Michael Lewis, author of “The Big Short: Inside the Doomsday Machine”, talks about the Wall Street casino on 60 Minutes. The Times reviewed his book this morning. Meanwhile, it is clear that the financial reform package that Sen. Dodd is planning to unveil this afternoon is far from being a humdinger. Also these United States risks losing our triple A rating...  The downgrade really should mean zilch given the fact that rating companies like Moody's are part of the casino...

About that hedge fund called Iceland

A tale of Iceland where yesterday's fishermen suddenly morphed into investment bankers (and are 'unmorphing' right back into what they do best - fishing).

From Vanity Fair: When Neil Armstrong took his small step from Apollo 11 and looked around, he probably thought, Wow, sort of like Iceland—even though the
moon was nothing like Iceland. But then, he was a tourist, and a tourist can’t help but have a distorted opinion of a place: he meets unrepresentative people, has unrepresentative experiences, and runs around imposing upon the place the fantastic mental pictures he had in his head when he got there. When Iceland became a tourist in global high finance it had the same problem as Neil Armstrong. Icelanders are among the most inbred human beings on earth—geneticists often use them for research. They inhabited their remote island for 1,100 years without so much as dabbling in leveraged buyouts, hostile takeovers, derivatives trading, or even small-scale financial fraud. When, in 2003, they sat down at the same table with Goldman Sachs and Morgan Stanley, they had only the roughest idea of what an investment banker did and how he behaved—most of it gleaned from young Icelanders’ experiences at various American business schools. And so what they did with money probably says as much about the American soul, circa 2003, as it does about Icelanders. They understood instantly, for instance, that finance had less to do with productive enterprise than trading bits of paper among themselves. And when they lent money they didn’t simply facilitate enterprise but bankrolled friends and family, so that they might buy and own things, like real investment bankers: Beverly Hills condos, British soccer teams and department stores, Danish airlines and media companies, Norwegian banks, Indian power plants.

...Back away from the Icelandic economy and you can’t help but notice something really strange about it: the people have cultivated themselves to the point where they are unsuited for the work available to them. All these exquisitely schooled, sophisticated people, each and every one of whom feels special, are presented with two mainly horrible ways to earn a living: trawler fishing and aluminum smelting. There are, of course, a few jobs in Iceland that any refined, educated person might like to do. Certifying the nonexistence of elves, for instance.

Comment on a recent report of brain drain

Yesterday, President Obama announced a $500K salary cap on executives of companies that were planning on using the bailout money from TARP funds. I immediately heard commentators on the evening radio (NPR) lamenting about a brain drain on Wall Street due to the reduced incentive structures. My view is that if these are the brains that have managed to get us into this financial sinkhole, then the right solution is to drain the place of such brains. No, we do not need brains of this nature gallivanting around Wall Street anymore. The brain drain might actually be a good thing for the nation.

Chart data from here.

Greed is good

From here:

Despite crippling losses, multibillion-dollar bailouts and the passing of some of the most prominent names in the business, employees at financial companies in New York, the now-diminished world capital of capital, collected an estimated $18.4 billion in bonuses for the year. That was the sixth-largest haul on record, according to a report released Wednesday by the New York State comptroller.
Many corporate governance experts, investors and lawmakers question why financial companies that have accepted taxpayer money paid any bonuses at all. Financial industry executives argue that they need to pay their best workers well in order to keep them, but with many banks cutting jobs, job options are dwindling, even for stars.

On my mind

Not too sure if one can find another place on earth where the public is taxed, part of the proceeds of public taxation is used to bailout large banks that were on the verge of bankruptcy and then the large banks decide to promptly reward their underperforming bankers with large bonuses. Ah, the joys of capitalism...

Read here and weep...

Pervasive Ponzi(ness)

The more I start to understand the methods employed by Wall Street firms to achieve profits, the more I am convinced that grandfather Madoff might not be the only one running a Ponzi scheme…

From here: After all, Madoff’s scheme -- at least in spirit, if not in its nefarious intent -- wasn’t much different than the business models at some of the nation’s largest failed financial institutions. Back in May, four months before it collapsed, American International Group Inc. increased its dividend at the same time it unveiled plans to raise $12.5 billion in capital. Later, when its cash ran out, AIG got a government bailout, the size of which has expanded to about $150 billion.

Whether you call that a Ponzi scheme or something less sinister, AIG was paying old investors with money raised from new investors. The same could be said of many banks that blew through billions of dollars in freshly raised capital the past couple of years, continuing to pay large dividends even as their balance sheets quietly imploded.

Geoffrey Raymond's caricature of Mr. Madoff (ripped from Dealbreaker)

Wall Street Ponzi

Tom Friedman sees no difference between the Ponzi scheme run by Mr. Madoff and the Ponzi scheme run by Wall Street. I could not agree more.

I have no sympathy for Madoff. But the fact is, his alleged Ponzi scheme was only slightly more outrageous than the “legal” scheme that Wall Street was running, fueled by cheap credit, low standards and high greed. What do you call giving a worker who takes only $14,000 a year a nothing-down and nothing-to-pay-for-two-years mortgage to buy a $750,000 home, and then bundling that mortgage with 100 others into bonds — which Moody’s or Standard & Poors rate AAA — and then selling them to banks and pension funds the world over? That is what our financial industry was doing. If that isn’t a pyramid scheme, what is?

'Tis the season

As the annual bonus tree blooms again on Wall Street, firms that were used to making multimillion dollar payouts to incompetant bankers are finally making some practical changes to their compensation structures.

But it was Morgan Stanley’s claw-back announcement, which will affect some 7,000 workers, that captured the attention of employment lawyers and recruiters. It is similar to a rule introduced by UBS, the big Swiss bank, in late November, but Morgan’s is far broader in its language. Pay can be retracted from workers who engage in “conduct detrimental to the firm,” according to an internal memorandum announcing the move, or who cause “a restatement of results, a significant financial loss or other reputational harm.”

Morgan Stanley already holds on to 35 to 60 percent of high earners’ bonuses, but in the past it has held that money entirely in stock and stock options. Now a large portion will be cash, the bank said. “So if you’re a trader and you’ve had a huge year and you get paid a lot of money and then the following year it turns out you were taking outsize risk, we can go back and ding your pay from the year before,” said
Jeanmarie McFadden, a spokeswoman for Morgan Stanley.

Bonus reductions

Projected bonus cuts on Wall Street here. About time those millions were cut (in my view) and redistributed. Of course, some of this might be companies posturing to the market in the hope of driving up stock prices. The same strategy employed when companies announce layoffs... Has anyone gone back a year later to some of these companies that garner headlines when they project layoffs and asked them exactly how much they laid off or exactly how much they cut bonuses? No. I am sure not. Yes, posturing for the markets is an important aspect of this exercise...

On the tragicomedy of investment bank bailouts and distressed homeowners

From 1929 to 1933, during the time of the Great Depression, U.S. gross national product declined 29% and unemployment rate reached 25%. About 9000 banks suspended operations because of the financial distresses. In order to remedy the situation and restore consumer confidence in the banking system, The Banking Act of 1935, was introduced and a separation of bank types according to their business (commercial and investment banking) was developed. This was about the time that the Federal Deposit Insurance Company (FDIC) was created for insuring consumer deposits when a bank falls under. This means that if an individual puts their money (and faith) in a bank that is ‘FDIC’ insured, and in the event of the bank falling under, the Federal Government would step in to cover the shortfall and the consumer can ‘bank’ on the faith that s(he) will be compensated for the banks follies. In order that banks have this extra level of protection and Federal backing, they had to submit to a set of terms and conditions that included laws like minimum fractional reserves held in bank vaults as a hedge to cover shortfalls. The Federal regulatory framework also included a host of additional laws and rules that made the banks more beholden to Federal oversight (as it should - they are holding our monies). All of this extended regulatory frameworks put in place in turn cleared up the muddied reputation that the banks had developed after the Depression years…

Recently, I had written about the Bear Stearns bailout and how in my opinion, Bear should have been allowed to fail thus paving the way for a 'structural (re)adjustment' of the economy. Yes, this is bitter medicine, but much better than to live within the hype of inflated expectations and trigger happy indices that yo-yo on moment’s whim. Well, what happed was just the reverse, the Federal Reserve stepped in, bailed out Bear and helped JPMorgan orchestrate what now seems like a slapdash deal done hastily and a little bit suspiciously... A largely ignored sub-aspect of the flurry of activity that surrounded the Bear brouhaha was fine print news that the Federal Reserve also opened up its money spigots to non-commercial banks (the investment banks on Wall Street) and told them to borrow any amount that they wished from the Reserve sans oversight nor regulation. It was an open call – come by, take Federal monies, shore up your finances – all in the name of ‘preserving financial liquidity’. Recent reports state that the amount of drawing out of monies from this 'fund (called under the complex title of Term Securities Lending Facility)' is estimated to be in the region of 33 billion dollars a day over the last week and the number doubling to about 60 billion dollars a day as recent as yesterday. Can you guess the interest rate? - It was 0.33% (yes, that is correct).

Contrast this situation with news surrounding the deepening crisis that homeowners face as a result of the mortgage mess and the current state where millions of homeowners are either unable to pay their mortgages or are in danger of losing their homes because they are behind on their mortgage payments… Politicians talked about the crisis and proposed broad government rescue plans for homeowners that would each cost about $30 billion. The reply they got from the current administration was a dismissal of such ideas as bailouts and a vow (and threat) to veto even modest bills to help homeowners.

From NY1 news "All we're saying is homeowners need assistance too," said Darren Duarte of the Neighborhood Assistance Corporation. "You can't bail out the investors, bail out the Wall Street firms who created this crisis and leave homeowners at risk. We think that's not fair. And that's not the American way."

It is indeed funny and sad to see that modest bailouts for distressed homeowners screwed over by unscrupulous lenders and investment banks have little chance of success and have to go through a board legislative procedure with the attendant veto threats while broad bailouts where investment banks have easy access to over 50 billion dollars a day with little legislative oversight, zero threats of veto and little or no regulatory network passes muster with little talk or analysis… It is indeed staggering.

Georges Rouault, 1871-1958, 'Clown Tragique', 1911, oil and peinture à l'essence on paper laid down on cradled panel

Signs - of the times we live in

Three singular, independent bits of news on health (and hubris), economy (and chicanery) and sex (in public lives) makes one reflect...

- My wife and I take our children to the pediatrician for their vaccinations - whether out of feelings of common good (childhood vaccinations are supposed to prevent societal outbreaks of measles, mumps, smallpox among others) or individual well being (to keep our children healthy and immune to any of the above dire sounding diseases).
News reports suggest a growing tribe of American parents who refuse to vaccinate their children pointing to dubious studies and claims that vaccination has no proven advantages for children in the modern world and reports that link vaccinations with neurological disorders. Twenty states, including California, Ohio and Texas, allow a personal exemption - that is parents can opt out of vaccinating their children. A statement by the mother of a six year old in San Diego summed up the collective hubris succinctly: “I refuse to sacrifice my children for the greater good” while she also agrees that “I cannot deny that my child can put someone else at risk”. More here.

- I still have not got over the bailout of our nations fifth largest investment bank (Bear Sterns) orchestrated by another Wall Street bank backed by a only too eager Fed with the ostensible reason that this single action was done for the greater economic good (while it was revealed a couple of days back that the whole thing started off as a whisper campaign which fed on the news that Bear was illiquid). Today’s editorial in the Times puts it perfectly.
Compared to the cold shoulder given to struggling homeowners, the cash and attention lavished by the government on the nation’s financial titans provides telling insight into the priorities of the Bush administration. It’s not simply a matter of fairness, though. If the objective is to encourage prudent banking and keep Wall Street’s wizards from periodically driving financial markets over the cliff, it is imperative to devise a remuneration system for bankers that put more of their skin in the game. More here.

- We live in oversexed times - take a look of the governorships of New York and New Jersey and you will know what I am referring to... While the brouhaha over Spitzer is reaching the back pages of most newspapers, reports of McGreevey threesomes and Paterson's past affairs keep the prurience on the front pages on a daily basis. An op-ed piece in today's Times has given us some alphabet soup to fortify our slicing and dissection of the psychological underpinnings of carnal needs, casual flings and cavalier lays with the air of an expert:

1. In the parlance of American couples recovering from adultery, “D-Day” is the day you discover your spouse has been cheating on you. And as with the birth of Jesus, time is reset from there.
2. X.O.W. is the “ex-other woman"
3. O.N.S. is a “one-night stand”
4. N.P.D. is the often diagnosed “narcissistic personality disorder”
5. A “cake man” is a husband who wants to have his wife and his mistress, too.
6. ‘Pinching the cat in the dark’ is a phrase employed by the Dutch when they find out that their partners have been shoring up their extra curricular activities in the libido department.

Article here.

On why Bear Stearns should have failed this time

For all the talk about 'government is the problem' and 'too much regulation stifles the free market', the events that unfolded over the weekend saw the government actually financing the purchase of a troubled investment bank (Bear Sterns) through a conduit (JP Morgan Chase) leaving one to believe ardently in the fact that, more, if not an excessive oversight of the financial markets would be the medicine for the boom-bust cycle that we seem to be living through (with a cyclic frequency approaching the 10 year mark - the last one I remember was the dot com bust).

The government yesterday evening, decided to underwrite the take-over of a troubled investment bank on Wall Street in the hopes that rescuing this one might stave off further collapse of the financial system. While, it is well intentioned, this has left me pondering on these open unanswered questions:

- In bailing out some of the key stakeholders of the financial system, isn’t the government also bailing out some of the same people who led us into this mess (people who lived and got their bonuses through promising people easy homes with no money down, interest only payments and adjustable rate mortgages)?

- By bailing out banks and institutional players in the industry, is the government also helping to prop up what might be a house of cards built upon the mortgage bubble? Shouldn’t the government just sit and wait this one out and let the structural readjustment process bring the hype to what the markets can nominally sustain? Isn’t the government just putting off for another day what might have happened today (a normal structural adjustment to prevailing levels)?

- Aren’t we, in effect, playing dice with 'free-market / market-knows-best’ principles that was embraced in better times but thrown to the winds at the first sign of trouble?

As this and other questions swirl in my mind, it is worth reading excerpts from the op-ed column by Paul Krugman in today’s Times

Between 2002 and 2007, false beliefs in the private sector — the belief that home prices only go up, that financial innovation had made risk go away, that a triple-A rating really meant that an investment was safe — led to an epidemic of bad lending. Meanwhile, false beliefs in the political arena — the belief of Alan Greenspan and his friends in the Bush administration that the market is always right and regulation always a bad thing — led Washington to ignore the warning signs.

The result of all that bad lending was an unholy financial mess that will cause trillions of dollars in losses. A large chunk of these losses will fall on financial institutions: commercial banks, investment banks, hedge funds and so on.

Nobody expects an investment bank to be a charitable institution, but Bear has a particularly nasty reputation. As Gretchen Morgenson of The New York Times reminds us, Bear “has often operated in the gray areas of Wall Street and with an aggressive, brass-knuckles approach.”

Bear was a major promoter of the most questionable subprime lenders. It lured customers into two of its own hedge funds that were among the first to go bust in the current crisis. And it’s a bad financial citizen: the last time the Fed tried to contain a financial crisis, after the collapse of Long-Term Capital Management in 1998, Bear refused to participate in the rescue operation.

Bear, in other words, deserved to be allowed to fail — both on the merits and to teach Wall Street not to expect someone else to clean up its messes.

At the time of writing this, the markets and futures are still falling globally, the Federal Reserve further cut the overnight lending rate and the New York Stock Exchange just opened with a 150 point drop in the DOW.

Bearish views

Wall Street blues - a poem

I took a quick afternoon walk
down Wall Street.
Walked past bankers, rapists,
couple of commonplace murderers,
some stray immigrants,
lovers, fruit vendors and students.

Some had just made a killing
off someone else's fortune.
Some had just killed
for someone else's fortune.
Some were learning to kill
over that self same thing.

Some had just made love
furtively in that empty office space
knowing fully well,
they would not confess.
Some forced their love
on unwilling terms, from positions
of advantage and carrots of promise.

Others were making their plans
of working the American dream,
using, of course - the gospel;
Gekko's famous lines as guide.

Others were just busy, buying lunch
and hurrying back to finish that deal
which will foreclose another home
somewhere else far away.

Some were selling fruit juice
in little plastic cups.
Four dollars for that little cup
seems to resonate
with the rest of the space; rapacious.

Yes, I passed them all
while walking
down Wall Street.

Sub prime meltdown - Part deux

A quote printed on June 29th 2000 from the New York Times: 'People who don't have good credit are preyed upon in all sorts of areas -- when they try to get a credit card, when they try to get a home-equity loan, when they try to get a mortgage on a house'' - Frank Torres, from an advocacy group that publishes Consumer Reports.

A quick scan of the results of typing in the words ‘gap rich poor America’ into any search engine will make it easy to understand how deep a problem we face with respect to the growing disparity between the haves and the have-nots. Many studies are now coming out with even more dire results that state that this gap is only set to widen with the fallout being that definitions of ‘middle class’ will become ever more murkier.

From a study by economists Arthur Kennickell and R. Louise Woodburn: “The richest ten percent of the US population - about ten million households - owned eighty-four percent of the stock and ninety percent of the bonds held by individuals. The bottom eighty percent only three percent.”

Sometime back, I had written a bit about the sub prime mess that we are living with right now… and for some reason I thought that in all of their pristine wisdom, we would see some kind of legislation come out from the lawmakers that could potentially help forestall devastating home foreclosures that are leaving families out on the streets because they are unable to pay devious mortgage payment schemes dreamed up by our ever inventive mortgage companies.

Terms like adjustable rate mortgages are but one example of an egregious trend of hoodwinking the ordinary citizen into believing that s(he) can dream to be a homeowner at a affordable rate of interest on the loan when in reality the rate would adjust itself in response to prevailing market indicators after a set period of time. Of course, a little transparency would have worked, but in a rush to close deals and ensure market capture, transparency and understanding the fine print were left as discretionary options resting on the shoulders of the confused homeowner (when in reality it should have been the responsibility of the mortgage company to come clean and spell it out).

In this troubled scenario of the citizenry, I was hopeful that the lawmakers would come to help the aggrieved, but was in for a rude shock yesterday when just the opposite happened. The lawmakers had acted, but clearly in favor of protecting the super-rich… I noticed that none other than the Treasury Department stewarded a deal in which various well off banks get together and create a ‘super fund’ of sorts that can in theory raise up to 200 billion in what can be called a ‘veiled bailout’ of the debt markets. Of course, nobody is going to call it a bailout, but the fact remains clear.

A report in the New York Times makes the case abundantly clear, but a few paraphrased words from the article will help us understand how the rich manage to take care of its brethren.

1. The biggest banks in the US, with active encouragement from the Treasury Department, unveiled a plan to keep the housing-related debt crisis from worsening.
2. The new entity, called a Master Liquidity Enhancement Conduit, or M-LEC, could raise as much as $200 billion or more through the issuance of its own securities
3. The banks hope to take minimal risk and avoid actually investing any of their own money
4. If the banks’ initiative works as planned, many investors that helped to finance risky loans will be spared distress

Here, it is clear from #3 that the wealthy investors/owners behind banks take minimal risk and avoid losing any of their money – while still protecting their bottom-line (of course, they always bring up the fact that they are doing all of this to stave off recession).

It is also clear from #4 that the wealthy investors who knowingly financed risky loans (the loans were risky because they depended on manipulating the goodwill of the poor hapless individual who buys homes using fancy mortgage vehicles like adjustable rate mortgages) will be spared distress and ensure return of their monies with the appropriate returns that were originally guaranteed to them.

Of course, the Treasury has repeatedly said that it was only a facilitator and no government money was involved. “I don’t see this as a bailout,” said James Paulsen, chief investment officer at Wells Capital Management. “There is no public money involved in this. The government’s role here is facilitating discussion among private players to take care of this them. If the private players can find a way to help alleviate this, then why shouldn’t they?”

OK, a silent question that remained unanswered amid the clamor and din at the end of the day was this: When is facilitation of the same kind going to be extended to the growing ranks of homeowners who are going to be homeless due to the financial machinations egregiously played by the Street?

Update (October 18, 2007): The treasury secretary outlined the plans behind helping people in distress yesterday: From the yesterday's NYT: Mr. Paulson predicted that foreclosure proceedings would begin on one million homes this year. But his main proposal was a voluntary alliance of mortgage-servicing companies that would try to reach out to homeowners before they fell behind on payments. He tiptoed around the issue that many analysts have argued is a central conflict of interest for rating agencies: that they earn their fees for evaluating a new security offering only after the offering has been sold to investors.

C'mon, when you knowingly admit that 1 million homes are going to be foreclosed over the next year, one would be expected to take stronger proposals than thinking about the creation of voluntary alliances to help consumers...