Thursday Reads

Good Morning!

It’s amazing what kind of nonsense the right wing can come up with when their interests and myths are threatened.  Here’s the latest Faux News canard about Occupy.  It’s an ACORN plot!  If any one believes that, I have a few bridges across the Mississippi I’d like to sell them.  The Crescent City Connection even comes with tolls!!

How can a group that folded 19 months ago secretly conspire to bolster Occupy protests? Apparently, “sources tell” Fox News that people who used to work for ACORN have now taken on roles helping organize Occupy protests. In fact, Fox News reports that the former director of New York ACORN and his aides are now working for New York Communities for Change (NYCC), which is turn supporting demonstrations.

I’m not sure why this would be especially interesting if true — if folks who used to be involved with one group then started playing a role with another, who cares? — but as it turns out, a spokesperson for Occupy Wall Street said the NYCC isn’t playing a role in the protests anyway. But don’t worry, Fox News’ unnamed “source” said the group really is up to secret misdeeds, adding, “And yes, we’re still ACORN, there is a still a national ACORN.”

It’s safe to assume that Fox News has reliable contacts among progressive activist organizations, right? There’s bound to be plenty of former ACORN staffers and Occupy activists eager to dish to the Republicans’ cable news outlet, right?

Please. It’s really no wonder at all why Fox News’ audience ends up believing so much nonsense.

They do believe the nonsense, which makes Fox News watchers very dangerous in the voting booth.

Dems on the Super Committee are offering up Medicaid and other ‘entitlements’ in order to get tax increases from Republicans.  It didn’t work, but you have to wonder exactly what all they’re willing to put on the table.

Republicans have pressured supercommittee members to reject any deficit-reduction deal that raises taxes — including stimulus spending for the economy would almost certainly be a non-starter for most in the party.

Democrats have said from the beginning that the supercommittee should produce a “jobs plan” that includes “investments” to help the economy.

The supercommittee is charged with devising a plan that will cut at least $1.2 trillion over 10 years from annual deficits, but deep divisions exist on the panel over whether to raise taxes and cut entitlements to meet that goal.

The members met again Wednesday afternoon and Democrats were looking to see if the GOP would present an alternative path to the grand bargain.

You may recall that the grand bargain was the giveaway President Obama offered to Boehner last summer during the debt ceiling talks.  More details are available at this WAPO link.

The panel has floundered since meetings began in September. If the supercommittee fails to reach agreement to trim borrowing by at least $1.2 trillion through 2021, automatic spending cuts of an equal amount would be triggered in January 2013. These cuts would strike especially hard at the Pentagon, an outcome that Republicans are eager to avoid.

Ralph B posted this tidbit downthread last night.  Chelsea Clinton is said to be considering a congressional run.

Clinton has been approached by “the right people” in the New York Democratic Party, according to one source in Albany. While no decision has been made, Clinton is said to be “actively considering” a Congressional run from New York State in 2012.

Chelsea Clinton, 31, is the only child of former U.S. President Bill Clinton and U.S. Secretary of State Hillary Rodham Clinton.

The discussions of running Chelsea Clinton for a house seat grew out of the redistricting plans currently underway in the New York State legislature in Albany.

The plan is to identify an open seat for Clinton in or around New York City where she currently resides with her husband, Marc Mezvinsky. While no specific district has been determined, New York City and Westchester are said to be the focus with New York’s 18th District considered a strong possibility. The 18th encompasses much of Westchester County, just south of where her parents have maintained a home for the past 12 years.

The Daily Beast reports that Herman Cain was delinquent in paying taxes in 2006.  Additionally, he fought paying the bill.

According to court documents obtained by The Beast, Cain and his wife, Gloria, were served in February 2008 with a tax lien totaling $8,558.46 for unpaid income taxes and penalty due for the 2006 calendar year.

Gordon said Cain had filed with the IRS and won a six-month reprieve in paying his 2006 federal taxes as he was undergoing his treatment for stage four lymphoma and believed that filing should also have bought him time with the state of Georgia. “In Georgia, a taxpayer can submit a copy of his federal extension to request an extension of state income taxes,” Gordon said.

But instead, the state sent a notice of overdue taxes in October 2007, and then proceeded with the tax lien four months later, he said.

Cain’s accountant fought the Georgia Department of Revenue on behalf of his client well into 2008 and the two sides finally settled the matter in November 2008. A court formally withdrew the state tax lien on Dec. 8, 2008, court records show.

Gordon said the campaign was researching the exact date on which Cain made the payment to extinguish the lien

Robert Reich thinks that Wall Street is still out of control.

Dodd-Frank is rife with so many loopholes and exemptions that the largest Wall Street banks – larger by far then they were before the bailout – are back to many of their old tricks.

It’s impossible to know, for example, the exposure of the Street to European banks in danger of going under. To stay afloat, Europe’s banks will be forced to sell mountains of assets – among them, derivatives originating on the Street – and may have to reneg on or delay some repayments on loans from Wall Street banks.

The Street says it’s not worried because these assets are insured. But remember AIG? The fact Morgan Stanley and other big U.S. banks are taking a beating in the market suggests investors don’t believe the Street. This itself proves financial reform hasn’t gone far enough.

If you want more evidence, consider the fancy footwork by Bank of America in recent days. Hit by a credit downgrade last month, BofA just moved its riskiest derivatives from its Merrill Lynch unit to a retail subsidiary flush with insured deposits. That unit has a higher credit rating because the Federal Deposit Insurance Corporation (that is, you and me and other taxpayers) are backing the deposits. Result: BofA improves its bottom line at the expense of American taxpayers.

Wasn’t this supposed to be illegal? Keeping risky assets away from insured deposits had been a key principle of U.S. regulation for decades before the repeal of Glass-Steagall.

The so-called “Volcker rule” was supposed to remedy that. But under pressure of Wall Street’s lobbyists, the rule – as officially proposed last week – has morphed into almost 300 pages of regulatory mumbo-jumbo, riddled with exemptions and loopholes.

It would have been far simpler simply to ban proprietary trading from the jump. Why should banks ever be permitted to use peoples’ bank deposits – insured by the federal government – to place risky bets on the banks’ own behalf? Bring back Glass-Steagall.

The EU announced a Debt Accord late last night which caused a rally in both Asian stocks and the Euro.

The MSCI Asia Pacific Index gained 0.9 percent to 120.25 as of 11 a.m. in Tokyo, set for the highest close since Sept. 9. Standard & Poor’s 500 Index futures added 0.8 percent. The 17- nation euro climbed 0.5 percent to $1.3979 and rose 0.3 percent to 106.26 yen. Treasury 10-year notes erased earlier gains. Copper, zinc and lead jumped more than 1.4 percent in London and crude climbed 1.9 percent in New York.

French President Nicolas Sarkozy said the euro region’s bailout fund will be leveraged by four to five times, and investors have agreed to a voluntary writedown of 50 percent on Greek debt. Sarkozy plans to call Chinese leader Hu Jintao today to discuss contributions from the Asian nation to a fund European leaders may set up to fight the crisis, a person familiar with the matter said.

The news of a deal is “certainly mildly positive news for markets,” Adarsh Sinha, head of strategy for Group of 10 foreign exchange at Bank of America, said in a Bloomberg Television interview in Hong Kong. “We have got a plan out but a lot of the details aren’t in place.”

CNN announced the details late last night.

French President Nicolas Sarkozy said Greek bondholders voluntarily agreed to write down the value of Greek bonds by 50%, which translates to €100 billion and will reduce the nation’s debt load to 120% from 150%.

Sarkozy said the leaders agreed to boost the firepower of the EU bailout fund, known as the European Financial Stability Facility, “by four or five fold.” He added that officials have negotiated additional funding from the International Monetary Fund.

The writedowns were one of three inter-related problems political leaders must solve to devise a comprehensive solution to Europe’s debt crisis. They must also determine how to leverage a government-backed bailout fund and stabilize the banking sector.

EU leaders had pledged to resolve these issues Wednesday at their summit in Brussels. But given the bondholders’ resistance, it was unclear until the early hours of Thursday if the leaders would be able to follow through.

Earlier, the European Council issued a statement saying heads of state had agreed to raise capital requirements for banks vulnerable to losses on euro-area government bonds.

Under the terms outlined by EU officials, banks would be required to sharply increase core capital levels to 9% to create a buffer against potential losses. The amount to be raised would be determined after accounting for declines in the value of euro-area government bonds, including debt issued by Greece.

Based on market rates in September, banks will need to raise a total of €106 billion to meet the new targets, according to the European Banking Authority.

So, that’s the headlines that have grabbed my attention today.  What’s on your blogging and reading list today?


Derivatives – The Dark Market

[Dakinikat here:  We at Sky Dancing would like welcome fiscalliberal to the Front page!!!]

The major objective of this article is to begin the process of understanding the financial market to enable intelligent discussion on the blog.

One of the major pillars of financial collapse was Derivatives. They are very complex financial instruments with a wide diversity. They are described by a gaggle of terminology used by the high priests of finance. Because of complexity most of the books on the collapse skirt the detail of the Derivative Market. After we get through some basic definitions, we will focus on Credit Default Swaps (CDS); a subset of the Derivatives offerings. We will see how the government created a non regulated environment where fraud, compromised regulators and incompetent people ran the Investment Financial community in a very high risk mode.

Derivatives Defined

A Derivative is a financial instrument whose value is dependent on the value of another entity at a future time. Its primary function is to mitigate risk. A simple analogy would be your Home insurance. These policies guarantee that you will be remunerated if the value of your home falls due to fire, wind, or accident.  A relatively small premium of money can mitigate a large potential financial catastrophe. State regulators are in charge of most regular Insurance products and solvency is less of an issue as adequate capital reserves are defined.

We need to think of Derivatives as a “risk tool” meant to stabilize the financial businesses (markets). The wide variety of Derivatives creates confusion, so we are going to restrict our discussion to Credit Default Swaps (CDS).   Anticipating problems with Sub Prime mortgages, Securities were insured by investors. It was the Credit Default Swaps inability to perform that was a party to the financial collapse after the Lehman bankruptcy. They did not have the financial reserves to back up the policies they wrote How did that happen?

Deregulation

For our discussion today, three government deregulation actions are relevant.

  • 1999 Graham Leach Bliley Act repealed the 1933 Glass Steagall act. The Glass-Steagall Act prohibited any one institution from acting as any combination of an investment bank, a commercial bank, and an insurance company.
  • April 28, 2004 SEC drastically relaxed leverage standards for the Big Five Investment Banks: Goldman, Merrill, Bear, Lehman and Morgan Stanly. This created a very high risk environment.  The session can be viewed here.

Financial self regulation brought the system down in 8 years. Bush de-funded Federal regulation. Greed, incompetence and corruption reigned supreme. Enron people went to jail. As of 2010, under Obama only bit players have been jailed. Civil fines are a joke.

Securitization Market

We need to understand the environment created by the above regulation changes  to understand the role of CDS Derivative failure. We will concentrate on the Real Estate Industry

Traditionally, the real estate industry was handled by local banks who retained the loans. Their exposure to losses resulted in more careful origination of loans. For a long time, Fannie, Freddie and FHA were packaging (securitizing) mortgages and selling them to Investors. They enjoyed a good reputation because they had good loan origination standards. These were categorized as Prime mortgages. Generally these securities obtained a AAA rating which rarely changed. Good consistent returns were recorded with these products.

Early in the 2000 decade the Investment banks adopted the securitization model called Private Label Securities. They purchased their mortgages from unregulated brokers (Country Wide, Ameriquest etc) who had little or no standards regarding underwriting of loans. The private label market latched on to the fact that high risk “Sub Prime”  loans carried higher interest rates, hence higher profits. They had no exposure to the failure of the loan as risk was passed on to the Investors. They simply collected the lucrative fee’s.

Investment Banks packaged the loans (millions and billion level). They paid the rating agencies (S&P. Moody and Fitch) for ratings structuring the packages to get AAA ratings. It is clear the rating agencies did not do their job as traditionally solid AAA ratings were changed as the packages started to fail. These packages were sold to the domestic and world markets. Trillions of dollars were involved. The banks simply passed the risk on to the investors and collected the origination and servicing fee’s

CDS Market

Risk could be mitigated by purchasing a CDS against the failure of the security. So if the security failed the investor was held harmless. Remember that as of 2000 the CDS  market was unregulated. AIG – London Financial Services is the poster child of the CDS industry. AIG wrote most of the CDS contracts cheaply as they held inadequate reserves (in the event of a default) and had a good company rating based on the parent insurance company whose operations were regulated. Office of Thrift Supervision was the responsible regulator, but their presence was effectively non existent, Goldman Sachs (Hank Paulson as CEO) was one of their major clients.

However, late 2006 / 2007 AIG FP realized they were over exposed and got out of the market retaining the previous contracts. Recall in the unregulated market anyone could write CDS and the big banks did. As the Mortgage Backed Securities began to fail, the banks started writing CDS between the banks to mitigate risk always falsely believing the market would recover. This was necessary because When Bear and Lehman started to fail the banks were joined at the hip, guaranteeing each others toxic securities. Based on the 2004 SEC relaxing reserve requirements, that banks were leveraged up and things were starting to fail. In a leveraged market things get serious to critical in a matter of hours.

The daily, weekly and monthly credit markets froze up because nobody trusted anybody. Even GE was having trouble borrowing for daily operations. Andrew Ross Sorkin’s book‘Too Big to Fail’– gives a good account of the scenario in 2008. Fannie and Freddie were in conservator ship, near bankruptcy Bear was bought on a fire sale by JP Morgan, Lehman was bankrupt, Merrill near bankruptcy was bought by Bank Of America and AIG had to be rescued by the Federal Government. Morgan Stanly and Goldman were within days of bankruptcy, but got bailed out by Warren Buffet and a Korean financial entity.

The AIG story is discussed in this newspaper article ‘Behind Insurer’s Crisis, Blind Eye to a Web of Risk’.

It is interesting to know that just before the 2008 collapse, the rating agencies down graded AIG forcing them to hold more reserves. They were forced to raise cash in a collapsing market.  In a high leverage industry, when it rains it pours.

Naked CDS

Investors can buy CDS on securities even though they do not own the security. This is equivalent to a neighbor buying insurance on your house. So if you know that a Mortgage Backed Security has a lot of high risk loans in it and is headed to failure, you buy a CDS anticipating the default. Michael Lewis’ book‘The Big Short’–is all about the people who anticipated the failures and bought CDS products. A Bloomberg video interviews Lewis and it provides a lot of insight into the mess that evolved.

I look to Dakinkat, Gillian Tett, Yves Smith, and Janet Tavakoli on technical issues of Derivatives. Lewis’ forte is being able to write to the general public. His book gives a lot of insight to the CDS market nuances. It is interesting that Smith and Tavakoli consider Lewis to be a light weight. Yet, his book sales exceed theirs.

To get a notion of the size of the CDS market we need to look at these numbers. The size of our national economy this year is roughly $15 trillion. The whole world GDP is about $56 trillion. At the time of the 2008 failure, the size of the Credit Default Swaps (CDS) market was $64 trillion. The exposure at the time of the collapse was huge. The magnitude of the Naked CDS is not known, but is understood to be huge.

Given that the unregulated CDS underwriters were prone to not provide adequate capital reserves for defaults, there was a massive liquidity problem, hence the government had to step in and bail out the likes of AIG and banks who wrote these products.

The whole CDS market is described as being part of the Casino Gambling image in the financial markets

Current Status

The Dodd Frank Bill has a moderate approach for Derivatives Regulation. However it is up to the regulators for implementation and the banks are attempting to minimize the impact of regulation. This is documented by two recent NYT articles.

It’s Not Over Until It’s in the Rules

A Secretive Banking Elite Rules Trading in Derivatives

A short summary of the above articles is that the big banks are attempting to save their Oligopoly through the Risk Committees of the Clearing Houses. This is being done by imposing high capital reserve requirements for participants. This has the effect of limiting competition which limits price competition and transparency. The elephant in the room is the risk committee’s saying certain derivatives are to complex to be cleared. This gets us right back to where we were in the financial crisis. Over the Counter non clearing house products are the most profitable and open to risk.

In the spirit of Brooksly Born regulation, It has been proposed that Derivatives be run using a Clearing House or a Exchange Trading Requirement.

From The Economist:

Clearing House: A clearing requirement is a requirement that all eligible derivatives be cleared on a central clearinghouse (also known as a central counterparty, or CCP). A clearinghouse provides critical counterparty risk mitigation by mutualizing the losses from a clearing member’s failure, netting clearing members’ trades out every day, and requiring that parties post collateral every day. Clearinghouses also centralize trade reporting, and can provide any level of post-trade transparency to the OTC derivatives markets that your heart desires — same-day trade reporting, including prices, aggregate and counterparty-level position data, etc. Virtually all of the harmful opacity and murkiness of the current OTC derivatives markets can be ended with just a clearing requirement — that is, a clearing requirement is a prerequisite for getting rid of the harmful opacity in OTC derivatives

Exchange Trading: An exchange-trading requirement, on the other hand, is simply a requirement that all eligible derivatives use a particular type of trade execution venue: exchanges (also known as “boards of trade”)..The exchange is just the trade execution venue (think NYSE vs. Nasdaq). The only thing that an exchange-trading requirement adds to the clearing requirement is “pre-trade price transparency.”

The clearing house is obviously the better because it brings a degree of financial integrity and transparency. It certainly is the more expensive of the options, but its cost  is minuscule when we think of the financial collapse.

However based on the articles above, it is clear that the big bankers are attempting to preserve their oligopoly in terms of the CDS market. They also want to preserve the option to take the market back to the opaque high risk environment because of profit opportunities.  The Opaque Over the Counter market is the biggest threat to the stability of the market

In Dodd – Frank, the CFTC and SEC have co-jurisdiction The CFTC commission seems to be moving to the bankers view. SEC has been relatively quiet on this subject

We need to remember that Mary Schapiro (SEC)  and Gary Gensler (CFTC) were part of the problem before the 2008 Financial Crisis. It remains to be seen how well they address the problem. Will they do the right thing or are they financial industry moles?