Yves Smith and Junior on TARP

Yves Smith (YS) has a 23 June 2010 post at her Naked Capitalism blasting "Timmy Boy" Geithner's recent comments about TARP's "success". YS's got this knocked. Here's a link: http://www.nakedcapitalism.com/2010/06/geithner-yet-again-misrepresents-tarp-performance.html. YS notes that to make TARP look successful the Fed and Treasury sanctioned accounting fraud. What else is new? Remember, the SEC, part of the Treasury, controls the PCAOB. Doesn't that give you the "warm and fuzzies"? The supposed "police force" of the CPA profession must ignore banks' accounting fraud. Think about it.

Junior at Junior Deputy Accountant delivers a Sonny Liston-like left hook on 23 June 2010 to Timmy Boy, here:

http://www.jrdeputyaccountant.com/2010/06/tim-geithner-has-completely-forgotten.html. Go Junior!

Financial Engineering and BP

"In retrospect, the pattern seems clear. Years before the Deepwater Horizon rig blew, BP was developing a reputation as an oil company that took safety risks to save money. An explosion at a Texas refinery killed 15 workers in 2005, and federal regulators and a panel led by James A. Baker III, the former secretary of state, said that cost cutting was partly to blame. The next year, a corroded pipeline in Alaska poured oil into Prudhoe Bay. None other than Joe Barton, a Republican congressman from Texas and a global-warming skeptic, upbraided BP managers for their 'seeming indifference to safety and environmental issues.' ... The people running BP did a dreadful job of estimating the true chances of events that seemed unlikely--and may even have been unlikely--but that would bring enormous costs. ... For all the criticism BP executioves may deserve, they are far from the only people to struggle with such low-probability, high-cost events. Nearly everyone does. 'These are precisely the kinds of events that are hard for us as humans to get our hands around and react to rationally,' Robert N. Stavins, an environmental economist at Harvard says. We make two basic--and opposite--types of mistakes. When an event is difficult to imagine, we tend to underestimate its likelihood. This is the proverbial black swan. Most of the people running Deepwater Horizon probably never had a rig explode on them. So they assumed it would not happen, at least not to them. ... On the other hand, when an unliklely event is all to easy to imagine, we often go in the opposite direction and overestimate the odds. After the 9/11 attacks, Americans canceled plane trips and took to the road. There were no terrorist atttacks in this country in 2002, yet the additonal driving apprarently led to an increase in traffic fatalities. ... In a little-noticed provision in a 1990 law passed after the Exxon Valdez spill, Congress capped a spiller's liability over and above cleanup costs at $75 million for a rig spill. Even if the economic damages--to tourism, fishing and the like--stretch into the billions, the responsible party is on the hook for only $75 million. ... Without the cap, executives would have to weigh the possible revenue from a well against the cost of drilling there and the risk of damage. With the cap, they can largely ignore the potential damage beyond cleanup costs", David Leonhardt at the NYT, 6 June 2010, link:

http://www.nytimes.com/2010/06/06/magazine/06fob-wwln-t.html.

$50 million. Apply these principles to the CPA and rating agency businesses and see what happens.

The SEC and DOJ Fold

"The Justice Department's decision last week to abandon a criminal probe against current and former exectuives at [AIG] underscores the difficulty facing prosecutors who want to hold individuals criminally accountable for the financial crisis. ... But, late last Friday, Mr. Cassano and two colleagues who were also investigated were told through their lawyers that they wouldn't face criminal charges after prosecutors found evidence supporting Mr. Cassano's account, people familar with the matters said. ... The conclusion of the two-year criminal investigation marks a setback for prosecutors who have come under public and political pressure to find evidence of criminal conduct in the wake of the recession. ... The travails aren't over for Mr. Cassano. The [SEC], which has to meet a lower standard of proof, is considering whether to file civil charges, according to people familiar with the matter. Mr. Cassano's lawyers declined to comment on the civil probe. ... For months, they believed Mr. Cassano hadn't disclosed to senior AIG executives or its auditors, PricewaterhouseCoopers LLC, that an accounting adjustment allowed his unit to avoid writing down the value of its swaps by billions of dollars, these people said. PwC declined to comment", Amri Efrati at the WSJ, 24 May 2010: http://online.wsj.com/article/SB10001424052748704904604575262942729708122.html.

"The [SEC] dropped its investigation of a former [AIG] executive who ran a subsidiary at the center of AIG's problems, following a similar move last month by prosecutors. ... Federal investigtors looked into whether [Joseph] Cassano misled investors with reassuring statements about AIG's exposure to mortgage losses, people familiar with the matter have said. A turning point came when prosecutors found evidence Mr. Cassano did make key disclosures. ... Mr. Cassano's lawyers called the SEC's move 'completely appropropriate in light of the facts.' They said the SEC staff 'realized that our client acted in good faith, kept his superiors informed, and was honest with investors", Kara Scannell at the WSJ, 17 June 2010, link: http://online.wsj.com/article/SB10001424052748703513604575311350142446886.html.

Well SEC? Will you now go after PWC for its wonderful AIG audit? Well PCAOB?

I expected this after the DOJ folded.

Atomic Accounting

"The Pentagon has now told the public, for the first time, precisely how many nuclear weapons the [US] has in its arsenal: 5,113. That is exactly 4,802 more than we need. ... The treaty's ceiling of 1,550 warheads deployed on 700 missiles and bombers will leave us with fewer warheads than an any time since John F. Kennedy was president. Yet the [US] could further reduce its reliance on nuclear weapons without sacrificing security. Indeed, we have calculated that the country could address its conceivable national defense and military concerns with only 311 strategic nuclear weapons (While we are civilian Air Force employees, we speak only for ourselves and not the Pentagon.) This may seem a trifling number compared with the arsenals built up in the cold war, but 311 warheads would provide the equivalent of 1,900 megatons of explosive power, or nine-and-a-half times the amount that Secretary of Defense Robert McNamara argued in 1965 could incapacitate the Soviet Union by destroying 'one-quarter to one-third of its population and about two-thirds of its industrial capacity.' ... In addition, should we want to hit an enemy without destroying its society, the 311 weapons would be adequate for taking out a wide range of 'hardened targets' like missile silos or command-and-control bunkers", my emphasis, Gary Schaub & Joseph Forsyth (S&F) at the NYT, 24 May 2010, link: http://www.nytimes.com/2010/05/24/opinion/24schaub.html.

David Deming tells us, "Never Give Up Your Weapons", American Thinker, 31 May 2010, link: http://www.americanthinker.com/2010/05/never_give_up_your_weapons.html. Right on.

Tom Hoffman writes, "A nation that renounces violence, no matter how just the cause, signs its own death certificate--and for a violent death at that", American Thinker, 31 May 2010, link: http://www.americanthinker.com/2010/05/when_masculine_virtues_go_out.html.

What arrogant, ignorant buffoons. Precisely? In the real world: weapons fail to detonate, miss their targets, etc., etc. What do S&F know about Russian targeting strategy and Russia's concept of "nuclear battles within a war"? I almost titled this piece "Megaton Morons". S&F could be financial engineers and work for the Vampire Squid. McNamara was our worst SecDef in my lifetime, see my 20 August 2009 post: http://skepticaltexascpa.blogspot.com/2009/08/mcnamaras-ghost.html. I wonder if S&F realize Russia "hardened" many of its military facilities after 1965? The buffoons "teach" at Air War College and Advanced Air and Space Studies. Wow! What course do they teach? "Road to National Suicide-301"?

Let's do some arithmetic. Would 1,900 megatons be adequate? Would 1,900 megatons have the same war fighting capability on 38 "Tsar Bombas" or 3,800 500 KT warheads? Well? A nuclear weapon's destructive capability is roughly proportional to the 2/3 root of its size. I'll explain. When Little Boy (LB) exploded over Hiroshima, it yielded 15 KT and had a fireball 410 meters in diameter. When Castle Bravo exploded over Bikini Atoll in 1954 with a 15 MT yield it had a 7,000 meter fireball. Whaaaat? 15 MT divided by 15 KT is 1,000. 1,000 x 410 = 410,000 meters, not 7,000. What's going on here? The cube root of 1,000 is: 10 (10 x 10 x 10 = 1,000). Now 10 x 10 = 100. Ergo Castle Bravo only had about 100X LB's destructive capability. 7,000 / 410 = 17.1, not too far from 10. Why square 10? Because the "footprint" an atomic weapon leaves approximates the square of its diameter. See? Two five MT bombs can do more damage than one ten. Similarly, five ones can do more damage than one five.

Tsar Bomba's fireball has been reported at 4,600 and 8,000 meters in diameter. Using 8,000 meters, at least it's larger than Castle Bravo's. Note: neither figure is close to 23,300 meters (7,000 x 3.33). 8,000 / 7,000 = 1.14, close to the cube root of 3.33, 1.49.

Why did the "Rooskies" stop building bigger warheads in the early 1960s? Does anyone remember the SS-6? It had a 3 MT warhead and a 5,000 meter CEP (circular error probable). Why did the Russians outfit the SS-18 with smaller warheads? Because they were more accurate! The SS-18 typically was fitted with ten 600 KT warheads, each with about a 400 meter CEP and 40 "pendevs", penetration devices to confuse potential defenders as to which were the real warheads. More accurate targeting leads to less destruction. That's why we use JDAMs today. After the Big War in the 1940s, the Army Air Corps, now Air Force, estimated that 97% of the bombs we dropped in WWII did not hit their targets, falling in fields destroying crops, not military installations and factories. That's a lot of wasted ordinance.

Guys like S&F, if working for say a manufacturing company, would look at the company's total inventory and ignore its components. You can have plenty of inventory dollars and still suffer "stockouts" if lacking item 15789 while having 5,000 units of 15788. I can imagine S&F endorsing just in time inventory. Of course, if the factory is located in a place which snows in the winter ... S&F's piece is appalling. It's so bad, I'm sure George Stephanopolous would endorse it.

Greece Today, America Tomorrow

"Are Europe and America headed to where Athens is today? ... Protected by the [US] through a half-century of Cold War, Europe cut back on defense and ratcheted up spending for La Dolce Vita. ... As the cradle-to-grave welfare states rose, an ever-increasing share of the labor force left the private sector for the security of the public sector. ... The fertility rate of Greece and every European nation fell below 2.1 births per woman needed to replace an existing population. Greece's birth rate has been below zero population growth for three decades. ... Were Greece a company, the solution would be bankruptcy. ... Because, should Greece decide not to take a chainsaw to her welfare state, but walk away from her debts and default, she would blow a hole in the balance sheets of the biggest banks in Europe. ... Rather than savage their welfare-state programs, and risk riots in the streets and a massacre at the polls, Madrid and Lisbon, too, might look ageeably at default. ... For how much longer will Greeks work longer, retire later and live on smaller pensions, so holders of Greek bonds can get their interest payments right on time? ... But the crisis will return. For the nations of Europe have made commitments beyond their capacity to keep, given their growing debts and aging population. ... And the unfunded liabilities of Social Security, Medicare and federal pensions rival those of Western Europe. States like California and New York, larger than Greece, look a lot like Greece. ... While the temptation is great for Washington to bail them out again, the [US] government itself has now begun to attract the concerned notice of holders of US debt", my emphasis, Pat Buchanan at World Net Daily, 6 May 2010, link:

http://www.worldnetdaily.com/index.php?pageId=150649.

"Crisis--from the Greek word 'Krisis'--is one of the many English words we owe to the ancient Athenians. Now their modern descendants and reminding us what it really means. ... So serious was the situation that it took a European version of the 2008 TARP bailout of US banks to save the euro. ... If fully implemented, it will be the mother of all bailouts--and one of the biggest admissions of error in modern financial history. The design of the European currency has been fatally flawed from the outset. It just took the Greek crisis to expose it. .... It would end forever the exchange-rate volatility that has bedeviled the continent since the breakdown of the Bretton Woods system of fixed exchange rates in the 1970s. ... A single European currency also seemed to offer a sweet deal. Countries with excessive public debt would get German-style low inflation and interest rates. And the Germans could quietly hope that the euro would be a little weaker than their own super-strong Deutsche mark. ... But the worst defect in the design of the Economic and Monetary Union (EMY), we argued, was that it united Europe's currecies but left its fiscal policies completely uncoordinated. ... The design of the EMU illustrates a profoundly important truth about human institutions. Just because you don't create a formal procedure for something you would rather not happen, that doesn't mean it won't happen. ... Problem solved? Unfortunately not. ... For one thing, it's simply not credible that the Greek government will be able to deliver the fiscal tightening it has promised at a time of deep recession. ... It will surely be at least a year before investors wake up to the fact that the fiscal predicament of the [US] is actually worse than that of the euro zone", Niall Ferguson at Newsweek, 24 May 2010, link:

http://www.newsweek.com/id/237645.

In about 1985 I remember reading a Fortune interview of Barton Biggs (BB). The substance of what BB said was, "The notion of 250 million South Americans slaving away in the hot sun to repay some New York banks does not comport with my notion of political reality". Well said BB Mine neither. Between now and 2017 I expect the "Venezuelanization" of most of Europe and the US. Got bonds? Sell while there's still time.

I disagree with NF. The Greek bailout did not save the euro. It saved banks holding Greek paper. It will kill the euro. There is nothing any European country could have done with respect to taxing and spending before the coming of the euro it couldn't do after. The euro was and is a "whole lotta nuttin". The euro was sold as a piece of financial engineering!

The WSJ's Got It!

"The [SEC's] complaint against Goldman Sachs is playing in the media as the Rosetta Stone that finally exposes the Wall Street perfidy and double-dealing behind the financial crisis. Our reaction is different: Is that all there is? ... Far from being the smoking gun of the financial crisis, this case looks more like a water pistol. ... Regarding the second point, the offering documents for the 2007 CDO made no claim that we can find that Mr. Paulson's firm was betting alongside ACA. ... More fundamentally, the investment at issue did not hold mortgages, or even mortgage-backed securities. ... Perhaps the SEC's enforcement division doesn't understand the difference between a cash CDO--which contains slices of mortgage-backed securities--and a synthetic CDO containing bets against these securities. ... Did Goldman have an obligation to tell everyone that Mr. Paulson was the one shorting subprime? ... Mr. Paulson bet against German bank IKB and America's ACA, neither of which fell off a turnip truck at the corner of Wall and Broad Streets. ... By the way, Goldman was also one of the losers here. Although the firm received a $15 million fee for putting the deal together, Goldman says it ended up losing $90 million on the transaction itself, because it ultimately decided to bet alongside ACA and IKB. ... Which leads us to the real impact of this case, which is political. The SEC charges conveniently arrive on the brink of the Senate debate over financial reform, and its supporters are already using the case to grease the bill's passage", my emphasis, WSJ Editorial, 19 April 2010, link:

http://online.wsj.com/article/SB10001424052702303491304575188352960427106.html.

Yes, convenient. Coincidence? We don't think so. Why did the SEC choose this case? See my 5 May 2010 post: http://skepticaltexascpa.blogspot.com/2010/04/vampire-squidking-canute-of_25.html. That the case is weak is a Yves Smithian "feature. not bug". Vampire Squid's losing money on this deal means nothing to me, except possibly that was one of the SEC's considerations in selecting this deal for "enforcement"

Old News at S & P

"In 2004, well before the risks embedded in Wall Street's bets on subprime mortgages became widely known, employees at Standard & Poor's, the credit rating agency, were feeling pressure to expand the business. One employee warned in internal e-mail that the company would lose business if it failed to give high enough ratings to collateralized debt obligations, the investments that later emerged at the heart of the financial crisis. ... In June 2005, and S&P employee warned that tampering 'with criteria to "get the deal" is putting the entire S&P franchise at risk--it's a bad idea. A Senate panel will release 550 pages of exhibits on Friday--including these and other internal messages--at a hearing scrutinizing the role S&P and the ratings agency Moody's Investors Service played in the 2008 financial crisis. The panel, the Permanent Subcommittee on Investigations, released excerpts of the messages Thursday. ... The investigation, which began in November 2008, found that S&P and Moody's used inaccurate ratings models in 2004-7 that failed to predict how high-risk residential mortgages would perform; allowed competitive pressures to affect their ratings; and failed to reassess past ratings after improving their models in 2006. ... A sweeping financial overhaul being debated in the Senate would subject the credit rating agencies to comprehensive regulation and examination by the [SEC] for the first time. The legislation also contains provisions that would open the agencies to private lawsuits charging securities fraud, giving investors a chance to hold the companies accountable", Sewell Chan at the NYT, 23 April 2010, link:

http://www.nytimes.com/2010/04/23/business/23ratings.html.

The SEC will be as effective in regulating the rating agencies as it has the CPA industry. What's the problem? How do CPA firms operate?

Another Impossible Product

"Some big changes are happening in funds favored by safety-seeking retirement savers. ... 'What the credit crisis exposed is that these vehicles are much more complex than people assumed,' says Steve Deutsch, who tracks the funds at investment-research firm Morningstar Inc. ... This added protection allows investors to trade in and out at a relatively stable value rather than at the underlying portfolio's actual market value, which can bounce around. ... Some funds' market value dropped sharply, making them more reliant on their wrap contracts to deliver book value to investors. That, combined with general bond-market upheaval, made issuers more reluctant to offer the protection. Though the market has stabilized, there is still a significant shortage of wrap contracts, causing higher fees and other headaches for stable-value funds [SVFs] and their investors. ... The Employees Retirement System of Texas, which administers 401(k) and 457 plans for state employees, late last year decided not to renew its contract with its stable-value provider. Its fund's market value early last year dropped to just 89% of book value--helping to push the 'crediting rate,' essentially the yield investors receive, to 3% currently, down from 4% at the start of 2009. ... The shortage of wrap contracts is causing come managers to hold bigger cash stakes, a drag on performance. ... Given the great demand and limited supply of wrap contracts, the issuers of these contracts have plenty of power to dictate their own terms, which aren't always favorable to investors. One outcome: higher fees. ... The wrap provides 'can be as strict as their want to be on terms,' says Chris Tobe, a senior consultant at Bridenbach Capital Consulting who helps employers review [SVFs]. ... All this adds up to lower returns for investors. The average [SVF] delivered 3.1% last year, down from 4.6% in 2008, according to Hueler Cos., which tracks the stable-value industry. ... Investors may also find tighter restrictions on their ability to move from the funds to other investments. Many [SVFs] have long considered certain other investment options, such as money-market funds 'competing funds.' ... Stable-value investors also are vulnerable to rising interest rates. When rates start to rise, yields of money-market mutual funds will likely tick up faster than those on [SVFs]. ... Many newer stable-value products have a number of different wrap-contact issuers, ensuring that investors can trade in and out at book value. Amid the shortage of wrap insurance, though, some firms are seizing the opportunity to reintroduce older types of stable-value products that are backed by a single insurer and carry considerable risks", my emphasis, Eleanor Laise at the WSJ, 1 May 2010, link:

http://online.wsj.com/article/SB10001424052748703572504575214723494032604.html.

SVFs always struck me as a scam. They are sold as if they are bank deposits. If you want to be able to redeem your "investment" at par, you should hold bank deposits. But they pay lower interest rates than other "investments". Precisely. The limit to how "strict" the wrap providers can be is the bank interest rate. The existence of SVFs is another result of Zimbabwe Ben's zero interest rate policy. Of course SVF interest rates change slower than money-market funds. SVFs have longer maturities than money-market funds. Mencius Moldbug has done some fine work describing maturity transformation, which is what SVFs try to sell.

More WSJ Propaganda

"The [Fed] has acquired more than $1 trillion of mortgage-backed securities in the past 15 months. At their policy meeting next week, Fed officials will decide how and when to get rid of them without jarring financial markets and the nascent economic recovery. ... The more challenging issue will be agreeing on a long-term plan to shrink a balance sheet of $2.38 trillion, or more than double the pre-crisis levels, according to Fed insiders. ... It is also possible that the Fed won't signal its intentions on the matter in its post-meeting statement on Wednesday. But markets are on edge because its mortgage-bond holdings are so large. ... Fed staff next week will present models to forecast how different approaches to reducing the portfolio might play in markets. ... But Fed Chairman Ben Bernanke made his preferences clear. 'I currently do not anticipate that the [Fed] will sell any of its security holdings in the near term, at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery,' he said in February testimony before Congress", Jon Hilsenrath at the WSJ, 24 April 2010, link:

http://online.wsj.com/article/SB10001424052748704388304575202413074193720.html.

When will Zimbabwe Ben (ZB) sell these fine securities? Try 2110! This is just more Fed smoke screening. If ZB sells this crap, it's true value might be exposed along with the Fed's insolvency.

Khuzami and and CDOs

"[SEC] enforcement chief Robert Khuzami oversaw a group of lawyers at his old firm, Deutsche Bank AG [DB], that was closely involved in developing collateralized debt obligations, the same product in the agency's fraud lawsuit against Goldman Sachs Group In., according to people familiar with the matter. ... As part of that job he worked with lawyers who advised on the CDOs issued by the German bank and how details about them should be disclosed to investors. ... Liek Goldman, [DB] has faced allegations of inadequate control over its creation of CDOs. It isn't clear if Mr. Khuzami personally reviewed any sturctured-finance deal documents in his role at the bank, and outside law firms were also involved in CDO work. ... Because of Mr. Khuzami's old job and his financial interest in the company, he has recused himself from any matters related to [DB], according to an SEC spokesman. ... SEC officials say Mr. Khuzami's resume is a nonissue, adding thjat the agency will go after illegal conduct wherever it occurs. ... Mr. Khuzami has vowed to pursue wrongdoing against Wall Street firms in high-profile areas such as subprime mortgages and CDOs. ... Mr. Khuzami is the first SEC enforcement director in recent history to come directly from an investment bank. ... Some securities lawyers say Mr. Khuzami's high-level position at [DB] could have given him insight into structured-finance products, an area where the SEC has been criticized for a shortage of expertise", Aaron Lucchetti & Kara Scannell at the WSJ, 24 April 2010, link: http://online.wsj.com/article/SB10001424052748704388304575202562283283500.html.

Khuzami's appointment did nothing for me. It still doesn'. See my 20 February 2009 post:

http://skepticaltexascpa.blogspot.com/2009/02/sec-at-large.html.

The Vampire Squid's Serfs

"Mike Mayo is a veteran of six Wall Street [WS] banks. In the wake of the street's disaster, he found refuge at a boutique brokerage and has lately taken to startling his peers with the question 'What part of Goldman Sachs is good for the country?' Regular people will be tempted to answer, 'None of it,' but the question reminds us that, at least in theory, [WS] serves society (not the other way around). And as opposed to Harrah's, Trump Casino and their ilk, [WS] is endorsed and regulated--with marked restraint--so as to let it perform an important task. Because some people have savings and others need capital, some unifying force must bring the two together. ... [WS] privatized this function, aggregating the savings of disparate individuals through the sale of stocks and bonds. ... These instruments, in the main, did not involve selling bonds so that a DuPont could build new factories; they were rearrangements--new permutations, new alignments of risk--on flows of cash that already existed. ... The point of these and many other new financial instruments was to charge a hefty fee and to furiously trade them, and no one was in a bettter position to do that than their [WS] creators. If trading was, for society, a zero-sum game (someone wins, someone loses), it was, for the street, a gold mine. ... For much of [WS], capital-raising is now a sideshow", Roger Lowenstein at the NYT, 21 March 2010, link: http://www.nytimes.com/2010/03/21/magazine/21FOB-WWLN-t.html.

Decades ago WS performed a useful service as a "dating service" for capitalists. Now by and large, it's just a big fee-generating paper shuffle.

Banks and CPAs

"With all the attention to banking regulation, it seems strange that something called Basel III has escaped widespread notice, even though its various new rules have been up for public discussion since January and the window closed on that opportunity on Friday, April 16. Maybe it's because the Basel Accords, a set of rules agreed to by bank regulators around the world, have been something of an embarrasment to the authors. ... The idea was to give an increasingly globalized financial-services industry a common set of rules so that bankers could have more confidence in the solidity of their global counterparties. ... In an unsuprisingly generous gesture toward national treasuries, banks were allowed to regard government-issued securities as zero risk, meaning they would require not offsetting capital. ... Japanese banks were boasting that they were over-compliant with Basel standards right before they tanked in 1990. ... But the Basel standards proved to be largely irrelevant to the factors that caused the fall 2008 near-meltdown of global finance. For example, Lehman Brothers had close to triple the core capital required by the Basel standards when it crashed. ... The 2008 crisis resulted when the Fed-created credit bubble collapsed and soaring housing prices deflated as well. ... One of the great ironies of our times is that the two strongest defenders of the Fannie-Freddie shell game, Chris Dodd and Barney Frank, are now in charge of reforming banking regulation. ... Aside from giving Washington an even tighter grip on the banking industry, the Dodd bill partly institutionalizes what Ben Bernanke at the Fed and Henry Paulson at Treasury, and Timothy Geithner at the New York Fed did ad hoc in the fall of 2008. It permits backdoor bailouts and gives enormous powers to the same Fed that crafted the housing bubble", my emphasis, George Melloan at the WSJ, 24 April 2010, link:

http://online.wsj.com/article/SB10001424052748704508904575192534100550538.html.

The Dodd bill stinks. It's more of the same and more TBTF bailout. I agree with Melloan. There is virtually no rule that banks can't "engineer" around. Irony? Or as Yves Smith says, "Feature, not bug".

The SEC's Vampire Squid Action, In Context

"Goldman Sachs Group Inc. [GSG] Chief Executive Lloyd C. Blankfein said the firestorm over civil-fraud charges leveled by the [SEC] is 'certainly uncomfortable,' but urged employees to remain focused. ... 'Following my message to you on Friday, I wanted to update all of you and let you know that we have been taking all appropriate steps to defend the firm and its reputation. ... Still, it is important to put the SEC's action in context. The core of the SEC's case is the allegation that one employee misled two professional investors by failing to disclose the role of another market participant in a transaction. ... I will repeat what you have heard me say many times in the past: [GSG] has never condoned and would never condone inappropriate activity by any of our people. On the contrary, we would be the first to condemn it and take immediate action. ... As you return to work on Monday morning, I ask that you maintain the level of focus on our clients that is at the heart of [GSG's] success over the past 140 years'," Joe Bel Bruno at the WSJ, 20 April 2010, link: http://online.wsj.com/article/SB10001424052748704671904575194111583096750.html.

"The biggest bummer to arise from the allegations that the revered and feared Wall Street puppet master [GSG] had played us all for patsies is this: the dial on the Wall Street capital-formation machine, the engine that was supposed to be the driving force of the greatest economic system on earth, was purposely set to junk--worthless, synthetic junk. ... JPMOrgan Chase played procurer for Magnetar, a hedge fund so artful in profiting from the meltdown that Northwestern's Kellogg School of Management praised it last year in a case study. ... In the end, it was in fact all one big scam predicated on rising housing prices. Certainly, greedy consumers played a minor role in feeding the fenzy. But the Street made sure that those of us who are not members of its elite club remained the suckers. ... One the surface, these deals look complicated. They are. ... Only now, in the wake of the SEC suit against Goldman, are investors beginning to suspect they were hoodwinked. ... A synthetic CDO is at its core a trade, meaning it has a long and short position, and grownup investors are free to take sides. ... The reality is that Wall Street's CDO synthesizer set on of the economy's largest sectors off in the direction of creating nothing but waste--pure economic waste. ... These CDOs were the last stop in a vast transfer of wealth from a large group of American mortgage holders to a much small group of already rich traders who profted as the CDOs failed. ... By picking a fight with [GSG]--the 'great white whale' of Wall Street, as Eliot Spitzer put it on Monday--the SEC is signaling that it has now adopted a feistier approach. ... In a sense, [GSG] is relying on the so-called big-boy defense: There are no victims on Wall Street, just fools. ... Beyond any legal issues, the [GSG] case has become the battering ram for financial-reform legislation that congressional Democrats have been looking for", my emphasis, Stephen Gandel at Time, 3 May 2010, link: http://www.time.com/time/business/article/0,8599,1983747,00.html.

The only "inappropriate" act at Vampire Squid (VS) is losing money. What's going on here? Did Lloyd Antoinette Blankfein (LAB) write this memo for VS's employees, or the American public? The SEC's case fails to impress me. Fab Touree, looks like VS's "sacrificial lamb", shades of Joe Jett of 1994's Kidder Peabody. While LAB weeps crockodile tears for VS, I think the case was a setup to push the Dodd bill through. I can see LAB telling Touree, "Look boy, take this one for the team. We'll take care of you. There's $100 million for you in Switzerland. Chill out".

Not the "last stop". That's Zimbabwe Ben's interest-rate suppression policy. The SEC did not pick a fight with VS. It got permission to appear to annoy the VS. Why did tthe SEC bother with this insignificant case instead of the AIG fiasco? VS wants the Dodd bill passed and is using this case to derail legislation that might hurt it.

Houston's Loren Steffy called the SEC's action "A slap on the tentables for the vampire squid", Houston Chronicle, 17 April 2010, link: http://blogs.chron.com/lorensteffy/2010/04/a_slap_on_the_t.html. Well said .

What Loophole?

"As it neared collapse in 2008, Lehman used an accounting gimmick to move $50 billion in assets off its books. The firm did this thanks to a more-than-questionable interpretation of accounting rules governing the treatment of repo transactions. ... Yet this apparently didn't raise red flags with the firm's auditor, Ernst & Young LLP, or the [SEC]. The lesson: Regulators should move toward a system where companies are judged by the substance of what they are trying to achieve, rather than meeting the definition of accounting rules", my emphasis, David Reilly (DR) at the WSJ, 13 March 2010, link: http://online.wsj.com/article/SB10001424052748704131404575117733017612228.html.

"The UK's Financial Reporting Council, the regulator for accounting and auditing, said Monday it had started looking at how Lehman Brothers Holdings Inc. repo transactions were accounted for and audited in the UK. It said it was seeking extra information from Lehman's former auditor, [E&Y]", Greg Manuel at the WSJ, 16 March 2010, link: http://online.wsj.com/article/SB10001424052748703909804575123913796112340.html.

DR, here's news for you: that's what we supposedly have now! The lawyer-infested SEC can't function at a level beyond that of "summary judgement". I don't know how many times I discussed "substance vs. form" with SEC personnel. They just don't get. Or do they? The IRS has a "step transaction doctrine" and realizes the substance and form of transactions may differ. The SEC apparently doesn't.

It's good to see someone look at this aside from the SEC.

Financial Reform, Chicago-Style

"A 'trilemma' is like a dilemma, only there are three things to choose from and you can have just two. The current debate over post-crisis financial regulation suggests we face such a trilemma: We can choose any two of the following: but not all three: 1) efficient capital markets 2) no bailouts to big banks and 3) a depression-free economy. ... But the idea that big banks might be able to get new capital from the Treasury was scarcely even contemplated. Choosing one and two resulted in a global financial and economic crisis worthy of the name depression. ... Either the bill does not imply future bailouts, as Republicans argue. Or, as seems more plausible to us, it is going to introduce such a wide range of new financial regulations that the efficiency of our capital markets will be significantly diminshed. ... Whether or not there is any basis for the SEC's claim that [Goldman] misled investors, the key point is that the collateralized debt obligation (CDO) at issue was nothing more than an elaborate wager on the future price of some mortgage-backed securities--a wager with as much economic utility as a gigantic bet on a roulette wheeel or a horse race. ... But [derivatives] increased the instability of the global financial system. And taxpayers have paid a heavy price since the system all but collapsed in late 2008. ... There was never a good reason for treating credit default swaps and their ilk differently from commodity futures, which are standardized and traded on exchanges. ... The nightmare possibility arises: Could the proposed cure turn out to be just another symptom of the same disease? As the rules become ever so more convoluted, so the opportunities for the unscrupulous increase--and the efficency of the financial system as a whole decreases. ... First, in the more controlled capital markets of the 1970s, borrowers generally paid more for their loans because there was less competition. ... Second, it is not at all clear that our crisis was exclusively caused by a failure of regulation as opposed to a failure of monetary policy. ... Third, the crisis of 2007-2009 originated in one of the most highly regulated sectors of the financial system: the US residential mortgage market", my emphasis, Niall Ferguson & Ted Forstmann (F&F) at the WSJ, 23 April 2010, link:

http://online.wsj.com/article/SB10001424052748703876404575200104219993576.html.

I only disagree with F&F over this: we cannot have a "depression-free economy". Apparently F&F don't favor the Dodd bill either.

Multistate Debt Crisis

"California, New York and other states are showing many of the same signs of the debt overload that recently took Greece to the brink--budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay. And states are responding in sometimes desperate ways, raising concerns that they, too, could face a debt crisis. ... Connecticut has tried to issue its own accounting rules. Hawaii has inaugurated a four-day school week. California accelerated its corporate income tax this year, making companies pay 70 percent of their 2010 taxes by June 15. And many states have balanced their budgets with federal health care dollars that Congress has not yet appropriated. Some economists fear the states have a potentially bigger problem with their recession-induced budget woes. If investors become reluctant to buy the states' debt, the result could be a credit squeeze, not entirely different from the financial strains in Europe, where markets were reluctant to refinance billions in Greek debt. ... California's stated debt--the value of all of its bonds outstanding--looks manageable, at just 8 percent of its total economy, But California has big unstated debts, too. If the fair value of the shortfall in California's big pension fund in counted, for instance, the state's debt burden more than quadruples, to 37 percent of its economic output, according to one calculation. ... Unstated debts pose a bigger problem to states with smaller economies. ... State officials say a Greece-style financial crisis is a complete nonissue for them, and the bond markets so far seem to agree. All 50 states have investment-grade ratings, with California the lowest, and even California is still considered 'average,' according to Moody's Investors Service. The last state that defaulted on its bonds, Arkansas, did so during the Great Depression. ... Some states have taken even more forceful measures to build creditor confidence. New York State has a trustee that intercepts tax revenues and makes some bond payments before the state can get to the money. California has a 'continuous appropriation' for debt payments, so bondholders know they will get their interest even when the budget is hamstrung. ... In fact, New Jersey and other states have used a whole bagful of tricks and gimmicks to make their budgets look balanced and to push debts into the future. ... Some economists think the last straw for states and cities will be debt hidden in their pension obligations", my emphasis, Mary Walsh at the NYT, 30 March 2010: http://www.nytimes.com/2010/03/30/business/economy/30states.html.

Why shouldn't Connecticut have its own accounting rules? Doesn't Zimbabwe Ben? Who cares what state officals or the rating agencies say? NY's trustee does nothing for me. His existence is purely cosmetic. Do you still want to own muni bonds?

Vampire Squid in the Briar Patch

"Goldman Sachs Group Inc. [GSG]--one of the few Wall Street titans to to thrive during the financial crisis--was charged with deceiving clients by selling them mortgage securities secretly designed by a hedge-fund firm run by John Paulson, who made a killing betting on the housing market's collapse. ... 'The SEC's charges are completely unfounded in law and fact,' said Goldman in a statement, promising to 'contest them and defend the firm and its reputation.' ... Goldman's shares fell 13%, one of the steepest slides since the firm went public in 1999, erasing some $12 billion of market capitalization. ... Regulators say Goldman allowed Mr. Paulson's firm, Paulson & Co., to help design a financial investment known as a CDO, or collateralized debt obligation, built out of a specific set of risky mortgage assets--essentially setting up the CDO for failure. ... 'The product was new and complex, but the deception and conflicts are old and simple,' said Robert Khuzami, the SEC's enforcement chief. ... The SEC said Mr. Tourre was 'principally responsible' for piecing together the bonds and touting them to investors. ... But he was hardly alone, the SEC alleges: The deals, were signed off by senior Goldman executives, though the SEC didn't specify how high up it believes the knowledge extended. ... Goldman has vehemently denied putting its own interests ahead of its clients.'," Gregory Zuckerman, Susanne Craig and Serena NG at the WSJ, 17 April 2010, link: http://online.wsj.com/article/SB10001424052702303491304575187920845670844.html.

I put no stock in this suit, concluding the SEC and Vampire Squid (VS) needed some headlines to make it appear "the cop is back on the beat" and help pass Dodd's toothless "reform" bill. So the SEC brought this suit with VS playing Brer Rabbit not wanting to be thrown in the briar patch.

Frightening! On 30 April 2010, while editing I came across a post by Junior at Junior Deputy Accountant:

http://www.jrdeputyaccountant.com/2010/04/goldman-sachs-gets-thrown-in-briar.html. Go Junior! Your father is proud.

What New Rule?

"Discover Financial Services Inc. will implement a new accounting rule requiring companies to bring their off-the-books securitized loans onto their balance sheet in fiscal 2010. The rule would result in a $1.3 billion after-tax charge to equity in the first quarter, the company said in December. As a result of this change, Discover will bring on its books $21 billion of assets and increase reserves by $2.1 billion. ... In a report published Friday, analysts at Barclays Capital said, 'We believe the reserve build is one-time in nature and could lead to more rapid earnings improvement in subsequent quarters as the company front-loads reserves'," Aparajita Saha-Bubna at the WSJ, 15 March 2010, link:

http://online.wsj.com/article/SB10001424052748704131404575117730637019818.html.

What new rule? Likely Discover kept these assets off its books by misapplying existing rules. See my 6 February 2008 post:

http://skepticaltexascpa.blogspot.com/2008/02/treasury-and-banks.html.

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?

Sic Semper Whistleblower-2

"A crusading legislator who had made a considerable reputation following up on whistleblower charges once told me that nearly all the whistleblowers she had met shared two qualities. First, they were onto something--that is, there was at least some truth to what they were saying. Second, they were 'a little bit nuts.' ... Through common sense at first, but ultimately through brilliant analytical detective work, Mr. Markopolos [HM] figured out precisely what Mr. Madoff was up to--and showed why Mr. Madoff could not bea earning the amazingly consistent returns that he claimed for his investors. ... The response of the SEC's enforcement staff was nothing less than appalling--a complete derelication of duty. ... The crook simply outmatched the watchdog. As Mr. Markopolos observes: 'The quants who create these financial products understand differential equations and nonnormal statistics; they program in languages the SEC doesn;t speak; they run statistical packages the SEC doesn't even know exist. The quants are busy data mining with supercomputers while the SEC is still panning by hand.' ... Mr. Markopolos writes: 'In my mind, at leat, I was convinced that someone high up at the Journal had decided it was too dangerous to go after Bernie Madoff.' No evidence for this charge is offered or even suggested. ... Now we come to the second quality that whistleblowers often sow. The author of 'No One would Listen' is fond of describing himself as 'slightly eccentric,' but he is not exactly self-aware. ... Mr. Markopolos tells us that for years, fearing for his own and his family's safety, he checked for bombs under his car; he also carried a loaded gun and slept with it at his bedside. He did so becase he believed--though he offers no evidence--that Mr. Madoff's clients included Russian mobsters and Latin drug cartels", Richard Tofel books review at the WSJ, 9 March 2010, link:

http://online.wsj.com/article/SB10001424052748703936804575108180543849168.html.

RT's condescending manner to HM indicates RT never blew the whistle. My experience with the (In)Justice Department makes me believe HM missed his biggest danger: the SEC would turn him over to Madoff and Madoff's cronies. Having blown the whistle in 1991 on a fraud, admittedly small by today's standards, only about $210 million in 2010 dollars, HM's fears were justified. I had the tires of my car slashed four times. I then parked it blocks away from my apartment. My apartment was burglarized. Strangely, nothing was taken. The investigating Los Angeles Police Department officer asked me who I thought did it and why. I told him. He said I might be in big trouble. I told him If I got killed tell the FBI it was a witness killing, punishable under 18 USC 1513(a). He saw I meant it. I looked under my car for bombs every day for 18 months. I had over 200 "hang up" phone calls from midnight to 1:00 AM in the morning. Who the hell does RT think he is talking to?