The Fed's Bad Loans

"The Federal Reserve Bank of New York [FRBNY] doesn't have to look far to understand the woes of banks and investors that hold loans and securities underpinned by real estate. It can look at its own books. ... In an unexpected twist, the takeover of the Bear assets effectively leaves the [FRNBY] as holder of credit-default swaps on bonds issued by the states of Nevada, California and Florida, That protection rises in value when the bonds decrease in value. ... Fair values are based on observable market proces, data points that can underpin as asset, and cash flow. ... Maiden Lane II's holdings include oddly named securities like a $29 million piece of New Century Home Equity Loan Trust 2005-3, which was stuffed with subprime loans originated by failed mortgage lender New Century Mortgage Corp. ... Among the residential mortgage loans and securities, about half were secured by homes in California and Florida. ... As a result, the Maiden Lane fund inherited about $4 billion of Bear's old Hilton debt. Blackstone is close to finalizing a deal to reduce its $20 billion loan by about 20%, according to people familiar with the matter", Carrick Mollencamp, Lingling Wei & Serena Ng at the WSJ, 2 April 2010, link:

http://online.wsj.com/article/SB10001424052702303395904575158331936921388.html.

The Fed is no better at buying subprime assets than anyone else. It exists to be "worse". Others had to lose on these assets had the Fed not bailed them out. Why unexpected? To whom?

Who is the US?

"The US government lost the first major criminal trial spawned by the financial crisis as two former Bear Stearns hedge-fund managers were acquitted of securities fraud. Some prosecutors had viewed the case as a blueprint for future charges against Wall Street executives. ... The acquittals are a setback for the US attorney's office in Brooklyn, NY, which along with several other offices is investigating Wall Street for possible criminal wrongdoing stemming from the credit crisis, including at Lehman Brothers Holdings Inc. [LBHI] and [AIG]. ... There 'was nothing that was clear and convincing, said juror Tabasam Bhatti, a 31-year-old civil servant. ... The federal bailout of Wall Street has raised the ire of taxpayers and put pressure on the Justice Department to hold top executives accountable for the crisis. ... 'We're thrilled with the verdict,' said Susan Brune, a lawyer for Mr. [Matthew] Tannin. Messrs. [Ralph] Cioffi and Tannin [C&T] still face a civil-fraud lawsuit, which was brought alongside the criminal charges last year, by the [SEC]. John Nester, and SEC spokesman, said the agency expected to go forward with the litigation", my emphasis, Amir Efrati (AE) and Peter Lattman at the WSJ, 11 November 2009, link: http://online.wsj.com/article/SB10001424052748703808904574529464269179406.html.

"The acquittals of two former Bear Stearns Cos. hedge-fund managers on securities-fraud charges is causing some soul-searching amid prosecutors who hope to hold Wall Street accountable for excessive risk-taking that helped lead to the financial crisis. ... This is particularly true for the investigations of former executives at [LBHI] and [AIG] which could be brought by the US attorney in Brooklyn, people famuilar with the matter have said. The Bear case was tried in Brooklyn. A spokesman for the Brooklyn US attorney declined to comment. ... Andrew Hruska, a former federal prosecutor [said] 'There's not as much unthinking animus [against Wall Street] by jurors as some prosecutors believe, and they can't just count on juries to gloss over facts that don't fit with the government's theory.' ... To be sure, the Bear case had certain unique characteristics, such as judicial rulings and expert witness testimony that was favorable to the defense. These advantages mightn't come into play in future cases. ... But the jury found that the emails, when read in their entirety, showed that the defendant's private ruminations weren't at odds with public comments", my emphasis, AE at the WSJ, 12 November 2009, link: http://online.wsj.com/article/SB10001424052748703811604574529921128557610.html.

"The quick 'not guilty' verdict reached Tuesday afternoon by a Brooklyn jury in the federal criminal trial of two former Bear Stearns hedge fund managers was at once surprising--for its failure to comport with the zeitgeist--but also entirely understandable, based on a close reading of the prosecution's arguments and the evidence the judge allowed to be introduced. 'There was a reasonable doubt on every charge, one juror told the Times afterward. 'We just didn't feel that the case had been proven.' ... But the jury eventually saw the entire message, in which Mr. Tannin ruminated at length about various courses of action ans seemed to be striving to make the soundest financial choice. In other words, it was just about what you would hope your fund manager would be worrying about in a precarious time. ... For now, [C&T] remain the only bankers indicted for their professional behavior in what became one of the worst financial crises in our history", my emphasis, William Cohan at the NYT, 12 November 2009, link: http://www.nytimes.com/2009/11/12/opinion/12cohan.html.

"The nasty juggernaut known as the US [DOJ] usually gets it man, regardless of whether or not the man targeted has committed any crimes. ... However, every once in a while, there is good news to report, and on Tuesday afternoon, the government's lousy case against former Bear Stearns hedge fund managers [C&T] was deep-sixed by a jury that could recognize the prosecutors' dearth of evidence. I don't have much confidence in federal juries, and I am sure that I never would be permitted to serve on one (Oh joy), but on this day, a federal jury in Brooklyn did its job and did it well. ... Second, they had a legal team that shot down everything that the federal prosecutors threw at them. Third, Judge Frederick Block could smell the dishonesty of the government's case and he was not afraid to do his job. Unlike most federal judges, Block did not see himself as being an arm of the prosecution, and that made a huge difference in the trial. Fourth, the government had no case. NO case. ... I closely followed this case and had a sense of where it was headed. (Interestingly, most of the media chose to present a rosy picture of the government's case, and at the breaks, reporters were seen laughing and joking with the prosecutors. ... However, the biggest howler came from prosecutors Illene Jaroslaw and Patrick Sinclair [J&S], who made off-the-record remarks that the Brooklyn jury was too unsophisticated to understand the intricacies of the case. ... First, and most important, the last thing that [J&S] wanted was for their presentation to be eye-glazing and they were hoping that the defense would present the argument that the securities markets were very complicated and maybe jurors should not try to figure out what constituted a crime and what was not a crime. ... Second, the reason that the trial was held in Brooklyn instead of Manhattan was because the court-shopping prosecutors wanted a Brooklyn jury, reasoning that a jury of working-class people would not be able to relate to a couple of once-wealthy Wall Street traders. [J&S] purposely wanted what they believed would be an 'unsophisticated' jury that would not understand the information the defense was going to present. Thus, to claim that the jury's alleged 'stupidity' was the reason that they lost is the ultimate proof that federal prosecutors are an arrogant lot", my emphasis, William Anderson at Lew Rockwell, 12 November 2009, link: http://www.lewrockwell.com/anderson/anderson270.html.

This case stank and always stank. C&T are "top executives"? It was brought to divert public attention from Vampire Squid's actions. It's the worst case since the Joe Jett fiasco, see my 8 August 2008 post: http://skepticaltexascpa.blogspot.com/2008/08/joe-jetts-alive.html.

Yes, Hruska, BC wanted the jurors to convict C&T for VS's actions. Soul searching by prosecutors? That presumes a fact not in evidence. Objection sustained. What is unique about "judicial rulings ... favorable to the defense"? What is AE saying about our federal judges? Hey, BC, did you ever hear of the Federal Rules of Evidence? Acquaint yourself with Rule 106, my 12 September 2009 post: http://skepticaltexascpa.blogspot.com/2009/09/goldmans-schtarkes-4.html.

Was BC trying to deceive the jury into convicting C&T? I am clearly convinced. Why has no one else been indicted? This article was titled, "How the Scapgoats Escaped". Well done.

I despise federal prosecutors. To call them arrogant is a compliment. Every AUSA seems to think he's Albert Einstein. They're not. I haven't met an Einstein working for the DOJ yet.

Question Conventional Wisdom

"Conventional question: Did the government's quick intervention on Wall Street last year save us from another Great Depression? Alternative question, one that I prefer: Did government intervention make matters worse? ... Next, consider the view that the crisis was prolonged by a misdiagnosis that led to more interventions. When the crisis first flared up, government officials argued that high interest rates in the money markets were due to a shortage of liquidity rather than to risk on the banks' balance sheets. ... Now, with the recent one-year anniversary of the Lehman bankruptcy, people are discussing why the financial crisis worsened so much in the panic last fall. Many still say that the big government mistake was not stopping the failure of Lehman. I do not think the evidence supports that view. Of course the losses for Lehman's creditors and the run on certain money market funds were a jolt to the market. But far worse was the chaotic intervention by the government in the following weeks, including the Treasury Deparment's not vey credible description of how it would remove toxic assets from the banks' balance sheets, the huge amount of money it asked for with only two and a half pages of legislation and the scare stories it let loose about another Great Depression if the legislation was not passed. ... The government interventions during this time of panic were part of a pattern of ad hoc responses starting with the Bear Stearns bailout. No guidance was given following Bear Stearns about the circumstances under which another firm, such as Lehman, would be rescued", my emphasis, John Taylor (JT) at Forbes, 2 November 2009.

I agree with JT, a Stanford economics professor. Uncle Sam made things worse. Remember MLEC in its various incarnations, see my 22 December 2007 post: http://skepticaltexascpa.blogspot.com/2007/12/mlec-rip.html.

Derivatives Spread Risk?

"Since it is chillingly clear that US financial institutions have for a good while been regulated no more stringently than, say, demolition derby drivers, Washington has belatedly locked the garage door and begun to debate strict new rules. ... A basic reason for favoring regulation is that derivatives create a kind of mirage. They don't extinguish risk, they simply transfer it to a third party--a counterparty, as the term goes. ... Roughly a year later [1995], there was a rash of derivatives problems that punished companies like Proctor & Gamble and American Greetings and supported the notion that most nonfinancial CEOs didn't have a clue about the intricacies of these instruments. ... Robert Steel, a ranking member of Henry 'Hank' Paulson's US Treasury team, remembers the case against a rescue: 'Gee whiz, this isn't a depository institution. It should just go out of business.' ... Derivatives, in other words, had changed Bear from a broker-dealer that could have been simply the latest name on a Wall Street tombstone to an entity that the government needed to save because it was too interconnected to fail. ... The feds essentially decided at this point that it was better to save AIG than to risk a domino effect among its counterparties, which were about two dozen prominent financial institutions in North America and Europe. ... But the Lehman saga illustrates another toxic aspect of derivatives: They are often a mess to value. That can lead, intentionally or not, to misreported profits and assets. ... But within two weeks of the bankruptcy filing, BofA sued Lehman to recover the $357 million, saying that Lehman in fact owed derivatives payments to BofA. Ultimately BofA placed the amount it was owed at $1.95 billion! In other words, by BofA's thinking, Lehman didn't have a plus of $357 million, but rather a minus of $1.95 billion. ... Considering the unending complications of derivatives, wouldn't we be better off without them? ... 'It doesn't matter what they do in Washington,' said a New York derivatives trader recently, showing Wall Street's all too common contempt for policymakers. 'The smart guys who come out of business school don't take regulatory jobs there. The smart guys go to places where there are chances to do well. And if there are new rules, the smart guys will just deal with them and move ahead'," original italics, my emphasis, Carol Loomis at Fortune, 6 July 2009.

If "smart guys" start getting long prison terms for peddling this "financial crack", they will stop. No regulation will work as well as prison terms which smart guys can't "diversify" out of. Derivatives "don't extinguish risk ... they simply transfer it". This is key. We can use this concept to kill them. Have derivative accounting conformed at issuance and quarterly. If A says the derivative is worth $1 million, counterparty B agrees, or else the contract is closed and its value arbitrated. If A or B can't pay, it goes bankrupt. Period. Yes Steel, Bear wasn't a "depository institution". It should have gone bankrupt. I would prohibit depository institutions from dealing in derivatives. To hell with AIG's counterparties. Why bail out Lloyd Blankfein (LB)? Just because Henry Paulson is a Goldman alumus? LB has enough money, he doesn't need Joe Schmoe's. Yes, "derivatives are often a mess to value". That's one reason bank accounting stinks. I see financial statements with model derived derivative values that I believe no one would pay to buy the instrument. They look like fiction to me.

Black Rock, Black Hat?

"BlackRock helped shape the government's toxic-asset plan, which critics have said helps vulture investors buy assets on the cheap while exposing taxpayers to the bulk of the losses if the investments sour. Meantime, BlackRock continues to manage $132 billion in mortgage assets, some of which have defaulted. BlackRock's multiple hats put it in the enviable position of having influence on setting the prices of both the assets it is buying and selling. 'BlackRock is too close to the problem to be objective,' says Janet Tavakoli, a former Wall Street derivatives trader and now president of a financial-consulting firm. 'One should question how much they are part of the problem.' ... 'We have a two-decade record of managing conflicts, which is why we have been hired by many global institutions and governments,' says Mr. [Laurence] Fink, a former Wall Street trader. 'Our clients trust us.' ... Ben Bernanke ... also wrote that the Fed may and has audited BlackRock's compliance with [confidentiality] rules and its methods for valuing securities. ... Mr. Fink's Rolodex reaches deep into Wall Street and Washington. He speaks frequently with Timothy Geithner, Treasury Secretary and former New York [Fed] president. It was Mr. Geithner who asked him to value the assets at Bear Stearns and AIG, among other things. ... Mr. Fink's ties to Wall Street and Washington were evident in the collapse and rescue of Bear Stearns last year. As the securities firm teetered in mid-March, JPMorgan Chase & Co. asked Mr. Fink to value Bear Stearns's assets to help the big bank formulate a buyout offer. ... The request: to switch gears and help the Fed choose which of those Bear assets could be used to collateralize a $29 billion government loan as part of the deal. Several months later, Mr. Fink paved the way to be involved in the problems at AIG. ... BlackRock also was involved in the fallout from the bankruptcy of Lehman Brothers in September. Ken Wilson, an adviser to former Treasury Secretary Henry Paulson, says Mr. Fink was the first executive he talked to after the Lehman collapse who had a strong understanding of what was going on in the money markets. 'People talk to him because he is substantive,' says Mr. Wilson, a former Goldman Sachs Group Inc. [GSG] partner now in private practice. ... In September Mr. Fink called Morgan Stanley [MS] CEO John Mack about his pending investment from Mitsubishi UFJ Financial Group. BlackRock, which says it was subsequently hired by Mitsubishi, provided a financial opinion on [MS's] balance sheet. The opinion helped seal the deal. ... In its latest role, BlackRock has advised the government on how to craft what is called the Public-Private Investment Program", my emphasis, Liz Rappaport and Susanne Craig at the WSJ, 19 May 2009.

Aren't you pleased that a Wall Street "insider" like BlackRock is working in the public interest? That it has private clients and helps draft public policy? Will PPIP help BlackRock's private clients? That its tentacles have GSG all over them? Why would Mitsubishi need a "financial opinion" on MS's balance sheet? Where's the PCAOB? What did MS pay Deloitte & Touche $47 and $52 million in 2007 and 2008 for? Is BlackRock a CPA firm too? BlackRock should be removed from any further contact with the Treasury or Fed. Forcibly.

Congressional Comics

"As Mike O'Rourke, strategist at broker BTIG, remarked with a dismissive tone: 'Congress allowed [Tim Geithner] to shell out $30 billion with questionable legal authority for the Bear Stearns acquisition and now they are complaining about $30,000", Michael Santoli at Barron's, 19 January 2009.

"It now falls to Geithner to lead the way out of this mess. ... Colleagues say Geithner privately acknowledges that the U.S. economy is still sinking fast and the root cause of the problem--the housing bust and ensuing credit crunch--is still very much with the nation", my emphasis, Bill Powell at Time, 26 January 2009.

I agree with O'Rourke. I opposed Geithner's appointment as SecTreas, but his not paying $34,000 isn't why. That this miniscule item arose in the Congressional hearings shows Congress lack of perspective on its duties. Congress can look into steroid use in baseball, but doesn't supervise the SEC. What a joke. If Uncle Sam needs $34,000, let him ask Lloyd Blankfein for it. I'm sure Goldman Sachs (GSG) has $34,000. Didn't GSG get $10 billion in bailout money in December? It must have $34,000 left.

Privately? Why listen to anything Geithner says?

More Good News

"In a closely watched move that may be followed across Wall Street, the top executives at Goldman Sachs Group Inc. [GSG] have decided to forgo their 2008 bonuses. In doing so, they are giving up potentially tens of millions of dollars in payouts in a year that reshaped the securities industry. ... The executives will only be eligible for their base salaries, $600,000 for each. A firm spokesman said the executives felt it was 'the right thing' to do. ... The debate over bonuses and how much should be paid out has been raging for months across Wall Street. Some investment bankers have argued that even if it was an ugly year, only a handful of people are responsible for the losses and not everyone should be punished for that. ... Many of these employees performed well in 2008 despite the market turmoil, these people say, but could get plucked away by rival firms if compensation practices are significantly altered. ... At many financial firms, about half of all revenue is allocated to compensation, and multimillion-dollar bonuses are routinely paid out to ensure the best talent stays put. ... Since the start of 2002, Goldman, Morgan Stanley, Merrill, Lehman and Bear have paid a total of $312 billion in compensation and benefits to its employees", my emphasis, Susanne Craig at the WSJ, 17 November 2008.

"Bring out the hair shirts? The decision by top executives at [GSG] to join peers at Deutsche Bank and UBS in forgoing bonuses for the year is a sensible act of contrition. But it is hardly radical. Against the backdrop of a financial crisis and intense public scrutiny--particularly after gorvernment capital injections--they had little choice. ... But cutting the pay of a handful of top executives is window dressing. What matters is the size of broader bonus pools", my emphasis, Thorold Baker at the WSJ, 18 November 2008.

"Citigroup Inc. Chief Executive Vikram Pandit vowed to keep slimming down the financial giant, announcing about 25,000 new job cuts that will shrink the number of employees by 20% since he took over last December", David Enrich at the WSJ, 18 November 2008.

"Capital is key to Citigroup's future. And on that score, investors are still worried, even after the banking giant announced plans Monday to cut 50,000 employees. ... Tangible assets, which don't include goodwill or intangibles, are 55 times the bank's tangible equity. J.P.Morgan Chase, by contrast, is 31.4 times, with Bank of America is 31.3", David Reilly at the WSJ, 18 November 2008.

"Behind headlines of record losses, a small group of Wall Street traders on commodities, currencies and interest-rate trading desks have made huge profits for the banks that employ them. That is setting up a scramble as traders vie for dwindling pools of bonus money once heaped on such top performers. So far, they look to be on the losing side of the trade. ... UBS, meanwhile, is crafting packages that withhold short-term pay if long-term bets go sour. Shaken by the global financial crisis and increasing government oversight, banks are groping with a new way of doing business: Pay out huge sums and risk public ire and perhaps more government intervention. Pay too little, and tempt defections or insurrection from the few people who are driving this year's profits. ... While Morgan Stanley's chief financial officer cited the commodities-trading group on an analyst call this year as one of the bank's 'two top businesses,' some traders in the unit in the past have argued that the commodities group is undercompensated relative to its contribution. ... The best traders at top-tier commodities and currency trading desks made $10 million to $20 million or more last year, and the next level down, traders who brought in $100 million in revenues, might have made $4 million to $5 million [Michael Karp] says. Generally, traders look for bonuses of up to 10% of profits they made for a firm, with adjustments for the performance of the unit and the overall firm. ... [Gustavo] Dolfino says star foreign-exchange traders who expected to make $25 million this year after earning the firm $250 million may get less if it isn't clear the feat can be repeated without the use of borrowed money. Acess to the firm's capital has been a key element to the returns of Morgan [MS] and Goldman [GSG], who have led a virtual duopoly in this commodities-trading business for more than two decades. ... Goldman, the other dominant Wall Street commodity dealer, could make as much as $3 billion in net revenue, say people familar with the results", my emphasis, Ann Davis (AD) at the WSJ, 19 November 2008.

"'The villagers are at the gates of the castle with burning torches,' says one compensation consultant. The sheer amount that bankers are paid riles people at the best of times. When the economy is ravaged and the source of the trouble is banks themselves, the pitchforks come out. Politicians on both sides of the Atlantic are gleefully grilling bankers on pay. ... Bankers are desperately trying to placate their critics. ... Paying out billions in bonuses will still look awful. Worse, many expect the ratio of compensation to income, which normally hovers just below 50%, to balloon as banks' revenues fall faster than their pay bills. ... Surely things are so bad that banks could still afford to disappoint even their better employees by screwing down on their pay? Banks everywhere are ditching staff, after all. ... Mob justice may have deserving targets but it is always crude and usually goes too far. Attacks on bankers' pay are no different", Economist, 20 November 2008, link: http.www.economist.com/finance/PrinterFriendly.cfm?story_id=12650356.

"Treasury Secretary Henry Paulson, under fire from lawmakers and others for his approach to resolving the financial-sector crisis, defended his actions as 'necessary steps to prevent a financial collapse.' Mr. Paulson said Thursday that Washington should take a hard look at compensation practices in the financial-services industry, as well as the process of securitzing loans and selling them to investors. ... Mr. Paulson said he has dealt with matters as best as he could, and blamed the turmoil on factors including 'government action and mistaken actions, outdated U.S. and global financial regulatory sytems, and ... the excessive risk-taking of financial institutions'," my emphasis, Deborah Solomon at the WSJ, 21 November 2008.

"Wall Street firm [GSG] said Friday that it will issue debt backed by the Federal Deposit Insurance Corp. under the new Temporary Liquidity Guarantee Program, or TLGP", Matthew Cowley at the WSJ, 22 November 2008.

Mike Shedlock's 20 November 2008 post about Citigroup is worth reading: http://globaleconomicanalysis.blogspot.com/2008/11/citigroup-blames-short-sellers-for.html.

Yves Smith's (YS) 20 November 2008 post about Citigroup is also worth reading, http://www.nakedcapitalism.com/2008/11/citi-considers-selling-itself-in-whole.html.

YS has another post about Citigroup, 23 November 2008 worth reading, http://www.nakedcapitalism.com/2008/11/new-york-times-citi-woes-due-to-lousy.html. I add, "Where were the CPAs"? CPAs are supposed to evaluate a client's "business risks" among other things while doing an audit. The American Institute of Certified Public Accountants published Assessing and Responding to Audit Risk in a Financial Statement Audit (Assessing), 2006, a 498-page tome about how CPAs should consider risk during audits, 498 pages of junk to me. I read all 498 pages. Silly me. Lots of words, no substance. If Citi has "risk control" problems, whatever that means, what did KPMG get $88 million in 2007 for? Plaintiff's bar, start your engines. I smell a lawsuit. Section 4.21 of Assessing reads, "Usually, management identifies business risks and develops approaches to address them. This process for managing risk is an element of the client's internal control and should be evaluated as part of your procedures to gain an understanding of internal control". Then what? Another gem, "During the audit, you may identify risks of material misstatement in the financial stattements that management failed to identify. In such cases, you should consider why the client's risk assessment process failed to identify those risks and whether their process is appropriate to the client's circumstances". Well KPMG? Does anyone at Citi or KPMG know what cost of capital means? Isn't Robert Rubin (RR), "formerly" of Goldman Sachs and Treasury a Citi director? Why does Citi pay RR, double Ivy Leaguer, Harvard followed by Yale Law School, $17 million a year? Much of auditing is window dressing. Hey Mark Olson, of the PCAOB, did you read this NYT article? What if anything, will you do about it? Hey RR, do you know what cost of capital means?

GSG "top executives"? You're kidding. That these guys are eligible for any bonuses shows Wall Street compensation practices are bizzare. Joe Schmoe gets "punished" to support overpaid incompetants and worse, who want bonuses! What chutzpa; i.e., asking a judge for mercy after murdering your parents saying, "Your honor, I'm an orphan". What are investment banks today? A scam! They pay employees every dime possible, then having pushed themselves to the brink of insolvency, scream for bailouts. And get them! Babe Ruth, the Sultan of Swat, El Bambino, in 1931, during the depression asked for an $80,000 ($3 million today) salary. When told that's more than President Hoover makes, $75,000, responded, "I had a better year than he did". Did you have a better year than Bush, Lloyd Antoinette Blankfein (LAB)? Is your public approval rating better than Bush's 20%? LAB, here's a tip: keep your head down.

I agree, it's window dressing. Treasury should tell GSG and its competitors, not ask, tell, until all Treasury funds are repaid in full, including dividends, your bonus pools will be: zero! You don't like it, leave. "But I'm a $50 million a year trader". Really? Without the Fed's suppressing interest rates and fleecing the public to your benefit, you would be lucky to shine shoes in Grand Central Station. Would the capital markets cease to function if you stopped trading? I doubt it.

When you read the whole article, it appears only about 12,000 "job cuts" will come from layoffs. This is still a good opportunity for GSG. It might get 12,000 CNC guillotine rentals from Citigroup. I wonder how GSG bills for its use? Does GSG charge "day rates" or "per chop" like drilling contractors charge "per foot" in the oil patch?

Citigroup is woefully undercapitalized.

MS and GSG may be as poorly managed from each's shareholders perspective as GE. They have traders getting 10% of "their" profits. How do GSG and MS, among others, measure profits? Do they: use Kidder Peabody accounting, appropriately allocate cost of capital? AD notes, "Access to the firm's capital has been a key element to the returns of Morgan and Goldman". Whose capital is it? The traders, or the shareholders? I think these firms are ripe for shareholder revolts. Imagine thousands of "exploited" traders storming Capitol Hill, their Bastille! Will Barney Frank (BF) say, "Mr. Peckinsniff, trader, you made $25 million last year, right? With millions jobless, what are you complaining about? That it wasn't $50 million?" As outside the Capitol thousands of traders carrying pitchforks shake their fists and rebuild 1932's "Bonus Army Village".

How can traders be "undercompensated"? Why do they stay? Does anyone remember microeconomics? You should have encountered "marginal revenue product" (MRP). A firm will hire more of a factor, until its MRP less its marginal cost (MC) equals zero. If a "top" trader only gets 10% of his MRP, he's being enslaved! Why isn't his pay almost ten times his current pay? I see a 13th Amendment problem here. Traders of the world unite, you have nothing to lose but your chains! In 1847 Abraham Lincoln said, "To secure to each labourer the whole product of his labour, or as nearly as possible, is a most worthy object of good government". Traders, you are on the right side of history! Throw Lincoln's statement in BF's face! March around the Capitol with megaphones blaring about your exploitation at the hands of the greedy capitalists. Hand out hundreds of thousands of leaflets explaining your plight. Organize. Join the teamsters' union! If slaves got only 10% of their MRP's, I suspect the slaves' price in the antebellum South would have been much higher that it was. I look at these compensation practices and think, the bailout was an even bigger "mistake" than I thought before. Do MS and GSG do anything which is profitable? Why didn't these "exploited" traders leave years ago? Suppose one of them can make a $250 million pre-tax profit. At even a four PE multiple, he's "worth" $1 billion! Why is he with GSG or MS? What's going on? This sounds like a job, not for Superman, but Joel Stern. Maybe he can get into these firms and figure it out. If GSG's and MS's profits can walk out the door, what PE multiple should they be accorded? Why are they worth anything? On 19 November GSG was $55.18 a share, for a $21.8 billion market cap. If say 50 traders can walk out the door, the rest of GSG may be worth nothing. It may be worth nothing now.

Disagreeing with the Economist, we should reduce bankers' pay until they leave. It's one way to find their MRP given how bad I suspect the banks "responsibility accounting" is. If the traders, etc., don't like it, tough. They should ask their senior management's to return the bailout money. Until then, traders be grateful you haven't had a "date" with the CNC guillotine. The peasants aren't interested in your problems after having paid over $1 trillion to keep you arrogant ingrates in Rolexes and Rolls Royces. At least the unnamed compensation consultant saw the villagers with torches and pitchforks! There is a way to placate the peasants, seppuku!

When a company blames short sellers for the fall in its stock price, you should start its death watch. Is Citigroup's $800 million man this stupid? Doesn't he know when to shut up? Apparently not.

Hey Paulson, why should Washington look at say, GSG's compensation practices? Weren't you GSG's CEO? What did you do for GSG's shareholders when you were GSG's CEO? Did you discharge your job responsibilities correctly? Did you breach a fiduciary duty to them?

GSG employees want bonuses and need Uncle Sam to guarantee GSG's debt? Peasants, pitchforks at the ready. Storm the Bastille.

Delicious Irony

Yves Smith (YS) has a 31 October 2008 post at her Naked Capitalism about how investment banks were apparently "undone" by the 2005 bankruptcy law changes they lobbied for. "'The changes were introduced to promote the orderly unwinding of transactions but they ended up speeding up the bankruptcy process,' said William Goldman, a partner at DLA Piper, the law firm. 'They wanted to protect the likes of Lehman and Bear Stearns from the domino effect that would have ensued had a counterparty gone under. They never thought the ones to go under would have been Lehman and Bear'." Here's a link to the post: http://www.nakedcapitalism.com/2008/10/investment-banks-hoist-on-2005.html.

There may be some justice in the world. I never considered when reading about the 2005 bankruptcy bill that it might have the effect YS describes. I remember Elizabeth Warren (EW), Harvard Law School professor, blasting the bill because of its anti-consumer and pro-bank provisions and agreeing with EW's analysis of the bill's provisions.

Yves Smith Didn't Make This Up

Yves Smith (YS) has a 4 November 2008 post at her Naked Capitalism about the New York Fed's hiring Michael Alix, formerly of Bear Stearns as a senior vice president in its "Bank Supervision Group". YS writes, "You cannot make this stuff up". I know. Here's a link: http://www.nakedcapitalism.com/2008/11/fed-hires-bear-stearns-risk-chiefto.html.

The Fed does not want to be outdone by Henry Paulson's (HP) Treasury. My 18 August 2008 post, "I Didn't Make This Up", is about HP hiring Morgan Stanley to work on Fannie and Freddie's rescue plan. Here's a link: http://skepticaltexascpa.blogspot.com/2008/08/i-didnt-make-this-up.html.

Laugh! We in the US are living on the far side of the looking glass.

Who is Stephen Cutler?-2

"A federal inquiry has concluded that the [SEC] should consider disciplining its director of enforcement and two supervisors for their role in handling an insider trading investogation that led to the firing of an S.E.C. lawyer for trying to interview an influential Wall Street executive. The commission's inspector general, H. David Kotz, said in a 191-page report obtained by the New York Times that he had found evidence that 'raised serious questions about the impartiality and fairness' of the S.E.C.'s investigation of possible insider trading at Pequot Capital Management, a giant hedge fund. Mr. Kotz, also condemned what he called the 'common practice' of giving outside lawyers' clients access to high-level S.E.C. officials when they had complaints about front-line investigators. ... Aguirre complained that he was fired in September 2005, shortly after receiving a merit raise, because he wanted to take testimony from John J. Mack, currently the chief executive of Morgan Stanley [MS] and a close friend of Pequot's founder, Arthur J. Samburg. ... The inspector general primarily sided with Mr. Aguirre's version of events, accusing enforcement officials of failing 'in numerous respects' to properly manage him and for allowing 'inappropriate reasons to factor into its decision to terminate him.' As a result, Mr. Kotz recommended possible disciplinary action against the director of enforcement, Linda Thomsen, Mr. Aguirre's direct supervisor, Robert Hanson; and the assistant director of enforcement, Mark Kreitman. Ms. Thomsen was criticized for providing 'relevant information' about the commission's evidence aginst Mr. Mack to [MS's] counsel, Mary Jo White, a former [US] attorney. At the time, [MS] was vetting Mr. Mack to be its new chief executive. ... Kotz said it was 'fairly routine' for outside lawyers to bypass front-line investigators and speak to S.E.C. supervisors when they had complaints about how their clients were being treated. This practice, Mr. Kotz said, would allow prominent lawyers to have better access to S.E.C. officials than less prominent ones. ... John J. Nester, an S.E.C. spokesman, said Mr. Kotz's report had concluded that the Pequot matter had been 'aggressively pursued' and that 'the investigation did not find that enforcement cases are generally affected by political decisions or the prominence of defendants'," my emphasis, Walt Bogdanich at the NYT, 7 October 2008.

"A rare inside look at an enforcement case against Bear Stearns Cos. [BS] that was ultimately dropped highlights the sensitivity of the 'revolving door' between government and industry. In one of several scathing reports released in recent weeks, the [SEC's] inspector general said that a senior SEC official closed a long-running case against [BS] amid an 'ongoing personal relationship' with the lawyer representing Bear in the matter. ... While the inspector general 'did not find evidence of a direct connection' between the relationship and the decision to close the investigation, 'even the appearance of a conflict is disturbing and could potentially damage the reputation of the Commission.' The report recommends disciplinary action against [David] Nelson. ... In a statement, the SEC said 'the report does not cite a single instance of improper communication or undue influence.' ... The allegations illustrate the delicate dealings in industries where lawyers and others cycle between roles in government regulation and private practice. Many enforcement lawyers have left the agency for jobs representing clients in SEC cases. ... Still some SEC executives in Miami were 'stunned' at the decision, the report says. Jon Jordan, a Miami branch chief ... said he didn't complain because that 'would do nothing' for him but make his 'life miserable' and 'definitely would not help' his career at the SEC", my emphasis, Michael Siconolfi at the WSJ, 18 October 2008.

"[BS] improperly valued certain assets to avoid taking write-offs in 2007 as the credit crunch was beginning to unfold, according to the [SEC's] inspector general. ... Albert Kyle, a finance professor at the University of Maryland who conducted the review for the inspector general, said it was improper for risk managers to allow [BS] in effect to adopt two valuations for the same asset. ... The SEC's regulatory staff, which was responsible at the time for overseeing the firm's risk management, rejected the report's contentions. ... Charles Mulford, an accounting professor at the Georgia Institute of Technology, reviewed the report and said it 'raises a lot of questions.' Using different valuations for the same asset is 'improper accounting,' he said. 'Whether it rises to the level of fraud is for somebody with jurisdiction to decide'," Kara Scannell at the WSJ, 18 October 2008.

"The FBI is struggling to find enough agents and resources to investigate criminal wrongdoing tied to the country's economic crisis, according to current and former officials. ... According to previously undisclosed internal FBI data, the cutbacks have been particularly severe in staffing for white-collar crimes like mortgage fraud, with a loss of 625 agents, or 36 percent of its 2001 levels", Houston Chronicle, 19 October 2008.

"Serious questions"? Hahahaha! The SEC is a joke. Do lawyers other than NY Biglaw get regular access to senior SEC personnel? The SEC should give Linda Thomsen a new title, director of questionable practices concealment. Mary Jo White, again. She's everywhere. The SEC should adopt a new policy: log every contact made by NY Biglaw and have someone not associated with the SEC, like a prominent member of the plaintiff's bar investigate them. This looks like a job for, no not Superman, but Melvyn Weiss as soon as he's released from prison. Now that would please the Mikado's Lord High Executioner. I conclude SEC enforcement cases are almost invariably subject to political influence. Some relevant prior posts:

http://skepticaltexascpa.blogspot.com/2008/02/who-is-stephen-cutler.html.

http://skepticaltexascpa.blogspot.com/2008/05/sec-v-spitzer.html.

http://skepticaltexascpa.blogspot.com/2008/07/2008s-palmer-raids.html.

http://skepticaltexascpa.blogspot.com/2008/07/first-amendment-1-sec-0.html.

http://skepticaltexascpa.blogspot.com/2008/10/chris-cox-deaf-dumb-blind-criminal-or.html.

Potentially damage? Rigorous enforcement might end one's SEC career. Sounds like the major CPA firms.

Which other firms use Bear's valuation techniques today?

Perhaps the FBI should give up its "Palmer" raids and focus on serious crime.

Ritholtz on the SEC

Barry Ritholtz (BR) skewers the SEC at rgemonitor.com on 18 September 2008, "Is Financial Innovation just another word for excessive and reckless leverage? Apparently so. ... [T]he events of the past year are not a mere accident, but are the results of a conscious and willful SEC decision to allow [investment banks] to legally violate existing net capital rules that, in the past 30 years, had limited broker dealers debt-to-net capital ratio to 12-to-1. ... Who were the five that received this special exemption? You won't be surprised to learn that they were Goldman, Merrill, Lehman, Bear Stearns and Morgan Stanley. ... So while the SEC runs around reinstating short selling rules, and clueless pension fund managers mindlessly point to the wrong issue, we learn that it was the SEC who was in large part responsible for the reckless leverage that led to the current crisis. You couldn't make this stuff up if you tried. ... As the SEC itself has noted, this alternative program requires significant judgment, as contrasted with the numerical tests and capital charges (the haircuts) imposed on broker-dealers under the basic net capital rule. The alternative approach requires substantial SEC resources for complex oversight, which apparently are not always available", my emphasis.

Right on BR. Imagine, Chris Cox's (CC) SEC wants to replace GAAP, with its hard and fast numerical tests with the "more judgmental" IFRS. Why? The SEC favors more bad accounting among other things. Even CC, JD and MBA Harvard, ain't that dumb. CC understands the implications of replacing GAAP with IFRS. BR notes certain "SEC resources ... apparently are not always available". That's interesting. Why not? Because the SEC pursues ridiculous cases like that of the Price Waterhouse Two, my 19 January 2008 post, http://skepticaltexascpa.blogspot.com/2008/01/of-planks-and-specks.html.

Spengler on Leverage

"It is remarkable that the US authorities, exhausted from their efforts to bail out the mortgage guarantors and other firms, have left Lehman to its fate. An enormous hoax has been perpetrated on the global financial community during the past 10 years. ... Where the underlying profitability of the American economy was poor, financial engineering managed to transform thin profits into apparently fat ones through the magic of leverage. ... Wall Street and the City of London rode an unprecedented wave of profitability by providing overpriced leverage to consumer and corporate markets. Led by the financial engineers at Lehman, the securities industry grew an enormous infrastructure of staff, systems, and financial exposure. They were so successful that when the music stopped, there was no way to liquidate this mechanism gracefully. It could only be allowed to collapse. ... The aging pensioners of Europe and Asia must find young people to pay interest into their pensions at home. ... But one-fifth of Germans now are on the threshold of retirement and half will be there by mid-century. ... There is nothing complicated about finance. It is based on old people lending to young people. ... Never before in human history, though, has a new generation simply failed to appear. ... It is tempting to see in the failure of Lehman Brothers and the forced merger of Merrill Lynch with Bank of America a failure of 'corporate culture'. In the case of a great financial firm that has weathered many storms, the failure of a business culture contains more information. ... Lehman''s culture was held up as an exemplar, a beacon to the ambitious and avaricious. Lehman's demise is a minor event next to the travails of America's mortgage guarantee agencies, which required a government bailout last week, to be sure, but it is a landmark in the unravelling of American corporate governance. ... Bear was a group of scrappy outsiders, led by Jews of no social pedigree. ... Bear proudly rejected corporate culture and management philosophy as a matter of scruffy pride. ... [Jimmy] Cayne was not our class, dear; the jumped-up refugeee from a junkyard had risen too high and received his comeuppance. ... Everyone may like Dick Fuld, who presides over a socially-connected, politically-involved, army of networking specialists who have one of Wall Street's best stock of favors done and collectable in return, But no one likes Fuld well enough to buy his firm. ... What took both firms down, rather, is a sudden break in the chain of expectations between the present and the future", Spengler at http://www.atimes.com/, 15 September 2008.

I looked at Fannie's Board of Directors. Wow. It's 12 members include: a former FBI director, an accounting professor and seven persons in the "finance" industry. How much do these people know? As for corporate culture, whatever that is, bah humbug, see my 29 February 2008 post on Stephen Cutler.

Connie Yu, are you listening yet? Come home. Go to work for Exxon USA!

Chris Cox-Obfuscator

"Last week, in close consultation with the Treasury and the Fed, the SEC issued an order to further the objective of existing commission rules that restrict naked short selling. It applies to precisely those financial firms that the Fed has designated as eligible for access to its liquidity facilities--and for which the taxpayer could be on the hook. The order carefully protects legitimate short selling in these securities. Our agency's rules have long been supportive of short selling. ... Illegitimate naked short selling is different. In the context of a potential 'distort and short' campaign aimed at an otherwise sound financial institution, this kind of manipulative activity can have drastic consequences. Eliminating the prospect of naked short selling will help assure investors that it is safe for them to participate, and that when the market declines it is not because of unseen manipulators and "distort and short" artists. ... The SEC is committed to maintaining orderly securities markets. It neither can nor should direct the market's fluctuations, up or down", my emphasis, Chris Cox (CC) at the WSJ, 24 July 2008.

"The SEC is focusing on four rumors that circulated about Wall Street firm Lehman Brothers Holdings Inc. in recent weeks, as the commission's investigation into potential market manipulation heats up. ... Top Lehman executives believe traders who profit when a stock falls, known as short sellers, have been spreading allegedly false rumors about their stock in an attempt to drive it down. ... Market-manipulation cases are difficult to prove. ... Authorities must prove that traders knew the information was false and spread it with the intention of profiting from its dissemination", Kara Scannell and Susanne Craig at the WSJ, 28 July, 2008.

"Asked for an example of false market rumors bringing down a firm, Harvard financial historian Niall Ferguson thought for a moment. 'You might look at France in the 18th century,' he suggested. ... Ironies abound. For one thing, rumors about Bear Stearns losses appear to have been true, confirmed by the federal regulators who oversaw the forced sale of the firm. For another, the list of the largest financial firms being protected from naked short selling by hedge funds ... includes several being investigated for potential manipulation of Bear Stearns and Lehman shares. Still another, Fannie Mae and Freddie Mac are among those being protected, even though forensic-accounting short sellers (naked or not) were right over the years to warn that the federal housing insurers were putting taxpayers at real risk. A final irony: In the credit crisis, the one class of financial-services firm that has not collapsed or begged for a bailout is the hedge-fund industry. James Chanos ... last week wrote Mr. Cox that 'artificial restrictions on short sales undermine the integrity of prices in our markets because they remove liquidity and, more importantly healthy skepticism from the market-place. ' There is a long history of selling short the short-selling messengers of bad news that turned out to be accurate", my emphasis, L. Gordon Crovitz at the WSJ, 28 July 2008.

How does CC distinguish legitimate from illegitimate short sales? Why is naked short selling illegitimate? What is CC talking about? Is an Einhorn or Ackman short illegitimate by virtue of who made it? Are shorts only illegitimate when made on shares of companies managed by CC's friend? Or companies CC seeks a future position with? CC supports short selling? Do Einhorn, Ackman or Chanos agree? How would CC know if the "victim" of a "distort and short" campaign is "sound"? Did CC think Bear Stearns was sound in March? The SEC's actions against short sellers convince me it is manipulating the markets. Imagine, the Treasury, SEC and Fed, the three biggest market manipulators are warring on short sellers. They all reside on the other side of the looking glass.

This SEC investigation is a joke. If the Lehman executives "knew" of these rumors, they also should have known LEH-NYSE was underpriced. Did they buy LEH stock recently?

Chanos is correct. Cox is aware of what Chanos writes. That's precisely why the SEC is warring against short sellers.

The Button Men

"Bruno and Iacono were indicted along with 86 others for a conspiracy to import, sell and possess narcotics; some were acquitted; others, besides these two, were convicted, but they alone appealed. ... The evidence allowed the jury to find that there had existed over a substantial period of time a conspiracy embracing a great number of persons, whose object was to smuggle narcotics into the Port of New York and distribute them to addicts both in this city and in Texas and Louisiana. This required the cooperation of four groups of persons; the smugglers who imported the drugs; the middlemen who paid the smugglers and distributed to the retailers; and two groups of retailers--one in New York and one in Texas and Louisiana--who supplied the addicts. ... The evidence did not disclose any cooperation or communication between the smugglers and either group of retailers, or between the two groups of retailers, or between the two groups of retailers themselves; however, the smugglers knew that the middlemen must sell to the retailers, and the retailers knew that the middlemen must buy of importers of one sort or another. Thus the conspirators at one end of the chain knew that the unlawful business would not, and could not, stop with their buyers; and those at the other end knew that it had not begun with their sellers. That being true, a jury might have found that all the accused were embarked on a venture, in all parts of which each was a participant, and an abettor in the sense that the success of that part with which he was immediately concerned, was dependent upon the success of the whole", my emphasis, US v. Bruno, 105 F2d 921, 922 (2 Cir., 1939) reversed on other grounds at Bruno v. US, 84 L ed 257 (1939).

"John Nathanson, one of the federal prosecutors handling the securities-fraud case against two former Bear Stearns hedge-fund managers, is being promoted to a supervisory position in the U.S. attorney's office in Brooklyn, N.Y. ... Before joining the government, he spent seven years at Manhattan law firm Rogers & Wells, which is now part of Clifford Chance LLP, where in the late 1990s he helped defend Merrill Lynch & Co. in civil and regulatory matters for the bank's role in a copper-market manipulation scandal", WSJ, 18 July 2008.

"Federal prosecutors Friday said they may seek additional charges against former managers of two Bear Stearns Cos. funds who were indicted in June ocver the collapse of the funds last year. At a hearing in Brooklyn Friday, [AUSA] Patrick Sinclair said the government was anticipating the possibility of additional charges against Ralph Cioffi and Matthew Tannin, the former managers of two high-profile bond portfolios in Bear Stearns's asset-management unit. Superceeding indictments are often filed to add new charges, additional counts, expanded allegations or even new defendants", Chad Bray at the WSJ, 19 July 2008.

Why cite a 69-year old narcotics conspiracy case? Because, giving Benton Campbell (BC), the benefit of the doubt, our EDNY US Attorney, did not use this type of "thinking" in the Bear Stearns Two (BST) case, my 3 July 2008 post. I see them at worst as being two "button men". Who didn't the DOJ indict? Why? Stupidity, or worse? Who originated the "product" C&T sold? BC seems to be trying to portray C&T as big time swindlers. I say of who? BC, are you familiar with West's criminal law key 772(5), the "wilful blindness" or "ostrich" instruction? Well? I can see it now, co-conspirators showing up in court as crime victims. What a country.

Good boy Nathanson. Now roll over and play dead. Beg. Good boy. I await the BST case second superceeding indictment to see who and what will not be named co-conspirators.

I await new defendants in the BST indictment. This may be a DOJ charge "pile on" in the hope of forcing the BST to plead guilty to something. The article was titled, "Bear Stearns-Case Charges May Grow". This reminded me of Pinocchio's nose. How strange Uncle Sam is. We will spend billions, possibly hundreds of billions to bail out Fannie and Freddie and Franklin Raines was not indicted for anything.

SEC-Stock Manipulator

"The [SEC], under fire for not responding more vigorously to a raft of rumors that have pounded stock prices, says it is cracking down on firms or individuals that illegally spread false rumors. ... The announcement was timed to be released hours before the trading week began in Asia, in hopes it would serve as a warning shot to traders, a senior official said. ... Nothing final has been decided, but Lehman executives have long pushed for SEC action to stop the rumor mongering around their stock. Sunday, people close to the firm said Lehman hopes the SEC move will stop the fall of its stock until it has time to put together a plan. ... The SEC began its antirumor campaign Friday, calling several hedge funds to warn that subpoenas for their trading records related to Lehman were imminent, people familiar with the matter said. SEC officials weren't specific about what period of trading they planned to examine, these people said. ... Many top Wall Street executives have complained privately about the apparent lack of action, saying traders knowingly spreading false rumors were in part responsible for the unraveling of Bear Stearns Cos., which was sold to J.P. Morgan Chase & Co. in March for a fire-sale price. ... Lehman Chairman and Chief Executive Officer Richard Fuld Jr. [RF] has been encouraged to step up and buy shares of Lehman as a vote of confidence in the firm he has run since 1993", my emphasis, Kara Scannell, Susanne Craig and Dennis Berman (SC&B) at the WSJ, 14 July 2008.

"The [SEC] has sent subpoenas to more than 50 hedge-fund advisers as part of its investigation into whether individuals spread false rumors to manipulate shares of two Wall Street firms, a person familar with the matter said", WSJ, 15 July 2008.

"'When markets are moving this fast, people have a right to expect the information they are trading on is reliable.' SEC Chairman Christopher Cox said Monday. 'We want people to understand that the cop is on the beat, that subpoenas are going out, there are investigations under way'," Houston Chronicle, 15 July 2008.

"Lehman Brothers, which has seen its shares tumble sharply over the past few weeks, would seem to have much to gain from news that federal regulators are dialing up their scrutiny of market rumor mongering. The firm has complained that false rumors have been a driver of its recent share declines", WSJ, 15 July 2008.

"Bear markets often involve bear-knuckle fights, but it is still a shock when the referee starts punching below the belt. The [SEC] has intervened in the epic struggle between financial companies and the hedge funds that are short-selling their shares. ... The SEC's moves deserve scrutiny. Investment banks must have a dizzying influence over the regulator to win special protection from short-selling, particularly as they act as prime brokers for almost all short-sellers. ... The SEC's initiatives are asymmetric. It has not investigated whether bullish investors and executives talked bank share prices up in good times. Application is also inconsistent. ... Like the Treasury and the [Fed], the SEC is improvising in order to try to protect banks. But when the dust settles, the incoherence of taking a wild swing may become clear for all to see", Economist, 17 July 2008, www.economist.com/finance/displaystory.cfm?story_id=11751227.

"As the dust settled from the rout of financial stocks earlier this week, the little clown cars came zigzagging up the Street. Have no fear, the [SEC] is on the case. Christopher Cox, the regulator whose only visibility during this financial crisis has been to proclaim Bear Stearns' soundness just hours before its collapse, will shake down every short-seller in America if he must to find someone he can blame for the financial flameout. ... In fact, what Cox has done is just one more distraction, one more attempt to make people think that maybe this crisis can be solved with easy pen strokes. ... The SEC, though, is more concerned with silencing the skeptics. We blame the short-sellers. We blame the speculators. Never, though, do we blame the people who made bad decisions. ... For all the fretting about rumors, Cox and his clown squad haven't announced a single investigation into misleading statements by CEOs. ... The SEC's move, then, is exactly what it seems: market meddling that props up the dogs while silencing the critics", Loren Steffy (LS) at the Houston Chronicle, www.chron.com/disp/story.mpl/business/steffy/5894371.html, 18 July 2008.

"In the latest game of markets blameball, hedge funds are getting slammed. Should they be? ... Members of Wall Street's establishment, including J.P.Morgan Chase & Co. Chairman James Dimon and top corporate-attorney Martin Lipton, have urged regulators to step up their patrol, and even put a crimp on short selling in general. ... Some say the assaults are little more than the latest chapter in a long history of financial scapegoating. ... High-profile managers such as David Einhorn and William Ackman have been leveling criticism against giant financial firms for more than a year. Judging by the numbers, they have been vindicated, but their pointed attacks have engenderd hard feelings", WSJ, 18 July 2008.

The SEC's contempt for the public is appalling. Alan Sloan of Fortune, my 18 July 2008 post reported RF got $489 million from stock sales over the past few years. What is RF complaining about? RF has a terrific opportunity. I give RF another put up or shut up. Lehman (LEH-NYSE) is currently $21.10. It was $14.27. Did you, RF, buy any at $14.27? If you didn't, SHUT UP! If it's worth more than $21.10, buy. On margin. Plenty. RF, I salute you. At least you unloaded Erin Callahan. The SEC's "investigation" is a blatant attempt to support investment bank shares. I didn't think stock manipulation was the SEC's job. This is more poor WSJ reporting. If SC&B "know" rumors are pounding stock prices, did they buy? Why are they reporters as opposed to running a hedge fund? If the SEC is still harassing David Einhorn, I hope he gives it another black eye. Or worse. Maybe Einhorn and Ackman should hire an attorney who was an AUSA and have him draft "indictments"for RF, Chris Cox, and anyone else they think appropriate, then hand deliver the "indictments" to Mike Garcia (MG) at a "press conference" in front of the SDNY US Attorneys Office. Maybe Justin Fox, my 9 July 2008 post will attend and ask MG what he intends to do with the "indictments"? Maybe it's time for a hedge fund manager to tell MG that the SEC is aiding and abetting securities fraud. Well Mike, will you look into it? The complaints of "top Wall Street executives" are more nonsense. If rumors killed Bear, why didn't these executives outbid JPMorgan and buy Bear? Why give JPMorgan this "bargain"?

The SEC can say whatever it wants. I think it sent the subpoenas to prop up investment banks' share prices.

Well Cox, are investors entitled to "reliable" information in slow markets? What do the securities laws require? If there is inaccurate information, where do you think it comes from in large part? Hedge fund operators or SEC registrants? That's it Cox, do your best Captain Renault routine, "Round up the usual suspects".

I note that Erin Callahan recently left LEH. False rumors? List them.

The Economist has this knocked. Well Cox?

I agree with LS. I await any Wall Street CEO's being added to the Bear Stearns Two indictment.

Well Cox, will you join Lipton's firm when you leave the SEC? Why don't you do something useful like investigate LEH's disclosures for the past few years?

London Banker's Casino

London Banker (LB) has a fine 11 July 2008 post at RGE Monitor, about the proposed single central counterparty (CCP) to clear OTC derivatives, which is so skeptical I would like to have written it. The link: www.rgemonitor.com/financemarkets-monitor/252947. Read, enjoy, join the Mogambu Guru and SCREAM! Some gems, "As in any casino, a team of sharks working together only has to shift the odds from 51-49 favoring the house to 51-49 favoring the sharks to win big money consistently. ... If they co-opt the casino commission, hey baby, no worries. What happens in Vegas, stays in Vegas. ... To put in mildly, one might have some concerns about the independence of CCP governance and oversight. With the New York Fed as the principal cheerleader and proposed regulator for the CCP, it begins to look more CCCP than CCP. If you trust [Tim] Geithner and his chosen seventeen banks to act in the best interests of all the millions of global economic and financial actors of the world who are affected by and deal in the global derivatives markets, go ahead and back the CCP".

"If they co-opt"? LB mentioned a "commission". Does LB mean the Fed hosted meetings for these 17 banks which are today's answer to 1957's Little Apalachin (LA) meeting which led to 63 arrests? LA gave rise to US v. Bufalino, 285 F2d 408 (1960). LA could never happen today. Why? Today's "commission" influences the: Fed, SEC, FBI, DOJ and CFTC. You can't beat it. A "commission" member wants to buy Bear Stearns, no problem. Drop $29 billion on the Fed and you're golden. Could Meyer Lansky (ML) have done that? Imagine if ML could have gotten say, $2 billion from the Fed in 1947 to build Vegas. Where would "the commission" be today?

The Fed's Inflation Fight

"The [Fed] stayed true to its recent news leaks yesterday and held its target interest rate at 2%. In lieu of action, Chairman Ben Bernanke and his mates decided merely to talk tougher about inflation, signalling that they may lack the will to tighten money in an election year. ... The consumer price index is rising at a rate roughly double the fed funds rate, and the CPI is a lagging indicator. ... Every American who drives or shops for groceries understands this, except at the Fed, where they bow before something called 'core inflation.' ... But don't worry: Yesterday's Fed statement averred that it 'expects inflation to moderate later this year and next year.' ... According to the Conference Board's June survey of consumer sentiment, Americans believe inflation over the next 12 months will be 7.7%. That's up from 6.8% in April, 5.4% in February, 5% last September, and the highest in the last 20 years. ... Meanwhile, inflation continues to rise around the world, especially in what the Paul Volker Fed understood was the 'dollar bloc'," my emphasis, Editorial at the WSJ, 26 June 2008.

"The [Fed] in March believed it had no choice but to help facilitate the rescue of iconic Wall Street investment firm Bear Stearns Co. [BS] to protect financial markets, minutes of March meetings released Friday show. ... 'Given the fragile condition of the financial markets at the time, the prominent position of [BS] in those markets and the expected contagion that would result from the immediate failure of [BS], the best alternative was to provide temporary emergency financing to [BS] through an arrangement with J.P.Morgan Chase & Co.,' according to the minutes of a March 14 meeting of the Fed's Board of Governors. ... J.P.Morgan said certain [BS] assets would add 'significant uncertainty to the level of risk it would assume at the same time it was acquiring the remainder of [BS],' the minutes said", WSJ, 28 June 2008.

I disagree with the WSJ's statement, the Fed bows "before something called 'core inflation'." I no more believe that than I do in the tooth fairy. Core inflation is something Uncle Sam created to justify lowering TIPS interest rates, increasing tax bracket creep and reducing future social security payments.

Talk of "moral hazard"! The Fed "bought" $29 billion of assets I assume JPMorgan didn't want and tried to conceal this by making it appear to have loaned $29 billion against them. If the "Street" was so afraid of contagion, Vikram Pandit, Stephen Schwartzman, Lloyd Blankfein, et. al., should have bailed out BS with each's personal assets. What was the Fed afraid of? A few investment bankers getting smaller bonuses this year? The Street plays a good game of "chicken' with the Fed. It's more than time the Fed let the Street drown in its own mess.

The Bear Stearns Two

"A federal grand jury in Brooklyn, New York, indicted two former Bear Stearns Cos. hedge-fund managers, alleging they misled investors when their fund was in peril, lied about their financial interest in the portfolios and destroyed evidence in the investigation. ... The 27-page indictment paints a picture of the scramble by the managers, Ralph Cioffi and Matthew Tanin, to keep their hedge funds alive. ... The managers pleaded not guilty and were released. Messers' Cioffi and Tannin [C&T] posted $4 million and $1.5 million bonds, respectively, secured by various properties. ... 'We are shocked and disappointed that the government has seen fit to fix blame on these two decent men,' said Edward Little, Mr. Cioffi's lawyer in a prepared statement. ... In a separate statement, Susan Brune, who represents Mr. Tannin, described him as 'a scapegoat for a widespread market crisis.' ... Defense lawyers are likely to argue that debates about the economy and the stability of the credit markets were standard fare last year as U.S. housing prices began a long slide", my emphasis, WSJ, 20 June 2008.

"When I heard that federal authorities has arrested the people that the government tells us were responsible for much of the subprime meltdown, I anxiously awaited the perp walk that would befall some notorious characters. Would we see Ben Bernanke wearing handcuffs, still dressed in his cams after having thrown even more money from the helicopter? Would the person shuffling before the media be Alan Greenspan, the architect of 18 years of legal counterfeiting? Had the federal authorities finally come to their senses and arrested the people most responsible for the chicanery and outright theft of the savings and investments of millions of people? ... Instead, I was to find that the Great Villians of Wall Street are [C&T], two former Bear Stearns hedge fund managers. ... Moreover, we can be sure that this is going to be the beginning of a busy prosecutorial season in which government officials will attempt to criminalize the actions of people who, in the end, were far less responsible for the meltdown than officials from the [Fed] and the U.S. Department of the Treasury. Indeed, the latest criminal charges are based on the fact that [C&T] privately had doubts about the quality and future of their hedge fund, but did not tell investors about their doubts. Lest anyone believe that such a state of affairs is 'criminal,' perhaps we should then wonder why Greenspan and Bernanke are let off the hook? After all, both men--and especially Bernanke--have made optimistic statements before Congress, only to be proven wrong. ... The larger point is that [C&T] are scapegoats, pure and simple. ... As more indictments come down the pipe, don't expect the media to ask the hard questions", William Anderson, (WA) at http://www.lewrockwell.com/, 20 June 2008.

"Anyone surprised by last week's arrest of two former Bear Stearns hedge fund managers must have slept through the Enron era. If Enron, WorldCom, Tyco--and the list goes on--taught us anything, it is that whenever the investing public suffers staggering losses on Wall Street, we can expect to see someone hauled off in handcuffs. ... Despite the complex nature of the subprime meltdown, the government has presented an indictment that reads very much like a garden-variety fraud. ... There is no question that at some point permissible spin crosses the line and becomes willful misrepresentation. That is really what this prosecution is all about. ... All of these alleged misrepresentations go to the question of intent--whether the statements made by [C&T] to their investors were knowingly false--and form the basis of the charges of securities fruad, wire fraud and insider trading. But this case also raises the more troubling question of whether all of Wall Street's ills can--or should--be reduced to criminal prosecutions, rather than leaving it up to appropriate financial regulators. ... Let's put this case in some perspective. This is not Enron. ... Nor is it Tyco. ... Rather, this is part of a much larger failure that extends well beyond these two defendants and their former employer to include many of our largest financial institutions. ... But these two hedge fund managers were not alone in reaping huge profits for years from the subprime market", my emphasis, Robert Mintz (RM) at the WSJ, 26 June 2008.

I wonder if Little and Brune will conduct a "scorched earth defense"? Whaaaat? For a first witness, call, drumroll please, Helicopter Ben (HB). Ask him if he and the other Fed heads discuss the condition of the economy. Introduce Fed minutes as subject to judicial notice. Who knows? If C&T regularly discussed the same things HB & Co., did, I can see it now: Hank Paulson (HP), "formerly" of Goldman Sachs (GS) calls Benton Campbell (BC), US attorney for NY's Eastern District and mirable dictu, the indictment is quashed. Alternatively, the jury will wonder why HP and HB aren't on trial. I can see HB in the witness box as an "adverse" witness, yet C&T's expert.

I agree with WA, C&T look like scapegoats to me. I went to the WSJ's website and found the 27-page indictment. I conclude C&T are guilty of something thousands of others are: puffery and incompetence. I saw two statements in the indictment, which if proven, look criminal. They were statements of fact, not opinion. Why did BC select C&T for prosecution? My answer: to help HP's case for increasing the Fed's powers to protect investment banks (IB). On 19 June Chris Cox, SEC chairman had a piece in the WSJ, looking to expand supposed regulation of IB, see my 2 July 2008 post. The only thing I saw in it was granting IB Fed discount window access. The indictment indicated to me that C&T did not understand the products they sold. They could have used Eugene Fama's or Bob Hamada's class at Chicago. They might have learned something. Another witness for C&T, Moody's Yuri Yoshizawa. She only looks backwards. Also, drumroll please, the GSer who said we saw a 25-sigma event, see my 15 August 2007 post. Why not indict him? A 25-sigma event, wow! A mere 6-sigma event is a 1.01 billion to one shot!

I agree with RM about the "larger failure". Perhaps RM, now with McCarter & English and a former federal prosecutor can explain to us why C&T were selected for prosecution. I think I have the answer.

Chris Cox in Chavez's Venezuela

"The Fed's opening of new lending facilities to large investment banks this spring, after financing the sale of Bear Stearns [BS], has helped restore confidence to financial markets. It has also posed some difficult questions. ... When [BS] was acquired by J.P. Morgan, Bear's overall capital ratio comfortably met the [Fed's] 10% 'well-capitalized' standard for commercial bank holding companies. Yet this didn't prevent a run on the bank. ... Investment banks, according to the conventional wisdom, were not subject to a run because they do not take deposits. Instead the SEC regulation was supposed to protect the broker-dealer's customers, which it did. ... It is clear that these protections are no longer enough. The Bear experience demonstrated that an investment bank can suffer a crisis of confidence that leads it customers and counterparties to precipitously withdraw funds--and threaten the financial system. This threat is what led the Fed to use its authority as 'lender of last resort' in the Bear crisis. ... [T]he Fed was required to find that Bear's imminent bankruptcy constituted an emergency threatening a severe, adverse impact on the economy. But making Fed lending available to all investment banks has exposed a lack of symmetry with respect to the explicit statutory terms on which commerial banks get this privilege. ... [R]elatively intrusive regulation has long been thought necessary to mitigate the moral hazard problem of central bank backstop liquidity, and other elements of the banking safety net such as deposit insurance. Now the provision of backstop liquidity to the major investment banks has unavoidably reduced the penalties they face for taking excessive risk. ... In my judgment, explicit legislative authorization for what is now a purely voluntary program of SEC supervision [of investment banks] is vital. ... Properly functioning investment banks are a critical engine of growth and innovation. We must be careful to construct a regulatory approach that meets our regulatory objective without disouraging risk-taking or neutering Wall Street's ability to fuel economic growth and innovation", my emphasis, Chris Cox (CC) at the WSJ, 19 June 2008.

The US no longer has the "rule of law". The Fed's invoking "emergency" to bail out JPMorgan reeks of Chavez and "decree laws" in Venezeula. No, I repeat no action CC proposes will reduce "moral hazard". What are CC's "regulatory objective[s]"? To maximize investment banker compensation? How about reducing "moral hazard" this way: any financial institution, aside from deposit takers, must decide if it wants "backstop liquidity". If it does, its executives go to the local OCC office and sign an agreement making the executive personally liable, not subject to extinguishment in bankruptcy for three times his last three years compensation. Such agreements, in the case of publicly-held companies, like National City, would be filed as Form IA-1. Form IA-2 would be the executive's annual statement of compensation and assets and liabilities. Deposit takers must be subject to this. If the executive can't meet his obligation, when the time comes for it, he is forced into bankruptcy. I suspect these enterprises will view risk differently when their managers know their personal fortunes are on the line and any monies they received during the last three years could be returned, thrice! If one doesn't want to be subject to this, let him work somewhere else. Suppose BS had gone bankrupt. What then? My guess, oil might be $20 a barrel cheaper, similarly, wheat, corn, soybeans, etc. all would be cheaper. Well CC, do you think avoiding BS bankruptcy was good for the "economy" whatever that means? I don't. Or maybe you think the "economy" starts at the Battery and ends on 57th Street and only includes Wall Street MDs earning over $2 million a year?

Volker on the Fed

"Former [Fed] Chairman Paul Volker said the Fed's independence could be hurt by the wide variety of assets it has taken on its balance sheet to combat the credit cruch. ... It has so far not directly purchased [loans backed by subprime mortgages]. It did, however, make an unprecdented loan of $29 billion to facilitate the sale of Bear Stearns Cos. to J.P. Morgan Chase & Co. ... Volker [said] 'If its' going to be looked to as the rescuer or supporter of a particular section of the market, that is not strictly a monetary function in the way it's been interpreted in the past.' ... Volker also laid part of the blame for the current crisis at the feet of banking regulators, including the Fed. 'Why were [the banks] permitted to set up those off-balance-sheet entities that may or may not have had some formal relationship with the bank? They were not regulated and [banks] didn't hold an adequate amount of capital against them. Why did that happen after the experience of Enron?' ... In 2003 and 2004, the Fed and other regulators ruled that the new accounting standards wouldn't compel banks to hold aditional capital for such entities. But when investors refused to refinance the entities' commerical paper last year, some banks were forced to take the entities back on their own balance sheets", WSJ, 15 May 2008.

I agree with Volker, See my 6 February 2008 post on the banks QSPE accounting.