botham, Jorge A. Chan-Lau, Yingyuan Chen, Ken Chikada, Julian Chow, Nehad Chowdhury, Sean Craig, Reinout De Bock, Jennifer Elliott, Michaela Erbenova, Jeanne Gobat, Brenda González-Hermosillo, Dale Gray, Sanjay Hazarika, Heiko Hesse, Changchun Hua, Anna Ilyina, Tommaso Mancini-Griffoli, S. Erik Oppers, Bradley Jones, Marcel Kasumovich, William Kerry, John Kiff, Frederic Lambert, Rebecca McCaughrin, Peter Lindner, André Meier, Paul Mills, Nada Oulidi, Hiroko Oura, Evan Papageorgiou, Vladimir Pillonca, Jaume Puig, Jochen Schmittmann, Miguel Segoviano, Jongsoon Shin, Stephen Smith, Nobuyasu Sugimoto, Narayan Suryakumar, Takahiro Tsuda, Kenichi Ueda, Nico Valckx, and Chris Walker. Martin Edmonds, Mustafa Jamal, Oksana Khadarina, and Yoon Sook Kim provided analytical support. Gerald Gloria, Nirmaleen Jayawardane, Juan Rigat, Adriana Rota, and Ramanjeet Singh were responsible for word processing. Eugenio Cerutti, Ali Sharifkhani, and Hui Tong provided database and programming support. Joanne Johnson and Gregg Forte of the External Relations Department edited the manuscript and the External Relations Department coordinated production of the publication.

This particular issue draws, in part, on a series of discussions with banks, clearing organizations, securities firms, asset management companies, hedge funds, standards setters, financial consultants, pension funds, central banks, national treasuries, and academic researchers. The report reflects information available up to April 2, 2013.

The report benefited from comments and suggestions from staff in other IMF departments, as well as from Executive Directors following their discussion of the Global Financial Stability Report on April 1, 2013. However, the analysis and policy considerations are those of the contributing staff and should not be attributed to the Executive Directors, their national authorities, or the IMF.

Jensen Comment
Note that much of this report deals with the state of Credit Default Swaps.

 


CitiBank Foreign Investment Shareholders
Although CitiBank is one of the largest banks in the world with millions of shareholders, it's important to note that CitiBank in particular has a high proportion of wealthy Arabs and some wealthy Chinese investors who invested billions in 2007 and 2008 to help keep CitiBank from failing. Hence these wealthy Arab and Chinese investors not only bought MBS-CDO investments that unexpectedly contained turds, they also bought heavily into CitiBank common stock that they predicted would be a high return investment. Saudi Arabian prince Alwaleed bin Talal, has a major stake (billions of dollars) in Citigroup.

Recently, the investment arm of the Abu Dhabi government agreed to invest $7.5 Billion into Citigroup – a company that makes its money through riba. The move exposes the reality of the “Islamic Banking” initiative supported by the same government. Shar’iah compliant transactions cannot come into reality without courts and governments that solely abide by what Allah (swt) has revealed. Islamic economics cannot exist without an Islamic State.
"CitiBank Bailout: A Failed Investment," The Politically Aware Muslim," December 14, 2007 --- http://awaremuslim.blogspot.com/2007/12/citibank-bailout-failed-investment.html 

"CitiBank Bailout is $14 B From China, Kuwait," by Henry Sender, Financial Times (UK), January 11 2008 --- http://johnibii.wordpress.com/2008/01/12/citibank-bailout-is-14-b-from-china-kuwait/

        Subprime Mortgage Fraud as Explained by Forrest Gump
Mortgage Backed Securities are like boxes of chocolates. Criminals on Wall Street and one particular U.S. Congressional Committee stole a few chocolates from the boxes and replaced them with turds. Their criminal buddies at Standard & Poors rated these boxes AAA Investment Grade chocolates. These boxes were then sold all over the world to investors. Eventually somebody bites into a turd and discovers the crime. Suddenly nobody trusts American chocolates anymore worldwide. Hank Paulson now wants the American taxpayers to buy up and hold all these boxes of turd-infested chocolates for $700 billion dollars until the market for turds returns to normal. Meanwhile, Hank's buddies, the Wall Street criminals who stole all the good chocolates are not being investigated, arrested, or indicted. Momma always said: "Sniff the chocolates first Forrest." Things generally don't pass the smell test if they came from Wall Street or from Washington DC.
Forrest Gump as quoted at http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html

Unbooked Entitlements Debt
This is the amount owing for future entitlement obligations of the United States for which money has not been borrowed or set aside from taxes to meet these obligations, including unfunded military retirement pay, Veterans Administration benefits, Social Security benefits, Medicare benefits, the Medicare drug program, etc. The amount is unknown, but experts set this obligation between $40 and $65 trillion --- See Appendix A.

Booked National Debt
This is the debt of the United States that has been borrowed and interest expense is charged for debt that has not been paid. This booked national debt is now over $10 trillion. This was growing at a rate of nearly $4 billion per day, but it is much higher now that the bail out funds are being borrowed as well and are not funded by taxpayers.

The National Debt has continued to increase an average of $3.93 billion per day since September 28, 2007!
The National Debt Amount This Instant (Refresh your browser for updates by the second) --- http://www.brillig.com/debt_clock/
History of the National Debt --- http://en.wikipedia.org/wiki/National_Debt 
Entitlements --- http://www.trinity.edu/rjensen/entitlements.htm


History of the National Debt --- http://en.wikipedia.org/wiki/National_Debt 

Foreign Investment Bankers (FIBs)
I define this group as comprised of foreign sovereign wealth funds, foreign banks, and foreign individuals holding more than a billion of U.S. Treasury Bonds that comprise most of the $10 trillion current booked U.S. National Debt. These foreign "bankers" now hold nearly 50% of what the U.S. Government currently owes. We rely heavily on them to also buy the new U.S. Treasury borrowings that average well over $4 billion per day. They buy this debt at relatively low interest rates due to the historic tradition of U.S. debt as being "risk free" ---
http://en.wikipedia.org/wiki/Risk-free_interest_rate

Though a truly risk-free asset exists only in theory, in practice most professionals and academics use short-dated government bonds of the currency in question. For USD investments, usually US Treasury bills are used, while a common choice for EUR investments are German government bills or Euribor rates. The mean real interest rate of US treasury bills during the 20th century was 0.9% p.a. (Corresponding figures for Germany are inapplicable due to hyperinflation during the 1920s.)

These securities are considered to be risk-free because the likelihood of these governments defaulting is extremely low, and because the short maturity of the bill protects the investor from interest-rate risk that is present in all fixed rate bonds (if interest rates go up soon after the bill is purchased, the investor will miss out on a fairly small amount of interest before the bill matures and can be reinvested at the new interest rate).

Since this interest rate can be obtained with no risk, it is implied that any additional risk taken by an investor should be rewarded with an interest rate higher than the risk-free rate (on an after-tax basis, which may be achieved with preferential tax treatment; some local government US bonds give below the risk-free rate).

Since news of the subprime mortgage scandal and the roughly $1 trillion being borrowed for the bail out of the financial industry, the U.S. Treasury bonds are becoming more risky in terms of the rising slope of their yield curves. This means that the cost of borrowing more National Debt is increasing.

The 2008 Bailout's Hidden Agenda
I speculate that the Hidden Agenda of Hank Paulson, Nancy Pelosi, Senator Dodd, Senator Reid, and others directly engaged in obtaining the bail out funding is to first save the FIBs, those foreign investors upon whom we depend too heavily for obtaining both new and rolled over National Debt at relatively low (and less steep yield curve) interest rates. The FIBs hold nearly $5 trillion of the present National Debt and buy nearly half of the $4+ billion debt added each day on average to the National Debt. If the FIBs commence to demand higher interest rates for new U.S. Treasury Bonds and for maturing bonds that need to be rolled over (refinanced), the United States of America is in deep, deep trouble because for the last eight years of the Bush Administration, the U.S. Government's credit bubble has been ballooning to the point of bursting when the growth in GDP can no longer absorb such billions in debt added each day.

For evidence of this Hidden Agenda first consider the $100 billion of bailout funds give to AIG at the blink of an eye. If AIG declared bankruptcy and could not meet its CDS credit swap obligations to reimburse chocolate investors who got turds, the investors hit the hardest would be the FIBs foreign investors who now hold the lion's share of our National Debt. When Wall Street either knowingly or unknowingly sold mortgage backed security turds and chocolates, the FIBs would be very, very angry if we did not pay billions to buy back those turds or otherwise repay the FIBs for their losses. Hence we gave AIG the bailout funds to make good on the credit derivate insurance against bad mortgage investments. This probably also accounts for the bailout funding given to Bear Stearns.

Apparently Washington Mutual, Lehman Brothers, and Merrill Lynch were stupid enough to keep high proportions of turds in their own portfolios. Perhaps these were CDO investments that they had not yet unloaded on the FIBs. Whatever the reason, wiping out the shareholder value in those companies would not impact the cost of our National Debt nearly as much as if we let AIG fail. Since the "Hidden Agenda" was to hold down the cost of our National Debt, AIG got bailed out, and the others got nothing other than what it took the FDIC to make good on banking demand deposits (checking accounts) held by customers. For example, unlike AIG shareholders, the WaMu shareholders were wiped out.

Now Consider Citibank. For several years CitiBank has been in trouble and FIBs from the Middle East and Asia have been investing billions in CitiBank common stock. They in fact held large voting blocks of power in CitiBank. If Hank Paulsen did not guarantee upwards of $300 million for the mortgage turds held by CitiBank, the FIB foreign investors in CitiBank would be wiped out much like the investors in WaMu were wiped out. But the "Hidden Agenda" dictates that we keep the FIBs happy since they hold nearly 50% of our $10 trillion National Debt.

If the FIBs decided to significantly raise the interest rates required to roll over maturing National Debt and to purchase new U.S. Treasury Bonds, the entire future of the United States of America is at stake. All the promises, dreams, and plans of our new President Obama and the huge majority of Democratic Party legislators would be dashed since the U.S. worldwide interest rate would be much higher and no longer be viewed as risk-free. Programs such as national health care, increased aid to states for human services, and a modernized military force would be dashed all due to turds created by Turds on Main Street such as mortgage brokers and banks on Main Street and Wall Street scammers who sold them off to the FIBs and others in chocolate boxes.

I’ve often wondered why Hank Paulson never tried to explain this in the Congressional Hearings questioning his judgment for bailing out only selected outfits like Bear Stearns, AIG, and CitiBank. Now I think I have an answer, and if you discover anybody who has written something similar I would really like to know, because the media still does not seem to understand why CitiBank (the largest saved bank in the world) is more important to the Treasury Department than Washington Mutual (the largest bank failure in the world).

All of this of course begs the question of why the Bailout's Hidden Agenda remains hidden when Hank Paulsen and other leaders are asked to explain why the "fat cats" of AIG and CitiBank get bailed out for upwards of $500 billion and the small shareholders of WaMu, Lehman, and Merrill Lynch are told to take a hike? I think the reason is that virtually all our leaders in Washington DC prefer not to explain or dwell upon how our booked National Debt and our unbooked entitlement obligations have put the United States of America in a terribly deep hole in which the only hope of crawling back out rests in the hands of the foreign investors, particularly those in China (which owns nearly 10% of the Federal Debt), Japan, Singapore, and wealthy Middle Eastern oil producing states. The best we can hope for now is continued rolling over of U.S. Treasury Bonds at the lowest possible rates such tat our low cost of capital remains lower than the long-term fixed rates of interest needed to revive the real estate market in the U.S. See Appendix A.

If the cost of the National Debt should rise higher than the low interest rate that the U.S. Government may soon be setting for home owners refinancing their mortgages and buyers seeking new long term mortgages, then the only way out of the deep hole may be slow the rate of increase in the National Debt with destructive inflation that comes with printing money to pay the difference between the borrowing rates and the spending rates of the U.S. Government. Zimbabwe has shown us how destructive inflation can become when a nation tries to pay its debts by simply printing more currency.

Hence I conclude that the Hidden Agenda is a noble cause to save the good faith and credit of the United States when the National Debt is increasing $4 billion to $6 billion a day and greater deficits to come when the U.S. Congress intends to deficit finance over the next eight years at unsurpassed billions separating tax revenues from program expenditures.

Even if the FIBs continue to give the U.S. a great deal on borrowing rates for the National Debt, we are in deeper trouble due to our unbooked entitlements debt that will be coming increasingly expensive as the baby boomers age --- http://www.trinity.edu/rjensen/entitlements.htm

"Uncle Sam's Credit Line Running Out," by Randall Forsyth, Barron's, November 11, 2008 ---
http://online.barrons.com/article/SB122633310980913759.html

We Can't Tax Our Way Out of the Entitlement Crisis," by R. Glenn Hubbard, The Wall Street Journal, August 21, 2008; Page A13 --- http://online.wsj.com/article/SB121927694295558513.html 

We can also secure a firm financial footing for Social Security (and Medicare) without choking off economic growth or curtailing our flexibility to pursue other spending priorities. Three actions are essential: (1) reduce entitlement spending growth through some form of means testing; (2) eliminate all nonessential spending in the rest of the budget; and (3) adopt policies that promote economic growth. This 180-degree difference from Mr. Obama's fiscal plan forms the basis of Sen. McCain's priorities for spending, taxes and health care.

The problem with Mr. Obama's fiscal plans is not that that they lack vision. On the contrary, the vision is plain enough: a larger welfare state paid for by higher taxes. The problem is not even that they imply change. The problem is that his plans are statist.

While the candidate is sending a fiscal "Ich bin ein Berliner" message to Americans, European critics of his call for greater spending on defense are the canary in the coal mine for what lies ahead with his vision for the United States.

Professor R. Glenn Hubbard is Dean of the College of Business at Columbia University and a member of the President's Council of Economic Advisors.

Bob Jensen's threads on the "Entitlement Crisis" are at http://www.trinity.edu/rjensen/entitlements.htm

Bob Jensen's threads on entitlements are at http://www.trinity.edu/rjensen/entitlements.htm

It may well be that the U.S. Treasury pledge most of the bailout money to AIG and CitiBank because "they are just too big to fail" in a sense that failure of these two might bring down the entire world wide financial house of cards. I just don't think this is the case since CitiBank could've saved the CitiBank creditors without saving the shareholders. This is essentially what happened when Freddie Mac and Fannie Mae shareholders were wiped out.

Question
What's the significance of the off-balance sheet liabilities in CitiBank versus the U.S. Treasury?

Answer
Both CitiBank and the U.S. Treasury have managed to keep more of their debts off balance sheet than they have booked on the balance sheet. According to the former top accountant in the U.S., David Walker, the total debt of the U.S. is about $55 trillion (now in excess of $100 trillion), of which $11 trillion is booked on the balance sheet as National Debt --- See Appendix A.
The total debt of CitiBank is over $2 trillion with slightly over half being booked on the balance sheet. Some analysts argued that Citibank had a handle on its total debt before the meltdown, but this is no longer the case --- http://www.monkeybusinessblog.com/mbb_weblog/2008/07/citi-off-balanc.html

What's sad is that even saving the shareholders in Citibank in order to prevent shareholder wipeouts of the shareholders from China, Singapore, Japan, and the Middle East, that may not be enough to keep the interest rates on the U.S. National Debt as low as we would like.
"The issuance issue," The Economist, Nov. 2--Dec. 5, 2008, Page 77 --- http://www.economist.com/finance/displaystory.cfm?story_id=12700894

“ROLL up, roll up. Get your government bonds here. They may not pay much, but they’re safe. Buy ’em now in case stockmarkets don’t last.”

As the recession deepens, finance ministers round the world may be forced to resort to the tactics of the market stallholder. Politicians hope that deficit financing will be the way to stimulate the economy. But someone has to buy all those bonds.

They are easy to sell at the moment. The prices of risky assets like shares and corporate bonds have been plunging. Banks are so desperate for the security of government paper that they are accepting yields close to zero on three-month Treasury bills. Yields on American ten-year Treasury bonds have fallen to around 3%, their lowest in a generation. British government bonds, or gilts, with the same maturity are returning about 4%, despite the rise in the budget deficit planned by Alistair Darling, the chancellor.

Government-bond markets are benefiting from the deteriorating economic outlook, which is leading some forecasters to predict both a recession and a brief period of deflation in 2009. A nominal yield of 3-4% looks attractive in real terms if prices are falling.

A surge in supply could be matched by higher demand. The potential precedent is Japan, where nearly two decades of fiscal deficits and a deteriorating debt-to-GDP ratio have not stopped investors from buying bonds at yields of less than 2%.

But is this really an encouraging example? Most Americans and Europeans would not consider low government-bond yields to be adequate compensation for the nearly two decades of sluggish economic growth that Japan has suffered. And Japan is different from America and Britain: it runs current-account surpluses and thus has not been dependent on foreign capital. The Anglo-American economies rely on the kindness of strangers.

There has been no sign, so far, that foreigners are tiring of funding the American deficit. Indeed, the dollar has risen against most currencies (the yen is a notable exception) in recent months. Being the world’s largest economy has helped, as has the flight out of emerging-market currencies. But Britain does not have the same advantages. The pound was treated for many years as a high-yielding version of the euro. That is no longer so after recent rate cuts and sterling has suffered against both the euro and the dollar.

Mr Islam reckons overseas investors have been buying around 30% of recent gilt issuance. Given the losses they have already suffered through the pound’s fall, will they step up their purchases, especially as the growth rate of global foreign-exchange reserves is slowing?

So domestic investors may be required to shoulder the burden. Pension funds may be eager to add to their holdings, given the losses they have suffered on shares and in alternative asset classes, such as hedge funds and private equity.

But retail investors may also be needed. A rise in the savings rate is widely forecast as the economy slows (although this is likely to be driven by a fall in borrowing more than by a surge in savings itself). If, as many economists forecast, the Bank of England cuts short-term rates to 2%, British savers could be tempted by the allure of government bonds yielding 3-4%. The same may be true in America, where money-market funds are already offering paltry returns. This will be a big change of habit: according to Morgan Stanley, America’s net Treasury-bond purchases, outside those by the finance industry, have been zero since 1992.

Perhaps a more cautious generation of investors will rediscover the virtues of government debt, as they did in the 1930s and 1940s. “People will be buying bonds as Christmas presents,” predicts Matt King, a credit strategist at Citigroup.

Paradoxically, the real problem for governments may only occur if they manage to revive their economies. At that point, deflation worries will disappear and investors will switch to riskier assets. Given the deficits in both Britain and America, it seems unlikely that any cyclical rebound will be strong enough to bring the budget back to balance. In 2010 or 2011, issuing government bonds may prove a much harder (and more expensive) task.

This above section of the Essay with additional details and replies from readers is reproduced in Appendix Y --- Click Here

Great Public Sector Reform Speech ---
http://njn.net/television/webcast/ontherecord.html


The Bailout's Hidden Noble and  Ignoble Agendas

Aesop:  We hang the petty thieves and appoint the great ones to public office.

Bankers bet with their bank's capital, not their own. If the bet goes right, they get a huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital Louria Hahn, "Missing:  How Poor Risk-Management Techniques Contributed to the Subprime Mess," CFO Magazine, March 2008, Page 53 --- http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to bail out these crooks with taxpayer funds makes it all the worse.

The bourgeoisie can be termed as any group of people who are discontented with what they have, but satisfied with what they are
Nicolás Dávila

That some bankers have ended up in prison is not a matter of scandal, but what is outrageous is the fact that all the others are free.
Honoré de Balzac

In the Opinion of Economics Professor Meltzer from Carnegie-Mellon University
"Preventing the Next Financial Crisis:  Don't be fooled by the bond market. Banks are holding prices down because they can buy Treasurys with free money from the Fed," The Wall Street Journal, by Alan H. Meltzer, October 22, 2009 ---
http://online.wsj.com/article/SB10001424052748704224004574489251193581802.html?mod=djemEditorialPage

The United States is headed toward a new financial crisis. History gives many examples of countries with high actual and expected money growth, unsustainable budget deficits, and a currency expected to depreciate. Unless these countries made massive policy changes, they ended in crisis. We will escape only if we act forcefully and soon.

As long ago as the 1960s, then French President Charles de Gaulle complained that the U.S. had the "exorbitant privilege" of financing its budget deficit by issuing more dollars. Massive purchases of dollar debt by foreigners can of course delay the crisis, but today most countries have their own deficits to finance. It is unwise to expect them, mainly China, to continue financing up to half of ours for the next 10 or more years. Our current and projected deficits are too large relative to current and prospective world saving to rely on that outcome.

Worse, banks' idle reserves that are available for lending reached $1 trillion last week. Federal Reserve Chairman Ben Bernanke said repeatedly in the past that excess reserves would run down when banks and other financial companies repaid their heavy short-term borrowing to the Fed. The borrowing has been repaid but idle reserves have increased. Once banks begin to expand loans or finance even more of the massive deficits, money growth will rise rapidly and the dollar will sink to new lows. Do we have to wait for a crisis before we replace promises with effective restraint?

Many market participants reassure themselves that inflation won't come by noting the decline in yields on longer-term Treasury bonds and the spread between nominal Treasury yields and index-linked TIPS that protect against inflation. They measure expectations of higher inflation by the difference between these two rates, and imply long-term investors aren't demanding higher interest rates to protect themselves against it. But those traditional inflation-warning indicators are distorted because the Fed lends money at about a zero rate and the banks buy Treasury securities, reducing their yield and thus the size of the inflation premium.

Further, the Fed is buying massive amounts of mortgages to depress and distort the mortgage rate. This way of subsidizing bank profits and increasing their capital bails out these institutions but avoids going to Congress for more money to do so. It follows the Fed's usual practice of protecting big banks instead of the public.

The administration admits to about $1 trillion budget deficits per year, on average, for the next 10 years. That's clearly an underestimate, because it counts on the projected $200 billion to $300 billion of projected reductions in Medicare spending that will not be realized. And who can believe that the projected increase in state spending for Medicaid can be paid by the states, or that payments to doctors will be reduced by about 25%?

While Chinese government purchases of our debt may delay a dollar and debt crisis, they also delay any effective program to reduce the size of that crisis. It is far better to begin containing the problem before we blow a hole in the dollar and start another downturn.

A weak economy is a poor time to reduce current government spending or raise tax rates, but we don't require draconian immediate changes. We do need a fully specified, multi-year program to restore fiscal probity by reducing spending, and a budget rule that limits the size and frequency of deficits. The plan should be announced in a rousing speech by the president. The emphasis should be on reducing government spending.

The Obama administration chooses to blame outsize deficits on its predecessor. That's a mistake, because it hides a structural flaw: We no longer have any way of imposing fiscal restraint and financial prudence. Federal, state and local governments understate future spending and run budget deficits in good times and bad. Budgets do not report these future obligations.

Except for a few years in the 1990s, both parties have been at fault for decades, and the Obama administration is one of the worst offenders. Its $780 billion stimulus bill, enacted earlier this year, has been wasteful and ineffective. The Council of Economic Advisers was so pressed to justify the spending spree that it shamefully invented a number called "jobs saved" that has never been seen before, has no agreed meaning, and no academic standing.

One reason for the great inflation of the 1970s was that the Federal Reserve gave primacy to reducing unemployment. But attempts to tame inflation later didn't last, and the result was a decade of high and rising unemployment and prices. It did not end until the public accepted temporarily higher unemployment—more than 10.5% in the fall of 1982—to reduce inflation.

Another error of the 1970s was the assumption there was a necessary trade-off along a stable Phillips Curve between unemployment and inflation—in other words, that more inflation was supposed to lower unemployment. Instead, both rose. The Fed under Paul Volcker stopped making those errors, and inflation fell permanently for the first time since the 1950s.

Both errors are back. The Fed and most others do not see inflation in the near term. Neither do I. High inflation is unlikely in 2010. That's why a program beginning now should start to lower excess reserves gradually so that the Fed will not have to make its usual big shift from excessive ease to severe contraction that causes a major downturn in the economy.

A steady, committed policy to reduce future inflation and lower future budget deficits will avoid the crisis that current policies will surely bring. Low inflation and fiscal prudence is the right way to strengthen the dollar and increase economic well being.

Dr. Meltzer is professor of political economy at Carnegie Mellon University and the author of the multi-volume "A History of the Federal Reserve" (University of Chicago, 2004 and 2010).

Breaking the Bank Frontline Video
In Breaking the Bank, FRONTLINE producer Michael Kirk (Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to reveal the story of two banks at the heart of the financial crisis, the rocky merger, and the government’s new role in taking over — some call it “nationalizing” — the American banking system.
Simoleon Sense, September 18, 2009 --- http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout --- http://www.trinity.edu/rjensen/2008Bailout.htm

The video is a anti-Bernanke musical performance by the Dean of Columbia Business School ---
http://www.youtube.com/watch?v=3u2qRXb4xCU
Ben Bernanke (Chairman of the Federal Reserve and a great friend of big banks) --- http://en.wikipedia.org/wiki/Ben_Bernanke
R. Glenn Hubbard (Dean of the Columbia Business School) ---
http://en.wikipedia.org/wiki/Glenn_Hubbard_(economics)


"The Triumph of Propaganda," by Nemo Almen, American Thinker, January 2, 2011 ---
http://www.americanthinker.com/2011/01/the_triumph_of_propaganda.html

Does anyone remember what happened on Christmas Eve last year?  In one of the most expensive Christmas presents ever, the government removed the $400 billion limit on their Fannie and Freddie guaranty.  This act increased taxpayer liabilities by six trillion dollars; however, the news was lost in the holiday cheer.  This is one instance in a broader campaign to manipulate the public perception, gradually depriving us of independent thought.

Consider another example: what news story broke on April 16, 2010?  Most of us would say the SEC's lawsuit against Goldman Sachs.  Goldman is the market leader in "ripping the client's face off," in this instance creating a worst-of-the-worst pool of securities so Paulson & Co could bet against it.  Many applauded the SEC for this action.  Never mind that singling out one vice president (the "Fabulous Fab") and one instance of fraud is like charging Al Capone with tax evasion.  The dog was wagged.

Very few caught the real news that day, namely the damning complicity of the SEC in the Stanford Ponzi scheme.  Clearly, Stanford was the bigger story, costing thousands of investors billions of dollars while Goldman later settled for half a billionWorse, the SEC knew about Stanford since 1997, but instead of shutting it down, people left the SEC to work for Stanford.  This story should have caused widespread outrage and reform of the SEC; instead it was buried in the back pages and lost to the public eye.

Lest we think the timing of these was mere coincidence, the Goldman lawsuit was settled on July 15, 2010, the same day the financial reform package passedThe government threw Goldman to the wolves in order to hide its own shame.  When the government had its desired financial reforms, it let Goldman settle.  These examples demonstrate a clear pattern of manipulation.  Unfortunately, our propaganda problem runs far deeper than lawsuits and Ponzi schemes.

Here is a more important question: which companies own half of all subprime and Alt-A (liar loan) bonds?  Paul Krugman writes that these companies were "mainly out of the picture during the housing bubble's most feverish period, from 2004 to 2006.  As a result, the agencies played only a minor role in the epidemic of bad lending."[iii]  This phrase is stupefying.  How can a pair of companies comprise half of a market and yet have no major influence in it?  Subprime formed the core of the financial crisis, and Fannie and Freddie (the "agencies") formed the core of the subprime market.  They were not "out of the picture" during the subprime explosion, they were the picture.  The fact that a respectable Nobel prize-winner flatly denies this is extremely disturbing.

Amazingly, any attempt to hold the government accountable for its role in the subprime meltdown is dismissed as right-wing propaganda This dismissal is left-wing propaganda.  It was the government that initiated securitization as a tool to dispose of RTC assets.  Bill Clinton ducks all responsibility, ignoring how his administration imposed arbitrary quotas on any banks looking to merge as Attorney General Janet Reno "threatened legal action against lenders whose racial statistics raised her suspicions."[iv]  Greenspan fueled the rise of subprime derivatives by lowering rates,[v] lowering reserves,[vi] and beating down reasonable opposition.  And at the center of it all were Fannie and Freddie bribing officials, committing fraud, dominating private-sector competition, and expanding to a six-trillion-dollar debacle.  The fact that these facts are dismissed as propaganda shows just how divorced from reality our ‘news' has become.  Yes, half of all economists are employed by the government, but this is no reason to flout one's professional responsibility.  As a nation we need to consider all the facts, not just those that are politically expedient.

Continued in article

Nemo Almen is the author of The Last Dodo: The Great Recession and our Modern-Day Struggle for Survival.

Bob Jensen's Rotten to the Core threads are at
http://www.trinity.edu/rjensen/FraudRotten.htm


"Is stock market still a chump's game? Small investors won't have a fair shot until a presumption of integrity is restored. It's not clear that Obama's proposed remedy will resolve the conflicts," by Eliot Spitzer, Microsoft News, August 19, 2009 ---
http://articles.moneycentral.msn.com/Investing/Extra/is-stock-market-still-a-chumps-game.aspx
Link forwarded by Steve Markoff [smarkoff@KIMSTARR.ORG]

One of America's great accomplishments in the last half-century was the so-called "democratization" of the financial markets.

No longer just for the upper crust, investing became a way for the burgeoning middle class to accumulate wealth. Mutual funds exploded in size and number, 401k plans made savings and investing easy, and the excitement of participating in the growth of our economy gripped an ever larger percentage of the population.

Despite a backdrop of doubters -- those who knowingly asserted that outperforming the average was an impossibility for the small investor -- there was a growing consensus that the rules were sufficient to protect the mom-and-pop investor from the sharks that swam in the water.

That sense of fair play in the market has been virtually destroyed by the bubble burstings and market drops of the past few years.

Recent rebounds notwithstanding, most people now are asking whether the system is fundamentally rigged. It's not just that they have an understandable aversion to losing their life savings when the market crashes; it's that each of the scandals and crises has a common pattern: The small investor was taken advantage of by the piranhas that hide in the rapidly moving currents.

And underlying this pattern is a simple theme: conflicts of interest that violated the duty the market players had to their supposed clients.

It is no wonder that cynicism and anger have replaced what had been the joy of participation in the capital markets.

Take a quick run through a few of the scandals:

The unifying theme is apparent: Access to information and advice, the very lifeblood of a level playing field, is not where it needs to be. The small investor still doesn't have a fair shot.

While there have been case-specific remedies, the aggregate effect of all the scandals is still to deny the market the most essential of ingredients: the presumption of integrity.

The issue confronting those who wish to solve this problem is that there really is no simple fix.

Bob Jensen's threads on the economic crisis are at
http://www.trinity.edu/rjensen/2008Bailout.htm

 


"JPMorgan (read that Chase Bank) faces SEC lawsuit," by Aline van Duyn and Francesco Guerrera, Financial Times, May 8, 2009 ---

JPMorgan Chase may be sued by US regulators for violating securities laws and market rules related to the sale of bonds and interest-rate swaps to Jefferson County, Alabama.

The potential Securities and Exchange Commission action is the latest twist in a complex debt financing saga which has already led to charges against Jefferson County officials and which has left the municipality struggling to avoid default on over $3bn of debt, much of it taken on to improve its sewage system.

JPMorgan said in a regulatory filing, made late on Thursday just as the results of bank stress tests were being released, that it had been told about the SEC action on April 21. It said it “has been engaged in discussions with the SEC staff in an attempt to resolve the matter prior to litigation”. The bank had no further comment on Friday.

Jefferson County is one of the most indebted municipalities in the US due to its expensive overhaul of its sewage system. JPMorgan is one of the lenders which has repeatedly extended the deadline on payments due by Jefferson County on its debt and derivatives.

A law is currently being considered that would create a new tax which would provide revenues to pay the sewer debt. If Jefferson County defaults, it would be the biggest by a US municipality, dwarfing the problems faced by California’s Orange County in the 1990s.

The mayor of Birmingham, Alabama, and two of his friends were last year charged by US regulators in connection with an undisclosed payment scheme related to municipal bond and swap deals.

The SEC alleged that Larry Langford, the mayor, received more than $156,000 in cash and benefits from a broker hired to arrange bond offerings and swap agreements on behalf of Jefferson County, where Birmingham is located.

Although the details of the SEC investigation are not known, it is likely to be related to the payment scheme through which banks like JPMorgan paid fees to local brokers at the request of Jefferson County.

The credit crisis has brought to light numerous problems in the municipal bond markets. Many borrowers relied on bond insurance to sell their deals, and the collapse in the credit ratings of bond insurers has made it difficult for many to raise funds or to do so at low interest rates.


The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print

The legislation's guidelines for crafting the rescue plan were clear: the TARP should protect home values and consumer savings, help citizens keep their homes and create jobs. Above all, with the government poised to invest hundreds of billions of taxpayer dollars in various financial institutions, the legislation urged the bailout's architects to maximize returns to the American people.

That $700 billion bailout has since grown into a more than $12 trillion commitment by the US government and the Federal Reserve. About $1.1 trillion of that is taxpayer money--the TARP money and an additional $400 billion rescue of mortgage companies Fannie Mae and Freddie Mac. The TARP now includes twelve separate programs, and recipients range from megabanks like Citigroup and JPMorgan Chase to automakers Chrysler and General Motors.

Seven months in, the bailout's impact is unclear. The Treasury Department has used the recent "stress test" results it applied to nineteen of the nation's largest banks to suggest that the worst might be over; yet the International Monetary Fund, as well as economists like New York University professor and economist Nouriel Roubini and New York Times columnist Paul Krugman predict greater losses in US markets, rising unemployment and generally tougher economic times ahead.

What cannot be disputed, however, is the financial bailout's biggest loser: the American taxpayer. The US government, led by the Treasury Department, has done little, if anything, to maximize returns on its trillion-dollar, taxpayer-funded investment. So far, the bailout has favored rescued financial institutions by subsidizing their losses to the tune of $356 billion, shying away from much-needed management changes and--with the exception of the automakers--letting companies take taxpayer money without a coherent plan for how they might return to viability.

The bailout's perks have been no less favorable for private investors who are now picking over the economy's still-smoking rubble at the taxpayers' expense. The newer bailout programs rolled out by Treasury Secretary Timothy Geithner give private equity firms, hedge funds and other private investors significant leverage to buy "toxic" or distressed assets, while leaving taxpayers stuck with the lion's share of the risk and potential losses.

Given the lack of transparency and accountability, don't expect taxpayers to be able to object too much. After all, remarkably little is known about how TARP recipients have used the government aid received. Nonetheless, recent government reports, Congressional testimony and commentaries offer those patient enough to pore over hundreds of pages of material glimpses of just how Wall Street friendly the bailout actually is. Here, then, based on the most definitive data and analyses available, are six of the most blatant and alarming ways taxpayers have been scammed by the government's $1.1-trillion, publicly funded bailout.

1. By overpaying for its TARP investments, the Treasury Department provided bailout recipients with generous subsidies at the taxpayer's expense.

When the Treasury Department ditched its initial plan to buy up "toxic" assets and instead invest directly in financial institutions, then-Treasury Secretary Henry Paulson Jr. assured Americans that they'd get a fair deal. "This is an investment, not an expenditure, and there is no reason to expect this program will cost taxpayers anything," he said in October 2008.

Yet the Congressional Oversight Panel (COP), a five-person group tasked with ensuring that the Treasury Department acts in the public's best interest, concluded in its monthly report for February that the department had significantly overpaid by tens of billions of dollars for its investments. For the ten largest TARP investments made in 2008, totaling $184.2 billion, Treasury received on average only $66 worth of assets for every $100 invested. Based on that shortfall, the panel calculated that Treasury had received only $176 billion in assets for its $254 billion investment, leaving a $78 billion hole in taxpayer pockets.

Not all investors subsidized the struggling banks so heavily while investing in them. The COP report notes that private investors received much closer to fair market value in investments made at the time of the early TARP transactions. When, for instance, Berkshire Hathaway invested $5 billion in Goldman Sachs in September, the Omaha-based company received securities worth $110 for each $100 invested. And when Mitsubishi invested in Morgan Stanley that same month, it received securities worth $91 for every $100 invested.

As of May 15, according to the Ethisphere TARP Index, which tracks the government's bailout investments, its various investments had depreciated in value by almost $147.7 billion. In other words, TARP's losses come out to almost $1,300 per American taxpaying household.

2. As the government has no real oversight over bailout funds, taxpayers remain in the dark about how their money has been used and if it has made any difference.

While the Treasury Department can make TARP recipients report on just how they spend their government bailout funds, it has chosen not to do so. As a result, it's unclear whether institutions receiving such funds are using that money to increase lending--which would, in turn, boost the economy--or merely to fill in holes in their balance sheets.

Neil M. Barofsky, the special inspector general for TARP, summed the situation up this way in his office's April quarterly report to Congress: "The American people have a right to know how their tax dollars are being used, particularly as billions of dollars are going to institutions for which banking is certainly not part of the institution's core business and may be little more than a way to gain access to the low-cost capital provided under TARP."

This lack of transparency makes the bailout process highly susceptible to fraud and corruption. Barofsky's report stated that twenty separate criminal investigations were already underway involving corporate fraud, insider trading and public corruption. He also told the Financial Times that his office was investigating whether banks manipulated their books to secure bailout funds. "I hope we don't find a single bank that's cooked its books to try to get money, but I don't think that's going to be the case."

Economist Dean Baker, co-director of the Center for Economic and Policy Research in Washington, suggested to TomDispatch in an interview that the opaque and complicated nature of the bailout may not be entirely unintentional, given the difficulties it raises for anyone wanting to follow the trail of taxpayer dollars from the government to the banks. "[Government officials] see this all as a Three Card Monte, moving everything around really quickly so the public won't understand that this really is an elaborate way to subsidize the banks," Baker says, adding that the public "won't realize we gave money away to some of the richest people."

3. The bailout's newer programs heavily favor the private sector, giving investors an opportunity to earn lucrative profits and leaving taxpayers with most of the risk.

Under Treasury Secretary Geithner, the Treasury Department has greatly expanded the financial bailout to troubling new programs like the Public-Private Investment Program (PPIP) and the Term Asset-Backed-Securities Loan Facility (TALF). The PPIP, for example, encourages private investors to buy "toxic" or risky assets on the books of struggling banks. Doing so, we're told, will get banks lending again because the burdensome assets won't weigh them down. Unfortunately, the incentives the Treasury Department is offering to get private investors to participate are so generous that the government--and, by extension, American taxpayers--are left with all the downside.

Joseph Stiglitz, the Nobel-prize winning economist, described the PPIP program in a New York Times op-ed this way:

Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year's time. The average "value" of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is 'worth.' Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!

Assume that one of the public-private partnerships the Treasury has promised to create is willing to pay $150 for the asset. That's 50 percent more than its true value, and the bank is more than happy to sell. So the private partner puts up $12, and the government supplies the rest--$12 in "equity" plus $126 in the form of a guaranteed loan.

If, in a year's time, it turns out that the true value of the asset is zero, the private partner loses the $12, and the government loses $138. If the true value is $200, the government and the private partner split the $74 that's left over after paying back the $126 loan. In that rosy scenario, the private partner more than triples his $12 investment. But the taxpayer, having risked $138, gains a mere $37."

Worse still, the PPIP can be easily manipulated for private gain. As economist Jeffrey Sachs has described it, a bank with worthless toxic assets on its books could actually set up its own public-private fund to bid on those assets. Since no true bidder would pay for a worthless asset, the bank's public-private fund would win the bid, essentially using government money for the purchase. All the public-private fund would then have to do is quietly declare bankruptcy and disappear, leaving the bank to make off with the government money it received. With the PPIP deals set to begin in the coming months, time will tell whether private investors actually take advantage of the program's flaws in this fashion.

The Treasury Department's TALF program offers equally enticing possibilities for potential bailout profiteers, providing investors with a chance to double, triple or even quadruple their investments. And like the PPIP, if the deal goes bad, taxpayers absorb most of the losses. "It beats any financing that the private sector could ever come up with," a Wall Street trader commented in a recent Fortune magazine story. "I almost want to say it is irresponsible."

4. The government has no coherent plan for returning failing financial institutions to profitability and maximizing returns on taxpayers' investments.

Compare the treatment of the auto industry and the financial sector, and a troubling double standard emerges. As a condition for taking bailout aid, the government required Chrysler and General Motors to present detailed plans on how the companies would return to profitability. Yet the Treasury Department attached minimal conditions to the billions injected into the largest bailed-out financial institutions. Moreover, neither Geithner nor Lawrence Summers, one of President Barack Obama's top economic advisors, nor the president himself has articulated any substantive plan or vision for how the bailout will help these institutions recover and, hopefully, maximize taxpayers' investment returns.

The Congressional Oversight Panel highlighted the absence of such a comprehensive plan in its January report. Three months into the bailout, the Treasury Department "has not yet explained its strategy," the report stated. "Treasury has identified its goals and announced its programs, but it has not yet explained how the programs chosen constitute a coherent plan to achieve those goals."

Today, the department's endgame for the bailout still remains vague. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, wrote in the Financial Times in May that the government's response to the financial meltdown has been "ad hoc, resulting in inequitable outcomes among firms, creditors, and investors." Rather than perpetually prop up banks with endless taxpayer funds, Hoenig suggests, the government should allow banks to fail. Only then, he believes, can crippled financial institutions and systems be fixed. "Because we still have far to go in this crisis, there remains time to define a clear process for resolving large institutional failure. Without one, the consequences will involve a series of short-term events and far more uncertainty for the global economy in the long run."

The healthier and more profitable bailout recipients are once financial markets rebound, the more taxpayers will earn on their investments. Without a plan, however, banks may limp back to viability while taxpayers lose their investments or even absorb further losses.

5. The bailout's focus on Wall Street mega-banks ignores smaller banks serving millions of American taxpayers that face an equally uncertain future.

The government may not have a long-term strategy for its trillion-dollar bailout, but its guiding principle, however misguided, is clear: what's good for Wall Street will be best for the rest of the country.

On the day the mega-bank stress tests were officially released, another set of stress-test results came out to much less fanfare. In its quarterly report on the health of individual banks and the banking industry as a whole, Institutional Risk Analytics (IRA), a respected financial services organization, found that the stress levels among more than 7,500 FDIC-reporting banks nationwide had risen dramatically. For 1,575 of the banks, net incomes had turned negative due to decreased lending and less risk-taking.

The conclusion IRA drew was telling: "Our overall observation is that US policy makers may very well have been distracted by focusing on 19 large stress test banks designed to save Wall Street and the world's central bank bondholders, this while a trend is emerging of a going concern viability crash taking shape under the radar." The report concluded with a question: "Has the time come to shift the policy focus away from the things that we love, namely big zombie banks, to tackle things that are truly hurting us?"

6. The bailout encourages the very behaviors that created the economic crisis in the first place instead of overhauling our broken financial system and helping the individuals most affected by the crisis.

As Joseph Stiglitz explained in the New York Times, one major cause of the economic crisis was bank overleveraging. "Using relatively little capital of their own," he wrote, banks "borrowed heavily to buy extremely risky real estate assets. In the process, they used overly complex instruments like collateralized debt obligations." Financial institutions engaged in overleveraging in pursuit of the lucrative profits such deals promised--even if those profits came with staggering levels of risk.

Sound familiar? It should, because in the PPIP and TALF bailout programs the Treasury Department has essentially replicated the very over-leveraged, risky, complex system that got us into this mess in the first place: in other words, the government hopes to repair our financial system by using the flawed practices that caused this crisis.

Then there are the institutions deemed "too big to fail." These financial giants--among them AIG, Citigroup and Bank of America-- have been kept afloat by billions of dollars in bottomless bailout aid. Yet reinforcing the notion that any institution is "too big to fail" is dangerous to the economy. When a company like AIG grows so large that it becomes "too big to fail," the risk it carries is systemic, meaning failure could drag down the entire economy. The government should force "too big to fail" institutions to slim down to a safer, more modest size; instead, the Treasury Department continues to subsidize these financial giants, reinforcing their place in our economy.

Of even greater concern is the message the bailout sends to banks and lenders--namely, that the risky investments that crippled the economy are fair game in the future. After all, if banks fail and teeter at the edge of collapse, the government promises to be there with a taxpayer-funded, potentially profitable safety net.

The handling of the bailout makes at least one thing clear, however. It's not your health that the government is focused on, it's theirs-- the very banks and lenders whose convoluted financial systems provided the underpinnings for staggering salaries and bonuses, while bringing our economy to the brink of another Great Depression.

Bob Jensen's threads how your money was put to word (fraudulently) to pay for the mistakes of the so-called professionals of finance --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Bob Jensen's threads on why the infamous "Bailout" won't work --- http://www.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity

Bob Jensen's "Rotten to the Core" threads --- http://www.trinity.edu/rjensen/FraudRotten.htm


The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print

"Lack of Candor and the AIG Bailout:  If AIG wasn't too big to fail, why did the government rescue it? And why do we need to turn the financial system upside down?" by Peter J. Wallison, The Wall Street Journal, November 27, 2009 ---
http://online.wsj.com/article/SB10001424052748704779704574551861399508826.html?mod=djemEditorialPage 

Since last September, the government's case for bailing out AIG has rested on the notion that the company was too big to fail. If AIG hadn't been rescued, the argument goes, its credit default swap (CDS) obligations would have caused huge losses to its counterparties—and thus provoked a financial collapse.

Last week's news that this was not in fact the motive for AIG's rescue has implications that go well beyond the Obama administration's efforts to regulate CDSs and other derivatives. It's one more example that the administration may be using the financial crisis as a pretext to extend Washington's control of the financial sector.

The truth about the credit default swaps came out last week in a report by TARP Special Inspector General Neil Barofsky. It says that Treasury Secretary Tim Geithner, then president of the New York Federal Reserve Bank, did not believe that the financial condition of AIG's credit default swap counterparties was "a relevant factor" in the decision to bail out the company. This contradicts the conventional assumption, never denied by the Federal Reserve or the Treasury, that AIG's failure would have had a devastating effect.

So why did the government rescue AIG? This has never been clear.

The Obama administration has consistently argued that the "interconnections" among financial companies made it necessary to save AIG and Bear Stearns. Focusing on interconnections implies that the failure of one large financial firm will cause debilitating losses at others, and eventually a systemic breakdown. Apparently this was not true in the case of AIG and its credit default swaps—which leaves open the question of why the Fed, with the support of the Treasury, poured $180 billion into AIG.

The broader question is whether the entire regulatory regime proposed by the administration, and now being pushed through Congress by Rep. Barney Frank and Sen. Chris Dodd, is based on a faulty premise. The administration has consistently used the term "large, complex and interconnected" to describe the nonbank financial institutions it wants to regulate. The prospect that the failure of one of these firms might pose a systemic risk is the foundation of the administration's comprehensive regulatory regime for the financial industry.

Up to now, very few pundits or reporters have questioned this logic. They have apparently been satisfied with the explanation that the "interconnectedness" created by those mysterious credit default swaps was the culprit.

But the New York Fed is the regulatory body most familiar with the CDS market. If that agency did not believe AIG's failure would have actually brought down its counterparties—and ultimately the financial system itself—it raises serious questions about the administration's credibility, and about the need for its regulatory proposals. If "interconnections" among financial institutions are indeed the source of the financial crisis, the administration should be far more forthcoming than it has been about exactly what these interconnections are, and how exactly a broad new system of regulation and resolution would eliminate or reduce them.

The administration's unwillingness or inability to clearly define the problem of interconnectedness is not the only weakness in its rationale for imposing a whole new regulatory regime on the financial system. Another example is the claim—made by Mr. Geithner and President Obama himself—that predatory lending by mortgage brokers was one of the causes of the financial crisis.

No doubt some deceptive practices occurred in mortgage origination. But the facts suggest that the government's own housing policies—and not weak regulation—were the source of these bad loans.

At the end of 2008, there were about 26 million subprime and other nonprime mortgages in our financial system. Two-thirds of these mortgages were on the balance sheets of the Federal Housing Administration, Fannie Mae and Freddie Mac, and the four largest U.S. banks. The banks were required to make these loans in order to gain approval from the Fed and other regulators for mergers and expansions.

The fact that the government itself either bought these bad loans or required them to be made shows that the most plausible explanation for the large number of subprime loans in our economy is not a lack of regulation at the mortgage origination level, but government-created demand for these loans.

Finally, although there may be a good policy argument for a new consumer protection agency for financial services and products, the scope of what the administration has proposed goes far beyond lending, or even deposit-taking. In the administration's proposed legislation, the Consumer Financial Protection Agency would cover any business that provides consumer credit of any kind, including the common layaway plans and Christmas clubs that small retailers offer their customers.

Under the guise of addressing the causes of a global financial crisis, the Obama administration's bill would have regulated credit counseling, educational courses on finance, financial-data processing, money transmission and custodial services, and dozens more small businesses that could not possibly cause a financial crisis. Even Chairmen Frank and Dodd balked at this overreach. Their bills exempt retailers if their financial activity is incidental to their other business. Still, many vestiges of this excess remain in the legislation that is now being pushed toward a vote.

The lack of candor about credit default swaps, the effort to blame lack of regulation for the subprime crisis and the excessive reach of the proposed consumer protection agency are all of a piece. The administration seems to be using the specter of another financial crisis to bring more and more of the economy under Washington's control.

With the help of large Democratic majorities in Congress, this train has had considerable momentum. But perhaps—with the disclosure about credit default swaps and the AIG crisis—the wheels are finally coming off.

Bob Jensen's threads on the Greatest Swindle in the World are at
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze


General Moters:  Robbing Sam to Pay Sam
"The Flight of the Money: Where Has It Gone?," by David Kennedy, Townhall, July 17, 2010 ---
http://townhall.com/columnists/DanKennedy/2010/07/17/the_flight_of_the_money_where_has_it_gone

Two months ago, the “new” General Motors made possible by government bailouts, theft of shareholders’ equity for forced re-distribution to unions, and managerial change at government’s gunpoint, was held up as shining example of success – it was even repaying its debt to Uncle Sam early.

But the week of the Independence Day, GM announced its urgent need to borrow five billion dollars, to use in re-paying debt (ie. paying its VISA bill with a new MasterCard) and as cash reserves to counter anticipated slumping sales.

As Arte Johnson used to say on “Laugh-In:” v-e-r-y interesting.

If you go to a movie set, you will see perfect-looking streets, each building front rich in detail, looking as real as real can be. Yet its only façade. One thin piece of painted sheetrock propped up. Walk around behind it, there’s nothing there.

That’s GM. State pension funds in 30-plus states people are counting on, upside down in toto by trillions. Obama’s stimulus. There are signs stuck here or there with his logo on them, proclaiming the dirt mound or torn up street his “stimulus at work.” The sign-maker was stimulated. Who else? That’s this entire economy. A façade. Walk around behind it: there’s nothing there. No real job creation, no business investment, no real estate investment, nothing much happening but very un-hopeful hoarding. Where has all the money gone?

There is flight of capital. Companies like Ford and Microsoft moving hundreds of millions of dollars to investments overseas. Mega-investors like Buffett are breaking long-standing, self-imposed prohibition on investing in non-U.S. companies in foreign lands. Insurers and health care companies are quietly buying up land beyond our borders.

A major business story going unreported: the long, long list of iconic American brand companies closing countless stores, shops and restaurant locations here while expanding and opening outlets like mad in other countries. That means they are draining money out of local economies here and moving it over there. Starbucks. Wal-Mart. Etc. Can’t you hear this giant sucking sound?

There is capital on strike. An estimated $2-trillion of excess cash reserves in companies other than financial institutions – although they are hoarding rather than lending, too. And this is calculated from examining big, public companies. As somebody intimately in touch with thousands of small business owners, I can personally assure you, their reluctance to invest or spend is profound, and, in aggregate, they are likely keeping trillions more inactive.

Continued in article


Ketz Me If You Can
"GM's IPO: A Way to Reduce the Deficit," by: J. Edward Ketz, SmartPros, November 2010 ---
http://accounting.smartpros.com/x70813.xml 

The ballyhooed IPO by GM has or soon will take place. This is amazing inasmuch as General Motors transformed itself from a solid, steady manufacturer with a clean reputation into a troubled U.S. automaker and then into another twenty-first century accounting fraudster before almost becoming another bankrupt has-been.

This Phoenix rises with the blessings of the White House and now appears as a budding star, even though its accounting is as clean as an 100,000 mile-engine whose oil has never been changed. I wondered why the Obama administration tinkered with this bankruptcy the way it did and wondered about the back room deals. But no longer—I have finally figured out the relationship between GM and Washington.

The SEC flagged GM for accounting issues in 2006, and the firm confessed to several accounting deficiencies that overstated earnings by at least $2 billion. Further, it cited problems with its internal control system, problems that have yet to be rectified four years later! Its recent S-1 stated, “We have determined that our disclosure controls and procedures and our internal control over financial reporting are currently not effective. The lack of effective internal controls could materially adversely affect our financial condition and ability to carry out our business plan.” So, the firm that issued accounting lies to the investment community over the last decade is getting ready to issue a ton of stock with little assurance that the accounting numbers are worth the electronic bits they’re written on. What a deal! But wait—there’s more.

General Motors, with the help of its auditor and investment banker and the White House, discovered—make that created—positive equity by recognizing a huge amount of accounting goodwill. Many observers have booed the presence of this goodwill, as much of it is due to FASB’s idiotic concept of writing down liabilities because of a firm’s own credit risk. (The FASB needs to realize its role is setter of accounting standards, not setter of financial analytic methods.) These arguments are all correct, for the goodwill number is built on whims, at best. GM’s goodwill serves as a wonderful example why goodwill is really not an asset. But wait—there’s more.

General Motors faces gargantuan pension obligations now and in the future. GM itself says in the S-1 that its unfunded liabilities are around $37 billion, a number I expect to grow rapidly in the next few years. I wonder why anybody would pay a premium for GM’s stock given the extent of these pension debts. These liabilities did not get reduced while GM was in bankruptcy, presumably as a result of the Faustian deal it made with the White House. I presume the Obama administration did this to avoid a huge stress on the PBGC if these pension obligations had been relieved.

Recently we learned through a Wall Street Journal report that the government allowed GM to keep its tax carryforwards even though it went into corporate bankruptcy. Clearly, this adds value to GM but not for the reason most pundits cite. Many marvel that GM’s future profits will not get taxed for years to come, but I am less optimistic about GM’s ability to generate future profits. As GM has not and cannot solve its internal control problems and has not shown much ability to manufacture anything efficiently over the long haul, I foresee losses in GM’s future. But, these tax loss carryforwards might be valuable to others, assuming there are no restrictions on their use by acquiring companies. If GM has positive equity, it is primarily because somebody else can take advantage of these carryforwards.

Continued in article

Bob Jensen's threads on the bailout mess ---
http://www.trinity.edu/rjensen/2008bailout.htm


Taibbi vs. Goldman Sachs: Whose side are you on?

Place a barf bag in your lap before watching these videos!
But are they accurate?
In June and July Goldman Sachs put up a pretty good defense.
Now I'm not so sure.

Questions
Why is the SEC still hiding the names of these tremendously lucky naked short sellers in Bear Sterns and Lehman Bros.?
Was it because these lucky speculators were such good friends of Hank Paulson and Timothy Geithner?
Or is Matt Taibbi himself a fraud as suggested last summer by Wall Street media such as Business Insider?

Jensen Comment
Evidence suggests that the SEC may be protecting these Wall Street thieves!
Or was all of this stealing perfectly legal? If so why the continued secrecy on the part of the SEC?
Suspicion:  The stealing may have taken place in top investors needed by the government for bailout (Goldman Sachs?)

"Wall Street's Naked Swindle" by Matt Taibbi
Watch the Video at one of the following sites:
You Tube --- http://www.youtube.com/watch?v=OqZUbe9KIMs
Google video --- Click Here
Read the complete article --- Click Here

Video Updates for Matt Taibbi
GRITtv: Matt Taibbi & Michael Lux: Goldman's Coup --- http://www.youtube.com/watch?v=nFWjXQLDkXg

"Matt Taibbi's Goldman Sachs Story Is A Joke," Joe Weisenthal, Business Insider, July 13, 2009 ---
http://www.businessinsider.com/matt-taibbis-goldman-sachs-story-is-a-joke-2009-7

 "Goldman Sachs responds to Taibbi Post," by: Felix Salmon, Rueters, June 26, 2009 ---
Calls Taibbi "Hysterical" ---
http://blogs.reuters.com/felix-salmon/2009/06/26/goldman-sachs-responds-to-taibbi/

Others Now Argue it Is Not a Joke
"Taibbi's Naked-Shorting Rage: Goldman's Lobbying, SEC's Fail,
"l by bobswern. Daily Kohs, September 30, 2009 ---
http://www.dailykos.com/story/2009/9/30/787963/-Taibbis-Naked-Shorting-Rage:-Goldmans-Lobbying,-SECs-Fail 

Now, off we go to Goldman Sachs' notorious lobbying hubris, the historically-annotated, umpteenth oversight failure of the Securities Exchange Commission ("SEC"), and what I'm quickly realizing may well turnout to be the story with regard to it becoming the poster child for regulatory capture and supervisory breakdown as far as our Wall Street-based corporatocracy/oligarchy is concerned. Here's the link to Taibbi's preview blog post: "An Inside Look at How Goldman Sachs Lobbies the Senate."

Yesterday, as described in this lead-in piece from the Wall Street Journal, the SEC held a public roundtable discussion on "New Rules for Lending of Securities." (See link here:  "SEC Weighs New Rules for Lending of Securities.")

SEC Weighs New Rules for Lending of Securities
BY KARA SCANNELL AND CRAIG KARMIN
Wall Street Journal
Saturday, September 26th, 2009

Securities regulators are exploring new regulations for the multitrillion-dollar securities-lending market, the first major step regulators have taken in the area in decades.

Securities and Exchange Commission Chairman Mary Schapiro said she wants to shine a light on the "opaque market." After many large investors lost millions in last year's credit crunch, she said, "we need to consider ways to enhance investor-oriented oversight."

The SEC is holding a public round table Tuesday to explore several issues around securities lending, which has expanded into a big moneymaker for Wall Street firms and pension funds. Regulation hasn't kept pace, some industry participants...
 

Enter Taibbi: "An Inside Look at How Goldman Sachs Lobbies the Senate."

An Inside Look at How Goldman Sachs Lobbies the Senate
Matt Taibbi
TruSlant.com
(very early) Tuesday, September 29th, 2009

 

The SEC is holding a public round table Tuesday to explore several issues around securities lending, which has expanded into a big moneymaker for Wall Street firms and pension funds. Regulation hasn't kept pace, some industry participants contend. Securities lending is central to the practice of short selling, in which investors borrow shares and sell them in a bet that the price will decline. Short sellers later hope to buy back the shares at a lower price and return them to the securities lender, booking a profit. Lending and borrowing also help market makers keep stock trading functioning smoothly.

--SNIP--

Later on this week I have a story coming out in Rolling Stone that looks at the history of the Bear Stearns and Lehman Brothers collapses. The story ends up being more about naked short-selling and the role it played in those incidents than I had originally planned -- when I first started looking at the story months ago, I had some other issues in mind, but it turns out that there's no way to talk about Bear and Lehman without going into the weeds of naked short-selling, and to do that takes up a lot of magazine inches. So among other things, this issue takes up a lot of space in the upcoming story.

Naked short-selling is a kind of counterfeiting scheme in which short-sellers sell shares of stock they either don't have or won't deliver to the buyer. The piece gets into all of this, so I won't repeat the full description in this space now. But as this week goes on I'm going to be putting up on this site information I had to leave out of the magazine article, as well as some more timely material that I'm only just getting now.

Included in that last category is some of the fallout from this week's SEC "round table" on the naked short-selling issue.

The real significance of the naked short-selling issue isn't so much the actual volume of the behavior, i.e. the concrete effect it has on the market and on individual companies -- and that has been significant, don't get me wrong -- but the fact that the practice is absurdly widespread and takes place right under the noses of the regulators, and really nothing is ever done about it.

It's the conspicuousness of the crime that is the issue here, and the degree to which the SEC and the other financial regulators have proven themselves completely incapable of addressing the issue seriously, constantly giving in to the demands of the major banks to pare back (or shelf altogether) planned regulatory actions. There probably isn't a better example of "regulatory capture," i.e. the phenomenon of regulators being captives of the industry they ostensibly regulate, than this issue.
 

Taibbi continues on to inform us that none of the invited speakers to this government-sponsored event represented stockholders or companies that could, or have, become targets/victims of naked short-selling. Also "...no activists of any kind in favor of tougher rules against the practice. Instead, all of the invitees are (were) either banks, financial firms, or companies that sell stuff to the first two groups."

Taibbi then informs us that there is only one panelist invited that's in favor of what may be, perhaps, the most basic level of regulatory control with regard to this industry practice: a "simple reform" called "pre-borrowing." Pre-borrowing requires short-sellers to actually possess the stock shares before they're sold.

It's been proven to work, as last summer the SEC, concerned about predatory naked short-selling of big companies in the wake of the Bear Stearns wipeout, instituted a temporary pre-borrow requirement for the shares of 19 fat cat companies (no other companies were worth protecting, apparently). Naked shorting of those firms dropped off almost completely during that time.

The lack of pre-borrow voices invited to this panel is analogous to the Max Baucus health care round table last spring, when no single-payer advocates were invited. So who will get to speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a hedge fund that has done the occasional short sale, to put it gently), Credit Suisse, NYSE Euronext, and so on.

Taibbi then tells us of increased efforts by industry players, specifically noting Goldman Sachs being at the forefront of this effort,  and having "their presence felt."

Taibbi mentioned that he'd received two completely separate calls from two congressional staffers from different offices--folks whom Taibbi never met before--who felt compelled to inform him of Goldman's actions.

We learn that these folks both commented on how these Goldman folks were lobbying against restrictions on naked short-selling. One of the aides told Taibbi that they had passed out a "fact sheet about the issue that was so ridiculous that one of the other staffers immediately thought to send it to me. "

I would later hear that Senate aides between themselves had discussed Goldman's lobbying efforts and concluded that it was one of the most shameless performances they'd ever seen from any group of lobbyists, and that the "fact sheet" the company had had the balls to hand to sitting U.S. Senators was, to quote one person familiar with the situation, "disgraceful" and "hilarious."

Checkout the whole story on his blog. Apparently, in the upcoming Rolling Stone piece, he gets into the nitty gritty with regard to how naked short-selling brought down both Bear Stearns and Lehman, last  year.

Should be pretty powerful stuff.

Meanwhile, getting back to the SEC roundtable, noted above, strike up the fifth item that I've now documented in the past 48 hours where it's becoming self-evident that our elected representatives and our government agencies aren't even bothering to author the new regulations and legislation that's so needed to prevent a recurrence of events such as those we witnessed through the economic/market catastrophes of the past 24 months; these legislators and high-ranking government officials are actually having the lobbyists navigate the discussion and write the damn stuff, too!

How much worse can it get? I really don't want to know the answer  to that rhetorical question. But, with the inmates running the asylum, we may just find out sooner than we think!

Bailing Out Big Banks Engaged in Sleaze and Sex
"Goldman Laid Down with Dogs," by Ryan Chittum, Columbia Journalism Review, November 4, 2009 ---
http://www.cjr.org/index.php 
This link was forwarded by my friend Larry.

Dean Starkman has been applauding McClatchy’s series on Goldman Sachs (an Audit funder) for a couple of days now. Add another Audit appreciation today.

McClatchy has been doing what Dean has been calling for for a long time now: Looking much more closely at how Wall Street fueled the mortgage crisis and how it was deeply connected to the shadier parts of the housing industry. Or as McClatchy’s Greg Gordon puts it:

… one of Wall Street’s proudest and most prestigious firms helped create a market for junk mortgages, contributing to the economic morass that’s cost millions of Americans their jobs and their homes.

Today, McClatchy examines Goldman’s relationship with New Century Financial, a firm that was something of the canary in the coalmine of this financial crisis—it was the second-biggest subprime mortgage lender when it went belly-up in April 2007, which was very, very early. In other words, it was one of the worst actors in the whole mess:

Perhaps no mortgage lender was more emblematic of the go-go atmosphere in the sprouting industry that was seizing an outsize share of the home loan market.

 

Traversing the country in private jets and zipping around Southern California in Mercedes Benzes, Porsches and even a Lamborghini, New Century executives reveled as the firm’s annual residential mortgage sales rocketed from $357 million in 1996 to nearly $60 billion a decade later…

What does that have to do with Goldman Sachs and Wall Street?

For $100 million in mortgages, New Century could command fees from Wall Street of $4 million to $11 million, ex-employees told McClatchy. The goal was to close loans fast, bundle them into pools and sell them to generate money for the next round.

 

Inside the mortgage company, the former employees said, pressure was intense to increase the firm’s share of an exploding market for mortgages that depended almost entirely on Wall Street’s seemingly unlimited hunger for bigger, faster returns.

Aha! But wait—why did Wall Street want to buy this trash?

Goldman and other investment banks could put $20 million in the till by taking a 1 percent fee for assembling, securitizing and selling a $2 billion pool of mostly triple-A rated bonds backed by subprime loans — and that was just stage one.

That takes you toThe Giant Pool of Money.” And that was far from the only juice being squeezed from these lemons. Goldman et al got servicing fees and the like, plus they “extended lines of credit to New Century — known as “warehouse loans” — totaling billions of dollars to finance the issuance of more home loans to other marginal borrowers. Goldman Sachs’ mortgage subsidiary gave the firm a $450 million credit line.”

In other words, Wall Street lent the money to the predatory firms to create the shady loans so it could buy them from them, slice them into securities and sell them to the greater fools. This was so profitable there weren’t enough decent loans to be made. So to feed the beast, mortgage lenders came up with disastrous inventions like NINJA loans (No Income, No Jobs, No Assets) and Wall Street, ahem, looked the other way.

It was a vicious circle of profit (virtuous—if you were one of those who lined their pockets through it) and was interrupted only when the underlying loans got so bad that borrowers like the ones with no income, no jobs, and no assets in many instances couldn’t even make a single payment on the loan. Panic!

McClatchy does well to report on the New Century culture, helpful in illustrating the lie-down-with-dogs-get-up-with-fleas thing, writing about the sexualization of some of the work, something reminds us of BusinessWeek’s fascinating story on the subprime industry’s descent into decadence (the sub headline on that one should be all that’s needed to entice you to read that one: “The sexual favors, whistleblower intimidation, and routine fraud behind the fiasco that has triggered the global financial crisis.”)

But it wasn’t just sex. New Century was giving kickbacks to mortgage brokers to get their loans, McClatchy quotes a former top underwriter there as saying.

Let’s not forget, and McClatchy doesn’t, thankfully, that borrowers were the marks here and took it on the chin:

The loans laid out financial terms that protected investors but punished homebuyers. They offered above-market interest rates, typically starting at 8 percent, with provisions that Lee said were “rigged” to guarantee the maximum 3 percent rise in interest rates after two years and almost assuredly another 3 percent increase through ensuing, twice-yearly adjustments.

This is top-notch work by McClatchy. It deserves a wide airing.

Bob Jensen's threads on Bailing Out Big Banks and Mortgage Companies Engaged in Sleaze and Sex ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze

 


 

A Step Back in History


Marvene is a poor and unemployed elderly woman who lost her shack to foreclosure in 2008.
That's after Marvene stole over $100,000 when she refinanced her shack with a subprime mortgage in 2007.
Marvene wants to steal some more or at least get her shack back for free.
Both the Executive and Congressional branches of the U.S. Government want to give more to poor Marvene.
Why don't I feel the least bit sorry for poor Marvene?
Somehow I don't think she was the victim of unscrupulous mortgage brokers and property value appraisers.
More than likely she was a co-conspirator in need of $75,000 just to pay creditors bearing down in 2007.
She purchased the shack for $3,500 about 40 years ago --- http://online.wsj.com/article/SB123093614987850083.html

 


Marvene Halterman, an unemployed Arizona woman with a long history of creditors, took out a $103,000 mortgage on her 576 square-foot-house in 2007. Within a year she stopped making payments. Now the investors with an interest in the house will likely recoup only $15,000.
The Wall Street Journal slide show of indoor and outdoor pictures --- http://online.wsj.com/article/SB123093614987850083.html#articleTabs%3Dslideshow
Jensen Comment
The $15,000 is mostly the value of the lot since at the time the mortgage was granted the shack was virtually worthless even though corrupt mortgage brokers and appraisers put a fraudulent value on the shack. Bob Jensen's threads on these subprime mortgage frauds are at http://www.trinity.edu/rjensen/2008Bailout.htm
Probably the most common type of fraud in the Savings and Loan debacle of the 1980s was real estate investment fraud. The same can be said of the 21st Century subprime mortgage fraud. Welcome to fair value accounting that will soon have us relying upon real estate appraisers to revalue business real estate on business balance sheets --- http://www.trinity.edu/rjensen/Theory01.htm#FairValue

The Rest of Marvene's Story --- http://www.trinity.edu/rjensen/FraudMarvene.htm

Accounting Implications

 

CEO to his accountant:  "What is our net earnings this year?"
Accountant to CEO:  "What net earnings figure do you want to report?"

The sad thing is that Lehman, AIG, CitiBank, Bear Stearns, the Country Wide subsidiary of Bank America, Fannie Mae, Freddie Mac, etc. bought these
subprime mortgages at face value and their Big 4 auditors supposedly remained unaware of the millions upon millions of valuation frauds in the investments. Does professionalism in auditing have a stronger stench since Enron?
Where were the big-time auditors? --- http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

 

September 30, 1999

Fannie Mae Eases Credit To Aid Mortgage Lending

By STEVEN A. HOLMES

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.'' 
Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the Americ an Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Under Fannie Mae's pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000 -- a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped.

Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary mark et. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

 

 

The best place to begin reading about this 2008 Wall Street bailout is at http://en.wikipedia.org/wiki/United_States_housing_bubble
It's important to understand how the housing bubble grew and then burst before even thinking about understanding the bailouts to date and the pending bailouts still tied up in Congress. Those who are accounting and finance geeks can get a lot more out of the Fannie Mae Website and in particular Fannie's Investor Relations site --- http://www.fanniemae.com/ir/index.jhtml;jsessionid=5PA54Q3LN1BS5J2FQSISFGI?p=Investor+Relations
After previously being caught with accounting fraud for purposes of padding executive bonuses, having to change auditors from KPMG to PwC (as mandated by the government), and putting Dennis Beresford in charge of the Audit Committee, Fannie made a monumental effort to use proper accounting and make full (really too full) disclosures (but without mentioning Barney Frank by name).

Doctors, hospitals, medical labs, pharmaceutical companies, and medical equipment dealers get taxpayer dollars by directly billing the Medicare and Medicaid "programs." When farmers and agri-businesses get their government checks they come from farm aid/subsidy "programs." There are countless U.S. Government "programs" that divert taxpayer dollars into corporations annually. Government diverts a lot of taxpayer dollars to K-12 schools and higher education through a vast array of education and research "programs."

Sometimes a "program" merely entails government backing of loans in case a company fails. This was the intent of the Fannie Mae and Freddie Mack quasi-public corporations. As long as Fannie Mae and Freddie Mack could attract equity capital and business loans, cash from taxpayers was not necessary. But if Fannie and Freddie should be on the verge of bankruptcy, loans were in most cases backed by the U.S. Government and might have to be paid off with taxpayer dollars. In the case of Fannie and Freddie at the moment, however, there is almost no chance of having the government pay off troublesome debts and then let Fannie and Freddie try to continue on their own. Equity shareholders lost their money in Fannie/Freddie common stock and are not about to invest in corporations that suddenly have little hope for profits because of Congressional mandates to lend billions to people who have little chance to pay off their mortgages owned by Fannie and Freddie.

A one-time government intervention to save a failing company is generally called a "bailout" instead of a "program." Government intervention can take on a wide range of forms. In some instances, a government may lend a failing business cash with an expectation that the loan will be repaid, possibly with interest. In some instances the government may also insist on options for equity share ownership in the bailed out company. In other instances the government will provide a gift in the form of a grant and may or may not receive benefits in return. For example, government may have an interest in the results of a research grant that initially is little more than a bailout gift. If Bath Iron Works was on the verge of bankruptcy, the government would probably give it contracts for new Navy ships. The military does not want most of its major suppliers to fail.

Probably the most interesting and successful bailout in history was the U.S. Government bailout of Chrysler Corporation in 1979.

The Chrysler Corporation on September 7, 1979 petitioned the United States government for US$1.5 billion in loan guarantees to avoid bankruptcy. At the same time former Ford executive Lee Iacocca was brought in as CEO. He proved to be a capable public spokesman, appearing in advertisements to advise customers that "If you find a better car, buy it." He would also provide a rallying point for Japan-bashing and instilling pride in American products. His book Talking Straight was a response to Akio Morita's Made in Japan.

The United States Congress reluctantly passed the "Chrysler Corporation Loan Guarantee Act of 1979" (Public Law 96-185) on December 20, 1979 (signed into law by President Jimmy Carter on January 7, 1980), prodded by Chrysler workers and dealers in every Congressional district who feared the loss of their livelihoods. The military then bought thousands of Dodge pickup trucks which entered military service as the Commercial Utility Cargo Vehicle M-880 Series. With such help and a few innovative cars (such as the K-car platform), especially the invention of the minivan concept, Chrysler avoided bankruptcy and slowly recovered.

In February 1982 Chrysler announced the sale of Chrysler Defense, its profitable defense subsidiary to General Dynamics for US$348.5 million. The sale was completed in March 1982 for the revised figure of US$336.1 million.[7]

By the early 1980s, the loans were being repaid at a brisk pace and new models based on the K-car platform were selling well. A joint venture with Mitsubishi called Diamond Star Motors strengthened the company's hand in the small car market. Chrysler acquired American Motors Corporation (AMC) in 1987, primarily for its Jeep brand, although the failing Eagle Premier would be the basis for the Chrysler LH platform sedans. This bolstered the firm, although Chrysler was still the weakest of the Big Three.

Another significant aspect of Chrysler's recovery was the revitalization of the company's manufacturing facilities, led by Richard Dauch[citation needed]. The factories were streamlined with more efficient machinery, more robots, better paint equipment, and so on[vague][citation needed]. The resultant improvements in efficiency and vehicle quality played a big role in saving the company.

In the early 1990s, Chrysler made its first steps back into Europe, setting up car production in Austria, and beginning right hand drive manufacture of certain Jeep models in a 1993 return to the UK market. The continuing popularity of Jeep, bold new models for the domestic market such as the Dodge Ram pickup, Dodge Viper (badged as "Chrysler Viper" in Europe) sports car, and Plymouth Prowler hot rod, and new "cab forward" front-wheel drive LH sedans put the company in a strong position as the decade waned.

Congress passed the bill 21 December 1979, but with strings attached. Congress required Chrysler to obtain private financing for $1.5 billion -- the government was co-signing the note, not printing the money -- and to obtain another $2 billion in "commitments or concessions [that] can be arranged by Chrysler for the financing of its operations." One of those options, of course, was reduce employees wages; in prior discussions, the union had failed to budge, but the contingent guarantee moved the union. On 7 January 1980, Carter signed the legislation (Public Law 86-185):
 

(Liberal) Economist John Kenneth Galbraith suggested that taxpayers be "accorded an appropriate equity or ownership position" for the loan. "This is thought a reasonable claim by people who are putting up capital."

Under the leadership of Lee Iacocca, Chrysler doubled its corporate average miles-per-gallon (CAFE). In 1978, Chrysler introduced the first domestically produced front-wheel drive small cars: the Dodge Omni and Plymouth Horizon.

In 1983, Chrysler paid off the loans that had been guaranteed by US taxpayers. The Treasury was also $350 million richer.

The problem in 2008 with AIG, and the huge Wall Street firms like Bear Stearns, Lehman, Merrill Lynch, and the others now desperate for liquidity, is that they financed their long-term mortgage investment portfolios with short term borrowing from Paul that is now due. Paul refuses to extend the payment maturities, and Peter will not loan the money to these giants desperate to pay off Paul and stave off bankruptcy. How they got into this mess is complicated, but the bottom line is that de-regulation in the Ronald Reagan era allowed these investment companies to become commercial banks and vice versa. As such they could use short-term demand deposits from Paul to finance long-term investments like mortgages purchased from local banks who participated in the sub-prime frauds to make home loans to people who could not possibly afford to make the payments once the low starting rates kicked up to higher rates.

So where does AIG's bailout money go?
Remember that AIG, unlike Bear Stearns, Lehman Brothers, and Merrill Lynch, is primarily an insurance company. As such it entered into heavy credit default swaps which are derivative financial instruments that protect against a swap counterparties bad debt losses due to customers' credit downgrades. For example, if the counterparty holds fixed rate investments such that values plunge if the customer's credit rating plunges, the counter parties receive swap payments based the decline in the value of the debt that is defaulted. Credit default swaps are virtual insurance policies protecting against a default under the debt instrument. However, because the the debt itself can be virtual (i.e., no real default loss transpires), counterparties can speculate using credit default swaps. And unlike insurance contracts, credit default swaps until very recently are unregulated.

The three firms that dominate the $5 billion-a-year credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch Ratings - have been faulted for failing to identify risks in subprime mortgage investments, whose collapse helped set off the global financial crisis. The rating agencies had to downgrade thousands of securities backed by mortgages as home-loan delinquencies have soared and the value of those investments plummeted. The downgrades have contributed to hundreds of billions in losses and writedowns at major banks and investment firms. The agencies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company's ability to raise or borrow money, and at what cost which securities will be purchased by banks, mutual funds, state pension funds or local governments. A yearlong review by the SEC, which issued the results last summer, found that the three big (credit rating) agencies failed to rein in conflicts of interest in giving high ratings to risky securities backed by subprime mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November 19, 2008 --- http://accounting.smartpros.com/x63855.xml

"Florida stands to lose $1 billion because of Lehman Brothers' bankruptcy," by Sydney P. Freeberg and Connie Humburg, St. Petersburg Times, June 5, 2009 http://www.tampabay.com/news/politics/article1007445.ece

A price tag is now emerging for what last year's collapse of investment giant Lehman Brothers could cost the state of Florida: more than $1 billion.

The losses could make Florida and its citizens among the biggest casualties in the biggest bankruptcy ever.

More than $440 million disappeared from the pension fund that pays benefits for some 1 million retirees and public employees.

Counties, cities and school districts face a loss of more than $300 million for roads, sewers and schools.

The state has $290 million less to pay for everything from hurricane claims to health care, community colleges and care for infants with disabilities.

While the general losses have been expected, this is the first public accounting of the magnitude of the Lehman-related public losses for Florida.

The outlook is bleak in bankruptcy court. In years to come, the state will be lucky to collect pennies on the dollar.

In an interview, even the ever-optimistic Gov. Charlie Crist could not muster a sunny side: "It is, to say the least, an unfortunate situation.''

• • •

Lehman Brothers, which built the nation's railroads and survived the Great Depression, filed for bankruptcy protection last September.

Its failure sank banks and stocks, but the fallout reverberated far beyond Wall Street.

In Florida, Lehman Brothers was an icon of finance and real estate, managing public assets, selling securities, underwriting bond deals and handling residential and commercial mortgages.

In the last decade, Florida paid Lehman at least $27 million in fees for managing public investments and brokering and underwriting bond deals.

The storied bank hired former Gov. Jeb Bush as a consultant in June 2007, five months after he left office. As governor, Bush also served as a trustee for the State Board of Administration, which invests public money.

Lehman was the dominant Wall Street broker that sold the SBA $1.4 billion of risky, mortgage-related securities that started tanking in August 2007.

Bush has said he had nothing to do with those sales.

"As Governor Bush has stated several times in response to your inquiries, his role as a consultant to Lehman Brothers was in no way related to any Florida investments,'' said his spokeswoman, Kristy Campbell.

"It is unfortunate the St. Petersburg Times continues to perpetuate this incorrect and baseless conjecture.''

"Your Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson, The New York Times, September 20, 2008 --- http://www.nytimes.com/2008/09/21/business/21gret.html

If federal regulators and political leaders want to earn back some trust, they could do two things. First, they could provide us with some transparency about whom precisely we are backing in the recent bailouts.

Take, for example, the rescue on Tuesday of the American International Group, once the world’s largest insurance company. It was pretty breathtaking. Since when do insurance companies, whose business models seem to consist of taking in premiums and stonewalling claims, deserve rescues from beleaguered taxpayers?

Answer: Ever since the world became so intertwined that the failure of one company can topple a host of others. And ever since credit default swaps, those unregulated derivative contracts that allow investors to bet on a debt issuer’s financial prospects, loomed so big on balance sheets that they now drive every bailout decision.

The deal to save A.I.G. involves a two-year, $85 billion loan from taxpayers. In exchange, the new owners — us — get 80 percent of the company. If enough of A.I.G.’s assets are sold for good prices, we may get our money back.

Credit default swaps, which operate like insurance policies against the possibility that an issuer of debt will not pay on its obligations, were the single biggest motivator behind the A.I.G. deal.

A.I.G. had written $441 billion in credit insurance on mortgage-related securities whose values have declined; if A.I.G. were to fail, all the institutions that bought the insurance would have been subject to enormous losses. The ripple effect could have turned into a tsunami.

So, the $85 billion loan to A.I.G. was really a bailout of the company’s counterparties or trading partners.

Now, inquiring minds want to know, whom did we rescue? Which large, wealthy financial institutions — counterparties to A.I.G.’s derivatives contracts — benefited from the taxpayers’ $85 billion loan? Were their representatives involved in the talks that resulted in the last-minute loan?

And did Lehman Brothers not get bailed out because those favored institutions were not on the hook if it failed?

We’ll probably never know the answers to these troubling questions. But by keeping taxpayers in the dark, regulators continue to earn our mistrust. As long as we are not told whom we have bailed out, we will be justified in suspecting that a favored few are making gains on our dimes.

A.I.G.’s financial statements provided a clue to the identities of some of its credit default swap counterparties. The company said that almost three-quarters of the $441 billion it had written on soured mortgage securities was bought by European banks. The banks bought the insurance to reduce the amounts of capital they were required by regulators to set aside to cover future losses.

Enjoy the absurdity: Billions in unregulated derivatives that were about to take down the insurance company that sold them were bought by banks to get around their regulatory capital requirements intended to rein in risk.

Got that?

Which brings us to Item 2 for policy makers. Stop pretending that the $62 trillion market for credit default swaps does not need regulatory oversight. Warren E. Buffett was not engaging in hyperbole when he called these things financial weapons of mass destruction.

“The last eight years have been about permitting derivatives to explode, knowing they were unregulated,” said Eric R. Dinallo, New York’s superintendent of insurance. “It’s about what the government chose not to regulate, measured in dollars. And that is what shook the world.”

Continued in article

Also see "A.I.G., Where Taxpayers’ Dollars Go to Die," The New York Times, March 7, 2009 --- http://www.nytimes.com/2009/03/08/business/08gret.html

Bob Jensen's threads on accounting for credit default swaps are under the C-terms at
http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms

These Main Street lenders also lied about the values of the homes that they knew were appraised way above what could be recovered in foreclosures. Although I think Wall Street's infectious greed was a huge part of the sub-prime frauds, the roots of the deception are firmly planted along Main Street USA (e.g., Countrywide Financial, a subsidiary of Bank of America) where local lenders passed on (fenced?) fraudulent loans all the way up the mortgage system.

Many Main Street borrowers themselves who signed sub-prime mortgages, at almost no down payments, knew full well that for a short while they could make payments at the early subprime teaser interest rates. But they also knew full well that they could not sustain mortgage payments once the higher rates kicked in on their mortgage contracts. But their plan was to sell the house when the higher interest rates kicked in and profit from the increase in home values while they paid on the basis of the teaser rates. The flaw was their assumption that housing values just keep increasing like they did since the end of World War II.  These buyers never counted on the bursting of the sub-prime real estate bubble.

Congress has not yet agreed to the additional $700  billion bailout of other big Wall Street investment banks, and how far it will go is yet to be decided in, gasp, Congress. The government did bail out AIG. The 2008 bail out of AIG has hope for taxpayers that was similar to the hope for Chrysler in 1979. The U.S. Government is loaning the AIG enormous insurance conglomerate $85 billion with an option to acquire ownership of 80% of AIG if and when AIG's fortunes are turned around. Since AIG is so enormous globally, I predict this could be a very good deal for taxpayers unless our idiotic Congress fails to resell its AIG shares and attempts to turn the insurance industry into a Fannie Mae fiasco.

Now we come to the 2008 additional proposed bailouts of more banks and investment banks across the nation borrowed from Paul to buy the same fraudulent sub-prime mortgages from thousands of local banks around the nation. Many homeowners at all levels of income and home values cannot possibly pay off these mortgages. Foreclosures will only return half or less of what Fannie, Freddie, and the Men in Black on Wall Street paid for the fraudulent mortgages. There's still much debate on how much mortgage buying conglomerates knew about the frauds perpetrated on Main Street that were passed on to Fannie, Freddie, and Wall Street. Most of this is bullshit!
See how it really worked (hit the arrow keys to move forward or backward) --- Click Here

The Men in Black on Wall Street knew full well that their sub-prime mortgages, purchased with short-term debt, had loan values well in excess of mortgage collateral (due to phony real estate appraisals on Main Street) and were likely to become non-performing when the cheap starting sub-prime interest rates kicked up to very high interest rates that made payments well in excess of what many buyers could afford. The problem is that the Men in Black were too greedy to care about risks imposed on their own investment banks. Like drug dealers who cut cocaine bags into crack, the Men in Black cut fraudulent sub-prime mortgages that they purchased into CDOs (collateralized debt obligations) that they then sold for huge commissions/bonuses to unsuspecting investors (many from across the Atlantic and Pacific).

In the current environment, I am an ardent supporter of those who would resist calls to suspend fair value accounting rules. But, when I was at the SEC, I had a front-row seat on what was perhaps one of the most brazen abuses of fair value accounting in history. I was reminded of it by Joseph Stiglitz's recent commentary on CNN.com, in which he characterized the mortgage securitization craze as just another pyramid scheme. Keep that in mind as I tell you the story of Stephen Hoffenberg's $400 million fraud.
Tom Selling, "The Anti-Fair Value Lobby Has a Point (Even if They Don't Know It)" The Accounting Onion, September 22, 2008 --- http://accountingonion.typepad.com/

The greedy, greedy, greedy Men in Black (read that Wall Street bankers) got their CDO sales commissions/bonuses with no regard that those sales were with recourse such that when the loans defaulted, the fraudulent loans would eventually become "junk" or "trash" paper bought back by their employers such as Bear Stearns, AIG, Lehman, Merrill Lynch, etc. In other words the Men in Black got their CDO sales commissions knowing full well shareholders in their banks would ultimately take a huge hit!!!

Bankers (Men in Black) bet with their bank's capital, not their own. If the bet goes right, they get a huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital Louria Hahn, "Missing:  How Poor Risk-Management Techniques Contributed to the Subprime Mess," CFO Magazine, March 2008, Page 53 --- http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Government is going to bail out these speculators with taxpayer funds makes it all the worse.

Peter Pan, the manager of Countrywide Financial on Main Street, thought he had little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures would be Wall Street’s problems and not his local bank’s problems. And he got his nice little commission on the sale of the Emma Nobody’s mortgage for $180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was almost certain in Emma’s case because she only makes $12,000 waitressing at the Country Café. So what if Peter Pan fudged her income a mite in the loan application along with the fudged home appraisal value? Let Wall Street or Fat Fannie or Foolish Freddie worry about Emma after closing the pre-approved mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over millions of wealthy shareholders of Wall Street investment banks. Peter Pan is more concerned with his own conventional mortgage on his precious house just two blocks south of Main Street. This is what happens when risk is spread even farther than Tinkerbell can fly!
For details see http://papers.nber.org/papers/w14358
Read about the extent of cheating, sleaze, and subprime sex on Main Street in Appendix U.

At the moment the initial 2008 Treasury Department bailout plan does not have conditions anywhere close to the 1979 bailout plan for Chrysler --- which in many ways were punitive conditions that made Chrysler pay dearly for past mistakes. In fact the 2008 bailout initially proposed by the Treasury Department to Congress only entails buying up paper trash owned by the Men in Black from Wall Street for $700 billion --- way above the recycled worth of the trash. There were no other conditions in the initial bailout proposal. The Men in Black who dealt in this trash on Wall Street would still get their millions in compensation in some form or another. Many of them would stay in the business of inventing newer types of creative trash that they could foist on investors at enormous commissions. Along the way they will do some good by inventing creative financing that brings us such good companies as Google.

Here are some of some of the unmentioned problems in the Treasury Department bailout plan of 2008 that were not part of the 1979 Chrysler bailout"

  1. After the 2008 bailout was first proposed, the media and Congress jumped on the wrong concerns such as the fairness issue of multimillion bailout rewards to Men in Black who got us into this mess. Concerns are also being raised that the poor people on Main Street who lost or are losing their homes are not being compensated. Little mention is made that the people losing their homes probably put nothing or very little into the homes since the sub-prime mortgage deals being offered entailed little or no down payments.

     
  2. At the moment in the Autumn of 2008 both the media and Congress are not looking closely enough into the "trash" or "junk" that the Men in Black are trying to sell (foist is a better word) to the U.S. Government at values no doubt much greater than a true fair value --- value that cannot really be determined in this busted real estate market.
     
  3. Ignoring the more complex derivative financial instruments losers, other "junkers" are trash paper mortgages on non-performing or under-performing mortgage investments. A non-performing piece of paper is typically collateral on a vacant foreclosed house and its lot. Perhaps the loan was for $300,000 on property that is not selling at the moment for $150,000. These collateral values and foreclosure prices range across the board, but in the case of a $300,000 loan the Men in Black will probably negotiate a bailout price of something like $150,000 or maybe even somewhat less. Now that sounds like a possibly good deal if the Treasury Department can wait it out until the real estate market recovers a bit and the property can be sold for more than the bailout price.              

    But even really bad accountants know better in the case of real estate and horses!

     
  4. At the moment Congress is not proposing to look closely enough into the mouth of each horse it will be buying in the bailout. In the case of a purchased horse the buyer has to feed it, shelter it, pay the veterinarian bills and tie up money invested. In the case of the bailout "trash paper," the Men in Black are darned tired of having to pay the bills on foreclosed real estate --- the lawyer fees, the property taxes, the casualty insurance premiums, and the maintenance bills for security, repairs, pest control, lawn mowing, pool cleaning, and on and on and on. And don't forget the time value of money lost if $150,000 in cash is tied up for ten years at zero interest.
     
  5. I think the reason the Men in Black are so willing to sell their trash at discount (call that bailout) prices is that they're smarter than the media and Congress. The Men in Black suspect they will otherwise have to give the foreclosed properties away just to get out of all the dreaded home ownership costs.
     
  6. What I fear is that, if the Men in Black are willing to forego a year's salary or 90% of their severance pay, our naive Congress will take the Treasury Department's bailout deal. Obama makes a big deal about how many houses John McCain now owns. Ha! Either Barack Obama or John McCain will soon have to start paying the ownership costs of 5 million empty houses. The only thing to do with these burdens will be one of the following:


    (1) pay years and years of losing ownership costs until offers are received somewhere close to bailout prices (probably the McCain solution since with a rich wife he personally does not pay attention to interim home ownership costs) or


     (2) unload the houses at way below bailout prices so that taxpayers lose big time or



    (3) give the vacant houses to poor people (probably the Obama populist solution).
     
  7. But there's a downside to giving the foreclosed empty houses to poor people. Most poor people probably cannot afford to pay the property taxes and the other costs of home ownership. They will sell their magnificent gift houses for whatever they can get, have some really good times afforded from the proceeds, and then go back into public housing or apply for rent subsidies. So much for populism that only brings on a few days of good times.
     
  8. In a bailout purchase of trash paper be careful of what you wish for --- you may get what you wished for. The concept of loan collateral used to mean that the collateral had greater value then the amount loaned --- so that, in case of default, the collateral would cover the loan. The roots of this crisis lie in the loans made by mortgage lenders on Main Street (e.g., Bank of America’s Countrywide Finance that made loans at phony collateral values when the actual collateral values were way less than the loan amounts).
     
  9. The magnitude of the ultimate loss to taxpayers is likely to be much less unless the bailout fails to keep the economy out a deep depression and/or Congress tinkers with the bailout to make it an opportunity to make a populist wealth transfer from taxpayers to non-taxpayers.

Still, we have to consider potential risks of these governmental actions. Taxpayers may be stuck with hundreds of billions, and perhaps more than a trillion, dollars of losses from the various insurance and other government commitments. Although the media has nade much of this possibility through headlines like "$750 billion bailout", that magnitude of loss is highly unlikely as long as the economy does not fall into a sustained major depression. I consider such a depression highly unlikely. Indeed, the government may well make money on its actions, just as the Resolution Trust Corporation that took over many saving and loan banks during the 1980s crisis did not lose much, if any, money. By buying assets when they are depressed and waiting out the crisis, there may be a profit on these assets when they are finally sold back to the private sector. Making money does not mean the government involvements were wise, but the likely losses to taxpayers are being greatly exaggerated. Future moral hazards created by these actions are certainly worrisome. On the one hand, the equity of stockholders and of management in Fannie and Freddie, Bears Stern, AIG, and Lehman Brothers have been almost completely wiped out, so they were not spared major losses. On the other hand, that makes it difficult to raise additional equity for companies in trouble because suppliers of equity would expect their capital to be wiped out in any future forced governmental assistance program. Furthermore, that bondholders in Bears Stern and these other companies were almost completely protected implies that future financing will be biased toward bonds and away from equities since bondholders will expect protections against governmental responses to future adversities that are not available to equity participants. Although the government was apparently concerned that foreign central banks were major holders of the bonds of the Freddies, I believe it was unwise to give them and other bondholders such full protection.
Nobel Laureate Gary Becker, The Becker-Posner Blog, September 21, 2008 --- http://www.becker-posner-blog.com/

Jensen Comment
I think this is baloney, because Becker does not factor in the cost of "ownership" of millions of empty houses acquired in the bailout. This will destroy the opportunity to recover what the bad debts in the bailout's reverse auction initially cost the government. The real problem is the subsequent costs added to the auctioned costs.




Unregulated investment banking on a large scale has probably ended in 2008 --- See Appendix D of this paper.

Real Estate Nobody Wants
Sharon Little says she was shocked to find out she was still listed as the owner of a rental property on a busy Cleveland street. She walked away from the house in 2006 when she declared bankruptcy. Since then, thieves have stripped the house of siding, copper plumbing, and even windows. She found out her name was still on the deed only when she got a summons last October to appear in housing court. "Eventually, they're going to tear this house down," Little says. "Somebody's going to have to foot the bill, and frankly I think it should be the bank because it's their house. It's not my house really, so ..."
Mhari Saito, "Banks Refusing to Take Back Foreclosed Properties," NPR, March 8, 2009 --- http://www.npr.org/templates/story/story.php?storyId=101386052
Jensen Comment
The former owner doesn't want the property. The mortgage holder forgave the loan but does not want title to the foreclosed property. The city by all rights should take title to the property for back taxes, but the city knows nobody will even pay the back taxes on the property. These properties are like hazardous waste sites without the hazardous wastes. It's simply that the value of the property is less than the cost of property taxes, maintenance, and insurance with no improvement in the property's value in sight.

That some bankers have ended up in prison is not a matter of scandal, but what is outrageous is the fact that all the others are free.
Honoré de Balzac

The bourgeoisie can be termed as any group of people who are discontented with what they have, but satisfied with what they are
Nicolás Dávila


"Fatal Risk: The Must-Read Story Of AIG's Downfall," by John Hemton, Business Insider, April 18, 2011 ---
http://www.businessinsider.com/fatal-risk-the-must-read-story-of-aigs-downfall-2011-4

There are dozens of books on the financial crisis: I have read many of them and the Kindle samples for just about all of them. There are only two I would recommend: those are Bethany McLean and Joe Nocera’s excellent All the Devils are Here and the much more specifically detailed Fatal Risk from Roddy Boyd. Roddy's book is solely concerned with the failure of AIG.

Both books start without any strong ideological preconceptions and let the facts woven into a good story do the talking - and both wind up ambivalent about many of the major players - with many players having human weaknesses (gullibility, delusion, arrogance etc) but committing nothing that looks like a strong case for criminal prosecution. Reading these you can see why there are so few criminal prosecutions from the crisis. And you will also see just how extreme the human failings that caused the crisis are.

Continued in article
 

Bob Jensen's Primer on Derivatives ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Primer


The largest bank failure in history!
How could Deloitte give a thumbs up audit report on these scams known by the bank's executives?

"Eyes Open, WaMu Still Failed," by Floyd Norris, The New York Times, March 24, 2011 ---
http://www.nytimes.com/2011/03/25/business/25norris.html?_r=1

At that same bank, executives checking for fraudulent mortgage applications found that at one bank office 42 percent of loans reviewed showed signs of fraud, “virtually all of it attributable to some sort of employee malfeasance or failure to execute company policy.” A report recommended “firm action” against the employees involved.

In addition to such internal foresight and vigilance, that bank had regulators who spotted problems with procedures and policies. “The regulators on the ground understood the issues and raised them repeatedly,” recalled a retired bank official this week.

This is not, however, a column about a bank that got things right. It is about Washington Mutual, which in 2008 became the largest bank failure in American history.

What went wrong? The chief executive, Kerry K. Killinger, talked about a bubble but was also convinced that Wall Street would reward the bank for taking on more risk. He kept on doing so, amassing what proved to be an almost unbelievably bad book of mortgage loans. Nothing was done about the office where fraud seemed rampant.

The regulators “on the ground” saw problems, as James G. Vanasek, the bank’s former chief risk officer, told me, but the ones in Washington saw their job as protecting a “client” and took no effective action. The bank promised change, but did not deliver. It installed programs to spot fraud, and then failed to use them. The board told management to fix problems but never followed up.

WaMu, as the bank was known, is back in the news because the Federal Deposit Insurance Corporation sued Mr. Killinger and two other former top officials of the bank last week, seeking to “hold these three highly paid senior executives, who were chiefly responsible for WaMu’s higher-risk home-lending program, accountable for the resulting losses.”

Mr. Killinger responded by going on the attack. His lawyers called the suit “baseless and unworthy of the government.” Mr. Killinger, they said, deserved praise for his excellent management.

I’ll let the courts sort out whether Mr. Killinger will become the rare banker to be penalized for making disastrously bad loans. But I am fascinated by how his bank came to make those loans despite his foresight.

Answers are available, or at least suggested, in the mass of documents collected and released by the Senate Permanent Subcommittee on Investigations, which held hearings on WaMu last year. Mr. Killinger wanted both the loan book and profits to rise rapidly, and saw risky loans as a means to those ends.

Moreover, this was a market in which a bank that did not reduce lending standards would lose a lot of business. A decision to publicly decry the spread of high-risk lending and walk away from it — something Mr. Vanasek proposed before he retired at the end of 2005 — might have saved the bank in the long run. In the short run, it would have devastated profits.

Ronald J. Cathcart, who became the chief risk officer in 2006, told a Senate hearing he pushed for more controls but ran into resistance. The bank’s directors, he said, were interested in hearing about problems that regulators identified over and over again. “But,” he added, “there was little consequence to these problems not being fixed.”

There were consequences for him. He was fired in 2008 after he took his concerns about weak controls and rising losses to both the board and to regulators from the Office of Thrift Supervision.

By early 2007, the subprime mortgage market was collapsing, and the bank was trying to rush out securitizations before that market vanished. The Federal Deposit Insurance Corporation, a secondary regulator, was pushing to impose tighter regulation, but the primary regulator, the Office of Thrift Supervision, was successfully resisting allowing the F.D.I.C. to even look at the bank’s loan files.

Continued in article

 


The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print

Taibbi vs. Goldman Sachs: Whose side are you on?

The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print

Place a barf bag in your lap before watching these videos!
But are they accurate?
In June and July Goldman Sachs put up a pretty good defense.
Now I'm not so sure.

Questions
Why is the SEC still hiding the names of these tremendously lucky naked short sellers in Bear Sterns and Lehman Bros.?
Was it because these lucky speculators were such good friends of Hank Paulson and Timothy Geithner?
Or is Matt Taibbi himself a fraud as suggested last summer by Wall Street media such as Business Insider?

Jensen Comment
Evidence suggests that the SEC may be protecting these Wall Street thieves!
Or was all of this stealing perfectly legal? If so why the continued secrecy on the part of the SEC?
Suspicion:  The stealing may have taken place in top investors needed by the government for bailout (Goldman Sachs?)

"Wall Street's Naked Swindle" by Matt Taibbi
Watch the Video at one of the following sites:
You Tube --- http://www.youtube.com/watch?v=OqZUbe9KIMs
Google video --- Click Here
Read the complete article --- Click Here

Video Updates for Matt Taibbi
GRITtv: Matt Taibbi & Michael Lux: Goldman's Coup --- http://www.youtube.com/watch?v=nFWjXQLDkXg

"Matt Taibbi's Goldman Sachs Story Is A Joke," Joe Weisenthal, Business Insider, July 13, 2009 ---
http://www.businessinsider.com/matt-taibbis-goldman-sachs-story-is-a-joke-2009-7

 "Goldman Sachs responds to Taibbi Post," by: Felix Salmon, Rueters, June 26, 2009 ---
Calls Taibbi "Hysterical" ---
http://blogs.reuters.com/felix-salmon/2009/06/26/goldman-sachs-responds-to-taibbi/

Others Now Argue it Is Not a Joke
"Taibbi's Naked-Shorting Rage: Goldman's Lobbying, SEC's Fail,
"l by bobswern. Daily Kohs, September 30, 2009 ---
http://www.dailykos.com/story/2009/9/30/787963/-Taibbis-Naked-Shorting-Rage:-Goldmans-Lobbying,-SECs-Fail 

Now, off we go to Goldman Sachs' notorious lobbying hubris, the historically-annotated, umpteenth oversight failure of the Securities Exchange Commission ("SEC"), and what I'm quickly realizing may well turnout to be the story with regard to it becoming the poster child for regulatory capture and supervisory breakdown as far as our Wall Street-based corporatocracy/oligarchy is concerned. Here's the link to Taibbi's preview blog post: "An Inside Look at How Goldman Sachs Lobbies the Senate."

Yesterday, as described in this lead-in piece from the Wall Street Journal, the SEC held a public roundtable discussion on "New Rules for Lending of Securities." (See link here:  "SEC Weighs New Rules for Lending of Securities.")

SEC Weighs New Rules for Lending of Securities
BY KARA SCANNELL AND CRAIG KARMIN
Wall Street Journal
Saturday, September 26th, 2009

Securities regulators are exploring new regulations for the multitrillion-dollar securities-lending market, the first major step regulators have taken in the area in decades.

Securities and Exchange Commission Chairman Mary Schapiro said she wants to shine a light on the "opaque market." After many large investors lost millions in last year's credit crunch, she said, "we need to consider ways to enhance investor-oriented oversight."

The SEC is holding a public round table Tuesday to explore several issues around securities lending, which has expanded into a big moneymaker for Wall Street firms and pension funds. Regulation hasn't kept pace, some industry participants...
 

Enter Taibbi: "An Inside Look at How Goldman Sachs Lobbies the Senate."

An Inside Look at How Goldman Sachs Lobbies the Senate
Matt Taibbi
TruSlant.com
(very early) Tuesday, September 29th, 2009

 

The SEC is holding a public round table Tuesday to explore several issues around securities lending, which has expanded into a big moneymaker for Wall Street firms and pension funds. Regulation hasn't kept pace, some industry participants contend. Securities lending is central to the practice of short selling, in which investors borrow shares and sell them in a bet that the price will decline. Short sellers later hope to buy back the shares at a lower price and return them to the securities lender, booking a profit. Lending and borrowing also help market makers keep stock trading functioning smoothly.

--SNIP--

Later on this week I have a story coming out in Rolling Stone that looks at the history of the Bear Stearns and Lehman Brothers collapses. The story ends up being more about naked short-selling and the role it played in those incidents than I had originally planned -- when I first started looking at the story months ago, I had some other issues in mind, but it turns out that there's no way to talk about Bear and Lehman without going into the weeds of naked short-selling, and to do that takes up a lot of magazine inches. So among other things, this issue takes up a lot of space in the upcoming story.

Naked short-selling is a kind of counterfeiting scheme in which short-sellers sell shares of stock they either don't have or won't deliver to the buyer. The piece gets into all of this, so I won't repeat the full description in this space now. But as this week goes on I'm going to be putting up on this site information I had to leave out of the magazine article, as well as some more timely material that I'm only just getting now.

Included in that last category is some of the fallout from this week's SEC "round table" on the naked short-selling issue.

The real significance of the naked short-selling issue isn't so much the actual volume of the behavior, i.e. the concrete effect it has on the market and on individual companies -- and that has been significant, don't get me wrong -- but the fact that the practice is absurdly widespread and takes place right under the noses of the regulators, and really nothing is ever done about it.

It's the conspicuousness of the crime that is the issue here, and the degree to which the SEC and the other financial regulators have proven themselves completely incapable of addressing the issue seriously, constantly giving in to the demands of the major banks to pare back (or shelf altogether) planned regulatory actions. There probably isn't a better example of "regulatory capture," i.e. the phenomenon of regulators being captives of the industry they ostensibly regulate, than this issue.
 

Taibbi continues on to inform us that none of the invited speakers to this government-sponsored event represented stockholders or companies that could, or have, become targets/victims of naked short-selling. Also "...no activists of any kind in favor of tougher rules against the practice. Instead, all of the invitees are (were) either banks, financial firms, or companies that sell stuff to the first two groups."

Taibbi then informs us that there is only one panelist invited that's in favor of what may be, perhaps, the most basic level of regulatory control with regard to this industry practice: a "simple reform" called "pre-borrowing." Pre-borrowing requires short-sellers to actually possess the stock shares before they're sold.

It's been proven to work, as last summer the SEC, concerned about predatory naked short-selling of big companies in the wake of the Bear Stearns wipeout, instituted a temporary pre-borrow requirement for the shares of 19 fat cat companies (no other companies were worth protecting, apparently). Naked shorting of those firms dropped off almost completely during that time.

The lack of pre-borrow voices invited to this panel is analogous to the Max Baucus health care round table last spring, when no single-payer advocates were invited. So who will get to speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a hedge fund that has done the occasional short sale, to put it gently), Credit Suisse, NYSE Euronext, and so on.

Taibbi then tells us of increased efforts by industry players, specifically noting Goldman Sachs being at the forefront of this effort,  and having "their presence felt."

Taibbi mentioned that he'd received two completely separate calls from two congressional staffers from different offices--folks whom Taibbi never met before--who felt compelled to inform him of Goldman's actions.

We learn that these folks both commented on how these Goldman folks were lobbying against restrictions on naked short-selling. One of the aides told Taibbi that they had passed out a "fact sheet about the issue that was so ridiculous that one of the other staffers immediately thought to send it to me. "

I would later hear that Senate aides between themselves had discussed Goldman's lobbying efforts and concluded that it was one of the most shameless performances they'd ever seen from any group of lobbyists, and that the "fact sheet" the company had had the balls to hand to sitting U.S. Senators was, to quote one person familiar with the situation, "disgraceful" and "hilarious."

Checkout the whole story on his blog. Apparently, in the upcoming Rolling Stone piece, he gets into the nitty gritty with regard to how naked short-selling brought down both Bear Stearns and Lehman, last  year.

Should be pretty powerful stuff.

Meanwhile, getting back to the SEC roundtable, noted above, strike up the fifth item that I've now documented in the past 48 hours where it's becoming self-evident that our elected representatives and our government agencies aren't even bothering to author the new regulations and legislation that's so needed to prevent a recurrence of events such as those we witnessed through the economic/market catastrophes of the past 24 months; these legislators and high-ranking government officials are actually having the lobbyists navigate the discussion and write the damn stuff, too!

How much worse can it get? I really don't want to know the answer  to that rhetorical question. But, with the inmates running the asylum, we may just find out sooner than we think!

Bob Jensen's threads on noble and ignoble agendas of the bailout machine ---
http://www.trinity.edu/rjensen/2008Bailout.htm#IgnobleAgendas


Bailing Out Big Banks Engaged in Sleaze and Sex
"Goldman Laid Down with Dogs," by Ryan Chittum, Columbia Journalism Review, November 4, 2009 ---
http://www.cjr.org/index.php 
This link was forwarded by my friend Larry.

Dean Starkman has been applauding McClatchy’s series on Goldman Sachs (an Audit funder) for a couple of days now. Add another Audit appreciation today.

McClatchy has been doing what Dean has been calling for for a long time now: Looking much more closely at how Wall Street fueled the mortgage crisis and how it was deeply connected to the shadier parts of the housing industry. Or as McClatchy’s Greg Gordon puts it:

… one of Wall Street’s proudest and most prestigious firms helped create a market for junk mortgages, contributing to the economic morass that’s cost millions of Americans their jobs and their homes.

Today, McClatchy examines Goldman’s relationship with New Century Financial, a firm that was something of the canary in the coalmine of this financial crisis—it was the second-biggest subprime mortgage lender when it went belly-up in April 2007, which was very, very early. In other words, it was one of the worst actors in the whole mess:

Perhaps no mortgage lender was more emblematic of the go-go atmosphere in the sprouting industry that was seizing an outsize share of the home loan market.

 

Traversing the country in private jets and zipping around Southern California in Mercedes Benzes, Porsches and even a Lamborghini, New Century executives reveled as the firm’s annual residential mortgage sales rocketed from $357 million in 1996 to nearly $60 billion a decade later…

What does that have to do with Goldman Sachs and Wall Street?

For $100 million in mortgages, New Century could command fees from Wall Street of $4 million to $11 million, ex-employees told McClatchy. The goal was to close loans fast, bundle them into pools and sell them to generate money for the next round.

 

Inside the mortgage company, the former employees said, pressure was intense to increase the firm’s share of an exploding market for mortgages that depended almost entirely on Wall Street’s seemingly unlimited hunger for bigger, faster returns.

Aha! But wait—why did Wall Street want to buy this trash?

Goldman and other investment banks could put $20 million in the till by taking a 1 percent fee for assembling, securitizing and selling a $2 billion pool of mostly triple-A rated bonds backed by subprime loans — and that was just stage one.

That takes you toThe Giant Pool of Money.” And that was far from the only juice being squeezed from these lemons. Goldman et al got servicing fees and the like, plus they “extended lines of credit to New Century — known as “warehouse loans” — totaling billions of dollars to finance the issuance of more home loans to other marginal borrowers. Goldman Sachs’ mortgage subsidiary gave the firm a $450 million credit line.”

In other words, Wall Street lent the money to the predatory firms to create the shady loans so it could buy them from them, slice them into securities and sell them to the greater fools. This was so profitable there weren’t enough decent loans to be made. So to feed the beast, mortgage lenders came up with disastrous inventions like NINJA loans (No Income, No Jobs, No Assets) and Wall Street, ahem, looked the other way.

It was a vicious circle of profit (virtuous—if you were one of those who lined their pockets through it) and was interrupted only when the underlying loans got so bad that borrowers like the ones with no income, no jobs, and no assets in many instances couldn’t even make a single payment on the loan. Panic!

McClatchy does well to report on the New Century culture, helpful in illustrating the lie-down-with-dogs-get-up-with-fleas thing, writing about the sexualization of some of the work, something reminds us of BusinessWeek’s fascinating story on the subprime industry’s descent into decadence (the sub headline on that one should be all that’s needed to entice you to read that one: “The sexual favors, whistleblower intimidation, and routine fraud behind the fiasco that has triggered the global financial crisis.”)

But it wasn’t just sex. New Century was giving kickbacks to mortgage brokers to get their loans, McClatchy quotes a former top underwriter there as saying.

Let’s not forget, and McClatchy doesn’t, thankfully, that borrowers were the marks here and took it on the chin:

The loans laid out financial terms that protected investors but punished homebuyers. They offered above-market interest rates, typically starting at 8 percent, with provisions that Lee said were “rigged” to guarantee the maximum 3 percent rise in interest rates after two years and almost assuredly another 3 percent increase through ensuing, twice-yearly adjustments.

This is top-notch work by McClatchy. It deserves a wide airing.


"The Meltdown That Wasn't:  A primer on credit default swaps, the latest Beltway scapegoat," The Wall Street Journal, November 15, 2008 --- http://online.wsj.com/article/SB122670411909729683.html?mod=djemEditorialPage

On Friday, the Federal Reserve, SEC and CFTC announced an agreement to begin anointing "central counterparties" for the credit default swap market. Before the pols create still more institutions that are too big to fail, and further endanger taxpayers, they might want to spend time defining the problem they intend to solve.

The same goes for House Oversight Chairman Henry Waxman. On Thursday he held his latest hearing designed to blame everything other than failed housing policy for the credit debacle. Eager to avoid being scapegoated, hedge-fund managers at the hearing agreed that the credit default swap market is a problem in need of a regulatory solution. But no matter how many financiers can be made to swear under the hot lights that credit default swaps are the problem, reality is not cooperating with this politically convenient theory. This derivatives market continues to perform better than the market from which it is derived.

Mr. Waxman's committee exists to stage show trials; he doesn't have jurisdiction to legislate about credit markets or anything else. But his media events are helpful to his comrade in exculpation, Barney Frank. The House Financial Services Chairman is among the most desperate to blame something other than housing, where he famously vowed to "roll the dice" with Fannie Mae. He too has fingered credit default swaps and now promises "sensible" regulation. If he does to this market what he did to housing, he will again be rolling the dice with other people's money.

Credit default swaps are contracts that insure against a borrower defaulting on its bonds. The buyer of a CDS contract essentially pays annual premiums and the seller agrees to pay back the principal if the issuer of the bonds doesn't. It's different from insurance in that an investor doesn't actually have to own the underlying bonds -- he can simply buy a CDS as a way to make a bearish bet on a company or to offset other risks.

Shattering Beltway illusions, the unregulated CDS market is holding up better than the regulated bond market. Here we are more than a year into the credit meltdown and the CDS market is offering more liquidity than the actual cash market. Eraj Shirvani at Credit Suisse notes that "over the last 18 months, the CDS market -- not the bond market -- has been the only functioning market that has consistently allowed market participants to hedge or express a credit view."

Large investors have often struggled mightily this autumn to find buyers for their bonds, but they could still trade CDS. The U.K. government seems to agree this is a good thing. Her Majesty's Treasury has recognized the CDS market as an efficient mechanism for setting prices by using it as the benchmark to set the rates in its Credit Guarantee Scheme for banks.

In the U.S., meanwhile, the market has spoken, and CDS contracts are the way that investors now price credit. This means Congress should tread very carefully unless it wants to prolong the downturn. In an environment in which fewer companies are able to issue bonds and trading is light, a liquid CDS market that can put a price on credit will hasten the day when more companies are able to borrow money to build their businesses. A Congressional overreaction or too heavy a hand from the New York Fed could delay needed capital from reaching Main Street.

But the Beltway crowd has a vague sense that while they may not understand this market, financial Armageddon will result when a major participant fails. Lehman Brothers was supposed to be exhibit A. The firm was on one end of roughly $5 trillion in CDS contracts, according to Moody's, and Lehman was itself the subject of $72 billion in CDS, in which other investors were betting on Lehman's success or failure. Here was the doomsday scenario, with a major player in CDS going bankrupt.

It turned out to be the meltdown that never melted. Amazing as it is to Washington ears, those greedy, crazy people running large financial institutions did a decent job of managing their exposures to Lehman. When large banks and insurance companies were vulnerable to Lehman, many had offsetting trades that paid off when Lehman went bust. The net amount of $6 billion owed by sellers of credit protection on Lehman was far smaller than expected and was arrived at through the same orderly settlement auction process that has smoothly managed about a dozen such failures -- and all without government regulation.

This is not to say that Lehman's failure didn't damage credit markets. But the problem was not a failure of the CDS market, nor was Lehman's failure caused by CDS. Toxic mortgages killed Lehman. Once Lehman went bust, CDS contracts added relatively little stress to other banks. The stress came from the failure of a big investment bank, which made people unwilling to lend to other banks.

Identifying major systemic risks in the CDS market has proven much harder than the pols expected. The big dealers that trade CDS often demand collateral from customers who owe them money on a trade. But these big dealers usually don't post collateral when the roles are reversed and they owe the customer. While this is not necessarily a sweet deal for small hedge funds doing business with a Goldman or a J.P. Morgan, it minimizes counterparty risks for the major firms. Also, the large dealers generally make their money facilitating trades for customers, not betting one way or another on corporate defaults. So if they sell a lot of credit protection to one customer, they will seek to buy it from somebody else.

AIG, by contrast, was almost entirely a seller of CDS. By selling credit protection on mortgage-backed securities, the firm used CDS to make a big bet on housing, which again is the cause of this crisis. Meanwhile, the search continues for the major counterparty that would have been destroyed by AIG's collapse.

As for Mr. Waxman, he should spend more time investigating the cause, not the effects, of market turmoil. Mr. Frank would seem to be the perfect witness.

For an in-depth legal study of the Bailout decisions, go to http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1306342


Barney's Rubble

PJ O’Rourke’s Parliament of Whores --- http://snipurl.com/parliamentwhores   

Barney Frank: I've destroyed the economy, my work here is done.
Washington Times headline, Nov. 29, 2011
Barney's Rubble --- http://www.trinity.edu/rjensen/2008Bailout.htm#Rubble
Also see http://www.rep-am.com/articles/2011/12/08/opinion/604618.txt


Oh, and don't forget Fannie Mae and Freddie Mac, those two government-sponsored mortgage giants that engineered the 2008 subprime mortgage fiasco and are now on the public dole. The Fed kept them afloat by buying over a trillion dollars of their paper. Now, part of the Treasury's borrowing from the public covers their continuing large losses.
George Melloan, "Hard Knocks From Easy Money:  The Federal Reserve is feeding big government and harming middle-class savers," The Wall Street Journal, July 6, 2010 --- http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t


"The Mortgage Crisis: Some Inside Views Emails show that risk managers at Freddie Mac warned about lower underwriting standards—in vain, and with lessons for today," by Charles W. Calomiris, The Wall Street Journal, October 28, 2011 ---
http://online.wsj.com/article/SB10001424053111903927204576574433454435452.html?mod=djemEditorialPage_t

Occupy Wall Street is denouncing banks and Wall Street for "selling toxic mortgages" while "screwing investors and homeowners." And the federal government recently announced it will be suing mortgage originators whose low-quality underwriting standards produced ballooning losses for Fannie Mae and Freddie Mac.

Have they fingered the right culprits?

There is no doubt that reductions in mortgage-underwriting standards were at the heart of the subprime crisis, and Fannie and Freddie's losses reflect those declining standards. Yet the decline in underwriting standards was largely a response to mandates, beginning in the Clinton administration, that required Fannie Mae and Freddie Mac to steadily increase their mortgages or mortgage-backed securities that targeted low-income or minority borrowers and "underserved" locations.

The turning point was the spring and summer of 2004. Fannie and Freddie had kept their exposures low to loans made with little or no documentation (no-doc and low-doc loans), owing to their internal risk-management guidelines that limited such lending. In early 2004, however, senior management realized that the only way to meet the political mandates was to massively cut underwriting standards.

The risk managers complained, especially at Freddie Mac, as their emails to senior management show. They refused to endorse the move to no-docs and battled unsuccessfully against the reduced underwriting standards from April to September 2004. Here are some highlights:

On April 1, 2004, Freddie Mac risk manager David Andrukonis wrote to Tracy Mooney, a vice president, that "while you, Don [Bisenius, a senior vice president] and I will make the case for sound credit, it's not the theme coming from the top of the company and inevitably people down the line play follow the leader."

Risk managers had already experimented with lower lending standards and knew the dangers. In another email that day, Mr. Bisenius wrote to Michael May (another senior vice president), "we did no-doc lending before, took inordinate losses and generated significant fraud cases. I'm not sure what makes us think we're so much smarter this time around."

On April 5, Mr. Andrukonis wrote to Chief Operating Officer Paul Peterson, "In 1990 we called this product 'dangerous' and eliminated it from the marketplace." He also argued that housing prices were already high and unlikely to rise further: "We are less likely to get the house price appreciation we've had in the past 10 years to bail this program out if there's a hole in it."

Donna Cogswell, a colleague of Mr. Andrukonis, warned that Fannie and Freddie's decisions to debase underwriting standards would have widespread ramifications for the mortgage market. In a Sept. 7 email to Freddie Mac CEO Dick Syron and others, she specifically described the ramifications of Freddie Mac's continuing participation in the market as effectively "mak[ing] a market" in no-doc mortgages.

Ms. Cogswell's Sept. 4 email to Mr. Syron and others also anticipated the potential human costs of the mortgage crisis. She tried to sway management by appealing to their decency: "[W]hat better way to highlight our sense of mission than to walk away from profitable business because it hurts the borrowers we are trying to serve?"

Politics—not shortsightedness or incompetent risk managers—drove Freddie Mac to eliminate its previous limits on no-doc lending. Commenting on what others referred to as the "push to do more affordable [lending] business," Senior Vice President Robert Tsien wrote to Dick Syron on July 14, 2004: "Tipping the scale in favor of no cap [on no-doc lending] at this time was the pragmatic consideration that, under the current circumstances, a cap would be interpreted by external critics as additional proof we are not really committed to affordable lending."

Sensing that his warnings were being ignored, Mr. Andrukonis wrote to Michael May on Sept. 8: "At last week's risk management meeting I mentioned that I had reached my own conclusion on this product from a reputation risk perspective. I said that I thought you and or Bob Tsien had the responsibility to bring the business recommendation to Dick [Syron], who was going to make the decision. . . . What I want Dick to know is that he can approve of us doing these loans, but it will be against my recommendation."

The decision by Fannie and Freddie to embrace no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for example, total subprime and Alt-A mortgage originations were $395 billion. In 2004, they rose to $715 billion. By 2006, they were more than $1 trillion.

In a painstaking forensic analysis of the sources of increased mortgage risk during the 2000s, "The Failure of Models that Predict Failure," Uday Rajan of the University of Michigan, Amit Seru of the University of Chicago and Vikrant Vig of London Business School show that more than half of the mortgage losses that occurred in excess of the rosy forecasts of expected loss at the time of mortgage origination reflected the predictable consequences of low-doc and no-doc lending. In other words, if the mortgage-underwriting standards at Fannie and Freddie circa 2003 had remained in place, nothing like the magnitude of the subprime crisis would have occurred.

Taxpayer losses at Fannie and Freddie alone may exceed $300 billion. The costs of the financial collapse and recession brought on by the mortgage bust are immeasurably higher. Unfortunately, the Obama administration has perpetuated the low underwriting standards that gave us the crisis and encouraged the postponement of foreclosures by lending support to various states' efforts to sue originators for robo-signing violations.

Continued in article


"Barney Frank Comes Home to Facts ," by Larry Kudlow, Townhall, August 20, 2010 ---
http://townhall.com/columnists/LarryKudlow/2010/08/21/barney_frank_comes_home_to_facts 

Can you teach an old dog new tricks? In politics, the answer is usually no. Most elected officials cling to their ideological biases, despite the real-world facts that disprove their theories time and again. Most have no common sense, and most never acknowledge that they were wrong.

But one huge exception to this rule is Democrat Barney Frank, chairman of the House Financial Services Committee.

For years, Frank was a staunch supporter of Fannie Mae and Freddie Mac, the giant government housing agencies that played such an enormous role in the financial meltdown that thrust the economy into the Great Recession. But in a recent CNBC interview, Frank told me that he was ready to say goodbye to Fannie and Freddie.

“I hope by next year we’ll have abolished Fannie and Freddie,” he said. Remarkable. And he went on to say that “it was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.” He then added, “I had been too sanguine about Fannie and Freddie.”

When I asked Frank about a long-term phase-out plan that would shrink Fannie and Freddie portfolios and mortgage-purchase limits, and merge the agencies into the Federal Housing Administration (FHA) for a separate low-income program that would get government out of middle-income housing subsidies, he replied: “Larry, that, I think, is exactly what we should be doing.”

Frank also said that any federal housing guarantees should be transparently priced and put on budget. But he added that the private sector must be encouraged to re-enter housing finance just as the government gradually withdraws from it.

Some would say Frank’s mea culpa is politically motivated in advance of an election where bailout nation and big government are public enemies number one and two. Of course, poll after poll shows that the $150 billion Fan-Fred bailout, which the Congressional Budget Office estimates could rise to $400 billion, is detested by voters and taxpayers everywhere.

In fact, these failed government agencies are in such bad shape that they can’t even pay Uncle Sam the dividends owed under the conservatorship deal reached two years ago. That’s right. In order to pay a $1.8 billion dividend on Treasury department stock, Fan and Fred had to borrow $1.5 billion from -- you guessed it -- the Treasury.

Then there’s this head-scratching detail: In an absolutely outrageous move last Christmas Eve, President Obama signed off on $42 million in bonuses for the top twelve Fannie and Freddie executives, including $6 million apiece for the two CEOs. (Hat tip to attorney Stephen B. Meister.)

Voters are on to all this.


May 31, 2011 message from Roger Collins

Of possible interest...

http://www.nytimes.com/2011/05/29/books/review/book-review-reckless-endangerment-by-gretchen-morgenson-and-joshua-rosner.html?ref=books

"It’s hardly news that the near meltdown of America’s financial system enriched a few at the expense of the rest of us. Who’s responsible? The recent report of the Financial Crisis Inquiry Commission blamed all the usual suspects — Wall Street banks, financial regulators, the mortgage giants Fannie Mae and Freddie Mac,
and subprime lenders — which is tantamount to blaming no one. “Reckless Endangerment” concentrates on particular individuals who played key roles.

The authors, Gretchen Morgenson, a Pulitzer Prize-winning business reporter and columnist at The New York Times, and Joshua Rosner, an expert on housing finance, deftly trace the beginnings of the collapse to the mid-1990s, when the Clinton administration called for a partnership between the private sector and Fannie and Freddie to encourage home buying. The mortgage agencies’ government backing was, in effect, a valuable subsidy, which was used by Fannie’s C.E.O.,
James A. Johnson, to increase home ownership while enriching himself and other executives. A 1996 study by the Congressional Budget Office found that Fannie pocketed about a third of the subsidy rather than passing it on to homeowners. Over his nine years heading Fannie, Johnson personally took home roughly $100 million. His successor, Franklin D. Raines, was treated no less lavishly...."

continued in article...

Roger

Bob Jensen's threads on earnings management fraud at Fanny Mae ---
http://www.trinity.edu/rjensen/Theory02.htm#Manipulation

Bob Jensen's threads on slease in thesubprime scandals ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze


$6 billion here, $6 billion there, who cares as long as taxpayers foot the bill?

"Freddie Mac Loses $4.4B in Third Quarter, Requests $6B More From Treasury," Fox News, November 3, 2011 --- Click Here
http://www.foxnews.com/politics/2011/11/03/freddie-mac-loses-44b-in-third-quarter-requests-6b-more-from-treasury/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+foxnews%2Fpolitics+%28Internal+-+Politics+-+Text%29&utm_content=My+Yahoo 

Government-controlled mortgage giant Freddie Mac has requested $6 billion in additional aid after posting a wider loss in the third quarter.

Freddie Mac said Thursday that it lost $4.4 billion, or $1.86 per share, in the July-September quarter. That compares with a loss of $4.1 billion, or $1.25 a share, in the same quarter of 2010.

This quarter's $6 billion request from taxpayers is the largest since April 2010.

Freddie's losses are increasing mainly for two reasons: Many homeowners are paying less interest because they are able to refinance at lower mortgage rates. And failing and bankrupt mortgage insurers are not paying out as much money when homeowners default.

The government rescued McLean, Va.-based Freddie Mac and sibling company Fannie Mae in September 2008 after massive losses on risky mortgages threatened to topple them. Since then, a federal regulator has controlled their financial decisions.

Taxpayers have spent about $169 billion to rescue Fannie and Freddie, the most expensive bailout of the 2008 financial crisis. The government estimates it could cost up to $51 billion more to support the companies through 2014.

Freddie and Washington-based Fannie own or guarantee about half of all U.S. mortgages, or nearly 31 million home loans worth more than $5 trillion. Along with other federal agencies, they backed nearly 90 percent of new mortgages over the past year.

Charles E. Haldeman Jr., Freddie's chief executive, said many homeowners are refinancing at lower mortgage rates or are shortening the terms of their mortgage. While that saves homeowners money, it is pushing Freddie deeper into the red.

"In fact, borrowers we helped to refinance will save an average of $2,500 in interest payments during the next year," he said.

For Freddie, those losses are temporary because interest rates will remain low for the foreseeable future, said Jim Vogel, an interest-rate specialist at FTN Financial.

Still, many homeowners are still defaulting on their mortgages. Unemployment remains stubbornly high at 9.1 percent. The percentage of those who are late by 90 days or more on their monthly mortgage payments was virtually unchanged at 3.51 percent in the July-September quarter.

Another reason Freddie needs more aid is because it has received less money from mortgage insurers.

Many riskier mortgage loans require insurance, which is meant to protect lenders and investors from losses if a homeowner defaults and the lender doesn't recoup costs through foreclosure. The borrower pays a monthly premium for the insurance, typically a set percentage of the total mortgage loan. But when those mortgage insurers fail, they pay out less in claims.

Continued in article


"What the Demise of Fannie Mae and Freddie Mac Means for the Future of Homeownership," Knowledge@Wharton, March 16, 2011 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2737

By most accounts, the federally sponsored mortgage giants Fannie Mae and Freddie Mac did not cause the housing and mortgage crisis. But they were a big part of the problem, prompting a taxpayer bailout costing more than $130 billion.

Now, seeking to protect taxpayers from future meltdowns, the Obama administration wants to phase out the two firms over an unspecified period and leave the lion's share of the mortgage market to private lenders. It would be a dramatic change, given that the private market has shriveled in recent years, leaving Fannie, Freddie and the Federal Housing Administration to back about 90% of all new home loans. The administration also proposes a reduced role for the FHA, one that would focus on providing mortgages for the needy.

How would a phase-out of Fannie and Freddie affect the availability of mortgages, loan rates and home prices? In the end, would such a dramatic change be good for homeowners or not?

Opinions vary, and no one can know for sure. The mortgage and housing markets are complex, and a controlled experiment that removes Fannie and Freddie but leaves everything else the same is obviously not possible, says Wharton real estate professor Todd Sinai. "There's a debate over whether Fannie and Freddie successfully reduced mortgage rates paid by borrowers, or increased the mortgage availability for borrowers, or whether they just took their implicit [government] subsidy and generated higher returns for shareholders," Sinai says. "If Fannie and Freddie were successful in making mortgage credit cheaper and more available, then eliminating [them] would have a negative impact on house prices."

It is not clear that the private market can or would absorb the volume of business done by Fannie and Freddie, which cover trillions of dollars worth of loans, according to Wharton real estate professor Susan M. Wachter. "That's a good question," she says, noting that even if the private market were to take over, borrowers would probably not get the attractive deals they can today.

"The 30-year [mortgage] would become more expensive," she states, adding that some experts predict a three percentage point rate rise. With the 30-year, fixed-rate loan now averaging around 5%, that would take it to 8%, raising the monthly payment for every $100,000 borrowed from $537 to $733. This would make the 30-year fixed loan "noncompetitive" with adjustable-rate loans, Wachter says. ARMs can offer lower rates because lenders face less risk, given that they can raise rates as market conditions change

Jack M. Guttentag, an emeritus professor of finance at Wharton who runs a website called The Mortgage Professor, thinks fixed rates might go up only three quarters of a percentage point rather than three points. But with the two firms' loan guarantees removed from the market, lenders would probably demand larger down payments than they have in the past, and be less willing to provide loans to those with less-than-stellar credit. Indeed, today's tight lending standards, a reaction to the recent crisis, could become permanent.

"Things like qualification standards have become extremely strict," Guttentag says, noting that it is now all but impossible for a self-employed applicant to get a mortgage. "The biggest part of it would be the increase in the down payment; 20% would probably become the minimum throughout the marketplace."

Larger down payments reduce the lender's risk because borrowers are reluctant to default if they have equity in the home, and because a smaller loan relative to the home's value makes it easier for the lender to recover in a foreclosure. Currently, most lenders require 20% down payments; a few years ago, however, it was possible to get a loan with nothing down. The Obama administration wants underwriting standards to require at least 10%, though the FHA would continue to offer low-down payment loans to certain less-affluent borrowers.

Planning a Phase-out

Fannie, the Federal National Mortgage Association, was formed as a government agency in 1938 and was converted to a publicly traded company in 1968. Freddie, the Federal Home Loan Mortgage Corp., is a publicly traded company created by the government in 1970 to provide competition for Fannie. Their primary role is to buy and insure mortgages issued by private lenders. Some loans stay on Fannie and Freddie's books, but most are bundled into mortgage securities sold to investors like other types of government and corporate bonds. Fannie and Freddie provide investors certain guarantees that interest and principal payments will be made even if homeowners default.

Continued in article

Bob Jensen's threads on Fannie and Freddie are at the following links:

http://www.trinity.edu/rjensen/2008Bailout.htm

http://www.trinity.edu/rjensen/Theory02.htm#Manipulation


"Taxpayers to Pay for Fannie, Freddie Aid:  Treasury Removed Caps on Assistance," SmartPros, January 13, 2010 ---
http://accounting.smartpros.com/x68543.xml

A recent move by the Treasury Department to remove $200 billion caps on assistance to Fannie Mae and Freddie Mac eliminates any doubt that taxpayers will pay for all their losses for the next three years and appears to be a major step toward formally nationalizing the housing enterprises, analysts say.

The government took control of the companies, and effectively much of the U.S. mortgage market, in September 2008 and started purchasing all their mortgage-backed securities. But the Treasury previously used the $200 billion caps on aiding each company to try to limit taxpayer exposure to their mounting losses.

Republicans charge that Treasury has given the Depression-era companies a "blank check" to pay for burgeoning losses on defaulting loans.

The two housing enterprises last year guaranteed and secured nearly 70 percent of new mortgages, primarily made to "prime" borrowers with the best credit ratings, while the Federal Housing Administration insured most loans to subprime borrowers, leaving only a tiny share of the mortgage market in private hands.

In its Christmas Eve statement announcing the little-noticed changes, the Treasury insisted that it wants to preserve "an environment where the private market is able to provide a larger source of mortgage finance."

But analysts say Treasury's move may push off any return to a normal mortgage market for years -- possibly forever. Treasury removed the liability caps for three years and loosened restrictions on Fannie's and Freddie's purchases of their own mortgage securities -- enabling them to maintain their dominant share of the mortgage market.

"These actions would preserve and strengthen the governments involvement and control over the countrys housing finance system and make it harder to reintroduce substantial private-sector involvement later on," said Edward Pinto, a housing consultant and former chief credit officer at Fannie Mae.

When combined with a separate move by regulators not to provide common stock as part of executive compensation at Fannie and Freddie, the administration's recent actions suggest that it is moving to nationalize the companies, Mr. Pinto said.

Nationalization, or total government control and ownership of the companies, would wipe out the value of Fannie and Freddie stock, making it worthless as a way to pay executives. The value of the stock has plummeted to between $1 and $2 a share in the wake of the government's takeover.

Treasury spokesman Andrew Williams declined to elaborate on the Treasury's actions, but denied that nationalization was the goal.

The administration is preparing to present its proposals for governing Fannie and Freddie in the future -- a major question not addressed in financial reform legislation pending in Congress -- when it presents its budget in February. Options range from fully nationalizing the enterprises to reprivatizing them or turning them into public "utilities" like the closely regulated gas and electric companies.

Sen. Bob Corker, Tennessee Republican, questioned whether the administration was moving toward nationalization in a letter to Treasury Secretary Timothy F. Geithner this week, urging the Treasury to incorporate fully in its February budget the cost of any additional Fannie and Freddie liabilities the government is acquiring.

"Due to the level of support that this administration and the previous one have created for Fannie Mae and Freddie Mac, would you not consider your latest move an effective nationalization?" asked Mr. Corker, a member of the Senate Banking, Housing and Urban Affairs Committee. "If so, then the liabilities of these two firms should absolutely be reflected on the balance sheet of the U.S. Treasury."

Fully nationalizing the enterprises would permanently increase costs for taxpayers and would bloat the government's balance sheets. Fannie and Freddie currently guarantee about $5.5 trillion of outstanding mortgages and debts -- nearly as much as the Treasury's own public debt. If the companies were fully nationalized, the government's books would have to reflect both the revenues and losses from those obligations.

But even if the administration and Congress stop short of formally incorporating the enterprises into the federal government, the removal of the caps at least for now has eliminated any doubt that the government stands behind all Fannie and Freddie obligations and will cover their losses for the next three years.

Treasury reportedly told Mr. Corker that the move was needed to calm markets.

Apparently, it deemed the certainty of government backing to be critical at a time when the Federal Reserve has announced that it will end its program of purchasing $1.25 trillion in Fannie and Freddie mortgage bonds in March. The Fed's program -- another unprecedented federal intervention in the mortgage market -- provided most of the funding to finance prime mortgages in the past year.

Many housing analysts and economists worry that the Fed's withdrawal from the mortgage market will cause a sharp rise in 30-year mortgage rates of as much as one percentage point from 5 percent to 6 percent as private investors demand higher yields to compensate for the increased likelihood of defaults on mortgages.

Nearly one in eight mortgages is in default, with prime mortgages guaranteed by Fannie and Freddie having taken over subprime last year as the principal source of delinquencies.

Rapidly rising delinquencies have prompted some analysts to predict a collapse in the mortgage market once the Fed stops buying most of Fannie and Freddie's debt. The Treasury's move appears designed to reassure investors and prevent that from happening.

"When you have someone as big as the Fed was in 2009 walking away cold turkey, there have to be bumps along the road," said Ajay Rahadyaksha, managing director at Barclays Capital. But he expects investors to be enticed back into the mortgage market because they have "massive amounts of cash" to invest.

While full nationalization of the enterprises would be controversial, and likely provoke overwhelming Republican opposition, most parties agree that after the massive efforts to prop up the mortgage market in the past two years it would be difficult for the government to entirely extricate itself in the future.

Former Treasury Secretary Henry M. Paulson Jr. said he intended to keep the government's options open when he designed the plan to take 79.9 percent control of Fannie and Freddie and put them under government conservatorship.

But he said they should not be returned to their previous ambiguous structure, where they were owned by private stockholders even as they carried out a government mission. He said the best structure in the future might be to turn them into public utilities that funnel the government's guarantee on mortgage-backed securities for a fee.

The Mortgage Bankers Association and other private groups have endorsed a permanent federal role in guaranteeing pools of prime mortgages, perhaps through a revamped Fannie and Freddie.

One reason heavy government involvement is likely to continue is that Fannie and Freddie -- unlike many banks that received bailouts from the Treasury -- likely will never be able to fully repay the nearly $100 billion in assistance they have received so far from taxpayers, analysts say.

Their losses are growing by the day, and many of them now are incurred as a result of new mandates from the Treasury and Congress to spearhead the government's efforts to alleviate the home foreclosure crisis and make credit available as widely as possible.

For example, Fannie recently said it may liberalize its rules for mortgages used to buy condominiums in Florida -- an area that has been plagued with high rates of default and foreclosure, while it is giving preference to homeowners over investors when it sells foreclosed properties, even if investors offer a better deal.

Many analysts expect the administration to soon increase the subsidies the enterprises are providing to homeowners and banks that renegotiate mortgages to try to avoid foreclosure, and some suspect it already is using Fannie and Freddie to make loans available to riskier borrowers.

Mr. Corker said the proliferation of government mandates for the enterprises has essentially turned them into "a direct extension of the Treasury Department."

How Fannie Mae creatively managed earnings and cooked the books to give then CEO Franklin Raines millions and then had to fire Franklin and issued restated financial statements --- http://www.trinity.edu/rjensen/theory01.htm#Manipulation


"The Biggest Losers Behind the Christmas Eve taxpayer massacre at Fannie and Freddie," The Wall Street Journal, January 3, 2009 ---
http://online.wsj.com/article/SB10001424052748704152804574628350980043082.html?mod=djemEditorialPage

Happy New Year, readers, but before we get on with the debates of 2010, there's still some ugly 2009 business to report: To wit, the Treasury's Christmas Eve taxpayer massacre lifting the $400 billion cap on potential losses for Fannie Mae and Freddie Mac as well as the limits on what the failed companies can borrow.

The Treasury is hoping no one notices, and no wonder. Taxpayers are continuing to buy senior preferred stock in the two firms to cover their growing losses—a combined $111 billion so far. When Treasury first bailed them out in September 2008, Congress put a $200 billion limit ($100 billion each) on federal assistance. Last year, the Treasury raised the potential commitment to $400 billion. Now the limit on taxpayer exposure is, well, who knows?

The firms have made clear that they may only be able to pay the preferred dividends they owe taxpayers by borrowing still more money . . . from taxpayers. Said Fannie Mae in its most recent quarterly report: "We expect that, for the foreseeable future, the earnings of the company, if any, will not be sufficient to pay the dividends on the senior preferred stock. As a result, future dividend payments will be effectively funded from equity drawn from the Treasury."

The loss cap is being lifted because the government has directed both companies to pursue money-losing strategies by modifying mortgages to prevent foreclosures. Most of their losses are still coming from subprime and Alt-A mortgage bets made during the boom, but Fannie reported last quarter that loan modifications resulted in $7.7 billion in losses, up from $2.2 billion the previous quarter.

The government wants taxpayers to think that these are profit-seeking companies being nursed back to health, like AIG. But at least AIG is trying to make money. Fan and Fred are now designed to lose money, transferring wealth from renters and homeowners to overextended borrowers.

Even better for the political class, much of this is being done off the government books. The White House budget office still doesn't fully account for Fannie and Freddie's spending as federal outlays, though Washington controls the companies. Nor does it include as part of the national debt the $5 trillion in mortgages—half the market—that the companies either own or guarantee. The companies have become Washington's ultimate off-balance-sheet vehicles, the political equivalent of Citigroup's SIVs, that are being used to subsidize and nationalize mortgage finance.

This subterfuge also explains the Christmas Eve timing. After December 31, Team Obama would have needed the consent of Congress to raise the taxpayer exposure beyond $400 billion. By law, negative net worth at the companies forces them into "receivership," which means they have to be wound down.

Unlimited bailouts will now allow the Treasury to keep them in conservatorship, which means they can help to conserve the Democratic majority in Congress by increasing their role in housing finance. With the Federal Reserve planning to step back as early as March from buying $1.25 trillion in mortgage-backed securities, Team Obama is counting on Fan and Fred to help reflate the housing bubble.

That's why on Christmas Eve Treasury also rolled back a key requirement of the 2008 bailout—that Fan and Fred begin shrinking the portfolios of mortgages they own on their own account, which total a combined $1.5 trillion. Risk-taking will now increase, so that the government can once again follow Barney Frank's infamous advice that the companies "roll the dice" on subsidies for affordable housing.

All of which would seem to make the CEOs of Fannie and Freddie the world's most overpaid bureaucrats. A release from the Federal Housing Finance Agency that also fell in the Christmas Eve forest reports that, after presiding over a combined $24 billion in losses last quarter, Fannie CEO Michael Williams and Freddie boss Ed Haldeman are getting substantial raises. Each is now eligible for up to $6 million annually.

Freddie also has one of the world's highest-paid human resources executives. Paul George's total compensation can run up to $2.7 million. It must require a rare set of skills to spot executives capable of losing billions of dollars.

Where is Treasury's pay czar when we actually need him? You guessed it, Fannie and Freddie are exempt from the rules applied to the TARP banks. The government gave away the game that these firms are no longer in the business of making profits when it announced that the CEOs will be paid entirely in cash, though it is discouraging that practice at other big banks. Who would want stock in the Department of Housing and Urban Development?

Meanwhile, these biggest of Beltway losers continue to be missing from the debate over financial reform. The Treasury still hasn't offered its long-promised proposals even as it presses reform on banks that played a far smaller role in the financial mania and panic. Senate Banking Chairman Chris Dodd (D., Conn.) and ranking Republican Richard Shelby recently issued a joint statement on their "progress" toward financial regulatory reform, but their list of goals also doesn't mention Fannie or Freddie.

Since Mr. Shelby has long argued for reform of these government-sponsored enterprises, their absence suggests that Mr. Dodd's longtime effort to protect Fan and Fred is once again succeeding. It would be worse than a shame if, having warned about the iceberg for years, Mr. Shelby now joins Mr. Dodd in pretending that these ships aren't sinking.

In today's Washington, we suppose, it only makes sense that the companies that did the most to cause the meltdown are being kept alive to lose even more money. The politicians have used the panic as an excuse to reform everything but themselves.


The Price for Fannie and Freddie Keeps Going Up:  Barney Frank's decision to 'roll the dice' on subsidized housing is becoming an epic disaster for taxpayers," by Peter J. Wallison, The Wall Street Journal, December 29, 2009 ---
http://online.wsj.com/article/SB10001424052748703278604574624681873427574.html?mod=djemEditorialPage

On Christmas Eve, when most Americans' minds were on other things, the Treasury Department announced that it was removing the $400 billion cap from what the administration believes will be necessary to keep Fannie Mae and Freddie Mac solvent. This action confirms that the decade-long congressional failure to more closely regulate these two government-sponsored enterprises (GSEs) will rank for U.S. taxpayers as one of the worst policy disasters in our history.

Fannie and Freddie's congressional sponsors—some of whom are now leading the administration's effort to "reform" the financial system—have a lot to answer for. Rep. Barney Frank (D., Mass.), chairman of the House Financial Services Committee, sponsored legislation adopted in 2008 that established a new regulatory structure for the GSEs. But by then it was far too late. The GSEs had begun buying risky loans in 1993 to meet the "affordable housing" requirements established under congressional direction by the Department of Housing and Urban Development (HUD).

Most of the damage was done from 2005 through 2007, when Fannie and Freddie were binging on risky mortgages. Back then, Mr. Frank was the bartender, denying that there was any cause for concern, and claiming that he wanted to "roll the dice" on subsidized housing support.

In 2005, the Senate Banking Committee, then controlled by Republicans, adopted tough regulatory legislation that would have established more auditing and oversight of the two agencies. But it was passed out of committee on a partisan vote, and with no Democratic support it never came to a vote.

By the end of 2008, Fannie and Freddie held or guaranteed approximately 10 million subprime and Alt-A mortgages and mortgage-backed securities (MBS)—risky loans with a total principal balance of $1.6 trillion. These are now defaulting at unprecedented rates, accounting for both their 2008 insolvency and their growing losses today. Since 2008, under government control, the two agencies have continued to buy dicey mortgages in order to stabilize housing prices.

There is more to this ugly situation. New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A.

In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.

An Alt-A mortgage is one in which the quality of the mortgage or the underwriting was deficient; it might lack adequate documentation, have a low or no down payment, or in some other way be more likely than a prime mortgage to default. Fannie and Freddie were also reporting these mortgages as prime, according to Mr. Pinto.

It is easy to see how this misrepresentation was a principal cause of the financial crisis.

Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007. Of the 26 million subprime and Alt-A loans outstanding in 2008, 10 million were held or guaranteed by Fannie and Freddie, 5.2 million by other government agencies, and 1.4 million were on the books of the four largest U.S. banks.

In addition, about 7.7 million subprime and Alt-A housing loans were in mortgage pools supporting MBS issued by Wall Street banks—which had long before been driven out of the prime market by Fannie and Freddie's government-backed, low-cost funding. The vast majority of these MBS were rated AAA, because the rating agencies' models assumed that the losses that are incurred by subprime and Alt-A loans would be within the historical range for the number of high-risk loans known to be outstanding.

But because of Fannie and Freddie's mislabeling, there were millions more high-risk loans outstanding. That meant default rates as well as the actual losses after foreclosure were going to be outside all prior experience. When these rates began to show up early in 2007, it was apparent something was seriously wrong with assumptions on which AAA ratings had been based.

Losses, it was now certain, would invade the AAA tranches of the mortgage-backed securities outstanding. Investors, having lost confidence in the ratings, fled the MBS market and ultimately the market for all asset-backed securities. They have not yet returned.

By the end of 2007, the MBS market collapsed entirely. Assets once carried at par on financial institutions' balance sheets could not be sold except at distress prices. This raised questions about the stability and even the solvency of most of the world's largest financial institutions.

The first major victim was Bear Stearns, the smallest of the five major Wall Street investment banks but one invested heavily in risky MBS. The government rescue of Bear Stearns in March 2008 signaled that the U.S. government, and perhaps others, would stand behind other large financial institutions. The moral hazard this engendered was deadly when Lehman Brothers' solvency came under challenge. Spreads in the credit default swap market for Lehman, despite massive short-selling, showed very little alarm by investors until just before the fateful weekend of Sept. 13 and 14, when they blew out on fears that the firm might not be rescued.

By that time it was too late for Lehman's counterparties to take the protective action that might have cushioned the shock. As it turned out, however, none of Lehman's largest counterparties failed—so much for the idea that the financial market is "interconnected"—but all market participants now realized they had to know the true financial condition of their counterparties. The result was a freeze-up in interbank lending.

For most people, that freeze-up is the beginning of the financial crisis. But its roots go back to 1993, when Fannie and Freddie began stocking up on subprime and other risky loans while reporting them as prime.

Why Fannie and Freddie did this is still to be determined. But the leading candidate is certainly HUD's affordable housing regulations, which by 2007 required that 55% of all the loans the agencies acquired had to be made to borrowers at or below the median income, with almost half of these required to be low-income borrowers.

Another likely reason for Fannie and Freddie's mislabeling of mortgages was their desire to retain congressional support by "rolling the dice" while making believe they weren't betting. With the Federal Housing Administration, Wall Street investment banks, and Fannie and Freddie all competing for these loans, the bottom of the barrel had long before been scraped and the financial system set up for a crisis.


What happened was an explosion of loans being made outside of the regular banking system. It was largely the unregulated sector of the lending industry and the underregulated and the lightly regulated that did that.
Barney Frank

Question
How did banks circumvent mortgage regulations in before the subprime scandal broke?

Jensen Comment
For once I would like to bless Barney Frank, although as chairman of the House Financial Services Committee when these scandals were taking place, he should have stopped this banking house of cards before this banking fraud came tumbling down. In spite of yelling foul now, Rep. Frank helped create this pile of "Barney's Rubble." Pardon me for not blessing Barney now ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Rubble
Was he left in the dark about mortgage fraud? Wink! Wink!
I'm about to puke!

Hint
They used a ploy much like corporations used to keep real estate and other debt of the balance sheet before accounting standard setters put an end to the sham. For example, Avis Car rental at one time avoided putting millions of debt for financing its cars by creating a sham subsidiary financing subsidiary and then (in those good old days) did not consolidate the financing subsidiary into the consolidated balance sheet of Avis. Similarly, Safeway appeared to not own any stores or have any mortage debt on those stores because all this was hidden in an unconsolidated subsidiary. It took way to long in the United States for the FASB to put an end to the sham of off-balance-sheet-financing (OBSF):
FAS 94:  Consolidation of All Majority-owned Subsidiaries--an amendment of ARB No. 51, with related amendments of APB Opinion No. 18 and ARB No. 43, Chapter 12 (Issued 10/87) --- http://www.fasb.org/summary/stsum94.shtml

In the case of banks circumventing regulations on selling mortgages, here's how it worked with sham mortgage company subsidiaries.

"Subprime and the Banks: Guilty as Charged," by Joe Nocera. The New York Times, October 14, 2009 ---
http://executivesuite.blogs.nytimes.com/2009/10/14/subprime-and-the-banks-guilty-as-charged/

“There has not been a case made that there is an enforcement problem with banks,” Edward Yingling, the head of the American Bankers Association, said last week. “There is a problem with enforcement on nonbanks.”

As I wrote in my column last week, this has become something of a mantra for the banking industry. We aren’t the ones who brought the world to the brink of financial disaster, they proclaim. It was those awful nonbanks, the mortgage brokers and originators, who peddled those terrible subprime loans to unsuspecting or unsophisticated consumers. They’re the ones who need to be regulated!

Apparently, when you say something long enough and loud enough, people start to believe it, even when it defies reality. Here, for instance, is the normally skeptical