SEC as Idiot-2

"In the days when square-rigged galleons plied the spice route to the East, the Dutch outlawed a band of rebels that they feared might plunder their new-found riches. ... Their offense: shorting the shares of the Dutch East India Company, purportedly the first company in the world to issue stock. ... Now short sellers are drawing fire once again, this time from some unexpected quarters. ... The uproar has drwan the attention of Washington. 'This goes beyond rumors,' Senator Christopher J. Dodd said at a recent Senate hearing about Bear Stearns [BS]. 'This is about collusion.' Short sellers dismiss the idea that they killed off [BS]. They say they often get the blame when things go wrong in the markets. 'Show me the evidence,' said James S. Chanos, one of Wall Street's most prominent short sellers. 'It's always easier to blame someone else, some unnamed market force than the people responsible.' ... Market watchdogs in Iceland, meantime, are looking into whether short sellers are behind a plunge in that tiny nation's currency, the krona, whaihc has lost a quarter of its vlaue this year. ... And in the [US], concern about short sellers' growing power gained new urgency last week when the [SEC] accused a former trader of spreading rumors about a big takeover and then profiting from the ploy. ... But another reason that shorts are drawing fire in that hedge funds that specialize in this kind of trading are making money--lots of it--at a time many other investors are losing. ... In the past few years, shorts warned about the troubles brewing at Enron and Tyco and also uncovered financial shenanigans at many small companies. As the financier Bernanrd M. Baruch once said, 'A market without bears whold be like a nation without a free press.' Owen A. Lamont, a finance professor at the Yale School of Management, studied a group of companies that battled with short sellers and found that those companies' share prices fell 42 percent on average over the next three years, suggesting their share prices were inflated, just as the shorts had claimed. Other Wall Street banks have also been buffeted by short sellers this year. Shares of Lehman Brothers fell almost 40 percent the day before that investment bank reported earnings in March. ... But Wall Street deals in rumors all the time. For regulators, the challenge is proving that short sellers tried to profit by spreading false information", my emphasis, http://www.nytimes.com/, 30 April 2008.

The SEC has been after short sellers (SS) since at least the Ray Dirks fiasco, see my 6 October 2007 and 9 and 28 April 2008 posts. Hey Cox, Riccardi & Co., (CRC), why don't you worry about all the optimistic forescasts that companies out out? The SEC's crusade against SS is insane. SS do some of the SEC's work for it. One would think the SEC could show some gratitude. Is the SEC trying to protect Citigroup and the rest of Wall Street from SS which the SEC is afraid might dredge up some damaging information about these entities that the SEC and Treasury would just as soon conceal?

The Ship is Sinking

"As a number of other commentators have written in Asia Times Online, including Julian Delasantis and the Mogambo Guru, the problem with the US is that of excessive borrowing that has fueled a consumption boom. Almost three-quarters of the US economy is consumption, compared with the more usual 50-50 mix considered 'normal' in Economics 101 texbooks. ... What many of us on this website have been writing about is that this edifice is cracking and quite likely to fall over. On Thursday (May 1), the finance minister of Kuwait, Mustafa al-Shiwali, suggested that Gulf Cooperation Council (GCC) countries were considering an idea to abandon their long-standing US dollar pegs. This is a minor news item to be tucked away in page 20 of the financial press, which it has been--but rather emblematic of a systemic shift. ... These were the same countries that considered the same action in the 1970s, and indeeed it was the Kuwati finance minister of that time who famously asked, 'Why should we sell our black gold in exchange for unguaranteed currency notes [US dollars]'? ... Despite owing a debt of gratitude for getting their country back, it is interesting that Kuwait today is concerned more about domestic inflation that has run away to absurd levels, and less about kicking the US when it is down. Call that the new world if you will. ... I however think it is more likely we will see actual selling of ... US Treasury bonds that offer yields roughly in line with official inflation and less than half of unofficial inflation figures. ... The final consequence of the decline of US power is global in nature, namely a search for an absolute value reserve. That would be physical commodities, including oil, copper and whatever have you. The easiest though would be gold", Chan Akya (CA) at http://www.asiatimes.com/, 2 May 2008.

I agree with CA and keep wondering when the Kuwaitis will pull the plug on the dollar. They may just be waiting for the next administration to take office.

AAA-Failure

"Over the last decade, Moody's and its two principal competitors, [S&P] and Fitch, played this game to perfection--putting what amounted to gold seals on mortgage securities that investors swept up with increasing elan. ... No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and--their capital thus replenished--wrote new loans at a much quicker pace. ... Almost all of those subprime loans ended up in securitized pools; indeed, the reason banks were willing to issue so many risky loans is that they could fob them off on Wall Street. ... Thus the agencies became the de facto watchdog over the mortgage industry. In a practical sense, it was Moody's and [S&P] that set the credit standards that determined which loans Wall Street could repackage and, ultimately which borrowers would qualify. ... Arthur Levitt, the former chairman of the [SEC], charges that 'the credit-rating agencies suffer from a conflict of interest--perceived and apparent--that may have distorted their judgment, especially when it came to complex structured financial products. ... Moody's did not have access to the individual loan files. ... 'We aren't loan officers,' Claire Robinson, a 20-year veteran who is in charge of asset-backed finance for Moody's told me. 'Our expertise is as statisticians on an aggregate basis. We want to know of 1,000 individuals, based on historical performance, what percent will pay their loans?' ... Nearly half of the borrowers [in this pool], however, took out a simultaneous second loan. Most often, their two loans added up to all of their property's presumed resale value, which meant the borrowers had not a cent of equity. ... That a vehicle backed by subprime mortgages could borrow at triple-A rates seems like a trick of finance. 'People say, "How can you create triple-A out of B-rated paper?'" notes Arturo Cifuentes, a former Moody's credit analyst who now designs credit instruments. It may seem like a scam, but it's not. ... However elegant [structured finance's] models, forecasting the behavior of 2,303 mortgage holders is an uncertain business. 'Everyone assumed the credit agencies knew what they were doing,' says Joseph Mason, a credit expert at Drexel University. 'A structural engineer can predict what load a steel support will bear; in financial engineering we can't predict as well.' ... Moody's used statistical models to assess C.D.O.'s; it relied on historical patterns of default. ... Jamie Dimon, the chief executive of JPMorgan Chase ... says, 'There was a large failure of common sense' by rating agencies and also by banks like his. 'Very complex securities shouldn't have been rated as if they were easy-to-value bonds' ... The ratings are meant to be an estimate of probabilities, not a buy or sell recommendation. ... In effect, the government outsourced its regulatory function to three for-profit companies. ... As [Frank] Partnoy says, rather than selling opinions to investors, the rating agencies were now selling 'licenses' to borrowers. Indeed, whether their opinions were accurate no longer mattered so much. Just as a police officer stopping a motorist will want to see his license but not inquire how well he did on his road test, it was the rating--not its accuracy--that mattered to Wall Street. ... Nothing sent the agencies into high gear as much as the development of structured finance. ... According to Lewis Ranieri, the Salomon Brothers banker who was a pioneer in mortgage bonds, 'The whole creation of mortgage securities was involved with a rating.' What the bankers in these deals are really doing is buying a bunch of I.O.U.'s and repackaging them in a different form. Something has to make the package worth--or seem to be worth--more than the sum of its parts, otherwise there would be no point in packaging such securities, nor would there be any profits from which to pay the bankers' fees. That something is the rating. Credit markets are not continuous; a bond that qualifies, though only by a hair, as investment grade is worth a lot more than one that just fails. As with a would-be immigrant traveling from Mexico, there is a lot of incentive to get over the line. The challenge to investment banks is to design securities that just meet the rating agencies' tests. ... 'Every agency has a model available to bankers that allows them to run the numbers until they get something they like and send it in for a rating,' a former Moody's expert in securitization says. In other words, banks were gaming the system; according to Chris Flanagan, the subprime analyst at JPMorgan, 'Gaming is the whole thing.' ... The evidence on whether rating agencies bend to the bankers' will is mixed. ... But in structured finance, the agencies face pressures that did not exist when John Moody was rating railroads. On the traditional side of the business, Moody's has thousands of clients. ... No one of them has much clout. But in structured finance, a handful of banks return again and again, paying much bigger fees. ...And the banks pay only if Moody's delivers the desired rating. ... If Moody's and a client bank don't see eye to eye, the bank can either tweak the numbers or try its luck with a competitor like S.&P., a process known as 'ratings shopping.' ... James Kragenbring, a money manager with Advantus Capital Management, complained to the agencies as early as 2005 that their ratings were too generous. ... Poring over the data, Moody's discovered that the size of people's first mortgages was no longer a good predictor of whether they would default; rather it was the size of their first and second loans--that its, their total debt combined. ... Amy Tobey, leader of the team that monitored XYZ, told me, 'It seems there was a shift in mentality; people are treating homes as investment assets.' Indeed. And homeowners without equity were making what economists call a rational choice: they were abandoning properties rather than make mayments on them. ... A C.D.O. operates like a mutual fund; it can buy or sell mortgage bonds and frequently does. ... 'We're structure experts,' Yuri Yoshizawa, the head of Moody's derivative group explained. 'We're not underlying-asset experts.' They were checking the math, not the mortgages. But no C.D.O. can be better than its collateral. ... The agencies have blamed the large incidence of fraud, but then they could have demanded verification of the mortgage data or refused to rate securities where the data were not provided. That was, after all, their mandate", my emphasis, Roger Lowenstein (RL) at http://www.nytimes.com/, 27 April 2008.

RL sees the rating agencies (RA) much as I do. The RA and CPA firms are in the same business, selling third-party certifications. Like the SEC requires audited financial statements of SEC registrants, the market requires ratings to sell mortgage-backed securities. RA sell borrowers licenses, CPA firms sell SEC registrants licenses. Like CPA firms, which try to disclaim, responsibility for finding fraud, the RA blame fraud too. The RA could have asked their CPA firms what do do when faced with "insufficient evidential matter" to support a rating. Walk away. Yoshizawa's comment is telling, she's not an "underlying-asset" expert. What then? An overpaid clerk using spreadsheets she does not understand? A "handful of banks". Have we a repeat player advantage here? The RA's fees must not be contingent on their ratings. They must be paid in advance. Every mortgage-backed security sold must have an originator "certificate" that the mortgages in it were not "cherry-picked". Violations of my no "cherry-picking" rule should be securities fraud. "Ratings shopping", oh no. RA look like CPA firms. Wow, a homeowner with no equity in his property sees his "ownership" as economically equivalent to owning a call option combined with a lease. Is Moody's so stupid, it didn't understand that? Yes, a CDO operates like a mutual fund. See my 15 November 2007 post in which Allan Sloan likens investment bankers to butchers. I add, overpaid butchers selling hamburger as filet mignon. See also my 8 November and 12 December 2007 and 2 February 2008 posts.

R&R Consulting's Ann Rutledge has two good posts at her blog, http://www.creditspectrum.blogspot.com/ on 15 March and 5 April 2008 concerning securitization economics. She describes "five preferred (often inter-related) ways to mask the true credit condition of a structured bond". Unfortunately the system was gamed for years.

The: Fed, Dollar and Commodities

"There are plenty of reasons to stop cutting, Real interest rates are firmly negative. ... A growing chorus worries that ever lower policy rates are adding to America's problems. Some prominent economists have urged the central bank to stop. Fed cuts, they argue, are doing little to reduce borrowing costs but have sent commodity prices soaring--fueling inflation and hitting Americans' wallets hard. ... But oil--and other commodities--are the crux of the problem. In the past, economic weakness in America has usually pushed the price of oil and other commodities down. That relationship has weakened thanks to demand growth in big commodity-intensive emerging economies. ... Could the culprit be the Fed? ... Jeff Frankel, a Harvard economist, has long pointed out that low real interest rates lead to higher commodity prices. ... An analysis by Jens Nordvig and Jeffrey Currie of Goldman Sachs show that the correlation between weekly changes in the oil price and the euro/dollar exchange rate has risen from 1% between 1999 and 2004 to 52% in the past six months. ... But commodity prices have risen even when priced in non-dollar currencies. ... So is the weaker dollar driving oil prices up or are high oil prices driving the dollar down? The Goldman analysts argue the latter because oil exporters import more from Europe than America and hold less of their oil revenues in dollars", my emphasis, http://www.economist.com/, 1 May 2008.

Is Jeffrey Currie (JC) serious? Only the Fed prints dollars. Higher oil prices are a change in relative prices, not inflation. I can't believe JC believes what he's saying. Did Hank Paulson induce him to say this to give Helicopter Ben (HB) another rationalization to keep the blades spinning? I keep picking on JC, 24 October and 9 November 2007, 4 and 5 February, 9 and 15 March and 5 April 2008. Is JC a "good GS guy" and part of the apparent GS lobbying effort?

Incentives Count-For Gold Miners Too!

"But what is certain is that 160 years after a flake of gold found not far from [Colfax, CA] incited a frenzied stampede to the Sierra Nevada foothills, a new gold rush in on. ... 'Anywhere gold have been found in the past,' said Corey Randoph, the field operations director for the Gold Prospectors Association of America. 'That's where they're going again.' ... Mining shops say they cannot keep equipment on the shelves. 'We had a lady in here on crutches, not a young lady either, saying, "I want to buy this $3,200 metal detector and a $1,000 power sluice",' said Steve Herschbach, an owner of Alaska Mining and Diving, a supply shop in Anchorage. 'We tried to talk her down a bit, but she was dead set.' ... Perhaps nowhere is the rush more spirited than in California, home of the Sierra's famed Mother Lode, where the discovery of gold in 1848 caused a national migration. Like their forebears, many of today's prospectors have little more than a pan, a shovel and a dream. ... 'There's nothing like finding gold,' said Pat Putnam, 57, who found a nickel-sized chunk of ore a few years back. 'It's just an unbelievable feeling. Because you know you're the first person to ever lay eyes on that.' ... Jerry Keene, 73, the chief executive of Keene engineering, a leading manufacturer of mining equipment, said, 'Anything connected with gold, we're just about out of'," http://www.nytimes.com/, 5 April 2008.

See my 1 March 2008 post. Incentives count. Americans are withdrawing real resources from other pursuits to go into gold mining. When will our current gold fever end? One sign: when Harvard MBAs prefer companies like: Hecla, Barrick, Newmont, Freeport McMoran C&G, Coeur, Kinross, Goldcorp, etc., as employers to: Goldman Sachs! We'll see if the Harvard MBA Indicator, my 25 Ocotober 2007 and 20 January 2008 posts, holds true for gold mining too. Bear in mind, it takes real resources to produce gold, unlike "Bernankes". I wonder if any of these firms even recruit Harvard MBAs?

Solomon Islands' Fed

"Even Rick Houenipwela [RH], the governor of the Central Bank of the Solomon Islands, says he is an investor in teeth, having purchased a 'huge amount' a few years ago. 'Dolphin teeth are like gold,' [RH] says. 'You keep them as a store of wealth--just as if you'd put money in a bank.' ... The teeth are used like cash to buy local produce. Fifty teeth will purchase a pig; a handful are enough for some yams and cassava. ... Teeth are the currency of choice for this payment: one healthy bride costs at least 1,000 teeth. That necessitates the killing of dozens of dolphins. Local spinner dolphins yield more than 20 teeth, each about an inch long. ... 'It's better than dollars. It lasts longer and has more value than money," [Sharon Faisi] said. ... As the demand for dolphin teeth has increased, the supply can't keep up, [Robert Satu] laments: 'People want more teeth, and its not that easy to get dolphins. It's a very tiring job.' Organized on particularly calm days several times a year, Malaita dolphin hunts are complicated endeavors, involving dozens of villagers and a flotilla of paddle boats. ... Dolphin teeth and other animal products were used as currency in the Solomon Islands and other parts of Melanesia long before European colonizers arrived here in the late 19th century. ... [RH] ... says that some entrepreneurs have recently asked him for permission to establish a bank that would take deposits in teeth. ... [Dolphin hunter Henry] Sukufatu says, 'white people' visited his stall, trying to offer him and some of his colleagues from Malaita a large sum of money in they would pledge to stop killing dolphins, The offer was quickly rebuffed, he says: 'The white man's money will end, but the dolphin teeth will always be there for us'," my emphasis, WSJ, 30 April 2008.

Henry Sukufatu (HS) would make an excellent Fed Chairman. Dolphin's teeth are a better store of value than "Bernankes" because it's difficult to get more of them. It takes effort. History indicates HS is correct, our paper dollars will likely become worthless sooner or later. RH might read Frederich von Hayek's essay on "Free Choice in Currency". Who knows? If he can resolve some technical issues, like what is a "standard" dolphin tooth, he might become the world's premier central banker.

Captain Renault Returns-2

"The [federal] probe is moving forward on two fronts, looking at whether the managers deliberately misled investors about the funds' health and whether [Ralph] Cioffi and his team conjured up fraudulent values for the funds' risky subprime securities. The latter is what matters most to other investment banks. ... 'If the valuations become a criminal issue [for] Bear Stearns, it would send a warning shot across the bow of every firm that marketed these exotic products,' says Steven B. Caruso, a litigator representing several Bear investors. ... Prosecutors need evidence that the managers intentionally put a false price on a security. In other words, it usually comes down to a smoking-gun-e-mail. 'You need a debate that ends with someone saying: "I don't care what the facts are, we are going to use this valuation",' says former top federal prosecutor David Esseks, now a partner at Allen & Overy in Manhattan. ... 'This was a Streetwide failure,' says another former federal prosecutor", my emphasis, BusinessWeek, 5 May 2008.

I don't know who represents Cioffi, but it looks like Cioffi is the victim of a selective prosecution. Suppose, don't think it, Goldman Sachs (GS) and Citigroup used Bear's valuation techniques. Let Benton Campbell explain why no actions have been brought against GS and Citi executives. Sure. See my 27 April 2008 post. Cioffi's prosecution looks like another instance of Captain Renault at work, "Round up the usual suspects". See my 18 September 2007 post. Esseks thinks he needs a "smoking gun e-mail". Huh? Esseks, did you ever hear of an "ostrich" or "wilful blindness" instruction? I believe you can find it at West's criminal law key 782 or thereabouts. Or does the DOJ only use them in small drug distribution cases? Esseks used to work for Mike Garcia and went to the University of Michigan Law School. Does Michigan teach evidence?

Fed Critics

"So [Fed] officials are whispering to reporters that they will consider a 'pause' after another interest-rate cut this week. Perhaps we should be more respectful, but this sounds like the alcoholic who tells his wife he'll quit drinking next weekend after one more bender. What Chairman Ben Bernanke needs isn't a gradual withdrawal from easy money but membership in Central Bankers Anonymous. ... Meanwhile, the Fed's decision to open the general monetary spigots has inspired a global commodities boom unlike any seen since the 1970s. ... The popular media explanation is that this price surge is a result of rising global demand, greedy speculators and human profligacy. All of a sudden, without warning, the world is said to be running out of food. ... No doubt commodity traders are having a field day, but what they are speculating on is the Fed's refusal to stop the free-fall of the dollar. ... Just when the U.S. economy needs a resilient consumer given the fall in housing prices, these price increases have eviscerated consumer pocketbooks. In its attempt to help Wall Street and the financial system, Fed policy is punishing average Americans. The public is frustrated and angry with these price increases, and it has a right to be. Inflation is the thief of the thrifty middle class. ... The Fed's problem has been both political and intellectual. Politically, Mr. Bernanke has been unwilling to say no to Wall Street and the Beltway political class, which reflexively demand easier money in a crisis. ... As for the intellectual problem, the Fed and much of Wall Street convinced themselves that the only inflation measure that matters is 'core inflation,' which excludes food an energy", my emphasis, editorial at the WSJ, 28 April 2008.

"The [Fed's] rescue of Bear Stearns Cos. will come to be seen as its 'worst policy mistake in a generation,' a former top Fed staffer said. ... Congress and analysts have deferred to the Fed's judgment. ... [Vincent] Reinhardt said the bailout 'eliminated forever the possibility the Fed could serve as an honest broker.' In 1998, the Fed coaxed private creditors of Long-Term Capital Management to bail out the hedge fund but didn't have to put up its own money. If it ever tries a similar maneuver on a Wall Street cohort, the said, 'The reasonable question any person in the room will ask is, "How much money will you contribute to the solution?''", WSJ, 29 April 2008.

The WSJ is too kind to Helicopter Ben (HB) (1590 SATs). HB ain't stupid. I doubt HB believes as much in the significance of "core inflation" as he does the tooth fairy. I conclude HB believes as I do, core inflation was invented to deceive the public. This is now permeating the MSM. See my 24 April 2008 post citing a Fortune article. I agree with the WSJ, HB lacks the guts to tell Henry Paulson and the inflationists "get lost". HB is Clark Kent, not Superman. Would HB call a press conference to explain to the American public what he is doing, who he is helping and how? No way.

I agree with Reinhardt the Fed bailout was a mistake. However, Bear was not bailed out, the rest of the Street was. Was this mistake more serious than lowering interest rates with the dollar collapsing? More serious than the Greenspan Fed igniting the housing boom? As for asking the question, welcome aboard Reinhardt. What do you think Henry Paulson has pushed for months? Using public funds to bail out Wall Street firms. See my 7 April 2008 post, among others.

TPTF

"The two 'government-sponsored' mortgage giants aren't held to the same standards of accountability as everyone else in American business. ... The upshot is that former CEO Franklin Raines will forfeit some underwater stock options, make a donation to charity and pay $2 million to the government, although that sum will be convered by Fannie's officers-and-directors insurance. ... We fear this settlement--which Ofheo, the regulator values at $31 million for the three executives involved--is one more sign that Fannie Mae exists in a separate, politically protected universe. ... Friday's paltry settlement shows once again that Fannie and Freddie are dangerous because, as creatures of Congress, they can never be seen to have failed. So their accounting fraud is explained as merely a mistake, and their former executives keep the bulk of their riches", Editorial at the WSJ, 21 April 2008.

I agree. See also my 27 April 2008 post. The settlement was a joke.

SEC as Idiot

"David Einhorn's hedge fund isn't the biggest. He doesn't usually badger companies, nor does he broadcast his opinions about the market. Still, Mr. Einhorn is emerging as one of the most public faces of an industry accused of reticence and secrecy. While not known for being overly critical of companies, the 39-year-old manager of Greenlight Capital has lambasted credit-rating firms and bond insurers at events in recent months before hundreds of investors. ... Now, Mr. Einhorn is ramping up his effort to combat what he sees as deep-rooted problems undercutting the financial system: He is ripping regulators, Congress, auditors, boards of directors and investigative reporters in 'Fooling Some of the People All of the Time,' his new book. ... 'Who works at these government agencies that are so uncaring about the misuse of taxpayer money?' he asks in the book. He asserts that regulators have an 'indifferent attitude' towards wrongdoing. ... Einhorn, who found himself investigated by the [SEC] after he criticized Allied, is hoping to put pressure on regulators and others to more thoroughly scrutinize companies. He is also hoping to pursuade the SEC, which he accuses of going easy on Allied, to levy larger penalties on companies that commit financial misdeeds. 'The SEC is run by a corporate advocate, not an investor advocate, so investors are getting a false sense of security,' Mr. Einhorn says in an interview. ... An SEC spokesman wouldn't confirm that the agency in the past investigated Mr. Einhorn or comment on the Allied situation", my emphasis, WSJ, 28 April 2008.

Einhorn is going easy on the SEC. If it only was "indifferent" to wrongdoing. I think the SEC tries to conceal it if done by the politically well-connected. It would be interesting for the SEC to study where each of its attorneys who left in say the last 10 years went to work. I would be curious to see how many went to work for the securities plaintiffs' bar. The penalties the SEC usually levies on companies are insignificant. The SEC's choices of complaints to investigate is often amazing. It's regularly settling cases without an admission of wrongdoing is appalling.