Chris B

Paulson Throws Bernanke Under the Bus, Backs Ken Lewis

Another take on this situation is that BAC would have been the victim of the systematic and counterparty risk of a Merrill collapse, much as AIG was eventually demolished by the Lehman bankruptcy. Lewis had the choice of (1) letting the fragile BAC be bankrupted by the collapse of Merrill, or (2) buying Merrill and potentially getting a bunch of government loans to see them through (taking on Merrill's liabilities, but avoiding the counterparty and systemic risks). He chose the later course of action because it was the only non-hopeless option.

Next, his "fiduciary duty" to shareholders was to squeeze the most money and the best terms out of his new creditor, the government. He figured threatening to back out of the deal would do that. It was certainly worth a shot. In a best case scenario, BAC would get to keep the govt. loans but not have to take on Merrill's losses. Merrill would go under, but the loans would allow BAC to survive the losses.

Paulson anticipated such brinksmanship and was having none of it. As a creditor and shareholder to BAC, the govt. had little leverage but they could probably get the already-on-thin-ice board and management fired. Paulson alluded to that leverage, and the brinkmanship was over.

Results of this minor skirmish: BAC lost, taxpayers won.

Bring in the Antitrust Division (on Banking)

"The Department of Justice’s Antitrust Division should be called in..."
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If we rely on the judgement of bureaucrats to determine when Goldman has become a monopoly, and then wait a dozen more years for the lawsuits to be cleared up, we will already be living in a new Guilded Age, with national finances dominated by one corrupt company similar to the situation with JP Morgan 100 years ago.

Here's a better alternative. Reinstate the Glass-Steagal Act. Isolate commercial banking, which facilitates economic activity, from investment banking, which facilitates asset trading. Heavily regulate commercial banks and step in with the FDIC to protect depositors when needed. Then we could let the investment banks fail without having to worry about reducing the availability of commercial and consumer credit. Require strict mark-to-market accounting for investment banks and strict mark-to-present value of cash flow accounting for commercial banks.

Basically, reset the bank regulatory structure to what it was prior to 1999.

The pre-1999 model of national financial regulation has over 60 years of banking stability and world-leading economic growth to it's credit. The idea of combining investment banking and commercial banking, on the other hand, has been tried twice. Once in the 1920's and once in the 2000's. Each attempt resulted in a nationwide financial crisis and massive unemployment.

I fear that the administration will try to get through this crisis without reinstating this basic, vital reform. I fear that they will declare victory in the short term with a brief spurt of economic growth, but leave the flawed system in place. The results of such a mistake are predictable.

Bring in the Antitrust Division (on Banking)

Goldman is obviously taking advantage of its position to gain market share here. Now that the taxpayer has ensured their survival, they want to jump on their weaker rivals, buy out their top employees and their accounts, and achieve monopoly status.

Also I wouldn't be surprised if these claims of fine health were accompanied with profitable trading activity on Goldman's part.

Let's Hurt the American Financial Services Industry

1) "you tax and regulate the stuff you want less of."

This is true and certainly effective (e.g. increasing tobacco or alcohol taxes have been shown to reduce purchases). It is also true that we've reduced taxes and regulations on the financial industry over the last 15-20 years, which means we got more of it. Taxes on capital gains, dividends, and interest were dropped to 15% to encourage more of this activity. Meanwhile, manufacturers WHO ACTUALLY PRODUCE THINGS AND EMPLOY PEOPLE still faced tax rates more than twice those amounts. Suppose you wanted to start a business. Would you start a factory and be taxed at 30% or a financial firm and be taxed at 15% (maybe)? It's no wonder that US manufacturing has been in decline for so long!

2) Much of the profit in the financial industry comes from credit cards. Watch the checkout counter at Wal Mart sometime - almost all card transactions. Visa and Mastercard get 2% of every sale. It's amazing. Their margins are often higher than the retailers'!

3) The traditional commercial lending banking model has only grown as fast as the economy in general. The "investment" banking model, credit cards, and the CDS market, however, have expanded much faster. Since Citigroup lobbyists persuaded Congress in 1999 to repeal the Glass-Steagal Act of 1933, it will be increasingly difficult to shave down the non-commercial side while preserving the commercial lending that keeps our economy growing. How do you hobble Bank of America or Citigroup without cutting off some productive business from one of its sources of financing, resulting in layoffs?

How Much Risk is the Treasury Really Assuming from Financial Institutions?

Aw heck... too much thinking. Let's just let the banks fail and start the next depression. How much would that cost the government in lost revenue? $50 Trillion over 10 years? That's not so bad, is it?

The U.S. Banking System's Terrifying Balance Sheet

Those balance sheets are weak because assets have been marked down, per mark-to-market rules. The cash flows from these assets, however, such as mortgage payments, have declined only slightly. For the truth about bank strength, look at the statement of cash flows, not balance sheets or income statements. A bank can be technically insolvent on the balance sheet, have massive losses on the income statement, but making money hand over fist on the cash flow statement. This situation occurs when their assets are marked down to pennies on the dollar and counted as losses, even as they continue to produce income.

Govt. support is based on helping the banks to maintain capital ratios until markets recover a year or two from now.

The banks, meanwhile, are hoarding all the cash they can so that they won't be forced to sell their mortgage-backed securities for pennies on the dollar. That's their real goal in all of this. When those mark-to-market paper losses flip into paper gains, the insiders will be participating, I assure you.

FASB Changes Perpetuate Fair Value Lying

Something tells me this guy has never even taken an accounting or economics class. Such cheerleaders appear in every bubble.

Do you really think "runtogold.com" would become "runfromgold.com" if the price of gold became too high or inflation expectations subsided? Nope. This is pure ideology (see his inverted pyramid graphic, ha!). Just consider how ridiculous it would be if I started a website called "runtowheatfutures.com."

How quickly people forget all the here-today, gone tomorrow sites that promoted real estate or tech stocks as the new can't-lose investment! Just do your kids a favor and keep their college funds in bank CD's.

What Else Are the Banks Hiding?

Why are the banks doing everything they can - selling buildings, laying off workers, issuing bonds, issuing equity, etc. - just to try to avoid selling their mortgage-backed securities? Think about it.

They're doing that because the present value of the income streams from these assets is greater than the market price by a large magnitude. These "bad" or "toxic" securities, as the media likes to call them, are still spinning off cash, just not as much as was originally thought when they were created. Compare the foreclosure rate to MBS prices. Their cash flows are too high to justify their pennies-on-the-dollar prices. The PV's of these securities might only be between 0.50 and 0.75 on the dollar, but that's a lot better than the 0.25 the market is offering. The banks' highest margin activity is finding a way to avoid selling these securities for pennies on the dollar, with returns from that activity much higher than what is available from originating new loans. GS will borrow from Warren Buffet at 10% to avoid missing out on those kinds of cash flows. Essentially, management is still operating on mark-to-model (or mark-to-cash flow) while the financial statements report mark-to-market.

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"My concern is that the embedded losses in their balance sheets will overwhelm them before they can earn their way out."
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Debt/equity ratios may continue to increase, and shareholders are very likely to be diluted, but the key fact is that the government has become dedicated to not allowing the failure of another big bank - or even insurance company. If debt servicing requirements became too burdensome, the Fed's loan window is open for business, although the bond and equity markets are increasingly looking like cheaper sources of capital. Of course I have to ask, is dilution really that harmful to existing shareholders if it props up the company and ensures its survival vs. bankruptcy?

Increasingly, it looks to me like all the big banks will survive, paying off their government debts with MBS cash flows, and some of those mark-to-market losses could someday return as unexpected mark-to-market gains.

Why Banks Want to Return TARP Money

Despite posting an industry-wide quarterly loss of $32.1 billion and continued deterioration in asset qualify, the industry's cash flow position improved during the crisis..
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When the markets realize that the banks are fine on a cash flow basis, and that their assets are only "toxic" due to mark-to-market accounting, there will be a major pop in the markets.

Oh wait, that already happened since the info is finally filtering down to this website. How much are they up now?

Why do you think the banks have been so reluctant to sell these assets at market prices? Because they know the PV of their cash flows are worth many times that amount.

The only remaining question is if mark-to-market gains will fool investors like mark-to-market losses did!

How to Profit from Market Manipulation

1) How sad. People who don't know how to calculate the fundamental value of a company are often awestruck at how the value of a company's equity can change by millions of dollars from day to day or hour to hour. They have no better source of information than past prices to inform themselves about the price they should be willing to pay or sell for. Yet, markets can't be efficient if we have swings of this magnitude! This leads some to technical analysis, and others to conspiracy theories! Only a handful of people learn how to figure out what "low" and "high" are and how to buy and sell at close to those points. Is education manipulation?

2) Rising price volatility is a sign of both bottoms and tops. In both situations, the number of buyers declines and transactional frequency becomes more erratic. In a top situation, fewer and fewer buyers are willing to take increased risk for less and less return which eventually turns the price once the sellers capitulate. In a bottom situation, many potential buyers are sitting outside of the market, waiting for it to go up a ways before they get in. Fast, sharp swings are the result of either situation.

3) I never heard complaints about manipulation when markets were going up. Yet hundreds of thousands of financial Neanderthals are now calling their 401(k) administrators demanding a return of their money, which they feel was taken away from them, obviously by nefarious conspirators. Ha!

4) Trading in and out of stocks is inherently a zero sum game. For party A to make a profit, party B must take a loss - or at least miss out on ownership of profits for a period of time. For manipulation to occur, party A would have to convince party B to pay too much for shares, while not themselves overpaying for shares from party C. I don't follow from this article how exactly such a scheme would be sustainable in a market with millions of well-informed participants. Perhaps the better question is this: How could short-term stock prices ever be predictable and not attract attention from the millions of participants looking for arbritage opportunities?

Is the Megabank Model Dead?

Time to reinstate the Glass-Steagal Act of 1933 (repealed in 1999 under the influence of Citigroup lobbyists).

Why are we having a credit crisis? Because investment banking and commercial banking have been combined. Any time this occurs, losses on the investment side of the bank will necessarily curtail lending on the commercial side of the bank. That's how losses in mortgage backed securities and derivitives led to your former employer being unable to obtain financing for productive work, which led to your layoff. That's how the collapse of AIG led to businesses being unable to provide financing for their customers. The end result in both 1929 and 2009?: a depression.

Glass-Steagal was followed by 60 years of banking stability, which attracted massive amounts of foreign capital to the US, further boosting economic growth. When we forgot the lessons of our grandparents, we set ourselves up for this catastrophe. Look at what this failure to learn the lessons of history has cost us.

The irony is, the people arguing for the repeal of Glass-Steagal were worried about the US losing global dominance in finance and banking. How has that worked out so far?

Added Debt Won't Rescue the Great American Ponzi Scheme

That's why the internet can be a crappy source of information. People can spout off whatever cheap lowbrow populist slogans they want... often anonymously or with a pseudonym, so as not to embarass oneself - which makes the internet the absolute bottom on the accountability scale. 90% of the brainiacs who are advocating a repeat of the great depression because that it morally right or something put twice as much thought into what color shirt to wear each day.


On Mar 24 05:50 AM zagnzig wrote:

> He writes: “Consequently, solutions to date have not only failed
> to “fix” anything, they have made the problem worse.” How obviously
> wrong can anyone be? People, please do not forget the consequences
> and the scale of the crisis.
>
> Imagine the “solution” this author proposes: C, BAC, WFC, MS, AIG,
> FNM, FRE, JPM…all failing? What sort of solution would that be? Any
> suggestion that letting them fail would be better than our current
> predicament is nonsense! What grocery store would remain; would you
> still have your job? How would you feed your family or keep them
> warm?
>
> Violent civil unrest would ensue. The nation would be blown to pieces.
>
>
> Reading the comments here makes me wonder if the people who think
> bank failures are the cure are not honestly considering the final
> consequences of their decisions.

Added Debt Won't Rescue the Great American Ponzi Scheme

"the only “solution” to this crisis is price discovery, to allow asset prices to fall to whatever level they need to in order for markets to clear. This is bad news for over-levered balance sheets, but there’s nothing else to be done."
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You're channeling Andrew Mellon now: "Liquidate, liquidate, liquidate..." The consequences of such policies have been established by history.

The problem with a liquidationist attitude is not just that companies with over-levered balance sheets will go under. It is that healthy, responsible companies will go under or be forced to shrink too. That means layoffs even for the people who did everything right, which only further shrinks demand for the remaining companies. Andrew Mellon's and Herbert Hoover's policies led to a downward spiral of unemployment and poverty that affected everyone.



"The great Ponzi scheme that is the Western World’s economy has grown so big there’s simply no “fixing” it."
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A rising consumer savings rate, back to the historical norm of around 10%, will certainly whack GDP (an increase from 0-10% would in itself knock roughly 7% off GDP). However, was life really that bad in the 80's and early 90's when consumer savings were double what they are today? The third-world-country predictions are a bit emotional I think. Just 1-2 years of high savings would do wonders for reducing consumer debt, and capitalism can self-correct, as it has during every recession. Maybe in the future blue-collar laborers won't commute from McMansions 50 miles to work in $40k Tahoes. Oh well.

Regarding government debt, I would agree that the public needs to quit supporting the whole "kick the can down the road" attitude. I wonder how popular the $3 Trillion Iraq/Afghanistan projects would have been if we were actually paying for it in extra taxes instead of invisible debt? I suspect there would be riots! Yet, the time to balance budgets is in the good times. I would support a balanced budget amendment, with borrowing allowed only in times of emergency - as declared by a board of non-politicians such as the Supreme Court. Right now, however, we are in just such an emergency and we risk a depression if we repeat the mistakes and inaction of the 1930's.



"It’s long past time we took our own medicine. If we don’t take it voluntarily, the bond market will stuff it down our throat anyway."
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The market for US treasuries has demonstrated very little weakness, despite below-zero real interest rates. Your statement makes for a neat slogan, but does it agree with the facts?

FASB Unlikely to Suspend Mark to Market

The underlying problem is that investment banking and commercial lending are inherently incompatible activities.

Investment values should be marked to market. To do otherwise is to claim that the owner has some special insight into the asset's performance and future value that every other participant in the market lacks. That clairvoyance is not likely. I can have an opinion that an asset is worth $500k, but if the markets disagree, who am I to put my opinion in my financial books - especially when my whole business model is based on booking gains from buying and selling investments and I fully intend to sell this investment in the future?

The value of traditional commercial loans that the bank plans to hold until maturity, on the other hand, should be based on an estimation of present value based on future cash flows, impaired to the extent that similar loans are defaulting.

There are three solutions to this subtle difference.

1) Reinstate something like Glass-Steagal, requiring commercial lenders to be separate businesses from asset-flipping commercial banks. Apply strict and universal mark-to-model guidelines to commercial lenders and mark-to-market to investment banks. Split Citi, BAC, and JPM.

2) Allow banks to identify individual assets as either investments or held-till-maturity assets and apply either mark-to-market or mark-to-model respectively. If a bank wants to change how the asset is categorized, for example if they wanted to sell a held-till-maturity asset, require them to list the effect of these changes on the balance sheet and describe each recategorization in footnotes. Allow only one recategorization during the life of the asset.

3) Require institutions with bank-like functions to report both mark-to-model and mark-to-market balance sheets.

Of the 3 options, #1 seems the simplest / least vulnerable to abuse, despite its high initial cost in terms of industry restructuring. It also may have the benefit of providing for economic stability, because as separate institutions, commercial lenders will not be impaired by investment bank losses (this basic dynamic caused both the depression and the current crisis). That is, after all, the phenomenon we are trying to avoid in the future.

Financial Times Debunks Citi's Memo

I hope the SEC is looking into insider trading or stock manipulation on this deal.

Let's see, the CEO sends employees a memo overnight (non SEC document) claiming profits, said memo is immediately leaked to Wall Street, and any employee who bought at the open on Mon. gains 20% in a day and a half. They would have made 10% just by buying at the open and selling at the close.

Let's hope that none of the insiders who bought 7.655 MILLION shares on March 2-3 for less than the current price have sold any of that stash. They're up 23%. Let's really hope there were no preplanned sales that just happened to be scheduled to execute that day.