Einhorn on Truth

Greenlight Capital's David Einhorn (DE) has an interesting 27 May 2010 post at the NYT:

http://www.nytimes.com/2010/05/27/opinion/27einhorn.html. DE asks, "how long will the capital markets continue to finance government borrowings that may be refinanced but never repaid on reasonable terms. And second, to what extent can obligations that are not financed through traditional fiscal means be satisfied through central bank monetization of debts--that is, by the printing of money? ... Despite the promises by the [Fed] chairman, Ben Bernanke, not to print money or 'monetize' the debt, when push comes to shove, there is a good chance the Fed will do so, at least to the point where significant inflation shows up even in government statistics. ... " DE raises other issues I have. My bottom line: eventually all will see the emperor is naked.

Illinois Deficit

"Illinois lawmakers were in disarray Thursday as they groped for stopgap measures to address a $13 billion deficit equaling nearly half of the state's general-fund revenue. ... But the confusion in the legislature indicates that serious steps to fix state finances won't be taken until after the November elections--if then. ... An income-tax increase proposed by Democratic Gov. Pat Quinn is going nowhere. Even temporary steps, such as borrowing to make pension payments, have stalled. Illinois is months late on many of its bills and has no plan for catching up. ... A bill under consideration in the state House would give Mr. Quinn greater leeway to shift money among state funds and to require agencies to set aside part of their budgets now in case of future cuts. ... 'We are lucky in that we can still borrow,' [Donne] Trotter said, noting that lawmakers responded to rating-agency concerns last month by reducing pension benefits and lifting the retirement age for new state employees to 67 from 60. Lawmakers also are weighing the idea of postponing pension payments for the first half of the fiscal year until January, Mr. Trotter said. ... Mr. Quinn presented a budget in March that would still leave the state with a $10.6 billion deficit. His plan projected a deficit of $4.7 billion for the coming fiscal year beginning July 1--which he planned to cover through borrowing--and a $5.9 billion deficit carried over from the current budget. ... California officials said this week that April personal income tax collections lagged projections by 30% Federal estimates don't bode well for states, either", Amy Merrick at the WSJ, 7 May 2010: http://online.wsj.com/article/SB10001424052748703686304575228582377071698.html.

Illinois budget looks worse than California's. An old Chinese curse was, "May you live in interesting times". An updated version might be, "May your portfolio consist of 50% Illinois and 50% California muni bonds".

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?

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?

Small Banking From Boston

"The publishing world is too slow for Laurence J. Kotlikoff. On a frigid January day, the 58-year-old Boston University economist is pecking away at his computer keyboard in his office overlooking the Charles River. ... 'We have miscreants running the financial system left, right and center,' says Kotlikoff. 'Nobody is calling the [Obama] Adminsitration to task and saying, "You guys are putting a Band-Aid on cancer".' ... Instead of taking deposits and making loans, banks would connect borrowers and depositors with ultrasafe mutual funds created for those purposes. ... Kotlikoff sounds so unrealistic that, like George Bailey, he could use a guardian angel to set him straight. But he's beginning to catch the attention of powerful policymakers and the economists who have their ears. ... In the US, Kotlikoff's limited-purpose banking' idea is finding support among economists across the political spectrum, including University of Chicago Nobel Laureate Robert Lucas on the right and Columbia University's Jeffrey Sachs on the left. ... 'The problem,' he writes in his book, 'is the leveraging of the taxpayer by people with no formal training in finance or economics, no personal downside, an assortment of Napoleonic complexes, the money to buy ratings in New York and policy in Washington, and the ability to run circles around regulators.' ... In Kotlikoff's scenario, banks would be shorn of their risk-taking functions. ... Mutual funds would supply loans, too. Already, companies raise money by issuing bonds, which are bought by fixed-income mutual funds on behalf of investors. ... The advantage is that if certain borrowers didn't repay, there would be no systemic, global-economy-threatening crisis, liek the ones that can occur when one bank goes down and drags other with it. Instead, the worst that could happen is that investors who funded a particular loan would lose part or all of their investment. One side benefit: Kotlikoff says 100-plus regulatory agencies could be disbaded because financial firms would no longer have other people's money to play with", Peter Coy at Businessweek, 15 February 2010: http://www.businessweek.com/magazine/content/10_07/b4166042289206.htm.

Go Kotlikoff! I've favored "small banking" for decades. Frank Graham suggested 100% reserve banking in 1936, my 24 December 2007 post: http://skepticaltexascpa.blogspot.com/2007/12/fed-and-four-letter-word-gold.html.

Debt Bomb

"Kyle Bass has bet the house against Japan--his own house, that it. ... 'Japan is the most asymmetric opportunity I have ever seen,' he says, 'way better than subprime.' ... If 2008 was the year of the subprime meltdown, 2010, he thinks, will be the year entire nations start going broke. ... National governments will issue an estimated $4.5 trillion in debt this year, almost triple the average for mature economies over the preceeding five years. ... Whether or not you believe the spending spree was morally justified, you have to be concerned about the prospect of a dismal, debt-burdened fiscal future. More debt weighs heavily on GDP, says Carmen Reinhart, a University of Maryland economist. ... America is a nation of spendthrifts, addicted to easy credit and dependent on the kindnesss of savers overseas to keep us comfortable. ... The personal savings rate has climbed from negative 0.4% in 2006 to a positive 4.5% rate now, but that it still a pathetic figure for a nation whose government is un-saving all that and more with its budget deficit. ... If the GDP doesn't expand at 'normal' rates of 3% to 5% coming out of this recession, wrestling down the debt will be very tough, indeed--perhaps impossible without drastic cuts in spending and higher taxes of many fronts. ... US corporate tax receipts were down 55% in the year ended Sept. 30, 2009 to $138 billion. ... If Congress and the Obama Administration don't trim spending [Benn Steil] says, 'we will get to the point where credit is much more expensive in the US than it has been in the past.' ... 'US states are like emerging markets,' says Reinhart. 'They spent a lot during the boom years and then were forced to retrench during the down years.' ... But Brian Coulton, head of global economics at Fitch Ratings in London, warns that once rock-solid economies like the US and UK could join shakier nations like Japan and Ireland in losing their AAA ratings if they don't get their bad habits under control. ... Most investors seem to believe, as the late Citibank chairman Walter Wriston put it, that 'countries don't go bust.' The opposite is true. ... Even if countries don't stiff creditors outright, they can sometimes accomplish the same thing through inflation", Daniel Fisher at Forbes, 8 February 2010, link:

http://www.forbes.com/forbes/2010/0208/debt-recession-worldwide-finances-global-debt-bomb.html.

"In 2009 investors were warned about bubbles: a bubble in Treasuries, a gold bubble, and, finally, warnings of a rapidly expanding bond mutual fund bubble forming. It's brought to us by the [Fed's] 0% interest rate policy. Whether the flood into bond funds of all types was an intended consequence or not, it's now a flood that could go just as quickly the other way. ... There is a lot of unsophisticated money in bonds now, and I'm not sure investors understand how miserable things can get when the low interest rate party ends", Marilyn Cohen at Forbes, 8 February 2010: http://www.forbes.com/forbes/2010/0208/finances-junk-bonds-yield-interest-capital-markets.html.

If you have any type of bonds, no matter in what currency, sell! As for Walter Wriston, see my 30 October 2008 post: http://skepticaltexascpa.blogspot.com/2008/10/book-review-walter-wristons-bits-bytes.html.

I agree, the bond market is a disaster waiting to happen.

Jiyza for California?

"There isn't a single compelling reason to provide the girly-man of American gubernatorial fiscal responsibility, Arnold Schwarzenegger [AS], with a nickel from our federal coffers. ... It's clearly time to start killing and slashing. For decades California has enabled its spendthrift legislators, feather-bedding public-sector employee unions and welfare recipients (comprised of both native-born and illegal immigrants) to the tune of a $21 billion annual deficit with no sign of sufficient tax revenue in sight. Meanwhile the confiscatory tax policies and unfriendly business environment of the Granola State continue to hemmorhage both businesses and jobs to more enlightened states. According to the IBD, California is home to more than 1/3 of the nation's welfare recipients. ... In addition, California is rated 48th out of the 50 states in terms of tax-competitiveness with over $493 billion worth of new tax regulations for businesses since the year 2000. Where is the light at the end of this tunnel? ... Why should we contribute to ensure expensive gold-plated retirement packages for the 'the public employee unions that have systematically looted the public' coffers of California and now come looking for more sensible Americans to fund their fiscal insanity. Let 'em hit the wall and file bankruptcy. It's time for the insolvent public sector in California to start turning away welfare recipients, closing government offices, and defaulting on public employee union benefits including pensions until they can be renegotiated in light of fiscal responsibility to all Californians, not just the special pleaders", Ralph Alter at American Thinker, 27 December 2009, link:

http://www.americanthinker.com/blog/2009/12/not_one_nickel_for_california.html.

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"The US economy survived the traumas of 2009, thanks to good policy and good luck. What worries me, looking ahead, is what might be called the 'Californiazation' of America--the growing tendency of our political system to make promises in social spending programs that it isn't prepared to pay for with tax increases. ... What's worrisome this year isn't economic decline but political dysfunction. And nowhere is that clearer than in California, where politicians--despite some serious bipartisan efforts--haven't been able to make the decisions that would put the state on a sound financial footing. The political forces that generate deficits are just too strong: a Democratic Party in hock to public-employee unions and a Republican Party in love with tax cuts. ... What many state governments want is a federal bailout, which would free them of the consequences of overspending. It's a classic case of what economists call 'moral hazard'--in that the bailouts would allow the irresponsible behavior to continue, rather than force a halt. One prominent economist argues that if the states were countries, the International Monetary Fund would grant relief only if it came with conditions that imposed fiscal discipline. So will Washington become like California? Some would argue that has already happened, with the fiscal disaster masked by the federal government's ability to sell its massive debt cheaply and print money to pay the bills", David Ignatius at Washington Post, 3 January 2010: http://www.realclearpolitics.com/articles/2010/01/03/the_californiazation_of_america_99749.html.

"Gov. [AS] of California was on the mark when he said this week that the state needed to change policies that spend more money on prisons than on the state's once-vaunted higher education systems, which are being bled to death in budget cuts. Mr. [AS] was way off the mark when he suggested that the answer was to privatize prison services or to pass yet another constitutional amendment, this time to limit prison spending. ... It would generally be impossible for the state to unilaterally lower prison spending without first cutting the prison population dramatically. ... The only real way for California to cut prison costs is to reverse sentencing policies that have filled its prisons to bursting and have driven up costs by about 50 percent over the last decade alone", NYT Editorial, 8 January 2010, link: http://www.nytimes.com/2010/01/08/opinion/08fri3.html.

"Republican Gov. [AS] asked for $6.9 billion in federal funds in his state-budget proposal Friday and warned that state health and welfare programs would be threatened without the emergency help. ... 'It's time to enact long-term reforms that will change the way the most populous state and the federal government work together,' Mr. Schwarzenegger said. He and state legislative leaders plan to visit Washington to lobby for federal bailout money. White House budget officials weren't available to comment on the governor's request. ... The governor said California deserved the federal funds because the state sends far more tax money to Washington than it receives in return. Federal mandates, he added, 'force us to spend money that we do not have,' ... Mr. Schwarzenegger called the state legislature into a special budget session. He proposed cutting $2.4 billion from health and welfare spending and $1.2 billion from prison spending. He also called for cuts in salaries and pensions for state workers. ... State Senate President Darrell Steinberg, a Democrat, said: 'I have one reaction: You've got to be kidding me.' He and other legislative leaders said they were opposed to any more cuts to welfare and health programs. Instead they said they preferred federal help or taxes on, for example, oil drilling and tobacco sales. ... The state has delayed billions of dollars of payments and issued IOUs to keep the government from defaulting. ... 'My concern at this point is that the negotiations could go on longer than the amount of cash the state has on hand,' said Gabriel Petek, analyst at Standard & Poor's Corp. which has California on a negative ratings outlook", Stu Woo & Jim Carlton at the WSJ, 9 January 2010, link: http://online.wsj.com/article/SB126297948893221947.html.

I agree.

I said this was coming decades ago. This is no surprise.

I agree with the NYT. Repeal Caifornia's drug laws. Now. Prison privatization is another panacea, see my 7 November 2009 post: http://skepticaltexascpa.blogspot.com/2009/11/wait-listed-by-jail-11.html.
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California is hopeless, unless you're an illegal alien or anchor baby. If neither, leave.

Argentina's Lock Box

"Argentine President Cristina Kirchner's [CK] political troubles turned into an open standoff Wednesday, when the country's central banker rejected her request to resign following his refusal to transfer billions in foreign-currency reserves to pay the country's debt. ... Mrs. Kirchner, along with her husband and predecessor Nestor Kirchner, have tried to assert more control over the economy--nationalizing pension funds and an airline--even as their popularity has declined among Argentines. The latest conflict puts the couple on a collision course with both the central bank and a newly invigorated congressional opposition. ... Mrs. Kirchner announced the creation of the 'Bicentennial Fund for Stability and Reduced Indebtedness,' [BF] to be funded with central-bank reserves, on Dec. 14. ... Financial markets had welcomed the creation of the fund, coming as Argentina plans to start borrowing again after eight years of being largely frozen out of markets in the wake of a massive 2002 debt default", my emphasis, Matt Moffett & Matthew Cowley (M&C) at the WSJ, 7 January 2010, link:

http://online.wsj.com/article/SB126282620632718915.html.

"Argentine President [CK] said she was firing the country's central-bank chief Thursday, escalating a battle over foreign-currency reserves into a nascent constitutional crisis. ... Some Argentine legal specialists also said the president doesn't have the authority to unilaterally dismiss the top banker, saying the dismissal decree is unconstitutional. ... The announcement came after markets closed Thursday. It was unclear how the opposition-dominated Congress would respond, but some if its leaders called for Mr. Redrado not to comply with the decree. ... Argentina's decree, signed by all cabinet members and issued late Thursday afternoon, followed two days of mounting government pressure on Mr. Redrado to transfer $6.57 billion in reserves to a fund Mrs. Kirchner unveiled in December to conver some of Argentina's debt payments. ... The opposition maintains Mrs. Kirchner and her husband and predecessor, Nestor Kirchner, are trying to steamroll the central bank, as they already have the media, the national statistics bureau, agribusiness and other institutions to seize foreign-currency reserves so they can boost patronage spending and sustain their power", my emphasis, Matt Moffett at the WSJ, 8 January 2010, link: http://online.wsj.com/article/SB126289800502920289.html.

"A federal judge blocked President [CK] from using foreign-currency reserves to pay Argentina's national debt and revoked the dismissal of the central-bank chief who opposed that policy. ... On Friday morning, federal judge Maria Hose Sarmiento granted an injunction request by two opposing parties barring the central bank from transferring money into the so-called [BF], which Mrs. Kirchner had hoped to create with $6.57 billion from the reserves. A few hours later, Judge Sarmiento ordered the reinstatement of the bank president, Martin Redrado, whom Mrs. Kirchner dismissed on Thursday for refusing the make the transfer. ... Earlier in the day he defended his action in defying Mrs. Kirchner. 'The reserves belong to all Argentines and if they are to be used for some purposed besides backing the currency, ther matter should go before Congress,' he said. ... Underlying the dispute is the Kirchner administration's need for funds to sustain the Peronist patronage machine. Last year, public spending grew at three times the rate of revenue. ... Now the whole idea of the [BF] may have boomeranged, revealing the fragility of Argentina institutions. ... Roberto Sifon Arevalo, a director in the Latin America Sovereign Ratings Group at Standard & Poor's said compromising central-bank authority is disturbing to investors. 'There is a conceptual reason why people focus on the independence of the central bank,' he said", my emphasis, M&C at the WSJ, 9 January 2010, link: http://online.wsj.com/article/SB126296529801421655.html.

"Few Argentine politicians are prepared to pay the political cost of spending cuts or tax rises to pay off bondholders. As it is [CK] may have turned the Central Bank chief into a martyr for the cause of integrity in public policy", Economist, 9 January 2010, link: http://www.economist.com/world/americas/PrinterFriendly.cfm?story_id=15213761.

My idea: let's swap Redrado for Zimbabwe Ben (ZB) and Robert Schiller! What idiocy, to welcome creating a paper fund instead of reductions in Argentine spending. This fund would have as much substance as the Social Security "lockbox". CK wanted this fund to further her confidence game.

Bienvenidos a Argentina. Was this article really about Argentina, or the Obama administration?

How closely are ZB and Peter Orzag following this?

I await ZB's following Redrado's lead.

Pimco, the New Vampire Squid

"A switch in how state regulators size up insurers' risks will save the industry more than $5 billion in capital requirements, New York officials said Monday. ... In ditching the ratings firms, the regulators said they had lost faith in the ratings firms' ability to size up risk in insurers' big holdings of residential-mortgage bonds. In choosing Pimco for the high-profile assignment, they cited the rating firms' widely publicized shortcomings in initially rating many of the bonds as triple-A, the highest rating, then last year downgrading waves of the bonds to 'junk' status. ... Some have critcized the regulators for changing their methodology in a way that could lead to a more-lenient outcome for the insurance companies, saying the move could weaken protection for policy holders", Leslie Scism at the WSJ, 5 January 2010, link:

http://online.wsj.com/article/SB10001424052748704350304574638823927363010.html.

Apparently Pimco is our new Vampire Squid (VS) as old VS developed a foul odor since it claimed to do "God's work". Neal Kasksahri formerly of VS and Treasury recently went to work for Pimco. When will Hank Paulson and Robert Steel decamp to Pimco? Will this regulatory change do anything for insurance company policyholders? Why ask?

Uncle Sam's Credit

"Romanian President Traian Basescu was inaugurated for a second term Wednesday and began working with political parties to form a government that can enforce the tough budget changes required by the International Monetary Fund. ... Romania had pledged to keep next year's budget deficit below 5.9% of [GDP]. The deficit is likely to be around 7.3% of GDP this year", Christopher Emsden & Joe Parkinson at the WSJ, 17 December 2009, link:

http://online.wsj.com/article/SB126097910690093879.html.

"We only hope Republicans aren't foolish enough to fall down this trap door, though some are already tempted. A budget deficit commission is nothing more than a time-tested ploy to get Republicans to raise taxes. In the 2009 version, Republicans are being teed up to hold hands with Democrats and agree to become the tax collectors for Obamanomics. The deficit reduction commission is a long-standing idea that is now pushed with renewed fervor by Republican Frank Wolf of Virginia and Democrat Jim Cooper of Tennesse in the House and Democrat Kent Conrad of North Dakota and Republican Judd Gregg of New Hampshire in the Senate. ... Mr. Wolf says the commission would be 'a 16-member panel that would look at everything--from what the government is required to spend on mandatory entitlements to spending on all other programs to tax policy.' ... They're correct that current federal commitments are unsustainable, starting with $37 trillion in unfunded Medicare liabilities. ... The real goal is to get GOP cover for tax increases so Democrats aren't run out of town in 2010 and 2012 for blowing up the national balance sheet. ... In 1983 Ronald Reagan and Congressional Republicans agreed to decades of job-destroying increases in payroll taxes to 'fix' Social Security, which you may have noticed still isn't fixed. ... Democrats would agree to means-tested entitlements, which means that middle and upper-class (i.e., GOP) voters would get less than they were promised in return for a lifetime of payroll taxes. ... New taxes will only reduce the pressure to cut future spending", my emphasis, WSJ Editorial, 29 December 2009: http://online.wsj.com/article/SB10001424052748703939404574566034074899214.html.

Is Romania a better credit than Uncle Sam? Moody's gives Romania a Baa-3 rating. Why?

The GOP should tell Obama and Pelosi, "No tax increases. No hell. No way. We remember Bush the Elder's promise and won't be fooled again". As for means-tested entitlements, consider if tax and social security policy are to be reviewed, what that implies for Roth IRAs.

Vampire Squid Exposed

"Goldman Sachs Group [GSG] played a bigger role than has been publicly disclosed in fueling the mortgage bets that nearly felled [AIG]. [GSG] was one of 16 banks paid off when the US government last year spent billions closing out soured trades that AIG made with the financial firms. ... [GSG] originated or bought protection from AIG on about $33 billion of the $80 billion of US mortgage assets that AIG insured during the housing boom. That is roughly twice as much as Societe Generale and Merrill Lynch, the banks with the biggest exposure to AIG after [GSG], according an analysis of ratings-firm reports and an internal AIG document that details several financial firms' roles in the transactions. ... The trades yielded [GSG] less than $40 million in profits, which were mostly booked from 2004 to 2006, according to a person familar with the matter. But they piled risks onto AIG's books, which later came to haunt the insurer and [GSG]. The trades also gave [GSG] a unique window into AIG's exposure to losses on securities linked to mortgages. ... A [GSG] spokesman says that until AIG was rescued by the government, the insurer 'was viewed as one of the most sophisticated financial counterparties in the world. It wasn't until the government intervened in September 2008 that the full extent of AIG's problems became apparent. ... More clarity has emerged recently over the roles that firms such as [GSG] played as complex deals carried out by banks are now being untangled in legal and regulatory inquiries. Last month a government audit of part of the AIG bailout described [GSG's] middleman role. ... The trades seemed prudent at the time given AIG's strong credit rating and the fact that AIG agreed to make payments to [GSG]. known as collateral, if the value of the CDOs declined", Serena NG and Carrick Mollenkamp at the WSJ, 12 December 2009, link: http://online.wsj.com/article/SB10001424052748704201404574590453176996032.html.

Where was PWC which "audited" AIG and GSG during the relevant time? Why hasn't the PCAOB yanked PWC's practice rights? There's more to come out.

Argentina Shows America How

"Argentina's government said it will set aside a portion of the central bank's foreign-currency reserves into a fund dedicated to debt service, in an effort to allay investor concerns about the country once again defaulting. ... But some economists said the creation of the fund raises longer-term questions about the Argentine government's commitments to control spending, which has been growing at a worrisome rate. ... Gabriel Torres, an economist at Moody's Investors Service ... said the debt bill is less onerous than it seems because much of the debt is held by Argentine government pension funds, banks, and other institutions that would surely roll it over. Nevertheless, Argentina's track record makes it risky. In 2001, Argentina declared the largest sovereign-debt default in history on about $100 billion in debt. ... 'Foreign-exchange reserves are to buffer you against all kinds of external shocks,' said Simon Johnson, a professor at the Massachusetts Institute of Technology and former IMF chief economist. Mr. Johnson said using some of the reserves to pay down debt could help shore up confidence in the Argentine market as some investors get unsettled about countries with big fiscal imbalances. ... Longer term, however, economists raised concerns over whether the Kirchner government was using the central-bank resources to avoid dealing with a growing fiscal problem", my emphasis, Matt Moffett and Matthew Cowley at the WSJ, 15 December 2009, link: http://online.wsj.com/article/SB126084511452791541.html.

Old South (OS), 10 November 2009, asks of Argentina's "plan to issue NEW sovereign debt", do the "money managers out there planning to buy in ... know, when push comes to shove, they can now dump the resultant losses on the US Treasury and taxpayer", link: http://mainstreetmattersmore.blogspot.com/2009/11/proof-positive-theres-one-born-every.html.

What distinguishes America's financial position from Argentina's: the US dollar is the world's reserve currency. For now. Set aside? Like the "social security lockbox"? This is accounting nonsense like "appropriated retained earnings". Argentina's supposed sinking fund lacks economic significance. I don't doubt Argentina's willingness to reduce spending. It won't. Moody's must be staffed with fools. Disagreeing with Torres, it doesn't matter who holds Argentina's debt. Who holds it governs who will lose when Argentina next defaults. Why should who holds Argentina's debt affect its value? Does who holds XOM affect its value? Disagreeing with Johnson, how can Argentina pay down debt net, without reducing spending? Argentina's actions are part of a continuing con game. Does the US have a big fiscal imbalance? Why are 30-year US Treasuries yielding 4.45%? Is Uncle Sam using Zimbabwe Ben to "avoid dealing with a growing fiscal problem"?

OS raises a good point. Did Argentina "clear" its proposed bond issues with His Obamaness? Will Argentina become the new Citigroup, with its hand continually in the taxpayers' pocket?

Vampire Squid Strikes Again!

"Back two years ago when the mortgage meldown was heating up, we wrote an article called 'Junk Mortgages Under the Microscope' (see fortune.com) dissecting a particularly wretched mortgage-backed securties issue peddled by Goldman Sachs [GSG]. ... We thought this was a cautionary tale--but it's turned into a horror story. All the tranches of this issue, GSAMP-2006 S3, that were originally rated below AAA have defaulted. Two of the three original AAA-rated tranches (French for 'slices') are facing losses of about 90%, and even the 'super senior', safer-than-mere-AAA slice is facing losses of 25%. ... Our tale begins in April 2006, when [GSG] sold $494 million of securities to institutional investors seeking yields somewhat above those that were available on US Treasuries or high-rated corporate bonds. ... In our case, borrowers' stated equity in their homes averaged less than 1%--0.71%, to be precise. Even that was doubtless overstated because a majority of the mortgages were low-documentation and no-documentation. Despite these problems, the formulas used by Moody's and S&P allowed [GSG] to market the top three slices of the security--cleverly called A-1, A-2 and A-3--as AAA-rated. That meant they were supposedly as safe as US Treasury Securities. ... As of Oct. 26., date of the most recent available trustee's report, only $79.6 million of mortgages were left, supporting $159.5 million of bonds. In other words, each dollar of bonds had a claim on less than 50 cents of mortgages. ... Now to the investment lessons: The first is, Don't put your faith in rating agencies, even though some branches of the federal government, including the [Fed], use ratings to determine whether certain securities qualify as collateral under federal loan programs to financial institutions. ... The second lesson is: No matter how fancy the name is on the offering statement--[GSG], the calumny being heaped on it lately notwithstanding, is still Wall Street's alpha outfit--you're on your own if the issue heads south", Allan Sloan and Doris Burke at Fortune, 21 December 2009.

I commented on this issue on 29 October 2007, link: http://skepticaltexascpa.blogspot.com/2007/10/how-stupid-are-rating-agencies.html. Imagine, Vampire Squid is Wall Street's "alpha outfit". What an indictment!

31 More Years?-6

"When the financial crisis began, few players on Wall Street looked more ripe for reform than the Big Three credit rating agencies. ... It was the near universal agreement that potential conflicts were embedded in the ratings model. For years, banks and other issuers have paid rating agencies to appraise securities--a bit like a restaurant paying a critic to review its food, and only if the verdict is highly favorable. ... What explains the timidity of Congress' proposals? This is not a case of lobbyists beating back ideas thay might hurt their clients, say those close to the discussion. Instead, Congress is worried that bold measures may backfire. The Big Three, by allowing companies and public entities to raise money by issuing debt, are an essential engine in the country's vast credit factory, and given the still-fragile condition of the equipment, lawmakers are reluctant to try anything but basic repairs, patches and a new alarm system. ... While Congress may be happy with cosmetic surgery, law enforcement officials are getting more aggressive. Dozens of lawsuits have been filed against the rating agencies, inclduing a case filed on Nov. 20 by the Ohio attorney general on behalf of public pension funds. The Ohio suit, as well as the earlier suits, seeks billions of dollars in damages from the rating agencies and accuses the firms of negligence and fraud. ... But even if there is no foolproof way to reform the rating agencies, the measures that Congress is now backing are strikingly weak, a number of critics say. There is no talk, for instance, about creating a fee-financed, independent credit rating agency, one modeled along the lines of the [PCAOB]. ... Academics and former rating agency employees who have been warning lawmakers about the Big Three for years, say Congress is tiptoeing when it ought to be charging ahead. ... Both bills enhance the power of the SEC to supervise the rating agencies and both require the companies to bulk up their compliance teams. ... 'I think these bills are misguided and wrongheaded because they will have the ironic effect of making the incumbents even more important,' said Lawrence J. White, an econmics professor at the Stern School of Business at New York University. 'They're going to encrust the procedures already in place and discourage new business models'," my emphasis, David Segal at the NYT, 8 December 2009, link: http://www.nytimes.com/2009/12/08/business/08ratings.html.

Even if there was a ratings agency like the PCAOB, who would staff it? Former S&P executives?Until rating agency executives live in terror of being indicted for aiding and abetting securities fraud, nothing will change. Any more than Sarbox cleaned up the CPA business. Why are the Big Three essential? If you can't sue them, they're just paper shufflers. What "foolproof" way fixed the CPA business? What's ironic? Didn't Sarbox help the Big 87654?

Yves Smith on Rating Agency non-Reform

Yves Smith has an 8 December 2009 post at her Naked Capitalism about rating agency non-Reform which I generally agree with, link: http://www.nakedcapitalism.com/2009/12/non-reform-of-rating-agencies.html. I oppose creating a rating agency PCAOB. If created, it would be as successful at improving ratings as the PCAOB has been at improving the Big 87654's work, i.e., not at all.

Jeremy Siegel on the EMH

"Financial journalist and best-selling author Roger Lowenstein didn't mince any words in a piece for the Washington Post this summer, 'The upside of the current Great Recession is that is could drive a stake through the heart of the academic nostrum known as the efficient-market hypothesis.' ... But is the Efficient Market Hypothesis (EMH) really responsible for the current crisis? The answer is no. The EMH, originally put forth by Eugene Fama of the University of Chicago in the 1960s, states that the prices of securities reflect all known information that impacts their value. The hypothesis does not claim that the market price is always right. ... The fact that the best and the brightest on Wall Street made so many mistakes shows how hard it is to beat the market. ... Regulators wrongly believed that financial firms were offsetting their credit risks, while the banks and credit rating agencies were fooled by the faulty models that underestimated the risk in real estate. ... From 2000 through 2006, national home prices rose by 88.7%, far more than the 17.5% gain in the consumer price index or the paltry 1% rise in median household income. Never before have home prices jumped that far ahead of prices and incomes. This should have sent up red flags and cast doubts on using models that looked only at historical declines to judge future risk. But these flags were ignored as Wall Street was reaping large profits bundling and selling the securities while Congress was happy that more Americans could enjoy the 'American Dream' of home ownership. Indeed, through government-sponsored enterprises such as Fannie Mae and Freddie Mac, Washington helped fuel the subprime boom. ... With few exceptions (Goldman Sachs being one), financial firms ignored these warnings. CEOs failed to exercise their authority to monitor overall risk of the firm and instead put their faith in technicians whose narrow models could not capture the big picture. One can only wonder if the large investment banks would have taken on such risks when they were all partnerships and the lead partner had all his wealth in the firm, as they were just a few decades ago", my emphasis, Jeremy Siegel (JS) at the WSJ, 28 October 2009, link: http://online.wsj.com/article/SB10001424052748703573604574491261905165886.html.

JS is a Wharton professor, (boo), Fama is a Chicago professor (yay). I agree with JS. The models fail the EMH's "weak form", i.e., in relying on "historical information" they were a form of "technical stock market analysis". No Chicago grad since 1972 should have been fooled by this. For that matter, no: Wharton, Stanford, Tuck or ... grad since 1972 should have been fooled the rating agencies models. Well, maybe a Tuck grad. If Wall Street's "best and brightest" were fooled by what was covered in Finance 301 (1972 Chicago house number), how smart are they? Are they worth tens of millions a year? I mention JS on 29 April 2008 and 11 March 2009:

http://skepticaltexascpa.blogspot.com/2008/04/chinas-nasdaq-moment.html.

http://skepticaltexascpa.blogspot.com/2009/03/s-pe.html.

Moody's Exonerated

"Moody's Corp., the owner of credit-ratings firm Moody's Investors Service, boosted its profit forecast for the year as a boom in corporate-debt issuance helped it maintain operating margins of almost 40%. The New York-based company also said an external investigation into allegations of impropriety by a former analyst has been completed and found no evidence of wrongdoing. ... Moody's had engaged a law firm to conduct the investigation into Mr. [Eric] Kolchinsk'y complaint. 'Investigators found that the allegations were not supported by facts and were without merit,' Moody's Chief Executive Raymond McDaniel said in a conference call on Thursday. ... Rep. Edolphus Towns (D, NY), chairman of the House Committee on Oversight and Government Reform, said the committee is still examining the matter and on Thursday sent a formal request to Moody's for a report of the investigation and copies of records provided to the law firm. An SEC spokesman declined to comment", Serena Ng at the WSJ, 30 October 2009, link: http://online.wsj.com/article/SB125681601973515657.html.

Big deal. Another nothingburger investigation by a "board-hired law firm". Why would anyone pay any attention to such report? I last mentioned Kolchinsky on 19 October 2009: http://skepticaltexascpa.blogspot.com/2009/10/rating-agency-snake-oil-2.html.

Newsflash, Moody's Does Something

"Spanish banks are failing to recognize the true scale of their losses during the deep slump in Europe's fifth-largest economy--something that could hamstring the sector's growth for years, Moody's Investors Service said Tuesday. ... Moody's said the banks set aside less than half the Euro108 billion ($160 billion) in loan losses it estimates they will suffer during the course of the downturn. ... Spanish banks deny they are concealing any losses. A spokeswoman for Spain's banking association said its members, which include Spain's listed banks, continued to report strong earnings and had moved to bolster their capital. She added that the Bank of Spain [BOS] had performed stress tests on the banks and hadn't detected any irregularities. An official at the [BOS] said the Spanish regulator 'certainly doesn't allow banks to hide any losses, and will continue to act with rigor'," Thomas Catan & Christopher Bjork at the WSJ, 14 October 2009, link: http://online.wsj.com/article/SB125545053140882671.html.

I'm sure the BOS cleared its stress test protocol with Zimbabwe Ben before applying it. I wonder if Moody's contacted the various banks CPAs about its findings.

Rating Agency Snake Oil-2

"As scrutiny of credit-ratings firms in Washington heats up, a second official of Moody's Corp. has emerged and is expected to testify about concerns he took to regulators earlier this year. ... Mr. [Scott] McCleskey wrote to the [SEC] in March this year, chiefly to complain that Moody's doesn't adequately monitor credit ratings it assigned to tens of thousands of municipal bonds. He also took issue with changes the company made to its compliance department last year, which preceded his departure. ... In his letter, Mr. McCleskey said that while he was head of compliance, 'virtually no surveillance was being performed' on the 'vast majority' of Moody's municipal-bond ratings. ... An SEC spokesman said the agency is 'focusing on the tips and complaints we receive and following up, where appropriate, with examinations targeting suspected problems.' ... The SEC earlier this month passed new rules, but critics still say the fundamental problems haven't been fixed", Serena NG at the WSJ, 30 September 2009, link: http://online.wsj.com/article/SB125426055962950527.html.

"A senior Moody's Corp. executive said at a congressional hearing that an outside legal firm investigating claims by a former analyst has so far found no evidence of wrongdoing. ... Richard ... Cantor told the House Committee for Oversight and Government Reform that Moody's hired law form Kramer Levin Naftalis & Frankel LLP to investigate a July complaint submitted by Eric Kolchinsky, a managing director who left Moody's in mid-September", Serena Ng and Sarah Lynch at the WSJ, 1 October 2009, link: http://online.wsj.com/article/SB125432192757352625.html.

"This morning we had hoped to be able to praise House Financial Services Chairman Barney Frank, who seemed ready to break up the credit ratings racket that did so much to inflame the financial panic. But just when you think Barney will free up competition, he reinforces the cartel. ... A former Moody's employee, Eric Kolchinsky, described a 'reckless disregard for the truth' in an August memo to a Moody's official. Yesterday he tesified that those responsible for ensuring sound ratings methodology are 'routinely bullied' by management. ... Yet despite the path of financial destruction paved by the Big Three raters, Washington still won't yank their privileged status as Nationally Recognized Statistical Ratings Organizations (NRSROs). Based on the draft reform written by Mr. Frank's colleague, Paul Kanjorski (D., Pa.), the raters can expect more compliance and legal costs, but no threat to their official role as America's judges of credit risk. ... Appearing in CNBC in September, Mr. Frank said, 'We have exalted rating agencies too much.' He added, 'We need to repeal laws that mandate the use of rating agencies.' ... The bureaucrats at the [Fed], SEC and elsewhere merely need to study the issue and report back to Congress. These are the same people who wrote the flawed rules, so why would they eliminate them? ... But by bleeding the NRSROs while leaving intact rules that require their services, Mr. Kanjorski could be creating a senario in which regulators are soon calling S&P and Moody's too big to fail. This is essentially what Sarbanes-Oxley did for the accounting firms after Enron: In the name of punishing them, make then even more important", my emphasis, Editorial at the WSJ, 1 October 2009, link: http://online.wsj.com/article/SB10001424052748704471504574441273559132330.html.

Nor will they be fixed until the individual SEC staffers incentives change.

So?

What can we expect from the geniuses who brought us Sarbox? Praise Frank, like Marc Antony did Brutus in Julius Caesar 3:2:1-34. Let us bury Sarbox. It's the product of the actions of honorable men. Just like say the AIG bailiout.

Martin Hutchinson on Capitalism

Martin Hutchinson (MH) has a 28 September 2009 post attacking: financial alchemy, economists, bad accounting, the Fed, ratings agencies, banks, AIG, Goldman Sachs, phony statistics and the bond markets. He writes heresy, "It would have been much better to allow Goldman Sachs and the other major counterparties to AIG credit default swaps to suffer the full losses, and then send some random collection of CDS dealers and maangers to jail for a couple of decades or so, as was done after the Drexel Burnham and Enron collapses". Off with MH's head. Here's a link: http://www.prudentbear.com/index.php/thebearslairview?art_id=10282. MH says it all.